2005 Ruling 2005-0161521R3 - Postamble of 212(1)(b)

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: whether postamble of 212(1)(b) applies

Position: No

Reasons: See previous ruling 2003-0047713. Based on the particular fact situation. Although the interest payable employs a variable that is the result of a formula of debt to EBITDA, these extra amounts payable simply use EBITDA as a tool to assess creditworthiness. As the borrower becomes more profitable, its payments decrease; this reflects the opposite of participating debt. Considering the modern rule of statutory interpretation and the apparent purpose of paragraph 212(1)(b), we are of the view that the phrase "computed by reference to" revenue, profit, cash flow, commodity price or any other similar criterion, has a somewhat narrower meaning in the context of the postamble of 212(1)(b) than it may bear in other sections of the Act.

XXXXXXXXXX 							2005-016152

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

We are writing in response to your letters of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above taxpayer.

To the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request are:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or a related person;

(iii) under objection by the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.

DEFINITIONS

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended to the date hereof, and unless otherwise stated, a reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act and the regulations thereunder are referred to as the "Regulations";

(b) "Applicable Margin" means the portion of interest payable by the Borrowers to the Lender under the Grid Option in addition to LIBOR, as described in paragraphs 4 to 6 below;

(c) "Borrowers" means Canco and Parentco;

(d) "Canco" means XXXXXXXXXX, formerly Old Canco, a corporation amalgamated with Subco under the XXXXXXXXXX having its head office in XXXXXXXXXX. Canco is a wholly-owned subsidiary of Parentco, a corporation resident in the United States. The business number of Canco is XXXXXXXXXX. It is resident within the jurisdictions of the XXXXXXXXXX Taxation Services Office and the XXXXXXXXXX Taxation Centre;

(e) "CRA" means Canada Revenue Agency;

(f) "Closing" means the date on which the Facility is put in place;

(g) "Commitment Letter" means the Facility Commitment Letter among Parentco, Canco and the Lender;

(h) "EBITDA" means, for any period, the earnings before interest, taxes, depreciation and amortization calculated in accordance with United States generally accepted accounting principles;

(i) "Facility" means the US$XXXXXXXXXX Senior Secured Credit Facility comprised of the Multicurrency Credit Facility and the Term Loan;

(j) "Lender" means XXXXXXXXXX;

(k) "LIBOR" means a rate of interest per annum equal to the London interbank offered rate for US dollars;

(l) "Multicurrency Credit Facility" means collectively: (a) a US$XXXXXXXXXX revolving credit facility available for Parentco as Tranche 1 due on XXXXXXXXXX; and (b) a US$XXXXXXXXXX multi-draw term loan facility available for Canco as Tranche 2. Advances under this facility can be made during the initial XXXXXXXXXX period, during which multiple term loans may be borrowed, voluntarily repaid and readvanced, provided that, at no time, the amount so advanced exceeds US$XXXXXXXXXX. On day XXXXXXXXXX (the "Determination Date") no further loans will be permitted and the aggregate outstanding principal balance of the loans becomes due and payable on XXXXXXXXXX (or XXXXXXXXXX from any extended Determination Date), unless voluntarily prepaid;

(m) "Old Canco" means XXXXXXXXXX prior to its amalgamation with Subco;

(n) "Parentco" means XXXXXXXXXX corporation resident in the United States.;

(o) "Subco" means XXXXXXXXXX , a corporation incorporated under the XXXXXXXXXX

(p) , a taxable Canadian corporation for purposes of the Act and a wholly- owned subsidiary of Parentco;

(p) "Term Loan" means collectively (a) a term loan to Parentco, and (b) a term loan to Canco, each maturing on the next day following the XXXXXXXXXX anniversary of Closing, to be made available to the Borrowers at Closing by the Lender, in an aggregate principal amount of US$XXXXXXXXXX;

(q) "TFD" means total funded debt of the Borrowers; and

(r) "Total Leverage Ratio" on a particular date means the ratio of TFD to EBITDA.

STATEMENT OF FACTS

1. All of the then issued and outstanding common shares of Old Canco were acquired by Subco on XXXXXXXXXX in consideration for exchangeable preference shares of Subco, exchangeable at the option of the holder for special voting shares of Parentco. Immediately thereafter, Old Canco and Subco amalgamated to form Canco. Following the amalgamation, Parentco held all of the common shares of Canco and the former exchangeable preference shareholders of Subco held all of the exchangeable preference shares of Canco.

2. Canco carries on the business XXXXXXXXXX in Canada and in the United States through a branch.

PROPOSED TRANSACTIONS

3. The Borrowers will enter into the Facility with the Lender on Closing. A draft of the Commitment Letter sets out the proposed terms of the Facility. The Facility is comprised of the Multicurrency Credit Facility and the Term Loan.

4. The Term Loan to be provided to Canco will be structured in order to comply with the requirements of the withholding tax exemption described in subparagraph 212(1)(b)(vii) of the Act.

5. The terms of the Facility will provide that the interest rate for both the Multicurrency Credit Facility and the Term Loan will be, at the Borrowers' option, either: (i) the Lender's prime rate minus XXXXXXXXXX%, as determined by the Lender's treasury department (the "Prime Rate Option"), or (ii) LIBOR plus the Applicable Margin (the "Grid Option").

6. The Applicable Margin will vary according to a grid based on Canco's Total Leverage Ratio.

7. The Grid Option specifies the following ranges for Canco's Total Leverage Ratio and a corresponding Applicable Margin for the Facility:

(i) if the Total Leverage Ratio = 2 then the Applicable Margin is XXXXXXXXXX%;

(ii) if the Total Leverage Ratio < 2 but = 1.5 then the Applicable Margin is XXXXXXXXXX%;

(iii) if the Total Leverage Ratio < 1.5 but = 1 then the Applicable Margin is XXXXXXXXXX%; and

(iv) if the Total Leverage Ratio < 1 then the Applicable Margin is XXXXXXXXXX%.

8. The interest payable by Canco under the Grid Option will decrease as the Total Leverage Ratio decreases. In general, as the Total Leverage Ratio increases from one range to the next, the interest payable by Canco under the Grid Option will increase by a specified percentage. Conversely, if the Total Leverage Ratio declines to a lower range, the interest payable by Canco under the Grid Option will decrease by a specified percentage. The interest payable by Canco under the Grid Option may vary from one quarter to the next even though there is no change in EBITDA (i.e. there is a change only in the TFD). The Grid Option will therefore create a situation inverse to that created under a participating debt arrangement. Under a participating debt arrangement, the interest rate payable to the lender would increase with revenue, profit, cash flow, commodity price, or a similar criterion of the borrower. Under the Grid Option however, the interest payable by Canco will decrease as Canco's EBITDA increases. The Grid Option will result in an increase in Canco's cost of funds as its borrowing capacity declines and allow Canco to benefit from a reduced interest rate margin as its borrowing capacity increases. This adjustment serves as a credit assessment mechanism, in lieu of a credit rating calculated by a credit rating agency, and compensating the Lender for a decline in the creditworthiness of Canco as its TFD increases or its EBITDA deteriorates. It does not provide the Lender with a participation in the revenue, cash flow or profits of Canco.

9. If the Lender can perfect an enforceable first priority lien on all of the assets of Canco and its subsidiary, the Applicable Margin will be reduced by XXXXXXXXXX%.

10. Interest payable on Prime Rate Option will be payable monthly in arrears based on a XXXXXXXXXX. Interest with respect to Grid Option will be payable at the end of the applicable interest period based on a XXXXXXXXXX.

ADDITIONAL INFORMATION

11. It should be assumed that, except for the issue which is the object of the present advance income tax ruling request, all other requirements for the application of the withholding tax exemption provided in subparagraph 212(1)(b)(vii) of the Act are satisfied.

PURPOSE OF THE PROPOSED TRANSACTIONS

12. Canco will use the proceeds of the term loan facility under the Multicurrency Credit Facility to provide working capital and for general corporate purposes. Canco will use the proceeds of the Term Loan to refinance existing term debt, assist in financing new fixed asset expansion and long term working capital.

13. The purpose of the Grid Option in both the Multicurrency Credit Facility and the Term Loan is:

(i) to allow Canco's cost of financing to be reduced if its financial performance, as measured by the Total Leverage Ratio, improves after Closing, and

(ii) to allow the Lender to earn a greater return on the Facility if Canco's creditworthiness (and therefore, the Lender's credit risk), as measured by the Total Leverage Ratio, deteriorates after Closing.

RULING

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our ruling is as set forth below:

The use of the Grid Option in the Facility described in 7 and 8 above will not, in and of itself, cause the postamble of paragraph 212(1)(b) to apply to deem payments of interest from Canco to Lender made under the Term Loan or the term loan facility of the Multicurrency Credit Facility not to be interest described in subparagraph 212(1)(b)(vii).

CAVEAT

The above ruling is given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CRA on May 17, 2002, and are binding provided the Proposed Transactions above are completed on or before XXXXXXXXXX.

The ruling is based on the Act in its present form and does not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted:

(i) the GST implications of any of the proposed transactions; nor

(ii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein, and in particular, whether the proposed transactions fall within the ambit of subparagraph 212(1)(b)(vii) of the Act.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries and Exempt Institutions Division
Income Tax Rulings Directorate