2006 Ruling 2005-0161711R3 - Participating Interest

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: Can the Additional Interest paid or payable be deducted under paragraph 20(1)(c) provided it does not exceed a reasonable amount?

Position: YES

Reasons: IT-533, par 2 - not an equity investment.

XXXXXXXXXX 								2005-016171

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letters of XXXXXXXXXX, and is further to our telephone conversations of XXXXXXXXXX, wherein you request an advance income tax ruling on behalf of the above-named taxpayer.

We understand that to the best of your knowledge and that of the taxpayer involved, none of the issues involved in this ruling request herein is:

(i) in a return of the taxpayer 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 taxpayer or a related person;

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

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

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate of the CRA to the taxpayer or a related person.

To the best of the taxpayer's knowledge, the Transactions will not have any impact on outstanding tax liabilities, if any, of the taxpayer.

Unless otherwise stated, all statutory references are to the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c.l, as amended to the date of this letter (the "Act"). Throughout this letter, the singular should be read as plural and vice versa where the circumstances so require.

DEFINITIONS

In this letter, the following terms are defined as follows:

(a) XXXXXXXXXX;

(b) "ACo Debt" means debt evidenced by one or more interest bearing promissory notes issued by AcquisitionCo in partial consideration for the transfer to AcquisitionCo of certain of the XCo CS; the terms and conditions of such notes will include interest at a maximum rate, currently estimated to be XXXXXXXXXX% per annum, payable annually and comprised of (i) Base Interest, and (ii) Additional Interest; with any Interest that has become payable but has not been paid within a specified period of time being added to the principal amount of the ACo Debt then outstanding;

(c) "ACo Share" means a common share in the capital of AcquisitionCo;

(d) "XXXXXXXXXX Note" means an interest bearing promissory note issued by AcquisitionCo in partial consideration for the transfer to AcquisitionCo of certain of the XCo CS;

(e) "AcquisitionCo" means a Taxable Canadian Corporation formed as an unlimited liability corporation under the XXXXXXXXXX, all of the shares of which initially will be held by MFT and subsequently will be held by LP;

(f) "Additional Interest" means interest that will be payable annually by the Debtor and will be equal to the lesser of a specific percentage amount of the outstanding principal amount of the ACo Debt, currently estimated to be XXXXXXXXXX% per annum (being an amount intended to increase the effective interest rate on the ACo Debt to the prevailing market rate of interest for comparable debt), and an amount equal to the taxable income of the Debtor less $XXXXXXXXXX calculated without regard to the Additional Interest component;

(g) "Amalgamation" means the amalgamation of XCo and certain subsidiaries of XCo under subsection 87(1) of the Act to become XAmalco;

(h) "Base Interest" means interest at a fixed rate, currently estimated to be XXXXXXXXXX% per annum, of the outstanding principal amount of the ACo Debt that will be payable annually by the Debtor;

(i) XXXXXXXXXX

(j) XXXXXXXXXX

(k) "CRA" means the Canada Revenue Agency;

(l) "Debtor" means the debtor under the ACo Debt, XXXXXXXXXX;

(m) "Disposition" means the disposition by XCo of the shares of certain subsidiary corporations to XXXXXXXXXX in exchange for the XXXXXXXXXX Consideration, and is further described in 9 below;

(n) "Electing Shareholders" means XCo Shareholders who are eligible and validly elect to transfer their XCo CS to LP;

(o) "FMV" means fair market value;

(p) "GAAR" means the general anti-avoidance rule under section 245 of the Act;

(q) "GPCo" means a Taxable Canadian Corporation incorporated under the XXXXXXXXXX to function as the general partner of LP, and whose share capital is wholly-owned by the MFT;

(r) "Indenture" means the declaration of trust made by the trustee of the MFT to, among other things, hold in trust any and all property of the MFT and any income and gains therefrom, for the benefit of the MFT Unitholders;

(s) "Interest" means the interest payable in respect of the principal amount owing under the ACo Debt from time to time, comprised of the Base Interest plus the Additional Interest;

(t) "LP" means a limited partnership formed under the XXXXXXXXXX pursuant to the LP Agreement;

(u) "LP Agreement" means the written partnership agreement entered into between GPCo, as general partner, and the MFT, as limited partner of the LP;

(v) "XXXXXXXXXX Note" means a promissory note issued by LP in partial consideration for the transfer to LP of certain of the XCo CS;

(w) "LP Unit" means an interest in the LP's capital issued pursuant to the terms of the LP Agreement;

(x) "XXXXXXXXXX Note" means a promissory note issued by LP in partial consideration for the transfer to LP of certain of the XCo CS;

(y) "MFT" means a mutual fund trust created and governed under the laws of the Province of XXXXXXXXXX and formed pursuant to the Indenture;

(z) "MFT Unit" means a trust unit of MFT, each such unit representing an equal fractional undivided beneficial interest in any distributions from the MFT and in any net assets of the MFT in the event of termination of the MFT;

(aa) "MFT Unitholder" means a holder of a MFT Unit;

(bb) XXXXXXXXXX;

(cc) "mutual fund trust" has the meaning assigned by subsection 132(6) of the Act;

(dd) "Non-Electing Shareholders" means XCo Shareholders who fail or are ineligible to transfer their XCo CS to LP;

(ee) XXXXXXXXXX;

(ff) "Option" means an option to acquire a XXXXXXXXXX CS pursuant to an agreement as contemplated under subsection 7(1) of the Act;

(gg) "Partners" means GPCo and MFT and each person who from time to time becomes a partner of the LP;

(hh) "Public Corporation" has the meaning assigned by subsection 89(1) of the Act;

(ii) "Taxable Canadian Corporation" has the meaning assigned by subsection 89(1) of the Act;

(jj) "Transactions" means those recently completed transactions and events described in paragraphs 10 to 15;

(kk) XXXXXXXXXX;

(ll) XXXXXXXXXX;

(mm) "XXXXXXXXXX Consideration" means XXXXXXXXXX;

(nn) "XXXXXXXXXX Note" means an XXXXXXXXXX Note or a XXXXXXXXXX Note;

(oo) "XXXXXXXXXX Shares" means approximately XXXXXXXXXX common shares in the capital of XXXXXXXXXX;

(pp) "XAmalco" means XCo, the corporation resulting from the Amalgamation;

(qq) "XCo" means XXXXXXXXXX. It is serviced by the XXXXXXXXXX Tax Services Office and files its tax returns at the XXXXXXXXXX Taxation Centre;

(rr) "XCo CS" means a common share in the capital of XCo and a common share in the capital of XAmalco following the Amalgamation; and

(ss) "XCo Shareholder" means a beneficial owner of one or more XCo CS.

FACTS

1. XCo is an XXXXXXXXXX incorporated company, is a Taxable Canadian Corporation and a Public Corporation.

2. The XCo CS are listed on the XXXXXXXXXX.

3. XCo had XXXXXXXXXX Options to acquire XCo common shares outstanding as at XXXXXXXXXX.

4. XCo had approximately XXXXXXXXXX XCo CS outstanding as at XXXXXXXXXX. XCo does not anticipate issuing any more XCo CS prior to the Transactions herein, other than pursuant to Options which may be exercised.

5. XCo carries on the business of XXXXXXXXXX through numerous directly and indirectly owned subsidiaries and partnerships.

6. No new equity capital will be raised as part of the Transactions.

7. The amount of the Interest will be reasonable in the circumstances and an investment banker has provided such an opinion.

8. For financial statement purposes, any Interest that is paid or becomes payable in a year pursuant to the terms of the ACo Debt will be recorded as an expense and any amount of Interest that has become payable but has not been paid in a fiscal period will be accrued as a liability of the Debtor.

9. The Disposition occurred on XXXXXXXXXX and the consideration received by XCo XXXXXXXXXX. The proceeds of disposition to XCo for purposes of the Act was equal the FMV of the consideration received.

TRANSACTIONS

The following transactions have all been completed:

10. MFT was established in accordance with the terms of the Indenture and qualifies as a mutual fund trust.

11. MFT incorporated GPCo and subscribed for XXXXXXXXXX common share in the capital of GPCo for $XXXXXXXXXX.

12. LP was formed by way of execution of the LP Agreement and the contribution of $XXXXXXXXXX and $XXXXXXXXXX by each of GPCo and MFT (each a Partner), respectively, in consideration for LP Units. The LP Agreement provides that:

(a) GPCo is the managing partner of the LP and responsible for all LP decisions relating to matters in the ordinary course of business or under a ceiling amount (with extraordinary decisions and decisions above the ceiling amount requiring the approval or agreement of all Partners);

(b) the fiscal period of the LP will end on XXXXXXXXXX;

(c) all income, loss and other amounts incurred by the LP in a fiscal period will be allocated to the Partners at the end of the applicable fiscal period;

(d) at all times:

(i) the Partners will act in accordance with the LP Agreement;

(ii) the Partners will hold themselves out as partners of the LP; and

(iii) LP will establish bank accounts, stationary books of account, and other administrative indicia evidencing the existence of the LP; and

(e) the Partners generally will carry on all activities of the LP in common with a view to profit.

13. MFT formed AcquisitionCo and subscribed for XXXXXXXXXX ACo Share for $XXXXXXXXXX.

14. Pursuant to a plan of arrangement ("POA"), inter alia, the following transactions were undertaken:

(a) Non-Electing Shareholders transferred their XCo CS to AcquisitionCo in exchange for 1) XXXXXXXXXX Notes and 2) ACo Debt;

(b) XXXXXXXXXX;

(c) The former XCo Shareholders described in (a) above transferred their ACo Debt to MFT in exchange for that number of MFT Units having a FMV equal to the principal amount of the ACo Debt so transferred;

(d) MFT transferred the ACo Debt acquired in (c) above and its ACo Share to LP in exchange for additional LP Units;

(e) Where appropriate notification was made, Electing Shareholders transferred their XCo CS to LP in exchange for 1) XXXXXXXXXX Notes, 2) XXXXXXXXXX Notes and 3) LP Units. An election was filed under subsection 97(2) of the Act by those transferors who elected to receive LP Units with the result that their particular transfer will occur on a tax-deferred basis to the extent permitted under those provisions;

(f) The former XCo Shareholders described in (e) above transferred their LP XXXXXXXXXX Notes to MFT in exchange for that number of MFT Units having a FMV equal to the principal amount of XXXXXXXXXX Notes so transferred;

(g) MFT transferred the XXXXXXXXXX Notes to LP in exchange for additional LP Units;

(h) LP transferred any XCo CS acquired in (e) above to AcquisitionCo in exchange for FMV consideration comprised of the assumption of LP's obligation under the XXXXXXXXXX Notes, additional ACo Debt and additional ACo Shares. The FMV of the ACo Shares was $XXXXXXXXXX. An election will be filed as contemplated under subsections 85(1), (2) and (6) of the Act with the result that this transfer occurs on a tax-deferred basis. The total principal amount of the ACo Debt was approximately $XXXXXXXXXX;

(i) AcquisitionCo acquired the XXXXXXXXXX Consideration from XAmalco; and

(j) AcquisitionCo transferred the XXXXXXXXXX Consideration to each holder of XXXXXXXXXX Notes in exchange for and in cancellation of such notes.

15. XXXXXXXXXX

16. In the future LP may acquire other assets. However, the nature and timing of such acquisitions cannot be predicted at this time.

PURPOSE OF THE TRANSACTIONS

The purpose of the Transactions was to convert XCo into a mutual fund trust structure.

RULINGS GIVEN

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, Transactions and purpose of the Transactions, and provided that the Transactions were completed in the manner described above, we rule as follows:

A. Provided that the Debtor continues to have a legal obligation to pay the ACo Debt and the ACo Debt continues to be held for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business, the Base Interest paid or payable by the Debtor in respect of a particular taxation year will be deductible by the Debtor as interest under paragraph 20(1)(c) of the Act to the extent such amount does not exceed a reasonable amount.

B. Provided the ACo Debt continues to be held for the purpose of gaining or producing income from the property or for the purpose of gaining or producing income from a business, the Additional Interest paid or payable by the Debtor in respect of a particular taxation year will be deductible by the Debtor as interest under paragraph 20(1)(c) of the Act to the extent such amount does not exceed a reasonable amount.

C. Subsection 245(2) of the Act will not be applied to the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 issued by the CRA and are binding on the CRA.

These rulings are based on the Act as it currently reads and do not take into account any future amendments, whether currently proposed or not 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.

Yours truly,

XXXXXXXXXX
For Director,
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch