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: Cross-currency swap and termination payment
Position: Capital for portion representing notional principal amount of the loan. Income treatment for periodic amounts, representing interest and currencies.
Reasons: Established positions on cross-currency swaps
Re: Advance Income Tax Ruling
This is in reply to your letter of XXXXXXXXXX, and further to additional information received on XXXXXXXXXX, and 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) dealt with in an earlier return of the taxpayer or a related person;
(ii) being considered by a tax services office or a taxation centre in connection with any income tax return previously filed by 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 previous ruling issued by the Income Tax Rulings Directorate to the taxpayer or a related person.
(a) "A Co" means XXXXXXXXXX., further described in paragraphs 1 and 2;
(b) "Act" means the Income Tax Act, R. S. C. 1985 (5th Supp.) c.1, as amended to the date hereof;
(c) "B Co" means XXXXXXXXXX.;
(d) "Counterparties" means the individual members of a syndicate of banks with which A Co has entered into Swaps;
(e) "CRA" means the Canada Revenue Agency;
(f) "ISDA" means International Swap Dealers Association;
(g) "Notes" means the XXXXXXXXXX% Senior Subordinated Notes issued by A Co; and,
(h) "Swaps" means the cross-currency interest rates swaps as further described in 5, 6 and 7 below.
1. A Co is a Canadian XXXXXXXXXX company. XXXXXXXXXX. A Co files its federal income tax returns at the XXXXXXXXXX Taxation Centre and is serviced by the XXXXXXXXXX Taxation Services Office.
3. On XXXXXXXXXX, A Co issued Notes having an aggregate principal amount of US$XXXXXXXXXX at XXXXXXXXXX% due on XXXXXXXXXX. A Co received proceeds of US$XXXXXXXXXX, reflecting a price equal to XXXXXXXXXX% of the principal amount of the Notes. At the time the Notes were issued, the exchange rate was US$1 = C$1.6107. The Canadian dollar equivalent of US$XXXXXXXXXX at that time was C$XXXXXXXXXX.
4. A Co used all the proceeds from the Notes for capital purposes.
5. On or around XXXXXXXXXX, A Co entered into separate cross-currency Swaps with the Counterparties in order to hedge its US dollar exposure and associated interest rate risk on the Notes. The Swaps all have substantially similar terms.
6. The Swaps are governed by the terms and conditions of the ISDA Master Agreement dated as of XXXXXXXXXX as amended and supplemented from time to time, and subject to confirmations dated around XXXXXXXXXX (but effective XXXXXXXXXX) and subsequent confirmations.
7. Pursuant to the Swaps:
a) A Co and the Counterparties have agreed to make a final exchange on the approximate maturity date of the Notes, whereby A Co would pay the Counterparties an aggregate amount of C$XXXXXXXXXX and the Counterparties would pay A Co an aggregate amount of US$XXXXXXXXXX (the "Notional Principal Amounts"). The Notional Principal Amounts are to be exchanged on XXXXXXXXXX or, if the parties elect pursuant to the "Optional Early Termination Provisions" to terminate the Swaps on XXXXXXXXXX (the "Optional Early Termination Date"), on that earlier date.
b) A Co has agreed to pay the Counterparties aggregate fixed payments at an annual rate of XXXXXXXXXX % of the C$ Notional Principal Amount and the Counterparties have agreed to pay A Co's aggregate fixed payments at an annual rate of XXXXXXXXXX% of the US$ Notional Principal Amount (the "Periodic Payments"). The Periodic Payments are to be paid XXXXXXXXXX, up to such time as the Swaps are terminated.
c) As noted, either party to each of the Swaps may elect to terminate the Swap on XXXXXXXXXX. In these circumstances, the Swaps each provide that a calculating agent will calculate the amounts to be paid or received based on standard "make-whole" practices and procedures.
8. On XXXXXXXXXX, A Co XXXXXXXXXX commenced a XXXXXXXXXX cash tender offer and solicitations to purchase for cash any and all outstanding Notes. The offer was to expire on XXXXXXXXXX.
9. Assuming that US$1 is worth less than C$1.6107 on the day that A Co purchases the Notes, A Co will realize a foreign exchange gain on the repurchased Notes.
10. A Co is currently in negotiations with the Counterparties to terminate, modify and/or substitute the Swaps. The agreements to terminate, modify and/or substitute the Swaps have been or will be entered into as soon as possible with an effective settlement date coinciding with the date it purchases the Notes, estimated to be XXXXXXXXXX. It is intended that A Co will obtain new dollar funding for a XXXXXXXXXX term at current market rates, and that the existing Swaps will be modified, or new Swaps entered into with the same Counterparties, to hedge this facility.
11. Although the date on which the Swaps are proposed to be terminated or modified precedes the Optional Early Termination Date, the net amount that A Co will be required to pay each Counterparty (or that each Counterparty will be required to pay A Co) (in aggregate, the "Aggregate Settlement Payment") can be readily ascertained by the application by the calculation agent under each Swap of standard "make-whole" practices and procedures. A Co will be required to make, rather than receive, the Aggregate Settlement Payment because prevailing exchange and interest rates will be used to estimate the payments that A Co and the Counterparties would each have made under the Swaps if they were not terminated. Assuming that the exchange rate used in the calculation is US$1 < C$1.6107, the calculation will assume that A Co would have been required under the Swaps to make aggregate net payments to the Counterparties in respect of the Notional Principal Amounts and the Periodic Amounts. As a consequence, on the premature termination or modification of the Swaps, A Co will be required to make an Aggregate Settlement Payment to the Counterparties to compensate them for not receiving the anticipated net Notional Principal Amounts and net Periodic Amounts. For example, had the Swaps been terminated or modified by mutual agreement on XXXXXXXXXX, A Co would have been required to pay an estimated aggregate amount of approximately C$XXXXXXXXXX in order to settle any claims the Counterparties would otherwise have under the Swaps.
12. It is proposed that the Aggregate Settlement Payment will be subdivided into four components, which will be transacted over an estimated XXXXXXXXXX period, with a settlement date of XXXXXXXXXX in each case and will include:
a) An amount that will compensate the Counterparty under each Swap for not receiving net payments of the Notional Principal Amounts (the aggregate amounts under all the Swaps is referred to as the "Aggregate Notional Principal Commutation Payments"). For example, had the Swaps been terminated by mutual agreement on XXXXXXXXXX, A Co would have been required to make Aggregate Notional Principal Commutation Payments in the amount of approximately C$XXXXXXXXXX.
b) Three amounts that will together compensate the Counterparty under each Swap for not receiving net payments of the Periodic Amounts (the aggregate amounts under all the Swaps is referred to as the "Aggregate Periodic Commutation Payments"). The three amounts will be calculated by conceptually separating the obligations of the parties under the Swaps with respect to the Periodic Amounts into three notional payment streams under three notional swaps:
i. The first amount would be received by A Co and would be a net amount based on the existing entitlement of A Co under the Swaps to receive periodic payments of XXXXXXXXXX% of US$XXXXXXXXXX, and the notional obligation of A Co to make periodic payments of the relevant US dollar floating rate applied to US$XXXXXXXXXX . (This notional swap is referred to as the "US Dollar Interest Rate Swap" and A Co's aggregate related receipts is referred to as the "Aggregate US Dollar Interest Rate Swap Receipts".)
ii. The second amount would be paid by A Co and would be a net amount based on the notional entitlement of A Co to receive periodic payments of the relevant US dollar floating rate applied to US$XXXXXXXXXX and the notional obligation of A Co to make periodic payments of the relevant Canadian dollar floating rate applied to C$XXXXXXXXXX. (This notional swap is referred to as the "Basis Swap" and the aggregate related payments by A Co is referred to as the "Aggregate Basis Swap Payments".)
iii. The third amount would be paid by A Co and would be a net amount based on the notional entitlement of A Co to receive periodic payments of the relevant Canadian dollar floating rate applied to C$XXXXXXXXXX and A Co's existing obligations under the Swaps to make periodic payments of XXXXXXXXXX% of C$XXXXXXXXXX. (This notional swap is referred to as the "Canadian Dollar Interest Rate Swap" and the aggregate related payments by A Co is referred to as the "Aggregate Canadian Dollar Interest Rate Swap Payments".)
The Aggregate US Dollar Interest Rate Swap Receipts, Aggregate Basis Swap Payments and Aggregate Canadian Dollar Interest Rate Swap Payments may be made on the same day or on different days during an estimated XXXXXXXXXX period. The timing of each separate component will depend on market conditions. For example, if the Swaps had been terminated by mutual agreement on XXXXXXXXXX and the Aggregate US Dollar Interest Rate Swap Receipts, Aggregate Basis Swap Payments and Aggregate Canadian Dollar Interest Rate Swap Payments were all received or paid on that same day, the estimated Aggregate US Dollar Interest Rate Swap Receipts would have been approximately C$XXXXXXXXXX, the estimated Aggregate Basis Swap Payments would have been approximately C$XXXXXXXXXX, and the estimated Aggregate Canadian Dollar Interest Rate Swap Payments would have been approximately C$XXXXXXXXXX (netting to Aggregate Periodic Commutation Payments by A Co of C$XXXXXXXXXX).
Purpose of Proposed Transaction:
A Co has offered to purchase the US$ Notes that it issued on XXXXXXXXXX. A Co intends to seek new XXXXXXXXXX financing XXXXXXXXXX. Since A Co will purchase the Notes, A Co also proposes to terminate or modify certain related Swaps with an effective date of XXXXXXXXXX.
Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we rule as follows:
A. On the termination or modification of the Swaps, A Co will be considered to have realized a capital loss pursuant to subsections 38(b) and 39(2) of the Act from the disposition of property in an amount equal to the Aggregate Notional Principal Commutation Payments.
B. The Aggregate Periodic Commutation Payments as described in 12(b) above will be considered to be paid and received by A Co on income account pursuant to section 9 of the Act.
On the date of issuance of this ruling, the proposed transactions have been completed. 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.
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and
Regulatory Affairs Branch
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