2006 Ruling 2006-0195501R3 - Withholding Tax Exemption

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: 1. Use of Finco - on-loan to an LP 2. Events of Default acceptable

Position: 1. Acceptable 2. YES

Reasons: 1. Accepted before in 2005-015364, 2006-017101 2. Standard Triggering Events

XXXXXXXXXX 								2006-019550

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling - XXXXXXXXXX ("Finco")

This is in reply to your letter of XXXXXXXXXX, and further to your e-mails of XXXXXXXXXX wherein you request an advance income tax ruling on behalf of the above-named corporation with respect to the withholding tax exemption under subparagraph 212(1)(b)(vii) of the Income Tax Act (the "Act").

To the best of your knowledge and that of the taxpayer, none of the issues involved in this ruling contained herein is:

(i) dealt with in a return of Finco or a related person;

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

(iii) under objection by Finco or a related person;

(iv) the subject of a ruling previously issued by the Income Tax Rulings Directorate of the CRA to Finco or a related party; nor

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

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended, and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Definitions:

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

(a) "A Co" means XXXXXXXXXX, a Taxable Canadian Corporation;

(b) "Act" means the Income Tax Act, R.S.C. 1985 (5th supp.), c. 1, as amended;

(c) "Arm's Length" has the meaning assigned by section 251 of the Act;

(d) "Called Principal" means, with respect to any Senior or Subordinated Note, the principal of such note that is to be prepaid or is declared to be immediately due pursuant to the Finco Loan Agreements, as the context requires;

(e) "CRA" means Canada Revenue Agency;

(f) "Finco" means XXXXXXXXXX, a wholly-owned subsidiary of A Co and a Taxable Canadian Corporation;

(g) "Finco Loan" means the loan of approximately $XXXXXXXXXX to be made to Finco under the Finco Loan Agreements;

(h) "Finco Loan Agreements" means the agreements under which Finco will borrow the Finco Loan from the Lender;

(i) "LP#1" means XXXXXXXXXX limited partnership the only Partners of which are A Co and Holdco;

(j) "GP Co" means XXXXXXXXXX, a wholly-owned subsidiary of A Co and a Taxable Canadian Corporation;

(k) "Holdco" means XXXXXXXXXX, a wholly-owned subsidiary of A Co and a Taxable Canadian Corporation and the general partner of LP#1;

(l) "Lender" means XXXXXXXXXX, a non-resident of Canada for purposes of the Act, which is the lender under the Finco Loan Agreements;

(m) "LP#2" means XXXXXXXXXX limited partnership the only Partners of which are LP#1 and GP Co;

(n) "Make-Whole Premium" means a potential premium payable by Finco to the Lender if Finco repays all or a portion of the Finco Loan prior to the date set in the Finco Loan Agreements for repayment of the Finco Loan, calculated as, with respect to any senior note or subordinate note, an amount equal to the excess, if any, of the discounted value of the remaining scheduled payments with respect to the Called Principal of such senior note or subordinate note over the amount of such Called Principal, provided that the make-whole amount may in no event be less than zero;

(o) "Partner" or "Partners" means the Partner or Partners from time to time of LP#1 or LP#2 or both;

(p) "Partnership(s)" means LP#1 or LP#2 or both;

(q) "Principal Amount" has the meaning assigned by subsection 248(1) of the Act;

(r) "Proposed Transactions" means the transactions and events described in 7 to 21;

(s) "Senior Notes" means any senior notes of Finco issued under the Finco Loan Agreements from time to time which are outstanding;

(t) "Subordinated Notes" means any subordinated notes of Finco issued under the Finco Loan Agreements from time to time which are outstanding; and

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

Facts:

1. Finco is located at XXXXXXXXXX. Finco does not yet have a Business Number and has not yet filed an income tax return, but will eventually file at the XXXXXXXXXX Taxation Centre, XXXXXXXXXX

2 XXXXXXXXXX ("B Co") is a Taxable Canadian Corporation currently dealing at Arm's Length with A Co.

3. B Co owns a number of XXXXXXXXXX and wants to sell the XXXXXXXXXX.

4. A Co wants to establish a two-tier Partnership structure to acquire the XXXXXXXXXX, with LP#1 owning units of LP#2, which will own and be licensed to operate the XXXXXXXXXX.

5. XXXXXXXXXX.

6. A Co contemplates that third parties may be interested in acquiring units of one of the Partnerships. A Co is presently discussing such an investment with third parties but no deal has been finalized at this time.

Proposed Transactions:

7. LP#2 needs to borrow funds to acquire the XXXXXXXXXX. On behalf of LP#2, A Co has negotiated the Finco Loan Agreements of approximately $XXXXXXXXXX with the Lender. A Co believes that the Finco Loan Agreements with the Lender provide Finco with its lowest possible cost of acquiring funds and the maximum loan-to-value ratio. The Lender is not a resident of Canada for purposes of the Act. A Co and the Lender deal with each other at Arm's Length.

8. The Finco Loan Agreements have not yet been finalized and are currently under negotiation. The parties are waiting, in part, for this Ruling to be issued before finalizing the Finco Loan Agreements.

9. A Co and the Lender have agreed that the Finco Loan will be structured so that interest paid or credited to the Lender will be exempt from Part XIII tax under subparagraph 212(1)(b)(vii) of the Act. Under the terms of the Finco Loan Agreements, Finco will not, under any circumstances, be obligated to repay more than 25% of the Principal Amount of the Finco Loan within five years from the date the Finco Loan is issued, except in the event of a failure or default under the terms of the Finco Loan Agreements (or if the terms of the Finco Loan Agreements or any agreement relating thereto become unlawful or are changed by virtue of legislation or by a court, statutory board or commission).

10. Finco may, either at its option or under certain events of default, prepay all or a portion of the Finco Loan. To exercise its option, Finco must notify the Lender in writing of its intention to prepay all or a specified portion of the Finco Loan. If Finco so notifies the Lender, Finco becomes obligated to prepay the portion of the Finco Loan set out in the notification and to pay the Make-Whole Premium, if any.

11. If a Make-Whole Premium would otherwise be payable, Finco may offer to repay the Finco Loan without payment of the Make-Whole Premium but the Lender need not accept that offer.

12. The Finco Loan Agreements will provide for appropriate representations and warranties, covenants and events of default. Generally, events of default may only be caused by actions of parties to the Finco Loan Agreements, however, there is an event of default that may be caused by actions of persons who are not parties to the Finco Loan Agreements, XXXXXXXXXX if it were to cancel the operating license.

13. The events of default will be those which are typical for loans such as the Finco Loan, including but not limited to:

(a) failure to pay principal or interest when due to the Lenders in connection with the loan when due; unless such failure or default by the security trustee or by a wiring or transfer delay not caused by Finco, in which event the time to pay shall be extended by the time reasonably required to correct such failure;

(b) failure to pay fees or any other payments (other than payments of principal or interest) properly payable to the Lenders in connection with the loan within 30 days following receipt by Finco of an invoice with respect to such fees or other payments;

(c) breach of representations, warranties or covenants not cured within specified cure periods after actual notice thereof by a senior officer of Finco or the receipt by Finco of written notice thereof from a Lender;

(d) cancellation or lack of enforceability of any material provision of the Loan (including security documents) or the denial by Finco of any further liability or obligation thereunder;

(e) cancellation or amendment of any material governmental approvals or licences, or any material agreements, necessary to the operation of the project where such event would reasonably be expected to have a material adverse effect;

(f) bankruptcy, insolvency, winding-up, liquidation, etc., of Finco;

(g) A Co, LP#2 or GP Co ceasing to own, directly or indirectly at least 55% of the issued and outstanding shares or ownership of Finco, subject to Lender approval, not to be unreasonably withheld, provided that no such Lender approval shall be required in respect of any entity holding the issued and outstanding shares or ownership interests of Finco that results in (a) Finco or such entity becoming a reporting issuer or ceasing to be a private company for the purposes of Canadian securities laws, and (b) A Co and/or its affiliates and/or its senior management continuing and/or the initial equity participants to exercise control in fact of Finco or such entity and owning, directly or indirectly, at least 20% of all the issued and outstanding shares or ownership interests of Finco or such entity;

(h) default by Finco under any material agreements where such event would reasonably be expected to have a material adverse effect;

(i) cross payment default or cross acceleration with respect to any other default with respect to other obligations of Finco exceeding $XXXXXXXXXX (escalating yearly based on the Consumer Price Index); and

(j) unsatisfied final judgements against Finco in excess of $XXXXXXXXXX (escalating yearly based on the Consumer Price Index) or execution of any judgement against Finco.

14. As the XXXXXXXXXX are to be owned by LP#2, and as its Partners may not always be corporations resident in Canada, and as the Finco Loan is to be exempt under subparagraph 212(1)(b)(vii) of the Act, the parties have agreed that the Finco Loan will be made to Finco rather than directly to LP#2.

15. The Lender will issue the Finco Loan to Finco on an agreed date. Part of the security for the Finco Loan will be a mortgage granted by LP#2 over the XXXXXXXXXX, a limited guarantee from A Co and a pledge by A Co of its units in LP#1. The terms of the Finco Loan will be such that, in Finco's opinion, it will not be required to withhold any tax under Part XIII of the Act on the interest payable to the Lender, pursuant to subparagraph 212(1)(b)(vii) of the Act. The Finco Loan Agreements provide that if tax under Part XIII of the Act is payable by the Lender in respect of the interest paid or credited to it by Finco, then the interest rate on the Finco Loan will be grossed up so that, after withholding, the net interest paid to the Lender will be equal to the agreed net rate.

16. Finco will immediately lend all of the Finco Loan to LP#2. The terms of Finco's loan to LP#2 will be identical to the terms of the Finco Loan, other than the interest rate, which will be XXXXXXXXXX % greater than the interest rate on the loan that Finco receives from the Lender.

17. LP#2 will immediately lend a portion of its loan from Finco to A Co at an interest rate that is fixed at XXXXXXXXXX%, which will be higher than the rate LP#2 pays Finco. The terms of LP#2's loan to A Co, other than the interest rate, will be substantially identical to the terms as in 16 above, except that the A Co Loan does not require Make-Whole Payments and permits A Co to defer interest payments to LP#2 under certain circumstances.

18. A Co will use its borrowed funds to acquire all the shares of B Co from B Co's current shareholders.

19. LP#2 will acquire the XXXXXXXXXX. As partial payment, it will assume certain debt previously incurred by B Co to finance the XXXXXXXXXX. LP#2 will use its remaining borrowed funds to pay off all or part of any debt on the XXXXXXXXXX, which it assumes, and to pay other expenses associated with the acquisition.

20. LP#2 will own and operate the XXXXXXXXXX . For XXXXXXXXXX, GP Co (or another nominee company) will hold legal title to the XXXXXXXXXX in trust for the Partners of LP#2, while the intent is that LP#2 will have the beneficial ownership of the XXXXXXXXXX.

21. As noted above, Finco has the option to prepay all or part of the Finco Loan. If Finco does so then it may be required to pay a Make-Whole Premium to the Lender. If Finco exercises its option then LP#2 will prepay an equal portion of its loan to Finco and pay equal Make-Whole Premiums to Finco.

Other Information:

22. It is anticipated that the Lender may assign its participation in the Finco Loan to other lenders not related to Finco pursuant to the Finco Loan Agreements. The Finco Loan Agreements will provide that no such assignment shall be nor shall it be deemed to be a discharge, rescission, extinguishment, novation or substitution of any portion of the Finco Loan and that the portion of the Finco Loan so assigned shall continue to be the same obligation and not a new obligation.

Purpose of the Proposed Transactions:

23. The overall purpose of the proposed transactions is for A Co to acquire the XXXXXXXXXX through LP#2. The purpose of inserting LP#1 into the structure is to allow A Co to provide security over its units of LP#1 XXXXXXXXXX.

24. The purpose of acquiring the XXXXXXXXXX through LP#2 is to allow A Co the opportunity of interesting third parties in investing in the XXXXXXXXXX by acquiring units of LP#1.

25. Finco is being used to:

(a) facilitate, from a commercial perspective, the entry of Partners into or exit of Partners from the Partnerships;

(b) avoid any uncertainty with respect to the application of subparagraph 212(l)(b)(vii) of the Act to the Partnerships;

(c) avoid any uncertainty that might arise should a Partner dispose of its interest in a Partnership or should a new Partner be admitted to a Partnership, specifically with respect to whether a new debt obligation might be created as a result of such a disposition; and

(d) to ensure that subparagraph 212(1)(b)(vii) of the Act will not cease to apply if a person that is not a corporation resident in Canada becomes a Partner.

Rulings Given:

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, Proposed Transactions and the purpose of the Proposed Transactions, and that the financing agreement referred to in this letter is substantially the same as reflected herein, and provided further that the Proposed Transactions are completed in the manner described above, our ruling is as follows:

A. Interest payments made by Finco to a non-resident Lender pursuant to the Finco Loan Agreements will be exempt from withholding taxes under Part XIII of the Act, provided that at all relevant times the Lender and Finco deal with each other at Arm's Length and the other conditions of subparagraph 212(1)(b)(vii) are met and provided the interest rate is reasonable.

B. Provided that Finco's Make-Whole Premium payment, if any, does not exceed the value, at the time the Make-Whole Premium is paid, of the interest Finco would have paid or been required to pay on the Finco Loan for taxation years ending after that time, such payment will, pursuant to paragraphs 18(9.1)(e) and (f) of the Act, be deemed to be payable by Finco to the Lender as interest for purposes of subparagraph 212(1)(b)(vii) of the Act.

C. Neither the disposition by a Partner of its interest in a Partnership nor the admission of a new Partner to a Partnership will, in and of itself, preclude the application of subparagraph 212(1)(b)(vii) of the Act to interest payable by Finco to the Lender pursuant to the Finco Loan Agreements, regardless of whether the new Partner is a corporation resident in Canada.

D. Finco's requirement to make an offer to repay the Finco Loan under certain conditions as outlined in 10 to 13 above, will not, in and of itself, preclude the application of subparagraph 212(1)(b)(vii) of the Act to the interest payable by Finco to the Lender.

E. The assignment by the Lender of its interest in the Finco Loan as described in 22 above will not, in and of itself, preclude the application of subparagraph 212(1)(b)(vii) of the Act to interest payments made by Finco to a Lender pursuant to the Finco Loan Agreements.

F. As a result of the Proposed Transactions, in and by themselves, subsection 245(2) will not be applied to re-determine the tax consequences confirmed in the rulings above.

These rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5, dated May 17, 2002, and are binding on the CRA provided the Proposed Transactions are completed by XXXXXXXXXX.

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

Yours truly,

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