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. Is the Project involving a license agreement for XXXXXXXXXX years acceptable as a class 14 asset? 2. Are the events of default acceptable for the withholding tax exemption?
Position: 1. Yes, 2. Yes
Reasons: 1. License Agreement and given before in 2004-0105611, 2005-013328 2.
Re: Advance Income Tax Ruling
XXXXXXXXXX (the "Partnership")
XXXXXXXXXX ("Z Co") BN XXXXXXXXXX
We are writing in response to your letter of XXXXXXXXXX, and further to a letter of XXXXXXXXXX, wherein you requested an advance income tax ruling in respect of the above-named taxpayers. XXXXXXXXXX We also acknowledge information provided to us in numerous telephone conversations.
Considering that Finco and the Partnership have not been created and that all the agreements relating the Project are still in draft form, none of the issues involved in this ruling request are:
(i) dealt with in an earlier return of Finco, the Partnership, its members or a related person;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of Finco, the Partnership, its members or a related person;
(iii) under objection by Finco, the Partnership, its members or a related person;
(iv) the subject of a ruling previously issued by the Income Tax Rulings Directorate to the taxpayers or a related person; nor
(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.
To the best of your knowledge, and that of the taxpayer involved, the proposed transactions will not impact the ability of any taxpayer involved to pay its existing tax liabilities.
In this letter, unless otherwise indicated, all statutory references are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c. 1, as amended, (the "Act").
Unless otherwise specified all dollar amounts are denominated in Canadian dollars.
In this letter, the following terms have the meanings specified:
(a) "Arrangers" will be entities that are banks, that deal at arm's length with Z Co and that are not resident of Canada;
(b) "Concession" means the rights that the Minister will grant to the Partnership, pursuant to the Concession Agreement, to use and access the Site and the Facility, for the purposes of constructing and operating the Facility during the Operating Period;
(c) "Concession Agreement" is the agreement referred to in 8 below to be entered into by the Partnership and the Minister;
(d) "Construction Period" is the period that will begin when the Concession Agreement is entered into and will end when the Substantial Completion of the Facility is achieved. The Construction Period is expected to last for approximately XXXXXXXXXX years;
(e) "Contract Period" is the period that includes the Construction Period and the Operating Period and is expected to last for a period of XXXXXXXXXX years;
(f) "Contractor" means a joint venture to be undertaken between a wholly-owned subsidiary of Z Co and a co-venturer, that is a resident of Canada, both of which are duly licensed to execute construction works in the Province of XXXXXXXXXX;
(g) "Engineers" means Z Co, XXXXXXXXXX, a non-resident of Canada, and XXXXXXXXXX, a resident of Canada;
(h) "EPC Contract" means the engineering, procurement and construction contract that will be concluded between the Partnership and the Contractor. Such contract will be drafted upon confirmation that the Partnership will win the contest to be the private party in the Concession Agreement;
(i) "Facility" is the XXXXXXXXXX;
(j) "Finco" is a corporation to be formed under the CBCA, all the issued and outstanding shares of which will be held by GP;
(k) "GP" is a corporation to be formed under the CBCA, all the issued and outstanding shares of which will be held by Newco;
(l) "Lenders" are the lenders under the Loan Agreement, one or more of which will not be residents of Canada for the purposes of the Act and all of which will be dealing at arm's length with Z Co, Finco, GP and Newco;
(m) "Loan Agreement" is the agreement between Z Co, Arrangers, Finco, the Partnership, GP and the Lenders pursuant to which the Lenders will make a loan to Finco;
(n) "Minister" means the XXXXXXXXXX;
(o) "Newco" is a corporation to be formed under the CBCA, all of the issued and outstanding shares of which will be held by Z Co;
(p) "Operating Period" is the part of the Contract Period that begins immediately after the Construction Period and ends at the end of the Contract Period;
(q) "Partnership" is a limited partnership formed under the laws of XXXXXXXXXX called the XXXXXXXXXX, with Z Co as the limited partner and GP as the general partner;
(r) "Primary Loan" is the funding to be obtained by Finco from the Lenders in order to allow the Partnership to complete the Facility;
(s) "Project" is the design, construction, financing, testing, operation, maintenance and rehabilitation of the Facility;
(t) "Regulations" means the Income Tax Regulations, Consolidated Regulations of Canada, Chapter 945 as amended to the date hereof;
(u) "Secondary Loan" is the loan of the proceeds of the Primary Loan to be made by Finco to the Partnership;
(v) "Site" is the land on which the Facility will be constructed;
(w) "Substantial Completion" means the substantial completion of the construction of the Facility as outlined in the Concession Agreement; and
(x) "Z Co" is XXXXXXXXXX.
1. The Project is a public-private partnership XXXXXXXXXX. The aggregate cost of the Project will be approximately $XXXXXXXXXX.
2. The Partnership will be formed under and subject to the XXXXXXXXXX law as a limited partnership pursuant to a limited partnership agreement upon confirmation that it has been chosen by the Minister to sign the Concession Agreement with the Minister. The limited partner of the Partnership will be Z Co and the general partner of the Partnership will be GP (from time to time, the "Partners" or a "Partner"). It is contemplated that additional Canadian corporations may be admitted as limited partners of the Partnership before the closing date of the transaction.
3. Z Co is a taxable Canadian corporation and a public corporation for the purposes of the Act that files its tax returns in the XXXXXXXXXX Tax Services Office.
4. GP will be a taxable Canadian corporation. All the issued and outstanding shares of GP will be legally and beneficially owned by Newco. Z Co will own all of the issued and outstanding shares of Newco.
5. Finco will be a taxable Canadian corporation all of the issued and outstanding shares of which will be legally and beneficially owned by GP.
6. The proposed transactions below are further described in the Concession Agreement and in the Partnership Agreement. The Loan Agreement and the EPC Contract will provide further precisions on the proposed transactions when they are drafted and signed.
7. The total Contract Period is expected to last for XXXXXXXXXX years. The Contract Period can be separated into two periods. The first period is the Construction Period that includes the design and construction of the Facility. The Construction Period ends once the Substantial Completion has occurred. The second period is the Operating Period and this period starts immediately after Substantial Completion and runs to the end of the Contract Period. During the Operating Period, the Partnership will be responsible for the maintenance of the Facility XXXXXXXXXX.
8. To the extent that it is retained by the Minister as being the chosen bidder, the Partnership will enter into the Concession Agreement with the Minister. The Concession Agreement will set out the obligations of the Minister and the Partnership during the Construction Period and the Operating Period.
9. The Partnership will not acquire an interest in the Site nor in the Facility. The Concession Agreement specifically provides that the Concession will not be construed as granting any legal or other interest in the land nor in the Facility to the Partnership. The Minister will reserve the rights to all archaeological works and items of geological, historical or archaeological interest or value.
10. The Minister will be the owner of the Facility at all times. The Minister will become the owner of the Facility as it is erected by the Partnership.
11. The Partnership will be responsible for designing, constructing, completing and testing the Facility, operating and maintaining the Facility throughout the Operating Period (XXXXXXXXXX) and rehabilitating the Facility at the end of the Contract Period, all in accordance with the requirements set out in the Concession Agreement. The Partnership will be required to finance all of the above activities at its own cost and risk except for an amount of $XXXXXXXXXX that the Minister will pay to the Partnership during the Construction Period. The Partnership will agree to be liable for any defects that may be found during the Operating Period.
12. The Minister will grant the Concession to the Partnership. The period for the Concession will start when the Concession Agreement is entered into and will run to the end of the Contract Period. The Concession will grant the Partnership access to the Site and adjacent areas for the purposes of constructing the Facility and operating it during the Operating Period. In return for the grant of the Concession, the Partnership will agree to construct the Facility and operate it during the Operating Period at its own expenses except for the amount of $XXXXXXXXXX that the Minister will pay to the Partnership during the Construction Period.
13. Before the end of the Contract Period, the Partnership will have to rehabilitate the Facility before remitting it to the Minister in a state provided for in the Concession Agreement.
14. It is anticipated that the costs incurred by the Partnership during the Construction Period will be approximately $XXXXXXXXXX. The costs will include the costs of constructing the Facility (including construction costs of materials, labour and equipment as required under the Concession Agreement). The cost of the Concession will also include the costs incurred by the Partnership during the Operating Period to the extent that such costs relate to any variations to the construction of the Facility previously agreed to by the Partnership and the Minister and any costs incurred to repair any defects in the construction of the Facility that are capital expenditures.
15. For the purposes of apportioning the capital cost of the Concession over the remaining period of the Concession in accordance with paragraph 1100(1)(c) of the Regulations, the Partnership will aggregate its total costs incurred with respect to the Concession on a quarterly basis and amortize that quarterly amount over the remaining period of the Concession.
16. The Minister or the Province of XXXXXXXXXX owns or has rights to the real property interests on which the Facility will be constructed. The Minister or the Province of XXXXXXXXXX will grant the use of the real property interests to the Partnership for the purpose of constructing and operating the Facility. Ownership of the Facility and improvements will remain with the Minister. The Partnership will enter into an EPC Contract with the Contractor. The Contractor will have the responsibility to construct the Facility. The Contractor will enter into one or several contracts with the Engineers.
17. During the Contract Period, the Partnership will construct and operate the Facility. The Minister will pay the Partnership $XXXXXXXXXX based on the progress of the construction of the Facility during the Construction Period and performance payments during the Operating Period, which will be based on a formula contained in the Concession Agreement. This $XXXXXXXXXX aggregate payment by the Minister will be a contribution towards the cost of the Concession.
18. During the Operating Period, the Minister will make payments to the Partnership based on a formula contained in the Concession Agreement. XXXXXXXXXX.
19. The Partnership will be financially at risk should the payments to be received from the Minister during the Construction Period and the Operating Period be less than the expenses incurred by the Partnership during the Contract Period.
20. Pursuant to the Loan Agreement, Finco will borrow the funds it needs to finance the Project from the Lenders on normal commercial terms. Finco will loan all of the proceeds of the Primary Loan to the Partnership on substantially the same financial terms as those under the Primary Loan except that the interest rate charged by Finco on the Secondary Loan will be XXXXXXXXXX% higher than the interest rate charged by the Lenders and payable by Finco on the Primary Loan. The Partnership will pay the interest owed to Finco on the Secondary Loan to Finco who in turn will pay interest on the Primary Loan to the Lenders.
21. The security given to the Lenders for the Primary Loan will be as follows:
(a) Finco will give a security interest by way of a general security agreement in all of Finco's present and after-acquired property. It is expected that the sole asset of Finco will be the Secondary Loan and the security for the Secondary Loan;
(b) the Partnership will provide the Lenders with a guarantee secured by a security interest created under a trust indenture in all of the Partnership's present and after acquired property; and
(c) the limited Partner and the GP will pledge their units or interest in the Partnership directly to the Lenders.
22. The Secondary Loan will be secured by a security interest created under a trust indenture in all of the Partnership's present and after-acquired property.
23. The Primary Loan will be drawn down over the initial period of the Loan Agreement (the "Disbursement Period") and will be repaid on the repayment dates specifically set out in the Loan Agreement.
24. Under the terms of the Loan Agreement, Finco will not, under any circumstances, be obligated to pay more than 25% of the principal amount (within the meaning of that term in subsection 248(1) of the Act) of the Primary Loan within five years from the end of the Disbursement Period of the Primary Loan during which amounts may be drawn under the Primary Loan except in the event of a failure or default under the terms of the Loan Agreement (or if the terms of the Loan Agreement or any agreement relating thereto become unlawful or are changed by virtue of legislation or by a court, statutory board or commission). The Loan Agreement also provides that certain changes in the Partners, as described in 25(k) below, will trigger a default.
25. The Loan Agreement will provide for certain representations and warranties, covenants and events of default considered appropriate in the context of the Loan Agreement and the Project. These events of default are briefly summarized below:
(a) a default by Finco or the Partnership in the payment of any amount payable under the Loan Agreement and related agreements;
(b) Finco, the Partnership or Z Co (a "Loan Party") defaults in observing or performing any other covenant or agreement in the Loan Agreement or in any other loan document and, in the case of certain covenants or agreements, the default on its part to be performed continues for a specified period;
(c) funds on deposit in certain accounts are used by Finco or the Partnership for purposes other than those specified in the Loan Agreement;
(d) Z Co fails to contribute capital as required under an equity funding agreement;
(e) any representation or warranty given by a Loan Party, the Contractor or any other participant in the Project is incorrect;
(f) an uninsured judgment is entered against a Loan Party or Contractor and a stay of execution is not obtained within XXXXXXXXXX days;
(g) a writ of execution is executed against the Facility and remains in effect for XXXXXXXXXX days;
(h) a Loan Party, the Contractor or any participant in the Project becomes insolvent or makes a general assignment for the benefit of creditors or insolvency proceedings are instituted in respect of such a person, subject to an ability to remedy;
(i) any principal document relating to the Project becomes unenforceable or ceases to be a legal obligation of a Loan Party;
(j) the security given for the Primary Loan under the Loan Agreement ceases to be continuing or in full force or effect, its validity is challenged or it fails to create the intended priority;
(k) any unauthorized change in the Partners or the direct or indirect ownership by Z Co in the members of the Partnership;
(l) any seizure or appropriation of all or a substantial part of the assets of Finco or the Partnership;
(m) the Project is wholly or substantially abandoned by the Partnership;
(n) the Partnership or any participant in the Project fails to perform any material term in the principal documents relating to the Project or any of the principal documents are terminated or repudiated, certain defaults occur under the Concession Agreement, notices of significant deficiencies in the Project are given or any government funding agency or any Partner defaults in making payments or fails to perform a material obligation, or certain events of default occur under the operating agreement, subject to an ability to remedy;
(o) a Loan Party or other participant in the Project defaults in any of its indebtedness resulting in an acceleration of the maturity of such indebtedness;
(p) the Partnership fails to comply with any environmental law or an event of force majeure occurs that is reasonably expected to have a material adverse effect;
(q) certain governmental approvals are not obtained;
(r) the Facility is damaged and the Partnership does not submit a restoration plan within a certain period or abandons such restoration work;
(s) certain financial ratios are not met or insurance is not maintained; and
(t) the Project is not completed or it is reasonably likely not to be completed on a timely basis based on an independent engineer's certificate.
Purpose of the Proposed Transactions
26. The purpose of the proposed transactions is to enable the Partnership to design, engineer, construct, perform testing of the Facility during the Construction Period, to operate (XXXXXXXXXX) and maintain the Facility during the Operating Period and to rehabilitate the Facility at the end of the Contract Period.
27. The Partnership will acquire the Concession which will enable it to complete the Project, in accordance with the terms of the Concession Agreement and to receive the construction payments during the Construction Period and the performance based payments during the Operating Period.
28. The Minister will be the owner of the Facility at all material times and will have the Facility maintained by the Partnership during the Operating Period.
29. The Primary Loan is being obtained from the Lenders to secure the best financing terms and interest rate for the purpose of funding the construction and operation of the Project.
30. Finco is being used in the structure to:
(a) facilitate, from a commercial perspective, the entry or exit of limited partners of the Partnership;
(b) avoid any uncertainty with respect to the application of subparagraph 212(1)(b)(vii) of the Act as it applies to a limited partnership; and
(c) avoid any uncertainty that might arise should a Partner dispose of its interest in the Partnership in the future or should a new partner be admitted to the Partnership, specifically with respect to whether a new debt obligation might be created as a result of such a disposition.
31. The security granted by the Partnership, Finco and the Partners, is required by the Lenders in order to provide the loan under the Loan Agreement to Finco upon the financing terms and interest rate provided thereunder.
32. It is anticipated that in the future one or more Partners will sell or otherwise dispose of all or a portion of their interest in the Partnership and/or one or more new Partners will be admitted to the Partnership.
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the proposed transactions and purpose of the proposed transactions, and that the final agreements described in this letter are substantially the same as the documents, either provided to us or as described to us and reflected herein, and provided further that the proposed transactions are completed in the manner described above, our rulings are as set forth below:
A. The Concession granted to the Partnership as described in 8 and 9 above will be included in Class 14 of Schedule II of the Regulations.
B. For the purposes of the definition of undepreciated capital cost in subsection 13(21) of the Act, paragraph 20(1)(a) of the Act and paragraph 1100(1)(c) of the Regulations, the capital cost of the Concession will include the total of the costs incurred by the Partnership in respect of the Concession, as described in 12, 13, and 14 above.
C. For the purposes of paragraph 20(1)(a) of the Act, the capital cost of the Concession, as determined in the manner described in 15 above, will be deductible by the Partnership in accordance with the provisions of paragraph 1100(1)(c) of the Regulations.
D. Paragraphs 18(1)(a) and 18(1)(b) of the Act will not apply to deny the Partnership a deduction for all outlays and expenses incurred by the Partnership for the maintenance and repairs to the Facility, provided such outlays and expenses are incurred to satisfy the requirements of the Concession Agreement and are not capital expenditures described in Ruling B above.
E. By virtue of subsection 13(26) of the Act, and in applying the definition of undepreciated capital cost in subsection 13(21) for the purposes of paragraph 20(1)(a) and any of the Regulations made for the purposes of paragraph 20(1)(a) of the Act, in computing the Partnership's income for a taxation year, no amount shall be included in calculating the undepreciated capital cost of the Concession before the time the Concession is considered to have become available for use by the Partnership.
F. For the purposes of subsection 13(26) of the Act, the Concession will be considered to have become available for use, pursuant to subsection 13(27) of the Act, at the earlier of:
(a) the beginning of the Operating Period, i.e., when the Construction Period will end, and
(b) the time that is immediately after the beginning of the first taxation year of the Partnership that begins more than 357 days after the end of the taxation year of the Partnership in which the cost in respect of the Concession are incurred.
G. Notwithstanding the fact that the Partnership will be entitled to the construction payments totalling $XXXXXXXXXX during the Construction Period, the payments received by the Partnership during the Construction Period as described in 12 and 17 above totalling $XXXXXXXXXX will be considered as a reduction of the capital cost of the Concession for the purpose of the Act and not be included in determining the profit of the Partnership under section 9, paragraph 12(1)(b) or any other provision of the Act.
H. During the Operating Period, the Partnership will include the performance based payments in income in a taxation year in accordance with section 9 of the Act and paragraph 12(1)(b) of the Act, i.e., as they become payable.
I. Interest payments made by Finco to the Lenders pursuant to the Loan Agreement will be exempt from withholding taxes under Part XIII of the Act pursuant to subparagraph 212(1)(b)(vii) of the Act provided that at the time of the payment, the Lenders deal at arm's length with Finco (within the meaning of that term in section 251 of the Act).
J. Subparagraph 212(1)(b)(vii) of the Act will continue to apply to interest payments made by Finco to the Lenders pursuant to the Loan Agreement should a Partner dispose of its interest in the Partnership and/or should a new partner be admitted to the Partnership, provided that Finco deals at arm's length with the Lenders at the time of the payment.
K. For the purposes of the five year period within which not more than 25% of the principal amount of an obligation can be payable for purposes of subparagraph 212(1)(b)(vii) of the Act, a disposition of an interest by a Partner in the Partnership or the acquisition by a person of an interest as a partner in the Partnership will not result in the issuance of a new debt obligation.
L. Provided that the Partnership has a legal obligation to pay interest on the Secondary Loan, and provided the Partnership continues to be involved in the Project, the Partnership will be entitled to deduct in a taxation year, the interest paid or payable (depending on the method regularly followed by the Partnership in computing its income) on the Secondary Loan in respect of the taxation year, pursuant to paragraph 20(1)(c) of the Act, to the extent that the interest is reasonable.
M. Provided that Finco continues to have a legal obligation to pay interest on the Primary Loan, and provided Finco continues to be involved in the Project, Finco will be entitled to deduct, in a taxation year, pursuant to paragraph 20(1)(c) of the Act, the interest paid or payable to the Lenders on the Primary Loan in respect of the taxation year, to the extent the interest is reasonable.
N. The financing costs incurred by the Partnership in the course of obtaining the Secondary Loans as described in 20 above will be deductible by the Partnership in accordance with paragraph 20(1)(e) of the Act, to the extent such financing costs are reasonable in the circumstances.
O. The financing costs incurred by Finco in the course of obtaining the Primary Loan as described in 20 above will be deductible by Finco in accordance with paragraph 20(1)(e) of the Act, to the extent such financing costs are reasonable in the circumstances.
P. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act 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 forth in Information circular 70-6R5 dated May 17, 2002 issued by the CRA, and are binding provided the Concession Agreement and Loan Agreement are entered into on or before XXXXXXXXXX.
These rulings are based on the Act in its present form and do 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;
(ii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein; nor
(iii) the nature of the legal relationship entered into or contemplated by the entities named above.
This letter is based solely on the facts and proposed transactions described above. The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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