2007 Ruling 2007-0227501R3 - XXXXXXXXXX

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: Deductibility of interest as part of a corporate reorganization involving an amalgamation which results in a replacement of paid-up capital with debt.

Position: Favourable rulings given.

Reasons: The law.

XXXXXXXXXX 								2007-022750

XXXXXXXXXX, 2007

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, and your other correspondence, in which you requested an advance income tax ruling on behalf of the taxpayers described in this letter. You have advised that to the best of your knowledge, and that of the responsible officers of each of the taxpayers, none of the issues involved in this Ruling is:

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

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

(iii) under objection by any of the taxpayers 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.

You have also advised that to the best of your knowledge, and that of the responsible officers of each of the taxpayers, that the proposed transactions will not result in any of the taxpayers or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a) "Aco" means XXXXXXXXXX;

(b) "Act" means the Income Tax Act R.S.C. 1985 (5th Supp.) c.1 as amended from time to time and consolidated to the date of this letter and unless otherwise expressly stated every reference herein to a part, section or subsection, paragraph or subparagraph, and clause or subclause is a reference to the relevant provision of the Act, and the Income Tax Regulations thereunder are referred to as the Regulations;

(c) "adjusted cost base" has the meaning assigned by subsection 248(1);

(d) "agreed amount" has the meaning assigned by subsection 85(1);

(e) "BCA" means the Business Corporations Act (XXXXXXXXXX);

(f) "BN" means the business number issued to the particular entity by CRA;

(g) "cost amount" has the meaning assigned by subsection 248(1);

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

(i) "Common Shares" means the common shares of Aco (or its predecessor corporations, as the context requires);

(j) "Election" means the prescribed election to not be a public corporation as provided for in paragraph 89(1)(c) of the definition of public corporation;

(k) "eligible property" has the meaning assigned by subsection 85(1.1);

(l) "Exchangeable Shares" means the Exchangeable Shares of Aco (or its predecessor corporations, as the context requires);

(m) "Fund" means XXXXXXXXXX;

(n) "Fund Unit" means a unit of the Fund, each such unit representing an equal undivided beneficial interest therein;

(o) "mutual fund trust" has the meaning assigned by subsection 132(6);

(p) "paid-up capital" has the meaning assigned by subsection 89(1);

(q) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;

(r) "predecessor corporation" has the meaning assigned by subsection 87(1);

(s) "principal amount" has the meaning assigned by subsection 248(1);

(t) "Proposed Transactions" means the transactions described in Paragraphs 11 to 14;

(u) "public corporation" has the meaning assigned by subsection 89(1);

(v) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(w) "Special Voting Units" means the special voting units of the Fund;

(x) "stated capital" means the amount of capital determined in respect of a class or series of shares in accordance with the BCA;

(y) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1); and

(z) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

FACTS

1. The Fund was formed under the laws of the Province of XXXXXXXXXX pursuant to a declaration of trust dated XXXXXXXXXX, and amended and restated as of XXXXXXXXXX (the "Declaration of Trust"). The Fund is a resident of Canada and is a mutual fund trust. The Fund files its federal tax returns at the XXXXXXXXXX Centre and the XXXXXXXXXX TSO administers its federal tax matters.

2. Under the Declaration of Trust, the Fund may issue an unlimited number of Fund Units and Special Voting Units. There are approximately XXXXXXXXXX Fund Units issued and outstanding. No Special Voting Units are outstanding. The Fund Units are widely-held and are listed on the XXXXXXXXXX Stock Exchange.

3. Aco is the successor corporation that was formed under the BCA as a result of multiple amalgamations with various predecessor corporations that have taken place since the shares of Aco were directly or indirectly acquired by the Fund as described in Paragraph 7. Aco carries on a XXXXXXXXXX business in Canada, XXXXXXXXXX. Aco is a taxable Canadian corporation and a public corporation. Aco files its federal returns at the XXXXXXXXXX TC and the XXXXXXXXXX TSO administers its federal tax affairs.

4. The authorized share capital of Aco consists of (i) an unlimited number of Common Shares, of which XXXXXXXXXX are issued and outstanding, and (ii) an unlimited number of Exchangeable Shares, of which XXXXXXXXXX are issued and outstanding. The Common Shares and Exchangeable Shares of Aco are collectively referred to as the "Aco Shares". The Fund owns all of the Aco Shares and such shares are held as capital property. The aggregate adjusted cost base and paid-up capital of the Common Shares is $XXXXXXXXXX. The aggregate adjusted cost base of the Exchangeable Shares is $XXXXXXXXXX. The specific amount of paid-up capital of the Exchangeable Shares is not known at this time, however, such amount is less than the adjusted cost base of such shares.

5. In addition to the Fund's investment in the Aco Shares, the Fund also holds $XXXXXXXXXX principal amount of notes (the "Aco Notes") that were issued by Aco or one or more of its predecessor corporations as described below. The Aco Notes bear interest at a rate of XXXXXXXXXX% per annum, with interest payable monthly. The Aco Notes mature on XXXXXXXXXX. The Fund holds the Aco Notes as capital property.

XXXXXXXXXX

6. The main predecessor corporation of Aco was XXXXXXXXXX ("Old Aco"). Old Aco was a taxable Canadian corporation and a public corporation. Prior to XXXXXXXXXX, the Common Shares of Old Aco (the "Old Aco Shares") were widely-held and listed for trading on the XXXXXXXXXX Stock Exchange.

7. Pursuant to a plan of arrangement, effective on XXXXXXXXXX, all of the issued and outstanding Old Aco Shares were acquired, directly or indirectly, by the Fund or a by a subsidiary wholly-owned corporation of the Fund ("AcquisitionCo").

XXXXXXXXXX

8. Following the share transfers described in Paragraph 7, the Fund transferred all of the Old Aco Shares XXXXXXXXXX that it acquired, as described in Paragraph 7, to AcquisitionCo in exchange for AcquisitionCo issuing notes and Common Shares to the Fund having an aggregate fair market value equal to the aggregate fair market value of the Old Aco Shares and XXXXXXXXXX. Following these share transfers, AcquisitionCo owned all of the Old Aco Shares, either directly or indirectly XXXXXXXXXX. The Fund owned all of the issued and outstanding Common Shares of AcquisitionCo.

9. The Exchangeable Shares that were initially issued by AcquisitionCo, XXXXXXXXXX, have, over time, been acquired either directly by the Fund or indirectly through a wholly-owned subsidiary of the Fund in various stages. These corporations, though a series of amalgamations, ultimately formed Aco. There are currently no Exchangeable Shares outstanding other than the XXXXXXXXXX Exchangeable Shares currently held by the Fund.

10. No shares of Aco, or of any other predecessor corporation that was in existence after XXXXXXXXXX, have been listed on any stock exchange after XXXXXXXXXX. However, neither Aco nor any of its predecessor corporations (including Old Aco) have filed an Election and accordingly, Aco continues to be a public corporation.

PROPOSED TRANSACTIONS

11. The Fund will incorporate a new wholly-owned subsidiary ("Newco") under the BCA. Newco will be a taxable Canadian corporation. The authorized share capital of Newco will consist of an unlimited number of common shares. On incorporation, the Fund will subscribe for one common share for $XXXXXXXXXX.

12. The Fund and Newco will enter into a purchase and sale agreement, pursuant to which, the Fund will sell the Aco Shares to Newco for an aggregate purchase price equal to their fair market value. Newco will satisfy the purchase price by issuing additional common shares of Newco (together with the existing common share of Newco, the "Newco Common Shares") and debt, evidenced by two promissory notes (the "Newco Notes"), to the Fund. One of the Newco Notes (the "Interest Bearing Note") will bear interest at the rate of XXXXXXXXXX% per annum and will mature on XXXXXXXXXX, whereas the other Newco Note (the "Non-Interest Bearing Note") will not bear interest and will be payable on demand.

For greater certainty, the aggregate principal amount of the Newco Notes that are issued as consideration for such Aco Shares will not exceed the greater of the adjusted cost base to the Fund (subject to paragraphs 84.1(2)(a) and (a.1)) of such shares and the aggregate paid-up capital of such shares at the time of the transfer.

The Fund and Newco will jointly elect, in prescribed form and within the time specified in subsection 85(6), to have the provisions of subsection 85(1) apply to the respective transfers of the Common Shares and Exchangeable Shares described in this Paragraph. The agreed amount in respect of the Common Shares and the Exchangeable Shares, respectively, will be an amount not less than the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii). For greater certainty, each agreed amount will not be less than the amount permitted under paragraph 85(1)(b).

For the purposes of the BCA, the aggregate addition to the stated capital of the Newco Common Shares issued by Newco as consideration for the Common Shares or the Exchangeable Shares, as the case may be will not exceed the amount determined as B for the purposes of paragraph 84.1(1)(a).

13. Newco and Aco (and possibly one or more other subsidiary wholly-owned corporations of Aco that have been recently acquired in unrelated transactions) will undertake a vertical short-form amalgamation under the provisions of the BCA to form a new corporation ("Amalco") in such a manner that:

(i) all of the property (except any amounts receivable from any predecessor corporation or shares of the capital stock of any predecessor corporation) of the predecessor corporations held immediately before the amalgamation will become property of Amalco by virtue of the amalgamation;

(ii) all of the liabilities (except any amounts payable to any predecessor corporation) of the predecessor corporations immediately before the amalgamation will become liabilities of Amalco by virtue of the amalgamation; and

(iii) all of the Aco Shares held by Newco (and, if applicable, all of the shares of such other subsidiary wholly-owned corporations), immediately prior to the amalgamation will be cancelled by virtue of the amalgamation, and the Newco Common Shares owned by the Fund prior to the amalgamation will become common shares of Amalco (the "Amalco Common Shares").

In accordance with the provisions of the BCA, the articles of amalgamation of Amalco will be the same as the articles of Newco, and Amalco will not issue any securities or distribute any assets in connection with the amalgamation. Following the amalgamation, Amalco will continue to hold and use the assets formerly held by Aco (and such other subsidiary wholly-owned corporations, if applicable) for purposes of gaining or producing income from its business.

14. Upon the completion of the amalgamation of Newco and Aco (and any other predecessor corporations) to form Amalco as described in Paragraph 13, the Fund will hold all of the issued and outstanding shares of Amalco as well as the Aco Notes and the Newco Notes.

ADDITIONAL INFORMATION

15. It is anticipated that at one or more times in the future, Amalco may borrow money from the Fund on an interest-bearing basis to repay all or a portion of the principal amount of the Non-Interest Bearing Note.

16. The Proposed Transactions will occur in the order presented unless otherwise indicated with the exception of filing the applicable election form as described in Paragraph 12, which will be filed within the applicable due date following the completion of the Proposed Transactions.

PURPOSE OF PROPOSED TRANSACTIONS

17. The purpose of the Proposed Transactions is to enable Aco to reorganize its capital structure, and specifically, to replace a portion of its share capital (to the extent of adjusted cost base and paid-up capital) with debt, some of which will be immediately interest-bearing and the remainder of which may be replaced with interest-bearing debt in the future. The purpose for issuing the Non-Interest Bearing Note described in Paragraph 12, is to provide for the future refinancing of the Non-Interest Bearing Note with an interest-bearing debt obligation without Aco having to undertake similar reorganization transactions in the future.

RULINGS

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

A. Subject to the application of subsection 69(11), provided the appropriate joint election is filed in the prescribed form and manner within the time limits specified in subsection 85(6), the provisions of subsection 85(1) will apply to the transfer of the Common Shares and Exchangeable Shares by the Fund to Newco as described in Paragraph 12, such that the agreed amount in respect of each such transfer will be deemed to be the Fund's proceeds of disposition and Newco's cost thereof. For greater certainty, paragraph 85(1)(e.2) will not apply in respect of these transfers of property.

B. On the amalgamation of Newco and Aco (and such other subsidiary wholly-owned corporations, if applicable) to form Amalco, as described in Paragraph 13, the provisions of:

(a) subsection 87(1) will, by virtue of subsection 87(1.1), apply; and

(b) provided the Newco Common Shares were capital property to the Fund immediately before the amalgamation, the provisions of subsection 87(4) other than paragraphs (c), (d) and (e) thereof will apply, such that:

(i) the Fund will be deemed by paragraph 87(4)(a) to have disposed of its Newco Common Shares for proceeds of disposition equal to the ACB to the Fund of such shares immediately before the amalgamation; and

(ii) the Fund will be deemed by paragraph 87(4)(b) to have acquired its shares of Amalco at an aggregate cost equal to those proceeds of disposition;

(c) the cancellation of any of the shares of any predecessor corporation by virtue of the amalgamation will not give rise to a gain or loss; and

(d) subsection 87(7) will apply to a debt or other obligation of any predecessor corporation that was outstanding immediately before the amalgamation and became a debt or other obligation of Amalco on the amalgamation including, in particular, the Aco Notes and the Newco Notes, where the amount payable by Amalco on the maturity of such the debt or other obligation, as the case may be, is the same as the amount that would have been payable by such predecessor corporation on the maturity of such the debt or other obligation, as the case may be.

C. Provided that interest paid or payable to the Fund (depending on the method regularly followed by Aco in computing its income for purposes of the Act) on the Aco Notes described in Paragraph 5 was deductible by Aco under paragraph 20(1)(c), and provided that, following the amalgamation of Aco and Newco (and any other predecessor corporations) to form Amalco as described in Paragraph 13, Amalco continues to have a legal obligation to pay interest on the Aco Notes and the property acquired by Amalco, as a result of such amalgamation, continues to be used by Amalco for the purposes of gaining or producing income therefrom (other than exempt income), Amalco will, pursuant to paragraph 20(1)(c), be entitled to deduct, in computing its income for a taxation year, the interest paid or payable (depending on the method regularly followed by Amalco in computing its income for purposes of the Act) to the Fund, to the extent that the interest is reasonable.

D. Provided that Newco had a legal obligation to pay interest on the Interest Bearing Note in respect of its acquisition of the Aco Shares described in Paragraph 12, and that the Aco Shares were acquired by Newco for the purpose of gaining or producing income therefrom, and provided that, following the amalgamation of Aco and Newco (and any other predecessor corporations) to form Amalco as described in Paragraph 13, Amalco continues to have a legal obligation to pay interest on the Interest Bearing Note and the property acquired by Amalco, as a result of such amalgamation, continues to be used by Amalco for the purposes of gaining or producing income therefrom (other than exempt income), Amalco will, pursuant to paragraph 20(1)(c), be entitled to deduct, in computing its income for a taxation year, the interest paid or payable (depending on the method regularly followed by Amalco in computing its income for purposes of the Act) to the Fund, to the extent that the interest is reasonable.

E. Provided that at the time of the transfer of the Aco Shares described in Paragraph 12, the aggregate fair market value of the Newco Notes that are issued as consideration for the Aco Shares, does not exceed the greater of (i) the PUC of such shares and (ii) the aggregate adjusted cost base of such shares (subject to paragraphs 84.1(2)(a) and (a.1)), the Fund will not be deemed to have received any dividend from Newco pursuant to paragraph 84.1(1)(b) as a consequence of such transfer.

F. Subsection 84(4.1) will not apply to deem the Fund to have received a dividend on the Aco Shares or Amalco Shares as a result of the Proposed Transactions.

G. Subsection 245(2) will not be applied, as a result of the Proposed Transactions, in and of themselves, to re-determine the tax consequences described in the rulings given.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on CRA provided that the Proposed Transactions are completed by XXXXXXXXXX. The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the paid-up capital of any share or the cost amount, adjusted cost base or fair market value of any property referred to herein; or

(c) the reasonableness of the rate of interest charged on the Aco Notes or on the Interest Bearing Note;

(c) the deductibility of interest under paragraph 20(1)(c) on any possible future refinancing of the Non-Interest Bearing Note or the application of subsection 20(3) in respect of any such refinancing; and

(d) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the ruling given above.

Yours truly,

XXXXXXXXXX
for Director
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch