2007 Ruling 2007-0237921R3 - Thin capitalization

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: Whether administrative position not to apply subsection 18(6) is applicable?

Position: Administrative position not to apply subsection 18(6) applies.

Reasons: Arrangement does not circumvent or frustrate subsection 18(6) and is in compliance with the position in ITTN #15.

XXXXXXXXXX 								2007-023792

XXXXXXXXXX , 2007

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter dated XXXXXXXXXX, wherein you request several advance income tax rulings on behalf of the above taxpayers with respect to transactions some of which are described herein. For the purposes of this letter our review has been restricted to the facts and proposed transactions described in this letter and we are ruling herein only on the application of clause 18(4)(a)(ii)(C) and subsection 18(6) of the Act.

This document is based solely on the facts, proposed transactions and the purpose of the proposed transactions described below. The documentation submitted with your request does not form part of the facts, proposed transactions and the purpose of the proposed transactions and any references thereto are provided solely for the convenience of the reader.

It is our understanding that, to the best of your knowledge and that of the participants of the proposed transactions described herein, none of the issues involved in this ruling, as they apply specifically to such respective parties:

(i) is in an earlier return;

(ii) is being considered by a tax services office or taxation centre in connection with a previously filed tax return;

(iii) is under objection;

(iv) is before the courts; or if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(v) is the subject of a previously issued ruling.

Definitions

In this letter unless expressly stated:

(a) all references to a statute are to the Income Tax Act, R.S.C. 1985, c.l (5th Supp.), as amended to the date hereof (the "Act"), and all monetary amounts are expressed in Canadian dollars;

(b) "Aco" is XXXXXXXXXX;

(c) "Act1" means Canada Business Corporations Act;

(d) "Act2" means XXXXXXXXXX;

(e) "Acquireco" is XXXXXXXXXX;

(f) "Acquireco Common Shares" has the meaning assigned by paragraph 7(i);

(g) "Acquireco Holdco Loan" has the meaning assigned by paragraph 19;

(h) "Acquireco Third-Party Loan" has the meaning assigned by paragraph 19;

(i) "Asub 1" is XXXXXXXXXX;

(j) "Asub 2" is XXXXXXXXXX;

(k) "Bco" is XXXXXXXXXX;

(l) "Bsub 1" is XXXXXXXXXX;

(m) "Bsub 2" is XXXXXXXXXX;

(n) "Bsub 3" is XXXXXXXXXX;

(o) "Canco" has the meaning assigned by paragraph 7(vii);

(p) "Grid Loans" has the meaning assigned by paragraph 12;

(q) "Holdco" is XXXXXXXXXX;

(r) "Holdco Common Shares" has the meaning assigned by paragraph 7(iii);

(s) "Holdco Loan" has the meaning assigned by paragraph 15;

(t) "Partnership" has the meaning assigned by paragraph 7(x);

(u) "private corporation" has the meaning assigned by subsection 89(1) of the Act;

(v) "resident" and "non-resident" of Canada mean, respectively, resident and non-resident of Canada for purposes of the Act;

(w) "Shareholder Loans" has the meaning assigned by paragraph 11;

(x) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) and 248(1) of the Act;

(y) "Third-Party Loans" has the meaning assigned by paragraph 17;

(z) "Topco" is XXXXXXXXXX;

(aa) "Topco Class A Shares" has the meaning assigned by paragraph 7(iv), and

(bb) "Topco Class B Shares" has the meaning assigned by paragraph 7(iv).

Facts

1. Aco is listed on the XXXXXXXXXX Stock Exchange. The Aco group of companies is a XXXXXXXXXX.

2. Asub 1 is a wholly-owned XXXXXXXXXX subsidiary of Aco.

3. XXXXXXXXXX.

4. Bsub 3 is a wholly-owned subsidiary of Bco.

5. Aco, Asub 1, Bco and Bsub 3 are non-residents of Canada.

6. Acquireco was incorporated on XXXXXXXXXX under Act1 and it is a taxable Canadian corporation.

7. Prior to the implementation of the Proposed Transactions described in paragraphs 8 to 20 below, Acquireco will be owned as follows:

i) All of the common shares of Acquireco ("Acquireco Common Shares"), which will be all of the issued and outstanding shares of Acquireco, will be held by Holdco;

ii) Holdco was incorporated under Act1 and is a taxable Canadian corporation;

iii) All of the common shares of Holdco ("Holdco Common Shares"), which will be all of the issued and outstanding shares of Holdco, will be held by Topco;

iv) Topco was incorporated under Act2. Topco's authorized share capital will consist of two classes of shares, Class A voting with no dividend entitlement or liquidation entitlement beyond the amount paid in for the shares ("Topco Class A Shares") and Class B non-voting, participating common shares ("Topco Class B Shares");

v) XXXXXXXXXX% of the issued Topco Class A Shares and Topco Class B Shares will be held by Bsub 2 which will be a wholly-owned XXXXXXXXXX subsidiary of Bsub 1, Bsub 2 will be a non-resident of Canada;

vi) Bsub 1 will be a wholly-owned XXXXXXXXXX subsidiary of Bsub 3. Bsub 1 will be a non-resident of Canada;

vii) XXXXXXXXXX . ("Canco") will be incorporated under Act1. Canco will be a wholly-owned subsidiary of Asub 2;

viii) XXXXXXXXXX % of the issued Topco Class A Shares will be held by Canco;

ix) Asub 2 will be a wholly-owned XXXXXXXXXX subsidiary of Asub 1 and will be a non-resident of Canada;

x) Asub 2 and Canco will enter into a partnership agreement to form XXXXXXXXXX , a general partnership (the "Partnership"). Pursuant to the terms of such partnership agreement, Canco will have a XXXXXXXXXX% partnership interest, with the remaining XXXXXXXXXX% held by Asub 2;

xi) XXXXXXXXXX % of the issued Topco Class B Shares will he held by the Partnership and,

xii) Acquireco, Holdco, Topco and Canco will be private corporations.

Proposed Transactions

8. Aco will arrange for appropriate amounts of funding, which may be by way of loans, in Asub 1, Asub 2, Canco and the Partnership to fund the shares subscriptions and loans described below.

9. Bco will arrange for appropriate amounts of funding, which may be by way of loans, in Bsub 1 and Bsub 2 to fund the share subscriptions and loans described below.

10. The Partnership and Bsub 2 will each subscribe, in the same number and amount, for additional Topco Class B shares for cash consideration.

11. Asub 1 and Bsub 1 will lend money to Topco by way of interest bearing loans (the "Shareholder Loans").

12. Each of Asub 1, Bsub 1 and Topco will enter into a grid promissory note ("Grid Loans") pursuant to which Topco can borrow from Asub 1 and Bsub 1 from time to time.

13. The debt to equity ratio of Topco for the purposes of subsection 18(4) will be maintained at a ratio of no more than XXXXXXXXXX with respect to the borrowings described in paragraphs 11 and 12 above.

14. Topco will use the cash proceeds from the issuance of the Topco class B common shares to subscribe for additional Holdco Common Shares.

15. Topco will lend the cash proceeds from the Shareholder Loans to Holdco on an interest bearing basis (the "Holdco Loan"). The interest rate on the Holdco Loan will marginally exceed the interest rate on the Shareholder Loans.

16. Topco and Holdco will enter into a grid promissory note pursuant to which Holdco can borrow from Topco from time to time.

17. Holdco will borrow money (the "Third-Party Loans") from third-party lenders.

18. Holdco will use the cash proceeds from the issuance of the Holdco Common Shares to subscribe for Acquireco Common Shares.

19. Holdco will lend the proceeds from each of the Holdco Loan and the Third-Party Loans to Acquireco on an interest bearing basis (the "Acquireco Holdco Loan" and "Acquireco Third-Party Loan", respectively). The interest rate on the Acquireco Holdco Loan will marginally exceed the interest rate on the Holdco Loan and the interest rate on the Acquireco Third-Party Loan will marginally exceed the interest rate on the Third-Party Loans. The Acquireco Third-Party Loan will be structured as a grid note to accommodate future loans.

20. Holdco and Acquireco will enter into a grid promissory note pursuant to which Acquireco can borrow from Holdco from time to time.

Additional Information

21. At a future time, Asub 1 may transfer the shares of Asub 2 and any loans receivable from Topco (forming part of the Shareholder Loans and Grid Loans) to another (i.e. the same) entity. Alternatively, Asub 1 may transfer any loans from Topco (forming part of the Shareholder Loans and Grid Loans) to Asub 2 in connection with a transfer of the shares of Asub 2 to another entity. XXXXXXXXXX.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to fund Acquireco in order to enable it to make a capital acquisition.

Ruling Given

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 the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Subsection 18(6) will not be applied for the purposes of subsections 18(4) and (5) to cause any of the debts of Holdco owing to Topco described in paragraphs 15 and 16 above or any the debts of Acquireco owing to Holdco described in paragraphs 19 and 20 above to be "outstanding debts to specified non-residents" as defined in subsection 18(5).

B. For the purposes of clause 18(4)(a)(ii)(C), the Topco Class B Shares held by the Partnership will not be shares owned by a person other than a specified non-resident shareholder of the corporation.

Comments

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 and are binding on the CRA as long as the proposed transactions are carried out before XXXXXXXXXX.

Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed any tax consequences relating to the facts and proposed transactions other than those specifically set out in the rulings given above or whether other provisions of the Act could cause any interest paid or payable on the debts of Acquireco or Holdco to be denied a deduction in computing income. In addition, other than Ruling B above, nothing in this letter should be construed as implying that the CRA has agreed or reviewed whether the provisions of subsection 18(4) of the Act will restrict the amount that may be deducted in respect of the interest paid or payable by Topco on the indebtedness described paragraphs 11 and 12 above.

Yours truly,

XXXXXXXXXX
Manager
For Director
International Tax and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch