7 July 2009 Income Tax Severed Letter 2008-0300101R3 - Deductibility of interest

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.

SUMMARY: Deductibility of interest—ITA-20(1)(c), 212(3), 143.3(3), 212(1)(b)—Advance income tax ruling—Whether interest paid or payable by a taxpayer in a particular situation is on a participating debt obligation. Whether the interest paid or payable is deductible under para. 20(1)(c). Whether para. 143.2(3)(a) applies to re-determine the interest expense where the interest is paid by the issuance of preferred shares.

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) Will the interest paid or payable by the taxpayer be on a participating debt obligation? (2) Will the interest paid or payable be deductible under paragraph 20(1)(c)? Will paragraph 143.2(3)(a) be applied to re-determine the Interest expense where the interest is paid by the issuance of preferred Shares?

POSITION: (1) no (2) yes (3) No

REASONS: (1) The interest is not contingent or dependent on the use or production from a property and is not computed by reference to anything but the principal amount of the debt. (2) Consistent with similar previous rulings and tax policy. (3) The Amount of Interest deductible is equal to the stated capital of the Preferred Shares.

XXXXXXXXXX 2008-030010

XXXXXXXXXX, 2009

Dear XXXXXXXXXX

Re: Advance Income Tax Ruling

XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, wherein you request an advance income tax ruling on behalf of the above named taxpayer. We also acknowledge documents you provided in correspondence, including the draft prospectus and related documents received from you on XXXXXXXXXX, and additional information you provided to us during various telephone conversations (XXXXXXXXXX) in connection with your ruling request.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request 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 a previously filed tax return of 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, and
• (v) the subject of a previous ruling issued to the taxpayer or a related person by the Income Tax Rulings Directorate.

Our understanding of the facts, proposed transactions and the purposes of the proposed transactions is as follows:

DEFINITIONS

In this letter, the following terms or expressions have the meanings specified:
• (a) “Act” means theIncome Tax Act(Canada), RSC 1985 (5th supp.), c.1, as amended to the date hereof, and, unless otherwise indicated, all statutory references are to the Act;
• (b) “ACO” means XXXXXXXXXX.;
• (c) “arm's length” has the meaning assigned by subsection 251(1);
• (d) “CRA” means Canada Revenue Agency;
• (e) “FMV” means fair market value;
• (f) “Indenture” means the indenture to be entered into between ACO and the XXXXXXXXXX acting as trustee in respect of the issuance of the Notes governing certain terms and conditions in connection with the issue of the Notes;
• (g) “Interest” means the interest calculated at a fixed rate of XXXXXXXXXX% per annum on the principal amount of the Note;
• (h) “Maturity” means XXXXXXXXXX, being the expiration of the term of XXXXXXXXXX years from the date of issuance of the Notes;
• (i) “Non-Resident Noteholders” means Noteholders that are non-residents of Canada for purposes of the Act;
• (j) “Note” or “Notes” means the unsecured and subordinated debt obligation, XXXXXXXXXX, to be issued by ACO as described herein;
• (k) “Noteholder” or “Noteholders” means a holder or holders of a Note or Notes from time to time;
• (l) “Participating debt interest” has the meaning assigned by subsection 212(3);
• (m) “Preferred Shares” means preferred shares of ACO's capital stock as described in paragraph 6 below;
• (n) “Redemption Value” means, in respect of a Preferred Share, an amount of XXXXXXXXXX plus any accrued and unpaid dividends to the date of redemption whether or not such dividends have been declared by ACO;
• (o) “Proposed Section 143.3” means Section 143.3 of the Act as proposed by Bill C-10Income Tax Amendments Act, 2006passed by the House of Commons on October 29, 2007;
• (p) “Public corporation” has the meaning assigned by subsection 89(1); and
• (q) “Taxable Canadian corporation” has the meaning assigned by subsection 89(1).

FACTS
• 1. ACO is a Taxable Canadian corporation and a Public corporation. XXXXXXXXXX
• 2. ACO's head office is situated at XXXXXXXXXX. Its Taxation Centre is the XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office.
• 3. ACO's authorized capital includes common shares which trade on the XXXXXXXXXX under the symbol “XXXXXXXXXX” for its XXXXXXXXXX, and on the XXXXXXXXXX as “XXXXXXXXXX” for its XXXXXXXXXX.

PROPOSED TRANSACTIONS
• 4. Subject, inter alia, to the receipt of a favourable advance income tax ruling, ACO proposes to issue the Notes in a public offering to Noteholders in XXXXXXXXXX.
• The offering is of a minimum of XXXXXXXXXX to a maximum of XXXXXXXXXX Notes, denominated in principal amounts of XXXXXXXXXX for an aggregate principal amount of XXXXXXXXXX to XXXXXXXXXX. The Noteholders participate by investing a minimum of XXXXXXXXXX each (excluding an issue fee of XXXXXXXXXX%) acquiring XXXXXXXXXX Notes each with a principal amount of XXXXXXXXXX.
• The proceeds of the issuance of the Notes will be used by XXXXXXXXXX for general business purposes. The general business purposes include, amongst others, the refinancing or the redemption of existing indebtedness of XXXXXXXXXX and strengthening of the working capital of XXXXXXXXXX.
• 5. The main terms and conditions of the Notes will be the following:
• Denomination
• The Notes will be issued in denominations of XXXXXXXXXX and will be issued for a purchase price equal to their principal amount.
• Repayment on Maturity
• The principal amount will be repayable in cash on XXXXXXXXXX.
• Interest
• The Notes will bear interest at a fixed rate of XXXXXXXXXX% per annum which will reflect market rates on the issue date for the Notes. Interest will be paid XXXXXXXXXX. ACO will have the option to satisfy its obligation to pay such interest either (i) in cash; or (ii) by issuing fully-paid and non-assessable Preferred Shares, to be issued for an agreed upon price, and having an aggregate Redemption Value and a stated capital, in each case, equal to the amount of the Interest payable. If Preferred Shares are issued on more than one interest payment date, each such issuance will constitute a separate series of shares.
• Status and subordination
• The Notes (including the obligation to pay interest thereon) will constitute unsecured and subordinated obligations of ACO and will rank pari passu with all other subordinated indebtedness of ACO without any preference among themselves and will be subordinated to all other obligations of ACO except liabilities which by their terms rank in right of payment equally with or subordinate to the Notes.
• The Notes will rank in priority to ACO shares in the event of ACO's insolvency, liquidation, dissolution or winding up.
• A Noteholder will have no right to vote at any meeting of shareholders of ACO and will have no right to participate in the profits of ACO.
• Early redemption
ACO will have the right to redeem the Notes, in whole or in part, at a price equal to XXXXXXXXXX% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest to the date of redemption, by giving not less than XXXXXXXXXX and no more than XXXXXXXXXX days' prior notice on account of:
• • the termination of XXXXXXXXXX in respect of ACO's future obligations to pay the interest owing under the terms of the Initial Notes;
• • XXXXXXXXXX; any payment in respect of the Note becoming subject to additional amounts pursuant to a change of law, provided that no such notice of redemption shall be given earlier than XXXXXXXXXX days prior to the earliest date on which the ACO would be obliged to pay such additional amounts in relation to a payment in respect of Notes in accordance with the Indenture
• General redemption right
• The Notes shall be redeemable commencing XXXXXXXXXX and on each interest payment date thereafter, in whole or in part, at the option of ACO on not less than XXXXXXXXXX and not more than XXXXXXXXXX day's notice at a redemption price equal to XXXXXXXXXX% of the principal amount thereof, together in each case with accrued and unpaid interest to the date fixed for redemption.
• Other relevant terms of Notes
Other relevant terms of Notes would include:
• i. Events of default,
• ii. Description of use of proceeds,
• iii. Issuer covenants,
• iv. Gross up for withholding taxes, if any, on interest payments,

all as provided for in the Indenture.

6. The main terms and conditions of the Preferred Shares will be the following:
• non-voting unless required by law;
• entitlement to a cumulative dividend if payable, as and when declared by the board of directors out of the earnings of ACO properly applicable to the payment of dividends, at a fixed rate of XXXXXXXXXX% per year such dividends will accrue from the issue date of the Preferred Shares whether or not declared;
• entitlement, in the event of liquidation, dissolution or winding-up of ACO, to receive an amount equal to Redemption Value (the Redemption Value means an amount of XXXXXXXXXX plus any accrued and unpaid dividends to the date of redemption whether or nor such dividends have been declared by ACO);
• priority over the other shares of ACO ranking junior to the Preferred Shares in respect of dividend entitlement and liquidation entitlement;
mandatory obligation for ACO to redeem all the issued Preferred Shares for an amount equal to the Redemption Value on any date that ACO:
• i. elects to pay interest in cash, in whole or in part, in respect of the Notes;
• ii. declares a dividend in any form on any shares of ACO ranking junior to the Preferred Shares;
• iii. redeems, purchases, acquires by any means or returns or distributes capital of any shares of ACO ranking junior to the Preferred Shares or pari passu with the Preferred Shares, if any.
7. In ACO's balance sheet presented under Canadian Generally Accepted Accounting Principles or International Financial Reporting Standards, the present value of the principal amount of the Notes repayable on Maturity will be presented as a debt.
• XXXXXXXXXX
• 8. ACO, in the past XXXXXXXXXX years, has made regular XXXXXXXXXX dividend payments on its common shares. ACO may continue to pay these XXXXXXXXXX dividends, as determined upon from time to time by the board of directors.
• Any payment of dividends on the common shares would trigger a mandatory redemption for cash of any outstanding Preferred Shares that may have been issued before the payment of the dividends. In such a case, the issuance of the Preferred Shares would not have achieved any meaningful financial objective as cash, in an amount at least equivalent to the interest payable, would have to be paid out on the mandatory redemption. Accordingly, it is expected that ACO will generally elect to pay the Interest on the Notes in cash if dividends are to continue to be paid by ACO on a regular basis. Even if ACO decides to change its existing dividend policy and to cease paying dividends for a certain period of time, it may well decide to continue to pay the Interest payable on the Notes in cash.

PURPOSES OF THE PROPOSED TRANSACTIONS
9. The purposes of the proposed transactions are:
• to borrow money to be used for the purpose of earning income from a business or property (other than to acquire property the income of which would be exempt or to acquire a life insurance policy); and
• XXXXXXXXXX

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we rule as follows:
• A. Provided that the proceeds from the issue of the Notes are used and continue to be used for the purpose of earning income from a business or property, and the proceeds are not used to acquire a life insurance policy or property the income from which would be exempt, ACO will be entitled, pursuant to paragraph 20(1)(c), and subsection 20(3) as the case may be, to deduct in computing its income for a taxation year from a business or property the amount paid in the year or payable in respect of the year (depending upon the method regularly followed by ACO in computing its income) the Interest on the Notes, to the extent that the amount paid or payable is reasonable and is paid pursuant to a legal obligation to pay interest.
• B. For the purposes of paragraph 212(1)(b), the Interest that will be paid or payable on the Notes (whether paid in cash or through the issuance of Preferred Shares) will not be Participating debt interest.

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 Notes are issued 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 which, if enacted into law, could have an effect on the rulings provided herein.

OPINION GIVEN

We are of the opinion that Proposed Subsection 143.3(3) will not apply to the Proposed Transactions, in and by themselves, to re-determine the amount of Interest deductible if the Proposed Subsection 143.3(3) is passed as it is proposed.

COMMENTS

Nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:
• (a) the FMV or the paid-up capital of the Preferred Shares;
• (b) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

The rulings given herein are based solely on the facts, proposed transactions and purposes of the proposed transactions described above. Facts and proposed transactions in the documents submitted with your request not described above do not form part of the facts and proposed transactions on which these rulings are based and any reference to these documents is provided solely for the convenience of the reader.

An invoice for our fees in connection with this ruling request will be forwarded to you under separate cover.

Yours truly,

for Director

Financial Sector and Exempt Entities Division

Income Tax Rulings Directorate

Legislative Policy and Regulatory Affairs Branch