2010 Ruling 2010-0361591R3 - Article IV(7)(b) Restructuring

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 Article IV(7)(b) applies to interest paid by Canadian-resident company that is fiscally transparent under the taxation laws of the United States?

Position: No.

Reasons: United States income tax treatment of interest income to recipient will be the same whether or not Canadian-resident company is fiscally transparent.

XXXXXXXXXX
						2010-036159
XXXXXXXXXX , 2010

Dear Sirs/Mesdames:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent e-mail correspondence, and in the course of various telephone conversations. You have advised us that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayer or persons related to the taxpayer;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or persons related to the taxpayer;

(iii) under objection by the taxpayer or persons related to the taxpayer;

(iv) before the courts; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

Unless otherwise noted, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (hereinafter referred to as the "Act"). Unless otherwise noted, all references to currency are to Canadian dollars.

DEFINITIONS

(a) "Asset A" means XXXXXXXXXX ;

(b) "Asset B" means XXXXXXXXXX ;

(c) "Canadian partnership" has the meaning assigned in subsection 102(1);

(d) "Canco" means XXXXXXXXXX , an unlimited liability company incorporated under the Company Legislation on XXXXXXXXXX ;

(e) "Canco 2" means XXXXXXXXXX , an unlimited liability company incorporated under the Company Legislation;

(f) "Canco 3" means XXXXXXXXXX , a corporation incorporated on XXXXXXXXXX under the Canada Business Corporations Act;

(g) "Canco Sub" means XXXXXXXXXX , an unlimited liability company incorporated on XXXXXXXXXX under the Company Legislation;

(h) "Cansub" means XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX ;

(i) "Code" means the Internal Revenue Code of 1986, 26 U.S.C., as amended;

(j) "Company Legislation" means the XXXXXXXXXX ;

(k) "Convention" means the Canada-United States Income Tax Convention (1980), as amended;

(l) "Interest Payment Date" means XXXXXXXXXX ;

(m) "New Note" means the note issued by Canco to US Loanco on XXXXXXXXXX for US$XXXXXXXXXX bearing interest at a rate equal to the rate under the Note and payable at the Interest Payment Date, XXXXXXXXXX ;

(n) "Note" means a note issued by Canco to USco on XXXXXXXXXX for $XXXXXXXXXX which bears interest at a rate of XXXXXXXXXX ;

(o) "Paragraph" means a numbered paragraph in this letter;

(p) "Parentco" means XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX ;

(q) "Parentco Group" has the meaning assigned in Paragraph 22;

(r) "Partnership A" means XXXXXXXXXX , a general partnership formed under the laws of XXXXXXXXXX ;

(s) "Partnership B" means XXXXXXXXXX , a limited partnership formed under the laws of XXXXXXXXXX on XXXXXXXXXX ;

(t) "PSub 1" means XXXXXXXXXX , a limited liability company formed under the laws of XXXXXXXXXX ;

(u) "PSub 2" means XXXXXXXXXX , a corporation formed under the laws of XXXXXXXXXX ;

(v) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(w) "US Holdco" means XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX ;

(x) "US Loanco" means XXXXXXXXXX , a corporation formed under the laws of XXXXXXXXXX ; and

(y) "USco" means XXXXXXXXXX , a corporation formed under the laws of XXXXXXXXXX .

FACTS

1. Parentco was incorporated under the laws of XXXXXXXXXX . The common stock of Parentco is listed for trading on the XXXXXXXXXX .

2. Parentco is the sole member of PSub 1 and holds all of the issued and outstanding shares of US Holdco. PSub 1 holds all of the issued and outstanding shares of PSub 2. US Holdco holds all of the issued and outstanding shares of USco.

3. The share capital of US Loanco consists of one class common shares and a number of series of preferred shares. Parentco holds XXXXXXXXXX % of the issued and outstanding common shares of US Loanco. PSub 2 holds the remaining issued and outstanding common shares of US Loanco. The issued and outstanding preferred shares of US Loanco are held by Parentco and by entities that are either direct or indirect wholly-owned subsidiaries of Parentco.

4. Parentco, PSub 2, US Holdco, USco and US Loanco are not resident in Canada for the purposes of the Act. Each corporation is a resident of the United States under the Convention and a "qualifying person" within the meaning of Article XXIX A of the Convention. None of these corporations is a fiscally transparent entity under the taxation laws of the United States for the purposes of the Convention.

5. USco holds all of the issued and outstanding shares of Canco, Canco 2 and Canco 3. Canco holds all of the issued and outstanding shares of Canco Sub.

6. Canco, Canco 2, Canco 3, Canco Sub and Cansub are taxable Canadian corporations. Their Canadian federal income tax returns are filed with the XXXXXXXXXX Tax Centre and their Canadian federal income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

7. Canco, Canco 2 and Canco Sub are disregarded as entities separate from their shareholders for United States federal income tax purposes. Canco, Canco 2 and Canco Sub are fiscally transparent entities under the taxation laws of the United States for the purposes of the Convention.

8. Canco and Canco 2 are the partners of Partnership A, holding XXXXXXXXXX % and XXXXXXXXXX % interests in Partnership A, respectively. Partnership A is a Canadian partnership. In accordance with the provisions of the Code, an election was made to treat Partnership A as a corporation for United States income tax purposes.

9. Partnership A and Canco 3 are the partners of Partnership B, a Canadian partnership. Partnership A is the limited partner of Partnership B, holding a XXXXXXXXXX % interest. Canco 3 is the general partner of Partnership B, holding a XXXXXXXXXX % interest. Partnership B owns Asset B, which was acquired from Partnership A as described in Paragraph 14. In accordance with the provisions of the Code, an election was made to treat Partnership B as a corporation for United States income tax purposes.

10. Canco Sub owns a XXXXXXXXXX % interest in Asset A and holds XXXXXXXXXX % of the issued and outstanding shares of Cansub which was acquired from Canco as described in Paragraph 13.

11. On XXXXXXXXXX , Canco acquired from USco (i) XXXXXXXXXX % of the issued and outstanding shares of Cansub, (ii) a XXXXXXXXXX % undivided ownership interest in Asset A and (iii) full ownership of Asset B in consideration for common shares of Canco and issuance of the Note. At the time of issue, the Note had a principal amount of $XXXXXXXXXX , with a maturity date of XXXXXXXXXX . Interest was initially payable on the Note annually at a fixed rate of XXXXXXXXXX %.

12. After acquiring ownership of Asset B from USco as described in Paragraph 11, Canco transferred ownership of Asset B to Partnership A on XXXXXXXXXX as a contribution to the capital of Partnership A. Upon contributing Asset B, Canco acquired the XXXXXXXXXX % interest in Partnership A referred to in Paragraph 8, which Canco has held continuously to the present time.

13. On XXXXXXXXXX , Canco transferred to Canco Sub XXXXXXXXXX % of the issued and outstanding shares of Cansub and a XXXXXXXXXX % undivided ownership interest in Asset A in consideration for common shares of Canco Sub.

14. On XXXXXXXXXX , Canco transferred its interest in Partnership B to Partnership A. On XXXXXXXXXX , Partnership A transferred ownership of Asset B to Partnership B as a contribution to the capital of Partnership B. As a consequence of contributing Asset B, Partnership A acquired the XXXXXXXXXX % interest in Partnership B referred to in Paragraph 9, which Partnership A has held continuously to the present time. Partnership B has continued to own Asset B to the present time.

15. On XXXXXXXXXX , Canco amended the terms of the Note for it to be denominated in United States dollars. This amendment did not result in a novation or rescission of the Note.

16. On XXXXXXXXXX , Canco prepaid an amount of interest on the Note equal to the amount of interest that would accrue from XXXXXXXXXX to XXXXXXXXXX .

17. As of XXXXXXXXXX , the amount payable by Canco under the Note was US$XXXXXXXXXX , which included capitalized interest of US$XXXXXXXXXX for interest that accrued in XXXXXXXXXX and XXXXXXXXXX .

18. In XXXXXXXXXX , the following occurred:

(a) On XXXXXXXXXX , Canco and USco agreed that interest would no longer accrue on the outstanding amount of the Note;

(b) On XXXXXXXXXX , US Loanco made an interest-bearing loan to Canco in the amount of US$XXXXXXXXXX and Canco issued the New Note as evidence of such loan; and

(c) On XXXXXXXXXX , Canco used the funds received from US Loanco on the New Note to repay a portion of the Note in the amount of US$XXXXXXXXXX and USco consented that such repayment would be allocated to the principal of the Note, excluding the interest referred to in Paragraph 17, which has been capitalized and remains unpaid.

PROPOSED TRANSACTION

19. On the Interest Payment Date, Canco will pay an amount of interest that is due and payable on the New Note to US Loanco.

PURPOSES OF THE PROPOSED TRANSACTION

20. The purposes of the proposed transaction are (i) to allow Parentco and its subsidiaries to maintain the existing corporate structure without triggering an increased withholding tax burden on intercompany indebtedness paid by Canco, (ii) to allow USco to maintain the holding of its interest in Asset A through a branch for United States federal income tax purposes, and (iii) to allow USco, for United States federal income tax purposes, to maintain access to foreign tax credits on Canadian income tax paid by Canco on the income received from Partnership A in respect of profits earned from Asset B.

ADDITIONAL INFORMATION

21. Canco was incorporated so that USco could operate in Canada in branch form for United States federal income tax purposes with respect to Asset A, which allows USco to better manage its Canadian tax position. Specifically, operating in branch form for such purposes allows USco to deduct losses realized in respect of the Canadian operations and to claim foreign tax credits on Canadian income taxes paid by Canco for United States federal income tax purposes.

22. Parentco, PSub 2, US Holdco, USco and US Loanco, among others, are members of an affiliated group of corporations that have elected to file an income tax return on a consolidated basis for United States federal income tax purposes (the "Parentco Group"). As such, the respective incomes of Parentco, PSub 2, US Holdco, USco and US Loanco are included in the computation of the "consolidated taxable income" of the Parentco Group. In calculating the group's consolidated taxable income, the "separate taxable income" of each member of the group must be first determined and calculated under the Code for United States federal income tax purposes.

23. In the calculation of its "separate taxable income" for a taxation year, US Loanco is required to include the amount of interest on the New Note that accrues in the year. The payment of the interest by Canco to US Loanco on the New Note will be treated as a payment of an interest to US Loanco and will not be disregarded for United States federal income tax purposes.

24. If Canco were not considered fiscally transparent under the taxation laws of the United States for the purposes of the Convention, the same amount of interest from the New Note would be included in the income of US Loanco in the manner described in Paragraph 23. The payment of interest by Canco to US Loanco on the New Note would also be treated as a payment of interest to US Loanco for United States federal income tax purposes in such circumstances.

25. Subject to the application of the dual consolidated loss ("DCL") rules of section 1503(d) of the Code and the regulations prescribed thereunder, interest expense on the New Note may be deductible in the computation of the consolidated taxable income of the Parentco Group. Under the DCL rules, Canco, Canco 2 and Canco Sub will be a "separate unit" of USco for the purposes of determining whether USco has a DCL. Under the DCL rules, net income or loss of the separate unit will be computed for each taxable year of the Parentco Group and the amount of interest expense on the New Note for the year will be deducted in the computation of that income or loss. A net loss determined in respect of this separate unit will be a DCL and will not be deductible in computing the consolidated taxable income of the Parentco Group because a "domestic use" of the DCL of the separate unit will not be permitted. In addition, the losses of the separate unit will have a "foreign use", within the meaning of the DCL rules, because the expenses attributable to the loss, including the interest expense on the New Note, will be deductible under the Act. As a consequence, a domestic use election cannot (and will not) be made in respect of the DCL of the separate unit. Therefore, interest expense on the New Note that is attributable to any DCL of the separate unit of Canco, Canco 2 and Canco Sub will not be deductible in computing the consolidated taxable income of the Parentco Group. However, interest expense on the New Note that is attributable to a DCL of the separate unit of Canco, Canco 2 and Canco Sub may be deductible in computing the consolidated taxable income of the Parentco Group in another taxable year, but only to the extent that the separate unit has taxable income in that taxable year, as determined under the DCL rules.

26. Although the deductibility of interest on the New Note attributable to a DCL will be restricted in computing the consolidated taxable income of the Parentco Group as described in Paragraph 25, US Loanco will nevertheless be required to include in its income the full amount of interest on the New Note from Canco for United States federal income tax purposes in the manner described in Paragraph 23. Consequently, the full amount of interest income on the New Note will continue to be included in the computation of the consolidated taxable income of the Parentco Group.

27. If an amount of the interest under the New Note that is due and payable on the Interest Payment Date, but is not paid at the end of the second taxation year following the taxation year in which the interest expense is incurred by Canco, Canco and US Loanco will file an agreement in prescribed form and within the time prescribed by paragraph 78(1)(b), with the result that the unpaid interest will be deemed to be paid by Canco and received by US Loanco at the time described in paragraph 78(1)(b).

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the proposed transaction and the purposes of the proposed transaction, and provided further that the proposed transaction is completed in the manner described above, we rule as follows:

A. Article IV(7)(b) of the Treaty will not apply to the payment of interest by Canco to US Loanco on the New Note as described in Paragraph 19.

B. Subsection 245(2) will not apply to re-determine the tax consequence confirmed in the ruling given above.

The above-noted rulings are based on the Act and the Convention in their present form and do not take into account any proposed amendments to the Act or the Convention which, if enacted, could have an effect on the rulings provided herein.

These rulings are based solely on the facts, the proposed transaction and the additional information described above and are subject to the limitations and qualifications set forth in Information Circular IC 70-6R5 issued on May 17, 2002. This ruling is binding on the CRA provided that the proposed transaction is completed on or before XXXXXXXXXX .

OPINION

Article IV(7)(b) of the Convention will not apply to treat an amount as not having been paid to or derived by a resident of the United States solely because the amount was deemed to have been paid by paragraph 78(1)(b) of the Act.

CAVEAT

Nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

(a) whether Canco is fiscally transparent under the taxation laws of the United States for the purposes of the Convention or whether Canco will be fiscally transparent under those laws;

(b) the application of the DCL rules described in Paragraphs 25 and 26; and

(c) any tax consequences relating to the facts and proposed transaction described herein other than those described in the rulings given above.

Yours truly,

for Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch