2014 Ruling 2013-0514191R3 - Debt restructuring, forgiveness and winding-up

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. Whether the amendments to the notes described in the Proposed Transactions will result in a disposition of the notes.
2. Whether section 51.1 will apply with respect to the exchange of the old notes for the new notes.
3. Whether the exchange of the notes and the winding-up will result in a forgiven amount.
4. Whether the exchange of the notes and the winding-up will result in a foreign exchange gain or loss with respect to the debtor.
5. Whether paragraph 53(1)(f.1) will apply with respect to the transfer of the notes in favour of a related corporation.
6. Whether subsection 245(2) will apply.

Position: 1. Provided there is no novation, no.
2. Yes.
3. No.
4. No.
5. Yes.
6. No.

Reasons: 1. Previous positions with respect to minor changes without novation.
2. The conditions to apply section 51.1 are met.
3. Wording of the Act and election filed pursuant to subsection 80.01(4) at the time of winding-up.
4. The debtor will not realize a gain and will not sustain a loss.
5. Previous positions and wording of the Act.
6. Previous positions.

XXXXXXXXXX
2013-051419

XXXXXXXXXX, 2014

Sir,

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you requested certain advance income tax rulings regarding the proposed transactions described herein.

To the best of Canco1 and Canco3's knowledge, none of the issues involved in this advance rulings request is:

(i) in an earlier return of Canco1, Canco3 or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of Canco1, Canco3 or a related person;

(iii) under objection by Canco1, Canco3 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 rulings previously issued by the Income Tax Rulings Directorate.

Except as otherwise noted, all statutory references in this request for an advance income tax ruling are references to the provisions of the Act.

Legal Entity Definitions

Throughout this letter, the taxpayers will be referred to as follows:

(a) "Canco1" means XXXXXXXXXX, a subsidiary wholly-owned corporation of Canco 2, incorporated under the CBCA that is a taxable Canadian corporation. Canco1's business number is XXXXXXXXXX;

(b) "Canco2" means XXXXXXXXXX, an inactive subsidiary wholly-owned corporation of XXXXXXXXXX, incorporated under the CBCA that is a taxable Canadian corporation. Canco2's business number is XXXXXXXXXX;

(c) "Canco3" means XXXXXXXXXX, a taxable Canadian corporation continued under the CBCA on XXXXXXXXXX, the non-voting common shares of which are held by Parent and the voting preferred shares and the voting non-participating shares of which are held by Canco1. Canco3's business number is XXXXXXXXXX;

(d) "New ULC" means a new company to be incorporated by Canco1 more fully described in paragraph 14;

(e) "Parent" means XXXXXXXXXX, a XXXXXXXXXX corporation incorporated under the laws of XXXXXXXXXX; and

(f) "XXXXXXXXXX" means XXXXXXXXXX, a XXXXXXXXXX corporation incorporated under the laws of XXXXXXXXXX.

Definitions

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, RSC 1985 (5th supp.), c.1, as amended to the date hereof, and, unless otherwise indicated, all statutory references are to the Act;

(b) "adjusted cost base" or "ACB" has the meaning assigned by section 54;

(c) "CAN$" means Canadian dollar;

(d) "Canco1 Debt" means the intercompany debt described in paragraph 5;

(e) "Canco1 Note A" means the intercompany debt described in paragraph 9;

(f) "Canco1 Note B" means the intercompany debt described in paragraph 12;

(g) "CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44 as amended to the date hereof;

(h) "CRA" means Canada Revenue Agency;

(i) "FMV" means fair market value;

(j) "Notes A" means the promissory notes described in paragraph 4;

(k) "Notes B" means the promissory notes described in paragraph 11;

(l) "Note C" means the promissory note described in paragraph 15;

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

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

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

(p) XXXXXXXXXX.

Facts

1. Parent forms, with its subsidiaries and affiliated corporations, a XXXXXXXXXX. The organization owns or operates XXXXXXXXXX, and XXXXXXXXXX assets in Canada. The shares of Parent trade under the stock symbol XXXXXXXXXX on both the XXXXXXXXXX and the XXXXXXXXXX. Consolidated revenues of Parent for the year ended XXXXXXXXXX totaled XXXXXXXXXX$XXXXXXXXXX with consolidated net loss amounting to approximately XXXXXXXXXX$XXXXXXXXXX.

2. XXXXXXXXXX.

3. Canco1 is a holding corporation which owns all the issued and outstanding voting shares of the capital stock of Canco3, being the voting preferred shares and the voting non-participating shares. The voting preferred shares have a FMV, fixed preferential liquidation value, redemption value, ACB and PUC of approximately CAN$XXXXXXXXXX (i.e, the Canadian dollar equivalent of XXXXXXXXXX$XXXXXXXXXX at the time the shares were issued). The voting non-participating shares of the capital stock of Canco3 have a nominal FMV, ACB and PUC. Canco1 does not own any other material assets.

4. Canco1 owes XXXXXXXXXX$XXXXXXXXXX to Canco3 pursuant to two non-interest bearing notes issued on XXXXXXXXXX and XXXXXXXXXX (the "Notes A"). The exchange rates at the time the Notes were incurred were XXXXXXXXXX$XXXXXXXXXX = CAN$XXXXXXXXXX for a tranche of XXXXXXXXXX$XXXXXXXXXX and XXXXXXXXXX$XXXXXXXXXX = CAN$XXXXXXXXXX for the balance of XXXXXXXXXX$XXXXXXXXXX. The stated maturity dates were XXXXXXXXXX and XXXXXXXXXX, respectively, but the Notes A have not been repaid nor has any demand been made for their payment. A formal acknowledgement of indebtedness was entered into in XXXXXXXXXX such that the Notes A are not statute-barred. The Notes A were issued in a commercial context.

5. Canco1 also owes CAN$XXXXXXXXXX to Canco3 ("Canco1 Debt"). The Canco1 Debt arose as XXXXXXXXXX. The Canco1 Debt is not documented in writing but has always been treated by the parties as non-interest bearing and payable on demand.

6. Canco3 owns or operates XXXXXXXXXX.

7. The ACB of the Notes A owned by Canco3 is CAN$XXXXXXXXXX and the FMV is significantly less than its principal amount. The ACB and principal amount of the Canco1 Debt is CAN$XXXXXXXXXX. This amount is also higher than its FMV. The Notes A and Canco1 Debt are capital property to Canco3. There has been no acquisition of control of Canco3 since the Notes A and Canco1 Debt have been established.

8. The Notes A are denominated in XXXXXXXXXX$ and have a principal amount of XXXXXXXXXX$XXXXXXXXXX. As of the date of this letter, Canco1 has a significant latent foreign exchange gain under subsection 39(2) (approximately CAN$XXXXXXXXXX). Canco3, as holder of the Notes A, has a corresponding latent foreign exchange loss (which is "embedded" in the overall latent capital loss mentioned in paragraph 7 above).

Proposed Transactions

9. The Canco1 Debt will be formally documented with a promissory note ("the Canco1 Note A"). The Canco1 Note A will be:

A. denominated in CAN$;
B. non-interest bearing;
C. governed by the laws of XXXXXXXXXX; and
D. payable on demand.

10. The terms of the Notes A will be amended to change the governing law from XXXXXXXXXX to XXXXXXXXXX. Legal counsel will confirm that this amendment will not result in a novation of the debt from a legal perspective. The amendment document will confirm that it is not the intention of the parties to novate the Notes A and to create a new contract, but merely that the existing debt obligation continue to exist as amended.

11. The terms of the Notes A will be amended to add an exchange right allowing the holder to exchange such notes into new notes ("Notes B") having the following terms:

A. denominated in XXXXXXXXXX$;
B. bearing interest at the rate of XXXXXXXXXX% per annum; and
C. payable on demand.

Legal counsel will confirm that this amendment will not result in a novation of the debt from a legal perspective. The amendment document will confirm that it is not the intention of the parties to novate the Notes A and to create a new contract, but merely that the existing debt obligation continue to exist as amended.

12. The terms of the Canco1 Note A will be amended to add an exchange right allowing the holder to exchange such note into a new note ("Canco1 Note B") having the following terms:

A. denominated in CAN$;
B. bearing interest at the rate of XXXXXXXXXX% per annum; and
C. payable on demand.

Legal counsel will confirm that this amendment will not result in a novation of the debt from a legal perspective. The amendment document will confirm that it is not the intention of the parties to novate the Canco1 Note A and to create a new contract, but merely that the existing debt obligation continue to exist as amended.

13. Canco3 will exercise the exchange right and exchange the Notes A into Notes B and the Canco1 Note A into the Canco1 Note B. Upon the exchange, the Notes A and the Canco1 Note A will be cancelled and replaced with the Notes B and the Canco1 Note B respectively.

14. Canco1 will incorporate New ULC XXXXXXXXXX which will be a taxable Canadian corporation. Canco1 will own all of the issued and outstanding shares of the capital stock of New ULC.

15. Approximately XXXXXXXXXX months after the exchange described in paragraph 13 above, Canco3 will sell to New ULC the Notes B and the Canco1 Note B in consideration for a demand non-interest bearing note payable by New ULC (the "Note C") with a principal amount equal to the FMV of the Notes B and the Canco1 Note B (i.e. approximately CAN$XXXXXXXXXX). The accrued and unpaid interest will, in each case, be transferred together with the underlying obligation. For greater certainty, such accrued interest will be included in Canco3's income in accordance with paragraph 20(14)(a).

16. New ULC will be wound-up into Canco1 under subsection 88(1). Immediately before the wind-up, Canco1 will own XXXXXXXXXX% of the shares of the capital stock of New ULC. The Notes B and the Canco1 Note B (including all accrued and unpaid interest thereon) will be settled as a result of the wind-up as a matter of law due to a merger of rights of debtor and creditor. Canco1 will file an election under subsection 80.01(4) to deem the Notes B and the Canco1 Note B to have been settled for an amount equal to New ULC's cost amount. As result of the wind-up, the debt evidenced by Note C will be assumed by Canco1.

17. Canco3 will reduce the stated capital of the voting preferred shares of its capital stock by an amount equal to the face value of the Note C and will distribute to Canco1 as payment for such reduction, the Note C, which will be settled as a matter of law. The reduction of the stated capital of the voting preferred shares of the capital stock of Canco3 will not exceed the PUC of the said voting preferred shares and the ACB to Canco1. The preferential liquidation value, the redemption value and the FMV of the voting preferred shares will be reduced by the FMV of the Note C so distributed.

Purpose of the Proposed Transactions

18. The purpose of the proposed transactions is to eliminate the Notes A and the Canco1 Debt without having: (i) to recognize any of the latent capital gain and the latent capital loss to Canco1 and Canco3 respectively and (ii) to [sic, not] realize a "forgiven amount" for Canco1 as a result of settling or extinguishing the Notes B and the Canco1 Note B.

Because of commercial and legal considerations XXXXXXXXXX, the combination of Canco1 and Canco3 by way of amalgamation or wind-up is not a viable alternative to eliminate the Notes A and the Canco1 Debt. Indeed, under the XXXXXXXXXX, a change in the direct control of Canco 3 would allow XXXXXXXXXX.

Rulings Given

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant Facts, Proposed Transactions and Purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as follows:

A. Provided that neither the formal documentation of the Canco1 Debt as described in paragraph 9 above nor the addition of the exchange right described in paragraph 12 above results in a novation of the Canco1 Debt or the Canco1 Note A, neither the issuance of the Canco1 Note A nor the addition of the exchange right to the Canco1 Note A will result in a "disposition" of the Canco1 Debt or the Canco1 Note A, as defined in subsection 248(1).

B. Provided that neither the change of the governing law as described in paragraph 10 above nor the addition of the exchange right described in paragraph 11 above results in a novation of the Notes A, neither the change of governing law nor the addition of the exchange right to the Notes A will result in a "disposition" of the Notes A, as defined in subsection 248(1).

C. Section 51.1 will apply to the exchange of the Notes A into the Notes B and the exchange of the Canco1 Note A into the Canco1 Note B as described in paragraph 13 above, such that Canco3 will be considered to have disposed of the Notes A and the Canco1 Note A for proceeds equal to its ACB of the Notes A and of the Canco1 Note A respectively and to have acquired the Notes B and the Canco1 Note B respectively for the same amount.

D. The exchange of the Notes A for the Notes B and the exchange of the Canco1 Note A for the Canco1 Note B described in paragraph 13 above will not give rise to a "forgiven amount" for Canco1 for the purposes of section 80.

E. Canco1 will not realize a foreign exchange gain and will not sustain a foreign exchange loss under subsection 39(2) as a result of the exchange of the Notes A for the Notes B described in paragraph 13 above.

F. The provisions of paragraphs 40(2)(e.1) and 53(1)(f.1) will apply to the transfer of the Notes B and the Canco1 Note B to New ULC, described in paragraph 15 above, such that:

(i) the capital loss realized by Canco3 will be deemed to be nil, and

(ii) the ACB to New ULC of the Notes B and the Canco1 Note B will be increased by an amount equal to the amount of the loss so denied.

G. Subsection 88(1) will apply to the wind-up of New ULC into Canco1 described in paragraph 16 above.

H. Provided the election referred to in subsection 80.01(4) is filed in a timely manner, the extinction of the Notes B and the Canco1 Note B (including, in each case, all accrued interest thereon) as a result of the wind-up of New ULC described in paragraph 16 above will not give rise to a "forgiven amount" for Canco1 for the purposes of section 80.

I. Provided the election referred to in subsection 80.01(4) is filed in a timely manner, Canco1 will not realize a foreign exchange gain and will not sustain a foreign exchange loss under subsection 39(2) as a result of the settlement of the Notes B upon the wind-up of New ULC described in paragraph 16 above.

J. The elimination of Note C as described in paragraph 17 above will not give rise to a "forgiven amount" for Canco1 for the purposes of section 80.

K. Subsection 245(2) will not be applicable as a result of the proposed transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the Proposed Transactions are completed before 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, could have an effect on the rulings provided herein.

COMMENTS

1. Unless otherwise confirmed, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed, made any determination, or accepted any method for the determination in respect of:

(a) the PUC of any share or the ACB or FMV of any property referred to herein, or the outstanding balance of various tax accounts for any of the corporate entities described herein; or

(b) 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 rulings given above.

Nothing in this letter should be construed as a confirmation, express or implied, that, for the purpose of any of the rulings given above, any adjustment to the FMV of the properties transferred or the redemption amount of the shares issued as consideration, whether pursuant to a price adjustment clause or otherwise, will be effective retroactively to the time of the transfer and issuance of shares. Furthermore, none of the rulings given in this letter are intended to apply to or in the event of the operation of a price adjustment clause, since such adjustment will be due to circumstances that do not constitute proposed transactions that are seriously contemplated. The general position of the CRA with respect to price adjustment clauses is stated in Income Tax Folio S4-F3-C1, Price Adjustment Clauses, which replaces and cancels Interpretation Bulletin IT-169.

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

Yours truly,

XXXXXXXXXX
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch