9 October 2015 APFF Roundtable Q. 11, 2015-0595771C6 F - Deductibility of interest in a leveraged buyout

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20(1)(c)

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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.

Q. 11 Bank loan to Target with on-loan to Buyco

Principal Issues: 1) Can a Target deduct interest paid on borrowed funds that it uses to make an interest-bearing loan to an Acquisitionco which uses the loan to acquire shares of Target? 2) Can Acquisitionco deduct interest on its borrowing from Target? 3) Can the merged company deduct interest on the borrowing originally made by Target?

Position: No position taken on this hypothetical fact pattern, but the CRA would be prepared to consider such a question in the context of an advance ruling request.

Reasons: This is not a typical leveraged buyout structure, and it looks a lot like the structure used in the CRB Logging case.

9 OCTOBER 2015 FEDERAL TAX ROUNDTABLE
2015 APFF CONFERENCE

Question 11

Leveraged buy-out and paragraph 20(1)(c)

In the context of a leveraged buy-out, the Bank lends $1,000,000 to the corporation which is the object of the acquisition ("Target"), and not to the corporation which will purchase the Target shares ("Acquireco"), which bears interest at a rate of 5% and is secured by a hypothec on all the assets of Targets. This structure is required by the Bank because it wishes to lend to the entity holding the assets that will be used to secure this loan.

Target subsequently lends $1,000,000 to Acquireco, which loan bears interest at the rate of 5.5%. Acquireco uses the sum of $1,000,000 to purchase all of the shares held by Mr. X ("Seller") in the capital of Target. Finally, Acquireco and Target amalgamate (to form "Amalco").

For purposes of paragraph 20(1)(c), Target has borrowed $1,000,000 to lend the same sum at a higher interest rate than that charged by the Bank and, thus, in order to thereby earn income. For its part, Acquireco borrowed the sum of $1,000,000 from Target in order to acquire all the shares held by the Vendor in the capital of Target and, thus, in order to earn income. Following the amalgamation, Amalco thus finds itself with a loan owing to the Bank, which was incurred by Target in order to earn income.

Questions to the CRA

Can the CRA confirm that, in the situation described above:

(a) interest payable on the loan made by the Bank to Target is deductible under paragraph 20(1)(c);

(b) interest payable on the loan made by Target to Acquireco is deductible under paragraph 20(1)(c); and.

CRA Response

The submitted situation is not a typical leveraged buy-out structure. It instead more resembles that in C.R.B. Logging Co. Ltd. v. The Queen, 2000 D.T.C. 6547, [2000] 4 C.T.C. 157 (TCC) [Docket: 96-95-IT-G]. We are not currently disposed to take a position respecting such a hypothetical scenario, but would be prepared to consider this question in the context of an advance ruling request.

Yves Grondin
2015-059577

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Text of Severed Letter

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.

Principales Questions: 1) Can a Target deduct interest paid on borrowed funds that it uses to make an interest-bearing loan to an Acquisitionco which uses the loan to acquire shares of Target? 2) Can Acquisitionco deduct interest on its borrowing from Target? 3) Can the merged company deduct interest on the borrowing originally made by Target?

Position Adoptée: No position taken on this hypothetical fact pattern, but the CRA would be prepared to consider such a question in the context of an advance ruling request.

Raisons: This is not a typical leveraged buyout structure, and it looks a lot like the structure used in the CRB Logging case.

TABLE RONDE SUR LA FISCALITÉ FÉDÉRALE DU 9 OCTOBRE 2015
APFF - CONGRÈS 2015

Question 11

Achat par endettement et l’alinéa 20(1)c) L.I.R.

Dans le cadre d’un achat par endettement (« leveraged buyout »), la Banque prête la somme de 1 000 000 $ en faveur de la société faisant l’objet de l’acquisition (« Cible »), et non à la société qui achètera les actions de la Cible (« Acquisico »), lequel prêt porte intérêt au taux de 5 % et est garanti par une hypothèque sur la totalité des éléments d’actif de Cible. Cette structure est exigée par la Banque, car elle veut prêter à l’entité détenant les actifs qui serviront à garantir ce prêt.

Cible prête par la suite la somme de 1 000 000 $ en faveur d’Acquisico, lequel prêt porte intérêt au taux de 5,5 %. Acquisico utilise la somme de 1 000 000 $ afin d’acheter la totalité des actions détenues par M. X (« Vendeur ») dans le capital de Cible. Finalement, Acquisico et Cible fusionnent (« Fusionco »).

Aux fins de l’application de l’alinéa 20(1)c) L.I.R., Cible a emprunté la somme de 1 000 000 $ afin de prêter cette même somme à un taux d’intérêt plus élevé que celui chargé par la Banque et donc, dans le but de gagner un revenu. De son côté, Acquisico a emprunté la somme de 1 000 000 $ de Cible afin d’acquérir la totalité des actions détenues par le Vendeur dans le capital de Cible et donc, dans le but de gagner un revenu. Suite à la fusion, Fusionco se retrouve donc avec un prêt dû en faveur de la Banque, prêt encouru par Cible afin de gagner un revenu.

Questions à l’ARC

Est-ce que l’ARC peut confirmer que dans la situation décrite ci-haut :

a) les intérêts payables sur le prêt effectué par la Banque en faveur de Cible sont déductibles en vertu de l’alinéa 20(1)c) L.I.R.?

b) les intérêts payables sur le prêt effectué par Cible en faveur d’Acquisico sont déductibles en vertu de l’alinéa 20(1)c) L.I.R.?

c) les intérêts payables sur le prêt dû par Fusionco en faveur de la Banque sont déductibles en vertu de l’alinéa 20(1)c) L.I.R.?

Réponse de l’ARC

La situation soumise n’est pas une structure typique d’achat par endettement. Elle ressemble beaucoup, d’ailleurs, à la cause C.R.B. Logging Co. Ltd. c. La Reine, 2000 D.T.C. 6547, [2000] 4 C.T.C. 157 (CAF). Nous ne sommes pas disposés présentement à prendre une position à l’égard d’un tel scénario hypothétique, mais nous serions prêts à considérer cette question dans le contexte d’une demande de décision anticipée.

Yves Grondin
2015-059577

Summaries

Summary Under

Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c)

CRA non-committal on interest deductibility where only the indirect use of borrowed funds is to acquire Target’s shares

translated at Q. 11 Bank loan to Target with on-loan to Buyco

When asked about interest deductibility where, in the context of a leveraged buy-out, the Bank lends to Target under a secured loan bearing interest at 5%, Target lends the same sum to Acquireco at 5.5% interest, and Acquireco uses the same sum to purchase all of the shares of Target, CRA stated:

The submitted situation is not a typical leveraged buy-out structure. It instead more resembles… C.R.B. Logging… . We are not currently disposed to take a position respecting such a hypothetical scenario, but would be prepared to consider this question in the context of an advance ruling request.

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9 October 2015 APFF Roundtable Q. 11, 2015-0595771C6 F - Deductibility of interest in a leveraged buyout

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