7 July 1996 Income Tax Severed Letter 9608843 - Distress 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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

PRINCIPAL ISSUES:

% ownership and amount being financed by DPS.

POSITION:

Give rulings.

REASONS:

Only % holding of debt being refinanced.

XXXXXXXXXX

XXXXXXXXXX 960884 XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1996

Dear Sirs:

Re: XXXXXXXXXX

We are writing in response to your letter dated XXXXXXXXXX wherein you requested an advance income ruling on behalf of the above-noted taxpayers. We also acknowledge your letters dated XXXXXXXXXX and our several telephone conversations.

Except as otherwise noted, all statutory references in this ruling application are references to the provisions of the Income Tax Act (the "Act").

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

Facts

1. XXXXXXXXXX is a private corporation and a taxable Canadian corporation

XXXXXXXXXX

The terms "private corporation" and "taxable Canadian corporation" as used here and subsequently, have the meanings assigned by subsection 89(1).

XXXXXXXXXX a taxable Canadian corporation.

XXXXXXXXXX

XXXXXXXXXX is a restricted financial institution and a specified financial institution as such terms are defined in subsection 248(1) and XXXXXXXXXX deals at arm's length with XXXXXXXXXX

2. The authorized share capital XXXXXXXXXX consists of an unlimited number of common shares and an unlimited number of Class XXXXXXXXXX voting, redeemable and retractable preferred shares. The issued share capital of XXXXXXXXXX consists of XXXXXXXXXX common shares and XXXXXXXXXX Class XXXXXXXXXX preferred shares, owned as follows:

Adjusted Paid-up Number Cost Base Capital Common shares

XXXXXXXXXX Class XXXXXXXXXX preferred shares

XXXXXXXXXX

The terms "paid-up capital" and "adjusted cost base" as used here and subsequentlyXXXXXXXXXX have the meanings assigned by subsection 89(1) and section 54 respectively.

XXXXXXXXXX

3. XXXXXXXXXX

4. XXXXXXXXXX

5. XXXXXXXXXX

6. XXXXXXXXXX

7. XXXXXXXXXX

a) XXXXXXXXXX

b) XXXXXXXXXX

8. XXXXXXXXXX

9. XXXXXXXXXX

10. XXXXXXXXXX

11. Each of the properties XXXXXXXXXX, is subject to one or two mortgages securing loans (collectively, the "Mortgage Loans") that were incurred XXXXXXXXXX The details of the Mortgage Loans, XXXXXXXXXX, which are owed to XXXXXXXXXX proposes to refinance XXXXXXXXXX with distress preferred shares is as follows:

XXXXXXXXXX

Mortgage Balance Interest Property XXXXXXXXXX Rate

XXXXXXXXXX

XXXXXXXXXX

12. XXXXXXXXXX has resulted in extreme cash flow pressures

XXXXXXXXXX

The resulting decline in revenues XXXXXXXXXX has placed XXXXXXXXXX in a position of severe financial difficulty.

13. XXXXXXXXXX

constitutes a default under the terms of the various Mortgage Loan agreements with

XXXXXXXXXX

14. XXXXXXXXXX

it is reasonably expected that XXXXXXXXXX will not be in a position to meet its obligations to make principal and interest payments under its various Mortgage Loans XXXXXXXXXX

Without the conversion of the Mortgage Loans into share capital as outlined in the proposed transactions described below, XXXXXXXXXX perceive that, XXXXXXXXXX will have to exercise XXXXXXXXXX various rights under the default provisions of XXXXXXXXXX respective Mortgage Loan agreements with XXXXXXXXXX

15. XXXXXXXXXX has not been able to convince any alternative financing source

XXXXXXXXXX

16. XXXXXXXXXX

17. There have been no dividends paid by XXXXXXXXXX on its common or preferred shares since their issuance.

18. XXXXXXXXXX any unencumbered assets of significant value that could alleviate XXXXXXXXXX financial difficulties or that could be used as security for significant additional financing.

XXXXXXXXXX

19. XXXXXXXXXX cash flow projection for the calendar years XXXXXXXXXX indicate continuing deficiencies if the Mortgage Loans are not converted into share capital as outlined in the proposed transactions describe below. Indicated below is a summary of the projected cash flows assuming that the Mortgage Loans remain outstanding and, in the alternative, assuming that the Mortgage Loans are converted into share capital as outlined in the proposed transactions described below.

XXXXXXXXXX

Cash flow before preferred share issue XXXXXXXXXX

Cash flow after preferred share issue XXXXXXXXXX

20. XXXXXXXXXX deal with XXXXXXXXXX and its shareholders XXXXXXXXXX at arm's length within the meaning assigned to this term by section 251(1).

21. To the best of your knowledge and that of XXXXXXXXXX, none of the issues in respect of which rulings are herein requested is currently under consideration by a tax services office or taxation centre in connection with a tax return or notice of objection already filed.

Proposed Transactions

22. XXXXXXXXXX will incorporate a new corporation ("Newco A") under XXXXXXXXXX The authorized share capital of Newco A will include a limited number of voting and participating common shares. Newco A will be a single-purpose corporation that will not engage in any business or activity except as provided for in the proposed transactions. XXXXXXXXXX will subscribe for a nominal amount of common shares of Newco A for a nominal cash consideration.

23. Newco A will incorporate two new corporations (each referred to as a "Lender Newco") under XXXXXXXXXX each of which will be a taxable Canadian corporation. Newco A will subscribe for a nominal amount of common shares of each Lender Newco for a nominal cash consideration. Each Lender Newco will be a single-purpose corporation that will not engage in any business or activity except as provided for in the proposed transactions.

24. The authorized share capital of each Lender Newco will include:

a) an unlimited number of voting and participating common shares, and

b) an unlimited number of Class XXXXXXXXXX preferred shares, the attributes of which will include the following:

i)non-voting;

ii)non-participating except for a preferential cumulative fixed dividend entitlement equivalent to approximately XXXXXXXXXX% per annum in the case of the Lender Newco in which XXXXXXXXXX will subscribe for shares and approximately XXXXXXXXXX% per annum in the case of the Lender Newco in which XXXXXXXXXX will subscribe for shares, as described in paragraph 28 below;

iii)redeemable at $XXXXXXXXXX per share plus accrued unpaid dividends less any amounts previously returned to the shareholder as a return of capital;

iv)redeemable at the option of the holder, at $XXXXXXXXXX per share plus accrued unpaid dividends less any amounts previously returned to the shareholder as a return of capital, upon the occurrence of a Designated Event, as described in paragraph 31 below, or, in any event, on the XXXXXXXXXX anniversary of their issuance; and

v)in the event of the liquidation, dissolution or winding-up of Newco A, the holders of Class XXXXXXXXXX Preferred Shares will be entitled to receive in priority to the holders of the common shares an amount equal to $XXXXXXXXXX per share plus accrued and unpaid dividends less any amounts previously returned to the shareholders as a return of capital.

25. XXXXXXXXXX will XXXXXXXXXX advance an amount of cash to a different Lender Newco equal to the principal amount of XXXXXXXXXX Mortgage Loans XXXXXXXXXX as at the day of the Advance (the "Advances"). The Advances will be for a term of one day, will be non-interest bearing and will be evidenced by a note. XXXXXXXXXX and Newco A will guarantee the obligations of each Lender Newco to XXXXXXXXXX under the terms of the Advances.

26. Each Lender Newco will loan the full proceeds of the Advance received by it to Newco A (the "Newco Loans"). The Newco Loans will be repayable on demand or in XXXXXXXXXX, whichever is earlier, and will be interest-bearing. Each Lender Newco will however waive all rights to receive any interest from Newco A with respect to its Newco Loans. XXXXXXXXXX will guarantee all of Newco A's obligations to the Lender Newcos under the terms of the Newco Loans.

27. Newco A will purchase the Mortgage Loans from XXXXXXXXXX as well as all related security (the "Purchase"). The purchase price will be equal to the principal amount of each Mortgage Loan XXXXXXXXXX as at the day of the Purchase (the "Purchase Price") and will be paid in cash using the proceeds of the Newco Loans. It will be agreed between Newco A and XXXXXXXXXX that interest will accrue on the Mortgage Loans for the XXXXXXXXXX but will not be payable by XXXXXXXXXX on any particular Mortgage Loan for as long as Newco A holds the Mortgage Loan. Newco A will thereafter waive all rights to receive any interest from XXXXXXXXXX with respect to the Mortgage Loans until the occurrence of a Designated Event, as described in paragraph 31 below or, in any event, on the XXXXXXXXXX anniversary of the Purchase. If, on the XXXXXXXXXX anniversary of the Purchase, all dividends are paid on the Class XXXXXXXXXX Preferred Shares to be issued by a particular Lender Newco, as described in paragraph 28 below, the XXXXXXXXXX of accrued interest on the appropriate Mortgage Loan will be deemed to be cancelled immediately before Newco A transfers the mortgage Loan to XXXXXXXXXX Interest will begin to accrue again when the Mortgage Loans are reacquired by XXXXXXXXXX

The purpose for the accrual of interest for XXXXXXXXXX is to provide XXXXXXXXXX with access to the old security at an amount in excess of the amount of any indebtedness under a Mortgage Loan in the event that XXXXXXXXXX requires the Class XXXXXXXXXX Preferred Shares to be acquired for an amount in excess of the amount of the indebtedness under the related Mortgage Loans as set out in paragraph 31 below.

28. Each of XXXXXXXXXX will subscribe for a number of Class XXXXXXXXXX preferred shares of the Lender Newco to which it made an Advance (the "Class XXXXXXXXXX Preferred Shares"). The stated capital and the subscription price, which will be paid in cash, of the Class XXXXXXXXXX Preferred Shares issued to XXXXXXXXXX will be equal to the Purchase Price of XXXXXXXXXX Mortgage Loans.

The entire amount of the subscription proceeds received by XXXXXXXXXX from the issuance of the Class XXXXXXXXXX Preferred Shares will be added to the Lender Newco's stated capital account maintained by it with respect to such shares. If required by XXXXXXXXXX the stated capital account for the Class XXXXXXXXXX Preferred Shares will be reduced to a nominal amount without any distribution of any amount to the shareholders of the Lender Newco.

29. The articles of Newco A and of each Lender Newco, as well as a unanimous shareholders agreement entered into between the shareholders of Newco A and the shareholders of each Lender Newco, respectively, will provide that without the unanimous approval of such shareholders:

a) no transfer or encumbrance of the common shares of Newco A or the Lender Newco will be effective;

b) no additional shares of Newco A or the Lender Newco will be issued;

c) no transfer or encumbrance of assets of Newco A or the Lender Newco will be effective; and

d) other than as contemplated herein, Newco A or the Lender Newco, as the may be, will not carry on any activities, engage in any business transaction, incur any indebtedness, create any security over its assets, make any guarantee, amalgamate, merge or consolidate, declare or pay dividends (other than on the Class XXXXXXXXXX Preferred Shares), or purchase or redeem any of its shares (other than the Class XXXXXXXXXX Preferred Shares).

30. Each Lender Newco will repay its Advance in full to XXXXXXXXXX subscribing for its Class XXXXXXXXXX Preferred Shares using the proceeds of the issuance of its Class XXXXXXXXXX Preferred Shares.

31. Newco A and XXXXXXXXXX will enter into an agreement which will provide that, after the occurrence of certain events (herein the Designated Events), XXXXXXXXXX will have the following options:

a) Newco A will be required, at the request of XXXXXXXXXX, to purchase all or some of the Class XXXXXXXXXX Preferred Shares from XXXXXXXXXX for a purchase price equal to the amount then outstanding under the corresponding portion of XXXXXXXXXX Mortgage Loans adjusted to compensate XXXXXXXXXX for any tax liabilities with respect to the Class XXXXXXXXXX Preferred Shares different from those outlined in the rulings requested. At XXXXXXXXXX option, the purchase price will be paid in the following manner:

i)by the reassignment of the corresponding portion of XXXXXXXXXX Mortgage Loans by Newco A to XXXXXXXXXX, or

ii)in cash.

To secure its obligation to purchase the Class XXXXXXXXXX Preferred Shares from XXXXXXXXXX and to pay the purchase price, Newco A will assign XXXXXXXXXX Mortgage Loans together with all related security to XXXXXXXXXX as collateral security. XXXXXXXXXX will guarantee all of Newco A's obligations to XXXXXXXXXX

b) Newco A will be required to sell all or some of XXXXXXXXXX Mortgage Loans to XXXXXXXXXX for an amount to be paid in cash equal to the principal amount of the portion of the Mortgage Loan to be sold, adjusted to compensate XXXXXXXXXX for any tax liabilities with respect to the Class XXXXXXXXXX Preferred Shares different from those outlined in the rulings requested.

Concurrently, Newco A will be required to purchase all of some of the Class XXXXXXXXXX Preferred Shares held by XXXXXXXXXX utilizing the cash proceeds it receives from XXXXXXXXXX from the sale of the Mortgage Loans.

To secure its obligation to purchase the Class XXXXXXXXXX Preferred Shares held by XXXXXXXXXX and to pay the purchase price, Newco A will assign to XXXXXXXXXX its right to receive the sale proceeds from XXXXXXXXXX will guarantee all of Newco A's obligations to XXXXXXXXXX

The Designated Events will include events which coincide in large part with the events of default under the various agreements between XXXXXXXXXX and XXXXXXXXXX which govern the Mortgage Loans.

32. Dividends payable by the Lender Newcos on their Class XXXXXXXXXX Preferred Shares and any fees or expenses of Newco A or the Lender Newcos incurred to maintain their good standing under all applicable laws will be funded by capital contributions from time to time by XXXXXXXXXX to Newco A and, as applicable, by equivalent capital contributions by Newco A to the Lender Newcos.

33. The capital contributions referred to in paragraph 32 above will be regarded as funds to be held for the benefit of XXXXXXXXXX until such time as Newco A or the Lender Newcos require the funds to make the payments referred to paragraph 32 above. Neither of Newco A nor the Lender Newcos will add such contributions of capital to the stated capital of their common shares.

34. Notwithstanding the terms and conditions of the Class XXXXXXXXXX Preferred Shares or any mandatory redemptions of the Class XXXXXXXXXX Preferred Shares that may be required by XXXXXXXXXX all "Excess Cash Flow", as defined in paragraph 35 below, arising in each fiscal period shall be applied to redeem the Class XXXXXXXXXX Preferred Shares issued by the Lender Newcos within XXXXXXXXXX after the end of that fiscal period. Any Excess Cash Flow will be attributed among the Lender Newcos to fund redemptions in a manner to be agreed upon by XXXXXXXXXX

35. Excess Cash Flow in respect of a particular fiscal period shall be the change or increase in cash flow for such fiscal period of XXXXXXXXXX from all sources, as would be reported on a Consolidated Statement of Changes of Financial Position prepared in accordance with generally accepted accounting principles, if only directly and indirectly wholly-owned subsidiaries of XXXXXXXXXX, as well as the Lender Newcos, were so included, but before outlays for:

a) the payment of dividends other than dividends on the Class XXXXXXXXXX Preferred Shares;

b) capital expenditures or any payment on capital account other than in respect of:

i)the purchase or redemption of the Class XXXXXXXXXX Preferred Shares, other than purchases or redemptions made in the period in respect of a prior period's excess cash flow;

ii)repayments of indebtedness incurred in the normal and ordinary course of business by XXXXXXXXXX and in existence at the date the Class XXXXXXXXXX Preferred Shares are issued;

iii)repayments of additional debt incurred for the specific purpose of funding current operating requirements. Additional debt for this purpose shall not include debt used for the purpose of expanding the business of XXXXXXXXXX

iv)expenditures or payments between any of XXXXXXXXXX and the Lender Newcos;

v)reasonable capital expenditures or payments on capital account, including tenant inducements, incurred in the normal and ordinary course of the existing business of XXXXXXXXXX and repayments of additional debt for the specific purpose of making such capital expenditures or payments on capital account; and

vi)repayments of additional debt incurred for the specific purpose of enabling Newco A to purchase the Class XXXXXXXXXX Preferred Shares or the Lender Newcos to redeem the Class XXXXXXXXXX Preferred Shares or to pay dividends thereon;

c) repayments of loans to shareholders of XXXXXXXXXX or redemptions of any of the shares of XXXXXXXXXX; and

d) loans to directors, officers and shareholders of XXXXXXXXXX or to other persons, firms or corporations.

For purposes of this definition of Excess Cash Flow, additional debt shall not include a debt which arose as a result of the use of cash or funds for a purpose that is not envisaged herein.

36. The redemption by any Lender Newco of the Class XXXXXXXXXX Preferred Shares will be funded through the repayment by x to Newco A of all or part of XXXXXXXXXX Mortgage Loan and by the parallel repayment of all or part of the Newco Loan by Newco A to the Lender Newco.

37. Newco A will be wound up immediately after the earlier of:

a) the date upon which there are no longer any Class XXXXXXXXXX Preferred Shares of any Lender Newco outstanding; and

b) the date that is XXXXXXXXXX after the date upon which the Class XXXXXXXXXX Preferred Shares are issued.

38. Each Lender Newco will be wound up immediately after the earlier of:

a) the date upon which there are no longer any of its Class XXXXXXXXXX Preferred Shares outstanding; and

b) the date that is five years after the date upon which its Class XXXXXXXXXX Preferred Shares are issued.

Other Information

39. XXXXXXXXXX

40. XXXXXXXXXX

41. XXXXXXXXXX

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to convert a large part of XXXXXXXXXX long-term debt into share capital, thereby increasing XXXXXXXXXX cash flow so as to allow it to continue its operations and to better its overall financial situation.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts and proposed transactions and the purposes of the proposed transactions, we confirm the following:

A. The Class XXXXXXXXXX Preferred Shares of each Lender Newco to be issued to XXXXXXXXXX, as described in paragraph 28 above, XXXXXXXXXX will be:

i) shares described in subparagraph (e) (iii) of the definition of "term preferred share" in subsection 248(1) for a period not exceeding five years from the date of their issuance; and

ii) "exempt shares" pursuant to paragraph (c) of the definition thereof in subsection 112(2.6) during that same period;

and accordingly, subsections 112 (2.1), (2.2), (2.3) and (2.4) will not apply to deny XXXXXXXXXX a deduction under subsection 112(1) or 138(6) for dividends received or deemed to have been received by it on any Class XXXXXXXXXX Preferred Shares during such period.

B. No amount will be included in the income of Newco A or any Lender Newco pursuant to paragraphs 12(1)(c) or 12(1)(x), or subsections 12(3), 12(9), 16(1) or 246(1) or section 9 in respect of capital contributions made or required to be made by XXXXXXXXXX to Newco A or by Newco A to any Lender Newco as described in paragraph 32 above, nor will any such amounts constitute "proceeds of disposition", as defined in section 54, to Newco A or any Lender Newco from the disposition by it of any property.

C. No amount will be included in computing the income of XXXXXXXXXX under subsection 56(2) in respect of any capital contributions made by XXXXXXXXXX to Newco A or by Newco A to any Lender Newco as described in paragraph 32 above.

D. No amount will be included in computing the income of x, Newco A, XXXXXXXXXX pursuant to subsections 15(1) and 246(1), and section 80 will not apply to XXXXXXXXXX or Newco A, by virtue of the fact that interest will not be paid or payable by XXXXXXXXXX to Newco A in respect of the Mortgage Loans or by Newco to the Lender Newcos in respect of the Newco Loans or as a result of the failure of Newco A to demand repayment of the Mortgage Loans or the failure of any Lender Newco to demand repayment of any Newco Loan.

E. Subject to paragraph 20(1)(e.1), expenses incurred by Newco A or any Lender Newco in the course of borrowing money and by any Lender Newco in the course of issuing the Class XXXXXXXXXX Preferred Shares will be deductible by Newco A or any Lender Newco, as the case may be, pursuant to paragraph 20(1)(e) to the extent such expenses are reasonable in the circumstances.

F. Subject to paragraph 20(1)(e.1), expenses incurred by XXXXXXXXXX in the course of restructuring the Mortgage Loans, other than expenses described in Ruling E above, incurred in respect of Newco A or any Lender Newco, will be deductible by XXXXXXXXXX pursuant to paragraph 20(1)(e) to the extent such expenses are reasonable in the circumstances.

G. The cost amount, within the meaning of subsection 248(1), to any Lender Newco of its Newco Loan, immediately after the time that it is made to Newco A, will be equal to the amount of the proceeds of the Advance received by the particular Lender Newco, as described in paragraph 25 above.

H. The cost amount, within the meaning of subsection 248(1), to Newco A of the Mortgage Loans, immediately after the time that they are acquired from XXXXXXXXXX will be equal to the Purchase Price paid therefor by Newco A as described in paragraph 27 above.

I. The cost amount, within the meaning of subsection 248(1), to XXXXXXXXXX of the Class XXXXXXXXXX Preferred Shares acquired by it, immediately after the time of their issue, will be equal to the subscription price paid therefor by XXXXXXXXXX as described in paragraph 28 above.

J. If any of the Mortgage Loans are reacquired by XXXXXXXXXX as described in paragraph 31 above, the cost amount, within the meaning of subsection 248(1), to XXXXXXXXXX of the reacquired Mortgage Loan will be:

a) where the Mortgage Loan is reacquired by XXXXXXXXXX as described in paragraph 31(a)(ii) or 31(b) of the proposed transactions, the amount paid therefor by XXXXXXXXXX; and

b) in any other case, the fair market value of the consideration paid therefor.

K. XXXXXXXXXX

L. Subsection 112(4) will not apply, in respect of any dividends received by XXXXXXXXXX on the Class XXXXXXXXXX Preferred Shares, to any loss realized by XXXXXXXXXX on any Mortgage Loan subsequent to it being reacquired by XXXXXXXXXX from Newco A in the circumstances described in paragraph 31 above.

M. As a result of the proposed transactions, in and of themselves, subsection 245(2) will not apply to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R2 dated September 28, 1990 and are binding on Revenue Canada, Taxation provided that the proposed transactions described herein are completed by XXXXXXXXXX

Our rulings are based on the Act in its present form and do not take into consideration any proposed amendments to the Act.

XXXXXXXXXX

XXXXXXXXXX

Yours truly,

for Director Financial Industries Division Income Tax Rulings and Interpretations Directorate Policy and Legislation Branch

XXXXXXXXXX