30 November 1995 Ruling 9625393 - 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:

DPS Financing Requested

Position:

Accept

Reasons:

Corporation in financial difficulty

XXXXXXXXXX							962539
XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1996

Re: XXXXXXXXXX

This is in response to your letters of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of XXXXXXXXXX.

Unless otherwise specified, all references to statute are to the Income Tax Act.

You advise that to the best of your knowledge and that of XXXXXXXXXX none of the issues involved in the ruling request has been considered by a tax services office or a taxation centre in connection with a tax return already filed and, none of the issues involved in the ruling request is the subject of a notice of objection or under appeal.

Our understanding of the facts, proposed transactions and their purpose is as follows.

FACTS

1.XXXXXXXXXX is a corporation incorporated pursuant to the laws of the Province of XXXXXXXXXX. XXXXXXXXXX is a "Canadian corporation" and a "taxable Canadian corporation" within the meaning of those terms in subsection 89(1) of the Act. XXXXXXXXXX deals with the XXXXXXXXXX Tax Services Office and files its tax return with the XXXXXXXXXX Taxation Centre. XXXXXXXXXX corporate tax account number is XXXXXXXXXX.

2.XXXXXXXXXX is a "Canadian corporation" and a "taxable Canadian corporation" within the meaning of those terms in subsection 89(1) of the Act. XXXXXXXXXX is engaged in the business of XXXXXXXXXX. XXXXXXXXXX deals at arm's length with XXXXXXXXXX.

3.The issued and outstanding capital of XXXXXXXXXX consists of

XXXXXXXXXX.

4. The authorized capital of XXXXXXXXXX is:

a.an unlimited number of Common Shares without nominal or par value;

b.an unlimited number of XXXXXXXXXX%, non-cumulative, redeemable, retractable, Class XXXXXXXXXX Voting Shares;

c.an unlimited number of redeemable, non-voting Class XXXXXXXXXX Special Shares;

d.an unlimited number of redeemable, non-voting Class XXXXXXXXXX Special Shares; and

e.an unlimited number of XXXXXXXXXX% non-cumulative, redeemable, non-voting Preference Shares.

5.The shareholders of XXXXXXXXXX are:

XXXXXXXXXX.

6.On XXXXXXXXXX will amalgamate.

7.The Officers of XXXXXXXXXX are:

XXXXXXXXXX.

8.XXXXXXXXXX owns and operates XXXXXXXXXX.

9.XXXXXXXXXX are all actively engaged in the operations of

XXXXXXXXXX.

10.The aggregate compensation paid to all of XXXXXXXXXX totalled only $XXXXXXXXXX for the fiscal year ended XXXXXXXXXX. XXXXXXXXXX received no compensation from XXXXXXXXXX.

11. XXXXXXXXXX.

12. XXXXXXXXXX.

13.XXXXXXXXXX is currently indebted to XXXXXXXXXX pursuant to XXXXXXXXXX loans.

XXXXXXXXXX.

14. XXXXXXXXXX.

15. XXXXXXXXXX.

16.XXXXXXXXXX provided operating credit to XXXXXXXXXX. XXXXXXXXXX advanced the principal sum of $XXXXXXXXXX This loan is secured by, among other things, a second charge over the inventory of XXXXXXXXXX which is located in XXXXXXXXXX The second charge of XXXXXXXXXX was postponed in favour of the second debenture in favour of XXXXXXXXXX with the exception of trade accounts receivable and trade inventory of XXXXXXXXXX. XXXXXXXXXX has personal guarantees for this indebtedness from XXXXXXXXXX.

17.XXXXXXXXXX received a loan from XXXXXXXXXX in the principal amount of approximately $XXXXXXXXXX.

18.One of the shareholders of XXXXXXXXXX provided financing in the principal amount of $XXXXXXXXXX This financing was secured by a mortgage over the property of XXXXXXXXXX The mortgage has been postponed in favour of XXXXXXXXXX No payments have been made on this debt.

19.The shareholders of the company have as a group contributed approximately $XXXXXXXXXX in personal loans and the contribution of property XXXXXXXXXX No payments have been made on these loans.

20.XXXXXXXXXX suffered losses in each of its fiscal years XXXXXXXXXX as set out

XXXXXXXXXX.

21.XXXXXXXXXX has been adversely affected by the recession in that it had been unable until XXXXXXXXXX.

22.In order to more effectively compete with XXXXXXXXXX made XXXXXXXXXX expenditures totalling $XXXXXXXXXX.

23.While XXXXXXXXXX considered essential for XXXXXXXXXX the cash used XXXXXXXXXX resulted in cash-flow difficulties for XXXXXXXXXX.

24. XXXXXXXXXX.

25.XXXXXXXXXX is currently in arrears in its obligations to XXXXXXXXXX in the amount of approximately $XXXXXXXXXX, and is considered by XXXXXXXXXX to be in default under their agreement. This amount was personally guaranteed by XXXXXXXXXX As a result of its default under its agreement with XXXXXXXXXX.

26.None of XXXXXXXXXX are able to provide further financial assistance to XXXXXXXXXX at this time.

27On XXXXXXXXXX served XXXXXXXXXX with a Notice of Intention to Enforce Security pursuant to subsection 244(1) of the Bankruptcy and Insolvency Act. On XXXXXXXXXX proposed a settlement of the claim of XXXXXXXXXX This settlement was dependent on XXXXXXXXXX being able to exchange its current debt obligations to XXXXXXXXXX for preferred shares of XXXXXXXXXX which would not be term preferred shares of XXXXXXXXXX as that term is defined in subsection 248(1) of the Act by virtue of the exception in paragraph (e) thereof. As part of the settlement with XXXXXXXXXX it was agreed that initially the XXXXXXXXXX loans which are currently owing by XXXXXXXXXX would be combined into one new loan which would be restated and secured by a first fixed and floating charge debenture on all of the assets, present and future, of XXXXXXXXXX The interest rate on the new debenture would be XXXXXXXXXX cost of funds plus XXXXXXXXXX%. The preferred shares which are to be issued in substitution for this indebtedness, would bear a dividend rate of XXXXXXXXXX.

28.Cash flow projections for XXXXXXXXXX show the situation of XXXXXXXXXX with and without the exchange of the current debt obligations to XXXXXXXXXX with preferred shares.

XXXXXXXXXX.

PROPOSED TRANSACTIONS

29.XXXXXXXXXX will incorporate Newco. Newco will be a "Canadian corporation" and a "taxable Canadian corporation" as those terms are defined in subsection 89(1) of the Act. Its fiscal year end will coincide with that of XXXXXXXXXX The authorized share capital of Newco will consist of a limited number of common shares, all of which will be beneficially owned by XXXXXXXXXX, and a limited number of non-voting preferred shares.

30.The preferred shares will have the following characteristics:

a. a term of five (5) years from the date of issue;

b. non-voting (except when a Retraction Event, as described herein, has occurred and is continuing);

c. preferential cumulative dividends, such dividends to be at a rate which is equal to XXXXXXXXXX. The initial dividend will accrue from the first day of the month following the date of the letter granting the rulings herein, notwithstanding that preferred shares will be issued after that date;

d. redeemable by XXXXXXXXXX at stated capital plus accrued unpaid dividends at any time;

e. retractable by the holder at stated capital plus accrued unpaid dividends after a Retraction Event, and in any event on or after the fifth anniversary of the date of issue; and

f. in the event of a liquidation, dissolution or winding-up of Newco, the holders of the preferred shares will be entitled to receive in priority to the holders of common shares an amount equal to the stated capital of the preferred shares plus accrued unpaid dividends on the preferred shares.

31.XXXXXXXXXX will subscribe for preferred shares of Newco for cash consideration equal to the face value, plus all accrued and unpaid interest thereon, of the amount owing by XXXXXXXXXX ("the Debt"). Newco will issue the preferred shares to XXXXXXXXXX The entire amount of the cash consideration from the issue of the preferred shares to XXXXXXXXXX will be added to Newco's stated capital account maintained for the preferred shares.

32.The proceeds resulting from the issuance of the preferred shares to XXXXXXXXXX as described in the previous paragraph will be used by Newco to purchase from XXXXXXXXXX the Debt, along with the related security. Effective immediately prior to its acquiring the Debt, Newco will agree with XXXXXXXXXX to receive no interest in respect of the Debt owing from XXXXXXXXXX for the period during which Newco continues to own the Debt.

33.XXXXXXXXXX will agree to make payments to Newco as contributions of capital to provide Newco with sufficient funds to meet Newco's dividend payments on the preferred shares and any fees and expenses incurred by Newco in connection with the transactions described in the previous two paragraphs. In addition, XXXXXXXXXX will agree to cause the amount of the Debt to Newco to be reduced in order to provide sufficient funds for Newco to redeem preferred shares from time to time.

34.Notwithstanding the terms and conditions of the preferred shares or any mandatory redemptions of the preferred shares that may be required by XXXXXXXXXX, all Excess Cash Flow (as defined in paragraph 35) arising in a fiscal period shall be applied to redeem the preferred shares after the end of the said fiscal period.

35.Excess Cash Flow in respect of a particular fiscal period shall be the changes in cash flow for the period of XXXXXXXXXX from all sources, as would be reported on a Consolidated Statement of Changes in Financial Position prepared in accordance with generally accepted accounting principles, but before outlays for:

a. the payment of dividends other than dividends paid on the preferred shares;

b. capital expenditures or any payment on capital account other than

i. in respect of the purchase or redemption of the preferred shares, other than redemptions made in the period in respect of the prior period's Excess Cash Flow,

ii.repayments of indebtedness incurred in the normal and ordinary course of business and in existence at the date the preferred shares are issued,

iii. repayments of additional debt incurred for the specific purpose of funding current operating requirements,

iv. reasonable capital expenditures or payments on capital account incurred in the normal and ordinary course of the existing business, and repayments of additional debt incurred for the specific purpose of making such capital expenditures or payments on capital account, and

v. repayments of additional debt incurred for the specific purpose of enabling Newco to redeem the preferred shares or to pay dividends on the preferred shares;

vi. costs incurred in connection with the issuance of the preferred shares;

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.

36.The Articles of Newco will provide that without the unanimous approval of all of the shareholders of Newco, including the holders of the preferred shares:

a.no transfer or encumbrance of common shares of Newco would be effective;

b. no transfer or encumbrance of assets of Newco (other than a transfer of Debt in satisfaction of the redemption/retraction price of preferred shares as described above, or a payment of dividends on the preferred shares) would be effected; and

c. other than as contemplated herein, Newco would not carry on any activities, engage in any business transactions, incur any indebtedness, create any security over its assets, make any guarantee, amalgamate, merge, or consolidate, pay any dividends, other than on the preferred shares, or purchase or redeem any of its shares, other than the preferred shares.

37.The payments of the redemption/retraction price for the preferred shares on any redemption or retraction may be satisfied by Newco transferring to XXXXXXXXXX an equivalent amount of the Debt together with the related security.

38."Retraction Event" means any of the following events:

a. Newco shall have failed to pay the regular dividend payable on the preferred shares as and when the same is payable in accordance with the terms and conditions of such shares;

b. Newco shall have failed to redeem all or any part of the preferred shares at the time and in the manner required by the terms and conditions of such shares;

c. XXXXXXXXXX shall have failed to make a required contribution of capital or principal repayment as described above;

d. an Order shall have been made or an effective Resolution shall have been passed for the winding-up, dissolution or liquidation of Newco; and

e. XXXXXXXXXX or Newco shall have made a general assignment for the benefit of its creditors or a Proposal under the Bankruptcy and Insolvency Act, or shall be declared bankrupt, or if a custodian or sequestrator or receiver/manager (or both) or any other officer with similar power shall be appointed of XXXXXXXXXX or Newco, or of the property of XXXXXXXXXX or Newco, or any part thereof that is, in the opinion of the holder, a substantial part thereof.

39.If a Retraction Event occurs, XXXXXXXXXX, at its option, will have the right to cause the preferred shares to be redeemed by Newco in exchange for the Debt and the related security acquired by Newco from XXXXXXXXXX.

40.Subject to the operation of any applicable law to which Newco is subject, Newco will be wound-up without any undue delay after the earlier of:

a. the time at which all of Newco's preferred shares are repurchased, redeemed or cancelled; or

b. the time that is five (5) years after the date that the first of such preferred shares was issued.

41.In the event that Newco is precluded by law from redeeming all of the preferred shares on the earlier of the times referred to above, then Newco shall redeem such preferred shares on the first day thereafter that Newco is not precluded from doing so.

PURPOSE OF PROPOSED TRANSACTIONS

42.The purpose of the proposed transactions is to effect a corporate and financial reorganization of certain debt relating to business carried on in Canada by XXXXXXXXXX, so as to reduce the debt service costs of XXXXXXXXXX and thereby enable XXXXXXXXXX to return to financial health and to continue to carry on its business.

RULINGS GIVEN

Provided all relevant facts, proposed transactions and their purposes have been fully disclosed and, as summarized above, are accurate, we confirm the following.

A.The preferred shares to be issued by Newco to XXXXXXXXXX as described in paragraph 30 above will be:

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

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

and, accordingly, subsections 112(2.1), (2.2), (2.3) and (2.4) of the Act will not apply to deny XXXXXXXXXX a deduction under subsection 112(1) of the Act for dividends received or deemed to have been received by it on the preferred shares during such period.

B.No amount will be included in computing the income of Newco pursuant to paragraphs 12(1)(c), or 12(1)(x) of the Act or subsections 12(3), 12(9), 16(1), or 246(1) or section 9 of the Act in respect of any capital contributions or other payments made or required to be made by XXXXXXXXXX to Newco, as described in paragraph 33 above, nor will such amounts otherwise be considered to be "proceeds of disposition", as defined in section 54 of the Act, to Newco from the disposition by it of any property.

C.No amount will be included in computing the income of XXXXXXXXXX under subsections 15(1) or 246(1) of the Act and section 80 of the Act will not apply to XXXXXXXXXX or Newco by virtue of the fact that interest will not be paid or payable by XXXXXXXXXX to Newco on the Debt, for the period ending on the earlier of the dates referred to in paragraph 40 above or as a result of the failure of Newco to demand repayment of the Debt.

D.Subject to paragraph 20(1)(e.1) of the Act, expenses incurred by XXXXXXXXXX in the course of the restructuring of the XXXXXXXXXX debt will be deductible pursuant to paragraph 20(1)(e) of the Act to the extent such expenses are reasonable in the circumstances.

E.The cost amount, within the meaning of subsection 248(1) of the Act to:

i.Newco of the Debt, immediately after the time that it is acquired from XXXXXXXXXX, will be equal to the purchase price paid therefor as described in paragraph 32 above.

ii. XXXXXXXXXX of the preferred shares will, immediately after the time the shares are issued, be equal to the amount paid by XXXXXXXXXX for those preferred shares as described in paragraph 31 above.

F.Upon the occurrence of a Retraction Event as described in paragraph 38, the cost amount within the meaning of subsection 248(1) of the Act, to:

i.XXXXXXXXXX or Newco of the Shares will, immediately after the time the shares are acquired, be equal to the amount paid by XXXXXXXXXX or Newco for those preferred shares as described in paragraph 39 above.

ii. XXXXXXXXXX of the Debt will, immediately after the time it is acquired from Newco, be equal to the amount paid therefor as described in paragraph 39 above; and

G.No amount will be included in computing the income of XXXXXXXXXX under subsection 56(2) of the Act in respect of any capital contributions made by XXXXXXXXXX to Newco as described in paragraph 33 above.

H.Provided that the Debt arose from one or more loans made by XXXXXXXXXX in the course of its money-lending business, the Debt reacquired by XXXXXXXXXX as described in paragraph 39 will be considered to have been acquired by XXXXXXXXXX in the ordinary course of its business of lending money for the purposes of paragraphs 20(1)(1) and 20(1)(p) of the Act.

I.Subsection 112(4) of the Act will not apply, in respect of any dividends received by XXXXXXXXXX on the preferred shares, to any loss realized by XXXXXXXXXX on the Debt subsequent to it being reacquired by XXXXXXXXXX from Newco, as described in paragraph 39 above.

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

This ruling is given subject to the general limitations and qualifications set forth in Information circular 70-6R2 issued by Revenue canada on September 28, 1990, and is binding on the Department provided the preferred shares are issued as described above on or before XXXXXXXXXX This ruling is based on the Act in its present form and does not take into account the effects of any proposed amendments thereto.

Yours truly,

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