30 November 1995 Ruling 9628093 - DISTRESS PRFERRED 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.

RULINGS DIRECTORATE

CORRESPONDENCE SUMMARY

Principal Issues:

Acceptable Distress Preferred Share ("DPS") proposal given in File 961598. XXXXXXXXXX now requesting DPS for additional creditor/lender.

Position TAKEN:

Favourable ruling issued.

Reasons FOR POSITION TAKEN:

Default/impending default met with respect to existing debt notwithstandng that certain debts have already been refinanced with DPS.

XXXXXXXXXX 962809

Attention: XXXXXXXXXX

XXXXXXXXXX, 1996

Dear Sirs:

Re: Advance Income Tax Ruling Request
XXXXXXXXXX

This is in reply to your letter dated XXXXXXXXXX, requesting an advance income tax ruling on behalf of XXXXXXXXXX with respect to a distress preferred share ("DPS") issuance. An advanced income tax ruling 961598 was issued XXXXXXXXXX, 1996 (the "XXXXXXXXXX Ruling") and supplemental rulings issued XXXXXXXXXX, 1996 (our File #962423) and XXXXXXXXXX, 1996 (our file #962656) (collectively the "supplementaries") with respect to XXXXXXXXXX to provide for the refinancing of the respective debts with DPS.

XXXXXXXXXX corporate account number is XXXXXXXXXX and it files its tax return at the XXXXXXXXXX Taxation Centre.

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 taxation 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 any notice of objection or is under appeal.

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

FACTS

1.XXXXXXXXXX was formed by the amalgamation of XXXXXXXXXX pursuant to the XXXXXXXXXX. XXXXXXXXXX is governed by the laws of XXXXXXXXXX.

XXXXXXXXXX is a "private corporation" and a "taxable Canadian corporation" within the meaning assigned to these expressions by subsection 89(1) and a "Canadian-controlled private corporation" within the meaning assigned to this expression by subsection 125(7). The corporate account number is XXXXXXXXXX. Income tax returns are filed in the XXXXXXXXXX tax services office.

XXXXXXXXXX current fiscal period is XXXXXXXXXX.

2.XXXXXXXXXX is a wholly-owned subsidiary of

XXXXXXXXXX

has no assets or liabilities of its own other than its shares in XXXXXXXXXX

XXXXXXXXXX

3. XXXXXXXXXX

4. XXXXXXXXXX

5. XXXXXXXXXX

6.XXXXXXXXXX is indebted to a number of creditors ("lenders") in respect of the following loans XXXXXXXXXX (dollar value indicates the principal amount of long-term indebtedness plus accrued interest less insurance policy loans at XXXXXXXXXX:

A. XXXXXXXXXX: (Approximately $XXXXXXXXXX). (These individual debts will be referred to collectively as XXXXXXXXXX)

-XXXXXXXXXX mortgage on XXXXXXXXXX TOTAL = $XXXXXXXXXX

		-XXXXXXXXXX mortgage on                                                     XXXXXXXXXX   TOTAL = $XXXXXXXXXX

-XXXXXXXXXX mortgage on XXXXXXXXXX TOTAL = $XXXXXXXXXX

- XXXXXXXXXX loan debenture on XXXXXXXXXX TOTAL = $XXXXXXXXXX

B. XXXXXXXXXX: (Approximately $XXXXXXXXXX)

-XXXXXXXXXX loan, bearing interest at XXXXXXXXXX

A favourable ruling was issued XXXXXXXXXX, 1996 and supplemental rulings issued XXXXXXXXXX, 1996 (our File #962423) and XXXXXXXXXX, 1996 (our file #962656) with respect to XXXXXXXXXX to provide for the refinancing with DPS.

C. XXXXXXXXXX: (Approximately $XXXXXXXXXX)

-XXXXXXXXXX mortgage

XXXXXXXXXX

D. XXXXXXXXXX

-XXXXXXXXXX mortgage XXXXXXXXXX

E. XXXXXXXXXX

-XXXXXXXXXX promissory note XXXXXXXXXX

F. XXXXXXXXXX

-XXXXXXXXXX mortgage XXXXXXXXXX

The proceeds of each of the above borrowings were used by XXXXXXXXXX to XXXXXXXXXX.

7.XXXXXXXXXX is a financial institutions that is a "taxable Canadian corporation" and "specified financial institution" ("SFI") within the meanings assigned to those terms in subsections 89(1) and 248(1) respectively. XXXXXXXXXX deals with XXXXXXXXXX and its' shareholders at arms' length within the meaning assigned to this expression by subsection 251(1).

8. XXXXXXXXXX.

9. XXXXXXXXXX.

In a letter, dated XXXXXXXXXX confirmed their agreement to proceed with the refinancing of their long-term debt with DPS. In the event such refinancing proves to be unattainable XXXXXXXXXX stated their intention to exercise option (C) above.

10.XXXXXXXXXX suffered losses of XXXXXXXXXX The deficit at the end of its' XXXXXXXXXX fiscal year was XXXXXXXXXX

11.XXXXXXXXXX currently operates without an operating line of credit or overdraft privileges due to its present financial situation. Therefore positive cash flows are only possible through the deferral of excess cash flow as indicated in paragraph 46 of the XXXXXXXXXX Ruling as amended by the XXXXXXXXXX, 1996 (our file #962656) supplementary ruling.

12.XXXXXXXXXX is currently unable to produce sufficient revenue to enable XXXXXXXXXX to remain current upon its obligation to XXXXXXXXXX described in paragraph 6(C) above. XXXXXXXXXX has however remained current upon its obligations to XXXXXXXXXX but only through the redirection of cash flows generated through properties other than XXXXXXXXXX After XXXXXXXXXX and pursuant to the XXXXXXXXXX 11 Ruling and supplementaries cash flows from XXXXXXXXXX properties will no longer be available to service the XXXXXXXXXX Debt.

XXXXXXXXXX

The above figures do not take anticipated declining revenues into consideration as a result of reduced capital expenditures.

XXXXXXXXXX

13.XXXXXXXXXX is unable to raise additional financing from other sources. All of the assets of XXXXXXXXXX have been pledged as security including XXXXXXXXXX. Guarantees by XXXXXXXXXX and assignments of life insurance and business interruption insurance by XXXXXXXXXX have also been provided as security for certain indebtedness. XXXXXXXXXX also been pledged as security for certain indebtedness.

14.XXXXXXXXXX a wholly-owned subsidiary of XXXXXXXXXX experienced losses in each XXXXXXXXXX fiscal years in the amount of XXXXXXXXXX With a long-term debt load of $XXXXXXXXXX against total assets of $XXXXXXXXXX as at year end, XXXXXXXXXX is currently running an accumulated deficit of $XXXXXXXXXX and is not in a position to financially assist its parent. XXXXXXXXXX

15. XXXXXXXXXX are unable to alleviate the financial problems within XXXXXXXXXX.

16. XXXXXXXXXX

17.XXXXXXXXXX cash flow projections for XXXXXXXXXX for the fiscal years XXXXXXXXXX indicate continuing deficiencies if the XXXXXXXXXX is not converted into DPS as outlined in the proposed transactions described below. The following summarizes the projected cash flows XXXXXXXXXX assuming firstly, that the XXXXXXXXXX remains outstanding and secondly, that the XXXXXXXXXX is converted to DPS as outlined in the proposed transactions described below:

        		FISCAL YEAR		CASH FLOW		CASH FLOW
								Without DPS 	With DPS

XXXXXXXXXX

Cash flow projections are based upon:

XXXXXXXXXX

PROPOSED TRANSACTIONS - XXXXXXXXXX

The following transactions are proposed with respect to the XXXXXXXXXX debt as described in paragraph 6(c) above.

XXXXXXXXXX

18.XXXXXXXXXX will incorporate a new corporation ("Subco C") under the CBCA. Subco C will be a taxable canadian corporation as defined in subsection 89(1) of the Act. The first fiscal year end of Subco C will be XXXXXXXXXX. The activities of Subco C will be limited to acquiring, holding and realizing upon certain indebtedness as described below, issuing the shares as described below and activities ancillary thereto.

19.The authorized share capital of Subco C will consist of XXXXXXXXXX common shares all of which will be beneficially owned by XXXXXXXXXX and one class of non-voting preferred shares (the "Subco C Shares"). The common shares will be issued to XXXXXXXXXX for nominal consideration. The Subco C Shares will have, amongst others, the following attributes:

(a)issuable for $XXXXXXXXXX each;

(b)non-voting (except when an event of default has occurred and is continuing. An event of default includes a failure to pay dividends on a scheduled dividend payment date and a failure to make a payment to a holder of the Subco C Shares as a reduction of capital as and when required);

(c)purchasable for cancellation for an amount equal to its initial stated capital plus accrued and unpaid dividends less any amounts previously paid out by way of a return of capital as contemplated in paragraphs 24 below (the "Purchase Amount");

(d)monthly preferential cumulative dividends at a fixed rate of XXXXXXXXXX%;

(e)in the event of a liquidation, dissolution or winding-up of Subco C, the holders of the Subco C Shares will be entitled to receive in priority to the holders of common shares an amount equal to the Purchase Amount.

20.XXXXXXXXXX has also agreed to advance funds to XXXXXXXXXX to allow XXXXXXXXXX to pay for a portion of the costs (to a maximum of $XXXXXXXXXX) of the refinancing proposed herein. Such amount advanced will be included in the debts to be refinanced with the Subco C Shares. The XXXXXXXXXX Debt is scheduled to mature on XXXXXXXXXX.

21.Subco C will borrow, on a daylight loan basis (the "Daylight Loan") from XXXXXXXXXX an amount equal to the XXXXXXXXXX Debt of approximately $XXXXXXXXXX as described in paragraph 6(c) above adjusted for accrued interest and the refinancing costs referred to in paragraph 20 above. Subco C will immediately use the funds so borrowed to purchase from XXXXXXXXXX the XXXXXXXXXX Debt owing by XXXXXXXXXX and held by XXXXXXXXXX along with related security.

XXXXXXXXXX

Subco C will guarantee the present and future obligations of XXXXXXXXXX to XXXXXXXXXX under agreements referred to in paragraph 31 below and will pledge the XXXXXXXXXX Debt and related security in support of the guarantee. Subco C will enter into an agreement with XXXXXXXXXX pursuant to which XXXXXXXXXX will have the right to purchase the XXXXXXXXXX Debt and related security from Subco C for an amount equal to the amount of the XXXXXXXXXX Debt then outstanding.

22.XXXXXXXXXX will subscribe for the Subco C Shares described in paragraph 19 above, for an aggregate subscription price, XXXXXXXXXX, equal to the aggregate amount of the XXXXXXXXXX Debt which XXXXXXXXXX has sold to Subco C as described in paragraph 21 above. The aggregate amount of the proceeds from the issue of the Subco C Shares will be added to Subco C's stated capital account maintained for the Subco C Shares. The Subco C Shares will be issued for $XXXXXXXXXX per share.

23.XXXXXXXXXX will use the proceeds of the subscription referred to in paragraph 22 above to repay the Daylight loan referred to in paragraph 21 above.

24.XXXXXXXXXX will agree to make payments to Subco C as contributions of capital to provide Subco C with sufficient funds to meet Subco C's required dividend payments on the Subco C Shares and any fees and expenses incurred by Subco C in connection with the transactions described herein. It will be agreed that such capital contributions will be regarded as funds held for the benefit of XXXXXXXXXX until such time as Subco C requires the funds to make these payments. In addition, it will be agreed that XXXXXXXXXX will make the scheduled monthly repayments of principal on the XXXXXXXXXX Debt held by Subco C and that Subco C will use the funds when received to make payments to XXXXXXXXXX by way of a return of capital on the Subco C shares. The return of capital is a reduction in arriving at the Purchase Amount of the Subco C Shares as described in paragraph 19 above.

25.With regard to the XXXXXXXXXX will provide for a calculation of excess cash flow from that property with respect to each fiscal period of XXXXXXXXXX which will be applied to reduce the capital of the Subco C shares (in the manner described in paragraph 30 below) on the dividend payment date which is closest to XXXXXXXXXX.

26.Notwithstanding the terms and conditions of the Subco A, Subco B (both referred to in the July 11 Ruling) and Subco C Shares, the reduction of capital to be made to the Subco A, B and C Shares that may be required by XXXXXXXXXX and the ECF formulations negotiated between XXXXXXXXXX an amount not less than the "excess cash flow for a fiscal period", as defined in paragraph 27 below ("ECF") shall be applied to either redeem or reduce the capital of the Subco A, B and C Shares within 120 days after the end of that fiscal period ("first ECF payout") except to the extent that all or part of that ECF, if any, is reasonably required to meet operating capital requirements that would not otherwise be met without borrowing additional funds in the immediately following fiscal period up to June 30 ("second ECF payout"). The balance of the ECF shall be applied to either redeem or reduce the capital of the Subco A, B and C Shares on or before the second ECF payout.

The purpose of the first and second ECF payouts are to provide for the cyclical nature of XXXXXXXXXX business. The second ECF payout ensures that XXXXXXXXXX has adequate cash flow to carry them through the winter months (the period between the first and second ECF payouts) where cash shortfalls are experienced rather than require that ECF be paid out in its entirety by the first ECF payout.

27.ECF shall be the change or increase in cash flow for such period of XXXXXXXXXX, as would be reported on a Consolidated Statement of Changes in Financial Position prepared in accordance with generally accepted accounting principles, if only directly or indirectly wholly-owned subsidiaries of XXXXXXXXXX, excluding XXXXXXXXXX, were so included, but before outlays for:

(a)the payment of dividends other than dividends paid on any DPS or dividends paid by any of XXXXXXXXXX directly or indirectly owned subsidiaries and dividends paid,
XXXXXXXXXX

(b)capital expenditures or any payment on capital account, other than in respect of the following:

(i) the purchase or redemption of any of the DPS other than purchases or redemptions made in the period in respect of the prior period's ECF,

(ii) repayments of indebtedness incurred in the normal and ordinary course of business and in existence at the date the DPS are issued,

(iii) repayments of additional debt incurred for the specific purpose of funding current operating requirements:

(iv) expenditures or payments between XXXXXXXXXX and its directly and indirectly wholly-owned subsidiaries;

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

(vi) repayments of additional debt incurred for the specific purpose of enabling Subco A, Subco B and Subco C to redeem or reduce the capital of the DPS or to pay dividends on the DPS;

(c)repayments of loans to shareholders of XXXXXXXXXX or persons related to shareholders; and

(d) loans to directors, officers and shareholders of XXXXXXXXXX or to other persons, firms or corporations except for any loan(s) between XXXXXXXXXX from any of their directly or indirectly owned subsidiaries;

For the purposes of this definition of ECF:

(1)the foregoing shall be adjusted as appropriate to avoid any unintended duplication of amounts;

(2) additional debt should not include a debt which arose as a result of the use of cash or funds for a purpose not envisaged herein, and

(3)where proceeds of insurance are received in a particular period in respect of damage or destruction to property and such proceeds are intended to be used in the immediately following period to repair or replace such property then those proceeds shall not be included in calculating ECF for the particular period but shall be included in calculating the ECF for the immediately following period, provided that such proceeds are set aside, with the consent of XXXXXXXXXX or other lenders as appropriate, in the particular period to repair or replace such property, and not used for any other purpose.

At XXXXXXXXXX, an inter-corporate balance of $XXXXXXXXXX was owed to XXXXXXXXXX from XXXXXXXXXX. Any increase in this balance will be added back in the calculation of the ECF calculation for the year it occurs. Any reduction on the XXXXXXXXXX inter-corporate account balance will be set aside and agreement reached between XXXXXXXXXX as to the application of these funds between capital expenditures and debt reduction on a pro-rata basis between the secured debt holders. If no agreement between the parties is reached then the amount of the reduction in the intercorporate account is to be applied on a pro-rata basis between the XXXXXXXXXX Debts and the XXXXXXXXXX Debt.

28.The articles of Subco C will provide that there will be no transfer of the common shares of Subco C without the consent of XXXXXXXXXX. XXXXXXXXXX has agreed not to create any encumbrance on the common shares which it owns in Subco C. A unanimous shareholders agreement to be entered into between the shareholders of Subco C will provide that XXXXXXXXXX as voting shareholder will vote such that:

(a)no transfer or encumbrance of the assets of Subco C will be made other than as permitted by the agreements relating to the refinancing; and

(b)other than as contemplated therein or in such refinancing agreements, Subco C will not carry on any activities; engage in any business transaction; incur indebtedness, create any security over its assets; make any guarantee; amalgamate, merge or consolidate; declare or pay any dividends (other than on the Subco C Shares); or purchase or redeem any of its shares (other than the Subco C Shares).

29.Subject to the operation of any applicable law to which Subco C is subject, Subco C will be wound up without any undue delay after the earlier of:

(a)the time at which all of the Subco C Shares are repurchased, redeemed or cancelled, or

(b)the fifth anniversary of the closing date.

If Subco C is precluded by law from repurchasing all of the shares issued by it by the time referred to in paragraph 29(b) above, then Subco C will repurchase the shares on the first business day thereafter that it is not so precluded.

30. XXXXXXXXXX.

31.XXXXXXXXXX will enter into share put and debt put/call agreements, support agreements, indemnity and other agreements. The rights of XXXXXXXXXX under the put agreements, support agreements, indemnity and other agreements will be secured by pledges of the common shares of Subco C by XXXXXXXXXX.

32.XXXXXXXXXX will agree to indemnify XXXXXXXXXX on a tax-adjusted basis for certain matters in relation to the Subco C Shares. Such indemnity may, in certain circumstances, be paid by the payment of additional dividends on the shares.

PURPOSE OF PROPOSED TRANSACTIONS

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

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 shares to be issued to XXXXXXXXXX, as described in paragraph 22 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 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) for that same period

and, accordingly, subsections 112(2.1), 112(2.2), 112(2.3) or 112(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 such shares during such period;

B.No amount will be included in the income of Subco C pursuant to paragraphs 12(1)(c) or 12(1)(x) or subsections 12(3), 12(9), 16(1), or 246(1) or section 9 of the Act in respect of capital contributions made or required to be made by XXXXXXXXXX to Subco C, as described in paragraph 24 above, nor will such amounts constitute proceeds of disposition, as defined in section 54 of the Act, to Subco C from the disposition by it of any property;

C.Section 80 of the Act will not apply to XXXXXXXXXX by virtue of the fact that interest will not be paid or payable by XXXXXXXXXX to Subco C in respect of the XXXXXXXXXX Debt referred to in paragraph 21 above or by virtue of the failure of Subco C to demand payment of the XXXXXXXXXX Debt;

D.Subject to paragraph 20(1)(e.1) of the Act, expenses incurred by Subco C in the course of borrowing money and issuing shares 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, of the Subco C Shares to XXXXXXXXXX, as described in paragraph 22 above, immediately after their issuance will be equal to the amount paid by XXXXXXXXXX for those shares;

F.The cost amount, within the meaning of subsection 248(1) of the Act, to Subco C of the XXXXXXXXXX Debt will, immediately after it is acquired from XXXXXXXXXX by Subco C, as described in paragraph 21 above, will equal the purchase price paid thereof;

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 Subco C, as described in paragraph 24 above;

H.If the XXXXXXXXXX Debt is reacquired by XXXXXXXXXX pursuant to agreements described in paragraph 31 above, the cost amount, within the meaning of subsection 248(1) of the Act, to XXXXXXXXXX, of the debt immediately after it is acquired will be the purchase price paid therefor;

I.No amount will be included in the income of XXXXXXXXXX pursuant to subsections 15(1) or 246(1) of the Act solely by virtue of the fact that interest will not be paid or payable by XXXXXXXXXX to Subco A in respect of the XXXXXXXXXX Debt as described in paragraph 21 above or as a result of the provision of the guarantee by Subco C to XXXXXXXXXX also described in paragraph 21 above;

J.Provided that the XXXXXXXXXX Debt arose from one or more loans made by XXXXXXXXXX in the course of its money lending business, the XXXXXXXXXX Debt reacquired by XXXXXXXXXX as described in paragraph 21 above 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)(l) and 20(1)(p) of the Act;

K.Subsection 112(4) of the Act will not apply to any loss realized by XXXXXXXXXX on the XXXXXXXXXX Debt subsequent to the reacquisition of this debt by XXXXXXXXXX in respect of any dividends received by XXXXXXXXXX on the Subco C Shares;

L.By virtue of paragraph 84(1)(c.3) of the Act, no dividend will be deemed to have been paid by Subco C when it increases its stated capital as described in paragraph 30 above;

M.No amount will be included in the income of Subco C pursuant to subsections 12(3), 12(9), 20(14) or section 9 of the Act in respect of the interest accrual described in paragraph 24 above;

N.An amount will be deductible by XXXXXXXXXX pursuant to paragraph 20(1)(c) of the Act in respect of the interest accrual described in paragraph 24 above only where the transfer described therein occurs in the taxation year in which the interest accrued.

O.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 preference shares of Newco 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 & Legislation Branch