25 November 1996 External T.I. 9636535 - MODIFICATIONS TO ECF 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:

1.whether the early repayment of Debentures is permitted from ECF

2. whether the acquisition of a significant interest in another entity operating a similar business or the entering into of a joint venture with this entity is considered as capital expenditures in the normal and ordinary course of the existing business of XXXXXXXXXX.

Position:

1.yes
2.no

Reasons:

1.The Debentures replaced existing debt of XXXXXXXXXX at the date the DPS were issued.

2.This would result in expansion of the existing business which is not permitted out of ECF

XXXXXXXXXX 963653

Attention: XXXXXXXXXX

November 25, 1996

Dear Sirs:

Re: XXXXXXXXXX

This is in reply to your letters of October 31, 1996, and November 19, 1996, wherein you requested our consideration as to the impact on the Excess Cash Flow of XXXXXXXXXX of certain contemplated transactions. Unless otherwise defined, all capitalized terms have the same meaning as assigned in the ruling issued on XXXXXXXXXX, 1996 in respect of XXXXXXXXXX (our reference 952975) (the "Ruling").

1.Subordinated Debentures

On XXXXXXXXXX issued Debentures with an aggregate principal amount of $XXXXXXXXXX to the XXXXXXXXXX Lenders pro rata in satisfaction of the same amount of the principal amount of the debt advanced under the XXXXXXXXXX Credit. The Debentures are non-interest bearing, subordinated to certain other debts of XXXXXXXXXX and repayable at maturity in five years from their issue date.

Debentures with an aggregate principal amount of $XXXXXXXXXX were also issued to XXXXXXXXXX pro rata in satisfaction of $XXXXXXXXXX of trade payables of XXXXXXXXXX owing to those persons (in aggregate). You have confirmed that these trade payables arose with respect to services provided with respect to XXXXXXXXXX business carried on in Canada in arms' length commercial transactions. In particular, the trade payables owing to XXXXXXXXXX arose with respect to rent for premises used in Canada, for XXXXXXXXXX in Canada and with respect to rental, legal, payroll and consulting services provided to XXXXXXXXXX. The trade payables owing to XXXXXXXXXX arose with respect to XXXXXXXXXX The trade payables owing to XXXXXXXXXX arose with respect to consulting services provided to XXXXXXXXXX.

XXXXXXXXXX is considering repaying some or all of the Debentures prior to their maturity for the present value of the Debentures at the date of repayment.

It is your position that such repayment of the Debentures would be treated in the same manner as the repayment of the original indebtedness which the Debentures replaced and should constitute a "repayment of indebtedness incurred in the normal and ordinary course of business and in existence at the date the Distress Preferred Shares were issued" as contemplated in paragraph 86(ii)(b) of the Ruling.

We confirm this position.

2.Possible Future Activities

You advise that XXXXXXXXXX is considering various business ventures and other participation opportunities relating to the current services XXXXXXXXXX Some of these will require XXXXXXXXXX to incur capital expenditures.

XXXXXXXXXX You enquire as to whether expenditures incurred in respect of these transactions would be considered as

" capital expenditures incurred in the normal and ordinary course of the existing business of XXXXXXXXXX" for purposes of paragraph (ii)(e) of the definition of ECF in paragraph 86 of the Ruling".

As noted in Information Circular 70-6R2 issued by Revenue Canada, Taxation in September, 1990, we do not provide opinions or rulings on alternative courses of action. Consequently, we will only provide the following general comments.

Pursuant to a telephone conversation on November 4, 1996, (XXXXXXXXXX), you have requested that we provide some guidelines with respect to what constitutes capital expenditures incurred in the normal and ordinary course of the existing business. We are unable to provide specific guidelines on this issue as it is primarily a determination of fact. However, we note that the purpose of the excess cash flow requirements is to provide us with additional comfort that the refinancing using distress preferred shares is a consequence of financial difficulty rather than for some other purpose such as expansion. In this regard we direct your attention to the comments made in the speech given by Brian Darling, Revenue Canada Taxation, at the 1992 Corporate Management Tax Conference, wherein he states that the limitations to the definition of Excess Cash flow are intended to

"restrict expenditures to those necessary to carry on the existing business as opposed to expanding the business."

Consistent with the foregoing comments, in our view, any expenditures incurred in order to acquire another entity or to otherwise expand the existing business, such as entering into a joint venture or XXXXXXXXXX, would be considered as expenditures incurred in expanding the business and, consequently, would not be permitted to be made from the excess cash flow of a corporation which has issued distress preferred shares.

Yours truly,

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