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) capitalization of interest by the contractor in building a water treatment facility for a city and
2) whether the transactions in which the building\facility is sold to city under an arrangement by which the builder will operate the factility for XXXXXXXXXX years would be recharacterized as a leaseback arrangement
Position:
ruled as requested that 1) the interest incurred during the building of the facility must be capitalized by reason of 18(3.1) and that 2) we would not recharacterize the transaction
Reasons:
1) water treatment facility is a building and thus, interest incurred during the period of construction must be capitalized
2) As structured, the City will pay for the facility in full, with the advance payments received in respect of the lease and license given to the contractor - 18(9) will ensure that lease payments are deductible over the period of the lease and not in the initial year when paid and payable
Note that although there is nothing to suggest that the amounts paid for the lease & license are unreasonable, we cannot rule on whether the quantum is reasonable
XXXXXXXXXX 971512
XXXXXXXXXX
Attention: XXXXXXXXXX
XXXXXXXXXX, 1998
Dear Sir:
Re: Advance Income Tax Ruling
XXXXXXXXXX
This is in reply to your request for an advance income tax ruling dated XXXXXXXXXX, concerning the proposed building and operation of a water treatment plant for XXXXXXXXXX (the “City”). We acknowledge receipt of additional submissions dated XXXXXXXXXX.
Facts
1. XXXXXXXXXX is an indirectly held wholly-owned subsidiary of XXXXXXXXXX and is a taxable Canadian corporation as defined under subsection 89(1) of the Income Tax Act (the “Act”). XXXXXXXXXX is a non-resident corporation.
2. XXXXXXXXXX is a Canadian-controlled private corporation as defined under subsection 125(7) of the Act and is incorporated in the province of XXXXXXXXXX. The XXXXXXXXXX Group is an alliance between XXXXXXXXXX.
3. The City needs a new water treatment plant (Facility). To this end, a proposal for the design, construction, financing, and operation of a Facility has been submitted to the City by the XXXXXXXXXX Group.
4. XXXXXXXXXX is a taxable Canadian corporation as defined under subsection 89(1) of the Act and is incorporated under the laws of XXXXXXXXXX.
Proposed Transactions
5. XXXXXXXXXX will enter into three agreements with the City, namely, a Development Agreement, a Lease Agreement and an Operating Agreement as described below.
Development Agreement
6. XXXXXXXXXX will construct the Facility for a guaranteed price of $XXXXXXXXXX by a specific date. The construction price will be subject to adjustment only for certain events which increase construction costs, and only if such events are not the result of negligence or willful misconduct of XXXXXXXXXX.
7. XXXXXXXXXX will provide all funds necessary during construction, through equity or indebtedness incurred by XXXXXXXXXX. XXXXXXXXXX will source its initial capital for the project from equity sources from its two corporate shareholders and project financing debt from an arm's length party. Debt will comprise approximately XXXXXXXXXX% of the total initial capital or $XXXXXXXXXX and equity will comprise approximately XXXXXXXXXX% of the total initial capital or $XXXXXXXXXX.
8. XXXXXXXXXX will contribute XXXXXXXXXX% of the total equity component or $XXXXXXXXXX from internal liquid funds. XXXXXXXXXX will contribute the remaining XXXXXXXXXX% of the total equity or $XXXXXXXXXX from its internal liquid funds.
9. XXXXXXXXXX will provide certain insurance for the Facility and performance bonds for construction. XXXXXXXXXX will indemnify the City for XXXXXXXXXX negligence and willful misconduct. The City will indemnify XXXXXXXXXX for, among other things, pre-existing environmental conditions and subsurface conditions.
10. Ownership of the Facility will be transferred to the City only after it is constructed and has passed specific performance tests set forth in the Development Agreement. At the end of the construction period and at the commencement of the operating period, XXXXXXXXXX will test the Facility and transfer it to the City for the amount of $XXXXXXXXXX.
Lease Agreement
11. XXXXXXXXXX will enter into the Lease Agreement with the City to obtain the rights to use the Facility for a period of XXXXXXXXXX years. The amount of $XXXXXXXXXX to be paid under this lease is the result of negotiations between the City and XXXXXXXXXX. The full amount of the payments required under the lease are due at the commencement of the lease period.
12. The Lease Agreement contains no provision for renewal of the lease. Upon termination of the lease, the City will take control of the water treatment operations, unless the City extends or renegotiates the Operating Agreement (see paragraphs 13 to 17 below).
Operating Agreement
13. XXXXXXXXXX will enter into an Operating Agreement to obtain the exclusive right to sell water to the City for a XXXXXXXXXX year period. The determination of the amount XXXXXXXXXX will pay the City for the exclusive license/right is the result of negotiations between XXXXXXXXXX and the City. The aggregate of amounts paid by XXXXXXXXXX to the City at the commencement of the operating period for the lease of the Facility and for the right to sell water to the City will equal the City's cost of the Facility. Consequently, there will be no net cash outlay by the City at the point the Facility is transferred to the City (see paragraph 10 above).
14. The City will pay an annual water fee, the price of which will be determined by agreement, structured to include a fixed capital cost component, a fixed operating cost component and a unit consumption cost component. The annual water fee will be subject to adjustment for inflation and the unforeseen increase in costs resulting from changes in applicable law and force majeure events.
15. Based on the design and performance criteria negotiated with the City, the first year’s total annual water fee, payable upon commencement of commercial operations, will be $XXXXXXXXXX. Such fee is comprised of a fixed capital cost of $XXXXXXXXXX, a fixed operating cost of $XXXXXXXXXX, and a consumption unit rate of XXXXXXXXXX.
16. Under the Operating Agreement, XXXXXXXXXX will assume the management, operating and maintenance risks and guarantee volume and quality output for a period of XXXXXXXXXX years.
17. XXXXXXXXXX will make all capital improvements to the Facility over the XXXXXXXXXX year term of the Operating Agreement and will make all repairs to the Facility as a result of a force majeure and will provide insurance for such eventualities.
Purpose of the Proposed Transactions
18. The purpose of the proposed transactions is to develop a long-term relationship between XXXXXXXXXX and the City for the purpose of designing, constructing, and operating a new Facility in the City. Under the proposed arrangement, XXXXXXXXXX will assume responsibility for all of the City's water treatment operations in order to provide a more economical, reliable and integrated service. This arrangement will provide the City, and its surrounding areas, with high quality water that meets or exceeds Canadian Drinking Water Specifications at the lowest possible cost to the City and its rate payers.
19. To the best of your knowledge and that of your clients, none of the issues involved in the requested rulings is being considered by an office of Revenue Canada in connection with a tax return already filed, and none of such issues is the subject of any notice of objection or is under appeal.
Advance Income Tax Rulings Given
Provided that the above statements of the facts and the proposed transactions are accurate and constitute a complete disclosure of all the relevant facts and proposed transactions, and that the proposed transactions are executed as proposed herein, we confirm that:
A. The license given to XXXXXXXXXX by the City pursuant to the Operating Agreement for the exclusive right to sell water to the City for a period of XXXXXXXXXX years constitutes property described in Class 14 of Schedule II of the Income Tax Regulations ("Regulations") and XXXXXXXXXX will be entitled to deduct capital cost allowance in respect thereto under paragraph 20(1)(a) of the Act to the extent provided by paragraph 1100(1)(c) of the Regulations.
B. Any capital expenditures incurred by XXXXXXXXXX in respect of the Facility during the period of the Operating Agreement will be considered to be leasehold improvements of XXXXXXXXXX and will be included in class 13 of Schedule II of the Income Tax Regulations.
C. XXXXXXXXXX will be entitled to deduct capital cost allowance in respect of the leasehold improvements referred to in ruling B above, under the provisions of paragraph 20(1)(a) of the Act to the extent provided by paragraph 1100(1)(b) of the Regulations.
D. The payments made by XXXXXXXXXX in a taxation year pursuant to the Lease Agreement will, subject to section 67 and subsection 18(9) of the Act, be deductible by XXXXXXXXXX in computing its income for tax purposes for that taxation year in accordance with section 9 of the Act.
E. The financing costs incurred during the construction of the Facility on the loans payable by XXXXXXXXXX to its creditors will be capitalized by reason of subsection 18(3.1) of the Act and taken into account in determining the inventory cost to XXXXXXXXXX of the Facility.
These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R3 dated December 30, 1996 issued by the Department of National Revenue, Taxation and are binding on the department provided that the construction of the water treatment plan commences on or before XXXXXXXXXX.
Yours truly,
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
XXXXXXXXXX
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