30 November 1997 Ruling 9803323 - INTEREST DEDUCTIBILITY

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: Deductibility of interest in targetco which is profitable. Transfer of interest expense to operating subsidiary.

Position: OK

Reasons: Previously given in other rulings. Purpose and use of borrowing is to acquire preferred shares of Newco having a dividend rate > interest rate on borrowing.

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XXXXXXXXXX 		980332
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Attention: XXXXXXXXXX

XXXXXXXXXX, 1998

Re: XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letters of XXXXXXXXXX and various phone calls requesting an advance income tax ruling on behalf on the above noted taxpayers.

To the best of your knowledge and that of the above noted companies, none of the issues or matters involved in this advance income tax ruling request have been or are being considered by a District Tax Services Office or a Taxation Centre in connection with a tax return filed nor are any of the issues under objection and/or appeal.

In this letter, the following terms have the meanings specified:

a) Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1 as amended (the “Act”) and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated;

b) “Company A” means XXXXXXXXXX and is more fully described in paragraph 1 below;

c) “Company B” means XXXXXXXXXX and is more fully described in paragraph 1 below;

d) “Company C” means XXXXXXXXXX and is more fully described in paragraph 1;

e) “Company D” means XXXXXXXXXX and is more fully described in paragraph 3;

f) “Company E” means XXXXXXXXXX and is more fully described in paragraph 3;

g) “Company F” means XXXXXXXXXX and is more fully described in paragraph 4;

h) “Company G” means XXXXXXXXXX and is more fully described in paragraph 5;

i) “Company H” means XXXXXXXXXX and is more fully described in paragraph 8;

j) “Company I” means XXXXXXXXXX and is more fully described in paragraph 9;

k) “Company J” means XXXXXXXXXX and is more fully described in paragraph 14;

l) “Company K” meansXXXXXXXXXX and is more fully described in paragraph 13.

Facts

1. Company A, incorporated under the laws of XXXXXXXXXX, was formed to acquire the assets and liabilities of the Company B from XXXXXXXXXX an arm's length party. Company A is a taxable Canadian corporation and a private corporation under subsection 89(1) of the Act. Company A has authorized capital of XXXXXXXXXX common shares (without nominal or par value). A XXXXXXXXXX company, Company C, owns the one outstanding common share in Company A. The acquisition of Company B was completed on XXXXXXXXXX. The business number of Company A is XXXXXXXXXX.

2. Company C is an indirectly owned subsidiary of XXXXXXXXXX.

3. Company D was incorporated under the laws of XXXXXXXXXX. Company D is a taxable Canadian corporation and a private corporation under subsection 89(1) of the Act. Company D has authorized capital of XXXXXXXXXX common shares (without nominal or par value). A XXXXXXXXXX company, Company E, owns the one outstanding common share in Company D. Company E is an indirectly owned subsidiary of XXXXXXXXXX.

4. Company F is a public corporation and a taxable Canadian corporation under subsection 89(1) of the Act. The business number of Company F is XXXXXXXXXX. On XXXXXXXXXX, an offer was made by Company D to acquire all the outstanding common shares of Company F. Over XXXXXXXXXX% of the outstanding common shares of Company F have been acquired by Company D. The balance of the common shares are being acquired by Company D through an involuntary squeeze out.

5. Company G is a taxable Canadian corporation under subsection 89(1) of the Act. Company G has authorized capital consisting of XXXXXXXXXX non-voting, no par value preferred shares with a XXXXXXXXXX% non-cumulative dividend entitlement and XXXXXXXXXX no par value common shares. Company F owns all of the XXXXXXXXXX outstanding common shares. There are no preferred shares outstanding. The business number of Company G is XXXXXXXXXX.

6. Both Company D and Company A have borrowed funds from arm's length financial institutions to fund the purchases of Company F and Company B respectively.

The borrowings are in the amount of approximately $XXXXXXXXXX for Company A and $XXXXXXXXXX for Company D. The interest paid or payable on the $XXXXXXXXXX loan is deductible by Company D pursuant to paragraph 20(1)(c) of the Act.

7. Company C will purchase all of the issued and outstanding shares of Company D from Company E for fair market value. A Canadian tax clearance certificate under Section 116 of the Act will be applied for with respect to this purchase.

8. Company F will incorporate a new XXXXXXXXXX subsidiary ("Company H"). Company H's authorized capital will be comprised of no par value common shares. One common share will be issued to Company F for nominal consideration.

9. Company F's wholly-owned subsidiary Company G will be continued into the province of XXXXXXXXXX. Company I, a Canadian corporation in which Company G owns XXXXXXXXXX% of the issued and outstanding common shares, will remain as a separate legal entity.

10. Company F will transfer all of its assets (other than the shares in Company I and Company H) and liabilities to Company H. This transfer will be made pursuant to subsection 85(1) of the Act.

On the transfer of the assets and liabilities to Company H, Company F will receive a combination of shares of Company H and interest bearing debt of Company H.

11. Company F will commence procedures to wind-up into its parent, Company D, pursuant to subsection 88(1) of the Act.

12. Company C will transfer the shares of Company A to Company D in exchange for common shares of Company D, having a fair market value equal to the value of Company A and paid up capital equal to the paid up capital of Company A. This transfer will be made pursuant to subsection 85(1) of the Act. A Section 116 clearance certificate will be applied for on the transfer.

13. Company A, Company G and Company H will amalgamate pursuant to subsection 87(1) of the Act to form Company K.

Proposed Transactions

14. Company C will incorporate a new Canadian company incorporated in XXXXXXXXXX ("Company J"). Company J will be a taxable Canadian corporation and a private corporation as defined in subsection 89(1) of the Act. It’s taxation year-end will be XXXXXXXXXX.

15. Company J will have authorized share capital consisting of common shares and preferred shares. The preferred shares will be non-voting, cumulative dividend, redeemable and retractable. The cumulative dividends payable on the preferred shares will be calculated daily by reference to the redemption/retractable price of the preferred shares at a rate equal to XXXXXXXXXX Dividends will be payable annually in arrears on or before the year-end. Company C will acquire the common shares for nominal consideration.

16. Company K will borrow approximately $XXXXXXXXXX from a syndicate of arm's length financial institutions ("the Syndicate"). The loan will be used by Company K to purchase $XXXXXXXXXX of preferred shares in Company J and repay the $XXXXXXXXXX borrowed to fund the Company B acquisition. The interest rate on this loan is expected to be approximately XXXXXXXXXX.

The loan with the Syndicate will be guaranteed by non-Canadian companies controlled by XXXXXXXXXX. A market rate guarantee fee will be paid annually by Company K with respect to the guarantee and is expected to be approximately XXXXXXXXXX% of the principal amount.

17. Company D will amend its Articles of Incorporation to allow for a class of preference shares to be issued. The preferred shares will be non-voting, cumulative dividend, redeemable and retractable. The cumulative dividends payable on the preferred shares will be calculated daily by reference to the redemption/retraction price of the preferred shares at a rate equal to XXXXXXXXXX % and will be payable annually in arrears on or before the year-end.

18. Company J will purchase $XXXXXXXXXX of preferred shares in Company D.

19. Company D will repay the funds borrowed to finance the purchase of the Company F shares and interim financing costs.

20. On or before the last day of each year Company J will pay a dividend on the preferred shares to Company K. These dividend payments will be funded by the payment of dividends by Company D to Company J on Company D’ s preferred shares held by Company J.

To the extent that, on the date dividends are to be paid on Company D’s preferred shares, Company D does not have sufficient cash on hand, or sufficient earnings to legally pay a dividend the following transactions will occur:

(a) Company K will pay a dividend (to the extent legally allowed) on its common shares to Company D, to provide Company D with an amount sufficient to allow Company D to pay the dividends on its preferred shares;

(b) If necessary, additional funds will be contributed by Company C to Company D in the form of contributed surplus, if required to meet legal restrictions on the ability for Company D to pay dividends;

(c) Company D will then pay dividends on its preferred shares to Company J;

(d) Company J will use the funds received to pay dividends on its preferred shares to Company K.

Purposes Of The Proposed Transaction

The purposes of the proposed transactions are to combine the operations of Company F, G and B into one legal entity ( Company K ) so operating efficiencies can be achieved and thereby eliminate costs associated with maintaining several operating entities. It is also expected that financing can be obtained more readily and locally if the separate operating companies are combined into one legal entity. Effectively, the proposed transactions permit the application of interest charges with respect to the Company A and D debt against the operating income of Company K.

The combined entity will be incorporated in XXXXXXXXXX for legal reasons related to the citizenship of the board of directors and financial assistance provisions contained in the XXXXXXXXXX statutes.

Rulings Given

Provided that the preceding statements of fact are accurate and complete and the proposed transactions are carried out as described above, the following rulings are provided:

A. Provided that Company K has a legal obligation to pay interest on the $XXXXXXXXXX loan from the Syndicate referred to in paragraph 16 above, in computing its income for a taxation year, Company K will be entitled to deduct pursuant to paragraph 20(1)(c) of the Act the lesser of the interest paid or payable in respect of that year or a reasonable amount in respect thereof on the portion of the loan used to acquire the preferred shares of Company J provided that the preferred shares of Company J continue to be held for the purpose of gaining or producing income (other than income which would be exempt).

B. Provided that Company K is entitled to claim a deduction pursuant to paragraph 20(1)(c) of the Act on the interest paid or payable in respect of the $XXXXXXXXXX loan presently outstanding, pursuant to subsection 20(3) of the Act, it will be entitled to deduct, in computing its income for a taxation year, the lesser of the interest paid or payable in respect of the difference between the $XXXXXXXXXX loan from the Syndicate referred to in paragraph 16 above and the portion of the loan used to acquire the preferred shares of Company J, in respect of that taxation year or a reasonable amount thereof.

C. The guarantee fee paid by Company K will be deductible pursuant to paragraph 20(1)(e.1) of the Act, provided that the guarantee fee can reasonably be considered to relate solely to the year and is incurred for the purpose of borrowing money to be used for the purpose of gaining or producing income (other than income which would be exempt income).

D. The provisions of subsection 245(2) of the Act will not be applied as a result of the proposed transactions, in and by themselves as to redetermine the tax consequences confirmed in the rulings given.

These rulings are given subject to the general limitations and qualifications and qualifications set out in Information Circular 70-6R3 dated December 30, 1996 (“IC-70-6R3”) are binding on Revenue Canada, Taxation provided that the proposed transactions 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.

Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any tax implications of the facts and proposed transactions.

Opinion

As stated in subparagraph 15(i) of IC-70-6R3, we are not able to rule on your request with respect to Part I.3 since the advance ruling would require an opinion as to generally accepted accounting principles. However, it is our view that for purposes of Part I.3 of the Act, it is the legal nature of the financial instrument that governs its classification irrespective of its accounting treatment.

The foregoing opinion is given in accordance with the practice referred to in paragraph 22 of IC-70-6R3 and is not binding on Revenue Canada, Taxation.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate