1998 Ruling 982599A - JOINT VENTURE - TAX SHELTER

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. Can a ruling with regard to "tax shelter" be given in a joint venture context?

2. Can the acquisition of property on behalf of joint venture participants commence before those participants are identified and the execution of the joint venture agreement?

Position:

1. Yes, in respect of interests in property to be acquired directly by participants.

2. No.

Reasons:

1. The ruling provided was in a format similar to that given in file 971152 and was only with respect to the "statements and representations" specified. In addition, confirmation was not provided as to the nature of the relationship to be created between the parties to the joint venture agreements, i.e., the determination of whether such relationship is in the nature of partnership rather than joint venture is appropriately to be made on an audit basis.

2. In our view, prior to such identification and the execution of the relevant agreements, investors could not be participants in a joint venture.

XXXXXXXXXX
XXXXXXXXXX 982599
XXXXXXXXXX

Attention: XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX, 1998

Dear Sirs:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter dated XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of XXXXXXXXXX. We acknowledge your additional correspondence as well as our various telephone conversations concerning this matter.

XXXXXXXXXX files its corporate income tax returns under account number XXXXXXXXXX, and is serviced by the XXXXXXXXXX Tax Services Office and the XXXXXXXXXX Tax Centre.

You advise that, to the best of your knowledge and that of the parties involved, none of the issues described herein is being considered by a Tax Services Office or a Tax Centre in connection with any tax return already filed or is the subject of any notice of objection or is under appeal.

Definitions

Unless otherwise stated, in this letter the following terms and expressions have the meanings specified below:

“A Co.” means XXXXXXXXXX.

“Acquisition Phase” means that portion of the joint venture program proposed to be carried out by A Co. on behalf of a Participant pursuant to an Agreement, commencing on or after the closing of the Offering and execution of that Agreement and terminating on the earlier of:

(a) XXXXXXXXXX; or

(b) The date upon which the Participant’s Participant Investment has been fully committed (or reasonably expected to be committed) for expenditure by A Co. and provided that A Co. has given written notice to that Participant of such termination.

“Act” means the Income Tax Act R.S.C. 1985 (5th Supp.), c.1 as amended to the date of this letter.

“Agreement” means the separate joint venture and participation agreement to be entered into between A Co. and each Participant as described in paragraph 17 below.

“B Co.” means XXXXXXXXXX.

“C Co.” means XXXXXXXXXX.

“Draft Document #1” means the draft document entitled XXXXXXXXXX.

“Draft Agreement” means the draft document entitled “XXXXXXXXXX”.

“Draft Offering Documentation” means Draft Document #1, the Draft Agreement as well as two draft documents entitled, respectively,XXXXXXXXXX.

“Joint Venture Program” means the XXXXXXXXXX to be carried out by A Co. on behalf of a Participant pursuant to an Agreement.

“Joint Venture Property” means, collectively, XXXXXXXXXX.

XXXXXXXXXX

“Offering” means the private offering of securities by A Co. described in paragraph 16 below.

XXXXXXXXXX

“Participant” means a person subscribing to the Offering and entering into a joint venture and participation agreement with A Co. as described in paragraph 17 below.

“Participant Investment” means the amount subscribed by a Participant under the Offering, i.e., either $XXXXXXXXXX or $XXXXXXXXXX or such other minimum amount permissible under applicable securities legislation, reduced for any brokerage fee associated with that subscription and increased for amounts contributed to A Co. as an agreed increase to that participant’s capital requirement during the Acquisition Phase.

“prescribed benefit” has the meaning assigned by subsection 231(6) of the Regulations.

“Prior Joint Ventures” means joint venture arrangements entered into between A Co. and various participants prior to those proposed to be entered into as described in paragraph 17 below.

“private corporation” has the meaning assigned to that expression by subsection 89(1) of the Act.

XXXXXXXXXX

“Regulations” means the Income Tax Regulations.

“taxable Canadian corporation” has the meaning assigned to that expression by subsection 89(1) of the Act.

“Y” means XXXXXXXXXX.

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

Facts

1. A Co. is a taxable Canadian corporation and a private corporation. It was incorporated on XXXXXXXXXX.

The authorized share capital of A Co. consists of XXXXXXXXXX non-cumulative voting redeemable preferred shares and XXXXXXXXXX common shares. The issued share capital of A Co. consists of XXXXXXXXXX common shares owned by B Co.

2. B Co. is a taxable Canadian corporation and a private corporation which is engaged in the XXXXXXXXXX business. It was incorporated on XXXXXXXXXX.

The authorized share capital of B Co. consists of an unlimited number of Class “A” Common shares and an unlimited number of non-voting Class “B” Preferred shares. The issued share capital of B Co. consists of XXXXXXXXXX Class “A” Common shares owned by Y who is an individual resident in Canada for purposes of the Act.

3. C Co. is a taxable Canadian corporation and a private corporation which was incorporated on XXXXXXXXXX. The authorized share capital of C Co. consists of an unlimited number of Class A shares while its issued share capital consists of XXXXXXXXXX Class A shares owned by Y. C Co. commenced carrying on XXXXXXXXXX business in XXXXXXXXXX.

4. A Co.’s business is to conduct XXXXXXXXXX.

XXXXXXXXXX

Under the agreements governing the above annual joint venture programs, A Co. acts as agent for the respective participants in conducting XXXXXXXXXX programs.

5. A Co. has no significant assets or liabilities. All XXXXXXXXXX assets held by A Co. are beneficially owned by joint venture participants.

6. To the best of A Co.'s knowledge, participants in the XXXXXXXXXX joint venture programs are individuals and corporations which are resident in Canada for purposes of the Act. Members of management and staff of A Co., B Co. and other persons related to A Co. for purposes of the Act .have generally participated in approximately XXXXXXXXXX % of the funding for XXXXXXXXXX joint venture program.

7. In addition to a participant's initial subscription, contributions of further capital are required by the participants in XXXXXXXXXX joint venture program as the properties are developed. For example, each participant in the XXXXXXXXXX joint venture program has been required to contribute total capital of $XXXXXXXXXX (including an initial $XXXXXXXXXX subscription) between XXXXXXXXXX.

8. XXXXXXXXXX joint venture program acquires XXXXXXXXXX assets, mainly in XXXXXXXXXX. Acquisitions fall within two categories: XXXXXXXXXX.

9. Under the agreements relating to a respective joint venture program, the participants directly acquire beneficial XXXXXXXXXX interests in the XXXXXXXXXX properties acquired and developed. Investors share in XXXXXXXXXX revenue and expenses and receive the benefit of certain income tax deductions and credits and government assistance, if any.

10. The joint venture agreement applicable to XXXXXXXXXX program gives A Co. the authority to commingle funds of all past and present joint ventures and of third parties. A Co. therefore commingles all funds including revenues, cash calls and receivables. These funds form part of the working capital balance required by A Co. to manage all XXXXXXXXXX joint venture activity.

11. A Co. also borrows from B Co. or C Co. to meet its working capital requirements. Those corporations have established bank lines of credit which they may borrow against if A Co. requires temporary working capital. Funds are borrowed by the particular corporation from the bank and then loaned to A Co. at competitive borrowing rates. Interest and administrative costs incurred by virtue of A Co.’s short-term borrowings are borne by the participants in the current year's joint venture program. However, the costs so borne are offset by any overhead recovered from the owners of XXXXXXXXXX and projects operated by A Co.

12. In its offering memorandum and any other document provided to prospective investors for a particular annual joint venture program, A Co. makes no financial projections for that joint venture, however, it reports the results of selected XXXXXXXXXX. For example, information concerning the XXXXXXXXXX was included in the offering memorandum for the XXXXXXXXXX and is intended to be included in the proposed offering described in paragraph 16 below.

None of the documents provided to prospective investors for XXXXXXXXXX has contained, or in the case of the joint venture program proposed to commence as described in paragraph 17 below, will contain, any statements or representations that would indicate any participant (including a Participant) could reasonably expect that deductions, in computing that participant’s income or taxable income under the Act, in respect of property acquired by that participant as a result of investing in the program would exceed the cost for purposes of the Act of such property (less any prescribed benefit) at the end of a particular taxation year ending within XXXXXXXXXX after acquiring such property. In addition, with regard to the XXXXXXXXXX joint venture program, in addition to such an excess of “deductions” over “cost less prescribed benefit” not occurring at the end of a particular taxation year ending within XXXXXXXXXX after acquiring such property, it has not occurred over the XXXXXXXXXX.

13. Tax shelter registration numbers were applied for and received pursuant to subsection 237.1(2) of the Act with respect to XXXXXXXXXX of A Co. and for the proposed private offering of securities described in paragraph 16 below. The applications were made to avoid exposure to potential penalties under subsection 237.1(7.4) although A Co. was of the view that the tax shelter rules did not apply.

14. You have indicated that none of the materials comprising the Draft Offering Documentation or any similar documentation concerning the private offering described in paragraph 16 below has been provided, or will have been provided, to any potential investor thereunder or to any third party, excluding directors, officers or employees of A Co., who will solicit such an investment, prior to the date of this letter.

15. No statements or representations have been made, or have been proposed to be made, to the date of this letter indicating that if a person were to acquire an interest in property as a result of entering into an Agreement, at the end of any particular taxation year ending within XXXXXXXXXX after the day on which the interest is acquired, the total amount determined under paragraph (a) of the definition of "tax shelter" in subsection 237.1(1) of the Act in respect of such interest would equal or exceed the amount determined under paragraph (b) of that definition of "tax shelter."

Proposed Transactions

16. A Co. will commence a private offering of securities, being the joint venture and participation agreements envisioned in paragraph 17 below, to residents of certain provinces in Canada pursuant to statutory exemptions which will require investors to make a minimum subscription of $XXXXXXXXXX or $XXXXXXXXXX depending upon the jurisdiction of residence (the former amount applying to residents of XXXXXXXXXX while the latter amount will apply to residents of XXXXXXXXXX) or such other minimum amount permissible under applicable securities legislation. This offering will be made by way of a confidential offering memorandum substantially in the form of Draft Document #1; no prospectus relating to the above securities will be filed with any jurisdiction.

Subscriptions to the offering will be solicited by A Co. and its directors and officers, and may also potentially be made through a securities broker. Although such brokers have been utilized XXXXXXXXXX, their involvement is not anticipated with regard to the XXXXXXXXXX joint venture program.

The confidential offering memorandum will indicate that the principal objectives of the above offering will be to provide investors with an opportunity to participate directly XXXXXXXXXX in XXXXXXXXXX properties.

The offering will not be subject to any aggregate minimum subscription level, however, A Co. hopes to raise between $XXXXXXXXXX and $XXXXXXXXXX therefrom. At a $XXXXXXXXXX subscription level, it is anticipated that participation by management, staff and persons related to A Co. will be slightly in excess of XXXXXXXXXX per cent. The subscription price will be payable as to $XXXXXXXXXX by certified cheque upon subscription with the remainder to be paid through monthly installments in XXXXXXXXXX such that the subscription price will be fully paid by XXXXXXXXXX. Subscription proceeds will be received by A Co. in trust pending closing of the offering which is expected to take place on or about XXXXXXXXXX.

All expenses associated with the offering will be paid by XXXXXXXXXX, and will not be paid from the subscription proceeds, with the exception of brokerage fees, if any, paid to a third party which will be paid from the proceeds of the particular subscriber obtained from the efforts of the broker. For the purposes of the joint venture program and, specifically, for the purposes of calculating the XXXXXXXXXX interest of such subscriber, the investment of a subscriber whose subscription is obtained through a broker will be the amount of that subscription less the specific brokerage fee associated therewith.

In the confidential offering memorandum, A Co. will indicate to potential investors that there is no public market for the contractual interest in the agreement described in paragraph 17 below or the XXXXXXXXXX interests in the Joint Venture Properties to be acquired as a result of investing in the offering, and it is not expected that such a market will develop.

17. Upon closing of the Offering, separate joint venture and participation agreements, substantially in the form of the Draft Agreement, between A Co. and each investor will be executed for the primary purpose of carrying out an XXXXXXXXXX. Investors will become participants in a joint venture and will earn XXXXXXXXXX in all XXXXXXXXXX properties acquired by A Co. (with limited exceptions) during the Acquisition Phase.

Each investor’s own XXXXXXXXXX with regard to the above XXXXXXXXXX properties will be equivalent to the proportion which that investor’s Participant Investment bears to the aggregate Participant Investment of all investors under the Offering.

18. All proceeds of the Offering, net of any brokerage fees, will be used during the Acquisition Phase by A Co. to XXXXXXXXXX. During the Acquisition Phase, A Co. may propose to Participants that the Participant's expenditure commitment be increased over the initial subscription. Each Participant can elect to participate or not participate in such additional Acquisition Phase expenditures.

Sufficient working capital for the Joint Venture is expected to, in part, be provided through borrowing from C Co., which in turn will borrow on its line of credit. Interest expense on any short-term borrowing from C Co. will be at C Co.’s competitive rates and will be included in a Participant's overhead expense.

19. The interests in XXXXXXXXXX properties to be acquired by A Co. after the execution of the respective Agreements, as referred to in the preceding paragraph, will be acquired by A Co. as agent for the respective Participants.

XXXXXXXXXX

XXXXXXXXXX

20. A Participant may discontinue participation in the joint venture program prior to the expiry of the Acquisition Phase, provided the written consent of A Co. is obtained and a termination fee in an amount equal to three times the Participant’s monthly fixed XXXXXXXXXX and administrative overhead fee (estimated to be $XXXXXXXXXX per month under the estimate described in paragraph 26 below) is paid to A Co.

If a Participant defaults under the obligation to pay the subscription amount as required from time to time, A Co. will charge the Participant interest at the XXXXXXXXXX on outstanding amounts from the date the funds were due.

Upon the above discontinuation of participation or default, A Co. will have the option of giving the Participant written notice that it has lost its right to continue in the joint venture program and, effective as of the date of such notice, the Participant will no longer be entitled to a share in the overhead recoveries described in paragraph 26 below and will be obligated to pay A Co. the termination fee described above.

21. Following the Acquisition Phase, the undeveloped XXXXXXXXXX and XXXXXXXXXX properties acquired by A Co. on behalf of the Participants will be managed, operated and developed by A Co. for the Participants.

Capital requirements subsequent to the Acquisition Phase will be funded by the Participants and will be in addition to the Participants original subscription under the Offering. A Co. anticipates that such future capital contributions will be required as the properties acquired during the Acquisition Phase are developed. Based on historical experience, A Co. anticipates that the Participants will be required to contribute additional capital of approximately $XXXXXXXXXX after the Acquisition Phase is completed; approximately $XXXXXXXXXX expected to be required in XXXXXXXXXX and $XXXXXXXXXX in XXXXXXXXXX.

Future funding requirements will be paid through monthly installments and deficient installments, upon notice from A Co., will bear interest at the XXXXXXXXXX calculated from the date the funds are due.

22. In the confidential offering memorandum provided to potential investors as contemplated in paragraph 16 above, A Co. will make the following comments in the “Offering Summary” section:

Income Tax Deductions

XXXXXXXXXX

XXXXXXXXXX.

XXXXXXXXXX

XXXXXXXXXX

In addition, in the “Canadian Federal Income Tax Consequences” section of the confidential offering memorandum provided to potential investors as contemplated in paragraph 16 above, A Co. will make the following comments:

Income Tax Deductions

XXXXXXXXXX

23. In the XXXXXXXXXX section of the confidential offering memorandum provided to potential investors as contemplated in paragraph 16 above, A Co. will include XXXXXXXXXX; one determined utilizing XXXXXXXXXX and one determined utilizing XXXXXXXXXX. Included in the information provided on each of those XXXXXXXXXX will be the following figures for cumulative XXXXXXXXXX invested by participants (which would include initial as well as additional capital contributions by participants) and XXXXXXXXXX:

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

On each of these schedules the line XXXXXXXXXX will contain a reference to the following XXXXXXXXXX to those schedules:

(10) Cumulative tax write-offs are tax shelter available to participants by virtue of their investment in itemized [A Co.] joint ventures based on capital as of XXXXXXXXXX. These write-offs were available to shelter net operating income from [A Co.] programs as well as other income. In no case is it anticipated that a participant’s cumulative income tax deductions exceed total capital employed at the end of each of the participant’s XXXXXXXXXX taxation years following the day the investment is made.

24. In the documentation provided to a potential investor in respect of the Offering, A Co. will :

i) make no statements or representations regarding the amount of any deductions in computing income or taxable income under the Act which may be available to a Participant except to the extent of the information described in paragraphs 22 and 23 above;

ii) indicate that XXXXXXXXXX tax credits may be available to Participants but will make no representation of the amounts nor the timing of any such credit (XXXXXXXXXX ); and

iii) indicate that all incentives, assistance, tax credits, and the like receivable under federal or provincial programs, if any, applicable to the XXXXXXXXXX of any Joint Venture Property will be shared by the Participants in proportion to their respective interests in such property.

25. The Agreement will contain, inter alia, the following provisions (the terms and expressions used in this paragraph have the meaning assigned by the Agreement as reflected below or as described in the listing above):

						XXXXXXXXXX 

       				XXXXXXXXXX 

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

26. Under the Agreements, A Co. will be authorized to, and it will, enter into a management agreement with C Co. Thereunder A Co. will, on behalf of all the Participants, engage C Co. to assist as manager of the XXXXXXXXXX joint venture program, in consultation with A Co., for a term of one year commencing XXXXXXXXXX. In particular, C Co. will be authorized to retain the services of managers and experts, such as engineers, evaluators and consultants and will provide administrative, accounting, financial, clerical and other general management services.

In order to recover the costs that C Co. is expected to so incur in XXXXXXXXXX, the Participants will be obligated under the Agreements to pay to A Co. during XXXXXXXXXX, in aggregate, a fixed XXXXXXXXXX and administrative overhead fee of $XXXXXXXXXX per month. Such fee will be borne by each Participant in the proportion which that Participant’s Expenditure Commitment is to the aggregate of such expenditure commitments of all Participants. Based upon a $XXXXXXXXXX Participant initial investment and a $XXXXXXXXXX aggregate initial investment commitment of all Participants, a Participant’s share of such fee would amount to $XXXXXXXXXX per month.

Subsequent to the Acquisition Phase, under the Agreement a Participant will pay to A Co. an administrative fee to reimburse A Co. for costs it incurs in continuing to manage Joint Venture Properties on behalf of the Participant. This fee will be XXXXXXXXXX per cent of the current year’s capital expenditures (excluding the Participant’s Expenditure Commitment) incurred by the Participant on the Joint Venture Properties subsequent to the Acquisition Phase. However, this fee will be waived during the period of time the Participant becomes liable for a portion of the fixed fee described in the preceding paragraph relating to a subsequent year’s joint venture program by virtue of investing in that program, provided such investment is at a level not less than that Participant’s Expenditure Commitment.

Overhead recoveries received by A Co. during the period from XXXXXXXXXX from participants in previous years’ joint venture programs by virtue of the above XXXXXXXXXX per cent fee, and/or pursuant to the XXXXXXXXXX, as well as any interest earned during that period on monies advanced to A Co. from time to time by the Participant and other parties (being participants in XXXXXXXXXX joint venture programs or parties to XXXXXXXXXX or projects operated by A Co. and which A Co. is not specifically obligated to distribute otherwise ) will be credited to the account of a Participant pro rata to their respective Expenditure Commitments. These overhead recoveries will credited to the Participants on a monthly basis during XXXXXXXXXX and A Co. estimates, but will give no assurances, that the aggregate of such recoveries will amount to $XXXXXXXXXX per month. Based upon a $XXXXXXXXXX Participant initial investment and a $XXXXXXXXXX aggregate initial investment commitment of all Participants, a Participant’s share of such recoveries would amount to approximately $XXXXXXXXXX per month.

As such, it is estimated that a Participant’s share of the above fixed XXXXXXXXXX and administrative overhead fee will be approximately $XXXXXXXXXX per month after crediting the estimated overhead recoveries described in the preceding paragraph.

The fixed XXXXXXXXXX and administrative overhead fee is established by A Co. as a cost recovery mechanism and anticipates certain third party and in-house consulting costs to be charged directly to projects and not to general overhead. When consulting costs can be identified with specific projects such charges are allocated accordingly. This is to assist with cost control as well as to have third parties, participants in prior year joint venture programs and the Participants bear costs appropriately.

27. Neither A Co., nor any party with which it does not deal at arm’s length for purposes of the Act, will offer funding assistance - debt or otherwise - to Participants in respect of their subscription under the Offering or their participation in the joint venture program described in paragraph 17 above. A Co. will make no representation in the documentation provided to potential investors in respect of the Offering regarding the income tax deductibility of any interest incurred should a Participant borrow funds for the purpose of such subscription or participation.

28. There is not, and it is not intended that there will be, any agreement or other arrangement under which a Participant has a right, either absolutely or contingently, to dispose of all or any part of the Participant's contractual interest in the Agreement or the XXXXXXXXXX in the Joint Venture Properties.

Purpose of the Proposed Transactions

29. The purpose of the proposed transactions is to XXXXXXXXXX.

Ruling Given

Provided that the above statements of facts, proposed transactions and purpose of the proposed transactions are accurate and constitute complete disclosure thereof, and that the proposed transactions are carried out as set forth herein, the following ruling is given:

Provided that, as of the date of this letter, the only statements and representations (as contemplated in the definition of “tax shelter” in subsection 237.1(1) of the Act) proposed to be made in connection with a Participant’s investment in property during the Acquisition Phase pursuant to an Agreement to be entered into after the date of this letter, are those described in paragraphs 22 through 24 above, we confirm that these statements and representations, in and by themselves, will not cause the Participant’s investment in such property to be a tax shelter within the meaning of subsection 237.1(1) of the Act.

However, nothing in this ruling should be construed as implying that the Participant’s investment in property during the Acquisition Phase pursuant to the Agreement will not become a tax shelter upon the happening of a future event or a future statement or representation, including any revision to the statements and representations described in paragraphs 22 through 24 above.

The above ruling is given subject to the general limitations and qualifications set forth in Information Circular 70-6R3 issued by Revenue Canada on December 30, 1996 and is also based on our understanding that the Draft Offering Documentation with respect to these facts and proposed transactions will, when finalized, be in accordance with the facts and proposed transactions set out above. The above ruling is binding on Revenue Canada provided that the closing of the Offering occurs by XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments thereto. Except as expressly stated, our rulings do not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions. In particular, nothing in this letter should be interpreted as confirming, either expressly or implicitly:

i) the nature of the relationship between the parties to an Agreement and, in particular, whether any such relationship alone, or in any number or combination of such relationships, would constitute a partnership;

ii) the income tax implications to an investor of entering into an Agreement;

iii) the classification, deductibility, reasonableness or fair market value of any expenditures, or assets to be acquired, referred to in this letter; or

iv) the amount of, or whether any particular amount would constitute, a prescribed benefit in respect of an interest in any property acquired by an investor as a consequence of entering into an Agreement.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch

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