1999 Ruling 9904683 - UTILIZATION OF DEDUCTIONS

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: Utilization of deduction and interest deductibility. Whether requirements of 66.7(1O)(h) are met to permit the designation of income for purposes of 66.7(2)b),

Position: okay

Reasons: Requirements of 66.7(1O((h) are met as are the requirements of 20(1)(c).

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xxxxxxxxxx 990468
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Attention: XXXXXXXXXX

XXXXXXXXXX, 1999

Dear Sirs:

Re: XXXXXXXXXX - Advance Income Tax Ruling

This is in response to your letter of XXXXXXXXXX, requesting an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge your letters of XXXXXXXXXX.

We understand that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling are being considered by a Tax Services Office or a Taxation Centre in connection with any tax return already filed, and none of the issues involved in the requested rulings is the subject of any notice of objection or is under appeal.

In this letter "the Act” means the Income Tax Act, RSC 1985, Fifth Supplement, c.1, as amended from time to time.

Facts

1. XXXXXXXXXX ("Aco") is a public corporation. Aco is engaged in the exploration for, and the development and production of, petroleum and natural gas within Canada and abroad both directly and through subsidiary corporations.

2. Aco owns all of the issued and outstanding shares of XXXXXXXXXX ("Bco") and XXXXXXXXXX ("Cco"). Each of Aco, Bco and Cco are taxable Canadian corporations.

3. Bco and Cco owned certain foreign resource properties and incurred foreign exploration and development expenses ("FEDE") in respect of these properties. Bco has approximately $XXXXXXXXXX of FEDE which it has not deducted for tax purposes. Cco has approximately $XXXXXXXXXX of FEDE which it has not deducted for tax purposes.

4. As a result of the acquisition of control of XXXXXXXXXX ("Dco"), the former parent of Bco and Cco, by Aco on XXXXXXXXXX, Bco and Cco are subject to the successor corporation provisions in subsection 66.7(2) and 66.7(10) of the Act with respect to the FEDE amounts referred to above. At that time Dco owned certain foreign resource properties and was also engaged in the exploration for, and the development and production of, petroleum and natural gas within Canada and abroad both directly and through subsidiary corporations.

5. Aco is the continuing corporation in respect of several amalgamations described below and as a result of which its current taxation year commenced on XXXXXXXXXX and will end on or before XXXXXXXXXX.

6. Aco has credit facilities in place (the "credit facilities") which currently provide Aco with available credit capacity of approximately $XXXXXXXXXX. Borrowings under the credit facilities are available in the form of prime rate loans and Canadian bankers' acceptances.

7. Aco owns all of the issued and outstanding shares of XXXXXXXXXX. Accordingly, Aco, Bco and Cco are specified financial institutions by virtue of paragraph (g) of the definition of “specified financial institution" in subsection 248(1) of the Act. The acquisition of the shares of Bco and Cco did not occur in the ordinary course of the business carried on by Aco. There are not, and will not be at any time prior to the completion of the Proposed Transactions described herein, any guarantee agreements of the type described in subsection 112(2.2) of the Act in respect of any of the issued and outstanding shares of Bco or of Cco. Neither Bco nor Cco has entered into, or will enter into, a dividend rental arrangement in respect of any of their issued and outstanding shares. None of the circumstances described in subsection 112(2.4) of the Act will apply to any of the issued and outstanding shares of Bco or Cco. Neither Bco nor Cco is a financial intermediary corporation nor a restricted financial institution.

Proposed Transactions

8. Aco will borrow by way of one or more loans at a fixed rate of interest from its lead banker, XXXXXXXXXX. The loans will bear interest at a commercial rate. If the loans are outstanding for less than one day, a full day's interest will nevertheless accrue on the loans.

9. Aco will immediately use the borrowed funds to acquire from Bco and from Cco additional Class A common shares of each of Bco and Cco for cash consideration of $XXXXXXXXXX per share.

1O. Each of Bco and Cco will add to the stated capital account maintained by it in respect of its Class A common shares the full amount of the cash consideration received by it from Aco as consideration for the issuance of the shares. Each of Bco and Cco will immediately deposit the funds received by them with the same Bank and will earn a rate of interest on the funds that is slightly less than the rate of interest referred to in paragraph 8. If the deposits are outstanding for less than one day, a full day's interest will nevertheless accrue on the deposits.

11. Each of Bco and Cco will thereafter and on the same day withdraw the funds from the deposits and lend the proceeds to Aco. The terms of each loan will be as follows:

a) All or any portion of the principal amount of each loan will be repayable by Aco to the particular lender XXXXXXXXXX days after demand by the lender for repayment. Aco will also be able to repay all or any portion of the principal amount of each loan at any time without premium or penalty.

b) Each loan will bear interest at a fixed rate equal to the rate of interest payable by Aco under the borrowings described in paragraph 8, plus XXXXXXXXXX%.

c) Interest on each loan will accrue daily on principal and will be payable on or before December 30 of each year. Interest will also accrue daily at the same rate on interest that is not paid when due and will itself be payable on the last business day of each taxation year of the lender.

d) The terms and conditions of each loan will be in writing and will be governed by the laws of XXXXXXXXXX.

12. Aco will use the proceeds of the loans from Bco and Cco to immediately repay the loans referred to in paragraph 8 above.

13. The total amount borrowed by Aco from the Bank will not exceed the credit limit available to Aco under the credit facilities. Therefore, the total amount paid by Aco for the Class A common shares of Bco and Cco will not exceed the amount that Aco could reasonably be expected to borrow at one time for use in its business.

14. Aco and each of Bco and Cco will agree to have the provisions of paragraph 6G.7(10)(h) of the Act apply to them in respect of the current taxation year of Aco referred to in paragraph 5 above. Aco will be the “transferor" referred to in paragraph 66.7(10)(h). Aco and each of Bco and Cco will notify the Minister in writing of their agreement in the return of Aco under Part I for that taxation year. In that return. Aco will designate, pursuant to paragraph 66.7(10)(h) of the Act and in respect of that taxation year, an amount in favour of Bco and an amount in favour of Cco. The total of all amounts each of which is an amount so designated will not exceed Aco's income for that taxation year that may reasonably be regarded as being attributable to:

a) the production from foreign resource properties owned by Dco at the time of the acquisition of Dco referred to in paragraph 4 above, and

b) the disposition of any foreign resource properties owned by Dco at the time of the acquisition of Dco,

determined without taking into account any deductions available to Aco under sections 65 to 66.5 and section 66.7 of the Act.

15. Aco expects that the amounts that it will designate will be sufficient to allow each of Bco and Cco to fully deduct their respective successor FEDE referred to in paragraph 3 above in their taxation years that will end on XXXXXXXXXX.

16. Each of Bco and Cco will earn interest income under the particular loan made by it to Aco. Each will declare and pay dividends to Aco on their Class A common shares which dividends will be paid out of the interest income earned by them. Each of Bco and Cco may reduce their corporate stated capital account in respect of their Class A common shares, without any distribution of property, to an amount that will, under corporate law, allow the interest income to be paid to Aco by way of dividend

17. As soon as each of Bco and Cco have earned sufficient interest income to allow the deduction of the full amount of their respective successor FEDE referred to in paragraph 3 above, Aco will repay the loans to Bco and Cco described in paragraph 11 above. It is expected that this will occur on or before XXXXXXXXXX. Aco will make these repayments by issuing a Note to each of Bco and Cco.

18. Each note will clearly indicate that they were issued as payment for and in satisfaction of all obligations in respect of the loans referred to in paragraph 11 above and will be interest-free and payable on demand.

Other Information

19. All of the amalgamations described herein involved a parent corporation and a subsidiary corporation all of the shares of which were owned by the parent and were subject to the rules in section 87 of the Act. In respect of each amalgamation, the amalgamated corporation has continued to use the name Aco.

XXXXXXXXXX

20. At the time control of Bco was acquired, Bco owned an interest in a foreign resource property located in XXXXXXXXXX but did not own any Canadian resource properties and had non-capital losses. At that time Bco owed Dco $XXXXXXXXXX which had been loaned by Dco to Bco to fund its operations, the fair market value of which was significantly less than its principal amount such that the adjusted cost base of this debt was reduced to that fair market value pursuant to paragraph 111(4)(c) of the Act. Subsequently, Bco transferred XXXXXXXXXX% of the beneficial interest in the XXXXXXXXXX property to Dco in consideration of an interest-free note payable on demand. Each of these debts is still outstanding. The liabilities of Bco exceed its assets such that Bco is insolvent. As of XXXXXXXXXX the non-capital losses of Bco were $XXXXXXXXXX. Bco currently has no source of income,

21. At the time of the acquisition of control of Cco, Cco did not own any foreign resource properties or Canadian resource properties. It did, however, own at that time, and has continued to own, an interest in XXXXXXXXXX and had non-capital losses. At the time of the acquisition of control, Cco owed Dco $XXXXXXXXXX which had been loaned by Dco to Cco to fund its operations. The fair market value of this loan was significantly less than its principal amount at the time of the acquisition of control, and therefore the adjusted cost base to Dco of this debt was reduced to that fair market value pursuant to paragraph 111(4)(c) of the Act and is still outstanding. The liabilities of Cco exceed its assets such that Cco is insolvent. As of XXXXXXXXXX the non-capital losses of Cco were $XXXXXXXXXX. Cco currently earns income from the XXXXXXXXXX.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to allow for the consolidation of the undeducted successor FEDE of each of Bco and Cco with the outlays and expenses of Aco.

In its current taxation year, Aco has disposed of some of the foreign resource properties that were owned by Dco at the time that Aco acquired Dco. One effect of these dispositions is that it will reduce the amount of income Aco will have from production from foreign resource properties originally owned by Dco and will therefore reduce the amount that Aco can thereafter designate in favour of Bco and Cco under paragraph 66.7(1O)(h).

Aco currently expects to have sufficient deductions in computing its income and taxable income such that it will not have any tax payable under Part I of the Act at least until its XXXXXXXXXX taxation year. Although Aco is not currently cash taxable, it is prudent to take steps tc consolidate the successor FEDE deductions of Bco and Cco into Aco before the end of Aco's current taxation year.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Provided that:

a) Bco and Cco were each a wholly-owned subsidiary of Dco immediately before and at the time of the acquisition of control by Aco,

b) throughout the taxation year ending XXXXXXXXXX of Aco, Aco owns all of the issued and outstanding shares of each of Bco and Cco,

c) Aco and each of Bco and Cco enter into an agreement to have paragraph 66.7(1O)(h) of the Act apply to them in respect of that taxation year and notify the Minister in writing of the agreement in the return of income under Part I of the Act of Aco for that taxation year, and

d) Aco designates, in respect of that taxation year, an amount in favour of Bco and an amount in favour of Cco, and the total of the amounts so designated does not exceed the income of Aco for that taxation year that may reasonably be regarded as being attributable to:

i) the production from foreign resource properties owned by Dco at the time of the acquisition of Dco referred to in paragraph 4 above, and

ii) the disposition of any foreign resource properties owned by Dco at the time of the acquisition of Dco referred to in paragraph 4 above,

determined without taking into account any deductions available to Aco under sections 65 to 66.5 and section 66.7 of the Act,

the amount so designated in favour of Bco and Cco, as the case may be, will, pursuant to subparagraph 66.7(1O(h)(v) of the Act, be an amount referred to in clauses 6"6.7(2)(b)(i)(A) or (B) of the Act in respect of Bco or Cco, as the case may be, for its taxation year in which that taxation year of Aco ends. Amounts so designated will be excluded from the amounts referred to in clauses 66.7(2)(b)(i)(A) or (B) of the Act in respect of Aco for that taxation year of Aco pursuant to subparagraph 66.7(1O)(h)(vi) of the Act.

B. Provided that Aco acquires and holds the Class A common shares of Bco and Cco, respectively, for the purpose of gaining or producing income therefrom, Aco will be entitled, pursuant to paragraph 20(1)(c) of the Act, to deduct in computing its income for a taxation year, an amount paid in that taxation year or payable by it in respect of that taxation year (depending upon the method regularly followed by Aco in computing its income) in respect of interest on the loans made by Bco and Cco, as the case may be, and referred to in paragraph 11 above, or a reasonable amount in respect thereof, whichever is the lesser.

C. Dividends declared by Bco and Cco on their Class A common shares and received by Aco will be included in Aco's income for the taxation year of Aco in which the dividends are received pursuant to subsection 82(1) of the Act, and will be deductible in computing the taxable income of Aco for that taxation year pursuant to subsection 112(1) of the Act. The deduction under subsection 112(1) will not be denied by any of subsections 112(2.1), (2.2), (2.3) or (2.4) of the Act.

D. Part VI.1 will not apply to the dividends paid to Aco by Bco and Cco on their Class A common shares owned by Aco because the dividends will be excluded dividends pursuant to paragraph (a) of the definition of "excluded dividend" in subsection 191(1) of the Act.

E. Part IV.1 will not apply to the dividends received by Aco from Bco and Cco on their Class A common shares owned by Aco because the dividends will be "excepted dividends" pursuant to paragraph (b) of the definition of "excepted dividend" in section 187.1 of the Act.

F. The difference between the amount paid by Aco for the Class A common shares of each of Bco and of Cco, as described in paragraph 9 above, and their respective fair market values at the time of acquisition by Aco will be regarded as a contribution of capital for the purposes of paragraph 53(1)(c) of the Act and in each case the difference will be added to the adjusted cost base of the Class A common shares of Bco or of Cco, as the case may be.

G. None of subsections 15(1), 56(2) or 246(1) of the Act will apply as a result of any of the Proposed Transactions.

H. 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 set out in Information Circular IC 70-6R3 dated December 30, 1996, and are binding on Revenue Canada, Taxation provided that the proposed transactions described in paragraphs are completed by XXXXXXXXXX.

Yours truly,

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