2011 Ruling 2011-0411821R3 - Interest deductibility and loss carry backs

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.

Principal Issues: Will Amalco be entitled to deduct interest, pursuant to paragraph 20(1)(c), on borrowed money previously used by its predecessor to fund a return of capital? 2. Will subsection 87(2.11) apply to the amalgamation? 3. Will subsection 245(2) be applied to the transactions?

Position: 1. Yes 2. Yes 3. No

Reasons: 1. The requirements of the provision are met. 2. The requirements of the provision are met. 3. The transactions are not avoidance transactions.

XXXXXXXXXX
						2011-041182

XXXXXXXXXX , 2011

Dear XXXXXXXXXX :

Subject: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the additional information that you provided in your subsequent email correspondences the last of which was received on XXXXXXXXXX .

This letter is based solely on the facts, Proposed Transactions and additional information described below. Any documentation submitted in respect of your request does not form part of the facts, Proposed Transactions and additional information, and any references thereto are provided solely for the convenience of the reader.

To the best of your knowledge, and that of the above-noted taxpayers, none of the issues involved in this advance income tax ruling are:

(i) in an earlier tax return of the above-noted taxpayers or of a related person;

(ii) being considered by a Tax Services Office or a Taxation Centre in connection with a previously filed tax return of the above-noted taxpayers or of a related person;

(iii) under objection by the above-noted taxpayers or by a related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously considered by the Income Tax Rulings Directorate in connection with the above-noted taxpayers or a related person.

Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter (the "Act") or the Income Tax Regulations (the "Regulations"), and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the facts, Proposed Transactions and the purpose of the Proposed Transactions is as follows:

Definitions

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

a) "ACB" has the meaning assigned to "adjusted cost base" by section 54 of the Act;

b) "Aco" means XXXXXXXXXX further described in 5 below;

c) "Amalgamation" means the transaction described in 23 below;

d) XXXXXXXXXX

e) "Bco" means XXXXXXXXXX further described in 4 below;

f) "Bco Shares" means all of the issued and outstanding shares of Bco further described in 4 below;

g) "BForCoop" means XXXXXXXXXX further described in 2 below;

h) "BForHoldco" means XXXXXXXXXX further described in 3 below;

i) "BForLP" means XXXXXXXXXX further described in 1 below;

j) "Contributed Capital" means contributed capital as that term is described in paragraph 23 of Interpretation Bulletin IT-533, entitled 'Interest Deductibility and Related Issues';

k) "Daylight Loan" means the loan described in 10 below;

l) "FMV" means fair market value;

m) "New Opco" means the new corporation formed by way of a vertical short-form amalgamation of Bco and Opco as described in 23 below;

n) "Opco" means XXXXXXXXXX further described in 6 below;

o) "Opco Class A Common Shares" means all of the issued and outstanding Class A common shares of Opco further described in 7 below;

p) "Opco Class B Common Shares" means all of the issued and outstanding Class B common shares of Opco further described in 8 below;

q) "Opco New Class A Preferred Shares" means the shares described in the preamble of 16 below;

r) "Opco New Class B Preferred Shares" means the shares described in 16 c. and 19 below;

s) "Opco New Class C Common Shares" means the shares described in 16 a. and 17 below;

t) "Opco New Class C Preferred Shares" means the shares described in 16 d. and 20 below;

u) "Opco New Class D Common Shares" means the shares described in 16 b. and 18 below;

v) "Opco Preferred Shares" means all of the issued and outstanding preferred shares of Opco further described in 7 below;

w) "Proposed Transactions" means the transactions described in 10 to 24 below;

x) "PUC" has the meaning assigned to "paid-up capital" by subsection 89(1) of the Act;

y) "related" has the meaning assigned by section 251 of the Act;

z) "Share Exchange" means the proposed transaction described in 22 below;

aa) "Sub Debt" means the debt described in 11 below;

bb) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act; and

cc) "Tuck-Under" means the proposed transaction described in 21 below.

Facts

1. BForLP is a XXXXXXXXXX limited partnership. Each of the limited partners of BForLP owns less than a XXXXXXXXXX percent interest in BForLP. All of the limited partners of BForLP deal at arm's length with each other.

2. BForCoop is a XXXXXXXXXX holding co-operative and is a resident of XXXXXXXXXX and a non-resident of Canada for Canadian income tax purposes. Substantially all of the membership interests in BForCoop are held by BForLP.

3. BForHoldco is a holding company and is a resident of XXXXXXXXXX and a non-resident of Canada for Canadian income tax purposes. All of the issued and outstanding shares of BForHoldco are owned by BForCoop.

4. Bco is a taxable Canadian corporation incorporated under the XXXXXXXXXX and its mailing address XXXXXXXXXX . Bco files its tax return with the XXXXXXXXXX Tax Services Office and otherwise deals with the XXXXXXXXXX Taxation Centre. The Bco Shares are owned by BForHoldco. BForHoldco's ACB and PUC of the Bco Shares is approximately $XXXXXXXXXX . The Bco Shares are not "taxable Canadian property" as defined in subsection 248(1) of the Act.

5. Aco is a taxable Canadian corporation.

6. Opco is a taxable Canadian corporation incorporated under the XXXXXXXXXX and its mailing address is XXXXXXXXXX . The principal business of Opco is XXXXXXXXXX . Opco files its tax return with the XXXXXXXXXX Tax Services Office and otherwise deals with the XXXXXXXXXX Taxation Centre.

7. Aco owns the Opco Class A Common Shares and the Opco Preferred Shares. The Opco Class A Common Shares are without par value; the FMV of these shares is approximately $XXXXXXXXXX , and their ACB and PUC are a lower amount. The Opco Class A Common Shares give Aco a XXXXXXXXXX voting and equity interest in Opco. The Opco Preferred Shares are non-voting, non-par value, and have a redemption value of approximately $XXXXXXXXXX . Aco holds the Opco Class A Common Shares and Opco Preferred Shares as capital property.

8. Bco owns the Opco Class B Common Shares. Bco's Contributed Capital was used to purchase the Opco Class B Common Shares. The Opco Class B Common Shares are without par value, and their ACB, PUC, and FMV is approximately $XXXXXXXXXX . The Opco Class B Common Shares give Bco a XXXXXXXXXX voting and equity interest in Opco.

9. Bco and Aco are not related and deal at arm's length with each other. Neither Bco nor Aco has any rights which, if exercised, would allow either one of them de jure control of Opco.

Proposed Transactions

Daylight Loan and Sub Debt

10. BForLP obtains a daylight loan from an arm's length lender in the principal amount of $XXXXXXXXXX (the "Daylight Loan").

11. BForLP uses the proceeds from the Daylight Loan to lend $XXXXXXXXXX , with interest, to Bco (the "Sub Debt"). Interest is calculated in arrears on the last day of each month, non-compounding, and is payable upon maturity of the Sub Debt. The term of the Sub Debt is XXXXXXXXXX subject to extension by either BForLP or Bco (and following the Amalgamation, New Opco). The rate of interest will be an arm's length rate that is reflective of prevailing market rates for debts with similar terms and credit risks. Bco issues a debenture to BForLP evidencing the Sub Debt.

Capital Reduction

12. Bco uses the proceeds from the Sub Debt to reduce the PUC of the Bco Shares by $XXXXXXXXXX and to distribute that amount to BForHoldco as a return of capital. The aggregate principal amount of the Sub Debt used to fund the return of capital will not exceed Bco's Contributed Capital that was being used for purposes that would have qualified for interest deductibility had the Contributed Capital been borrowed money.

13. BForHoldco uses the proceeds from the return of capital in 12 above to reduce its share capital by $XXXXXXXXXX and to distribute that amount to BForCoop.

14. BForCoop uses the proceeds from the return of capital in 13 above to reduce its capital by $XXXXXXXXXX and to distribute that amount to BForLP.

15. BForLP uses the proceeds from the return of capital in 14 above to repay the Daylight Loan.

Reorganization of the Authorized Share Capital of Opco

16. Opco alters its authorized share capital by renaming the Opco Preferred Shares as Class A Preferred Shares (the "Opco New Class A Preferred Shares") and creating the following new classes of shares:

a. Class C Common Shares ("Opco New Class C Common Shares");

b. Class D Common Shares ("Opco New Class D Common Shares");

c. Class B Preferred Shares ("Opco New Class B Preferred Shares"); and

d. Class C Preferred Shares ("Opco New Class C Preferred Shares").

17. The Opco New Class C Common Shares will have the following rights and restrictions:

• voting;
• participating with respect to dividends, pari passu with the existing classes of common shares and the Opco New Class D Common Shares, but subject to the rights of the holders of other classes of shares; and
• on liquidation, dissolution or winding-up, entitled to receive pari passu with the existing classes of common shares and the Opco New Class D Common Shares, but subject to the rights of the holders of other classes of shares, the remaining property of Opco.

18. The Opco New Class D Common Shares will have the following rights and restrictions:

• voting;
• participating with respect to dividends, pari passu with the existing classes of common shares and the Opco New Class C Common Shares, but subject to the rights of the holders of other classes of shares; and
• on liquidation, dissolution or winding-up, entitled to receive pari passu with the existing classes of common shares and the Opco New Class C Common Shares, but subject to the rights of the holders of other classes of shares, the remaining property of Opco.

19. The Opco New Class B Preferred Shares will have the following rights and restrictions:

• non-voting;
• non-participating with respect to dividends except, in the discretion of the directors, a cumulative annual dividend entitlement at a stipulated rate, payable in one or more instalments;
• convertible into Opco New Class C Common Shares;
• non-retractable; and
• on liquidation, dissolution or winding-up, entitled to receive pari passu with the Opco New Class C Preferred Shares, in priority of the existing classes of common shares, the Opco New Class C Common Shares and the Opco New Class D Common Shares, but behind the Opco New Class A Preferred Shares, a redemption amount of $XXXXXXXXXX per share and no more.

20. The Opco New Class C Preferred Shares will have the following rights and restrictions:

• non-voting;
• non-participating with respect to dividends except, in the discretion of the directors, a cumulative annual dividend entitlement at a stipulated rate, payable in one or more instalments;
• convertible into Opco New Class D Common Shares;
• non-retractable; and
• on liquidation, dissolution or winding-up, entitled to receive pari passu with the Opco New Class B Preferred Shares, in priority of the existing classes of common shares, the Opco New Class C Common Shares and the Opco New Class D Common Shares, but behind the Opco New Class A Preferred Shares, a redemption amount equal to $XXXXXXXXXX per share and no more.

Tuck-Under and Share Exchange

21. BForHoldco sells the Bco Shares to Opco for FMV proceeds, estimated by the parties to be $XXXXXXXXXX (the "Tuck-Under"). Opco pays the purchase price by issuing Opco New Class D Common Shares to BForHoldco. BForHoldco and Bco jointly elect in prescribed form and within the time determined under subsection 85(6) for subsection 85(1) to apply to the sale. The agreed amount will not exceed the FMV of the Bco Shares and will not be less than the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) or (ii). BForHoldco will not be required to apply for a certificate under section 116 of the Act since the Bco Shares do not constitute "taxable Canadian property".

22. Concurrently with the Tuck-Under, Aco exchanges all of its Opco Class A Common Shares for Opco New Class C Common Shares having an estimated FMV of $XXXXXXXXXX and Opco New Class B Preferred Shares having an estimated FMV of $XXXXXXXXXX (the "Share Exchange"). The Share Exchange is to be governed by section 86 of the Act. The Share Exchange is to occur concurrently with the Tuck-Under so as to preclude Aco's acquisition of control of Opco. Immediately after the Tuck-Under, the number of issued Opco Class A Common Shares and, therefore, votes in Opco, would exceed the number of Opco New Class D Common Shares issued to BForHoldco on the sale. Accordingly, and absent the concurrent Share Exchange, Aco would acquire control of Opco, which result is not intended by either BForLP or Aco.

Amalgamation

23. Bco and Opco amalgamate, by way of a vertical short-form amalgamation (the "Amalgamation"), to form New Opco in such a manner that:

• all of the property (except amounts receivable from either Bco or Opco or shares of Bco or Opco) of Bco and Opco immediately before the Amalgamation becomes property of New Opco by virtue of the Amalgamation;
• all of the liabilities (except amounts payable to either Bco or Opco) of Bco and Opco immediately before the Amalgamation become liabilities of New Opco by virtue of the Amalgamation;
• the Bco Shares held by Opco immediately before the Amalgamation will be cancelled;
• the Opco Class B Common Shares held by Bco immediately before the Amalgamation will be cancelled; and
• Aco and BForHoldco are deemed by subsection 87(1.1) of the Act to have received shares of the capital stock of New Opco by virtue of the Amalgamation for purposes of subsection 87(1);

otherwise than as a result of the acquisition of property of one corporation by another corporation, pursuant to the purchase of that property by the other corporation or as a result of the distribution of that property to the other corporation on the winding-up of the corporation. Accordingly, subsection 87(1) of the Act will apply to the Amalgamation.

24. The Amalgamation will be carried out under the XXXXXXXXXX . As per subsection XXXXXXXXXX of that Act, no new shares of New Opco will be issued as the result of the Amalgamation. Accordingly, immediately after the Amalgamation:

a) Aco will hold the following shares of New Opco:

• Opco New Class C Common Shares having an estimated FMV of $XXXXXXXXXX ;
• Opco New Class A Preferred Shares having an estimated FMV of $XXXXXXXXXX ;
• Opco New Class B Preferred Shares having an estimated FMV of $XXXXXXXXXX ; and

b) BForHoldco will hold Opco New Class D Common Shares having an estimated FMV of $XXXXXXXXXX .

Purpose of the Proposed Transactions

25. The purpose of the Proposed Transactions is to

a. replace a portion of the indirect equity investment of BForLP in Opco with debt financing, without altering the economic interests of BForLP and Aco in Opco; and

b. simplify the corporate structure through the elimination of Bco while providing for the carryback of any future losses in New Opco to offset income earned in a pre-amalgamation taxation year of Opco.

Additional Information

26. As the result of the $XXXXXXXXXX capital reduction described in 12 above, the PUC of the Bco Shares will be $XXXXXXXXXX .

27. There will be an acquisition of control of Bco upon the transfer of the Bco Shares described in 21 above.

28. The agreed amount under subsection 85(1) for the transfer of the Bco Shares described in 21 above will be equal to the ACB of the shares (except if the FMV of the shares is less than the ACB).

29. The Opco New Class D Common Shares received by BForHoldco in 21 above will have an estimated FMV, ACB and PUC of $XXXXXXXXXX .

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, Proposed Transactions and purpose of the Proposed Transactions, and provided further that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Provided that Bco had a legal obligation to pay interest on the Sub Debt, and that following the Amalgamation, New Opco continues to have a legal obligation to pay interest on the Sub Debt, in computing its income for a taxation year, New Opco will be entitled to deduct, pursuant to paragraph 20(1)(c), the lesser of (i) the interest paid in the year or payable in respect of the year (depending on the method regularly followed by New Opco in computing its income for purposes of the Act) on the Sub Debt that was previously used by Bco to fund the return of capital, as described in 12 above, or (ii) a reasonable amount in respect thereof.

B. Subsection 87(2.11) of the Act will apply to the Amalgamation.

C. The provisions of subsection 245(2) will not be applied, as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the ruling given above.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided that the Proposed Transactions are completed by XXXXXXXXXX .

The above rulings are based on the law as it presently reads and does not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Comments

Nothing in this ruling letter should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(a) the FMV, ACB or PUC of any shares referred to herein;

(b) the amount of any non-capital loss or any other amount of any corporation referred to herein; or

(c) any tax consequences relating to the facts and Proposed Transactions described herein other than those specifically described in the rulings provided above.

Yours truly,

XXXXXXXXXX
For Director
Financial Industries Division
Income Tax Rulings Directorate