2011 Ruling 2010-0375111R3 - XXXXXXXXXX - ATR

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: (i) Whether the interest earned by Finco on the Core Receivable and the Opco Note would be treated as income of Finco from carrying on an active business by virtue of subparagraph 95(2)(a)(ii)(B) of the Income Tax Act? (ii) Whether subsection 258(3) would apply to any dividends paid from the shares of Finco?

Position: (i) Yes. (ii) No.

Reasons: (i) Subparagraph 95(2)(a)(ii)(B) applies. (ii) The exception contained in subsection 258(4) would apply.

XXXXXXXXXX 					2010-037511

Attention:  XXXXXXXXXX 

XXXXXXXXXX , 2011

Dear Sirs or Madams:

Re: XXXXXXXXXX ("Pubco")
Business Number XXXXXXXXXX
Advance Income Tax Ruling _______

We are writing in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-referenced taxpayer. We also acknowledge your email of XXXXXXXXXX in which the ruling request was amended.

Pubco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre.

To the best of your knowledge and that of the taxpayers involved, none of the issues involved with this request is:

(i) involved in an earlier return of the taxpayers or a related person;
(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by the taxpayer or a related person;
(iii) under objection;
(iv) before the courts or, if a judgement has been issued, the time limit for appeal has not expired; or
(v) the subject of a ruling previously considered by the Income Tax Rulings Directorate, XXXXXXXXXX .

The rulings given herein are based solely on the facts, proposed transactions and purposes of the proposed transactions described below. Facts and proposed transactions in the documents submitted with your request not described below do not form part of the facts and proposed transactions on which this ruling is based and any reference to these documents is provided solely for the convenience of the reader.

Unless otherwise stated, all references to a statute are references to the provisions of the Income Tax Act, R.S.C. 1985 c.1 (5th Supp.) as amended to the date hereof (the "Act"), and every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provisions of the Act.

Definitions

In this letter the following terms have the meanings specified:
(a) "Cansub" means XXXXXXXXXX , an entity incorporated under the laws of XXXXXXXXXX and a taxable Canadian Corporation;
(b) XXXXXXXXXX ;
(c) "Core Receivable" means the portion of the Initial Receivable that bears interest and that is described in paragraphs 32 to 34 below;
(d) "Country 1" means XXXXXXXXXX ;
(e) "Country 2" means XXXXXXXXXX ;
(f) "Country 3" means XXXXXXXXXX ;
(g) "Country 4" means XXXXXXXXXX ;
(h) "Country 5" means XXXXXXXXXX ;
(i) "Country 6" means XXXXXXXXXX ;
(j) "CRA" means the Canada Revenue Agency, together with its predecessors, the Canada Customs and Revenue Agency and Revenue Canada;
(k) "excluded property" has the meaning assigned by subsection 95(1);
(l) "FAPI" means foreign accrual property income as defined in subsection 95(1);
(m) "Finco" means a XXXXXXXXXX that was established under the laws of Country 1;
(n) "Forco1" means XXXXXXXXXX , a cooperative established under the laws of Country 2;
(o) "Forco2" means XXXXXXXXXX established under the laws of Country 2;
(p) "Foreign Subsidiaries" means, collectively, Finco, Forco1, Forco2 and Opco;
(q) "Holdco1" means XXXXXXXXXX , a limited liability company established under the laws of State A;
(r) "Holdco2" means XXXXXXXXXX , a corporation established under the laws of Country 4;
(s) "Holdco3" means XXXXXXXXXX , a corporation established under the laws of Country 5;
(t) "Initial Advances" means the series of advances made from XXXXXXXXXX to present by Pubco to Opco, in the aggregate amount of approximately XXXXXXXXXX , for purposes of funding the XXXXXXXXXX and capital requirements of the Project;
(u) "Initial Receivable" means the receivable currently held by Pubco in respect of the Initial Advances made to Opco;
(v) "Investment Agreement" means the investment agreement among Pubco, Opco, Norco2 and the Government of Country 3 entered into on XXXXXXXXXX ;
(w) "MRPS" means the mandatorily redeemable preferred shares to be issued by Finco;
(x) "Non-Core Receivable" means the portion of the Initial Receivable that does not bear interest and that is described in paragraphs 32 to 34, below;
(y) "Opco" means XXXXXXXXXX , a body corporate incorporated under the Company Law of Country 3;
(z) "Opco Note" means the promissory note dated XXXXXXXXXX , and as is described more fully in paragraph 38, below;
(aa) "Norco1" means XXXXXXXXXX , a public company whose shares are listed on the XXXXXXXXXX Stock Exchange;
(bb) "Norco2" means XXXXXXXXXX , a member of the group of companies controlled by Norco1;
(cc) "principal amount" has the meaning assigned by subsection 248(1);
(dd) "private corporation" has the meaning assigned by subsection 89(1);
(ee) "Project" means the XXXXXXXXXX located in XXXXXXXXXX Country 3 and as is described more fully in paragraph 21, below;
(ff) "Pubco Group" means Pubco and all its direct and indirect subsidiaries, including Finco, Forco1, Forco2 and Opco;
(gg) "Pubco" means XXXXXXXXXX , a corporation XXXXXXXXXX under the laws of XXXXXXXXXX ;
(hh) "Pubco Branch" means the branch that was established by Pubco in Country 1 and as is described more fully in paragraph 43, below;
(ii) "public corporation" has the meaning assigned by subsection 89(1);
(jj) "qualifying interest" has the meaning assigned by paragraph 95(2)(m);
(kk) XXXXXXXXXX ;
(ll) "Shareholders' Agreement" means the shareholders' agreement relating to Opco entered into by Stateco, Holdco3, Forco2 and Opco on XXXXXXXXXX ;
(mm) "State A" means the State of XXXXXXXXXX in Country 6;
(nn) "Stateco" means XXXXXXXXXX , a state-owned company of Country 3 incorporated under the Company Law of Country 3;
(oo) "Tax Treaty" has the meaning assigned by subsection 248(1); and
(pp) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

Facts

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

Pubco

1. Pubco is a taxable Canadian corporation and a public corporation incorporated under the laws of Canada. Pubco's shares are widely held and are listed and traded on the XXXXXXXXXX . Norco1 currently owns approximately XXXXXXXXXX % of the common equity of Pubco. If Norco1 chooses to exercise all of its contractual rights vis-à-vis Pubco under various agreements, it may increase its stake in Pubco to up to approximately XXXXXXXXXX %.

2. Pubco is an XXXXXXXXXX company.
While it also does some of its XXXXXXXXXX in Canada, generally Pubco's activities in Canada are otherwise limited to XXXXXXXXXX activities. All or substantially all of the XXXXXXXXXX activities carried on by members of the Pubco Group are all performed outside Canada.

3. Pubco currently has a taxation year-end of XXXXXXXXXX . Its business number is XXXXXXXXXX and it is served by the XXXXXXXXXX Taxation Centre. Pubco has not made a functional currency election under section 261.

Finco

4. Finco is XXXXXXXXXX that was established under the laws of Country 1 and is resident in Country 1 for the purposes of the Tax Treaty that Canada has entered into with Country 1. Pubco is of the view that Finco is a corporation for the purposes of the Act. All of the equity interests in Finco are owned by Pubco. It is anticipated that the activities of Finco will be limited to providing financing to Opco and engaging in the transactions described herein.

5. In accordance with its constating documents, Finco has the following general characteristics:

(a) Finco is a legal entity separate from its members;
(b) Finco has the capacity to contract in its own name, for its own account and at its own risk;
(c) Finco is incorporated for an indefinite period;
(d) ownership interests in Finco are divided into shares;
(e) admission and transfer of shares in Finco is subject to shareholders' approval;
(f) each shareholder is entitled to at least one vote;
(g) profits are available to Finco and can be retained by Finco unless the members vote in favour of distribution;
(h) the board of directors has authority to represent Finco; and
(i) members are excluded from any liability for any of Finco's debts or losses.

6. The authorized share capital of Finco consists of ordinary common shares and MRPS. The general attributes of the MRPS are as follows:

(a) Finco has a mandatory redemption duty at the end of XXXXXXXXXX years (or sooner) from the date of issuance of the MRPS assuming that the MRPS are neither converted nor redeemed by the holder;
(b) the MRPS shall not carry a dividend entitlement;
(c) the MRPS shall carry full voting rights;
(d) all or a portion of the MRPS are convertible at any time into a fixed value of Finco common shares at the option of the holder (i.e., convertible into that number of common shares that results in a fair market value of the shares issued equal to the par value of the MRPS converted);
(e) all or a portion of the MRPS are convertible into another class of MRPS at the option of the holder;
(f) the MRPS are redeemable before the maturity date (i.e., XXXXXXXXXX years or sooner) at the option of the holder with prior notice; and
(g) the rights of the MRPS holders to receive redemption proceeds are subordinated to other debt obligations by Finco.

7. For XXXXXXXXXX tax purposes in Country 1, the MRPS will be considered debt rather than equity of Finco. However, for all other XXXXXXXXXX purposes in Country 1, the MRPS will be considered equity of Finco.

Forco1

8. Forco1 is a cooperative established under the laws of Country 2 and is resident in Country 2.

9. In accordance with its constating document, Forco1 has the following general characteristics:

(a) Forco1 is a legal entity separate from its members;
(b) Forco1 has the capacity to contract in its own name, for its own account and at its own risk;
(c) Forco1 is incorporated for an indefinite period;
(d) admission and transfer of membership in Forco1 is subject to members' approval;
(e) each member is entitled to at least one vote, and the total number of votes is in proportion to the capital accounts;
(f) members have separate capital accounts the repayment of which is subject to the approval of all members;
(g) profits are available to Forco1 and can be retained by Forco1 unless the members vote in favour of distribution;
(h) the board of directors has authority to represent Forco1; and
(i) members are excluded from any liability for any of Forco1's debts or losses.

10. All of the equity interests in Forco1 are owned, directly or indirectly, by Pubco. Pubco directly owns XXXXXXXXXX % of the equity interest in Forco1 and the remaining XXXXXXXXXX % is owned by Cansub, which is XXXXXXXXXX % owned by Pubco. Cansub is a corporation incorporated in Canada and is a taxable Canadian corporation. The activities of Forco1 are anticipated to be limited to holding equity in and providing financing to Forco2.

11. Under the domestic tax law of Country 2, Forco1 is viewed as a corporation and by virtue of the fact that it is established under the laws of Country 2, it is normally subject to Country 2's corporate tax on its worldwide profits at a top rate of XXXXXXXXXX %, subject to any available exemptions.

Forco2

12. Forco2 is a XXXXXXXXXX established under the laws of Country 2 and is resident in Country 2.

13. All of the equity interests in Forco2 are owned by Forco1. The activities of Forco2 are anticipated to be limited to holding equity in and providing equity and debt financing to Opco.

14. Under the domestic tax law of Country 2, Forco2 is viewed as a corporation and by virtue of the fact that it is established under the laws of Country 2, it is normally subject to Country 2's corporate tax on its worldwide profits at a top rate of XXXXXXXXXX %, subject to any available exemptions. However, because XXXXXXXXXX , Forco1 will be primarily responsible for Forco2's tax liabilities to Country 2. Forco2 will be directly responsible to Country 2's tax authorities for its own tax liabilities only if Forco1 fails to pay those amounts.

Holdco1, Holdco2, and Holdco3

15. Pubco owns all the equity interest in Holdco1, a company established under the laws of State A. Holdco 1 owns all the equity interest in Holdco 2, a corporation established under the laws of Country 4. Holdco 2 owns all the equity interest in Holdco3, a corporation established under the laws of Country 5.

Opco

16. Opco is a body corporate established under the laws of Country 3 and is a resident of Country 3 for the purposes of the Tax Treaty that Canada has entered into with Country 3. Pubco is of the view that Opco is a corporation for the purposes of the Act.

17. In accordance with its enabling legislation, the Company Law of Country 3, Opco has the following general characteristics:

(a) it is "a legal person" and has a name;
(b) its capital is divided into shares;
(c) shares in Opco represent ownership interests in Opco, and not an ownership interest in any of Opco's separate property;
(d) it has its own separate property;
(e) its charter includes Opco's full name, its place of business and information relating to its authorized common shares and preferred shares;
(f) it is established for an indefinite duration;
(g) its common shareholders are entitled to vote;
(h) it is a limited liability company;
(i) there are pre-emptive rights applicable to the transfer of its common shares;
(j) its shareholders are generally not liable for Opco's obligations and only bear risk of loss to the extent of the shares held;
(k) it may pay dividends if certain conditions (e.g., solvency) are met;
(l) a resolution to pay dividends must be made through Opco's Board of Directors;
(m) it has a Board of Directors, which is its governing body between shareholder meetings; and
(n) its Board of Directors consists of XXXXXXXXXX members, who are elected by the vote of holders of common shares only.

18. The Shareholders' Agreement provides that Stateco, a state-owned company of Country 3 incorporated under the Company Law of Country 3, is entitled to nominate XXXXXXXXXX directors to Opco's Board of Directors and Forco2 and Holdco 3 are entitled to nominate the remaining XXXXXXXXXX directors.

19. Opco is in the business of XXXXXXXXXX in Country 3. Opco's principal asset is the Project. All or substantially Opco's assets are used in its active business. Under the tax law of Country 3, Opco is taxable on its revenues generated both in Country 3 and in a foreign country in a given year because it is a body corporate established under the laws of Country 3.

20. Currently, all of the common shares in Opco are owned by Forco2, (as to approximately XXXXXXXXXX %), Holdco3 (as to approximately XXXXXXXXXX %), and Stateco (as to approximately XXXXXXXXXX %). XXXXXXXXXX .

The Project

21. The Project is located in Country 3 in XXXXXXXXXX .

22. It is currently anticipated that the Project will cost in excess of XXXXXXXXXX . To date, these costs have been funded through a mix of common and preferred share equity purchased in Opco and loans to Opco (in proportions that meet Country 3's thin capitalization limitations). In the future funding will comprise a mix of these resources and, potentially, direct financing from arm's-length sources.

23. XXXXXXXXXX

24. Currently, any new debt of Opco used to fund the Project bears interest at XXXXXXXXXX % per annum and any preferred share equity acquired in Opco bears cumulative dividends at XXXXXXXXXX % per annum. XXXXXXXXXX .

25. XXXXXXXXXX

26. The current estimated net present value of the Project is at least XXXXXXXXXX taking into account all anticipated expenditures. Total capital expenditures over the life of the Project are anticipated to be approximately XXXXXXXXXX .

27. XXXXXXXXXX

The Initial Advance and Subsequent Negotiations with XXXXXXXXXX

28. Commencing in XXXXXXXXXX , Pubco made the Initial Advances to Opco in several tranches and in an aggregate principal amount of approximately XXXXXXXXXX . Approximately XXXXXXXXXX of the cash used by Pubco to make the Initial Advances was obtained from Pubco's own equity capital and the balance from the proceeds of the issuance of XXXXXXXXXX .

29. XXXXXXXXXX

30. The Initial Advances were used by Opco to fund the initial capital requirements of the Project, which involved XXXXXXXXXX .

31. As a result of the Initial Advances, Pubco currently holds the Initial Receivable in an amount equal to the aggregate of the Initial Advances to Opco.

32. The Initial Receivable was initially non-interest-bearing. However, XXXXXXXXXX , the holder of the Initial Receivable is entitled to receive interest at the annual rate of XXXXXXXXXX %, XXXXXXXXXX on a specified portion of the Initial Receivable if and when XXXXXXXXXX . The portion of the Initial Receivable that now bears interest is referred to herein as the "Core Receivable" while the portion that does not bear interest is referred to herein as the "Non-Core Receivable".

33. XXXXXXXXXX

34. XXXXXXXXXX

35. Any interest that is ultimately paid on the Core Receivable will be subject to Country 3's withholding tax at the rate of XXXXXXXXXX %, subject to reduction by an applicable income tax convention. The deduction of interest in Country 3 is subject to thin capitalization limitations (XXXXXXXXXX ) and in certain circumstances interest expense must be capitalized.

36. The initial capital requirements of the Project were funded directly by Pubco through the Initial Advances rather than through the structure involving Finco because this was initially viewed as the best means to:

(a) XXXXXXXXXX ;
(b) XXXXXXXXXX ;
(c) XXXXXXXXXX ;
(d) XXXXXXXXXX ; and
(e) minimize general and administrative costs.

37. XXXXXXXXXX

The Opco Note

38. On or about XXXXXXXXXX , Opco became indebted to Pubco as a result of XXXXXXXXXX . This debt was evidenced by Opco Note, dated XXXXXXXXXX . The essential terms of the Opco Note are as follows:

(a) it has a principal amount of XXXXXXXXXX .42 (footnote 1) ;
(b) it bears interest at the rate of XXXXXXXXXX % XXXXXXXXXX ;
(c) it is payable XXXXXXXXXX ; and
(d) XXXXXXXXXX .

39. XXXXXXXXXX

40. XXXXXXXXXX

41. XXXXXXXXXX

Other Information

42. To finance the future capital needs of the Project, Pubco anticipates using a portion of the funds obtained from XXXXXXXXXX . As well, Pubco has begun seeking project financing of up to XXXXXXXXXX sources including commercial banks and other financial agencies.

43. To facilitate the proposed transactions discussed below, Pubco has established a branch office constitutive of a permanent establishment in Country 1 (the "Pubco Branch"). For domestic Country 1 tax purposes, the Pubco Branch and Finco will be treated as a single taxpayer (i.e., "fiscal unity"). The Pubco Branch will be staffed by an employee of Pubco and it will have separate accounting and a separate Country 1 bank account for its activities. However, as a branch of a Canadian corporation, any income earned by Pubco through its Pubco Branch will be subject to tax in Canada under the Act.

44. The use of the Pubco Branch is not motivated by any Canadian tax or commercial objectives. Rather, the use of a Country 1 branch to hold the Finco shares is part of XXXXXXXXXX .

Proposed Transactions

45. Pubco proposes to transfer its ownership of the Core Receivable and Opco Note to Finco. In particular:

(a) Pubco will assign the Core Receivable to Finco in exchange for MRPS in Finco with a value equal to the principal amount of the Core Receivable (including any accrued interest); and
(b) Pubco will assign the Opco Note to Finco in exchange for MRPS in Finco with a value equal to that of the Opco Note (including any accrued interest).

46. The equity contribution transactions described in paragraph 45 above will be booked by Pubco through its Pubco Branch (i.e., prior to those equity contributions to Finco, Pubco will effect an internal "contribution" of the related assets from itself to the Pubco Branch). Since this step involves only one legal entity (Pubco), it will have no effect under the Act.

Purpose of the Proposed Transactions

47. The purpose of the proposed transactions is to allow Pubco to restructure its existing capital to facilitate the completion of the Project in a manner that meets the commercial, regulatory and tax requirements of all parties. Ultimately, it is also intended to satisfy XXXXXXXXXX .

48. XXXXXXXXXX

Rulings Given

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

A. The interest income earned by Finco in respect of the Opco Note and the Core Receivable will be included in computing Finco's income from an active business by virtue of clause 95(2)(a)(ii)(B).

B. Provided that Finco is resident in Country 1 under common law principles, the interest income earned by Finco on the Opco Note and the Core Receivable will be included in its exempt earnings for the year in which it is earned.

C. Subsections 17(1) and 17(2) will not apply to Pubco to impute an income inclusion in connection with the proposed transactions described in paragraphs 45 and 46 above.

D. Paragraph 95(6)(b) will not apply to Pubco's direct and indirect interests in Finco.

E. Paragraph 17(14)(b) will not apply to Pubco's direct and indirect interests in Finco.

F. Subsection 258(3) will not apply to recharacterize any dividends received by Pubco from Finco to be interest by virtue of the exception contained in subsection 258(4).

G. Any loss incurred by Pubco on the transfer of the Opco Note and the Core Receivable to Finco will be deemed to be nil by virtue of paragraph 40(2)(e.1).

H. The provisions of subsection 245(2) will not apply as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences stated in the rulings given above.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the Canada Revenue Agency ("CRA") provided that the proposed transactions are completed by XXXXXXXXXX .

These rulings are based on the Act in the present form and do not take into account amendments to the Act which, if enacted into law, could have an effect on the rulings provided herein.

Other Comments

Nothing in this ruling should be construed as implying that the CRA has agreed to or reviewed any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above. In particular, nothing in this ruling should be construed as implying that the CRA has agreed to or reviewed the following:

(i) the fair market value of any property described in this letter;
(ii) the classification of the any entity described in this letter for the purposes of the Act; and
(iii) the residence of any person referred to in this letter.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Following XXXXXXXXXX , an adjustment of $XXXXXXXXXX was made reflecting XXXXXXXXXX , increasing the principal amount of the Opco Note to XXXXXXXXXX .