2011 Ruling 2011-0415801R3 - Borrowed money, shares of subsidiary

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: (1) Would the taxpayer be required to accrue and include in income, under section 9 of the Act, foreign exchange gains and losses in reference to its borrowings; (2) would expenses incurred in the course of the issuance of a portion of its borrowings be deductible under paragraph 20(1)(e)(ii); (3) would interest payable on its borrowings be deductible pursuant to paragraph 20(1)(c) and subsection 20(3)?

Position: (1) No; (2) Yes; (3) Yes

Reasons: (1) and (3) Borrowed money was used to purchase shares of a foreign affiliate that was "capital property" to the taxpayer, within the meaning of section 54; (2) the expenses were incurred in the course of borrowing money used for the purpose of earning income from property which was not exempt income.

XXXXXXXXXX 						2011-041580

XXXXXXXXXX , 2011

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX (amended XXXXXXXXXX ), wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge the additional information provided to us in your emails, the last of which was dated XXXXXXXXXX . In general terms, the transactions described herein involve the above-noted taxpayer using borrowed money to fund the purchase price of an acquisition of shares representing XXXXXXXXXX % of the voting rights and approximately XXXXXXXXXX % of the total fair market value of all of the issued and outstanding shares of a foreign corporation.

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 taxpayer, none of the issues involved in this advance income tax ruling are:

(i) in an earlier tax return of the above-noted taxpayer 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 taxpayer or of a related person;
(iii) under objection by the above-noted taxpayer 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 issued by the Income Tax Rulings Directorate to the above-noted taxpayer 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. "XXXXXXXXXX Portion" means approximately XXXXXXXXXX $XXXXXXXXXX of the net proceeds from the issuance of the XXXXXXXXXX Bonds as described in 12 below;

b. "Aco" means the XXXXXXXXXX , a taxable Canadian corporation and a public corporation further described in 1 below;

c. "Bco" means XXXXXXXXXX ;

d. "Bco Option" means the option issued by Bco to Forsub on XXXXXXXXXX , and further described in 5 below;

e. "Closing Date" means XXXXXXXXXX , the day the transaction described in 3 below closed;

f. "XXXXXXXXXX Bond Portfolio" means the assets of the Guarantor further described in 14 below;

g. "XXXXXXXXXX Bonds" means the new XXXXXXXXXX -denominated "XXXXXXXXXX bonds" issued by Aco as described in 11 below;

h. "Fees" means those expenses, further described in 18 below, incurred by Aco in the course of borrowing money;

i. "FMV" means XXXXXXXXXX $XXXXXXXXXX , the fair market value, as determined by an independent valuation, of Bco's shares in Forsub;

j. "Forfam" means, collectively, the XXXXXXXXXX , their XXXXXXXXXX and XXXXXXXXXX ;

k. "Forsub" means XXXXXXXXXX , a corporation formed under the laws of XXXXXXXXXX and further described in 2 below;

l. "Forsub Competitor" is defined in the XXXXXXXXXX as an entity that has its head office in XXXXXXXXXX and is either engaged predominantly in the XXXXXXXXXX business or derives more than XXXXXXXXXX % of its revenues or more than XXXXXXXXXX $XXXXXXXXXX per year from XXXXXXXXXX activities in XXXXXXXXXX ;

m. "Forsub Shares" means the shares of Forsub acquired by Aco on XXXXXXXXXX , as further described in 3, 5 and 7 below;

n. "Guarantor" means XXXXXXXXXX , a limited partnership formed under the Limited Partnerships Act (XXXXXXXXXX ) and further described in 13 below;

o. XXXXXXXXXX ;

p. XXXXXXXXXX ;

q. "public corporation" has the meaning assigned by subsection 89(1) of the Act;

r. "Purchase Price" means XXXXXXXXXX $XXXXXXXXXX , the purchase price of the Forsub Shares as described in 6 below;

s. "XXXXXXXXXX " means the registration rights agreement accompanying the XXXXXXXXXX ;

t. "Specified XXXXXXXXXX " means approximately XXXXXXXXXX $XXXXXXXXXX of a XXXXXXXXXX $XXXXXXXXXX XXXXXXXXXX that was specifically used to pay the Purchase Price and otherwise fund Aco's acquisition of the Forsub Shares;

u. "XXXXXXXXXX " means the XXXXXXXXXX executed by Aco, Forfam and Forsub in conjunction with the acquisition of the Forsub Shares;

v. "XXXXXXXXXX " means the XXXXXXXXXX between Forsub and Aco;

w. XXXXXXXXXX ; and

x. "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act.

Facts

1. Aco is a XXXXXXXXXX . Aco's address is XXXXXXXXXX and its taxation year ends on XXXXXXXXXX of each year. Aco files its tax returns at the XXXXXXXXXX Tax Services Office and it otherwise deals with the XXXXXXXXXX Taxation Centre.

2. Forsub is a leading XXXXXXXXXX -based XXXXXXXXXX company which has approximately XXXXXXXXXX operating subsidiaries which derive substantially all of their income XXXXXXXXXX . Forsub and its subsidiaries have approximately XXXXXXXXXX employees and carry on substantially all of their business activities in XXXXXXXXXX . No class of shares of Forsub is listed on a stock exchange.

3. On XXXXXXXXXX , Aco entered into an agreement to acquire a XXXXXXXXXX % equity interest in Forsub (the Forsub Shares). The closing of that transaction took place on the Closing Date.

4. Forsub is controlled by Forfam who own shares representing over XXXXXXXXXX % of the fair market value of Forsub's issued and outstanding capital stock, as well as over XXXXXXXXXX % of the voting rights attaching to shares issued by Forsub. The remaining shares of Forsub are held by XXXXXXXXXX , Forsub employees XXXXXXXXXX and Aco. All of the non-Aco existing Forsub shareholders are not related or affiliated to Aco and deal with Aco at arm's length all for purposes of the Act.

5. The Forsub Shares acquired by Aco on the Closing Date were held by Bco. Pursuant to the Bco Option, Forsub had the right to purchase Bco's shares, XXXXXXXXXX .

6. XXXXXXXXXX . On the Closing Date, Aco paid the Purchase Price in XXXXXXXXXX in cash.

7. XXXXXXXXXX

8. Certain consequential amendments to Forsub's by-laws and certificate of incorporation were also made as contemplated by the XXXXXXXXXX . XXXXXXXXXX :

(a) Aco is entitled to nominate XXXXXXXXXX of Forsub's XXXXXXXXXX directors and to have XXXXXXXXXX of its director nominees appointed to the audit committee of the board of directors XXXXXXXXXX ;

(b) the Aco's nominee directors' consent is explicitly required for certain fundamental and strategic business issues described below:

XXXXXXXXXX

9. The XXXXXXXXXX and XXXXXXXXXX impose material restrictions on Aco's ability to dispose of its Forsub Shares. These limitations can be summarized as follows:

XXXXXXXXXX

10. On the Closing Date, Aco paid the Purchase Price in XXXXXXXXXX in cash. Aco funded its acquisition of the Forsub Shares through the Specified XXXXXXXXXX . The Specified XXXXXXXXXX was required to be repaid on XXXXXXXXXX .

Proposed Transactions

11. Aco replaced its short-term funding of the acquisition of the Forsub Shares, which had been achieved through the Specified XXXXXXXXXX, through the issuance of the XXXXXXXXXX Bonds on XXXXXXXXXX . The aggregate principal amount of the XXXXXXXXXX Bonds issued in such offering was XXXXXXXXXX $XXXXXXXXXX .

12. The XXXXXXXXXX Portion of the XXXXXXXXXX Bonds was used directly to repay the Specified XXXXXXXXXX that was used to satisfy Aco's obligation to pay the Purchase Price in XXXXXXXXXX currency at the Closing Date and otherwise fund Aco's acquisition of the Forsub Shares. As the XXXXXXXXXX Bonds were issued in XXXXXXXXXX denominations, with a minimum subscription of XXXXXXXXXX $XXXXXXXXXX , Aco was able to trace the XXXXXXXXXX Portion that was used to repay the Specified XXXXXXXXXX . The XXXXXXXXXX Portion was credited to a special, external bank account and was used solely to repay the Specified XXXXXXXXXX . The funds raised through the XXXXXXXXXX Bond issuance in excess of the XXXXXXXXXX Portion were added to Aco's general pool of funds.

13. The XXXXXXXXXX Bonds were issued under Aco's existing XXXXXXXXXX , and pursuant to a renewal of Aco's shelf prospectus. The XXXXXXXXXX Bonds are listed on the XXXXXXXXXX . Pursuant to the terms of the XXXXXXXXXX Bonds, payments of interest and principal in respect of the XXXXXXXXXX Bonds will be irrevocably guaranteed by the Guarantor. Aco is the sole limited partner of the Guarantor and Aco's limited partnership interests in the Guarantor represent XXXXXXXXXX % of the total partnership interests in the Guarantor. There are two general partners of the Guarantor, a managing general partner, XXXXXXXXXX , and a liquidation general partner, XXXXXXXXXX . The managing general partner of the Guarantor is a wholly-owned subsidiary corporation of Aco incorporated under the laws of Canada. It holds XXXXXXXXXX % of the general partner interests. The liquidation general partner is also incorporated under the laws of Canada and it holds the remaining XXXXXXXXXX % of the general partner interests in the Guarantor. Thus, the managing general partner holds XXXXXXXXXX % of the total partnership interests in the Guarantor while the liquidation general partner holds XXXXXXXXXX % of the total partnership interests. XXXXXXXXXX % of the issued and outstanding shares in the liquidation general partner is owned by XXXXXXXXXX as trustee of the Aco XXXXXXXXXX (the beneficiary of which is XXXXXXXXXX ) while the remaining XXXXXXXXXX % of the shares of the liquidation general partner is owned by Aco. The liquidation general partner will generally not be involved in the management of the Guarantor except in certain circumstances such as in the event that the Guarantor's guarantee is to be called or where the managing general partner of the Guarantor becomes insolvent. In such situations, the responsibilities of managing the Guarantor would be assumed by the liquidation general partner from the managing general partner.

14. In the event that the guarantee of the XXXXXXXXXX Bonds given by the Guarantor is called on, the "XXXXXXXXXX Bond Portfolio" would be used to repay the holders of the XXXXXXXXXX Bond holders before they would be made available for the benefit of Aco's unsecured creditors. The XXXXXXXXXX Bond Portfolio consists of XXXXXXXXXX . The security provided by the Guarantor allows the XXXXXXXXXX Bonds to be issued at a lower rate of interest than would be the case were Aco to issue conventional bonds with the same term as the XXXXXXXXXX Bonds.

15. Prior to the issuance of the XXXXXXXXXX Bonds, Aco advanced funds to the Guarantor, in Canadian dollars, as a loan, XXXXXXXXXX . This enabled the Guarantor to increase the size of the XXXXXXXXXX Bond Portfolio in order to maintain sufficient collateral to support the Guarantor's obligations and satisfy the possible claims of holders of XXXXXXXXXX Bonds. As noted above, the XXXXXXXXXX Portion was used by Aco to repay the Specified XXXXXXXXXX that was used to pay the Purchase Price in XXXXXXXXXX currency at the Closing Date and otherwise fund Aco's acquisition of the Forsub Shares. No part of the proceeds from the issuance of the XXXXXXXXXX Bonds, including the XXXXXXXXXX Portion, was used directly or indirectly to fund the Guarantor or to fund XXXXXXXXXX .

16. The XXXXXXXXXX Bonds have a term of XXXXXXXXXX years (due XXXXXXXXXX ) and constitute XXXXXXXXXX . The XXXXXXXXXX Bonds are not redeemable by Aco prior to their maturity (except in limited circumstances such as illegality, a change in law resulting in the application of withholding tax to interest paid to non-resident holders or acceleration as a consequence of an event of default). Aco is opting to fund the investment in Forsub Shares with a shorter-term, secured funding (as opposed to an unsecured XXXXXXXXXX -year term funding previously contemplated) because of the current volatility in the debt markets and XXXXXXXXXX -year unsecured debt offering.

17. The XXXXXXXXXX Bonds carry a fixed coupon paid semi-annually in arrears in accordance with market convention at an arm's length rate of interest to be determined shortly before the issuance of the XXXXXXXXXX Bonds. The XXXXXXXXXX Bonds may be issued at a slight discount or premium expected in any case to be less than XXXXXXXXXX % of the principal amount of the XXXXXXXXXX Bonds in order to ensure that the XXXXXXXXXX Bonds yield a return equal to the prevailing market rate of interest at the time of their issuance. Payments due under the XXXXXXXXXX Bonds are not conditional upon receipt by Aco of any distributions or other payments from the Guarantor.

18. Aco paid the Fees incurred in the course of the XXXXXXXXXX Bond offering including the XXXXXXXXXX Portion. Such amounts included agency fees, legal expenses and other related expenses incurred in the course of the issuance of the XXXXXXXXXX Bonds. Specifically, excluded from the Fees are any legal and other related expenses relating to the incorporation and organization of the general managing partner and the liquidation general partner. None of the Fees pertain to the acquisition of the Forsub Shares.

Additional Information

19. Neither the proceeds from the Specified XXXXXXXXXX nor the proceeds from the XXXXXXXXXX Portion were or will be used as part of the normal XXXXXXXXXX business of Aco, which includes XXXXXXXXXX .

20. Aco's acquisition of Forsub Shares was a strategic investment. Aco has no intention or ability to dispose of the Forsub Shares (as is evident from the restrictions on transfer to which Aco has agreed in the XXXXXXXXXX and XXXXXXXXXX ). The Forsub Shares were not acquired in the ordinary course of business carried on by Aco. The proposed transactions required the approval of Aco's senior executive team and Aco's board of directors, and were subject to XXXXXXXXXX . Aco will use the equity method of accounting for its investment in Forsub (which is indicative of significant influence in Forsub's strategic policies). Aco expects to receive regular and substantial dividends from Forsub.

21. It is expected that the Forsub Shares will not be "mark-to-market property" under the definition in subsection 142.2(1) (by virtue of Aco's ownership of shares representing more than XXXXXXXXXX % of the "votes and value" of Forsub), and that the Forsub Shares will be "capital property" to Aco as defined in subsection 248(1) and section 54 of the Act.

22. Forsub and its subsidiaries are "foreign affiliates" of Aco under the definition in subsection 95(1) of the Act. All of the income earned by Forsub and its subsidiaries is expected to be included in "exempt earnings" as that term is defined in paragraph (d) of subsection 5907(1) of the Regulations and all dividends received by Aco from Forsub are expected to be deductible under paragraph 113(1)(a) of the Act.

23. Funding the Forsub acquisition with the XXXXXXXXXX Bonds gives Aco the appropriate accounting treatment for foreign exchange gains or losses associated with the Forsub investment. Forsub and its subsidiaries all use the XXXXXXXXXX as their functional currency. Fluctuations in the value of XXXXXXXXXX currency relative to Canadian currency will affect the Canadian dollar-equivalent value of Aco's investment in Forsub.

24. For financial statement purposes, the XXXXXXXXXX Portion of the XXXXXXXXXX Bonds will be designated as a hedge of Aco's foreign currency exposure arising under the Forsub Shares. Under this accounting treatment, accrued foreign exchange gains or losses relating to the XXXXXXXXXX Portion, as well as the Forsub Shares will be reflected as adjustments to a sub-account included in shareholders' equity. Such amounts will not be included or deducted in computing current period accounting profits. No foreign exchange gains or losses will be recognized in Aco's accounting income until the sale or other disposition of the Forsub Shares held by Aco or the repayment of the XXXXXXXXXX Portion of the XXXXXXXXXX Bonds. Upon the occurrence of such events, only the net foreign exchange gain or loss would be reported in Aco's accounting income.

25. Assuming that Aco maintains both the investment in Forsub Shares and the XXXXXXXXXX Portion of the XXXXXXXXXX Bonds for the full XXXXXXXXXX -year term, the net change to Aco's shareholders' equity account and net accounting income in respect of the fully-hedged investment would be XXXXXXXXXX . In the event that the XXXXXXXXXX Bonds mature and Aco continues to hold the Forsub Shares, the accounting treatment of foreign exchange fluctuations as described in this and the previous paragraph would continue provided that Aco issues new XXXXXXXXXX debt obligations in the amount of the XXXXXXXXXX Portion which new debt is designated as a continuing hedge of Aco's investment in the Forsub Shares. This funding and hedging strategy would also XXXXXXXXXX .

Purpose of Proposed Transactions

26. The purpose of issuing the XXXXXXXXXX Portion of the XXXXXXXXXX Bonds is to provide long-term stable funding for the Forsub acquisition.

Rulings

A. Provided that the proceeds from the Specified XXXXXXXXXX and the XXXXXXXXXX Portion are not used as part of the normal XXXXXXXXXX business of Aco, as described in 19 above, and that the Forsub Shares continue to be held by Aco for the purpose of gaining or producing income from property, for taxation years prior to and including the taxation year in which the XXXXXXXXXX Portion is redeemed or matures, Aco is not required to accrue and include in income under section 9 of the Act, foreign exchange gains and losses in reference to the Specified XXXXXXXXXX and the XXXXXXXXXX Portion, as described in 24 above.

B. The amount of the Fees incurred in connection with the XXXXXXXXXX Portion, as described in 18 above, will be deductible by Aco in accordance with the provisions of subparagraph 20(1)(e)(ii) of the Act, to the extent that such amount is reasonable in the circumstances.

C. Provided that the Forsub Shares continue to be held by Aco for the purpose of gaining or producing income from property and that Aco has the legal obligation to pay interest on the Specified XXXXXXXXXX and the XXXXXXXXXX Portion, Aco will be entitled to deduct, in computing its income for a taxation year, the lesser of the interest paid or payable thereon (depending on the method regularly followed by Aco in computing its income for the purposes of the Act) in respect of that taxation year pursuant to subsection 20(3) and paragraph 20(1)(c), to the extent such amount does not exceed a reasonable amount.

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 entered into 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 GST implications of any of the proposed transactions;
(b) the reasonableness of any amount;
(c) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;
(d) any tax consequences that may occur when the XXXXXXXXXX Bonds are redeemed; nor,
(e) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate