2010 Ruling 2009-0348041R3 - Article IV(7)(b)

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) Whether Article IV(7)(b) applies to interest paid in XXXXXXXXXX by a Canadian-resident unlimited liability company (ULC) that is fiscally transparent for US tax purposes to a US-resident corporation where the US-resident corporation's subsidiary is the sole shareholder of the ULC and the US-resident corporation and the subsidiary are part of a group that consolidates income for US tax purposes. 2) Whether GAAR applies to the transfer of interest-bearing debt of the ULC owing to the subsidiary for the purpose of avoiding the application of Article IV(7)(b)?

Position: 1) No. 2) Not in the circumstances.

Reasons: 1) US-resident corporation is required to include the interest in the computation of its United States income tax liability. 2) Does not frustrate or defeat the underlying purpose/rationale of Article IV(7)(b).

XXXXXXXXXX  							2009-034804

XXXXXXXXXX , 2010

Dear Sir:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX , in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent correspondence dated XXXXXXXXXX , and in the course of various telephone conversations and e-mail correspondence. You have advised us that to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayers or persons related to the taxpayers;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or persons related to the taxpayers;
(iii) under objection by the taxpayers or persons related to the taxpayers;
(iv) before the courts; or
(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.
Unless otherwise noted, all statutory references herein are to the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended (the "Act"). Unless otherwise noted, all references to currency are to Canadian dollars.

DEFINITIONS

(a) "Aco" means XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by Parentco;

(b) "adjusted cost base" has the meaning assigned in section 54;

(c) "BCo" means XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by Aco;

(d) "Canco" means XXXXXXXXXX , an unlimited liability company formed on amalgamation under the laws of the Province of XXXXXXXXXX , and a private corporation, taxable Canadian corporation and principal business corporation, all of the issued and outstanding common shares of which are owned by Holdco;

(e) "Cansub 1" means XXXXXXXXXX . , a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by Canco;

(f) "Cansub 2" means XXXXXXXXXX ., an unlimited liability company incorporated under the laws of the Province of XXXXXXXXXX , all of the issued and outstanding shares of which are held by Canco;

(g) "Cansub 3" means XXXXXXXXXX , an unlimited liability company incorporated under the laws of the Province of XXXXXXXXXX , all of the issued and outstanding common shares of which are owned by Canco;

(h) "Cansub 4" means XXXXXXXXXX ., a corporation incorporated under the laws of the Province of XXXXXXXXXX , all of the issued and outstanding common shares of which are held by Canco;

(i) "Cansub 5" means XXXXXXXXXX ., a corporation incorporated under the laws of the Province of XXXXXXXXXX , all of the issued and outstanding common non-voting and common voting shares of which are held by Cansub 3 and Cansub 4, respectively;

(j) "Cansub 6" means XXXXXXXXXX ., a corporation incorporated under the laws of the Province of XXXXXXXXXX , all of the issued and outstanding common shares of which are held by the Partnership;

(k) "Cansub 7" means XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding common shares of which are owned by Canco;

(l) "Cco" means XXXXXXXXXX , a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by USco;

(m) "Code" means the Internal Revenue Code, 26 U.S.C.;

(n) "Convention" means the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital signed on September 26, 1980, as amended by the Protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007;

(o) "CRA" means the Canada Revenue Agency;

(p) "Dco" means XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by USco;

(q) "Eco" means XXXXXXXXXX , a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by Cco;

(r) "Fco" means XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , XXXXXXXXXX % of the issued and outstanding shares of which are held by Dco and XXXXXXXXXX % of which are held by Gco;

(s) "Gco" means the XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , XXXXXXXXXX % of the issued and outstanding shares of which are held by Bco and XXXXXXXXXX % of which are held by Dco;

(t) Holdco" means XXXXXXXXXX a corporation incorporated under the laws of XXXXXXXXXX and a disregarded entity for the purposes of the Code, all of the issued and outstanding shares of which are owned by USSub;

(u) XXXXXXXXXX

(v) "paid-up capital" has the meaning assigned by subsection 89(1);

(w) "Paragraph" means a numbered paragraph in this letter;

(x) "Parentco" means XXXXXXXXXX a corporation incorporated under the laws of XXXXXXXXXX , all of the issued and outstanding equity of which is listed for trading on the XXXXXXXXXX stock exchanges;

(y) "Partnership" means XXXXXXXXXX , a general partnership formed under the laws of the Province of XXXXXXXXXX , the partners of which are Canco, Cansub 2, Cansub 3, Cansub 5 and Cansub 6 as to XXXXXXXXXX respectively;

(z) "principal-business corporation" has the meaning assigned by subsection 66(15);

(aa) "private corporation" has the meaning assigned by subsection 89(1);

(bb) "related persons" has the meaning assigned by subsection 251(2);

(cc) "Subject Transactions" means the transactions described in Paragraphs 18 to 22;

(dd) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(ee) "taxable Canadian property" has the meaning assigned by subsection 248(1);

(ff) "United States" means the United States of America;

(gg) "USco" means XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by Bco. USco is primarily a holding company that owns, directly or indirectly, all of the issued and outstanding shares of Cco, Dco, Eco, Fco, Gco and USSub;

(hh) "USco Group" means USco and its direct and indirect United States subsidiaries;

(ii) "USco Notes" means USco Note 1, USco Note 2 and USco Note 3;

(jj) "USco Note 1" means the promissory note issued by Canco to USco evidencing indebtedness owing on XXXXXXXXXX in the principal amount of $XXXXXXXXXX and bearing interest annually at the rate of XXXXXXXXXX ;

(kk) "USco Note 2" means the promissory note issued by Canco to USco evidencing indebtedness owing by Canco on XXXXXXXXXX in the principal amount of $XXXXXXXXXX and bearing interest annually at the rate of XXXXXXXXXX %;

(ll) "USco Note 3" means the promissory note issued by Canco to USco evidencing indebtedness owing on XXXXXXXXXX in the principal amount of $XXXXXXXXXX and bearing interest annually at the rate of XXXXXXXXXX ;

(mm) "USSub" means XXXXXXXXXX ., a corporation incorporated under the laws of the State of XXXXXXXXXX , all of the issued and outstanding shares of which are owned by USco;

(nn) "USSub Debentures" means USSub Debenture 1 and USSub Debenture 2;

(oo) "USSub Debenture 1" means the debenture issued by Canco in XXXXXXXXXX evidencing the principal amount owing on XXXXXXXXXX of USD$XXXXXXXXXX and bearing interest at a rate of XXXXXXXXXX % payable semi-annually;

(pp) "USSub Debenture 2" means the debenture issued by Canco in XXXXXXXXXX evidencing the principal amount owing on XXXXXXXXXX of USD$XXXXXXXXXX and bearing interest at a rate of XXXXXXXXXX % payable semi-annually; and

(qq) USSub Note" means the promissory note evidencing indebtedness owing by Canco that was originally issued on XXXXXXXXXX and that is due on XXXXXXXXXX to USSub in the principal amount of $XXXXXXXXXX and bearing interest quarterly at the rate of XXXXXXXXXX .

FACTS

1. Canco is in the business of XXXXXXXXXX . Canco acquires XXXXXXXXXX from the Partnership and from third parties in Canada. Canco employs approximately XXXXXXXXXX employees in Canada and is active in the Provinces of XXXXXXXXXX . For United States income tax purposes, Canco is disregarded as an entity separate from its sole shareholder, USSub, and is therefore fiscally transparent under the taxation laws of the United States. Canco files its Canadian federal tax returns with the XXXXXXXXXX Tax Centre and its Canadian federal income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

2. The Partnership is in the business of XXXXXXXXXX . Canco is the managing partner of the Partnership and owns a XXXXXXXXXX % interest in the Partnership and as such is engaged in the business of the Partnership. Cansub 2 and Cansub 3 respectively own an XXXXXXXXXX % and a XXXXXXXXXX % interest in the Partnership and, as such, are engaged in the business of the Partnership.

3. In addition to its interest in the Partnership, Cansub 3 is in the business of:

(a) XXXXXXXXXX
(b) XXXXXXXXXX
(c) XXXXXXXXXX

4. Cansub 4 is in the business of XXXXXXXXXX

5. Cansub 1 is in the business of XXXXXXXXXX Cansub 1 acquires these products from Canco, Cansub 3 and Cansub 4, as well as from members of the USco Group, including Eco and Fco, and from third parties in the United States.

6. Cansub 7 is in the business of XXXXXXXXXX in the United States.

7. USco and its direct and indirect subsidiaries, including the members of the USco Group, operate an XXXXXXXXXX business. Through its affiliated entities, Cco, Eco and Fco, the USco Group is XXXXXXXXXX :

XXXXXXXXXX

8. For the year ended XXXXXXXXXX , the USco Group reported total revenues of US$XXXXXXXXXX of which US$XXXXXXXXXX and US$XXXXXXXXXX were located in the United States and Canada, respectively. Total assets of USco Group as at XXXXXXXXXX were US$XXXXXXXXXX of which US$XXXXXXXXXX and US$XXXXXXXXXX were located in the United States and Canada, respectively.

9. The USco Group employs approximately XXXXXXXXXX people in the United States and has offices in XXXXXXXXXX states.

10. Canco owes approximately $XXXXXXXXXX to USco pursuant to the terms of the USco Notes. Interest on the USco Notes for the period from XXXXXXXXXX to the date hereof is payable, but has not been paid.

11. Interest income received by USco is paid by Canco from the income earned by it, directly or indirectly, in the conduct of the active trade or business of Canco and its related entities, including the Partnership. These activities are highly integrated with the business activities conducted by the USco Group. USco and its direct and indirect subsidiaries, including the members of the USco Group, are the XXXXXXXXXX

12. XXXXXXXXXX

13. XXXXXXXXXX

14. The income earned, directly or indirectly, by Canco from the sale of XXXXXXXXXX to third parties and to the USco Group is used, in conjunction with its other income (e.g., income from XXXXXXXXXX with third parties and the USco Group), to pay the interest on the USSub Note, the USco Notes and the USSub Debentures.

15. USco, USSub, Bco, Cco, Dco, Eco, Fco, Gco and Canco are related persons.

16. USco and USSub are residents of the United States under the Convention.

17. Before XXXXXXXXXX , Canco paid to USSub:

(a) interest that was accrued, but unpaid, on the USSub Note and the interest accruing on the USSub Note to XXXXXXXXXX ;

(b) interest that was accrued, but unpaid, on USSub Debenture 1 and the interest accruing on USSub Debenture 1 to XXXXXXXXXX ; and

(c) interest that was accrued, but unpaid, on USSub Debenture 2 and the interest accruing on USSub Debenture 2 to XXXXXXXXXX .

SUBJECT TRANSACTIONS

18. Prior to XXXXXXXXXX , USSub sold the USSub Note to USco for cash consideration equal to the fair market value of the USSub Note.

19. On XXXXXXXXXX , Canco and USco extended the maturity date of the USSub Note to XXXXXXXXXX and set the interest rate on such note at the prevailing market rate of interest.

20. On or before XXXXXXXXXX , USSub will sell the USSub Debentures to USco, for cash consideration equal to the fair market value of the USSub Debentures.

21. On or before XXXXXXXXXX , Canco will pay the interest payable, but not paid, for XXXXXXXXXX on the USco Notes.

22. Beginning on or before XXXXXXXXXX , Canco will pay all interest payable on the USco Notes, the USSub Notes and the USSub Debentures on each due date under the terms of the respective debt obligations.

ADDITIONAL INFORMATION

23. The USSub Note and the USSub Debentures will not constitute an interest in or option in respect of property described in paragraphs (a) to (k) of the definition of "taxable Canadian property".

24. Effective on XXXXXXXXXX , the maturity date of USco Note 1 was extended to XXXXXXXXXX and the interest rate was set at the prevailing market rate of interest as of XXXXXXXXXX , with the result that the fair market value of USco Note 1 on XXXXXXXXXX was the same as the principal amount outstanding on such note. At that time, the interest payable, but not paid, on the USco Note 1 for the period after XXXXXXXXXX remained unpaid.

25. Effective on XXXXXXXXXX , the maturity date of USco Note 3 was extended to XXXXXXXXXX and the interest rate was set at the prevailing market rate of interest as of XXXXXXXXXX , with the result that the fair market value of USco Note 3 on XXXXXXXXXX was the same as the principal amount outstanding on such note. At that time, the interest payable, but not paid, on the USco Note 3 for the period after XXXXXXXXXX remained unpaid.

26. USco does not carry on business in Canada within the meaning of the Act.

27. For the purposes of the Code, Canco, Cansub 2 and Cansub 3 are disregarded as entities separate from their respective owners and the Partnership is treated as a partnership. As a result, XXXXXXXXXX % of the income of the Partnership is included in the income of USSub for United States income tax purposes. Any transaction between Canco and USco, including the payment of interest by Canco to USco, is treated as a transaction between USSub and USco.

28. Bco has elected to file a consolidated income tax return with its qualifying United States entities in the USco Group under Code section 1502 and the regulations thereto. The group of qualifying United States entities includes USco and USSub. The respective incomes of Cansub 1 and Cansub 7 are also included in the computation of the "consolidated taxable income" of this group. In calculating the group's consolidated taxable income, the "separate taxable income" of each member of the group must first be calculated under the provisions of the Code.

29. In determining its separate taxable income for a taxable year, USco is required to include the interest income from the indebtedness owed to it by Canco that accrues in the year; interest expense relating to such indebtedness may be deductible in the computation of the separate taxable income of USSub. In the computation of the consolidated taxable income of the group of entities that includes USco and USSub, the interest included in the separate taxable income of USco may be offset in full by the interest expense deducted in the computation of the separate taxable income of USSub. There may be circumstances where the interest income and interest expense on such indebtedness is not taken into account in the same taxable year by the respective parties, such as when the interest expense is required to be capitalized under Code section 263A (relating to interest expense incurred during a "production period"). In such circumstances, the interest income would continue to be included in the computation of USco's separate taxable income on the accrual basis described above, but any deduction of the associated interest expense by USSub would be deferred to future taxable years in the computation of its separate taxable income.

30. If Canco was not fiscally transparent for the purposes of the Code, the same amount of interest income from the indebtedness owed by Canco to USco accruing in a taxable year of USco would be included in the computation of the separate taxable income of USco for that taxable year. The interest would be considered to be interest from indebtedness owing to USco by Canco, and could, depending on the circumstances, be considered to have a geographic source different than the geographic source that will be attributed to such interest having regard to Canco's fiscal transparency under the Code. However, USco would be required to include the same amount of interest income from the indebtedness on the accrual basis described in Paragraph 29 notwithstanding any difference in geographic source.

31. The interest to be paid to USco on the USSub Note, the USSub Debentures and the USco Notes, as described in Paragraphs 21 and 22, will constitute interest within the meaning of Article XI(2) of the Convention.

32. The income of Canco and its subsidiaries derived from the business activities described in Paragraphs 1 to 6 is earned directly by Canco or indirectly through such subsidiaries.

33. At each time a payment of interest described in Paragraph 21 or 22 is made, (i) Canco and its subsidiaries will carry on the business activities described in Paragraphs 1 to 6, (ii) Bco and the related entities described in Paragraph 15 will carry on the business activities described in Paragraph 7, and (iii) the relative size of the business activities described in Paragraph 7 in relation to the described in Paragraphs 1 to 6 will not be substantially different.

PURPOSE OF THE SUBJECT TRANSACTIONS

31. The purpose of the Subject Transactions is to maintain USco as the principal finance company of Canco and to consolidate all of Canco's borrowings from related parties by transferring the current indebtedness of Canco held by USSub to USco. The transfer of the indebtedness of Canco by USSub to USco was made so that treaty benefits under Article XI(1) of the Convention could apply to interest payments made by Canco after XXXXXXXXXX in respect of the transferred debt obligations.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, the transactions described in Paragraphs 18 and 19, the proposed transactions and the purposes of the Subject Transactions, and provided further that the Subject Transactions are completed in the manner described above, we rule as follows:

A. Pursuant to Article XXIX-A(3) of the Convention, the benefits of the Convention, including, in particular, any benefit under Article XI of the Convention will apply to interest paid to USco by Canco as described in Paragraphs 21 and 22.

B. Subject to Articles XI(3), XI(5) and XI(6) of the Convention, and provided that USco is the beneficial owner of the interest paid to it by Canco as described in Paragraphs 21 and 22, no amount of tax will be payable under Part XIII in respect of such payments of interest by Canco to USco pursuant to Article XI(1) of the Convention.

C. No amount of tax will be payable under Part XIII on the respective transfers of the USSub Debentures and the USSub Note described in Paragraphs 18 and 20.

D. Subsection 245(2) will not apply to the Subject Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

CAVEAT

Finally, nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:

(a) the determination of the adjusted cost base, paid-up capital or fair market value of any shares or other property referred to herein; and

(b) any tax consequences relating to the facts and Subject Transactions described herein other than those described in the rulings given above.

This ruling is based solely on the facts, Subject Transactions and additional information described above and is subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002. This ruling is binding on the Canada Revenue Agency provided that the Subject Transactions are completed on or before XXXXXXXXXX .

Yours truly,

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