2003 Ruling 2003-0005273 - Unwinding NRO Structure

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Will certain transactions undertaken to unwind an NRO structure permit debts owed to the NRO to be transferred to a limited partnership and interest on those debts to continue to be deductible by Canco?

Position: Yes. The transactions have the effect of winding up the NRO into the limited partnership and, subject to the thin capitalization rule, the interest on the debts involved will continue to be deductible to Canco.

Reasons: See issue sheets of files #2001-0114583 and #2001-0089903.

XXXXXXXXXX 2003-000527

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Canco")
XXXXXXXXXX ("NRO")
XXXXXXXXXX ("US Parent")
XXXXXXXXXX ("US Sub")
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 taxpayers. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

Canco and NRO's tax affairs are administered by the XXXXXXXXXX Tax Services Office and they file their tax returns at the XXXXXXXXXX Taxation Centre under Account Numbers XXXXXXXXXX, respectively.

We understand that to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:

(i) is an earlier return of the taxpayers or a related person;

(ii) is being considered by a tax services office or a taxation centre in connection with a previous filed tax return of the taxpayer or a related person;

(iii) is under objection by the taxpayer or a related person;

(iv) is before the courts or, if a judgement has been issued, the time limit for appeal has not expired; or

(v) is the subject of a ruling previously issued by the Directorate.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp;), c.1, as amended (the "Act"), 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" means adjusted cost base as defined in section 54;

(b) "ARTOH" means allowable refundable tax on hand as defined in subsection 133(9);

(c) "business" has the meaning assigned by subsection 248(1);

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

(e) "Canco Debt" means the indebtedness owing by Canco to NRO in the amount of $XXXXXXXXXX pursuant to a promissory note issued on XXXXXXXXXX toUS Parent and subsequently assigned to NRO on XXXXXXXXXX and amended and restated on XXXXXXXXXX. The indebtedness is a demand note with interest rate at prime plus XXXXXXXXXX% reset annually on XXXXXXXXXX;

(f) "carrying on business" has its extended meaning as stated in subsection 253(1);

(g) "CBCA" means the Canada Business Corporations Act;

(h) "the Code" means the United States Internal Revenue Code of 1986;

(i) "corporation" has the meaning assigned by subsection 248(1);

(j) "cumulative taxable income" has the meaning assigned by subsection 133(9);

(k) "FMV" means fair market value;

(l) "non-resident-owned investment corporation" has the meaning assigned by subsection 133(8);

(m) XXXXXXXXXX;

(n) "PUC" means paid up capital as defined in subsection 89(1);

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

(p) "the Treaty" means the Canada-United States Income Tax Convention.

Facts

1. Canco is a taxable Canadian corporation incorporated pursuant to the XXXXXXXXXX. Canco's taxation year-end is XXXXXXXXXX. Canco is in the XXXXXXXXXX business.

2. The capital of Canco consists of voting common shares with stated capital of $XXXXXXXXXX and preferred shares. The preferred shares have an XXXXXXXXXX% non-cumulative dividend entitlement, are non-voting, and are redeemable at $XXXXXXXXXX each with stated capital of $XXXXXXXXXX. US Sub owns all of the issued and outstanding shares of Canco.

3. US Sub is a corporation incorporated under the laws of the state of XXXXXXXXXX, and is a resident of the United States for purposes of the Act and the Treaty. US Sub is a wholly owned direct subsidiary of US Parent.

4. US Parent is a corporation incorporated under the laws of the state of XXXXXXXXXX, and is a resident of the United States for purposes of the Act and the Treaty.

5. US Parent and US Sub do not carry on business in Canada and do not have a permanent establishment in Canada for purposes of the Act or the Treaty.

6. NRO is a corporation incorporated under the XXXXXXXXXX and is resident in Canada for purposes of the Act. NRO is a wholly owned direct subsidiary of US Parent and has elected within the prescribed time and in the prescribed manner to be taxed as a non-resident-owned investment corporation under Section 133 of the Act.

7. As at XXXXXXXXXX, NRO had XXXXXXXXXX common shares issued and outstanding with an aggregate stated capital of $XXXXXXXXXX. NRO also has issued and outstanding XXXXXXXXXX First Series Class A shares having an aggregate stated capital of $XXXXXXXXXX. The PUC and ACB of the common shares is $XXXXXXXXXX. The PUC and ACB of the First Series Class A shares is $XXXXXXXXXX.

8. NRO's only assets consist of Canco Debt, interest receivable, cash held on deposit, and refundable taxes receivable.

9. NRO's taxation year-end is XXXXXXXXXX.

10. The FMV of Canco Debt on or about XXXXXXXXXX is estimated to be its face amount of $XXXXXXXXXX.

11. At its XXXXXXXXXX taxation year-end, NRO had an ARTOH balance of approximately $XXXXXXXXXX and a cumulative taxable income of approximately $XXXXXXXXXX.

Proposed Transactions

12. Prior to the transactions described below, US Parent will transfer the shares of NRO to US Sub in exchange for shares of US Sub equal to the fair market value of NRO. A request for a tax clearance certificate will be made, with respect to this transfer, as required by section 116 of the Act.

13. Prior to XXXXXXXXXX, US Sub will form a XXXXXXXXXX unlimited liability company ("ULC 1") with capital of approximately $XXXXXXXXXX and ULC 1 will form a XXXXXXXXXX unlimited liability company ("ULC 2") with capital of approximately $XXXXXXXXXX. US Sub will elect, in accordance with the applicable provisions of the Code and associated regulations, to have ULC 1 and ULC 2 treated as disregarded entities for US tax purposes.

14. By XXXXXXXXXX, ULC 1 and ULC 2 will form a limited partnership governed by the laws of XXXXXXXXXX ("Partnership"). ULC 1 will have a XXXXXXXXXX% interest in the Partnership and will be a limited partner. ULC 2 will have a XXXXXXXXXX% interest in the Partnership and will be the general partner. The initial contributions to the Partnership will be cash of $XXXXXXXXXX by ULC 2 and cash of $XXXXXXXXXX by ULC 1.

15. ULC 1 and ULC 2 will elect, in accordance with the applicable provisions of the Code and associated regulations, that the Partnership will be treated as a foreign corporation for US tax purposes.

16. Prior to XXXXXXXXXX, US Sub will contribute all its preferred shares of Canco (value of $XXXXXXXXXX) to ULC 1 in exchange for shares of ULC 1. US Sub and ULC 1 will jointly elect under subsection 85(1) of the Act to transfer the preferred shares of Canco for proceeds of disposition that result in no gain or loss being realized by US Sub. A request for a tax clearance certificate will be made, with respect to this transaction, as required in section 116 of the Act. US Sub will file the necessary Canadian corporate tax returns reporting the disposition.

17. Also, prior to XXXXXXXXXX, NRO will declare and pay a cash and stock dividend to US Sub in an amount equal to its cumulative taxable income. The amount of the dividend will approximate $XXXXXXXXXX. The stated capital of NRO's common shares will increase by the amount of stock dividend paid.

18. With respect to the cash and stock dividends paid as described in 17 above, NRO will satisfy the 10% Part XIII withholding tax requirement that will arise on the dividends by withholding all or a portion of the cash dividend. That tax will be remitted to Canada Customs and Revenue Agency (the "CCRA") by or on behalf of NRO on or before the XXXXXXXXXX day of the month following the date the dividend was paid.

19. Canco will pay all interest accrued to XXXXXXXXXX on Canco Debt to NRO on XXXXXXXXXX.

20. Pursuant to Section 501 of the Income Tax Regulation, NRO will revoke its election to be taxed as an NRO under section 133 of the Act effective XXXXXXXXXX. NRO will elect to have section 134.2 of the Act apply and will specify an "elected time" that is XXXXXXXXXX. As a result, NRO will have a taxation year that ends immediately before that time at XXXXXXXXXX ("Year End A").

21. NRO will make an election pursuant to section 134.1 of the Act for its taxation year commencing at the "elected time" of XXXXXXXXXX.

22. Effective XXXXXXXXXX (the first moment of NRO's taxation year which begins after XXXXXXXXXX), NRO will declare and pay a cash and stock dividend to US Sub. The stock dividend portion will be completed by issuing to US Sub additional common shares of NRO. The total cash and stock dividend paid will equal the cumulative taxable income of NRO at that time.

23. With respect to the cash and stock dividends paid as described in 22 above, NRO will satisfy the 10% Part XIII withholding tax requirement that will arise on the dividends by withholding all or a portion of the cash dividend. That tax will be remitted to the CCRA by or on behalf of NRO on or before XXXXXXXXXX.

24. At XXXXXXXXXX, and immediately after the transactions described above, US Sub will sell its shares of NRO to ULC 1 in exchange for an interest-bearing note with a principal amount owing of approximately $XXXXXXXXXX (the "ULC 1 Debt") and additional common shares of ULC 1. The ULC 1 Debt will have an interest rate that will not exceed the interest rate applicable to the Canco Debt. Total consideration received by US Sub will equal the FMV of the shares of NRO which will be greater than the FMV of the ULC 1 Debt. US Sub and ULC 1 will jointly elect under subsection 85(1) of the Act to transfer the shares of NRO for proceeds of disposition that result in no gain or loss being realized by US Sub. A request for a tax clearance certificate will be made, with respect to this transaction, as required in section 116 of the Act and US Sub will file the necessary Canadian corporate tax return reporting the disposition. It is expected that the assets of NRO at the time of the transfer to ULC 1 will consist principally of the Canco Debt and cash.

25. At XXXXXXXXXX, ULC 1 will sell XXXXXXXXXX% of the common shares of NRO to ULC 2 in exchange for common shares of ULC 2. ULC 1 and ULC 2 will jointly elect under subsection 85(1) of the Act to transfer the shares of NRO for proceeds of disposition that result in no gain or loss being realized by ULC 1.

26. At XXXXXXXXXX, ULC 1 and ULC 2 will contribute the shares of NRO to Partnership in exchange for Partnership units. ULC 1, ULC 2 and Partnership will jointly elect under subsection 97(2) of the Act to transfer the shares of NRO for proceeds of disposition that result in no gain or loss being realized by ULC 1 or ULC 2.

27. Effective at XXXXXXXXXX, and subsequent to the transactions described above, NRO will distribute to Partnership its net assets as a return of capital, which should include Canco Debt, cash, and the rights to its income taxes receivable. Prior to the distribution, NRO will undertake to

a) make all required remittances and filings with the CCRA in respect of the NRO's taxation years ending on Year End A and at Year End B (as described in 28 below) and an application for a refund of NRO's allowable refund for each such year, in the manner and within the time referred to in subsection 133(6) of the Act;

b) make all required remittances to the CCRA in connection with the dividends paid as set out above;

c) make all filings and take all other actions necessary to obtain any tax refunds to which NRO is entitled;

d) receive any tax refunds to which NRO is entitled and forthwith remit these amounts to the Partnership; and

e) retain sufficient funds to permit NRO to make any such payments and perform these activities.

Pursuant to the distribution agreement, the beneficial ownership in all of the property of NRO and all of the liabilities of NRO will become the property and liabilities of the Partnership as at XXXXXXXXXX.

28. NRO will apply to the appropriate Tax Services Office for approval to change its fiscal period to end on XXXXXXXXXX ("Year End B") in accordance with subsection 249.1(7).

29. Once the tax refunds have been obtained for Year End A and Year End B taxation years, NRO will be dissolved and will file a terminal tax return for the period commencing after Year End B to the date of dissolution.

30. ULC 1 may issue further shares for cash and/or borrow further amounts. ULC 1 would use any such cash proceeds for various purposes including subscribing for further preferred shares of Canco or to further capitalize the Partnership.

31. ULC 1 will pay interest to US Sub on the ULC 1 Debt in accordance with the terms of that debt. ULC 1 will have a variety of sources of cash to provide it with cash to pay the interest. The sources include distributions from the Partnership, borrowings by ULC 1 and the issuance of shares by ULC 1 for cash. ULC 1 will withhold Part XIII tax on such interest payments at the reduced treaty rate and will remit to the CCRA as required.

32. Thereafter in accordance with the provisions of the Canco Debt, Canco will pay interest on Canco Debt to the Partnership.

33. The Partnership will either distribute or invest within or outside Canada the interest income it earns from Canco and the cash received for the tax refunds due to NRO.

34. The Partnership will maintain a bank account in Canada with a Canadian financial institution in which interest payments will be deposited.

Purpose of the Proposed Transactions

35. The purpose of the proposed series of transactions is to unwind the NRO financing structure and to refinance other intercompany debts without creating adverse Canadian or United States income tax consequences.

Rulings Requested and 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. Subsections 69(5) and 84(2) of the Act will apply in respect of the winding-up of NRO as described in 27 and 29 above such that:

(i) NRO will be deemed to have disposed of all of its property for an amount equal to the fair market value of such property at the time it is distributed to the Partnership;

(ii) The Partnership will be deemed to have acquired the property referred to in (i) above, for the amount referred to in (i) above; and

(iii) NRO will be deemed to have paid a dividend to the Partnership and the Partnership will be deemed to have received a dividend from NRO, in the amount, if any, by which the amount referred to in (1) above, less the NRO liabilities assumed by the Partnership, exceeds the amount, if any, by which the PUC in respect of its common shares and First Series Class A Shares is reduced on the distribution.

B. Provided NRO files returns of income for taxation years ending on Year End A and Year End B at the time of its dissolution, and an application for a refund of its allowable refund for such taxation years is made by NRO, in the manner and within the time referred to in subsection 133(6) of the Act, subsection 133(6) thereof will be applicable.

C. Provided Canco has a legal obligation to pay interest on the Canco Debt and Canco continues to use the proceeds of this debt to earn income from a business or property (other than to acquire property the income from which would be exempt or to acquire a life insurance policy), the interest paid or payable to the Partnership pursuant to the Canco Debt in respect of each of Canco's taxation years (depending on the method regularly followed by Canco in computing its income) will be deductible by Canco to the extent that it is reasonable.

D. Subject to subsection 18(4) of the Act and provided ULC 1 has a legal obligation to pay interest on the ULC 1 Debt and ULC 1 continues to use the proceeds of this debt to earn income from a business or property (other than to acquire property the income from which would be exempt or to acquire a life insurance policy), the interest paid or payable to US Sub pursuant to the ULC 1 Debt in respect of each of ULC 1's taxation years (depending on the method regularly followed by ULC 1 in computing its income) will be deductible by ULC 1 to the extent that it is reasonable.

E. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences described in the rulings given above to any of the parties described in this ruling letter.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001, and are binding on the CCRA 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.

Comments

Nothing in this ruling should be construed as implying that the CCRA 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 CCRA has agreed to or reviewed:

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

(b) the tax treatment of any interest owing from the government of Canada in respect of the tax refunds described herein;

(c) the application of section 212.1 of the Act to the transaction described in 24 above;

(d) the application of subsection 18(4) of the Act regarding any debt owing to US Sub; and

(e) whether a valid partnership exists for purposes of the Act. In this regard, we have not reviewed any documents in respect of the proposed limited partnership.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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