2001 Ruling 2000-0036913 - GAAR; CONTROL; LOSSES

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 Department.

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

Principal Issues:

1 whether change of control
2 whether OpCo and Partnership are non-arms length
3 whether 53(1)(e)(iv) applies re capital contribution from SubCo to Partnership
4 whether foreign currency gain is on capital account

Position:

1 yes - favourable ruling
2 yes - favourable ruling
3 yes - favourable ruling
4 yes - to the extent funds were borrowed for long term financing of construction - favourable ruling

Reasons:

1 249(4) ITA
2 facts of situation
3 no benefit to related party
4 IT-95

XXXXXXXXXX 2000-003691

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Rulings

We are writing in response to your letter of XXXXXXXXXX wherein you requested advance income tax rulings on behalf of the above taxpayers as well as your subsequent letters and our (XXXXXXXXXX) telephone conversations on this matter.

To the best of your knowledge, and that of the taxpayers involved, none of the issues contained herein is:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of one or any of the taxpayers or a related person;

(iii) under objection by one or any of the taxpayers or a related person;

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

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

(a) "Act" means the Income Tax Act, R.S.C 1985 (5th Supp.) c.1, as amended to the date hereof, and, unless otherwise stated, every reference herein to a Part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "ACB" means "adjusted cost base" within the meaning assigned by section 54 of the Act;

(c) "affiliated persons" has the meaning assigned by subsection 251.1(1) of the Act;

(d) "Amalco" means the corporation that is to be formed by the statutory amalgamation of SubCo and OpCo;

(e) "capital cost" means the amount included as item A in the computation of undepreciated capital cost as set out in subsection 13(21) of the Act;

(f) "capital cost allowance" ("CCA") means the amount that is deductible in respect of the capital cost of property, pursuant to paragraph 20(1)(a) of the Act and relevant Regulations;

(g) "Capital Contribution Agreement" means an agreement to be entered into between SubCo, ForeignCo and Limited Partnership as part of the Proposed Transactions pursuant to which Amalco would contribute an agreed upon amount of capital to Limited Partnership to be added to Amalco's aggregate limited partnership capital for income tax purposes;

(h) "CCRA" means the Canada Customs and Revenue Agency;

(i) "XXXXXXXXXX Limited Partnership Interest" means an interest in the Limited Partnership entitling the holder to payments totalling $XXXXXXXXXX after providing for payments to partners to discharge the partners' Canadian tax liabilities and for the entitlements of the holders of XXXXXXXXXX Units, if any, but prior to making any other distributions to Limited Partners, plus a XXXXXXXXXX% interest in the profits and losses and in the capital of the Limited Partnership remaining after deducting the entitlements of the holders of XXXXXXXXXX Units, if any, and the prior return of the XXXXXXXXXX entitlement;

(j) "XXXXXXXXXX Limited Partnership Interest" means an interest in the Limited Partnership entitling the holder to a XXXXXXXXXX% interest in the profits and losses and in the capital of the Limited Partnership remaining after deducting the entitlements of the holders of XXXXXXXXXX Units, if any, and the prior return of the $XXXXXXXXXX entitlement;

(k) "Company Act" means the Company Act of XXXXXXXXXX;

(l) "corporation" has the meaning assigned by subsection 248(1) of the Act;

(m) "cost amount" has the meaning assigned by subsection 248(1) of the Act;

(n) "cumulative eligible capital"("CEC") as the meaning set out in subsection 14(5) of the Act;

(o) "depreciable properties" means all depreciable property of OpCo as defined in subsection 13(21) of the Act, that is transferred to Limited Partnership pursuant to the Proposed Transactions;

(p) "eligible capital property" has the meaning assigned by section 54 of the Act;

(q) "XXXXXXXXXX Units" means units of the limited partnership interest in the Limited Partnership with the following attributes: the Limited Partnership may from time to time issue XXXXXXXXXX Units at a price of $XXXXXXXXXX per unit and from time to time to cause all or any part of the XXXXXXXXXX Units so issued to be redeemed upon payment of a redemption price of $XXXXXXXXXX per Unit; in the event of dissolution of the Limited Partnership, the holders any issued XXXXXXXXXX Units will be entitled to receive the sum of $XXXXXXXXXX per Unit before any distribution of assets of the Limited Partnership is made with respect to the Limited Partnership Interests;

(r) "FMV" means fair market value;

(s) "ForeignCo" means XXXXXXXXXX, a corporation incorporated in XXXXXXXXXX the shares of which are XXXXXXXXXX;

(t) "ForeignCoSub" means XXXXXXXXXX ., a taxable Canadian corporation incorporated on XXXXXXXXXX [Business #: XXXXXXXXXX Taxation Centre] and a subsidiary wholly-owned corporation of ForeignCo;

(u) "forgiven amount" has the meaning assigned by subsection 80(1) of the Act;

(v) "General Partner" means., the general partner of the Limited Partnership;

(w) "General Partnership Interest" means the interest of the General Partner in the Limited Partnership entitling General Partner to XXXXXXXXXX% interest in the profits and losses and in the capital of the Limited Partnership remaining after deducting the entitlements of the holders of XXXXXXXXXX Units, if any, and the prior return of the $XXXXXXXXXX entitlement;

(x) "Limited Partners" means OpCo, subsequently Amalco, and ForeignCo;

(y) "Limited Partnership Agreement" means an agreement to be entered into between General Partner Co. and OpCo as initial limited partner under which the Limited Partnership is constituted and restated with General Partner Co., OpCo and ForeignCo as partners;

(z) "ManageCo" means, XXXXXXXXXX, a corporation to be incorporated, the shares of which will be held as described below;

(aa) "net capital loss" has the meaning assigned by subsection 111(8) of the Act;

(bb) "NewCo means a newly incorporated Canadian subsidiary wholly-owned corporation of ParentCo;

(cc) "non-capital loss" has the meaning assigned by subsection 111(8) of the Act;

(dd) "OpCo Properties" means the properties of OpCo, including depreciable assets, other capital property, eligible capital property and inventory;

(ee) "OpCo" means XXXXXXXXXX, a taxable Canadian corporation incorporated on XXXXXXXXXX [Business No.XXXXXXXXXX Taxation Centre];

(ff) "OpCo Debt" means the indebtedness of OpCo, as described in 14 below;

(gg) "OpCo Note" means the non-interest bearing note that will be issued by OpCo to purchase its shares held by ForeignCo;

(hh) "paid-up capital" ("PUC") has the meaning assigned by subsection 248(1) of the Act;

(ii) "ParentCo" means XXXXXXXXXX, a taxable Canadian corporation constituted under the Company Act, the common shares of which are listed and traded on XXXXXXXXXX Stock Exchange. [Business No. XXXXXXXXXX Taxation Centre];

(jj) "Partners" means General Partner Co. and the Limited Partners;

(kk) "proceeds of disposition" has the meaning assigned by section 54 or subsection 13(21) of the Act;

(ll) "Proposed Transactions" means the transactions described in 21 to 35 below;

(mm) "Province" means the Province of XXXXXXXXXX;

(nn) "Regulations" means the Income Tax Regulations;

(oo) "Stub Year" means the taxation year of OpCo that will end immediately prior to the acquisition of control of OpCo by SubCo;

(pp) "SubCo" means XXXXXXXXXX, a taxable Canadian corporation and a wholly-owned subsidiary of ParentCo that was formed by amalgamation on XXXXXXXXXX [Business No.XXXXXXXXXX Taxation Centre];

(qq) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1) of the Act;

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

(ss) "taxable Canadian property" has the meaning assigned by paragraph 115(1)(b) of the Act;

(tt) "tax shelter" has the meaning assigned by subsection 237.1(1) of the Act;

(uu) "undepreciated capital cost" ("UCC") has the meaning assigned by subsection 13(21) of the Act.

FACTS

1. OpCo is a corporation resident in Canada.

2. All of the issued and outstanding common and redeemable preferred shares of the capital stock of OpCo are owned equally by ParentCo and ForeignCo. All of the XXXXXXXXXX issued and outstanding XXXXXXXXXX shares of the capital stock in OpCo are owned by ForeignCo.

3. OpCo derives substantially all of its income from XXXXXXXXXX.

4. XXXXXXXXXX.

5. ParentCo has a wholly-owned subsidiary, SubCo. Like OpCo, SubCo is in the business of XXXXXXXXXX.

6. XXXXXXXXXX.

7. XXXXXXXXXX.

8. OpCo commenced operations in XXXXXXXXXX. ForeignCo received XXXXXXXXXX% of the shares in the capital stock of OpCo in consideration for $XXXXXXXXXX in cash.

9. The objectives of OpCo were to:

XXXXXXXXXX.

10. XXXXXXXXXX.

11. The issued and outstanding share capital of OpCo, which is equal to PUC for income tax purposes, is as follows:

XXXXXXXXXX.

12. The FMV of each share in the capital stock of OpCo held by ParentCo is less than its ACB to ParentCo. Each share in the capital stock of OpCo has an ACB equal to its par value.

13. The common, redeemable preference shares and the XXXXXXXXXX shares of OpCo owned by ForeignCo, and the common and redeemable preference shares of OpCo owned by ParentCo constitute capital property to ForeignCo and ParentCo, respectively. They were acquired by ForeignCo and ParentCo respectively for the purpose of facilitating the holding of their indirect interests in OpCo's assets and business, which were contemplated as long-term investments from which net revenues and cash-flows would be derived.

14. As at XXXXXXXXXX OpCo was indebted to arm's length non-resident lenders as follows:

XXXXXXXXXX.

15. The indebtedness described in 14 above was incurred by OpCo primarily for the long-term financing requirements of OpCo's XXXXXXXXXX program described in 10 above and in part as working capital of OpCo.

16. OpCo also has short term, Canadian dollar credit facilities with several lenders. At XXXXXXXXXX, the outstanding balance was $XXXXXXXXXX.

17. XXXXXXXXXX.

18. As a result of XXXXXXXXXX, OpCo has incurred substantial losses since commencement of its operations. In XXXXXXXXXX, ParentCo wrote-off its investment in OpCo in accordance with accounting requirements after concluding that the value of the investment was impaired and no further financial support would be provided.

19. OpCo has utilized only a small part of the CCA available to it under the Act. OpCo's UCC at the end of XXXXXXXXXX was over $XXXXXXXXXX, however at XXXXXXXXXX, the fair market value of these properties was estimated at between $XXXXXXXXXX and $XXXXXXXXXX.

Summary of OpCo's UCC per XXXXXXXXXX Federal Income Tax Return:

Class

XXXXXXXXXX

20. General tax advice has been received from respective tax advisors. However, no representations have been made nor are proposed to be made in connection with the Proposed Transactions, including the formation of the Limited Partnership, that losses are expected to be incurred by the Limited Partnership nor that the amount of losses (if any) incurred by the Limited Partnership would equal or exceed the cost to persons holding an interest in the Limited Partnership (being ForeignCo, Amalco, OpCo and General Partner) of their respective interest in the Limited Partnership nor that losses (if any) incurred by the Limited Partnership will be deductible by persons holding an interest in the Limited Partnership.

PROPOSED TRANSACTIONS

21. NewCo will be incorporated pursuant to the Company Act. XXXXXXXXXX% of all shares of each class of the capital stock of NewCo will be held by ParentCo. ManageCo will be incorporated pursuant to the Company Act. XXXXXXXXXX% of all shares of each class of the capital stock of ManageCo will held by each of NewCo and ForeignCoSub. NewCo and ManageCo will be resident in Canada.

22. General Partner will be incorporated with all shares of each class of its capital stock owned by NewCo. ForeignCoSub will hold an option to purchase from NewCo XXXXXXXXXX% of the shares of each class of the capital stock of General Partner. ManageCo and General Partner will enter into a contract pursuant to which ManageCo will provide management services to General Partner.

23. NewCo and ForeignCoSub will enter into a Shareholders' Agreement and a Transfer Restriction Agreement with respect to ManageCo and, subsequently, with respect to General Partner.

24. A new limited partnership, "Limited Partnership", will be formed by OpCo and General Partner under the laws of the Province to acquire and carry on the business currently carried on by OpCo. The Limited Partnership Agreement will allow for the issuance of a General Partnership Interest, XXXXXXXXXX Limited Partnership Interest, XXXXXXXXXX Limited Partnership Interest, and XXXXXXXXXX Units.

25. ParentCo will transfer its common and redeemable preference shares of OpCo to SubCo in consideration for the issuance of additional shares in the capital stock of SubCo.

26. SubCo, subsequently Amalco, and the Limited Partnership will enter into Supply Agreements whereby SubCo will, for a period of XXXXXXXXXX years, contractually commit to the Limited Partnership to:

XXXXXXXXXX.

27. Pursuant to a Plan of Arrangement under the Company Act of the Province, the transactions described in paragraphs 28, 29, 30 and 32 will be effected concurrently on a day (the "Transaction Date") but in the following sequence:

28. The common shares, redeemable preference shares and XXXXXXXXXX shares in OpCo held by ForeignCo will be transferred to OpCo in consideration for the issuance by OpCo of the OpCo Note. The amount of the OpCo Note will be the aggregate fair market value of all the shares in OpCo that OpCo purchased for cancellation from ForeignCo. No election will be filed pursuant to subsection 256(9) of the Act with respect to the acquisition of control of OpCo.

29. OpCo will contribute to the Limited Partnership the OpCo Properties in consideration for the following:

(i) the assumption by the Limited Partnership of all of the obligations and liabilities of OpCo as at the commencement of the day that the Plan of Arrangement is effected; and

(ii) the issuance by the Limited Partnership to OpCo of one (1) XXXXXXXXXX Limited Partnership Interest and one (1) XXXXXXXXXX Limited Partnership Interest. OpCo will hold its interest in the Limited Partnership as capital property.

30. OpCo will transfer at fair market value to ForeignCo OpCo's XXXXXXXXXX Limited Partnership Interest. As consideration, OpCo will cancel a portion of the OpCo Note. The fair market value of the XXXXXXXXXX Limited Partnership Interest transferred to ForeignCo will equal the amount of the OpCo Note that is cancelled. ForeignCo intends to hold its XXXXXXXXXX Limited Partnership Interest as capital property. The outstanding balance of the OpCo Note will be contributed by ForeignCo to the Limited Partnership.

31. Limited Partnership, at the discretion of General Partner, will make distributions to discharge each Limited Partner's liability for Canadian federal and provincial income tax, Large Corporations Tax and provincial capital tax in respect of a Limited Partner's investment in the Limited Partnership for the fiscal year.

32. SubCo and OpCo will be amalgamated pursuant to the provisions of the Company Act of the Province and shall continue as one company under the terms and conditions set out in the Plan of Arrangement. Amalco will be resident in Canada. No time will be specified in the certificate of amalgamation obtained in respect of the amalgamation.

33. As part of the assumption by the Limited Partnership of the OpCo Debt, the lenders will be asked to release OpCo in respect of the assumed debt.

34. Limited Partnership will carry on the XXXXXXXXXX business formerly carried on by OpCo for profit or with a reasonable expectation of profit.

35. Amalco will make contributions to the Limited Partnership under the Capital Contribution Agreement.

SUBSEQUENT EVENTS

36. Approximately XXXXXXXXXX months after Transaction Date, ForeignCoSub will exercise its option to purchase XXXXXXXXXX% of the shares of each class in the capital stock of the General Partner.

37. At some future date, ManageCo and General Partner may be amalgamated to simplify the corporate structure.

PURPOSE OF THE PROPOSED TRANSACTIONS

38. XXXXXXXXXX.

39. OpCo's options in terms of restructuring its operations are quite limited. For business and financial reasons, the shareholders of OpCo cannot change (other than on a transitory basis through a plan of arrangement) their XXXXXXXXXX ratio of holdings in the business currently carried on by OpCo.

ForeignCo cannot take control of the business of Limited Partnership because of its desire to have a XXXXXXXXXX% partner in all businesses in which it invests which are carried on outside of XXXXXXXXXX.

XXXXXXXXXX.

Finally, because of OpCo's huge debtload, neither ParentCo nor ForeignCo can justify any further injections of cash to pay down debt under the present financial structure.

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 set forth below:

A. Paragraph 40(3.4)(a) will apply to deem ParentCo's loss from the disposition of the common and redeemable preference shares of OpCo to SubCo to be nil. Paragraph 40(3.4)(b) will apply to ParentCo's loss from the disposition (determined without reference to paragraph 40(2)(g) and subsection 40(3.4)) to be a loss of ParentCo from a disposition of the common and redeemable preference shares of OpCo at the time that is immediately before the first time, after the disposition, described in subparagraphs 40(3.4)(b)(i) to (v).

B. For the purposes of subsections 111(4), (5), (5.1), (5.2), and 249(4), SubCo will be considered to have acquired control of OpCo as a result of the share purchase by OpCo described in 28 above.

C. The loss ("ForeignCo's loss") that ForeignCo realizes on the transfer of its common shares, redeemable preferred shares and XXXXXXXXXX shares in the capital stock of OpCo to OpCo in exchange for the OpCo Note will be on account of capital. Paragraph 40(1)(b) will apply such that the amount of ForeignCo's loss will be the amount by which the total of the ACB to ForeignCo of each property immediately before the disposition, and any outlays and expenses to the extent that they were made or incurred for the purpose of making the disposition, exceeds the FMV of the OpCo Note.

D. Subsection 40(3.6) will not apply to the disposition described in 28 above since ForeignCo and OpCo are not affiliated persons at that time.

E. ForeignCo's allowable capital losses from the disposition of its shares of OpCo will be from the disposition of taxable Canadian properties.

F. Subsection 97(1) will apply to the acquisition by the Limited Partnership of each of the OpCo Properties to deem the Limited Partnership to have acquired each OpCo Property for an amount equal to its fair market value and to deem OpCo to have disposed of each OpCo Property at that time for proceeds of disposition equal to its fair market value.

G. To the extent that the indebtedness of OpCo described in 14 above was incurred for the long-term financing requirements of the construction program described in 10 above, any foreign currency losses sustained therefrom by OpCo on the assumption by the Limited Partnership of the OpCo Debt will be on account of capital. The amount of any such foreign currency loss on the assumption of indebtedness by the Limited Partnership, as described in 29(i) above, will be the difference between the FMV of the OpCo debt in Canadian currency at the time it was incurred by OpCo and the FMV in Canadian currency of the OpCo debt at the time it is assumed by the Limited Partnership.

H. Provided all the other conditions set out in subparagraph 212(1)(b)(vii) are met, the exemption provided for in subparagraph 212(1)(b)(vii) will not be disqualified if all the members of Limited Partnership are corporations that deal at arm's length with all the persons to whom any interest is payable and the partners are either resident in Canada or are non-residents who manufacture or process goods in Canada and subsection 212(13.2) applies.

I. For the purposes of section 80, no forgiven amount will result from the settlements of the OpCo Note described in 30 and 33 above.

J. Subsection 1100(2.2) of the Regulations will not apply to limit the amount of CCA which Limited Partnership may claim with respect to the depreciable assets acquired that are OpCo properties.

K. Subsection 1102(14)(d) will apply with respect to OpCo properties acquired by the Limited Partnership to deem each property of a prescribed class or a separate prescribed class of OpCo to be a property of that same prescribed class or separate prescribed class of the Limited Partnership.

L. Provided that there are no statements or representations of the type referred to in the definition of "tax shelter" found in subsection 237.1(1) of the Act made or proposed to be made by any person in connection with the Partnership Interest in the Limited Partnership that ForeignCo, OpCo, Amalco or General Partner will acquire, as described in the Proposed Transactions above, their interests in Limited Partnership will not be "tax shelters" as that term is defined in subsection 237.1(1).

M. Amounts paid by Amalco to the Limited Partnership under the Capital Contribution Agreement will be added to the ACB of the XXXXXXXXXX Limited Partnership Interest held by Amalco, pursuant to subparagraph 53(1)(e)(iv).

N. The amount that is the outstanding balance of the OpCo Note that is contributed by ForeignCo to the Limited Partnership will be added to the ACB of the XXXXXXXXXX Limited Partnership Interest held by ForeignCo, pursuant to subparagraph 53(1)(e)(iv).

O. Provided ForeignCo and Amalco continue to hold their respective interests in the Limited Partnership as capital property, subparagraph 53(2)(c)(v) will apply in computing the adjusted cost base to ForeignCo or Amalco, respectively, of its respective interest in the Limited Partnership to deduct therefrom the amount of any distribution described in paragraph 31 above made by the Limited Partnership to ForeignCo or to Amalco respectively that is received as, on account or in lieu of payment of, or in satisfaction of, a distribution of ForeignCo or Amalco's respective share of the profits or capital of the Limited Partnership.

P. The provisions of paragraph 12(1)(x) will not apply with respect to the payment of amounts by Amalco to the Limited Partnership under the Capital Contribution Agreement.

Q. The provisions of paragraph 12(1)(x) will not apply with respect to the contribution described in 30 above by ForeignCo of the outstanding balance of the OpCo Note to the Limited Partnership.

R. The provisions of subsection 87(2.1) will apply to deem Amalco to be the same corporation as, and a continuation of, SubCo and OpCo for the purposes of and subject to the restrictions in subsection 87(2.1).

S. Provided that the XXXXXXXXXX business of OpCo described in 3 above is carried on by the Limited Partnership for profit or with a reasonable expectation of profit throughout a particular taxation year ending after the acquisition of control of OpCo by SubCo, as described in 28 above, and the amalgamation of SubCo with OpCo, as described in 32 above, and subject to the time limitations set out in paragraph 111(1)(a), the restrictions set out in subsection 111(3), and any other requirements in the Act regarding deductibility of non-capital losses, the non-capital losses of OpCo may be deducted under paragraph 111(5)(a) in computing the taxable income of Amalco for that taxation year to the extent of the income earned by Amalco for that particular year from carrying on a XXXXXXXXXX business.

T. Provided that no election pursuant to subsection 256(9) of the Act is filed with respect to the acquisition of control of OpCo as described in paragraph 28 above and no time is specified in the certificate of amalgamation obtained in respect of the amalgamation described in paragraph 32 above and both the transactions described in paragraphs 28 and 32 are executed on the same day and in the same sequence as described above, OpCo will have only one deemed year end as a result of the acquisition of control of OpCo by SubCo and the amalgamation of SubCo and OpCo.

U. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to redetermine the income tax consequences confirmed in the rulings given.

CAVEAT

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R3 (the "Circular") issued by the CCRA on December 30, 1996, and are binding provided the proposed transactions are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act.

Nothing in this letter should be construed as implying that CCRA has agreed to or accepted:

(i) the determination of FMV, ACB or UCC of any property referred to in this letter;

(ii) the GST implications of any of the proposed transactions; and

(iii) any other tax consequences arising from the facts or proposed transactions described herein, other than those specifically confirmed in the rulings given.

Yours truly,

XXXXXXXXXX
for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings Directorate
Policy and Legislation Branch