2002 Ruling 2002-0133053 - INNOVATIVE INSTRUMENTS - PARA 20(1)(c)

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:

1. Whether the Deposit Note to be issued to a special purpose vehicle in a loan-backed innovative instrument financing will evidence borrowed money for the purpose of paragraph 20(1)(c).

2. Whether subsection 104(7.1) will apply to deny a deduction to the special purpose vehicle under paragraph 104(6)(b) of amounts payable to its unitholders.

Position:

1. Yes.

2. No.

XXXXXXXXXX 2002-013305

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: Advance income tax ruling request
XXXXXXXXXX ("X Co.")
XXXXXXXXXX ("Y Co.")

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request (XXXXXXXXXX).

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 in an earlier return of the taxpayer or a related person,

(ii) is being considered by a tax services office or taxation center in connection with a previously 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 judgment has been issued, the time limit for appeal to a higher court has not expired, and

(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

"Bank Act" means the Bank Act (Canada);

"Deposit Note" means the deposit note issued by X Co. as described more fully in paragraphs 22-30 below;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

XXXXXXXXXX;

"Special Securities" means the Special Trust Securities, being voting units of beneficial interest of Y Co. to be owned by X Co. as described more fully in paragraph 8 below;

"Superintendent" means the Superintendent of Financial Institutions (Canada).

"XXXXXXXXXX Event" means XXXXXXXXXX;

"Trust Securities" means the XXXXXXXXXX, issuable in series, being non-voting units of beneficial interest in Y Co. which will be offered for investment to the public in Canada as described more fully below;

XXXXXXXXXX;

"X Co." means XXXXXXXXXX; and

"Y Co." means XXXXXXXXXX to be established as described more fully in paragraphs 6-9 below.

Facts

1. X Co. is a Schedule 1 Canadian chartered bank, XXXXXXXXXX The head office of X Co. is located at XXXXXXXXXX. Its Business Number is XXXXXXXXXX , its Tax Services Office is the XXXXXXXXXX Tax Services Office and its Tax Centre is XXXXXXXXXX. X Co. is a public corporation within the meaning of subsection 89(1) of the Act.

2. X Co. has authorized capital consisting of an unlimited number of common shares ("X Co. Common Shares") and an unlimited number of preferred shares ("X Co. Preferred Shares"). X Co. Common Shares are widely held by members of the public, as are X Co. Preferred Shares that are currently outstanding. In connection with the proposed transactions, X Co. Preferred Shares Series W (the "Series W Shares") and X Co. Preferred Shares Series X (the "Series X Shares") have been authorized.

3. In July of 1999, the Superintendent issued innovative Tier 1 capital guidelines governing the issue by Canadian banks of securities which were entitled to be treated as qualifying Tier 1 capital for purposes of the regulations under the Bank Act. In August of 2001, OSFI issued the OSFI Guidelines, which extended the application of the guidelines to address capital and surplus requirements of all federally regulated financial institutions including banks and life insurance companies.

4. XXXXXXXXXX.

5. XXXXXXXXXX.

Proposed Transactions

6. Y Co. will be established by way of declaration of trust under the laws of XXXXXXXXXX and will be resident in Canada for purposes of the Act. The Trustee of Y Co. will be XXXXXXXXXX . The capital of Y Co. will be represented by units of beneficial interest in Y Co..

7. It is intended that Y Co. qualify as a unit trust described in paragraph 108(2)(a) of the Act.

8. Y Co. proposes to issue two classes of units: Trust Securities and Special Securities. The Special Securities are expected to represent less than XXXXXXXXXX% of the total capital of Y Co. represented by units, will be voting and will be subscribed for cash. The Special Securities will be owned at all material times by X Co.. On the closing date X Co. will subscribe for XXXXXXXXXX Special Securities for an aggregate issue price of $XXXXXXXXXX.

9. Y Co. proposes to issue one series of Trust Securities, the "XXXXXXXXXX". Trust Securities will be offered to the public in Canada by way of prospectus, and will be non-voting except in certain limited circumstances involving proposed changes to the terms and conditions of Trust Securities. Trust Securities are expected to be widely held and will account for virtually all of the capital of Y Co. represented by units. The issue price for each Y Co. Security will be $XXXXXXXXXX.

10. Trust Securities will XXXXXXXXXX (each a "Distribution Date"). The XXXXXXXXXX is non-cumulative and will be payable only to the extent that Y Co. earns sufficient XXXXXXXXXX to permit distributions in an amount equal to the XXXXXXXXXX. On each Distribution Date that is a "Regular Distribution Date" (which will be any Distribution Date other than a Distribution Diversion Date - a "Distribution Diversion Date" will be a Distribution Date on which a Distribution Diversion Event, as defined below, occurs or is continuing), Y Co. will pay the XXXXXXXXXX on Trust Securities (if sufficient XXXXXXXXXX exist) and any remaining XXXXXXXXXX on the Special Securities.

11. The XXXXXXXXXX will not be payable by Y Co. to holders of Trust Securities in the event that a Distribution Diversion Event occurs or is continuing. In such circumstances all of the XXXXXXXXXX, if any, of Y Co. will be distributed to the holder of the Special Securities. A "Distribution Diversion Event" will be defined to be XXXXXXXXXX Common Shares if there be no X Co. Preferred Shares outstanding at that time, in the three month period immediately prior to the commencement of the period ending on the day preceding the next Distribution Date. Once a Distribution Diversion Event no longer exists, the XXXXXXXXXX will once again be payable by Y Co. to holders of Trust Securities as described above.

12. Y Co. will cause all of its XXXXXXXXXX, if any, to be payable annually to the holders of Trust Securities on a pro rata basis, to a maximum of the XXXXXXXXXX, and then to the holder of Special Securities, in respect of any balance of XXXXXXXXXX of Y Co..

13. The property of Y Co. will be limited to the Deposit Note (or the Series W Shares or Series X Shares for which the Deposit Note may be exchanged pursuant to the exercise of the Holder Exchange Right or upon an Automatic Exchange, respectively), cash, amounts receivable from third parties, and Government of Canada debt obligations.

14. Except upon the occurrence of a XXXXXXXXXX Event or XXXXXXXXXX Event, Trust Securities will not be redeemable by Y Co. until XXXXXXXXXX. On that date and on any Distribution Date thereafter, XXXXXXXXXX, and on not less that 30 days or more than 60 days prior notice to holders, Y Co. at its option, may redeem all or part of the then outstanding Trust Securities by the payment of an amount in cash. In the case of a redemption of Trust Securities prior to XXXXXXXXXX, such amount will be equal to the greater of (A) $XXXXXXXXXX per Y Co. Security together with any unpaid XXXXXXXXXX to the date of redemption (the "Redemption Price"), and (B) XXXXXXXXXX (the greater of (A) and (B) being the "Early Redemption Price"). In the case of a redemption of Trust Securities on or after XXXXXXXXXX, such amount will be the Redemption Price. XXXXXXXXXX.

15. Trust Securities will be redeemable at the option of Y Co. at any time upon the happening of a XXXXXXXXXX Event or a XXXXXXXXXX Event. Where a XXXXXXXXXX Event or a XXXXXXXXXX Event occurs prior to XXXXXXXXXX, Y Co. may redeem Trust Securities for an amount of cash equal to the Early Redemption Price. Where a XXXXXXXXXX Event or a XXXXXXXXXX Event occurs on or after XXXXXXXXXX, Y Co. may redeem Trust Securities for an amount of cash equal to the Redemption Price.

16. Holders of Trust Securities will have the right at any time to surrender all or part of their Trust Securities (the "Holder Exchange Right") for a price (the "Exchange Price") equal to XXXXXXXXXX Series W Shares. X Co. will have the right to arrange for substituted purchasers to purchase Trust Securities tendered by a holder under the Holder Exchange Right, so long as the holder has not withheld consent to the purchase at a price which is not less XXXXXXXXXX Series W Shares will have the attributes described below in paragraph 38.

17. As required XXXXXXXXXX, all of the then outstanding Trust Securities will be automatically and mandatorily exchanged (an "Automatic Exchange") for XXXXXXXXXX Series X Shares, upon one of the following events (each a "XXXXXXXXXX Event"): XXXXXXXXXX. Series X Shares will have the attributes described below in paragraphs 30-37.

18. The surrender of Trust Securities by a holder thereof to Y Co. for Series W Shares upon exercise of the Holder Exchange Right as described above in paragraph 16, and the Automatic Exchange of Trust Securities for Series X Shares as described above in paragraph 17 will be effected by Y Co.:

(a) converting $XXXXXXXXXX principal amount of Deposit Note held by it into XXXXXXXXXX Series W Shares (or XXXXXXXXXX Series X Shares), as applicable, in accordance with the terms thereof as set out below, for each Trust Security so exchanged or surrendered, and

(b) redeeming each Trust Security in consideration of the transfer to the holder thereof by Y Co. of XXXXXXXXXX Series W Shares (or XXXXXXXXXX Series X Shares), as applicable.

19. Accordingly, upon a XXXXXXXXXX Event, holders of Trust Securities will receive XXXXXXXXXX Series X Shares for each Trust Security held by them.

20. On and after the XXXXXXXXXX anniversary of the issue of Trust Securities, XXXXXXXXXX, Trust Securities may be purchased by Y Co. for cancellation in the open market or by tender or private contract at any price.

21. In the event of the termination of Y Co., holders of Trust Securities and the Special Securities will be entitled to participate, pari passu, in the distribution of the remaining property of Y Co..

22. Coincident with the establishment of Y Co. and the issuance of Trust Securities, X Co. proposes to issue the Deposit Note to Y Co.. Y Co. will subscribe for the Deposit Note using the proceeds from the issue of Trust Securities. The Deposit Note will mature on XXXXXXXXXX. Interest on the Deposit Note will be payable XXXXXXXXXX (an "Interest Payment Date") and the Deposit Note will carry a fixed rate of interest equal to the XXXXXXXXXX on Trust Securities as described in paragraph 10 above.

23. It is intended that the proceeds from the issue of the Deposit Note will be used by X Co. for the purpose of earning income (other than exempt income) from business or property.

24. Except upon the occurrence of a XXXXXXXXXX Event or XXXXXXXXXX Event, the Deposit Note will not be redeemable by X Co. prior to XXXXXXXXXX. The Deposit Note will be redeemable by X Co., XXXXXXXXXX, in whole or part on XXXXXXXXXX and on any Interest Payment Date thereafter for an amount in cash per $XXXXXXXXXX principal amount of the Deposit Note. In the case of a the Deposit Note redemption prior to XXXXXXXXXX, such amount (the "Deposit Note Early Redemption Price") will be equal to the greater of (A) $1,000 plus any accrued and unpaid interest on such Deposit Note to the date of redemption (the "Deposit Note Redemption Price"), and (B) the XXXXXXXXXX, determined on the business day immediately preceding the date on which X Co. has given notice of the redemption of the Deposit Note. In the case of a Deposit Note redemption on or after XXXXXXXXXX such amount will equal the Deposit Note Redemption Price. XXXXXXXXXX.

25. Upon the occurrence of a XXXXXXXXXX Event or a XXXXXXXXXX Event, X Co., XXXXXXXXXX, may redeem at any time the Deposit Note in whole (but not in part) for an amount in cash for each $XXXXXXXXXX principal amount of the Deposit Note. If the Deposit Note is redeemed prior to XXXXXXXXXX, such amount will be equal to the Deposit Note Early Redemption Price. If the Deposit Note is redeemed on or after XXXXXXXXXX, such amount will be the Deposit Note Redemption Price. If X Co. has redeemed the Deposit Note, in whole or in part, Y Co. will be required to redeem a corresponding amount of Trust Securities.

26. The Deposit Note will be convertible into shares of X Co. at any time at the option of the holder on the basis of XXXXXXXXXX Series W Shares per $XXXXXXXXXX principal amount of Deposit Note.

27. In order to XXXXXXXXXX permit the exchange of Trust Securities for Series X Shares, upon the occurrence of a XXXXXXXXXX Event, the Deposit Note will automatically and mandatorily be converted by its terms into XXXXXXXXXX Series X Shares per $XXXXXXXXXX principal amount of Deposit Note. Immediately after or coincident with such conversion, Y Co. will redeem Trust Securities and the holders of Trust Securities will receive from Y Co. in exchange the Series X Shares as described in paragraph 18 above.

28. The Deposit Note will be a deposit liability of X Co.. XXXXXXXXXX, failure by X Co. to make payment under the Deposit Note in accordance with the terms thereof will not entitle Y Co. to accelerate payment of the principal amount owing under the Deposit Note.

29. X Co. will be required to pay in cash in full the principal amount of the Deposit Note and any accrued and unpaid interest thereon to Y Co. at the maturity of the Deposit Note. XXXXXXXXXX, if a XXXXXXXXXX Event occurs after maturity of the Deposit Note, Y Co. will subscribe for, and X Co. will issue Series X Shares to satisfy Y Co.'s obligation to deliver such shares to the holders of the then outstanding Trust Securities.

30. The Series X Shares will have an issue price of $XXXXXXXXXX per share. Accordingly, XXXXXXXXXX Series X Shares will be issued for each $XXXXXXXXXX of principal amount of the Deposit Note converted upon the occurrence of a XXXXXXXXXX Event. The Series X Shares will carry a fixed, non-cumulative preferential cash dividend at a rate of approximately XXXXXXXXXX% per annum.

31. The Series X Shares will not be redeemable by X Co. prior to XXXXXXXXXX. On and after that date, X Co. may, XXXXXXXXXX, redeem all or any part of the outstanding Series X Shares by the payment of cash in an amount equal to the issue price per share plus all declared and unpaid dividends to the date fixed for redemption ("Series X Share Cash Redemption Price").

32. X Co. may, XXXXXXXXXX, deliver fully-paid and freely tradable X Co. Common Shares for each Series X Share so redeemed, the number of which will be determined by dividing the Series X Share Cash Redemption Price by the greater of (i) $1.00 and (ii) XXXXXXXXXX.

33. On and after XXXXXXXXXX, X Co. may at any time, XXXXXXXXXX, purchase Series X Shares for cancellation in the open market or by tender or private contract.

34. The Series X Shares will be exchangeable for X Co. Common Shares, at the option of the holder thereof, provided that any XXXXXXXXXX Event which has occurred is not then continuing, on the last day of XXXXXXXXXX in each year commencing on XXXXXXXXXX on not more than 90 and not less than 60 days' prior written notice before the date fixed for exchange. Such shares will be exchangeable for that number of fully-paid and freely tradable X Co. Common Shares determined by dividing $XXXXXXXXXX, together with any declared and unpaid dividends on the Series X Shares to the date of exchange, by the greater of (i) $1.00 and (ii) XXXXXXXXXX. Any such exchange will be effected by way of the transfer by the holder to X Co. of the Series X Shares to be so exchanged in consideration for the applicable X Co. Common Shares. Upon receipt of notice of exercise of the exchange right, X Co. may, XXXXXXXXXX, at its option either (i) redeem the Series X Shares proposed to be exchanged by the payment of the Series X Share Cash Redemption Price, or (ii) require the holder to sell Series X Shares proposed to be exchanged to another purchaser or purchasers arranged by X Co. for an amount equal to the Series X Share Cash Redemption Price.

35. Holders of Series X Shares will not have any voting rights except in certain extraordinary circumstances. The Series X Shares will rank equally with all other non-cumulative X Co. Preferred Shares and in priority to X Co. Common Shares and any other shares ranking junior to the Series X Shares.

36. Subject to and in accordance with the provisions of Part VI.1, X Co. will elect to pay the 40% tax on dividends on the Series X Shares.

37. X Co. intends to apply to list the Series X Shares on the XXXXXXXXXX.

38. The Series W Shares will be identical to the Series X Shares, except that they will carry a fixed non-cumulative preferential cash dividend at a rate of XXXXXXXXXX%. X Co. also intends to apply to list the Series W Shares on the XXXXXXXXXX and will make the election referred to in paragraph 37 above pursuant to Part VI.1 with respect to the Series W Shares.

Purpose of Proposed Transactions

The purpose of the proposed transactions is for X Co. to XXXXXXXXXX.

The purpose of the provisions in the terms of Trust Securities and Special Securities relating to distributions upon a Regular Distribution Date and a Distribution Diversion Date, and of the inclusion in the terms of Trust Securities of conditions permitting or requiring the exchange of Trust Securities, and in the terms of the Deposit Note of conditions permitting or requiring the conversion, into Series W Shares or Series X Shares of X Co., XXXXXXXXXX.

Rulings requested and given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions, and provide further that the proposed transactions are carried out as described above, our Rulings are as follows:

We confirm that

A. Provided that the proceeds from the issue of the Deposit Note referred to in paragraph 22 above are used and continue to be used for the purpose of earning income from a business or property and the proceeds are not used to acquire a life insurance policy or property the income from which would be exempt, X Co. will be entitled, pursuant to paragraph 20(1)(c), to deduct in computing its income for a taxation year from business or property the amount paid in the year or payable in respect of the year (depending on the method regularly followed in computing its income) as interest on the Deposit Note to the extent that the amount paid or payable is reasonable and is paid pursuant to a legal obligation to pay interest.

B. Subsection 104(7.1) will not apply to deny a deduction to Y Co. under paragraph 104(6)(b) of amounts payable to its unit holders pursuant to paragraph 12 above.

Other comments

The rulings given are subject to the limitations and qualifications set out in Information Circular 70-6R4 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

Yours truly,

Section Manager
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
11