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: Interest deductibility - Current use of borrowed money.
Position: Opinion on the adjusted equity test in proposed section 20.2
Reasons: In this case, funds from a bank loan were used to make a loan to a corporate shareholder and a positive spread was earned. On the reduction of the paid-up capital, which will be paid by settling the shareholder loan, the source of income will disappear. However, it can reasonably be considered that the current use of the loan is to reduce capital, which falls within the proposed legislation in respect of using borrowed money to make corporate distributions and satisfies the adjusted equity test in proposed section 20.2.
XXXXXXXXXX 2001-011291
XXXXXXXXXX, 2002
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling Request
XXXXXXXXXX ("ACO")- (XXXXXXXXXX)
This is in reply to your letter of XXXXXXXXXX, requesting an advance income tax ruling on behalf of the above-noted taxpayer. We also acknowledge your letters of XXXXXXXXXX providing additional information and amendments concerning the proposed transactions.
To the best of your knowledge and that of any of the taxpayers, none of the issues involved in this ruling request is:
i. involved in an earlier return of any 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 any of the taxpayers or a related person;
iii. under objection by any of the taxpayers or a related person;
iv. before the courts; or
v. the subject of a ruling previously issued by the Income Tax Rulings Directorate.
Facts
1. ACO is a taxable Canadian corporation as defined in subsection 89(1) of the Income Tax Act (the "Act"). ACO was incorporated under the XXXXXXXXXX. The authorized capital of ACO consists of an unlimited number of Class A shares without par value, an unlimited number of Class B Common shares without par value, and an unlimited number of Preferred shares without par value. At the present time, XXXXXXXXXX ("BCO") holds XXXXXXXXXX Class A Common shares and XXXXXXXXXX ("CCO") holds XXXXXXXXXX Class B Common shares and this represents all of the issued and outstanding shares of ACO.
2. BCO is a taxable Canadian corporation. BCO was incorporated under the XXXXXXXXXX and is a public corporation. BCO's authorized capital consists of an unlimited number of Common Voting shares, an unlimited number of Non-Voting shares and an unlimited number of Special shares. BCO's issued and outstanding share capital consists of XXXXXXXXXX Common Voting shares and XXXXXXXXXX Non-Voting shares.
3. CCO is a taxable Canadian corporation as defined in subsection 89(1) of the Act, which was incorporated under the XXXXXXXXXX. CCO's authorized capital consists of an unlimited number of common shares. CCO's issued and outstanding share capital consists of XXXXXXXXXX Common shares issued to XXXXXXXXXX ("DCO"), an XXXXXXXXXX public corporation.
4. The adjusted cost base ("ACB") within the meaning of section 54 of the Act, and the paid-up capital ("PUC") within the meaning of subsection 89(1) of the Act to BCO of its Class A Common Shares of ACO is $XXXXXXXXXX. These shares were acquired as part of a series of transactions that included a subsection 85(1) rollover between BCO and ACO on XXXXXXXXXX.
5. The ACB and the PUC to CCO of its shares of ACO is $XXXXXXXXXX. The shares were acquired as part of a series of transactions that included a subsection 85(1) rollover of a royalty interest (the "Royalty Interest") in XXXXXXXXXX from CCO to ACO on XXXXXXXXXX.
6. The aggregate of the retained earnings and accounting share capital of ACO as of XXXXXXXXXX, was $XXXXXXXXXX. This is comprised of share capital of $XXXXXXXXXX and a deficit of $XXXXXXXXXX. The interim Balance Sheet of ACO as of XXXXXXXXXX, shows a net amount of $XXXXXXXXXX as equity because the amount of the ACO Loan described in paragraph 8 below ($XXXXXXXXXX Canadian dollars) has been applied to reduce the equity figure for accounting presentation purposes.
7. At the present time, CCO is indebted to DCO for approximately $XXXXXXXXXX. This amount comprises two loans. The first one originated on XXXXXXXXXX for $XXXXXXXXXX and with accrued interest has an approximate balance of $XXXXXXXXXX. The second loan in XXXXXXXXXX for $XXXXXXXXXX (the "DCO Loan") was incurred for the purpose of providing CCO with funds to purchase the Royalty Interest described above. A portion of the DCO Loan was repaid on XXXXXXXXXX, as described in paragraph 10 below.
8. At the present time, CCO is indebted to ACO for approximately $XXXXXXXXXX U.S. (the "ACO Loan"). CCO used the ACO Loan to repay a portion of the DCO Loan on XXXXXXXXXX. The terms of the ACO Loan are as follows:
a. Interest payable monthly at a rate equal to the interest for Credit A of the XXXXXXXXXX Loan, as described in paragraph 9 below, plus XXXXXXXXXX%;
b. Maturity date for repayment of principal is XXXXXXXXXX;
c. Security granted is a promissory note and a pledge of shares of ACO owned by CCO.
9. ACO is currently indebted to XXXXXXXXXX. in the aggregate amount of approximately $XXXXXXXXXX (U.S.) (the "XXXXXXXXXX Loan") under a Credit Agreement effective on XXXXXXXXXX. The terms of the XXXXXXXXXX Loan as set out in the Credit Agreement are as follows:
a. The XXXXXXXXXX Loan is divided into Credit A (non-revolving), for $XXXXXXXXXX (U.S.), and Credit B (revolving), for $XXXXXXXXXX (U.S.);
b. Credit A to be used, as to $XXXXXXXXXX (U.S.) to make a loan to CCO (as described in paragraph 8 as the ACO Loan) to allow CCO to repay part of the DCO Loan, and as to $XXXXXXXXXX (U.S.), to make a loan, pay a dividend or make another form of distribution to BCO (this description of the use is contained in the Credit Agreement, but the $XXXXXXXXXX has actually been used as working capital for inventory, receivables and the production of XXXXXXXXXX, in the normal course of ACO's business);
c. Credit B to be used to finance general corporate requirements, including repayment of loans made by XXXXXXXXXX to ACO for working capital requirements;
d. Credit A to be repaid by quarterly instalments until XXXXXXXXXX;
e. Interest payable at a rate which will fluctuate depending on the type of advance made and when advance made, ranging from prime rate to prime rate plus XXXXXXXXXX% or LIBOR plus XXXXXXXXXX%;
f. Interest accrues daily and is payable monthly or no longer than every XXXXXXXXXX months, depending on the type of advance; and
g. Security granted over all present and future property of ACO.
10. On XXXXXXXXXX, $XXXXXXXXXX (U.S.) of the loan proceeds of Credit A of the XXXXXXXXXX Loan was loaned to CCO as the ACO Loan, as described in paragraph 8 above. CCO used those loan proceeds to repay a portion of the DCO Loan. The remaining $XXXXXXXXXX (U.S.) was used by ACO as working capital in its XXXXXXXXXX business for the financing of inventory, receivables and the production of XXXXXXXXXX. $XXXXXXXXXX has been drawn down on Credit B for working capital in ACO's business.
11. ACO's only business is XXXXXXXXXX.
12. CCO provides management services to ACO in respect of the XXXXXXXXXX pursuant to a Management Services Agreement dated XXXXXXXXXX.
13. DCO has recently undertaken certain equity financing through a public offering. Part of the offering involves issuing approximately $XXXXXXXXXX of flow-through shares. In connection with this offering, ACO will also be issuing flow-through shares to DCO when it incurs XXXXXXXXXX expenses. The flow-through shares ACO will issue to DCO will not be of the same class as the shares currently owned by CCO and BCO, but will be of a separate class.
Proposed Transactions
14. A new class of shares will be created for ACO designated as Class C.
15. The Class A and Class B shares of ACO held by BCO and CCO will be subdivided so that CCO's XXXXXXXXXX Class B shares of ACO will be subdivided into XXXXXXXXXX shares, and BCO's XXXXXXXXXX Class A shares of ACO will be subdivided into XXXXXXXXXX shares.
16. XXXXXXXXXX Class C shares of ACO will then be issued to DCO when ACO incurs the XXXXXXXXXX expenses.
17. ACO will pass a special resolution to reduce the capital of its Class A Common shares by $XXXXXXXXXX (U.S.) and of its Class B Common Shares by $XXXXXXXXXX (U.S.), and to pay the amount of the capital reduction to its shareholders.
18. ACO will pay $XXXXXXXXXX cash (U.S.) to BCO in respect of the reduction of the Class A Common Share capital, and ACO will assign the $XXXXXXXXXX (U.S.) ACO Loan to CCO in satisfaction of the reduction of the Class B Common Share capital which will also result in the principal amount of the ACO Loan being settled in full.
Purpose of the Proposed Transactions
The purpose of the proposed transactions is to repay the ACO Loan and to maintain interest deductibility on the XXXXXXXXXX Loan.
Rulings
A. The provisions of subsection 84(4) of the Act will not apply to deem ACO to have paid and BCO or CCO to have received a dividend on the respective Class A or Class B shares as a result of the reduction of paid-up capital as described in paragraph's 17 and 18 above as the amount paid by ACO on the reduction of the respective capital will not exceed the amount by which the paid-up capital of the respective shares has been reduced.
B. The provisions of subparagraph 53(2)(a)(ii) will apply to reduce the ACB of the Class A shares of ACO held by BCO and of the Class B shares of ACO held by CCO upon the payment made in respect of the reduction of the capital of the respective shares of ACO as described in paragraphs 17 and 18 above.
C. The settlement of the principal amount of the ACO Loan as described in paragraph 18 above will not give rise to a "forgiven amount" in respect of the ACO Loan within the meaning of subsection 80(1) by virtue of paragraph 80(2)(k) of the Act.
D. The provisions of subsection 245(2) of the Act will not be applied as a result of the proposed transactions, in and by themselves, so as to redetermine the tax consequences confirmed in the rulings given.
Opinion
? We are unable to confirm the ruling requested pertaining to paragraph 20(1)(c) in regards to interest payable by ACO on the XXXXXXXXXX Loan. However, we can offer the following opinion.
Provided the provisions of proposed section 20.2 are enacted in substantially the same form as is proposed in the December 20, 1991 Technical Notes (interest deductibility) published by the Department of Finance (the "Draft Legislation"), proposed subsection 20.2(1) will apply to ACO in respect of the XXXXXXXXXX Loan described in paragraph 9 above. Accordingly, the XXXXXXXXXX Loan amount shall be deemed to be borrowed money used for the purpose of earning income from a business or property of ACO to the extent that the XXXXXXXXXX Loan does not exceed ACO's adjusted equity immediately before the reduction of the PUC of its Class A and Class B shares as described in paragraph's 17 and 18 above. Moreover, the future interest deductions on the borrowing will be based on the adjusted equity at the time of the distribution and the provisions of paragraph 20(1)(c) will determine in each year, the interest deduction available for that particular year. The expression "adjusted equity" has the meaning assigned by proposed subsection 20.2(2).
These rulings are given subject to the general limitations and qualifications set out in Information Circular IC 70-6R4 dated January 29, 2001, and are binding on the Agency provided the proposed transactions are completed before XXXXXXXXXX. Also, these rulings are based on the Act and the Income Tax Regulations in their present form and do not take into account the effects of any proposed amendments thereto other than the opinion with respect to proposed section 20.2 for the purposes of paragraph 20(1)(c) of the Act.
This ruling letter should not be construed as indicating there has been any modification in the CCRA's administrative practices with regard to interest deductibility.
Yours truly,
XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate
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