2013-0479701R3 Transfer of US dollar loan

Principal Issues: The application of the loss denial rules to the foreign exchange loss incurred on the transfer of a US dollar loan.

Position: Where paragraph 40(2)(e.1) and subparagraph 40(2)(g)(ii) both apply to deny the foreign exchange loss, the ACB adjustment under paragraph 53(1)(f.1) is applicable.

Reasons: See below.

Author: XXXXXXXXXX
Section: 40(2)(e.1); 40(2)(g)(ii); 53(1)(f.1)

XXXXXXXXXX
                                                                                                                                                                  2013-047970

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re:  XXXXXXXXXX
        Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers.  We also acknowledge the information provided in correspondence and conversations concerning your request.  Any information you have provided to us forms part of this ruling only to the extent it is expressly referred to or described herein. 

To the best of your knowledge and that of the above-referenced taxpayers, none of the issues involved in this ruling is:

a)    dealt with in an earlier tax return of the above-referenced taxpayers, or a related person,

b)    being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of the above-referenced taxpayers or a related person,

c)    under objection or appeal by the above-referenced taxpayers, or a related person,

d)    before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired, or

e)    the subject of a ruling previously issued by the Income Tax Rulings Directorate. 

Further, the above-referenced taxpayers represent that the Proposed Transactions described herein will not result in it or any related person being unable to pay its outstanding tax liabilities.  Unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter (the “Act”), and the Income Tax Regulations thereunder are referred to as the “Regulations”.

DEFINITIONS

In this letter, unless otherwise specified, all references to monetary amounts are in Canadian dollars and the following terms have the meanings specified:

“adjusted cost base” has the meaning assigned by section 54;

“Amalco” means the corporation described in Paragraph 15;

“Amalgamation” means the amalgamation of Holdco1 and Subco, described in Paragraph 15;

“Amendment” means the amendment to the terms and conditions of the US Loan, described in Paragraph 12;

“BCA1” means the XXXXXXXXXX;

“BCA2” means the XXXXXXXXXX;

“Canadian Loan” has the meaning assigned by Paragraph 11;

“disposition” has the meaning assigned by subsection 248(1);

“Dividends” has the meaning described in Paragraph 10;

“forgiven amount” has the meaning assigned by subsection 80.01(1);

“Holdco1” means XXXXXXXXXX, a corporation further described in Paragraph 1;

“Holdco2” means XXXXXXXXXX, a corporation further described in Paragraph 6;

“Mr. X” means XXXXXXXXXX, an individual resident in Canada;

“New Note” means the note described in Paragraph 14;

“Paragraph” refers to a numbered paragraph in this advance income tax ruling;

“Proposed Transactions” means the transactions described in Paragraphs 12 to 15;

“Shares” has the meaning described in Paragraph 10;

“Subco” means XXXXXXXXXX, a corporation further described in Paragraph 1;

“Trust I” means the XXXXXXXXXX established under the laws of XXXXXXXXXX by a Deed of Trust dated XXXXXXXXXX between Mr. X, as settlor and XXXXXXXXXX, XXXXXXXXXX and Mr. X, as trustees;

“Trust II” means the XXXXXXXXXX established under the laws of XXXXXXXXXX by a Deed of Trust dated XXXXXXXXXX between Mr. X, as settlor and XXXXXXXXXX, XXXXXXXXXX and Mr. X, as trustees;

“Trusts” means Trust I and Trust II;

“US Loan” means the loans described in Paragraph 8; and

“US Principal Amount” has the meaning described in Paragraph 8.

FACTS

1.    Holdco1 and Subco were incorporated under the BCA1 and are taxable Canadian corporations.  Their taxation year-end is XXXXXXXXXX.  The primary activity of Holdco1 and Subco is holding portfolio investments for long-term capital appreciation.  Holdco1 and Subco file their federal income tax returns with the XXXXXXXXXX Tax Centre and their income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

2.    Mr. X owns all of the voting, non-participating shares of Holdco1, and controls Holdco1.  The other shareholders of Holdco1 are Trust I and Trust II, which own, respectively, XXXXXXXXXX Class B non-voting common shares and XXXXXXXXXX Class C non-voting common shares.

3.    Trust I is a discretionary trust and the beneficiaries of Trust I include Mr. X’s spouse, children and grandchildren, namely XXXXXXXXXX.

4.    Trust II is a discretionary trust and the beneficiaries of Trust II include Mr. X’s siblings, namely XXXXXXXXXX, and their issue.

5.    Holdco1 owns all the issued and outstanding shares of Subco.

6.    Holdco2 was incorporated under the BCA2 and is a taxable Canadian corporation.  Its taxation year-end is XXXXXXXXXX.  Holdco2 is primarily a holding corporation.  Holdco2 files its federal income tax returns with the XXXXXXXXXX Tax Centre and its income tax affairs are administered by the XXXXXXXXXX Tax Services Office.

7.    Mr. X owns all the issued and outstanding shares of Holdco2.

8.    Holdco2 has made seven demand interest-free loans (collectively, the “US Loan”), each with identical terms and conditions, to Subco.  The US Loan was denominated in US dollars and was advanced over the period from XXXXXXXXXX to XXXXXXXXXX, having an aggregate principal amount of US$XXXXXXXXXX (the “US Principal Amount”).  The US Loan is capital property to Holdco2 and is governed by XXXXXXXXXX law.  The proceeds of the US Loan have been used by Subco to make portfolio investments.

9.    The adjusted cost base of the US Loan to Holdco2 is $XXXXXXXXXX.  The Canadian dollar equivalent of the US Principal Amount, as of XXXXXXXXXX, was $XXXXXXXXXX.  Therefore, on XXXXXXXXXX, Holdco2 and Subco had, respectively, an accrued foreign exchange loss and accrued foreign exchange gain on the US Loan of approximately $XXXXXXXXXX.

10.   Between XXXXXXXXXX and XXXXXXXXXX, Holdco2 held XXXXXXXXXX Class E non-voting preferred shares of Subco (the “Shares”).  The Shares were entitled to a discretionary dividend not exceeding XXXXXXXXXX% per annum of the total redemption amount of $XXXXXXXXXX.  The Shares were issued on the rollover of portfolio investments from Holdco2 to Subco on XXXXXXXXXX.  Between XXXXXXXXXX and XXXXXXXXXX the Shares were redeemed resulting in aggregate deemed dividends to Holdco2 of $XXXXXXXXXX (the “Dividends”). 

11.   Commencing in XXXXXXXXXX, Holdco2 advanced to Subco, for investment purposes, pursuant to a grid demand promissory note at an interest rate of XXXXXXXXXX% per annum, a loan aggregating $XXXXXXXXXX (the “Canadian Loan”).  Subco has paid interest annually on the Canadian Loan.

PROPOSED TRANSACTIONS

12.   The terms and conditions of the US Loan will be amended such that it will become interest-bearing at a rate of XXXXXXXXXX% per annum (the “Amendment”).  The interest on the US Loan will be payable on a monthly basis.  The parties will agree that the Amendment, its execution, and the changes to the interest rate shall not constitute a novation nor substitution and that all provisions and characteristics of the US Loan not amended shall remain in full force and effect, without change, amendment or modification thereto other than those consequential to or required by the Amendment.

13.   Immediately before the transaction described in Paragraph 14, Subco will pay any interest which accrued on the US Loan from the date of the Amendment.

14.   Holdco2 will transfer the US Loan to Holdco1 in consideration for a demand promissory note, bearing interest at XXXXXXXXXX%, denominated in Canadian dollars having a principal amount equal to the Canadian dollar equivalent of the US Principal Amount (the “New Note”). 

15.   Holdco1 and Subco will undertake a short form amalgamation under the BCA1 to form Amalco in such a manner that section 87 will apply to the amalgamation (the “Amalgamation”).  Upon the Amalgamation, the US Loan will be settled by the operation of law.

ADDITIONAL INFORMATION

16.   The Amendment will not result in a novation nor a substitution of the US Loan and it will not create a new debt obligation under the common law applicable in XXXXXXXXXX.

17.   The terms and conditions of the New Note will include a price adjustment clause whereby the principal amount of the New Note will be adjusted in the case of a successful challenge of the fair market value of the US Loan by the tax authorities.

PURPOSES OF THE PROPOSED TRANSACTIONS

18.   The overall purpose of the Proposed Transactions is to simplify the corporate structure in a tax-efficient manner and to have the intercorporate debt between Holdco2 and Amalco denominated in a currency that is more representative of the currency of the assets held by Amalco.

19.   The purpose of the Amendment is for Holdco2 to earn income on the US Loan at a commercial rate of interest and to ensure that the fair market value of the US Loan will be equal to the fair market value of the New Note at the time of the transfer, described in Paragraph 14.

20.   The purpose of Holdco2’s transfer of the US Loan to Holdco1 in consideration for a promissory note denominated in Canadian dollars is to eliminate the financial risks due to fluctuations in the value of the Canadian dollar relative to the US dollar.

21.   The purpose of the amalgamation of Holdco1 and Subco is to eliminate an unnecessary holding corporation owned by the Trusts, consolidate all portfolio investments in one entity, and eliminate the US Loan between Holdco1 and Subco in order to eliminate the financial risk due to currency fluctuations related to the US Loan.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purposes of the Proposed Transactions and provided further that the Proposed Transactions are carried out as described above, we rule as follows:

A.    The Amendment will not result in a disposition of the US Loan.

B.    Subco will not make a gain and Holdco2 will not sustain a loss, within the meaning of subsection 39(2), as a result of the Amendment. 

C.    The capital loss realized by Holdco2 on the disposition of the US Loan will be deemed to be nil by virtue of paragraph 40(2)(e.1).

D.    The amount of the capital loss deemed to be nil in Ruling C will be added to Holdco1’s adjusted cost base in respect of the US Loan by virtue of paragraph 53(1)(f.1).

E.    Pursuant to the provisions of subsection 80.01(3), the settlement and cancellation of the US Loan upon the amalgamation of Holdco1 and Subco, described in Paragraph 15, will result in such indebtedness being deemed to have been settled immediately before the time that is immediately before the amalgamation by the payment, made by Subco and received by Holdco1, of an amount equal to the amount that would have been Holdco1’s cost amount of the US Loan (calculated as described in paragraphs 80.01(3)(a) and (b)), at that time, such that no forgiven amount will arise.

F.    Subsection 245(2) will not apply as a result of the Proposed Transactions, in and by themselves, to redetermine the tax consequences in the rulings requested above.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the Proposed Transactions are completed prior to XXXXXXXXXX.  The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

COMMENTS

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

a)    the paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein, or the outstanding balance of various tax accounts for any of the corporate entities described herein; and

b)    any other tax consequences relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not.

Nothing in this letter should be construed as confirmation, express or implied, that, for the purpose of any of the rulings given above, any adjustment to the fair market value of the US Loan and/or the New Note, whether pursuant to a price adjustment clause or otherwise, will be effective retroactively to the time of the transfer.  Furthermore, none of the rulings given in this letter are intended to apply to or in the event of the operation of a price adjustment clause, since such adjustment will be due to circumstances that do not constitute proposed transactions that are seriously contemplated.  The general position of the CRA with respect to price adjustment clauses is stated in Income Tax Folio S4-F3-C1 Price Adjustment Clauses.   

Yours truly,

XXXXXXXXXX
for Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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