2013-0511761R3 CROSS-BORDER FINANCING CANADA - USA

Principal Issues: 1) Whether IV(7)b) of the Canada-USA tax treaty is applicable. 2) Whether the limitation of benefit clause denies the treaty benefits in regard of the interest paid by the Canadian Corporation to a related US Corporation.

Position: 1) No. 2) No.

Reasons: 1) The source of income, profit or gains receives the same treatment. 2) The active trade or business test is satisfied.

Author: XXXXXXXXXX
Section: Canada-United States tax treaty, IV(7)b) XXIXA(3)

XXXXXXXXXX
                                                                                                                                                                  2013-051176

XXXXXXXXXX, 2014

Dear Sir,

Re:   XXXXXXXXXX (CanSub)
        Business Number XXXXXXXXXX
        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 taxpayer. 

CanSub’s tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre.

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

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

(ii)  being considered by a Tax Services Office or a Taxation Centre in connection with a previously filed tax return of the taxpayer or a related person;

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

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

(v)   the subject of a previous ruling issued to the taxpayer or a related person by the Income Tax Rulings Directorate.

The rulings given herein are based solely on the Facts, Proposed Transactions, Purposes of the Proposed Transactions and Additional Information described below.

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 definitions unless otherwise indicated.

Definitions

In this letter the following terms have the meanings specified:

(a)   XXXXXXXXXX;
(b)   “ABC Partnership” means XXXXXXXXXX;
(c)   “arm’s length” has the meaning assigned by subsection 251(1) of the Act;
(d)   “Canada-Netherlands Treaty” means the Canada-Netherlands Tax Convention signed on May 27, 1986 and amended by the Protocols signed on March 4, 1993 and August 25, 1997;
(e)   “CanSub” means XXXXXXXXXX, an unlimited liability company formed under the laws of the Province of XXXXXXXXXX which is disregarded for United States of America federal income tax purposes but which is a corporation resident in Canada for the purposes of the Act, the Canada-Netherlands Treaty and the Treaty;
(f)   “CanSub Note” has the meaning set out in Paragraph 10;
(g)   “Common Units” means the common units of ForCo XXXXXXXXXX which are listed on the XXXXXXXXXX;
(h)   “Consolidated Group” means ForCo XXXXXXXXXX and its direct and indirect subsidiaries;
(i)   “DutchCo” means XXXXXXXXXX, a corporation formed pursuant to the laws of the Netherlands that is not a person resident in Canada for the purposes of the Act and a person resident in the Netherlands for the purposes of the Canada-Netherlands Treaty;
(j)   “DutchCo Note” has the meaning set out in Paragraph 10;
(k)   “ForCo XXXXXXXXXX” means XXXXXXXXXX that is not a person resident in Canada for the purposes of the Act;
(l)   “ForSub” means XXXXXXXXXX, a corporation formed pursuant to the laws of the State of XXXXXXXXXX, which is a wholly-owned indirect subsidiary of ForCo XXXXXXXXXX that is not a person resident in Canada for the purposes of the Act and a person resident of United States for the purposes of the Treaty;
(m)   “ForSub Note” has the meaning set out in Paragraph 14;
(n)   “LLC” means a limited liability company formed pursuant to the laws of the State of XXXXXXXXXX;
(o)   “XXXXXXXXXX Business” has the meaning set out in Paragraph 11;
(p)   “Operating LLCs” means the LLCs in the Consolidated Group that carry on the XXXXXXXXXX Business in the U.S., being (i) XXXXXXXXXX, (ii) XXXXXXXXXX, and (iii) XXXXXXXXXX, which are each a wholly-owned indirect subsidiary of ForCo XXXXXXXXXX and each of which is not a person resident in Canada for the purposes of the Act;
(q)   “Operations LLC” means XXXXXXXXXX and not a person resident in Canada for the purposes of the Act;
(r)   “Paragraph” means a numbered paragraph in this advance tax ruling;
(s)   “participating debt interest” means participating debt interest as that term is defined in subsection 212(3) and in section 806.2 of the Income Tax Regulations;
(t)   “taxable Canadian corporation” means a taxable Canadian corporation as that term is defined in subsection 89(1);
(u)   “taxable Canadian property” means taxable Canadian property as that term is defined in subsection 248(1);
(v)   “Thin Capitalization Rules” means the limitation on interest deduction contained in subsections 18(4) to 18(6) of the Act;
(w)   “Treaty” means the Convention between the United States of America and Canada with respect to Taxes on Income and on Capital signed on 26 September 1980, as amended by Protocols signed on 14 June 1983, 28 March 1984, 17 March 1995, 29 July 1997 and 21 September 2007;
(x)   “U.S.” means United States of America; and
(y)   “USD” means the U.S. dollar.

Unless otherwise indicated in this letter, all dollar amounts referred to herein are in Canadian dollars.

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

Facts

1.    ForCo XXXXXXXXXX is an LLC.  ForCo XXXXXXXXXX is colloquially referred to as a XXXXXXXXXX, and is treated as a XXXXXXXXXX for U.S. federal income tax purposes.  The Common Units of ForCo XXXXXXXXXX are listed on the XXXXXXXXXX. 
2.    The status of ForCo XXXXXXXXXX as a XXXXXXXXXX for U.S. federal income tax purposes is subject to ForCo XXXXXXXXXX meeting XXXXXXXXXX on an ongoing basis.  If ForCo XXXXXXXXXX were to fail the XXXXXXXXXX test, it would automatically be treated as XXXXXXXXXX for U.S. federal income tax purposes.  
3.    Approximately XXXXXXXXXX% of the beneficial holders of the Common Units are resident in the U.S. for U.S. federal income tax purposes.  The majority of the board of directors of ForCo XXXXXXXXXX is resident in the U.S. for U.S. federal income tax purposes and its central management and control is exercised in the United States.
4.    ForCo XXXXXXXXXX has its main assets and operations in Canada and in the U.S. and it operates XXXXXXXXXX assets in North America. 
5.    Operations LLC is an LLC and is a wholly-owned subsidiary of ForCo XXXXXXXXXX. 
6.    ForCo XXXXXXXXXX and Operations LLC own XXXXXXXXXX% and XXXXXXXXXX%, respectively, of DutchCo's equity. 
7.    DutchCo and Operations LLC are each disregarded for U.S. federal income tax purposes.
8.    CanSub is a taxable Canadian corporation and is a wholly-owned subsidiary of DutchCo.  CanSub is disregarded for U.S. federal income tax purposes.  CanSub, through its XXXXXXXXXX% ownership interest in the ABC Partnership, carries on substantially all of the XXXXXXXXXX Business in Canada.  The remaining XXXXXXXXXX% is owned by a wholly owned subsidiary of CanSub.
9.    ForSub holds some miscellaneous assets which have a fair market value of approximately USD $XXXXXXXXXX.  ForSub is regarded for U.S. federal income tax purposes and is a resident of the U.S. for purposes of the Treaty.
10.   CanSub is indebted to DutchCo (the “CanSub Note”) and, in turn, DutchCo is indebted to ForCo XXXXXXXXXX (the “DutchCo Note”) in amounts equal to USD $XXXXXXXXXX.  CanSub adheres to the Thin Capitalization Rules with respect to the indebtedness of CanSub. The interest rate on the CanSub Note, being XXXXXXXXXX%, is an arm’s length interest rate.  The interest of the CanSub Note is not participating debt interest. The interest rate on the DutchCo Note is XXXXXXXXXX %.
11.   The Consolidated Group carries on a business in the XXXXXXXXXX sector (the “XXXXXXXXXX Business”) and it is noted that:
a)    The XXXXXXXXXX Business consists of XXXXXXXXXX;
b)    The XXXXXXXXXX Business is the same in both Canada and the U.S.;
c)    All the persons that carry on the XXXXXXXXXX Business in Canada and the U.S. are related persons to each other within the meaning of subsection 251(2);
d)    The average annual revenues for the U.S. and Canada over the past two years (XXXXXXXXXX and XXXXXXXXXX), for accounting purposes, are $XXXXXXXXXX and $XXXXXXXXXX, respectively;
e)    The average number of employees for the U.S. and Canada in the fiscal year ended on XXXXXXXXXX is XXXXXXXXXX and XXXXXXXXXX respectively;
f)    The average fixed asset base in the U.S. and Canada over the past two years (XXXXXXXXXX and XXXXXXXXXX), for accounting purposes, is $XXXXXXXXXX and $XXXXXXXXXX, respectively; and
g)    The interest income on the CanSub Note is derived, directly or indirectly, from the XXXXXXXXXX Business carried in Canada through CanSub.
12.   Substantially all of the XXXXXXXXXX Business in the U.S. is conducted through the Operating LLCs.
Proposed Transactions
13.   DutchCo will repay USD $XXXXXXXXXX of its indebtedness to ForCo XXXXXXXXXX on the DutchCo Note to ForCo XXXXXXXXXX by assigning USD $XXXXXXXXXX of its interest in the CanSub Note to ForCo XXXXXXXXXX;
14.   ForCo XXXXXXXXXX will assign the portion of the CanSub Note received as described above in Paragraph 13 to ForSub in exchange for (i) equity of ForSub of approximately USD $XXXXXXXXXX; and (ii) a new Note (the “ForSub Note”) with a principal amount of approximately USD $XXXXXXXXXX.  The interest rate on the ForSub Note will be XXXXXXXXXX%. 

The principal amount of the ForSub Note may be decreased (and the amount of equity issued by ForSub increased) to ensure that, under U.S. federal income tax purposes, the ForSub Note is respected as debt;

15.   CanSub will make interest payments on the CanSub Note to ForSub and to DutchCo in accordance with the terms of the CanSub Note.

Purpose of the Proposed Transactions
16.   The principal purpose of the proposed transactions described in Paragraphs 13 to 15, is to minimize the Canadian withholding tax burden on interest payment made on CanSub Note.

Additional Information

17.   Neither ForCo XXXXXXXXXX nor ForSub is a “qualifying person” as defined in paragraph 2 of Article XXIX A of the Treaty.

18.   ForSub is subject to U.S. federal income tax on a comprehensive basis.  ForSub and ForCo XXXXXXXXXX will not file a consolidated income tax return to the U.S. Internal Revenue Services.
Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions, purpose of the proposed transactions and additional information, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A.    Subject to the exceptions in paragraphs 3 to 6 of Article XI of the Treaty, and provided that ForSub is the beneficial owner of any interest payments described in Paragraph 15 made by CanSub to ForSub on the portion of the CanSub Note owed to ForSub, no amount of tax will be payable under Part XIII in respect of such interest payments by CanSub to ForSub pursuant paragraph 1 of Article XI of the Treaty.

B.    Article IV(7)(b) of the Treaty will not apply to any interest payments described in Paragraph 15 made by CanSub to ForSub on the portion of the CanSub Note owed to ForSub.
C.    ForSub will be entitled to the benefit of the Treaty by virtue of paragraph 3 of Article XXIX A of the Treaty in respect of any interest payments described in Paragraph 15 made by CanSub to ForSub on the portion of the CanSub Note owed to ForSub.
The above rulings are given subject to the general 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 by XXXXXXXXXX.
The above-noted rulings are based on the Act and the Treaty in their present forms and do not take into account any proposed amendments to the Act or the Treaty which, if enacted, could have an effect on the rulings provided herein.
Other Comments

Nothing in this letter should be construed as implying that the CRA 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 letter should be construed as implying that the CRA has agreed to or reviewed the following:

i.    the fair market value of any property described in this letter;
ii.   any tax consequences relating to the Facts and Proposed Transactions described herein other than those described in the rulings given above;
iii.  the application of the Thin Capitalization Rules to any interest payments described in Paragraph 15 made by CanSub to ForSub on the CanSub Note;
iv.   the application of subsection 245(2) in regard to any transactions described in the facts or proposed transactions;|
v.    the reasonableness of the interest rates on the CanSub Note;
vi.   the application of subsection 247(2) to any transfer pricing arrangement between the entities involved;
vii.  the classification of the any entity described in this letter for the purposes of the Act; and
viii. the residency of any person referred to in this letter.
An invoice for our fees in connection with this ruling request will be forwarded to you under separate cover.

Yours truly,

XXXXXXXXXX
Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch

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