2013-0514551R3 Convertible Debentures and Paragraph 212(1)(b)

Principal Issues: 1) Whether Aco will be required to withhold any amount in respect of the conversion of the Public and Private Debentures held by a non-resident of Canada or by virtue of any interest payment or any Make-Whole Amount made by Aco to arm's length entities pursuant to paragraph 212(1)(b) of the Income Tax Act (the “Act”)? 2) Whether payments made by Aco to the Debenture holders are "participating debt interest" within the meaning of the definition in subsection 212(3) of the Act? 3) Can a resident of the United States rely on paragraph 1 of Article XI of the Canada-United States Tax Convention (1980)?

Position: 1) No. 2) No. 3) Yes.

Reasons: The conditions of paragraph 212(1)(b) of the Act are not applicable.

Author: XXXXXXXXXX
Section: 212(1)(b), 212(3), 215(1), 51

XXXXXXXXXX
                                                                                                                                                2013-051455

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
       XXXXXXXXXX

 This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling are:

(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 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, if a judgment has been issued, the time limit for an appeal to a higher court has expired; or

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

DEFINITIONS

      (a) “Aco” means XXXXXXXXXX, the corporation described in paragraph 1;

      (b) “Act” means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof. Unless otherwise stated, all statutory references are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

      (c) “Agent” means XXXXXXXXXX;

      (d) “arm’s length” has the meaning assigned by subsection 251(1) of the Act;

      (e) “CBCA” means the Canada Business Corporations Act, R.S.C. 1995, c.C-44 as amended;

      (f) “common share” means class A common shares of Aco;

      (g) “excluded obligation” has the meaning assigned by subsection 214(8) of the Act;

      (h) “fully exempt interest” is defined in subsection 212(3) of the Act;

      (i) “Make-Whole Amount” has the meaning described in paragraph 8;

      (j) “participating debt interest” is defined in subsection 212(3) of the Act;

      (k) “Private Debentures” has the meaning described in paragraph 24;

      (l) “Private Indenture” means the Indenture to be entered into on the date of closing of the Private Debentures between Aco and XXXXXXXXXX;

      (m) “Public Debentures” means the minimum offering of XXXXXXXXXX units ($XXXXXXXXXX) to XXXXXXXXXX maximum units ($XXXXXXXXXX) of XXXXXXXXXX% convertible unsecured unsubordinated debentures and XXXXXXXXXX share purchase warrants of Aco pursuant to an agency agreement dated XXXXXXXXXX (and amended on XXXXXXXXXX);

      (n) “Public Indenture” means the indenture dated XXXXXXXXXX between Aco and XXXXXXXXXX, a trust company incorporated under the laws of Canada;

      (o) “subscription agreement” has the meaning described in paragraph 22;

      (p) “Subscriber” means USco, XXXXXXXXXX;

      (q) XXXXXXXXXX; and

      (r) “USco” means XXXXXXXXXX, a corporation resident in the United States.

FACTS

1.    Aco is a Canadian corporation that is incorporated under the CBCA. Aco is a public corporation as defined in subsection 89(1) of the Act. Aco has XXXXXXXXXX. Aco’s shares are listed on the XXXXXXXXXX under the stock symbol “XXXXXXXXXX” and on the XXXXXXXXXX under the symbol “XXXXXXXXXX”. Aco is currently seeking public and private financing. Aco files its T2 Returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. Aco’s corporate address is XXXXXXXXXX.

Public Debentures
2.    Aco entered into an agency agreement on XXXXXXXXXX with XXXXXXXXXX (the “Agent”) pursuant to which the Agent agreed to offer for purchase, on a best efforts basis, a minimum of XXXXXXXXXX units of Aco for a subscription price of $XXXXXXXXXX and a maximum of XXXXXXXXXX units of Aco for a subscription price of $XXXXXXXXXX.
3.    Further to deteriorating market conditions, since the pricing of its contemplated public offering of units on XXXXXXXXXX, Aco filed an amended and restated final short-form prospectus providing revised pricing of its marketed offering of units. The offering closed on XXXXXXXXXX. Each unit consisted of $XXXXXXXXXX principal amount of XXXXXXXXXX% unsecured unsubordinated convertible debentures and XXXXXXXXXX warrants (the “Public Debentures”). The     principal amount of the debentures is convertible into common shares at a price of $XXXXXXXXXX per     share and each warrant is exercisable into one common share of Aco at a price of $XXXXXXXXXX.

4.    The Public Debentures will mature XXXXXXXXXX years from the issue date and will bear interest at a rate of XXXXXXXXXX% per annum payable semi-annually in arrears on XXXXXXXXXX and XXXXXXXXXX of each year. The interest on the Public Debentures will be payable, at the option of Aco, in cash or in class A shares in the share capital of Aco (“common share”).
5.    Aco will deliver for each $XXXXXXXXXX of semi-annual interest amount, that number of common shares obtained by dividing each $XXXXXXXXXX of interest amount by the current market price of the common shares on the date falling XXXXXXXXXX days prior to the interest payment date or, at its option, shall deliver the equivalent amount in cash.
6.    Each Public Debenture will be convertible into common shares at the option of the holder at any time prior to the close of business on the XXXXXXXXXX business day immediately preceding the maturity date of the debenture at a conversion price of $XXXXXXXXXX per common share (“Conversion Price”), subject to certain adjustments.
7.    The Public Indenture will provide for the adjustment of the Conversion Price in certain events including: (i) the payment of dividends or distributions by Aco to all holders of common shares where the dividend or distribution is in the form of shares of Aco; (ii) the subdivision or consolidation of the outstanding common shares; (iii) the issuance of rights or warrants to all the holders of common shares entitling them to acquire common shares or other securities convertible into common shares at less than XXXXXXXXXX% of the then current market price (i.e. the volume weighted average trading price of the common shares on the XXXXXXXXXX for the XXXXXXXXXX consecutive trading days ending on the XXXXXXXXXX trading day preceding the date of the applicable event) (“Current Market Price”) of the common shares; and (iv) the distribution to all or substantially all holders of common shares of any securities or assets (other than common shares) or evidences of indebtedness or other assets of Aco.
8.    Holders who convert their Public Debentures will receive accrued and unpaid interest for the period from the date of the latest interest payment date to the date of conversion. To compensate for the loss of the interest amount that the holder would have otherwise received, the holder will receive a make-whole interest payment equal to the interest amount that the holder would have received if such holder had held the Public Debentures until the    maturity date (the “Make-Whole Amount”).
9.    The Make-Whole Amount is payable exclusively in common shares in the share capital of Aco.
10.   The accrued and unpaid interest may be paid, at the sole option of Aco, in cash or in common shares.
11.   Aco will pay any accrued and unpaid interest that it elected to pay in common shares by issuing and delivering to the holder that number of common shares obtained by dividing the amount of any accrued and unpaid interest that it elected to pay in common shares by the current market price on the date falling XXXXXXXXXX days prior to the date of conversion.
12.   The holder shall also receive payment of the Make-Whole Amount, by way of the number of common shares obtained by dividing the Make-Whole Amount by the current market price on the date falling XXXXXXXXXX trading days prior to the conversion date.
13.   The Make-Whole Amount shall be reduced by XXXXXXXXXX% for each XXXXXXXXXX% that the current market price at the time of conversion exceeds the conversion price.
14.   Aco may, at its sole discretion, require a debenture holder to convert not less than all of the Public Debentures held at any time beginning on the XXXXXXXXXX year anniversary of the closing date. Upon such forced conversion, Aco will be required to pay, in cash or in common shares at its option, the accrued and unpaid interest and the Make-Whole Amount, if any.
15.   The Public debentures will be direct, unsecured obligations of Aco, ranking equally with one another and with all other existing and future unsecured indebtedness of Aco.
16.   Each full warrant entitles the holder thereof to purchase one common share at the price of $XXXXXXXXXX (which is equal to the conversion price of the Public Debentures plus a XXXXXXXXXX% premium) for a period of XXXXXXXXXX months following the closing date.
17.   No holder will be allowed to exercise warrants for an amount which would result in the issuance of common shares providing the holder with more than XXXXXXXXXX% of the issued and outstanding common shares of Aco (taking into account all other common shares held by the holder).
18.   The debentures are listed on the XXXXXXXXXX.
19.   USco acquired $XXXXXXXXXX dollars of the $XXXXXXXXXX dollar public offering that closed on XXXXXXXXXX.
20.   Aco deals at arm’s length with USco.

Private Debentures
21.   Aco also seeks concurrent financing by way of a private placement. USco has also agreed to subscribe for $XXXXXXXXXX dollars in additional units as described below.
22.   Under the terms of a subscription agreement (the ‘Subscription Agreement”) entered into on XXXXXXXXXX, between Aco and USco (the “Subscriber”), USco agreed to subscribe and purchase from Aco, by way of a private placement on the date that falls XXXXXXXXXX months following the closing of the public placement: (i) XXXXXXXXXX series X subscription rights (‘Series X Subscription Rights”) and (ii) XXXXXXXXXX series Y subscription rights (“Series Y Subscription Rights”) and collectively with Series X Subscription Rights (the “Subscription Rights”) at the subscription price of $XXXXXXXXXX per Subscription Right.
23.   USco is a corporation resident in the United States for purposes of the Act and any applicable Tax Treaty.
24.   Each Subscription Right shall, upon exercise by USco or Aco, as the case may be, require USco to purchase one unit of Aco (“Private Unit”) at a price of $XXXXXXXXXX per Private Unit, with each Private Unit consisting of a $XXXXXXXXXX principal amount of XXXXXXXXXX% convertible unsecured unsubordinated debenture of Aco due XXXXXXXXXX years from its issuance (the “Private Debenture”) and a number of share purchase warrants of Aco which is equivalent to XXXXXXXXXX% of the common shares of Aco into which the principal amount of a Private Debenture is convertible.
25.   The principal amount of the Private Debenture will be convertible at a price equal to the XXXXXXXXXX-day volume weighted average trading price of the common shares on the XXXXXXXXXX on the last trading day prior to the date on which the Subscription Rights first become exercisable. Each warrant will entitle USco to purchase one common share for a period of XXXXXXXXXX months   from issuance at a XXXXXXXXXX% premium over the conversion price of the Private Debentures.
26.   In no event shall the number of common shares issuable or issued upon conversion of the Private Debentures and the exercise of the warrants exceed XXXXXXXXXX% of the number of common shares outstanding as at the date of issuance of the Subscription Rights unless approved by Aco’s shareholders. Failing such consent, all the unexercised Subscription Rights will immediately expire.
27.   The Private Debentures and warrants underlying the Subscription Rights may not be converted or exercised if their conversion or exercise would result in USco holding more than XXXXXXXXXX% of the issued and outstanding common shares at such time.
28.   The Private Debentures will be subject to the terms and conditions set forth in the trust indenture (the “Private Indenture”) between Aco and a Canadian trust company and the warrants will be subject to the terms and conditions set forth in the warrant indenture   between Aco and a Canadian trust company.
29.   The terms of the Private Indenture shall be substantially similar to the Public Indenture (including the inclusion of a Make-Whole Amount on conversion of the Private Debentures for common shares) and the warrant indenture shall be substantially similar to the one governing the public warrants, except, in each case, with appropriate adjustments to reflect the applicable conversion price and the term of the Private Debentures and exercise price and expiry of the warrants.|30.   There is currently no market through which the Subscription Rights, the Private Debentures and the warrants may be sold and purchasers may not be able to resell the securities.

PROPOSED TRANSACTIONS
31.   As provided in the Public and Private Indentures (the “Indentures”), Aco will make each of the semi-annual payments of interest to each holder of Debentures until the maturity date. Upon the exercise of the conversion feature of the Debentures, Aco will issue to the holder a number of common shares as determined by the conversion formula, that includes any Make-Whole Amount provided for in the Indentures and described above. Aco will also pay an amount, either in cash or in shares, for any accrued and unpaid interest for the period from the date of the previous interest payment date to the date of conversion of the Debentures.

PURPOSE OF PROPOSED TRANSACTIONS
32.   The purpose of the proposed transactions is to obtain financing for working capital purposes and finalization of the XXXXXXXXXX facility in XXXXXXXXXX.

RULINGS 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 provided that the Proposed Transactions are completed in the manner described above, we rule as follows:

A.    The payments made by Aco to the Debenture holders, described in Paragraph 31, are not “participating debt interest” within the meaning of the definition in subsection 212(3) of the Act.

B.    Paragraph 212(1)(b) of the Act will not apply to the conversion of any of the Public Debentures or Private Debentures held by a non-resident of Canada or by virtue of any interest payment or any Make‑Whole Amount under the Public Debentures or the Private Debentures, provided that the holder of the debenture deals at arm’s length with Aco.

C.    To the extent that Ruling B does not apply, a resident of the United States, entitled to the benefits under the Canada-United States Tax Convention (1980) (“Convention”), can rely on paragraph 1 of Article XI of the Convention and as a result, Aco would not be required to withhold any amount on the conversion of the Public and Private Debentures or from any interest payment or any Make‑Whole Amount paid to such a resident of the United States under the Public Debentures or Private Debentures.

The above rulings are given 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 by XXXXXXXXXX. In addition, the above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

COMMENTS:

Nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(a)   the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(b)   whether any person deals at arm’s length with Aco; or

(c)   any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

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

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