2015-0564731R3 Loss consolidation

Principal Issues: Is the loss consolidation arrangement acceptable?

Position: Yes

Reasons: The proposed transactions conform to our requirements for loss consolidation structures.

Author: XXXXXXXXXX
Section: 20(1)(c), 112, 245

XXXXXXXXXX                                                                                                             2015-056473

XXXXXXXXXX, 2015

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling
         XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling in respect of the above-noted taxpayers (the “Taxpayers”). We also acknowledge subsequent e-mails and telephone conversations in this respect. In general terms, you are asking us to rule on a series of proposed transactions that are designed to effect a consolidation of losses, and other tax attributes, within a group of affiliated and related corporations.

You have represented to us that, to the best of your knowledge, none of the issues involved in this ruling request are:

(i)   dealt with in a previously filed tax return of either of the Taxpayers, or of a person related to either of the Taxpayers;

(ii)  being considered by a tax services office or a taxation centre in connection with a previously filed tax return of either of the Taxpayers, or of a person related to either of the Taxpayers;

(iii) under objection by either of the Taxpayers, or a person related to either of the Taxpayers;

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

(v)   the subject of a ruling previously considered by the Income Tax Rulings Directorate in connection with either of the Taxpayers, or a person related to either of the Taxpayers.

Unless otherwise stated, all references herein to statutory provisions are to the Act, and all references to monetary amounts are to Canadian dollars.

Legal Entities

The transactions described in this ruling letter involve the following entities:

(a)   “ACO” means XXXXXXXXXX, a taxable Canadian corporation XXXXXXXXXX;

(b)   “Canco1” means XXXXXXXXXX, a taxable Canadian corporation XXXXXXXXXX of ACO, XXXXXXXXXX, all of the non-voting common shares of which are held by Parent and all of the voting preferred shares and the voting non-participating shares of which are held by Canco3. Canco1’s business number is XXXXXXXXXX;

(c)   “Canco2” means XXXXXXXXXX, a wholly-owned subsidiary of Parent, XXXXXXXXXX, that is a taxable Canadian corporation. Following the transactions described in paragraph 12 hereof, USco will own shares in Canco2. Canco2’s business number is XXXXXXXXXX;

(d)   “Canco3” means XXXXXXXXXX, a taxable Canadian corporation XXXXXXXXXX that is indirectly wholly-owned by Parent. Canco3’s business number is XXXXXXXXXX;

(e)   “Canco4” means XXXXXXXXXX, a wholly-owned subsidiary of Parent, XXXXXXXXXX, that is a taxable Canadian corporation. Canco4’s business number is XXXXXXXXXX;

(f)   “LP General Partner” means Newco2, as referred in paragraph 19 hereof;

(g)   “LP Limited Partners” means Canco2 and Canco4, as referred in paragraph 20 hereof;

(h)   “LP Partners” means Canco2, Canco4 and Newco2;

(i)   “New LP” means a new limited partnership to be established pursuant to the laws of the province of XXXXXXXXXX which is more fully described in paragraph 18 hereof;

(j)   “Newco1” means XXXXXXXXXX which is more fully described in paragraphs 15 and 16 hereof;

(k)   “Newco2” means XXXXXXXXXX, a wholly-owned subsidiary of Canco2, XXXXXXXXXX, that is a taxable Canadian corporation, which is more fully described in paragraph 17 hereof. Newco2’s business number is XXXXXXXXXX;

(l)   “Parent” means XXXXXXXXXX, a U.S. corporation incorporated under the laws of XXXXXXXXXX; and

(m)   “Parent Affiliated Group” means Parent and its subsidiaries;

(n)   “USco” means XXXXXXXXXX, a U.S. corporation XXXXXXXXXX, the shares of which are held in part by Parent and in part by XXXXXXXXXX;

Definitions

In this ruling letter, unless otherwise specified, the following terms have the meanings specified below:

(a)   “Act” means the Income Tax Act, RSC 1985 (5th supp.), c.1, as amended to the date hereof, and, unless otherwise indicated, all statutory references are to the Act;

(b)   “adjusted cost base” or “ACB” has the meaning assigned by section 54;

(c)   “affiliated persons” has the meaning assigned by subsection 251.1(1);

(d)   “Anniversary Date” means each anniversary of the day preceding the execution of the Purchase and Forward Repurchase Agreement, up until the unwinding of the structure;

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

(f)   “CAD” means Canadian dollars;

(g)   “Call Right” means the right described in paragraph 28(xi) hereof;

(h)   “Canadian Partnership” has the meaning assigned by subsection 102(1);

(i)   “Canco1 Loan” means the intercompany debt described in paragraph 22 hereof;

(j)   “CBCA” means the Canada Business Corporations Act, RSC 1985, c. C-44 as amended to the date hereof;

(k)   “Code” means the Internal Revenue Code of 1986, as amended, Title 26 of the U.S. Code;

(l)   “controlled foreign corporation” has the meaning assigned by section 957 of the Code;

(m)   “CRA” means Canada Revenue Agency;

(n)   “dividend rental arrangement” has the meaning assigned by subsection 248(1);

(o)   “financial intermediary corporation” has the meaning assigned by subsection 191(1);

(p)   “FMV” means fair market value;

(q)   “Forward Purchase Date” means the date described in paragraph 28(ix) hereof;

(r)   “Forward Purchase Price” means the price described in paragraph 28(ix) hereof;

(s)   “GAAR” means the general anti-avoidance rule;

(t)   “investment tax credit” or “ITC” has the meaning assigned by subsection 127(5);

(u)   “New LP Promise to Pay” means the intercompany debt described in paragraph 27 hereof;

(v)   “non-capital loss” has the meaning assigned by subsection 111(8);

(w)   XXXXXXXXXX;

(x)   “paid-up capital” or “PUC” has the meaning assigned by subsection 89(1);

(y)   “Preferred Shares” means the preferred shares described in paragraph 16 hereof;

(z)   “principal amount” has the meaning assigned by subsection 248(1);

(aa)  “Purchase and Forward Repurchase Agreement” means the agreement described in paragraph 27 hereof;

(bb)  “Put Right” means the right described in paragraph 16(i) hereof;

(cc)  “Put Right Notice” means the notice described in paragraph 28(xi) hereof;

(dd)  “Put Right Shares” means the shares described in paragraph 28(xi) hereof;

(ee)  “Redemption Notice” means the notice described in paragraph 16(v) hereof;

(ff)  “Redemption Price” means the price described in paragraph 16(i) hereof

(gg)  “Redemption Right” means the right described in paragraph 16(v) hereof;

(hh)  “Security Agreement” means the agreement entered into by Canco1 and New LP described in paragraph 28(vii) hereof pursuant to which New LP will grant a security interest in the Preferred Shares in favour of Canco1 securing payment of the New LP Promise to Pay;

(ii)  “specified financial institution” has the meaning assigned by subsection 248(1);

(jj)  “SR&ED pool” corresponds to the amount computed pursuant to section 37;

(kk)  “Support Agreement” means the agreement described in paragraph 26 hereof;

(ll)  “taxable Canadian corporation” has the meaning assigned by subsection 89(1);

(mm)  “U.S.” means United States of America; and

(nn)  “USD” means US dollars.

Facts

1.    Parent, with its subsidiaries and affiliated corporations, is XXXXXXXXXX. The organization owns or operates XXXXXXXXXX.

2.    XXXXXXXXXX

3.    XXXXXXXXXX

Consolidated revenues of Parent for the year ended XXXXXXXXXX totalled USD XXXXXXXXXX. The consolidated financial results of Parent for its XXXXXXXXXX quarterly report indicate that Parent and its subsidiaries had:

(a)   assets of approximately USD XXXXXXXXXX;

(b)   liabilities of approximately USD XXXXXXXXXX; and

(c)   total equity of approximately USD XXXXXXXXXX which includes non-controlling interests and retained earnings.

XXXXXXXXXX

4.    Canco3 is a holding corporation which owns all the issued and outstanding voting shares of Canco1, being the voting preferred shares and the voting non-participating shares.  Canco3 does not own any other material assets.

5.    Canco1 owns or operates XXXXXXXXXX facilities in Canada. Canco1 is the main Canadian operating entity in the group.  The taxation year of Canco1 ends on XXXXXXXXXX.

6.    The non-consolidated balance sheet of Canco1 as at XXXXXXXXXX is summarized as follows:

(a)   assets of approximately CAD XXXXXXXXXX;

(b)   liabilities of approximately CAD XXXXXXXXXX which includes: (i) CAD XXXXXXXXXX advance from affiliates, and (ii) CAD XXXXXXXXXX pension and other benefit obligations; and

(c)   total equity of approximately CAD XXXXXXXXXX.

7.    As at XXXXXXXXXX, the aggregate non-capital losses of Canco1 are CAD XXXXXXXXXX.  More specifically, all non-capital losses were incurred from XXXXXXXXXX and after and are not restricted by the acquisition of control rules in subsections 111(5) and 88(1.1).  Also, Canco1 has a SR&ED pool balance of deductible expenditures of CAD XXXXXXXXXX and an ITC pool balance of CAD XXXXXXXXXX, of which CAD XXXXXXXXXX and CAD XXXXXXXXXX, respectively, arose after XXXXXXXXXX.  At the end of its XXXXXXXXXX taxation year, Canco1 had an undepreciated capital cost of depreciable property of CAD XXXXXXXXXX.

8.    Canco1’s taxable income for its XXXXXXXXXX prior taxation years was as follows:

Taxation Year Ending    Taxable Income

XXXXXXXXXX              XXXXXXXXXX

9.    Canco1 has establishments in XXXXXXXXXX Canadian provinces. Its allocation of income among the provinces in its XXXXXXXXXX taxation year was as follows:

XXXXXXXXXX

10.   Canco1 expects to earn income in future taxation years, but not enough to use all of its tax attributes mentioned in paragraph 7 above in the foreseeable future. More specifically, Canco1 estimates that it will not earn any taxable income in the time period of the Proposed Transactions (because of the tax attributes available).

11.   In XXXXXXXXXX, Parent incorporated Canco2. The intent is for each of Canco1 and Canco2 to be generally accountable for its performance and to support the liabilities associated with its operations. Canco2 will be carrying on and growing certain segments of the XXXXXXXXXX business in Canada. To this end, Canco1 will transfer directly or indirectly to Canco2 its shares of, or net assets related to, its XXXXXXXXXX activities in XXXXXXXXXX. Canco4 was formed to XXXXXXXXXX. Canco1, Canco2 and Canco4 have provided, and will continue to provide, certain financial guarantees in respect of certain of the Parent Affiliated Group’s liabilities. In addition, each company has, and will have, liabilities that may not be subject to similar financial guarantees by the members of the Parent Affiliated Group.

12.   The taxation year of Canco2 and Canco4 ends, or will end, on XXXXXXXXXX. It is expected that Canco2 and Canco4 will each generate sufficient annual taxable income in XXXXXXXXXX and subsequent taxation years to fully offset their respective annual share of the interest expense allocated to them as limited partners of New LP in respect of interest paid or payable by New LP on the New Promise to Pay described in paragraphs 28, 31, 33(iii) and 34(iii) below. More specifically, the taxable income (before the Proposed Transactions) of Canco4 for XXXXXXXXXX and each of the following taxation years is estimated at CAD XXXXXXXXXX annually. The taxable income (before the Proposed Transactions) of Canco2 is estimated at CAD XXXXXXXXXX for XXXXXXXXXX and at CAD XXXXXXXXXX for each of the following taxation years. 

It is expected that Canco2 will have a permanent establishment in XXXXXXXXXX and that Canco4 will have permanent establishments in XXXXXXXXXX.

After the implementation of the Proposed Transactions, Canco1 will maintain permanent establishments in XXXXXXXXXX and it is expected that the allocation of its income among these provinces will be approximately XXXXXXXXXX in XXXXXXXXXX and subsequent taxation years.

13.   The arm’s-length borrowings of the Parent Affiliated Group currently amount to approximately USD XXXXXXXXXX and its cash, or cash equivalents, on hand is approximately USD XXXXXXXXXX. The Parent Affiliated Group is in a position to increase its current arm’s-length borrowings by an amount of USD XXXXXXXXXX (more than CAD XXXXXXXXXX) which is equal to its borrowing capacity of USD XXXXXXXXXX minus the current arm’s-length borrowings net of cash, or cash equivalents, on hand.

14.   Canco1, Canco2 and Canco4 are controlled foreign corporations for U.S. federal income tax purposes. Parent is therefore subject to the U.S. anti-deferral rules contained in Subpart F of the Code with respect to certain categories of income (commonly referred to as Subpart F income) earned by Canco1, Canco2 and Canco4. Subpart F income includes most types of passive income, such as dividends, interest, royalties and gains from the sale of property that produces passive income or that is held for investment. If Canco1, Canco2 or Canco4 has Subpart F income, Parent must include that income in its gross income as a deemed dividend, unless certain narrow exceptions apply.

Proposed Transactions

The Proposed Transactions described below will be implemented before XXXXXXXXXX. It is proposed that the transactions described in paragraphs 15 to 20 with respect to the creation of the entities will be completed as part of the first phase. The transactions described in paragraphs 21 to 25 will take place over a XXXXXXXXXX period following the first phase. Shortly after the implementation of the transactions described in paragraphs 21 to 25, the transactions described in paragraphs 26, 27 and 28 will be implemented.  The unwinding of the loss consolidation arrangement will be executed when jointly determined by Canco1, Canco2, Canco4, New LP and Newco1, but no later than XXXXXXXXXX, except to the extent that the maturity date of the Purchase and Forward Repurchase Agreement is extended, as described in subparagraph 28(iv) below. If such an extension is desired, the Taxpayers may seek a favourable ruling from the CRA, whether by renewal of this ruling or otherwise.

15.   Canco1 has incorporated Newco1 under the XXXXXXXXXX. Newco1 will be a taxable Canadian corporation, XXXXXXXXXX.  Newco1 will issue common shares of its capital stock to Canco1 for nominal consideration. Canco1 will have de jure control of Newco1 at all times during the life of this structure as Canco1 will hold all of the voting shares of Newco1. The taxation year-end of Newco1 will be XXXXXXXXXX. Newco1 will not carry on any business. Its activities will be limited to entering into the Support Agreement and the Purchase and Forward Repurchase Agreement, issuing the Preferred Shares, investing the proceeds received upon the issuance of its Preferred Shares in the Canco1 Loan and paying dividends on the Preferred Shares.

16.   The authorized capital of Newco1 will consist of an unlimited number of common shares and preferred shares (referred to in this letter as “Preferred Shares”).  The common shares of Newco1 will be without par value and will be voting.  The Preferred Shares will have the following terms and conditions:

(i)   redeemable (in whole or in part) at any time at the option of the holder (referred to in this letter as the “Put Right”) at a redemption price denominated in Canadian dollars equal to the cash consideration received upon issuance plus any accrued but unpaid dividends (referred to in this letter as the “Redemption Price”);

(ii)  entitle the holder to cumulative dividends at a rate of XXXXXXXXXX% per annum payable annually on the Anniversary Date and immediately prior to any sale, transfer, redemption, disposition or other alienation of the Preferred Shares. The dividends will accrue and be calculated daily by reference to the cash consideration received upon issuance of the Preferred Shares;

(iii) entitle the holder upon dissolution to a payment, in priority to the holders of any other class of shares outstanding, of an amount equal to the Redemption Price;

(iv)  non-voting; and

(v)   redeemable at the option of Newco1 (referred to in this letter as the “Redemption Right”) for the Redemption Price. In the event that Newco1 desires to exercise its Redemption Right, it would have to provide a XXXXXXXXXX-year prior written notice to the holder indicating its intention to redeem all or a portion the Preferred Shares for cash (referred to in this letter as the “Redemption Notice”).

Upon receipt of a Redemption Notice, New LP will inform Canco1 which will in turn be required to repurchase the Preferred Shares pursuant to the Purchase and Forward Repurchase Agreement as described in paragraph 28(xii) below.

17.   Canco2 has incorporated Newco2 under XXXXXXXXXX. Newco2 is a taxable Canadian corporation. Newco2 will issue common shares of its capital stock to Canco2 for nominal consideration. Canco2 will have, at all times during the life of this structure, de jure control of Newco2 as Canco2 will hold all of its voting shares. The taxation year-end of Newco2 will be XXXXXXXXXX. Newco2’s activities will be limited to those described in this letter. The authorized capital of Newco2 will only consist of an unlimited number of common shares. The common shares of Newco2 will be without par value and will be voting. The holders of common shares will be entitled to dividends at the discretion of the directors, and will be entitled to receive the remaining property of the corporation upon its winding-up or dissolution.

18.   The LP Partners will form a new limited partnership (referred to in this letter as the “New LP”) under the laws of the province of XXXXXXXXXX. New LP will be a partnership and a “Canadian partnership” for the purposes of the Act. The fiscal period-end of New LP will be XXXXXXXXXX. New LP's activities will be limited to those described in the Proposed Transactions, including purchasing the Preferred Shares and entering into the Support Agreement and the Purchase and Forward Repurchase Agreement.

19.   Newco2 will be the general partner of New LP (referred to in this letter as the “LP General Partner”). Newco2 will have a XXXXXXXXXX% ownership interest in New LP and will be entitled to a XXXXXXXXXX% share of the income or loss of New LP.

20.   Canco2 and Canco4 will be the limited partners of New LP (referred to in this letter as the “LP Limited Partners”). Based on initial contributions to New LP, Canco2 will have a XXXXXXXXXX% ownership interest in New LP and will be entitled to a XXXXXXXXXX% share of the income or loss of New LP. Canco4 will have a XXXXXXXXXX% ownership interest in New LP and will be entitled to a XXXXXXXXXX% share of the income or loss of New LP.

21.   Before the Proposed Transactions, Canco1 will arrange to have approximately USD XXXXXXXXXX of cash on hand. Canco1 will use approximately CAD XXXXXXXXXX to subscribe for Preferred Shares of Newco1 which will be issued immediately before the transaction described in paragraph 27 below. The PUC of the Preferred Shares will be equal to the subscription price represented in Canadian dollars.

22.   Newco1 will use all the proceeds received from the Preferred Shares to make a non-interest-bearing loan denominated in CAD to Canco1 (referred to in this letter, together with the additional amounts referred to in paragraph 23 below, as the “Canco1 Loan”). The Canco1 Loan will have the following features:

(i)   a term of XXXXXXXXXX years with the possibility to be prepaid at any time without penalty by Canco1;

(ii)  the Canco1 Loan will be secured by a second-ranking security interest over the New LP Promise to Pay (for so long as the New LP Promise to Pay is outstanding), subject to any rights which may be granted pursuant to external financing; and

(iii) if Canco1 exercises its option to extend the term of the Purchase and Forward Repurchase Agreement (as described in paragraph 28(iv) below), the term of the Canco1 Loan will be extended if required.

23.   Shortly after the transactions described in paragraphs 21 and 22 above (no more than within XXXXXXXXXX), the cash on hand of Canco1 will be used in the same manner, by the same parties, and for the same purposes, first, to subscribe for Preferred Shares as described in paragraph 21 and, secondly, to increase the amount of the Canco1 Loan as described in paragraph 22.

24.   The total (and final) amount of the Preferred Shares and of the Canco1 Loan will, after the implementation of the transactions described in paragraphs 21, 22 and 23 above, be CAD XXXXXXXXXX.  Such amount will not exceed the amount that the Parent Affiliated Group could borrow from arm’s length lenders, which is USD XXXXXXXXXX minus the outstanding third party debt of approximately USD XXXXXXXXXX (net of cash or cash equivalent).  Thus, the amount of the loss utilization arrangement described in the Proposed Transactions will be CAD XXXXXXXXXX, which is less than the arm’s length borrowing capacity of the Parent Affiliated Group that is currently unused, which amounts to approximately USD XXXXXXXXXX.

25.   The purpose for carrying out the transactions described in paragraphs 21, 22 and 23 above solely with the cash on hand without drawing on the existing credit facility is to minimize borrowing fees and to avoid the administrative burden with the lenders.  The transactions will be implemented, wire transfers will be made, and there will be appropriate record-keeping thereof. Depending on the amount of cash on hand at the time of the transactions, Canco1 could draw the required amount on a daylight loan basis under its existing asset-based credit facility.

26.   Canco1, Newco1 and New LP will enter into a binding support agreement (referred to in this letter as the “Support Agreement”) which will require Canco1 to make capital contributions to Newco1 to enable Newco1 to fund dividends on its issued and outstanding Preferred Shares upon each of the following occurrences:

(i)   the Anniversary Date of each year;

(ii)  immediately prior to the acquisition of the Preferred Shares by Newco1 following the exercise of the Put Right (where no Call Right is exercised); and

(iii) immediately prior to the acquisition of the Preferred Shares by Canco1 pursuant to the Purchase and Forward Repurchase Agreement (including the exercise of the Call Right).

The Support Agreement will also require Canco1 to make capital contributions to Newco1 in the form of share subscriptions or repayments against the Canco1 Loan to enable Newco1 to redeem at the option of the holder some (but not all) of the Preferred Shares following the exercise of the Put Right (where no Call Right is exercised).  Canco1 will finance the contributions pursuant the Support Agreement with its cash on hand, borrowed money or a combination of both.

The term of the Support Agreement will be for so long as the Preferred Shares are issued and outstanding.

27.   Canco1, New LP and Newco1 will enter into a purchase, forward repurchase and call agreement (referred to in this letter as the “Purchase and Forward Repurchase Agreement”) whereby Canco1 will sell the Preferred Shares to New LP in exchange for an interest-bearing promise to pay by New LP in favour of Canco1 in the amount of CAD XXXXXXXXXX (referred to in this letter as the “New LP Promise to Pay”) and whereby Canco1 agrees to repurchase the Preferred Shares owned by New LP on the Forward Purchase Date.

The New LP Promise to Pay will be based on, and will not exceed, the amount that the Parent Affiliated Group could borrow from arm’s length lenders of USD XXXXXXXXXX minus the current external debts of approximately USD XXXXXXXXXX (net of cash or cash equivalent).

28.   The Purchase and Forward Repurchase Agreement will have the following features:

(i)   simple interest on the outstanding principal amount owing under the New LP Promise to Pay will accrue at a rate of XXXXXXXXXX% per annum, calculated daily;

(ii)  the interest on the New LP Promise to Pay will be payable immediately after Canco1 makes a cash contribution to Newco1 and New LP receives a dividend, including on each Anniversary Date, and will be paid by New LP using the proceeds received on account of the dividends on the Preferred Shares;

(iii) a term of XXXXXXXXXX years, but the New LP Promise to Pay could be prepaid without penalty, either in part or in full, as described in subparagraph (xiii) of this paragraph 28 or with the proceeds received by New LP on account of its exercise of the Put Right;

(iv)  Canco1 will have the option to extend the Forward Purchase Date and the term of the New LP Promise to Pay for successive periods of XXXXXXXXXX. The outstanding principal amount of the New LP Promise to Pay would be payable upon Canco1’s demand during the extension period(s) (all without detracting from New LP’s prepayment right described in subparagraph (xiii) of this paragraph 28);

(v)   New LP’s obligations to Canco1 pursuant to the New LP Promise to Pay will be satisfied only by using the proceeds received on account of the Redemption Price, or by using the proceeds received from any other disposition of the Preferred Shares pursuant to the Purchase and Forward Repurchase Agreement, or pursuant to the set-off contemplated in subparagraph (ix) of this paragraph 28;

(vi)  in the event of a default on New LP’s obligations in respect of the New LP Promise to Pay that is not cured within the applicable cure period provided in the Purchase and Forward Repurchase Agreement (if any), whether on account of principal or interest, the Forward Purchase Date will be accelerated, as described in subparagraph (ix) of this paragraph 28;

(vii) the Preferred Shares owned by New LP will be pledged by New LP to Canco1 as collateral for New LP’s obligations in respect of the New LP Promise to Pay. Accordingly, possession of the share certificates representing such Preferred Shares will be with Canco1 in its capacity as secured creditor, but New LP will receive all amounts paid on account of any dividend or Redemption Price (and will retain any voting rights) on the Preferred Shares as owner of the Preferred Shares, all such payments on the Preferred Shares to be applied immediately to service the New LP Promise to Pay, unless and until the security is realized pursuant to the Security Agreement;

(viii)      upon receipt of the Redemption Price following the exercise of its Put Right, New LP will have a binding obligation to use the cash proceeds received to repay the New LP Promise to Pay and any accrued and unpaid interest on such debt;

(ix)  Canco1 will repurchase all the Preferred Shares then owned by New LP for an amount equal to the Redemption Price of such Preferred Shares (referred to in this letter as the “Forward Purchase Price”) on the expiry date of the Purchase and Forward Repurchase Agreement, as may be extended following Canco1’s option to extend the term for successive XXXXXXXXXX extension periods (referred to in this letter as the “Forward Purchase Date”).  Effective on the Forward Purchase Date, the Preferred Shares then owned by New LP will be transferred to Canco1 and Canco1’s obligation to pay the Forward Purchase Price shall be considered by the parties as a liquid and exigible debt as of and from the Forward Purchase Date.  The Purchase and Forward Repurchase Agreement will provide that certain events, including and without limiting those listed below, will accelerate the Forward Purchase Date:

a.    immediately prior to any liquidation, insolvency, bankruptcy, arrangement and similar events relating to Newco1, Canco1 or New LP;

b.    immediately upon the issuance of a Put Right Notice in respect of all the Preferred Shares then owned by New LP (as described in subparagraph (xi) of this paragraph 28);

c.    immediately upon the issuance of a Redemption Notice by Newco1 in respect of all of the Preferred Shares then owned by New LP;

d.    the exercise by New LP of its option to prepay in full the New LP Promise to Pay before the expiry date of the Purchase and Forward Repurchase Agreement; and

e.    an event of default under the Purchase and Forward Repurchase Agreement or the Support Agreement that is not cured within the applicable cure period.

If Canco1 does not pay the Forward Purchase Price in cash on the Forward Purchase Date, Canco1’s obligation to pay such Forward Purchase Price shall be set off against the corresponding amount of the New LP Promise to Pay and New LP shall have no further obligation in connection with such repayment of the New LP Promise to Pay;

(x)   Canco1’s obligations under the Purchase and Forward Repurchase Agreement will be secured in favour of New LP by Canco1 pledging to New LP all of its rights, title and interest in and to the Purchase and Forward Repurchase Agreement, including the New LP Promise to Pay. Such security will be first-ranking, including in priority to the interest that Newco1 has in the New LP Promise to Pay in order to secure the Canco1 Loan, subject to any rights which may be granted pursuant to external financing;

(xi)  Prior to the exercise of its Put Right with respect to any of the Preferred Shares, New LP will provide notice to Canco1 (referred to in this letter as the “Put Right Notice”) informing Canco1 of its intention to exercise its Put Right with respect to such Preferred Shares.  If the Put Right Notice is in respect of some (but not all) of the Preferred Shares then owned by New LP (referred to in this letter as the “Put Right Shares”), Canco1 will then have a right (referred to in this letter as the “Call Right”) to repurchase the Put Right Shares from New LP for a purchase price equal to the Redemption Price, payable in cash or by promissory note.  If the Put Right Notice is in respect of all the Preferred Shares then owned by New LP, the Put Right Notice will accelerate the term of the Purchase and Forward Repurchase Agreement such that Canco1 will purchase all of the Preferred Shares then owned by New LP in the manner provided in subparagraph (ix) of this paragraph 28;

(xii) upon receipt of a Redemption Notice with respect to some (but not all) of the Preferred Shares then owned by New LP, New LP will inform Canco1, which will be required to repurchase the Preferred Shares that are the subject of the Redemption Notice within a reasonable period, for a purchase price equal to the Redemption Price, payable in cash or by promissory note.  The Preferred Shares would remain outstanding in the hands of Canco1 until the end of the XXXXXXXXXX-year prior notification period described in subparagraph 16(v) above before they are redeemed by Newco1. If the Redemption Notice is with respect to all the Preferred Shares then owned by New LP, the term of the Purchase and Forward Repurchase Agreement will be accelerated such that Canco1 will purchase all of the Preferred Shares then owned by New LP in the manner provided in subparagraph (ix) of this paragraph 28;

(xiii)      New LP will have the option to prepay the New LP Promise to Pay (either in part or in full) without penalty.  New LP’s option to prepay with respect to the full outstanding amount of the New LP Promise to Pay will be exercised by New LP sending a notice to Canco1 advising it of such, which notice will have the effect of accelerating the Forward Purchase Date.  New LP’s option to prepay with respect to a portion (but not all) of the outstanding amount of the New LP Promise to Pay will be exercised by New LP sending a notice to Canco1 advising it of such, which notice will require Canco1 to repurchase the number of Preferred Shares corresponding to the amount of the partial prepayment, for a purchase price equal to the Redemption Price of such Preferred Shares, payable in cash or by promissory note;

(xiv) during the term of the Purchase and Forward Repurchase Agreement, New LP will be prohibited from disposing of the Preferred Shares other than pursuant to the terms of the Purchase and Forward Repurchase Agreement or upon the exercise of the Call Right or the Put Right with respect to all or a portion of the Preferred Shares; and

(xv)  the Purchase and Forward Repurchase Agreement will be governed by the laws of the Province of XXXXXXXXXX.

29.   On each Anniversary Date, Canco1 will, pursuant to the Support Agreement, make a contribution of capital to Newco1 equal to the amount of the dividend payable by Newco1 on the Preferred Shares.  The amount of this contribution will be recorded as contributed surplus for accounting purposes.  No share will be issued by Newco1 with respect to the contribution of capital and no amount will be added to the PUC of Newco1, at any time, in respect of the contribution.

30.   Upon receipt of the contribution described in paragraph 29 above, Newco1 will, subject to any applicable solvency tests under its corporate statute, pay a dividend to the holder of the Preferred Shares in the amount referred to in subparagraph 16(ii) above.

31.   New LP will use the amount received as dividends from Newco1 to pay the accrued interest on the New LP Promise to Pay and, with the excess cash available, make a distribution to the LP Partners in the proportion of their ownership interests in New LP.

Besides the interest expense incurred by New LP in respect of the New LP Promise to Pay, New LP’s “other expenses” to be included in the computation of its income for any taxation year will be non-existent or negligible.  Consequently, except as noted immediately following, no further reference to these other expenses will be made.  For greater certainty, each year the amount of dividends payable on the Preferred Shares (see paragraphs 30, 33(ii) and 34(ii) of this letter) will exceed the aggregate, in that particular year, of the amount of interest on the New LP Promise to Pay, plus any amount of other expenses incurred by New LP.  Consequently, each year during which this loss utilization arrangement is in place, New LP is expected to have net income, computed in accordance with subsection 96(1).

32.   The amount of the loss utilization arrangement described in this letter will be reduced or eliminated (e.g. if it is no longer expected that the LP Partners will generate sufficient annual taxable income to fully offset their annual share of the interest expense allocated to them, in respect of interest paid or payable by New LP) on the acquisition of the Preferred Shares pursuant to the Purchase and Forward Repurchase Agreement, or the exercise of the Call Right or Put Right as described in paragraphs 33 and 34 below.

33.   Subject to paragraph 34 below, the following transactions will be undertaken when Preferred Shares are acquired by Canco1 pursuant to the Purchase and Forward Repurchase Agreement:

(i)   Canco1 will make a contribution of capital to Newco1 equal to the amount of the dividend payable by Newco1 on the Preferred Shares held by New LP pursuant to the Support Agreement. No share will be issued by Newco1 with respect to the contribution of capital and no amount will be added to the PUC of Newco1, at any time. The amount of this contribution will be recorded as contributed surplus for accounting purposes.

(ii)  Upon receipt of the contribution described in subparagraph 33(i) above, Newco1 will, subject to any applicable solvency tests under its corporate statute, pay the accrued dividend to New LP in the amount referred to in subparagraph 16(ii) above.

(iii) New LP will use the amount received on account of the dividends from Newco1 to pay the accrued interest on the New LP Promise to Pay and, with the excess cash available, make a distribution to the LP Partners in the proportion of their ownership interests in New LP.

(iv)  New LP will repay the New LP Promise to Pay in the manner described in paragraph 28 above.

(v)   Newco1 will acquire all the Preferred Shares acquired by Canco1 in subparagraph 33(iv) above in consideration for the reduction of the Canco1 Loan for an amount equal to the Redemption Price.

34.   Notwithstanding paragraph 33 above, the following transactions will be undertaken if some (but not all) of the Preferred Shares are redeemed pursuant to the exercise of the Put Right and the Call Right is not exercised by Canco1:

(i)   Canco1 will make a contribution of capital to Newco1 equal to the amount of the dividend payable by Newco1 on the Preferred Shares held by New LP pursuant to the Support Agreement. No share will be issued by Newco1 with respect to the contribution of capital and no amount will be added to the PUC of Newco1, at any time. The amount of this contribution will be recorded as contributed surplus for accounting purposes.

(ii)  Upon receipt of the contribution described in subparagraph 34(i) above, Newco1 will, subject to any applicable solvency tests under its corporate statute, pay the accrued dividend to New LP in the amount referred to in subparagraph 16(ii) above.

(iii) New LP will use the amount received on account of the dividends from Newco1 to pay the accrued interest on the New LP Promise to Pay and, with the excess cash available, make a distribution to the LP Partners in proportion of their ownership interests in New LP.

(iv)  Pursuant to the Support Agreement, Canco1 will make a capital contribution to Newco1 in the form of a share subscription or will repay the Canco1 Loan for an amount equal to the Redemption Price of the Preferred Shares redeemed pursuant to the exercise of the Put Right.

(v)   Newco1 will use the cash received from Canco1 in subparagraph 34(iv) above to pay to New LP the Redemption Price of the Preferred Shares so redeemed pursuant to the exercise of the Put Right.

(vi)  New LP will use the cash received from Newco1 in subparagraph 34(v) above to pay a corresponding portion of the New LP Promise to Pay.

35.   Shortly after Newco1 becomes a wholly-owned corporation of Canco1, Canco1 will cause Newco1 to be wound-up in such manner that all the assets of Newco1 are acquired by Canco1 and all of the liabilities (if any) of Newco1 are assumed by Canco1. As a result, the Canco1 Loan and the shares of Newco1 (common shares and Preferred Shares) owned by Canco1 will be cancelled.

Additional Information

36.   Canco2 and Canco4 will compensate Canco1 for the use of its available tax attributes. The compensation will be negotiated at an arm’s length price between Canco1 and each of Canco2 and Canco4. The compensation may be achieved by distributions by Canco2 and Canco4 (more precisely by a reduction of capital) followed by contributions of capital to Canco1 of such amounts received.

37.   The Preferred Shares, which will be issued as described in paragraphs 21 and 23 above, will not be, at any time during the implementation of the Proposed Transactions described herein:

(a)   the subject of any undertaking that is referred to in subsection 112(2.2) as a “guarantee agreement”;

(b)   the subject of a dividend rental arrangement;

(c)   the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or

(d)   issued for consideration that is or that includes:

i.    an obligation of the type described in subparagraph 112(2.4)(b)(i); or

ii.   any right of the type described in subparagraph 112(2.4)(b)(ii).

38.   None of Canco1, Canco2, Canco4, Newco1 and Newco2 is or will be a specified financial institution or a financial intermediary corporation.

39.   Canco1, Canco2 and Canco4 are affiliated persons and are related to each other.

40.   Based on its existing assets and resources, Canco1 will have the ability to make the contributions of capital to Newco1 as described in paragraphs 29, 33(i) and 34(i) above.

41.   The annual dividends paid on the preferred shares of Newco1 to New LP, as described in paragraph 30 above, as well as the dividends described in subparagraphs 33(ii) and 34(ii), have no other purpose than the purpose described under the heading “Purpose of the Proposed Transactions”.

42.   The Proposed Transactions will not have the direct or indirect effect of extending the life of any of Canco1’s tax attributes beyond their normal carry forward periods.

43.   The Proposed Transactions have been legally structured as a sale-and-repurchase of preferred stock to avoid certain adverse U.S. federal income tax consequences for Parent. In the event that the parties would not have entered into the Purchase and Forward Repurchase Agreement as described in paragraphs 27 and 28 above, the interest on the New LP Promise to Pay and the dividends on the Preferred Shares would have resulted in significant Subpart F income inclusions to Parent. No exceptions would apply to such items of income under the current Subpart F rules. Parent could also have had to recognize a significant Subpart F income inclusion upon the unwind transactions described in paragraphs 32, 33 and 34 above.

The Proposed Transactions were therefore structured as a sale-and-repurchase transaction to mitigate the creation of Subpart F income. The U.S. federal income tax consequences of the Proposed Transactions must be determined based on their economic substance instead of their legal form. In this case, the legal form, which applies for Canadian tax purposes, is that of a sale of the Preferred Shares in exchange for the New LP Promise to Pay, followed, a few years later, by the repurchase by Canco1 of those shares. On the other hand, for U.S. federal income tax purposes, the sale of Preferred Shares by Canco1 to New LP in paragraph 27 above and the subsequent reacquisition of such shares by Canco1 pursuant to the Purchase and Forward Repurchase Agreement entered into between the parties in paragraphs 27 and 28 above are intended to be disregarded, and Canco2 and Canco4 are intended not to be viewed as the beneficial owners of the Preferred Shares for U.S. federal income tax purposes during the term of the Purchase and Forward Repurchase Agreement. Under such a “recast”, the interest on the New LP Promise to Pay and the dividends on the Preferred Shares are also intended to be disregarded for U.S. federal income tax purposes and thus are intended not to result in any significant Subpart F inclusions for Parent. The Call Right described in subparagraph 28(xi) above and the Support Agreement described in paragraph 26 above provides additional support to conclude that the beneficial ownership of the Preferred Shares will remain with Canco1 for U.S. federal income tax purposes.

Purpose of the Proposed Transactions

44.   The purpose of the Proposed Transactions is to consolidate taxable income and tax attributes within a group of affiliated and related persons.

Rulings

Provided that the above Facts, Proposed Transactions, Additional Information and Purpose of the Proposed Transactions constitute a complete and accurate disclosure of all of the information relevant to the ruling request, we rule as follows, in reliance on the above information, in respect of the Proposed Transactions that will occur up to XXXXXXXXXX:

A.    Provided that New LP has a legal obligation to pay interest on the New LP Promise to Pay and that the Preferred Shares continue to be held by New LP for the purpose of gaining or producing income, in computing its income for a taxation year, New LP will be entitled to deduct, pursuant to paragraph 20(1)(c), the lesser of (i) the interest on the New LP Promise to Pay, as described in paragraph 28 above, paid in the year or payable in respect of the year (depending on the method regularly followed by New LP in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

B.    The dividends received by New LP in respect of the Preferred Shares in a particular year will be taxable dividends, and pursuant to subsection 112(1), an amount equal to the gross amount of those dividends will be deductible in computing the taxable income of the LP Partners for the year in which the dividends are received and allocated by New LP to the LP Partners in accordance with subsection 96(1). For greater certainty, such deductions will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4).

C.    Neither Part IV.1 nor Part VI.1 of the Act will apply to the dividends received by New LP on the Preferred Shares, as described in paragraphs 30, 33(ii) and 34(ii) above, because the dividends will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1), respectively.

D.    No amount will be included in the income of Newco1 pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital made by Canco1 as described in paragraphs 29, 33(i) and 34(i) above.

E.    Subsections 15(1), 56(2) and 246(1) will not apply as a result of the Proposed Transactions in and by themselves.

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

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R6 dated August 29, 2014, and are binding on the CRA provided that the Proposed Transactions, other than the transactions described in paragraphs 29 to 35 above, are completed by XXXXXXXXXX.

The above rulings are based on the Act as it exists on the date of this letter and they do not take into account any proposed amendments to the Act. Any such proposed amendments could, if enacted, have a material effect on the rulings provided herein.

Opinion

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions, additional information and purposes of the proposed transactions, provided that the Proposed Transactions are undertaken in the manner described above, and provided that the Act is amended in accordance with the Notice of Ways and Means Motion to amend the Income Tax Act and other tax legislation tabled on April 21, 2015, it is our opinion that neither subsection 55(2) nor subsection 112(2.3) will apply in respect of the dividends described in Ruling B above.

However, for greater certainty, we do not express any opinion as to whether subsection 112(2.3) would apply if the alternative proposal in respect of so-called “synthetic equity arrangements”, as outlined on page 463 of the Supplementary Information in Annex 5 of the 2015 Budget Plan, is enacted.

The foregoing opinions are not rulings and, as noted in paragraph 19(f) of Information Circular 70-6R6, are not binding on the CRA.

Comments

Nothing in this ruling letter 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)   the reasonableness or fair market value of any fees or expenditures referred to herein;

(c)   the amount of any non-capital loss, net capital loss or of any similar tax attribute of any corporation referred to herein, nor the availability of any such tax attributes arising before the XXXXXXXXXX acquisition of control referred to herein;

(d)   the provincial allocations of income in respect of the Proposed Transactions;

(e)   any tax consequences relating to the compensation paid by Canco2 and Canco4 to Canco1 for the use of its tax attributes;

(f)   the reasonableness of the allocations, in respect of dividends received by New LP on the Preferred Shares, of income under subsection 96(1) and of deductions under subsection 112(1) by New LP to the LP Partners;

(g)   any transactions contemplated herein that occur after XXXXXXXXXX; or

(h)   any other tax consequences relating to the Facts, Proposed Transactions and Additional Information described herein, other than those specifically described in the rulings given above.

An invoice for our fees in connection with this ruling will be sent to you under separate cover.

Yours truly,

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

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