2016-0664041R3 Participating debt interest - contingent payment

Principal Issues: Whether an additional payment that is contingent on the price of a commodity would taint the periodic interest payment on an obligation if an additional payment is never paid or becomes payable on that obligation, i.e., would the periodic interest be considered "participating debt interest."

Position: No.

Reasons: The definition of a "participating debt interest" refers to interest "that is paid or payable on an obligation, all or any portion of which …". Since a contingent amount would not be considered "payable," until an additional payment is paid or becomes payable, the periodic interest would not be considered participating debt interest. However, once an additional payment is paid or becomes payable, the periodic interest on such obligation would be considered participating debt interest from that point of time onwards.

Author: XXXXXXXXXX
Section: 212(1)(b)(ii); 212(3)

XXXXXXXXXX                                                                                                      2016-066404

XXXXXXXXXX, 2016

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling Request
         XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayer (the “Taxpayer”).  We also acknowledge the information provided in various emails and telephone conversations.

To the best of your knowledge and that of the Taxpayer, none of the issues involved in the ruling request is:

i.    in a previously filed tax return of any of the Taxpayer or a related person;

ii.   being considered by a tax services office or a tax centre in connection with a previously filed tax return of any of the Taxpayer or a related person;

iii.  under objection by the Taxpayer or a related person;

iv.   the subject of a current or completed court process involving the Taxpayer or a related person; or

v.    the subject of a ruling request previously considered by the Directorate.

Unless specified otherwise, all statutory references herein are to provisions or parts of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c. 1, as amended to the date hereof (the “Act”) and all references to monetary amounts are in Canadian dollars unless otherwise specified.

DEFINITIONS:

“Additional Payment” has the meaning described in Paragraph 13(d);

“Additional Payment Period” means each XXXXXXXXXX month period ending on XXXXXXXXXX (or such other period as the Lender and Taxpayer may agree to) while the Loan is outstanding, except that (i) the initial Additional Payment Period shall be the period commencing on the date the Loan is made and ending on XXXXXXXXXX of the following calendar year, and (ii) the final Additional Payment Period shall be the period commencing immediately after the end of the preceding Additional Payment Period and ending on the Maturity Date;

“Additional Payment Reference Price” has the meaning described in Paragraph 13(d);

“Additional Payment Trigger Date” means the date, if any, on which the obligation by Taxpayer under the Loan Agreement to make an Additional Payment first arises; for greater certainty, the obligation to make an Additional Payment in respect of any Additional Payment Period is only considered to arise at such time, if any, as the Additional Payment Reference Price for such Additional Payment Period exceeds the Trigger Price;

“Annual Reference Price” means the arithmetic mean for the Reference Price for the preceding XXXXXXXXXX-month period;

“Applicable Rate” has the meaning described in Paragraph 13(d);

XXXXXXXXXX;

“Canada-Country A Treaty” means the XXXXXXXXXX, as amended to the date hereof;

“Commodity” means XXXXXXXXXX;

“controlled foreign affiliate” has the meaning assigned by subsection 95(1) of the Act;

“Country A” means XXXXXXXXXX;

“CRA” means the Canada Revenue Agency;

“Exchange” means the XXXXXXXXXX;

“Interest Period” means each XXXXXXXXXX-month period ending on XXXXXXXXXX (or such other period as the Lender and Taxpayer may agree to) while the Loan is outstanding, except that (i) the initial Interest Period shall be the period commencing on the date the Loan is made and ending on XXXXXXXXXX of the following calendar year, and (ii) the final Interest Period shall be the period commencing immediately after the end of the preceding Interest Period and ending on the Maturity Date;

“Lender” means XXXXXXXXXX;

“Loan” means a loan in the principal amount of XXXXXXXXXX anticipated to be advanced by the Lender to Taxpayer pursuant to and in accordance with the Loan Agreement;

“Loan Agreement” means a loan agreement between Taxpayer, as borrower, and the Lender, as lender, providing for the Loan;

“Maturity Date” means XXXXXXXXXX, or such earlier date as the Loan is repaid in full;

“Parent” means XXXXXXXXXX, a corporation organized under the laws of XXXXXXXXXX;

“Periodic Interest” has the meaning described in Paragraph 13(c);

“Project” means the development project relating to the Commodity carried on by Subco XXXXXXXXXX;

“Quoted Rate” means the XXXXXXXXXX;

“Reference Price” means the XXXXXXXXXX, quoted on the Exchange for the Commodity;

“Shareholder Loan” means a loan in the amount of XXXXXXXXXX anticipated to be advanced by Taxpayer to Subco;

“Subco” means XXXXXXXXXX, a company incorporated and resident in Country A and a controlled foreign affiliate of Taxpayer, together with its predecessors;

“Taxpayer” means XXXXXXXXXX, a corporation established under the laws of Canada, together with its predecessors;

“Trigger Price” means XXXXXXXXXX;

XXXXXXXXXX; and

XXXXXXXXXX

FACTS:

1. Taxpayer is a taxable Canadian corporation incorporated under the laws of Canada.  It has a fiscal period and taxation year ending XXXXXXXXXX. Taxpayer is served by the XXXXXXXXXX Tax Services Office and files its tax returns with the XXXXXXXXXX Tax Centre. Its mailing address is XXXXXXXXXX.

2. Taxpayer is indirectly wholly-owned by Parent.  Parent is the XXXXXXXXXX. Parent’s headquarters are located in XXXXXXXXXX.

3.    Taxpayer is the XXXXXXXXXX.

4.    Taxpayer also operates XXXXXXXXXX.

5.    Taxpayer will be the borrower under the Loan Agreement and, as such, will be obligated to make certain payments to the Lender as described below under the heading “Proposed Transactions”.

6.    The Lender is a non-resident of Canada for purposes of the Act and is a resident of Country A for the purposes of the Canada–Country A Treaty.

7.    The Lender is not related (within the meaning of subsection 251(2)) to Taxpayer and deals at arm's length with Taxpayer for purposes of the Act.

8.    The Lender will be the lender under the Loan Agreement and, as such, will be entitled to receive certain payments as described below under the heading “Proposed Transactions”.

9.    Subco is XXXXXXXXXX under the laws of Country A. XXXXXXXXXX.

10.   XXXXXXXXXX.

11.   Subco carries on the Project XXXXXXXXXX.

PROPOSED TRANSACTIONS

12.   Taxpayer proposes to enter into the Loan Agreement with the Lender, pursuant to which the Lender will advance the Loan to Taxpayer. The purpose of the Loan is to permit Taxpayer to make a loan to Subco, in order to permit Subco to fund ongoing operations relating to the Project.

13.   The Loan Agreement will have the following notable terms and conditions:

(a)   The principal amount of the Loan will be XXXXXXXXXX.

(b)   All payments under the Loan will be required to be made XXXXXXXXXX.

(c)   Interest for each Interest Period will be payable at a rate per annum equal to the applicable Quoted Rate plus XXXXXXXXXX basis points (“Periodic Interest”). The applicable Quoted Rate for a particular Interest Period will be the Quoted Rate on the business day preceding the commencement of such Interest Period for deposits XXXXXXXXXX for a period corresponding to the particular Interest Period. Periodic Interest accruing in an Interest Period will be payable on the last business day of such Interest Period.

(d)   In addition to Periodic Interest, the Lender will be entitled to receive an additional payment (“Additional Payment”) in respect of an Additional Payment Period if the Additional Payment Reference Price for such Additional Payment Period exceeds the Trigger Price. The Additional Payment, if any, for an Additional Payment Period will be equal to the Applicable Rate for such Additional Payment Period multiplied by the outstanding principal amount of the Loan at the start of such Additional Payment Period. Any Additional Payment for an Additional Payment Period must be paid within XXXXXXXXXX calendar days following such Additional Payment Period.

For the purposes of the above:

(i)   The “Additional Payment Reference Price” for an Additional Payment Period will be equal to the Annual Reference Price determined as of the last day of the month of XXXXXXXXXX in such Additional Payment Period; and

(ii)  The “Applicable Rate” for an Additional Payment Period will be determined as follows: (A) if the Additional Payment Reference Price for such Additional Payment Period exceeds the Trigger Price, the Applicable Rate is XXXXXXXXXX%; and (B) for each XXXXXXXXXX increase in the Additional Payment Reference Price over the Trigger Price, the Applicable Rate will be increased by a further XXXXXXXXXX%.

(e)   The term of the Loan will be until the Maturity Date.

(f)   Subject to mandatory prepayment as described in Paragraph 13(g) below and voluntary prepayment as described in Paragraph 13(h) below, Taxpayer will be required to repay the principal amount of the Loan as follows:

(i)   On the last business day of XXXXXXXXXX in each calendar year from XXXXXXXXXX to and including XXXXXXXXXX, an amount of XXXXXXXXXX; and

(ii)  On each of XXXXXXXXXX and XXXXXXXXXX, an amount of XXXXXXXXXX.

(g)   The Lender may require Taxpayer to prepay the Loan as follows:

(i)   Effective on XXXXXXXXXX, if the Annual Reference Price as of XXXXXXXXXX exceeds XXXXXXXXXX; or

(ii)  Within XXXXXXXXXX months of the applicable determination date if, at any time after XXXXXXXXXX, the Annual Reference Price (calculated at each month end) exceeds XXXXXXXXXX.

(h)   Taxpayer may, at its option, voluntarily prepay the Loan in whole or in part at any time without penalty.

(i)   Taxpayer and certain of its subsidiaries will grant to the Lender, as security for the Loan, a first priority security interest over Taxpayer’s XXXXXXXXXX.

(j)   Taxpayer’s obligations to the Lender under the Loan Agreement will be guaranteed by Parent.

(k)   Taxpayer will be required to “gross up” the Lender for any Canadian withholding tax applicable to the Periodic Interest or Additional Payment.

14.   Following the advance of the Loan by the Lender to Taxpayer, Taxpayer will advance the Shareholder Loan to Subco XXXXXXXXXX. The Shareholder Loan will be advanced XXXXXXXXXX, and is otherwise anticipated to be made on similar general terms and conditions as the Loan. Subco will use the proceeds of the Shareholder Loan to fund Subco’s working capital requirements with respect to the Project.

15.   During the term of the Loan, Taxpayer will make annual payments of Periodic Interest (and, if applicable, pay Additional Payments, if any) in accordance with the terms of the Loan Agreement.

16.   The interest rate for the Periodic Interest was negotiated at arm’s length between Taxpayer and the Lender and reflects a commercial rate of interest.

17.   XXXXXXXXXX.

18.   XXXXXXXXXX.

ADDITIONAL INFORMATION

19.   Taxpayer originally proposed that the Loan be made directly to Subco. However, due to XXXXXXXXXX, the Lender was not prepared to make the Loan directly to Subco.  Moreover, because Taxpayer has a stronger balance sheet than Subco, the Lender’s preference was to look to Taxpayer’s stronger credit. Similarly, the Lender required security for the Loan above and beyond Subco’s interest in the Project, which additional security Taxpayer was in the best position to provide. Accordingly, Taxpayer and the Lender agreed on a “back-to-back” loan arrangement whereby the Lender would make the Loan directly to Taxpayer in order to permit Taxpayer to make the Shareholder Loan to Subco. In connection with the foregoing, it should be noted that the Shareholder Loan would bear interest at a rate in excess of the rate of interest on the Loan, resulting in net interest income to Taxpayer.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Loan and the Shareholder Loan is to finance Subco’s working capital requirements with respect to the Project. The Loan terms are intended to ensure that the Loan complies with laws and regulations applicable to the Lender.

RULING PROVIDED

Provided that

(a)   the preceding statements constitute a complete and accurate disclosure of all of the relevant Facts, Proposed Transactions, Additional Information, and the Purpose of the Proposed Transactions,

(b)   the Proposed Transactions are completed in the manner described above, and

(c)   there are no other transactions which may be relevant to the rulings requested,

we rule that:

A. Subparagraph 212(1)(b)(ii) of the Act will not apply to any payment of Periodic Interest by Taxpayer to Lender provided that (i) Taxpayer deals at arm’s length with the Lender at the time of such payment and (ii) no Additional Payment has been or become payable by Taxpayer at or before that time as a result of an Additional Payment Trigger Date having occurred at or before that time. For greater certainty, once an Additional Payment Trigger Date has occurred such that an Additional Payment is paid or becomes payable on the Loan, all subsequent payments of Periodic Interest will be subject to Part XIII withholding tax.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R7 dated April 22, 2016, and are binding on the CRA provided that the Plan is implemented on or before XXXXXXXXXX.

The above rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

COMMENTS

Nothing in this 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 ACB 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 any other amount of any corporation referred to herein; and

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

Yours sincerely,

XXXXXXXXXX
for Director
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate

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