2008 Ruling 2008-0289761R3 - Loss consolidation

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Standard loss consolidation ruling without significant provincial allocation issues.

XXXXXXXXXX 						2008-028976

XXXXXXXXXX , 2008

Dear Sir:

Subject: XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge receipt of your emails.

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

(a) in an earlier return of the above-referenced taxpayers or a related person;
(b) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the above-referenced taxpayers or a related person;
(c) under objection by the above-referenced taxpayers or a related person;
(d) before the courts; or
(e) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

The above-referenced taxpayers have confirmed that the Proposed Transactions will not affect their ability to pay any of their outstanding tax liabilities.

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.

DEFINITIONS

In this letter, the following terms or expressions have the meanings specified:

"A Co" means XXXXXXXXXX . A Co was incorporated under the XXXXXXXXXX . The authorized capital of A Co includes XXXXXXXXXX , redeemable preference shares and class B, C and D preference shares. Redeemable preference shares and Class B, C and D preference shares can be issued in one or more series. The preference shares that are issued and outstanding are XXXXXXXXXX , class B preference series A, Class B preference series C, Class B preference series D, Class C preference series A, and Class C preference series B. Currently, XXXXXXXXXX are held by XXXXXXXXXX The preference shares are held by XXXXXXXXXX , some of which do not hold XXXXXXXXXX ;

"affiliated persons" has the meaning assigned by section 251.1;

"agreed amount" means the amount determined pursuant to paragraph 85(1)(a), which, for greater certainty, is adjusted in accordance with paragraphs 85(1)(b) to 85(1)(e.4) inclusive;

"arm's length" has the meaning assigned by subsection 251(1);

"B Co" means XXXXXXXXXX ;

"BCO Subsidiaries" means C Co, XXXXXXXXXX , the wholly owned subsidiaries of those corporations and an investment entity called XXXXXXXXXX ;

"C Co" means XXXXXXXXXX . C Co's primary business is XXXXXXXXXX . The authorized capital of C Co includes both common shares and preferred shares that can be issued in one or more series. The common shares are the only shares with voting rights. Currently issued and outstanding shares are common shares, class A preference series A, class A preference series B, class B preference, class D preferences series A, class D preference series B, class D preference series C, class E preference series A, class F preference series A and class G preference series A;

"CRA" means Canada Revenue Agency;

"dividend rental arrangement" has the meaning assigned by subsection 248(1);

"E Co" means a corporation to be incorporated under the First Act;

"excepted dividend" has the meaning assigned in section 187.1;

"excluded dividend" has the meaning assigned in subsection 191(1);

"financial intermediary corporation" has the meaning assigned by subsection 191(1);

"First Act" means the Canada Business Corporations Act;

"guarantee agreement" has the meaning assigned by subsection 112(2.2);

"insurance corporation" has the meaning assigned by subsection 248(1);

"Loan 1" means a $XXXXXXXXXX loan to B Co from an arm's-length financial institution;

"Loan 2" means a loan of $XXXXXXXXXX made by B Co to E Co, which will bear interest at an annual rate based on market conditions at the time the loan is granted and which will be considered by B Co to be a reasonable commercial rate in these circumstances (at XXXXXXXXXX , such rate would have been equal to XXXXXXXXXX %). Interest on Loan 2 will be payable at the earlier of XXXXXXXXXX of every year or the moment when Loan 2 is repaid;

"Loan 3" means a $XXXXXXXXXX demand, interest-free loan made by Newco to B Co;

"Loan 4" means a $XXXXXXXXXX loan to B Co from an arm's-length financial institution which is made after Loan 1;

"non-capital loss" has the meaning assigned by subsection 111(8);

"Newco" is a corporation to be incorporated under the First Act;

"Newco Preferred Shares" means the preferred shares issued by Newco. Each Newco Preferred Share will be non-voting, redeemable and retractable for the amount for which it is issued. Dividends on the Newco Preferred Shares will accrue on a daily basis and will be payable on the earliest of XXXXXXXXXX and the time at which any Newco Preferred Shares are repurchased for cancellation. The dividend rate on Newco Preferred Shares will be XXXXXXXXXX % over the interest rate on Loan 2 ;

"Paragraph" means a numbered paragraph of this letter;

"Proposed Transactions" means the transactions described in Paragraphs 5 to 14;

"public corporation" has the meaning assigned by subsection 89(1);

"related" has the meaning assigned by section 251;

"specified financial institution" has the meaning assigned by subsection 248(1);

"taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

"PUC" means "paid-up capital" and has the meaning assigned by subsection 89(1).

STATEMENT OF FACTS:

1. A Co is a taxable Canadian corporation. The taxation years of A Co end on XXXXXXXXXX .

2. A Co owns all the issued and outstanding common shares, Class A special and preference shares of B Co. B Co is a taxable Canadian corporation, continued under the First Act. B Co is not a "financial institution" as defined in subsection 142.2(1). B Co assets in Canada include the shares of the B Co Subsidiaries.

The taxation year of B Co ends on XXXXXXXXXX .

3. B Co owns all the issued and outstanding common shares of C Co. The Class A preference shares of C Co are traded on the XXXXXXXXXX and the other classes of preference shares are held by employees, XXXXXXXXXX and former policyholders. C Co is a taxable Canadian corporation and it is the parent of several direct and indirect subsidiaries.

The taxation year of C Co ends on XXXXXXXXXX .

4. C Co's taxable income was equal to $XXXXXXXXXX in fiscal XXXXXXXXXX

As at the end of the XXXXXXXXXX taxation year of B Co, the balance of B Co's non-capital losses carried forward amounted to $XXXXXXXXXX , incurred as follows:

XXXXXXXXXX

B Co estimates that its non-capital losses for its XXXXXXXXXX taxation year will be $XXXXXXXXXX and that they will be in the magnitude of $XXXXXXXXXX in each of its XXXXXXXXXX to XXXXXXXXXX taxation years.

PROPOSED TRANSACTIONS

The Proposed Transactions will occur in the following order:

5. B Co will incorporate Newco and subscribe for and acquire common shares of Newco for $XXXXXXXXXX . Newco will be a taxable Canadian corporation and will not be a financial intermediary corporation. The taxation year of Newco will end on XXXXXXXXXX . Newco will not carry on any business and its activities will be limited to making Loan 3 with the proceeds received upon the issuance of the Newco Preferred Shares.

The authorized capital of Newco will consist of two classes of shares: common shares and Newco Preferred shares.

6. B Co will incorporate E Co and subscribe for and acquire common shares of E Co for $XXXXXXXXXX . E Co will be a taxable Canadian corporation and will not be a financial intermediary corporation. The taxation year of E Co will be XXXXXXXXXX . E Co will not carry on any business and its activities will be limited to investing the Loan 2 proceeds in the Newco Preferred Shares. The authorized capital of E Co will consist of common shares.

7. B Co will borrow under Loan 1. The total amount of Loan 1 represents an amount that B Co could reasonably borrow from an arm's length financial institution. Bco can be leveraged to a maximum of XXXXXXXXXX % of its net equity position, on a consolidated basis and it can borrow Loan 1 and still meet the financial tests required under its debt covenants.

8. B Co will use the total proceeds received from Loan 1 to make Loan 2.

9. E Co will use the total proceeds received from Loan 2 to subscribe for Newco Preferred Shares having an aggregate redemption/retraction price equal to the total subscription proceeds. Dividends will be paid on the Newco Preferred Shares on the earlier of XXXXXXXXXX and the moment when all the Newco Preferred Shares are repurchased and cancelled.

10. Newco will use the total proceeds received from the Newco Preferred Share subscriptions to make Loan 3.

11. B Co will use the total proceeds received from Loan 3 to repay Loan 1.

12. While Loan 2 is outstanding, the following will occur when jointly determined by B Co, Newco and E Co:

(a) B Co will make a contribution of capital to Newco in an amount equal to the dividend payable by Newco on the Newco Preferred Shares held by E Co at that time. No share will be issued by Newco with respect to the contribution of capital and no amount will be added to the stated capital of Newco. The amount of the contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be income of Newco pursuant to generally accepted accounting principles.

(b) Newco will pay a dividend to E Co equal to the amount (subject to the applicable solvency test) of the dividend payable at that time by Newco on its Newco Preferred Shares.

(c) E Co will pay to B Co the interest due pursuant to the terms of Loan 2.

(d) B Co will borrow Loan 4 and will use the proceeds of that loan to repay Loan 3 to Newco. The total amount of Loan 4 represents an amount that B Co could reasonably borrow from an arm's length financial institution. Bco can be leveraged to a maximum of XXXXXXXXXX % of its net equity position, on a consolidated basis and it can borrow Loan 4 and still meet the financial tests required under its debt covenants;

(e) Newco will use the proceeds of repayment of Loan 3 to redeem the Newco Preferred Shares held by E Co;

(f) E Co will use the proceeds from the redemption of the Newco Preferred Shares to repay Loan 2;

(g) B Co will use the amount received on the repayment of Loan 2 to repay Loan 4.

13. B Co and C Co will enter into an agreement whereby B Co will sell its common shares in E Co to C Co in consideration for common shares having a fair market value equal to the fair market value of the E Co common shares.

B Co will jointly elect with C Co, in prescribed form and within the time allowed by subsection 85(6), to have the rules of subsection 85(1) apply to the transfer of the E Co shares to C Co. The agreed amount in respect of the E Co shares transferred will be the lesser of the FMV of the E Co shares transferred and their cost amount to B Co at that time.

C Co will add to its stated capital account maintained for its common shares the agreed amount pursuant to subsection 85(1).

14. In the taxation year in which C Co obtains the shares of E Co, C Co as sole shareholder of E Co, will pass a resolution authorizing and requiring E Co to be wound-up into C Co. As a consequence, E Co's assets will be transferred to C Co and C Co will assume E Co's liabilities.

B Co as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound-up into B Co and Newco will be wound-up simultaneously with E Co.

OTHER REPRESENTATIONS

15. It is anticipated that the steps described in the Proposed Transactions will be undertaken at the beginning of each of the XXXXXXXXXX to XXXXXXXXXX taxation years of B Co with new entities to be created having the same attributes as E Co and Newco. It is currently estimated that the aggregate amount of B Co's loans and preferred share subscriptions to a new entity for those years will be $XXXXXXXXXX .

16. B Co, C Co, Newco and E Co are related to a particular corporation described in paragraph (d) of the definition specified financial institution.

17. There will not be at any time prior to the completion of the Proposed Transactions, any agreements or undertakings that constitute or include a guarantee agreement in respect of any of the issued shares referred to herein (including the shares to be issued as described in the Proposed Transactions).

18. The Newco Preferred Shares will not, at any time during the implementation of the Proposed Transactions described herein, be:

(a) the subject of a dividend rental agreement;

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

(c) issued for consideration that is or 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).

PURPOSE OF THE PROPOSED TRANSACTIONS

In taxation year XXXXXXXXXX , B Co acquired a majority controlling interest in XXXXXXXXXX . The acquisition was funded in part by its outstanding debt issuance. As a result, the interest on the B Co debt is financed partially with dividends from the subsidiaries. Without giving effect to the Proposed Transactions, it is expected that B Co will generate non-capital losses caused principally by the interest expense on B Co's debt.

The purpose of the Proposed Transactions is to effect a tax consolidation of B Co and C CO by causing B CO to earn interest income on Loan 2, thus permitting C Co to utilize E Co's non-capital losses in C Co's taxation year commencing after the Proposed Transactions.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, Proposed Transactions, additional information and purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above:

A. Provided that B Co holds the common shares of E Co as capital property immediately before the transfer described in Paragraph 13, and provided that B Co and C Co jointly file an election pursuant to subsection 85(1) in the prescribed form and manner and within the time specified in subsection 85(6) and subject to the application of subsection 69(11), the provisions of subsection 85(1), other than paragraph 85(1)(e.2), will apply to the transfer of the common shares of E Co by B Co to C Co such that the agreed amount in respect of the transfer of the common shares of E Co will be deemed to be B Co's proceeds of disposition and C Co's cost of the common shares of E Co pursuant to paragraph 85(1)(a).

B. The provisions of subsection 88(1) will apply to the winding-up of E Co into C Co as described in Paragraph 14, such that, provided that the requirements of paragraphs 88(1.1)(a) and (b) are satisfied, subsection 88(1.1) will apply to the wind-up of E Co into C Co described in Paragraph 14 such that, for the purposes of computing C Co's taxable income under Part I or tax payable under Part IV for any taxation year commencing after the commencement of the winding-up, any remaining portion of the non-capital loss incurred by E Co will be deemed, for C Co's taxation year in which E Co's particular loss year ended, to be a non-capital loss of C Co derived from the source from which E Co derived the loss and that was not deductible by C Co in computing its taxable income for any taxation year that commenced before the commencement of the winding-up, subject to the limitations in Paragraph 88(1.1)(e) and section 111. For greater certainty, for the purposes of subsection 88(1.1) E Co will not be considered to have been wound-up until it has been formally dissolved.

C. Provided that E Co has a legal obligation to pay interest on Loan 2 and the Newco Preferred Shares continue to be held by E Co, E Co will be entitled, pursuant to paragraph 20(1)(c), to deduct the lesser of the interest paid or payable (depending on the method regularly followed by E Co in computing its income for the purposes of the Act) in respect of that taxation year or a reasonable amount in respect thereof.

D. No amount will be included in the income of Newco pursuant to section 9, paragraphs 12(1) (c) or 12(1) (x) in respect of the contributions of capital made by B Co as described in Paragraph 12(a).

E. The dividends received (or deemed to be received) by E Co on its Newco Preferred Shares as described in Paragraphs 12(b) and 12(e) will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of E Co for the taxation year in which the dividends are received (or deemed to be received), and for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), or 112(2.4).

F. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11) and 246(1) will not apply as a result of the Proposed Transactions in and by themselves.

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

These rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R5 issued on May 17, 2002, and are binding on the CRA provided that the Proposed Transactions are completed not later than XXXXXXXXXX . The above rulings are based on the Act in its present form 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 or reviewed:

(a) the amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein;

(b) the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

(c) the application or non-application of the general anti-avoidance provisions of any province;

(d) any tax consequences relating to the facts, Proposed Transactions and other representations described herein, other than those specifically described in the rulings given; or

(e) the characterization as capital or inventory of the assets owned by one of the entities listed herein.

Yours truly,

XXXXXXXXXX
Manager
Corporate Reorganizations Section I
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch