2010 Ruling 2010-0389321R3 - Loss Consolidations

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: Is the loss utilization arrangement acceptable?

Position: YES

Reasons: Meets the established position

XXXXXXXXXX
									2010-038932
									XXXXXXXXXX 

XXXXXXXXXX , 2011

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX ("Aco")
XXXXXXXXXX ("Dco")

This is in reply to your letter of XXXXXXXXXX , and further to information submitted on XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-named taxpayers. We also acknowledge e-mails and telephone conversations (XXXXXXXXXX ) on the subject. In general terms, the Proposed Transactions involve the use of losses within a group of affiliated and related corporations.

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

(i) dealt with in an earlier return of Aco, Dco, or a related person;

(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by Aco, Dco, or a related person;

(iii) under objection by Aco, Dco, or a related person;

(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to Aco, Dco, or a related person; nor

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

DEFINITIONS

(a) "Aco" means XXXXXXXXXX , the corporation described in 1 below;

(b) "Aco Note" means the demand non-interest-bearing promissory note described in 19 below;

(c) "Aco Note2" means the demand non-interest-bearing promissory note described in 31 below;

(d) "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;

(e) "adjusted cost base" has the meaning assigned by section 54;

(f) "affiliated person" has the meaning assigned by section 251.1;

(g) "Bco" means XXXXXXXXXX , the corporation described in 2 below;

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

(i) "Cco" means XXXXXXXXXX , the corporation described in 3 below;

(j) "Daylight Loan 1" has the meaning specified in 16 below;

(k) "Daylight Loan 2" has the meaning specified in 28 below;

(l) "Dco" means XXXXXXXXXX , the corporation described in 4 below;

(m) "Dco Note" means the debenture described in 18 below;

(n) "General Anti-avoidance Provision of an Agreeing Province" means:
XXXXXXXXXX

(o) "Lossco" means XXXXXXXXXX , the corporation described in 7 below;

(p) "Lossco Common Shares" means the common shares described in 7 below;

(q) "Lossco Note" means the promissory note described in 29 below;

(r) "Newco1" means XXXXXXXXXX , the corporation described in 5 below;

(s) "Newco1 Common Shares" means the common shares described in 5 below;

(t) "Newco1 Preferred Shares" means the preferred shares described in 15 below;

(u) "Newco2" means XXXXXXXXXX , the corporation described in 6 below;

(v) "Newco2 Common Shares" means the common shares described in 6 below;

(w) "Newco2 Preferred Shares" means the preferred shares described in 26 and 27 below;

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

(y) "paid-up capital" has the meaning assigned by subsection 89(1);

(z) "Parentco" means XXXXXXXXXX , a taxable Canadian corporation and a public corporation, the common shares of which are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX ";

(aa) "Proposed Transactions" means the transactions described in 15 to 40 below;

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

(cc) XXXXXXXXXX ;

(dd) "refundable dividend tax on hand" has the meaning assigned by subsection 129(3);

(ee) "related persons" has the meaning assigned by subsection 251(2);

(ff) "SFI" means a specified financial institution, as defined in subsection 248(1);

(gg) "subject corporation" has the meaning assigned by subsection 186(3);

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

(ii) XXXXXXXXXX .

Facts:

1. Aco is a taxable Canadian corporation and a public corporation. Parentco holds approximately XXXXXXXXXX % of the common shares in Aco and approximately XXXXXXXXXX % of the votes attached to all issued and outstanding shares in the capital of Aco. Aco has a taxation year end of XXXXXXXXXX . The common shares of Aco are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX ". Aco is a XXXXXXXXXX . Aco is serviced by the XXXXXXXXXX Tax Services Office and files its return at the XXXXXXXXXX Taxation Centre.

2. Bco is a taxable Canadian corporation and a public corporation which is controlled by Aco who owns directly or indirectly approximately XXXXXXXXXX % of the issued and outstanding common shares of Bco. The remaining shares are widely held by members of the public. Bco has a taxation year end of XXXXXXXXXX . The common shares of Bco are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX ". Bco is XXXXXXXXXX .

3. Cco is a taxable Canadian corporation and is a wholly-owned subsidiary of Bco. Cco has a taxation year end of XXXXXXXXXX . Cco is a XXXXXXXXXX .

4. Dco is a taxable Canadian corporation and is a wholly-owned subsidiary of Cco. Dco has a taxation year end of XXXXXXXXXX . Dco's principal business activity is XXXXXXXXXX Dco is serviced by the XXXXXXXXXX Tax Services Office and files its tax return with the XXXXXXXXXX Taxation Centre.

5. Newco1 is a corporation existing under the laws of the CBCA. Newco1 is a taxable Canadian corporation. The share capital of Newco1 consists of an unlimited number of common shares (the "Newco1 Common Shares"), all of which are owned by Aco. Newco1 has been an inactive corporation since its incorporation and it has nominal assets. Newco1 will not carry on any business and its activities will be limited to acquiring the Aco Note.

6. Newco2 is a corporation existing under the laws of the CBCA. Newco2 is a taxable Canadian corporation. The share capital of Newco2 consists of an unlimited number of common shares (the "Newco2 Common Shares"), all of which are owned by Aco. Newco2 has been an inactive corporation since its incorporation and it has nominal assets. Newco2 will not carry on any business and its activities will be limited to acquiring the Aco Note2.

7. Lossco is a corporation existing under the CBCA. Lossco is a taxable Canadian corporation. The share capital of Lossco consists of an unlimited number of common shares (the "Lossco Common Shares") all of which are owned by Aco. Lossco has been an inactive corporation since its incorporation and it has nominal assets. Lossco will not carry on any business and its activities will be limited to investing the proceeds received from the Lossco Note in the Newco2 Preferred Shares.

8. Aco is estimated to have unexpired non-capital loss carryforwards of approximately $XXXXXXXXXX as of the end of its taxation year ended on XXXXXXXXXX .

9. It is anticipated that Aco will incur additional non-capital losses of approximately $XXXXXXXXXX annually for the next XXXXXXXXXX taxation years.

10. The borrowing capacity of Aco and its subsidiaries significantly exceeds the maximum amount of $XXXXXXXXXX required to complete the Proposed Transactions described in 15 to 40 below. As of XXXXXXXXXX , Aco had a net equity value of over $XXXXXXXXXX and its market capitalization exceeded $XXXXXXXXXX.

11. Dco has generated taxable income in each of its last three taxation years and it is anticipated that it will continue to do so in the next three taxation years.

12. The borrowing capacity of Bco significantly exceeds the amount of $XXXXXXXXXX required to complete the Proposed Transactions described in 15 to 25 below.

13. Aco operates through permanent establishments in the Provinces of XXXXXXXXXX and XXXXXXXXXX . Aco has an allocation factor of approximately XXXXXXXXXX % to the Province of XXXXXXXXXX and of approximately XXXXXXXXXX % to the Province of XXXXXXXXXX , based on the interprovincial allocation for Aco's XXXXXXXXXX taxation year.

14. Dco operates through permanent establishments in XXXXXXXXXX . Dco has, based on the interprovincial allocation for Dco's XXXXXXXXXX taxation year, approximately the following allocation factor:

XXXXXXXXXX

Proposed Transactions:

Structure #1

15. Newco1's share capital will be amended to include an unlimited number of preferred shares ("Newco1 Preferred Shares").

The Newco1 Preferred Shares will have the following attributes:

a) non-voting;
b) non-participating;
c) redeemable at the option of the issuer and retractable at the option of the holder, subject to applicable law, at any time for an amount equal to the cash amount for which they were issued. The payment of the redemption or retraction price may be satisfied, at the holder's option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of redemption equal to the aggregate redemption amount, or, (iii) the Aco Note, in each case together with an amount in cash equal to all declared and unpaid dividends and any accrued dividends which have not been declared and paid up to but excluding the date fixed for such redemption or retraction; and,
d) entitlement to a cumulative dividend, payable quarterly, calculated daily and accruing by reference to the redemption amount of Newco1 Preferred Shares at a rate equal to XXXXXXXXXX % per annum.

16. Aco will borrow $XXXXXXXXXX on a "daylight loan" basis from an arm's length financial institution or from a related entity ("Daylight Loan1"). Aco has obtained a letter from a third party financial institution that provides support for the credit required to fund the amount of the daylight loan.

17. Aco will use the proceeds from Daylight Loan1 to subscribe for Newco1 Preferred Shares for a total amount of $XXXXXXXXXX . The aggregate redemption amount, fair market value, retraction amount, adjusted cost base and paid-up capital of the Newco1 Preferred Shares issued will be $XXXXXXXXXX .

18. Aco will immediately transfer all the Newco1 Preferred Shares to Dco at a purchase price of $XXXXXXXXXX . As sole consideration for such transfer, Dco will issue a secured debenture (the "Dco Note") to Aco that will have a principal amount equal to the aggregate redemption amount of such Newco1 Preferred Shares. The Dco Note will bear interest that will be payable quarterly at a rate of XXXXXXXXXX % per annum and will be repayable on demand. The Dco Note will also provide that Aco's recourse under the Dco Note will be limited to the Newco1 Preferred Shares (together with all proceeds from such shares) only, and not to any other assets of Dco. As security for the indebtedness evidenced by the Dco Note, Dco will grant Aco a security interest in the Newco1 Preferred Shares. The Dco Note will also provide that the principal amount may be satisfied at Dco's option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the principal amount, (iii) delivery of the Newco1 Preferred Shares or, (iv) by way of set-off against the Aco Note if the Aco Note belongs to Dco at the time of repayment. The amount of dividends received by Dco on the Newco1 Preferred Shares held by Dco will be sufficient to permit Dco to realize a profit on its investment in the Newco1 Preferred Shares, after the deduction of any interest on the Dco Note and its other related expenses.

19. Newco1 will use the proceeds from the issuance of the Newco1 Preferred Shares to make a non-interest-bearing loan of $XXXXXXXXXX to Aco. This loan will be evidenced by a demand non-interest-bearing promissory note (the "Aco Note").

20. Aco will use the proceeds from the Aco Note to repay Daylight Loan 1.

21. The following transactions will occur in immediate sequence when jointly determined by Aco, Dco and Newco1, but no later than XXXXXXXXXX :

a) At least quarterly, pursuant to a capital contribution agreement, Aco will make a contribution of capital to Newco1 in an amount equal to the amount of any accrued and unpaid dividends, if any, on the Newco1 Preferred Shares. No shares will be issued by Newco1 with respect to the contribution of capital and no amount will be added to the stated capital of Newco1. The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be income to Newco1 pursuant to generally accepted accounting principles. Aco will not claim, at any time, a capital loss in respect of its investment in Newco1;
b) Newco1 will pay the accrued and unpaid dividends on the Newco1 Preferred Shares; and
c) Dco will pay the accrued and unpaid interest on the Dco Note.
Structure #1 will be unwound in the following manner no later than XXXXXXXXXX

22. Newco1 will redeem the Newco1 Preferred Shares held by Dco for an amount equal to their aggregate redemption amount.

23. As payment for the redemption of the Newco1 Preferred Shares, Newco1 will deliver the Aco Note to Dco.

24. The Aco Note and the Dco Note will be satisfied and extinguished by way of set-off.

25. Aco, as sole shareholder of Newco1, will pass a resolution authorizing and requiring Newco1 to be wound-up into Aco pursuant to subsection 88(1). As a consequence, Newco1's assets will be transferred to Aco and Aco will assume Newco1's liabilities.

Structure #2

26. The authorized share capital of Newco2 will be amended to include an unlimited number of preferred shares ("Newco2 Preferred Shares").

27. The Newco2 Preferred Shares will have the following attributes:

a) non-voting;

b) non-participating;

c) redeemable at the option of the issuer and retractable at the option of the holder, subject to applicable law, at any time for an amount equal to the cash amount for which they were issued. The payment of the redemption or retraction price may be satisfied, at the holder's option, either by (i) payment of cash, or (ii) delivery of property (including the Aco Note2) having a fair market value at the time of redemption equal to the aggregate redemption amount, in each case together with an amount in cash equal to all declared and unpaid dividends and any accrued dividends which have not been declared and paid up to but excluding the date fixed for such redemption or retraction; and

d) entitlement to annual cumulative dividends, calculated daily and accruing by reference to the redemption amount of Newco2 Preferred Shares at a rate equal to XXXXXXXXXX % per annum.

28. Aco will borrow $XXXXXXXXXX on a "daylight loan" basis from an arm's length financial institution or from a related entity ("Daylight Loan2"). Aco has obtained a letter from a third party financial institution confirming the amount of the daylight loan.

29. Aco will use the proceeds of Daylight Loan2 to make a $XXXXXXXXXX loan bearing interest at the rate of XXXXXXXXXX % per annum to Lossco, and the indebtedness arising by virtue of such loan shall be evidenced by a promissory note (the "Lossco Note"). The Lossco Note will be payable on demand.

30. Lossco will use the proceeds from the Lossco Note to subscribe for Newco2 Preferred Shares for a total amount of $XXXXXXXXXX . The aggregate redemption amount, fair market value, retraction amount, adjusted cost base and paid-up capital of the Newco2 Preferred Shares issued will be $XXXXXXXXXX . The amount of dividends received by Lossco on the Newco2 Preferred Shares held by Lossco will be sufficient to permit Lossco to realize a profit on its investment in the Newco2 Preferred Shares, after the deduction of any interest on the Lossco Note and its other related expenses.

31. Newco2 will use the proceeds from the issuance of the Newco2 Preferred Shares to make a non-interest-bearing loan of $XXXXXXXXXX to Aco. This loan will be evidenced by a demand non-interest-bearing promissory note (the "Aco Note2").

32. Aco will use the proceeds from the Aco Note2 to repay Daylight Loan2.

33. The following transactions will occur when jointly determined by Aco, Lossco and Newco2 but no later than XXXXXXXXXX :

a) Pursuant to a capital contribution agreement, Aco will make a contribution of capital to Newco2 in an amount equal to the amount of the accrued and unpaid dividends, if any, on the Newco2 Preferred Shares. No shares will be issued by Newco2 with respect to the contribution of capital and no amount will be added to the stated capital of Newco2. The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be income to Newco2 pursuant to generally accepted principles. Aco will not claim, at any time, a capital loss in respect of its investment in Newco2;

b) Newco2 will pay the accrued and unpaid dividends on the Newco2 Preferred Shares; and

c) Lossco will pay the accrued and unpaid interest on the Lossco Note.

Structure #2 will be unwound in the following manner no later than XXXXXXXXXX :

34. Newco2 will redeem the Newco2 Preferred Shares held by Lossco for an amount equal to their aggregate redemption amount.

35. As payment for the redemption of the Newco2 Preferred Shares, Newco2 will assign the Aco Note2 to Lossco.

36. The Aco Note2 and the Lossco Note will be satisfied and extinguished by way of set-off.

37. Aco and Dco will enter into and consummate an agreement whereby Aco will sell, at a purchase price equal to fair market value, its Lossco Common Shares to Dco. The purchase price of the Lossco Common Shares will be negotiated between the parties. Aco will not claim at any time a capital loss in respect of the Lossco Common Shares.

38. In the taxation year in which Dco obtains the Lossco Common Shares, Dco, as sole shareholder of Lossco, will pass a resolution authorizing and requiring Lossco to be wound-up into Dco pursuant to subsection 88(1). As a consequence, Lossco's assets will be transferred to Dco and Dco will assume Lossco's liabilities.

39. After the wind-up of Lossco, the transactions described in 28 through 38 above will be repeated once annually (except that a new "Lossco" will be formed for each such repetition) during each subsequent taxation year through to and including the taxation year ending on XXXXXXXXXX . On the repetition of the transactions described in 28 through 38 above, the amount of each new "Lossco Note" referred to in such paragraphs will not exceed $XXXXXXXXXX .

40. Following completion of the repetition of the steps referred to in paragraph 40, Aco, as sole shareholder of Newco2, will pass a resolution authorizing and requiring Newco2 to be wound-up into Aco pursuant to subsection 88(1). As a consequence, Newco2's assets will be transferred to Aco and Aco will assume Newco2's liabilities.

Other Relevant Transactions:

41. Prior to XXXXXXXXXX , Aco transferred certain shares in related corporations to another related corporation (XXXXXXXXXX ) in exchange for shares, in order to generate a taxable gain sufficient to utilize a non-capital loss of Aco in respect of a prior year that would otherwise expire after XXXXXXXXXX .

Representations:

42. Dco and Lossco, as well as all other taxpayers involved in the Proposed Transactions, are, on the basis that they are related to a corporation described in paragraphs (b) or (d) of the definition of SFI, SFIs pursuant to paragraph (g) of that definition. It is, however, understood that Dco and Lossco will not acquire the Newco1 Preferred Shares and the Newco2 Preferred Shares, respectively, in the ordinary course of their businesses.

43. None of the corporations involved in the Proposed Transactions has or will have entered into a "dividend rental arrangement" as defined by subsection 248(1) with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

44. None of the shares on which a dividend is declared or paid in the course of the Proposed Transactions is guaranteed in any way described in subsection 112(2.2) by an SFI or a specified person in relation to an SFI.

45. None of the shares to be issued as part of the Proposed Transactions will be issued or acquired as part of a transaction or series of transactions of the type described in subsection 112(2.5).

46. Aco, Bco, Cco, Dco, Newco1, Newco2 and Lossco are subject corporations, as defined in subsection 186(3). However, since Newco1 and Newco2 will not have any refundable dividend tax on hand, no Part IV tax will be payable on the dividends paid by Newco1 on the Newco1 Preferred Shares held by Dco or on the dividends paid by Newco2 on the Newco2 Preferred Shares held by Lossco.

47. The interest deducted by Dco pursuant to paragraph 20(1)(c) in respect of the Dco Note will not create a non-capital loss for Dco during the period in which the transactions described in 15 through 25 above occur. However, Dco could incur a non-capital loss as a result of claiming a deduction in computing taxable income under paragraph 110(1)(k) should Dco enter into an agreement with a related party with respect to Part VI.1 tax otherwise payable by such related party, in accordance with subsection 191.3(1). Any such resulting non-capital loss would be carried back to a prior taxation year in accordance with the rules in section 111. Dividends received by Dco and Lossco, respectively, on the Newco1 Preferred Shares and the Newco2 Preferred Shares as described in 21 and 33 above will be excepted dividends within the meaning assigned by section 187.1 of the Act and excluded dividends within the meaning assigned by section 191(1) of the Act.

48. The significance of the amounts involved in the Proposed Transactions is the reason why the taxpayers are requesting confirmation of the tax treatment of the Proposed Transactions.

Purpose of the Proposed Transactions:

49. The purpose of the Proposed Transactions is to consolidate taxable income and non-capital losses within a group of affiliated and related persons. The Proposed Transactions will enable Aco to earn interest income on the Dco Note and the Lossco Note and permit Dco to effectively utilize Aco's non-capital losses.

Rulings Given:

Provided that the preceding statements constitute 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. Provided that Dco has a legal obligation to pay interest on the Dco Note and that the Newco1 Preferred Shares continue to be held by Dco for the purpose of gaining or producing income, in computing its income for a taxation year, Dco will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the Dco Note, as described in 18 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Dco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

B. Provided that Lossco has a legal obligation to pay interest on the Lossco Note and that the Newco2 Preferred Shares continue to be held by Lossco for the purpose of gaining or producing income, in computing its income for a taxation year, Lossco will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the Lossco Note, as described in 29 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Lossco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

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

D. No amount will be included in the income of Newco1 or Newco2 pursuant to section 9, or paragraphs 12(1)(c) or 12(1)(x) of the Act in respect of the contributions of capital made by Aco as described in 21 and 33 above.

E. Dividends received by Dco and Lossco, respectively, on the Newco1 Preferred Shares and the Newco2 Preferred Shares, as described in 21 and 33 above, will be taxable dividends and such dividends will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of the recipient corporation for the year in which the dividends are received by Dco and by Lossco and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4) of the Act.

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

G. The general anti-avoidance provision of a province with which the Government of Canada has entered into a tax collection agreement will not be applied, as a result of the Proposed Transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given above, in respect of a taxation year in respect of which such tax collection agreement is in effect.

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 other than those transactions in 21 to 25 above and 33 to 40 above are completed by XXXXXXXXXX .

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

(c) the provincial income tax implications relating to the allocation of income and expenses under the proposed transactions; nor

(d) 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
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch