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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues: Interest Deductibility
Position: OK
Reasons: Previous Ruling given on Loss Consolidation using Dividends
XXXXXXXXXX 2000-003991
Attention: XXXXXXXXXX
XXXXXXXXXX , 2000
Dear Sirs:
Re: Advance Income Tax Ruling - XXXXXXXXXX
This is in response to your letter of XXXXXXXXXX, requesting an advance income tax ruling on behalf of the above-noted taxpayer.
We understand that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are being considered by a Tax Services Office or a Taxation Centre in connection with any tax return already filed, and none of the issues involved in the requested rulings is the subject of any notice of objection or is under appeal.
In this letter "the Act" means the Income Tax Act, RSC 1985, Fifth Supplement, c.1, as amended from time to time.
Facts
1. XXXXXXXXXX ("FCO"), XXXXXXXXXX ("CCO"), XXXXXXXXXX ("ACO"), XXXXXXXXXX ("DCO") and XXXXXXXXXX ("BCO") are taxable Canadian controlled private corporations within the meaning of subsection 89(1) of the Act. XXXXXXXXXX (the "Trust") was a domestic, inter-vivos trust within the meaning of subsection 108(1) of the Act.
2. ACO, a wholly owned subsidiary of CCO, is a XXXXXXXXXX. DCO, a wholly owned subsidiary of ACO, is in the XXXXXXXXXX business and has gross sales of over $XXXXXXXXXX per annum. CCO is a wholly owned subsidiary of FCO which is owned by XXXXXXXXXX.
3. BCO was incorporated on XXXXXXXXXX and is currently being used to XXXXXXXXXX.
4. BCO is in the business of XXXXXXXXXX.
5. XXXXXXXXXX.
6. On XXXXXXXXXX, the Trust was settled with XXXXXXXXXX as its sole trustee and ACO as its sole beneficiary.
7. On XXXXXXXXXX, BCO redeemed its share from ACO for an amount equal to its fair market value. The Trust subscribed for new shares in BCO and obtained XXXXXXXXXX% ownership of BCO.
8. On XXXXXXXXXX, the Trust was wound-up and, in the process, all the issued and outstanding shares of BCO owned by it were distributed to ACO pursuant to subsection 107(2) of the Act. Effective XXXXXXXXXX, ACO owns all of the issued and outstanding shares of BCO and, as such, BCO and ACO are affiliated pursuant to subparagraph 251.1(1)(b)(i) of the Act.
9. XXXXXXXXXX.
10. BCO completed its first taxation year on XXXXXXXXXX. As described in Ruling 1999-001398, BCO borrowed $XXXXXXXXXX from CCO and lent $XXXXXXXXXX to ACO on XXXXXXXXXX. The loan from CCO was non-interest bearing whereas the loan to ACO is interest bearing at a rate of prime plus XXXXXXXXXX%.
11. For the taxation year ending in XXXXXXXXXX, BCO expects to generate a small operating loss with respect to XXXXXXXXXX of approximately $XXXXXXXXXX and with respect to XXXXXXXXXX of approximately $XXXXXXXXXX before depreciation. As such, the tax losses that will be generated will be primarily due to the amount of CCA claimed.
12. As at XXXXXXXXXX, CCO and DCO had the following balances:
- ACO's interest bearing loans receivable $XXXXXXXXXX
- ACO's non-interest bearing loans receivable $XXXXXXXXXX
- ACO's cash and short term deposits $XXXXXXXXXX
- DCO's loan receivable from ACO $XXXXXXXXXX
- DCO's loan receivable from BCO $XXXXXXXXXX
13. For the year ended XXXXXXXXXX the retained earnings balance of ACO was $XXXXXXXXXX and for DCO was $XXXXXXXXXX.
14. The expected retained earnings balance for ACO at XXXXXXXXXX, after taking into consideration an $XXXXXXXXXX dividend to CCO in XXXXXXXXXX and $XXXXXXXXXX of estimated earnings to XXXXXXXXXX amounts to $XXXXXXXXXX. The expected retained earnings balance for DCO after taking into consideration $XXXXXXXXXX of estimated earnings to XXXXXXXXXX amounts to $XXXXXXXXXX. The retained earnings will be computed on an unconsolidated basis and do not include any appraisal surplus and profits resulting from non-arm's length transactions that transform appraisal surplus to retained earnings either on a taxable, non-taxable or tax deferred basis.
15. ACO has an available credit facility with the XXXXXXXXXX to borrow the $XXXXXXXXXX referred to in paragraph 17 below.
Proposed Transactions
16. DCO will declare and pay a dividend of up to $XXXXXXXXXX to ACO. As payment DCO will offset a portion of its $XXXXXXXXXX loan receivable from ACO against the amount of the dividend.
17. ACO will borrow up to $XXXXXXXXXX from an arm's length financial institution (the "Bank Loan") and use the proceeds from this loan to declare and pay a dividend to CCO of up to $XXXXXXXXXX.
18. CCO will use the proceeds from the ACO dividend to lend to BCO (the "CCO Loan") by way of a demand non-interest bearing loan.
19. ACO will borrow up to $XXXXXXXXXX from BCO (the "BCO Loan") to repay the Bank Loan referred to in paragraph 17 above.
20. The BCO Loan will be payable on demand, unsecured and interest bearing. The interest rate on the BCO Loan will be the XXXXXXXXXX prime rate plus 1%. It is intended that the rate charged represents a commercial market rate for such loans from an arm's length third party lender.
21. From time to time, excess cash in BCO in the future will either be used to declare and pay dividends, to repay its loan to CCO and/or repay its loan to DCO.
22. From time to time the companies may increase, decrease or eliminate the inter-company loans in circumstances where the interest income generated in BCO is expected to be lesser or greater than, respectively, the amount required to offset its expected losses (and any loss carryforwards) for the year.
Purpose of the Proposed Transactions
The purpose of the proposed transactions is ensure that ACO is in the same net position for tax purposes as it would have been had it owned XXXXXXXXXX directly instead of through BCO. As it is not advisable for ACO to own XXXXXXXXXX directly, the proposed transactions are intended to consolidate the profits of ACO and the losses of BCO.
Rulings
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:
A. The provisions of subsection 20(3) of the Act will be applicable to ACO on the use of the proceeds of the BCO Loan to repay the Bank Loan.
B. Provided that:
i) the dividend paid by ACO to CCO as described in paragraph 17 above does not exceed ACO's retained earnings at the time the dividend is paid,
ii) the interest is paid or becomes payable in a year pursuant to a legal obligation to pay interest on the BCO Loan, and
iii) ACO continues to use the BCO Loan for the purpose of earning income
the interest on the BCO Loan will be deductible by ACO pursuant to paragraph 20(1)(c) of the Act.
C. Subsections 15(1) and 56(2) will not be applicable to the proposed transactions described herein.
D. The provisions of subsection 245(2) of the Act 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.
These rulings are given subject to the general limitations and qualifications set out in Information Circular IC 70-6R3 dated December 30, 1996, and are binding on the Agency provided the proposed transactions described in paragraphs 16 to 20 are completed before XXXXXXXXXX. Also, these rulings are based on the Act and the Income Tax Regulations in their present form and do not take into account the effects of any proposed amendments thereto.
Yours truly,
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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