2002 Ruling 2002-0123813 - Loss Consolidation within Affiliated Grp.

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Loss consolidation in an affiliated group; impact of CRB Logging where a subsidiary purchases shares of subsidiary of its parent.

Position: Favourable ruling given.

Reasons: Parent will have sufficient assets independent of its investment in its subsidiary to fund the amount by which the dividends exceed the interest income received.

XXXXXXXXXX 2002-012381

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: ADVANCE INCOME TAX RULING
XXXXXXXXXX ("Aco") XXXXXXXXXX ("Bco")

This is in reply to your letter of XXXXXXXXXX in which you request an advance income tax ruling on behalf of the above named taxpayers. We also acknowledge the information provided in subsequent correspondence and during our various telephone conversations in connection with your request.

You advised that to the best of your knowledge, none of the issues involved in this advance income tax ruling request are being considered by a Tax Services Office or Taxation Centre in connection with a tax return already filed and none of these issues are under objection or appeal.

You advised that the Proposed Transactions will not result in any taxpayer described herein being unable to pay its outstanding tax liabilities.

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

DEFINITIONS

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

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Suppl.) c.1, as amended to the date hereof, and unless otherwise stated, a reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

(b) "affiliated persons" has the meaning assigned by subsection 251.1(1);

(c) "CBCA" means Canada Business Corporations Act as amended;

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

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

(f) "forgiven amount" has the meaning assigned by subsection 80(1) or 80.01(1);

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

(h) "Newco" means the new corporation as described in Paragraph 8;

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

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

(k) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(l) "principal amount" has the meaning assigned by subsection 248(1);

(m) "Proposed Transactions" means the transactions described in Paragraph 8 to Paragraph 17;

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

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

(p) "subsidiary controlled corporation" has the meaning assigned by subsection 248(1);

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

(r) "taxable dividend" has the meaning assigned by subsection 89(1).

FACTS

1. XXXXXXXXXX ("Cco") is the corporation resulting from the amalgamation of XXXXXXXXXX, which amalgamation was effective on XXXXXXXXXX. Cco is governed by the CBCA and is a "public corporation" and a "taxable Canadian corporation".

2. Aco was incorporated in XXXXXXXXXX. As part of transactions which were the subject of an advance income tax ruling #3-990262 dated XXXXXXXXXX, 1999, as amended by our letter dated XXXXXXXXXX, 1999, Aco became a holding corporation that owns all of the issued and outstanding common shares of Bco. Aco is governed by the CBCA and it is a "taxable Canadian corporation".

As at XXXXXXXXXX, Aco had outstanding XXXXXXXXXX common shares, XXXXXXXXXX common shares and XXXXXXXXXX shares. The XXXXXXXXXX voting common shares are all held by Cco. The XXXXXXXXXX shares are all held by Cco and are non-voting.

The XXXXXXXXXX voting common shares are all held by a trust the beneficiaries of which are XXXXXXXXXX and the trustee of which is XXXXXXXXXX (these XXXXXXXXXX corporations are incorporated under the laws of XXXXXXXXXX).

3. Bco is a "public corporation", a "taxable Canadian corporation" and a "subsidiary controlled corporation" of Aco which holds XXXXXXXXXX% of Bco's issued and outstanding common shares. Bco is governed by the CBCA. The authorized and issued share capital of Bco also includes XXXXXXXXXX preferred shares. These shares are currently held by parties that are not related to Bco.

XXXXXXXXXX

4. As a result of a transfer of income earning assets from Cco to Aco, Aco has interest-bearing notes payable to Cco in the principal amount of approximately $XXXXXXXXXX and will therefore incur significant interest expense in its XXXXXXXXXX and subsequent taxation years. Aco has interest-bearing notes receivable from Bco of approximately $XXXXXXXXXX.

5. Aco has a XXXXXXXXXX taxation year end. As at XXXXXXXXXX, Aco had non-capital losses carried-forward of approximately $XXXXXXXXXX. It is currently estimated that Aco will generate non-capital losses of approximately $XXXXXXXXXX for the taxation years ending XXXXXXXXXX, respectively and also generate non-capital losses in years subsequent to 2002.

6. Bco has a XXXXXXXXXX taxation year end and generates sufficient taxable income against which the non-capital losses of Aco could be deducted. The federal taxable income reported by Bco for its XXXXXXXXXX taxation year was approximately $XXXXXXXXXX. Bco's currently estimated federal taxable income for its XXXXXXXXXX taxation years is expected to amount to approximately $XXXXXXXXXX respectively.

7. Bco has paid regular XXXXXXXXXX common share dividends to Aco since it became the parent of Bco in XXXXXXXXXX (and previously to Cco). Taxable dividend payments by Bco on its common shares in the XXXXXXXXXX taxation years were $XXXXXXXXXX respectively. The current dividend policy of Bco is that subject to certain cash flow constraints, it will generally pay annual dividends on its common shares of not less than XXXXXXXXXX% of the year's consolidated net income available to common shareholders as set out in the consolidated statement of operations for the year.

PROPOSED TRANSACTIONS

8. Aco will incorporate a new corporation Newco under the CBCA. Newco will have a XXXXXXXXXX taxation year-end and will be a "taxable Canadian corporation".

The authorized share capital of Newco will consist of an unlimited number of common shares without nominal or par value ("Newco Common Shares") and an unlimited number of redeemable and retractable preferred shares ("Newco Preferred Shares").

The Newco Preferred Shares will have rights and restrictions described as follows:

(a) the shares will be non-participating and non-voting;

(b) entitled to an annual cumulative dividend rate, applied to the redemption amount of the shares (as described in Paragraph 11) equal to the prime lending rate of Bco's leading banker, in force at the time of the determination of the dividend rate, plus XXXXXXXXXX%. The dividend rate will be determined at the time of the Proposed Transactions, and subsequently, at the beginning of each taxation year;

(c) redeemable at any time at the option of the holder or Newco for cash or by delivering a financial asset of Newco (including the Aco Demand Loan issued under Paragraph 12) for an amount equal to the aggregate of the fair market value of the consideration for which the shares were issued and any unpaid dividends.

The Newco Preferred Shares may also be redeemed by setting off amounts owing under the Bco Demand Loan against the redemption price of the Newco Preferred Shares in circumstances where Newco becomes the holder of the Bco Demand Loan as described in Paragraph 12. The terms of the Aco Demand Loan and the Bco Demand Loan described in Paragraph 10 will provide that if Bco becomes the holder of the Aco Demand Loan, the Aco Demand Loan can, at the option of either Aco or Bco, be set off against the Bco Demand Loan.

Aco will subscribe for one Newco Common Share for $XXXXXXXXXX on incorporation.

9. Aco will borrow an amount not to exceed $XXXXXXXXXX on a daylight basis from an arm's length financial institution (the "Daylight Loan").

10. Aco will lend the proceeds from the Daylight Loan to Bco on a subordinated demand basis (the "Bco Demand Loan"). The Bco Demand Loan will bear interest at a rate equal to the prime lending rate of Bco's leading banker in force at the time of the determination of the interest rate. The interest rate will be determined at the time of the Proposed Transactions, and subsequently, at the beginning of each taxation year. The interest will be payable annually in arrears.

The terms of the Bco Demand Loan will provide that repayment may be settled in cash or by delivering a financial asset of Bco (including the Aco Demand Loan described in Paragraph 12).

Based on Bco's financial projections, it has the financial capacity to pay the interest on the Bco Demand Loan from its own cash flow (calculated as its net accounting income before depreciation and taxes). The interest charged on the Bco Demand Loan will not create or increase a non-capital loss in Bco. A letter dated XXXXXXXXXX from XXXXXXXXXX provides confirmation that Bco has the ability to borrow up to $XXXXXXXXXX above and beyond current indebtedness of approximately $XXXXXXXXXX.

11. Bco will use the proceeds of the Bco Demand Loan to subscribe for Newco Preferred Shares having a redemption amount and paid-up capital equal to the principal amount of the Bco Demand Loan.

Dividends on the Newco Preferred Shares will be paid on an annual basis. The dividends will be funded by capital contributions made by Aco as described in Paragraph 15.

12. Newco will lend to Aco the subscription proceeds received in Paragraph 11 on an interest-free demand basis (the "Aco Demand Loan"). The terms of the Aco Demand Loan will allow Aco to repay the Aco Demand Loan by assigning the Bco Demand Loan (see Paragraph 10) to Newco.

13. Aco will use the proceeds from the Aco Demand Loan to repay the Daylight Loan.

14. Bco will pay interest to Aco on the Bco Demand Loan on an annual basis.

15. Aco will agree to and will make contributions of capital to the Newco Common Share capital of Newco on an annual basis equal to the amount of dividends to be paid by Newco to Bco in respect of the Newco Preferred Shares for so long as such preferred shares are outstanding. The contributions of capital to the Newco Common Share capital, including those contributions of capital referred to in Paragraph 17(b) below, will not be income of Newco pursuant to generally accepted accounting principles. Aco will however not be required to make such contributions of capital where Newco is no longer paying dividends to Bco. Aco will have a source of income, independent of its investment in Bco, sufficient to fund the amount of the capital contribution to Newco in excess of the interest income received by Aco on the Bco Demand Loan.

16. Newco will use the amount received as capital contributions in Paragraph 15 to pay dividends on the Newco Preferred Shares to Bco on an annual basis.

17. Once Aco has decided to unwind the Proposed Transactions in whole or in part:

(a) Bco will pay the balance of any accrued and unpaid interest on the portion of the Bco Demand Loan settled under Paragraph 17(e);

(b) Aco will make capital contributions to the Newco Common Share capital equal to the amount of any accrued and unpaid dividends on the Newco Preferred Shares;

(c) Newco will pay the balance of any accrued and unpaid dividends on the Newco Preferred Shares redeemed under Paragraph 17(d);

(d) Newco will redeem all or a portion of the Newco Preferred Shares held by Bco and settle the amount owing on redemption by assigning a corresponding amount of the Aco Demand Loan to Bco;

(e) Bco will repay all or a portion of the Bco Demand Loan equal to the amount of Newco Preferred Shares redeemed under Paragraph 17(d) by setting off the amount owing to Aco with a corresponding amount of the Aco Demand Loan and such portions of the Aco Demand Loan and the Bco Demand Loan will be cancelled; and

(f) Once all of the Newco Preferred Shares held by Bco have been redeemed and all of the Aco Demand Loan has been assigned to Bco as described in Paragraph 17(d) and Paragraph 17(e), Newco will be wound up into Aco pursuant to subsection 210(3) of the CBCA.

ADDITIONAL INFORMATION

18. Aco, Bco and Newco are neither "specified financial institutions" nor "financial intermediary corporations".

19. None of the issued shares referred to herein (including the shares to be issued as described in the Proposed Transactions) is or will be subject to a "guarantee agreement".

20. None of the issued shares referred to herein (including the shares to be issued as described in the Proposed Transactions) has been or will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5).

21. None of the issued shares referred to herein (including the shares to be issued as described in the Proposed Transactions) is or will be subject to a "dividend rental agreement".

22. Aco and Bco are "affiliated persons".

23. Each of Aco and Newco will agree with Bco that Newco shall be a single purpose company, shall have no liabilities and shall carry on (and Aco will cause to carry on) no business other than that contemplated by the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

The overall purpose of the Proposed Transactions is to enable Aco to earn sufficient interest income, over a period of time, so as to utilize its accumulated non-capital losses and non-capital losses that it would otherwise incur in a taxation year.

In order to undertake the Proposed Transactions in a legally effective manner, it is necessary to incorporate Newco (described in Paragraph 8) to enable Bco to hold an interest in Newco Preferred Shares (described in Paragraph 11). Under section 30(1) of the CBCA, Bco is precluded from acquiring and holding shares in Aco.

The purpose of making capital contributions to the Newco Common Shares (as described in Paragraph 15) versus subscribing for additional Newco Common Shares, is to ensure that Newco will not be precluded from declaring dividends on the Newco Preferred Shares pursuant to section 42 of the CBCA. In the case of the issuance of additional Newco Common Shares, the realizable value of Newco's assets (the Aco Demand Loan) after the payment of a dividend would be less than the aggregate of its liabilities and its stated capital of both Newco Common Shares and Newco Preferred Shares.

RULINGS REQUESTED AND GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purpose of the proposed transactions and provided further that the proposed transactions are carried out as described above, our rulings are as follows:

A. The dividends received by Bco, as described in Paragraph 16 and Paragraph 17(c) above will be "taxable dividends" that will, pursuant to subsection 112(1), be deductible in computing the taxable income of Bco for the year in which the dividend is received, and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) and 112(2.4).

B. Part IV.1 of the Act will not apply to the dividends described in Paragraph 16 and Paragraph 17(c) because the dividends will be an "excepted dividend" in section 187.1.

C. Part VI.1 of the Act will not apply to the dividends described in Paragraph 16 and Paragraph 17(c) because the dividends will be excluded dividends pursuant to paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

D. Provided that Bco has a legal obligation to pay interest on the Bco Demand Loan issued in Paragraph 10, and the Newco Preferred Shares described in Paragraph 8 and Paragraph 11, continue to be held by Bco, Bco will be entitled pursuant to paragraph 20(1)(c) to deduct the lesser of (i) the interest paid or payable (depending on the method regularly followed by Bco in computing its income for purposes of the Act) in respect of the year on the Bco Demand Loan or (ii) a reasonable amount in respect thereof.

E. 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 described in Paragraph 15 and Paragraph 17(b).

F. The set-off of all or any part of the Aco Demand Loan against the corresponding amount of the Bco Demand Loan described in Paragraph 17(e) will not give rise to a "forgiven amount".

G. Provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events that includes the Proposed Transactions, then by virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the taxable dividends described in Rulings A above. For greater certainty, the proposed transactions described herein, in and by themselves, will not be considered to result in any disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v).

H. The provisions of subsection 88(1) will apply to the winding-up of Newco into Aco described in Paragraph 17(f).

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

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

The rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R4 dated January 29, 2001 and are binding on the Canada Customs and Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX. These rulings are based on the Act as it currently reads and do not take into account any future amendments, whether currently proposed or not to the Act.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Brach