2002 Ruling 2002-0151343 - Loss Carryforward Under 111(5)

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: Does subsection 111(5) allow the losses of a loss company to be carried forward by an acquiror corporation if the acquisition is carried out in two stages - acquisition of the assets of the loss business followed 15 months later by an acquisition of control of the loss company - if all the requirements of subsection 111(5) respecting the carrying on of the business are satisfied?

Position: Yes.

Reasons: The technical requirements of subsection 111(5) are satisfied.

XXXXXXXXXX 2002-015134

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

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 facsimiles and emails as well as the information provided in various telephone conversations.

Throughout this letter, certain individuals and corporations will be referred to as follows:

XXXXXXXXXX . Holdco
XXXXXXXXXX . Lossco
XXXXXXXXXX . Subco
XXXXXXXXXX . Bco
XXXXXXXXXX . Opco
XXXXXXXXXX . Parentco
XXXXXXXXXX . USco

Lossco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns have been filed at the XXXXXXXXXX Taxation Centre. Opco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns have been filed at the XXXXXXXXXX Taxation Centre. Lossco and Opco are resident in Canada for the purposes of the Act.

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

(i) involved in an earlier return of any of the taxpayers or a related person;

(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of any of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

(iv) before the courts; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

The taxpayers have represented that the proposed transactions will not affect their ability to pay any of their outstanding tax liabilities.

Unless otherwise indicated, all references to monetary amounts are in Canadian dollars.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

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

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

(c) "arm's length" has the meaning assigned by section 251;

(d) "BCA" means the Companies Act (XXXXXXXXXX);

(e) "CBCA" means the Canada Business Corporations Act and, where applicable, its predecessor statutes;

(f) "cumulative eligible capital" ("CEC") has the meaning assigned by subsection 14(5);

(g) "depreciable property" has the meaning assigned by subsection 13(21);

(h) "disposition" has the meaning assigned by subsection 248(1);

(i) "eligible capital property" has the meaning assigned by section 54;

(j) "forgiven amount" has the meaning assigned by subsection 80(1) and 80.01(1);

(k) "net capital loss" has the meaning assigned by subsection 111(8);

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

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

(n) "Paragraph" refers to a numbered paragraph in this letter;

(o) "parent" has the meaning assigned by subsection 88(1);

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

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

(r) "subsidiary" has the meaning assigned by subsection 88(1);

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

(t) "terminal loss" means a deduction pursuant to subsection 20(16); and

(u) "undepreciated capital cost" ("UCC") has the meaning assigned by subsection 13(21).

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

FACTS

1. Lossco is a taxable Canadian corporation incorporated under the CBCA. The shares of Lossco traded on the XXXXXXXXXX Stock Exchange until they were suspended from trading in XXXXXXXXXX. Holdco is the majority shareholder of Lossco, owning approximately XXXXXXXXXX% of its common shares. Lossco's taxation year-end is XXXXXXXXXX .

2. Lossco owns or has owned various subsidiary companies in Canada and in countries other than Canada including XXXXXXXXXX. Its Canadian subsidiaries include Subco, a wholly-owned subsidiary incorporated under the CBCA.

3. Prior to the transactions described below, Lossco carried on two separate businesses XXXXXXXXXX Lossco has treated the XXXXXXXXXX business and the XXXXXXXXXX business as separate divisions and businesses for financial accounting and income tax purposes.

4. In XXXXXXXXXX, Lossco and Subco obtained a protective order from the XXXXXXXXXX Superior Court of Justice under the Companies' Creditors Arrangement Act (the "CCAA") in respect of creditors of their respective Canadian operations, and Lossco obtained a protective order under Section 304 of the United States Bankruptcy Code in respect of its U.S. assets.

5. Since receiving the protective orders, Lossco has been engaged in soliciting orders for the sale of its assets for the benefit of its creditors. In connection with this, Lossco sold the majority of the assets of the XXXXXXXXXX business to Opco on XXXXXXXXXX (the "Lossco/Opco Sale").

6. Opco is a taxable Canadian corporation and is a wholly-owned subsidiary of Parentco. Opco XXXXXXXXXX was incorporated in XXXXXXXXXX for the purposes of the Lossco/Opco Sale. Opco's taxation year-end is XXXXXXXXXX.

7. Parentco is a taxable corporation incorporated and headquartered in XXXXXXXXXX and is wholly-owned by an indirect wholly-owned subsidiary of USco. Parentco was acquired in XXXXXXXXXX as part of a worldwide acquisition when USco purchased an XXXXXXXXXX company. Parentco's only asset is its share of Opco.

8. USco is a taxable corporation that is headquartered in XXXXXXXXXX, U.S.A. and is a publicly traded company listed on the XXXXXXXXXX Stock Exchange.

9. Opco and Lossco deal at arm's length and are not related persons. Opco and any corporation related to it are not related to, and deal at arm's length with, the creditors of Lossco.

10. On XXXXXXXXXX, Lossco sold the XXXXXXXXXX business to an independent third party. Lossco realized a terminal loss in XXXXXXXXXX in respect of the undepreciated capital cost of depreciable property of prescribed classes of the XXXXXXXXXX business as a result of the sale of the XXXXXXXXXX business in XXXXXXXXXX.

11. Lossco has also recently disposed of its interests in some of its subsidiaries and realized capital losses as a consequence. Certain of these losses arose by virtue of Lossco's elections in respect of those subsidiaries pursuant to subsection 50(1). In addition, USco has agreed, subject to certain conditions being satisfied, to purchase the shares of Bco, a U.S. corporation wholly-owned by Subco. Other transactions involving Lossco and third parties are in the process of being concluded.

12. As a result of the various dispositions referred to above, Lossco currently owns:

(a) Certain redundant and surplus assets of the XXXXXXXXXX business (the "Residual Assets");

(b) A warehouse in XXXXXXXXXX (the "Warehouse") that operated as a plant of the XXXXXXXXXX business prior to its closure in XXXXXXXXXX and is now being leased to Opco in connection with the XXXXXXXXXX business;

(c) Shares, loans and intercompany balances with affiliates and subsidiaries; and

(d) Cash.

13. Unlike the XXXXXXXXXX business, Lossco has not realized a terminal loss in respect of the UCC of depreciable property of prescribed classes or a terminal allowance in respect of the cumulative eligible capital of eligible capital property of the XXXXXXXXXX business (the "XXXXXXXXXX business UCC/CEC ") since Lossco continues to own the Residual Assets that constitute depreciable property and eligible capital property included in the XXXXXXXXXX business UCC/CEC. This ruling request relates primarily to the losses that Lossco will realize in respect of the XXXXXXXXXX business UCC/CEC.

14. The following table indicates the amounts of Lossco's losses by year and of the XXXXXXXXXX business UCC/CEC by class, as set out in the tax return filed by Lossco in respect of its year ended XXXXXXXXXX:

Item
Year of Origin / Class
Amount ($ 000's)
Non-capital losses
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Total

XXXXXXXXXX
Net capital losses
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Total

XXXXXXXXXX
XXXXXXXXXX business UCC / CEC

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
Total

XXXXXXXXXX

15. The XXXXXXXXXX business has been carried on, without interruption, throughout a period commencing well before XXXXXXXXXX (by Lossco and, commencing on XXXXXXXXXX, by Opco) and continues to be carried on by Opco, without interruption. The XXXXXXXXXX business carried on by Lossco prior to the Lossco/Opco Sale and the XXXXXXXXXX business carried on by Opco on and after the Lossco/Opco Sale are one and the same XXXXXXXXXX business. This is evident from the table below which illustrates the similarity of the identity and continuity of plants, employees, customers, suppliers and equipment, (there being a distinction only in respect of the usage of name), between the XXXXXXXXXX business carried on by Lossco prior to the Lossco/Opco Sale and the XXXXXXXXXX business carried on by Opco on and after the Lossco/Opco Sale.

Characteristic of Business
Lossco, pre-XXXXXXXXXX
Opco, post-XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

16. On XXXXXXXXXX, Lossco became a bankrupt for the purposes of the Act by reason of making a voluntary assignment in bankruptcy pursuant to the Bankruptcy and Insolvency Act (the "BIA") in respect of which XXXXXXXXXX. has been appointed trustee-in-bankruptcy. At the time of making the voluntary assignment, Lossco was indebted to its secured and unsecured creditors (the "Lossco Creditors") for approximately $XXXXXXXXXX (the "Lossco Indebtedness"). Pursuant to paragraph 128(1)(d), Lossco is deemed to have a taxation year ending on XXXXXXXXXX and a new taxation year commencing on XXXXXXXXXX.

PROPOSED TRANSACTIONS

17. During the administration of the bankruptcy of Lossco, the trustee-in-bankruptcy will endeavour to sell the Warehouse (included in Class 1 in the table in Paragraph 14 above) and the debt and/or shares of the remaining affiliates and subsidiaries of Lossco to independent third parties. Those properties that remain unsold will be disposed of by Lossco, prior to implementing the proposal referred to in Paragraph 18 below, to an entity that will liquidate such properties for the account of the Lossco Creditors. It is anticipated that such sales and/or dispositions will result in Lossco realizing a Class 1 terminal loss in respect of the Warehouse and capital losses in respect of such debt and/or shares. Thus, at the time of such proposal, the assets of Lossco will consist of cash and the Residual Assets.

18. A proposal will be made by the trustee-in-bankruptcy on behalf of Lossco under the BIA (the "Lossco Proposal") providing for settlement of monetary claims of claimants against Lossco (the "Claims Settlement"), a reorganization of the share capital of Lossco (the "Capital Reorganization") and certain other corporate steps necessary to effect the transactions contemplated hereunder. In order for the Lossco Proposal to be effective, it must be approved by the creditors of Lossco in accordance with the provisions of the BIA, and by the XXXXXXXXXX Superior Court of Justice.

19. Under the Claims Settlement component of the Lossco Proposal, the Lossco Indebtedness to the Lossco Creditors will be settled for approximately $XXXXXXXXXX in cash and a $XXXXXXXXXX principal amount promissory note (the "Recovery Note"). The Recovery Note will be held by the trustee-in-bankruptcy or other entity (the "Custodian") as nominee for and on behalf of the Lossco Creditors. It will be paid over XXXXXXXXXX years in accordance with a formula (to be monitored by a third party) dependent on utilization of the tax attributes of Lossco in respect of the XXXXXXXXXX business by the company formed on the amalgamation of Lossco and Opco ("Amalco") described below. It is anticipated that approximately $XXXXXXXXXX of the Lossco Indebtedness will be forgiven on the issuance of the Recovery Note. At the end of the XXXXXXXXXX-year term of the Recovery Note, the Recovery Note will be extinguished.

20. The following table illustrates the expected application of section 80 to the anticipated forgiveness of approximately $XXXXXXXXXX of the Lossco Indebtedness, having regard to the existing losses and XXXXXXXXXX business UCC/CEC of Lossco, as set out in the tax return filed by Lossco in respect of its taxation year ended XXXXXXXXXX and summarized in the table in Paragraph 14 above. It is recognized that adjustments will be required due to losses incurred after XXXXXXXXXX.

($ 000's)
Approximate forgiveness

Applied to:

Non-capital losses
Capital losses
XXXXXXXX Business UCC / CEC
Balance
$ XXXXXX

(XXXXXX)
(XXXXXX)
(XXXXXX)
Nil

21. Under the Capital Reorganization component of the Lossco Proposal, all of the issued and outstanding voting common shares and preferred shares of Lossco will be converted into preferred shares (the "Lossco Preferred Shares"), and a new class of authorized voting common shares will be created. The Lossco Preferred Shares will have a nominal aggregate redemption amount and will be non-voting prior to the commencement of XXXXXXXXXX (except in matters as required by law) and voting commencing on XXXXXXXXXX. No shares that are voting at the time of the Capital Reorganization will be issued with the result that the issued share capital of Lossco immediately following the Capital Reorganization will be limited to the Lossco Preferred Shares.

22. Lossco's bankruptcy will be annulled pursuant to the BIA and, as a result, an absolute order of discharge from bankruptcy will not be granted in respect of Lossco.

23. Subsequent to the Capital Reorganization, the following transactions will occur in sequence on XXXXXXXXXX as part of the Lossco Proposal:

(i) Parentco, the parent corporation of Opco, will subscribe for 1 non-voting Lossco Preferred Share; and

(ii) Lossco will redeem all of the Lossco Preferred Shares with the exception of the single Lossco Preferred Share held by Parentco, which will result in Parentco becoming the sole holder of the Lossco Preferred Shares and the sole shareholder of Lossco.

24. On or after XXXXXXXXXX, and subsequent to the Lossco Proposal, described in Paragraphs 18 to 23 above, Lossco will have been continued under the BCA as a company limited by shares, and Lossco will be amalgamated with Opco pursuant to the BCA to form Amalco, XXXXXXXXXX (the "Amalgamation"). Upon the Amalgamation, the Lossco Preferred Shares and the issued and outstanding share capital of Opco will become issued voting common shares of Amalco. Since Parentco will be the sole shareholder of both Lossco and Opco prior to the amalgamation, Parentco will be the sole shareholder of Amalco upon the conversion of the respective shares of Lossco and Opco into shares of Amalco. Lossco will not make an election under subsection 256(9) in its tax return for its taxation year ending immediately before the acquisition of control of Lossco by Parentco and the certificate of amalgamation of Amalco will not specify an effective time of the Amalgamation.

25. The losses of Lossco for purposes of the Act for its taxation year ending immediately before the acquisition of control of Lossco by Parentco will be approximately as shown in the table below. It is recognized that adjustments will be required due to losses incurred after XXXXXXXXXX.

($ 000's)
Remaining XXXXXXXXXX
business UCC / CEC

Estimated fair market value

Total loss available after application
of subsections 111(5.1) / (5.2)

$ XXXXXX

XXXXXX

$ XXXXXX

26. Lossco will not claim any deduction under paragraphs 20(1)(a) or (b), or subsection 20(16) in its taxation year ending immediately before the acquisition of control of Lossco by Parentco.

27. Amalco will carry on the XXXXXXXXXX business formerly carried on sequentially by Lossco and Opco, for profit or with a reasonable expectation of profit.

28. The Recovery Note will become an obligation of Amalco by reason of the Amalgamation. The former Lossco Creditors will receive, as beneficial holders of the Recovery Note, any payments made by Amalco pursuant to the terms of the Recovery Note.

PURPOSE OF THE PROPOSED TRANSACTIONS

29. The purpose of the proposed transactions is to maximize the recovery to the Lossco Creditors through potential recovery pursuant to the Recovery Note. This would be accomplished by an amalgamation of Lossco and Opco, thereby enabling Amalco to utilize the tax attributes of Lossco in respect of future income from the XXXXXXXXXX business. The proposed transactions would put Opco and Lossco in the same position as if Parentco had purchased all of the issued shares of Lossco, which, in the circumstances of the CCAA process, was not practicable at the time of the Lossco/Opco Sale.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. The Residual Assets and the Warehouse have not begun to be used by Lossco for "some other purpose" within the meaning of paragraph 13(7)(a) and, as a consequence, are not deemed to be disposed of by Lossco in accordance with such paragraph.

B. Notwithstanding Lossco's becoming a bankrupt, paragraph 128(1)(g) will not apply to Lossco or Amalco provided the bankruptcy of Lossco is annulled pursuant to the Lossco Proposal.

C. The provisions of paragraph 80(2)(h) will apply to the Recovery Note such that the principal amount of the Recovery Note upon issuance will be deemed to be paid by Lossco in satisfaction of the principal amount of the Lossco Indebtedness in respect of which the Recovery Note is issued by Lossco. The amount by which the Lossco Indebtedness exceeds the principal amount of the Recovery Note upon issuance will become the forgiven amount in respect of the Lossco Indebtedness for purposes of the application of the debt forgiveness rules in section 80.

When the Recovery Note is extinguished at the end of XXXXXXXXXX years following its issuance, the debt forgiveness rules in section 80 will also apply to the amount, if any, by which the principal amount of the Recovery Note exceeds the sum of all amounts paid out to the creditors under the terms of the Recovery Note during the XXXXXXXXXX-year period.

D. The provisions of section 80 will apply to the Recovery Note only at the time the Recovery Note is extinguished pursuant to its terms in XXXXXXXXXX years.

E. For purposes of subsections 111(4), (5), (5.1), (5.2) and 249(4), Parentco will be considered to have acquired control of Lossco at the commencement of XXXXXXXXXX.

F. The provisions of subsection 87(2.1) will apply to deem Amalco to be the same corporation as, and a continuation of, Lossco and Opco, for the purposes and subject to the restrictions set out in subsection 87(2.1).

G. If the amalgamation of Lossco and Opco occurs on XXXXXXXXXX , and provided that no election pursuant to subsection 256(9) is made with respect to the acquisition of control of Lossco by Parentco and no effective time is specified in the certificate of amalgamation obtained in respect of the Amalgamation, all as described in Paragraph 24 above, Lossco will have only one deemed taxation year end as a result of the acquisition of control of Lossco by Parentco and the Amalgamation.

If the amalgamation is not concluded on XXXXXXXXXX, Lossco will have one deemed taxation year end as a result of the acquisition of control of Lossco by Parentco and a second deemed taxation year end as a result of the Amalgamation.

H. Immediately before the acquisition of control of Lossco by Parentco, the amount by which:

(a) the UCC of depreciable property of a prescribed class of the XXXXXXXXXX business exceeds the fair market value of all the property of that class will be required, by reason of subsection 111(5.1) and paragraph 20(1)(a), to be deducted in computing the income of Lossco for its taxation year ending at such time; and

(b) the CEC of eligible capital property of the XXXXXXXXXX business exceeds 3/4 of the fair market value of the eligible capital property of that business will be required, by reason of subsection 111(5.2) and paragraph 20(1)(b), to be deducted in computing the income of Lossco for its taxation year ending at such time.

I. Provided that Lossco's XXXXXXXXXX business, described in Paragraphs 3 and 15 above, is carried on by Amalco for profit or with a reasonable expectation of profit throughout a particular taxation year ending after the acquisition of control of Lossco by Parentco, as described in Paragraph 23 above, and the amalgamation of Lossco with Opco, as described in Paragraph 24 above, and subject to the time limitations set out in paragraph 111(1)(a), the restrictions set out in subsection 111(3), and any other requirements of the Act regarding deductibility of non-capital losses, the non-capital loss of Lossco resulting from the deductions pursuant to subsections 111(5.1) and (5.2), described in Ruling H above, will be a non-capital loss of Amalco by reason of subsection 87(2.1) and may be deducted by Amalco under paragraph 111(5)(a) in computing its taxable income for that taxation year to the extent of the income earned by Amalco for that particular year from carrying on the XXXXXXXXXX business.

J. Subsection 245(2) will not be applied to the proposed transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

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 Canada Customs and Revenue Agency provided that the proposed transactions 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

1. Nothing in this ruling should be construed as implying that the Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the fair market value or ACB of any particular asset, the paid-up capital in respect of any shares referred to herein, or the UCC, CEC, non-capital losses or net capital losses of any corporation; or

(b) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

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

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