2002 Ruling 2002-0152583 - 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.

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: Whether interest is deductible in a proposed loss consolidation arrangement

Position: Yes.

Reasons: Meets the requirements under paragraph 20(1)(c).

Meets our requirements for loss consolidation arrangements.

XXXXXXXXXX 2002-015258

XXXXXXXXXX, 2002

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Lossco")
XXXXXXXXXX ("Profitco")

This is in reply to your letters of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers.

To the best of your knowledge, and to the best of the knowledge of the responsible officers of Lossco and Profitco, none of the issues involved in this ruling:

1. is in an earlier return;

2. is being considered by a tax services office or taxation centre in connection with a previously filed tax return;

3. is under objection;

4. is before the courts; or

5. is the subject of a ruling previously considered by the Directorate.

DEFINED TERMS

In this letter, unless otherwise indicated all statutory references are to the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended to the date hereof (the "Act").

In this letter the following terms have the meanings specified:

(a) "affiliated group of persons" has the meaning assigned by subsection 251.1(3);

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

(c) "BCA" means the Canada Business Corporations Act;

(d) "Daylight Loan" has the meaning assigned in paragraph 15 below;

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

(f) "FMV" means fair market value;

(g) "Lossco" means XXXXXXXXXX;

(h) "Lossco Demand Loan" has the meaning assigned in paragraph 18 below;

(i) "Lossco Group" means Lossco and its Canadian subsidiaries;

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

(k) "Newco" means a newly-incorporated corporation described in paragraph 13 below;

(l) "Newco Common Shares" has the meaning assigned in paragraph 13 below;

(m) "Newco Preferred Shares" has the meaning assigned in paragraph 13 below;

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

(o) "Profitco" means XXXXXXXXXX;

(p) "Profitco Demand Loan" has the meaning assigned in paragraph 16 below;

(q) "proposed transactions" means the proposed transactions described in this letter under the heading "Proposed Transactions";

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

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

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

(u) "taxable dividend" has the meaning assigned by subsection 89(1); and

(v) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

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

FACTS

1. Lossco is a corporation incorporated under the BCA. Lossco is a taxable Canadian corporation and a public corporation. Shares and debentures of Lossco are listed for trading on XXXXXXXXXX Stock Exchange. The head office of Lossco is located at XXXXXXXXXX, and it deals with the XXXXXXXXXX Tax Services Office and files its returns with the XXXXXXXXXX Tax Centre. Lossco's Business Number is XXXXXXXXXX . Lossco's taxation year ends on XXXXXXXXXX.

2. No single shareholder or related group of shareholders owns more than XXXXXXXXXX% of the issued and outstanding voting shares in the capital of Lossco. No person or group of persons has acquired control of Lossco at any relevant time.

3. Profitco is a corporation incorporated under the laws of the province of XXXXXXXXXX. Profitco is a taxable Canadian corporation. The head office of Profitco is located at XXXXXXXXXX, and it deals with the XXXXXXXXXX Tax Services Office and files its returns with the XXXXXXXXXX Tax Centre. Profitco's Business Number is XXXXXXXXXX. Lossco owns, and since XXXXXXXXXX has owned, all of the issued and outstanding shares in the capital of Profitco. Accordingly, Lossco and Profitco are affiliated persons. Profitco's taxation year ends on XXXXXXXXXX.

4. Each of Lossco and Profitco carries on business as XXXXXXXXXX.

5. Profitco does not have federal non-capital losses or net capital losses. Profitco has approximately $XXXXXXXXXX of XXXXXXXXXX non-capital losses as at XXXXXXXXXX.

6. As a result of the proposed transactions, Profitco will incur additional interest expense to a maximum of about $XXXXXXXXXX. Profitco expects that the additional interest expense in XXXXXXXXXX will create a non-capital loss of about $XXXXXXXXXX before discretionary deductions. Profitco proposes to deduct fully the resulting non-capital loss in computing its taxable income in its XXXXXXXXXX taxation year.

7. As at XXXXXXXXXX, the Lossco Group's current and long-term liabilities amounted to approximately $XXXXXXXXXX. These liabilities consisted of long-term debt of $XXXXXXXXXX; short-term debt of $XXXXXXXXXX; accounts payable of $XXXXXXXXXX; an employee future benefit accrual of $XXXXXXXXXX; and other miscellaneous liabilities of $XXXXXXXXXX. The XXXXXXXXXX Annual Report of Lossco states that Lossco has a XXXXXXXXXX renewable operating credit facility totaling $XXXXXXXXXX. As at XXXXXXXXXX, the Lossco Group had an available balance in its lines of credit of $XXXXXXXXXX. As at XXXXXXXXXX, the Lossco Group had available balances in its lines of credit of $XXXXXXXXXX.

8. Based on its existing assets and resources, Lossco will have the ability to make the capital contributions described in paragraph 20 below without taking into account the interest income that it would earn as a result of the proposed transactions.

9. As of XXXXXXXXXX, Lossco's non-capital losses, together with the year of their origin, were as follows:

Year			Federal Non-capital loss

XXXXXXXXXX

ADDITIONAL INFORMATION

10. The shares in the capital stock of Newco that will be issued as described in paragraph 17 below will not be, at any time during the implementation of the proposed transactions described herein:

(1) the subject of any undertaking that is referred to in subsection 112(2.2) of the Act as a "guarantee agreement";

(2) the subject of a dividend rental arrangement as that term is defined in subsection 248(1) of the Act;

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

(4) issued for consideration that is or includes:

(a) an obligation of the type described in subparagraph 112(2.4)(b)(i), other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b)); or

(b) any right of the type described in subparagraph 112(2.4)(b)(ii).

11. None of the taxpayers is a specified financial institution or a financial intermediary corporation for the purposes of the Act.

12. Each of Lossco and Newco will agree with Profitco that Newco will be a single purpose company, will have no liabilities and will carry on no business other than those contemplated by the proposed transactions and subsequent transactions.

PROPOSED TRANSACTIONS

13. Lossco will incorporate Newco under the BCA. Newco will have a XXXXXXXXXX taxation year-end and will be a taxable Canadian corporation. Newco's authorized capital will consist of one class of an unlimited number of common shares (the "Newco Common Shares") and one class of an unlimited number of preferred shares (the "Newco Preferred Shares") which will include the following attributes:

(1) the Newco Common Shares will be voting; and

(2) the Newco Preferred Shares will be

(a) non-voting;

(b) redeemable and retractable, for an amount equal to the amount for which they were issued and any unpaid dividends which have accumulated prior to their redemption or retraction; and

(c) entitled to an annual cumulative dividend at a rate of XXXXXXXXXX% calculated on the amount for which they were issued and will have a preference on dissolution over the Newco Common Shares for the return of their redemption amount plus unpaid dividends.

14. Lossco will subscribe for XXXXXXXXXX Newco Common Shares for $XXXXXXXXXX on the incorporation of Newco.

15. Lossco will borrow amounts on a daylight basis to a maximum total amount of $XXXXXXXXXX (the "Daylight Loan"). Lossco may borrow the Daylight Loan in a series of draws on an existing credit facility. Accordingly, the steps described in this paragraph and in paragraphs 16 to 19 below may be repeated as necessary to obtain a total amount equal to the amount of the Daylight Loan. The amount of the Daylight Loan will not exceed the maximum amount that Lossco could borrow from an arm' s length lender.

16. Lossco will lend proceeds from the Daylight Loan to Profitco on a demand basis (the "Profitco Demand Loan"). As evidence for such indebtedness, Profitco will issue to Lossco a demand promissory note bearing an interest rate of XXXXXXXXXX%. Based on Profitco's financial projections, it has the financial capacity to pay the interest on the Profitco Demand Loan from its own cash flow. For greater certainty, for the purposes of the foregoing sentence, Profitco's cash flow will be considered to include the dividends it will receive from the Newco Preferred Shares. The interest charged on the Profitco Demand Loan will not create or increase a non-capital loss in Profitco which will be carried forward beyond a time period that the non-capital losses of Lossco would have been utilized by Lossco.

17. Profitco will use the proceeds of the Profitco Demand Loan to subscribe for Newco Preferred Shares having an aggregate FMV, PUC, stated capital for the purposes of the BCA and redemption and retraction amounts equal to the amount subscribed. The dividends on the Newco Preferred Shares will be paid at least annually. The dividends will be funded by capital contributions made by Lossco as described below.

18. Newco will lend the proceeds from the issuance of the Newco Preferred Shares to Lossco on an interest-free demand basis (the "Lossco Demand Loan").

19. Lossco will use the proceeds from the Lossco Demand Loan to repay the Daylight Loan.

20. Lossco will agree to make contributions of capital to the common share capital of Newco at least annually in a total amount equal to the amount of the dividends to be paid by Newco on the Newco Preferred Shares as long as such shares are outstanding. The contributions of capital will not be income of Newco pursuant to generally accepted accounting principles. Lossco will no longer be required to make such contributions of capital where Newco is no longer paying dividends to Profitco.

21. Newco will use the amount received as contributions of capital to pay dividends on the Newco Preferred Shares to Profitco at least annually.

SUBSEQUENT TRANSACTION

21A. Lossco may undertake transactions materially identical to the transactions described above to consolidate losses with profitable wholly-owned subsidiaries other than Profitco. In these subsequent transactions, Lossco may use Newco for the same function that it performs in the proposed transactions described above.

22. Lossco and Profitco will unwind the structure created by the transactions described above and any structure or structures created by the transactions described in the previous paragraph. In connection with the unwinding, Lossco will cause Newco to be wound-up and the Lossco Demand Loan will be cancelled.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to allow the consolidation of profits and losses within an affiliated group of taxable Canadian corporations. The consolidation is achieved by allowing Lossco to earn investment income that is sheltered by its accumulated non-capital losses, and by allowing Profitco to reduce its income for tax purposes by the interest expense incurred under the Profitco Demand Loan.

RULINGS

Provided that the above statements constitute a complete and accurate disclosure of all the relevant facts, purposes of the proposed transactions and proposed transactions, we rule as follows:

A. As a result of the payment of the dividends by Newco to Profitco as described above:

(1) The dividends received by Profitco will be taxable dividends and Profitco will be required to include the dividends in computing its income pursuant to paragraph 12(1)(j) of the Act, and Profitco will be entitled to deduct the dividends in computing its taxable income for the year in which the dividend is received pursuant to subsection 112(1); and

(2) for greater certainty, none of subsections 112(2.1), (2.2), (2.3) and (2.4) will apply to deny the subsection 112(1) deduction in respect of such dividends.

B. No tax will be payable under either section 187.2 or section 191.1 in respect of the dividends that Newco will pay to Profitco because the dividends will be "excepted dividends" within the meaning assigned by paragraph (b) of the definition of "excepted dividend" in section 187.1 and "excluded dividends" within the meaning of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

C. Provided that the Newco Preferred Shares continue to be held by Profitco, Profitco will be entitled to deduct, pursuant to paragraph 20(1)(c), interest paid or payable in the year on the Profitco Demand Loan, depending on the method regularly followed by Profitco in computing its income for the purposes of the Act, to the extent that the interest is reasonable in the circumstances.

D. Profitco will be entitled to carry-back and deduct from its taxable income for the taxation year ending XXXXXXXXXX, the non-capital loss incurred in its taxation year, ending XXXXXXXXXX, as described in paragraph 6 above, within the limits provided in paragraph 111(1)(a).

E. No amount will be included in the income of Newco pursuant to paragraphs 12(1)(c) or 12(1)(x), or section 9 in respect of the capital contributions made or required to be made by Lossco to Newco as described in paragraph 20 above.

F. Subsections 15(1), 56(2), 69(1), 69(4), 69(11) and 246(1) will not apply to the proposed transactions.

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

The above 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 Canada Customs and Revenue Agency provided that the proposed transactions are completed before 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 Canada Customs and Revenue Agency has agreed to or reviewed:

(a) the determination of the adjusted cost base, the paid-up capital or FMV of any shares referred to herein; or

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

For example, we are not commenting on the tax consequences of the transaction described in paragraphs 21A and 22 above.

Yours truly,

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