2002 Ruling 2002-0158523 - Loss Utilization in a Related Group

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 utilization in a related group of companies.

Position: The loss utilization is acceptable.

Reasons: In accordance with our revised policy on interest deductibility, it is no longer necessary for the dividend rate on the preferred shares to be greater than the interest rate on the loan (a so-called "positive" spread), as had been customary in our previous loss utilization rulings. In this ruling, there is a "zero" spread, that is, the dividend rate on the preferred shares is equal to the interest rate on the loan.

XXXXXXXXXX 2002-015852

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 Topco
XXXXXXXXXX Opco
XXXXXXXXXX Holdco
XXXXXXXXXX Aco
XXXXXXXXXX Bco

Topco and Opco file their corporate income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office. Topco, Opco and Holdco 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 transactions described herein will not result in any taxpayer described herein being unable to pay its 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) "affiliated persons" has the meaning assigned by subsection 251.1(1);

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

(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 described in Paragraph 9 below;

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

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

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

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

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

(n) "Proposed Transactions" means the transactions described in Paragraphs 10 to 19 below;

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

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

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

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

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

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

FACTS

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

2. In addition to Holdco shares described in Paragraph 3 below, Topco holds a number of other significant investments including:

XXXXXXXXXX.

3. Holdco is a taxable Canadian corporation that was incorporated in XXXXXXXXXX under the CBCA. Holdco is a holding corporation which holds all of the common shares as well as some of the debt of Opco. As at XXXXXXXXXX , Holdco had outstanding XXXXXXXXXX. The XXXXXXXXXX common shares are voting and are all held by Topco. The XXXXXXXXXX common shares are voting and are all held by a trust (the "Trust"), the beneficiaries of which are affiliates of Aco and the trustee of which is Bco, a corporation incorporated under the laws of XXXXXXXXXX and controlled by Aco. The XXXXXXXXXX shares are non-voting and are all held by Topco.

4. On XXXXXXXXXX, Topco, Holdco and entities controlled by Aco reached a negotiated agreement that will lead to the repurchase by Topco of Aco's indirect interest in Holdco for approximately $XXXXXXXXXX. The repurchase of a XXXXXXXXXX% interest in Holdco closed on XXXXXXXXXX and a payment of $XXXXXXXXXX was made by Holdco to the Trust on XXXXXXXXXX.

Pursuant to the terms of the agreement, Topco had the option (the "Topco Option") to repurchase, and Aco has the option (the "Aco Option") to sell, the remaining XXXXXXXXXX common shares of Holdco, in either case, at an aggregate price of approximately $XXXXXXXXXX. The Topco Option could only be exercised between XXXXXXXXXX, and the Aco Option can only be exercised between XXXXXXXXXX. Topco exercised the Topco Option on XXXXXXXXXX and the transaction is expected to close on or before XXXXXXXXXX.

5. Opco is a public corporation, a taxable Canadian corporation and a subsidiary controlled corporation of Holdco which holds XXXXXXXXXX% of Opco's issued and outstanding common shares. Opco is governed by the CBCA. Opco also has outstanding preference shares, XXXXXXXXXX. All the preference shares are held by persons who are not related to Topco.

XXXXXXXXXX

6. In XXXXXXXXXX, Topco had taxable income of approximately $XXXXXXXXXX and paid tax of approximately $XXXXXXXXXX, but expects to generate net capital losses in XXXXXXXXXX in excess of $XXXXXXXXXX that it intends to carry back and apply against significant capital gains realized in XXXXXXXXXX. A carryback of such net capital losses would result in a reinstatement of non-capital losses of approximately $XXXXXXXXXX which had been applied to reduce taxable income in XXXXXXXXXX. In addition, Topco expects to generate non-capital losses in XXXXXXXXXX totalling approximately $XXXXXXXXXX.

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

8. Opco has paid regular XXXXXXXXXX common share dividends to Holdco since Holdco became the parent of Opco in XXXXXXXXXX (and previously to Topco). Taxable dividend payments by Opco on its common shares in the XXXXXXXXXX taxation years were $XXXXXXXXXX respectively. The current dividend policy of Opco 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. In turn, the policy of Holdco is that it will generally make distributions on its common shares in an aggregate amount equal to all dividends received from Opco and all other cash flows less principal and interest payments on Holdco's outstanding debts.

In order to reflect the fact that Topco's non-capital losses will effectively be used by Opco, it is intended that Opco will pay, in addition to its regular XXXXXXXXXX common share dividend, an additional amount of dividends to Holdco. The additional amount of dividends will reflect the estimated time utilization of the non-capital losses of Topco and other consideration and is estimated for the purposes of this ruling to be no more than XXXXXXXXXX% of the amount of the non-capital losses utilized in the year.

9. Holdco and certain of its subsidiary corporations, including Opco, are parties to particular tax loss consolidation transactions for which advance income tax rulings have been issued (Documents 2002-012381 dated XXXXXXXXXX, 2002, and 2000-003887 dated XXXXXXXXXX, 2000).

PROPOSED TRANSACTIONS

10. Topco will incorporate a new corporation, Newco, under the CBCA. Newco will have a XXXXXXXXXX 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 and redeemable and retractable preferred shares (the "Newco Preferred Shares").

The Newco Preferred Shares will be:

(a) non-participating and non-voting;

(b) entitled to an annual cumulative dividend rate, applied to the redemption amount of the shares, described in Paragraph 13 below, equal to the interest rate applicable to the Opco Demand Loan, described in Paragraph 12 below. 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 Newco for an amount equal to the aggregate of the redemption amount and any unpaid dividends, by Newco:

(i) paying cash equal to such amount;

(ii) assigning the Topco Demand Loan, issued under Paragraph 14 below, to Opco and paying cash equal to any unpaid dividends; or

(iii) setting-off amounts owing under the Opco Demand Loan against the redemption amount of the Newco Preferred Shares in circumstances where Newco has become the holder of the Opco Demand Loan, as described in Paragraph 14 below, and paying cash equal to any unpaid dividends; and

(d) retractable at any time at the option of the holder for an amount equal to the aggregate of the redemption amount and any unpaid dividends, by Newco assigning the Topco Demand Loan, issued under Paragraph 14 below, to Opco and paying cash equal to any unpaid dividends, unless Newco:

(i) pays cash equal to such amount; or

(ii) sets off amounts owing under the Opco Demand Loan against the redemption amount of the Newco Preferred Shares in circumstances where Newco has become the holder of the Opco Demand Loan, as described in Paragraph 14 below, and pays cash equal to any unpaid dividends.

The terms of the Topco Demand Loan and the Opco Demand Loan, described in Paragraph 12 below, will provide that if Opco becomes the holder of the Topco Demand Loan, the Topco Demand Loan can, at the option of either Topco or Opco, be set off against the Opco Demand Loan.

Topco will subscribe for one common share of Newco for $XXXXXXXXXX on incorporation.

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

12. Topco will lend the proceeds from the Daylight Loan to Opco on a subordinated demand basis (the "Opco Demand Loan"). The Opco Demand Loan will bear interest at a rate equal to the commercial market rate applicable for such a loan. 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 Opco Demand Loan will provide that repayment may be made in cash or by delivering a financial asset of Opco (including the Topco Demand Loan described in Paragraph 14 below).

Based on Opco's financial projections, it has the financial capacity to pay the interest on the Opco Demand Loan from its own cash flow (calculated as its net accounting income before depreciation and taxes). A letter dated XXXXXXXXXX, from XXXXXXXXXX provides confirmation that Opco has the ability to borrow up to an additional amount of $XXXXXXXXXX, above and beyond its current outstanding indebtedness of approximately $XXXXXXXXXX.

13. Opco will use the proceeds of the Opco Demand Loan to subscribe for Newco Preferred Shares having a redemption amount and paid-up capital equal to the principal amount of the Opco 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 Topco, as described in Paragraph 17 below.

14. Newco will lend the subscription proceeds received in Paragraph 13 above to Topco on an interest-free demand basis (the "Topco Demand Loan"). The terms of the Topco Demand Loan will allow Topco to repay the Topco Demand Loan by assigning the Opco Demand Loan (see Paragraph 12 above) to Newco.

15. Topco will use the proceeds from the Topco Demand Loan to repay the Daylight Loan.

16. Opco will pay interest to Topco on the Opco Demand Loan on an annual basis.

17. Topco will agree to, and will make contributions of capital to the Newco common share capital on an annual basis equal to the amount of dividends to be paid by Newco to Opco 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 19(b) below, will not be income of Newco pursuant to generally accepted accounting principles. Topco, however, will not be required to make such contributions of capital where Newco is no longer paying dividends to Opco.

18. Newco will use the amounts received as capital contributions, described in Paragraph 17 above, to pay dividends on the Newco Preferred Shares to Opco on an annual basis.

19. Once Topco has decided to unwind the Proposed Transactions in whole or in part:

(a) Opco will pay the balance of any accrued and unpaid interest on the portion of the Opco Demand Loan settled under Paragraph 19(e) below;

(b) Topco will make capital contributions to the common share capital of Newco 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 19(d) below;

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

(e) Opco will repay all or a portion of the Opco Demand Loan equal to the redemption amount of the Newco Preferred Shares redeemed under Paragraph 19(d) above by setting off the amount owing to Topco with a corresponding amount of the Topco Demand Loan and such portions of the Topco Demand Loan and the Opco Demand Loan will be cancelled; and

(f) Once all of the Newco Preferred Shares held by Opco have been redeemed and all of the Topco Demand Loan has been assigned to Opco, as described in Paragraph 19(d) and Paragraph 19(e) above, Newco will be wound up into Topco pursuant to subsection 210(3) of the CBCA.

ADDITIONAL INFORMATION

20. Topco, Opco and Newco are neither specified financial institutions nor financial intermediary corporations.

21. None of the issued shares referred to herein (including the shares to be issued as described in the Proposed Transactions) are or will be, at any time during the implementation of the Proposed Transactions described herein:

(a) the subject of any undertaking that is a guarantee agreement;

(b) the subject of a dividend rental arrangement;

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

(d) issued for consideration that is or includes:

(i) 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

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

22. Topco and Opco are affiliated persons.

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

PURPOSE OF THE PROPOSED TRANSACTIONS

24. The overall purpose of the Proposed Transactions is to enable Topco 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.

25. In order to undertake the Proposed Transactions in a legally effective manner, it is necessary to incorporate Newco, described in Paragraph 10 above, to enable Opco to hold an interest in Newco Preferred Shares, described in Paragraph 13 above. Under subsection 30(1) of the CBCA, Opco is precluded from acquiring and holding shares in Topco.

26. The purpose of making capital contributions to the common shares of Newco (as described in Paragraph 17 above) versus subscribing for additional common shares of Newco, 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 common shares, the realizable value of Newco's assets (the Topco Demand Loan) after the payment of a dividend would be less than the aggregate of its liabilities and its stated capital of both common shares and Newco Preferred Shares.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and 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 dividends received by Opco, described in Paragraphs 18 and 19(c) above, will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of the recipient 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. Opco will not be subject to Part IV.1 tax under section 187.2 in respect of the dividends received from Newco, described in Paragraphs 18 and 19(c) above, by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

C. Newco will not be subject to Part VI.1 tax under section 191.1 in respect of the dividends paid to Opco, described in Paragraphs 18 and 19(c) above, by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

D. Provided that Opco has a legal obligation to pay interest on the Opco Demand Loan, described in Paragraph 12 above, and Opco continues to hold the Newco Preferred Shares, described in Paragraphs 10 and 13 above, Opco 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 Opco in computing its income for purposes of the Act) in respect of the year on the Opco 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, paragraph 12(1)(c) or paragraph 12(1)(x) in respect of the contributions of capital described in Paragraph 17 and Paragraph 19(b) above.

F. The set-off of all or any part of the Topco Demand Loan against the corresponding amount of the Opco Demand Loan, described in Paragraph 19(e) above, 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 Ruling 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 wind-up of Newco described in Paragraph 19(f) above.

I. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11), and 246(1) will not apply to the Proposed Transactions described in Paragraphs 10 to 19 above, in and by themselves.

J. 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.

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 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

??