2003 Ruling 2003-0037453 - 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:

Loss consolidation carried out several times within related group

Position:

Similar to earlier rulings, with the exception that the full amount will not be borrowed up front and there will be a series of investments in preferred shares of Lossco and loans to Profitco using Profitco's current line of credit in order to minimize bank fees.

Reasons: ITA

XXXXXXXXXX 							2003-003745

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above taxpayers, as well as your letters of XXXXXXXXXX and our (XXXXXXXXXX) telephone conversations.

To the best of your knowledge and that of the taxpayers involved, the proposed transactions will not impact the ability of the taxpayers involved to pay their existing tax liabilities.

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

(i) dealt with in an earlier return 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 the taxpayers or a related person;

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

(iv) subject to a ruling previously issued by the Income Tax Rulings Directorate; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

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 and the regulations thereunder are referred to as the "Regulations";

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

(c) "CBCA" means the 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) "Guarantee agreement" has the meaning assigned by subsection 112(2.2);

(g) "Holdings" refers to XXXXXXXXXX;

(h) "Investment tax credit" ("ITC") has the meaning assigned by subsection 127(9);

(i) "Lossco" refers to XXXXXXXXXX;

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

(k) "Numberco" refers to XXXXXXXXXX;

(l) XXXXXXXXXX;

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

(n) "Principals" means XXXXXXXXXX;

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

(p) "Products A" means XXXXXXXXXX;

(q) "Products B" means XXXXXXXXXX;

(r) "Profitco" refers to XXXXXXXXXX;

(s) "Proposed transactions" means the transactions described in Paragraphs 14 - 18 below;

(t) "Public corporation" has the meaning assigned by subsection 89(1);

(u) "Related persons" has the meaning assigned by section 251.

(v) "Specified financial institution" has the meaning assigned by subsection 248(1);

(w) "Taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(x) "Taxable dividend" has the meaning assigned by subsection 89(1).

(y) "TC" means Taxation Centre;

(z) "TSO" means Tax Services Office.

STATEMENT OF FACTS

1. Lossco was incorporated on XXXXXXXXXX and has a year end for tax purposes of XXXXXXXXXX. Lossco files its tax returns at the XXXXXXXXXX TC and is serviced by the XXXXXXXXXX. Lossco's federal tax account number is XXXXXXXXXX.

2. Lossco operates a business whose principal business activities include research, development, manufacturing, and sales of Products A. XXXXXXXXXX % of Lossco's salaries and wages and gross revenue are generated in XXXXXXXXXX.

3. Lossco's issued share capital consists of:

XXXXXXXXXX Class A common shares
XXXXXXXXXX Preferred shares
XXXXXXXXXX Class A preferred shares

These class A common shares, preferred shares and class A preferred shares are voting. Principals, who are Canadian residents, own XXXXXXXXXX of the class A common shares each, totaling XXXXXXXXXX shares. Principals hold XXXXXXXXXX% of the voting shares of, and control, Lossco.

4. Pursuant to an agreement dated XXXXXXXXXX entered into between Lossco and Profitco, a transfer of assets (the "Assets") from the division of Profitco that would now be carried on by Lossco was received by Lossco pursuant to subsection 85(1). The price for Assets was their fair market value, which Profitco and Lossco agreed was $XXXXXXXXXX, and was paid as follows: non-share consideration of $XXXXXXXXXX and XXXXXXXXXX preferred shares of Lossco with a stated capital of $XXXXXXXXXX was paid for and/or issued to Profitco. The amount agreed to by Lossco and Profitco in their subsection 85(1) elections was $XXXXXXXXXX.

5. Lossco has the following non-capital losses generated in the years identified:

XXXXXXXXXX.

Lossco's projected non capital loss for XXXXXXXXXX is approximately $XXXXXXXXXX. Lossco also has an ITC closing balance at XXXXXXXXXX of $XXXXXXXXXX.

6. Profitco was incorporated on XXXXXXXXXX under the CBCA and continued on XXXXXXXXXX. Profitco has a year end for tax purposes of XXXXXXXXXX. Profitco's federal tax account number is XXXXXXXXXX. Profitco files its tax returns at the XXXXXXXXXX TC and is serviced by the XXXXXXXXXX TSO. Profitco amalgamated with XXXXXXXXXX.

Profitco has the following taxable income generated in the years identified:

XXXXXXXXXX.

Profitco's projected taxable income for XXXXXXXXXX is approximately $XXXXXXXXXX.

7. Profitco operates a business whose principal business activities include developing, wholesale, and retail sales of Products B. Profitco files federal income tax returns as well provincial income tax returns in multiple provinces of Canada. In XXXXXXXXXX% of the salaries and wages and XXXXXXXXXX% gross revenue was generated in XXXXXXXXXX.

8. Profitco's issued share capital consists of XXXXXXXXXX common shares. The common shares are voting shares and Holdings holds all XXXXXXXXXX common shares. Holdings controls Profitco.

9. Holdings was incorporated on XXXXXXXXXX under the CBCA and amended its articles on XXXXXXXXXX.

10. Holdings is a company that holds investments in subsidiaries and owns land and buildings that are mostly rented to its subsidiaries.

11. Holdings's issued share capital consists of XXXXXXXXXX common shares which are owned as follows:

XXXXXXXXXX XXXXXXXXXX
XXXXXXXXXX XXXXXXXXXX
XXXXXXXXXX XXXXXXXXXX
XXXXXXXXXX

Therefore, XXXXXXXXXX owns XXXXXXXXXX% of the outstanding voting shares of Holdings and, therefore, controls Holdings.

12. Numberco is a holding company. It's issued share capital and shareholders are as follows:

Principals XXXXXXX Class A special shares
Principals XXXXXXX Class B special shares
XXXXXXXX XXXXXXX Common shares

13. The class A special shares are non-voting. The class B special shares and the common shares are voting. Principals hold XXXXXXXXXX% of the voting shares and control Numberco.

PROPOSED TRANSACTIONS

14. A new class of preferred shares, Class B preferred shares (the "Lossco Preferred Shares"), will be created in Lossco. The Lossco Preferred Shares will be:

a) non-participating and non-voting;

b) entitled to an annual dividend rate, applied to the redemption amount of the shares. The dividend rate will be fixed by the Board of Directors;

c) redeemable at any time at the option of the corporation for an amount equal to the aggregate of the redemption amount and any unpaid dividends;

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; and

e) the redemption amount is equal to $XXXXXXXXXX per share.

15. Profitco has an additional short- to medium-term borrowing capacity of $XXXXXXXXXX.

Profitco will not borrow $XXXXXXXXXX due to the additional bank fees that would be payable. Instead, Profitco will borrow funds (the "Cash Proceeds") from up to the maximum amount ($XXXXXXXXXX) of its present demand-revolving loan (operating loan), which is currently available to Profitco through its XXXXXXXXXX. These funds will be used by Profitco to invest in Lossco Preferred Shares. The dividends to be paid on the Lossco Preferred Shares will be fixed at approximately XXXXXXXXXX% of the rate of interest charged on the Profitco Loan.

16. Lossco will receive the Cash Proceeds as consideration for the issuance of the Lossco Preferred Shares to Profitco. Lossco will loan the Cash Proceeds to Profitco (the "Profitco Loan"). The Profitco Loan will be evidenced by a promissory note and Profitco will have a legal obligation to pay interest pursuant to this promissory note at a rate of interest, of XXXXXXXXXX%. Profitco will repay the demand-revolving loan described in Paragraph 15.

17. As the current line of credit is at approximately $XXXXXXXXXX, the transactions described in Paragraphs 15 & 16 will be repeated XXXXXXXXXX times, over a period of XXXXXXXXXX days as follows. On Day 1, Profitco will borrow $XXXXXXXXXX to invest in Lossco Preferred Shares. Lossco will then loan the $XXXXXXXXXX to Profitco at a rate of interest of XXXXXXXXXX% and this will be evidenced by a promissory note. Profitco will repay the demand-revolving loan. On Day 2, Profitco will borrow $XXXXXXXXXX to invest in additional Lossco Preferred Shares. Lossco will then loan the $XXXXXXXXXX to Profitco at a rate of interest of XXXXXXXXXX% and this will be evidenced by another promissory note. Profitco will repay the demand-revolving loan. This will occur in the same manner on Days XXXXXXXXXX.

18. The transaction is not unwound before repeating each borrowing. The steps are only repeated to arrive at the total borrowing of $XXXXXXXXXX. The preferred shares and the promissory notes will remain in place for at least a year until a total of $XXXXXXXXXX of the losses and tax credits of Lossco for the period from XXXXXXXXXX to XXXXXXXXXX (approximately XXXXXXXXXX% of Lossco's losses and tax credits for that period) have been used. [$XXXXXXXXXX is the amount of interest that a $XXXXXXXXXX loan would have generated over a period of one year.]

ADDITIONAL INFORMATION

19. Lossco, Holdings, Profitco, and Numberco are neither specified financial institutions nor financial intermediary corporations.

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

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(2.3)(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).

21. Lossco and Profitco are affiliated persons.

22. Lossco and Profitco are related persons.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to enable Lossco to earn sufficient interest income, over a period of approximately one year, to utilize most of it's accumulated non-capital losses and other tax attributes. Profitco will obtain an interest deduction to be used against its taxable income. The funds are to be borrowed from the operating loan or line of credit to be able to facilitate the tracing of the use of the borrowed funds.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties on pages 1 and 2 of this advance income tax ruling, as well as 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 set forth below:

A. Provided that Profitco has a legal obligation to pay interest on the Profitco Loan, and Profitco continues to hold the Lossco Preferred Shares, Profitco 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 Profitco in computing its income for purposes of the Act) in respect of the year on the Profitco Loan or (ii) a reasonable amount in respect thereof.

B. 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.

CAVEATS

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R5 (the "Circular") issued by the CCRA on May 17, 2002, and are binding provided the Proposed Transactions described in paragraphs 14 to 17 above are completed on or before XXXXXXXXXX.

These rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act. In particular, on October 31, 2003, the Department of Finance released draft proposal regarding the deductibility of interest and other expenses. The proposals are intended to have effect for taxation years beginning after 2004.

Nothing in this letter should be construed as implying that the CCRA has agreed to or accepted:

(i) the cost or fair market value of any property referred to in this letter;

(ii) the GST implications of any of the proposed transactions;

(iii) any other tax consequences of the proposed transactions or of related transactions or events that are not described herein.

Yours truly,

XXXXXXXXXX
for Director
Financial Industries Division
Income Tax Rulings Directorate