2003 Ruling 2003-0044293 - LOSS CONSOLIDATION INTEREST DEDUCTIBILITY

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

Position: Similar to previous loss consolidations

Reasons: ITA

XXXXXXXXXX 								2003-004429

XXXXXXXXXX, 2003

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX
Two New Corporations to be incorporated under the Companies Act of 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 submissions of XXXXXXXXXX.

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) "ACB" means "adjusted cost base" and has the meaning assigned by section 54;

(b) "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";

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

(d) "agreed amount" means the amount agreed on in respect of a property in an election filed pursuant to subsection 85(1);

(e) "Canco" means XXXXXXXXXX;

(f) "CCRA" means the Canada Customs and Revenue Agency;

(g) "Corporate Act" means the Companies Act of XXXXXXXXXX \;

(h) "capital cost allowance" refers to the deduction allowed under paragraph 20(1)(a);

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

(j) "FMV" means fair market value;

(k) "Lossco" means XXXXXXXXXX. Lossco was incorporated as OldCo under the Corporate Act in XXXXXXXXXX. OldCo was subsequently renamed to XXXXXXXXXX;

(l) "Newco #1 Preferred Shares" means the preferred shares described in paragraph 15;

(m) "Newco #2 Note" means the promissory note in Paragraph 18,

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

(o) "OldCo" means XXXXXXXXXX;

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

(q) "Proposed Transactions" means the transactions described in Paragraphs 15 to 20;

(r) "Province" means XXXXXXXXXX;

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

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

(u) XXXXXXXXXX;

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

(w) "Subco" means XXXXXXXXXX. Subco, formerly XXXXXXXXXX, was incorporated under the Corporate Act in XXXXXXXXXX;

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

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

(z) "TC" means Taxation Centre; and

(aa) "TSO" means Tax Services Office.

STATEMENT OF FACTS

1. Lossco is a public corporation and a taxable Canadian corporation and its shares are publicly traded on the XXXXXXXXXX Stock Exchange under the symbol XXXXXXXXXX.

2. Subco is a public company and a taxable Canadian corporation. Subco is Lossco's principal Canadian operating subsidiary, XXXXXXXXXX.

Following a share for share exchange on XXXXXXXXXX, Subco became a wholly owned subsidiary of Oldco (now Lossco).

3. XXXXXXXXXX.

4. XXXXXXXXXX.

5. Lossco, through its holdings in Subco and various other Canadian and US partnerships and subsidiaries, is a XXXXXXXXXX company.

6. Lossco and all of its subsidiaries have XXXXXXXXXX as a taxation year-end, file tax returns at the XXXXXXXXXX TC and are serviced by the XXXXXXXXXX TSO. Lossco's federal tax account number is XXXXXXXXXX.

7. As at XXXXXXXXXX, Subco has issued and outstanding XXXXXXXXXX common shares, and XXXXXXXXXX Preferred Shares.

8. All of Subco's common shares are held by Lossco. All Subco's preference shares are held by the public.

9. The Subco common shares have an ACB to Lossco of $XXXXXXXXXX and the aggregate PUC of these shares is $XXXXXXXXXX.

10. It is estimated that Subco will pay annual dividends to its common share holder(s) in the range of $XXXXXXXXXX for years XXXXXXXXXX.

11. As a result of significant interest expense incurred on third party loans used to invest in subsidiaries and significant business development costs incurred in XXXXXXXXXX, Lossco has $XXXXXXXXXX in accumulated non-capital losses as at XXXXXXXXXX. It is estimated that Lossco will continue to incur non-capital losses in years subsequent to XXXXXXXXXX in the range of $XXXXXXXXXX per year. The existing non-capital losses are set to expire as follows:

Year Amount
XXXXXXXXXX
12. As at XXXXXXXXXX Subco has $XXXXXXXXXX in accumulated non-capital losses. It is projected that Subco will have an annual amount of income for tax purposes in the range of $XXXXXXXXXX for years XXXXXXXXXX

Subco has $XXXXXXXXXX of assets. Subco's total capitalization as at XXXXXXXXXX is $XXXXXXXXXX and its debt as at XXXXXXXXXX is $XXXXXXXXXX . Subco has established credit facilities of $XXXXXXXXXX for long term debt and $XXXXXXXXXX for short term debt. As of XXXXXXXXXX, Subco has drawn $XXXXXXXXXX of the available $XXXXXXXXXX short term credit facility.

13. The head office and location of all books and records of Lossco and all of its Canadian subsidiaries is XXXXXXXXXX.

14. All of Lossco's and Subco's income is earned in the Province, for purposes of Part IV of the Regulations.

PROPOSED TRANSACTIONS

15. Lossco will incorporate Newco #1 under the Corporate Act. The authorized share capital of Newco #1 will consist of XXXXXXXXXX common shares (the "Newco #1 Common Shares") and XXXXXXXXXX redeemable and retractable preferred shares (the "Newco #1 Preferred Shares").

The Newco #1 Preferred Shares will have rights and restrictions as follows:

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

b) the shares will be entitled to an annual cumulative dividend rate, applied to the redemption amount of the shares (described in Paragraph 16), equal to the rate of interest charged on the Newco #2 Note plus XXXXXXXXXX%.

c) The shares will be redeemable and retractable at any time for an amount equal to the redemption amount described in Paragraph 17a, plus any unpaid dividends.

Lossco will subscribe for one common share of Newco #1 for a nominal amount.

16. Lossco will incorporate Newco #2 under the Corporate Act. The authorized share capital of Newco #2 will consist of XXXXXXXXXX common shares. Lossco will subscribe for one common share of Newco #2 for a nominal amount.

17. XXXXXXXXXX, Lossco will transfer XXXXXXXXXX% of the common shares of Subco to Newco #1 and as consideration therefor, Newco #1 will issue the following shares to Lossco:

a) Newco #1 Preferred Shares with a redemption amount equal to the ACB of the common shares of Subco so transferred to Newco #1 (estimated to be approximately $XXXXXXXXXX), and

b) Newco #1 Common Shares for the balance of the FMV of the transferred shares.

Lossco and Newco #1 will jointly elect under subsection 85(1) in prescribed form and manner and within the time allowed by subsection 85(6). The agreed amount for the purpose of the election will not be less than the lesser of the FMV of the Subco common shares transferred and their ACB amount.

18. Lossco will then transfer all of its Newco #1 Preferred Shares to Newco #2 in exchange for 1 common share of Newco #2 and a promissory note (the "Newco #2 Note") equal to the amount of the ACB of the Newco #1 Preferred Shares less $XXXXXXXXXX (estimated to be approximately $XXXXXXXXXX). The terms of the Newco #2 Note will be as follows:

a) The Newco #2 Note will bear a fixed rate of interest based on market rates of interest charged on indebtedness having similar terms and risk (Lossco's long term lending rate to subsidiaries is based on XXXXXXXXXX year Government of Canada bonds plus XXXXXXXXXX basis points);

b) Interest will be payable annually;

c) The terms of the Newco #2 Note will provide that repayment may be at any time for the full amount outstanding, including accrued interest; and

d) The terms of the Newco #2 Note will provide that it may not be transferred or assigned other than as described in Paragraph 20c.

Lossco and Newco #2 will jointly elect under subsection 85(1) in prescribed form and manner and within the time allowed by subsection 85(6). The agreed amount for the purpose of the election will not be less than the lesser of the FMV of the Newco #1 Preferred Shares transferred and their ACB amount.

19. Each year, the following transactions will be completed:

a) Newco #1 will receive XXXXXXXXXX% of the taxable dividend declared and paid on the common shares of Subco;

b) The cash flow received by Newco #1 will be used to pay dividends on the Newco #1 Preferred Shares. Any excess cash flow will be used to pay dividends on its common shares;

c) The cash flow received by Newco #2 will first be used to pay interest on the Newco #2 Note. Any remaining cash flow will be used to pay dividends on its common shares.

20. After XXXXXXXXXX years, or on or before XXXXXXXXXX, the following transactions will be completed:

a) Newco #1 will pay the balance of any accrued and unpaid dividends on the Newco #1 Preferred Shares,

b) Newco #2 will pay the balance of any accrued and unpaid interest on the Newco #2 Note,

c) Newco #2 will sell the Newco #1 Preferred Shares to Lossco. In consideration therefore, Lossco will assign the Newco #2 Note to Newco #2. The Newco #2 Note must be cancelled immediately after such assignment.

d) As a result of the transactions outlined in subparagraphs a) to c) Newco #2's assets will be nominal except for the value of its accumulated non-capital losses (estimated to be approximately $XXXXXXXXXX).

e) XXXXXXXXXX, Lossco will transfer at FMV all of its Newco #2 common shares described in Paragraphs 16 and 18 (the Newco #2 Common Shares") to Subco on a tax-deferred basis pursuant to subsection 85(1) in consideration for additional common shares of Subco with an equivalent FMV. Subco and Lossco will jointly elect, in prescribed form and manner and within the time allowed by subsection 85(6), to have the rules of subsection 85(1) apply. The agreed amount in respect of the Newco #2 Common Shares will not be less than the lesser of the FMV of the Newco #2 Common Shares transferred and their ACB amount at that time.

f) Newco #2 will then be wound up into Subco.

ADDITIONAL INFORMATION

21. Lossco and Subco are not specified financial institutions, and Newco #1 and Newco #2 will not be specified financial institutions.

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

a) the subject of a dividend rental arrangement; or

b) the subject of any undertaking described in paragraph 112(2.4)(a).

23. Lossco is an affiliated person of Subco and will be an affiliated person of each of Newco #1 and Newco #2.

PURPOSE OF THE PROPOSED TRANSACTIONS

24. The purpose of the proposed transactions is to utilize Lossco's non-capital losses to offset other income within the corporate group. The expected results of this transaction are:

a) Lossco will earn interest income on the Newco #2 Note which will serve to reduce its non-capital losses otherwise incurred;
b) Newco #2 will receive dividend income on its investment in Newco #1 Preferred Shares, providing the cash flow required to pay the interest on the Newco #2 Note issued to Lossco;

c) Newco #1 will have the financial capacity to pay the dividends on the Preferred Shares held by Newco #1 from its dividend income earned on the common shares of Subco transferred from Lossco (as described in paragraph 17).

25. The purpose of utilizing Newco #1 and Newco #2 is:

a) To facilitate the utilization of accumulated non-capital losses, XXXXXXXXXX;

b) XXXXXXXXXX Newco #2 could then be combined with another Lossco subsidiary where the losses could be used to shield income for tax purposes earned within such corporations;

26. Newco #1 will remain in existence for the purpose of providing Lossco the opportunity to repeat the transactions proposed in this Request through another newly formed subsidiary, say Newco #3, should further inter-corporate loss utilizations be necessary and subject to obtaining rulings from CCRA in respect of such possible transactions.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant warranties on page 1 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. Newco #2 will be entitled, pursuant to paragraph 20(1)(c), to deduct the interest paid or payable (depending on the method regularly followed by Newco #2 in computing its income for purposes of the Act) in respect of the year on the Newco #2 Note.

B. Subsection 112(2.3) will not apply to the dividends received by Newco #2 on the Newco #1 Preferred Shares.

C. Subparagraph 112(2.4)(b)(ii) will not apply to the dividends received by Newco #2 on the Newco #1 Preferred Shares.

D. 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.

CAVEAT

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 15 to 18 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.

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