2004 Ruling 2003-0049361R3 - 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.

Principal Issues: XXXXXXXXXX

Position: The loss utilization is acceptable.

Reasons: The ruling is consistent with our position in previous rulings and with Department of Finance policy. XXXXXXXXXX .

XXXXXXXXXX 2003-004936

XXXXXXXXXX, 2004

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 corporations will be referred to as follows:

XXXXXXXXXX Profitco
XXXXXXXXXX Lossco
XXXXXXXXXX Numco1
XXXXXXXXXX Numco2
XXXXXXXXXX Numco3

Profitco files its corporate income tax returns at the XXXXXXXXXX Tax Centre and its tax affairs are administered by the XXXXXXXXXX Tax Services Office. Lossco files its corporate income tax returns at the XXXXXXXXXX Tax Centre and its tax affairs are administered by the XXXXXXXXXX Tax Services Office. Profitco and Lossco are resident in Canada for the purposes of the Act.

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

(i) 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 confirmed that the proposed transactions described herein 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) "BCA" means the Canada Business Corporations Act and, where applicable, its predecessor statutes;

(d) "CRA" means the Canada Revenue Agency;

(e) "Canadian development expense" ("CDE") has the meaning assigned by subsection 66.2(5);

(f) "Canadian exploration expense" ("CEE") has the meaning assigned by subsection 66.1(6);

(g) "cumulative Canadian development expense" has the meaning assigned by subsection 66.2(5);

(h) "cumulative Canadian exploration expense" has the meaning assigned by subsection 66.1(6);

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

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

(k) "guarantee agreement" has the meaning assigned by subsection 112(2.2);

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

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

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

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

(p) "proposed transactions" means the transactions described in Paragraphs 10 to 17 below;

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

(r) "restricted financial institution" has the meaning assigned by subsection 248(1);

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

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

(u) "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. Profitco is a public corporation and a taxable Canadian corporation governed by the BCA. It has a taxation year-end of XXXXXXXXXX.

2. XXXXXXXXXX. As described in detail below, Profitco directly and indirectly owns all of the issued and outstanding shares of Lossco.

3. Based on XXXXXXXXXX, it is expected that Profitco will be taxable in XXXXXXXXXX.

4. Profitco owns all XXXXXXXXXX issued and outstanding common shares of Numco1. Numco1 is a taxable Canadian corporation governed by the BCA. It has a taxation year-end of XXXXXXXXXX.

5. Profitco owns all XXXXXXXXXX issued and outstanding common shares of Numco2. Numco2 is a taxable Canadian corporation governed by the BCA. It has a taxation year-end of XXXXXXXXXX.

6. Profitco owns all XXXXXXXXXX issued and outstanding common shares of Numco3. Numco3 is a taxable Canadian corporation governed by the BCA. It has a taxation year-end of XXXXXXXXXX.

7. Lossco is a taxable Canadian corporation governed by the laws of XXXXXXXXXX. It has a taxation year-end of XXXXXXXXXX. Lossco has XXXXXXXXXX issued and outstanding Class A common shares (the "Class A Common Shares"), of which XXXXXXXXXX are owned by Numco1, XXXXXXXXXX are owned by Numco2, XXXXXXXXXX are owned by Numco3, and XXXXXXXXXX are owned by Profitco, and XXXXXXXXXX issued and outstanding Class B common shares (the "Class B Common Shares"), all of which are owned by Profitco. Lossco also has XXXXXXXXXX issued and outstanding series A preferred shares, all of which are owned by Profitco.

8. XXXXXXXXXX.

9. As at XXXXXXXXXX, Lossco estimates that it has tax pools comprised of $XXXXXXXXXX of cumulative Canadian exploration expense, $XXXXXXXXXX of cumulative Canadian development expense, and $XXXXXXXXXX of non-capital losses realized in previous taxation years. It is anticipated that there will be audit adjustments to these pools. Lossco also has successor Canadian exploration expense and Canadian development expense in the amounts of $XXXXXXXXXX and $XXXXXXXXXX, respectively, which cannot be applied to reduce interest income earned by Lossco by virtue of subsections 66.7(3) and (4), respectively.

PROPOSED TRANSACTIONS

10. Lossco will amend its articles to create a new class of preferred shares (the "Preferred Shares"). The Preferred Shares will be:

(a) non-voting;

(b) redeemable and retractable, subject to applicable law, at any time for an amount equal to the amount for which they were issued; and

(c) entitled to an annual non-cumulative dividend on the amount for which they were issued at a rate that is XXXXXXXXXX greater than the interest rate on the Daylight Loan, described in Paragraph 11 below, and will have a preference on dissolution over the Class A Common Shares and Class B Common Shares for the return of the redemption amount plus unpaid dividends.

11. Profitco will borrow the amount of $XXXXXXXXXX from one or more arm's length Canadian financial institutions on a daylight basis (the "Daylight Loan"), which amount will be based on and will not exceed its credit facilities and borrowing capacity. A letter dated XXXXXXXXXX, from XXXXXXXXXX provides confirmation that Profitco has the ability to borrow $XXXXXXXXXX at XXXXXXXXXX% on a demand basis from an arm's length lender.

12. Profitco will use the proceeds of the Daylight Loan to subscribe for Preferred Shares of Lossco having an aggregate ACB and fair market value, as well as aggregate redemption and retraction amounts of $XXXXXXXXXX. Pursuant to the applicable provisions of the CBCA, the amount to be added to the stated capital of Lossco in respect of the issuance of the Preferred Shares will be $XXXXXXXXXX.

13. Lossco will pay annual dividends on the Preferred Shares held by Profitco.

14. Lossco will lend the proceeds from the subscription for the Preferred Shares to Profitco on an interest-bearing demand basis (the "Lossco Loan"). As evidence of the indebtedness, Profitco will issue to Lossco a demand promissory note with a principal amount and fair market value of $XXXXXXXXXX and bearing an interest rate of XXXXXXXXXX% per annum, which rate is not greater than the rate that Profitco would pay to an arm's length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms. The interest rate specified in the promissory note may vary, depending on the interest rates in effect at the time the transactions are carried out.

15. Profitco will use the proceeds from the Lossco Loan to repay the Daylight Loan.

16. The interest expense that will be deducted by Profitco in a particular taxation year in respect of the Lossco Loan described in Paragraph 14 above will not, based on current estimates, contribute to a non-capital loss of Profitco for a particular taxation year.

17. In the event that Lossco earns sufficient income to fully use its cumulative Canadian exploration expense, cumulative Canadian development expense, and non-capital losses:

(a) Lossco will pay the balance of any accrued and unpaid dividends on the Preferred Shares to be redeemed under Paragraph 17(c) below;

(b) Profitco will pay the balance of any accrued and unpaid interest on the Lossco Loan to be repaid under Paragraph 17(d) below;

(c) Lossco will redeem the Preferred Shares at fair market value, which amount will be equal to the aggregate of their redemption amounts, being $XXXXXXXXXX, and will issue a promissory note as evidence of its obligation to make payment in the amount of $XXXXXXXXXX to Profitco (the "Promissory Note"); and

(d) Profitco and Lossco will agree to set-off the Lossco Loan against the Promissory Note, and the set-off will constitute payment in full of the Lossco Loan and the Promissory Note in the amounts of $XXXXXXXXXX, respectively.

ADDITIONAL INFORMATION

18. None of the corporations referred to herein is or will be, at any time before the completion of the proposed transactions, a restricted financial institution or a financial intermediary corporation. Profitco and Lossco will each be a specified financial institution.

19. None of the shares referred to herein, including the shares to be issued as described in the proposed transactions, are or will be, at any time prior to the completion 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(2.4)(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) held on condition that it or property substituted therefor may revert or pass to Profitco or a person to be determined by Profitco.

20. Profitco will have the financial capacity to honour, upon presentation of a demand for payment, the amount payable under the Lossco Loan.

21. None of the proposed transactions will have a significant impact on any outstanding tax liabilities of Profitco or Lossco.

22. None of the purposes of paying the dividends described in the proposed transactions will be to effect a significant reduction in the portion of the capital gain that, but for the dividends, would have been realized on a disposition at fair market value of any of the shares referred to herein immediately before the payment of the dividends. The sole purpose of Lossco paying dividends on the Preferred Shares is to satisfy their terms and conditions.

PURPOSE OF THE PROPOSED TRANSACTIONS

23. The purpose of the proposed transactions is to consolidate profits and losses within a related group by enabling Lossco to earn sufficient interest income to deduct its various tax pools, including cumulative Canadian exploration expense, cumulative Canadian development expense and non-capital losses.

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. Provided that Profitco has a legal obligation to pay interest on the Lossco Loan, described in Paragraph 14 above, and that Profitco continues to hold the Preferred Shares, described in Paragraph 12 above, for the purpose of producing income (other than exempt income), Profitco will be entitled to deduct in computing its income for a taxation year, an amount payable as interest on the Lossco Loan in respect of that taxation year pursuant to subsection 20(3) and paragraph 20(1)(c), to the extent that such amount does not exceed a reasonable amount.

B. The dividends received by Profitco, described in Paragraph 13 above, will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of Profitco for the year in which such dividends are received, and, for greater certainty, such deduction will not be prohibited by any of subsections 112(2.1), (2.2), (2.3) or (2.4).

C Profitco will not be subject to Part IV.1 tax under section 187.2 in respect of the dividends received from Lossco, described in Paragraph 13 above, because such dividends will be excepted dividends by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

D. Lossco will not be subject to Part IV.1 tax under section 191.1 in respect of the dividends paid to Profitco, described in Paragraph 13 above, because such dividends will be excluded dividends by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

E. 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 B 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).

F. The provisions of subsections 15(1) and 246(1) will not apply to the proposed transactions described in Paragraphs 12 through 17 above, in and by themselves.

G. 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 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 Revenue Agency has agreed to, reviewed or has made any determination in respect of:

(a) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(b) the amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein;

(c) the provincial income tax implications relating to the allocation of income and expenses under the proposed transactions;

(d) the application or non-application of the general anti-avoidance provisions of any province; and

(e) any other 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 Planning Branch

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