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: Are losses still available on an acquisition of control.
Position: Question of fact but yes in this situation.
Reasons: The law.
XXXXXXXXXX 2004-008895
XXXXXXXXXX, 2004
Dear XXXXXXXXXX:
Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling Request
This is in reply to your letter of XXXXXXXXXX, as modified by your correspondence dated XXXXXXXXXX and your other correspondence, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are:
(i) in an earlier return of any of the taxpayers or a related person;
(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") 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, if a judgment has been issued, the time limit for appeal to a higher court has expired; or
(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.
The taxpayers have also represented that the proposed transactions described herein will not result in any taxpayer described herein being unable to pay its existing outstanding tax liabilities.
DEFINITIONS:
In this letter, unless otherwise specified, all monetary amounts are expressed in Canadian dollars and the following terms have the meanings specified below:
(a) "Act" means the Income Tax Act, R.S.C. 1986 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision, and the Income Tax Regulations thereunder are referred to as the "Regulations";
(b) "affiliated persons" has the meaning assigned by subsection 251.1(1);
(c) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);
(d) "CBCA" means the Canada Business Corporations Act;
(e) "CRA" means Canada Revenue Agency;
(f) "Lossco" means XXXXXXXXXX;
(g) "non-capital loss" has the meaning assigned by subsection 111(8);
(h) "Paragraph" refers to a numbered paragraph in this advance income tax ruling;
(i) "Profitco" means XXXXXXXXXX;
(j) "Proposed Transactions" means the transactions described in Paragraphs 20 to 26; and
(k) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).
FACTS
1. Lossco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated pursuant to the CBCA on XXXXXXXXXX. Lossco's CRA tax account number is XXXXXXXXXX and it files its tax returns with the XXXXXXXXXX TC and otherwise deals with the XXXXXXXXXX TSO. There are approximately XXXXXXXXXX shareholders in Lossco, who own common shares and/or preferred shares in the share capital of Lossco (the "Lossco Shareholders").
2. The taxation year-end of Lossco is XXXXXXXXXX.
3. XXXXXXXXXX (the "Lossco Business").
4. XXXXXXXXXX.
5. XXXXXXXXXX. The aforementioned intellectual property forms part of Lossco's business operations and is collectively referred to hereinafter as the "Lossco Intellectual Property".
6. XXXXXXXXXX. The other assets of Lossco include XXXXXXXXXX buildings, certain equipment, a pick-up truck and all the issued and outstanding shares in XXXXXXXXXX inactive corporations, XXXXXXXXXX. The property owned by Lossco other than the Lossco Intellectual Property is hereinafter referred to as the "Fixed Assets".
7. Since its incorporation in XXXXXXXXXX, Lossco has incurred non-capital losses which, as of XXXXXXXXXX, totalled approximately $XXXXXXXXXX. Approximately $XXXXXXXXXX of these non-capital losses are expected to expire at the end of Lossco's current taxation year.
8. All of Lossco's non-capital losses have been incurred by Lossco from the carrying on of the Lossco Business which includes the development and sale of the Lossco Properties.
9. As of XXXXXXXXXX, Lossco had unused scientific research and experimental development (SR&ED) investment tax credits in the amount of $XXXXXXXXXX and SR&ED expenditures which were not deducted in prior taxation years in the amount of $XXXXXXXXXX. These amounts relate entirely to the Lossco Business.
10. Profitco is a taxable Canadian corporation and a Canadian-controlled private corporation incorporated pursuant to the CBCA. Profitco's CRA tax account number is XXXXXXXXXX and it files its tax returns with the XXXXXXXXXX TC and otherwise deals with the XXXXXXXXXX TSO.
11. The taxation year-end of Profitco is XXXXXXXXXX.
12. Profitco is also in the business of XXXXXXXXXX.
13. Lossco and Profitco are not "related persons" as defined in subsection 251(2) and they deal with each other at arm's length for purposes of the Act. Further, neither Lossco and Profitco are affiliated persons before Profitco acquires the shares of Lossco as described in Paragraph 23 below and that none of the Lossco Shareholders are affiliated persons with Profitco at any time.
14. In XXXXXXXXXX, Lossco decided that it would require arm's-length parties in the XXXXXXXXXX business to assist it in the further commercialization of the Lossco Properties.
15. In XXXXXXXXXX, Lossco entered into various agreements with Profitco which essentially gave Profitco the exclusive right to distribute the Lossco Properties. Pursuant to a Master Purchase and Licensing Agreement, Profitco acquired certain assets used in the Lossco Business and under a Supply Agreement, Profitco agreed to purchase the XXXXXXXXXX from Lossco. Under the terms of a Licence Agreement, Profitco agreed to pay Lossco a XXXXXXXXXX% royalty on gross sales of the XXXXXXXXXX after XXXXXXXXXX and XXXXXXXXXX% of the gross revenues from the sales of the XXXXXXXXXX after XXXXXXXXXX. The sales by Lossco of the XXXXXXXXXX to Profitco as of XXXXXXXXXX amounted to $XXXXXXXXXX and Lossco earned royalties during that same period of approximately $XXXXXXXXXX.
16. XXXXXXXXXX.
17. After the agreements referred to in Paragraph 15 were entered into, Lossco allocated resources to document the improvements to be made to the existing XXXXXXXXXX in terms of efficiency, quality control and safety. Lossco also expended funds to finalize the design specifications of the new XXXXXXXXXX in preparation for its construction.
18. Since XXXXXXXXXX, Profitco has continued to carry on the commercialization process relating to the Lossco Properties.
19. Lossco has entered into a plan of arrangement ("Plan of Arrangement") under section 192 of the CBCA concerning the transactions described in Paragraphs 20 to 23 under the heading Proposed Transactions described below. For the Plan of Arrangement to become effective, XXXXXXXXXX% of the total votes cast on the resolution by the Lossco Shareholders are needed to approve of the Plan of Arrangement.
PROPOSED TRANSACTIONS
20. A new corporation ("Newco") will be incorporated pursuant to the CBCA. Newco will be a taxable Canadian corporation and a Canadian-controlled private corporation. The authorized capital of Newco will consist of a class of common shares (the "Class A Common Shares"). The holder of each Class A Common Share will have the right to: (i) dividends as and when declared by the board of directors of Newco; (ii) the remaining property and assets of Newco upon the dissolution, liquidation or winding-up of Newco; and (iii) receive notice and to attend all meetings of the shareholders of Newco and shall have one (1) vote for each Class A Common Share held by such holder. No shares of Newco will be issued on incorporation. One of the Lossco Shareholders will loan $XXXXXXXXXX to Newco on the incorporation of Newco. Unless otherwise indicated the following Proposed Transactions will take place in the order presented below.
21. On or about XXXXXXXXXX (the "Closing Date"), each Lossco Shareholder will sell his or her common shares and/or preferred shares of Lossco to Newco for consideration consisting of a number of Class A Common Shares of Newco and $XXXXXXXXXX in cash. Specifically, one (1) Class A Common Share of Newco will be issued in exchange for each common share of Lossco so transferred and XXXXXXXXXX Class A Common Shares of Newco will be issued in exchange for each preferred share of Lossco so transferred. The Class A Common Shares of Newco issued by Newco to each of the Lossco Shareholders will have an aggregate fair market value equal to the aggregate fair market value of such shareholder's common shares and preferred shares of Lossco so transferred less the $XXXXXXXXXX in cash received by such shareholder from Newco. The purpose for Newco issuing cash consideration on each such transfer is to prevent the automatic application of section 85.1 of the Act. As a result of the acquisition of all the issued and outstanding shares of Lossco by Newco described herein, Newco will control Lossco.
22. On the Closing Date, Lossco will sell ("sale") the Lossco Patents and all intellectual properties other than those specifically and exclusively related to the Lossco Business and the Fixed Assets (collectively referred to hereinafter as the "Disposed Assets") to Newco for a purchase price equal to the aggregate fair market value at that time of the Disposed Assets. Newco will assume all the liabilities of Lossco and issue a non-interest bearing demand promissory note ("Promissory Note 1") to Lossco as consideration for the Disposed Assets. The principal amount and fair market value of the Promissory Note 1 will be equal to the aggregate fair market value of the Disposed Assets so transferred to Newco less the amount of the said assumed liabilities of Lossco. After the sale, Lossco will continue to own the Lossco Trademarks, certain plans and specifications relating to the new XXXXXXXXXX as described in Paragraphs 16 and 17 above and the knowhow, goodwill and trade secrets relating specifically and exclusively to the Lossco Business. Lossco's right to royalties from Profitco pursuant to the Licence Agreement described in Paragraph 15 above will not be assigned to Newco and will remain payable to Lossco pursuant to the terms of the Licence Agreement and therefore will be extinguished on the amalgamation of Lossco and Profitco as described in Paragraph 24 below.
23. On the Closing Date, Profitco will acquire all the issued and outstanding shares of Lossco (the "Purchased Shares") from Newco for a purchase price equal to the aggregate fair market value at that time of the Purchased Shares. As consideration, Profitco will issue a non-interest bearing demand promissory note ("Promissory Note 2") to Newco having a principal amount and fair market value equal to the principal amount and fair market value of the Promissory Note 1. The balance of the purchase price will be paid in cash, being approximately $XXXXXXXXXX on the Closing Date and the balance on the first anniversary thereof. As a result of the acquisition of all the issued and outstanding shares of Lossco by Profitco described herein, Profitco will control Lossco.
24. On the Closing Date, Lossco and Profitco will amalgamate ("Amalgamation") to form a new corporation pursuant to subsection 184(1) of the CBCA in such a manner that:
(a) all of the property (except amounts receivable from any predecessor corporation or shares of the capital stock of any predecessor corporation) of the predecessor corporations immediately before the Amalgamation becomes property of the amalgamated corporation by virtue of the Amalgamation;
(b) all of the liabilities (except amounts payable to any predecessor corporation) of the predecessor corporations immediately before the Amalgamation become liabilities of the amalgamated corporation by virtue of the Amalgamation; and
(c) all of the shareholders (except any predecessor corporation), who owned shares of the capital stock of any predecessor corporation immediately before the Amalgamation, receive shares of the capital stock of the amalgamated corporation because of the Amalgamation.
The amalgamated corporation (hereinafter referred to as "Amalco") will retain the Profitco name. Following the Amalgamation, Newco and Amalco will enter into an amended and restated licence agreement (the "Amended and Restated Licence Agreement") which will include the following terms:
(d) Newco will grant to Amalco a perpetual and exclusive licence for the use of the Lossco Patents as required by Amalco for the purposes of exclusively and directly carrying on the Lossco Business without restrictions and without further royalties being paid or payable to Newco; and
(e) Amalco will be allowed to research and improve on the Lossco Patents relating to the Lossco Business. Any invention or improvement resulting from such research that is developed by Amalco will belong to Amalco.
Amalco and Newco will also enter into an amended and restated supply agreement (the "Amended and Restated Supply Agreement") providing for the obligation of Amalco to build its own XXXXXXXXXX by no later than XXXXXXXXXX and for the purchase by Amalco of the XXXXXXXXXX from Newco during the interim period. Amalco will complete the construction of its own XXXXXXXXXX using the plans and specifications as described in Paragraph 22 on or before XXXXXXXXXX. In the event that Amalco has not completed the construction of its own XXXXXXXXXX by XXXXXXXXXX, it will acquire the existing XXXXXXXXXX as described in Paragraph 6 above from Newco on or before that date, so that it will start to produce its own XXXXXXXXXX.
25. Amalco will continue to carry on the Lossco Business for profit or with a reasonable expectation of profit. No election will be made pursuant to subsection 256(9) of the Act in respect of the acquisition of the shares of Lossco by Profitco as described in Paragraph 23 above and no effective time will be specified in the certificate of amalgamation obtained in respect of the Amalgamation described in Paragraph 24 above.
26. The principal amount owing by Amalco to Newco under the Promissory Note 2 will be set-off against the principal amount owing by Newco to Amalco under the Promissory Note 1 such that each such note will be cancelled in full satisfaction of the obligations under each such note.
PURPOSE OF THE PROPOSED TRANSACTIONS
27. The Lossco Shareholders have decided to sell the Lossco Business to Profitco which will continue the Lossco Business for profit. The Lossco Shareholders, however, would like to develop the Lossco Patents using the know-how acquired in developing the Lossco Intellectual Property. Newco will retain the Lossco Patents and all intellectual properties other than those specifically and exclusively related to the Lossco Business in order to develop XXXXXXXXXX/Product and non-Lossco Business applications such as the development of products used to XXXXXXXXXX. Profitco will thus acquire all issued and outstanding shares of Lossco from Newco. The purpose for the Lossco Shareholders selling their shares to Newco before such shares are sold to Profitco, instead of having such shareholders sell their Lossco shares directly to Profitco, is that it facilitates the sale of Lossco since under the Plan of Arrangement only XXXXXXXXXX% of the total votes cast on the resolution by the Lossco Shareholders are needed to approve the sale and the representations and warranties on the sale only need to be provided by one shareholder, being Newco. Moreover, this allows the amount owing to Lossco by Newco under the Promissory Note 1 to be set-off in full against the amount owing to Newco by Profitco under the Promissory Note 2 after the amalgamation of Lossco and Profitco to form Amalco.
RULINGS
Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, Proposed Transactions and the 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 Amalco completes the construction of its own XXXXXXXXXX or acquires the existing XXXXXXXXXX from Newco as described in Paragraph 24 by no later than XXXXXXXXXX and the Lossco Business, described in Paragraphs 3 and 4 above, is carried on by Amalco for profit or with a reasonable expectation of profit throughout a particular taxation year ending after the acquisition of control of Lossco by Profitco, as described in Paragraph 23 above, and the Amalgamation described in Paragraph 24 above, and subject to the time limitations set out in paragraph 111(1)(a), the restrictions set out in subsection 111(3), and any other requirements of the Act regarding deductibility of non-capital losses, the non-capital loss of Lossco as determined pursuant to subsection 111(8), will be a non-capital loss of Amalco by reason of subsection 87(2.1) and may be deducted by Amalco under paragraph 111(5)(a) in computing its taxable income for that particular taxation year to the extent of the total of:
(i) the income earned by Amalco for that particular year from carrying on the Lossco Business; and
(ii) the income earned by Amalco for that particular year from carrying on any other business substantially all of the income of which is derived from the sale by Amalco of the Profitco Properties as described in Paragraph 12 above.
B. Provided that the principal amount and fair market value of the Promissory Note 1 held by Amalco is equal to the principal amount and fair market value of the Promissory Note 2 held by Newco at the time of the set-off and cancellation as described in Paragraph 25 above, such set-off and cancellation will not give rise to a "forgiven amount" within the meaning of subsection 80(1) or 80.01(1).
C. Subsection 245(2) will not be applied as a result of the Proposed Transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.
The above Rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on CRA 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 and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.
Nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:
(a) the paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein;
(b) the amount of non-capital losses, unused SR&ED investment tax credits or SR&ED expenditures of Lossco;
(c) the availability of Lossco's unused SR&ED investment tax credits or SR&ED expenditures (i) to Lossco, on the acquisition of control of Lossco by Newco as described in Paragraph 21 above, (ii) to Lossco, on the acquisition of control of Lossco by Profitco as described in Paragraph 23 above; and (iii) to Amalco, on the Amalgamation described in Paragraph 24 above; and
(d) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, 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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