2004 Ruling 2004-0091391R3 - 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.

Principal Issues: Standard loss-consolidation

XXXXXXXXXX 2004-009139

XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. In XXXXXXXXXX provided additional information concerning the facts and proposed transactions described in your original letter. We also acknowledge the information provided during our various telephone conversations.

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

(i) in an earlier return of one 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 one of the taxpayers or a related person;

(iii) under objection by one 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.

Definitions

In this letter, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act, 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, subparagraph or clause is a reference to the relevant provision of the Act;

(b) "adjusted cost base" has the meaning assigned by section 54;

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

(d) "associated corporations" has the meaning assigned by subsection 256(l);

(e) "BCA" means the XXXXXXXXXX Business Corporations Act, and, where applicable, its predecessor statutes;

(f) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

(g) "dividend refund" has the meaning assigned by subsection 129(1);

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

(i) "FMV" represents fair market value which means the highest price available in an open and unrestricted market between informed prudent parties acting at arm's length and under no compulsion to act and contracting for a taxable purchase and sale;

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

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

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

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

(n) "proposed transactions" means the transactions described in paragraphs 6 to 13;

(o) "RDTOH" means refundable dividend tax on hand as that expression is defined in subsection 129(3);

(p) "related persons" has the meaning assigned by subsection 251(2);

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

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

(s) "stated capital" has the meaning assigned by the provisions of the BCA;

(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 relevant facts, proposed transactions and purpose of the proposed transactions is as follows:

Facts

1. XXXXXXXXXX ("Lossco") is a taxable Canadian corporation and a Canadian-controlled private corporation. Lossco was incorporated under the BCA on XXXXXXXXXX. Lossco is a resident of Canada for the purposes of the Act.

Lossco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns are filed at the XXXXXXXXXX Taxation Centre. The fiscal and taxation year-end of Lossco is XXXXXXXXXX.

The issued and outstanding share capital of Lossco consists of XXXXXXXXXX voting common shares ("Lossco Common Shares"), of which

(a) XXXXXXXXXX are held by XXXXXXXXXX ("Individual A");

(b) XXXXXXXXXX are held by XXXXXXXXXX ("Individual B");

(c) XXXXXXXXXX are held by XXXXXXXXXX .("Xco"); and

(d) XXXXXXXXXX are held by XXXXXXXXXX .("Yco").

The Lossco Common Shares entitle the holder to have one vote per share at all meetings of the shareholders.

Individual A, Individual B, Xco and Yco subscribed for their Lossco Common Shares from Lossco's treasury shortly after Lossco was incorporated.

The adjusted cost base to each of Individual A, Individual B, Xco and Yco of their Lossco Common Shares is $XXXXXXXXXX per share.

Individual A, Individual B, Xco, Yco and Lossco are not related persons in respect of each other.

Lossco is in the business of XXXXXXXXXX and has experienced operating losses in recent years. As at XXXXXXXXXX, Lossco had

(i) aggregate assets of $XXXXXXXXXX;
(ii) aggregate debts of $XXXXXXXXXX;
(iii) an accumulated deficit of $XXXXXXXXXX; and
(iv) non-capital losses of $XXXXXXXXXX  which were incurred in the following years:
(I) XXXXXXXXXX  		 	$XXXXXXXXXX
(II) XXXXXXXXXX  		 	$XXXXXXXXXX   

It is anticipated that Lossco will incur additional non-capital losses in the amount of $XXXXXXXXXX in its XXXXXXXXXX taxation year prior to any claim for capital cost allowance.

As at XXXXXXXXXX Lossco was indebted to XXXXXXXXXX. ("Profitco") in the amount of $XXXXXXXXXX, of which only $XXXXXXXXXX was interest bearing (as evidenced by two promissory notes, one at a rate of bank prime plus XXXXXXXXXX% and the other at a rate of bank prime plus XXXXXXXXXX%).

Lossco does not have any balance in its RDTOH. It is expected that Lossco will not have any balance in its RDTOH at the end of each of its XXXXXXXXXX taxation years.

You have represented that the XXXXXXXXXX Lossco Common Shares owned by Individual A, Individual B, Xco and Yco have a fair market value of $XXXXXXXXXX, as Lossco has an accumulated deficit and its aggregate liabilities exceeded the aggregate FMV of its assets. Consequently, none of the payments of the dividends on the Lossco Preference Shares as described in paragraph 12 and subparagraph 13(b) below will reduce any gains accrued on those Lossco Common Shares.

2. Profitco is a taxable Canadian corporation and a Canadian-controlled private corporation. Profitco was incorporated under the provisions of the BCA on XXXXXXXXXX. Profitco is a resident of Canada for the purposes of the Act.

Profitco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns are filed at the XXXXXXXXXX Taxation Centre. The fiscal and taxation year-end of Profitco is XXXXXXXXXX.

The issued and outstanding share capital of Profitco consists of two common shares, of which one is owned by XXXXXXXXXX . ("Bco") and the other is owned by Individual A.

Profitco carries on a XXXXXXXXXX business. In its XXXXXXXXXX taxation year, Profitco earned taxable income of $XXXXXXXXXX . It is anticipated that Profitco will earn taxable income of between $XXXXXXXXXX and $XXXXXXXXXX per year in its XXXXXXXXXX and subsequent taxation years.

Individual A, Individual B, Xco, Yco and Profitco are not related persons in respect of each other.

Profitco and Lossco have always filed their federal corporate tax returns as associated corporations.

3. Bco is a taxable Canadian corporation and a Canadian-controlled private corporation. Bco was incorporated under the provisions of the BCA on XXXXXXXXXX Individual B owns XXXXXXXXXX% of the issued and outstanding voting common shares of Bco. Individual B controls Bco.

4. XXXXXXXXXX ("Loanco") is a taxable Canadian corporation and a Canadian-controlled private corporation. Loanco was incorporated under the provisions of the BCA on XXXXXXXXXX. Individual A owns all of the issued and outstanding shares of Loanco.

As at XXXXXXXXXX, Loanco had aggregate assets of $XXXXXXXXXX and aggregate debts of $XXXXXXXXXX. Loanco currently has over $XXXXXXXXXX in liquid assets.

5. You have represented that Individual A and Individual B have always acted in concert to control Profitco and Lossco, as they have always made joint decisions and voted their shares in Profitco and Lossco together in all matters relating to the business operations of Profitco and Lossco. Consequently, Profitco and Lossco are affiliated persons and related persons.

Proposed Transactions

Each of the proposed transactions will occur in the order presented below.

6. The articles of incorporation of Lossco will be amended to create one class of an unlimited number of class D preference shares ("Lossco Preference Shares") which will be

(a) voting (one vote per share);

(b) redeemable and retractable at a redemption amount of $XXXXXXXXXX per share plus any unpaid dividends which have accumulated prior to their redemption or retraction; and

(c) entitled to an annual cumulative dividend of XXXXXXXXXX% on the redemption amount and will have a preference on dissolution over all outstanding common shares with respect to the unpaid dividends.

7. Profitco will borrow an amount of $XXXXXXXXXX from Loanco on a daylight basis (the "Daylight Loan1"), which amount will be based on and will not exceed its credit facilities and borrowing capacity.

8. Profitco will use the proceeds of the Daylight Loan1 to subscribe for XXXXXXXXXX Lossco Preference Shares having an aggregate FMV and redemption and retraction amounts equal to $XXXXXXXXXX. The adjusted cost base to Profitco of the Lossco Preference Shares will be equal to $XXXXXXXXXX.

Pursuant to the applicable provisions of the BCA, the amount to be added to the stated capital of Lossco in respect of the issue of the Lossco Preference Shares will be equal to $XXXXXXXXXX.

The dividends on the Lossco Preference Shares will be paid on an annual basis.

The XXXXXXXXXX Lossco Preference Shares issued by Lossco to Profitco will constitute

(a) more than 10% but less than 50% of the issued share capital of Lossco having full voting rights under all circumstances; and

(b) more than 10% of the FMV of all of the issued shares of the capital stock of Lossco.

9. Lossco will lend the proceeds from the subscription of the Lossco Preference Shares to Profitco on a demand basis ("Lossco Demand Loan"). As evidence for such indebtedness, Profitco will issue to Lossco a demand promissory note with a principal amount and FMV equal to $XXXXXXXXXX and bearing a commercial interest rate of XXXXXXXXXX% per annum ("Profitco Note"), which rate will not be less than the rate which Profitco would pay to an arm's-length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms.

10. Profitco will use the proceeds from the Lossco Demand Loan to repay the Daylight Loan1.

11. Profitco will make annual interest payments on the Profitco Note. The interest expense that will be deducted by Profitco in a particular taxation year in respect of the Profitco Note will not contribute to a non-capital loss of Profitco for the particular taxation year.

12. Lossco will use the amount received as interest payments on the Profitco Note described in paragraph 11 above plus its internal funds from its operations to pay the annual XXXXXXXXXX% dividends on the Lossco Preference Shares held by Profitco.

13. Once sufficient income has been earned by Lossco to fully utilize its non-capital losses, and on a particular day but no later than XXXXXXXXXX:

(a) Profitco will pay the balance of any accrued and unpaid interest on the Profitco Note to be repaid under paragraph (c) below.

(b) Lossco will pay the balance of any accrued and unpaid dividends on the Lossco Preference Shares to be redeemed under paragraph (d) below.

(c) Profitco will use its internal funds from its operations, and if necessary, will obtain a daylight loan from Loanco (the "Daylight Loan2") to repay the Profitco Note held by Lossco, which Daylight Loan2 amount will be based on and will not exceed Profitco's credit facilities and borrowing capacity.

(d) Lossco will use the proceeds from the repayment of the Profitco Note under paragraph (c) above to redeem the Lossco Preference Shares held by Profitco at FMV, which amount will be equal to their aggregate redemption amounts and adjusted cost base, being $XXXXXXXXXX.

(e) Profitco will use the proceeds from the redemption of its Lossco Preference Shares under paragraph (d) above to repay the Daylight Loan2.

Additional Information

14. None of the corporations referred to herein is or will be, at any time before the completion of the proposed transactions as described herein, a specified financial institution or a restricted financial institution.

15. None of the Lossco Preference Shares to be issued, as described in the proposed transactions, 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);

(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; or

(e) will be issued or acquired as part of a transaction or event or series of transactions or events of the type described in subsection 112(2.5).

16. None of the corporations described above is or will be, at any time before the completion of the proposed transactions described above, a corporation described in any of the paragraphs (a) to (f) of the definition "financial intermediary corporation" in subsection 191(1) of the Act.

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

Purpose of the Proposed Transactions

18. The purpose of the proposed transactions is to consolidate profits and losses within an affiliated group by enabling Lossco to earn sufficient interest income to deduct its non-capital losses that it would otherwise incur or expire in its XXXXXXXXXX and subsequent taxation years.

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 follows:

A. Provided that Profitco has a legal obligation to pay interest on the Profitco Note, issued in the transaction described in paragraph 9 above, and that Profitco continues to hold the Lossco Preference Shares, described in paragraph 8 above, for the purpose of producing income (other than exempt income), Profitco will, to the extent that such amount does not exceed a reasonable amount, be entitled to deduct, in computing its income for a taxation year, an amount paid in the year or payable in respect of the year (depending on the method regularly followed by Profitco in computing its income for purposes of the Act) as interest on the Profitco Note in respect of that taxation year pursuant to subsection 20(3) and paragraph 20(1)(c) of the Act.

B. The taxable dividends received by Profitco as described in paragraph 12 and subparagraph 13(b) above,

(a) will be deductible by Profitco pursuant to subsection 112(1) in computing its taxable income for the year in which such dividends are received, and such deduction will not be prohibited by any of subsections 112(2.1), (2.2), (2.3) or (2.4);

(b) provided that Lossco is not entitled to a dividend refund in respect of its taxation year in which such taxable dividends are paid, will not be subject to Part IV tax under subsection 186(1) in respect of such taxable dividends; and

(c) will not be subject to tax under Parts IV.1 and VI.1 of the Act.

C. The provisions of subsection 55(2) will not apply to the taxable dividends referred to in ruling B above, received by Profitco on its Lossco Preference Shares.

D. On the redemption by Lossco of the Lossco Preference Shares held by Profitco as described in subparagraph 13(d) above,

(a) no dividend will be deemed to have been paid by Lossco and received by Profitco under subsection 84(3) of the Act; and

(b) no gain or loss will be realized or incurred by Profitco.

E. The provisions of 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 above.

These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 issued by Canada Revenue Agency ("CRA") on May 17, 2002 and are binding on the CRA provided that the proposed transactions, other than those described in paragraphs 11 to 13, are completed by XXXXXXXXXX.

The above rulings are based on the Act in its present form 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

Nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(a) the FMV 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 losses of Lossco referred to herein; and

(c) 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 Planning Branch