2004 Ruling 2004-0100991R3 - Loss utilization

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: Whether "zero" spread loss utilization within affiliated group pf companies is acceptable.

Position: Yes.

Reasons: See Statement of Principal Issues.

XXXXXXXXXX 2004-010099

XXXXXXXXXX, 2004

Dear Sirs:

Re: XXXXXXXXXX ("Lossco")
XXXXXXXXXX ("Profitco")
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the information provided in subsequent correspondence and various telephone conversations. 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 the taxpayers or related persons;

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return of the taxpayers or related persons;

(iii) under objection by the taxpayers or related persons;

(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, unless otherwise specified, all monetary amounts are expressed in Canadian dollars and 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 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 of the Act;

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

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

(d) "Bank Loan" has the meaning assigned in paragraph 11 below;

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

(f) "Demand Loan" has the meaning assigned in paragraph 12 below;

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

(h) "fair market value" ("FMV") 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, expressed in terms of cash;

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

(j) "forgiven amount" has the meaning assigned by subsection 80(1) or subsection 80.01(1);

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

(l) "Interest-Free Loan" has the meaning assigned in paragraph 14 below;

(m) "net capital loss" has the meaning assigned by subsection 111(8);

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

(o) XXXXXXXXXX;

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

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

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

(s) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

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

(u) "stated capital" has the meaning assigned by XXXXXXXXXX or section 26 of the CBCA, as the case may be;

(v) "Subco" means the new corporation described in paragraph 9 below;

(w) "Subco Preferred Shares" has the meaning assigned in paragraph 10 below;

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

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

FACTS

1. Profitco is a taxable Canadian corporation and a private corporation. Profitco was incorporated under the XXXXXXXXXX and has a XXXXXXXXXX year end. Profitco's principal business address is XXXXXXXXXX. It deals with the XXXXXXXXXX tax services office and the XXXXXXXXXX taxation centre.

2. XXXXXXXXXX.

3. Lossco is a taxable Canadian corporation and a private corporation with a XXXXXXXXXX year end. Lossco's principal business address is XXXXXXXXXX. It deals with the XXXXXXXXXX tax services office and the XXXXXXXXXX taxation centre.

4. XXXXXXXXXX.

5. Lossco acts as a holding company that owns Profitco and, through Profitco, XXXXXXXXXX.

6. Lossco expects that its total indebtedness outstanding at XXXXXXXXXX will be approximately $XXXXXXXXXX.

7. The non-capital losses of Lossco were realized in the following years and in the following amounts:

Year of Origin Amount

XXXXXXXXXX

Lossco estimates that its non-capital losses in XXXXXXXXXX to be $XXXXXXXXXX. Lossco is not expected to utilize any of its losses. Profitco, however, is not in a loss position. Profitco projects that it will have profits in the next XXXXXXXXXX years in the aggregate amount of approximately $XXXXXXXXXX which should be sufficient to offset Lossco's losses. All of Lossco's losses and all of Profitco's income have been and will be allocated to XXXXXXXXXX for provincial tax purposes.

8. Lossco has been advised by its investment bankers, XXXXXXXXXX, that it has the capacity based on its current financial position, to borrow $XXXXXXXXXX. A letter from XXXXXXXXXX, provides confirmation that Lossco's borrowing capacity is approximately $XXXXXXXXXX.

PROPOSED TRANSACTIONS

9. Lossco will incorporate a new corporation under the CBCA ("Subco"). Subco will have a XXXXXXXXXX year-end and will be a taxable Canadian corporation. The authorized share capital of Subco will consist of an unlimited number of common shares without nominal or par value and an unlimited number of redeemable and retractable preferred shares (the "Subco Preferred Shares"). Lossco will subscribe for one common share of Subco for $XXXXXXXXXX on incorporation.

10. The Subco Preferred Shares will be:

(a) non-participating and non-voting;

(b) entitled to an annual cumulative dividend rate, applied to the redemption amount (as described in paragraph 13 below) of the shares, equal to the interest rate applicable to the Demand Loan. The dividend rate will be determined at the time of the implementation of the proposed transactions. The dividends accruing in a taxation year of Profitco will be payable as described in paragraph 13 below;

(c) redeemable at any time at the option of Subco for an amount equal to the redemption amount and any unpaid dividends, by Subco

i. paying cash equal to such amount or

ii. assigning the Interest-Free Loan to Profitco and paying cash equal to any unpaid dividends; and

(d) retractable at any time at the option of the holder for an amount equal to the aggregate redemption amount and any unpaid dividends by Subco, by Subco assigning the Interest-Free Loan to Profitco and paying cash equal to any unpaid dividends, unless Subco

i. pays cash equal to such amount; or

ii. sets off amounts owing under the Demand Loan against the redemption amount of the Subco Preferred Shares in circumstances where Subco has become the holder of the Demand Loan, and pays cash equal to any unpaid dividends.

The terms of the Interest-Free Loan and the Demand Loan will provide that if Profitco becomes the holder of the Interest-Free Loan, the Interest-Free Loan may, at the option of either Lossco or Profitco, be set off against the Demand Loan.

11. Lossco will borrow an amount not exceeding $XXXXXXXXXX on a daylight basis from an arm's length financial institution (the "Bank Loan").

12. Lossco will lend the proceeds received from the Bank Loan to Profitco on a subordinated demand basis (the "Demand Loan"). The Demand Loan will bear interest at a rate not in excess of the commercial rate applicable for such loan. The interest rate will be ultimately determined at the time the proposed transactions are entered into. Based on the information received from XXXXXXXXXX, Lossco's investment bankers, the interest rate is expected to be not greater than XXXXXXXXXX%. The terms of the Demand Loan will provide that repayment may be made in cash, by delivering the Subco Preferred Shares, or a set-off with the Interest-Free Loan.

13. Profitco will use the proceeds of the Demand Loan to subscribe for Subco Preferred Shares having an aggregate redemption amount and paid-up capital equal to the principal amount of the Demand Loan. Dividends on the Subco Preferred Shares will be paid on the same day that the interest on the Demand Loan is paid. The dividends will be funded by capital contributions made by Lossco to Subco.

14. Subco will lend the subscription proceeds received from the issuance of the Subco Preferred Shares to Lossco on an interest-free demand basis (the "Interest-Free Loan"). The terms of the Interest-Free Loan will allow Lossco to repay the Interest-Free Loan by assigning the Demand Loan to Subco. Lossco will use the proceeds from the Interest-Free Loan to repay the Bank Loan.

15. Lossco will agree to and will make contributions of capital to the Subco common share capital on the same day that the interest on the Demand Loan is paid, equal to the amount of dividends to be paid by Subco to Profitco in respect of the Subco Preferred Shares for so long as such Subco Preferred Shares are outstanding. The contributions of capital by Lossco to Subco will not be income to Subco pursuant to generally accepted accounting principles. Lossco will not be required to make such contributions of capital where Subco is no longer paying dividends to Profitco.

16. Subco will use amounts received as capital contributions from Lossco to pay dividends on the Subco Preferred Shares owned by Profitco.

17. Profitco will pay interest to Lossco on the Demand Loan.

18. Once Profitco or Lossco has decided to unwind the proposed transactions in whole or in part, but no later than XXXXXXXXXX:

(a) Lossco will make capital contributions to the common share capital of Subco equal to the amount of any accrued and unpaid dividends on the Subco Preferred Shares;

(b) Subco will declare and pay the balance of any accrued and unpaid dividends on the Subco Preferred Shares;

(c) Profitco will pay the balance of any accrued and unpaid interest on the Demand Loan;

(d) Subco will redeem all or a portion of the Preferred Shares held by Profitco and settle the amount owing on redemption by assigning a corresponding amount of the Interest-Free Loan to Profitco; and

(e) Profitco will repay all or a portion of the Demand Loan equal to the amount of the Subco Preferred Shares redeemed above by setting off the amount owing to Lossco with a corresponding amount of the Interest-Free Loan, and such portions of the Interest-Free Loan and the Demand Loan will be cancelled.

19. Once all of the Subco Preferred Shares held by Profitco have been redeemed and all of the Interest-Free Loan has been assigned to Profitco, as described above, Subco will be wound up into Lossco pursuant to section 211 of the CBCA.

ADDITIONAL INFORMATION

20. There are no significant transactions that are contemplated prior to the time of the proposed transaction and there are no transactions contemplated after the completion of the proposed transactions that are part of the series of transactions or events that includes the proposed transactions.

21. None of Profitco, Lossco or any corporation to which either is related is a specified financial institution or a financial intermediary corporation.

22. None of the issued shares referred to herein are or will be, at any time 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(2.4)(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) a share that is issued or acquired as part of a transaction or series of transactions or events of the type described in subsection 112(2.5).

23. Profitco and Lossco are affiliated persons.

24. Neither Lossco nor Profitco has any outstanding tax liabilities that could be affected by the proposed transactions.

25. Each of Lossco, Profitco, and Subco will agree that Subco will be a single purpose company, that Subco will have no liabilities, and that Subco will carry on no activities other than those contemplated by the proposed transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

The overall purpose of the proposed transactions is to enable Lossco to earn sufficient interest income, over a period of time, so as to utilize some or all of its non-capital losses. The purpose of making capital contributions to the common share capital of Subco, as described above (as opposed to subscribing for additional common shares of Subco), is to ensure that Subco will not be precluded from declaring dividends on the Subco Preferred Shares pursuant to section 42 of the CBCA. If additional common shares of Subco were issued, the realizable value of Subco's assets would be less than the aggregate of its liabilities and its stated capital of both common shares and Subco Preferred Shares.

RULINGS REQUESTED

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. The dividends received by Profitco, described in paragraphs 16 and 18(b) above, will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of the recipient for the year in which the dividend is received, and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) and 112(2.4).

B. Profitco will not be subject to Part IV.1 tax under section 187.2 in respect of the dividends received from Subco, described in paragraphs 16 and 18(b), by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

C. Subco will not be subject to Part VI.1 tax under section 191.1 in respect of the dividends it pays to Profitco, described in paragraphs 16 and 18(b), by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

D. Provided that Profitco has a legal obligation to pay interest on the Demand Loan and Profitco continues to hold the Subco 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 Demand Loan or (ii) a reasonable amount in respect thereof.

E. No amount will be included in the income of Subco pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) in respect of contributions of capital described in paragraphs 16 and 18(a) above.

F. The set-off of all or any part of the Interest-Free Loan against the corresponding amount of the Demand Loan will not give rise to a forgiven amount.

G. The provisions of subsection 88(1) will apply to the wind-up of Subco, as described above.

H. 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 paragraph 16 and 18(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).

I. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11), and 246(1) will not apply to the proposed transactions, in and by themselves.

J. Subsection 245(2) will not apply to the proposed transactions, in and by themselves, to re-determine the tax consequences confirmed herein.

The Rulings given are 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 before XXXXXXXXXX.

COMMENTS

Nothing in this ruling should be construed as implying that the Canada Revenue Agency has agreed to or reviewed:

(a) the determination of the adjusted cost base, paid-up capital or FMV of any shares or other property referred to herein; or

(b) any tax consequences relating to the facts and proposed transactions described herein other than those described in the rulings given above.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch