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: Loss utilization within a corporate group
Reasons: Meets the technical requirements of the provisions
Re: Advance Income Tax Ruling
This is in reply to your letter of XXXXXXXXXX requesting an advance income tax ruling on behalf of the above named corporations. We acknowledge further information supplied in your letters of XXXXXXXXXX and telephone conversations of XXXXXXXXXX In general terms, the transactions described herein involve the use of losses within a group of related corporations.
To the best of your knowledge and that of the taxpayers involved, none of the issues involved contained herein is:
(i) in an earlier return of the taxpayers or related persons,
(ii) being considered by a tax services office or taxation centre 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, and
(v) the subject of a ruling previously considered by the Directorate.
In this letter, the following terms have the meanings specified:
? "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof;
? "A Co" means XXXXXXXXXX, the corporation described in paragraph 1;
? "B Co" means XXXXXXXXXX, the corporation described in paragraph 2;
? "Bank" means XXXXXXXXXX;
? "B Co Loan" means the loan described in paragraph 11;
? "CBCA" means the Canada Business Corporations Act;
? "C Co" means XXXXXXXXXX, (formerly XXXXXXXXXX), described in paragraph 1;
? "CRA" means Canada Revenue Agency;
? "D Co" means XXXXXXXXXX company described in paragraph 1;
? "Newco" means an entity to be incorporated by A Co, described in paragraph 9;
? "non-capital losses" has the meaning assigned by subsection 111(8) of the Act;
? "Newco Preferred Shares" means the preferred shares described in paragraph 9;
? "Public corporation" has the meaning assigned by subsection 89(1) of the Act;
? "Related persons" has the meaning assigned by subsection 251(2) of the Act; and,
? "Taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act.
STATEMENT OF FACTS
1. A Co is incorporated under the CBCA and operates as a XXXXXXXXXX. It is a resident of Canada under the Act. A Co is owned by C Co, which is incorporated under XXXXXXXXXX legislation and is a resident of Canada for tax purposes. The ultimate parent of C Co is D Co, an XXXXXXXXXX company formerly listed on the XXXXXXXXXX stock exchange. The tax services office responsible for A Co is the XXXXXXXXXX Tax Services office, and A Co files its tax return at the XXXXXXXXXX Taxation Centre.
2. B Co is also incorporated under the CBCA and a resident of Canada under the Act. It is a wholly owned subsidiary of A Co. It also operates as a XXXXXXXXXX. The tax services office responsible for B Co is the XXXXXXXXXX Tax Services office, and B Co files its tax return at the XXXXXXXXXX Taxation Centre.
3. As at its taxation year-end -XXXXXXXXXX- A Co had accumulated non-capital losses in the amount of $XXXXXXXXXX. $ XXXXXXXXXX of the accumulated non-capital losses was incurred in XXXXXXXXXX and the balance is a carry forward from XXXXXXXXXX.
4. As a result of financial irregularities at its parent company in XXXXXXXXXX, A Co was required to re-finance itself in XXXXXXXXXX. The re-financing was completed with the Bank on XXXXXXXXXX. The costs of re-financing and higher interest expense associated with the new loans will result in A Co being in a tax loss position in XXXXXXXXXX and XXXXXXXXXX and possibly later years.
5. As part of the new credit agreement between A Co and the Bank, B Co is a guarantor under the agreement and its assets, excluding its accounts receivable, are provided as security under the agreement.
The Bank credit agreement calls for two facilities:
(a) A "repurchase credit facility" in the amount of $XXXXXXXXXX due XXXXXXXXXX, at a fixed interest rate of XXXXXXXXXX% payable quarterly.
(b) A "term facility" in the amount of $XXXXXXXXXX due XXXXXXXXXX, at floating interest rates based on bankers' acceptance rates plus XXXXXXXXXX% or Canadian prime rate plus XXXXXXXXXX%. This loan is subject to certain mandatory repayments based on annual cash flows.
Both of these loans replace existing debt that was used to finance the Canadian operations of A Co and B Co. A small portion of the original debt was used by A Co to invest in a wholly owned US subsidiary, which continues to be owned by A Co. This subsidiary used the funds to purchase shares of XXXXXXXXXX business, which also continues to be owned indirectly by A Co.
6. B Co is expected to be in a taxable position in XXXXXXXXXX and future years.
7. There are two existing inter company loans that B Co owes to A Co. These loans are as follows:
(a) A demand loan in the amount of $XXXXXXXXXX which bears interest at a rate of XXXXXXXXXX%, and
(b) A term loan in the amount of $XXXXXXXXXX bearing interest at XXXXXXXXXX% and due XXXXXXXXXX. Under the terms of this second loan, B Co can repay the principal amount on this loan in whole or in part at any time.
These intercompany loans were recently amended, however, the principal amount of these loans was not changed. The term loan's due date and interest rate was amended to agree with the Bank loans.
8. Based on its existing assets and financial projections, B Co will have the financial capacity to pay interest on the loans from A Co (as described below under "Proposed Transaction") from its own cash flow.
9. A Co will incorporate a new company ("Newco") under the CBCA. Newco will be a taxable Canadian corporation. Its year-end will be the same floating year-end as A Co and B Co - XXXXXXXXXX. The authorized capital of Newco will consist of two classes of shares: common shares and non-voting, cumulative dividend, redeemable/retractable preferred shares (the "Newco Preferred Shares"). The cumulative dividends payable on the preferred shares will be calculated at a rate equal to XXXXXXXXXX%.
10. The common shares of Newco will be issued to A Co for $XXXXXXXXXX.
11. A Co will borrow $XXXXXXXXXX on a "daylight loan" basis under its current credit facility and lend it to B Co (the "B Co loan") at an interest rate of XXXXXXXXXX%. This amount of borrowing is below the current credit capacity of A Co. The XXXXXXXXXX% interest rate is equal to the rate charged by the Bank on the repurchase credit facility. A Co will also lend $XXXXXXXXXX to B Co from its current cash resources at a XXXXXXXXXX% interest rate. Based on B Co's financial projections, it has the financial capacity to pay the interest on these loans from A Co from its own cash flow. B Co will use the sum of these two amounts ($XXXXXXXXXX) to subscribe for Newco Preferred Shares having an aggregate redemption/retraction price equal to $XXXXXXXXXX. The Newco Preferred Shares will have a dividend rate equal to XXXXXXXXXX%.
12. At the actual transaction date, the availability of funds under the credit facility and cash resources may be slightly different.
13. Newco will use the proceeds resulting from the issuance of the Newco Preferred Shares to make a $XXXXXXXXXX demand, interest free loan to A Co (the "Newco loan"). A Co will then re-pay the $XXXXXXXXXX daylight loan.
14. In every year while the Newco loan is outstanding, A Co will make a capital contribution to Newco (accounted for as contributed surplus) in an aggregate amount equal to the dividend payable by Newco for that year on the Newco Preferred Shares. Newco will use such funds to pay B Co the dividends due for that year with respect to its preferred shares. A Co and Newco will enter into a support agreement whereby A Co will agree to make the necessary capital contributions to Newco to fund the dividend payments.
15. Upon receipt of the preferred share dividend, B Co will pay A Co the interest due on the B Co loan.
16. At some time in the future, but within XXXXXXXXXX years when A Co's accumulated losses have been utilized, a "Debt Decreasing Transaction" will be implemented as follows:
(a) A Co will borrow on its credit facility (the "New Daylight Loan"). A Co will use these funds to pay down the Newco loan. Alternatively it will pay down the loan with its own available cash.
(b) Newco will use the funds received through step 1 to redeem the Newco Preferred Shares.
(c) B Co will use the proceeds from the Newco Preferred Shares redemption to pay down the B Co loan.
(d) A Co will use the funds received on the repayment of the B Co loan to pay down the New Daylight Loan if a New Daylight Loan is required to implement this transaction.
(e) Newco will then be wound-up into A Co.
17. The interest charged on the A Co loan will not create or increase a non-capital loss in B Co that will be carried forward by B Co and applied to reduce B Co's income for a taxation year that ends after the time that A Co's non-capital losses would have otherwise expired.
Purpose of the Proposed Transactions
The purpose of the Proposed Transactions is to consolidate profit and losses between a parent and its subsidiary enabling A Co to earn sufficient interest income on the loans to B Co to eliminate or reduce its losses incurred in earlier years and the losses expected to be incurred in XXXXXXXXXX and XXXXXXXXXX and possibly later years. Effectively, the Proposed Transactions permits the transfer of these additional expenses in part from A Co to B Co.
Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the transactions are completed as proposed, we rule as follows:
A. Provided that the Newco Preferred Shares continue to be held for the purpose of gaining or producing income from property, the interest paid or payable on the B Co Note of $XXXXXXXXXX will be deductible by B Co pursuant to paragraph 20(l)(c) of the Act to the extent that such amount does not exceed a reasonable amount.
B. Dividends received by B Co on the Newco Preferred Shares as described in paragraph 14 above will be taxable dividends and such dividends will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of the recipient corporation for the year in which the dividends are received.
C. Subsection 245(2) of the Act will not be applicable as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.
These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 issued by the CRA, and are binding provided the proposed transactions are completed, excluding paragraphs 16, by XXXXXXXXXX.
These rulings are based on the Act as it currently reads and do not take into account any future amendments, whether currently proposed or not to the Act.
1. Nothing in this ruling should be construed as implying that the CRA 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 tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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