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 available after an acquisition of control?
Position: Question of fact - yes.
Reasons: Legislation
XXXXXXXXXX 2005-011346
XXXXXXXXXX, 2005
Dear Sir:
Re: XXXXXXXXXX ("Profitco")
XXXXXXXXXX ("Lossco")
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) "arm's length" has the meaning assigned by section 251;
(d) XXXXXXXXXX
(e) "cost amount" has the meaning assigned by subsection 248(1);
(f) "depreciable property" has the meaning assigned by subsection 13(21);
(g) "disposition" 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) "generally accepted accounting principles ("GAAP") has the meaning assigned by the Canadian Institute of Chartered Accountants Handbook;
(j) "net capital loss" has the meaning assigned by subsection 111(8);
(k) "non-capital loss" has the meaning assigned by subsection 111(8);
(l) "Office Equipment Assets" means approximately $XXXXXXXXXX dollars of office equipment, currently leased by Profitco to third parties, approximately half of the value of which is comprised of XXXXXXXXXX;
(m) "paid-up capital" ("PUC") has the meaning assigned by subsection 89(1);
(n) "Parentco" means XXXXXXXXXX.;
(o) "related persons" has the meaning assigned by subsection 251(2);
(p) "stated capital" has the meaning assigned by XXXXXXXXXX;
(q) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);
(r) "USco" means XXXXXXXXXX., a United States corporation; and
(s) "Xco" means XXXXXXXXXX.
FACTS
1. Profitco is a taxable Canadian corporation XXXXXXXXXX incorporated under the laws of XXXXXXXXXX. Profitco's taxation year-end is XXXXXXXXXX. Profitco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns are filed at the XXXXXXXXXX Taxation Centre. Profitco's principal business address is XXXXXXXXXX.
2. Profitco's operations are centralized in XXXXXXXXXX, Profitco has had sales offices or sales representation in XXXXXXXXXX, its customers have been commercial, governmental, quasi-government, and not-for-profit organizations.
3. Profitco provides financing principally through equipment leasing and short term rentals (i.e. month to month rentals at the end of the lease term at the option of the lessee). Profitco finances equipment for XXXXXXXXXX. Profitco leases various types of equipment to support these industries. Profitco commonly leases XXXXXXXXXX. Approximately XXXXXXXXXX% of Profitco's revenues from leasing is derived from XXXXXXXXXX. A portion of Profitco's income derives from the sale of equipment from expired leases. Profitco administers on average over XXXXXXXXXX lease agreements. These leases are for terms of XXXXXXXXXX months to XXXXXXXXXX months with the majority of them being between XXXXXXXXXX and XXXXXXXXXX months. A significant portion of these leases has been securitized.
Profitco's principal business is leasing property as described in subsection 1100(16) of the Income Tax Regulations (the "Regulations"). Profitco has elected, under subsection 1100(1.14) of the Regulations to deem all of its leased property to not be exempt property and to deem each property to have a fair market value in excess of $25,000. All of Profitco's leased properties with a lease term of greater than one year are specified leasing properties under subsection 1100(1.11) of the Regulations.
4. During the taxation year ending XXXXXXXXXX, Profitco's gross revenue from its leasing activities amounted to XXXXXXXXXX% of its revenue and gross revenue from sales of equipment at the end of a lease amounted to XXXXXXXXXX% of its revenue.
5. The general administration process of Profitco is as follows:
- The prospect is identified and quoted by sales representative.
- Profitco reviews and approves credit.
- Customer executes lease documentation.
- Vendor provides equipment to customer.
- Profitco enters lease details into Profitco's XXXXXXXXXX.
- Profitco pays vendor for equipment purchase.
- Profitco bills and collects lease payments from customer over the term of the contract.
- Profitco contacts customer XXXXXXXXXX months prior to end of lease with expiry options:
- lessee can continue renting equipment on a month-to-month basis;
- lessee can purchase equipment for a negotiated price; or
- lessee can return equipment to Profitco.
- Asset Management department sells returned equipment to a third party.
6. Lossco is a taxable Canadian corporation XXXXXXXXXX incorporated under the laws of XXXXXXXXXX. Lossco's taxation year-end is XXXXXXXXXX. Lossco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and its corporate tax returns are filed at the XXXXXXXXXX Taxation Centre. Lossco's principal business address is XXXXXXXXXX.
7. Currently, Lossco's only issued and outstanding shares are XXXXXXXXXX common shares owned by Parentco. Parentco also owns XXXXXXXXXX% of the shares of USco.
8. Since XXXXXXXXXX, Lossco has had sales offices located in XXXXXXXXXX, Lossco's customers have been XXXXXXXXXX. Currently Lossco leases or rents, to arm's-length third parties, XXXXXXXXXX, all of the types of assets described in the definition of "Office Equipment Assets" above ("Lossco Leasing Assets"). During the period beginning at the time the proposed transactions are implemented and ending at the time Lossco is wound up into Profitco, Lossco will continue to lease or rent the Lossco Leasing Assets to arm's-length third parties.
A sizeable portion of Lossco's income is derived from the sale of equipment from expired leases and rentals. Lossco disposes of used equipment via XXXXXXXXXX
9. During the taxation year ending XXXXXXXXXX, Lossco's gross revenue from its leasing and rental activities amounted to XXXXXXXXXX% of its total revenue and gross revenue from remarketing amounted to XXXXXXXXXX% of its total revenue. Gross revenue from remarketing includes the proceeds from the sale of equipment at the end of the lease or rental and proceeds from the resale of assets purchased from other parties to Lossco customers.
10. Since XXXXXXXXXX, the general administration process of Lossco has been as follows:
- Lease/rental/sale quote originated by sales representative.
- Credit approval required before equipment removed from equipment available list or equipment is ordered.
- Transaction documentation completed.
- Equipment removed from available inventory (or ordered if not available).
- Equipment delivered to customer.
- Contractual billings commence - billing and collection over term.
- Customer contacted prior to end of term regarding expiry alternatives.
- If customer returns equipment, Lossco takes back into stock, deconfigures it and determines if goods are acceptable to keep for another customer or sells to third party, either broker or through retail channel.
11. Lossco reported a non-capital loss from operations of $XXXXXXXXXX in its income tax return for the XXXXXXXXXX taxation year. On XXXXXXXXXX, all of the shares of Lossco were acquired by Xco. On the same day, Xco sold all of the shares of Lossco to Parentco. Lossco reported a non-capital loss of $XXXXXXXXXX in its XXXXXXXXXX income tax return. A large portion of this loss ($XXXXXXXXXX) resulted from the write-down of depreciable property on the acquisition of control pursuant to subsection 111(5.1) of the Act. For the taxation year ending XXXXXXXXXX, Lossco reported a non-capital loss of $XXXXXXXXXX and a total unused non-capital loss carry-forward balance of $XXXXXXXXXX.
PROPOSED TRANSACTIONS
12. On XXXXXXXXXX, Parentco will sell all of the issued and outstanding shares of Lossco to Profitco for cash consideration equal to the aggregate FMV of the shares at that time. As a result of the acquisition of all the issued and outstanding shares of Lossco by Profitco described herein, Profitco will control Lossco. Lossco will not make an election under subsection 256(9) in its tax return for its taxation year ending immediately before the acquisition of control of Lossco by Profitco.
13. On XXXXXXXXXX, Lossco will reduce its stated capital, to an amount equal to the amount of Profitco's cost amount of the Lossco shares, without making a payment to Profitco.
14. Lossco will continue to carry on its business, described in paragraphs 8,9 and 10 above, with a reasonable expectation of profit from the time Profitco acquires its shares until it distributes its assets to Profitco as part of the winding up described in paragraph 18 below.
15. On XXXXXXXXXX, Profitco will sell the Office Equipment Assets to Lossco. The intention will be to sell these assets on a tax deferred basis. Accordingly, if needed, an election under subsection 85(1) will be made by Profitco and Lossco. Lossco will issue additional common shares to Profitco representing the amount of fair market value of the assets in excess of their cost amount. Lossco will issue a promissory note or pay cash to Profitco in an amount equal to the cost amount of the assets.
If an election under subsection 85(1) is not made, Lossco will pay cash or issue a promissory note to Profitco for the entire purchase price of the Office Equipment Assets.
16. Profitco will provide administrative support to Lossco relating to the Office Equipment Assets. Lossco will pay a fair market value fee to Profitco for this service.
17. Lossco will file an election with its first tax return after the acquisition of control pursuant to subsection 1100(1.14) of the Regulations in respect of the Office Equipment Assets.
18. It is anticipated that Profitco will wind up Lossco before XXXXXXXXXX. Utilization of Lossco's non-capital losses will be a result of expected profitable operations and reduced capital cost allowance claims. At the time of winding up, it is anticipated that the UCC of Lossco's lease portfolio will exceed the fair market value of the lease portfolio. Lossco will not be wound up into Profitco until all of Lossco's non-capital losses have been utilized. Lossco will not dispose of any of the Office Equipment Assets prior to the time it is wound up into Profitco, other than as described below.
Lossco does not intend to sell or dispose of any assets received from Profitco before it is wound up into Profitco. In fact, the lease terms of the Office Equipment Assets extend beyond the expected time that Lossco will be wound up. However, there are situations in the normal course of business that may result in Lossco selling or taking back some of the Office Equipment Assets. These situations are: a default of the lease terms by the lessee, a buy-out of a lease before its expiry date by the lessee and a trade in for new equipment before the lease expiry date by the lessee. The lease contracts that the Office Equipment Assets are subject to do not contain provisions for the early buy out or trade-in of an asset. Lossco will not actively pursue buy out or trade-in situations as this increases administration costs and may reduce the finance income which can be earned on the asset. However, Lossco will accommodate lessees should the lessee wish to buy or trade-in one of the assets included in the Office Equipment Assets. XXXXXXXXXX
If the lessee buys the asset there will be a disposition of the asset by Lossco to the lessee which could result in Lossco realizing income from recaptured capital cost allowance depending on the fair market value and undepreciated capital cost of the asset at the time of the buy out.
With respect to a trade-in of an asset, Lossco will dispose of the asset to the original vendor of the equipment at fair market value and acquire a new asset that will be leased to the lessee. This could also result in Lossco realizing income from recaptured capital cost allowance depending on the fair market value and undepreciated capital cost of the asset at the time.
Lossco represents that there will not be any income realized in the event of a sale of any of the Office Equipment Assets received by it as a result of a default in respect of the lease terms governing the particular assets.
Based on historical experience, approximately XXXXXXXXXX percent of leases result in default, buy out or trade-in. Lossco will not dispose of any of the Office Equipment Assets that it received from Profitco other than in situations where there is a default, trade-in for a new asset before the expiry date of the lease contract or buy out of the asset by the lessee prior to the expiry date of the lease contract. The portion of Lossco's income for Federal income tax purposes, during the period commencing when Profitco acquires Lossco and ending when Lossco is wound up, which will arise from dispositions by Lossco, as a result of trade-ins or buy-outs of particular assets included in the Office Equipment Assets, will not exceed $XXXXXXXXXX in aggregate and is expected to be significantly less than that amount. In contrast, during the period commencing when Profitco acquires Lossco and ending when Lossco is wound up, Lossco's income for Federal income tax purposes from leasing the Office Equipment Assets will exceed $XXXXXXXXXX.
19. For purposes of the Act, Lossco and Profitco currently deal at arm's length and are not related persons.
20. The proposed transactions will not impact the ability of any of either Profitco or Lossco to pay their income tax liabilities
PURPOSE OF THE PROPOSED TRANSACTIONS
21. The purposes of the proposed transactions are to:
(i) provide Profitco access to new clients and sales representatives.
(ii) leverage Lossco's infrastructure with respect to business offerings such as remarketing assets through the internet and retail outlets; and
(iii) allow Profitco to utilize Lossco's non-capital losses to minimize the business risk of the acquisition.
22. The purpose of the stated capital reduction described in paragraph 13 is to ensure the PUC of Lossco's shares does not exceed the ACB of those shares at the time it is wound up into Profitco. Currently the PUC of Lossco's shares is approximately $XXXXXXXXXX. Profitco's ACB of its Lossco shares is expected to be between $XXXXXXXXXX and $XXXXXXXXXX.
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. For the purposes of subparagraph 111(5)(a)(ii) of the Act, the income of Lossco which will be derived from the leasing or rental of the Office Equipment Assets, which assets will be transferred to Lossco as described in paragraph 15 above, will be considered to be derived from properties similar to those leased or rented by Lossco in the course of carrying on its business, as described in paragraphs 8, 9 and 10.
B. Subsection 84(4) will not apply to deem Profitco to receive a dividend as a result of the stated capital reduction referred to in paragraph 13.
C. Subsection 1100(1.16) of the Regulations will apply to deem Lossco to be the same person as, and a continuation of, Profitco for the purposes of paragraph 1100(1.1)(a) of the Regulations and for the purpose of computing the income of Lossco in respect of the lease for any period after the time of the acquisition by Lossco of the Office Equipment Assets (as described in paragraph 15).
D. Subsection 245(2) will not be applied as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences of the proposed transactions confirmed in the rulings given above.
The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 (the "Circular") and are binding on the 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.
OPINION
Where a parent corporation winds-up a subsidiary wholly-owned corporation and, as a consequence, the parent corporation acquires property that was specified leasing property of the subsidiary wholly-owned corporation, subsection 1100(1.16) of the Regulations will apply to deem the parent corporation to be the same person as, and a continuation of, the subsidiary wholly-owned corporation for the purposes of paragraph 1100(1.1)(a) of the Regulations and for the purpose of computing the income of the parent corporation in respect of the lease for any period after the winding-up. For greater certainty, the amount deductible by the parent corporation pursuant to paragraph 20(1)(a) of the Act for a taxation year in respect of each specified leasing property acquired by the parent on the winding-up will be the lesser of the amounts determined pursuant to paragraphs (a) and (b) of subsection 1100(1.1) of the Regulations, computed as if the parent corporation were the same person as the former subsidiary wholly-owned corporation.
The opinions expressed above are provided in accordance with paragraph 22 of the Circular. These opinions do not constitute a binding advance income tax ruling and are not binding on the CRA.
The above Ruling A considers only the issue of whether, for the purposes of subparagraph 111(5)(a)(ii), the Office Equipment Assets are similar to the properties leased by Lossco. In particular, this letter does not express or imply, and should not be construed as expressing or implying, any ruling, opinion, confirmation or approval in respect of whether the existing business of Lossco will, be carried on by Lossco throughout a particular taxation year, and if so, whether it will be carried on for profit or with a reasonable expectation of profit throughout such taxation year.
In addition, nothing in this letter should be construed as implying that the CRA has agreed to or reviewed:
(a) the determination of the ACB, PUC or FMV of any shares or other property referred to herein;
(b) the amount of non-capital losses of Lossco; or
(c) 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
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