2005 Ruling 2005-0134461R3 - 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: Loss utilization in a related group of companies. This ruling incorporates numerous minor changes to an earlier ruling (2004-008854), and rescinds and replaces that earlier ruling.

Position: The loss utilization is acceptable.

Reasons: Consistent with our position in previous rulings and with Department of Finance policy.

XXXXXXXXXX 2005-013446

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested certain changes to a previously issued advance income tax ruling on behalf of the above-referenced taxpayers (Ruling No. 2004-008854, dated XXXXXXXXXX, 2004). This ruling incorporates those changes and rescinds and replaces that earlier ruling. We also acknowledge receipt of your facsimiles and emails as well as the information provided in various telephone conversations.

Throughout this letter, the following corporations will be referred to as follows:

XXXXXXXXXX . Parentco
XXXXXXXXXX . Lossco
XXXXXXXXXX . Profitco
XXXXXXXXXX . Subco

Profitco, Lossco and Subco (the "taxpayers") file their corporate income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office. The taxpayers are resident in Canada for the purposes of the Act.

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

(i) being considered by a tax services office or taxation centre in connection with a previously filed tax return of any of the taxpayers or a related person;

(ii) under objection by any of the taxpayers or a related person; or

(iii) before the courts.

The taxpayers have confirmed that the transactions described herein will not result in any taxpayer described herein being unable to pay its outstanding tax liabilities.

Unless otherwise indicated, all references to monetary amounts are in Canadian dollars.

DEFINITIONS

In this letter, unless otherwise expressly stated, 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 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) "BCA" means the Business Corporations Act (XXXXXXXXXX);

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

(f) "Class A Preferred Shares" means the preferred shares of Lossco, as described in Paragraph 19 below;

(g) "Class AA Preferred Shares" means the preferred shares of Subco, as described in Paragraph 21 below;

(h) "Consolidated Note" means the promissory note payable by Subco to Profitco, as described in Paragraph 18 below;

(i) "CRA" means the Canada Revenue Agency;

(j) "cumulative eligible capital" has the meaning assigned by subsection 14(5);

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

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

(m) "Lenders" means the persons who have made loans or provided credit facilities to Profitco pursuant to the Loan Agreement or the Revolving Operating Credit Agreement;

(n) "Loan Agreement" means the loan agreement entered into by Profitco, as described in Paragraph 10 below;

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

(p) "Note Purchase Agreement" means the note purchase agreement entered into by Profitco, as described in Paragraph 9 below;

(q) "Noteholders" means the persons holding notes issued by Profitco pursuant to the Note Purchase Agreement;

(r) XXXXXXXXXX;

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

(t) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(u) "Preferred Shares" means the Class A Preferred Shares and the Class AA Preferred Shares;

(v) "Prime" means the prime rate of interest of a Canadian chartered bank;

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

(x) "proposed transactions" means the transactions described in Paragraphs 15 to 24 below;

(y) "Revolving Operating Credit Agreement" means the revolving operating credit agreement entered into by Profitco, as described in Paragraph 10 below;

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

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

Our understanding of the facts, proposed transactions and purpose of the proposed transactions is as follows:

FACTS

1. Parentco is a taxable Canadian corporation governed by the laws of XXXXXXXXXX.

2. Lossco is a taxable Canadian corporation governed by the laws of Canada. Lossco has only common shares issued and outstanding. All of the issued and outstanding common shares of Lossco are held by Parentco. The stated capital and paid-up capital of the common shares of Lossco is approximately $XXXXXXXXXX.

3. Lossco has a XXXXXXXXXX taxation year-end. As at the end of its XXXXXXXXXX taxation year, Lossco had approximately $XXXXXXXXXX of non-capital losses available for carry-forward from its XXXXXXXXXX taxation year, approximately $XXXXXXXXXX of non-capital losses available for carry-forward from its XXXXXXXXXX taxation year, and approximately $XXXXXXXXXX of non-capital losses available for carry-forward from its XXXXXXXXXX taxation year (approximately $XXXXXXXXXX of the non-capital losses available for carry-forward from its XXXXXXXXXX taxation year and $XXXXXXXXXX of the non-capital losses available for carry-forward from its XXXXXXXXXX taxation year are deemed to be non-capital losses of Lossco by virtue of paragraph 88(1.1)(c) on the winding up of XXXXXXXXXX. that commenced in Lossco's XXXXXXXXXX taxation year). Lossco had a cumulative eligible capital balance of approximately $XXXXXXXXXX as at the end of its XXXXXXXXXX taxation year. In the absence of the proposed transactions, Lossco may not be able to substantially utilize its non-capital losses available for carry-forward within the carry-forward period provided by paragraph 111(1)(a) or its deductions under 20(1)(b) in respect of its cumulative eligible capital balance.

4. Profitco is a taxable Canadian corporation governed by the laws of XXXXXXXXXX. All of the issued and outstanding shares of Profitco are held by Parentco.

5. Profitco has a XXXXXXXXXX taxation year-end. In the absence of the proposed transactions, Profitco is expected to generate significant taxable income in its XXXXXXXXXX and subsequent taxation years. It is not anticipated that the proposed transactions will result in non-capital losses being incurred by Profitco in its XXXXXXXXXX or subsequent taxation years.

6. Subco is a taxable Canadian corporation governed by the laws of Canada. All of the issued and outstanding common shares of Subco are held by Profitco.

7. Lossco, Profitco and Subco are affiliated persons.

8. Profitco holds XXXXXXXXXX promissory notes payable by Subco. These XXXXXXXXXX promissory notes have an aggregate principal amount of $XXXXXXXXXX and bear interest at floating rates based on a spread above Prime. Each of these XXXXXXXXXX promissory notes is payable on demand. Subco has the right to repay the whole or any part of the outstanding principal amount of these XXXXXXXXXX promissory notes without notice, penalty or bonus.

9. Profitco issued notes pursuant to a Note Purchase Agreement dated as of XXXXXXXXXX, as subsequently amended. Profitco currently has debt owing under the Note Purchase Agreement. Subco and other affiliates of Profitco are guarantors of the obligations of Profitco under the Note Purchase Agreement.

10. Profitco entered into a Loan Agreement with a XXXXXXXXXX dated as of XXXXXXXXXX, as subsequently amended, and a Revolving Operating Credit Agreement with the XXXXXXXXXX dated as of XXXXXXXXXX, as subsequently amended. Profitco currently has debt owing under the Loan Agreement and the Revolving Operating Credit Agreement. Subco and other affiliates of Profitco are guarantors of the obligations of Profitco under the Loan Agreement and the Revolving Operating Credit Agreement.

ARRANGEMENTS WITH NOTEHOLDERS AND LENDERS

11. Prior to the implementation of the proposed transactions, Profitco will enter into a waiver and consent agreement with the Noteholders pursuant to which the Noteholders will provide consent to Profitco and Subco to implement the proposed transactions and will waive certain provisions of the Note Purchase Agreement and any defaults or events of default that would have otherwise occurred as a result of Profitco and Subco implementing the proposed transactions.

12. Prior to the implementation of the proposed transactions, Profitco will enter into a waiver and consent agreement with the Lenders pursuant to which the Lenders will provide consent to Profitco and Subco to implement the proposed transactions and will waive certain provisions of the Loan Agreement and the Revolving Operating Credit Agreement and any defaults or events of default that would have otherwise occurred as a result of Profitco and Subco implementing the proposed transactions.

13. In connection with the waiver and consent agreements referred to in Paragraphs 11 and 12 above, Subco and Lossco will enter into a subordination agreement with, inter alia, the Noteholders and the administrative agent for certain of the Lenders. The subordination agreement is intended to ensure that the Consolidated Note ranks junior to the debt owing to the Noteholders and Lenders, except with respect to amounts paid in respect of the Consolidated Note from dividends or redemption or retraction proceeds received by Subco with respect to the Class A Preferred Shares or amounts owing in respect of dividends or redemption or retraction amounts on the Class A Preferred Shares that are set-off against amounts owing by Subco on the Consolidated Note. The subordination agreement will include the following provisions:

(a) the payment of principal and interest on the Consolidated Note by Subco will be subordinate to the prior payment in full of the Noteholders and certain of the Lenders, except in circumstances described in Paragraph 13(e) below;

(b) until the Noteholders and certain of the Lenders are paid and discharged in full, no direct or indirect payment will be made or agreed to be made on account of the principal or interest on, or any other amount that may be due and owing on, the Consolidated Note, except in circumstances described in Paragraph 13(e) below;

(c) until the Noteholders and certain of the Lenders are paid and discharged in full, Lossco will not declare the Consolidated Note to be due and payable or demand or accept any payment in respect of the Consolidated Note and Subco will not make any such payments, except in circumstances described in Paragraph 13(e) below;

(d) in the event of prescribed insolvency or bankruptcy proceedings, or in the event of any proceedings for voluntary liquidation, dissolution or other winding-up of Subco, whether or not involving insolvency or bankruptcy, the Noteholders and certain of the Lenders will be entitled to receive payment in full before Lossco will be entitled to receive any payment on account of the Consolidated Note, except in circumstances described in Paragraph 13(e) below;

(e) notwithstanding the restrictions described in Paragraphs 13(a), (b), (c) and (d) above, where:

(i) all or any portion of the Class A Preferred Shares are redeemed by Lossco or retracted by Subco; or

(ii) dividends are paid on the Class A Preferred Shares;

Subco will, by set-off or otherwise, be entitled and obliged to immediately effect a repayment of amounts owing by Subco on the Consolidated Note by way of principal or interest, respectively, with amounts received by Subco as a result of (i) or (ii); and

(f) the Consolidated Note will not be sold, assigned or transferred in whole or part by Lossco unless the consent of Subco and certain of the Noteholders/

Lenders is obtained and unless the assignee becomes a party to the subordination agreement.

14. In connection with the waiver and consent agreements referred to in Paragraphs 11 and 12 above, Subco and Lossco will also enter into a limited purpose share pledge agreement with the trustee under a security trust deed entered into as of XXXXXXXXXX by the trustee and, inter alia, Profitco, Subco and other affiliates of Profitco. The limited purpose pledge is intended to ensure that the Class A Preferred Shares do not become subject to a security interest of anyone other than the Noteholders or the Lenders. The limited purpose pledge is also intended to ensure that dividends or redemption or retraction proceeds received by Subco with respect to the Class A Preferred Shares will be applied by Subco against any amounts owing by Subco on the Consolidated Note. The limited purpose pledge will include the following provisions:

(a) Subco will assign and pledge to the trustee and grant to the trustee a limited security interest in the Class A Preferred Shares;

(b) Subco will be entitled to exercise any and all voting and/or consensual rights and powers relating to the Class A Preferred Shares for any purpose not inconsistent with the terms of the limited purpose pledge agreement or the subordination agreement;

(c) Subco will be entitled to receive and retain any and all dividends or redemption or retraction proceeds payable with respect to the Class A Preferred Shares provided that, upon receipt of such proceeds, Subco will immediately apply such proceeds against any amounts owing on the Consolidated Note;

(d) the trustee may at any time request that Subco retract all or any part of the Class A Preferred Shares for purposes of applying the proceeds therefrom against its obligations owing under the Consolidated Note, in which event Subco shall forthwith exercise its right of retraction and extinguish its obligations under the Consolidated Note;

(e) the trustee may, in circumstances where:

(i) an event of default has occurred under the Note Purchase Agreement or the Loan Agreement; and

(ii) Subco has failed, for a period of XXXXXXXXXX banking days, to apply the proceeds of redemption or retraction of the Class A Preferred Shares or dividends paid with respect thereto against amounts owing under the Consolidated Note;

enforce the security interest granted under the limited purpose pledge agreement against the proceeds of the Class A Preferred Shares and apply such proceeds against amounts owing by Subco under the Consolidated Note or against amounts owing by Subco to the Noteholders or certain of the Lenders;

(f) in circumstances where Subco has failed for a period of XXXXXXXXXX banking days following receipt by it of dividends or redemption or retraction proceeds paid with respect to the Class A Preferred Shares to apply a like amount against amounts owing by it on the Consolidated Note, Subco will immediately thereafter exercise its right of retraction with respect to the Class A Preferred shares and forthwith apply the proceeds of such retraction against amounts owing by it under the Consolidated Note; and

(g) Subco may retract or Lossco may redeem all or any part of the Class A Preferred Shares at any time, in which case Subco's obligations under the Consolidated Note shall, to the extent of the proceeds of such retraction or redemption, be extinguished by Subco by way of set off or otherwise and the trustee shall take such steps as are reasonably requested by Subco in order to facilitate such retraction or redemption.

PROPOSED TRANSACTIONS

15. Lossco will reduce the stated capital of its common shares by an amount of $XXXXXXXXXX without distributing any amount in respect of the reduction, and add $XXXXXXXXXX to contributed surplus for accounting purposes. The stated capital and paid-up capital of Lossco's common shares will thereby be reduced from an amount of approximately $XXXXXXXXXX to an amount of approximately $XXXXXXXXXX.

16. Lossco will be continued under the laws of XXXXXXXXXX and the authorized share capital of Lossco will be amended to authorize an unlimited number of Class A Preferred Shares having the terms and conditions described in Paragraph 19 below.

17. The authorized share capital of Subco will be amended to authorize an unlimited number of Class AA Preferred Shares having the terms and conditions described in Paragraph 21 below.

18. All interest that has accrued on the indebtedness represented by the XXXXXXXXXX promissory notes described in Paragraph 8 above will be paid. The evidence of indebtedness represented by the XXXXXXXXXX promissory notes described in Paragraph 8 above will then be cancelled and replaced by a single new promissory note (the "Consolidated Note"). The principal amount of the Consolidated Note will be equal to $XXXXXXXXXX (i.e., the aggregate principal amount of the XXXXXXXXXX promissory notes described in Paragraph 8 above). The Consolidated Note will be payable on demand, subject to the restrictions described in Paragraph 13 above. Subco will have the right to repay the whole or any part of the outstanding principal amount of the Consolidated Note at any time without notice, penalty or bonus. The Consolidated Note will bear interest at a rate of Prime plus XXXXXXXXXX%, payable annually unless repayment of the Consolidated Note is demanded earlier. The Consolidated Note will also be subject to the restrictions on its assignment as described in Paragraph 13(f) above.

19. When issued, Lossco's Class A Preferred Shares will have an aggregate redemption amount equal to the principal amount of the Consolidated Note and rights and restrictions described as follows:

(a) non-participating and non-voting;

(b) entitled to a cumulative dividend, at a rate applied to the redemption amount of the shares of Prime plus XXXXXXXXXX %. The dividends accruing in a taxation year of Lossco will be payable as described in Paragraph 23 below;

(c) redeemable, in whole or in part, at any time at the option of Lossco for an amount equal to the redemption amount associated with the Class A Preferred Shares redeemed and any unpaid dividends on the Class A Preferred Shares redeemed; and

(d) retractable, in whole or in part, at any time at the option of the holder for an amount equal to the redemption amount associated with the Class A Preferred Shares retracted and any unpaid dividends on the Class A Preferred Shares retracted.

20. Profitco will transfer the Consolidated Note to Lossco in exchange for newly issued Class A Preferred Shares. Profitco and Lossco will jointly elect under the provisions of subsection 85(1) to transfer the Consolidated Note at an agreed amount equal to the principal amount of the Consolidated Note. The stated capital and paid-up capital of the Class A Preferred Shares will equal the principal amount of the Consolidated Note.

21. When issued, Subco's Class AA Preferred Shares will have an aggregate redemption amount equal to the redemption amount of the Class A Preferred Shares and rights and restrictions described as follows:

(a) non-participating and non-voting;

(b) entitled to a cumulative dividend, at a rate applied to the redemption amount of the shares of Prime plus XXXXXXXXXX%. The dividends accruing in a taxation year of Subco will be payable as described in Paragraph 23 below;

(c) redeemable, in whole or in part, at any time at the option of Subco for an amount equal to the redemption amount associated with the Class AA Preferred Shares redeemed and any unpaid dividends on the Class AA Preferred Shares redeemed; and

(d) retractable, in whole or in part, at any time at the option of the holder for an amount equal to the redemption amount associated with the Class AA Preferred Shares retracted and any unpaid dividends on the Class AA Preferred Shares retracted.

22. Profitco will transfer the Class A Preferred Shares to Subco in exchange for newly issued Class AA Preferred Shares. Profitco and Subco will jointly elect under the provisions of subsection 85(1) to transfer the Class A Preferred Shares at an agreed amount equal to the redemption amount of the Class A Preferred Shares. The stated capital and paid-up capital of the Class AA Preferred Shares will equal the stated capital and paid-up capital of the Class A Preferred Shares.

23. On an ongoing basis, dividends on the Class A Preferred Shares, interest on the Consolidated Note and dividends on the Class AA Preferred Shares will be paid on the same day.

24. Once Profitco or Lossco has decided to unwind the proposed transactions, in whole or in part, at a particular time:

(a) Lossco will pay the balance of any accrued and unpaid dividends on the Class A Preferred Shares;

(b) Subco will pay the balance of any accrued and unpaid interest on the Consolidated Note;

(c) Subco will pay the balance of any accrued and unpaid dividends on the Class AA Preferred Shares; and

(d) Lossco will redeem all or a portion of the Class A Preferred Shares and the amount owing on redemption will be settled by setting off that amount against the corresponding amount of the Consolidated Note.

ADDITIONAL INFORMATION

25. None of the Preferred Shares will be, at any time during the implementation of the proposed transactions described herein:

(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); or

(d) issued for consideration, except as described herein.

PURPOSES OF THE PROPOSED TRANSACTIONS

26. The primary purpose of the proposed transactions is to enable Lossco to earn sufficient interest income, over a period of time, to utilize some or all of its tax attributes.

27. The purpose of the continuance of Lossco into XXXXXXXXXX is to ensure that the proposed transactions may be effectively implemented under the governing corporate law. XXXXXXXXXX.

28. The purpose of the transactions described in Paragraphs 11 to 14 above is to accommodate the requests of the Noteholders and Lenders to protect their commercial position in order to obtain their consent to the proposed transactions described in Paragraphs 15 to 24 above.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purposes 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 the holders of the Preferred Shares, as described in Paragraphs 23, 24(a) and 24(c) 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. Subco will not be precluded, by virtue of the proposed transactions in and by themselves, from deducting interest payable on the Consolidated Note pursuant to paragraph 20(1)(c), provided that the interest payable on the six promissory notes described in Paragraph 8 above would otherwise be deductible pursuant to paragraph 20(1)(c).

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

The above rulings are given 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, excluding Paragraphs 23 and 24 above, 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 which, if enacted, could have an effect on the rulings provided herein.

COMMENTS

1. Nothing in this ruling should be construed as implying that the Canada Revenue 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.

Yours truly,

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

??