2005 Ruling 2005-0143711R3 - Loss utilization in a related group of companies.

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.

Position: The loss utilization is acceptable.

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

XXXXXXXXXX 2005-014371

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge receipt of your facsimiles and e-mails as well as the information provided in various telephone conversations.

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

XXXXXXXXXX Profitco
XXXXXXXXXX Lossco
XXXXXXXXXX Holdco1
XXXXXXXXXX Holdco2
XXXXXXXXXX Holdco3
XXXXXXXXXX Canco

Profitco and Lossco (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. Profitco and Lossco 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) involved in an earlier return of any 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 any of the taxpayers or a related person;

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

(iv) before the courts.

Profitco and Lossco 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, c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, every reference in this letter to a statutory provision is a reference to the relevant provision of the Act;

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

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

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

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

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

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

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

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

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

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

(l) "proposed transactions" means the transactions described in Paragraphs 10 to 19 below;

(m) "public corporation" has the meaning assigned by subsection 89(1);

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

(o) "subsidiary controlled corporation" has the meaning assigned by subsection 248(1);

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

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

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

FACTS

1. Lossco is the corporation resulting from the amalgamation of XXXXXXXXXX (which was originally incorporated under the CBCA in XXXXXXXXXX), XXXXXXXXXX, which amalgamation was effective XXXXXXXXXX. Lossco is governed by the CBCA and is a public corporation and a taxable Canadian corporation.

2. Holdco1 is a taxable Canadian corporation that was incorporated in XXXXXXXXXX under the CBCA. Holdco1 is a holding corporation that holds all the common shares of Canco. Lossco owns all the issued and outstanding shares of Holdco1.

3. Canco is the corporation resulting from the amalgamation of XXXXXXXXXX, which amalgamation was effective XXXXXXXXXX. Canco is a public corporation, a taxable Canadian corporation and a subsidiary controlled corporation of Holdco1. Canco is governed by the CBCA. Canco also has outstanding preferred shares, all of which are non-voting, fixed value, non-participating and not convertible into common shares. All the preferred shares are held by persons who are not related to Lossco. Canco owns all the issued and outstanding shares of Holdco2.

4. Holdco2 is the corporation resulting from the amalgamation of XXXXXXXXXX, which amalgamation was effective XXXXXXXXXX. Holdco2 is a taxable Canadian corporation governed by the CBCA. Holdco2 owns all the issued and outstanding shares of Holdco3.

5. Holdco3 is the corporation resulting from the amalgamation of XXXXXXXXXX, which amalgamation was effective XXXXXXXXXX. Holdco3 is a taxable Canadian corporation governed by the CBCA. Holdco3 owns all the issued and outstanding shares of Profitco.

6. Profitco is the corporation resulting from the amalgamation of XXXXXXXXXX, which amalgamation was effective XXXXXXXXXX. Profitco is a taxable Canadian corporation governed by the CBCA. XXXXXXXXXX.

7. As at XXXXXXXXXX, Lossco's non-capital losses carried forward were approximately $XXXXXXXXXX. Lossco estimates that it will also incur a loss of approximately $XXXXXXXXXX in XXXXXXXXXX and $XXXXXXXXXX in XXXXXXXXXX.

8. Profitco has a XXXXXXXXXX taxation year-end and generates sufficient taxable income against which the non-capital losses of Lossco could be deducted. The federal taxable income reported by Profitco for its XXXXXXXXXX taxation year was approximately $XXXXXXXXXX. Profitco's estimated federal taxable income for its XXXXXXXXXX taxation years is expected to amount to approximately $XXXXXXXXXX, respectively.

CORPORATION INCORPORATED FOR THE PROPOSED TRANSACTIONS

9. Prior to the implementation of the proposed transactions, Lossco will incorporate a new corporation ("Newco") under the CBCA and subscribe for one common share for $XXXXXXXXXX on incorporation. Newco will have a XXXXXXXXXX year-end and will be a taxable Canadian corporation.

The authorized share capital of Newco will consist of an unlimited number of one class of voting and fully-participating common shares and an unlimited number of one class of preferred shares. The preferred shares will be:

(a) non-participating and non-voting;

(b) entitled to an annual cumulative dividend rate, applied to the redemption amount of the shares, described in Paragraph 12 below, equal to the interest rate applicable to the Profitco Demand Loan, described in Paragraph 11 below, plus XXXXXXXXXX %. The dividend rate will be determined at the time of implementation of the proposed transactions and will subsequently be determined at the beginning of each taxation year;

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

(i) paying cash equal to such amount;

(ii) assigning the Lossco Demand Loan, described in Paragraph 13 below, to Profitco and paying cash equal to any unpaid dividends; or

(iii) setting-off amounts owing under the Profitco Demand Loan against the redemption amount of the Newco preferred shares in circumstances where Newco has become the holder of the Profitco Demand Loan, as described in Paragraph 13 below, 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 Newco assigning the Lossco Demand Loan to Profitco and paying cash equal to any unpaid dividends, unless Newco:

(i) pays cash equal to such amount; or

(ii) sets off amounts owing under the Profitco Demand Loan against the redemption amount of the Newco preferred shares in circumstances where Newco has become the holder of the Profitco Demand Loan, as described in Paragraph 13 below, and pays cash equal to any unpaid dividends.

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

PROPOSED TRANSACTIONS

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

11. Lossco will lend the proceeds from the Daylight Loan to Profitco on a subordinated demand basis (the "Profitco Demand Loan"). The Profitco Demand Loan will bear interest at a rate equal to the commercial market rate applicable for such loan. The interest rate will be determined at the time the proposed transactions are implemented, and subsequently, at the beginning of each taxation year.

The terms of the Profitco Demand Loan will provide that repayment may be settled in cash or by delivering a financial asset of Profitco (including the Lossco Demand Loan).

Based on Profitco's financial projections, it has the financial capacity to pay the interest on the Profitco Demand Loan from its own cash flow (calculated as its net accounting income before depreciation and taxes). Profitco's current third-party borrowings are all guaranteed by Canco. Any future borrowing would also be guaranteed by Canco. Considering this, Profitco has a similar borrowing capacity as Canco.

A letter from XXXXXXXXXX, provided confirmation that Canco had the ability to borrow up to an additional amount of $XXXXXXXXXX, above and beyond its then outstanding indebtedness of approximately $XXXXXXXXXX.

Since that time, Canco's financial situation has not materially changed and it is management's view that the total borrowing capacity of approximately $XXXXXXXXXX referred to in the XXXXXXXXXX letter is still appropriate. At the time the proposed transactions are implemented, Canco is expected to have outstanding indebtedness of approximately $XXXXXXXXXX. Accordingly, Canco will have the ability to borrow up to $XXXXXXXXXX. Since Profitco's borrowings are guaranteed by Canco, Profitco can borrow the same amount as Canco.

12. Profitco will use the proceeds of the Profitco Demand Loan to subscribe for Newco preferred shares having an aggregate redemption amount and paid-up capital equal to the principal amount of the Profitco Demand Loan.

Dividends on the Newco preferred shares will be paid at least annually. The dividends will be funded by capital contributions made by Lossco, as described in Paragraph 16 below.

13. Newco will lend the subscription proceeds received in Paragraph 12 above to Lossco on an interest-free demand basis (the "Lossco Demand Loan"). The terms of the Lossco Demand Loan will allow Lossco to repay the Lossco Demand Loan by assigning the Profitco Demand Loan to Newco.

14. Lossco will use the proceeds from the Lossco Demand Loan to repay the Daylight Loan.

15. Profitco will pay interest to Lossco on the Profitco Demand Loan at least annually.

16. Lossco will agree to and will make contributions of capital to the Newco common share capital at least annually equal to the amount of dividends to be paid by Newco to Profitco in respect of the Newco preferred shares for so long as such preferred shares are outstanding. The contributions of capital, including those contributions of capital referred to in Paragraph 18(b) below, will not be income of Newco pursuant to generally accepted accounting principles. Lossco will, however, not be required to make such contributions of capital where Newco is no longer paying dividends to Profitco.

17. Newco will use the amounts received as capital contributions, as described in Paragraph 16 above, to pay dividends on the Newco preferred shares to Profitco at least annually.

18. Once Lossco has decided to unwind the proposed transactions in whole or in part, at that time:

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

(b) Lossco will make capital contributions to the common share capital of Newco equal to the amount of any accrued and unpaid dividends on the Newco preferred shares;

(c) Newco will declare and pay the balance of any accrued and unpaid dividends on the Newco preferred shares;

(d) Newco will redeem all or a portion of the Newco preferred shares held by Profitco and settle the amount owing on redemption by assigning a corresponding amount of the Lossco Demand Loan to Profitco;

(e) Profitco will repay all or a portion of the Profitco Demand Loan equal to the aggregate redemption amount of the Newco preferred shares redeemed under Paragraph 18(d) above by setting off the amount owing to Lossco with a corresponding amount of the Lossco Demand Loan, and such portions of the Lossco Demand Loan and the Profitco Demand Loan will be cancelled; and

(f) Once all of the Newco preferred shares held by Profitco have been redeemed, Newco will be wound up into Lossco pursuant to subsection 210(3) of the CBCA.

19. In order to reflect the fact that Lossco's non-capital losses will be effectively used by Profitco, Profitco may pay a dividend to Holdco3, which would ultimately flow up to Lossco by having Holdco3 pay a dividend to Holdco2, followed by Holdco2 paying a dividend to Canco, followed by Canco paying a dividend to Holdco1, followed by Holdco1 paying a dividend to Lossco. The amount of the dividend would reflect the tax savings resulting from the utilization of the non-capital losses of Lossco and other considerations and is estimated for the purposes of this ruling to be no more than XXXXXXXXXX% of the amount of the non-capital losses utilized in the year.

ADDITIONAL INFORMATION

20. Profitco, Lossco and Newco are neither specified financial institutions nor financial intermediary corporations.

21. None of the issued shares referred to herein (including the shares to be issued as described in the proposed transactions) are or 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 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).

22. Profitco and Lossco are affiliated persons.

23. Each of Lossco and Newco will agree with Profitco that Newco shall be a single-purpose company, shall have no liabilities and shall carry on (and Lossco will cause Newco to carry on) no activities other than those contemplated by the proposed transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

24. The overall purpose of the proposed transactions is to enable Lossco to earn sufficient interest income, over a period of time, in order to utilize some or all of its accumulated non-capital losses.

25. In order to undertake the proposed transactions in a legally effective manner, it is necessary to use Newco to enable Profitco to hold an interest in Newco preferred shares. Under section 30(1) of the CBCA, Profitco is precluded from acquiring and holding shares in Lossco.

26. The purpose of making capital contributions to the common share capital of Newco, as described in Paragraph 16 above, versus subscribing for additional common shares of Newco, is to ensure that Newco will not be precluded from declaring dividends on the Newco preferred shares pursuant to section 42 of the CBCA. If additional common shares of Newco were issued, the realizable value of Newco's assets (the Lossco Demand Loan) after the payment of a dividend would be less than the aggregate of its liabilities and its stated capital of both common shares and Newco preferred shares, thus precluding the payment of dividends.

RULINGS GIVEN

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 17 and 18(c) above, and by Holdco3, Holdco2, Canco, Holdco1 and Lossco, as described in Paragraph 19 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 Newco, described in Paragraphs 17 and 18(c) above, by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

C. Newco will not be subject to Part VI.1 tax under section 191.1 in respect of the dividends paid to Profitco, described in Paragraphs 17 and 18(c) above, 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 Profitco Demand Loan, described in Paragraph 11 above, and Profitco continues to hold the Newco preferred shares, described in Paragraphs 9 and 12 above, 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 Profitco Demand Loan or (ii) a reasonable amount in respect thereof.

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

F. The set-off of all or any part of the Lossco Demand Loan against the corresponding amount of the Profitco Demand Loan, described in Paragraph 18(e) above, will not give rise to a forgiven amount.

G. 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 Ruling A 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).

H. The provisions of subsection 88(1) will apply to the wind-up of Newco described in Paragraph 18(f) above.

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 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 18 and 19 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

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