2006 Ruling 2006-0172311R3 - Appl. of s.111(5)(a)(ii) - acquisition of cont.

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: Can non-capital losses of Lossco arising prior to acquisition of control of Lossco by Profitco be offset by income from leasing property transferred from Profitco to Lossco subsequent to acquisition of control?

Position: Question of fact - yes

Reasons: Leasing assets to be transferred from Profitco to Lossco are of the same type that Lossco leased or rented in the leasing business it carried on before the acquisition of control. In addition, the assets to be transferred are similar to those transferred to Lossco in the transaction ruled upon in E 2005-011346.

XXXXXXXXXX 								2006-017231

XXXXXXXXXX, 2006

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

(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) "New Assets" means approximately XXXXXXXXXX dollars of office equipment acquired by Profitco subsequent to XXXXXXXXXX for leasing or renting to parties that deal at arm's length with Profitco, consisting of XXXXXXXXXX;

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

(k) "Office Equipment Assets" means approximately XXXXXXXXXX dollars of office equipment, XXXXXXXXXX;

(l) "Original Ruling" means advance tax ruling 2005-011346, which was issued to Profitco and Lossco on XXXXXXXXXX, 2005;

(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) "undepreciated capital cost" ("UCC") has the meaning assigned by subsection 13(21);

(s) "USco" means XXXXXXXXXX., a United States corporation; and

(t) "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.

4. 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.

5. For 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. These percentages did not materially differ for the taxation year that ended on XXXXXXXXXX.

6. 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.

7. 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.

8. Since XXXXXXXXXX, Lossco has had sales offices located in XXXXXXXXXX, Lossco's customers have been XXXXXXXXXX. Since XXXXXXXXXX, Lossco leases or rents, to third parties that deal at arm's length with Lossco, all of the types of assets described in the definition of "Office Equipment Assets" XXXXXXXXXX. In addition, since XXXXXXXXXX, Lossco leases XXXXXXXXXX to parties that deal at arm's length with Lossco as of consequence of acquiring the Office Equipment Assets from Profitco, as described in paragraph 16 below.

A sizeable portion of Lossco's income is derived from the sale of equipment from expired leases and rentals. Lossco disposes of used equipment XXXXXXXXXX.

9. For 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. These percentages did not materially differ for the taxation year that ended immediately before Profitco acquired control of Lossco, as described in paragraphs 13 and 14 below.

10. From XXXXXXXXXX to 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). 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.

12. On XXXXXXXXXX, Lossco's issued and outstanding share capital consisted of XXXXXXXXXX common shares, all of which were held by Parentco.

13. On XXXXXXXXXX, Parentco sold all of the issued and outstanding common shares of Lossco to Profitco for cash consideration equal to the aggregate FMV of the shares at that time.

14. As a result of the acquisition of all the issued and outstanding common shares of Lossco by Profitco as described in the preceding paragraph, Profitco acquired control of Lossco. Consequently, Lossco was deemed by subsection 249(4) to have a taxation year that ended immediately prior to the acquisition of control. In addition, Lossco was required to deduct $XXXXXXXXXX in computing its income for the taxation year ending immediately before the acquisition of control pursuant to subsection 111(5.1). Lossco has determined that it has a non-capital loss for the XXXXXXXXXX taxation year in the amount of $XXXXXXXXXX, thereby increasing the total amount of its non-capital losses to $XXXXXXXXXX.

15. After Profitco acquired the issued and outstanding common shares of Lossco, Lossco reduced the stated capital of the common shares of Lossco on

XXXXXXXXXX to an amount equal to the cost amount of those shares to Profitco. The reduction to the stated capital of the common shares of Lossco was made without any payment to Profitco.

16. After the stated capital reduction described in the preceding paragraph, Profitco sold the Office Equipment Assets to Lossco on XXXXXXXXXX, along with Profitco's interest in the leasing contracts associated with the Office Equipment Assets. As consideration for acquiring the Office Equipment Assets (and the interest in the associated leasing contracts) Lossco issued XXXXXXXXXX common shares and a promissory note for the balance of the purchase price. Profitco and Lossco jointly elected pursuant to subsection 85(1) within the time limits prescribed by subsection 85(6) with respect to this transaction.

17. In conjunction with sale of Office Equipment Assets to Lossco, Profitco agreed to provide administrative support to Lossco with respect to the Office Equipment Assets. Lossco agreed pay a fair market value fee to Profitco for this service.

18. Certain of the tax consequences associated with the transactions described in paragraphs 13, 15, 16 and 17 above were the subject of the Original Ruling. In the Original Ruling, Profitco and Lossco stated that the purposes of such transactions were to:

(i) provide Profitco access to new clients and sales representatives;

(ii) leverage Lossco's infrastructure with respect to business operations 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 of the common shares of Lossco.

19. Lossco has continued to carry on the business that it carried on before Profitco acquired the common shares of Lossco from Parentco, in the manner described in paragraphs 7, 8 and 10 above, with a reasonable expectation of profit. Lossco will continue to carry on this business with a reasonable expectation of profit until it distributes its assets to Profitco as part of the winding-up of Lossco described in paragraph 22 below.

PROPOSED TRANSACTIONS

20. In XXXXXXXXXX, Profitco will sell the New Assets to Lossco (along with Profitco's interest in the leasing contracts associated with the New Assets). 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 aggregate amount of fair market value of the assets in excess of their aggregate cost amount. Lossco will issue a promissory note or pay cash to Profitco in an amount equal to the aggregate 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 New Assets (and the interest in the associated leasing contracts).

21. Profitco will agree to provide administrative support to Lossco with respect to the New Assets. Lossco will agree to pay a fair market value fee to Profitco for this service.

22. It is anticipated that Profitco will wind-up Lossco before XXXXXXXXXX. At the time of winding-up, it is anticipated that the UCC of Lossco's lease portfolio will exceed the FMV thereof. Lossco will not be wound-up into Profitco until all of Lossco's non-capital losses have been utilized. Utilization of Lossco's non-capital losses will be a result of expected profitable operations and reduced capital cost allowance claims.

23. Except as described below, Lossco will not dispose of any of the New Assets prior to the time it is wound-up into Profitco. 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 New 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 New 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 New 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 a lessee should the lessee wish to buy or trade-in one of the assets included in the New Assets.

If a lessee buys such 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 FMV and UCC 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 FMV 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 FMV and UCC 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 New Assets received by it as a result of a default in respect of the lease terms governing the particular assets.

24. 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 New Assets that it receives 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 Office Equipment Assets and New 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 New Assets and the Office Equipment Assets will exceed XXXXXXXXXX dollars.

ADDITIONAL INFORMATION

25. Lossco has filed or will file an election pursuant to subsection 1100(1.14) of the Regulations in its return of income for the taxation year immediately following the taxation year of Lossco that ended on XXXXXXXXXX as a consequence of the acquisition of control by Profitco that occurred on XXXXXXXXXX.

26. Lossco has not made or will not make an election under subsection 256(9) in its return of income for the taxation year ending immediately before the acquisition of control by Profitco that occurred on XXXXXXXXXX.

27. 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

28. 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.

More specifically, Profitco and Lossco have agreed to complete the transfer of the New Assets (and Profitco's interest in the associated leasing contracts) in order to accelerate the utilization of Lossco's non-capital losses from previous taxation years, which are higher than what was anticipated by Profitco and Lossco at the time of the Original Ruling. Acquiring the New Assets (and Profitco's interest in the associated leasing contracts) will thereby allow Lossco to be wound-up at an earlier time. The proposed transfer of the New Assets (and Profitco's interest in the associated leasing contracts) could not have taken place in conjunction with the transactions described in the Original Ruling because the New Assets were acquired by Profitco in the course of carrying on its business after the completion of those transactions.

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), the income of Lossco which will be derived from the leasing or rental of the New Assets, which assets will be transferred to Lossco as described in paragraph 20 above, will be considered to be derived from properties similar to those that were leased or rented by Lossco in the course of carrying on its business before Profitco acquired control of Leasco on XXXXXXXXXX, in the manner described in paragraphs 7, 8 and 10.

B. 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 ruling given above.

The above rulings 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 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.

COMMENTS

The above Ruling A considers only the issue of whether, for the purposes of subparagraph 111(5)(a)(ii), the New Assets are similar to the properties leased or rented by Lossco before Profitco acquired control of Lossco on XXXXXXXXXX. 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 business of Lossco that existed before the acquisition of control on XXXXXXXXXX has been or will be carried on by Lossco throughout a particular taxation year, and if so, whether the business has been or 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 Canada Revenue Agency has agreed to or reviewed:

(a) the determination of the ACB, PUC or FMV of any shares or other property or the UCC of any class of depreciable property referred to herein;

(b) the amount of non-capital losses of Lossco;

(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; or

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

Finally, it is our view that the proposed transactions, if completed in the manner described herein, would not, in and by themselves, cause the Original Ruling to cease to be binding upon the Canada Revenue Agency.

Yours truly,

for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch