2006 Ruling 2006-0180321R3 - 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: Standard loss-consolidation within an affiliated corporate group.

Position: Acceptable.

Reasons: Consistent with similar previous rulings and tax policy.

XXXXXXXXXX 								2006-018032

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, wherein you request an advance income tax ruling on behalf of the above named taxpayers. We also acknowledge documents you provided to us on XXXXXXXXXX, and additional information you provided to us during various telephone conversations (XXXXXXXXXX) in connection with your ruling request.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request is:

(i) dealt with in an earlier return of the taxpayers or a related person;

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

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

(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 previous ruling issued to the taxpayers or a related person by the Income Tax Rulings Directorate.

Our understanding of the facts, proposed transactions, other representations and the purpose of the proposed transactions are as follows.

DEFINITIONS:

In this letter, the following terms or expressions have the meanings specified:

(a) "Act" means the Income Tax Act (Canada), RSC 1985 (5th supp.), c.1, as amended to the date hereof, and, unless otherwise indicated, all statutory references are to the Act;

(b) "A Co" means XXXXXXXXXX;

(c) "A Co Loan" means the loan made by Parent to A Co described in paragraph 9 below;

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

(e) "arm's length" has the meaning assigned by subsection 251(1);

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

(g) "CRA" means Canada Revenue Agency;

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

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

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

(k) "Newco" is a new corporation incorporated under XXXXXXXXXX as described in paragraphs 6 and 7 below;

(l) "Parent" means XXXXXXXXXX;

(m) "Parent Affiliated Group" means Parent, A Co and their subsidiaries;

(n) "P Co" means XXXXXXXXXX;

(o) "Parent Debt" means the borrowing made by Parent in order to acquire XXXXXXXXXX of its "A" shares as described in paragraph 2 below;

(p) "Parent Loan" means the loan made by Parent to Newco described in paragraph 11 below;

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

(r) XXXXXXXXXX;

(s) "related" has the meaning assigned by section 251;

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

(u) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

FACTS

1. Parent is governed by the XXXXXXXXXX and is a public corporation and a taxable Canadian corporation whose shares are listed on a prescribed stock exchange within the meaning of Part XXXII of the Income Tax Regulations. XXXXXXXXXX Parent, its subsidiaries and affiliated corporations currently employ approximately XXXXXXXXXX professionals and have offices in Canada, the United States, XXXXXXXXXX. Consolidated revenues of Parent for the year ended XXXXXXXXXX totaled more than $XXXXXXXXXX with consolidated net earnings amounting to approximately $XXXXXXXXXX. Parent is serviced by the XXXXXXXXXX Tax Services Office and files its income tax return at the XXXXXXXXXX Taxation Centre.

2. In XXXXXXXXXX, Parent acquired XXXXXXXXXX of its Class A shares owned by P Co at a price of $XXXXXXXXXX. Parent financed the acquisition with cash and the Parent Debt for an amount of $XXXXXXXXXX. The interest expenses on the Parent Debt are deductible pursuant to paragraph 20(1)(c) since the Parent Debt replaced contributed capital of the shares acquired and/or accumulated profits that were being used for eligible purposes under paragraph 20(1)(c). The fiscal period of Parent ends on XXXXXXXXXX . As at XXXXXXXXXX Parent had no non-capital loss. The interest on the Parent Debt is financed partially with dividends from the subsidiaries. Without giving effect to the proposed transactions, it is expected that Parent will generate some non-capital losses caused principally by the interest expense on the Parent Debt. The acquisition by Parent of XXXXXXXXXX of its Class A shares owned by P Co did not cause any acquisition of control of Parent. Parent has a permanent establishment only in XXXXXXXXXX.

3. A Co is a wholly-owned subsidiary of Parent incorporated under the CBCA, and is a taxable Canadian corporation. XXXXXXXXXX A Co has a permanent establishment only in XXXXXXXXXX. The fiscal period of A Co ends on XXXXXXXXXX It is expected that A Co will have sufficient income for tax purposes to fully utilize the interest paid or payable on the A Co Loan described in paragraph 9 below. A Co is serviced by the XXXXXXXXXX Tax Services Office and files its income tax return at the XXXXXXXXXX Taxation Centre.

4. The consolidated financial statements of Parent for its year ended XXXXXXXXXX indicate that Parent and its subsidiaries had:

(a) assets of approximately $XXXXXXXXXX;

(b) liabilities of approximately $XXXXXXXXXX; and

(c) shareholder's equity of approximately $XXXXXXXXXX which includes retained earnings and cumulative currency translation adjustments.

The arm's length borrowings of the Parent Affiliated Group currently amount to approximately to $XXXXXXXXXX. Parent Affiliated Group is in a position to increase its current arm's length borrowings by an amount of not less than $XXXXXXXXXX.

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

PROPOSED TRANSACTIONS

6. Parent will incorporate Newco under the XXXXXXXXXX. Newco will be a taxable Canadian corporation. The taxation year-end of Newco will be XXXXXXXXXX. Newco will not carry on any business and its activities will be limited to investing the proceeds received upon the issuance of its Preferred Shares to A Co as described in paragraph 10 below, in the non-interest bearing loan to Parent as described in paragraph 11 below.

7. The authorized capital of Newco will consist of two classes of shares, common shares and non-voting, cumulative dividend, redeemable, retractable preferred shares (the "Preferred Shares"). The cumulative dividends payable on the Preferred Shares will be calculated daily by reference to the redemption/retraction price of the Preferred Shares at a rate equal to the interest rate on the A Co Loan plus a small spread. Dividends will be payable annually in arrears on the XXXXXXXXXX. The common shares of Newco will be issued to Parent for $XXXXXXXXXX.

8. Parent will borrow in total an amount of $XXXXXXXXXX (in two tranches) on a "daylight loan" basis from an arm's-length financial institution (the "Daylight loan ").

9. Parent will use the total proceeds received from the Daylight Loan to make the A Co Loan of $XXXXXXXXXX to A Co "). Simple interest will accrue on the A Co Loan and will be calculated daily at a rate equal to the commercial market rate applicable to loans to Parent plus XXXXXXXXXX%. The interest on the A Co Loan will be paid annually on the XXXXXXXXXX.

10. A Co will use the total proceeds received from the A Co Loan to subscribe for Preferred Shares in Newco having an aggregate redemption/retraction price equal to the amounts contributed in total.

11. Newco will use the total proceeds received from the Preferred Shares subscriptions described in paragraph 10 above to make a demand, interest-free loan to Parent in the amounts equal to such proceeds (the "Parent Loan").

12. Parent will use the total proceeds received from Parent Loan to repay the Daylight Loan.

13. On the XXXXXXXXXX, while the A Co Loan is outstanding, Parent will make a contribution of capital to Newco in an amount equal to the dividend payable by Newco on that day on the Preferred Shares held by A Co. No share will be issued by Newco with respect to the contribution of capital and no amount will be added to the issued and paid-up capital of Newco. The amount of this contribution of capital, if any, will be recorded as contributed surplus for accounting purposes. The contribution of capital, if any, will not be income of Newco pursuant to generally accepted accounting principles.

14. Upon receipt of the contribution described in paragraph 13 above, Newco will, subject to the applicable solvency test, pay a dividend to A Co equal to the amount of the dividend payable by Newco on its Preferred Shares.

15. The following transactions will occur on XXXXXXXXXX to unwind the loss consolidation arrangement:

(a) Parent will make a contribution of capital to Newco in an amount equal to the amount of any accrued and unpaid dividend on the Preferred Shares of Newco held by A Co. No share will be issued by Newco with respect to the contribution of capital and no amount will be added to the issued and paid-up capital of Newco. The amount of this contribution of capital, if any, will be recorded as contributed surplus for accounting purposes. The contribution of capital, if any, will not be income of Newco pursuant to generally accepted accounting principles.

(b) Parent will borrow $ XXXXXXXXXX on a daylight loan basis (the "New Daylight Loan"). Parent will use these funds to pay the Parent Loan to Newco.

(c) Newco will use the funds ($XXXXXXXXXX + the amount of the contribution of capital, if any) received through step (a) and (b) above, to redeem the Preferred Shares held by A Co.

(d) A Co will pay the balance of any accrued and unpaid interest on the A Co Loan.

(e) A Co will use $XXXXXXXXXX from the proceeds from the redemption of the Preferred Shares received through step (c) to repay the A Co Loan.

(f) Parent will use the $XXXXXXXXXX received on the repayment of the A Co Loan to pay the New Daylight Loan.

16. Parent will cause Newco to be wound-up within XXXXXXXXXX days after all the Preferred Shares are redeemed and the A Co Loan and the Parent Loan are repaid.

17. The loss consolidation arrangement described in paragraphs 6 to 16 above will be undertaken in the taxation years following XXXXXXXXXX until the repayment of all or a portion of Parent Debt and until such time that Parent will cease to generate some non-capital losses caused principally by the interest expense on the Parent Debt.

OTHER REPRESENTATIONS

18. The Preferred Shares of Newco which will be issued as described in paragraph 10 above, will not be, at any time during the implementation of the proposed transactions described herein:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as 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:

A) 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

B) any right of the type described in subparagraph 112(2.4)(b)(ii).

19. Parent, Newco and A Co are affiliated persons and are related with each others.

20. None of Parent, Newco and A Co is or will be a financial intermediary corporation. Parent, Newco and A Co are related to a particular corporation described in paragraph (d) of the definition specified financial institution. By reason only of the proposed transactions described herein, A Co will not be considered to have acquired the Preferred Shares of Newco in the ordinary course of the business carried on by it.

PURPOSE OF THE PROPOSED TRANSACTIONS

21. The purpose of the proposed transactions is to effect a tax consolidation of Parent and A Co by causing Parent to earn interest income on the A Co Loan, thus permitting a netting of its interest deduction on its Parent Debt and to have A Co incuring an interest expense to reduce its taxable income.

RULINGS GIVEN

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we rule as follows:

A. Provided that A Co has the legal obligation to pay interest on the A Co Loan described in paragraph 9 above and the Preferred Shares of Newco continue to be held by A Co, A Co will be entitled to deduct, in computing its income for a taxation year, the lesser of the interest paid or payable (depending on the method regularly followed by A Co in computing its income for the purposes of the Act) in respect of that taxation year or a reasonable amount in respect thereof pursuant to paragraph 20(1)(c).

B. No amount will be included in the income of Newco pursuant to section 9, paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital made by Parent as described in paragraphs 13 and 15(a) above.

C. The dividends received by A Co (or deemed to be received) on its Preferred Shares of Newco as described in paragraphs 14 and 15(c) above will be taxable dividends that will, pursuant to subsection 112(1), be deductible in computing the taxable income of A Co for the taxation year in which the dividends are received, and for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), or 112(2.4).

D. Neither Part IV.1 nor Part VI.1 will apply to the dividends described in ruling C because the dividends will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1).

E. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11) and 246(1) will not apply as a result of the proposed transactions in and by themselves.

F. Subsection 245(2) 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.

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 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.

COMMENTS

Nothing in this ruling should be construed as implying that the CRA 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.

An invoice for our fees in connection with this ruling request will be forwarded to you under separate cover.

Yours truly,

for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch