2006 Ruling 2006-0185221R3 - 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 consolidation within a corporate group

Position: The loss utilization is acceptable.

Reasons: The ruling is consistent with our position in previous rulings and with Department of Finance policy.

XXXXXXXXXX 								2006-018522

XXXXXXXXXX, 2006

Re: Advance Income Tax Ruling
XXXXXXXXXX ("A Co")
XXXXXXXXXX ("B Co")

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-named taxpayers. In general terms, the transactions described herein involve the use of losses within a group of related corporations.

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

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

(ii) being considered by a tax services office or taxation centre of Canada Revenue Agency ("CRA") 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) subject to a ruling previously issued by the Income Tax Rulings Directorate to the taxpayers or a related person; or

(v) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.

Unless otherwise stated, statutory references in this letter are to the Income Tax Act, R.S.C. 1985 (5th Suppl.) c. 1, as amended to the date hereof (the "Act").

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

Facts

1. XXXXXXXXXX ("Parent") is a non-resident corporation and a management holding corporation which forms, with its subsidiaries and affiliated corporations ("Parent Group"), a XXXXXXXXXX group of companies. Parent is engaged in the XXXXXXXXXX business through A Co and other numerous worldwide subsidiaries, the XXXXXXXXXX business through B Co as well as their other numerous worldwide subsidiaries and in the XXXXXXXXXX business through other subsidiaries. Consolidated revenues of Parent for the year ended XXXXXXXXXX totalled $XXXXXXXXXX with consolidated net earnings amounting to approximately $XXXXXXXXXX.

2. The arm's length borrowings of Parent Group currently amount to approximately $XXXXXXXXXX all of which have been used to invest in XXXXXXXXXX, and shares in new corporations as new investments.

3. A Co is a taxable Canadian corporation within the meaning assigned by subsection 89(1). A Co was incorporated under the XXXXXXXXXX Business Corporations Act whose shares are held by non-resident corporations. The fiscal period of A Co ends on XXXXXXXXXX. A Co and associated corporations outside of Canada form a XXXXXXXXXX organization which is XXXXXXXXXX. Parent currently indirectly holds through wholly-owned subsidiaries XXXXXXXXXX% of the outstanding shares of A Co. A Co operates in XXXXXXXXXX. A Co's taxable income for XXXXXXXXXX was approximately $XXXXXXXXXX. Revenues of A Co for the year ended XXXXXXXXXX totalled $XXXXXXXXXX with net earnings amounting to $XXXXXXXXXX. The provincial allocation of income is as follows: XXXXXXXXXX. A Co's taxation centre is XXXXXXXXXX and is served by the XXXXXXXXXX tax services office.

4. B Co is a taxable Canadian corporation within the meaning assigned by subsection 89(1). B Co was incorporated under the Companies Act (XXXXXXXXXX). The authorized share capital of B Co consists of an unlimited number of common shares and several classes, namely Classes A, B, C, D, and E of preferred shares. Parent currently indirectly holds through a wholly-owned subsidiary, XXXXXXXXXX% of the outstanding common shares of B Co and XXXXXXXXXX% of the outstanding preferred shares of B Co. B Co's taxation centre is XXXXXXXXXX and is served by the XXXXXXXXXX tax services office.

5. B Co is an operating corporation which forms, with its associated corporations outside of Canada, a major group of corporations engaged in the XXXXXXXXXX business. The fiscal period of B Co ends on XXXXXXXXXX. From a federal perspective, B Co has approximately $XXXXXXXXXX non-capital losses, $XXXXXXXXXX of Scientific Research and Experimental Development ("SR&ED") expenditure pool and $XXXXXXXXXX of unused investment tax credits as at the end of its XXXXXXXXXX taxation year. B Co operates in XXXXXXXXXX. The provincial allocation of income is as follows in XXXXXXXXXX: XXXXXXXXXX B Co is taxable in XXXXXXXXXX and has no tax attributes of the nature described above. In XXXXXXXXXX, B Co has approximately $XXXXXXXXXX non-capital losses and $XXXXXXXXXX of SR&ED expenditure pool. The non-capital losses of B Co were incurred principally by the operating results of the XXXXXXXXXX business.

6. 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.

Parent is in a position to increase its current arm's length borrowings by an amount of at least $XXXXXXXXXX.

Proposed Transactions

7. The transactions described below ("Proposed Transactions") will follow sequentially.

8. The taxpayers confirm that the Proposed Transactions will not affect their ability to pay any of their outstanding tax liabilities.

9. The authorized capital of B Co will be modified to authorize an unlimited number of Class F preferred shares (the "Preferred Shares") which will have the following characteristics:

(a) non-voting;

(b) entitled to a cumulative annual dividend of XXXXXXXXXX% on the amount for which they were issued which will be calculated daily by reference to the redemption/retraction price at a rate equal to the interest rate on the loan B Co will make to A Co as described in 13 below, plus a small spread. Dividends will be payable XXXXXXXXXX;

(c) will have a preference on dissolution over the Class A to E preferred shares for the return of the redemption amount plus unpaid dividends; and

(d) redeemable and retractable, subject to applicable law, at any time for an amount equal to the amount for which they were issued.

10. Parent will draw down from an available line of credit, the sum of $XXXXXXXXXX from an arm's length financial institution. Parent has obtained third party confirmation that it has the ability to borrow $XXXXXXXXXX from the existing line of credit from an arm's length lender ("Parent Loan").

11. A Co will borrow an amount of $XXXXXXXXXX on a "daylight loan" basis from Parent according to Parent's lending policy within the corporate group (the "Daylight Loan").

12. A Co will use the proceeds received from the Daylight Loan to invest in $XXXXXXXXXX of Preferred Shares which have an aggregate adjusted cost base, fair market value, redemption and retraction price equal to the consideration for which such shares are issued, namely, $XXXXXXXXXX ("A Co Investment").

13. B Co will use the proceeds received from the A Co Investment which aggregate $XXXXXXXXXX, to make a demand loan to A Co with an annual interest rate of XXXXXXXXXX% which rate is not greater than the rate that A Co would pay to an arm's length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms ("B Co Loan").

14. A Co will use the proceeds of the B Co Loan to repay the Daylight Loan. Parent will use the repayment from A Co to repay the Parent Loan.

15. On XXXXXXXXXX, B Co will pay a dividend on the A Co Investment.

16. The following events will occur no later than XXXXXXXXXX to unwind the loss consolidation arrangement:

(a) A Co will repay the B Co Loan to B Co; and

(b) B Co will use the funds received through step (a) above, to redeem the A Co Investment at their aggregate redemption amount equal to the amount of the B Co Loan and the fair market value of the shares so redeemed, that is $XXXXXXXXXX.

Additional Information

17. The A Co Investment, which will be issued as described in 12 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);

(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); or

(e) a share that is issued or acquired as part of a transaction or series of transactions or events of the type described in subsection 112(2.5).

18. Parent, A Co and B Co (the "Parent Affiliated Group") are affiliated persons and are related with each other.

19. No member of the Parent Affiliated Group is a "specified financial institution" or "restricted financial institution" within the meanings assigned to those terms in subsection 248(1), or a "financial intermediary corporation" as defined in subsection 191(1).

20. Neither A Co nor B Co has any outstanding tax liabilities that could be affected by the Proposed Transactions.

21. A Co will have the financial capacity to repay the B Co Loan.

22. None of the purposes of paying the dividend described in the Proposed Transactions will be to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any of the shares referred to herein immediately before the payment of the dividend. The sole purpose of B Co paying the dividend on the A Co Investment is to satisfy their terms and conditions.

Purpose of the Proposed Transactions

23. The sole purpose of the Proposed Transactions is to allow for the consolidation of profit and losses between A Co and B Co. The consolidation will be achieved by B Co earning sufficient interest income, over a period not to extend beyond XXXXXXXXXX, so as to utilize its non-capital losses, SR&ED expenditure pool and investment tax credits available and allow A Co to reduce its taxable income by the equivalent interest income earned by B Co.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, Proposed Transactions and purpose of the Proposed Transactions, the final documents are substantially the same as the documents provided to us as reflected herein and provided that the Proposed Transactions are completed in the manner described above, our rulings are as follows:

A. Provided that A Co has the legal obligation to pay interest on the B Co Loan and the A Co Investment continues to be held by A Co for the purpose of gaining or producing income from property, 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 an amount in respect thereof pursuant to subsection 20(3) and paragraph 20(1)(c), to the extent such amount does not exceed a reasonable amount.

B. The dividend received by A Co on the A Co Investment described in 15 above will be a taxable dividend that will, pursuant to subsection 112(1), be deductible in computing the taxable income of A Co 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) or 112(2.4).

C. A Co will not be subject to Part IV.1 tax under section 187.2 in respect of the dividend received from B Co, described in 15 above, because such dividend will be an excepted dividend by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

D. B Co will not be subject to Part VI.1 tax under section 191.1 in respect of the dividend paid to A Co, described in 15 above, because such dividend will be an excluded dividend by virtue of paragraph (a) of the definition "excluded dividend" in subsection 191(1).

E. Provided B Co is not entitled to a dividend refund in respect of its taxation year in which it paid the dividend on the A Co Investment described in 15 above, A Co will not be subject to Part IV tax under subsection 186(1).

F. Subsection 245(2) will not be applied to the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given

The rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act and given subject to the general limitations and qualifications set forth in Information Circular 70-6R5, dated May 17, 2002, issued by the CRA, and are binding on the CRA provided the Proposed Transactions are completed on or before XXXXXXXXXX.

Nothing in this letter should be construed as implying that the CRA has agreed to or accepted:

(i) the GST implications of any of the Proposed Transactions;

(ii) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(iii) the amount of any non-capital loss or any other amount of any corporation referred to herein;

(iv) the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

(v) the application or non-application of the general anti-avoidance provisions of any province; and

(vi) any other tax consequences of the Proposed Transactions or of related transactions or events that are not described herein.

Yours truly,

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