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: Is the loss-utilization scheme involving a parent-sub situation acceptable?
Position: YES
Reasons: Reasonable and meets paragraph 32 of IT-533. No abuse or abuse of the Act read as a whole.
XXXXXXXXXX 2007-022615
XXXXXXXXXX, 2007
Dear XXXXXXXXXX:
Re: Advance Income Tax Ruling
XXXXXXXXXX (Parent)(BN XXXXXXXXXX )
Newco
XXXXXXXXXX (X Co) (BN XXXXXXXXXX )
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 an affiliated group of corporations.
We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request herein are:
(i) dealt with in an earlier return of Parent, X Co, Newco or a related person;
(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by Parent, X Co, Newco or a related person;
(iii) under objection by Parent, X Co, Newco or a related person;
(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to the taxpayers or a related person; nor
(v) before the courts, or if a judgment has been issued, the time limit for appeal to a higher court has expired.
To the best of the knowledge of Parent and X Co, the transactions described herein will not result in any taxpayer described herein being unable to pay its outstanding tax liabilities.
Definitions
In this letter, the following terms have the meanings specified:
(a) "Act" means the Income Tax Act;
(b) "Additional Percentage" means a rate expressed as a percentage that when added to the Prime Rate will result in a rate representing a commercial arm's length interest rate;
(c) "affiliated persons" has the meaning assigned by subsection 251.1(1) of the Act;
(d) "arm's length" has the meaning assigned by section 251 of the Act;
(e) "Y Co" means XXXXXXXXXX (formerly named XXXXXXXXXX), a XXXXXXXXXX company incorporated under the laws of XXXXXXXXXX, with its head office in XXXXXXXXXX;
(f) "First Daylight Loan" and "Second Daylight Loan" means the loans made in two tranches by an arm's length financial institution to Parent, as described in 10 and 15 below;
(g) "dividend rental agreement" has the meaning assigned by subsection 248(1) of the Act;
(h) "guarantee agreement" has the meaning assigned by subsection 112(2.2) of the Act;
(i) "X Co" means XXXXXXXXXX, a taxable Canadian corporation and the corporation that resulted from the amalgamation on XXXXXXXXXX of XXXXXXXXXX;
(j) "X Co Loan" means the loan made by Parent to X Co, as described in 11 below;
(k) "Newco" means the subsidiary wholly-owned corporation to be formed by Parent as described in 8 below;
(l) XXXXXXXXXX;
(m) "paid-up capital" has the meaning assigned by subsection 89(1) of the Act;
(n) "Parent" means XXXXXXXXXX, a public corporation incorporated under the laws of XXXXXXXXXX;
(o) "Parent Debt" means loans made by an arm's length financial institution to Parent in connection with the acquisition of Parent's investment in Y Co, as described in 3 below;
(p) "Parent Loan" means the interest-free demand loan to be made by Newco to Parent, as described in 13 below;
(q) "Predecessors" means XXXXXXXXXX;
(r) "Preferred Shares" means the preferred shares to be issued by Newco, as described in 9 below;
(s) "Prime Rate" means the rate of interest charged from time to time to its best and most creditworthy customers by the financial institution with which Parent has the credit facilities referred to in 3 below;
(t) "private corporation" has the meaning assigned by subsection 89(1) of the Act;
(u) "Proposed Transactions" means the transactions described in 8 to 19 below;
(v) "public corporation" has the meaning assigned by subsection 89(1) of the Act;
(w) "R Co" means XXXXXXXXXX, a corporation acquired by Y Co XXXXXXXXXX;
(x) "related" has the meaning assigned by section 251 of the Act to "related persons";
(y) "Subsequent Daylight Loan" means the loan made by an arm's length financial institution to Parent, as described in 18 below;
(z) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act; and
(aa) "taxable dividend" has the meaning assigned by subsection 89(1) of the Act.
Facts
1. Parent is governed by the XXXXXXXXXX and is a public corporation and a taxable Canadian corporation. The Class B shares of Parent are listed on the XXXXXXXXXX Stock Exchange. Parent owns a number of wholly owned subsidiary corporations that are in the business of XXXXXXXXXX. Parent is serviced by the XXXXXXXXXX Tax Services Office and files its income tax return at the XXXXXXXXXX Taxation Centre.
2. X Co was formed by amalgamation of the Predecessors under the XXXXXXXXXX on XXXXXXXXXX and is a taxable Canadian corporation. The Predecessors were both wholly-owned subsidiaries of Parent. X Co earns profit from carrying on the business of XXXXXXXXXX. The Predecessors were, and X Co will be, serviced by the XXXXXXXXXX Tax Services Office. Each of the Predecessors filed, and X Co will file, its income tax return at the XXXXXXXXXX Taxation Centre.
3. On XXXXXXXXXX, Parent paid $XXXXXXXXXX to acquire XXXXXXXXXX% of the issued and outstanding common shares of Y Co. On XXXXXXXXXX, Y Co acquired R Co. As a result, Parent made an additional investment of $XXXXXXXXXX in shares of Y Co on XXXXXXXXXX. Parent's total investment in Y Co of $XXXXXXXXXX was financed through the Parent Debt. XXXXXXXXXX.
4. The interest expense on the Parent Debt is deductible pursuant to paragraph 20(1)(c) because the Parent Debt represents money borrowed to acquire Parent's investment in the common shares of Y Co. In the absence of the Proposed Transactions, it is expected that Parent would realize non-capital losses due principally to the interest expense on the Parent Debt.
5. Y Co is a private corporation and a taxable Canadian corporation governed by the XXXXXXXXXX. Y Co is a XXXXXXXXXX company and its business includes XXXXXXXXXX. Y Co, directly and indirectly through its subsidiaries, XXXXXXXXXX.
6. As noted in 3 above, Parent has two existing lines of credit with an arm's length financial institution. The aggregate amount currently undrawn on these lines of credit is $XXXXXXXXXX. Notwithstanding the limit on the amount available under these particular lines of credit, Parent would be able to borrow an amount of at least $XXXXXXXXXX from an arm's length financial institution.
7. For purposes of provincial income tax, as of the date hereof, all of the income earned by Parent and X Co is or will be allocated to the province of XXXXXXXXXX. All income earned by the Predecessors was allocated to the province of XXXXXXXXXX.
Proposed Transactions
8. 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 X Co as described in 12 and from the Parent Loan as described in 13 below.
9. The authorized capital of Newco will consist of two classes of shares, common shares and the Preferred Shares. Parent will acquire all of the issued and outstanding common shares of Newco for a subscription price of $XXXXXXXXXX. The Preferred Shares will be non-voting, will bear cumulative dividends and will have a redemption/retraction price equal to the subscription price paid for them. The dividends payable on the Preferred Shares will be calculated by reference to the redemption/retraction price of the Preferred Shares and a floating rate equal to the Prime Rate plus a percentage slightly in excess of the Additional Percentage. Dividends on the Preferred Shares will be payable on an annual basis.
10. On a certain day following receipt of the rulings requested herein, Parent will borrow the amount of $XXXXXXXXXX on a daylight loan basis (the "First Daylight Loan") using its existing credit facilities referred to above.
11. Parent will use the total amount of proceeds from the First Daylight Loan to make a loan to X Co (the "X Co Loan"). The X Co Loan will bear interest at a floating rate equal to the Prime Rate from time to time plus the Additional Percentage.
12. X Co will use the total amount of the funds received from the X Co Loan to subscribe for Preferred Shares in Newco having an aggregate redemption/retraction price equal to the subscription price.
13. Newco will use the total proceeds received from the Preferred Share subscription described in 12 above to make the Parent Loan to Parent. The Parent Loan will be an interest-free loan, payable on demand.
14. Parent will use the funds received under the Parent Loan to repay the First Daylight Loan.
15. On the date following the date on which the transactions described in 10 to 14 above occur, Parent will again borrow $XXXXXXXXXX on a daylight loan basis (the "Second Daylight Loan") again using its credit facilities described above. The funds so borrowed will be used in the same manner, by the same parties, and for the same purposes, as is described above in 10 to 14 in connection with the First Daylight Loan. The purpose for carrying out the transactions in two tranches is to permit Parent to use its existing lines of credit to fund the First Daylight Loan and the Second Daylight Loan. The amount currently available under these lines of credit is not sufficient to enable Parent to borrow the total amount of the First Daylight Loan and the Second Daylight Loan in one tranche.
16. On each date that annual dividends are to be paid by Newco on the Preferred Shares while the X Co Loan is outstanding, Parent will make a contribution to the capital of Newco, in respect of the common shares of Newco, in an amount equal to the dividend payable by Newco on the Preferred Shares. No shares will be issued by Newco in respect of the contribution to capital and no amount will be added to the issued and paid-up capital of Newco. The amount of this contribution to capital will be recorded as contributed surplus for accounting purposes. The contribution to capital will not be treated as income of Newco pursuant to generally accepted accounting principles.
17. Upon the receipt of the contribution to capital described in 16 above, Newco will pay a dividend to X Co equal to the amount of the dividend payable on the Preferred Shares. X Co will then use the proceeds of the dividend so received to pay to Parent the interest owing on the X Co Loan.
18. On a future date, the following transactions will occur to unwind the structure described above:
(a) Parent will make a contribution to the capital of Newco, in respect of the common shares of Newco, in an amount equal to the amount of any accrued or unpaid dividends on the Preferred Shares held by X Co. No shares will be issued by Newco in respect of this contribution to capital and no amount will be added to the issued and paid-up capital of Newco. The amount of this contribution to capital will be recorded as contributed surplus for accounting purposes. The contribution to capital will not be treated as income of Newco pursuant to generally accepted accounting principles.
(b) Parent will borrow, in one or more tranches, $XXXXXXXXXX on a daylight loan basis (the "Subsequent Daylight Loan") from an arm's length financial institution. Parent will use the funds borrowed under the Subsequent Daylight Loan to repay the amount that it owes to Newco under the Parent Loan.
(c) Newco will use the funds received on the repayment of the Parent Loan, and any contribution of capital by Parent, as described in step (a) above, to pay any accumulated but unpaid dividends on the Preferred Shares and to redeem the Preferred Shares held by X Co.
(d) X Co will use the funds received by it in the preceding step to pay the balance of any accrued and unpaid interest on the X Co Loan and to repay the principal amount of the X Co Loan.
(e) Parent will use the proceeds from the repayment of the principal amount of the X Co Loan to repay the Subsequent Daylight Loan.
19. Parent will cause Newco to be wound-up shortly after the Preferred Shares are redeemed and the X Co Loan and Parent Loan are repaid.
20. The Proposed Transactions described herein will occur in the order described above.
21. It is represented that the amount of the X Co Loan represents an amount that X Co could reasonably borrow from an arm's length financial institution with a guarantee from Parent.
22. Based on financial projections, X Co has and will have the financial capacity to pay the interest on the X Co Loan from its own cash flow.
23. The Preferred Shares will not 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 agreement;
(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a) of the Act; or
(d) issued for consideration that is or includes:
(i) an obligation of the type described in subparagraph 112(2.4)(b)(i) of the Act other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b)) of the Act; or
(ii) any right of the type described in subparagraph 112(2.4)(b)(ii) of the Act.
24. Based on its existing assets and resources, Parent will have the ability to make the contributions of capital as described in 16 and 18.
25. Parent, and X Co are and Newco will be affiliated persons that are related to each other.
Purpose of the Proposed Transactions
26. The purpose of the Proposed Transactions is to allow for consolidation of profit and losses between Parent and X Co. The consolidation will be achieved by Parent earning sufficient interest income to enable it to offset its interest expense on the Parent Debt, while allowing X Co to reduce its taxable income by an equivalent amount in the form of interest expense payable by it on the X Co Loan.
Rulings Given
Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, the 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 the interest paid or payable by X Co on the X Co Loan as described in 11 is reasonable and is paid pursuant to a legal obligation to pay interest and that the Preferred Shares of Newco continue to be held by X Co for the purpose of producing income from property, X Co will be entitled to deduct, in computing its income for a taxation year, pursuant to paragraph 20(1)(c) of the Act, the interest paid or payable on the X Co Loan (depending on the method regularly followed by X Co in computing its income for the purposes of the Act) in respect of the taxation year to the extent such amount does not exceed a reasonable amount.
B. No amount will be included in the income of Newco pursuant to section 9, or paragraphs 12(1)(c) or 12(1)(x) of the Act, in respect of the contributions of capital made by Parent as described in 16 and 18 above.
C. The dividends received or deemed to be received by X Co on the Preferred Shares of Newco as described in 17 and 18 above will be taxable dividends that will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of X Co for the taxation year in which such dividends are 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) of the Act.
D. The provisions of subsections 15(1), 56(2), 69(1), 69(11) and 246(1) of the Act will not apply to the Proposed Transactions in and by themselves.
E. Subsection 245(2) of the Act will not be applicable as a result of the Proposed Transactions, in and by themselves, to redetermine the consequences confirmed in the rulings given above.
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 CRA provided that the Proposed Transactions, excluding 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.
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; nor
(e) any tax consequences relating to the facts and Proposed Transactions described herein other than those specifically described in the rulings given above.
Opinion:
In our view, on the future date when the transactions to unwind the structure occur, on the redemption of the preferred shares of Newco described in 18 above, no dividend will be deemed to have been paid by Newco and received by X Co under subsection 84(3) of the Act and no gain or loss will be realized or incurred by X Co at that time.
Yours truly,
XXXXXXXXXX
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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