2007 Ruling 2007-0243471R3 - 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 Utilization within a corporate group

Position: Acceptable

Reasons: Meets the technical requirements of the provisions

XXXXXXXXXX 							2007-024347

XXXXXXXXXX , 2007

Dear XXXXXXXXXX ,

Re: XXXXXXXXXX ("Subsidiary") BN XXXXXXXXXX
XXXXXXXXXX . ("Parent") BN XXXXXXXXXX )
Newco
Lossco
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX , wherein you request 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 also acknowledge information provided during numerous telephone conversations (XXXXXXXXXX ) and electronic correspondences.

We understand that, to the best of your knowledge and that of Parent, Subsidiary, Newco and Lossco involved, none of the issues contained in this ruling request herein is:

(i) dealt with in an earlier return of Parent, Subsidiary, Lossco, 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, Subsidiary, Lossco, Newco or a related person;

(iii) under objection by Parent, Subsidiary, Lossco, Newco or a related person;

(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to Parent, Subsidiary, Newco, Lossco 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.

Definitions:

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

(a) "ACB" means adjusted cost base as defined in section 54 of the Act;

(b) "Aco" means XXXXXXXXXX ;

(c) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.), c. 1, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

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

(e) "arm's length" has the meaning assigned by section 251 of the Act;

(f) "capital property" has the meaning assigned by section 54 of the Act;

(g) "CRA" means the Canada Revenue Agency;

(h) "Daylight Loan" has the meaning ascribed to it in 20 below;

(i) "dividend rental arrangement" has the meaning assigned by subsection 248(1) of the Act;

(j) "excepted dividends" has the meaning assigned by section 187.1 of the Act;

(k) "excluded dividends" has the meaning assigned by subsection 191(1) of the Act;

(l) XXXXXXXXXX ;

(m) "financial intermediary corporation" has the meaning assigned by subsection 191(1) of the Act;

(n) "FMV" means fair market value;

(o) "guarantee agreement" has the meaning assigned by subsection 112(2.2) of the Act;

(p) XXXXXXXXXX

(q) XXXXXXXXXX

(r) "Lossco" means a corporation to be incorporated by Parent under the laws of Canada or a province of Canada as described in 17 below;

(s) "Lossco Loan" has the meaning ascribed to it in 21 below;

(t) "Losses" has the meaning ascribed to it in 8 below;

(u) "Newco" means a corporation to be incorporated by Parent under the laws of Canada or a province of Canada as described in 12 below;

(v) "New Daylight Loan" has the meaning ascribed to it in 29 below;

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

(x) XXXXXXXXXX

(y) "Parent" means XXXXXXXXXX .;

(z) "Parent Loan" has the meaning ascribed to it in 24 below;

(aa) "Partial New Daylight Loan" has the meaning ascribed to it in 30(ii) below;

(bb) XXXXXXXXXX ;

(cc) "Preferred Shares" has the meaning ascribed to it in 22 below;

(dd) "private corporation" has the meaning assigned by subsection 89(1) of the Act;

(ee) "Proposed Transactions" means the transactions described in 12 to 38 below;

(ff) XXXXXXXXXX

(gg) "PUC" means paid-up capital as defined in subsection 89(1) of the Act;

(hh) "Regulations" means the Income Tax Regulations issued pursuant to the Act XXXXXXXXXX ;

(ii) "Special Share" has the meaning ascribed to it in 32 below;

(jj) XXXXXXXXXX

(kk) "subject corporation" has the meaning assigned by subsection 186(3) of the Act;

(ll) "Subsidiary" means XXXXXXXXXX ;

(mm) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1) of the Act;

(nn) "substantial interest" has the meaning assigned by subsection 191(2) of the Act;

(oo) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;

(pp) "taxable dividend" has the meaning assigned by subsection 89(1) of the Act; and

(qq) "taxation year" has the meaning assigned by section 249 of the Act.

Facts:

1. XXXXXXXXXX The authorized capital of Parent includes common shares, and XXXXXXXXXX preferred shares each issuable in one or more series. Only common shares and XXXXXXXXXX preferred shares of Parent are issued and outstanding. The common shares of Parent are listed on the XXXXXXXXXX . The XXXXXXXXXX preferred shares were issued to the public under prospectuses dated XXXXXXXXXX . Parent files its tax returns with the XXXXXXXXXX Tax Centre and is serviced by the XXXXXXXXXX Tax Services Office.

2. XXXXXXXXXX . Subsidiary is a subsidiary wholly-owned corporation of Parent. The authorized capital of Subsidiary includes common shares, and XXXXXXXXXX preferred XXXXXXXXXX . The common shares and the XXXXXXXXXX preferred shares of Subsidiary are owned by, and are capital property to, Parent. Subsidiary files its tax returns with the XXXXXXXXXX Tax Centre and is serviced by the XXXXXXXXXX Tax Services Office.

3. Subsidiary carries on the business of XXXXXXXXXX in Canada XXXXXXXXXX

4. XXXXXXXXXX

5. XXXXXXXXXX

6. Parent is a holding corporation for Subsidiary and XXXXXXXXXX . Parent is also a holding corporation for Aco and XXXXXXXXXX .

7. The taxation year of Parent ends on XXXXXXXXXX . In XXXXXXXXXX , Parent had incurred non-capital losses in its three previous taxation years and was expected to incur cumulative non-capital losses of approximately $XXXXXXXXXX by the end of its XXXXXXXXXX taxation year. Parent implemented a loss utilization strategy in order to use these accrued and projected non-capital losses (see advance tax ruling number 2003-003310).

8. XXXXXXXXXX Consequently, Parent had a deemed year-end for tax purposes on XXXXXXXXXX . XXXXXXXXXX , Parent was required to include in its income for its taxation year ending XXXXXXXXXX approximately $XXXXXXXXXX of gains resulting from the XXXXXXXXXX loss utilization strategy, described in 7 above. Parent used approximately $XXXXXXXXXX of non-capital losses available to be carried forward from XXXXXXXXXX to partially offset this taxable income.

Parent holds income-producing investments, including its equity investments in Subsidiary and Aco. As a result of Parent's interest expense incurred for general corporate purposes, including investments in subsidiaries (XXXXXXXXXX ), it has incurred or it is projected that Parent will incur the following approximate non-capital losses in its XXXXXXXXXX taxation years (the "Losses"):

Taxation Year
Losses
Losses Carried
Back
Losses Carried Forward

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

XXXXXXXXXX

9. The Losses from Parent's XXXXXXXXXX taxation year and a portion of the Losses from Parent's XXXXXXXXXX taxation year (approximately $XXXXXXXXXX and $XXXXXXXXXX , respectively) will be carried back to Parent's taxation year ending XXXXXXXXXX to offset any remaining taxable income from that year. The remaining Losses from Parent's XXXXXXXXXX taxation year and all of the Losses from Parent's XXXXXXXXXX taxation years (approximately XXXXXXXXXX , respectively) will be carried forward.

10. The taxation year of Subsidiary ends on XXXXXXXXXX . The consolidated net revenue of Subsidiary for the year ended XXXXXXXXXX was approximately $XXXXXXXXXX , and the consolidated net income was approximately $XXXXXXXXXX .

11. Parent is in a position to increase its current arm's length borrowings by an amount in excess of the amount of the Daylight Loan.

Proposed Transactions:

12. Parent will incorporate a new corporation ("Newco") under the laws of Canada or a province of Canada. Newco will be a taxable Canadian corporation. The taxation year of Newco will end on XXXXXXXXXX . The activities of Newco will be limited to the activities described in the Proposed Transactions, including investing the proceeds it receives upon the issuance of the Preferred Shares to Lossco as described in 22 below in the Parent Loan as described in 24 below.

13. The authorized share capital of Newco will consist of an unlimited number of common shares and preferred shares.

14. The common shares of Newco will be without par value and will be voting shares (1 vote per share). The holders of common shares will be entitled to dividends at the discretion of the directors, and will be entitled to receive the remaining property of the corporation upon its winding-up or dissolution.

15. The preferred shares of Newco will be without par value and will be non-voting shares. The preferred shares will be redeemable and retractable for a redemption price equal to the FMV of the consideration for which the shares are issued, plus any accrued but unpaid dividends. The holders of preferred shares will be entitled to cumulative dividends, calculated daily by reference to the redemption/retraction price of the preferred shares at a rate equal to the interest rate on the Lossco Loan (as described in 21 below) plus a small spread. The dividends on the preferred shares will be payable semi-annually on specified dates each year.

16. Newco will issue common shares of its capital stock to Parent for nominal consideration. Parent will have de jure control of Newco for the purposes of the Act.

17. Parent will incorporate a new corporation ("Lossco") under the laws of Canada or a province of Canada. Lossco will be a taxable Canadian corporation. The taxation year of Lossco will end on XXXXXXXXXX . The activities of Lossco will be limited to the activities described in the Proposed Transactions, including investing the proceeds it receives from Parent upon the issuance of the Lossco Loan (as described in 21 below) in the Preferred Shares of Newco as described in 22 below.

18. The authorized share capital of Lossco will consist of an unlimited number of common shares. The common shares will be without par value and will be voting shares (XXXXXXXXXX vote per share). The holders of common shares will be entitled to dividends at the discretion of the directors, and will be entitled to receive the remaining property of the corporation upon its winding-up or dissolution.

19. Lossco will issue common shares of its capital stock to Parent for nominal consideration. Parent will have de jure control of Lossco for the purposes of the Act.

20. Parent will borrow approximately $XXXXXXXXXX on a "daylight loan" basis from an arm's-length financial institution (the "Daylight Loan"). The amount borrowed by Parent will be based on, and will not exceed, its borrowing capacity. The terms of the Daylight Loan will be commercial arm's length terms.

21. Parent will use the entire proceeds received from the Daylight Loan to make a loan to Lossco (the "Lossco Loan"). Simple interest will accrue on the Lossco Loan and will be calculated at a commercial market rate. The interest rate will be determined at the time the Proposed Transactions are implemented. Interest on the Lossco Loan will be payable semi-annually on specified dates each year. The Lossco Loan will have a term of approximately XXXXXXXXXX months and its principal amount will be repayable at any time, in whole or in part, at Lossco's option.

22. Lossco will use the entire proceeds received from the Lossco Loan to subscribe for preferred shares in Newco (the "Preferred Shares") having an aggregate redemption/retraction price equal to the amount contributed. The PUC of the Preferred Shares will be equal to their aggregate redemption/retraction price. Lossco will be entitled to cumulative dividends on its Preferred Shares, calculated daily by reference to the redemption/retraction price of the Preferred Shares at a rate equal to the interest rate on the Lossco Loan plus a small spread.

23. The amount of dividends on the Preferred Shares held by Lossco will be sufficient to permit Lossco to realize a profit on its investment activities, after the deduction of its interest and other expenses.

24. Newco will use the entire proceeds received from the Preferred Shares subscription to make an interest-free loan to Parent (the "Parent Loan"). The Parent Loan will be payable, in whole or in part, on demand.

25. Parent will use the entire proceeds received from the Parent Loan to repay the Daylight Loan.

26. While the Lossco Loan is outstanding, Parent will make contributions of capital to Newco in an amount equal to the dividends payable by Newco on the Preferred Shares held by Lossco. No share will be issued by Newco with respect to the contributions of capital and no amount will be added to the stated capital account of Newco. The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes. The contributions of capital will not be treated as income of Newco pursuant to generally accepted accounting principles.

27. Upon receipt of the contributions of capital described in 26 above, Newco will use the amounts received to pay dividends to Lossco equal to the amount of the dividends payable by Newco on the Preferred Shares held by Lossco.

28. Lossco will use the amounts received as dividends from Newco to pay to Parent the interest on the Lossco Loan when due and payable.

29. The following transactions will occur no later than 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 dividends on the Preferred Shares held by Lossco. No share will be issued by Newco with respect to the contribution of capital and no amount will be added to the stated capital account of Newco. The amount of this contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be treated as income of Newco pursuant to generally accepted accounting principles.

(b) Newco will use the funds received on the contribution of capital to pay any accrued and unpaid dividends on the Preferred Shares held by Lossco.

(c) Lossco will use the amounts received as dividends from Newco to pay to Parent any accrued and unpaid interest on the Lossco Loan.

(d) Immediately thereafter, the Parent Loan and the Lossco Loan will be repaid and the Preferred Shares held by Lossco will be redeemed in the following manner:

(i) Newco will demand repayment of the Parent Loan;
(ii) Parent will borrow an amount equal to the principal amount outstanding on the Parent Loan on a daylight loan basis from an arm's-length financial institution (the "New Daylight Loan"). Parent will use these funds to repay the Parent Loan;
(iii) the Preferred Shares held by Lossco will be redeemed, and Newco will use the funds received on the repayment of the Parent Loan to pay the redemption price upon the redemption of the Preferred Shares held by Lossco;
(iv) Lossco will use the entire proceeds of the redemption of the Preferred Shares to repay the Lossco Loan; and
(v) Parent will use the funds received on the repayment of the Lossco Loan to repay the New Daylight Loan.

30. Prior to unwinding the loss consolidation arrangement as described in 29 above, it may be desired to reduce the principal amount outstanding on the Lossco Loan. In that event, the Parent Loan and the Lossco Loan would be partially repaid and some of the Preferred Shares held by Lossco would be redeemed in the following manner prior to unwinding the loss consolidation arrangement:

(i) Newco will demand a partial repayment of the Parent Loan in an amount equal to the amount by which it is desired to reduce the principal amount outstanding on the Lossco Loan;
(ii) Parent will borrow the amount referred to in 30(i) on a daylight loan basis from an arm's-length financial institution (the "Partial New Daylight Loan"). Parent will use these funds to partially repay the Parent Loan;
(iii) some of the Preferred Shares held by Lossco having a redemption price equal to the amount of the partial repayment of the Parent Loan will be redeemed, and Newco will use the funds received on the partial repayment of the Parent Loan to pay the redemption price upon the redemption of such Preferred Shares held by Lossco;
(iv) Lossco will use the proceeds of the redemption of such Preferred Shares to partially repay the Lossco Loan; and
(v) Parent will use the funds received on the partial repayment of the Lossco Loan to repay the Partial New Daylight Loan.

31. In the event that the principal amount outstanding on the Lossco Loan is reduced as described in 30 above, then, for purposes of 26 to 29 above, references to the Parent Loan and the Lossco Loan shall be to the principal amounts of such loans still outstanding following the partial repayments described in 30 above, and references to the Preferred Shares of Newco held by Lossco shall be to the number of such shares still outstanding following the redemption of some of those shares described in 30 above.

32. Immediately after the Proposed Transactions described in 29 above, Parent will transfer to the Subsidiary all of its common shares of Lossco in exchange for one preferred share of the Subsidiary (the "Special Share") having a redemption price equal to the FMV of the common shares of Lossco so transferred.

33. The Subsidiary will add to its stated capital account in respect of the Special Share issued to Parent an amount equal to the ACB to Parent of the common shares of Lossco. Parent and the Subsidiary will file a joint election, in prescribed form and within the time limits referred to in subsection 85(6) of the Act, to have the rules in subsection 85(1) of the Act apply to the transfer of the common shares of Lossco to the Subsidiary. The elected amount will be equal to the ACB to Parent of the common shares of Lossco. The ACB of the common shares of Lossco will be less than their FMV at the time of the disposition.

34. The FMV of the common shares of Lossco will be determined taking into consideration interest rates, the amount and estimated time of utilization of the non-capital losses of Lossco and other factors.

35. The Subsidiary will redeem for cash the Special Share issued to Parent as described in 32 above, for an amount equal to its redemption price.

36. Shortly after the transactions described in 32 above, the Subsidiary will cause Lossco to be wound-up. The assets of Lossco will be distributed to the Subsidiary and its liabilities, if any, will be assumed by the Subsidiary. Lossco will be dissolved within a short period of time thereafter.

37. The Subsidiary will subscribe for common shares of Newco for nominal consideration. Newco will subsequently purchase all its common shares owned by Parent for nominal consideration equal to the FMV of the common shares owned by Parent. Parent's loss from the disposition of its common shares of Newco will be deemed to be nil pursuant to subsection 40(3.6) of the Act. For greater certainty, subsections 40(3.3) and 40(3.4) of the Act and paragraph 40(3.6)(b) of the Act will not apply with respect to Parent's loss.

38. The Subsidiary will cause Newco to be wound-up shortly after the Proposed Transactions described in 37 above.

Additional Information:

39. Based on its existing assets and resources, Parent will have the ability to make the contributions of capital to Newco as described in 26 and 29 above, without taking into account the interest income which Parent will earn on the Lossco Loan described in 21 above.

40. The Preferred Shares of Newco and the Special Share of the Subsidiary, which will be issued as described in 22 and 32 above, will not at any time throughout the series of transactions that includes the Proposed Transactions be:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) of the Act 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) 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; or
(ii) any right of the type described in subparagraph 112(2.4)(b)(ii) of the Act.

41. Parent and Subsidiary are affiliated persons. Parent, Lossco and Newco will be, throughout the series of transactions that includes the Proposed Transactions, affiliated persons.

42. XXXXXXXXXX

43. XXXXXXXXXX

44. All of Parent's annual gross revenue is allocated to the province of XXXXXXXXXX . Subsidiary's annual gross Canadian revenue in its XXXXXXXXXX taxation year is allocated among the following provinces and territories in the specified percentages: XXXXXXXXXX This allocation does not differ materially from year to year.

Purpose of the Proposed Transactions:

45. The purpose of the Proposed Transactions is to allow for the use of the Losses of Parent by another corporation affiliated with Parent (i.e., the Subsidiary). For financial reporting purposes, Parent is prohibited from recognizing the tax recovery associated with the Losses unless Parent is able to demonstrate that it is more likely than not that there will be sufficient taxable income on an ongoing basis to utilize tax losses within the carry-forward periods available under the tax law. XXXXXXXXXX , it is very important that Parent be permitted to recognize the tax recovery associated with such losses for financial reporting purposes.

Rulings:

Provided that the preceeding 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 Lossco has a legal obligation to pay interest on the Lossco Loan described in 21 above, and that the Preferred Shares of Newco continue to be held by Lossco, Lossco will be entitled pursuant to paragraph 20(1)(c) of the Act to deduct in computing its income for a taxation year the lesser of (i) the interest paid or payable (depending on the method regularly followed by Lossco in computing its income for the purposes of the Act) on the Lossco Loan in respect of the taxation year, and (ii) a reasonable amount in respect thereof.

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 26 and 29 above.

C. The dividends received by Lossco on the Preferred Shares of Newco as described in 22 above will be taxable dividends that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Lossco for the taxation year in which the dividends are received. 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. On the redemption of the Special Share of the capital stock of the Subsidiary as described in 35 above, the amount, if any, by which the amount paid to redeem the share exceeds its PUC immediately before the redemption, will be deemed pursuant to subsection 84(3) of the Act to be a dividend paid by the Subsidiary to Parent. The deemed dividend will be deductible in computing the taxable income of Parent pursuant to subsection 112(1) of the Act for the taxation year in which the dividend is deemed to have been received. 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.

E. The provisions of paragraph 85(1)(e.2) of the Act will not apply to the transfer of the Lossco shares to the Subsidiary as described in 32 and 33 above.

F. By virtue of paragraph 55(3)(a) of the Act, subsection 55(2) of the Act will not apply to the taxable dividends described in Rulings C and D above. For greater certainty, the Proposed Transactions, in and by themselves, will not be considered to result in any disposition or increase in interest described in subparagraphs 55(3)(a)(i) to (v) of the Act.

G. After the winding-up of Lossco into the Subsidiary as described in 36 above is completed, the provisions of subsection 88(1.1) of the Act will apply to permit the Subsidiary to deduct the non-capital losses of Lossco in computing its taxable income for any taxation year commencing after the commencement of the winding-up, to the extent that the requirements in paragraphs 88(1.1)(a) and (b) of the Act are satisfied and subject to the limitations in paragraph 88(1.1)(e) and section 111 of the Act.

H. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11) and 246(1) of the Act will not apply to the Proposed Transactions, in and by themselves.

I. Subsection 245(2) of the Act 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 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 26 to 38 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

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.

Yours truly,

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