2007 Ruling 2007-0248441R3 - Loss Consolidation

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: Are the loss utilization transactions acceptable?

Position: YES

Reasons: Meets the technical requirements of the provision

XXXXXXXXXX                                      2007-024844

XXXXXXXXXX , 2007

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX ("Bidco") BN XXXXXXXXXX
Newco
XXXXXXXXXX ("Profitco") 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 also acknowledge information provided during numerous telephone conversations and electronic correspondences.

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 Bidco, Newco, Profitco, 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 Bidco, Newco, Profitco, or a related person;

(iii) under objection by Bidco, Newco, Profitco, or a related person;

(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to Bidco, Newco, Profitco, 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.

It should be noted that Bidco had submitted a separate Advance Income Tax Ruling request, dated XXXXXXXXXX , with respect to the application of the Act to transactions related to its acquisition of Target and its subsidiaries, including Profitco, as discussed in 2 below. On XXXXXXXXXX , 2006, CRA issued an Advance Income Tax Ruling (2006-018243) with respect to all but one of the rulings requested, and that one is still being considered as part of the XXXXXXXXXX , 2006 Advance Income Tax Ruling request (see 8 below).

Definitions:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof. Unless otherwise stated, all statutory references are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

(b) "Amalco" means the corporation that will result from the merger of Target and Subco, as described in 8 below;

(c) "Bidco" means XXXXXXXXXX ., the corporation described in 1 to 4 below;

(d) "Bidco Notes" means the promissory notes described in 20 below;

(e) "CBCA" means Canada Business Corporation Act. R.S.C. 1995, c. C-44, as amended;

(f) "Finance I" means XXXXXXXXXX , a "Société en Commandite par Actions";

(g) "Finance II" means XXXXXXXXXX .;

(h) "financial institution" has the meaning assigned by subsection 142(1) of the Act;

(i) "Newco" means the corporation that Bidco will incorporate as described in 15 below;

(j) "Newco Common Shares" means the common shares described in 15 below;

(k) "Newco Class A Preferred Shares" means the preferred shares described in 16 below;

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

(m) "Parent" means XXXXXXXXXX "Société Anonyme";

(n) "Profitco" means XXXXXXXXXX , the corporation described in 12 and 13 below;

(o) "Profitco Notes" means the promissory notes described in 20 below;

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

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

(r) XXXXXXXXXX ;

(s) "related persons" has the meaning assigned by subsection 251(2) of the Act;

(t) "SFI" means a specified financial institution, as defined in subsection 248(1) of the Act;

(u) "specified person" has the meaning assigned by paragraph (h) of the definition "taxable preferred share" in subsection 248(1) of the Act;

(v) "Subco" means the corporation that Bidco will incorporate and that will merge with Target to form Amalco as described in 8 below;

(w) "Target" means XXXXXXXXXX ., the corporation described in 6 below; and

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

Facts:

1. Bidco is a private corporation and a taxable Canadian corporation. Bidco was incorporated on XXXXXXXXXX under the CBCA and, until XXXXXXXXXX , was a wholly-owned subsidiary of XXXXXXXXXX ("Parent"). Bidco is serviced by the XXXXXXXXXX Taxation Services Office and files its tax returns at the XXXXXXXXXX Tax Centre.

2. On XXXXXXXXXX , Parent transferred legal title to XXXXXXXXXX % of the outstanding shares of Bidco to XXXXXXXXXX

3. Bidco has a permanent establishment only in the province of XXXXXXXXXX .

4. Bidco's main asset is its common share investment in its wholly-owned subsidiary, Target. Bidco acquired all the issued and outstanding shares of Target for approximately $XXXXXXXXXX in successive acquisitions XXXXXXXXXX

5. For the acquisition of Target, Bidco was financed on XXXXXXXXXX through a common share equity investment from Parent for an amount of $XXXXXXXXXX and a loan of $XXXXXXXXXX from Finance I, for a total of $XXXXXXXXXX . The loan granted by Finance I to Bidco currently bears interest at the rate of Canadian$ LIBOR XXXXXXXXXX % (subject to change upon completion of a transfer pricing study). It is expected that by XXXXXXXXXX , Bidco will obtain interest-bearing loans totalling $XXXXXXXXXX from Finance II, a XXXXXXXXXX based related entity. The proceeds of the new loans will be used by Bidco to repay the existing loan of $XXXXXXXXXX from Finance I.

6. Prior to the acquisition by Bidco, Target was a public corporation whose shares were traded on the XXXXXXXXXX Stock Exchange. Target is a taxable Canadian corporation. Target's business number is XXXXXXXXXX . Target's office is located at XXXXXXXXXX . Target has permanent establishments in XXXXXXXXXX .

7. XXXXXXXXXX

8. It is expected that Bidco will sell its investment in Target to a wholly-owned subsidiary ("Subco") to be incorporated once a favorable ruling related to the application of paragraph 88(1)(d) of the Act on a subsequent merger of Target and Subco originally submitted on XXXXXXXXXX (and updated on XXXXXXXXXX ) is issued by CRA (2006-018243). Target and Subco will subsequently merge to form a new corporation ("Amalco"). Following these transactions, Bidco's main asset would thus be its share investment in its wholly-owned subsidiary, Amalco, and notes receivable from Amalco.

9. Bidco and its subsidiaries were subject to an acquisition of control on XXXXXXXXXX , subsequent to the takeover made of XXXXXXXXXX .

10. It is estimated that Bidco will incur non-capital losses of approximately $XXXXXXXXXX for the taxation year ending on XXXXXXXXXX .

11. As all or substantially all of Bidco's income should be interest on intercompany notes from Amalco and taxable dividends from Amalco, Bidco will not be able to use non-capital losses carried over in subsequent taxation years as a result of the interest expenses on its $XXXXXXXXXX debt due to Finance II.

Profitco is a private corporation and a taxable Canadian corporation incorporated under the XXXXXXXXXX . Profitco is a XXXXXXXXXX Profitco has a permanent establishment only in the province of XXXXXXXXXX . Profitco is serviced by the XXXXXXXXXX Tax Services Office and files its tax returns at the XXXXXXXXXX Tax Centre.

12. Profitco has authorized capital consisting of an unlimited number of voting Common Shares, Class A Preferred Shares, Class B Preferred Shares and Class C Preferred Shares. As at XXXXXXXXXX , the issued and outstanding capital consisted of XXXXXXXXXX Common Shares of which XXXXXXXXXX were owned by Target and the remaining XXXXXXXXXX shares were owned by XXXXXXXXXX . A takeout of the common shares currently held by XXXXXXXXXX . is under review.

13. Profitco's taxable income for its taxation year ended XXXXXXXXXX was $XXXXXXXXXX (a XXXXXXXXXX -month short taxation year from XXXXXXXXXX ) and its taxable income for its taxation year ended XXXXXXXXXX was $XXXXXXXXXX (a XXXXXXXXXX -month short taxation year from XXXXXXXXXX ). It is expected that Profitco will continue to be taxable in the taxation year ending on XXXXXXXXXX and in subsequent taxation years.

Proposed Transactions:

14. Bidco will incorporate a new wholly-owned subsidiary ("Newco") with a nominal amount of Common Share capital. Newco will be a private corporation and a taxable Canadian corporation. Newco's share capital will include Common Shares (the "Newco Common Shares") and one class of Preferred Shares (the "Newco Class A Preferred Shares").

15. The Newco Class A Preferred Shares will have the following attributes:

a) non-voting;
b) non-participating;
c) redeemable at the option of the issuer and retractable at the option of the holder, subject to applicable law, at any time for an amount equal to the amount for which they were issued; and
d) entitled to an annual cumulative dividend at a rate of XXXXXXXXXX % on the amount for which they were issued that is payable annually (or more frequently).

16. Profitco will borrow $XXXXXXXXXX on a "daylight loan" basis. The amount of $XXXXXXXXXX has been established by the management of Profitco based on the availability of Profitco's credit facilities and Profitco's borrowing capacity. The principal amount of the loan will be equal to $XXXXXXXXXX .

17. Profitco will use the proceeds of the "daylight loan" to subscribe for Newco Class A Preferred Shares for a total amount of $XXXXXXXXXX . The aggregate redemption, retraction value, fair market value at the date of issuance, adjusted cost base and paid-up capital of the Newco Class A Preferred Shares issued will be $XXXXXXXXXX .

Newco will use the proceeds from the share issuance to make a non interest bearing loan of $XXXXXXXXXX to Bidco. This loan will be evidenced by promissory notes bearing no interest (the "Bidco Notes").

18. Bidco will use the proceeds resulting from the issuance of the Bidco Notes to lend $XXXXXXXXXX to Profitco. Interest bearing promissory notes (the "Profitco Notes") will be issued by Profitco to Bidco. Managements of Bidco and Profitco have concluded that a reasonable interest rate to be charged on the Profitco Notes would be XXXXXXXXXX %.

19. Profitco will use the funds resulting from the issuance of the Profitco Notes to repay the "daylight loan" referred to in 17 above.

20. Annually (or more frequently), Profitco will pay interest of approximately $XXXXXXXXXX per annum ($XXXXXXXXXX x XXXXXXXXXX %) to Bidco if the proposed structure is not partially unwound.

21. Annually (or more frequently), Bidco will subscribe for additional Newco Common Shares.

22. Newco will use the proceeds of Bidco's Common Share subscription to fund the Newco Class A Preferred Shares dividend payments to Profitco of $XXXXXXXXXX ($XXXXXXXXXX x XXXXXXXXXX %) if the proposed structure is not partially unwound.

23. Annually (or more frequently), Newco will pay dividends of $XXXXXXXXXX ($XXXXXXXXXX x XXXXXXXXXX %) to Profitco if the proposed structure is not partially unwound.

Unwind Structure:

24. The proposed structure (or a portion of the proposed structure in an amount agreed to by Profitco, Bidco and Newco) may be unwound after a certain period of time.

25. It is understood that as Bidco's only sources of income would be interest on intercompany notes from Amalco and Profitco and taxable dividends from Amalco, even though Bidco's non-capital loss balance may at some time be fully utilized, it is expected that the proposed structure will be kept in place by the parties in order to offset Bidco's interest expense on its $XXXXXXXXXX debt due to Finance II and avoid new non-capital losses being incurred by Bidco.

26. It is also understood that the proposed structure will completely be unwound no later than XXXXXXXXXX .

27. The proposed structure will be unwound, either partially through separate transactions occurring at different moments in time or wholly at one particular moment, under the following manner:

Newco will redeem the Newco Class A Preferred Shares held by Profitco (either a portion or all of the issued and outstanding Newco Class A Preferred Shares).

(a) As payment for the redemption of the Newco Class A Preferred Shares, Newco will assign the Bidco Notes (or a portion of the Bidco Notes) to Profitco.

(b) Profitco will repay the Profitco Notes (or a portion of the Profitco Notes) by assigning the Bidco Notes received from Newco to Bidco (or the portion of the Bidco Notes received as described at (b) above).

(c) The Bidco Notes (or the portion of the Bidco Notes received as described at (c) above) will be cancelled.

Additional Information:

28. Profitco is, on the basis that it is related to a corporation described in paragraph (d) of the definition of SFI, a SFI pursuant to paragraph (g) of that definition. It is, however, understood that Profitco will not acquire the Newco Class A Preferred Shares in the ordinary course of its business.

29. None of the corporations involved in the proposed transactions has or will have entered into a "dividend rental arrangement" as defined by subsection 248(1) of the Act.

30. None of the shares on which a dividend is declared or paid in the course of the proposed transactions is guaranteed in any way as described in subsection 112(2.2) of the Act by a financial institution or a specified person in relation to any such institution.

31. None of the shares to be issued as part of the proposed transactions will be issued or acquired as part of a transaction or series of transactions of the type described in subsection 112(2.5) of the Act.

32. The proposed transactions will not result in any of the taxpayers identified in this ruling being unable to pay their outstanding tax liabilities.

Purpose of the Proposed Transactions:

33. The purpose of the proposed transactions is to consolidate profits and losses within a group of related persons enabling Bidco to earn sufficient interest income to utilize its current non-capital loss balance, offset its expected non-capital losses for the taxation year ending on XXXXXXXXXX and avoid incurring additional non-capital losses in subsequent taxation years as a result of the interest expense on Bidco's $XXXXXXXXXX debt.

Rulings Given:

A. 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: Provided that the Newco Preferred Shares continue to be held for the purpose of gaining or producing income from property, the interest paid or payable on the Profitco Notes will be deductible by Profitco in computing its income for a taxation year, in respect of that taxation year pursuant to paragraph 20(1)(c) of the Act to the extent that such amount does not exceed a reasonable amount.

B. The provisions of subsection 15(1), 56(2), or 246(1) of the Act will not apply to any of the proposed transactions in and by themselves.

C. Dividends received by Profitco on the Newco Class A Preferred Shares as described above will be taxable dividends and such dividends will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of the recipient corporation for the year in which the dividends are received by Profitco 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. 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 ruling given.

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 30 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; nor

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

Opinions on the future transactions to unwind:

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 30 above, no dividend will be deemed to have been paid by Newco and received by Profitco under subsection 84(3) of the Act and no gain or loss will be realized or incurred by Profitco at that time. Further, in our view, no gain or loss will be realized on the repayments of the Bidco Notes and the Profitco Notes. In addition, the set-off of the Profitco Notes against the Bidco Notes will not give rise to a forgiven amount, as defined in section 80 of the Act, provided that the fair market value of the Bidco Notes and the Profitco Notes at the date of settlement is not less than their principal amount.

Yours truly,

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