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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: In the particular situation, whether there is an acquisition of control of a corporation.
Position: General comments
Reasons: Question of fact
2007-024925
XXXXXXXXXX S. Grégoire
(613) 957-2746
October 10, 2007Dear Sir,
Subject: Loss utilization - subsections 111(4) and 111(5) of the Income Tax Act
This is in response to your letter of August 15, 2007, in which you asked what happens to the tax losses of two corporations (a parent corporation and its subsidiary) in the event that you and another person acquire all the shares in the capital stock of the parent corporation.
Unless otherwise indicated, all statutory references herein are to provisions of the Income Tax Act (the "Act").
The Facts
You currently hold less than 10% of the shares in the share capital of Corporation 1, an inactive corporation with a "tax loss" balance. This corporation has XXXXXXXXXX shareholders who, apart from yourself, have not shown any interest in acquiring further shareholdings from the other shareholders. We also understand that a second person is interested in acquiring the shares in Corporation 1 held by the other shareholders. Corporation 1 holds more than 90% of the shares in the capital stock of Corporation 2, which is also inactive and currently in bankruptcy. This second corporation also has a "tax loss" balance.
Question
You asked whether the acquisition of shares in the capital stock of Corporation 1 either by you alone or with a second person would affect the availability of "tax losses".
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (the "CRA") not to issue written opinions on proposed transactions otherwise than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, that determination is made first by our Tax Services Offices as a result of their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may, however, under certain circumstances, not apply to your particular situation.
The Act contains certain provisions designed to limit the use of losses on an acquisition of control of a corporation. Subsections 111(4) with respect to capital losses and 111(5) with respect to non-capital losses are relevant in this regard.
De jure control of a corporation, as defined by case law, is the right of control attached to the ownership of such number of shares as entitles the holder to a majority of votes in the election of the corporation's board of directors. The Companies Act under which the corporation is governed, the register of shareholders, the articles and by-laws of the corporation as well as the unanimous shareholder agreement are important elements to consider in determining the de jure control of a corporation.
It is important to note that the loss restriction provisions apply when a person or group of persons acquires control of a corporation.
Generally, an acquisition of control of a corporation occurs when a person or group of persons acquires more than 50% of the voting rights necessary to elect the board of directors.
Essentially, a group of persons acquiring control of a corporation means two or more persons who collectively hold more than 50% of the voting rights necessary to elect the board of directors of a corporation and who agree to act in concert to control the corporation. The Canada Revenue Agency's position in this regard is contained in paragraphs 3 to 8 of Interpretation Bulletin IT-302R3, a copy of which is attached.
It should also be noted that, in a situation where the voting rights in a corporation are exercised equally by two shareholders, it is our view that it should be inferred that the corporation is controlled by that group of shareholders. Our position is set out in CRA's Income Tax Technical News No. 7.
As stated above, in the event that the acquisition of the shares of Corporation 1 shares resulted in an acquisition of control, the Act contains certain limitations on the use of capital losses as well as non-capital losses incurred by the corporation in taxation years ending before the acquisition of control.
Subsection 111(4) provides, inter alia, that no amount in respect of a net capital loss of a corporation in respect of which control is acquired may be deducted from the corporation's income for a taxation year ending after the time control is acquired.
Subsection 111(5) provides, inter alia, that no non-capital loss of the corporation for a taxation year before the acquisition of control may be deducted from the corporation's income for a taxation year after the acquisition of control. However, there is an exception to this rule. To the extent that the business that generated the loss was carried on by the corporation with a reasonable expectation of profit throughout the year ending after the acquisition of control, non-capital losses incurred by the corporation for a taxation year ending before the acquisition of control could be deductible in a taxation year ending after the acquisition of control. However, they could only be used to offset the corporation's income from carrying on the same business or any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services.
Whether a corporation carries on the same business after an acquisition of control remains a question of fact that can only be resolved after an analysis of all the facts of a particular situation. Interpretation Bulletin IT-302R3 contains some relevant criteria for determining whether a corporation was carrying on the same business.
In addition, we wish to point out that where a subsequent business of a corporation is of the same nature as the first, but the owners are different, it is our view that the two businesses will not normally be considered to be the same business where the first business ceases to operate before the second begins to operate. Whether a business ceases to be carried on depends on a number of factors. Interpretation Bulletin IT-206R, a copy of which is attached, contains some of those factors that may be helpful to you in determining that issue.
It should also be noted that where control of a corporation is acquired at a particular time by a person or group of persons, the corporation's taxation year is deemed to end immediately before the acquisition of control by virtue of subsection 249(4). That rule generally has the effect of accelerating the expiry of losses previously incurred by the corporation.
We also wish to draw your attention to the provisions of paragraph 128(1)(g), which provide that no loss incurred by a bankrupt corporation in a taxation year preceding the year in which an absolute order of discharge was granted is deductible pursuant to section 111 in computing taxable income for the taxation year in which the order was granted or any subsequent year.
The information available in your request is insufficient to determine whether control of the corporations has been acquired and, if so, whether losses incurred by the corporations prior to their acquisition of control could be deducted from their income for a subsequent taxation year. In the event that control of the corporations is acquired, it seems unlikely that the condition in subparagraph 111(5)(a)(i) could be satisfied because of the prior cessation of activities of the corporations concerned. As a result, the losses previously incurred by the corporations concerned could not be used after the acquisition of control.
We hope you find our comments of assistance and thank you for bringing these issues to our attention. Should you require any additional information regarding this matter, please do not hesitate to contact us.
Maurice Bisson, CGA
Manager
Corporate Reorganization and Resource Industries Section
Corporate Reorganization and Resource Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch.
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