2008 Ruling 2008-0279991R3 - Loss utilization - affiliated group

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: Whether loss utilization transaction is acceptable

Position: Yes

Reasons: Previous positions

XXXXXXXXXX 							2008-027999

XXXXXXXXXX , 2008

Dear Sir:

Re: Advance Income Tax Ruling

XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX in which you requested an advance income tax ruling on behalf of the taxpayers referred to above (the "Applicants"). We also acknowledge our subsequent telephone conversations and correspondence concerning your request. The documents submitted with your request are part of this document only to the extent described herein.

We understand that to the best of your knowledge and that of the Applicants, none of the issues raised in the Ruling Request are:

(a) identified in an earlier tax return of the Applicants or of a related person;

(b) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Applicants or of a related person;

(c) under objection by the Applicants or by a related person;

(d) before the courts with respect to the Applicants or persons related to the Applicants or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

(e) the subject of a ruling previously issued by the Income Tax Rulings and Interpretations Directorate of the Canada Revenue Agency, to the Applicants or persons related to the Applicants.

We understand that the Proposed Transactions are prospective in nature and the exact date of their completion is not currently known. We also understand that the Applicants intend to enter into the Proposed Transactions in the order set forth herein as soon as possible after the issuance of an advance income tax ruling by the CRA. Consequently, except where stated to be otherwise, the amounts referred to herein are estimates. However, the estimated amounts will approximate the actual amounts as at the relevant dates. Prior to implementation, each Proposed Transaction will receive any necessary approvals that may be required under corporate law.

All statutory references herein are to provisions of the Act, unless stated otherwise.

DEFINITIONS

1. The following definitions apply in respect of this Ruling Request:

(a) "A Co" means XXXXXXXXXX ;

(b) "A Co group" means A Co and the Canadian corporations controlled by A Co;

(c) "Act" means the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended to the date hereof;

(d) "affiliated persons" has the meaning assigned in subsection 251.1(1);

(e) "B Co" means XXXXXXXXXX ;

(f) XXXXXXXXXX ;

(g) "C Co" means XXXXXXXXXX ;

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

(i) "Canadian corporation" has the meaning assigned in subsection 89(1);

(j) "D Co" means XXXXXXXXXX ;

(k) "dividend rental arrangement" has the meaning assigned in subsection 248(1);

(l) "excepted dividend" has the meaning assigned in section 187.1;

(m) "excluded dividend" has the meaning assigned in subsection 191(1);

(n) "financial intermediary corporation" has the meaning assigned in subsection 191(1);

(o) "guarantee agreement" has the meaning assigned in subsection 112(2.2);

(p) "non-capital loss" has the meaning assigned in subsection 111(8);

(q) "paid-up capital" has the meaning assigned in subsection 89(1);

(r) "Preferred Shares" means the shares defined in paragraph 14 below;

(s) "Promissory Notes" means the promissory notes referred to in paragraph 16 and described in paragraph 29 below;

(t) "Proposed Transactions" means the various transactions that are the subject of this Ruling Request;

(u) "specified financial institution" has the meaning assigned in subsection 248(1);

(v) "taxable Canadian corporation" has the meaning assigned in subsection 89(1); and

(w) "taxable dividend" has the meaning assigned in subsection 89(1).

FACTS

2. A Co is a taxable Canadian corporation and is governed by the provisions of the XXXXXXXXXX . The common shares of A Co are listed and traded on the XXXXXXXXXX . A Co deals with the XXXXXXXXXX Tax Services Office of CRA, and files its corporate tax returns with the XXXXXXXXXX Taxation Centre.

3. A Co is the public holding company for the A Co group. A Co's primary asset is the shares of its subsidiary corporation, B Co. A Co's fiscal period ends on XXXXXXXXXX .

4. B Co is a taxable Canadian corporation and is governed by the provisions of the XXXXXXXXXX . B Co's fiscal period ends on XXXXXXXXXX of each calendar year. B Co deals with the XXXXXXXXXX Tax Services Office of CRA, and files its corporate tax returns with the XXXXXXXXXX Taxation Centre.

5. All of the common, voting shares of B Co are owned by A Co. B Co has three series of preferred shares that are issued and outstanding:

Share Features Registered Owner
First Preferred Non-voting, redeemable, $XXXXXXXXXX par value A Co
Fourth Preferred Non-voting, redeemable, $XXXXXXXXXX par value A Co
Fifth Preferred Non-voting, redeemable, $XXXXXXXXXX par value D Co

D Co is an inactive, wholly-owned subsidiary of B Co. Its only asset is the Fifth Preferred Shares of B Co.

6. B Co is XXXXXXXXXX company based in XXXXXXXXXX . It derives substantially all of its income from the sale of XXXXXXXXXX manufactured through operations located primarily in XXXXXXXXXX .

7. B Co holds rights to XXXXXXXXXX and carries on XXXXXXXXXX operations that provide XXXXXXXXXX for processing at its manufacturing plants. The company is a XXXXXXXXXX in Canada. B Co also produces XXXXXXXXXX .

8. C Co is a taxable Canadian corporation and is governed by the provisions of the XXXXXXXXXX . C Co has been a wholly-owned subsidiary of B Co since its incorporation in XXXXXXXXXX . Its fiscal period ends on XXXXXXXXXX of each calendar year. C Co deals with the XXXXXXXXXX Tax Services Office of CRA, and files its corporate tax returns with the XXXXXXXXXX Taxation Centre.

9. C Co purchases product from B Co and vends it to customers located in the United States.

10. B Co filed a XXXXXXXXXX income tax return reporting taxable income of $XXXXXXXXXX for that year.

11. B Co filed a XXXXXXXXXX income tax return reporting a non-capital loss of $XXXXXXXXXX and a capital loss of $XXXXXXXXXX . These losses were carried back and applied against its XXXXXXXXXX taxable income.

12. C Co filed a XXXXXXXXXX income tax return reporting taxable income of $XXXXXXXXXX . The source of this income was derived primarily from interest earned on the XXXXXXXXXX .

13. C Co will file a XXXXXXXXXX income tax return reporting taxable income that is estimated to be $XXXXXXXXXX .

PROPOSED TRANSACTIONS

14. B Co will authorize a new class of preferred shares (the "Preferred Shares") with the following features:

(a) non-voting;

(b) entitlement to a cumulative dividend at an annual rate equal to the interest rate of the Promissory Note plus one (1) basis point;

(c) redeemable as a class at any time at the option of B Co for an amount equal to the per share subscription price at which each such share was issued (the "Redemption Amount"), plus any accrued but unpaid dividends, by B Co:

(i) paying cash equal to the Redemption Amount and such accrued but unpaid dividends, or

(ii) assigning the Promissory Notes to C Co and paying cash equal to any such accrued but unpaid dividends;

(d) retractable as a class at any time at the option of the holder for an aggregate amount equal to the Redemption Amount, plus any accrued but unpaid dividends thereon, by B Co:

(i) paying cash equal to the Redemption Amount and such accrued but unpaid dividends, or

(ii) assigning the Promissory Notes to C Co and paying cash equal to any such accrued but unpaid dividends.

15. B Co currently has short-term investments of approximately $XXXXXXXXXX that are invested in short term money market instruments. B Co will allow these investments to mature and accumulate in the form of cash in its bank account.

16. B Co will use the cash proceeds from the maturing investments described in paragraph 15 to advance cash amounts to C Co in exchange for the issuance by C Co of the Promissory Notes.

17. C Co will invest the cash received as described in paragraph 16 in the Preferred Shares.

18. The transactions noted in paragraphs 16 and 17 will be repeated over a number of successive days until the aggregate amounts of the Promissory Notes and the C Co investment in the Preferred Shares each total $XXXXXXXXXX .

19. Following the completion of the transactions described in paragraphs 16 to 18, B Co will reinvest the funds in short-term money market instruments.

20. Effective on the last day of its XXXXXXXXXX taxation year, B Co will pay a dividend equal to the amount of the accrued but unpaid dividends on the Preferred Shares to C Co. If B Co does not have sufficient cash on hand, a daylight loan would be arranged.

21. Effective on the last day of its XXXXXXXXXX taxation year, C Co would use the funds from the dividends earned on the Preferred Shares to pay the interest on the Promissory Notes to B Co.

22. During the latter part of XXXXXXXXXX , the Preferred Shares would be redeemed by B Co by assigning the Promissory Notes to C Co and B Co would pay a dividend to C Co equal to the amount of accrued but unpaid dividends on the Preferred Shares. The Promissory Notes would be cancelled by the assignment of the Promissory Notes to C Co by B Co and C Co would immediately following that time pay any accrued interest on the Promissory Notes to B Co.

23. It is expected that the interest expense of C Co created by the above steps will result in non-capital losses for C Co for its XXXXXXXXXX taxation years.

24. On filing its XXXXXXXXXX corporate income tax returns, C Co will request loss carry backs to its XXXXXXXXXX taxation years in prescribed form.

ADDITIONAL INFORMATION

25. B Co's non-capital losses for XXXXXXXXXX are estimated to be $XXXXXXXXXX , respectively, without considering the Proposed Transactions.

26. C Co's taxable income is estimated to be $XXXXXXXXXX without considering the Proposed Transactions.

27. B Co has the ability to pay annual dividends during the period covered by the Proposed Transactions and has no legal impediment to doing so.

28. The total amount of the Promissory Notes to be issued by C Co in the amount of $XXXXXXXXXX represents an amount that C Co could reasonably borrow from an arm's length financial institution with a guarantee from A Co and B Co. The A Co Quarterly Officer's Certificate for its quarter ending XXXXXXXXXX indicates that under A Co's banking agreements it has the capacity to borrow an additional $XXXXXXXXXX and still meet the financial tests required under its debt covenants.

29. The Promissory Notes will have a term of XXXXXXXXXX months and will be repayable at the option of C Co, at any time, without penalty. The Promissory Notes will bear interest at XXXXXXXXXX %, a rate that is reasonable based on current market rates for BB+ rated industrial entities.

30. None of A Co, B Co or C Co is, or will be, a specified financial institution or financial intermediary corporation.

31. The Preferred Shares will not be, at any time during the implementation of the Proposed Transactions described herein:

(a) subject either to a guarantee agreement or to a dividend rental arrangement;

(b) the subject of a dividend rental arrangement; or

(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or,

(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) for consideration that includes any right of the type described in subparagraph 112(2.4)(b)(ii).

32. For XXXXXXXXXX , B Co allocated approximately XXXXXXXXXX % of its taxable income to XXXXXXXXXX . and XXXXXXXXXX % to XXXXXXXXXX . This allocation is reasonably representative of B Co's expected allocations in XXXXXXXXXX . C Co allocates all of its income to XXXXXXXXXX .

33. Control of B Co has not been acquired by any person or group of persons during any preceding taxation year that is relevant for the purpose of applying subsection 111(5) of the Act to the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

34. The purpose of the Proposed Transactions is to consolidate profits and losses of B Co and its affiliated wholly-owned subsidiary, C Co, by transferring the benefit of a portion of B Co's expected non-capital losses to C Co. B Co will earn interest income on the Promissory Notes in XXXXXXXXXX that will reduce the non-capital loss expected to be realized in those years. C Co will obtain an interest deduction in XXXXXXXXXX that will generate non-capital losses that will be carried back and applied against taxable income earned by C Co in its XXXXXXXXXX taxation years.

35. The tax attributes of B Co and C Co remain the same except for the transfer of the loss. There is no advantage or benefit conferred on any shareholder of the companies. The Proposed Transactions are not being undertaken to facilitate the use of any non-capital losses that would otherwise have expired.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, the Proposed Transactions, and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed as described, our rulings are as follows:

A. With respect to the interest expense incurred by C Co as described in paragraphs 21 and 22, provided that C Co has a legal obligation to pay interest on the Promissory Notes and C Co continues to hold the Preferred Shares for the purpose of gaining or producing income therefrom, C Co will be permitted pursuant to paragraph 20(1)(c) to deduct, in computing its income for a taxation year, the lesser of such interest and a reasonable amount in respect thereof paid in the year or payable in respect of the year (depending on the method that C Co regularly follows in computing its income from property for the purposes of the Act).

B. The dividends received by C Co as described in paragraphs 20 and 22 will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of C Co for the taxation year in which the particular 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. C Co will be permitted to carry the non-capital losses expected to arise in the XXXXXXXXXX taxation years back to its XXXXXXXXXX taxation years, subject to any applicable restrictions set out in section 111.

D. Part IV.1 will not apply to the dividends described in Ruling B above because the dividends will be excepted dividends.

E. Part VI.1 will not apply to the dividends described in Ruling B above because the dividends will be excluded dividends.

F. C Co will not be subject to tax under Part IV in respect of the taxable dividends it receives from B Co as described in Ruling B.

G. Subsections 15(1) and 246(1) will not apply to the Proposed Transactions in and by themselves.

H. The provisions of subsection 245(2) will not apply, as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

Our Comments:

Our rulings are given subject to the limitations set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided the Proposed Transactions described in Paragraphs 14 to 21 are completed by XXXXXXXXXX . Our rulings are based on the law as it currently reads and do not take into account any proposed amendments to the Act.

Nothing in this ruling should be construed as implying that CRA has reviewed any tax consequences relating to the facts or the Proposed Transactions (including any provincial tax implications relating to the allocation of income and expenses or the application of the general anti-avoidance provisions of any province) other than those described in the rulings given above, or has agreed to:

(a) the fair market value or adjusted cost base of any asset or to the paid-up capital of any share;

(b) the deductibility of any amount that is not described in Ruling A, B or C above; or

(c) to the amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch