2009 Ruling 2008-0304881R3 - 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: Is the loss arrangement among affiliated wholly-owned corporations acceptable?

Position: YES

Reasons: meets the requirements

XXXXXXXXXX 						2008-030488

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-named taxpayers. We acknowledge information provided to us by XXXXXXXXXX of your office on XXXXXXXXXX . In general terms, the transactions described herein involve the use of losses within affiliated 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 Profitco, Lossco 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 Profitco, Lossco or a related person;
(iii) under objection by Profitco, Lossco 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.

Profitco and Lossco file their corporate income tax returns at the XXXXXXXXXX Taxation Centre and deal with the XXXXXXXXXX Tax Services Office. The transactions described herein will not result in any taxpayer described herein being unable to pay its outstanding tax liabilities.

Definitions:

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c. 1, as amended from time to time and consolidated to the date of this letter, and unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph, clause or subclause is a reference to the relevant provision of the Act; and the Income Tax Regulations are referred to as the "Regulations";

(b) "adjusted cost base" or "ACB" has the meaning assigned by section 54 of the Act;

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

(d) "BCA" means the Business Corporations Act (XXXXXXXXXX);

(e) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7) of the Act;

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

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

(h) "forgiven amount" has the meaning assigned by subsection 80(1) of the Act;

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

(j) "Lossco" means XXXXXXXXXX ;

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

(l) "paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

(m) "Profitco" means XXXXXXXXXX ;

(n) "Proposed Transactions" means the proposed transactions described in 8 to 27 below;

(o) "related persons" has the meaning assigned by section 251 of the Act;

(p) "specified financial institution" has the meaning assigned by subsection 248(1) of the Act;

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

(r) "taxable dividend" has the meaning assigned by subsection 89(1) of the Act.

Facts:

1. Profitco is a taxable Canadian corporation and a Canadian-controlled private corporation. Profitco has a taxation year-end of XXXXXXXXXX . Profitco's current mailing address is XXXXXXXXXX . Profitco operates a XXXXXXXXXX .

2. In the recent past, Profitco has been a very profitable company with retained earnings of approximately $XXXXXXXXXX at XXXXXXXXXX . However, it is expected that Profitco will generate non-capital losses during its XXXXXXXXXX taxation year due to XXXXXXXXXX . It is also expected that Profitco may generate non-capital losses during its XXXXXXXXXX taxation years.

3. Profitco directly owns all of the issued and outstanding shares of Lossco.

4. Lossco was incorporated on XXXXXXXXXX under the BCA. Lossco has a taxation year-end of XXXXXXXXXX . Lossco's current mailing address is XXXXXXXXXX . Lossco is a taxable Canadian corporation and a Canadian-controlled private corporation.

5. Profitco acquired control of Lossco on XXXXXXXXXX . Both Profitco and Lossco operate in XXXXXXXXXX . Up until XXXXXXXXXX , Lossco's only purpose was to hold legal title to certain assets of XXXXXXXXXX as bare trustee and agent. At the time of the acquisition of control, Lossco did not hold the beneficial ownership of any assets. At the time of the acquisition of control, Lossco had $XXXXXXXXXX of non-capital loss carry forwards. Immediately after the acquisition of control, Lossco acquired the beneficial ownership of certain assets of XXXXXXXXXX from a general partnership that was not an affiliated person of Profitco at the time of purchase. The purchase price for these assets was approximately $XXXXXXXXXX which was funded by a non-interest bearing promissory note from Profitco.

6. As at XXXXXXXXXX , the balance of Lossco's non-capital losses is approximately $XXXXXXXXXX . Lossco's non-capital losses will begin to expire in XXXXXXXXXX . As at XXXXXXXXXX , Lossco has a net deficit for accounting purposes of approximately $XXXXXXXXXX .

7. Profitco has a line of credit of $XXXXXXXXXX from an arm's length Canadian financial institution secured by an assignment of accounts receivable and inventory. This line of credit was not being utilized at XXXXXXXXXX .

8. Profitco has a borrowing capacity of $XXXXXXXXXX . This assertion is based on the borrowing capacity of public corporations in the XXXXXXXXXX and is supported by the financial statements of Profitco and the views of management.

Proposed Transactions:

9. Lossco will amend its articles to create a new class of preferred shares (the "Preferred Shares"). The Preferred Shares will have the following rights and restrictions:

a) non-voting;
b) entitled to a cumulative dividend on the amount for which they were issued at an annual rate that is XXXXXXXXXX % greater than the interest rate on the Lossco Loans #1, #2, #3, and #4, described in 11, 15, 19 and 23 below;
c) redeemable at any time for an amount equal to the aggregate of the amount for which the shares were issued plus any accrued or unpaid dividends;
d) retractable at any time for an amount equal to the aggregate of the amount for which the shares were issued plus any accrued or unpaid dividends;
e) dividends and proceeds on winding up or dissolution rank ahead of any payment on all classes of common shares; and
f) on winding up or dissolution, holders will receive an amount equal to the aggregate of the amount for which the shares were issued plus any accrued but unpaid dividends.

10. Profitco will draw on its credit line an amount of approximately $XXXXXXXXXX on a daylight basis (the "Daylight Loan #1").

11. Profitco will use the proceeds of the Daylight Loan #1 to subscribe for Preferred Shares of Lossco having an aggregate ACB, fair market value, paid-up capital, redemption amount and retraction amount equal to the amount of Daylight Loan #1.

12. Lossco will lend the proceeds from the subscription for the Preferred Shares to Profitco on an interest-bearing demand basis (the "Lossco Loan #1"). The Lossco Loan #1 will bear simple interest at a rate equal to the XXXXXXXXXX prime rate of interest plus XXXXXXXXXX % per annum which is not greater than the rate that Profitco would pay to an arm's length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms.

13. Profitco will use the proceeds from the Lossco Loan #1 to repay the Daylight Loan #1.

14. Profitco will again draw on its credit line an amount of approximately $XXXXXXXXXX on a daylight basis (the "Daylight Loan #2").

15. Profitco will use the proceeds of the Daylight Loan #2 to subscribe for Preferred Shares of Lossco having an aggregate ACB, fair market value, paid-up capital, redemption amount and retraction amount equal to the amount of Daylight Loan #2.

16. Lossco will lend the proceeds from the subscription for the Preferred Shares to Profitco on an interest-bearing demand basis (the "Lossco Loan #2"). The Lossco Loan #2 will bear simple interest at a rate equal to the XXXXXXXXXX prime rate of interest plus XXXXXXXXXX % per annum which is not greater than the rate that Profitco would pay to an arm's length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms.

17. Profitco will use the proceeds from the Lossco Loan #2 to repay the Daylight Loan #2.

18. Profitco will again draw on its credit line an amount of approximately $XXXXXXXXXX on a daylight basis (the "Daylight Loan #3").

19. Profitco will use the proceeds of the Daylight Loan #3 to subscribe for Preferred Shares of Lossco having an aggregate ACB, fair market value, paid-up capital, redemption amount and retraction amount equal to the amount of Daylight Loan #3.

20. Lossco will lend the proceeds from the subscription for the Preferred Shares to Profitco on an interest-bearing demand basis (the "Lossco Loan #3"). The Lossco Loan #3 will bear simple interest at a rate equal to the XXXXXXXXXX prime rate of interest plus XXXXXXXXXX % per annum which is not greater than the rate that Profitco would pay to an arm's length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms.

21. Profitco will use the proceeds from the Lossco Loan #3 to repay the Daylight Loan #3.

22. Profitco will again draw on its credit line an amount of approximately $XXXXXXXXXX on a daylight basis (the "Daylight Loan #4").

23. Profitco will use the proceeds of the Daylight Loan #4 to subscribe for Preferred Shares of Lossco having an aggregate ACB, fair market value, paid-up capital, redemption amount and retraction amount equal to the amount of Daylight Loan #4.

24. Lossco will lend the proceeds from the subscription for the Preferred Shares to Profitco on an interest-bearing demand basis (the "Lossco Loan #4"). The Lossco Loan #4 will bear simple interest at a rate equal to the XXXXXXXXXX prime rate of interest plus XXXXXXXXXX % per annum which is not greater than the rate that Profitco would pay to an arm's length Canadian financial institution to borrow an equivalent amount on equivalent repayment terms.

25. Profitco will use the proceeds from the Lossco Loan #4 to repay the Daylight Loan #4.

26. The interest expense that will be deducted by Profitco in a particular taxation year in respect of the Lossco Loans #1, #2, #3 and #4 will likely contribute to a non-capital loss of Profitco. Profitco will utilize these non-capital losses incurred by it before the time that Lossco's non-capital losses indicated in 6 above would have otherwise expired. In addition, Profitco's non-capital losses will be carried back to prior taxation years pursuant to paragraph 111(1)(a) of the Act. The taxation years to which the losses will be carried back will be limited to the period of affiliation between Profitco and Lossco.

27. To the extent that, on the date annual dividends are paid by Lossco on the Lossco Preferred Shares, Lossco does not have sufficient cash on hand, Profitco will contribute additional funds to Lossco in the form of contributed surplus on the issued and outstanding common shares. It is expected that the loss arrangement will be in existence for XXXXXXXXXX years, such that Lossco will be required to pay one cumulative dividend in each of its XXXXXXXXXX taxation years.

28. It is proposed that, on or prior to XXXXXXXXXX :

a) Profitco will contribute sufficient funds to Lossco as described in 24 above equal to the amount of any cumulative accrued and unpaid dividends on the Preferred Shares;
b) Lossco will pay the balance of any cumulative accrued and unpaid dividends on the Preferred Shares;
c) Profitco will pay the balance of any accrued and unpaid interest on the Lossco Loans #1, #2, #3 and #4;
d) Lossco will redeem all the Preferred Shares held by Profitco for their face value of $XXXXXXXXXX , which amount will be equal to the fair market value of shares so redeemed, and will issue a non-interest bearing promissory note (the "Promissory Note") to Profitco in the amount $XXXXXXXXXX ;
e) Profitco and Lossco will agree to set-off the Lossco Loans #1, #2, #3 and #4 against the Promissory Note, and the set-off will constitute payment in full of the principal amounts of the Lossco Loans #1, #2, #3 and #4 and the Promissory Note; and
f) Lossco will be either wound up into Profitco or amalgamated with Profitco.

Additional Information:

29. The Proposed Transactions described herein will occur in the order presented.

30. None of Profitco or Lossco is or will be a specified financial institution or a financial intermediary corporation.

31. The Lossco 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 arrangement;
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) of the Act); or
II. any right of the type described in subparagraph 112(2.4)(b)(ii) of the Act.

32. Profitco will have the financial capacity to honour, upon presentation of a demand for payment, the amount payable under a Lossco Loan.

33. None of the Proposed Transactions will have a significant impact on any outstanding tax liabilities of Profitco or Lossco.

34. Based on the existing assets and resources, Profitco will have the ability to make contributions of capital to Lossco as described in 26 and 27(a) above.

Purpose of the Proposed Transactions:

35. The purpose of the Proposed Transactions is to consolidate profits and losses within a group of taxable Canadian corporations that are affiliated persons by enabling Lossco to earn sufficient interest income on the Lossco Loans #1, #2, #3 and #4 to fully utilize Lossco's non-capital losses by the end of Lossco's XXXXXXXXXX taxation year. Profitco will obtain an interest deduction that will likely increase its non-capital losses for its taxation years ending XXXXXXXXXX .

36. The purpose of Profitco making capital contributions to Lossco as described in 26 and 27(a) above, as opposed to having Profitco subscribe for additional common shares of Lossco, is to ensure that Lossco will not be precluded from declaring dividends on the Lossco Preferred Shares pursuant to subsection 70(2) of the BCA. If additional common shares of Lossco were subscribed for and issued, the realizable value of Lossco's assets after the payment of such a dividend would be less than the aggregate amount of its liabilities and stated capital of its common shares and its Preferred Shares, thus precluding the payment of dividends.

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. The dividends received by Profitco on the Lossco Preferred Shares as described in 24 and 25(b) above will be a taxable dividend that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Profitco 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) of the Act.

B. The taxable dividend received by Profitco, described in 26 and 27(b) above, will not be subject to tax under Part IV except as provided by paragraph 186(1)(b) of the Act.

C. Provided that Profitco has a legal obligation to pay interest on the Lossco Loans #1, #2, #3 and #4 and Profitco continues to hold the Lossco Preferred Shares, Profitco will be entitled, pursuant to paragraph 20(1)(c) of the Act, to deduct in computing its income for a taxation year, the interest paid or payable (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) to the extent such amount does not exceed a reasonable amount in respect of the taxation year.

D. On the redemption of the Lossco Preferred Shares described in 27(d) above;

(a) no dividend will be deemed to have been paid by Lossco and received by Profitco under subsection 84(3) of the Act ; and
(b) no gain or loss will be realized or incurred by Profitco.

E. No amount will be included in the income of Lossco pursuant to section 9, or paragraphs 12(1)(c) or 12(1)(x) of the Act in respect of the contribution of capital made by Profitco as described in 26 and 27(a) above.

F. The set-off of the Lossco Loans #1, #2, #3 and #4 against the Promissory Note, described in 27(d) above, will not give rise to a forgiven amount.

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

H. Subsection 245(2) will not apply to 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 27 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.

Yours truly,

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