2009 Ruling 2009-0312611R3 - 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 consolidation arrangement acceptable?

Position: Yes

Reasons: Meets published positions

XXXXXXXXXX 						2009-031261			

XXXXXXXXXX , 2009

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX ("OPCO") BN XXXXXXXXXX
XXXXXXXXXX ("New Canco") BN XXXXXXXXXX

This is in reply to your letters 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 expected use of future losses within an affiliated group of 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 OPCO, Newco, New Canco 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 OPCO, Newco, New Canco or a related person;
(iii) under objection by OPCO, Newco, New Canco 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.

OPCO and New Canco 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.

Unless otherwise stated, all references to a statute are to the provisions of the Income Tax Act, R.S.C. 1985, 5th Supplement, c.1, as amended to the date hereof (the "Act").

Definitions

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

b) "capital loss" has the meaning assigned by paragraph 39(1)(b) of the Act;

c) "CRA" means the Canada Revenue Agency;

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

e) "excepted dividend" has the meaning assigned by section 187.1 of the Act;

f) "excluded dividend" has the meaning assigned by subsection 191(1) of the Act;

g) "investment tax credit" has the meaning assigned by subsection 127(9) of the Act;

h) "Newco" is a new company to be incorporated by OPCO to facilitate this loss utilization and is further described in 13 below;

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

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

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

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

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

n) "taxable income" has the meaning assigned by subsection 248(1) and subsection 2(2) of the Act.

Facts

1. OPCO's taxation year ends on XXXXXXXXXX . OPCO does not have any expiring non-capital loss carryforwards at its taxation year that ended on XXXXXXXXXX . OPCO has claimed full discretionary tax deductions in all of its prior taxation years.

2. XXXXXXXXXX

3. OPCO is a public corporation and a taxable Canadian corporation. The common shares of OPCO are listed on the XXXXXXXXXX Stock Exchange. The common shares of OPCO are widely held with no person having control of OPCO.

4. OPCO currently carries on its XXXXXXXXXX Business directly and through a number of subsidiary companies. As part of a business restructuring, OPCO is in the process of transferring that part of its XXXXXXXXXX Business which is carried on directly to a new wholly-owned subsidiary ("New Canco").

5. It is anticipated that as a result of the restructuring referred to in 4 above, New Canco will have substantial taxable income in its future taxation years as a result of carrying on the XXXXXXXXXX Business and OPCO will generate non-capital loss carryforwards.

6. OPCO has obtained an independent financial opinion from its bankers that indicate that the maximum borrowing capacity is between $XXXXXXXXXX and $XXXXXXXXXX and interest rates would approximate XXXXXXXXXX %. It is expected that New Canco will be able to borrow those funds from an arm's-length lender based on financial projections prepared by management for the company. Accordingly, New Canco will borrow funds at a rate expected to be XXXXXXXXXX % per annum (the "New Canco Demand Loan Rate").

7. None of the preferred shares referred to below will be acquired by a specified financial institution in the ordinary course of business.

8. No specified financial institution will be obligated to effect an undertaking with respect to the transactions described in this letter which is described in subsection 112(2.2) of the Act.

9. None of the preferred shares referred to below will be subject to a dividend rental arrangement.

10. There will not be any guarantees, covenants or agreements as referred to in paragraph 112(2.4)(a) of the Act to purchase or repurchase any of the preferred shares described below. Furthermore the consideration for which any of the shares are issued will not include an obligation of an unrelated investor to make payments, any portion of which would be required to be included in computing the income of the issuer nor will it include any right to receive payments or property that may revert to the investor.

11. OPCO, Newco (once incorporated) and New Canco are related persons and affiliated persons for purposes of the Act.

12. OPCO currently has a source of income, independent from the XXXXXXXXXX Business, to fund capital contributions required under the proposed transactions described below. Its source of income consists primarily of dividends from other wholly-owned profitable subsidiaries in XXXXXXXXXX .

Proposed Transactions

13. OPCO will incorporate Newco under the laws of XXXXXXXXXX . Newco will be a taxable Canadian corporation and will have a XXXXXXXXXX taxation year end. The authorized share capital of Newco will consist of an unlimited number of common shares without par value as well as an unlimited number of preferred shares with the terms and conditions as follows (the "Newco Preferred Shares"):

• Non-participating
• Non-voting
• Annual cumulative dividend rate of XXXXXXXXXX % applied to the redemption amount
• Dividend rate may be adjusted each fiscal year
• Redeemable at any time at the option of Newco for an amount equal to the redemption amount and any unpaid dividends
• Redeemable by (1) paying cash or (2) assigning the OPCO Demand Loan and paying cash equal to unpaid dividends or (3) setting-off amounts owing under the New Canco Demand Loan in circumstances where Newco has become the holder of the New Canco Demand Loan and paying cash equal to unpaid dividends
• Retractable at any time at the option of New Canco for an amount equal to the redemption amount and any unpaid dividends

14. OPCO will borrow $XXXXXXXXXX on a daylight basis (the "Daylight Loan").

15. OPCO will use the proceeds from the Daylight Loan to make a subordinated interest-bearing loan to New Canco (the "New Canco Demand Loan"). The interest rate will be determined at the time of the proposed transactions, which is according to 6 above believed to be XXXXXXXXXX % and, subsequently, on an annual basis. The interest will be payable annually in arrears. The loan will be repayable in cash or by delivering a financial asset of New Canco, including the OPCO Demand Loan (described in 17 below).

16. New Canco will use the proceeds from the New Canco Demand Loan to subscribe for Newco Preferred Shares having a redemption amount and paid-up capital equal to the principal amount of the New Canco Demand Loan.

17. Newco will lend the subscription proceeds received from New Canco in 16 above to OPCO on an interest-free, demand basis loan (the "OPCO Demand Loan"). The terms of the OPCO Demand Loan will allow OPCO to repay the loan by assigning the New Canco Demand Loan to Newco.

18. OPCO will use the proceeds from the OPCO Demand Loan to repay the Daylight Loan.

19. OPCO will agree to and will make capital contributions to Newco at least annually equal to the amount of dividends to be paid by Newco to New Canco on the Newco Preferred Shares for so long as the preferred shares are outstanding. No shares will be issued by Newco in respect of the contributions of capital. The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes.

20. Newco will use the amounts received as capital contributions to pay dividends on the Newco Preferred Shares at least annually.

21. New Canco will use the amounts received as dividends from Newco to pay interest on the New Canco Demand Loan at least annually.

22. Within XXXXXXXXXX years, OPCO will unwind the proposed structure as follows:

a. OPCO will make capital contributions to the common share capital of Newco equal to the amount of any accrued and unpaid dividends on the Newco Preferred Shares.

b. Newco will declare and pay the balance of any accrued and unpaid dividends on the Newco Preferred Shares.

c. New Canco will pay the balance of any accrued and unpaid interest on the New Canco Demand Loan.

d. Newco will redeem all or a portion of the Newco Preferred Shares held by New Canco and will settle the amount owing on the redemption by assigning a corresponding amount of the OPCO Demand Loan to New Canco.

e. New Canco will repay all or a portion of the New Canco Demand Loan equal to the redemption amount of the Newco Preferred shares by setting off the New Canco Demand Loan with a corresponding amount of the OPCO Demand Loan and such portions of both loans will be cancelled.

Additional Information

23. OPCO and New Canco do not expect the proposed transactions to significantly affect the companies' respective provincial allocations and consequently the proposed transactions should not shift significant amounts of income from high tax provinces to low tax provinces.

24. It is expected that dividends paid to New Canco by Newco would be designated as eligible dividends.

Purpose of the Proposed Transactions

25. The purpose of the proposed transactions is to enable OPCO to earn sufficient interest income to offset its non-capital losses that are expected to arise as a result of transferring a large part of its business to New Canco and to allow New Canco to deduct interest expense on borrowed money used to acquire the Newco Preferred Shares in computing its profits for the year.

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. Provided the interest paid or payable by New Canco on the New Canco Demand Loan is reasonable and is paid pursuant to a legal obligation to pay interest and that the Preferred Shares of Newco continue to be held by New Canco for the purpose of producing income from property, New Canco will be entitled to deduct, in computing its income for a taxation year, pursuant to paragraph 20(1)(c) of the Act, the interest paid or payable by it in respect of the taxation year on the New Canco Loan to the extent such amount does not exceed a reasonable amount.

B. The dividends received (or deemed to be received) by New Canco on Newco Preferred Shares held by it as described in 20 and 22(b) above will be taxable dividends that will, pursuant to subsection 112(1) of the Act, be deductible in computing its taxable income for the taxation year in which the dividends are received, and for greater certainty, such deductions will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4) of the Act.

C. 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 OPCO as described in 19 and 22(a) above.

D. The provisions of subsections 15(1), 56(2), 69(4), 69(11) and 246(1) of the Act will not apply to any of the proposed transactions described herein.

E. As a result of the proposed transactions, in and by themselves, subsection 245(2) of the Act will not be applied to redetermine the tax consequences confirmed in the rulings given above.

F. The cancellation of the New Canco Demand Loan and the OPCO Demand Loan as described in 22(e) above will not give rise to a "forgiven amount" for purposes of section 80 of the Act.

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, other than 22 above, are commenced 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