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 utilization arrangement acceptable?
Position: Yes
Reasons: meets our published position
XXXXXXXXXX
2011-040824
XXXXXXXXXX
XXXXXXXXXX , 2011
Dear XXXXXXXXXX :
Re: 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. We acknowledge information provided during telephone conversations with XXXXXXXXXX on XXXXXXXXXX .
In very general terms, the transactions described herein involve a loss utilization transaction within an affiliated (and related) group of companies which will permit certain affiliated (and related) corporations to deduct the losses that would otherwise be incurred by Opco in respect of the use of certain tax attributes. Opco files its corporate income tax returns at the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office.
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 is:
(i) dealt with in an earlier return of Parentco, Finco, Opco, Lossco, Profitco, Holdco1, Holdco2, Holdco3, 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 Parentco, Finco, Opco, Lossco, Profitco, Holdco1, Holdco2, Holdco3, or a related person;
(iii) under objection by Parentco, Finco, Opco, Lossco, Profitco, Holdco1, Holdco2, Holdco3, or a related person;
(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to Parentco, Finco, Opco, Lossco, Profitco, Holdco1, Holdco2, Holdco3, 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.
Except as otherwise noted, all statutory references in this advance income tax ruling are references to the provisions of the Act. Unless otherwise noted, all references to currency are to Canadian dollars.
This letter is based solely on the facts and Proposed Transactions described below. The documentation submitted with your request does not form part of the facts and Proposed Transactions and any references thereto are provided solely for the convenience of the reader.
Definitions:
(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph, subparagraph or clause is a reference to the relevant provision of the Act;
(b) "ACB" has the meaning assigned to "adjusted cost base" by section 54 of the Act;
(c) "affiliated" has the meaning of affiliated person assigned by subsection 69(11) of the Act;
(d) "Arm's Length" has the meaning assigned to arm's length by subsection 251(1) of the Act;
(e) XXXXXXXXXX ;
(f) "Canadian Corporation" has the meaning assigned by subsection 89(1) of the Act;
(g) "CRA" means the Canada Revenue Agency;
(h) XXXXXXXXXX ;
(i) "Daylight Loan" means the loan described in 11 below;
(j) "Finco" means XXXXXXXXXX. Finco is a TCC XXXXXXXXXX ;
(k) "FMV" means fair market value;
(l) "Holdco1" means XXXXXXXXXX , a corporation governed by the XXXXXXXXXX and a TCC, and is a Subsidiary Wholly-Owned Corporation of Parentco;
(m) "Holdco2" means XXXXXXXXXX , a corporation governed by the XXXXXXXXXX and a TCC, and is a Subsidiary Wholly-Owned Corporation of Holdco1. All the issued and outstanding shares of Holdco2 are common shares;
(n) "Holdco3" means XXXXXXXXXX , a corporation governed by the XXXXXXXXXX and a TCC, and is a Subsidiary Wholly-Owned Corporation of Holdco2. All the issued and outstanding shares of Holdco3 are common shares;
(o) "Lossco" means a Subsidiary Wholly-Owned Corporation to be formed by Holdco2. Lossco will be incorporated under the XXXXXXXXXX , as part of the Proposed Transactions. Lossco will be a TCC;
(p) "Lossco Loan" means the loan made to Lossco as described in 12 below;
(q) "Minority Shareholder" means XXXXXXXXXX , a corporation resident in XXXXXXXXXX that is not related with any corporation within the Parentco Group;
(r) "New Daylight Loan" means the loan described in 20(e) below;
(s) "Non-Capital Losses" has the meaning assigned by subsection 111(8) of the Act;
(t) "Opco" means XXXXXXXXXX , a corporation governed by the XXXXXXXXXX , and is a Subsidiary Wholly-Owned Corporation of Parentco;
(u) "Opco Preferred Shares" means the preferred shares described in 13 below;
(v) "Opco Tax Attributes" means unclaimed SR&ED income tax credits as described in 4 below;
(w) "Parentco" means XXXXXXXXXX. Parentco is a TCC XXXXXXXXXX ;
(x) "Parentco Group" means XXXXXXXXXX ;
(y) "Profitco" means XXXXXXXXXX , an insurance corporation incorporated under XXXXXXXXXX and a TCC. Holdco3 owns XXXXXXXXXX % of all the issued and outstanding common shares and XXXXXXXXXX preferred shares of Profitco. The remaining XXXXXXXXXX % of the issued and outstanding common shares and 1 preferred share of Profitco are held by the Minority Shareholder;
(z) "Profitco Deemed Dividend" means the deemed dividend described in 25 below;
(aa) "Profitco Preferred Shares" means the preferred shares described in 22 below;
(bb) "Proposed Transactions" means the transactions described in 9 to 26 below;
(cc) "PUC" means "paid-up capital" and has the meaning assigned by subsection 89(1) of the Act;
(dd) "related" has the meaning of related persons assigned by subsection 251(2) of the Act;
(ee) "RFI" means "restricted financial institution" and has the meaning assigned by subsection 248(1) of the Act;
(ff) "SFI" means "specified financial institution" and has the meaning assigned by subsection 248(1) of the Act;
(gg) "SR&ED" means "scientific research and experimental development" and has the meaning assigned by subsection 248(1) of the Act;
(hh) "Subsidiary Wholly-Owned Corporation" has the meaning assigned by subsection 248(1) of the Act; and,
(ii) "TCC" means "taxable Canadian corporation" and has the meaning assigned by subsection 89(1) of the Act.
Facts
1. Parentco, Finco, Holdco 1, Holdco 2, Holdco 3, Opco, Profitco and Lossco are RFIs.
2. Opco share capital is as follows:
Class A, B, C and D shares are voting, entitled to a discretionary dividend, subject to the right of the Class E, F, G and H shares, and to receive the remaining property of the corporation upon liquidation or winding-up.
Class E preferred shares are voting, non-participating, redeemable and refundable in priority on all other classes of shares.
Class F preferred shares are non-voting, retractable and redeemable, entitled to a non-cumulative dividend of XXXXXXXXXX % per month and refundable in priority on Class A, B, C, D, G and H shares.
Class G preferred shares are non-voting, retractable and redeemable, entitled to a non-cumulative dividend of XXXXXXXXXX % per month and refundable in priority on Class A, B, C, D and H shares.
Class H preferred shares are non-voting, redeemable, entitled to a non-cumulative dividend of XXXXXXXXXX % per year and refundable in priority on Class A, B, C and D shares.
3. Opco is a corporation that XXXXXXXXXX . Opco renders services to the Parentco Group such as XXXXXXXXXX .
4. Some of Opco's activities qualify for SR&ED income tax credits. At the end of the XXXXXXXXXX taxation year, Opco estimates that it will have approximately $XXXXXXXXXX of unused SR&ED income tax credits (federal and provincial) (the "Opco Tax Attributes") if it was not for the additional income taxes due in respect of the interest to be earned as a result of the Proposed Transactions described herein. After XXXXXXXXXX , it is estimated that SR&ED income tax credits in excess of tax otherwise payable of approximately $XXXXXXXXXX would continue to be generated yearly.
5. In the taxation year XXXXXXXXXX , Opco had permanent establishments in XXXXXXXXXX and XXXXXXXXXX . The allocation of the taxable income between XXXXXXXXXX and XXXXXXXXXX is XXXXXXXXXX % and XXXXXXXXXX %, respectively. Opco expects the XXXXXXXXXX taxable income allocation to be similar.
6. Profitco authorized share capital is as follows:
An unlimited amount of common shares without par value; and XXXXXXXXXX preferred shares non-voting, non-participating and redeemable.
7. Profitco has permanent establishments only in XXXXXXXXXX .
8. As of XXXXXXXXXX , the shareholder equity of Profitco has a book value of approximately $XXXXXXXXXX . The FMV of all the issued and outstanding shares of Profitco is expected to be greater than the book value of $XXXXXXXXXX .
Proposed Transactions
9. Holdco2 will incorporate Lossco. The taxation year-end of Lossco will be XXXXXXXXXX . The activities of Lossco will essentially be limited to the activities described in the Proposed Transactions.
10. Lossco will issue common shares to Holdco2 for a nominal amount.
11. Opco will borrow from Finco an amount of money to fund a Lossco Loan sufficient to create enough interest income to use all or substantially all the Opco Tax Attributes (the "Daylight Loan"). The amount of the Daylight Loan and the rate of interest will be determined at the time the Proposed Transactions are implemented. The Daylight Loan should not exceed $XXXXXXXXXX . The amount of the Daylight Loan will not exceed the borrowing capacity of the Parentco Group.
12. Opco will use the proceeds of the Daylight Loan to make a loan of the same amount to Lossco (the "Lossco Loan"). Simple interest will accrue on the Lossco Loan and will be calculated at a rate that would not exceed a reasonable commercial Arm's Length rate. The interest rate will be determined at the time the Proposed Transactions are implemented. The Lossco Loan will be payable on demand. The interest on the Lossco Loan will be paid periodically.
13. Opco's share capital will be amended to create a new category of preferred shares, redeemable and retractable, entitled to cumulative dividends in priority on all other classes of share, calculated daily by reference to the redemption/retraction price at a rate equal to the interest rate on the Lossco Loan plus a small spread (5 basis point) (the "Opco Preferred Shares").
14. Lossco will use the proceeds of the Lossco Loan to subscribe for Opco Preferred Shares having an aggregate redemption/retraction price equal to the amount contributed. The PUC and the FMV of the Opco Preferred Shares will be equal to the amount contributed.
The amount of dividends on the Opco Preferred Shares held by Lossco will be sufficient to permit Lossco to realize a profit on its investment activity, after the deduction of all its expenses (not only its interest expenses).
15. Opco will use the proceeds received from the subscription of the Opco Preferred Shares to repay the Daylight Loan to Finco.
16. While the Lossco Loan is outstanding, Finco will, at least annually, make a non-interest bearing daylight loan to Lossco in an amount equal to the interest payable by Lossco on the Lossco Loan. Lossco will use the amounts received from Finco to pay interest to Opco equal to the amount of interest payable on the Lossco Loan.
17. Parentco will, at least annually, make a contribution of capital to Opco in an amount equal to the excess of the dividend payable on the Opco Preferred Shares over the interest payable by Lossco on the Lossco Loan. No shares will be issued by Opco with respect to these contributions of capital and no amount will be added to Opco's stated capital accounts. The amount of each contribution of capital will be recorded by Opco as contributed surplus for accounting purposes. The contributions of capital will not be treated as income of Opco pursuant to generally accepted accounting principles.
18. Opco will use the amounts of interest received from Lossco and the amount of capital contribution received from Parentco to pay to Lossco the dividends payable on the Opco Preferred Shares.
19. Lossco will use a portion of the amount of dividends received from Opco to repay the loan described in 16 above to Finco.
20. The following transactions will occur prior to XXXXXXXXXX , in order to unwind the loss consolidation arrangement:
(a) Finco will make a non-interest bearing daylight loan to Lossco in an amount equal to the interest payable by Lossco on the Lossco Loan. Lossco will use the amounts received from Finco to pay interest to Opco equal to the amount of interest payable on the Lossco Loan.
(b) Parentco will make a contribution of capital to Opco in an amount equal to the excess of the dividends payable on the Opco Preferred Shares over the interest payable by Lossco on the Lossco Loan. No shares will be issued by Opco and no amount will be added to its stated capital account in respect of the contribution. The amount of this contribution of capital, if any, will be recorded as contributed surplus for accounting purposes. The contribution of capital, if any, will not be income of Opco pursuant to generally accepted accounting principles.
(c) Opco will pay to Lossco the dividends payable on the Opco Preferred Shares.
(d) Lossco will use a portion of the amount of dividends received from Opco to repay the loan described in (a) to Finco.
(e) Opco will borrow on a daylight loan basis from Finco an amount equal to the redemption price of the Opco Preferred Shares (the "New Daylight Loan"). Opco will use these funds to redeem all the issued and outstanding Opco Preferred Shares held by Lossco.
(f) Lossco will use the proceeds of the redemption of the Opco Preferred shares received in (e) above to repay the Lossco Loan.
(g) Opco will use the funds received from Lossco on the repayment of the Lossco Loan to repay the New Daylight Loan.
21. Forthwith after the proposed transactions described in 20 above and before XXXXXXXXXX , Holdco2 will transfer all of its common shares of Lossco to Holdco3. Holdco2 will jointly elect with Holdco3 in prescribed form and within the time limit referred to in subsection 85(6) of the Act, to have the provisions of subsection 85(1) of the Act apply to the transfer. The agreed amount will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) of the Act. Consideration for the transfer of the common shares of Lossco will consist of one common share of Holdco3. Holdco3 will add an amount equal to the PUC of the common shares of Lossco to the stated capital of the common shares of Holdco3.
22. Profitco will amend its share capital in order to create a new class of preferred shares, non-voting, entitled to a non-cumulative dividend, redeemable and retractable (subject to the approval of the regulatory authorities) and having priority over all the other class of shares ("Profitco Preferred Shares").
23. Forthwith after the proposed transactions described in 21 and 22 above and before XXXXXXXXXX , Holdco3 will transfer all of its common shares of Lossco to Profitco. Holdco3 will jointly elect with Profitco in prescribed form and within the time limit referred to in subsection 85(6) of the Act, to have the provisions of subsection 85(1) of the Act apply to the transfer. The agreed amount will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) of the Act. Consideration for the transfer of the common shares of Lossco will consist of Profitco Preferred Shares with a FMV and redemption amount equal to the FMV of the common shares of Lossco transferred. Profitco will add an amount equal to the PUC of the common shares of Lossco to the stated capital of the Profitco Preferred Shares.
24. Shortly after the transaction described in 20 to 23 above and before XXXXXXXXXX , Profitco will cause Lossco to be wound-up in such a manner that all the assets of Lossco are acquired by Profitco and all of the liabilities, if any, of Lossco are assumed by Profitco. The provisions of subsection 88(1) of the Act will apply to the wind-up of Lossco. Lossco will be legally dissolved within a short period of time.
25. Subject to the approval of the regulatory authorities, Profitco will as soon as practically possible redeem the Profitco Preferred Shares issued in 23 above. Pursuant to subsection 84(3) of the Act, Profitco will be deemed to have paid and Holdco3 to have received a dividend of an amount equal to the excess of the redemption amount of the Profitco Preferred Shares over their PUC (the "Profitco Deemed Dividend").
26. After the wind-up of Lossco, the above transactions will be repeated each year in order to use the Opco Tax Attributes of each year. The amount of the Daylight Loan in 11 above may be reduced depending on the estimated Opco Tax Attributes for the year. To the extent that the Daylight Loan is reduced, the respective amounts in the Proposed Transactions will be reduced accordingly.
Purpose of the Proposed Transactions
The purpose of the Proposed Transactions is to allow for Profitco (i) to offset taxable income with the Non-Capital Losses of Lossco that would be created by the interest expense and (ii) to use the Opco Tax Attributes.
In a typical loss transfer arrangement, Opco would have lent to Profitco at a stated rate of interest and Profitco would in turn have used the borrowed funds to invest in the Opco Preferred Shares. However, a typical loss consolidation arrangement could not be implemented directly with Profitco because Profitco's business is regulated.
Lossco will not be used for any other purposes than those described in the Proposed Transactions. Also, Lossco should never be insolvent. Parentco will not claim, at any time, a capital loss in respect of its capital contribution to Opco.
After the transactions described in 9 to 20 above, the FMV of the common shares of Lossco should be equal to the aggregate of (i) the value of the tax savings resulting from the use of the Lossco's Non-Capital Losses (i.e., the value of the Opco Tax Attributes) and (ii) any amount of cash held by Lossco net of any liability. Such FMV is expected to be no more than approximately $XXXXXXXXXX .
The Opco Preferred Shares (as described in 13 above) and the Profitco Preferred Shares (as described in 22 above) will not, at any relevant time, be:
a) the subject of any undertaking that is a guarantee agreement (subsection 112(2.2));
b) the subject of a dividend rental arrangement (subsection 248(1));
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. any right of the type described in subparagraph 112(2.4)(b)(ii).
Rulings Given
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:
A. Provided that Lossco has a legal obligation to pay interest on the Lossco Loan and that the Opco Preferred Shares continue to be held by Lossco for the purpose of gaining or producing income, in computing its income for a taxation year, Lossco will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the Lossco Loan, as described in 16 and 17 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Lossco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.
B. No amount will be included in the income of Opco 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 Parentco to Opco as described in 17 and 20(b) above.
C. The dividends received by Lossco on the Opco Preferred Shares, as described in 18 and 20(c) above, will be taxable dividends that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Lossco for the taxation year in which the dividends are received, and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2) or 112(2.4) of the Act.
D. Provided that the requirements in paragraph 88(1.1)(a) and (b) of the Act are satisfied, the provisions of subsection 88(1.1) of the Act will apply after the winding-up of Lossco into Profitco is completed, as described in 24 above, to permit Profitco to deduct the Non-Capital Losses of Lossco in computing its taxable income for any taxation year commencing after the commencement of the winding-up, subject to the limitations in paragraph 88(1.1)(e) and section 111 of the Act. For this purpose, Lossco will not be considered to have been wound up until after it has been formally dissolved.
E. The Profitco Deemed Dividend deemed received by Holdco3 on the redemption of the Profitco Preferred Shares, as described in 25 above, will be a taxable dividend that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Holdco3 for the taxation year in which the dividends are deemed received, and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2) or 112(2.4) of the Act.
F. The provisions of subsections 15(1), 56(2), and 246(1) of the Act, in and by themselves, will not apply to the Proposed Transactions.
G. 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 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 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.
A. It is our view that the winding-up of Lossco into Profitco as described in 24 above would cause subsection 55(2) of the Act to apply to the taxable dividends that Holdco3 receives from Profitco on the Profitco Preferred Shares, that is the Profitco Deemed Dividend, as described in 25 above. However, the Department of Finance has issued a letter dated April 21, 2005 (the "comfort letter"), indicating that it was prepared to recommend to the Minister of Finance that situations described in the comfort letter (i.e. essentially where a wholly-owned subsidiary is amalgamated with, or wound-up into, its parent) should not result in a significant increase in the interest of the subsidiary solely as a result of the application of paragraphs 55(3.01)(b) and (c) of the Act. If such legislation is ever enacted and is effective for the period in which these Proposed Transactions take place, it is possible that subsection 55(2) of the Act will not apply to those dividends.
B. Unless otherwise confirmed in the above rulings, 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; nor,
(c) 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
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