2012 Ruling 2011-0427951R3 - 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 proposed loss consolidation acceptable?

Position: Yes

Reasons: Within established parameters.

XXXXXXXXXX
2011-042795
XXXXXXXXXX, 2012

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. We also acknowledge the additional information provided to us in your emails and letters, the last of which was dated XXXXXXXXXX.

This letter is based solely on the facts, Proposed Transactions and additional information described below. Any documentation submitted in respect of your request does not form part of the facts, Proposed Transactions and additional information, and any references thereto are provided solely for the convenience of the reader.

To the best of your knowledge, and that of the above-noted taxpayers, none of the issues involved in this advance income tax ruling are:

(i) in an earlier tax return of the above-noted taxpayers or of a related person;

(ii) being considered by a Tax Services Office or a Taxation Centre in connection with a previously-filed tax return of the above-noted taxpayers or of a related person;
(iii) under objection by the above-noted taxpayers or by a related person;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously considered by the Income Tax Rulings Directorate in connection with the above-noted taxpayers or a related person.

Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter (the “Act”) or the Income Tax Regulations (the “Regulations”), and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the facts, Proposed Transactions and the purpose of the Proposed Transactions is as follows:

Definitions

In this letter, the following terms have the meanings specified:

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

b. XXXXXXXXXX;

c. XXXXXXXXXX;

d. “XXXXXXXXXXBCA” means the XXXXXXXXXX Business Corporations Act (XXXXXXXXXX) and, where applicable, its predecessor statutes;

e. “dividend rental arrangement” has the meaning assigned by subsection 248(1) of the Act;

f. “financial institution” has the meaning assigned by subsection 190(1) of the Act;

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

h. XXXXXXXXXX;

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

j. “XXXXXXXXXXBCA” means the Business Corporations Act (XXXXXXXXXX);

k. “Opco1” means XXXXXXXXXX, a corporation further described in 11 below;

l. “Opco1 Loan” means the loan made by Opco1 to Subsidiary2 as described in 25 below;

m. “Opco1 Preferred Shares” means shares of the capital stock of Opco1 as defined in 22 below;

n. “Opco2” means XXXXXXXXXX, a corporation further described in 16 below;

o. “Opco2 Loan” means the loan made by Opco2 to Subsidiary2 as described in 30 below;

p. “Opco2 Non-streamed Non-capital Losses” means Opco2’s non-capital loss carryforwards in respect of taxation years following Subsidiary3's acquisition of control of Opco2 as further described in 17 below;

q. “Opco2 Preferred Shares” means shares of the capital stock of Opco2 as defined in 23 below;

r. “Opco2 Streamed Business” means the business carried on by Opco2 prior to its acquisition of control and from which the Opco2 Streamed Non-capital Losses were derived;

s. “Opco2 Streamed Non-capital Losses” means Opco2’s non-capital loss carryforwards in respect of taxation years prior to Subsidiary3's acquisition of control of Opco2 as further described in 17 below;

t. “Parent” means XXXXXXXXXX, a corporation further described in 1 below;

u. “Proposed Transactions” means the transactions described in 22 – 38 below;

v. “registered securities dealer” has the meaning assigned by subsection 248(1) of the Act;

w. “related” has the meaning assigned by section 251 of the Act;

x. “specified financial institution” has the meaning assigned by subsection 248(1) of the Act;

y. “Subsidiary1” means XXXXXXXXXX, a corporation further described in 4 below;

z. “Subsidiary1 Loan” means the loan made by Subsidiary1 to Opco1 as described in 24 below;

aa. “Subsidiary2” means XXXXXXXXXX, a corporation further described in 5 below;

bb. “Subsidiary3” means XXXXXXXXXX, a corporation further described in 15 below;

cc. “taxable Canadian corporation” has the meaning assigned by subsection 89(1) of the Act; and

dd. “Treaty” means the XXXXXXXXXX income tax convention.

Facts

1. Parent, through its subsidiary corporations, is a XXXXXXXXXX.

2. Parent is a corporation incorporated under the laws of XXXXXXXXXX, a non-resident of Canada for purposes of the Act and a resident of XXXXXXXXXX for the purposes of the Treaty. Parent is publicly listed and its shares are traded on the XXXXXXXXXX. Parent, as the indirect shareholder of Subsidiary3, XXXXXXXXXX, is regulated by XXXXXXXXXX, the XXXXXXXXXX. Parent is also supervised by the XXXXXXXXXX.

3. The consolidated financial statements of Parent for its fiscal year ended XXXXXXXXXX, indicate that Parent and its accounting consolidated group had:

(a) Total assets of approximately XXXXXXXXXX;
(b) Total liabilities of approximately XXXXXXXXXX; and
(c) Shareholder’s equity of approximately XXXXXXXXXX.

4. Subsidiary1 is a direct wholly-owned subsidiary of Parent. Subsidiary1 is a corporation incorporated under the laws of XXXXXXXXXX, a non-resident of Canada for purposes of the Act and a resident of XXXXXXXXXX for purposes of the Treaty. Subsidiary1 is the holding company for the XXXXXXXXXX operations of the corporate group.

5. Subsidiary2 is an indirect wholly-owned subsidiary of Subsidiary1. Subsidiary2 has been a subsidiary of Subsidiary1 since XXXXXXXXXX. Subsidiary2 is governed by the XXXXXXXXXXBCA and is a taxable Canadian corporation. Its registered address is XXXXXXXXXX, its Taxation Centre is the XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office. Subsidiary2’s fiscal year-end is XXXXXXXXXX.

6. Subsidiary2 is a XXXXXXXXXX regulated by XXXXXXXXXX that provides XXXXXXXXXX. Its corporate advisory services include XXXXXXXXXX. XXXXXXXXXX.

7. Subsidiary2’s taxable income for its three prior taxation years was as follows:

Taxation Year Ending Taxable Income
XXXXXXXXXX $XXXXXXXXXX

8. It is expected that Subsidiary2 will be able to fully utilize the interest paid or payable on each of the Opco1 Loan and the Opco2 Loan either against its income for the current taxation year in which the Proposed Transactions described in 22 to 37 below are undertaken or by carrying back any loss for that taxation year against its taxable income for its three prior taxation years.

9. Subsidiary2’s stand alone financial statements for its fiscal year-end XXXXXXXXXX, indicate that Subsidiary2 has assets of $XXXXXXXXXX.

10. Subsidiary2 has a permanent establishment in each of the provinces and territories listed below and, for its taxation year ending XXXXXXXXXX, its gross revenue and salary and wages, for purposes of Part IV of the Regulations, were allocated as follows:

Province/Territory Gross Revenue Salary and Wages
XXXXXXXXXX $XXXXXXXXXX $XXXXXXXXXX

11. Opco1 is a direct wholly-owned subsidiary of Subsidiary2. Opco1 has been a subsidiary of Subsidiary2 since XXXXXXXXXX. Opco1 is governed by the XXXXXXXXXXBCA and is a taxable Canadian corporation. Its registered address is XXXXXXXXXX, its Taxation Centre is the XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office. Opco1's fiscal year-end is XXXXXXXXXX. Opco1 carries on XXXXXXXXXX.

12. At XXXXXXXXXX, Opco1’s non-capital loss carryforwards amounted to $XXXXXXXXXX as noted in the table below.

Year of origin Year of expiry Non-capital Loss
XXXXXXXX XXXXXXXX XXXXXXXX

13. Opco1's financial statements for its fiscal year-end XXXXXXXXXX, indicate that Opco1 has assets of $XXXXXXXXXX.

14. Opco1 has a permanent establishment in each of the provinces and territories listed below and, for its taxation year ending XXXXXXXXXX, its gross revenue and salary and wages, for purposes of Part IV of the Regulations, were allocated as follows:

Province/Territory Gross Revenue Salary and Wages
XXXXXXXXXX $XXXXXXXXXX $XXXXXXXXXX

15. Subsidiary3 is a corporation incorporated under the laws of XXXXXXXXXX, a non-resident of Canada for purposes of the Act and a resident of XXXXXXXXXX for purposes of the Treaty. Subsidiary3 is XXXXXXXXXX. Subsidiary3 is the parent corporation of directly and indirectly owned subsidiaries and other entities that collectively comprise the XXXXXXXXXX operations of the corporate group.

16. Opco2 is an indirect wholly-owned subsidiary of Subsidiary3. Opco2 has been an indirect subsidiary of Subsidiary3 since XXXXXXXXXX. Opco2 is governed by the XXXXXXXXXXBCA. Opco2 is a taxable Canadian corporation and XXXXXXXXXX. Its registered address is XXXXXXXXXX, its Taxation Centre is the XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office. Opco2's fiscal year-end is XXXXXXXXXX. Opco2 conducts a XXXXXXXXXX.

17. As at XXXXXXXXXX, Opco2 had a balance of non-capital loss carryforwards of $XXXXXXXXXX as noted in the table below. Of those non-capital loss carryforwards, $XXXXXXXXXX are in respect of taxation years prior to Subsidiary3's acquisition of control of Opco2 and, therefore, are subject to the restrictions set out in subsection 111(5) of the Act (the “Opco2 Streamed Non-capital Losses”). The remaining, $XXXXXXXXXX of Opco2's non-capital losses are not subject to the restrictions set out in subsection 111(5) of the Act (the “Opco2 Non-streamed Non-capital Losses”).

Year of origin Year of expiry Non-capital Loss
XXXXXXXX XXXXXXXX XXXXXXXX

XXXXXXXXXX

18. Opco2's stand alone financial statements for its fiscal year-end XXXXXXXXXX, indicate that Opco2 has assets of $XXXXXXXXXX.

19. Opco2 has a permanent establishment in each of the provinces listed below and, for its taxation year ending XXXXXXXXXX, gross revenue and salary and wages, for purposes of Part IV of the Regulations, were allocated (or would be allocated if it had taxable income) as follows:

Province/Territory Gross Revenue Salary and Wages
XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX

20. XXXXXXXXXX

21 Subsidiary2, OpCo1 and OpCo2 estimate that they will earn taxable income, or incur non-capital losses, (before the Proposed Transactions) as follows:
Taxable Income Estimate
XXXXXXXX XXXXXXXX XXXXXXXX
Subsidiary2 $XXXXXXX $XXXXXXXX XXXXXXXX
OpCo1 $XXXXXXXX $XXXXXXXX XXXXXXXX
OpCo2 $XXXXXXXX $XXXXXXXX XXXXXXXX

As noted above, Opco1’s net income for income tax purposes for the year ended XXXXXXXXXX, is expected to be $XXXXXXXXXX, however, following the carryforward of non-capital losses from its year ended XXXXXXXXXX, its taxable income is expected to be XXXXXXXXXX.

Proposed Transactions

22. The authorized capital of Opco1 will be amended so that it will consist of three classes of shares, namely a class of common shares and two classes of preferred shares, one of which will be non-voting, cumulative dividend, redeemable, retractable preferred shares (the “Opco1 Preferred Shares”). The cumulative dividends payable on the Opco1 Preferred Shares will be calculated by reference to the redemption/retraction price of the Opco1 Preferred Shares at a rate equal to the interest rate on the Opco1 Loan, the proceeds of which will be used to acquire the Opco1 Preferred Shares, plus a small spread of XXXXXXXXXX%. Dividends will be paid monthly on the last business day of each month.

23. The authorized capital of Opco2 will be amended so that it will consist of two classes of shares, namely a class of common shares and a class of non-voting, cumulative dividend, redeemable, retractable preferred shares (the “Opco2 Preferred Shares”). The cumulative dividends payable on the Opco2 Preferred Shares will be calculated by reference to the redemption/retraction price of the Opco2 Preferred Shares at a rate equal to the interest rate on the Opco2 Loan, the proceeds of which will be used to acquire the Opco2 Preferred Shares, plus a small spread of XXXXXXXXXX%. Dividends will be paid monthly on the last business day of each month.

24. On a particular day to be determined by Subsidiary1 and Opco1, Subsidiary1 will make the Subsidiary1 Loan. The Subsidiary1 Loan will be in the principal amount of $XXXXXXXXXX.

25. On the same day that the Subsidiary1 Loan is made, Opco1 will use the proceeds received by it from the Subsidiary1 Loan to make the Opco1 Loan. The Opco1 Loan will be in the principal amount of $XXXXXXXXXX.

26. Interest will accrue on the Opco1 Loan at a rate equal to XXXXXXXXXX% per annum. The interest on the Opco1 Loan will be computed and paid monthly in arrears on the last business day of each month.

27. On the same day that the Opco1 Loan is made, Subsidiary2 will use the proceeds received by it from the Opco1 Loan to subscribe for the Opco1 Preferred Shares, which will have an aggregate redemption price equal to their subscription price of $XXXXXXXXXX.

28. On the same day that Subsidiary2 subscribes for the Opco1 Preferred Shares, Opco1 will use the total proceeds received by it from the subscription for the Opco1 Preferred Shares to repay the Subsidiary1 Loan.

29. On a particular day to be determined by Subsidiary3 and Opco2, Subsidiary3 will subscribe for the Opco2 Preferred Shares, which will have an aggregate redemption price equal to their subscription price of $XXXXXXXXXX.

30. On the same day that Subsidiary3 subscribes for the Opco2 Preferred Shares, Opco2 will use the proceeds received by it on Subsidiary3's subscription for the Opco2 Preferred Shares to make the Opco2 Loan. The Opco2 Loan will be in the principal amount of $XXXXXXXXXX.

31. Interest will accrue on the Opco2 Loan at a rate equal to XXXXXXXXXX% per annum. The interest on the Opco2 Loan will be computed and paid monthly in arrears on the last business day of each month.

32. On the same day that the Opco2 Loan is made, Subsidiary2 will use the proceeds received by it from the Opco2 Loan to acquire the Opco2 Preferred Shares from Subsidiary3. Subsidiary2 will, XXXXXXXXXX, acquire the Opco2 Preferred Shares from Subsidiary3 instead of directly subscribing for those shares.

33. Subsidiary2 will use revenue from its business to pay to each of Opco1 and Opco2 interest on each of the Opco1 Loan and the Opco2 Loan when due and payable.

34. OpCo1 will have revenue (other than from the OpCo 1 Loan) at least equal to the dividends payable on the OpCo1 Preferred Shares.

35. OpCo2 will have revenue (other than from the OpCo 2 Loan) at least equal to the dividends payable on the OpCo2 Preferred Shares.

36. To effect the payment of dividends on each of the Opco1 Preferred Shares and Opco2 Preferred Shares, the board of directors of each of Opco1 and Opco2 will agree in advance to declare and pay dividends on the last business day of each month (subject to meeting the relevant corporate solvency and liquidity tests).

37. With respect to the payment of interest and dividends, like amounts will be set-off with payment of the balance owing.

38. Subject to XXXXXXXXXX approval, the following transactions will occur at such time as Subsidiary2 has incurred sufficient interest expense to have utilized its resulting non-capital losses against its prior years’ taxable income (expected to be within XXXXXXXXXX years from the date the proposed transactions described in 22 to 37 above are undertaken):

(a) Subsidiary2 will repay the Opco1 Loan, including all accrued but unpaid interest;
(b) Opco1 will redeem the Opco1 Preferred Shares and pay the redemption price thereof including any accrued dividends.
(c) Subsidiary2 will repay the Opco2 Loan, including all accrued but unpaid interest; and
(d) Opco2 will redeem the Opco2 Preferred Shares and pay the redemption price thereof including any accrued dividends.

Additional Information

39. Subsidiary2 has sufficient borrowing capacity to effect the Proposed Transactions as evidenced by the fact that each of the OpCo1 Loan and the OpCo2 Loan XXXXXXXXXX.

40. Each of the Opco1 Preferred Shares and the Opco2 Preferred Shares, which will be issued as described in 27 and 29 above, respectively, will not, at any time during the implementation of the Proposed Transactions, be:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) of the Act as a “guarantee agreement”;
(b) the subject of a dividend rental arrangement as that term is defined in subsection 248(1) of the Act;
(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a) of the Act; or
(d) issued for consideration that is or includes:

(i) an obligation of the type described in subparagraph 112(2.4)(b)(i) of the Act, 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.

41. Subsidiary2 has been affiliated and related to Opco 1 and OpCo2 since XXXXXXXXXX, and XXXXXXXXXX, respectively.

42. None of Subsidiary2, OpCo1 and OpCo2 is, or will be, a financial institution or a financial intermediary corporation. Each of Subsidiary2, Opco1 and Opco2 is a specified financial institution.

43. The Proposed Transactions will not, in and of themselves, result in Subsidiary2 acquiring the Opco1 Preferred Shares or the Opco2 Preferred Shares in the ordinary course of the business carried on by it.

44. None of the Opco2 Streamed Non-capital Losses will be utilized by Opco2 to offset taxable income generated by the Opco2 Loan.

Purpose of the Proposed Transactions

45. The purpose of the Proposed Transactions is to effect a tax consolidation of Subsidiary2, Opco1 and Opco2 by causing each of Opco1 and Opco2 to earn interest income on the Opco1 Loan and the Opco2 Loan, respectively, thus permitting each of Opco1 and Opco2 to utilize its non-capital loss carryforwards and to have Subsidiary2 incur interest expense to reduce its income for its current taxation year, and to the extent this creates non-capital losses for Subsidiary2, to carry-back the non-capital losses to reduce its taxable income from prior taxation years.

Rulings

A. Provided that Subsidiary2 has a legal obligation to pay interest on the OpCo1 Loan and the OpCo2 Loan and that the Opco1 Preferred Shares and the Opco2 Preferred Shares continue to be held by Subsidiary2 for the purpose of gaining or producing income, in computing its income for a taxation year, Subsidiary2 will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the OpCo1 Loan and the OpCo2 Loan, as described in 26 and 31 above, respectively, paid in the year or payable in respect of the year (depending on the method regularly followed by Subsidiary2 in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

B. The dividends received by Subsidiary2 on each of the Opco1 Preferred Shares and the Opco2 Preferred Shares held by it as described in 34 and 35 above, respectively, above will be taxable dividends that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Subsidiary2 for the year in which such 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. Subsidiary2 will be entitled to carry back to its prior taxation years the non-capital losses that are expected to arise as a result of the deductions described in Ruling A above, subject to any applicable restrictions in section 111 of the Act.

D. In computing its taxable income for a taxation year, subject to the limitations in section 111 of the Act, Opco2 will be entitled to deduct under paragraph 111(1)(a):

a) the Opco2 Streamed Non-capital Losses (for the purposes of subparagraph 111(5)(a)(ii) of the Act, the interest income of Opco2 that is derived from the Opco2 Loan as described in 31 above will not be considered to be from the Opco2 Streamed Business or from 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 to those, if any, which had been sold, leased, rented, developed or rendered in the course of carrying on the Opco2 Streamed Business); and

b) provided that Opco2 deducts the Opco2 Streamed Non-capital Losses to which it is entitled in computing its income for that taxation year and the amount of taxable income is positive after taking into account such deduction, the Opco2 Non-streamed Non-capital Losses.

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

F. Subsection 245(2) of the Act will not be applied as a result of the Proposed Transactions, in and by themselves, to re-determine 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 is binding on the CRA provided that the Proposed Transactions, excluding 38 above, are commenced by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and does not take into account any proposed amendments to the Act which, if enacted, could have an effect on the ruling provided herein.

Comments

Nothing in this ruling letter should be construed as implying that the Canada Revenue Agency 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 or any other amount of any corporation referred to herein; or
(c) any tax consequences relating to the facts and Proposed Transactions described herein other than those specifically described in the rulings provided above.

Yours truly,

XXXXXXXXXX
For Director
Financial Industries Division
Income Tax Rulings Directorate