2012 Ruling 2011-0431851R3 - 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: Consistent with similar previous rulings and tax policy.

XXXXXXXXXX
2011-043185

XXXXXXXXXX, 2012

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
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. In general terms, the transactions described herein involve the use of losses within a related and affiliated group of corporations. We also acknowledge the additional information that you provided in your subsequent email correspondences, the last of which was received on 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; nor
(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"), all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated, and all amounts referred herein are in Canadian dollars.

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

Definitions

(a) "Adjusted cost base" has the meaning assigned by section 54 of the Act;

(b) "Affiliated Group" means Lossco, Profitco, Newco and their subsidiaries;

(c) "Affiliated person" has the meaning assigned by section 251.1 of the Act;

(d) "Agreeing Province" means a Province that has entered into an agreement with the Government of Canada under which the Government of Canada will collect taxes payable under the income tax statute of that Province and will make payments to that Province in respect of the taxes so collected;

(e) "Arm's length" has the meaning assigned by section 251(1) of the Act;

(f) "CRA" means Canada Revenue Agency;

(g) "Credit Facility" means the XXXXXXXXXX that allows the Affiliated Group to borrow up to $XXXXXXXXXX. The Credit Facility matures in XXXXXXXXXX;

(h) "General Anti-avoidance Provision of an Agreeing Province" means XXXXXXXXXX, as amended to the date of this letter;

(i) "Investment Tax Credit" ("ITC") has the meaning assigned by subsection 127(5) of the Act;

(j) XXXXXXXXXX;

(k) "Loan" has the meaning specified in 10 below;

(l) "Lossco" means XXXXXXXXXX, the corporation described in 1 below;

(m) "Lossco Notes" means the demand non-interest-bearing promissory notes described in 13 below;

(n) "Newco" means the corporation described in 7 below;

(o) "Newco Common Shares" means the common shares described in 7 below;

(p) "Newco Preferred Shares" means the preferred shares described in 7 and 8 below;

(q) "Non-capital losses" has the meaning assigned by subsection 111(8) of the Act;

(r) XXXXXXXXXX;

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

(t) "Profitco" means XXXXXXXXXX, the corporation described in 3 below;

(u) "Profitco Notes" means the promissory notes described in 11 below;

(v) "Proposed Transactions" means the transactions described in 7 to 17 below;

(w) "Public corporation" has the meaning assigned by subsection 89(1);

(x) "Refundable dividend tax on hand" has the meaning assigned by subsection 129(3) of the Act;

(y) "Related persons" has the meaning assigned by subsection 251(2) of the Act;

(z) "Scientific research and experimental development expense" ("SR&ED") has the meaning assigned by subsection 37(1) of the Act;

(aa) "Subject corporation" has the meaning assigned by subsection 186(3) of the Act;

(bb) "Taxable Canadian corporation" has the meaning assigned by subsection 89(1); and

(cc) XXXXXXXXXX.

Facts

1. Lossco is governed by the XXXXXXXXXX. Lossco is a public corporation and a taxable Canadian corporation whose shares are listed on the XXXXXXXXXX. Lossco's address is XXXXXXXXXX. It has a taxation year end of XXXXXXXXXX. Lossco's Taxation Centre and Tax Services Office are XXXXXXXXXX Tax Centre and XXXXXXXXXX Tax Services Office, respectively. Lossco and its affiliated corporations currently employ approximately XXXXXXXXXX professionals and have offices in Canada and other foreign jurisdictions including XXXXXXXXXX. Lossco's consolidated revenues for the year ended XXXXXXXXXX totalled more than $XXXXXXXXXX with consolidated net earnings amounting to approximately $XXXXXXXXXX. The common shares of Lossco are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX". The market capitalization of Lossco is $XXXXXXXXXX as of XXXXXXXXXX.

2. As at XXXXXXXXXX, Lossco had non-capital losses of $XXXXXXXXXX, undeducted SR&ED expenses of $XXXXXXXXXX and unused ITCs of $XXXXXXXXXX (all together hereafter referred to as the "Tax Attributes"). The followings represent the taxation year-end in which the Tax Attributes were generated:

a. Non-capital losses

XXXXXXXXXX

b. Undeducted scientific research and experimental development expense

XXXXXXXXXX

c. Unused investment tax credit

XXXXXXXXXX

3. Profitco is a wholly-owned subsidiary of Lossco incorporated under the XXXXXXXXXXBCA. Profitco is a taxable Canadian corporation. Profitco's address is XXXXXXXXXX. It has a taxation year end of XXXXXXXXXX. Profitco's Taxation Centre and Tax Services Office are XXXXXXXXXX Tax Centre and XXXXXXXXXX Tax Services Office, respectively. It is currently expected that Profitco will continue to be taxable and, as such, will have sufficient income for tax purposes to fully utilize as a deduction the interest paid or payable on the Profitco Notes described in 11 below. Profitco and Lossco have been related and affiliated since XXXXXXXXXX.

4. The consolidated financial statements of Lossco for its year ended XXXXXXXXXX indicate that Lossco and its subsidiaries had:

a. assets of approximately $XXXXXXXXXX;

b. liabilities of approximately $XXXXXXXXXX; and

c. shareholder's equity of approximately $XXXXXXXXXX.

As of XXXXXXXXXX, the arm's length borrowings of the Affiliated Group amount to approximately $XXXXXXXXXX, $XXXXXXXXXX of which was drawn from the Credit Facility of $XXXXXXXXXX available to Lossco. The remaining $XXXXXXXXXX is comprised mostly of governmental authorities' loans ($XXXXXXXXXX) and obligations under capital leases ($XXXXXXXXXX). As of XXXXXXXXXX, the cash and cash equivalent of the Affiliated Group amounted to approximately $XXXXXXXXXX. The Affiliated Group had, therefore, access to approximately $XXXXXXXXXX of liquidity, which was the sum of the unused Credit Facility ($XXXXXXXXXX) and the cash available to the Affiliated Group ($XXXXXXXXXX) as of XXXXXXXXXX. (As at XXXXXXXXXX, the unused credit facility available was $XXXXXXXXXX and the consolidated cash and cash equivalent available with Lossco is $XXXXXXXXXX, with a total available liquidity of $XXXXXXXXXX.)

5. For the taxation year ended XXXXXXXXXX, Lossco had permanent establishments in XXXXXXXXXX provinces: XXXXXXXXXX. For the purpose of the definition of Lossco's "taxable income earned in a province" pursuant to subsection 124(4) of the Act and Part IV of the Regulations, its provincial allocation is as follows: XXXXXXXXXX.

6. For the taxation year ended XXXXXXXXXX, Profitco had permanent establishments in XXXXXXXXXX provinces: XXXXXXXXXX. For the purpose of the definition of Profitco's "taxable income earned in a province" pursuant to subsection 124(4) and Part IV of the Regulations, its provincial allocation is as follows: XXXXXXXXXX.

Proposed Transactions

The following transactions will be completed sequentially in the order provided below:

7. Lossco will incorporate a new wholly-owned subsidiary ("Newco") under the XXXXXXXXXX. Newco will be a taxable Canadian corporation. Newco's share capital will include an unlimited number of common shares ("Newco Common Shares") and an unlimited number of preferred shares ("Newco Preferred Shares"). Newco will not carry on any business and its activities will be limited to investing the proceeds received upon the issuance of its Newco Preferred Shares to Profitco as described in 12 below, in the non-interest bearing loan to Lossco as described in 13 below.

8. The Newco Preferred Shares will have the following attributes:

a. non-voting;

b. non-participating;

c. redeemable at any time by Newco for an amount equal to the amount for which they were issued and any accrued but unpaid dividends which may accumulate prior to their redemption;

d. retractable at any time by Profitco for an amount equal to the amount for which they were issued and any accrued but unpaid dividends which may accumulate prior to their retraction;

e. entitlement to a cumulative dividend, payable annually, calculated daily and accruing by reference to the redemption amount of Newco Preferred Shares at a rate equal to XXXXXXXXXX% per annum; and

f. the payment of the redemption or retraction price may be satisfied, at the holder's option, either by (i) payment of cash, or (ii) delivery of property having a fair market value at the time of redemption (or retraction) equal to the aggregate redemption (or retraction) amount, (iii) or the Lossco Note.

9. Lossco will subscribe for Newco Common Shares for nominal consideration.

10. Lossco will borrow $XXXXXXXXXX by drawing on its available credit line (the "Loan") or by using its available cash or cash equivalent or a combination thereof.

11. Lossco will use the proceeds of the Loan to make a $XXXXXXXXXX loan bearing interest at the rate of XXXXXXXXXX% per annum to Profitco, and the indebtedness arising by virtue of such loan shall be evidenced by two promissory notes of $XXXXXXXXXX each (the "Profitco Note 1" and "Profitco Note 2", collectively referred as "Profitco Notes"). The Profitco Notes will be payable on demand.

12. Profitco will use the proceeds from the Profitco Notes to subscribe for Newco Preferred Shares for a total amount of $XXXXXXXXXX. The aggregate redemption amount, fair market value, adjusted cost base and paid-up capital of the Newco Preferred Shares issued will be $XXXXXXXXXX. The amount of dividends received by Profitco on the Newco Preferred Shares held by Profitco will be sufficient to permit Profitco to realize a profit on its investment in the Newco Preferred Shares, after the deduction of any interest on the Profitco Note.

13. Newco will use the proceeds from the issuance of the Newco Preferred Shares to make a non-interest-bearing loan of $XXXXXXXXXX to Lossco. This loan will be evidenced by two non-interest-bearing demand promissory notes of $XXXXXXXXXX each (the "Lossco Note 1" and "Lossco Note 2", collectively referred as "Lossco Notes").

14. Lossco will use the proceeds from the Lossco Notes to repay the Loan.

15. Where the proposed transactions as described in 10 to 13 above will be performed as two subsequent and distinct transactions, each involving an amount of $XXXXXXXXXX for an aggregate of $XXXXXXXXXX, the funds so borrowed each time will be used in the same manner, by the same parties, and for the same purposes, as is described in 10 to 13 above. Further, the two transactions, if so required, would occur on the same day depending on the clearing process of the bank.

16. The following transactions will occur when jointly determined by Lossco, Profitco and Newco on XXXXXXXXXX of every year the Profitco Notes are outstanding:

a. Pursuant to a capital contribution agreement, Lossco will make a contribution of capital to Newco in an amount equal to the amount of the accrued and unpaid dividends, if any, on the Newco Preferred Shares. No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the stated capital of Newco. The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be income to Newco pursuant to generally accepted principles;

b. Newco will pay the accrued and unpaid dividends on the Newco Preferred Shares; and

c. Profitco will pay the accrued and unpaid interest on the Profitco Notes.

17. The loss consolidation structure will be unwound, no later than XXXXXXXXXX years after the implementation of the Proposed Transactions, in the following manner once Lossco has used its Tax Attributes:

a. Newco will redeem the Newco Preferred Shares held by Profitco for an amount equal to their aggregate redemption amount.

b. As payment for the redemption of the Newco Preferred Shares, Newco will deliver the Lossco Notes to Profitco.

c. The Lossco Note and the Profitco Notes will be satisfied and extinguished by way of set-off.

d. Lossco, as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound-up into Lossco pursuant to subsection 88(1) of the Act. As a consequence, Newco's assets will be transferred to Lossco and Lossco will assume Newco's liabilities.

Additional Information

18. The issued Newco Preferred Shares 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), 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).

19. None of the shares to be issued as part of the Proposed Transactions will be issued or acquired as part of a transaction or series of transactions of the type described in subsection 112(2.5) of the Act.

20. The interest deducted by Profitco pursuant to paragraph 20(1)(c) of the Act in respect of the Profitco Notes may create a non-capital loss for Profitco during the period in which the Proposed Transactions occur. Any such resulting non-capital loss would be carried back to a prior taxation year in accordance with the rules in section 111.

21. The amount of the Loan borrowing is not in excess of the borrowing capacity of Affiliated Group.

22. The interest rate of the Profitco Notes is approximately equivalent to the rate that would be applicable on a loan to Profitco made by an arm's length Canadian financial institution under similar terms.

23. It is not expected that the life of any of the non-capital losses, SR&ED pool or ITCs will be extended beyond their normal carry-forward period.

24. Neither Lossco nor Profitco is, or will be at any time during the implementation of the Proposed Transactions, a specified financial institution, or a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1) of the Act.

25. Management of Lossco also decided to leverage Profitco with additional inter-company interest-bearing debt by causing Profitco to borrow from Lossco for an amount not exceeding $XXXXXXXXXX in order to allow Profitco to return paid-up capital in its shares and to pay a dividend on its shares. The pending transactions will be completed in accordance with the CRA's general administrative policy published in paragraph 23 of the Interpretation Bulletin IT-533, entitled ‘Interest Deductibility and Related Issues'.

Purpose of the Proposed Transactions

26. The purpose of the Proposed Transactions is to consolidate profits and losses within a related and affiliated group by enabling Lossco to earn sufficient interest income to deduct its various tax pools, including non-capital losses and SR&ED pool, and to use its ITC's while allowing Profitco to reduce its taxable income by the amount of interest payable to Lossco.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, Proposed Transactions and purpose of the Proposed Transactions, and provided further that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Provided that Profitco has a legal obligation to pay interest on the Profitco Notes and that the Newco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income, in computing its income for a taxation year, Profitco will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the Profitco Notes, as described in 11 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

B. 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.

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 Lossco as described in 16 above.

D. The dividends received by Profitco on the Newco Preferred Shares held by it, as described in 12 above, will be taxable dividends that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of Profitco for the year in which such dividends are received, and for greater certainty, such deductions will not be precluded by subsections 112(2.3), or 112(2.4) of the Act.

E. Subsection 245(2), 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.

F. The General Anti-avoidance Provision of an Agreeing Province 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, in respect of a taxation year for which such Province was an Agreeing Province.

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 17 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 rulings provided herein.

Comments

Nothing in this ruling letter 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, SR&ED pool, ITC, 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