2012 Ruling 2012-0439191R3 - 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 utilization arrangement acceptable?

Position: YES

Reasons: meets the established positions

XXXXXXXXXX
2012-043919

XXXXXXXXXX, 2012

Dear Sir:

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-named taxpayers. We also acknowledge e-mails and telephone conversations (XXXXXXXXXX) on the subject. In general terms, the proposed transactions involve the use of losses within a group of affiliated and related 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 Lossco, Profitco 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 Lossco, Profitco or a related person;
(iii) under objection by Lossco, Profitco, or a related person;
(iv) the subject of a ruling previously issued by the Income Tax Directorate to Lossco, Profitco, 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.

All references herein to statutory provisions are to the Act unless otherwise provided. None of the transactions will impact the currently outstanding tax liabilities, if there are any, of the parties to the ruling.

DEFINITIONS

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof. Unless otherwise stated, all statutory references are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

(b) "adjusted cost base" has the meaning assigned by section 54;

(c) "ADR" means American Depository Receipt;

(d) "affiliated person" has the meaning assigned by section 251.1;

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

(f) "CBCA" means the Canada Business Corporations Act;

(g) "CRA" means Canada Revenue Agency;

(h) "General Anti-avoidance Provision of an Agreeing Province" means:

XXXXXXXXXX

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

(j) "Loan" has the meaning specified in 13 below;

(k) "Lossco" means XXXXXXXXXX, the corporation described in 2 below;

(l) "Lossco Note" means the demand non-interest-bearing promissory note described in 16 below;

(m) "Newco" means the corporation described in 10 below;

(n) "Newco Common Shares" means the common shares described in 10 below;

(o) "Newco Preferred Shares" means the preferred shares described in 11 below;

(p) "non-capital losses" has the meaning assigned by subsection 111(8);

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

(r) "Parent" means XXXXXXXXXX, the corporation described in 1 below;

(s) "Parent Group" means Parent, XXXXXXXXXXco and all of their respective subsidiaries;

(t) "Profitco" means XXXXXXXXXX, the corporation described in 5 below;

(u) "Profitco Note" means the interest-bearing promissory note described in 14 below;

(v) "public corporation" has the meaning assigned by subsection 89(1);

(w) "XXXXXXXXXXCA" means XXXXXXXXXX Companies Act, XXXXXXXXXX as amended;

(x) "related persons" has the meaning assigned by subsection 251(2);

(y) "XXXXXXXXXXco" means XXXXXXXXXX, the corporation described in 1 below;

(z) "scientific research and experimental development expense" as the meaning assigned by subsection 37(1);

(aa) "SFI" means a specified financial institution, as defined by subsection 248(1);

(bb) "tax attributes" means non-capital losses, scientific research and experimental development expenses and/or Investment Tax Credits; and

(cc) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

STATEMENT OF FACTS

1. The Parent Group is a leading international XXXXXXXXXX group, combining Parent, a XXXXXXXXXX listed public company headquartered in XXXXXXXXXX, and XXXXXXXXXXco, which is listed on the XXXXXXXXXX and is headquartered in XXXXXXXXXX. The two companies are joined in a XXXXXXXXXX companies structure XXXXXXXXXX. The principal market for the shares of Parent is the XXXXXXXXXX In addition to its primary listing, Parent shares are also traded on XXXXXXXXXX as ADRs. The Parent Group is the XXXXXXXXXX.

The Parent Group's activities span the world but it is strongly represented in XXXXXXXXXX and has significant businesses in XXXXXXXXXX. The Parent Group currently employs more than XXXXXXXXXX people over XXXXXXXXXX countries and its consolidated revenues for the year ended XXXXXXXXXX totaled more than $XXXXXXXXXX with consolidated net earnings amounting to more than $XXXXXXXXXX.

2. Lossco is governed by the CBCA. Lossco is a taxable Canadian corporation and a wholly owned indirect subsidiary of Parent. Lossco is involved in XXXXXXXXXX, and operates XXXXXXXXXX business groups, each responsible for the different business units of which they are comprised, including XXXXXXXXXX.

3. On XXXXXXXXXX, the boards of Parent and XXXXXXXXXX ("Aco") jointly announced that they had reached an agreement for Parent to make an offer to acquire all of the issued and outstanding Aco common shares for US$XXXXXXXXXX share in a recommended, all-cash transaction. This represented a total equity consideration for Aco of approximately US$XXXXXXXXXX. Lossco is the resulting entity from the amalgamation of Aco and XXXXXXXXXX, a wholly owned Canadian subsidiary of the Parent Group used to acquire all outstanding shares of Aco on XXXXXXXXXX. The amalgamation took place on XXXXXXXXXX. Lossco currently employs approximately XXXXXXXXXX employees.

4. The fiscal period of Lossco ends on XXXXXXXXXX. As at XXXXXXXXXX, Lossco had unexpired non-capital loss carryforwards of $XXXXXXXXXX, capital loss carryforwards of $XXXXXXXXXX, undeducted XXXXXXXXXX expenses of $XXXXXXXXXX and unused Investment Tax Credits of $XXXXXXXXXX (all together hereafter referred to as the "Tax attributes"). The followings represent the taxation year-ends in which the non-capital losses and unused Investment Tax Credits were generated:

a. Non-capital losses

XXXXXXXXXX

b. Unused Investment Tax Credits

XXXXXXXXXX

In addition to the above figures, Lossco estimates its non-capital losses for the taxation year ended XXXXXXXXXX to be approximately $XXXXXXXXXX. Also, it is anticipated that Lossco will incur additional non-capital losses of $XXXXXXXXXX for the next XXXXXXXXXX taxation years.

5. Profitco is a corporation incorporated under the XXXXXXXXXX Companies Act and has been governed, since XXXXXXXXXX by the XXXXXXXXXX Business Corporations Act. It is a wholly-owned indirect subsidiary of Parent. It has been a related and affiliated corporation of Lossco continuously since XXXXXXXXXX and has been a sister company of Lossco continuously during the same period. Profitco is located and headquartered in XXXXXXXXXX and is a leading producer of XXXXXXXXXX.

6. The fiscal period of Profitco ends on XXXXXXXXXX. Profitco currently employs more than XXXXXXXXXX people and its revenues for the year ended XXXXXXXXXX totaled more than $XXXXXXXXXX while incurring a net loss amounting to $XXXXXXXXXX. Based on financial projections, it is currently expected that Profitco will be in a taxable position in its taxation years XXXXXXXXXX before taking into account the interest charge resulting from the Proposed Transactions. Profitco is currently contemplating a transfer of some of its business operations into a wholly-owned Canadian corporation, which could affect the profitability of Profitco over the years covered by the Proposed Transactions. In the event Profitco proceeds with such transactions, Profitco will consider contacting the CRA in the eventuality significant changes are made to the terms governing one or several of the Proposed Transactions.

7. The consolidated financial statements of the Parent Group for its year ended XXXXXXXXXX indicate that the Group had:

a. assets of approximately $XXXXXXXXXX;

a shareholder's equity of approximately $XXXXXXXXXX;

The borrowing capacity of the Parent Group significantly exceeds the maximum amount of $XXXXXXXXXX required to complete the Proposed Transactions described in 10 to 19 below. As at XXXXXXXXXX, the Parent Group had a net equity of US$XXXXXXXXXX, US$XXXXXXXXXX of cash and cash equivalents in its current assets and an unused credit facility of about US$XXXXXXXXXX. Moreover, as at XXXXXXXXXX, the Parent Group had a market capitalization of approximately US$XXXXXXXXXX. In addition, a financial institution has provided confirmation, in a letter dated XXXXXXXXXX, that Lossco has the ability to obtain borrowings up to $XXXXXXXXXX.

8. For the taxation year ended XXXXXXXXXX, Lossco had permanent establishments in XXXXXXXXXX provinces: XXXXXXXXXX. In addition, Lossco had a permanent establishment outside Canada (income is attributed from outside Canada). 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 was as follows in XXXXXXXXXX: XXXXXXXXXX.

9. For the taxation year ended XXXXXXXXXX, Profitco only had a permanent establishment in the province of XXXXXXXXXX. As such, all of its income and salaries were attributed or attributable to the province of XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. Lossco will incorporate a new wholly-owned subsidiary ("Newco") under the CBCA. 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 15 below, in the Lossco Note as described in 16 below.

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

a. non-voting;

non-participating;

b. redeemable at the option of the issuer and retractable at the option of the holder, subject to applicable law, at any time for an amount equal to the cash amount for which they were issued. The payment of the redemption or retraction price may be satisfied, at the issuer's option, either by (i) payment of cash, or (ii) delivery of property having a fair market value at the time of redemption equal to the aggregate redemption amount, (iii) the Lossco Note, or (iv) delivery of the Profitco Note, if such note is owned by Newco at the time of repayment, in each case together with an amount in cash equal to all declared and unpaid dividends and any accrued dividends which have not been declared and paid up to but excluding the date fixed for such redemption or retraction; and

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

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

13. Lossco will borrow $XXXXXXXXXX on a "daylight loan" basis from an arm's length financial institution or from a related entity (the "Loan").

14. Lossco will use the proceeds of the Loan to make a $XXXXXXXXXX loan bearing interest to Profitco at XXXXXXXXXX% per annum and the indebtedness arising by virtue of such loan shall be evidenced by a promissory note of $XXXXXXXXXX (the "Profitco Note"). The Profitco Note will have a term maturing on XXXXXXXXXX and Profitco can proceed, in its sole discretion, to an early repayment without any penalty. The Profitco Note will provide that Lossco's recourse under the Profitco Note will be limited to the Newco Preferred Shares (together with all proceeds from such shares) only, and not to any other assets of Profitco. As security for the indebtedness evidenced by the Profitco Note, Profitco will grant Lossco a security interest in the Newco Preferred Shares. The Profitco Note will also provide that the principal amount may be satisfied at Profitco's option, either by (i) payment of cash, (ii) delivery of property having fair market value at the time of repayment equal to the principal amount, (iii) delivery of the Newco Preferred Shares or, (iv) by way of set-off against the Lossco Note if the Lossco Note belongs to Profitco at the time of repayment. Profitco must provide a 30-day advance notice prior to the repayment. The amount of dividends received by Profitco on the Newco Preferred Shares will be sufficient to permit Profitco to realize a profit on its investment in the Newco Preferred Shares, after deduction of any interest paid or payable on the Profitco Note.

15. Profitco will use the proceeds from the Profitco Note 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.

16. 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 a non-interest-bearing demand promissory note (the "Lossco Note"). The Lossco Note will provide that Newco's recourse under the Lossco Note will be limited to the Profitco Note only, and not to any other assets of Lossco. As security for the indebtedness evidenced by the Lossco Note, Lossco will grant Newco a security interest in the Profitco Note. The Lossco Note will also provide that the principal amount may be satisfied at Lossco's option, either by (i) payment of cash, (ii) delivery of property having fair market value at the time of repayment equal to the principal amount, or (iii) delivery of the Profitco Note.

17. Lossco will use the proceeds from the Lossco Note to repay the Loan.

18. The following transactions will occur when jointly determined by Lossco, Profitco and Newco on XXXXXXXXXX of every year the Profitco Note is 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. Lossco will not claim, at any time, a capital loss in respect of these capital contributions in Newco;

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 Note.

19. The loss consolidation structure will be unwound in the following manner on or before XXXXXXXXXX.

a. Newco will pay any accrued and unpaid dividends on the Newco Preferred Shares to Profitco.

Profitco will pay any accrued and unpaid interest on the Profitco Note to Lossco.

b. In all circumstances and prior to the expiration of the 30-day advance notice prior to repayment as described in 14 above, Lossco will repay the Lossco Note by delivering the Profitco Note to Newco.

c. Newco will redeem the Newco Preferred Shares held by Profitco.

d. As payment for the redemption of the Newco Preferred Shares, Newco will deliver the Profitco Note to Profitco.

e. The Profitco Note will be satisfied by way of confusion.

f. 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). As a consequence, Newco's assets will be transferred to Lossco and Lossco will assume Newco's liabilities.

REPRESENTATIONS

20. Lossco and Profitco, as well as all other taxpayers involved in the Proposed Transactions, are SFIs pursuant to paragraph (g) of the definition of SFI on the basis that they are related to a corporation described in paragraph (d) of that definition. It is, however, understood that Profitco will not acquire the Newco Preferred Shares in the ordinary course of its business.

21. None of the corporations involved in the Proposed Transactions has or will have entered into a "dividend rental arrangement" as defined by subsection 248(1) with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

22. 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) as a "guarantee agreement";

(b) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a);

(c) issued for consideration that is or includes:

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

i. any right of the type described in subparagraph 112(2.4)(b)(ii).

(d) issued or acquired as part of a transaction or series of transactions of the type described in subsection 112(2.5).

23. The interest deducted by Profitco pursuant to paragraph 20(1)(c) in respect of the Profitco Note may create a non-capital loss for Profitco during the period in which the transactions described in 10 through 19 above occur. While Profitco was not in a taxable position in its previous three taxation periods, any non-capital loss resulting from the Proposed Transactions would be carried forward to a subsequent taxation year in accordance with the rules in section 111. Dividends received by Profitco on the Newco Preferred Shares as described in 18 above will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by section 191(1).

24. The life of any of the non-capital losses, undeducted scientific research and experimental development expenses and unused Investment Tax Credits will not be extended beyond their normal carry forward period.

PURPOSE OF THE PROPOSED TRANSACTIONS

25. The purpose of the Proposed Transactions is to consolidate taxable income and tax attributes within a group of affiliated and related persons. The Proposed Transactions will enable Lossco to earn interest income on the Profitco Note and permit Profitco to effectively utilize Lossco's tax attributes.

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 Profitco has a legal obligation to pay interest on the Profitco Note 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 Note, as described in 14 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) will not apply as a result of 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 18 above.

D. Dividends received by Profitco on the Newco Preferred Shares, as described in 18 and 19 above, will be taxable dividends and such dividends will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of Profitco for the year in which the dividends are received by Profitco 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.

E. 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.

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 those transactions in 19 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; nor

(d) 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 Industries Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch