2012 Ruling 2012-0451431R3 - 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: Within established parameters.

XXXXXXXXXX
2012-045143

Attention: XXXXXXXXXX

XXXXXXXXXX, 2012

Dear XXXXXXXXXX:

Re: Advance 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.

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;

(ii) under objection by the above-noted taxpayers or by a related person;

(iv) before the courts or, if a judgement 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 to 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

(a) "XXXXXXXXXXBCA" means the Business Corporation Act (XXXXXXXXXX)

(b) "AOC" means acquisition of control;

(c) "adjusted cost base" or "ACB" has the meaning assigned by section 54;

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

(e) "XXXXXXXXXX" means certain XXXXXXXXXX owned by ProfitCo all of which are XXXXXXXXXX depreciable assets (as defined below) that have a FMV in excess of their UCC (as defined below) but a FMV that is less that their original capital cost amount;

(f) "Capital Cost Allowance" or "CCA" has the meaning assigned by Regulation 1100;

(g) "capital property" has the meaning assigned by section 54 to mean any depreciable property (as defined below) and any property (other than depreciable property) the gain or loss from the disposition of which would be a capital gain or a capital loss;

(h) "cost amount" has the meaning assigned by subsection 248(1) and, moreover, in the case of capital property (other than depreciable property) the adjusted cost base for a capital property, and in the case of depreciable property of a prescribed class, the amount that would be that proportion of the UCC to the taxpayer of the property is of the capital cost to the taxpayer of all property of that class that had not been disposed of by the taxpayer;

(i) "CRA" means the Canada Revenue Agency;

(j) "depreciable property" has the meaning assigned by subsection 13(21);

(k) "elected amount" in the case of depreciable property has the meaning assigned by paragraph 85(1)(e);

(l) "eligible property" has the meaning assigned by subsection 85(1.1);

(m) "FMV" means fair market value;

(n) "Foreign Country 1" means XXXXXXXXXX;

(o) "Foreign Country 2" means XXXXXXXXXX;

(p) "Foreign Country 3" means XXXXXXXXXX;

(q) "Foreign Parent 1" means XXXXXXXXXX;

(r) "Foreign Parent 2" means XXXXXXXXXX;

(s) "Foreign Parent 3" means XXXXXXXXXX;

(t) XXXXXXXXXX has the meaning described in paragraph 4;

(u) "Lease Agreement" has the meaning described in paragraph 32;

(v) "LIBOR" means the 1-year London Interbank Offered Rate;

(w) "LossCo" means XXXXXXXXXX;

(x) "LossCo Common Shares" means the XXXXXXXXXX issued and outstanding common shares in the capital of LossCo;

(y) "LossCo Indebtedness" has the meaning described in paragraph 18;

(z) "LossCo Group" means the shares of each of XXXXXXXXXX, all of which are wholly-owned subsidiaries of LossCo;

(aa) "LossCo Note A Indebtedness" has the meaning described in paragraph 24;

(bb) "LossCo Note B Indebtedness" has the meaning described in paragraph 24;

(cc) "LossCo Preferred Shares" means the preferred shares in the capital stock of LossCo as described in paragraph 23;

(dd) "LossCo XXXXXXXXXX" means certain XXXXXXXXXX owned by LossCo all of which are XXXXXXXXXX depreciable property (as defined above) that have a FMV which is less than their UCC (as defined below) and their original capital cost amount;

(ee) "principal amount" has the meaning assigned by subsection 248(1), and, in general terms, means the amount that under the terms of the debt obligation or any related agreement is the maximum amount or maximum total amount payable on account of the debt obligation by its issuer (otherwise than as or on account of interest or any premium payable by the issuer conditional on the exercise by the issuer of a right to redeem the debt obligation before maturity);

(ff) "ProfitCo" means XXXXXXXXXX;

(gg) "ProfitCo Common Shares" means the XXXXXXXXXX issued and outstanding Class A common shares and the XXXXXXXXXX Class B common shares in the capital of ProfitCo;

(hh) "ProfitCo Group" means XXXXXXXXXX% of the shares of XXXXXXXXXX owned by ProfitCo and the shares of XXXXXXXXXX, both of which are wholly-owned subsidiaries of ProfitCo;

(ii) "ProfitCo Preferred Shares" means the issued and outstanding preferred shares of the capital of ProfitCo;

(jj) "NewCo" has the meaning described in paragraph 26;

(kk) "NewCo Common Shares" means all of the issued and outstanding common shares of NewCo;

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

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

(nn) "Redemption Amount" means the amount equal to the amount for which the LossCo Preferred Shares may be redeemed, as further described in paragraph 23 below;

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

(pp) "specified financial institution" or "SFI" has the meaning assigned by subsection 248(1);

(qq) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(rr) "taxable preferred shares" has the meaning assigned by subsection 248(1);

(ss) "Transferred Assets" means the XXXXXXXXXX transferred by ProfitCo to LossCo pursuant to subsection 85(1) as described in paragraph 30;

(tt) "Treaty" means XXXXXXXXXX, as amended;

(uu) "TSO" means Tax Service Office;

(vv) "undepreciated capital cost" or "UCC" has the meaning assigned by subsection 13(21) of the Act;

(ww) "XXXXXXXXXX Parent" means XXXXXXXXXX; and

(xx) "XXXXXXXXXX Parent" means XXXXXXXXXX.

FACTS

General Corporate Structure

1. XXXXXXXXXX Parent is a corporation formed under the laws of Foreign Country 1. All of the issued and outstanding shares of XXXXXXXXXX Parent are listed on XXXXXXXXXX. XXXXXXXXXX Parent is XXXXXXXXXX companies. The accounting and taxation year end of XXXXXXXXXX Parent is XXXXXXXXXX.

2. XXXXXXXXXX Parent is a corporation incorporated under the laws of XXXXXXXXXX of Foreign Country 2 and is a resident of XXXXXXXXXX for purposes of the Act and the Treaty.

3. Foreign Parent 1, Foreign Parent 2 and Foreign Parent 3 are all corporations incorporated under the laws of Foreign Country 3 and are non-residents of Canada for purposes of the Act. Further, Foreign Parent 1, Foreign Parent 2 and Foreign Parent 3 are XXXXXXXXXX in Foreign Country 2.

4. XXXXXXXXXX Parent indirectly owns all of the outstanding shares of XXXXXXXXXX Parent, Foreign Parent 1, Foreign Parent 2 and Foreign Parent 3 through various intermediary companies and in turn indirectly owns all of the outstanding shares of ProfitCo and LossCo through the aforementioned companies. For purposes of this ruling, the XXXXXXXXXX comprises all of the direct and indirect subsidiaries of XXXXXXXXXX Parent including the aforementioned entities.

5. Foreign Parent 1 and Foreign Parent 3 are wholly-owned subsidiaries of XXXXXXXXXX Parent. Foreign Parent 2 is indirectly owned by certain subsidiaries of XXXXXXXXXX Parent.

6. ProfitCo is a taxable Canadian corporation amalgamated under the XXXXXXXXXXBCA (business number XXXXXXXXXX). ProfitCo is a corporation that is a resident of Canada for purposes of the Act and the Treaty. However, ProfitCo is XXXXXXXXXX under the taxation laws of Foreign Country 2. ProfitCo has a floating taxation year end that generally ends on XXXXXXXXXX. ProfitCo deals with the XXXXXXXXXX TSO and files its federal income tax returns electronically. ProfitCo's current issued and outstanding share capital consists of the ProfitCo Common Shares and ProfitCo Preferred Shares. Foreign Parent 1 owns XXXXXXXXXX% of the non-voting ProfitCo common shares and the remaining non-voting ProfitCo common shares are owned by Foreign Parent 2. All of the issued and outstanding ProfitCo Preferred Shares are owned by Foreign Parent 1.

7. ProfitCo is in the XXXXXXXXXX business and is a XXXXXXXXXX in Canada. ProfitCo also owns the shares of the various taxable Canadian corporations comprising the ProfitCo Group.

8. ProfitCo currently owns XXXXXXXXXX that have a FMV that is in excess of the UCC but less than the original capital cost amount for tax purposes. Accordingly, any disposition of the XXXXXXXXXX would give rise to recapture but no capital gains. The current UCC balance of the XXXXXXXXXX based on amounts disclosed on ProfitCo's XXXXXXXXXX tax return was $XXXXXXXXXX. The estimated FMV of the XXXXXXXXXX is approximately $XXXXXXXXXX.

9. LossCo is a taxable Canadian corporation continued under the XXXXXXXXXXBCA (business number XXXXXXXXXX). LossCo is a corporation that is a resident of Canada for purposes of the Act and the Treaty. LossCo has a floating taxation year end that generally ends on XXXXXXXXXX. LossCo deals with the XXXXXXXXXX TSO and files its federal income tax returns electronically. LossCo's current issued and outstanding share capital consists of the LossCo Common Shares, all of which are owned by Foreign Parent 3.

10. LossCo is in the XXXXXXXXXX business and is a XXXXXXXXXX in Canada. In addition, LossCo also owns the various taxable Canadian corporations comprising the LossCo Group.

11. LossCo currently owns the LossCo XXXXXXXXXX that have a FMV that is less than the UCC and the original capital cost amount of these assets for tax purposes. Accordingly, a complete disposition of the LossCo XXXXXXXXXX would give rise to a terminal loss. The current UCC of the LossCo XXXXXXXXXX based on amounts disclosed on LossCo's XXXXXXXXXX tax return was $XXXXXXXXXX. The estimated FMV of the LossCo XXXXXXXXXX is approximately $XXXXXXXXXX.

12. On XXXXXXXXXX, LossCo and the predecessors of ProfitCo were subject to an AOC when XXXXXXXXXX Parent purchased all of the shares of XXXXXXXXXX Parent through one of its subsidiaries. As a consequence of the AOC, LossCo and the predecessors of ProfitCo were required to write-down the UCC of certain depreciable assets to their FMV and crystallize any inherent losses in respect of their taxation year ended XXXXXXXXXX. The write-down in depreciable property resulted in both LossCo and ProfitCo incurring substantial non-capital losses.

13. During XXXXXXXXXX a series of reorganization steps were undertaken to better align the Canadian group for XXXXXXXXXX income tax purposes. On XXXXXXXXXX, LossCo XXXXXXXXXX. With respect to ProfitCo, on XXXXXXXXXX several XXXXXXXXXX companies amalgamated to form an amalgamated entity which on XXXXXXXXXX amalgamated with ProfitCo. XXXXXXXXXX Parent contributed the stock of ProfitCo and LossCo to Foreign Parent 1 and Foreign Parent 3, respectively. Furthermore, additional stock transfers occurred to facilitate the ownership described in Paragraph 7.

14. ProfitCo has been profitable other than the loss it incurred on the write-down of its depreciable property in respect of its taxation year ended XXXXXXXXXX as a result of the AOC. At the end of ProfitCo's XXXXXXXXXX taxation year-end, the balance of the company's available non-capital loss carry forward was $XXXXXXXXXX, which were incurred as follows:

Taxation Year Amount of Remaining Loss
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
Total $XXXXXXXXXX

15. LossCo has not been profitable for several years as a result of XXXXXXXXXX in downturn financial markets. At the end of LossCo's XXXXXXXXXX taxation year-end, the balance of the company's available non-capital loss carry forward was $XXXXXXXXXX, which were incurred as follows:

Taxation Year Amount of Remaining Loss
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
XXXXXXXXXX $XXXXXXXXXX
Total $XXXXXXXXXX

16. Based on the foregoing summary, of LossCo's total non-capital losses, $XXXXXXXXXX were incurred pre-AOC, and the remaining $XXXXXXXXXX were incurred post-AOC.

17. In accordance with the policies set out in Information Circular 84-1, LossCo will file a request with the CRA to amend prior tax return returns in order to claim CCA which was previously not claimed. Provided the amendments are accepted by the CRA, it will result in LossCo's non-capital losses increasing from $XXXXXXXXXX by virtue of LossCo claiming additional CCA in respect of its XXXXXXXXXX taxation years. The aggregate additional CCA that is estimated to be claimed for these taxation years will total approximately $XXXXXXXXXX. As a result, this increase in LossCo's available non-capital losses will increase the company's post-AOC non-capital losses from $XXXXXXXXXX to approximately $XXXXXXXXXX.

18. As at XXXXXXXXXX, LossCo is indebted to ProfitCo in the amount of approximately $XXXXXXXXXX in respect of money advanced by ProfitCo to LossCo in order to fund the active business operation of LossCo (herein the "LossCo Indebtedness"). The LossCo Indebtedness was previously interest-bearing on which ProfitCo was earning interest income at an arm's length rate. However, on XXXXXXXXXX, in order to protect ProfitCo's original investment in the LossCo Indebtedness, it was converted from an interest-bearing obligation to a demand non-interest bearing obligation without any adverse Canadian tax implications. At the time the LossCo Indebtedness was converted from an interest-bearing to a demand non-interest bearing obligation, the total amount owing on the LossCo Indebtedness was $XXXXXXXXXX. All subsequent advances made by ProfitCo since XXXXXXXXXX totalling approximately $XXXXXXXXXX have been non-interest bearing. ProfitCo continued to make advances to LossCo on a non-interest bearing basis in order to continue to fund LossCo's active business operations and to protect its original investment in the LossCo Indebtedness. The LossCo Indebtedness is considered to be capital property to the holder.

19. LossCo is currently insolvent as the amount of the company's liabilities exceeds the FMV of its assets. The current estimated FMV of the LossCo Indebtedness is approximately $XXXXXXXXXX which is approximately $XXXXXXXXXX less than its $XXXXXXXXXX cost amount to ProfitCo.

20. ProfitCo is expected to be profitable for the foreseeable future and LossCo is forecasting taxable income for fiscal XXXXXXXXXX. More specifically, the business projections for ProfitCo indicate that the company is expected to have positive taxable income after deducting CCA once the proposed loss utilization transactions described below have been implemented. However, after deducting available prior year non-capital loss carry forwards, ProfitCo is expected to have no taxable income. Once ProfitCo's non-capital losses have been utilized, the company will commence to have positive taxable income.

21. ProfitCo and LossCo have been related and affiliated companies since XXXXXXXXXX.

22. For business and commercial reasons, the XXXXXXXXXX does not want to consolidate the assets of ProfitCo and LossCo through an amalgamation or wind-up of LossCo into ProfitCo.

PROPOSED TRANSACTIONS

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

23. LossCo will file Articles of Amendment to create a new class or series of special shares (the "LossCo Preferred Shares"), with rights and restrictions as follows:

(a) Voting;

(b) Redeemable at any time at the option of both the issuer and the holder for an amount equal to the amount for which the shares were issued less any returns of capital plus any undeclared cumulative dividends plus any declared but unpaid dividends (herein the "Redemption Amount");

(c) Annual cumulative dividend rate at a rate of [X%] per annum, which accrues daily and is prorated in the case of short days;

(d) Dividends rank in priority to any payment on the LossCo Common Shares or any other shares of LossCo;

(e) Ranks in priority to all other classes of equity of the issuer on liquidation and upon liquidation the holder is entitled to an amount equal to the Redemption Amount; and

(f) Distributions cannot be made (whether as a dividend or return of share capital or otherwise) on any other class of equity of the issuer if such distribution would impair the issuer's ability to pay dividends on the LossCo Preferred Shares or redeem such shares or pay-out the Redemption Amount.

24. The terms of the LossCo Indebtedness will be amended to add a conversion feature allowing ProfitCo the option to convert the LossCo Indebtedness into two new debt obligations. The first debt obligation ("LossCo Note A Indebtedness") will bear interest at LIBOR and will rank pari passu with general creditors and will otherwise have the same terms as the LossCo Indebtedness. The second debt obligation ("LossCo Note B Indebtedness") will bear interest at LIBOR plus XXXXXXXXXX% and will rank junior to the general creditor (i.e. subordinated to the general creditors) but will otherwise have the same terms as the LossCo Indebtedness. Under the terms of LossCo Note B Indebtedness, no payment of interest and/or principal shall be made on LossCo B Indebtedness until such time as LossCo Note A Indebtedness has been repaid or settled or extinguished and no amount thereof is outstanding. Legal counsel has confirmed this amendment should not result in a novation or settlement of the LossCo Indebtedness from a legal perspective. Moreover the supporting legal documents will confirm that it is not the intention of ProfitCo and LossCo to create a new obligation, but merely the LossCo Indebtedness continue to exist as amended (i.e., with the additional conversion feature).

25. ProfitCo will exercise the conversion right under the amended LossCo Indebtedness and will exchange (i) approximately $XXXXXXXXXX principal amount of the LossCo Indebtedness in consideration for $XXXXXXXXXX principal amount of LossCo Note A Indebtedness, and (ii) approximately $XXXXXXXXXX principal amount of the LossCo Indebtedness in consideration $XXXXXXXXXX principal amount of LossCo Note B Indebtedness. The LossCo Note A Indebtedness will have a principal amount and a FMV of approximately $XXXXXXXXXX. The LossCo Note B Indebtedness will have a principal amount of approximately $XXXXXXXXXX and a XXXXXXXXXX FMV, of say $XXXXXXXXXX.

26. ProfitCo will establish NewCo, XXXXXXXXXX governed under the XXXXXXXXXXBCA and will subscribe for NewCo Common Shares in exchange for $XXXXXXXXXX. NewCo will be a corporation that is a resident of Canada for purposes of the Act and the Treaty. NewCo will be considered a XXXXXXXXXX under the taxation laws of Foreign Country 2.

27. ProfitCo will transfer the LossCo Note B Indebtedness to NewCo in exchange for one share of NewCo electing under subsection 85(1) for proceeds of disposition of $XXXXXXXXXX (i.e., the approximate FMV of the LossCo B Indebtedness). Immediately prior to the transfer of the LossCo Note B Indebtedness to NewCo, LossCo will pay all accrued interest on the LossCo Note B Indebtedness.

28. ProfitCo will sell the NewCo Common Shares to LossCo in exchange for $XXXXXXXXXX (i.e., the approximate FMV of the NewCo Common Shares) with the price paid by LossCo to ProfitCo subject to a price adjustment clause whereby LossCo will issue a demand promissory note to ProfitCo in an amount equal to the amount of any price adjustment. After this transaction, NewCo will become a wholly-owned subsidiary of LossCo.

29. NewCo will be wound-up into LossCo on tax-deferred rollover basis pursuant to subsection 88(1). Immediately prior to the wind-up of NewCo, LossCo will pay all accrued interest on the LossCo Note B Indebtedness. NewCo is expected to be solvent at the time it winds-up into LossCo. The wind-up of NewCo into LossCo will result in a complete settlement of the LossCo Note B Indebtedness at its cost amount pursuant to subsection 80.01(4). LossCo will file the prescribed election (Form T2027) in order to satisfy the requirements of subsection 80.01(4). Moreover, once the LossCo Note B Indebtedness is settled, LossCo is expected to be solvent.

30. ProfitCo will dispose of the Transferred Assets to LossCo. As consideration for the Transferred Assets, LossCo will issue to ProfitCo XXXXXXXXXX LossCo Preferred Shares having an aggregate FMV and aggregate Redemption Amount equal to the FMV of the Transferred Assets. ProfitCo and LossCo will jointly elect in prescribed form and within the prescribed time limits referred to in subsection 85(6) to have the provisions of subsection 85(1) apply.

31. As a result of the transfer of the Transferred Assets, the beneficial ownership, the right to possession and use, and the risk of gain or loss in respect of the Transferred Assets will pass to LossCo. However, ProfitCo will retain legal title to the Transferred Assets under a nominee agreement whereby LossCo, may at any time, require ProfitCo to deliver legal title to any person designated by LossCo. Notwithstanding that ProfitCo retains legal title to the Transferred Assets, LossCo will enjoy and bear all incidents and obligations of ownership.

32. Immediately after the transfer of the Transferred Assets, LossCo will lease the Transferred Assets back to ProfitCo (herein the "Lease Agreement"). Under the Lease Agreement, LossCo will be entitled to receive lease payments from ProfitCo on the lease of Transferred Assets in the amount [$XXX] per day which lease rate is intended to be the same as persons dealing at arm's length would agree. Under the Lease Agreement, both LossCo and ProfitCo shall have the right to terminate the Lease Agreement at any time without penalty.

33. Approximately one day after implementation of the Lease Agreement, pursuant to the terms and conditions of the LossCo Preferred Shares, ProfitCo will call for the redemption by LossCo of its LossCo Preferred Shares for an amount equal to the Redemption Amount, and concurrently therewith, ProfitCo and LossCo shall terminate the Lease Agreement. In order to settle any inter-company liabilities between LossCo and ProfitCo the following will occur:

(a) ProfitCo will pay in cash the amounts owing by ProfitCo to LossCo under the Lease Agreement;

(b) LossCo will transfer beneficial ownership in the Transferred Assets, together with cash equal to the accrued dividend entitlement in satisfaction of the Redemption Amount.

(c) As a consequence of LossCo's transfer of the Transferred Assets back to ProfitCo in satisfaction of the Redemption Amount, the nominee agreement described above will be terminated as ProfitCo will hold both legal title and beneficial ownership of the Transferred Assets.

34. The transfer of the Transferred Assets back to ProfitCo will be a taxable event to LossCo because it should be considered to dispose of the Transferred Assets for an amount equal to their FMV. However, any income which arises on the disposition of the Transferred Assets will be offset through the use of LossCo's available non-capital loss carry forward excluding any pre-AOC losses.

35. ProfitCo and LossCo will carry out all necessary legal steps to give full effect to the aforementioned transactions including passing the relevant resolutions and supporting consent agreements.

ADDITIONAL INFORMATION

36. None of the LossCo Preferred Shares will, at any time during the implementation of the proposed transactions described herein, be:

(a) the subject of any undertaking that is a guarantee agreement;

(b) the subject of a dividend rental arrangement as that term is defined in 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).

37. The acquisition of the LossCo Preferred Shares by ProfitCo described above will not occur in the ordinary course of business carried on by ProfitCo.

38. At the time the LossCo Preferred Shares are issued and are subsequently redeemed, LossCo is expected to be solvent such that it will not be precluded from redeeming shares or paying dividends under the applicable corporate law governing LossCo.

39. ProfitCo and LossCo do not expect the proposed transactions to significantly affect the companies' respective provincial allocations, and more specifically, should not result in income shifting from significantly "higher" to "lower" tax provinces.

PURPOSE OF THE PROPOSED TRANSACTIONS

40. The purpose of the proposed transactions is to facilitate a tax-efficient use of LossCo's available non-capital losses within the affiliated group and enhance the overall tax efficiency of XXXXXXXXXX Canadian operations. As stated above, LossCo is not expected to be profitable until fiscal XXXXXXXXXX. In addition, for various business and commercial reasons, it is not desirable that the operations of ProfitCo and LossCo be combined because each company operates in a different XXXXXXXXXX that requires diverse management skills and operational expertise, and further, each business unit is subject to XXXXXXXXXX. Therefore, in order to reduce the overall Canadian tax burden for the XXXXXXXXXX, ProfitCo and LossCo will enter into the proposed transactions with respect to the Transferred Assets. The loss utilization plan should permit LossCo to utilize some or all of its non-capital losses excluding any pre-AOC losses to offset all of the recapture income realized on the disposition of the Transferred Assets to ProfitCo, while at the same time permitting ProfitCo to reacquire the Transferred Assets at an increased cost amount on which it should be entitled to claim additional CCA.

Rulings Given

Provided that the preceding statements constitute a complete and accurate disclosure ofall 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. The amendment of the LossCo Indebtedness by adding the conversion feature that permits the holder to convert the obligation into the LossCo Note A Indebtedness and the subordinated LossCo Note B Indebtedness will not result in a "disposition" of the LossCo Indebtedness for income tax purposes, as that term is defined under subsection 248(1) provided that under the laws of XXXXXXXXXX, the proposed amendment to the term of the LossCo Indebtedness will not result in a novation, a substitution or discharge, rescission or extinguishment of all or any part of the LossCo Indebtedness.

B. Section 51.1 will apply on the exercise of the conversion feature of the LossCo Indebtedness into LossCo Note A Indebtedness and LossCo Note B Indebtedness such that no gain or loss will be recognized by ProfitCo on the exercise of the conversion right and ProfitCo will acquire LossCo Note A Indebtedness and LossCo Note B Indebtedness with an ACB equal to the ACB of the relevant portion or principal amount of the LossCo Indebtedness that was converted into such debt. In addition, the conversion of the LossCo Indebtedness for LossCo Note A Indebtedness and LossCo Note B Indebtedness will not result in a "forgiven amount" to LossCo under the debt forgiveness rules in section 80.

C. The issuance of LossCo Note A Indebtedness and LossCo Note B Indebtedness as full repayment of the LossCo Indebtedness will not result in a "forgiven amount" to LossCo under the debt forgiveness rules contained in section 80. Further, ProfitCo will not realize any gain or loss on the full repayment of the LossCo Indebtedness and ProfitCo will have an ACB in the LossCo Note A Indebtedness equal to its principal amount of approximately $XXXXXXXXXX and LossCo Note B Indebtedness equal to its principal amount of approximately $XXXXXXXXXX.

D. Paragraph 40(2)(e.1) will apply to deem ProfitCo's capital loss otherwise determined to be nil, and paragraph 53(1)(f.1) will apply to add ProfitCo's capital loss otherwise determined to the ACB of the LossCo Note B Indebtedness acquired by NewCo thereby increasing the ACB of the LossCo Note B Indebtedness by an amount equal to the amount of the loss denied.

E. Subsection 88(1) will apply to the liquidation and dissolution of NewCo into LossCo. Furthermore, provided an election is filed in prescribed form and within the time limits as set out in subsection 80.01(4), no "forgiven amount" will result to LossCo under section 80 on settlement of the LossCo Note B Indebtedness and NewCo will not realize any gain or loss on the settlement of this obligation.

F. Provided the appropriate joint election is filed in prescribed form and manner within the time limits specified in subsection 85(6) the provisions of subsection 85(1) will apply to the disposition of the Transferred Assets such that: i) the elected amount in respect of the Transferred Assets will be deemed to be ProfitCo's proceeds of disposition thereof and LossCo's cost amount thereof, and ii) the cost to ProfitCo of the LossCo Preferred Shares received as consideration for the transfer will be equal to elected amount. In addition, the Transferred Assets will be characterized in the same UCC class as they were held by ProfitCo, being XXXXXXXXXX assets. Paragraph 85(1)(e.2) will not apply to the disposition of the Transferred Assets.

G. On the subsequent disposition of the Transferred Assets by LossCo to ProfitCo on termination of the Lease Agreement, LossCo will utilize its available non-capital loss carry forwards (excluding any pre-AOC losses but including additional losses arising from the amendment of prior year CCA claims) to offset any recapture income that it will realize on the disposition.

H. ProfitCo will acquire the Transferred Assets from LossCo with a cost amount and UCC equal to their FMV of such assets when the LossCo Preferred Shares are redeemed. ProfitCo will be permitted to claim CCA on the Transferred Assets based on the FMV of such assets without the application of the half year rule based on the rules contained in subsections 1100(2) and 1100(2.2) of the Income Tax Regulations.

I. As a result of the redemption of the LossCo Preferred Shares, pursuant to paragraphs 84(3)(a) and (b), respectively, LossCo will be deemed to have paid, and ProfitCo should be deemed to have received, a taxable dividend equal to the amount by which the amount paid to redeem the LossCo Preferred Shares exceeds the paid-up capital thereof, immediately before such redemption. The deemed dividend will be included in ProfitCo's income pursuant to paragraph 12(1)(j), and will be deductible in computing its taxable income for the taxation year in which such dividend is deemed to have been received pursuant to subsection 112(1). Subsections 112(2.1), (2.2), (2.3) or (2.4) will not apply to deny the subsection 112(1) deduction. Moreover, the deemed dividend will not be recharacterized as a capital gain under subsection 55(2) as the exception in paragraph 55(3)(a) of the Act will be satisfied since none of the proposed transactions will result in a disposition of property to, or a significant increase in the total direct interest in any corporation of, any person that is not related to ProfitCo.

J. Subsection 245(2) will not apply to the proposed transactions, in and by themselves, to redetermine any of the tax consequences confirmed herein.

K. Subsections 15(1), 56(2) and 246(1) will not apply to the proposed transactions in and by themselves.

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 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 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