2013 Ruling 2013-0483051R3 - 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 consolidation arrangement acceptable?

Position: Yes

Reasons: Within established parameters.

XXXXXXXXXX 2013-048305

Attention: XXXXXXXXXX

XXXXXXXXXX, 2013

Dear XXXXXXXXXX:

Re: XXXXXXXXXX and XXXXXXXXXX
Advance Income Tax Ruling Request

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 expected use of losses within a related 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. You have advised us that to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this rulings are:

(i) dealt with in an earlier return of the taxpayers or a related person;

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of any of the taxpayers or a related person;

(iii) under objection by any of the taxpayers or a related person;

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

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

DEFINITIONS

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

XXXXXXXXXX

"Act" means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended to the date hereof, and unless otherwise stated, every reference herein to a Part, Division, section, subsection, paragraph, subparagraph or clause is a reference to the relevant provision of the Act;

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

XXXXXXXXXX

"Lossco" means XXXXXXXXXX;

"Profitco" means XXXXXXXXXX;

"Newco" means a new corporation described in Paragraph 4;

"Bank" means the third party financial institution described in Paragraph 5;

"Daylight Loan" means the loan made by the Bank Institution to Lossco on a daylight-loan basis described in Paragraph 5.

"Lossco Loan" means the loan made by Lossco to Profitco described in Paragraph 6;

"Paragraph" refers to a numbered paragraph in this letter;

"Preferred Shares" means the preferred shares of Newco described in Paragraph 7;

"Proposed Transactions" means the transactions described in Paragraphs 4 to 16;

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

"Second Daylight Loan" means the loan made by the Bank to Lossco on a daylight-loan basis described in Paragraph 11.

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

"subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1);

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

Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is as follows:

RELEVANT FACTS

1. Lossco is a corporation incorporated under the XXXXXXXXXX. Lossco is a taxable Canadian corporation and a public corporation listed on the XXXXXXXXXX. Lossco carries on a XXXXXXXXXX services business in the XXXXXXXXXX sector directly and in the XXXXXXXXXX sector indirectly through subsidiary entities. Lossco has a XXXXXXXXXX taxation year-end. Lossco carries on all or substantially all of its business in XXXXXXXXXX. Lossco is not a specified financial institution. Lossco has permanent establishment only in XXXXXXXXXX.

2. Profitco is a wholly-owned subsidiary corporation of Lossco formed under the XXXXXXXXXX. Profitco was formed as a result of the amalgamation of two of Lossco's subsidiaries XXXXXXXXXX and XXXXXXXXXX which was effected on XXXXXXXXXX. Profitco is a taxable Canadian corporation and has a XXXXXXXXXX taxation year-end. Profitco carries on a XXXXXXXXXX services business. Profitco is not a specified financial institution.

Profitco carries on business through a permanent establishment (as defined in the Regulations) in XXXXXXXXXX.

3. As at XXXXXXXXXX Lossco had significant non-capital losses available to be carried forward into future years of approximately $XXXXXXXXXX (per federal income tax return for XXXXXXXXXX). You understand and have assumed that no portion of this non-capital loss is restricted due to a prior acquisition of control.

PROPOSED TRANSACTIONS

4. Lossco will incorporate a new wholly-owned subsidiary corporation ("Newco") under the laws of XXXXXXXXXX. Newco will be a taxable Canadian corporation, and its fiscal period-end will be XXXXXXXXXX. Newco's activities will be limited to those described in the Proposed Transactions.

5. Lossco will borrow an estimated amount of $XXXXXXXXXX on a daylight loan basis (the "Daylight Loan") from XXXXXXXXXX (the "Bank"). The amount of the Daylight Loan will not exceed Lossco's borrowing capacity as computed using industry accepted methodology.

6. Lossco will make an interest bearing loan to Profitco of an estimated $XXXXXXXXXX (the "Lossco Loan"). The Lossco Loan will bear interest at an annual rate, which will reflect a commercial arm's length rate in the circumstances. Lossco has limited capacity to borrow unsecured debt. As such, the company expects that any long term Lossco Loan will be in the form of a demand promissory note, which will bear an interest reflective of the risk associated with a non-convertible debenture of about XXXXXXXXXX% per annum.

7. Profitco will use the proceeds of the Lossco Loan to subscribe for non-voting, non-participating $XXXXXXXXXX par value preferred shares of Newco (the "Preferred Shares") in an estimated amount of $XXXXXXXXXX. The Preferred Shares will be redeemable by the issuer at any time for a redemption price equal to the fair market value of the consideration for which the shares are issued, plus any accrued unpaid dividends. The paid-up capital and the fair market value of the Preferred Shares will be equal to the subscription amount paid therefor. The holder of Preferred Shares will be entitled to cumulative dividends calculated daily by reference to the redemption/retraction price of the Preferred Shares at an expected rate of XXXXXXXXXX%. The dividends on the Preferred Shares will be payable annually on XXXXXXXXXX.

For greater certainty, when considering the application of section 112 of the Act, Profitco will not acquire or be considered to have acquired the Preferred Shares in the ordinary course of business carried on by it. Furthermore, the Preferred Shares should qualify as "term preferred shares" as defined in the Act.

At any time during the implementation of the Proposed Transactions described in this letter, the Preferred Shares will not 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;

(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; or

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

8. Newco will use the capital from the issuance of the Preferred Shares to make a non-interest bearing loan to Lossco of an estimated $XXXXXXXXXX (the "Newco Loan").

9. Lossco will use the proceeds from the Newco Loan to repay the Daylight Loan.

10. At a time when jointly determined by Lossco, Profitco and Newco:

(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 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 accounting principles;

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

(c) Profitco will pay the accrued and unpaid interest on the Lossco Loan.

The structure will be unwound on or before XXXXXXXXXX in the following manner:

11. Lossco will borrow an estimated amount of $XXXXXXXXXX on a daylight loan basis (the "Second Daylight Loan") from the Bank.

12. Lossco will use the proceeds of the Second Daylight Loan to repay the Newco Loan.

13. Newco will use the funds received from the repayment of the Newco Loan to redeem all of the issued Preferred Shares held by Profitco for an amount equal to their aggregate redemption amount, plus any accrued but unpaid dividends.

14. Profitco will use the Preferred Shares redemption proceeds to repay the Lossco Loan together with any unpaid accrued interest.

15. Lossco will use the proceeds from the Lossco Loan to repay the Second Daylight Loan.

16. Lossco, as sole shareholder of Newco, will pass a resolution authorising 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.

PURPOSE OF THE PROPOSED TRANSACTIONS

The primary objective of the Proposed Transactions is to permit Lossco to access non-capital losses within the Canadian operations which exist in different legal entities by: (a) having Lossco earn interest income on the Lossco Loan, thus permitting it to use its non-capital losses or current year losses; and (b) having Profitco incur tax deductible interest expense on the Lossco Loan, thereby allowing Profitco to reduce its taxable income.

RULINGS GIVEN

Provided that the preceding statements, including the additional information, constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below:

A. Provided that Profitco has a legal obligation to pay interest on the Lossco Loan 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 Lossco Loan, as described in 6 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), 69(4), and 246(1) of the Act will not apply as a result of the Proposed Transactions, in and by themselves.

C. Any dividends received by Profitco in respect of the Preferred Shares in a particular year will be taxable dividends, and pursuant to subsection 112(1) of the Act, an amount equal to the amount of those dividends will be deductible in computing the taxable income of the Profitco for the year in which the dividends are received. For greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), or 112(2.4) of the Act.

D. No amount will be included in the income of Newco pursuant to section 9 of the Act, 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 Paragraph 11 above. No additions will be made to the cost base of any property owned by Lossco, and no addition will be made to the paid-up capital of any class of shares issued by Newco.

E. Subsection 245(2) of the Act will not be applied as a result of entering into the Proposed Transactions, in and by themselves, to re-determine 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 are commenced 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
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch