2014 Ruling 2013-0483491R3 - Loss Consolidation Arrangement

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 LCA acceptable

Position: Yes

Reasons: Within established parameters. Similar to past Rulings.

XXXXXXXXXX
2013-048349

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re: Advance Income Tax Rulings Request
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers (the "Taxpayers"). We also acknowledge the information provided in various emails and telephone conversations with our office.

We understand that to the best of your knowledge and that of the Taxpayers, none of the issues involved in the ruling request is:

(i) is in an earlier return of either of the Taxpayers or a related person;
(ii) is being considered by a tax services office or a taxation centre in connection with any previously filed tax return of either of the Taxpayers or a related person;
(iii) is under objection by either of the Taxpayers or a related person;
(iv) is 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 issued by the Directorate to any of the Taxpayers or a related person.

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

This document is based solely on the facts and proposed transactions described below. The documentation submitted with your request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

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

DEFINITIONS

The following definitions have been used in this letter:

The following definitions have been used in this letter:

(a) “Act” means the Income Tax Act, R.S.C. 1985, c.1 (5th Supp.), as amended to the date hereof;

(b) “affiliated” has the meaning assigned by subsection 251.1(1);

(c) “arm’s length” has the meaning assigned by subsection 251(1);

(d) XXXXXXXXXX;

(e) “Canadian partnership” has the meaning assigned by subsection 102(1);

(f) “Daylight Loan” has the meaning set out in Paragraph 16 hereof;

(g) “Debt Indenture” has the meaning set out in Paragraph 6 hereof;

(h) “Forco” means XXXXXXXXXX;

(i) “Holdco 1” means XXXXXXXXXX;

(j) “Holdco 2” means XXXXXXXXXX;

(k) “Holdco 2 Subsidiary Group Borrowing Capacity” has the meaning set out in Paragraph 9 hereof;

(l) “Holdco 2 Loan” has the meaning set out in Paragraph 23(c) hereof;

(m) “LP Limited Partner” means Opco;

(n) “LP Partners” means Opco and Newco 2;

(o) “Newco 1” has the meaning set out in Paragraph 10 hereof;

(p) “Newco 1 Loan” has the meaning set out in Paragraph 21 hereof;

(q) “Newco 1 Preferred Shares” has the meaning set out in Paragraph 10 hereof;

(r) “Newco 2” has the meaning set out in Paragraph 13 hereof;

(s) “New LP” means a new limited partnership to be established pursuant to the laws of XXXXXXXXXX, as more fully described in Paragraph 15;

(t) “New LP Loan” has the meaning set out in Paragraph 17 hereof;

(u) “non-capital loss” has the meaning assigned by subsection 111(8);

(v) XXXXXXXXXX;

(w) “Opco” means XXXXXXXXXX;

(x) “paid-up capital” or “PUC” has the meaning assigned by subsection 89(1);

(y) “Paragraph” refers to a numbered paragraph in this letter;

(z) “Parentco” means XXXXXXXXXX;

(aa) “Redemption Amount” has the meaning set out in Paragraph 11(c) hereof;

(bb) “Redemption Proceeds” has the meaning set out in Paragraph 24(a);

(cc) “related” has the meaning assigned by subsection 251(2);

(dd) “taxable Canadian corporation” has the meaning assigned by subsection 89(1);

(ee) “taxable income” has the meaning assigned by subsection 248(1); and

(ff) XXXXXXXXXX.

FACTS

1. Parentco is a widely-held corporation formed under the laws of XXXXXXXXXX. Parentco holds indirectly all of the issued and outstanding shares of each of Forco, Holdco 1, Holdco 2 and Opco and will indirectly hold all of the issued and outstanding shares of Newco 1 and Newco 2.

2. Forco is a holding company formed under the laws of XXXXXXXXXX and a non-resident of Canada for purposes of the Act. On XXXXXXXXXX, Forco established Holdco 1, which is a wholly-owned subsidiary of Forco. Forco made an interest-bearing loan to Holdco 1 and Holdco 1 used the proceeds of the loan to acquire the shares of Holdco 2 on XXXXXXXXXX. XXXXXXXXXX.

3. Holdco 1 XXXXXXXXXX and is a taxable Canadian corporation. The taxation year of Holdco 1 ends on XXXXXXXXXX. Holdco 1 is a holding company that owns, directly or indirectly, shares of a number of subsidiary operating companies, which directly or indirectly carry on the business of XXXXXXXXXX. Subsection 261(5) applies to Holdco 1 which uses XXXXXXXXXX$ as its functional currency for purposes of the Act.

4. Holdco 1 has a legal obligation to pay interest on the funds that it has borrowed from Forco, as noted in Paragraph 2. The amount borrowed by Holdco 1 from Forco does not exceed XXXXXXXXXX times the paid-up capital in respect of shares of the capital stock of Holdco 1 owned by Forco. In the absence of the Proposed Transactions, it is estimated that Holdco 1 would incur a non-capital loss of approximately XXXXXXXXXX$XXXXXXXXXX for its taxation year ending XXXXXXXXXX, primarily resulting from interest expense on the borrowing from Forco. Holdco 1 has a non-capital loss of approximately XXXXXXXXXX$XXXXXXXXXX from its XXXXXXXXXX taxation year carried forward to its XXXXXXXXXX taxation year. All of the XXXXXXXXXX taxable income of Holdco 1, if any, would be allocated to the Province of XXXXXXXXXX.

5. Holdco 2 is a taxable Canadian corporation XXXXXXXXXX and is not a “public corporation” within the meaning assigned by subsection 89(1). Holdco 2 is a wholly-owned subsidiary of Holdco 1. The taxation year of Holdco 2 ends on XXXXXXXXXX. Holdco 2 indirectly through subsidiary companies carries on the business of XXXXXXXXXX. Subsection 261(5) applies to Holdco 2 which uses XXXXXXXXXX$ as its functional currency for purposes of the Act.

6. Holdco 2 has issued debt XXXXXXXXXX, which is governed by an indenture (the “Debt Indenture”). The Debt Indenture contains a number of restrictions which limit Holdco 2’s, and certain subsidiaries thereof including Opco, ability to enter into various transactions, which are described in more detail under “Purpose of the Proposed Transactions” below.

7. Opco is a taxable Canadian corporation XXXXXXXXXX. Opco is a wholly-owned subsidiary of Holdco 2. The taxation year of Opco ends on XXXXXXXXXX. Opco directly and indirectly carries on the business of XXXXXXXXXX. Opco operates XXXXXXXXXX located in the Province of XXXXXXXXXX and a XXXXXXXXXX business in the Provinces of XXXXXXXXXX and XXXXXXXXXX. Opco's estimated provincial income allocation for XXXXXXXXXX is XXXXXXXXXX. Subsection 261(5) applies to Opco which uses XXXXXXXXXX$ as its functional currency for purposes of the Act.

8. Holdco 1, Holdco 2 and Opco are each serviced by the XXXXXXXXXX Taxation Services Office and each files its tax returns at the XXXXXXXXXX Taxation Centre.

9. The borrowing capacity of Holdco 2 and its subsidiaries (“Holdco 2 Subsidiary Group Borrowing Capacity”) is equal to or exceeds the principal amount of the New LP Loan.

PROPOSED TRANSACTIONS

10. Holdco 1 will incorporate a new corporation (“Newco 1”) under XXXXXXXXXX. Newco 1 will be a taxable Canadian corporation. The taxation year-end of Newco 1 will be XXXXXXXXXX. Newco 1’s activities will be limited to those described in this letter. The authorized capital of Newco 1 will consist of an unlimited number of common shares and preferred shares (the “Newco 1 Preferred Shares”). The holders of common shares of Newco 1 will be entitled to vote, receive dividends at the discretion of the directors, and receive the corporation’s property remaining after the entitlement of the Newco 1 Preferred Shares to any property upon the corporation’s winding-up or dissolution. Newco 1 will meet the requirements under subsection 261(3) so that subsection 261(5) will apply to Newco 1 with the XXXXXXXXXX$ as its functional currency.

11. The Newco 1 Preferred Shares will have the following rights and restrictions:

(a) non-voting;

(b) annual cumulative dividend, calculated daily by reference to the redemption/retraction price of the Newco 1 Preferred Shares at a rate equal to the interest rate on the New LP Loan plus XXXXXXXXXX%;

(c) redeemable for an amount equal to the aggregate of the amount for which the share was issued and any accrued but unpaid dividends (the “Redemption Amount”);

(d) retractable for an amount equal to the aggregate of the amount for which the share was issued and any accrued but unpaid dividends;

(e) on winding up or dissolution, the holder will receive an amount equal to the aggregate of the amount for which the share was issued and any accrued but unpaid dividends;

(f) dividends and proceeds on redemption, retraction, winding-up or dissolution rank ahead of any payment on shares ranking junior including common shares;

(g) automatically retracted XXXXXXXXXX days prior to any bankruptcy or insolvency of Newco 1; and

(h) the capital of the share under XXXXXXXXXX will be equal to the amount for which the share was issued.

12. Newco 1 will issue common shares of its capital stock to Holdco 1 for nominal consideration. Holdco 1 will have de jure control of Newco 1.

13. Opco will incorporate a new corporation (“Newco 2”) under XXXXXXXXXX. Newco 2 will be a taxable Canadian corporation. The taxation year-end of Newco 2 will be XXXXXXXXXX. Newco 2’s activities will be limited to acting as the general partner of New LP. The authorized capital of Newco 2 will consist of an unlimited number of common shares. The holders of common shares will be entitled to vote, receive dividends at the discretion of the directors, and receive the corporation’s property upon the corporation’s winding-up or dissolution. Newco 2 will elect under subsection 261(5) to use XXXXXXXXXX$ as its functional currency.

14. Newco 2 will issue one common share of its capital stock to Opco for nominal consideration. Opco will have de jure control of Newco 2.

15. Opco and Newco 2 will establish a limited partnership (“New LP”) under the laws of XXXXXXXXXX, the salient features of which are as follows:

(a) New LP will be a Canadian partnership. The fiscal period-end of New LP will be XXXXXXXXXX;

(b) New LP’s activities will be limited to those described in the Proposed Transactions, including entering into the New LP Loan with Holdco 1 and purchasing the Newco 1 Preferred Shares;

(c) Newco 2 will be the general partner of New LP. Newco 2 will acquire a XXXXXXXXXX% ownership interest in New LP, funded by cash contributions to New LP, and will be entitled to a XXXXXXXXXX% share of the income or loss of New LP; and

(d) Opco will be the limited partner of New LP (also referred to in this letter as the “LP Limited Partner”). Opco will acquire a XXXXXXXXXX% ownership interest in New LP, funded by cash contributions to New LP, and will be entitled to a XXXXXXXXXX% share of the income or loss of New LP.

16. Holdco 1 will borrow funds on a “daylight loan” basis (the “Daylight Loan”) from an arm’s length financial institution. The interest rate on the Daylight Loan will be a commercial arm’s length rate, presently estimated to be XXXXXXXXXX% per annum. The amount of the Daylight Loan will not exceed the Holdco 2 Subsidiary Group Borrowing Capacity. Opco will provide a guarantee for the payment of the Daylight Loan on behalf of Holdco 1.

17. Holdco 1 will use the proceeds of the Daylight Loan to make a loan to New LP (the “New LP Loan”), on the following terms and conditions:

(a) Simple interest will accrue on the New LP Loan and will be calculated daily at an annual rate equal to a commercial arm’s length rate applicable in these facts and circumstances, presently estimated to be XXXXXXXXXX% per annum. The interest on the New LP Loan will be paid on or before the last business day of each calendar year;

(b) Holdco 1’s recourse against New LP to obtain repayment of the New LP Loan will be limited to the Newco 1 Preferred Shares owned by New LP, as further described in Paragraph 19 below;

(c) New LP will be entitled to settle the New LP Loan by transferring property in-kind, including its Newco 1 Preferred Shares, to Holdco 1;

(d) the New LP Loan will be repayable by New LP upon the earlier of: (i) demand by Holdco 1, (ii) XXXXXXXXXX; and (iii) XXXXXXXXXX days prior to an event of default including a bankruptcy or insolvency of New LP; and

(e) the New LP Loan will provide New LP with a right to prepay at any time without penalty.

18. The amount of the New LP Loan will be based on and will not exceed the Holdco 2 Subsidiary Group Borrowing Capacity.

19. New LP will use the proceeds received from the New LP Loan to subscribe for Newco 1 Preferred Shares having an aggregate issue price equal to the amount of the New LP Loan. For greater certainty, Newco 1 will be connected, within the meaning assigned by subsection 186(4), with each of Opco and Newco 2 by virtue of paragraph 186(4)(a). Newco 1 will be controlled for purposes of Part IV by each of Opco and Newco 2 by virtue of subsection 186(2).

20. New LP will incur only nominal annual expenses other than interest expense on the New LP Loan. Consequently, except as noted immediately following, no further reference to these other expenses need be made. For greater certainty, each year the amount of dividends payable on the Newco 1 Preferred Shares will exceed the aggregate, in that particular year, of the amount of interest accrued on the New LP Loan, plus the nominal amount of any other expenses incurred by New LP. Consequently, each year during which this loss utilization arrangement is in place, New LP will have net income computed in accordance with subsection 96(1).

21. Newco 1 will use the subscription proceeds received from New LP to make an interest-free, demand loan to Holdco 1 (the “Newco 1 Loan”). The terms and conditions of the Newco 1 Loan will provide Holdco 1 with a right to repay at any time without penalty.

22. Holdco 1 will use the proceeds received from the Newco 1 Loan to repay the Daylight Loan.

23. On or before the last business day of each calendar year in this order:

(a) Opco and Newco 2 will make pro rata cash capital contributions to New LP to provide New LP with sufficient funds to pay the interest accrued on the New LP Loan;

(b) New LP will utilize the contributions described in Paragraph 23(a) to pay the interest on the New LP Loan to Holdco 1. The interest on the New LP Loan will be paid annually on or before the last business day of the calendar year;

(c) Holdco 2 will loan (the “Holdco 2 Loan”) to Holdco 1 on a non-interest bearing basis a XXXXXXXXXX$ amount equal to the difference between the dividend entitlement on the Newco 1 Preferred Shares and the interest rate on the New LP Loan. The terms and conditions of the Holdco 2 Loan will provide Holdco 1 with a right to repay at any time without penalty;

(d) Holdco 1 will make a contribution of capital to Newco 1 in an amount equal to the dividend payable by Newco 1 on that day on the Newco 1 Preferred Shares held by New LP. No shares will be issued by Newco 1 with respect to the contribution of capital and no amount will be added to the stated capital or PUC of Newco 1. The amount of this contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be reported as income for purposes of the Act and will not be treated as income of Newco 1 pursuant to generally accepted accounting principles;

(e) Upon receipt of the contribution described in Paragraph 23(d), Newco 1 will, subject to any applicable corporate solvency test, pay a dividend to New LP equal to the amount of the dividends payable by Newco 1 on the Newco 1 Preferred Shares, as referred to in Paragraph 11; and

(f) New LP will use the amount received as dividends from Newco 1 to make a cash distribution to the LP Partners on a pro rata basis. The distribution will be made annually on or before XXXXXXXXXX.

24. The following transactions will occur to unwind the loss consolidation arrangement:

(a) Newco 1 will redeem the Newco 1 Preferred Shares held by New LP and will satisfy its obligation to pay the Redemption Amount by: (i) assigning its Newco 1 Loan receivable to New LP; and (ii) to the extent there is a difference between the Redemption Amount and the Newco 1 Loan receivable, paying cash to New LP equal to this difference (the consideration in (i) and (ii) collectively referred to as the “Redemption Proceeds”). The Redemption Proceeds will be accepted by New LP as a final and unconditional payment of the redemption price of the Newco 1 Preferred Shares;

(b) New LP will repay the New LP Loan and any accrued interest thereon in full by: (i) set-off with the Newco 1 Loan; and (ii) to the extent there is a difference between the New LP Loan and accrued interest thereon and the Newco 1 Loan, cash payment equal to the same. For greater certainty, New LP’s obligations in the respect of the New LP Loan and Holdco 1’s obligations in respect of the Newco 1 Loan will be cancelled in full pursuant to the set-off and payment described in this Paragraph;

(c) Newco 1 will be wound-up into or amalgamated with Holdco 1; and

(d) Newco 2 will be wound-up into or amalgamated with Opco, with the result that New LP will cease to exist.

25. It is estimated that the loss utilization arrangement described in the Proposed Transactions, will stay in existence for under XXXXXXXXXX years before it is completely unwound, as contemplated in Paragraph 24.

Additional Information

26. A Newco 1 Preferred Share 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) a share that is described in subsection 112(2.4); or

(c) the subject of a “dividend rental agreement” as defined in subsection 248(1).

27. Neither New LP, nor any of the LP Partners, will acquire, or be considered to have acquired the Newco 1 Preferred Shares in the ordinary course of business carried on by the respective entity.

28. None of Parentco, Forco, Holdco 1, Holdco 2, Opco, Newco 1 nor Newco 2 is or will be at any time during the implementation of the Proposed Transactions a corporation described in any of paragraphs (a) to (f) of the definition of “financial intermediary corporation” in subsection 191(1).

29. Based on its existing assets and resources, each of Holdco 1, Opco and Newco 2 will have the ability to make the contributions of capital to Newco 1 and New LP, respectively, as described in Paragraphs 15 and 23.

30. Each of Parentco, Forco, Holdco 1, Holdco 2, Opco, Newco 1, Newco 2 and New LP will be affiliated and, except for New LP, related at all times during the implementation of the Proposed Transactions.

31. All relevant amounts described in the Proposed Transactions including receipts and payments will be denominated or made in XXXXXXXXXX$.

Purpose of the Proposed Transactions

32. The purpose of the Proposed Transactions is to effect a tax consolidation of Opco and Holdco 1 by causing Holdco 1 to earn interest income on the New LP Loan. This will permit Holdco 1 to use its non-capital loss incurred from the date of Holdco 1’s acquisition of Holdco 2 to its taxation year ending XXXXXXXXXX or its current year interest expense for a taxation year ending after XXXXXXXXXX, and to have Opco incurring interest expense, thereby allowing it to reduce its taxable income.

33. Pursuant to the restrictions contained in the Debt Indenture, Holdco 1 cannot amalgamate with Holdco 2 or Opco to effect a tax consolidation of such parties. Consequently, the Proposed Transactions have been structured in a manner that complies with the terms and conditions of the Debt Indenture.

34. Opco is a limited partner of New LP to limit the potential claims and recourses of creditors of New LP (including Holdco 1) against assets of Opco, again to comply with the provisions of the Debt Indenture.

35. The Proposed Transactions will not be undertaken for the purpose of accessing any differential in provincial tax rates that may exist between various provinces.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions, the proposed transactions are completed in the manner described above, and there are no other transactions which may be relevant to the rulings requested, our rulings are as follows:

A. Provided that New LP has a legal obligation to pay interest on the New LP Loan, and the Newco 1 Preferred Shares continue to be held by New LP for the purpose of gaining or producing income therefrom, New LP will be entitled pursuant to paragraph 20(1)(c), to deduct in computing its income for a taxation year, the lesser of: (i) the interest paid or payable in respect of the New LP Loan for that taxation year (depending on the method regularly followed by New LP in computing its income for the purposes of the Act); and (ii) a reasonable amount in respect thereof, and such deduction will not be denied by virtue of the application of the provisions of subsection 18(4) of the Act.

B. The dividends received by New LP on the Newco 1 Preferred Shares will be taxable dividends and such dividends will, pursuant to paragraph 12(1)(j), be included in the computation of New LP’s income as contemplated in subsection 96(1).

C. To the extent that New LP has net income in a particular year, computed in accordance with subsection 96(1), then in that particular year each LP Partner will be required to report its share of that income in accordance with their respective ownership interests in New LP and in accordance with paragraph 96(1)(f). For greater certainty, in that case, none of the LP Partners will have a share of any loss from New LP for that year and consequently subsection 96(2.1) would not apply for that particular year.

D. The dividends received by New LP in respect of the Newco 1 Preferred Shares in a particular year will be taxable dividends, and pursuant to subsection 112(1), an amount equal to the amount of those dividends that is allocated to an LP Partner will be deductible in computing the taxable income of the LP Partner for the year in which the dividends are received and allocated by New LP to the LP Partner in accordance with subsection 96(1). 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).

E. Where New LP receives dividends in respect of the Newco 1 Preferred Shares and allocates the same to the LP Partners in accordance with subsection 96(1), the LP Partners will not be subject to tax under Part IV, except as provided under paragraph 186(1)(b), on such dividend received by New LP and included in income of the LP Partners as described in Ruling D above.

F. No amount will be included in the income of Newco 1 pursuant to section 9, paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital made by Holdco 1, as described in Paragraph 23.

G. Section 212.3 will not apply to Holdco 1, Holdco 2, Opco, Newco 1 or Newco 2 as a result of entering into the Proposed Transactions, in and by themselves.

H. The provisions of subsections 15(1), 56(2), 69(1) and 246(1) will not apply as a result of entering into the Proposed Transactions, in and by themselves.

I. Subsection 245(2) 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; and

(d) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that include other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
for Director
Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate