2013 Ruling 2013-0504301R3 - 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. Similar to past Rulings.

XXXXXXXXXX
2013-050430

XXXXXXXXXX, 2013

Dear XXXXXXXXXX:

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-noted taxpayers. We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling 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 judgment 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

(a) "Lossco" means XXXXXXXXXX, the corporation described in paragraph 1;

(b) "Lossco Note" means the demand non-interest-bearing promissory note described in paragraph 17;

(c) "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;

(d) "adjusted cost base" has the meaning assigned by section 54 of the Act;

(e) "affiliated person" has the meaning assigned by section 251.1 of the Act;

(f) "Bco" means XXXXXXXXXX, the corporation described in paragraph 2;

(g) "CBCA" means the Canada Business Corporations Act, R.S.C. 1995, c. C-44, as amended;

(h) "Cco" means XXXXXXXXXX, the corporation described in paragraph 3;

(i) "Daylight Loan" has the meaning specified in paragraph 14;

(j) "Profitco" means XXXXXXXXXX, the corporation described in paragraph 4;

(k) "Profitco Note" means the debenture described in paragraph 16;

(l) "Newco" means the corporation described in paragraph 12;

(m) "Newco Common Shares" means the common shares described in paragraph 12;

(n) "Newco Preferred Shares" means the preferred shares described in paragraph 12;

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

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

(q) "Parentco" means XXXXXXXXXX, a taxable Canadian corporation and a public corporation, the common shares of which are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX";

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

(s) XXXXXXXXXX;

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

(u) "related persons" has the meaning assigned by subsection 251(2) of the Act;

(v) "SFI" means a specified financial institution, as defined in subsection 248(1) of the Act;

(w) "subject corporation" has the meaning assigned by subsection 186(3) of the Act;

(x) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act; and

(y) XXXXXXXXXX.

STATEMENT OF FACTS

1. Lossco is a taxable Canadian corporation and a public corporation. Parentco holds approximately XXXXXXXXXX% of the common shares in Lossco and approximately XXXXXXXXXX% of the votes attached to all issued and outstanding shares in the capital of Lossco. Lossco has a taxation year end of XXXXXXXXXX. The common shares of Lossco are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX". Lossco is a XXXXXXXXXX. Lossco files its T2 returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Service Office.

2. Bco is a taxable Canadian corporation and a public corporation, the shares of which are widely held by members of the public and which is controlled by Lossco, which owns directly or indirectly, approximately XXXXXXXXXX% of the issued and outstanding common shares of Bco. Bco has a taxation year end of XXXXXXXXXX. The common shares of Bco are listed on the XXXXXXXXXX under the symbol "XXXXXXXXXX". Bco is XXXXXXXXXX.

3. Cco is a taxable Canadian corporation and is a wholly-owned subsidiary of Bco. Cco has a taxation year end of XXXXXXXXXX. Cco is a management and holding company XXXXXXXXXX.

4. Profitco is a taxable Canadian corporation and is a wholly-owned subsidiary of Cco. Profitco has a taxation year end of XXXXXXXXXX. Profitco's principal business activity is to XXXXXXXXXX. Profitco is XXXXXXXXXX. Profitco files its T2 returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office.

5. Lossco is estimated to have unexpired non-capital losses carried forward of approximately $XXXXXXXXXX as of the end of its taxation year ended on XXXXXXXXXX.

6. It is anticipated that Lossco will use $XXXXXXXXXX of non-capital losses in its taxation year ending XXXXXXXXXX, leaving a balance of $XXXXXXXXXX in non-capital losses.

7. The borrowing capacity of Lossco and its subsidiaries significantly exceeds the maximum amount of $XXXXXXXXXX required to complete the Proposed Transactions described in paragraphs 12 to 23. As of XXXXXXXXXX, Lossco had a net equity value of over $XXXXXXXXXX and its market capitalization exceeded $XXXXXXXXXX.

8. It is anticipated that Profitco will generate taxable income in each of the next XXXXXXXXXX taxation years.

9. The borrowing capacity of Bco significantly exceeds the maximum amount of $XXXXXXXXXX required to complete the Proposed Transactions described in paragraphs 12 to 23.

10. Lossco operates through permanent establishments in the Provinces of XXXXXXXXXX. Lossco has an allocation factor of approximately XXXXXXXXXX% to the Province of XXXXXXXXXX and of approximately XXXXXXXXXX% to the Province of XXXXXXXXXX, based on the interprovincial allocation for Lossco's XXXXXXXXXX taxation year.

11. Profitco operates through permanent establishments in XXXXXXXXXX. Profitco has, based on the interprovincial allocation for Profitco's XXXXXXXXXX taxation year, approximately the following allocation factors:

XXXXXXXXXX

PROPOSED TRANSACTIONS

12. 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 acquiring the Lossco Note.

The Newco Preferred Shares will have the following attributes:

a) non-voting;

b) non-participating;

c) 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 holder'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) or delivery of the Lossco Note, 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

d) entitlement to a cumulative dividend, payable quarterly, calculated daily and accruing by reference to the redemption amount of Newco Preferred Shares at a rate that is reasonable, based on the current prevailing market rate set out in paragraph 16 for the Profitco Note, plus XXXXXXXXXX% per annum.

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

14. Lossco will borrow an amount between $XXXXXXXXXX and $XXXXXXXXXX in one or more tranches to be determined by the company on a "daylight loan" basis from an arm's length financial institution or from a related entity ("Daylight Loan").

15. Lossco will use the proceeds from Daylight Loan to subscribe for Newco Preferred Shares for a total amount between $XXXXXXXXXX and $XXXXXXXXXX. The aggregate redemption amount, retraction amount, adjusted cost base and paid-up capital of the Newco Preferred Shares issued will be equal to the subscription amount of the Newco Preferred Shares.

16. Lossco will immediately transfer all the Newco Preferred Shares to Profitco at a purchase price equal to the redemption amount, which is their fair market value. As sole consideration for such transfer, Profitco will issue a secured debenture (the "Profitco Note") to Lossco that will have a principal amount equal to the aggregate redemption amount of such Newco Preferred Shares. The Profitco Note will bear interest that will be payable quarterly, established at a rate XXXXXXXXXX%, and will be repayable on demand. The Profitco Note will also 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 a 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. The amount of dividends received by Profitco on the Newco Preferred Shares held by Profitco will be sufficient to permit Profitco to realize a profit on its investment in the Newco Preferred Shares, after the deduction of any interest on the Profitco Note and its other related expenses.

17. Newco will use the proceeds from the issuance of the Newco Preferred Shares to make a non-interest-bearing loan of between $XXXXXXXXXX and $XXXXXXXXXX to Lossco. This loan will be evidenced by a demand non-interest-bearing promissory note (the "Lossco Note").

18. Lossco will use the proceeds from the Lossco Note to repay Daylight Loan.

19. The following transactions will occur in immediate sequence when jointly determined by Lossco, Profitco and Newco, but no later than XXXXXXXXXX:

a) At least quarterly, pursuant to a capital contribution agreement, Lossco will make a contribution of capital to Newco in an amount equal to the amount of any 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 international financial reporting standards;

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.

The structure will be unwound in the following manner no later than XXXXXXXXXX.

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

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

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

23. 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

24. Profitco, as well as all other taxpayers involved in the Proposed Transactions, are, on the basis that they are related to a corporation described in paragraphs (b) or (d) of the definition of SFI, SFIs pursuant to paragraph (g) of that definition. Profitco will not acquire the Newco Preferred Shares in the ordinary course of their business.

25. The issued Newco Preferred Shares will not be, at any time during the implementation of the proposed transactions described herein:

(1) the subject of any undertaking that is referred to in subsection 112(2.2) of the Act as a "guarantee agreement";

(2) the subject of a dividend rental arrangement as that term is defined in subsection 248(1) of the Act;

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

(4) issued for consideration that is or includes:

(a) 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

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

26. Lossco, Bco, Cco, Profitco and Newco are subject corporations, as defined in subsection 186(3) of the Act. However, since Newco will not have any refundable dividend tax on hand, no Part IV tax will be payable on the dividends paid by Newco on the Newco Preferred Shares held by Profitco.

27. The interest deducted by Profitco pursuant to paragraph 20(1)(c) of the Act in respect of the Profitco Note will not create a non-capital loss for Profitco during the period in which the transactions described in paragraphs 12 through 23 occur. However, Profitco could incur a non-capital loss as a result of claiming a deduction in computing taxable income under paragraph 110(1)(k) of the Act should Profitco enter into an agreement with a related party with respect to Part VI.1 tax otherwise payable by such related party, in accordance with subsection 191.3(1) of the Act. Any such resulting non-capital loss may be carried back to a prior taxation year in accordance with the rules in section 111 of the Act.

28. Dividends received by Profitco on the Newco Preferred Shares as described in 19 will be excepted dividends within the meaning assigned by section 187.1 of the Act and excluded dividends within the meaning assigned by section 191(1) of the Act.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to consolidate taxable income and non-capital losses 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 non-capital losses.

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 16 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

B. The provisions of subsections 15(1), 56(2), and 246(1) of the Act will not apply to the Proposed Transactions, in and by themselves.

C. No amount will be included in the income of Newco pursuant to section 9 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 19 above.

D. Dividends received by Profitco on the Newco Preferred Shares, as described 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 the recipient corporation 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.

F. The general anti-avoidance provision of a province with which the Government of Canada has entered into a tax collection agreement will not be applied, as a result of the Proposed Transactions, in and by themselves, to determine the tax consequences confirmed in the rulings given above, in respect of a taxation year in respect of which such a tax collection agreement is in effect.

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 described in 19 to 23, are completed by XXXXXXXXXX. In addition, 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