2013 Ruling 2013-0512321R3 - 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 of our published position.

XXXXXXXXXX
2013-051232

XXXXXXXXXX, 2013

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
Taxpayer: XXXXXXXXXX and certain of its affiliates

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-named taxpayers.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in this ruling request are:

(i) related to any earlier returns of the taxpayers or a related person;

(ii) being considered by a tax services office or a taxation centre in connection with a tax return previously filed by 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 appeal to a higher court has expired; or

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

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.

All dollar amounts stated herein are in Canadian currency.

Definitions

The following definitions have been used in this letter:

(a) "ACo" means XXXXXXXXXX;

(b) XXXXXXXXXX;

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

(d) "CBCA" means the Canadian Business Corporations Act, RSA 1985, c. C-44, as amended;

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

(f) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

(g) "eligible dividend" has the meaning assigned by subsection 89(1);

(h) "excepted dividend" has the meaning assigned by section 187.1;

(i) "excluded dividend" has the meaning assigned by subsection 191(1);

(j) "Financial Institution" means XXXXXXXXXX, the third party financial institution from whom Parent will borrow the Parent Daylight Loan;

(k) "Income Pooling Arrangement" means the transactions described in Paragraphs 8 to 17;

(l) "Lossco" means XXXXXXXXXX;

(m) "Lossco Loan" means the promissory note issued by Lossco to Profitco on the redemption of the Preferred Shares as described in Paragraph 16(c);

(n) "New Daylight Loan" means the loan made by Parent to Profitco on a daylight-loan basis described in Paragraph 9.

(o) "New Profitco Loan" means the loan made by Lossco to Profitco described in Paragraph 11;

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

(q) "Non-Streamed Non-Capital Losses" means Lossco's non-capital loss carryforward balances in respect of taxation years ending after the XXXXXXXXXX;

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

(s) "Paragraph" refers to a numbered paragraph in this letter;

(t) "Parent" means XXXXXXXXXX;

(u) "Parent Daylight Loan" means the loan made by the Financial Institution to Parent on a daylight-loan basis described in Paragraph 8;

(v) "Preferred Shares" means the preferred shares to be issued by Lossco as more fully described in Paragraphs 6 and 10;

(w) "ProfitCo" means XXXXXXXXXX;

(x) "Proposed Transactions" means the transactions described in Paragraphs 8 to 17;

(y) "Province" means the Province of XXXXXXXXXX;

(z) "Provincial BCA" means the Business Corporations Act XXXXXXXXXX;

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

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

(cc) "Streamed Non-Capital Losses" means Lossco's non-capital loss carryforward balances in respect of taxation years ending prior to or as a result of the XXXXXXXXXX;

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

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

(ff) "taxable dividend" has the meaning assigned by subsection 89(1).

Facts

1. Parent is a corporation incorporated under the CBCA. Parent is a taxable Canadian corporation and a public corporation and its shares are listed on the XXXXXXXXXX and the XXXXXXXXXX. Parent carries on XXXXXXXXXX business directly and indirectly through subsidiary entities and has a XXXXXXXXXX taxation year-end. Parent is not a specified financial institution.

Parent incurred a loss for tax purposes of approximately $XXXXXXXXXX for the year ending XXXXXXXXXX. Parent's consolidated gross revenues and consolidated net loss before tax for financial reporting purposes for the year ended XXXXXXXXXX were approximately $XXXXXXXXXX and approximately $XXXXXXXXXX, respectively.

Parent files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. Parent's business number is XXXXXXXXXX and its address is XXXXXXXXXX.

2. ACo is a corporation incorporated under the CBCA. ACo is a taxable Canadian corporation and a public corporation and its shares are listed on the XXXXXXXXXX. Parent owns approximately XXXXXXXXXX% of ACo's issued and outstanding shares.

ACo files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. ACo's business number is XXXXXXXXXX and its address is XXXXXXXXXX.

ACo has a provincial permanent establishment only in the Province of XXXXXXXXXX and has a XXXXXXXXXX taxation year end.

3. Lossco is a subsidiary wholly-owned corporation of ACo incorporated under the Provincial BCA. Lossco is a taxable Canadian corporation and has a XXXXXXXXXX taxation year-end.

Lossco carries on XXXXXXXXXX business directly and indirectly through subsidiary entities. Lossco's net income for tax purposes for the year ending XXXXXXXXXX was approximately $XXXXXXXXXX. Lossco's gross revenues and net income before tax for financial reporting purposes for the year ended XXXXXXXXXX were approximately $XXXXXXXXXX and approximately $XXXXXXXXXX, respectively. Lossco has a non-capital loss carryforward balance of approximately $XXXXXXXXXX as of XXXXXXXXXX. Without giving effect to the Proposed Transactions, it is expected that Lossco will generate net income for tax purposes in its XXXXXXXXXX and subsequent taxation years.

Lossco files its information returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office. Lossco's business number is XXXXXXXXXX and its address is XXXXXXXXXX.

In XXXXXXXXXX, Lossco had permanent establishments in XXXXXXXXXX Canadian provinces. Lossco's allocation of income among those XXXXXXXXXX provinces for its XXXXXXXXXX taxation year was as follows:

XXXXXXXXXX

On XXXXXXXXXX, Parent transferred all of its operations in XXXXXXXXXX to Lossco on a tax-deferred basis pursuant to subsection 85(1). Lossco's estimated provincial allocation for XXXXXXXXXX and subsequent taxation years is as follows:

XXXXXXXXXX

4. Profitco is a subsidiary wholly-owned corporation of ACo incorporated on XXXXXXXXXX under the Provincial BCA. Profitco is a taxable Canadian corporation and has a XXXXXXXXXX taxation year-end.

On XXXXXXXXXX, Parent transferred substantially all of its XXXXXXXXXX assets to Profitco on a tax-deferred basis pursuant to subsection 85(1). As a result, Profitco now carries on XXXXXXXXXX business.

Profitco will file its information returns with the XXXXXXXXXX Taxation Centre and will deal with the XXXXXXXXXX Tax Services Office. Profitco's business number is XXXXXXXXXX and its address is XXXXXXXXXX.

Profitco has a provincial permanent establishment only in XXXXXXXXXX. It is expected this will continue to be the case for Profitco's XXXXXXXXXX and subsequent taxation years.

5. It is expected that Profitco will generate sufficient annual taxable income to fully offset the interest expense on the New Profitco Loan (as described in Paragraph 11).

6. The authorized capital of Lossco includes (or will include prior to the implementation of the Proposed Transactions) non-voting, non-par value preferred shares (the "Preferred Shares"). 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 but 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 holders of the Preferred Shares will be entitled to cumulative dividends calculated daily by reference to the redemption price of the Preferred Shares at an expected rate equal to approximately XXXXXXXXXX% (XXXXXXXXXX% higher than the interest rate on the New Profitco Loan).

The dividends on the Preferred Shares will be payable semi-annually on XXXXXXXXXX and XXXXXXXXXX, or such earlier date as the Preferred Shares are redeemed. The dividends will be designated as eligible dividends. No Preferred Shares will be issued and outstanding at the time the Proposed Transactions are initiated.

7. As at XXXXXXXXXX, Lossco had non-capital loss carryforwards as follows:

Loss Year Expiry Non Capital Losses
XXXXXXXXXX XXXXXXXXXX XXXXXXXXXX

Since the Streamed Non-Capital Losses are in respect of taxation years ending prior to or as a result of the XXXXXXXXXX, they are subject to the restrictions set out in subsection 111(5) of the Act. The restrictions set out in subsection 111(5) of the Act do not apply to the Non-Streamed Non-Capital Losses.

Proposed Transactions

8. Parent will borrow $XXXXXXXXXX on a daylight loan basis from the Financial Institution. The amount of the Parent Daylight Loan will not exceed Parent's borrowing capacity. The Financial Institution will provide the funds to Parent by way of wire transfer.

9. Parent will make a non-interest bearing daylight loan to Profitco of an estimated $XXXXXXXXXX (the "New Daylight Loan").

10. Profitco will use the proceeds from the New Daylight Loan to subscribe for $XXXXXXXXXX of Preferred Shares of Lossco.

For greater certainty, when considering the application of section 112, Profitco will not acquire or be considered to have acquired the Preferred Shares in the ordinary course of its business.

11. Lossco will use the proceeds received from the Preferred Share subscription described in Paragraph 10 to make a loan to Profitco (the "New Profitco Loan") in the amount of $XXXXXXXXXX.

The New Profitco Loan will bear interest at an annual rate equal to a commercial arm's length rate in the circumstances. It is expected that the annual interest rate will be approximately XXXXXXXXXX%. The interest on the New Profitco Loan will be paid semi-annually on XXXXXXXXXX and XXXXXXXXXX, or such earlier date as the New Profitco Loan is repaid.

12. Profitco will use the proceeds from the New Profitco Loan to repay the New Daylight Loan owing to Parent.

13. Parent will use the proceeds from the repayment of the New Daylight Loan to repay the Parent Daylight Loan owing to the Financial Institution.

14. On each Preferred Share dividend payment date, Lossco will, subject to any applicable corporate law solvency tests, declare and pay a dividend to Profitco in accordance with the terms of the Preferred Shares and will designate such dividend as an eligible dividend.

15. On each interest payment date, Profitco will use the funds from the Preferred Share dividends to pay the interest on the New Profitco Loans.

16. Once it is determined that the interest income to be received by Lossco will be greater than the amount required to fully utilize the Non-Streamed Non-Capital Losses, the following transactions will occur to unwind the Income Pooling Arrangement:

(a) Lossco will, subject to any applicable corporate law solvency tests, declare and pay all accrued dividends to Profitco in accordance with the terms of the Preferred Shares.

(b) Profitco will use the proceeds from the Preferred Share dividends to pay the accrued interest on the New Profitco Loan.

(c) Subject to any applicable corporate law solvency tests, Lossco will redeem its issued and outstanding Preferred Shares held by Profitco in exchange for a promissory note (the "Lossco Loan").

(d) The Lossco Loan and New Profitco Loan will be extinguished by offset at their principal amounts.

17. It is estimated that the Income Pooling Arrangement will remain in place until at least XXXXXXXXXX before being unwound as described in Paragraph 16.

Additional Information

18. 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) 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); or

(d) issued for consideration that is or includes:

(i) an obligation of the type described in subparagraph 112(2.4)(b)(i); or

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

Purpose of the Proposed Transactions

19. The purpose of the Proposed Transactions is to effect a tax consolidation of Profitco and Lossco by

(a) having Lossco earn interest income on the New Profitco Loan, thus permitting Lossco to accelerate the use of its Non-Streamed Non-Capital Losses; and

(b) having Profitco incur interest expense on the New Profitco 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 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 New Profitco Loan and that the Lossco Preferred Shares continue to be held by Profitco over the course of the Income Pooling Arrangement for the purpose of gaining or producing income therefrom, then, pursuant to paragraph 20(1)(c), Profitco will be entitled to deduct in a taxation year the interest paid or payable as described in 11 and 15 above, in respect of the tax year to the extent that such amount does not exceed a reasonable amount in respect thereof.

B. The dividends received (or deemed to be received) by Profitco on the Lossco Preferred Shares held by it will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income for the taxation year in which the dividends are received (or deemed to be received). For greater certainty, such deductions will not be precluded by any of subsections 112(2.1), 112(2.2), 112(3), or 112(2.4).

C. Part IV.1 will not apply to the dividends described in Ruling B because the dividends will be excepted dividends within the meaning assigned by section 187.1.

D. Part VI.1 will not apply to the dividends described in Ruling B because the dividends will be excluded dividends within the meaning assigned by subsection 191(1).

E. The dividends received by Profitco in respect of the Preferred Shares will not be subject to tax under Part IV because Profitco will not be a "private corporation" or a "subject corporation" within the meaning assigned by subsection 186(1).

F. The provisions of subsections 15(1), 56(2), 69(1), 69(11) and 246(1) will not apply as a result of entering into the Proposed Transactions, in and by themselves.

G. The general anti-avoidance provision under subsection 245(2) will not be applied as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

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 described in 18 and 19 above, are completed by XXXXXXXXXX. The above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Comments

Nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(a) the fair market value or adjusted cost base of any property or the paid-up capital of any shares referred to herein;

(b) the amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein;

(c) the provincial tax implications relating to the allocation of income and expenses under the proposed transactions;

(d) the application or non-application of the general anti-avoidance provisions of any province; or

(e) 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