2014 Ruling 2014-0518451R3 - 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: Loss consolidation

Position: Favourable rulings issued.

Reasons: Meets statutory and administrative requirements.

XXXXXXXXXX
2014-051845

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge the information provided in correspondence and telephone conversations concerning your request. Any information you have provided to us forms part of this ruling only to the extent it is expressly referred to or described herein.

To the best of your knowledge and that of the above-referenced taxpayers, none of the issues involved in this ruling is:

a) dealt with in an earlier return of any of the above-referenced taxpayers, or a related person,

b) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of any of the above-referenced taxpayers or a related person,

c) under objection or appeal by any of the above-referenced taxpayers, or a related person,

d) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired, or

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

Further, the above-referenced taxpayers have advised that the Proposed Transactions described herein will not result in the taxpayers or any related person being unable to pay its outstanding tax liabilities.

Unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter (the "Act"), and the Income Tax Regulations thereunder are referred to as the "Regulations".

Unless otherwise noted, all references to currency are to Canadian dollars.

DEFINITIONS

In this letter, the following terms or expressions have the meanings specified:

"ACo" is a corporation to be incorporated under the BCA as described in Paragraph 10;

"ACo Common Shares" has the meaning assigned in Paragraph 10;

"adjusted cost base" has the meaning assigned by section 54;

"affiliated persons" has the meaning assigned by section 251.1 read without reference to the definition of "controlled" in subsection 251.1(3);

"agreed amount" means the amount that a transferor and transferee have agreed upon in a joint election under subsection 85(1) in respect of a transfer of eligible property;

"Agreeing Province" means a province that has entered into an agreement with the Government of Canada under which the Government of Canada will collect taxes payable under the income tax statute of that province and will make payments to that province in respect of the taxes so collected;

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

"BCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended;

"CRA" means the Canada Revenue Agency;

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

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

"excepted dividend" has the meaning assigned by section 187.1;

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

"fair market value" means the highest price available in an open and unrestricted market, between informed, prudent parties, acting at arm's length and under no compulsion to act, expressed in terms of cash;

"financial intermediary corporation" has the meaning assigned by subsection 191(1);

"General Anti-avoidance Provision of an Agreeing Province" means:

XXXXXXXXXX;

"guarantee agreement" has the meaning assigned by subsection 112(2.2);

XXXXXXXXXX;

"Loan 1" means a non-interest bearing loan made by Parent to Lossco, the principal amount of which will equal the principal amount of the Parent Loan;

"Loan 2" means an interest bearing loan made by Lossco to ACo, the principal amount of which will equal the principal amount of the Parent Loan. Loan 2 will bear interest at an annual rate, based on market conditions at the time the loan is granted, which will not exceed what would be a reasonable commercial rate in these circumstances. Interest on Loan 2 will be payable at the earlier of XXXXXXXXXX of each year or such time that Loan 2 is repaid;

"Loan 3" means a non-interest bearing loan made by Newco to Lossco, the principal amount of which will equal the principal amount of Parent Loan;

"Lossco" means XXXXXXXXXX;

"Lossco Subsidiaries" means Opco, XXXXXXXXXX, the wholly-owned subsidiaries of those corporations and an investment in XXXXXXXXXX;

"Newco" is a corporation to be incorporated under the BCA, as described in Paragraph 11;

"Newco Note" has the meaning assigned in Paragraph 24(a);

"Newco Preferred Shares" means the preferred shares to be issued by Newco described in Paragraph 12;

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

"Opco" means XXXXXXXXXX;

"Opco Common Shares" has the meaning assigned in Paragraph 25;

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

"Paragraph" means a numbered paragraph in this letter;

"Parent" means XXXXXXXXXX;

"Parent Loan" means a loan made by an unrelated, arm's length financial institution to Parent, the principal amount of which will be approximately $XXXXXXXXXX as described in Paragraph 13. The exact principal amount of Parent Loan will be finalized when the Proposed Transactions are implemented;

"principal amount" has the meaning assigned by subsection 248(1);

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

"Proposed Transactions" means the transactions described in Paragraphs 10 to 29;

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

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

"safe-income determination time" has the meaning assigned by subsection 55(1);

XXXXXXXXXX;

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

"taxable dividend" has the meaning assigned by subsection 89(1); and

"term preferred share" has the meaning assigned by subsection 248(1).

FACTS

1. Parent was incorporated under the XXXXXXXXXX and is a taxable Canadian corporation. The taxation year of Parent ends on XXXXXXXXXX. The authorized capital of Parent consists of a class of XXXXXXXXXX shares and XXXXXXXXXX classes of preference shares consisting of XXXXXXXXXX participation shares and XXXXXXXXXX preference shares. XXXXXXXXXX preference shares can be issued in one or more series. The currently issued and outstanding shares are XXXXXXXXXX shares, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX and Class XXXXXXXXXX. Currently, XXXXXXXXXX shares are held by XXXXXXXXXX. The XXXXXXXXXX are held by XXXXXXXXXX. Parent deals with the XXXXXXXXXX Tax Services Office and files its tax return with the XXXXXXXXXX Taxation Centre.

2. Lossco was continued under the BCA and is a taxable Canadian corporation. The taxation year of Lossco ends on XXXXXXXXXX. Lossco is a wholly-owned subsidiary of Parent and acts as a holding company. Lossco's assets in Canada include the Lossco Subsidiaries. Lossco generally does not have significant taxable income as it does not engage in significant activity besides performing centralized functions for the corporate group such as XXXXXXXXXX. While Lossco does recover some of its costs from the Lossco Subsidiaries, it does not mark up these costs and it does not currently have significant independent sources of income. Lossco deals with the XXXXXXXXXX Tax Services Office and files its tax returns with the XXXXXXXXXX Taxation Centre.

3. Parent owns all of the common shares and all of the Class XXXXXXXXXX of Lossco, representing all of the issued and outstanding share capital of Lossco.

4. If the Proposed Transactions were not undertaken in its XXXXXXXXXX taxation year, Lossco's estimated non-capital loss carry-forward would be $XXXXXXXXXX. The full amount of the $XXXXXXXXXX non-capital loss carry-forward would have been realized in the XXXXXXXXXX taxation year of Lossco.

5. Lossco expects that it will continue to incur non-capital losses because of interest-bearing debt obligations that it has outstanding. Lossco's non-capital losses are XXXXXXXXXX% allocable to XXXXXXXXXX (i.e., Lossco only has a permanent establishment in the province of XXXXXXXXXX).

6. Opco was continued under the XXXXXXXXXX and is a taxable Canadian corporation and a public corporation. The taxation year of Opco ends on XXXXXXXXXX. Opco is XXXXXXXXXX corporation and its primary business is XXXXXXXXXX. The authorized capital of Opco includes both common shares and preferred shares XXXXXXXXXX. The common shares are the only shares with voting rights. The currently issued and outstanding shares are common shares, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX, Class XXXXXXXXXX and Class XXXXXXXXXX. Opco deals with the XXXXXXXXXX Tax Services Office and files its tax return with the XXXXXXXXXX Taxation Centre.

7. Lossco owns all of the issued and outstanding voting common shares of Opco. The XXXXXXXXXX Opco are widely held and traded on the XXXXXXXXXX. The other classes of non-voting preference shares of Opco are XXXXXXXXXX.

8. In addition to carrying on XXXXXXXXXX business, Opco is the parent company of several directly-held subsidiaries.

9. Opco earned taxable income of $XXXXXXXXXX in fiscal XXXXXXXXXX and expects to continue to earn significant taxable income in subsequent taxation years. Opco's income is expected to be approximately XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. Lossco will incorporate ACo under the BCA. ACo will be a taxable Canadian corporation. The taxation year of ACo will end on XXXXXXXXXX. Lossco will subscribe for common shares of ACo on incorporation for $XXXXXXXXXX (the "ACo Common Shares"). Lossco will hold the ACo Common Shares as capital property. ACo will not carry on any business and its activities will be limited to investing the loan proceeds, received from Lossco, as described in Paragraph 15, in the Newco Preferred Shares, as described in Paragraph 16. ACo will not be a financial intermediary corporation.

11. Lossco will incorporate Newco under the BCA. Newco will be a taxable Canadian corporation. The taxation year of Newco will end on XXXXXXXXXX. Lossco will subscribe for common shares of Newco for $XXXXXXXXXX. Newco will not carry on any business and its activities will be limited to investing the proceeds received upon the issuance of the Newco Preferred Shares to ACo, as described in Paragraph 16, in a non-interest bearing loan to Lossco, as described in Paragraph 17. Newco will not be a financial intermediary corporation.

12. The authorized capital of Newco will consist of two classes of shares, common shares and preferred shares ("Newco Preferred Shares"). Each Newco Preferred Share will be non-voting, redeemable and retractable for the amount for which it was issued. Dividends on the Newco Preferred Shares will accrue at a fixed rate on a daily basis and will be payable on the earliest of XXXXXXXXXX of each calendar year and the time at which any Newco Preferred Shares are redeemed or retracted. The dividend rate, expressed as a percentage of the amount for which a Newco Preferred Share was issued will be equal to the sum of XXXXXXXXXX% plus the interest rate on Loan 2.

13. Parent will borrow approximately $XXXXXXXXXX from an arm's-length financial institution on a daylight loan basis (the "Parent Loan") on arm's-length commercial terms customary for that type of loan.

14. Parent will use the total proceeds received under Parent Loan to make Loan 1 to Lossco.

15. Lossco will use the total proceeds received under Loan 1 to make Loan 2 to ACo.

16. ACo will use the total proceeds received from Loan 2 to subscribe for Newco Preferred Shares having an aggregate redemption amount and fair market value equal to the total amount of the subscription proceeds. The full amount of the subscription proceeds will be added to the stated capital of the Newco Preferred Shares and will form part of the permanent capital of Newco. The paid-up capital of each Newco Preferred Share issued will be equal to its redemption amount.

17. Newco will use the total proceeds received from the Newco Preferred Share subscriptions described in Paragraph 16 to make Loan 3 to Lossco.

18. Lossco will use the total proceeds received from Loan 3 to repay Loan 1.

19. Parent will use the total proceeds received from the repayment of Loan 1 to repay the Parent Loan.

20. All of the transactions described in Paragraphs 13-19 will take place on the same day.

21. On XXXXXXXXXX or such earlier date as Lossco, Newco and ACo agree, while Loan 2 is outstanding, Lossco will make a contribution of capital to Newco in an amount equal to the accrued dividends payable at that time, by Newco, on the Newco Preferred Shares held by ACo. 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 any class of shares of Newco, or, for greater certainty, to the paid-up capital of any class of shares of Newco. For accounting purposes, the amount of the contribution of capital will be recorded as contributed surplus and will not be income of Newco pursuant to International Financial Reporting Standards.

22. Upon receipt of the contribution capital, described in Paragraph 21, Newco will pay all accrued and unpaid dividends on the Newco Preferred Shares held by ACo.

23. Upon receipt of the payments of the dividends described in Paragraph 22, ACo will pay all accrued and unpaid interest due and payable on Loan 2 to Lossco, pursuant to the terms of Loan 2.

24. Immediately following the payment of interest described in Paragraph 23, the following transactions will occur to unwind the loss consolidation arrangement:

a) Newco will redeem the Newco Preferred Shares held by ACo in consideration for a non-interest bearing promissory note issued by Newco (the "Newco Note"). The Newco Note will have a principal amount and fair market value equal to the redemption amount and fair market value of the Newco Preferred Shares redeemed;

b) ACo will repay Loan 2 by assigning the Newco Note to Lossco in full satisfaction of the amount due under Loan 2. Loan 2 will be cancelled; and

c) Lossco and Newco will agree to setoff the amount due under Loan 3 against the amount due under the Newco Note as payment in full. The obligations under Loan 3 and the Newco Note will be cancelled.

25. Immediately following completion of the transactions described in Paragraphs 24(a) to 24(c), Lossco will transfer all of its ACo Common Shares to Opco in exchange for additional common shares of Opco (the "Opco Common Shares"). The Opco Common Shares issued to Lossco by Opco will have a fair market value equal to the fair market value of the ACo Common Shares transferred.

26. Lossco will jointly elect with Opco, in prescribed form and within the time allowed by subsection 85(6), to have the rules of subsection 85(1) apply to the transfer of the ACo Common Shares to Opco. The agreed amount in respect of the ACo Common shares transferred will be the lesser of the fair market value of the ACo Common Shares transferred and $XXXXXXXXXX, being adjusted cost base of the ACo Common Shares owned by Lossco.

27. Opco will add to its stated capital account maintained for its common shares the agreed amount pursuant to subsection 85(1), as referred to in Paragraph 26. For greater certainty, the increase to the paid-up capital of the common shares of Opco will not exceed the maximum amount that could be added to the paid-up capital of such shares, having regard to subsection 85(2.1).

28. In the taxation year in which Opco acquires the ACo Common Shares, described in Paragraph 25, Opco, as sole shareholder of ACo, will pass a resolution authorizing and requiring ACo to be wound up into Opco. In addition, a general conveyance of the assets of ACo and assumption of liabilities of ACo will be executed between Opco and ACo. ACo will file articles of dissolution with the appropriate Corporate Registry within a reasonable time after the winding-up resolution is passed.

29. Immediately after the resolution to wind up ACo into Opco, Lossco, as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound up into Lossco. In addition, a general conveyance of assets of Newco and assumption of liabilities of Newco will be executed between Lossco and Newco. Newco will file articles of dissolution with the appropriate Corporate Registry within a reasonable time after the winding-up resolution is passed.

ADDITIONAL INFORMATION

30. It is anticipated that the steps described in the Proposed Transactions will be undertaken at the beginning of each future taxation year of Lossco, with new entities to be created having the same attributes as ACo and Newco. For fiscal years XXXXXXXXXX and XXXXXXXXXX it is currently estimated that the amount of loans and preferred share subscriptions in a new entity will be $XXXXXXXXXX for each of the years, based on interest rates in effect in fiscal XXXXXXXXXX.

31. At the time of the Proposed Transactions, Lossco will have the borrowing capacity to obtain a daylight loan, in an amount equal to the amount of Loan 1, directly from an arm's-length financial institution and will not cause Lossco to contravene its debt covenants.

32. At the time of the Proposed Transactions, Lossco will have the financial capacity, including accessing its leverage capacity, to make the capital contributions to Newco described in Paragraph 21. Lossco may obtain the funds to make the capital contributions to Newco by borrowing from one or more of its affiliates or from an arm's-length financial institution as a daylight loan. Lossco will have the borrowing capacity to borrow the amount of the capital contributions from an arm's-length financial institution.

33. At the time it is required to pay the dividends on the Newco Preferred Shares, described in Paragraph 22, Newco will have the financial capacity to satisfy the applicable solvency test and liquidity test under the BCA.

34. Lossco and Opco are affiliated persons and are related persons. ACo and Newco will be an affiliated persons and related persons with respect to Lossco, Opco and each other.

35. Opco and Lossco are XXXXXXXXXX. ACo and Newco will be XXXXXXXXXX.

36. The Newco Preferred Shares will be term preferred shares.

37. The Newco Preferred Shares that will be acquired by ACo will not be acquired in the ordinary course of ACo's business.

38. The Newco Preferred Shares will not, at any time during the implementation of the Proposed Transactions described herein, be:

a) the subject of any undertaking that is a guarantee arrangement;

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);

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).

39. Lossco is not a financial institution, as defined in subsection 190(1), for purposes of Part VI tax. ACo and Newco will not be financial institutions, as defined in subsection 190(1), for purposes of Part VI tax.

PURPOSES OF THE PROPOSED TRANSACTIONS

40. In fiscal XXXXXXXXXX, Lossco acquired a majority controlling interest in XXXXXXXXXX. The acquisition was funded in part by Lossco's debt issuance at that time. Lossco intends to grow through either acquisition(s) or internal organic growth. In XXXXXXXXXX, Lossco issued new debt during favourable market conditions in anticipation of future growth by acquisition. Lossco partially relies on dividends from the Lossco Subsidiaries to finance its outstanding debt. These taxable dividends are expected to continue to be deductible to Lossco pursuant to subsection 112(1). Absent the Proposed Transactions, it is expected that Lossco will annually generate non-capital losses. These non-capital losses are expected to accumulate in Lossco and would remain unused without the implementation of the Proposed Transactions.

41. The purpose of the Proposed Transactions is to effect a tax consolidation of Lossco and Opco in order to permit Opco to utilize the losses that Lossco is expected to incur in the XXXXXXXXXX taxation year. The purpose of the tax consolidation is not to shift income to a lower rate province. Any shift of income between provinces will be incidental to the Proposed Transactions.

42. Loan 2 is being made to ACo, instead of having Lossco make Loan 2 directly to Opco, to ensure that Opco, which is a public corporation, does not incur debt in order to implement the loss utilization.

43. The purpose of Parent obtaining the Parent Loan and lending that amount to Lossco under Loan 1, instead of Lossco borrowing amounts from an arm's-length financial institution, is that Parent has lower borrowing costs than Lossco due to existing banking relationships between Parent and an arm's-length financial institution.

44. The purpose of incorporating Newco is to have Newco issue the Newco Preferred Shares to ACo, rather than having Lossco issue preferred shares directly to ACo which would result in corporate incest.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, and purposes of the Proposed Transactions and provided further that the Proposed Transactions are carried out as described above, we rule as follows:

A. Provided that Opco and Lossco jointly file an election pursuant to subsection 85(1) within the time allowed by subsection 85(6), and subject to the application of subsection 69(11), the provisions of subsection 85(1), other than paragraph 85(1)(e.2), will apply so that the agreed amount in respect of Lossco's transfer of the ACo Common Shares to Opco, described in Paragraph 25, will be deemed to be Lossco's proceeds of disposition and Opco's cost of the ACo Common Shares pursuant to paragraph 85(1)(a).

B. Provided that the requirements of paragraphs 88(1.1)(a) and (b) are satisfied, subsection 88(1.1) will apply after the winding up of ACo into Opco, described in Paragraph 28, to permit Opco to deduct the non-capital losses of ACo in computing its taxable income or tax payable under Part IV for any taxation year commencing after the commencement of the winding-up, subject to the limitations in paragraph 88(1.1)(e) and section 111. For this purpose, ACo will not be considered to have been wound up until it has been formally dissolved.

C. Provided that ACo has a legal obligation to pay interest on Loan 2 and ACo continues to hold the Newco Preferred Shares it acquires for the purpose of gaining or producing income from property, as described in Paragraph 16, ACo will, pursuant to paragraph 20(1)(c), be entitled to deduct, in computing its income for a taxation year (depending on the method regularly followed by ACo in computing its income for the purposes of the Act), the lesser of

(a) the interest paid or payable on Loan 2 in respect of that taxation year; and

(b) a reasonable amount in respect thereof.

D. No amount will be included in the income of Newco pursuant to section 9, paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital to be made by Lossco as described in Paragraph 21.

E. Provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events that includes the Proposed Transactions, then, by virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the taxable dividends described in Ruling F. For greater certainty, the Proposed Transactions described herein, in and by themselves, will not be considered to result in any disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v).

F. The dividends received by ACo on its Newco Preferred Shares, as described in Paragraph 22, will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of ACo for the taxation year in which the dividends are received, 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).

G. Neither Part IV.1 nor Part VI.1 will apply to the dividends described in Ruling F, as the dividends will be excepted dividends and excluded dividends.

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

I. Subsection 245(2) 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 above.

J. The General Anti-avoidance Provision of an Agreeing Province will not be applied, as a result of the Proposed Transactions, in and by themselves, to redetemine the tax consequences confirmed in the rulings given above, in respect of a taxation year for which such Province was an Agreeing Province.

The above rulings are 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 prior to 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 and the Regulations which, if enacted into law, could have an effect on the rulings provided herein.

COMMENTS

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

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

b) the amount of any non-capital loss or any other tax account of any corporation referred to herein;

c) the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

d) subject to Ruling J, the application or non-application of a general anti-avoidance provision of any province; and

e) 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.

Yours sincerely,

XXXXXXXXXX
Section Manager
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch