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: Whether a reasonable expectation of an independent source of income to fund dividends is sufficient for a loss utilization transaction.
Position: Question of fact as to whether a reasonable expectation of income exists.
Reasons: Application of case law.
XXXXXXXXXX
2014-052225
Lara G. Friedlander
June 13, 2014
Dear XXXXXXXXXX:
Re: Loss Utilizations
This is in response to your email of February 27, 2014 concerning the requirement for an independent source of income to fund dividend payments in the context of a typical loss utilization structure.
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Also, where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. Nonetheless, we have provided some general comments below.
A profitable taxable Canadian corporation ("Profitco") is related to a taxable Canadian corporation with considerable non-capital losses ("Lossco"). Lossco is developing a significant commercial use building on a property with a significant accrued gain.
In order to utilize losses within the corporate group, Lossco lends money to Profitco at a reasonable stated rate of interest. Profitco in turn uses the proceeds to invest in preferred shares of Lossco. At the time that Lossco loans funds to Profitco, Lossco has no current independent source of income. Lossco anticipates that its development project will yield material profits in future years.
In the past, in connection with similar loss utilization transactions, the CRA has required that the loss corporation have an independent source of income. You have asked for our views regarding a loss utilization strategy undertaken by Profitco and Lossco on the basis that Lossco does not have a current independent source of income.
Our Comments
One of the requirements for the deductibility of interest on borrowed money under paragraph 20(1)(c) of the Act is that the borrowed money must be used for the purpose of earning income from a business or property (other than borrowed money used to acquire property the income from which would be exempt or to acquire a life insurance policy).
Income Tax Technical News No. 30 (May 21, 2004) makes the following comment regarding the CRA's views on typical loss utilization structures:
"While we have not reached the point where we would state that C.R.B. Logging is no longer good law, we have provided rulings on some upstream shareholding situations. The key criteria to be met in such situations is the existence of other assets in the parent company that can generate sufficient income to pay the dividends on the preferred shares held by the subsidiary".
Whether there are assets in the parent company that can generate sufficient income to pay the dividends on preferred shares held by the subsidiary is a question of fact. As indicated above, further guidance from the CRA regarding particular circumstances may be available through the advance income tax rulings process.
We trust that these comments will be of assistance.
Yours truly,
G. Moore
For Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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