2016 Ruling 2016-0673141R3 - Loss consolidation involving interco loans

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 profitcos could deduct interest paid on a loan from a related lossco where the proceeds of such loans were used to acquire preferred shares.

Position: Yes.

Reasons: Conforms to our requirements for these types of loss consolidations.

XXXXXXXXXX					2016-067314

XXXXXXXXXX, 2016

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling 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.

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

i. in a previously filed tax return of any of the Taxpayers or a related person;

ii. being considered by a tax services office or a tax 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. the subject of a current or completed court process involving the Taxpayers or a related person; or

v. the subject of a ruling request previously considered by the Directorate.

Unless specified otherwise, all statutory references herein are to provisions or parts of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c. 1, as amended to the date hereof (the “Act”) and all references to monetary amounts are in Canadian dollars.

DEFINITIONS

“#Co” means XXXXXXXXXX, a corporation wholly-owned by Lossco and a party to the loss utilization arrangement described in Paragraph 4 below;

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

“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 Lender” means XXXXXXXXXX;

XXXXXXXXXX

“capital loss” has the meaning assigned by paragraph 39(1)(b) of the Act;

“CBCA” means the (Canada) Business Corporations Act;

“CRA” means the Canada Revenue Agency;

“Daylight Loan” means the loan described in Paragraph 13 below;

“dividend rental arrangement” has the meaning assigned by subsection 248(1) of the Act;

“eligible dividend” has the meaning assigned by subsection 248(1) and subsection 89(1) of the Act;

“excepted dividend” has the meaning assigned by section 187.1 of the Act;

“excluded dividend” has the meaning assigned by subsection 191(1) of the Act;

XXXXXXXXXX

“GAAR” means the general anti-avoidance rule and encompasses the provisions set out in Part XVI of the Act;

“ITCs” means “investment tax credits” as defined under subsection 127(9) of the Act;

“Lossco” means XXXXXXXXXX, the corporation described in Paragraphs 1, 2, and 3;

“Lossco Demand Loan” means the loan described in Paragraph 15 below;

“Lossco Group” is the group of corporations described in Paragraph 2;

“Newco” means the new company described in Paragraph 12;

“Newco Preferred Shares” means the preferred shares to be issued by Newco as described in Paragraph 14;

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

XXXXXXXXXX

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

“Profitco” means any of Profitco 1, Profitco 2, Profitco 3 and Profitco 4;

“Profitco 1” means XXXXXXXXXX, the corporation described in Paragraph 6 below;

“Profitco 2” means XXXXXXXXXX, the corporation described in Paragraph 7 below;

“Profitco 3” means XXXXXXXXXX, the corporation described in Paragraph 8 below;

“Profitco 4” means XXXXXXXXXX, the corporation described in Paragraph 9 below;

“Profitcos” refers collectively to Profitco 1, Profitco 2, Profitco 3 and Profitco 4;

“Profitco Demand Loan” refers to any one of the 4 Profitcos Demand Loans;

“Profitcos Demand Loans” means the loans described in Paragraph 13 below;

“public corporation” has the meaning assigned by subsection 89(1) of the Act;

“Proposed Transactions” means the proposed transactions described in Paragraphs 12 to 20;

“related person” has the meaning assigned by subsection 251(2) of the Act;

XXXXXXXXXX

“taxable Canadian corporation” has the meaning assigned by subsections 248(1) and 89(1) of the Act;

“taxable dividend” has the meaning assigned by subsections 248(1) and 89(1) of the Act; and

“taxable income” has the meaning assigned by subsection 248(1) of the Act.

FACTS

1. Lossco is a public corporation and a taxable Canadian corporation. It was incorporated under the XXXXXXXXXX. The common shares of Lossco are listed on the XXXXXXXXXX. The common shares of Lossco are widely held with XXXXXXXXXX having control of Lossco.

2. Lossco is the corporate parent of a large group of Canadian and non-Canadian corporations (the “Lossco Group”) engaged in XXXXXXXXXX. Lossco does not conduct operations directly. Its registered address is XXXXXXXXXX, its Taxation Centre is XXXXXXXXXX Taxation Centre, its Tax Services Office is the XXXXXXXXXX Tax Services Office, and its business number is XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) of the Act and Part IV of the Income Tax Regulations, all of Lossco’s gross revenue and salaries and wages were allocated to XXXXXXXXXX in XXXXXXXXXX. This allocation is expected to hold for the duration of the Loss Consolidation Arrangement.

3. Lossco generates non-capital losses while its Canadian subsidiaries generate substantial taxable income. Lossco expects to continue to incur losses as a result of financing obtained for the Lossco Group.

4. Pubco, Profitco 1, Profitco 2, Profitco 3, Profitco 4, and #Co undertook transactions similar to the Proposed Transactions which was the subject of a ruling previously issued by the Rulings Directorate on XXXXXXXXXX, 2012 (2012-045867). The previous loss consolidation transactions will be unwound prior to the implementation of the Proposed Transactions in accordance with the previously issued ruling. In particular, the company is planning to unwind the loans and preferred shares on XXXXXXXXXX, and will be winding up #Co on XXXXXXXXXX.

5. Lossco directly and indirectly wholly owns all of the shares of Profitco 1, Profitco 2, Profitco 3 and Profitco 4.

6. Profitco 1 is a taxable Canadian corporation and has a XXXXXXXXXX year end. It was incorporated under the CBCA. Its authorized share capital consists of an unlimited number of common shares without par value and an unlimited number of preferred shares. Profitco 1 has XXXXXXXXXX common shares issued and outstanding; it has not issued preferred shares. Its registered address is XXXXXXXXXX, its Taxation Centre is XXXXXXXXXX Taxation Centre, its Tax Services Office is the XXXXXXXXXX Tax Services Office, and its business number is XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) of the Act and Part IV of the Income Tax Regulations, Profitco 1’s taxable income was allocated as follows in the XXXXXXXXXX taxation year:

Province			Percentage Allocated

XXXXXXXXXX			XXXXXXXXXX

The above allocation is expected to hold for the duration of the Loss Consolidation Arrangement.

7. Profitco 2 is a taxable Canadian corporation and has a XXXXXXXXXX year end. It was incorporated under the CBCA. Its authorized share capital consists of an unlimited number of common shares without par value. Profitco 2 has XXXXXXXXXX common shares issued and outstanding; it has not issued preferred shares. Its registered address is XXXXXXXXXX, its Taxation Centre is XXXXXXXXXX Taxation Centre, its Tax Services Office is the XXXXXXXXXX Tax Services Office, and its business number is XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) of the Act and Part IV of the Income Tax Regulations, Profitco 2’s taxable income was allocated as follows in the XXXXXXXXXX taxation year:

Province			Percentage Allocated

XXXXXXXXXX			XXXXXXXXXX

The above allocation is expected to hold for the duration of the Loss Consolidation Arrangement.

8. Profitco 3 is a taxable Canadian corporation and has a XXXXXXXXXX year end. It was incorporated under the XXXXXXXXXX. Its authorized share capital consists of an unlimited number of common shares without par value and an unlimited number of preferred shares. Profitco 3 has XXXXXXXXXX common shares issued and outstanding; it has not issued preferred shares. Its registered address is XXXXXXXXXX, its Taxation Centre is XXXXXXXXXX Taxation Centre, its Tax Services Office is the XXXXXXXXXX Tax Services Office, and its business number is XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) of the Act and Part IV of the Income Tax Regulations, Profitco 3’s taxable income was allocated as follows in the XXXXXXXXXX taxation year:

Province			Percentage Allocated

XXXXXXXXXX			XXXXXXXXXX

The above allocation is expected to hold for the duration of the Loss Consolidation Arrangement.

9. Profitco 4 is a taxable Canadian corporation and has a XXXXXXXXXX year end. It was incorporated under the CBCA. Its authorized share capital consists of an unlimited number of common shares without par value. It has XXXXXXXXXX common share issued and outstanding. Its registered address is XXXXXXXXXX, its Taxation Centre is XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office and its business number is XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) of the Act and Part IV of the Income Tax Regulations, all of Profitco 4’s taxable income in the XXXXXXXXXX taxation year was allocated to XXXXXXXXXX. This allocation is expected to hold for the duration of the Loss Consolidation Arrangement.

10. At XXXXXXXXXX, Lossco had non-capital losses available for carry forward as follows:

Year			Amount of Non-Capital Losses	

XXXXXXXXXX		XXXXXXXXXX

11. At XXXXXXXXXX, Lossco had ITCs available for carry forward as follows:

Year				Amount of ITCs

XXXXXXXXXX			XXXXXXXXXX

PROPOSED TRANSACTIONS

12. Lossco will incorporate a new company (“Newco”) under the XXXXXXXXXX. Newco will be a taxable Canadian corporation and will have a XXXXXXXXXX taxation year end. The authorized share capital of Newco will consist of an unlimited number of common shares without par value as well as an unlimited number of preferred shares (“Newco Preferred Shares”).

13. According to an independent financial report, the maximum amounts that Profitco 1, Profitco 2, Profitco 3 and Profitco 4 (collectively, “the Profitcos”) would be able to borrow from an arm’s length lender are $XXXXXXXXXX. On this basis, Lossco will borrow $XXXXXXXXXX on a daylight basis (the “Daylight Loan”) from Arm’s Length Lender and will use the proceeds from the Daylight Loan to make subordinated interest-bearing loans to the Profitcos (the “Profitcos Demand Loans”), based on their respective maximum borrowing capacities, at an annual interest rate of XXXXXXXXXX% which is XXXXXXXXXX. The interest will be payable annually in arrears. The Profitcos Demand Loans will be repayable in cash or by delivering a financial asset of Profitco 1, Profitco 2, Profitco 3 or Profitco 4, as the case may be, including the Lossco Demand Loan, described in Paragraph 15.

14. The Profitcos will use the proceeds from the Profitcos Demand Loans to subscribe for Newco Preferred Shares having a redemption amount, fair market value, adjusted cost base, and paid-up capital equal to the principal amount of the Profitcos Demand Loans. The Newco Preferred Shares will have the following attributes:

a) Non-participating;

b) Non-voting;

c) Annual cumulative dividend rate of XXXXXXXXXX% applied to the redemption amount;

d) Redeemable at any time at the option of Newco for an amount equal to the redemption amount and any unpaid dividends;

e) Redeemable by (1) paying cash or (2) assigning the Lossco Demand Loan and paying cash equal to unpaid dividends or (3) setting-off amounts owing under the Profitcos Demand Loans in circumstances where Newco has become the holder of the Profitcos Demand Loans and paying cash equal to unpaid dividends; and

f) Retractable at any time at the option of the Profitcos for an amount equal to the redemption amount and any unpaid dividends.

15. Newco will lend the subscription proceeds received from the Profitcos, as described in Paragraph 14, to Lossco on an interest-free, demand basis (the “Lossco Demand Loan”). The terms of the Lossco Demand Loan will allow Lossco to repay the loan by assigning the Profitcos Demand Loans to Newco.

16. Lossco will use the proceeds from the Lossco Demand Loan to repay the Daylight Loan.

17. Lossco will agree to and will make capital contributions to Newco at least annually equal to the amount of dividends to be paid by Newco to each of the Profitcos on the Newco Preferred Shares for so long as the preferred shares are outstanding. No shares will be issued by Newco in respect of the capital contributions. The amount of each capital contribution will be recorded as contributed surplus for accounting purposes.

18. Newco will use the amounts received as capital contributions to pay dividends on the Newco Preferred Shares at least annually.

19. The Profitcos will use the amounts received as dividends from Newco to pay interest on the Profitcos Demand Loans at least annually.

20. Within XXXXXXXXXX years from the date of this letter, the loss consolidation structure will be unwound in the following manner:

a) Lossco will make capital contributions to the common share capital of Newco equal to the amount of any accrued and unpaid dividends on the Newco Preferred Shares.

b) Newco will declare and pay the balance of any accrued and unpaid dividends on the Newco Preferred Shares.

c) The Profitcos will pay the balance of any accrued and unpaid interest on the Profitcos Demand Loans.

d) Newco will redeem the Newco Preferred Shares held by Profitco 1, Profitco 2, Profitco 3 or Profitco 4, as the case may be, and will settle the amount owing on the redemption by assigning a corresponding amount of the Lossco Demand Loan to Profitco 1, Profitco 2, Profitco 3 or Profitco 4, as the case may be.

e) Lossco and each of the Profitcos will set off the amounts due between them on the Profitcos Demand Loans and the Lossco Demand Loan, as the case may be, in full and absolute payment of each of these obligations.

f) Newco will be wound up into Lossco pursuant to subsection 88(1) of the Act.

OTHER REPRESENTATIONS

21. The Newco Preferred Shares 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. 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), 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

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

22. Lossco, Newco, Profitco 1, Profitco 2, Profitco 3 and Profitco 4 are related persons and affiliated persons for purposes of the Act and will continue to be related and affiliated persons throughout the period that the Loss Consolidation Arrangement is in place.

23. Lossco and the Profitcos are not, nor will they be at any time during the implementation of the Proposed Transactions, XXXXXXXXXX.

24. The Profitcos and Lossco are XXXXXXXXXX. However, none of the preferred shares will be acquired by the Profitcos in the ordinary course of their business and no guarantee arrangement has been entered into in the course of the Proposed Transactions.

25. The payment of dividends on the Newco Preferred Shares has no purpose other than the purpose described under the heading “Purpose of the Proposed Transactions”.

26. The Proposed Transactions will be legally effective.

27. At all times, Lossco will have the financial capacity to make the relevant capital contributions to Newco as described in Paragraph 17.

28. At all times, the Profitcos will have the solvency and liquidity to service the Profitcos Demand Loans.

29. At the time it is required to pay the dividends on the Newco Preferred Shares, described in Paragraphs 18 and 20, Newco will have the financial capacity to satisfy the applicable solvency and liquidity test under the XXXXXXXXXX (having regard to the contributions of capital received from Lossco).

30. If at any time before XXXXXXXXXX years, it is determined that Lossco will have sufficient taxable income to fully utilize its carry-forward of non-capital losses and ITCs as described in Paragraphs 10 and 11, the loss consolidation structure will be unwound at that time.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the Proposed Transactions is to enable Lossco to earn sufficient interest income to offset its non-capital losses and ITCs while allowing the Profitcos to deduct interest expense on borrowed money used to acquire the Newco Preferred Shares in computing their profits for the year.

The purpose of both the payment and the receipt of the dividends on each of the Newco Preferred Shares, as described in Paragraph 18, is to provide a reasonable return on the Newco Preferred Shares issued by Newco to the particular Profitco and to fund the interest payments by the particular Profitco on the particular Profitco Demand Loan. Furthermore, the purpose of the dividends is not to reduce the fair market value or capital gain of any share, nor to increase the total cost amounts of properties of any of the Profitcos.

RULINGS PROVIDED

Provided that

(a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions,

(b) the proposed transactions are completed in the manner described above, and

(c) there are no other transactions which may be relevant to the rulings requested,

we rule that:

A. Provided that the particular Profitco has a legal obligation to pay interest on the particular Profitco Demand Loan, and the particular Newco Preferred Shares continue to be held by the particular Profitco for the purpose of gaining or producing income therefrom, the particular Profitco 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 particular Profitco Demand Loan for that taxation year (depending on the method regularly followed by the particular Profitco in computing its income for the purposes of the Act); and (ii) a reasonable amount in respect thereof.

B. The dividends received by the particular Profitco in respect of the Newco Preferred Shares held by it in a taxation year will be taxable dividends that will be deductible in computing the taxable income of the particular Profitco for the taxation year in which the dividends are received pursuant to subsection 112(1), and 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).

C. Neither XXXXXXXXXX will apply to the dividends described in Ruling B, as the dividends will be excepted dividends and excluded dividends.

D. The receipt by Newco of capital contributions from Lossco as described in Paragraph 18 will not be included in the income of Newco.

E. Provided that the purpose of the dividends in Paragraphs 18 and 20 is what is described in the “Purpose of the Proposed Transactions” above and the Proposed Transactions are undertaken in the manner described above, subsection 55(2) will not apply in respect of the dividends described in Paragraphs 18 and 20 above.

F. The provisions of subsections 15(1), 56(2), 69(4), 69(11) and 246(1) will not apply as a result of entering into the Proposed Transactions, in and by themselves.

G. The settlement of the Profitcos Demand Loans and the Lossco Demand Loan as described in Paragraph 20(e) will not give rise to any “forgiven amount” for purposes of section 80.

H. 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.

I. 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 general limitations and qualifications set out in Information Circular 70-6R7 dated April 22, 2016, and are binding on the CRA provided that the Proposed Transactions are entered into on or before XXXXXXXXXX. As indicated in paragraph 20, the loss consolidation structure will be unwound within XXXXXXXXXX years from the date of this letter.

The above rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

COMMENTS

Nothing in this letter 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 reasonableness or fair market value of any fees or expenditures referred to herein;

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

(d) any tax consequences relating to the Facts and Proposed Transactions described herein, other than those specifically described in the rulings given above.

Yours sincerely,

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