2020 Ruling 2020-0868531R3 - Loss Consolidation Ruling

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 particular loss consolidation arrangement is acceptable. In this arrangement, Lossco obtains a daylight loan from a third party and uses the proceeds to make an interest bearing loan to Profitco, its sister corporation, which uses the proceeds to invest in preferred shares of Lossco. The main issues are whether Lossco would be entitled to apply existing non-capital losses against the interest income received on the loan; and whether Profitco would be entitled to deduct the interest expense paid on the loan and the dividends received on the Lossco Preferred Shares.

Position: Yes.

Reasons: The proposed transactions conform to our requirements for these types of loss consolidation rulings, in this case on the basis that the entities involved are related and affiliated. The proposed transactions would be legally effective and commercially plausible.

XXXXXXXXXX									2020-086853

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request

XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, as amended by 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 subsequent correspondence.

We understand that, to the best of your knowledge and that of the Taxpayers involved, none of the Proposed Transactions or issues involved in this Ruling request are the same or substantially similar to transactions or issues that are:

(i) in a previously filed tax return of the Taxpayers or a related person and:

a. being considered by the CRA in connection with such return;

b. under objection by the Taxpayers or a related person;

c. the subject of a current or completed court process involving the Taxpayers or a related person; or

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

The Taxpayers have also confirmed that the proposed transactions described herein will not result in the Taxpayers or any person related to the Taxpayers being unable to pay any of their outstanding tax liabilities.

This document is based solely on the Facts and Proposed Transactions described below. The documentation submitted with your request does not form part of the Facts and Proposed Transactions except as expressly referred to herein, and any references thereto are otherwise provided solely for the convenience of the reader.

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 the regulations made thereunder (the “Regulations”). All references to monetary amounts are in Canadian dollars.

DEFINITIONS

“ACB” means “adjusted cost base” and has the meaning assigned by section 54;

“Aco” means XXXXXXXXXX, the corporation described in Paragraph 1;

“affiliated person” has the meaning assigned by section 251.1, read without reference to the definition of “controlled” in subsection 251.1(3);

“arm’s length” has the meaning assigned by subsection 251(1);

“BCA1” means Business Corporations Act XXXXXXXXXX;

“BCA2” means Business Corporations Act XXXXXXXXXX;

“Bco” means XXXXXXXXXX, the corporation described in Paragraph 1;

“Canco 1” means XXXXXXXXXX, a taxable Canadian corporation that was amalgamated with Canco 4 and OldLossco 2 to form Lossco described in Paragraphs 4(c) and 4(d);

“Canco 2” means XXXXXXXXXX, a taxable Canadian corporation that was amalgamated with Canco 3 and OldLossco 1 to form OldLossco2 described in Paragraph 4(b);

“Canco 3” means XXXXXXXXXX, a taxable Canadian corporation that was amalgamated with Canco 2 and OldLossco 1 to form OldLossco 2 described in Paragraph 4(b);

“Canco 4” means XXXXXXXXXX, a taxable Canadian corporation that was amalgamated with Canco 1 and OldLossco 2 to form Lossco as described in Paragraphs 4(c) and 4(d);

“CRA” means Canada Revenue Agency;

“Daylight Loan” means a loan made by a third party financial institution to Lossco, as described in Paragraph 14;

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

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

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

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

“FMV” or “fair market value” means the highest price available in an open and unrestricted market between informed and prudent parties dealing at arm’s length and under no compulsion to act, expressed in terms of cash;

“financial institution” has the meaning assigned by subsection 190(1);

“forgiven amount” has the meaning assigned by subsections 80(1) and 80.01(1);

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

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

“Holdings” means XXXXXXXXXX, the corporation described in Paragraph 1;

“IB Note” means the interest bearing promissory note evidencing a loan from Lossco to Profitco described in Paragraph 15;

“Implementation Date” means in and around XXXXXXXXXX;

“Loss Consolidation Arrangement” means the transactions described in Paragraphs 14 to 17;

“Lossco” means XXXXXXXXXX, the corporation described in Paragraph 3;

“Lossco Parent (XXXXXXXXXX)” means XXXXXXXXXX, the corporation described in Paragraph 2;

“Lossco Preferred Shares” means the preferred shares described in Paragraph 16;

“NIB Note” means the demand non-interest bearing promissory note described in Paragraph 20(c);

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

XXXXXXXXXX;

“OldLossco 1” means XXXXXXXXXX, the corporation described in Paragraph 4(a);

“OldLossco 2” means XXXXXXXXXX, the corporation described in Paragraph 4(b);

“PUC” means “paid-up capital” and has the meaning assigned by subsection 89(1);

“Paragraph” means a numbered paragraph in this letter;

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

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

“Profitco” means XXXXXXXXXX, the corporation described in Paragraph 10;

“Profitco Parent (US)” means XXXXXXXXXX, the corporation described in Paragraph 9;

“Proposed Transactions” means the transactions described in Paragraphs 14 to 20;

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

“Rulings” means the advance income tax rulings labelled “A” to “I” in this letter;

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

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

“Taxpayers” mean the entities described on page 1 of this letter;

“Ultimate Parent” means XXXXXXXXXX, the corporation described in Paragraph 1; and

XXXXXXXXXX.

FACTS

1. Ultimate Parent is a XXXXXXXXXX resident corporation, the shares of which are listed on the XXXXXXXXXX under the symbol “XXXXXXXXXX”. Ultimate Parent holds all of the issued and outstanding shares of Holdings, a XXXXXXXXXX resident corporation. Holdings holds all of the issued and outstanding shares of Aco, a XXXXXXXXXX resident corporation, and all of the issued and outstanding shares of Bco, a XXXXXXXXXX resident limited liability corporation.

2. Aco holds all of the issued and outstanding shares of Lossco Parent (XXXXXXXXXX), a corporation resident in XXXXXXXXXX. Lossco Parent (XXXXXXXXXX) is the financing entity within the Ultimate Parent group. Lossco Parent (XXXXXXXXXX) holds all of the issued and outstanding shares of Lossco.

3. Lossco is a corporation formed by amalgamation under the BCA1 on XXXXXXXXXX and is a private corporation and a taxable Canadian corporation. Lossco is in the business XXXXXXXXXX. Lossco has a taxation year-end of XXXXXXXXXX. Lossco’s registered address is XXXXXXXXXX. Lossco files its return XXXXXXXXXX.

4. The following describes the history of Lossco’s predecessor corporations:

XXXXXXXXXX.

5. Lossco has an outstanding debt owing to Lossco Parent (XXXXXXXXXX) (the “NAL Debt”) in the amount of $XXXXXXXXXX related to the acquisition of Canco 1, Canco 2 and Canco 3. The NAL Debt carries interest at a rate of XXXXXXXXXX, and is repayable on demand. Lossco Parent (XXXXXXXXXX) obtained the funds to extend the NAL Debt to Lossco, through Preferred Equity Certificates from Aco.

6. Lossco has unexpired non-capital losses available to be carried forward of approximately $XXXXXXXXXX as at its taxation year ended XXXXXXXXXX. During its taxation years ending XXXXXXXXXX to XXXXXXXXXX, Lossco incurred approximately $XXXXXXXXXX in interest expense in respect of the NAL Debt. The breakdown of these losses is as follows:

XXXXXXXXXX

For greater certainty, none of the losses were incurred by a predecessor of Lossco.

7. The losses incurred in Lossco’s taxation years ending XXXXXXXXXX to XXXXXXXXXX were allocable to XXXXXXXXXX and XXXXXXXXXX. The losses incurred by Lossco for its taxation years ending XXXXXXXXXX to XXXXXXXXXX were allocable XXXXXXXXXX% to XXXXXXXXXX.

8. Lossco is expected to incur additional non-capital losses for its taxation years ending in XXXXXXXXXX. Lossco is expected to earn $XXXXXXXXXX of net income in XXXXXXXXXX:

XXXXXXXXXX

9. Bco holds all of the issued and outstanding shares of Profitco Parent (XXXXXXXXXX), a corporation resident in XXXXXXXXXX. Profitco Parent (XXXXXXXXXX) holds all of the issued and outstanding shares of Profitco.

10. Profitco is a private corporation and a taxable Canadian corporation and was incorporated under the BCA2 on XXXXXXXXXX. Profitco is a manufacturing and services corporation involved XXXXXXXXXX. Profitco has a taxation year-end of XXXXXXXXXX. Profitco’s registered address XXXXXXXXXX.

11. Profitco operates through permanent establishments in a number of provinces. The provincial allocation for Profitco’s XXXXXXXXXX taxation year was approximately as follows:

XXXXXXXXXX

12. Profitco’s taxable income (rounded) for the last three taxation years, and forecasted taxable income for XXXXXXXXXX to XXXXXXXXXX are as follows:

XXXXXXXXXX

13. Lossco and Profitco are the only Canadian resident entities within the Ultimate Parent group.

PROPOSED TRANSACTIONS

Implementation of the Loss Consolidation Arrangement

14. Lossco will borrow $XXXXXXXXXX from an unrelated, arm’s length financial institution on arm’s length commercial terms customary for this type of loan (“Daylight Loan”).

15. Using the proceeds of the Daylight Loan, Lossco will make an interest-bearing loan in the same amount to Profitco evidenced by a promissory note (the “IB Note”), on the following conditions:

a) Simple interest will accrue on the IB Note and will be calculated daily at an annual fixed rate that is a commercial arm’s length rate, estimated to be XXXXXXXXXX% per annum. The interest on the IB Note will be paid on or before the last business day of each fiscal year; and

b) The IB Note will be repayable on demand and will also provide that the principal amount may be satisfied at Lossco’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 Lossco Preferred Shares or, (iv) by way of set-off against the NIB Note if the NIB Note belongs to Profitco at the time of repayment.

16. Using the proceeds of IB Note, Profitco will subscribe for preferred shares of Lossco (“Lossco Preferred Shares”) for cash consideration of approximately $XXXXXXXXXX. The aggregate redemption amount, retraction amount, ACB and paid-up capital of the issued Lossco Preferred Shares will be equal to the subscription amount. The attributes of the Lossco Preferred Shares will be the following:

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 a redemption 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 the NIB 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;

d) The holder of the Lossco Preferred shares will be entitled to a cumulative dividend, payable annually, calculated daily and accruing by reference to the redemption amount of the Lossco Preferred Shares at a rate equal to the interest rate on the IB Loan plus XXXXXXXXXX% for an aggregate dividend rate of XXXXXXXXXX% per annum.

17. Using the proceeds from the issuance of the Lossco Preferred Shares, Lossco will repay the Daylight Loan.

Maintenance

18. Annually, Lossco will pay a dividend on the Lossco Preferred Shares to Profitco. The payment will be made by Lossco using cash made available by an entity of the Ultimate Parent group (but not Profitco) or using external financing on a daylight loan basis.

19. On the same day, Profitco will pay to Lossco the accrued and unpaid interest on the IB Note.

Unwind of the Loss Consolidation Arrangement

20. At the earlier of (i) 3 years after the implementation of the Loss Consolidation Arrangement or (ii) when Lossco’s non-capital losses described in Paragraphs 6 and 8 have been fully utilized, the Loss Consolidation Arrangement will be unwound in the following order:

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

b) Profitco will pay to Lossco the accrued and unpaid interest on the IB Note.

c) Subject to any applicable corporate law solvency tests, Lossco will redeem the issued and outstanding Lossco Preferred Shares held by Profitco for an amount equal to their aggregate FMV and redemption amount which will also be equal to the principal amount of the IB Note and will issue a non-interest bearing demand note (the “NIB Note”) to Profitco in satisfaction of the redemption proceeds.

d) Profitco and Lossco will enter into a set-off agreement whereby the NIB Note will be set-off against the IB Note.

ADDITIONAL INFORMATION

21. Lossco and Profitco are related persons and affiliated persons. Lossco and Profitco will be related persons and affiliated persons and will continue to be related persons and affiliated persons throughout the period that the loss consolidation structure is in place. The structure will be wound-up in the manner described in Paragraph 20 of the Proposed Transactions if any entity previously mentioned in this letter ceases to be affiliated following an acquisition of control by a non-affiliated third party.

22. None of the entities described in this letter, except for Canco 1, Canco 2, Canco 3 and Canco 4, have been subject to an acquisition of control and no such acquisitions are anticipated in the future.

23. Profitco will have sufficient income to utilize all of the interest expense incurred in respect of the IB Note, to either offset its current taxable income, or to carry back in the form of a loss to its three previous taxation years.

24. Lossco and Profitco will undertake steps to ensure that the interest income earned by Lossco under the Proposed Transactions will not exceed an amount that could be fully sheltered with Lossco’s non-capital losses.

25. The principal amount of the Daylight Loan will not exceed the amount that the Ultimate Parent group could reasonably be expected to borrow from an arm’s length financial institution.

26. The interest rate on the IB Note is a commercial rate, and the terms of the IB Note are commercial terms.

27. None of the corporations involved in the Proposed Transactions are, or will be, a specified financial institution or a restricted financial institution within the meaning of subsection 248(1), or a financial intermediary corporation within the meaning of subsection 191(1). Furthermore, Profitco will not acquire the Lossco Preferred Shares in its ordinary course of business.

28. At no time during the implementation of the Proposed Transactions will the Lossco Preferred Shares 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 as defined in subsection 248(1);

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:

ii. an obligation of the type described in subparagraph 112(2.4)(b)(i), other than an obligation of a corporation that is related (if the Act were read without reference to paragraph 251(5)(b)); or

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

29. At the time of the Loss Consolidation Arrangement:

a) Lossco will have the financial capacity to satisfy the applicable solvency test and liquidity test under corporate law to pay the dividends on the Lossco Preferred Shares described in Paragraphs 18 and 20(a), and to redeem the Lossco Preferred Shares as described in Paragraph 20(c).

b) Profitco will have the solvency and liquidity to service the IB Note as described in Paragraphs 19 and 20(b).

30. The Lossco Preferred Shares will be taxable preferred shares. However, dividends received by Profitco on the Lossco Preferred Shares, as described in Paragraphs 18 and 20(a), will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1).

31. The dividends paid and received on the Lossco Preferred Shares have no purpose other than the purpose described under the heading “Purpose of the Proposed Transactions.”

32. Profitco and Lossco are not financial institutions as defined under subsection 190(1), for purposes of Part VI tax.

33. The Proposed Transactions will be legally effective.

PURPOSE OF THE PROPOSED TRANSACTIONS

34. 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 IB Note and thus will enable Lossco to effectively utilize its non-capital losses already incurred, as well as the non-capital losses Lossco is forecasted to incur.

35. The purpose of the Proposed Transactions is not to shift income between provinces and any such shift of income between provinces will be incidental to the Proposed Transactions.

36. The purpose of both the payment and the receipt of the dividends on the Lossco Preferred Shares as described in Paragraphs 18 and 20(a) of the Proposed Transactions is to provide a reasonable return on such shares. More specifically, none of the purposes of the dividends is to reduce the fair market value or capital gain of any share, nor to increase the total cost amounts of any properties.

37. The Proposed Transactions are not being undertaken to refresh non-capital losses or facilitate the use of such losses in a taxation year after the taxation year in which the losses would have otherwise expired in the hands of Lossco.

RULINGS

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 as follows:

A. Provided that Profitco has a legal obligation to pay interest on the IB Note and that Profitco continues to hold the Lossco Preferred Shares for the purpose of gaining or producing income from business or property, Profitco will be entitled, pursuant to paragraph 20(1)(c), to deduct the lesser of (i) the interest paid or payable (depending on the method regularly followed by in computing its income for purposes of the Act) in respect of the year on the IB Note; or (ii) a reasonable amount in respect thereof.

B. Profitco will be entitled to carry back to its prior taxation years the non-capital losses that may arise as a result of the deductions described in Ruling A above, subject to any applicable restrictions in section 111.

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

D. Dividends received by Profitco on the Lossco Preferred Shares as described in Paragraphs 18 and 20(a), will be taxable dividends and such dividends will be deductible pursuant to subsection 112(1) in computing the taxable income of Profitco for the year in which the dividends are received; and, for greater certainty such deduction will not be precluded by any of subsections 112(2.1), (2.2), (2.3) or (2.4).

E. Part IV.1 and Part VI.1 will not apply to the dividends described in Ruling D.

F. Provided that the only purpose of the dividends in Paragraphs 18 and 20(a) is as described in the “Purpose of the Proposed Transactions,” and the Proposed Transactions are undertaken in the manner described above, subsection 55(2) will not apply in respect of the dividends received by Profitco on the Lossco Preferred Shares, as described in in Paragraphs 18 and 20(a) above.

G. The settlement of the IB Note and the NIB Note, as described in Paragraph 20(d) 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 tax collection agreement is in effect.

The above Rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R11 dated April 1, 2021, and are binding on the CRA provided that the Proposed Transactions described in Paragraphs 14 to 17 above are commenced and entered into on or before XXXXXXXXXX, and the Proposed Transactions described in Paragraph 20 are entered into on or before 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, could have an effect on the Rulings provided herein.

OTHER 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, or the outstanding balance of various tax accounts for any of the corporate entities described herein;

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

c) the deductibility of interest on the NAL Debt;

d) the reasonableness or fair market value of any fees or expenditures referred to herein;

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

f) Subject to Ruling I, the application or non-application of a general anti-avoidance provision of any province; and

g) any other tax consequence relating to the Facts, Proposed Transactions, or any transaction or event taking place either prior to or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the Ruling(s) given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that includes other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
for Director
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch