2022 Ruling 2022-0924291R3 - Loss Consolidation Arrangement

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 loss consolidation arrangement involving a loan to buy preferred shares for the purposes of earning income would meet the CRA's requirement for acceptable loss consolidation transactions.

Position: Yes.

Reasons: Consistent with previous rulings.

XXXXXXXXXX									2022-092429

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you requested an Advance Income Tax Ruling (the “Ruling”) on behalf of the above-named taxpayer. We also acknowledge the information provided in subsequent emails.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling request is:

(a) in a previously filed tax return of the taxpayers or a related person;

(b) being considered by the CRA in connection with such return of the taxpayers or a related person;

(c) under objection by the taxpayers or a related person;

(d) the subject of a current or completed court process involving the taxpayers or a related person; or

(e) the subject of a Ruling 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 the regulations made thereunder (the “Regulations”). All references to monetary amounts are in Canadian dollars.

DEFINITIONS

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

“affiliated” has the meaning assigned by subsection 251.1(1) 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 XXXXXXXXXX, as amended;

“BCA2” means XXXXXXXXXX, as amended;

“BCA3” means XXXXXXXXXX;

“CCPC” means “Canadian-controlled private corporation” as defined in subsection 125(7);

“CRA” means Canada Revenue Agency;

“Daylight Loan” means the loan described in Paragraph 15;

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

“EBIDTA” means earnings before interest, tax, depreciation and amortization;

“eligible dividend” has the meaning assigned by subsection 89(1);

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

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

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

“forgiven amount” has the meaning assigned by subsection 80(1) or 80.01(1);

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

"XXXXXXXXXX" means the group companies affiliated with Lossco, within the meaning of affiliated as defined by the BCA1;

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

“Lossco” means XXXXXXXXXX, a corporation governed by the BCA1;

“Lossco Loan” means the interest-free loan described in Paragraph 20;

“Newco” means the new corporation described in Paragraph 13;

“Newco Preferred Shares” means the Newco Class A preferred shares as described in Paragraph 13;

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

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

“Paragraph” means a numbered paragraph in this letter;

“permanent establishment” has the meaning assigned by subsection 400(2) of the Regulations;

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

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

“Profitco” means XXXXXXXXXX, a corporation governed by BCA3;

“Profitco Loan” means the interest-bearing loan described in Paragraph 16;

“Proposed Transactions” means the loss consolidation transactions as described in Paragraphs 13 to 26;

“Redemption Amount” means an amount equal to the per share subscription price at which each share was issued;

“Regulations” means Income Tax Regulations, C.R.C., c.945, as amended.

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

“specified financial institution” has the meaning assigned by subsection 248(1);

“Subscribed Newco Preferred Shares” means the Newco Class A preferred shares that Profitco subscribed for with the proceeds of the Profitco Loan as described in Paragraph 19;

“subsidiary controlled corporation” has the meaning assigned by subsection 248(1);

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

“taxable dividend” has the meaning assigned by subsection 89(1);

“taxable income” has the meaning assigned by subsection 248(1);

“taxable preferred share” has the meaning assigned by subsection 248(1);

“term preferred share” has the meaning assigned by subsection 248(1); and

“UCC” means undepreciated capital cost, and has the meaning assigned by subsection 248(1).

FACTS

1. XXXXXXXXXX

2. Lossco is the corporate parent of the XXXXXXXXXX. Lossco only has a permanent establishment in XXXXXXXXXX. It is headquartered in XXXXXXXXXX. Lossco’s primary assets are shares of subsidiary corporations. Lossco’s most significant sources of income are dividends, and management and administrative fees from its subsidiaries.

3. Lossco is a resident of Canada for the purposes of the Act, a taxable Canadian corporation and a CCPC. Its federal tax account number is XXXXXXXXXX.

4. Profitco is a resident of Canada for the purposes of the Act, a taxable Canadian corporation and a CCPC. Profitco is a wholly owned direct subsidiary of Lossco. The authorized capital of Profitco consists of XXXXXXXXXX fully paid common shares for $XXXXXXXXXX. Profitco’s federal tax account number is XXXXXXXXXX. The corporation’s XXXXXXXXXX is XXXXXXXXXX and XXXXXXXXXX Number is XXXXXXXXXX.

5. Profitco only has a permanent establishment in XXXXXXXXXX. Profitco has XXXXXXXXXX.

6. For the purposes of the definition “taxable income earned in a province” in subsection 124(4) and Part IV of the Regulations, all of Profitco's gross revenue and salaries and wages were allocated to XXXXXXXXXX for the year ended XXXXXXXXXX. This allocation is expected to continue for the duration of the proposed loss consolidation arrangement.

7. Lossco and Profitco both have a XXXXXXXXXX taxation year end.

8. Lossco and Profitco are related persons, and are affiliated to one another.

9. As at XXXXXXXXXX, Lossco had a non-capital loss balance of $XXXXXXXXXX and a UCC balance of $XXXXXXXXXX. The Lossco’s non-capital losses are as follows in each year:

XXXXXXXXXX

Lossco may continue to incur additional losses in subsequent years. The estimated non-capital losses and ending UCC balances for Lossco, absent the Proposed Transactions, are expected to be as follows in each year:

• XXXXXXXXXX – non-capital losses XXXXXXXXXX (taxable income $XXXXXXXXXX); UCC $XXXXXXXXXX;
• XXXXXXXXXX – non-capital losses $XXXXXXXXXX; UCC $XXXXXXXXXX;
• XXXXXXXXXX – non-capital losses XXXXXXXXXX (taxable income $XXXXXXXXXX); UCC $XXXXXXXXXX.

While losses have historically been incurred, the quantum of the expected losses has historically been difficult to predict. Lossco’s non-capital losses are generated primarily by stewardship expenses that cannot be charged out to its subsidiaries.

10. As at XXXXXXXXXX, Profitco had no non-capital losses and had a UCC balance of $XXXXXXXXXX, which may be carried forward to XXXXXXXXXX and subsequent taxation years. The EBIDTA of Profitco for the taxation years ended XXXXXXXXXX have been $XXXXXXXXXX, respectively. Subsequent years’ EBIDTA is expected to remain largely consistent with that generated in previous years.

11. Profitco’s taxable income for XXXXXXXXXX taxation years were $XXXXXXXXXX respectively. Absent the Proposed Transactions, the taxable income of Profitco for XXXXXXXXXX taxation years are expected to be approximately $XXXXXXXXXX, respectively.

12. XXXXXXXXXX.

PROPOSED TRANSACTIONS

13. Lossco will incorporate a new corporation (“Newco”) under BCA2. Newco will have a XXXXXXXXXX taxation year-end and will be a taxable Canadian corporation. The authorized share capital of Newco will consist of an unlimited number of common shares without nominal or par value (“Newco Common Shares”) and an unlimited number of redeemable and retractable Class A preferred shares (“Newco Preferred Shares”).

14. Lossco will subscribe for one Newco Common Share for $XXXXXXXXXX on Newco’s incorporation.

15. Lossco will borrow $XXXXXXXXXX on a daylight basis from an arm’s length financial institution on usual commercial terms (the “Daylight Loan”).

16. Lossco will lend the proceeds from the Daylight Loan to Profitco by making a subordinated interest-bearing loan (the “Profitco Loan”). The Profitco Loan will have a term of up to XXXXXXXXXX months and may be settled at the option of Profitco in cash or by delivering a financial asset, at any time before maturity, without penalty. The Profitco Loan will bear a fixed interest rate that will be equal to the market rate of interest applicable at the time the loan is made, payable XXXXXXXXXX in arrears.

17. Profitco will incur XXXXXXXXXX interest expense on the Profitco Loan in the amount of $XXXXXXXXXX. Based on Profitco’s financial projections, it has the financial capacity to pay the interest on the Profitco Loan from its own cash flow. The expected interest deductions will be approximately $XXXXXXXXXX such that the total income would be $XXXXXXXXXX in each of its XXXXXXXXXX taxation years, respectively.

18. The interest rate on the Profitco Loan will be XXXXXXXXXX% per annum calculated and payable XXXXXXXXXX and has been compared to similar commercial financial transactions entered into between independent parties where the borrower has a similar credit rating to Profitco. The data used to perform this analysis has been obtained from capital market databases.

19. Profitco will use the proceeds of the Profitco Loan to subscribe for Class A Preferred Shares in Newco (the “Subscribed Newco Preferred Shares”). The Subscribed Newco Preferred Shares will include the following terms and conditions:

i. non-voting;

ii. entitled to cumulative dividend at an XXXXXXXXXX equal to the XXXXXXXXXX interest rate on the Profitco Loan, plus XXXXXXXXXX basis point;

iii. redeemable at any time at the option of the holder for cash or delivery of a financial asset (including the Lossco Loan issued under Paragraph 20) in an amount equal to the per share subscription price at which each share was issued (the “Redemption Amount”), plus any accrued but unpaid dividends, by Newco; and

iv. retractable at any time at the option of Newco for cash or delivery of a financial asset (including the Lossco Loan issued under Paragraph 20) in an amount equal to the per share subscription price at which each share was issued (the “Redemption Amount”), plus any accrued but unpaid dividends, by Newco.

The terms of the Lossco Loan and the Profitco Loan will provide that if Profitco becomes the holder of the Lossco Loan, the Lossco Loan can, at the option of either Profitco or Lossco, be offset against the Profitco Loan.

20. Newco will lend to Lossco the subscription proceeds received in Paragraph 19 on an interest-free basis and will be due on demand (the “Lossco Loan”).

21. Lossco will use the proceeds from the Lossco Loan to repay the Daylight Loan.

22. Lossco will agree to, and will, make contributions of capital to the Newco Common Share capital on a XXXXXXXXXX basis equal to the amount of dividends to be paid by Newco to Profitco in respect of the Subscribed Newco Preferred Shares for so long as those shares are outstanding. Lossco will however not be required to make such contributions of capital if Newco is no longer under an obligation to pay dividends to Profitco.

23. Lossco will have other sources of income (as described in Paragraph 2), independent of its investment in Profitco, sufficient to fund the amount of the capital contribution to Newco.

24. Newco will use the amount received as capital contributions in Paragraph 22 to pay dividends on the Subscribed Newco Preferred Shares to Profitco on a XXXXXXXXXX basis.

25. Profitco will pay interest to Lossco on the Profitco Loan on a XXXXXXXXXX basis from its internal cash flow.

26. On or before the maturity of the Profitco Loan, the Proposed Transactions will unwind in whole or in part as follows:

a. Lossco will make capital contributions to the Newco Common Share capital equal to the amount of any accrued and unpaid dividends on the Subscribed Newco Preferred Shares;

b. Newco will pay the balance of any accrued and unpaid dividends on the Preferred Shares held by Profitco redeemed under Paragraph 26(d);

c. Profitco will pay the balance of any accrued and unpaid interest on the portion of the Profitco Loan settled under Paragraph 26(e);

d. Newco will redeem all the Subscribed Newco Preferred Shares held by Profitco for their aggregate Redemption Amount and settle the amount owing on redemption by assigning the Lossco Loan to Profitco;

e. Each of Profitco and Lossco will agree to set-off the Profitco Loan against the Lossco Loan in full satisfaction of the amounts due by it thereunder and the Profitco Loan and the Lossco Loan will be cancelled; and

f. Once all the Newco Preferred Shares held by Profitco have been redeemed and all of the Profitco Loan and the Lossco Loan have been cancelled as described in Paragraph 26(d) and Paragraph 26(e), Newco will be wound up into Lossco pursuant to subsection 88(1).

ADDITIONAL INFORMATION

27. Lossco, Profitco and Newco are neither specified financial institutions nor financial intermediary corporations.

28. The Subscribed Newco Preferred Shares will be taxable preferred shares and term preferred shares.

29. The Subscribed 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).

30. Lossco and Profitco are related persons and affiliated persons and will continue to be related and affiliated persons throughout the period that the loss consolidation arrangement is in place. Newco will be wholly owned by Lossco, and therefore will be related to Lossco and Profitco, and they will be affiliated persons, throughout Newco’s existence.

31. The amount of the Daylight Loan will be less than the amount that an arm's length financial institution would be willing to lend to Lossco as corporate parent of the XXXXXXXXXX.

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

33. Each of Lossco and Newco will agree with Profitco that Newco shall be a single purpose company, shall have no liabilities and shall carry on (and Lossco will cause to carry on) no business other than that contemplated by the Proposed Transactions.

34. The Proposed Transactions will be legally effective.

35. None of the entities involved in the Ruling have been involved in any acquisitions of control to which subsection 111(5) would apply. There are no planned transactions that would result in an acquisition of control involving Profitco or Lossco to which subsection 111(5) would apply.

36. 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.

37. It is expected that the Proposed Transactions will result in Profitco having sufficient income to utilize all of the interest expense that will be used to offset current taxable income.

38. 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.

39. 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 Newco or paid-up capital of Newco.

40. Lossco will not, at any time, claim a capital loss in respect of its investment in Newco.

41. The payment dates of the dividends on the Newco Preferred Shares will coincide with the payment dates of the interest on the Profitco Loan.

PURPOSE OF THE PROPOSED TRANSACTIONS

42. 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 is to enable Lossco to earn sufficient interest income, over a period of time of not more than 36 months, so as to utilize a portion of existing UCC balances, and its accumulated non-capital losses and non-capital losses that it would otherwise incur in a taxation year.

43. In order to undertake the Proposed Transactions in an efficient manner, it is necessary to include Newco to enable Profitco to subscribe for the Subscribed Newco Preferred Shares (described in Paragraph 19), in order for Lossco to remain compliant with legal restrictions against incestuous shareholdings as defined in the BCA1.

44. The purpose of both the payment and the receipt of the dividends on the Subscribed Newco Preferred Shares, as described in Paragraphs 24 and 26(b), is to provide a reasonable return on the Subscribed Newco Preferred Shares issued by Newco to Profitco. 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 Profitco.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, proposed transactions and purposes of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, we confirm the following:

A. Provided that Profitco has a legal obligation to pay interest on the Profitco Loan, and the Newco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income, 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 payable in respect of the Profitco Loan for that taxation year; and (ii) a reasonable amount in respect thereof.

B. The dividends received by Profitco, as described in Paragraph 24 and Paragraph 26(b) above will be taxable dividends that will, pursuant to subsection 112(1), be deductible in computing the taxable income of Profitco for the year in which the dividend is received, and, for greater certainty, such deductions will not be precluded by any of subsection 112(2.1), 112(2.2), 112(2.3) and 112(2.4).

C. Part IV.1 and Part VI.1 of the Act will not apply to the dividends described in Paragraph 24 and Paragraph 26(b) because the dividends will be an excepted dividend under section 187.1 and because the dividends will be excluded dividends pursuant to paragraph (a) of the definition “excluded dividend” in subsection 191(1).

D. The receipt by Newco of capital contributions from Lossco as described in Paragraph 22 and 26(a) will not be included in the income of Newco under any of section 9, or paragraph 12(1)(c) or 12(1)(x).

E. Provided that the payment and receipt of the dividends on the Subscribed Newco Preferred Shares, as described in Paragraphs 24 and 26(b), have no purpose other than 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 to such dividends.

F. The settlement of the Profitco Loan and Lossco Loan as described in Paragraph 26(e) will not give rise to any forgiven amount.

G. Subsections 15(1), 56(2) and 246(1) will not apply as a result of the Proposed Transactions in and by themselves.

H. Subsection 245(2), and its provincial equivalent in a province for which the Government of Canada has a tax collection agreement, will not apply as a result of entering into the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the Rulings given.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R12 dated April 1, 2022, and are binding on the CRA provided that the Proposed Transactions described at Paragraphs 13 to 21 are completed on or before XXXXXXXXXX and the Proposed Transactions described at Paragraph 26 are completed on or before XXXXXXXXXX.

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

d) Subject to Ruling H, the application or non-application of a general anti-avoidance provision of any province;

e) 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; and

f) the application of the proposed Excessive Interest and Financing Expenses Limitation rules contained in draft legislation released on February 4, 2022 to the Proposed Transactions.

An invoice for our fees in connection with this ruling will be forwarded to you under separate cover.

Yours sincerely,

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