2023 Ruling 2022-0949841R3 - 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 Newco 2 would be entitled to deduct interest paid as part of a loan under the loss consolidation transactions and whether Profitco will be entitled to deduct the non-capital losses of Newco 2 on winding-up Newco2.

Position: Yes.

Reasons: The proposed transactions conform to our requirements for these types of loss consolidation rulings. The proposed transactions would be legally effective and commercially plausible.

XXXXXXXXXX									2022-094984

XXXXXXXXXX, 2023

Dear XXXXXXXXXX:

Advance Income Tax Ruling

Re: XXXXXXXXXX

We are writing in response to your request dated XXXXXXXXXX for an advance income tax ruling on behalf of the above-noted taxpayers (the “Taxpayers”).

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

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

A. being considered by a tax services office or taxation centre in connection with a previously filed tax return of the Taxpayers or a related person;

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 an advance income tax ruling previously considered by the Income Tax Rulings Directorate in relation to the Taxpayers or a related person.

This document is based solely on the facts and proposed transactions described below. The documentation submitted with the request does not form part of the facts and proposed transactions and any references thereto are provided solely for the convenience of the reader.

The address, tax account number, Tax Services Office and the Tax Centre of the Taxpayer are as follows:

XXXXXXXXXX

Unless otherwise noted, all references herein to sections or components thereof are references to the Income Tax Act, RSC 1985, c 1 (5th Supp), as amended (the “Act”), or, where appropriate, the Income Tax Regulations C.R.C., c. 945, as amended (the “Regulations”) and all terms and conditions used herein that are defined in the Act or Regulations have the meaning given in such definition unless otherwise indicated. Unless otherwise noted, all references to monetary amounts are in Canadian dollars.

DEFINITIONS

In this letter, unless otherwise noted, the following terms have the meanings specified herein. All references in the singular include the plural.

“Act 1” means the XXXXXXXXXX;

“Act 2” means the XXXXXXXXXX;

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

“affiliated person” has the meaning assigned by section 251.1;

“arm’s length” has the meaning assigned by section 251;

XXXXXXXXXX;

“Canadian currency year” has the meaning assigned by subsection 261(1);

“CRA” means the Canada Revenue Agency;

“Daylight Debt” means a day credit overdraft provided by a third-party lender;

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

“Exchange” means the XXXXXXXXXX;

“functional currency year” has the meaning assigned by subsection 261(1);

“GAAR” means the general anti-avoidance rule found in section 245;

“IB Credit Facility” means the note described in Paragraph 11;

“IB Debt” means the loan described in Paragraph 11;

“investment tax credit” has the meaning assigned by subsection 127(9);

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

“LP” means XXXXXXXXXX referred to in Paragraph 6;

“Newco 1” means XXXXXXXXXX, which is described in Paragraph 8, having its head office located at XXXXXXXXXX;

“Newco 1 Preferred Shares” means the preferred shares described in Paragraph 13;

“Newco 2” means XXXXXXXXXX, which is described in Paragraph 9, having its head office located at XXXXXXXXXX;

“Newco 3” means XXXXXXXXXX, which is described in Paragraph 9, having its head office located at XXXXXXXXXX;

“Newco 4” means XXXXXXXXXX, which is described in Paragraph 9, having its head office located at XXXXXXXXXX;

“NIB Debt” means the loan described in Paragraph 14;

“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;

“Parentco” means XXXXXXXXXX, which is described in Paragraph 1;

“Parentco Group” means all of the entities held directly or indirectly by Parentco;

“Profitco” means XXXXXXXXXX, the corporation described in Paragraph 5;

“Proposed Transactions” means the transactions in Paragraphs 10 to 25;

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

“SEA” means “synthetic equity arrangement” which has the meaning assigned by subsection 248(1);

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

“Subco” means XXXXXXXXXX, the corporation described in Paragraph 2;

“Subject Transactions” means the transactions described in Paragraphs 8 and 9;

“Support Agreement” means an agreement between Parentco, Subco and Lossco providing Lossco with a funding entitlement in an amount equal to the dividends payable on the Newco 1 Preferred Shares and a commitment from Lossco that Newco 1 will use the proceeds to pay such dividends.

“tax reporting currency” has the meaning assigned by subsection 261(1);

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

XXXXXXXXXX.

FACTS

1. Parentco is a XXXXXXXXXX resident corporation whose shares are listed on the Exchange. Parentco indirectly owns and controls XXXXXXXXXX% of the shares of Subco, Lossco and Profitco.

2. Subco, a corporation incorporated under the XXXXXXXXXX and a XXXXXXXXXX resident corporation, owns XXXXXXXXXX% of the shares of Lossco.

3. Lossco is a taxable Canadian corporation and was incorporated under Act 1 on XXXXXXXXXX. Lossco has a taxation year-end of XXXXXXXXXX. Lossco’s tax reporting currency is the XXXXXXXXXX. Lossco is a general partner, with a XXXXXXXXXX% general equity interest, of XXXXXXXXXX, a limited partnership which is in the business of XXXXXXXXXX.

4. Lossco has unexpired non-capital losses carried forward and investment tax credits of approximately $XXXXXXXXXX and $XXXXXXXXXX, respectively, as of the end of its taxation year that ended XXXXXXXXXX.

5. Profitco is a taxable Canadian corporation and was incorporated under Act 1 on XXXXXXXXXX. Profitco has a taxation year-end of XXXXXXXXXX. Profitco’s functional currency (as defined in subsection 261(1)) and tax reporting currency is the XXXXXXXXXX dollar. Profitco holds interests in various entities XXXXXXXXXX.

6. Profitco has generated taxable income of approximately XXXXXXXXXX in each of its XXXXXXXXXX taxation years, respectively. It is expected that Profitco will generate taxable income in its next XXXXXXXXXX taxation years. All or substantially all of Profitco’s taxable income is attributable to Profitco’s interest in LP. Profitco has sufficient taxable income to utilize Lossco’s non-capital loss balance.

7. Profitco and Lossco operate in Canada through a permanent establishment in the XXXXXXXXXX.

SUBJECT TRANSACTIONS

For the purpose of implementing the Proposed Transactions, the following Subject Transactions were completed after the request for the advance tax ruling was submitted and before the date of this letter.

8. Lossco incorporated Newco 1 on XXXXXXXXXX and subscribed for XXXXXXXXXX common shares of Newco 1 for $XXXXXXXXXX per share. Newco 1’s tax reporting currency is the XXXXXXXXXX dollar and has a XXXXXXXXXX year-end. Newco 1 will not carry on any business and its activities will be limited to making the NIB Debt with the proceeds received from the issuance of the Newco 1 Preferred Shares. The authorized capital of Newco 1 consists of two classes of shares: common shares and Newco 1 Preferred Shares.

9. Lossco incorporated Newco 2, Newco 3 and Newco 4 on XXXXXXXXXX, and subscribed for XXXXXXXXXX common shares in each of the Newcos for $XXXXXXXXXX per share. The tax reporting currency of Newco 2, Newco 3 and Newco 4 is the XXXXXXXXXX dollar and each Newco has a XXXXXXXXXX year-end. Newco 2, Newco 3 and Newco 4 will not carry on any business and their activities will be limited to investing the proceeds from the IB Debt in the Newco I Preferred Shares. The authorised capital of Newco 2, Newco 3 and Newco 4 will consist of common shares.

PROPOSED TRANSACTIONS

Unless otherwise indicated, the proposed transactions will take place in the following order as soon as possible after receipt of this letter.

10. Lossco will obtain a Daylight Debt of approximately $XXXXXXXXXX.

11. Lossco will use the proceeds of the Daylight Debt to lend $XXXXXXXXXX to Newco 2 (the “IB Debt”) pursuant to a subordinated unsecured internal revolving credit facility (the “IB Credit Facility”) under the following conditions:

a. a term of XXXXXXXXXX years;

b. bearing interest at an annual rate based on market conditions at the time the credit facility is granted, and will be a reasonable commercial rate in these circumstances. The interest rate is a floating rate equivalent to the XXXXXXXXXX plus a margin of XXXXXXXXXX%, estimated to be approximately XXXXXXXXXX%. The interest will be paid annually;

c. it will also provide that the amount drawn under the IB Credit Facility as evidenced by the IB Debt may be satisfied, by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the amount drawn, or (iii) way of set-off against the NIB Debt if the NIB Debt belongs to Newco 2 at the time of repayment. The amount borrowed will not exceed Parentco Group’s borrowing capacity; and

d. repayments of borrowed amounts by Newco 2 at the end of XXXXXXXXXX will not cause the termination of the IB Credit Facility which shall continue in full force and effect for the benefit of Newco 3 and Newco 4 until the full utilization of Lossco’s non-capital losses.

12. Concurrently with the transaction in Paragraph 11, Parentco, Subco and Lossco will enter into the Support Agreement.

13. Newco 2 will use the $XXXXXXXXXX received from the IB Debt to subscribe for Newco 1 Preferred Shares having an aggregate redemption/retraction price equal to the total subscription price. The paid-up capital, the ACB and the fair market value of the Newco 1 Preferred Shares will be $XXXXXXXXXX. The terms of the Newco 1 Preferred Shares will be the following:

i. non-voting;

ii. non-participating;

iii. redeemable at the option of the issuer and retractable at the option of the holder, subject to applicable law, at any time for an 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, (ii) delivery of property having a fair market value at the time of redemption equal to the aggregate redemption amount, or (iii) the NIB Debt, in each case together with a payment in cash equal to the amount of all declared or accrued dividends which have not been paid up to but excluding the date fixed for such redemption or retraction; and

iv. the holder of the Newco 1 Preferred shares will be entitled to a cumulative dividend, payable annually, calculated daily and accruing by reference to the redemption amount of the Newco 1 Preferred Shares at a rate equal to the interest rate on the IB Debt plus XXXXXXXXXX%. The aggregate dividend rate is estimated at XXXXXXXXXX% per annum.

14. Newco 1 will use the proceeds received from the Newco 1 Preferred Shares subscription to make a non-interest-bearing loan to Lossco in an amount equal to $XXXXXXXXXX (the “NIB Debt”). The NIB Debt will be payable on demand.

15. Lossco will use the $XXXXXXXXXX received from the NIB Debt to repay the Daylight Debt.

Annual Maintenance of the Loss Utilization

16. On or before XXXXXXXXXX, Subco will subscribe for common shares of Lossco in an amount equal to the dividends payable by Newco 1 to Newco 2 on the Newco 1 Preferred Shares. The subscription price will be added to the paid-up capital of Lossco’s common shares.

17. Lossco will then contribute the amount received to the capital of Newco 1. No shares will be issued by Newco 1 with respect to such contribution and no amount will be added to the stated capital and Paid-up capital of the shares of Newco 1. The amount of such contribution will be recorded as contributed surplus for accounting purposes.

18. Newco 1 will declare all accrued dividends and will use the contribution received to pay all accrued but unpaid dividends to Newco 2 in accordance with the terms of the Newco 1 Preferred Shares.

19. Newco 2 will then use the amount received to pay the accrued and unpaid interest due to Lossco pursuant to the terms of the IB Debt.

20. Lossco will then reduce the paid up capital in its common shares held by Subco, by an amount equal to the amount received from Newco 2, and pay that amount to Subco.

Annual Unwind of the Loss Utilization

21. On the same day, but after the Proposed Transactions in Paragraphs 16 to 20, Newco 1 will redeem its Newco 1 Preferred Shares by transferring to Newco 2 the NIB Debt in accordance with the terms of the Newco 1 Preferred Shares. Newco 2 and Lossco will settle the NIB Debt against the IB Debt by right of offset.

22. Newco 2 will pay a dividend equivalent to the spread between the income earned on the Newco 1 Preferred Shares and the interest paid on the IB Debt (approximately $XXXXXXXXXX) to Lossco.

23. On XXXXXXXXXX, Lossco will sell all of its shares of Newco 2 to Profitco in consideration for cash consideration equal to FMV.

24. Profitco will then immediately, as sole shareholder of Newco 2, pass a resolution authorizing and requiring the wind-up and dissolution of Newco 2 into Profitco. As a result, Newco 2's assets will be distributed to Profitco and its liabilities, if any, will be assumed by Profitco. Newco 2 will then be formally dissolved on XXXXXXXXXX.

25. The transactions described in Paragraphs 10 to 24 will be repeated in XXXXXXXXXX with Newco 3 and XXXXXXXXXX with Newco 4, each time pursuant to a new IB Debt under the internal revolving credit facility described in Paragraph 11. When full utilisation of Lossco’s non-capital losses and investment tax credits is achieved, Lossco will authorise by resolution the wind-up and dissolution of Newco 1. As a result, Newco 1's assets will be distributed to Lossco and its liabilities, if any, will be assumed by Lossco.

OTHER REPRESENTATIONS

26. Lossco and Profitco are and will continue to be throughout the period that the loss utilization is in place, related and affiliated persons. The loss utilization will be unwound prematurely in the manner described in Paragraphs 21 to 25 of the Proposed Transactions if Lossco and Profitco cease to be affiliated persons following an acquisition of control by a non-affiliated third-party.

27. No acquisitions of control have occurred, or are anticipated to occur, as part of the series of transactions or events that includes the Proposed Transactions in respect of Parentco, Lossco, Profitco or Subco.

28. Profitco, Lossco, Newco 1 and Newco 2 are SFIs. However, Newco 2 will not acquire the Newco 1 Preferred Shares in the ordinary course of its business as its only activities are as described in the Proposed Transactions.

29. None of the corporations involved in the Proposed Transactions has or will have entered into a DRA, with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

30. The issued Newco 1 Preferred Shares, will not, at any time 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 that term is 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 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).

31. Dividends received by Newco 2 on the Newco 1 Preferred Shares as described in Paragraph 18 of the Proposed Transactions will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1).

32. The amount borrowed in order to complete the Proposed Transactions described in Paragraphs 10 to 25 will not exceed Parentco Group’s borrowing capacity.

33. At the time of the Proposed Transactions, because of the Support Agreement, Lossco will have the liquidity to make the capital contribution into Newco 1, as described in Paragraph 17, required for the payment of the dividends on the Newco 1 Preferred Shares.

34. Profitco’s tax reporting currency is the XXXXXXXXXX. Profitco’s first XXXXXXXXXX functional currency year was its taxation year ended XXXXXXXXXX. For financial accounting purposes, Lossco, Newco 1 and Newco 2’s functional currency will be the XXXXXXXXXX. Lossco, Newco 1 and Newco 2 will not make an election under subsection 261(3). Lossco has never made an election under subsection 261(3) and has never revoked an election under subsection 261(4).

35. Newco 2’s second fiscal period will begin at the first moment of the day on XXXXXXXXXX and will end upon its dissolution on the same day. Such short-term fiscal period will be Newco 2’s first XXXXXXXXXX functional currency year.

36. Proposed subsection 18.2(4) will not apply to limit the deductibility of the interest on the IB Debt as Lossco and Newco 2 are eligible group corporations in respect of one another and will elect to treat the interest payment under the IB Debt as excluded interest.

37. The Proposed Transactions will be legally effective.

38. Neither Lossco nor Profitco will claim, at any time, a capital loss in respect of a disposition of any common or preferred shares of Newco 1 or Newco 2 and Newco 2 will not claim, at any time, a capital loss in respect of a disposition of any Newco 1 Preferred Shares.

39. Newco 1 will be dissolved within a short period of time following the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

40. The purpose of the Proposed Transactions is to consolidate taxable income, non-capital losses and investment tax credits within a group of affiliated and related persons that includes Profitco and Lossco. The Proposed Transactions will enable Lossco to earn interest income on the IB Debt and thus will enable Lossco to effectively utilize its non-capital losses already incurred and investment tax credits already generated as well as any future investment tax credits or non-capital losses.

41. The purpose of both the payment and the receipt of the dividends on the Newco 1 Preferred Shares as described in Paragraph 18 is to provide a reasonable return on such shares and to fund the interest payments made by Newco 2 that will be due on the IB Debt. 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.

42. The purposes of the subscription by Subco for common shares of Lossco as described at Paragraph 16 is to fund the dividend payment on the Newco 1 Preferred Shares while ensuring that the amount contributed by Subco to Lossco creates paid-up capital that can subsequently be reduced as described in Paragraph 20 with the amount of the paid-up capital reduction paid to Subco not being subject to Canadian withholding tax.

43. None of the main purposes of the Proposed Transactions is to change, or enable the changing of, the currency, in which the Canadian tax results in respect of any one, or more, property for a taxation year would otherwise be determined.

RULINGS

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

A. Provided that Newco 2 has a legal obligation to pay interest on the IB Debt, and that Newco 2 continues to hold the Newco 1 Preferred Shares for the purpose of gaining or producing income, Newco 2 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 Newco 2 in computing its income for purposes of the Act) in respect of the year on the IB Debt, or (ii) a reasonable amount in respect thereof.

B. Provided that the requirements of paragraphs 88(1.1)(a) and (b) are satisfied, subsection 88(1.1) will apply after the windup-up of Newco 2 into Profitco, described in Paragraph 24, has been completed to permit Profitco to deduct the non-capital losses of Newco 2 in computing its taxable income for a taxation year commencing after the commencement of the winding-up, subject to the limitations in paragraph 88(1.1)(e) and 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 Newco 2 on the Newco 1 Preferred Shares, as described in Paragraph 18, will be taxable dividends and such dividends will, pursuant to subsection 112(1), be deductible in computing the taxable income of Newco 2 for the year in which the dividends are received by Newco 2 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).

E. Part IV, Part IV.1 and Part VI.1 will not apply to the dividends, described in Paragraph 18, received by Newco 2 on the Newco 1 Preferred Shares.

F. Provided that the only purpose of the payment and receipt of the dividends on the Newco 1 Preferred Shares is as described in Paragraph 41, subsection 55(2) will not apply to the dividends received by Newco 2 on the Newco 1 Preferred Shares, as described in Paragraph 18.

G. The provisions of subsection 80(2) and subsection 80.01(2) will not apply to the set-off and cancellation of the NIB Debt against the IB Debt described in Paragraph 21 and will not give rise to any gain or loss.

H. With respect to section 261:

a) Provided that the wind-up of Newco 2 into Profitco is a wind-up described in subsection 88(1), paragraph 261(16)(a) should apply to Newco 2, such that:

i. Notwithstanding subsection 261(3), subsection 261(5) will apply to Newco 2 in respect of its final taxation year commencing on XXXXXXXXXX (i.e., the taxation year that includes the time the wind-up commences (the “commencement time”));

ii. Newco 2 will be deemed to have XXXXXXXXXX dollar as its elected functional currency (i.e., Profitco’s tax reporting currency); and

iii. Newco 2’s first functional currency year will be the taxation year commencing on XXXXXXXXXX (i.e., the taxation year that includes the commencement time) and Newco 2’s last XXXXXXXXXX currency year will be the taxation year that ends XXXXXXXXXX of the same year (i.e., the taxation year that precedes its first functional currency year).

b) Subsections 261 (20) and 261(21) will not apply in determining the income, gain or loss of Lossco, Profitco, Newco 1, or Newco 2 in respect of the Proposed Transactions, in and by themselves.

c) Subsection 261(18) will not apply in respect of Profitco, Lossco, Newco 1, or Newco 2 as a result of the Proposed Transactions, in and by themselves.

I. No amount will be included in the income of Newco 1 pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) in respect of the capital contributions to be made by Lossco as described in Paragraph 17.

J. Subsection 245(2) will not apply as a result of entering into the Proposed Transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

This ruling is given subject to the limitations and qualifications set forth in Information Circular 70-6R12 issued on April 1, 2022, and is binding on the CRA, provided that the Proposed Transactions are completed no later than six (6) months after the date of this letter. The above ruling is based on the law as it reads at the date of this letter and does not take into account any proposed amendments to the Act and the Regulations, which if enacted, could have an effect on the ruling.

COMMENTS

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

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

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

(c) any provincial tax consequences of the Proposed Transaction; or

(d) any other income tax consequence relating to the facts, additional information or Proposed Transaction, or any transaction or event taking place either prior or subsequent to the Proposed Transaction, whether described in this letter or not, other than those specifically described in the ruling given above, including whether the Proposed Transaction 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 Division Director
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch