2023 Ruling 2023-0961551R3 - 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 purchase Newco Preferred Shares, which it sells to Profitco, its sub. Profitco issues Lossco an interest bearing note as consideration for Newco Preferred Shares. The main issues are whether Lossco would be entitled to apply existing non-capital losses against the interest income received on the interest bearing note; and whether Profitco would be entitled to deduct the interest expense paid on the note and the dividends received on the Newco 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									2023-096155

XXXXXXXXXX, 2023

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request

XXXXXXXXXX

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) except as provided herein, 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

In this ruling letter, unless otherwise specified, the following terms have the meanings specified below:

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

“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;

“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);

XXXXXXXXXX;

“CRA” means Canada Revenue Agency;

“Daylight Loan” means a loan made by a third party financial institution to Lossco, as described in Paragraph 11;

XXXXXXXXXX;

“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) for purposes of Part VI, and has the meaning XXXXXXXXXX;

“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;

“General Anti-avoidance Provision of an Agreeing Province” means:

(i) British Columbia: Section 68.1, Income Tax Act, R.S.B.C. 1996, c. 215, as amended;

(ii) Manitoba: Section 53.1, Income Tax Act, C.C.S.M. 1988, c. I10, as amended;

(iii) New Brunswick: Section 123, New Brunswick Income Tax Act, S.N.B. 2000, c. N-6.001, as amended;

(iv) Newfoundland: Sections 88 and 88.1, Income Tax Act, 2000, S.N.L. 2000, c. I-1.1, as amended;

(v) Northwest Territories: Section 56.2, Income Tax Act, R.S.N.W.T. 1988, c. I-1, as amended;

(vi) Nova Scotia: Section 80A, Income Tax Act, R.S.N.S., 1989, c. 217, as amended;

(vii) Ontario: Section 110, Taxation Act, 2007, S.O. 2007, C. 11, Sch. A, as amended;

(viii) Prince Edward Island: Section 83, Income Tax Act, R.S.P.E.I. 1988, c. I-1, as amended;

(ix) Saskatchewan: Section 139, Income Tax Act, 2000, S.S. 2000, c. I-2.01, as amended; and

(x) Yukon: Section 61, Income Tax Act, R.S.Y. 2002, c. 118, as amended;

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

“IB Note” means the interest bearing promissory note evidencing a debt owing by Profitco to Lossco as described in Paragraph 13;

XXXXXXXXXX;

“Loss Consolidation Arrangement” means the transactions described in Paragraphs 9 to 16;

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

“NIB Loan” means the non-interest bearing loan made by Newco to Lossco, as described in Paragraph 14;

“NIB Note” means the demand non-interest bearing promissory note described in Paragraph 14;

“Newco” means the new company to be incorporated as described in Paragraph 9;

“Newco Common Shares” means the common shares described in Paragraph 9;

“Newco Preferred Shares” means the preferred shares described in Paragraph 9;

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

“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);

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

“Proposed Transactions” means the transactions described in Paragraphs 9 to 17;

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

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

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

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

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

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

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

FACTS

1. Lossco is incorporated pursuant to the XXXXXXXXXX, is a taxable Canadian corporation and a public corporation. Each class and series of its issued shares is listed on the XXXXXXXXXX. Lossco is a XXXXXXXXXX holding company with interests in the XXXXXXXXXX through its subsidiaries, including Profitco. Lossco has a XXXXXXXXXX taxation year end. Lossco’s registered address is XXXXXXXXXX. Lossco files its return with the XXXXXXXXXX and is served by the XXXXXXXXXX.

2. Lossco has unexpired non-capital losses available to be carried forward of approximately $XXXXXXXXXX as at its taxation year ended XXXXXXXXXX. These losses are XXXXXXXXXX% allocable to XXXXXXXXXX.

3. Lossco is expected to incur additional non-capital losses for its taxation years ending in XXXXXXXXXXdue to an increase in third party financing, and it is expected that these forecasted losses will be XXXXXXXXXX% allocable to XXXXXXXXXX:

XXXXXXXXXX

4. Lossco holds all of the issued and outstanding shares of Profitco. Profitco is a XXXXXXXXXX incorporated XXXXXXXXXX. Profitco is a taxable Canadian corporation, a XXXXXXXXXX, and a specified financial institution. Profitco carries on the business of XXXXXXXXXX in Canada and XXXXXXXXXX. Profitco has a XXXXXXXXXX taxation year end. Profitco’s registered address is XXXXXXXXXX. Profitco files its return with the XXXXXXXXXX and is served by the XXXXXXXXXX.

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

XXXXXXXXXX

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

XXXXXXXXXX

7. There are no other profitable entities within the corporate group that are resident in Canada and that share a provincial allocation more closely with that of Lossco.

8. Lossco and Profitco (or its predecessor) have entered into prior loss consolidation arrangements for which Advance Income Tax Rulings have been issued: XXXXXXXXXX. The total value of the intercompany debt generated as a result of these prior transactions that remains outstanding as of the date of this letter is approximately $XXXXXXXXXX.

PROPOSED TRANSACTIONS

Implementation of the Loss Consolidation Arrangement

9. Lossco will incorporate a new corporation (“Newco”) under the XXXXXXXXXX that will be a taxable Canadian corporation and a specified financial institution. Newco will not be a financial intermediary corporation. Newco will have a XXXXXXXXXX taxation year end. Newco’s authorized capital will consist of one class of an unlimited number of common shares (the “Newco Common Shares”) and one class of an unlimited number of preferred shares (the “Newco Preferred Shares”) which will include the following attributes:

a. the Newco Common Shares will be voting;

b. the Newco Preferred Shares:

i. will be non-voting except where the XXXXXXXXXX otherwise requires a statutory vote;

ii. will be redeemable at any time by Newco for an amount equal to the amount for which they were issued and any unpaid dividends which may accumulate prior to their redemption;

iii. will be entitled to an annual cumulative dividend at a rate which will be XXXXXXXXXX basis points greater than the interest rate on the IB Note and calculated on their redemption amount; and

iv. on dissolution will have a preference over the Newco Common Shares for the return of their redemption amount plus any unpaid dividends which may accumulate prior to the dissolution.

10. Lossco will subscribe for XXXXXXXXXX Newco Common Shares for $XXXXXXXXXX on the incorporation of Newco. Newco will use the proceeds of the share subscription to acquire cash and bonds.

11. 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”).

12. Lossco will use the proceeds of the Daylight Loan to subscribe for Newco Preferred Shares. The amount to be added to the stated capital account maintained for the Newco Preferred Shares under the XXXXXXXXXX will be equal to the subscription price paid to Newco for the Newco Preferred Shares such that these shares will have an aggregate FMV, PUC and redemption amount equal to the subscription price.

13. Lossco will immediately sell all of the Newco Preferred Shares to Profitco. As payment, Profitco will issue an interest bearing note (the “IB Note”) to Lossco that will have a principal amount and FMV equal to the FMV of the Newco Preferred Shares. The IB Note will bear a market interest rate at the time of issue expected to be approximately XXXXXXXXXX% and will be repayable on demand. The IB Note will also provide that Lossco’s right to repayment will be restricted to having recourse to the Newco Preferred Shares only, and not to any other assets of Profitco. Profitco will give Lossco a secured interest in the Newco Preferred Shares (and any proceeds from their redemption or sale).

14. Newco will use all of the proceeds received from the issuance of Newco Preferred Shares to make a non-interest bearing demand loan to Lossco (the “NIB Loan”), evidenced by a non-interest bearing note (the “NIB Note”).

15. Lossco will apply the proceeds from the NIB Loan to repay the Daylight Loan.

Maintenance

16. The following transactions will occur on an annual basis:

a. Lossco will agree with Newco to make, and will make, annual capital contributions on the common share capital of Newco in a total amount equal to the amount of annual dividends to be paid by Newco on the Newco Preferred Shares held by Profitco for so long as any such shares are outstanding. 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 any class of shares of Newco, or, for greater certainty, to the paid-up capital of any class of shares of Newco. Based on Lossco’s existing assets and resources, Lossco will be able to make the capital contributions to Newco without taking into account the interest income it will receive from Profitco as described above. Under generally accepted accounting principles these capital contributions will be recorded as contributed surplus and will not be reported as income to Newco in its financial statements.

b. Newco will pay a dividend on the Newco Preferred Shares to Profitco.

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

Unwind of the Loss Consolidation Arrangement

17. At the earlier of (i) 2 years after the implementation of the Loss Consolidation Arrangement or (ii) when the aggregate of Lossco’s non-capital losses described in Paragraph 2 and the XXXXXXXXXX non-capital losses described in Paragraph 3 have been fully utilized, the Loss Consolidation Arrangement will be unwound in the following order:

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

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

c. Profitco will pay to Lossco the accrued and unpaid interest on the IB Note;

d. Subject to any applicable corporate law solvency tests, Newco will redeem the issued and outstanding Newco 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 assign the NIB Note to Profitco in satisfaction of the redemption proceeds;

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

f. Newco will dispose of any bonds acquired by it as described in Paragraph 10 of the Proposed Transactions, and pay the income taxes resulting from the disposition, if applicable; and

g. After the transactions in Paragraphs 17 (a) to 17 (f) have been completed such that the only issued and outstanding shares of Newco are the XXXXXXXXXX common shares owned by Lossco, Lossco as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound up into Lossco. In addition, a general conveyance of the remaining assets of Newco and assumption of liabilities of Newco, if any, will be executed between Newco and Lossco. Newco will file articles of dissolution with the appropriate corporate registry within a reasonable time after the winding-up resolution is passed and it has received its final assessment of tax.

ADDITIONAL INFORMATION

18. Lossco and Profitco are related persons and affiliated persons. Newco, 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 17 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.

19. None of the entities described in this letter have been subject to an acquisition of control and no such acquisitions are anticipated in the future.

20. Each of Lossco and Newco will agree with Profitco that Newco will be a single-purpose corporation, will have no liabilities and will carry on no activity other than as contemplated in the Proposed Transactions.

21. Profitco will have sufficient income to utilize all of the interest expense incurred in respect of the IB Note. Profitco expects to be subject to Part I taxes after the Proposed Transactions are completed.

22. 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.

23. The principal amount of the Daylight Loan will not exceed the amount that the Lossco group could reasonably be expected to borrow from an arm’s length financial institution, taking into consideration the group’s existing internal and external outstanding debt obligations.

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

25. At no time during the implementation of the Proposed Transactions will the Newco 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:

i. 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

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

26. At the time of the Loss Consolidation Arrangement, Newco will have the financial capacity to satisfy the applicable solvency test and liquidity test under corporate law to pay the dividends on the Newco Preferred Shares described in Paragraphs 16(b) and 17(b), and to redeem the Newco Preferred Shares as described in Paragraph 17(d).

27. Profitco has and will have (i) the financial capacity to honor the principal amount payable under the IB Note; and (ii) the financial capacity to pay the interest on the IB Note from its own cash flow. The interest charged on the IB Note will not create or increase a non-capital loss in Profitco.

28. The Newco Preferred Shares:

a. will not be XXXXXXXXXX of Profitco;

b. will be used or held by Profitco in the course of carrying on XXXXXXXXXX business in Canada; and

c. XXXXXXXXXX.

29. Newco is not a financial institution as defined under subsection 190(1), for purposes of Part VI tax. For greater certainty, the amount of Newco Preferred Shares will be reported as preferred shares in the equity section of Newco’s balance sheet of its financial statements at the end of any taxation year.

30. None of the entities described in this Ruling Request will, at any time, claim a capital loss in respect of its investment in Newco.

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

32. The Proposed Transactions will be legally effective.

PURPOSE OF THE PROPOSED TRANSACTIONS

33. 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 incurred by Lossco in XXXXXXXXXX.

For financial reporting purposes, Lossco is prohibited from recognizing the tax recovery associated with these losses unless it is able to demonstrate that it is more likely than not that it will have sufficient taxable income on an ongoing basis to utilize those deductions under the applicable tax law. The Proposed Transactions will allow Lossco to be able to meet the above criteria.

34. 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.

35. 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.

36. The purpose of both the payment and the receipt of the Newco dividends on the Newco Preferred Shares is to provide a reasonable return on the Newco Preferred Shares. Furthermore, the purpose of the Newco dividends is not to reduce the fair market value of any share, nor to increase the total cost amounts of properties of Profitco.

37. The reason that Lossco will subscribe for $XXXXXXXXXX of Newco Common Shares is XXXXXXXXXX.

38. The reason that Profitco will purchase the Newco Preferred Shares from Lossco is XXXXXXXXXX.

RULINGS

Provided that

a) the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the Purpose 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 Newco 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. Provided the Newco Preferred Shares are not XXXXXXXXXX of Profitco and XXXXXXXXXX in Canada as represented in Paragraph 28, the Newco Preferred Shares will, pursuant to XXXXXXXXXX will not apply to restrict the application of paragraph 20(1)(c) of the Act in respect of the interest on the IB Note referred to in Ruling A.

C. To the extent that Newco Preferred Shares are not acquired in the ordinary course of the business carried on by Profitco, the dividends received by Profitco on the Newco Preferred Shares as described in Paragraphs 16(b) and 17(b), will be taxable dividends that will be deductible pursuant to subsection XXXXXXXXXX of the Act in computing the taxable income of Profitco for the year in which such dividends are received; and such deduction will not be precluded by any of subsections 112(2.1), (2.2), (2.3) or (2.4) of the Act.

D. Provided that the only purpose of the dividends in Paragraphs 16(b) and 17(b) 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.

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

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

G. 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.

H. 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 70-6R12 dated April 1, 2022, and are binding on the CRA provided that the Proposed Transactions described in Paragraphs 9 to 15 above are commenced and entered into on or before XXXXXXXXXX, and the Proposed Transactions described in Paragraph 17 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 reasonableness or fair market value of any fees or expenditures referred to herein;

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

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

f) the application of the proposed Excessive Interest and Financing Expenses Limitation rules contained in draft legislation released on February 4, 2022 and revised November 3, 2022, to the Proposed Transactions; 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