2023 Ruling 2023-0964601R3 - 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 the loss consolidation arrangement is acceptable.

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									2023-096460

XXXXXXXXXX, 2023

Dear Sir/Madams:

Re: Advance Income Tax Ruling
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, and modified on 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, 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 tax return of the Taxpayers or a related person and:

A. being considered by the CRA in connection with any such tax return;

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

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 Ruling Directorate in relation to the Taxpayers or a related person.

The tax account numbers, addresses, Tax Services Offices and the Tax Centres of the Taxpayers are as follows:

XXXXXXXXXX

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.

Definitions

Unless otherwise stated:

i. all references herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Income Tax Act, R.S.C. 1985 (5th Supp.) c. 1, as amended, (the “Act”);

ii. all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

iii. all references to monetary amounts are in Canadian dollars; and

iv. the singular should be read as plural and vice versa where the circumstances so require.

The following abbreviations, terms and expressions have the meanings specified, and the relevant parties to the Proposed Transactions (as defined below) will be referred to as follows:

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

“affiliated persons” 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);

“CBCA” means the Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended;

“CRA” means the Canada Revenue Agency;

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

“Daylight Lossco 1 Loan” means the loan made by Parentco to Lossco 1, as described in Paragraph 14;

“Daylight Lossco 2 Loan” means the loan made by Parentco to Lossco 2, 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);

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

“IBL 1” means the interest-bearing loan made by Lossco1 to Profitco, as described in Paragraph 15;

“IBL 2” means the interest-bearing loan made by Lossco2 to Profitco, as described in Paragraph 16;

“IBLs” means, collectively, the IBL 1 and the IBL 2;

“Lossco 1” means XXXXXXXXXX;

“Lossco 1 Note” means the non-interest bearing promissory note described in Paragraph 25(c)(i);

“Lossco 1 Preferred Shares” means the preferred shares described in Paragraph 11;

“Lossco 2” means XXXXXXXXXX;

“Lossco 2 Note” means the non-interest bearing promissory note described in Paragraph 25(c)(ii);

“Lossco 2 Preferred Shares” means the preferred shares described in Paragraph 12;

“Losscos Preferred Shares” means, collectively, the Lossco 1 Preferred Shares and the Lossco 2 Preferred Shares;

“XXXXXXXXXX GP” means XXXXXXXXXX;

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

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

“Parentco” means XXXXXXXXXX;

“Partnerships” means, collectively, XXXXXXXXXX GP and XXXXXXXXXX GP;

“Previous Loss Consolidation Structures” means the loss consolidation structures previously in place between Parentco and Profitco, as described in Paragraph 10;

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

“Profitco” means XXXXXXXXXX;

“Proposed Transactions” means the transactions described in Paragraphs 11 to 25;

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

XXXXXXXXXX;

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

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

“XXXXXXXXXX GP” means XXXXXXXXXX;

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

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

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

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

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

“Ultimate Parent” means XXXXXXXXXX; and

“XXXXXXXXXX” means XXXXXXXXXX controlled by Ultimate Parent.

Facts

A complete description of all the relevant facts is as follows:

1. Parentco is a TCC incorporated under the CBCA. Parentco holds all of the issued and outstanding shares of the capital stock of Lossco 1, Lossco 2 and Profitco. Parentco is ultimately controlled by Ultimate Parent.

2. Lossco 1 is a TCC incorporated under the XXXXXXXXXX. The taxation year-end of Lossco 1 is XXXXXXXXXX. Lossco 1’s main source of income is partnership income from its interest in the Partnerships (XXXXXXXXXX GP and XXXXXXXXXX GP). In particular, Lossco 1 owns a XXXXXXXXXX% interest in XXXXXXXXXX GP and a XXXXXXXXXX% interest in XXXXXXXXXX GP. The Partnerships’ main source of income is from their respective XXXXXXXXXX. The Partnerships operate through permanent establishments in the provinces of XXXXXXXXXX. The Partnerships are Canadian partnerships, as defined in subsection 102(1).

3. Lossco 1 had unexpired non-capital losses carried forward of approximately $XXXXXXXXXX as of the end of its taxation year ended XXXXXXXXXX. The non-capital losses were incurred in the following taxation years:

XXXXXXXXXX

4. Lossco 1 is expected to incur additional non-capital losses in its taxation years ending from XXXXXXXXXX of approximately $XXXXXXXXXX in aggregate.

5. Lossco 2 is a TCC incorporated under the CBCA. The taxation year-end of Lossco 2 is XXXXXXXXXX. Lossco 2’s main source of income is from the XXXXXXXXXX. Lossco 2 operates through permanent establishments in XXXXXXXXXX.

6. Lossco 2 had unexpired non-capital losses carried forward of approximately $XXXXXXXXXX as of the end of its taxation year ended XXXXXXXXXX. The non-capital losses were incurred in the following taxation years:

XXXXXXXXXX

7. Lossco 2 is not expected to generate any material taxable income or to incur additional non-capital losses in its taxation years ending from XXXXXXXXXX.

8. Profitco is a private corporation and a TCC incorporated under XXXXXXXXXX. The taxation year-end of Profitco is XXXXXXXXXX. Profitco’s main source of income is from the XXXXXXXXXX. Profitco exclusively operates through a permanent establishment in XXXXXXXXXX.

9. Profitco has generated taxable income of approximately $XXXXXXXXXX in each of its XXXXXXXXXX taxation years, respectively. Profitco anticipates its taxable income to be approximately $XXXXXXXXXX in each of its XXXXXXXXXX taxation years.

10. Two loss consolidation structures were previously in place between Parentco and Profitco (through XXXXXXXXXX) for an amount of approximately $XXXXXXXXXX, respectively (the “Previous Loss Consolidation Structures”). The Previous Loss Consolidation Structures were unwound in XXXXXXXXXX, respectively.

Proposed Transactions

Implementation of the structure

11. Lossco 1 will amend its articles of incorporation to create a new class of preferred shares (the “Lossco 1 Preferred Shares”) having the following attributes:

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 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, or (ii) delivery of property having a FMV at the time of redemption equal to the aggregate redemption amount, 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. entitlement to a cumulative dividend, calculated daily and accruing by reference to the redemption amount of the Lossco 1 Preferred Shares, at a rate that is reasonable, based on the current prevailing market rate established at Paragraph 15 for the IBL 1, plus XXXXXXXXXX% per annum.

12. Lossco 2 will amend its articles of incorporation to create a new class of preferred shares (the “Lossco 2 Preferred Shares”).

The attributes of the Lossco 2 Preferred Shares will be the same as those of the Lossco 1 Preferred Shares, with the necessary modifications. For greater certainty, the Lossco 2 Preferred Shares will be entitled to a cumulative dividend, calculated daily and accruing by reference to the redemption amount of the Lossco 2 Preferred Shares, at a rate that is reasonable, based on the current prevailing market rate established at Paragraph 16 for the IBL 2, plus XXXXXXXXXX% per annum.

13. Parentco will borrow an amount not to exceed $XXXXXXXXXX from an arm’s length lender or from XXXXXXXXXX on arm’s length commercial terms customary for this type of loan (the “Daylight Loan”).

Parentco may borrow the Daylight Loan in a series of up to five loans. Accordingly, the transactions described in this Paragraph and in Paragraphs 14 to 21 below may be repeated as necessary to obtain a total amount equal to the amount of the Daylight Loan.

14. Using the proceeds of the Daylight Loan, Parentco will make a loan on arm’s length commercial terms to Lossco 1 (the “Daylight Lossco 1 Loan”) and Lossco 2 (the “Daylight Lossco 2 Loan”).

15. Using the proceeds of the Daylight Lossco 1 Loan, Lossco 1 will make an interest bearing loan to Profitco (the “IBL 1”), on the following conditions:

a. simple interest will accrue on the IBL 1 and will be calculated daily at an annual fixed rate that is reasonable and equal to a commercial arm’s length rate applicable in these facts and circumstances at the time of the implementation, currently estimated to be between XXXXXXXXXX% per annum (as determined by management). The IBL 1 will be subordinated to all other existing and future unsecured and unsubordinated indebtedness of Profitco. The interest on the IBL 1 will be paid each year on the anniversary date of the IBL 1; and

b. the terms of the IBL 1 will provide Profitco with a right to prepay the principal amount and any interest that may have accrued at any time without premium or penalty.

16. Using the proceeds of the Daylight Lossco 2 Loan, Lossco 2 will make an interest bearing loan to Profitco (the “IBL 2”).

The terms and conditions of the IBL 2 will be the same as those of the IBL 1, with the necessary modifications.

17. Using the proceeds of the IBL 1, Profitco will subscribe for Lossco 1 Preferred Shares. The aggregate redemption amount, retraction amount, ACB and PUC of the issued Lossco 1 Preferred Shares will be equal to the subscription amount.

18. Using the proceeds of the IBL 2, Profitco will subscribe for Lossco 2 Preferred Shares. The aggregate redemption amount, retraction amount, ACB and PUC of the issued Lossco 2 Preferred Shares will be equal to the subscription amount.

19. Using the proceeds from the issuance of the Lossco 1 Preferred Shares, Lossco 1 will repay the Daylight Lossco 1 Loan.

20. Using the proceeds from the issuance of the Lossco 2 Preferred Shares, Lossco 2 will repay the Daylight Lossco 2 Loan.

21. Using the proceeds from the repayment of the Daylight Lossco 1 Loan and the Daylight Lossco 2 Loan, Parentco will repay the Daylight Loan.

Maintenance of the structure

22. On an annual basis, Lossco 1 will pay all accrued dividends on the Lossco 1 Preferred Shares to Profitco. The payment will be made by Lossco 1 using available cash from its business operations.

23. On an annual basis, Lossco 2 will pay all accrued dividends on the Lossco 2 Preferred Shares to Profitco. The payment will be made by Lossco 2 using available cash from its business operations.

24. Immediately following completion of the transactions described in Paragraphs 22 and 23, Profitco will pay to Lossco 1 and Lossco 2 the accrued and unpaid interest on the IBLs.

Unwind of the structure

25. At the earlier of (i) 3 years after the implementation of the loss consolidation arrangement or (ii) when Lossco 1’s and Lossco 2’s non-capital losses respectively described in Paragraphs 3 and 6 have been fully utilized, the loss consolidation arrangement will be unwound in the following manner:

a. Subject to any applicable corporate law solvency tests:

(i) Lossco 1 will declare and pay all accrued but unpaid dividends on the Lossco 1 Preferred Shares to Profitco in accordance with the terms of the Lossco 1 Preferred Shares; and

(ii) Lossco 2 will declare and pay all accrued but unpaid dividends on the Lossco 2 Preferred Shares to Profitco in accordance with the terms of the Lossco 2 Preferred Shares.

b. Profitco will pay all accrued and unpaid interest on the IBLs to Lossco 1 and Lossco 2.

c. Subject to any applicable corporate law solvency tests:

(i) Lossco 1 will redeem the issued and outstanding Lossco 1 Preferred Shares held by Profitco for an amount equal to their redemption amount and will issue a non-interest bearing note (the “Lossco 1 Note”) to Profitco in satisfaction of the redemption proceeds. The principal amount and FMV of the Lossco 1 Note will equal the principal amount and FMV of the IBL 1; and

(ii) Lossco 2 will redeem the issued and outstanding Lossco 2 Preferred Shares held by Profitco for an amount equal to their redemption amount and will issue a non-interest bearing note (the “Lossco 2 Note”) to Profitco in satisfaction of the redemption proceeds. The principal amount and FMV of the Lossco 2 Note will equal the principal amount and FMV of the IBL 2.

d. Profitco, Lossco 1 and Lossco 2 will enter into set-off agreements whereby:

(i) the IBL 1 will be set-off against the Lossco 1 Note; and

(ii) the IBL 2 will be set-off against the Lossco 2 Note.

Additional information

26. Lossco 1, Lossco 2 and Profitco are related persons and affiliated persons and will continue to be related and affiliated throughout the period that the loss consolidation structure is in place. The structure will be unwound in the manner described in Paragraph 25 if any entity previously mentioned in this letter request ceases to be affiliated following an acquisition of control by a non-affiliated third party.

27. None of the corporations involved in the Proposed Transactions are, or will be, specified financial institutions, restricted financial institutions or financial intermediary corporations. Profitco will not acquire the Losscos Preferred Shares in its ordinary course of business.

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

29. The Losscos Preferred Shares will not, at any time during the implementation of the Proposed Transactions described herein, be:

a. subject of any undertaking that is referred to subsection 112(2.2) as a “guarantee agreement”;

b. the subject of a “dividend rental arrangement” as contemplated in subsection 112(2.3);

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); or

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

30. Dividends received by Profitco on the Losscos Preferred Shares, as described in Paragraphs 22, 23 and 25(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 borrowing capacity of Parentco exceeds the maximum amount required to complete the Proposed Transactions. In addition, Ultimate Parent’s borrowing capacity could be relied upon.

32. At the time of the Proposed Transactions, Profitco will have the solvency and liquidity to service the IBLs as described in Paragraphs 24 and 25(b).

33. At the time of the Proposed Transactions:

a. Lossco 1 will have the financial capacity to satisfy the applicable solvency test and liquidity test to pay dividends on the Lossco 1 Preferred Shares as described in Paragraphs 22 and 25(a)(i) and to redeem the Lossco 1 Preferred Shares as described in Paragraph 25(c)(i); and

b. Lossco 2 will have the financial capacity to satisfy the applicable solvency test and liquidity test to pay dividends on the Lossco 2 Preferred Shares as described in Paragraph 23 and 25(a)(ii) and to redeem the Lossco 2 Preferred Shares as described in Paragraph 25(c)(ii).

34. The dividends paid to Profitco on the Losscos Preferred Shares, as described in 22, 23 and 25(a), have no other purpose than the purpose described in Paragraph 41.

35. There is no intention for Profitco to generate a loss carryforward balance as a result of the Proposed Transactions (that cannot be carried back to prior taxation years of Profitco) and the Taxpayers will seek to unwind the structure at a time that is intended to prevent any significant loss carryforward balance.

36. Lossco 1, Lossco 2 and Profitco will undertake steps to ensure that the interest income earned by Lossco 1 and Lossco 2 under the Proposed Transactions will not materially exceed an amount that could be fully sheltered with Lossco 1’s and Lossco 2’s non-restricted non-capital losses. Profitco expects to earn taxable income in excess of the interest expense that will arise by virtue of the implementation of the Proposed Transactions. In the event that a non-capital loss is created for Profitco in the course of the Proposed Transactions, any such non-capital loss would be carried back to a prior taxation year or carried forward to a subsequent taxation year in accordance with the provisions of section 111.

37. None of the entities described in this letter have been subject to an acquisition of control except for Lossco 2 in XXXXXXXXXX and Profitco in XXXXXXXXXX, and no such acquisition of control is anticipated in the future.

38. Lossco 1, Lossco 2 and Profitco have independent sources of business income that is expected to exceed the annual payment of dividend/interest.

39. The Proposed Transactions will be legally effective.

Purposes of the Proposed Transactions

40. 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 1 and Lossco 2 to earn interest income on the IBLs and thus will enable Lossco 1 and Lossco 2 to effectively utilize their non-capital losses already incurred as well as the losses to be incurred.

41. The purpose of both the payment and the receipt of the Losscos Preferred Shares is to provide a reasonable return on the Lossco Preferred 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.

42. 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.

43. 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 1 and Lossco 2.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, additional information, proposed transactions and purpose 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 IBLs and that Profitco continues to hold the Losscos Preferred Shares for the purpose of gaining or producing income from 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 IBLs; 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 Losscos Preferred Shares, as described in Paragraphs 22, 23 and 25(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 22, 23 and 25(a) is as described in the “Purposes of the Proposed Transactions,” and the Proposed Transactions are undertaken in the manner described above, subsection 55(2) will not apply to such dividends received by Profitco on the Losscos Preferred Shares.

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

The above rulings are given subject to the limitations and qualifications set forth in Information Circular 70-6R12 issued on April 1, 2022, and are binding on the CRA, provided that the Proposed Transactions described in Paragraphs 11 to 21 are completed on or before XXXXXXXXXX and the Proposed Transactions described in Paragraphs 22 to 25 completed within the time frame described in this letter.

The above rulings are based on the law as it reads at the date of this letter 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.

Comments

Unless otherwise expressly confirmed, 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 FMV or ACB of any property referred to herein, or the PUC in respect of any share referred to herein;

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

c. the amount of the non-capital losses, or any other amount of any corporation referred to herein;

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

e. 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 November 3, 2022 to the Proposed Transactions; and

g. any tax consequences relating to the Facts and Proposed Transactions described herein other than those specifically described in the Rulings given above.

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

Yours truly,

XXXXXXXXXX.

for the Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch