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.
Dear Sirs:
This is in reply to your letter of June 14, 1989 in which you requested a technical interpretation of the above-noted provision and, in particular, an interpretation as to whether, given the following hypothetical facts, a corporation ("Company A") could apply the losses of a second acquired corporation ("Company L") against the former's profits.
The hypothetical facts as given are as follows:
- 1. Company A is a Canadian-controlled private corporation.
- 2. Company A is in the business of buying finished and unfinished materials and manufacturing garments from those materials. Company A sells the garments it manufactures through a number of its own retail outlets located throughout Ontario. Company A does not sell the manufactured garments to any other retailer. However, in addition to retailing garments it has manufactured, Company A retails garments manufactured by other persons.
- 3. In order to claim the manufacturing and processing tax credit, Company A maintains separate books for the manufacturing and retailing segments of its business.
- 4. Company A has been profitable over the last number of years.
- 5. Company A is considering purchasing one or two companies which have incurred losses over the past years.
6. Company A is considering purchasing either
- (i) a loss company that carries on a retail business (not necessarily involving clothing),
- (ii) a loss company that is carrying on a retail clothing business with a retail presence in malls across Ontario or other parts of Canada,
- (iii) a loss company that is carrying on a clothing manufacturing business, or
- (iv) a loss company that manufactures its own garments and sells the garments (as well as garments manufactured by other persons) through retail operations.
- 7. The acquired loss company, whatever business it is in, will be continued in substantially the same form after it's acquisition by Company A.
- 8. The business acquired will at all times be carried on with a reasonable expectation of profit.
It is your position that the loss incurred by the acquired company, if it carries on a business described at paragraph 6(ii), (iii), or (iv), can be applied against all the profits of Company A; that is, against the profits from both the manufacturing and the retailing segment of Company A's business. It is also your position that, if the acquired corporation carried on a business described in paragraph 6(i) this would not necessarily be the case, but would depend on the nature of the actual retail business.
Our Comments
Before we give you our opinion as to the deductibility of the losses in the hypothetical facts situation given, we wish to point out that Company A and Company L are separate taxpayers. Thus, in order for Company A to deduct the losses of Company L, they must take some step which results in the same entity carrying on both Company A's profitable business and Company L's business. We have assumed that Company L will be wound up into Company A pursuant to section 88 of the Act.
Whether or not the business carried on after a change in control is the same business as that carried on before the change and whether or not properties manufactured or sold are similar properties are, of course, questions of fact and as such depend on the particular circumstances in each case. Furthermore, whether the requirements of subparagraphs 88(1.1)(e)(i) and (ii) of the Act have been satisfied in a particular case is also a question of fact that can only be determined based on an examination of all of the relevant facts and related transaction. We offer, however, these general comments.
It is our view that the term "similar properties or the rendering of similar services" as stated in subparagraph 88(1.1)(e)(ii) of the Act must be given a strict meaning within the spirit of the general rule that limits the transfer of losses when there is a change in control. It is not sufficient that the products sold be similar, the businesses must truly and essentially be similar. Such losses are only deductible after a change in control against income earned from a similar business where substantially all of the income from that business is derived from the sale of similar properties.
Depending on the circumstances of a particular case, Company A could be carrying on one or two different businesses; the manufacturing of garments and the retailing of garments as one business or the manufacturing and retailing of garments as two separate businesses.
If we assume that the manufacturing and selling of each product are so interconnected and interdependent that they cannot be considered to be separate businesses then only the acquisition of a company described in paragraph 6(iv), a loss company that manufactures it's own garments and sells the garments (as well as garments manufactured by other persons) through retail operations, would be considered a similar business and satisfy the provisions of 88(1.1)(e)(ii) of the Act, where substantially all of the income of that business must be derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services.
If, however Company A is carrying on two separate businesses, (1) the manufacturing of garments and (2) the retailing of garments, in our opinion, Company A could deduct the losses of the acquired company described in paragraph 6 above, to the following extent:
- (i) retail business losses (not necessarily involving clothing) against the income of the retail business of Company A but only if the nature of the, actual retail business is in fact similar to Company A (ie. a similar product is being retailed).
- (ii) a loss company that is carrying on a retail clothing business with a retail presence in malls across Ontario or other parts of Canada against the retail part of its business, rather than against all the income of Company A.
- (iii) a loss clothing manufacturing business against the income of the manufacturing part of Company A's business rather than against all the income of Company A.
- (iv) a loss company that manufactures it's own garments and sells the garments (as well as garments manufactured by other persons) through retail operations against the respective business incomes of manufacturing and retailing of Company A as they would be considered separate businesses.
We trust our comments will be of assistance.
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