23 September 1991 Internal T.I. 9112807 F - Pre-acquisition Losses and I.T.S.

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.

7-911280

24(1)

Re: Pre-acquisition Losses and I.T.S.

This is in reply to your memorandum dated May 1, 1991 where in you requested technical interpretation of paragraphs 88(1.1)(e) and 88(1)(e.3) of the Income Tax Act (the "Act") under the circumstances described herein.

FACTS

1.     

2.     24(1)

3.     

4.     

5.     

6.     

7.

8.     24(1)

9.     

ISSUE

24(1)

RELEVANT LAW

The recent new "stop loss" rules which require, inter alia, a new taxation year upon acquisition of control under subsection 249(4), are applicable to acquisitions of control occurring after January 15, 1987 and therefore do not apply to the above fact

Pre-acquisition Losses after Wind-up

Generally, where there has been a wind-up under subsection 88(1) of the Act, the parent may deduct non-capital losses incurred by the subsidiary under subsection 111(1) subject to the provisions of subsection 88(1.1)

For the purpose of determining whether 24(1) paragraph 88(1.1)(e) of the Act states in part,that:

(e)  where, at any time, control of the parent or subsidiary has been acquired by a person or persons (each of whom is in this section referred to as the ("purchaser") such portion of the subsidiary's non-capital loss or farm loss for a taxation year ending before that time as may reasonably be regarded as its loss from carrying on a particular business is deductible by the parent for a particular taxation year ending after that time

(i)     only if that business was carried on by the subsidiary or  parent for profit or with a reasonable expectation of profit

(A)     throughout the part of the particular year that is after that time, where control of the parent or subsidiary was acquired in the particular year, and

(B)     throughout the particular year, in any other case, and

(ii) only to the extent of the aggregate of

(A)     the parent's income for the particular year from that business and, where properties were sold, leased, rented or developed or services rendered in the course of carrying on that business before that time, from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services, and ... (Underlining added)

Pre-acquisition ITC after Wind-up

24(1)

taxation year by virtue of paragraph 88(1)(e.3) of the Act which provides, in part:

(e.3) for the purpose of computing the parents investment tax credit at the end of any particular taxation year ending after the subsidiary was wound up.

(i)  property acquired or expenditures made by the subsidiary or an amount included in the investment tax credit of the subsidiary by virtue of paragraph (b) of the definition "investment tax credit" in subsection 127(9) in a taxation year (in this paragraph referred to as the "expenditure year") shall be deemed to have been acquired, made or included, as the case may be, by the parent in its taxation year in which the expenditure year of the subsidiary ended, and

(ii)  there shall be added to the amounts otherwise determined for the purposes of paragraphs (f) to (k) of the definition "investment tax credit" in subsection 127(9) in respect of the parent for the particular year...

(C)  the amount determined in respect of the subsidiary for the purposes of paragraph (j) of the definition "investment tax credit" in subsection 127(9) for its taxation year in which it was wound up except that, for the purpose of the calculation of this clause, where control of the subsidiary has been acquired by a person or group of persons (each of whom is referred to in this clause as the "purchaser") at any time  (in this clause referred to as "that time") before the end of the taxation year in which the subsidiary was wound up, there may be added to the amount determined under subparagraph 127(9 1)(d)(i) in respect of the subsidiary the amount, if any, by which that proportion of the amount that, but for subsections 127(3) and (5) and sections 126, 127.2 and 127.3, would be the parent's tax payable under this Part for the particular year, that

(I)       where the subsidiary carried on a particular business in the course of which a property was acquired, or an expenditure was made, before that time in respect of which an amount was included in computing the subsidiary's investment tax credit for its taxation year in which it was wound up, the amount, if any, by which the aggregate of all amounts each of which is the parent's income for the particular year from the particular business, the parent's income for the particular year from any other business substantially all the income of which was derived from the sale, leasing, rental or development of properties or the rendering of services similar to the properties sold, leased, rented or developed, or the services rendered, as the case may be, by the subsidiary in carrying on the particular business before that time, or the amount, if any, by which

1. the aggregate of the parent's taxable capital gains for the particular year from the disposition of property owned by the subsidiary at that time, other than property that was acquired from the purchaser or a person who did not deal at arm's length with the purchaser,

exceeds

2.   the aggregate of the parent's allowable capital losses for the particular year from the disposition of such property.

     exceeds, in the case of a winding-up commencing after June 5, 1987, the aggregate of the amounts, if any, deducted by the parent under paragraph 111(l)(a) or (d) for the particular year in respect of a non-capital loss or a farm loss, as the case may be, for a taxation year ln respect of the particular business

is of the greater of

(II) the amount determined under subclause (I), and

(III) the parent's taxable income for the particular year  exceeds the amount, if any, calculated under subparagraph 127(9.1)(d)(i) in respect of the particular business or the other business, as the case may be, in respect of the parent at the end of the particular year

     to the extent that such amounts determined in respect of the subsidiary may reasonably be considered to have been included in computing the parent's investment tax credit at the end of the particular year by virtue of subparagraph (i);

SUMMARY OF TAXPAYER'S CONTENTION

Pre-acquisition Losses

24(1)

The court cases Roy Hoffman v MNR, 50 DTC 284 (T.A.S.) and Canadian Dredge and Dock ComPany Limited v MNR, 81 DTC 154 (T.R.B.) were cited by 24(1) support of their view that the reference in subparagraph 88(1.1)(e)  "that business" in which  24(1) incurred "its loss from carrying on a particular business" refers to the general nature and type of business and not to the particular business which 24(1)   operated and in which the pre-acquisition losses were incurred

24(1)

Pre-acquisition ITC

24(1)

SAINT JOHN D.O.'S POSITION

The Saint John D.O.'S position is that:

24(1)

(Underlining added)

OUR COMMENTS

Pre-acquisition Losses Technical Interpretation of Subparagraph 88(1.1)(e)(i) - "that business"

We do not agree with   24(1) that the reference to "that business" in subparagraph 88(1.1)(e)(i) is a reference to only the nature and type of business of the subsidiary in which the pre-acquisition losses were incurred.

The preamble to subparagraph 88(1.1)(e) refers to the subsidiary's loss from carrying on a particular business and then subparagraph (i) refers to that business.  It is clear to us that subparagraph 88(1.1)(e)(i) refers to the particular business of the subsidiary and not to businesses of the parent that are the same general nature and type of business of the subsidiary, i.e., similar businesses

It is worthy to note that the definition of "business" is not an issue. 24(1)

Note also that the nature and type of business is but one of many factors that would be considered in determining whether there is a single business or separate business.  We refer you in this regard to IT-206R entitled separate Businesses for the factors to consider in making this determination.

Subparagraph 88(1.1) (e)(i) is analogous to subparagraph 111(5)(a)(i).  Both of these provisions would be meaningless if the words "that business" found therein were given a broad meaning, i.e., the nature and type of business. Clearly, subparagraphs (i) of 88(1.1)(e) and 111(5)(a) refer to the particular business in which the loss was incurred, i.e, the same business; whereas subparagraphs (ii) thereof refer, ln general terms, to similar  businesses.   It follows that if the reference to "that business" in subparagraphs (i) of 88(1.1)(e) and 111(5)(a) were to similar businesses, then subparagraphs (i) thereof would be meaningless and subparagraphs (ii) thereof which do refer to similar businesses would be worded differently.

Regarding the intent of the subsection 111(5) restrictions on the deductibility of non-capital losses when control of a corporation has been acquired or where control of a corporation has changed hands after the winding-up or discontinuance of the loss business, Andrew Trotta wrote in Business Losses - The New Rules, 82 Canadian Tax Journal, at page 919:

     The Act imposes these limitations to discourage tax-motivated trading in loss companies, and for this reason the present rules require that there be a continuity of business operations before the corporation will be permitted to deduct previous years' losses following a change in ownership.

He also wrote at page 920

      ...The fact that losses from one business would now become deductible against income from a similar business activity gave rise to a concern that the loss business could simply be discontinued by the corporation and that this would encourage, rather than discourage, trading in loss companies where the acquiring company was in a similar line of business.  Thus a double-barrelled test evolved that was designed to address both these issues: on a change of control, the previous year's business losses of a corporation should continue to be deductible against income from the same business or similar business activities provided however, that the business that originally sustained the loss continued to be carried on for profit or with a reasonable expectation of profit.

In view of the intent of subparagraph 88(1.1)(e)(i) and 111(5)(a)(i) that there be continuity of the particular business in which the loss was incurred, 24(1) contention that "that  business" refers to businesses that are similar to the loss business could not be correct.  If contention were correct, it would be possible for any Profitco to acquire an unrelated Lossco with non-capital losses, discontinue Lossco's particular business immediately after acquisition, wind-up Lossco into Profitco and then deduct Lossco's losses from Profitco's income from Profitco's businesses that are similar to Lossco's discontinued business.  This result is clearly contrary to the intent that there be continuity of the unrelated Lossco's particular business and is premised on an interpretation of said subparagraphs that renders them meaningless.

Our view is that "that business" in subparagraphs 88(1.1)(e)(i) and 111(5)(a)(i) refers to the particular business in which the loss was incurred by the subsidiary and not to separate business which happen to be of the same type.

Our view is shared ln the commentary in Income Taxation In Canada, Prentice Hall, at paragraph 47,328 which describes the "business continuance rule in subparagraph 111(5)(a)(i)":

     This rule only refers to the particular business which gave rise to the losses.  It does not refer to any other business which may be discontinued and which the company carried on when its control was acquired, nor to other businesses which it might later acquire or start up, even if they are similar to the particular business whose losses are being carried forward

Also, Income Tax Reporter CCH Canadian Limited, states at page 12,134:

     The provisions of subsection 88 (1.1) like the provisions of subsection 111(5) are intended to reduce or eliminate the  trading in "loss companies".  But for these provisions, a corporate purchaser could acquire control of a company which had accumulated losses and then wind up the purchased company such that the accumulated losses could be used to reduce the income for tax purposes of a profitable business carried on by the corporate purchaser.  The ability to use the accumulated losses of the acquired subsidiary in this manner will be restricted to situations where the profitable business derived substantially all its income from the sale, leasing, rental or development of properties or the rendering of services that are similar to the sold, leased, rented or developed properties or the services rendered by the acquired subsidiary's loss business and the subsidiary's loss business cannot be discontinued but rather must be continued to be carried on for profit or with a reasonable expectation of profit

The Hoffman and Canadian Dredge cases cited by the taxpayer do not assist in the determination of whether the words "that business" in subparagraph 88(1.1)(e)(i), which refers to the particular business of the subsidiary in which the loss was incurred, could be a similar business, i.e, a business of the parent that is of the same nature and type as the subsidiary's loss business.

The Hoffman case, which was decided by W.S. Fisher, merely held that a change in location of a business, by itself, is not decisive of whether the taxpayer has discontinued a business and commenced another.  In Roscommon Builders Limited v MNR, 63 DTC 997-18 (T.A.B.), W.S. Fisher (Roland St-Onge concurring) wrote regarding the Hoffman case at page 997-24:

     However, on re-reading my decision in the Hoffman appeal (supra), I find that I merely referred to the fact that the taxpayer therein was carrying on the same type of business but did not go so far as to make a finding that that factor alone gave the taxpayer the right to deduct losses of previous years. The other factors present in Mr Hoffman's particular circumstances were the deciding factors and had the most bearing on my decision

(Underlining added)

Thus, the Hoffman case does not support 24(1) contentions.

The Canadian Dredge case can also be distinguished from the  24(1) circumstances.  In that case, losses were incurred by the taxpayer in 1968 to 1970, inclusive, in a marine construction business conducted in the Maritimes.  In the loss application years, 1971 to 1973 inclusive, the taxpayer was carrying on "business" by means of two operations; one in Ontario and one in the Maritimes, although the Maritimes operation had been drastically reduced

In his analysis of the case law, L.J. Cardin pointed out at page 160 of the Canadian Dredqe case that:

The courts are consistent in holding that a company will not be entitled to deduct losses incurred in previous years if there has been a change of control in the company and if it has clearly interrupted, ceased and altered the business in which the losses were sustained.  Both these conditions are questions of fact. The change of control in the company is not in dispute.  Only the continuity of the appellant's business questioned here and later on at the same place, he stated that:

In these respects particularly, the facts of the instant appeal are distinguishable from those of the cases cited by the respondent in which the businesses carried on by the taxpayer had clearly ceased to be operated or had so been altered in the loss application years that they could not be considered as being the business carried on by the taxpayer during the loss years

The interpretation of subparagraph 88(1.1)(e)(i) which  24(1)  is seeking is one pertaining to circumstances in which the loss business has been discontinued.  The Canadian Dredge case is therefore distinguishable from the 24(1) circumstances in the same manner as described in L.J. Cardin's latter remarks above.

In the Roscommon Builders case, supra, it was held that while the company was carrying on in 1959 the same type of business as had been carried on ln 1956 and 1957, it could not be said that it was carrying on the business in which it had been engaged in 1956 and 1957 when the losses wore sustained.  The company had been completely inactive in 1958, and there was no continuity of the company's business when the company recommenced activities after it was taken over by new shareholders in 1958.

24(1)

In Garage Henri Brassard Limité v. MNR, 60 DTC 1205 (Exch Ct.), the taxpayer ceased its garage business operations on December 20, 1954 and sold all of its assets during 1954 and 1955.  Losses were incurred in 1954 and 1955.  On January 13, 1956, control of the corporation was acquired.  Subsequently, a new garage business was started which generated profits in 1956 and from which the 1954 and 1955 losses were deducted.  The question in this case was whether the appellant's income for the year 1956 stemmed from the business which had suffered the losses in 1954 and 1955.  The court considered the principle laid down in Eastern Textile Products Ltd. v. MNR, 57 DTC 1070 (Exch. Ct.) at page 1209:

When a person, who operates a business, sells it or disposes of all the assets and ceases operations, he cannot deduct losses arising from the operation of that business from the profits which he might realize from carrying on a new or other business even if the latter be similar to the former. (Underlining added)

The court therefore disallowed the losses claimed by the taxpayer in 1956

In Holiday Knitwear Ltd v MNR, 63 DTC 116 (T.A.B.), which was held  in favour of the Minister, the taxpayer advanced the same argument as   24(1)  that the business that is required to be carried on is not necessarily the particular business in which the loss was incurred, but rather, the same type of business.  This argument was rejected by the court.  The taxpayer's counsel gave the following example at page 125 to illustrate his argument:

     If one asks two laymen who were both in the hardware business whether they were in the same business I submit that they would certainly say yes.  This does not mean that they are partners in the same firm or shareholders in the same corporation, they are in the same business because they are both in the hardware business.  The expression "the same business" does not mean the identical business....

The above argument was rejected by J.O. Weldon for the court who stated that:

     In the view of the hearing member, if the two laymen were asked the question in a precise manner they would reply that they were in the same type of business or in like business, but they would not say that they were in the same business.

The above jurisprudence demonstrate that 24(1) contention that it is settled law that pre-acquisition of control losses may be deducted after the original loss business has been discontinued is not correct.  Indeed, as stated in the Canadian Dredge case, the courts are consistent in holding that a company will not be entitled to deduct losses incurred in previous years if there has been a change in control and the company and the business in which the loss was incurred has ceased.

Conclusion on Pre-acquisition Losses

24(1)

Pre-acquisition ITC: Technical Interpretation of Paragraph 88 (1)(e.3)

24(1)

21(1)(b)

If you have any questions or comments, please contact the writer.

Section ChiefResource Industries SectionBilingual Services and Resources Industries DivisionRulings directorate.