30 November 1994 Internal T.I. 9427470 - LOSS UTILIZATION

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

1994 Canadian Tax Conference

Loss Utilization within a Corporate Group

We have been asked to clarify our position concerning transactions that are designed to transfer, in effect, unused tax losses or deductions of one Canadian corporation to a related profitable Canadian corporation.

The Explanatory Notes to Draft Legislation and Regulations Relating to Income Tax Reform issued by the Minister of Finance in June 1988 indicate that the transfer of income or deductions between related corporations that is accomplished using transactions that are legally effective and comply with any applicable provisions of the Act would not usually result in a misuse of the provisions of the Act or an abuse of the Act read as a whole, for purposes of applying the general anti-avoidance rule in section 245. Revenue Canada follows that approach in dealing with such transactions.

Accordingly, in most domestic in-house loss-consolidation schemes that we have reviewed, section 245 has not been found to apply. The difficulties that are most frequently encountered in these schemes involve the requirements that the transactions be legally effective and comply with specific provisions of the Act which apply to the transactions. The following are examples of such difficulties:

1)Some schemes involve the triggering of gains by the conveyance of an asset by one corporation to another corporation in the group, followed by a reconveyance of the asset or an amalgamation of the transferor and transferee. In order for such transactions to achieve the desired result, there must be a disposition of the asset for tax purposes. The definition of "disposition" in section 54 of the Act provides that there is no disposition of a property where the legal ownership of the property changes without any change in the beneficial ownership thereof. If the property is held by the transferee under any circumstances which indicate that it does not enjoy the usual benefit or is not exposed to the usual risks of ownership of the asset, there may not have been a disposition of the asset to the transferee.

2)A similar difficulty can arise where the scheme involves the transfer of a depreciable asset of one corporation to another corporation in the group, followed by a transfer of the asset back to the transferor or yet another corporation in the group. Such schemes will not usually achieve the desired result unless the asset is depreciable property to the transferee (so that the transferee can deduct CCA, or so that certain CCA flow-through rules in Regulations 1100 to 1102 apply). In order for the asset to represent depreciable property to the transferee, Regulation 1102(1)(c) requires that the transferee acquire the asset for purposes of gaining or producing income. As the Federal Court-Trial Division confirmed in Hickman Motors Ltd. v. The Queen,¹ an asset is not necessarily acquired for the purpose of gaining or producing income merely because the asset is actually used by the transferee to gain or produce income for a short time. Whether the reasoning in Hickman Motors applies to a particular loss-consolidation scheme will depend on all of the relevant circumstances, including the length of time over which the asset is held by the transferee, the use to which the asset is put by the transferee and the income earned by the transferee with the asset.

3)Loss-utilization schemes often involve the borrowing of money by one corporation from another corporation in the group (See, for example, Income Tax Ruling ATR-44 or example 5 of Information Circular 88-2, Supplement 1. As the decision in Mark Resources Inc. v. The Queen²points out, in these situations, it is arguable that the borrowed money does not meet the requirement in paragraph 20(1)(c) that it be used for the purpose of earning income, when the "overriding ultimate economic purpose" of the borrowing is to permit losses to be used within the group. Nevertheless, as the Mark Resources decision has been appealed to the Federal Court of Appeal the Department will maintain its position with respect to the use of this type of scheme to transfer losses between related Canadian corporations, as it is reflected in ATR-44 and Information Circular 88-2. However, we will review our position once Mark Resources is decided on appeal and any change in our position resulting from that review will be announced in the Income Tax Technical News.

4)It is sometimes desirable to roll an asset from a profitable corporation to another corporation before an arm's-length sale of the asset, in order to make use of the transferee's losses. Where such a transaction involves intercorporate dividends, subsection 55(2) may apply to the dividends.³

The above are some examples of the technical difficulties that can arise in loss-utilization schemes, and are not meant to be an exhaustive list. The circumstances of each case must be examined before reaching any conclusions with respect to the application of section 245 and any other specific provisions that may apply.

Mark Symes
November 30, 1994

¹ 93 DTC 5040

² 93 DTC 1004

³ See Robert J.L. Read, "Section 55: A Review of Current Issues," in Report of Proceedings of the Fortieth Tax Conference, 1988 Conference Report, 18:2-3.

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