7 July 1997 Income Tax Severed Letter 9710583 - Loss consolidation

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.

SUMMARY: Loss consolidation—ITA-20(1)(c)—Advance income tax ruling—Tax implications of a proposed reorganization to consolidate losses in a corporate group.

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.

PRINCIPAL ISSUES:

Loss Consolidation

1. In order to avoid paying fee to bank to increase credit line to $XXXXXXXXXX to effect the loss consolidation, the t/p will draw down its existing line of credit twice (ie. XXXXXXXXXX) 2. Capital contributions to Newco will result in acb bump.

POSITION:

1. OK 2. OK

REASONS:

1. T/P can substantiate that it could otherwise qualify for a credit line of $XXXXXXXXXX 2. Requirement that Newco be wound-up subsequent to loss utilization.

XXXXXXXXXX 971058 XXXXXXXXXX

Attention: XXXXXXXXXX

XXXXXXXXXX, 1997

Dear Sirs:

Re: XXXXXXXXXX

We are writing in response to your correspondence of XXXXXXXXXX wherein you had requested an advance income tax ruling on behalf of the above noted corporations. We also acknowledge our (XXXXXXXXXX) various telephone conversations and your further submissions in support of this matter.

You have advised that, to the best of the knowledge of yourself and that of XXXXXXXXXX, none of the issues involved in this request for an advance income tax ruling is in an earlier return of income of XXXXXXXXXX or any related person, is under objection or appeal, or is being considered by a taxation services office or taxation centre of Revenue Canada in connection any tax return already filed.

The relevant facts, the proposed transactions and the purpose of the proposed transactions are as follows:

FACTS

1. XXXXXXXXXX is incorporated under the Canada Business Corporations Act and is both a "taxable Canadian corporation" and a "public corporation" as those terms are defined in subsection 89(1) of the Income Tax Act (the "Act").

2. XXXXXXXXXX is incorporated under the XXXXXXXXXX and is a "taxable Canadian corporation" as that term is defined in subsection 89(1) of the Act. XXXXXXXXXX is a wholly-owned subsidiary of XXXXXXXXXX.

3. Both of XXXXXXXXXX have a year end of XXXXXXXXXX.

4. It is anticipated that XXXXXXXXXX will incur losses of approximately $XXXXXXXXXX in the year ended XXXXXXXXXX and that XXXXXXXXXX will earn profits in excess $XXXXXXXXXX in that same period. The shareholder's equity and total assets of XXXXXXXXXX on a consolidated basis at XXXXXXXXXX were $XXXXXXXXXX respectively and the cash flow from operations for the year ended XXXXXXXXXX was approximately $XXXXXXXXXX. The market capitalization of XXXXXXXXXX is in excess of $XXXXXXXXXX. XXXXXXXXXX currently has a $XXXXXXXXXX line of credit which is, at present, drawn down by approximately $XXXXXXXXXX. This draw down is expected to decrease during the XXXXXXXXXX fiscal year. The consolidated pre-tax net income of XXXXXXXXXX is anticipated to be approximately $XXXXXXXXXX.

PROPOSED TRANSACTIONS

5. XXXXXXXXXX will incorporate a corporation ("Newco") under the XXXXXXXXXX. Newco will be a "taxable Canadian corporation" within the meaning of that term in subsection 89(1) of the Act. The taxation year end of Newco will be XXXXXXXXXX. Newco will not carry on any business and its activities will be limited to investing the proceeds received upon the issuance of its Preferred Shares to XXXXXXXXXX as described in paragraph 10, below, in the non-interest bearing loan to XXXXXXXXXX as described in paragraph 11, below.

6. The authorized capital of Newco will consist of XXXXXXXXXX classes of shares including common shares and non-voting, cumulative dividend, redeemable, retractable preferred shares (the "Preferred Shares"). The cumulative dividends payable on the Preferred Shares will be calculated daily by reference to the redemption/retraction price of the Preferred Shares at a rate of prime (as quoted by the Bank of Nova Scotia at Toronto) plus 100 basis points. Dividends will be payable monthly in arrears on the last day of every month.

7. The common shares of Newco will be issued to XXXXXXXXXX for $XXXXXXXXXX.

8. XXXXXXXXXX will borrow an amount (the "Principal Amount") of $XXXXXXXXXX against its currently existing available line of credit on a "daylight loan" basis from an arm's length institutional investor (the "Daylight Loan").

9. XXXXXXXXXX will use the proceeds received from the Daylight Loan to make a demand loan to XXXXXXXXXX (the "XXXXXXXXXX Loan"). Simple interest will accrue on the XXXXXXXXXX Loan and will be calculated daily at a rate of prime (as quoted by the Bank of Nova Scotia at Toronto) plus 99 basis points payable monthly in arrears on the last day of every month.

10. XXXXXXXXXX will use the proceeds received from the XXXXXXXXXX Loan to subscribe for Preferred Shares in Newco having an aggregate redemption/retraction price equal to the Principal Amount.

11. Newco will use the proceeds received from the Preferred Share subscription to make a demand, interest free loan to XXXXXXXXXX (the "XXXXXXXXXX Loan") in an amount equal to the Principal Amount.

12. XXXXXXXXXX will use the proceeds received from the XXXXXXXXXX Loan to repay the Daylight Loan.

13. The steps set out in paragraphs 8 through 12 will be repeated such that the aggregate Principal Amounts of the two Daylight Loans will be $XXXXXXXXXX and the amount of the XXXXXXXXXX Loan and the XXXXXXXXXX Loan will each be $XXXXXXXXXX. It is anticipated that interest received by XXXXXXXXXX on the XXXXXXXXXX Loan will be sufficient to offset the losses expected to be incurred by XXXXXXXXXX in fiscal XXXXXXXXXX. XXXXXXXXXX believes that it would be entitled to increase its available line of credit to at least $XXXXXXXXXX, however by drawing down its existing line of credit twice as described above it is able to avoid the costs associated with increasing the line of credit.

14. On the last day of each month while the XXXXXXXXXX Loan is outstanding, XXXXXXXXXX will make a contribution of capital to Newco in an amount equal to the dividends payable by Newco on that day on the Preferred Shares.

15. At such time as XXXXXXXXXX aggregate interest income derived from the XXXXXXXXXX Loan is sufficient to offset the non-capital losses incurred by XXXXXXXXXX in the year ended XXXXXXXXXX, XXXXXXXXXX will borrow an amount equal to the Principal Amount of $XXXXXXXXXX on a daylight basis (the "Second Daylight Loan"). XXXXXXXXXX will use these funds to repay one-half of the XXXXXXXXXX Loan.

16. Newco will use the funds received upon the repayment of the XXXXXXXXXX Loan to redeem one-half of the Preferred Shares.

17. XXXXXXXXXX will use the proceeds received upon the redemption of the Preferred Shares to repay one-half of the XXXXXXXXXX Loan.

18. XXXXXXXXXX will use the funds received upon the repayment of the XXXXXXXXXX Loan to repay the Second Daylight Loan.

19. The steps set out in paragraphs 15 through 19 will be repeated such that the both of the Second Daylight Loans will have been repaid, both the XXXXXXXXXX Loan will also have been fully repaid and all of the Preferred Shares of Newco will have been redeemed.

20. XXXXXXXXXX will cause Newco to be wound-up within sixty days after the Preferred Shares are redeemed and the Second Daylight Loans have been repaid. Other than as described above, XXXXXXXXXX will not dispose of the shares of Newco which it presently owns or will acquire as described in the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to consolidate profits and losses within a group of related taxable Canadian corporations by enabling XXXXXXXXXX to earn sufficient interest income so as to reduce losses that it would otherwise incur in its XXXXXXXXXX taxation year.

RULINGS PROVIDED

Provided that the preceding statements are accurate and complete and the proposed transactions are carried out as described above, we confirm the following:

A. Provided that XXXXXXXXXX has a legal obligation to pay interest on the XXXXXXXXXX Loan and provided that the Preferred Shares of Newco continue to be held for the purpose of gaining or producing income (other than income which would be exempt), XXXXXXXXXX will be entitled to deduct, in computing its income for a taxation year, the lesser of the interest paid or payable in respect of that taxation year or a reasonable amount in respect thereof pursuant to paragraph 20(1)(c) of the Act.

B. No amount will be included in the income of Newco pursuant to paragraph 12(1)(x) of the Act in respect of the contributions of capital made by XXXXXXXXXX to Newco as described in paragraph 14 of the Proposed Transactions.

C. The dividends to be received by XXXXXXXXXX on the Newco Preferred Shares will be deductible by XXXXXXXXXX pursuant to subsection 112(1) of the Act in computing its income for income tax purposes.

D. Subsection 245(2) of the Act will not be applicable as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given.

These rulings are provided subject to the limitations and qualifications set out in Information Circular 70-6R3 issued by Revenue Canada on December 30, 1996 and are binding upon the Department provided that the proposed transactions are completed by XXXXXXXXXX. The rulings are based on the Act and the Income Tax Regulations in their present form and does not take into account the effects of any proposed amendments thereto.

Yours truly,

for Director Financial Industries Division Income Tax Rulings and Interpretations Directorate Policy and Legislation Branch