2015 Ruling 2014-0554411R3 - 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.

Principal Issues: Is the loss consolidation acceptable?

Position: Yes.

Reasons: The proposed transactions conform to our requirements for loss consolidation structures.

XXXXXXXXXX 2014-055441

XXXXXXXXXX 2015

Dear XXXXXXXXXX:

Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling in respect of the above-noted taxpayers (the “Taxpayers”). We also acknowledge subsequent e-mails and telephone conversations in this respect. In general terms, you are asking us to rule on a series of proposed transactions that are designed to effect a consolidation of losses, and other tax attributes, within a group of affiliated and related corporations.

You have represented to us that, to the best of your knowledge, none of the issues involved in this ruling request are:

1. (i) dealt with in a previously filed return of XXXXXXXXXX (hereinafter “Lossco”), XXXXXXXXXX (hereinafter “Profitco”), or a person related to Lossco or Profitco;
2. (ii) being considered by a tax services office or a taxation centre in connection with a previously filed tax return of Lossco, Profitco, or a person related to Lossco or Profitco;
3. (iii) under objection by Lossco, Profitco, or a person related to Lossco or Profitco;
4. (iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or
5. (v) the subject of a ruling previously considered by the Income Tax Rulings Directorate in connection with Lossco, Profitco, or a person related to Lossco or Profitco, except as noted in paragraph 6 below.

Unless otherwise stated, all references herein to statutory provisions are to the Act, and all references to monetary amounts are to Canadian dollars.

Definitions

In this letter, unless otherwise stated, the following terms have the meaning specified below:

(a) “Act” means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof. Unless otherwise stated, all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

(b) “adjusted cost base” has the meaning assigned by section 54;

(c) XXXXXXXXXX;

(d) “affiliated person” has the meaning assigned by section 251.1;

(e) “agreeing Province” means a province or a territory that has entered into an agreement with the Government of Canada under which the Government of Canada will collect taxes payable under the income tax statute of that province or territory and will make payments to that province or territory in respect of the taxes so collected;

(f) “Annual Dividend Amount” means, with respect to any Annual Dividend Period, an amount equal to the product obtained by multiplying (a) the rate per annum on the Profitco Note plus XXXXXXXXXX basis points, which is currently estimated at XXXXXXXXXX% (b) the Base Redemption Amount in respect of such Newco Preferred Shares as are outstanding on the last day of such Annual Dividend Period, and (c) a fraction, (i) the numerator of which is the number of days in the related Annual Dividend Period, and (ii) the denominator of which is the number of days in the calendar year (365 or 366) in which the related Annual Dividend Payment Date occurs;

(g) “Annual Dividend Payment Date” means XXXXXXXXXX of every year the Profitco Note is outstanding, and the date the loss consolidation structure is unwound;

(h) “Annual Dividend Period” means each period from, and including, one Annual Dividend Payment Date to, but excluding, the next following Annual Dividend Payment Date, except that the initial Annual Dividend Period will commence on, and include, the date on which the Newco Preferred Shares are issued;

(i) “arm’s length” has the meaning assigned by subsection 251(1);

(j) “Base Redemption Amount” means an amount equal to the cash amount for which the Newco Preferred Shares are issued;

(k) “CBCA” means the Canada Business Corporations Act, as amended from time to time;

(l) “CRA” means the Canada Revenue Agency;

(m) “Canco 1” means XXXXXXXXXX;

(n) “Canco 2” means XXXXXXXXXX;

(o) “dividend rental arrangement” has the meaning assigned by subsection 248(1);

(p) “financial intermediary corporation” has the meaning assigned by subsection 191(1);

(q) “Forco Group” means Forco 1, Forco 2 and all of their respective subsidiaries;

(r) “Forco 1” means XXXXXXXXXX, the corporation described in paragraph 1;

(s) “Forco 2” means XXXXXXXXXX, the corporation described in paragraph 1;

(t) “Forco 3” means XXXXXXXXXX;

(u) “General Anti-Avoidance XXXXXXXXXX means XXXXXXXXXX;

(v) “guarantee agreement” has the meaning assigned by subsection 112(2.2);

(w) “Investment Tax Credit” has the meaning assigned by subsection 127(5);

(x) “Loan 1” has the meaning specified in paragraph 18;

(y) “Lossco” means XXXXXXXXXX, the corporation described in paragraphs 2 and 3;

(z) “Lossco Note” means the demand non-interest-bearing promissory note described in paragraph 21;

(aa) “Newco” means the corporation described in paragraph 15;

(bb) “Newco Common Shares” means the common shares described in paragraph 15;

(cc) “Newco Preferred Shares” means the preferred shares described in paragraphs 15 and 16;

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

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

(ff) “principal amount” has the meaning assigned by subsection 248(1);

(gg) “Profitco” means XXXXXXXXXX, the corporation described in paragraphs 7 to 12;

(hh) “Profitco Note” means the interest-bearing promissory note described in paragraph 19;

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

(jj) “Regulations” means the Income Tax Regulations, C.R.C., c. 945, as amended to the date hereof;

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

(ll) “scientific research and experimental development expense” has the meaning assigned by subsection 37(1);

(mm) “SFI” means a “specified financial institution”, within the meaning assigned by subsection 248(1);

(nn) “Tax Attributes” means the non-capital losses, scientific research and experimental development expenses and Investment Tax Credits of Lossco that are described in paragraph 5;

(oo) “taxable Canadian corporation” has the meaning assigned by subsection 248(1);

(pp) “taxable dividend” has the meaning assigned by subsection 248(1).

Facts

1. The Forco Group is XXXXXXXXXX.

2. Lossco is governed by the CBCA and is a taxable Canadian corporation. It is a wholly owned direct subsidiary of Forco 3 and an indirect subsidiary of Forco 1. The authorized capital of Lossco consists of common shares, preferred shares (Canadian dollar) and XXXXXXXXXX. The currently issued and outstanding shares are XXXXXXXXXX common shares, all held by Forco 3.

3. Lossco is headquartered in XXXXXXXXXX. Lossco is involved in many aspects of XXXXXXXXXX. Lossco currently employs approximately XXXXXXXXXX people.

4. The taxation year of Lossco ends on XXXXXXXXXX. During its taxation year ended XXXXXXXXXX, Lossco maintained permanent establishments in XXXXXXXXXX. Lossco's provincial allocation for XXXXXXXXXX, as determined under part IV of the Regulations, was as follows: XXXXXXXXXX. This provincial allocation may change slightly in the next few years, XXXXXXXXXX.

5. As at XXXXXXXXXX, Lossco had unexpired non-capital loss carryforwards of $XXXXXXXXXX, undeducted XXXXXXXXXX expenses of $XXXXXXXXXX and unused Investment Tax Credits of $XXXXXXXXXX (together referred to herein as the “Tax Attributes”). In addition, it is anticipated that Lossco will incur additional non-capital losses of $XXXXXXXXXX for the taxation years XXXXXXXXXX, before taking into account the interest income resulting from the Proposed Transactions. The following shows the taxation year-ends in which the non-capital losses and unused Investment Tax Credits were generated:

a) Non-capital losses

XXXXXXXXXX

b) Unused Investment Tax Credits

XXXXXXXXXX

6. Lossco and Canco 2 undertook transactions similar to the Proposed Transactions which were the subject of a previous ruling issued by this Directorate on XXXXXXXXXX. That loss consolidation structure was unwound on XXXXXXXXXX.

7. Profitco was incorporated on XXXXXXXXXX under the CBCA. It is a wholly-owned direct subsidiary of Canco 1 and an indirect subsidiary of Forco 1. It has been a related and affiliated corporation of Lossco continuously since its incorporation. The authorized capital of Profitco consists only of common shares. The currently issued and outstanding shares are XXXXXXXXXX common shares, all held by Canco 1.

8. From its incorporation to XXXXXXXXXX, Profitco did not own any assets nor did it carry on any business activities.

9. On XXXXXXXXXX, Canco 1 transferred all of its assets relating to its XXXXXXXXXX business to Profitco in a tax rollover transaction.

10. Profitco is located in XXXXXXXXXX but is headquartered in XXXXXXXXXX. It is a leading XXXXXXXXXX in Canada. Profitco employs approximately XXXXXXXXXX people.

11. The taxation year of Profitco ends on XXXXXXXXXX. Based on financial projections, it is currently forecast that Profitco will generate taxable income of approximately XXXXXXXXXX for the taxation years XXXXXXXXXX, before taking into account the interest charges resulting from the Proposed Transactions.

12. For its taxation year ending XXXXXXXXXX, Profitco had permanent establishments in XXXXXXXXXX. However, as all of its gross revenues and salaries were attributable to XXXXXXXXXX, its provincial XXXXXXXXXX allocation was XXXXXXXXXX. This allocation is expected to remain unchanged throughout the life of the Proposed Transactions.

13. The consolidated financial statements of the Forco Group for its year ended XXXXXXXXXX indicate that the Group had:

a) assets of approximately XXXXXXXXXX; and

b) shareholder's equity of approximately XXXXXXXXXX.

14. The borrowing capacity of the Forco Group significantly exceeds the maximum amount required to complete the Proposed Transactions. As at XXXXXXXXXX, the Forco Group had XXXXXXXXXX of cash and cash equivalents and an unused credit facility of approximately XXXXXXXXXX.

Proposed Transactions

The Proposed Transactions will be carried out in the order set out below:

15. Lossco will incorporate a new wholly-owned subsidiary (“Newco”) under the CBCA. Newco will be a taxable Canadian corporation. The taxation year of Newco will end on XXXXXXXXXX. Newco’s share capital will include an unlimited number of common shares (“Newco Common Shares”) and an unlimited number of preferred shares (“Newco Preferred Shares”). Newco will not be a "financial intermediary corporation" as defined in subsection 191(1). Newco will not carry on any business and its activities will be limited to investing the proceeds received upon the issuance of the Newco Preferred Shares to Profitco, as described in paragraph 20 below, in the Lossco Note, as described in paragraph 21 below.

16. The Newco Preferred Shares will have 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 issuer’s option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of redemption equal to the aggregate redemption amount, or (iii) delivery of the Lossco Note, in each case together with an amount in cash equal to all declared and unpaid Annual Dividend Amounts and any accrued dividends which have not been declared and paid up to, but excluding, the date fixed for such redemption or retraction; and

d. entitlement to a cumulative Annual Dividend Amount, payable at each Annual Dividend Payment Date, calculated on a daily basis by reference to the Base Redemption Amount of the Newco Preferred Shares at a fixed rate per annum equivalent to a current estimated rate of XXXXXXXXXX%, the rate per annum on the Profitco Note plus XXXXXXXXXX basis points, and accruing for the Annual Dividend Period.

17. Lossco will subscribe for Newco Common Shares for nominal consideration.

18. Lossco will borrow an amount of $XXXXXXXXXX on a “daylight loan” basis from an arm’s length financial institution or from a related entity (“Loan 1”).

19. Lossco will use the proceeds of Loan 1 to make an interest-bearing loan to Profitco at a fixed rate per annum based on market conditions at the time the loan is granted. This rate will not exceed a reasonable commercial rate in the circumstances, and is currently estimated at XXXXXXXXXX%. The indebtedness arising by virtue of such loan will be evidenced by a promissory note (the “Profitco Note”). The Profitco Note will be payable on demand. The Profitco Note will provide that Lossco’s recourse under the Profitco Note will be limited to the Newco Preferred Shares (together with all proceeds from such shares), and not to any other assets of Profitco. As security for the indebtedness evidenced by the Profitco Note, Profitco will grant Lossco a security interest in the Newco Preferred Shares. The Profitco Note will provide that the principal amount will be satisfied at Profitco’s option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the principal amount of the Profitco Note, or (iii) by way of set-off against the Lossco Note, if the Lossco Note belongs to Profitco at the time of repayment. The amount of dividends received by Profitco on the Newco Preferred Shares will be sufficient to permit Profitco to realize a profit on its investment in the Newco Preferred shares, after deduction of any interest paid or payable on the Profitco Note.

20. Profitco will use all of the proceeds from the Profitco Note to subscribe for Newco Preferred Shares. The aggregate redemption/retraction amount, adjusted cost base and paid-up capital of the Newco Preferred Shares issued will be the same amount as the principal amount of the Profitco Note.

21. Newco will use the proceeds from the issuance of the Newco Preferred Shares to make a non-interest-bearing loan to Lossco. This loan will be evidenced by a demand promissory note (the “Lossco Note”). The Lossco Note will provide that Newco’s recourse under the Lossco Note will be limited to the Profitco Note, and not to any other assets of Lossco. As security for the indebtedness evidenced by the Lossco Note, Lossco will grant Newco a security interest in the Profitco Note. The Lossco Note will also provide that the principal amount may be satisfied at Lossco’s option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the principal amount of the Lossco Note, or (iii) delivery of the Profitco Note.

22. Lossco will use the proceeds from the Lossco Note to repay Loan 1.

23. Lossco, Profitco and Newco will jointly enter into a settlement agreement. Under the agreement, the parties will agree to the terms below:

a) Lossco has the right, in all circumstances, to apply the amount due to it, and represented by the Profitco Note, against the amount due by it to Newco, and represented by the Lossco Note, by way of the remittance and delivery to Newco of the Profitco Note in satisfaction of the amounts owed to Newco. No scenario, even remote, should preclude Lossco’s right to settle the Lossco Note by the remittance of the Profitco Note.

b) Newco acknowledges that Lossco has the right to settle the amount owed to it, and represented by the Lossco Note, by the remittance and delivery of the Profitco Note. Newco further acknowledges that upon remittance of the Profitco Note, an amount equal to the amount owed to Lossco and represented by the Profitco Note shall be applied in reduction of the Lossco Note and automatically proportionally reduce Lossco’s obligations in favour of Newco.

c) Profitco acknowledges and agrees that Lossco has the right to settle the amount it owes to Newco by the remittance and delivery of the Profitco Note.

d) Profitco, Lossco and Newco recognize that the settlement as stipulated in paragraph a) constitutes a legally enforceable right of set-off and agree to proceed in accordance with the principles set out in the settlement agreement.

e) Profitco, Lossco and Newco declare that for the purposes of the settlement agreement, it is their intention to settle simultaneously the Profitco Note and the Lossco Note and agree to cooperate to the extent required to achieve such settlement.

24. The following transactions will occur when jointly determined by Lossco, Profitco and Newco on each Annual Dividend Payment Date:

a. Pursuant to a capital contribution agreement, Lossco will make, on or before each Annual Dividend Payment Date, a contribution of capital to Newco in an amount equal to the amount of the declared and unpaid dividends, if any, on the Newco Preferred Shares. No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the paid-up capital of Newco at any time. The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital will not be income to Newco pursuant to Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). Lossco will not claim, at any time, a capital loss in respect of these capital contributions to Newco;

b. Newco will declare and pay on the Annual Dividend Payment Date following each Annual Dividend Period a dividend on the Newco Preferred Shares in an amount equal to the Annual Dividend Amount for such Annual Dividend Period. Newco will use the capital contributions received from Lossco only for the purpose of paying dividends on the Newco Preferred Shares; and

c. On receipt of the dividend payment, Profitco will pay the accrued and unpaid interest on the Profitco Note out of the funds so received.

25. The structure will be unwound in the following manner on or before XXXXXXXXXX:

a. Lossco will assign and deliver the Profitco Note to Newco as repayment of the Lossco Note;

b. Newco will redeem the Newco Preferred Shares held by Profitco in consideration for the Profitco Note;

c. The Profitco Note will be extinguished by XXXXXXXXXX; and

d. Lossco, as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound-up into Lossco such that Newco’s assets will be transferred to Lossco and Lossco will assume Newco’s liabilities.

Additional Information

26. Lossco and Profitco, as well as all other taxpayers involved in the Proposed Transactions, are SFIs pursuant to paragraph (g) of the definition of SFI on the basis that they are related to a corporation described in paragraph (d) of that definition. However, Profitco will not acquire the Newco Preferred Shares in the ordinary course of its business.

27. The issued Newco Preferred Shares will not, at any time during the course of the Proposed Transactions, be:

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

(b) the subject of a “dividend rental arrangement”;

(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a);

(d) issued for consideration that is, or includes:

i. an obligation of the type described in subparagraph 112(2.4)(b)(i), other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b)) to Newco; or

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

(e) issued or acquired as part of a transaction or series of transactions of the type described in subsection 112(2.5).

28. The interest deducted by Profitco pursuant to paragraph 20(1)(c) in respect of the Profitco Note may create a non-capital loss for Profitco during the period in which the Proposed Transactions occur. Any such resulting non-capital loss would be carried back to a prior taxation year or carried forward to a subsequent taxation year in accordance with the rules in section 111.

29. The Proposed Transactions will not have the direct or indirect effect of extending the life of any of Lossco’s tax attributes beyond their normal carry forward periods.

30. The dividends paid on the Newco Preferred Shares to Profitco, as described in paragraph 24 above, have no other purpose than the purpose described under the heading “Purpose of the Proposed Transactions”.

Purpose of the Proposed Transactions

31. The purpose of the Proposed Transactions is to consolidate taxable income and tax attributes within a group of affiliated and related persons.

Rulings

Provided that the above Facts, Proposed Transactions, Additional Information and Purpose of the Proposed Transactions constitute a complete and accurate disclosure of all of the information relevant to the ruling request, we rule as follows, in reliance on the above information:

A. Provided that Profitco has a legal obligation to pay interest on the Profitco Note and that the Newco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income, in computing its income for a taxation year, Profitco will be entitled to deduct, pursuant to paragraph 20(1)(c), the lesser of (i) the interest on the Profitco Note, as described in paragraph 19 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

B. Subsections 15(1), 56(2), and 246(1) will not apply as a result of the Proposed Transactions, in and by themselves.

C. No amount will be included in the income of Newco pursuant to section 9, or paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital made by Lossco as described in paragraph 24 above.

D. Dividends received by Profitco on the Newco Preferred Shares, as described in paragraph 24 above, will be taxable dividends and such dividends will, pursuant to subsection 112(1), be deductible in computing the taxable income of Profitco for the year in which the dividends are received by Profitco and, for greater certainty, such deductions will not be precluded by any of subsections 112(2.1), (2.2), (2.3) or (2.4).

E. Subsection 245(2) 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 herein.

F. The General Anti-Avoidance XXXXXXXXXX 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 herein, in respect of taxation years for which XXXXXXXXXX is an agreeing Province.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R6, dated August 29, 2014, and are binding on the CRA provided that the Proposed Transactions, other than the transactions described in paragraphs 24 to 25 above, are completed by XXXXXXXXXX.

The above rulings are based on the Act as it exists on the date of this letter and they do not take into account any proposed amendments to the Act. Any such proposed amendments could, if enacted, have a material effect on the rulings provided herein.

Opinion

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions, additional information and purposes of the proposed transactions, provided that the Proposed Transactions are undertaken in the manner described above, and provided that the Act is amended in accordance with the Notice of Ways and Means Motion to amend the Income Tax Act and other tax legislation tabled on April 21, 2015, it is our opinion that neither subsection 55(2) nor subsection 112(2.3) will apply in respect of the dividends described in Ruling D above.

The foregoing opinions are not rulings and, as noted in paragraph 19(f) of Information Circular 70-6R6, are not binding on the CRA.

Comments

Nothing in this ruling letter should be construed as implying that the CRA has agreed to, reviewed, or made any determination in respect of:

(a) the fair market value or adjusted cost base of any property, or the paid-up capital of any shares referred to herein;

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

(c) the amount of any tax attributes described herein;

(d) the XXXXXXXXXX allocations of income in respect of the Proposed Transactions;

(e) any other tax consequences relating to the Facts, Proposed Transactions and Additional Information 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 sent to you under separate cover.

Yours truly,

XXXXXXXXXX
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch