2011 Ruling 2011-0409601R3 - 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.

SUBJECT: Loss Consolidation

Principal Issues: Is the proposed loss consolidation acceptable?

Position: Yes

XXXXXXXXXX
2011-040960
XXXXXXXXXX

XXXXXXXXXX , 2011

Dear XXXXXXXXXX :

Subject: Advance Income Tax Ruling
XXXXXXXXXX
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. In general terms, the transactions described herein involve the use of losses within a related and affiliated group of corporations. We also acknowledge the additional information that you provided in your subsequent email correspondences the last of which was received on XXXXXXXXXX .

This letter is based solely on the facts, Proposed Transactions and additional information described below. Any documentation submitted in respect of your request does not form part of the facts, Proposed Transactions and additional information, and any references thereto are provided solely for the convenience of the reader.

To the best of your knowledge, and that of the above-noted taxpayers, none of the issues involved in this advance income tax ruling are:

(i) in an earlier tax return of the above-noted taxpayers or of a related person;
(ii) being considered by a Tax Services Office or a Taxation Centre in connection with a previously filed tax return of the above-noted taxpayers or of a related person;
(iii) under objection by the above-noted taxpayers or by a related person;
(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or
(v) the subject of a ruling previously considered by the Income Tax Rulings Directorate to the above-noted taxpayers or a related person.

Unless otherwise stated, all references to a statute are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.), as amended to the date of this letter (the "Act") or the Income Tax Regulations (the "Regulations"), and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.

Our understanding of the facts, Proposed Transactions and the purpose of the Proposed Transactions is as follows:

Definitions

In this letter, the following terms have the meanings specified:

a) "affiliated" has the meaning assigned by subsection 251.1(1) of the Act;

b) "Agreeing Province" means a Province 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 and will make payments to that Province in respect of the taxes so collected;

c) "arm's length" has the meaning assigned by section 251 of the Act;

d) "Daylight Loan" means the loan ProfitCo will enter into as described in 12 below;

e) "ForCo" means XXXXXXXXXX , a non-resident corporation which is non-arm's length with both ProfitCo and SisterlossCo;

f) "General Anti-avoidance Provision of an Agreeing Province" means:

i) British Columbia: Subsection 68.1(2), Income Tax Act, R.S.B.C. 1996, c. 215, as amended to the date of this letter;

ii) Manitoba: Subsection 53.1(2), The Income Tax Act, C.C.S.M., c. I10, as amended to the date of this letter;

iii) New Brunswick: Section 123, New Brunswick Income Tax Act, S.N.B. 2000, c. N-6.001, as amended to the date of this letter;

iv) Newfoundland and Labrador: Section 88 and subsection 88.1(2), Income Tax Act, 2000, S.N.L. 2000, c. I-1.1, as amended to the date of this letter;

v) Northwest Territories: Section 56.1 and subsection 56.2(2), Income Tax Act, R.S.N.W.T. 1988, c. I-1, as amended to the date of this letter;

vi) Nova Scotia: Subsection 80A(2) and Section 100, Income Tax Act, R.S.N.S., 1989, c. 217, as amended to the date of this letter;

vii) Nunavut: Section 56.1 and subsection 56.2(2), Income Tax Act, R.S.N.W.T. (Nu.) 1988, c. I-1 , as amended to the date of this letter

viii) Ontario: Subsection 110(3), Taxation Act, 2007, S.O. 2007, c. 11, Sch. A, as amended to the date of this letter;

ix) Prince Edward Island: Section 83, Income Tax Act, R.S.P.E.I. 1988, c. I-1, as amended to the date of this letter;

x) Saskatchewan: Section 139, The Income Tax Act, 2000, S.S. 2000, c. I-2.01, as amended to the date of this letter; and

xi) Yukon: Section 61, Income Tax Act, R.S.Y. 2002, c. 118, as amended to the date of this letter;

g) "ITC" means investment tax credit as defined in subsection 127(9) of the Act;

h) "non-capital loss" has the meaning assigned by subsection 111(8) of the Act;

i) "Non-Resident" means: (i) a person (within the meaning of the Act but, for greater certainty, not including a partnership) who is not resident in Canada for the purposes of the Act; or (ii) a partnership that is not a "Canadian partnership" as defined in the Act;

j) XXXXXXXXXX ;

k) "ProfitCo" means XXXXXXXXXX , a taxable Canadian corporation further described in 2 below;

l) "Proposed Transactions" means the transactions described in 11 to 18 below;

m) "Province" means a province of Canada, and includes the Yukon Territory, the Northwest Territories and Nunavut;

n) "Redemption Amount" means the amount equal to the aggregate of the amount for which the SisterlossCo Special Shares were issued, as further described in 11 c) below;

o) "related" has the meaning assigned by subsection 251(2) of the Act;

p) "SisterlossCo" means XXXXXXXXXX , a taxable Canadian corporation further described in 1 below;

q) "SisterlossCo Loan" means the interest-bearing loan Profitco will enter into as described in 14 below;

r) "SisterlossCo Special Shares" means the shares described in 11 below;

s) "specified financial institution" has the meaning assigned by subsection 248(1) of the Act;

t) "SR&ED" means scientific research and experimental development as defined in subsection 248(1) of the Act;

u) "Stated Capital Account" has the meaning assigned by section XXXXXXXXXX of the XXXXXXXXXX ;

v) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;

w) "taxable income" has the meaning assigned by subsection 248(1) of the Act;

x) "XCo" means XXXXXXXXXX , a resident of XXXXXXXXXX for tax purposes;

y) "YCo" means XXXXXXXXXX , a resident of XXXXXXXXXX for tax purposes; and

z) "ZCo" means XXXXXXXXXX , a resident of XXXXXXXXXX for tax purposes.

Facts

1. SisterlossCo is a private corporation and its address is XXXXXXXXXX . All of the shares of SisterlossCo are held directly by XCo. SisterlossCo is incorporated under the authority of the XXXXXXXXXX . It has a taxation year end of XXXXXXXXXX , it files its corporate income tax returns at the XXXXXXXXXX Taxation Centre XXXXXXXXXX and it otherwise deals with the XXXXXXXXXX Tax Services Office.

2. ProfitCo is a private corporation and its address is XXXXXXXXXX . All of the shares in ProfitCo are held directly by YCo. ProfitCo is incorporated under the authority of the XXXXXXXXXX . It has a taxation year end of XXXXXXXXXX , it files its corporate income tax returns at the XXXXXXXXXX Taxation Centre and it otherwise deals with the XXXXXXXXXX Tax Services Office.

3. XCo and YCo are each XXXXXXXXXX % owned and controlled by ZCo.

4. SisterlossCo and ProfitCo have been related and affiliated companies since XXXXXXXXXX .

5. As at XXXXXXXXXX, SisterlossCo had non-capital losses carried forward of approximately $XXXXXXXXXX , a SR&ED pool balance of deductible expenditures of $XXXXXXXXXX , and an ITC pool balance of approximately $XXXXXXXXXX . SisterlossCo may file a SR&ED claim for the 2010 taxation year such that the above balances may change. The losses and tax pools did not arise in any taxation year prior to 2001 or to an acquisition of control of SisterlossCo.

6. SisterlossCo had taxable income for its taxation year ended XXXXXXXXXX . However, the taxable income of SisterlossCo was wholly offset by its non-capital losses carried forward. SisterlossCo continues to have a substantial non-capital loss pool subsequent to the application of the non-capital losses used to offset its 2010 taxable income. SisterlossCo's projected income from its business before the Proposed Transactions is expected to be such that it will not be able to use all its non-capital losses carried forward and ITC pool within the next XXXXXXXXXX years.

7. ProfitCo was profitable and had taxable income for its taxation year ended XXXXXXXXXX . It is expected to continue to be profitable and to have taxable income, after the Proposed Transactions, over the next XXXXXXXXXX years.

8. At XXXXXXXXXX, SisterlossCo owed approximately $XXXXXXXXXX to ForCo, bearing interest at a rate of XXXXXXXXXX % per annum. The amount of this loan respects the thin capitalization rules as detailed pursuant to subsection 18(4) of the Act. All non-resident withholding tax requirements have been satisfied with respect to interest payments made by SisterlossCo to ForCo on this debt. This loan became due on XXXXXXXXXX, at which time $XXXXXXXXXX of the $XXXXXXXXXX loan was repaid by SisterlossCo from surplus cash. The rest of the loan remained outstanding until XXXXXXXXXX, when it was repaid using funds advanced from ZCo. SisterlossCo has made repayments on this advance such that the balance outstanding at XXXXXXXXXX, was approximately $XXXXXXXXXX .

9. At XXXXXXXXXX, ProfitCo had a balance of approximately $XXXXXXXXXX in funds advanced during the 2010 taxation year to ForCo, bearing interest at an appropriate arm's-length rate. These advances to ForCo together with any further amounts advanced in the 2011 taxation year were completely repaid by ForCo on or about XXXXXXXXXX. On or about XXXXXXXXXX, ProfitCo used the proceeds from the repayment from ForCo to make an interest-bearing advance to ZCo. Further advances were made to ZCo such that the balance outstanding from ZCo at XXXXXXXXXX, was approximately $XXXXXXXXXX . These advances to ZCo together with any further amounts advanced in the 2011 taxation year are expected to be completely repaid by ZCo during the 2011 taxation year. ProfitCo will use the proceeds from the repayment from ZCo to advance funds to SisterlossCo on an interest-free basis, or ProfitCo will subscribe to preferred shares of SisterlossCo having a non-cumulative dividend entitlement. The funds received by ProfitCo on repayment of the advances to ZCo will not be commingled with the proceeds from the Daylight Loan described in 12 below or with funds received from any other borrowing. Profitco's use of the funds from the repayment of the advances to ZCo will be traceable to the advance to, or preferred share subscription in, SisterlossCo. SisterlossCo will use the proceeds from this advance, or preferred share issue, to repay the $XXXXXXXXXX owing to ZCo described in 8 above and/or to make a return of paid-up capital to XCo.

10. Due to potential business liability issues that may arise with respect to the operations of ProfitCo, it is not feasible from a business perspective to combine the operations of ProfitCo and SisterlossCo into a single legal entity to facilitate the use of SisterlossCo's tax pools.

Proposed Transactions

The following transactions will be completed sequentially in the order provided below:

11. SisterlossCo will file Articles of Amendment to create a new class or series of special shares (the "SisterlossCo Special Shares") with rights and restrictions as follows:

a) Voting;

b) Annual cumulative dividend rate specified by the directors with reference to prevailing interest rates at the time of issuance expected to be in the range of XXXXXXXXXX % per annum;

c) Shareholder can call for the redemption of some or all of the shares at any time for the Redemption Amount, any undeclared cumulative dividends and any declared but unpaid dividends;

d) The company does not have the right to redeem the shares without prior agreement with the shareholder; and

e) Dividends and proceeds on winding up or dissolution rank in priority to any payment on the common shares.

12. ProfitCo will borrow approximately $XXXXXXXXXX from one or more non-arm's length non-resident corporations (which could include ZCo) on a short-term basis (the "Daylight Loan").

13. ProfitCo will use the proceeds of the Daylight Loan to subscribe for SisterlossCo Special Shares having an aggregate adjusted cost base, stated capital and Redemption Amount equal to the amount of the subscription price of $XXXXXXXXXX . The cumulative dividend rate on the SisterlossCo Special Shares will be set at XXXXXXXXXX % higher than the interest rate applicable on the loan made in the following step.

14. SisterlossCo will use the proceeds from the issue of the SisterlossCo Special Shares to make an interest-bearing loan to ProfitCo (the "SisterlossCo Loan"), payable on demand. As evidence of the indebtedness, ProfitCo will issue to SisterlossCo a demand promissory note with a principal amount equal to the amount of the SisterlossCo Loan and bearing interest at an appropriate arm's length rate expected to be in the range of approximately XXXXXXXXXX % to XXXXXXXXXX %.

15. ProfitCo will use the proceeds from the SisterlossCo Loan to repay the Daylight Loan due to the non-arm's length parties.

16. SisterlossCo will declare and pay the cumulative dividends on the SisterlossCo Special Shares held by ProfitCo annually. It is expected that SisterlossCo will have sufficient cash-flow from its operations (excluding any interest income or additional funding from ProfitCo) to facilitate payment of the annual dividends on the SisterlossCo Special Shares.

17. ProfitCo will pay the interest on the SisterlossCo loan annually.

18. After such time as SisterlossCo earns sufficient income to have utilized all or a substantial portion of its non-capital losses, SR&ED pool and ITC's, and no later than 5 years after the implementation of the proposed transactions,:

a) SisterlossCo will redeem all or a portion of the SisterlossCo Special Shares at their aggregate Redemption Amount, plus any undeclared or unpaid cumulative dividends on the shares redeemed, and will issue a promissory note to ProfitCo in the amount of the Redemption Amount as evidence of its obligation to pay such amount;

b) ProfitCo and SisterlossCo will agree to set-off all or the appropriate portion of the SisterlossCo Loan against the promissory note in (a) above, and this will constitute payment in full of all or the appropriate portion of the principal amounts of the SisterlossCo loan and the promissory note; and

c) ProfitCo will pay to SisterlossCo the balance of any accrued and unpaid interest on the SisterlossCo Loan.

Additional Information

19. Neither SisterlossCo nor ProfitCo is, or will be at any time during the implementation of the Proposed Transactions, a specified financial institution, or a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1) of the Act.

20. The issued SisterlossCo Special Shares will not, at any time during the implementation 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 as that term is defined in subsection 248(1);
(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or
(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)); or
(ii) any right of the type described in subparagraph 112(2.4)(b)(ii).

21. The amount of the Daylight Loan borrowing is not in excess of the borrowing capacity of ProfitCo.

22. The SisterlossCo Loan interest rate is approximately equivalent to the rate that would be applicable on a loan to ProfitCo made by an arm's length Canadian financial institution under similar terms.

23. It is expected that the interest expense that will be deducted by ProfitCo in a particular taxation year in respect of the SisterlossCo Loan will not, based on current estimates, result in a non-capital loss for ProfitCo for a particular taxation year.

24. It is not expected that the life of any of the non-capital losses, SR&ED pool or ITCs will be extended beyond their normal carry forward period.

25. Profitco allocated XXXXXXXXXX % of its 2010 taxable income to XXXXXXXXXX , and SisterlossCo's 2010 provincial allocation of taxable income was as follows: XXXXXXXXXX .

Purpose of the Proposed Transactions

26. The purpose of the Proposed Transactions is to consolidate profits and losses within a related group by enabling SisterlossCo to earn sufficient interest income to deduct its various tax pools, including non-capital losses and SR&ED pool, and to use its ITC's while allowing ProfitCo to reduce its taxable income by the amount of interest payable to SisterlossCo.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, Proposed Transactions and purpose of the Proposed Transactions, and provided further that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. With respect to the interest expense incurred by ProfitCo on the SisterlossCo Loan, as described in 17 above, provided that ProfitCo has a legal obligation to pay interest on the SisterlossCo Loan and ProfitCo continues to hold the SisterlossCo Special Shares for the purpose of gaining or producing income therefrom, ProfitCo will be permitted, pursuant to paragraph 20(1)(c) and subsection 20(3) of the Act, to deduct, in computing its income for a taxation year, the lesser of such interest and a reasonable amount in respect thereof paid in the year or payable in respect of the year (depending on the method that ProfitCo regularly follows in computing its income from property for the purposes of the Act).

B. The dividends received by ProfitCo on the SisterlossCo Special Shares held by it as described in 16 above will be taxable dividends that will be deductible pursuant to subsection 112(1) of the Act in computing the taxable income of ProfitCo for the year in which such dividends are received, and for greater certainty, such deductions will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3), or 112(2.4) of the Act.

C. The provisions of subsections 15(1), 56(2) and 246(1) of the Act will not apply to the Proposed Transactions, in and by themselves.

D. Subsection 245(2) of the Act will not be applied as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

E. The General Anti-avoidance Provision of an Agreeing Province will not be applied, as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above, in respect of a taxation year for which such Province was an Agreeing Province.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002, and are binding on the CRA provided that the Proposed Transactions, excluding 18 above, are commenced by XXXXXXXXXX.

The above rulings are based on the law as it presently reads and does not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Comments

Nothing in this ruling letter should be construed as implying that the CRA has agreed to, reviewed or has 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 amount of any non-capital loss, SR&ED pool, ITC, or any other amount of any corporation referred to herein; or

(c) any tax consequences relating to the facts and Proposed Transactions described herein other than those specifically described in the rulings provided above.

Yours truly,

XXXXXXXXXX
For Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate