2011 Ruling 2010-0370751R3 - 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 loss consolidation acceptable?

Position: Yes

Reasons: Within established parameters.

XXXXXXXXXX
									2010-037075
									XXXXXXXXXX 

XXXXXXXXXX , 2011

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX

We are replying to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling with respect to the above-noted taxpayers (the "Taxpayers") regarding the implementation of an in-house loss consolidation transaction. We also acknowledge the additional information provided to us in your additional letters dated XXXXXXXXXX , as well as your emails the last of which was dated 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 Taxpayers, none of the issues involved in this advance income tax ruling are:

(i) in an earlier tax return of the 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 Taxpayers or of a related person;
(iii) under objection by the 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 issued by the Income Tax Rulings Directorate to the 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"), 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) "adjusted cost base" ("ACB") has the meaning assigned by section 54 of the Act;

(b) "Daylight Loan" means the loan described in 11 below;

(c) "Demand Loan" means the loan described in 14 below;

(d) "Fair Market Value" ("FMV") means the highest price available in an open and unrestricted market between informed, prudent parties acting at arm's length and under no compulsions to act;

(e) "financial institution" has the meaning assigned by subsection 190(1) of the Act;

(f) "Lossco" means XXXXXXXXXX , a corporation further described in 1 below;

(g) "non-capital loss" has the meaning assigned by section 111 of the Act;

(h) "paid-up capital" has the meaning assigned by subsection 89(1) of the Act;

(i) "permanent establishment" has the meaning assigned by Part IV of the Income Tax Regulations;

(j) "principal amount" has the meaning assigned by subsection 248(1) of the Act;

(k) "Profitco" means XXXXXXXXXX , a corporation further described in 3 below;

(l) "Profitco Note" means the note described in 13 below;

(m) "Proposed Transactions" means the transactions described in 10 to 21 below;

(n) "public corporation" has the meaning assigned by subsection 89(1) of the Act;

(o) "related persons" has the meaning assigned by section 251 of the Act;

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

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

(r) "taxable dividend" has the meaning assigned by subsection 89(1) of the Act; and

(s) "taxable income" has the meaning assigned by subsection 248(1) of the Act.

Facts

1. Lossco was incorporated on XXXXXXXXXX , and is a corporation formed under the laws of XXXXXXXXXX with shares traded on the XXXXXXXXXX Stock Exchange (XXXXXXXXXX ) and XXXXXXXXXX Stock Exchange (XXXXXXXXXX ). Lossco has XXXXXXXXXX taxation year-end. Lossco's address is XXXXXXXXXX and it files its tax returns with the XXXXXXXXXX Taxation Centre and otherwise deals with the XXXXXXXXXX Tax Services Offices.

2. Lossco is XXXXXXXXXX company headquartered in XXXXXXXXXX . Lossco's current business operations include XXXXXXXXXX .

3. Profitco was incorporated on XXXXXXXXXX , as a wholly-owned subsidiary of Lossco. It is a corporation formed under the laws of XXXXXXXXXX . It was formed to acquire the primary assets and liabilities used in the operation of the XXXXXXXXXX . Lossco holds all of the issued and outstanding shares of Profitco. Profitco has XXXXXXXXXX taxation year-end and its address is XXXXXXXXXX . Profitco files its tax returns with the XXXXXXXXXX Taxation Centre and otherwise deals with the XXXXXXXXXX Tax Services Offices.

4. XXXXXXXXXX

5. Lossco has a non-capital loss of $XXXXXXXXXX for its taxation year ended XXXXXXXXXX . At XXXXXXXXXX , its non-capital losses carryforwards amounted to $XXXXXXXXXX , made up as follows:

Year of origin
Year of expiry
Non-capital Loss
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

On XXXXXXXXXX , Lossco changed its fiscal year end from XXXXXXXXXX to XXXXXXXXXX to coincide with the year end of Profitco, and to coincide with the fiscal year end date commonly used in the XXXXXXXXXX industry. In XXXXXXXXXX , the company changed its year end for tax purposes as well. At no time since the XXXXXXXXXX taxation year has any single shareholder or related group of shareholders acquired more than XXXXXXXXXX % of the shares giving the right to vote at an annual general meeting of shareholders, i.e., there has not been an acquisition of control of Lossco.

6. Profitco currently has a non-capital loss balance of $XXXXXXXXXX which originated in the taxation year ended XXXXXXXXXX . The XXXXXXXXXX taxation year was an atypical year and Profitco is expected to generate significant taxable income in the future, projecting $XXXXXXXXXX of earnings before interest, depreciation and amortization for each of the XXXXXXXXXX taxation years. Profitco has approximately $XXXXXXXXXX of interest expense annually and nominal tax depreciation (capital cost allowance), prior to the Proposed Transactions being effected.

7. Lossco has a permanent establishment solely in the province of XXXXXXXXXX and allocates XXXXXXXXXX % of its taxable income or loss to that province. This provincial allocation is expected to remain unchanged throughout the life of the Proposed Transactions.

8. Profitco has a permanent establishment in the provinces of XXXXXXXXXX . In XXXXXXXXXX , Profitco's taxable income was fully attributed to XXXXXXXXXX . This allocation may change slightly in the next few years, as Profitco has submitted an application to XXXXXXXXXX in XXXXXXXXXX .

9. Lossco has a borrowing capacity of $XXXXXXXXXX Canadian dollars.

Proposed Transactions

10. Lossco will incorporate a new corporation ("Newco"), the authorized capital of which will consist of one class of common shares and one class of preferred shares (the "Newco Preferred Shares"). The common shares will be voting shares without par value. Lossco will subscribe for XXXXXXXXXX common shares of Newco for $XXXXXXXXXX . The Newco Preferred Shares will have the following rights and restrictions:

a) non-voting;

b) redeemable at any time for an amount equal to the aggregate of the amount for which the shares were issued plus any accrued but unpaid dividends;

c) retractable at any time for an amount equal to the aggregate of the amount for which the shares were issued plus any accrued but unpaid dividends;

d) entitled to a cumulative dividend on the amount for which they were issued at an annual rate that is XXXXXXXXXX % greater than the interest rate on the Profitco Note described in 13 below;

e) dividends and proceeds on winding up or dissolution rank ahead of any payment on the common shares for the return of their redemption amount plus any accrued but unpaid dividends; and

f) on winding up or dissolution, holders will receive an amount equal to the aggregate of the amount for which the shares were issued plus any accrued but unpaid dividends in preference to any payment to the common shareholders.

11. Lossco will borrow an amount from an arm's length lender of approximately $XXXXXXXXXX on a daylight basis (the "Daylight Loan"). The borrowing will be documented with a formal lending agreement.

12. Lossco will use the proceeds of the Daylight Loan to subscribe for the Newco Preferred Shares of Newco. The Newco Preferred Shares will have an aggregate ACB, FMV, and paid-up capital equal to the amount of the Daylight Loan. As noted in 10(b) and (c) above, the Newco Preferred Shares will have a redemption and retraction amount equal to the aggregate of the amount of the Daylight Loan plus any accrued but unpaid dividends.

13. Lossco will immediately transfer the Newco Preferred Shares to Profitco at a purchase price equal to their FMV. As sole consideration for the transfer of the Newco Preferred Shares, Profitco will issue an interest bearing promissory note (the "Profitco Note") to Lossco with a principal amount equal to the Newco Preferred Shares' FMV. The Profitco Note will bear simple interest at XXXXXXXXXX % per annum. This interest rate is not greater than the rate that Lossco would pay to an arm's length lender to borrow an equivalent amount on equivalent repayment terms on an unsecured basis.

14. Newco will lend the proceeds from the subscription of the Newco Preferred Shares to Lossco on an interest-free demand basis (the "Demand Loan").

15. Lossco will use the proceeds from the Demand Loan to repay the Daylight Loan.

16. Lossco will make an annual capital contribution on its common share holdings of Newco equal to the amount of any accumulated accrued and unpaid dividends owing to Profitco on the Newco Preferred Shares.

17. Newco will use the capital contributions received from Lossco to pay the balance of any cumulative accrued and unpaid dividends on the Newco Preferred Shares to Profitco.

18. Profitco will pay the balance of any accrued and unpaid interest to Lossco on the Profitco Note on an annual basis.

19. The annual interest payment date on the Profitco Note will be the same as the annual dividend payment date on the Newco Preferred Shares.

20. Lossco will discontinue making capital contributions to fund the dividends on the Newco Preferred Shares once the structure is unwound.

21. Subsequent to the utilization of the non-capital losses of Lossco, Lossco will unwind the structure created by the Proposed Transactions. The structure is expected to remain in place until XXXXXXXXXX . Following the unwind, Newco will remain a wholly-owned subsidiary of Lossco, however, its preferred shares will be redeemed by Profitco during the unwind.

Purpose of the Proposed Transactions

22. The purpose of the Proposed Transactions is to consolidate profits and losses within a group of taxable Canadian corporations that are related persons, by enabling Lossco to earn sufficient interest income on the Profitco Note to fully utilize Lossco's non-capital losses. Profitco will obtain an interest deduction that is expected to reduce its taxable income.

The purpose of Lossco making capital contributions to Newco as described in 16 above, as opposed to having Lossco subscribe for additional common shares of Newco, is to ensure that Newco will not be precluded from declaring dividends on the Newco Preferred Shares pursuant to the relevant corporate law. If additional common shares of Newco were issued, the realizable value of Newco's assets after the payment of a dividend would be less than the aggregate amount of its liabilities and stated capital of its common shares and preferred shares, thus precluding the payment of dividends.

Additional Information

23. The Proposed Transactions described herein will occur in the order presented.

24. At all relevant times, none of Lossco, Profitco and Newco will be a specified financial institution or a financial institution.

25. Based on financial projections, Profitco will have the financial capacity to honour its interest obligations under the Profitco Note.

26. None of the Proposed Transactions will have a significant impact on any outstanding tax liabilities of Lossco, Profitco or Newco, other than as set out herein.

27. The Newco Preferred Shares will not, at any relevant time, be:

a) the subject of any undertaking that is a guarantee agreement (subsection 112(2.2));

b) the subject of a dividend rental arrangement (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).

28. None of the purposes of paying the dividends described in the Proposed Transactions will be to effect a significant reduction in the portion of the capital gain that, but for the dividends, would have been realized on a disposition at FMV of any of the shares referred to herein immediately before the payment of the dividends. The purpose of Newco paying the dividends on the Newco Preferred Shares is to satisfy their terms and conditions.

29. Based on Lossco's existing and anticipated assets and resources, Lossco will be able to make the capital contributions to Newco without taking into account the interest income it will receive from Profitco as described in 18 above.

30. For the purposes of the Act, Lossco will not, at any time, include the disposition of its investment in Newco in the calculation of its capital losses.

Rulings

Provided that the preceding statements constitute a complete and accurate disclosure of all of 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. 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) of the Act, the lesser of (i) the interest on the Profitco Note, as described in 13 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. No amount will be included in the income of Newco in respect of the capital contributions made by Lossco to it as described in 16 above, pursuant to section 9 or paragraph 12(1)(c) or 12(1)(x) of the Act.

C. None of the provisions of subsections 15(1), 56(2) or 246(1) of the Act will apply to the Proposed Transactions, in and by themselves.

D. Dividends received by Profitco from Newco, as described in 17 above, will be taxable dividends and will be deductible by Profitco pursuant to subsection 112(1) of the Act.

E. The provisions of subsection 245(2) of the Act will not apply to the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

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 20 and 21 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, net capital loss 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 given above.

Yours truly,

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