2010 Ruling 2010-0355671R3 - 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 								2010-035567

XXXXXXXXXX , 2010

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 in our various email communications, 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) "affiliated persons" has the meaning assigned in 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 Debt" means the debt incurred by Lossco from arm's length third-party lenders;

(d) "CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44;

(e) "Canadian corporation" has the meaning assigned in subsection 89(1) of the Act;

(f) "dividend rental arrangement" has the meaning assigned in subsection 248(1) of the Act;

(g) "financial institution" has the meaning assigned in subsection 190(1) of the Act;

(h) "financial intermediary corporation" has the meaning assigned in subsection 191(1) of the Act;

(i) "guarantee agreement" has the meaning assigned in subsection 112(2.2) of the Act;

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

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

ii) Manitoba: Section 53.1, Income Tax Act, C.C.S.M. 1988, 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: Section 88, Income Tax Act, 2000, S.N.L. 2000, c. I-1.1, as amended to the date of this letter;

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

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

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

viii) 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;

ix) Saskatchewan: The Income Tax Act, 2000, S.S. 2000, c. I-2.01, assented to June 27, 2000, as amended to the date of this letter; and

x) Yukon: Section 55.1, Income Tax Act, R.S.Y. 2002, c. 118, as amended to the date of this letter;

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

(l) "Newco" means XXXXXXXXXX , a corporation further described in 7 below;

(m) "non-capital losses" has the meaning assigned in subsection 111(8) of the Act;

(n) XXXXXXXXXX ;

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

(p) "Preferred Shares" means the shares described in 19 below;

(q) "Profitco" means XXXXXXXXXX , a corporation further described in 2 below;

(r) "Profitco Loan" means the loan described in 24 below;

(s) "Profitco Payable" means the debts payable of Profitco described in 13 below;

(t) "Proposed Transactions" mean the transactions described in 19 to 39 below;

(u) "public corporation" has the meaning assigned in subsection 89(1) of the Act;

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

(w) "Subco1" means XXXXXXXXXX , a corporation further described in 5 below;

(x) "Subco2" means XXXXXXXXXX , a corporation further described in 6 below;

(y) "Support Agreement" means the agreement described in 20 below;

(z) "taxable Canadian corporation" has the meaning assigned in subsection 89(1) of the Act; and,

(aa) "taxable dividend" has the meaning assigned in subsection 89(1) of the Act.

Facts

1. Lossco is a public corporation incorporated under, and governed by, the CBCA. Lossco is a taxable Canadian corporation for the purposes of the Act and its common and preferred shares are listed on the XXXXXXXXXX . Lossco is a holding corporation, it has provided financing to certain related corporations and its taxation year end is XXXXXXXXXX . Lossco files its tax returns through the XXXXXXXXXX Tax Services Office and otherwise deals with the XXXXXXXXXX Taxation Centre.

2. Profitco is a wholly-owned direct subsidiary of Lossco and was incorporated under, and is governed by, the XXXXXXXXXX . Profitco is a taxable Canadian corporation for the purposes of the Act and its shares have been held by Lossco continuously since Profitco's incorporation on XXXXXXXXXX . Profitco carries on the business of XXXXXXXXXX , and its taxation year-end is XXXXXXXXXX . Profitco files its tax returns through the XXXXXXXXXX Tax Services Office and otherwise deals with the XXXXXXXXXX Taxation Centre.

3. Profitco is expected to remain a wholly-owned direct subsidiary of Lossco for the foreseeable future.

4. Profitco holds XXXXXXXXXX % of the shares of Subco1 and XXXXXXXXXX % of the outstanding shares of Subco2. Subco1 owns the remaining XXXXXXXXXX % of the outstanding shares of Subco2.

5. Subco1 is a holding corporation incorporated under, and governed by, the laws of XXXXXXXXXX . It is a resident of XXXXXXXXXX and its taxation year end is XXXXXXXXXX .

6. Subco2 is a holding corporation. It was incorporated under, and is governed by, the laws of XXXXXXXXXX . It is a resident only of XXXXXXXXXX and its taxation year end is XXXXXXXXXX .

7. Newco is a wholly-owned direct subsidiary of Lossco and was incorporated under, and is governed by, the CBCA. Newco is a taxable Canadian corporation for the purposes of the Act. Lossco owns XXXXXXXXXX common shares of Newco. Newco, is at the present time, a dormant corporation and has no assets or liabilities, and its taxation year end is XXXXXXXXXX .

8. Lossco has incurred the following non-capital losses in prior taxation years:

XXXXXXXXXX

9. Lossco expects to sustain additional non-capital losses in future taxation years. More specifically, Lossco estimates it will incur non-capital losses (after the interest income earned on the Profitco Payable and before the Proposed Transactions) as follows:

XXXXXXXXXX

10. The losses of Lossco are attributable principally to interest expense on the Arm's Length Debt and public company costs incurred by it. Lossco is in a position to increase its current Arm's Length Debt.

11. Profitco earns profit from carrying on its XXXXXXXXXX business. In prior years Profitco reported taxable income as follows:

XXXXXXXXXX

12. Profitco expects to be in a taxable position in future taxation years. More specifically, Profitco estimates it will have taxable income (after the interest expense incurred on the Profitco Payable and before the Proposed Transactions) as follows:

XXXXXXXXXX

13. Profitco has interest-bearing debts ("Profitco Payable") payable to Lossco aggregating approximately $XXXXXXXXXX at an average interest rate of XXXXXXXXXX %, arising principally as the unpaid purchase price from the acquisition of the shares of Subco2.

14. All interest payable on the Profitco Payable is deductible to Profitco under paragraph 20(1)(c) of the Act.

15. At all relevant times, Lossco, Profitco and Newco will be related to certain corporations that are specified financial institutions.

16. At all relevant times, Newco will not be a financial institution nor a financial intermediary corporation.

17. For the XXXXXXXXXX taxation year, Lossco allocated XXXXXXXXXX % of its income to XXXXXXXXXX for provincial income tax purposes. It is expected that this allocation will remain unchanged in future years.

18. For the XXXXXXXXXX taxation years, Profitco allocated its income as follows for provincial income tax purposes:

XXXXXXXXXX

It is not expected that Profitco's provincial allocation of income will change significantly in future years.

Proposed Transactions

19. The authorized capital of Newco will be amended to create a new class of redeemable, retractable preferred shares (the "Preferred Shares"). The Preferred Shares will have a redemption/retraction price equal to the subscription price paid for them. 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 equal to the interest rate on the Profitco Loan plus a small spread of XXXXXXXXXX basis points. Dividends on the Preferred Shares will be cumulative and payable XXXXXXXXXX in arrears.

20. Lossco and Newco will enter into a support agreement (the "Support Agreement") which will require Lossco to make capital contributions to Newco on an as needed basis to enable Newco to fund dividends on its issued and outstanding Preferred Shares.

21. Lossco will draw on a group credit facility (the "Facility") from an arm's length financial institution, an amount of $XXXXXXXXXX .

22. Lossco will use $XXXXXXXXXX of the Facility proceeds to subscribe for common shares of Profitco having a fair market value equal to their subscription price.

23. Profitco will use the proceeds from the common share subscription described in 22 above to fully repay the interest and principal on the Profitco Payable.

24. Lossco will make a loan to Profitco (the "Profitco Loan") in the amount of $XXXXXXXXXX , representing the aggregate of the remaining funds available under the Facility and the amount received from Profitco in 23 above. The Profitco Loan will bear interest at a rate of XXXXXXXXXX %, which represents the rate of interest used on all intercompany borrowings in the corporate group. Interest on the Profitco Loan will be paid XXXXXXXXXX .

25. Profitco will use the total amount of the funds received from the Profitco Loan to subscribe for Preferred Shares of Newco having an aggregate redemption/retraction price equal to the principal amount of the Profitco Loan.

26. Newco will use the total proceeds received from the Preferred Share subscription described in 25 above to make a demand, non-interest bearing loan to Lossco (the "Lossco Loan").

27. Lossco will use the funds received on the Lossco Loan to repay the amount of the Facility.

28. On each date that dividends are to be paid by Newco on the Preferred Shares while the Profitco Loan is outstanding, Lossco will, pursuant to the Support Agreement, make a capital contribution to Newco in an amount equal to the dividend payable by Newco on the Preferred Shares. No shares will be issued by Newco in respect of the capital contribution and no amount will be added to the paid-up capital of the Preferred Shares. The amount of such capital contributions will be recorded as contributed surplus for accounting purposes and will not be treated as income of Newco pursuant to generally accepted accounting principles.

29. Upon receipt of each capital contribution, Newco will declare and pay a dividend to Profitco on the Preferred Shares. Profitco will then use the proceeds of such dividend to pay interest owing to Lossco on the Profitco Loan.

30. Proposed Transactions 31 to 39 below will be carried out to unwind the structure.

31. Lossco will make a capital contribution to Newco in an amount equal to the amount of any accrued and unpaid dividends on the Preferred Shares held by Profitco. No shares will be issued by Newco in respect of this capital contribution and no amount will be added to the paid-up capital of the Preferred Shares. The amount of the capital contribution will be recorded as contributed surplus for accounting purposes and will not be treated as income of Newco pursuant to generally accepted accounting principles.

32. Lossco will draw on a group credit facility (the "New Facility") from an arm's length financial institution, an amount of $XXXXXXXXXX , or such lesser amount necessary to effect a partial unwind of the Proposed Transactions. Lossco will use the proceeds of the New Facility to repay all or part of the amount owing to Newco under the Lossco Loan.

33. Newco will use the funds received on the full or partial repayment of the Lossco Loan, and any capital contribution made by Lossco pursuant to 31 above, to pay any accrued but unpaid dividends on its Preferred Shares and to redeem some or all of such Preferred Shares.

34. Profitco will use the funds received by it in 33 above to pay any accrued and unpaid interest on the Profitco Loan and to repay all or part of the principal amount of the Profitco Loan.

35. Lossco will use the proceeds from the full or partial repayment of the principal amount of the Profitco Loan to repay the New Facility.

36. Lossco will cause Newco to be wound-up shortly after all the Preferred Shares have been redeemed and the Profitco Loan and the Lossco Loan have been repaid in full.

37. The unwind steps described in 31 to 36 above may be carried out once to completely unwind the structure established through the implementation of Proposed Transactions 19 to 29, or may be repeated to effect successive, partial unwinds of such structure.

38. At this time, it is intended that the structure will be kept in place until Lossco's non-capital loss carryforwards are fully utilized, which is currently estimated to be prior to the end of Lossco's XXXXXXXXXX taxation year. However, based on the corporate group's current structure, if the loss consolidation transaction described herein is fully unwound during Lossco's XXXXXXXXXX taxation year, Lossco would again generate loss carryforwards. Therefore, once Lossco has fully utilized its current non-capital loss carryforward balance, the parties to the Proposed Transactions contemplate a partial unwind of the Proposed Transactions. Thereafter, the structure will be kept in place in such a way as to allow Lossco to earn sufficient interest income, over a period of time, to utilize any non-capital losses it would otherwise incur in future years.

39. Furthermore, unless covered by a subsequent CRA ruling, the structure established through the implementation of Proposed Transactions 19 to 29 will be fully unwound before XXXXXXXXXX .

Purpose of the Proposed Transactions

40. The purpose of the Proposed Transactions described above is to consolidate the Profitco Payable into the Profitco Loan, and then allow for the consolidation of profit and losses between Lossco and Profitco. The consolidation of losses will be achieved by Lossco earning sufficient interest income to enable it to offset its public company costs and the interest expense on the Arm's Length Debt, while allowing Profitco to reduce its taxable income by an equivalent amount in the form of interest expense payable by it on the Profitco Loan.

Additional Information

41. The amount of the Profitco Loan represents an amount that Profitco could reasonably be expected to borrow from an arm's length financial institution with a parental guarantee. Profitco has and will have the financial capacity to pay the interest on the Profitco Loan from its own cash flow.

42. Newco will not carry on any business. Its activities will be limited to entering into the Support Agreement, issuing the Preferred Shares, investing the proceeds received upon the issuance of its Preferred Shares in the Lossco Loan and paying dividends on the Preferred Shares.

43. For the purposes of the Act, Lossco, or any present or future related or affiliated party of Lossco, will not, at any time, include the disposition of its investment in Newco in the calculation of its capital losses.

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

a) the subject of any undertaking that is 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); 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).

45. By reason only of the Proposed Transactions, Profitco will not be considered to have acquired the Preferred Shares in the ordinary course of the business carried on by it.

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. With respect to the interest expense incurred by Profitco on the Profitco Loan, as described in 24 above, provided that Profitco has a legal obligation to pay interest on the Profitco Loan and Profitco continues to hold the Preferred Shares for the purpose of gaining or producing income therefrom, Profitco will be permitted, pursuant to paragraph 20(1)(c), 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. No amount will be included in the income of Newco pursuant to paragraph 12(1)(x) or section 9 of the Act in respect of the capital contributions described in 28 and 31 above.

C. The dividends received by Profitco, as described in 28 and 33 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 taxation year in which the particular dividend is received, and for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4) of the Act.

D. Profitco will be entitled to carry back to its prior years the non-capital losses that are expected to arise as a result of the deductions described in Ruling A above, subject to any applicable restrictions set out in section 111 of the Act.

E. Subsections 15(1), 56(2), 69(1), 69(11) and 246(1) of the Act will not apply to the Proposed Transactions in and by themselves.

F. 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.

G. 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 30 to 39 above, are completed 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