2010 Ruling 2010-0353911R3 - Loss Utilization

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: Standard loss utilization transaction

Position: Ruling Issued

Reasons: Meets statutory and administrative requirements

XXXXXXXXXX 2010-035391

XXXXXXXXXX , 2010

Attention: XXXXXXXXXX

Dear Sirs:

Subject: XXXXXXXXXX
Advance Income Tax Ruling Request

We are writing in response to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge the information provided in correspondence and telephone conversations (XXXXXXXXXX ) concerning your request. The information contained in documents submitted with your request forms part of this ruling only to the extent it is expressly referred to or described herein.

To the best of your knowledge and that of the above-referenced taxpayers, none of the issues involved in this ruling is:

(i) dealt with in an earlier return of any of the above referenced taxpayers, or a related person,

(ii) being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return of any of the above-referenced taxpayers or a related person,

(iii) under objection or appeal by any of the above-referenced taxpayers, or a related person, or

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired.

Further, the above referenced taxpayers have advised that the Proposed Transactions described herein will not result in the taxpayers or any related person herein being unable to pay its outstanding tax liabilities.

Unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and the Income Tax Regulations thereunder are referred to as the "Regulations."

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

"A Co" means XXXXXXXXXX .;

"adjusted cost base" or "ACB" has the meaning assigned by section 54;

"affiliated persons" has the meaning assigned by section 251.1;

"agreed amount" means the amount that a transferor and transferee have agreed upon in a joint election under subsection 85(1) in respect of a transfer of eligible property;

"arm's length" has the meaning assigned by subsection 251(1);

"CBCA" means the Canada Business Corporations Act, R.S.C. 1985, c. C-44, as amended;

"CRA" means the Canada Revenue Agency;

"dividend rental arrangement" has the meaning assigned by subsection 248(1);

"eligible property" has the meaning assigned by subsection 85(1.1);

"excepted dividend" has the meaning assigned by section 187.1;

"excluded dividend" has the meaning assigned by subsection 191(1);

"Fair market value" or "FMV" means the highest price available in an open and unrestricted market, between informed, prudent parties, acting at arm's length and under no compulsion to act, expressed in terms of cash;

"financial intermediary corporation" has the meaning assigned by subsection 191(1);

"forgiven amount" has the meaning assigned by subsection 80(1) or 80.01(1);

"guarantee agreement" has the meaning assigned by subsection 112(2.2);

XXXXXXXXXX

"Loan 1" means a non-interest bearing daylight loan made by Parent to LossCo, the principal amount of which will equal the principal amount of Parent Loan;

"Loan 2" means an interest bearing loan made by LossCo to A Co, the principal amount of which will equal the principal amount of Parent Loan. Loan 2 will bear interest at an annual rate based on market conditions at the time the loan is granted which will not exceed what would be a reasonable commercial rate in these circumstances. The market interest rate quoted by LossCo's lender for the month of XXXXXXXXXX , to a borrower with the similar borrowing capacity and credit rating as LossCo, is approximately XXXXXXXXXX %. The principal amount of Loan 2 will not exceed the amount that LossCo could reasonably be expected to borrow from an arm's length financial institution and will not cause LossCo to exceed a debt leverage ratio of XXXXXXXXXX % of LossCo's net equity position, on a consolidated basis. Interest on Loan 2 will be payable at the earlier of XXXXXXXXXX of each year or such time that Loan 2 is repaid;

"Loan 3" means a non-interest bearing loan made by Newco to LossCo, the principal amount of which will equal the principal amount of Parent Loan;

"LossCo" means XXXXXXXXXX ;

"LossCo Subsidiaries" means Opco, XXXXXXXXXX , the wholly-owned subsidiaries of those corporations and an investment in XXXXXXXXXX .;

"Newco" is a corporation to be incorporated under the CBCA;

"Newco Preferred Shares" means the preferred shares to be issued by Newco described in Paragraph 16;

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

"Opco" means XXXXXXXXXX ;

"PUC" means "paid-up capital" and has the meaning assigned by subsection 89(1);

"Paragraph" means a numbered paragraph of this letter;

"Parent" means XXXXXXXXXX ;

"Parent Loan" means a loan made by an unrelated, arm's length financial institution to Parent, the principal amount of which will be approximately $XXXXXXXXXX . The exact principal amount of Parent Loan will be finalized when the Proposed Transactions are implemented;

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

"private corporation" has the meaning assigned by subsection 89(1);

"Proposed Transactions" means the transactions described in Paragraphs 15 to 36;

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

"related person" has the meaning assigned by subsection 251(2);

XXXXXXXXXX

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

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

"term preferred share" has the meaning assigned by subsection 248(1).

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

STATEMENT OF FACTS:

1. Parent was incorporated under the XXXXXXXXXX and is a private corporation and a taxable Canadian corporation. The taxation year of Parent ends on XXXXXXXXXX

2. Parent owns all of the common shares and all of the XXXXXXXXXX LossCo, representing all of the issued and outstanding share capital of LossCo.

3. LossCo was continued under the CBCA and is a private corporation and a taxable Canadian corporation. The taxation year of LossCo ends on XXXXXXXXXX .

4. LossCo is a wholly-owned subsidiary of Parent and acts as a holding company. LossCo's assets in Canada include the LossCo Subsidiaries.

5. As at XXXXXXXXXX , the balance of LossCo's non-capital loss carry-forward is expected to be $XXXXXXXXXX which was incurred in its fiscal year ending XXXXXXXXXX .

LossCo estimates that if the Proposed Transactions were not undertaken, its non-capital loss for each of its XXXXXXXXXX taxation years will be about $XXXXXXXXXX LossCo expects that non-capital losses will continue to be incurred because of an interest-bearing debt obligation that LossCo has outstanding. The losses previously incurred and future losses are XXXXXXXXXX % allocable to XXXXXXXXXX (XXXXXXXXXX).

6. LossCo owns all of the issued and outstanding voting common shares of Opco. The non-voting Class A preference shares of Opco are widely held and traded on the XXXXXXXXXX Stock Exchange. The other classes of non-voting preference shares of Opco are widely held by XXXXXXXXXX

7. Opco was continued under the XXXXXXXXXX and is a taxable Canadian corporation and a public corporation. The taxation year of Opco ends on XXXXXXXXXX . Opco is XXXXXXXXXX The authorized capital of Opco includes both common shares and preferred shares that can be issued in one or more series. The common shares are the only shares with voting rights. XXXXXXXXXX

8. XXXXXXXXXX

9. In addition to carrying on XXXXXXXXXX business, Opco is the parent company of several directly and indirectly-held subsidiaries.

10. Opco did not earn any taxable income in the XXXXXXXXXX taxation year due to unanticipated market conditions and events. However, Opco expects to earn significant taxable income in the XXXXXXXXXX taxation year and subsequent taxation years. Opco expects to earn taxable income in the XXXXXXXXXX taxation year of $XXXXXXXXXX

11. LossCo incorporated A Co and subscribed for common shares of A Co on incorporation for an aggregate subscription price of $XXXXXXXXXX . LossCo holds all of its common shares of A Co as capital property.

12. A Co was incorporated under the CBCA and is a taxable Canadian corporation. The taxation year of A Co ends on XXXXXXXXXX .

13. A Co does not carry on any business and its activities will be limited to investing the loan proceeds, received from LossCo as described in Paragraph 23, in the Newco Preferred Shares, as described in Paragraph 24.

14. A Co is not a "financial intermediary corporation" as defined in subsection 191(1).

PROPOSED TRANSACTIONS

Incorporation of Newco:

15. LossCo will incorporate Newco under the CBCA, and will subscribe for common shares of Newco for $XXXXXXXXXX .

16. The authorized capital of Newco will consist of two classes of shares, common shares and Newco Preferred Shares. Each Newco Preferred Share will be non-voting, and redeemable and retractable for the amount for which it was issued. Dividends on the Newco Preferred Shares will accrue at a fixed rate on a XXXXXXXXXX basis and will be payable on the earliest of XXXXXXXXXX and the time at which any Newco Preferred Shares are redeemed. The dividend rate will be equal to XXXXXXXXXX % plus the interest rate on Loan 2.

17. The subscription price for the Newco Preferred Shares will form part of the permanent capital of Newco.

18. Newco will be a taxable Canadian corporation. The taxation year of Newco will end on XXXXXXXXXX .

19. 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 A Co as described in Paragraph 24, in a non-interest bearing loan to LossCo as described in Paragraph 25.

20. Newco will not be a "financial intermediary corporation" as defined in subsection 191(1).

Implementation of Loss Consolidation Arrangement:

21. On or about XXXXXXXXXX , Parent will borrow under Parent Loan on a "daylight loan" basis from an arm's length financial institution.

22. Parent will use the total proceeds received under Parent Loan to make Loan 1 to LossCo.

23. LossCo will use the total proceeds received under Loan 1 to make Loan 2 to A Co.

24. A Co. will use the total proceeds received from Loan 2 to subscribe for Newco Preferred Shares having an aggregate redemption amount and FMV equal to the total amount of the subscription proceeds. The full amount of the subscription proceeds will be added to the stated capital of the Newco Preferred Shares. The PUC of each Newco Preferred Share issued will be equal to its redemption amount.

25. Newco will use the total proceeds received from the Newco Preferred Share subscriptions described in Paragraph 24 to make Loan 3 to LossCo.

26. LossCo will use the total proceeds received from Loan 3 to repay Loan 1.

27. Parent will use the total proceeds received from the repayment of Loan 1 to repay Parent Loan.

28. On XXXXXXXXXX or such earlier date as LossCo, Newco and A Co agree, while Loan 2 is outstanding, LossCo will make a contribution of capital to Newco in an amount equal to the accrued dividends payable at that time on the Newco Preferred Shares held by A Co. No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the stated capital of any class of shares of Newco. The amount of the contribution of capital will be recorded as contributed surplus for accounting purposes. The contribution of capital, if any, will not be income of Newco pursuant to generally accepted accounting principles.

29. Upon receipt of the contribution described in Paragraph 28, Newco will, XXXXXXXXXX , pay all accrued and unpaid dividends on the Newco Preferred Shares held by A Co.

30. Upon receipt of the payments of the dividends described in Paragraph 29, A Co will pay all accrued and unpaid interest due and payable on Loan 2, pursuant to the terms of Loan 2.

31. Immediately following the payment of interest described in Paragraph 30, the following transactions will occur to unwind the loss consolidation arrangement:

(a) LossCo will purchase the Newco Preferred Shares held by A Co in consideration for a non-interest bearing demand note with a principal amount and FMV equal to the redemption amount and FMV of the Newco Preferred Shares purchased (the "LossCo Note").

(b) LossCo and A Co. will agree to setoff the amount due under Loan 2 against the corresponding amount due under the LossCo Note as payment in full and the obligations under Loan 2 and the LossCo Note will be cancelled.

(c) Newco will redeem the Newco Preferred Shares held by LossCo in consideration of a non-interest bearing promissory note issued by Newco (the "Newco Note"). The Newco Note will have a principal amount and FMV equal to the redemption amount and FMV of the Newco Preferred Shares redeemed.

(d) LossCo and Newco will agree to setoff the amount due under Loan 3 against the corresponding amount due under the Newco Note as payment in full and the obligations under Loan 3 and the Newco Note will be cancelled.

32. Immediately following completion of the transactions described in Paragraphs 28 to 31, LossCo and Opco will enter into an agreement whereby LossCo will sell all of its common shares of A Co to Opco in exchange for additional common shares of Opco. The additional common shares issued to LossCo by Opco will have a FMV equal to the FMV of the common shares of A Co transferred to Opco.

33. LossCo will jointly elect with Opco, in prescribed form and within the time allowed by subsection 85(6), to have the rules of subsection 85(1) apply to the transfer of the A Co common shares to Opco. The agreed amount in respect of the A Co common shares transferred will be the lesser of the FMV of the A Co common shares transferred and $XXXXXXXXXX , which is their adjusted cost base to Opco.

34. Opco will add to its stated capital account maintained for its common shares the agreed amount pursuant to subsection 85(1) of the Act, as referred to in Paragraph 33.

35. In the taxation year in which Opco acquires the A Co common shares described in Paragraph 32, Opco, as sole shareholder of A Co, will pass a resolution authorizing and requiring A Co to be wound up into Opco. In addition, a general conveyance of the assets of A Co and assumption of liabilities of A Co will be executed between Opco and A Co. A Co will file articles of dissolution with the appropriate Corporate Registry within a reasonable time after the winding-up resolution.

36. Immediately after the resolution to wind up A Co into Opco, LossCo as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound up into LossCo. In addition, a general conveyance of assets of Newco and assumption of liabilities of Newco will be executed between LossCo and Newco. Newco will file articles of dissolution with the appropriate Corporate Registry within a reasonable time after the winding-up resolution.

ADDITIONAL INFORMATION

37. It is anticipated that the steps described in the Proposed Transactions will be undertaken at the beginning of each future taxation year of LossCo, with new entities to be created having the same attributes as A Co and Newco. For fiscal years XXXXXXXXXX and XXXXXXXXXX it is currently estimated that the amount of LossCo's loans and preferred share subscriptions in a new entity will be $XXXXXXXXXX based on interest rates in effect in fiscal XXXXXXXXXX .

38. LossCo has the borrowing capacity to obtain a loan equal to Loan 1 directly from an arm's length financial institution. The purpose of Parent obtaining the daylight loan under Parent Loan and lending the amount to LossCo under Loan 1 is the lower borrowing cost to Parent due to existing banking relationships between Parent and the arm's length financial institution.

39. LossCo will have the financial capacity to make the capital contributions to Newco described in Paragraph 28 and Newco will have the financial capacity to satisfy the applicable solvency test and liquidity test required to pay the dividends on the Newco Preferred Shares described in Paragraph 29. LossCo may obtain the funds to make the capital contributions to Newco by borrowing from one or more of its affiliates. Such borrowings will not result in LossCo exceeding its borrowing capacity.

40. LossCo, Opco, and A Co are affiliated persons and are related to each other within the meaning of subsection 251(2). Newco will be an affiliated person with respect to LossCo, Opco and A Co and will be related to each of them within the meaning of subsection 251(2).

41. XXXXXXXXXX

42. No amount in respect of any non-capital loss of Opco arising from the Proposed Transactions will be deducted by Opco in computing its income for any taxation year that ends more than 20 taxation years after the end of LossCo's XXXXXXXXXX taxation year (or such other period as may be prescribed from time to time under paragraph 111(1)(a), or any successor provision, for a non-capital loss incurred by LossCo in a taxation year ending on XXXXXXXXXX ).

43. The Newco Preferred Shares will be term preferred shares.

44. The Newco Preferred Shares that will be acquired by A Co will not be acquired in the ordinary course of A Co's business.

45. The Newco Preferred Shares will not, at any time during the implementation of the Proposed Transactions described herein, be:

(i) the subject of any undertaking that is a guarantee agreement;

(ii) the subject of a dividend rental arrangement;

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

(iv) issued for consideration that is or includes:

(a) 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

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

PURPOSE OF THE PROPOSED TRANSACTIONS

46. In the XXXXXXXXXX taxation year, LossCo acquired a majority controlling interest in XXXXXXXXXX . The acquisition was funded in part by LossCo's outstanding debt issuance. LossCo partially relies on dividends from the LossCo Subsidiaries to finance its outstanding debt. These taxable dividends are expected to be deductible to LossCo pursuant to subsection 112(1). Absent the Proposed Transactions, it is expected that LossCo will annually generate non-capital losses caused principally by the interest expense on LossCo's debt. These non-capital losses are expected to accumulate in LossCo and would remain unused without implementation of the Proposed Transactions.

The purpose of the Proposed Transactions is to effect a tax consolidation of LossCo and Opco in order to permit Opco to utilize the losses that LossCo is expected to incur from its business in the XXXXXXXXXX taxation year. The purpose of the tax consolidation is not to shift income to a lower rate province. Any shift of income between provinces will be incidental to the Proposed Transactions. A Co is being used to avoid having Opco, which is a public corporation, incur debt in order to implement the loss utilization.

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 carried out as described above, we rule as follows:

A. Subsection 85(1) will apply to the transfer of the shares of A Co from LossCo to Opco as described in Paragraph 32 such that the agreed amount in respect of the transfer of the common shares of A Co to Opco will be deemed to be LossCo's proceeds of disposition and Opco's cost of the common shares of A Co. For greater certainty, paragraph 85(1)(e.2) will not apply to the transfer.

B. Provided that the requirements of paragraphs 88(1.1)(a) and (b) are satisfied, subsection 88(1.1) will apply after the winding up of A Co into Opco described in Paragraph 35 to permit Opco to deduct the non-capital losses of A Co in computing its income for any taxation year commencing after the commencement of the winding-up, subject to the limitations in paragraph 88(1.1)(e) and section 111. For this purpose A Co will not be considered to have been wound up until it has been formally dissolved.

C. Provided that A Co has a legal obligation to pay interest on Loan 2 and the Newco Preferred Shares continue to be held by A Co, A Co will be entitled to deduct, pursuant to paragraph 20(1)(c), the lesser of the interest paid or payable (depending on the method regularly followed by A Co in computing its income for the purposes of the Act) in respect of that taxation year or a reasonable amount in respect thereof.

D. No amount will be included in the income of Newco pursuant to section 9, paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital made by LossCo as described in Paragraph 28.

E. The set-off of the amount owing on Loan 2 against the amount owing on the LossCo Note in Paragraph 31(b) will not give rise to a forgiven amount. Further, the set-off of the amount owing on Loan 3 against the amount owing on the Newco Note in Paragraph 31(d) will not give rise to a forgiven amount. Finally, none of LossCo, A Co, or Newco will realize any gain or incur any loss as a result of the set-offs and cancellations.

F. Subsection 55(2) will apply to the taxable dividends that A Co receives from Newco on the Newco Preferred Shares as described in Paragraph 29, unless none of the purposes of the dividend was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition at fair market value of any share of capital stock immediately before the dividend and that could be reasonably be considered to be attributable to anything other than income earned or realized, as determined in accordance with paragraph 55(5)(c), by any corporation after 1971 and before the relevant safe-income determination time as that term is defined in subsection 55(1).

G. Without considering the winding-up of A Co into Opco as described in Paragraph 35, the dividends received by A Co on its Newco Preferred Shares as described in Paragraph 29 will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of A Co for the taxation year in which the dividends are 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).

H. The dividends described in Ruling G will not be subject to tax under Part IV.1 or Part VI.1.

I. The provisions of subsections 15(1), 56(2) and 246(1) will not apply as a result of the Proposed Transactions in and by themselves.

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

K. The general anti-avoidance provision of a province with which the Government of Canada has entered into a Tax Collection Agreement will not be applied, as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the rulings given above, in respect of a taxation year in respect of which such Tax Collection Agreement is in effect.

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

OTHER COMMENTS

It is our view that the winding-up of A Co into Opco as described in Paragraph 35 would cause subsection 55(2) of the Act to apply to the taxable dividends referred to in Ruling F. However, the Department of Finance has issued a letter dated April 21, 2005 (the "comfort letter"), indicating that it was prepared to recommend to the Minister of Finance that situations described in the comfort letter (i.e. essentially where a wholly-owned subsidiary is amalgamated with, or wound-up into, its parent) should not result in a significant increase in the interest of the subsidiary solely as a result of the application of paragraphs 55(3.01)(b) and (c). If such legislation is ever enacted and is effective for the period in which these Proposed Transactions take place, it is possible that subsection 55(2) should not apply to the dividends described in Ruling F.

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the PUC of any share or the ACB or FMV of any property referred to herein;

(b) the amount of any non-capital loss or any other amount of any corporation referred to herein;

(c) the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

(d) subject to Ruling K, the application or non-application of a general anti-avoidance provisions of any province; or

(e) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that include other transactions or events that are not described in this letter.

Yours sincerely,

XXXXXXXXXX
Manager
Corporate Reorganizations Section II
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch