2010 Ruling 2010-0355031R3 - 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: Is the loss utilization arrangement acceptable?

Position: YES

Reasons: meets established and published positions

XXXXXXXXXX 								2010-035503

XXXXXXXXXX , 2010

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX ("Lossco")
XXXXXXXXXX ("Profitco")

This is in reply to your letter of XXXXXXXXXX , wherein you requested an advance income tax ruling on behalf of the above-named taxpayers. In general terms, the transactions described herein involve the use of losses within an affiliated group of corporations. We also acknowledge information provided during numerous telephone conversations and electronic correspondences.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request herein are:

(i) dealt with in an earlier return of Lossco, Profitco, or a related person;

(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by Lossco, Profitco, or a related person;

(iii) under objection by Lossco, Profitco, or a related person;

(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to Lossco, Profitco, or a related person; nor

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

Definitions:

(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 statutory references are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

(b) "affiliated persons" has the meaning assigned by subsection 69(11) of the Act;

(c) "CBCA" means Canada Business Corporations Act, R.S.C. 1995, c. C-44, as amended;

(d) "CRA" means the Canada Revenue Agency;

(e) "financial institution" has the meaning assigned by subsection 142.2(1) of the Act;

(f) "Lossco" means XXXXXXXXXX ., the corporation described in 1 below;

(g) "Lossco Note" means the promissory note described in 16 below;

(h) "Lossco Preferred Shares" means the preferred shares described in 7 below;

(i) "New Profitco Notes" means the promissory note described in 19 below;

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

(k) "Profitco" means XXXXXXXXXX ., the corporation described in 3 below;

(l) "Profitco Note" means the promissory note described in 10 below;

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

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

(o) XXXXXXXXXX

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

(q) "SFI" means a specified financial institution, as defined in subsection 248(1) of the Act; and

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

Facts:

1. Lossco is a private corporation and a taxable Canadian corporation. Lossco was incorporated on XXXXXXXXXX under the CBCA. XXXXXXXXXX Lossco is served by the XXXXXXXXXX Tax Services Office and files its tax return
at the XXXXXXXXXX Taxation Centre. Lossco has a permanent establishment in the province of XXXXXXXXXX . The provincial allocation of Lossco for its fiscal year ended XXXXXXXXXX is as follows:

XXXXXXXXXX

Lossco has authorized capital consisting of an unlimited number of voting and non-voting common shares and voting and non-voting preferred shares entitled to a cumulative dividend at a rate of $XXXXXXXXXX per share.

2. As at XXXXXXXXXX , Lossco has a non-capital loss carryforward balance of $XXXXXXXXXX . A small portion of these losses has been transferred from corporations acquired by Lossco from a third party. Accordingly, a portion of the non-capital losses denoted below, calculated at $XXXXXXXXXX and which is subject to subsection 111(5) of the Act, will not be utilized by Lossco to offset taxable income generated by the proposed transactions. Details of the non-capital losses carried over by Lossco as of XXXXXXXXXX are as follows:

XXXXXXXXXX

3. Profitco is a private corporation and a taxable Canadian corporation incorporated under the XXXXXXXXXX Profitco is served by the XXXXXXXXXX Tax Services Office and files its tax return at the XXXXXXXXXX Taxation Centre.

4. After a reorganization on XXXXXXXXXX , Profitco owns all the issued and outstanding shares of Lossco except XXXXXXXXXX voting preferred shares, which are held by XXXXXXXXXX ("Holdco"). Profitco is a wholly-owned subsidiary of XXXXXXXXXX ("ACo"). Holdco is the parent corporation of ACo.

5. Profitco's taxable income for its taxation year ended after the last time control of Profitco was acquired, for purposes of the Act, is as follows:

XXXXXXXXXX

6. Profitco is expected to have a tax loss of $XXXXXXXXXX for its XXXXXXXXXX fiscal year. Profitco and Lossco are affiliated and related for purposes of the Act.

Proposed Transactions:

7. Lossco will issue a new class of preferred shares ("Lossco Preferred Shares") having 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 amount for which they were issued; and

d) entitled to an annual cumulative dividend at a rate of XXXXXXXXXX % on the amount for which they were issued that is payable annually (or more frequently).

8. Lossco will amend its prior years' XXXXXXXXXX corporate tax returns so as to adjust its capital cost allowance claims, thereby, further increasing its non-capital losses listed in 2 above.

9. Lossco will borrow $XXXXXXXXXX on a "daylight loan" from one of the entities of the XXXXXXXXXX group and/or to the extent that it is required from a third party bank with the guarantee of the XXXXXXXXXX group's ultimate parent (the "Ultimate Parent"). The principal amount of the loan will be equal to the amount borrowed. The Ultimate Parent is a public listed company with a market capitalization of about US$XXXXXXXXXX and is headquartered in XXXXXXXXXX .

10. Lossco will use the proceeds of the "daylight loan" to lend to Profitco. Interest bearing promissory notes (the "Profitco Note") will be issued by Profitco to Lossco.
Management of the Ultimate Parent concludes that XXXXXXXXXX % is a reasonable interest rate to be charged on the Profitco Note. The Profitco Note could be repaid in whole or in part as agreed upon by the two parties.

11. Profitco will use the funds resulting from the issuance of the Profitco Notes to subscribe for the Lossco Preferred Shares. The aggregate redemption, retraction value, fair market value, adjusted cost base and paid-up capital of the Lossco Preferred Shares issued will be equivalent to the amount of the Profitco Note.

12. Lossco will use the funds resulting from the issuance of the Lossco Preferred Shares to repay the "daylight loan" referred to in 9 above.

13. Annually (or more frequently), Profitco will pay interest to Lossco.

14. Annually (or more frequently), the funds from 13 above will be used to pay dividends on the Lossco Preferred Shares held by Profitco.

Unwind Structure:

The proposed structure will be unwound no later than XXXXXXXXXX months after the implementation of the proposed transactions described in 7 to 14 above through redemption of the Lossco Preferred Shares held by Profitco. The Lossco Preferred Shares will be unwound, either partially at different times or wholly at one particular moment, in the following manner:

15. Lossco will redeem the Lossco Preferred Shares held by Profitco (either a portion or all of the issued and outstanding Lossco Preferred Shares).

16. As payment for the redemption of the Lossco Preferred Shares, Lossco will issue a non-interest bearing demand note to Profitco ("Lossco Note").

17. Profitco will repay the Profitco Note (or a portion of the Profitco Note) by exchanging the Lossco Note received from Lossco in 16 above.

18. Where the principal amount of the Lossco Note is equal to the Profitco Note the two notes will be set-off and simultaneously cancelled.

19. In the event not all the Lossco Preferred Shares are redeemed at the same time, and the principal amount of the Lossco Note is lower than the Profitco Note, the Lossco Note will be cancelled and the Profitco Note will be replaced by a new note with a principal amount equal to the difference between the principal amount of the original Profitco Note and the Lossco Note ("New Profitco Note"). The New Profitco Note will have the same terms and conditions as provided for the Profitco Note.

20. Provided that there is a partial repayment of the Profitco Note, the mechanism described in 18 and 19 above will be used for each unwound transaction.

Other Information:

21. The proposed transactions aim to utilize the non-capital losses of Lossco by Profitco, two related and affiliated persons. The implementation of the proposed transactions may result in a loss incurred by Profitco and this would depend on the performance of the global economy and the XXXXXXXXXX . However, any losses carried back by Profitco would be limited to the taxable income earned by Profitco after it became affiliated and related to Lossco.

22. Profitco is, on the basis that it is related to a corporation described in paragraph (d) of that definition, a SFI pursuant to paragraph (g) of the definition of a SFI. However, Profitco will not acquire the Lossco Preferred Shares in the ordinary course of its business.

23. None of the corporations involved in the proposed transactions has or will have entered into a "dividend rental arrangement" as defined by subsection 248(1) of the Act.

24. None of the shares on which a dividend is declared or paid in the course of the proposed transactions is guaranteed in any way as described in subsection 112(2.2) of the Act by a financial institution or a specified person in relation to any such institution.

25. As previously noted in 2 above, the utilization of Lossco's non-capital losses will take into consideration any restriction that would apply as a result of subsection 111(5) of the Act.

26. The proposed transactions will not result in any of the taxpayers identified in this ruling being unable to pay their outstanding tax liabilities.

Purpose of the Proposed Transactions:

26. The purpose of the proposed transactions is to consolidate profits and losses within a group of affiliated and related persons enabling Lossco to earn sufficient interest income to utilize its current non-capital loss carry forward balance.

Rulings Given:

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

A. Provided that the Lossco Preferred Shares continue to be held for the purpose of gaining or producing income from property, the interest paid or payable on the Profitco Notes and if applicable on the New Profitco Note, will be deductible by
Profitco in computing its income for a taxation year, in respect of that taxation year pursuant to paragraph 20(1)(c) of the Act to the extent that such amount does not exceed a reasonable amount.

B. The dividends received by Profitco on the Lossco Preferred Shares, as described in 14 above, will be taxable dividends that will, pursuant to subsection 112(1) of the Act, be deductible in computing its taxable income for the 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) of the Act.

C. Provided the Lossco Preferred Shares are redeemed for an amount that does not exceed the paid-up capital of those shares, on the redemption of the Lossco Preferred Shares held by Profitco as described in 15 above:

a) No dividend will be deemed to be paid by Lossco and received by Profitco by virtue of subsection 84(3) of the Act; and

b) No gain or loss will be realized or incurred by Profitco.

D. No gain or loss will be realized on the repayments of the Lossco Note as a result of the redemption of the Lossco Preferred Shares, and the set-off of the Profitco Note and the New Profitco Note as described in 17 to 20 above provided the adjusted cost bases of the Lossco Note, the Profitco Note and the New Profitco Note are equal to the amount paid.

E. Provided the fair market value of the Lossco Note, the Profitco Note and the New Profitco Note at the date of settlement is not less than their respective principal amount, the repayment of the Lossco Note, the Profitco Note and the New Profitco Note, as described in 15 to 20 above, will not give rise to a forgiven amount within the meaning of subsection 80(1) of the Act.

F. Subsection 245(2) of the Act will not be applicable as a result of the proposed transactions, in and by themselves, to redetermine the tax consequences confirmed in the ruling given.

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 are commenced 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 which, if enacted, could have an effect on the rulings provided herein.

Comments:

Nothing in this ruling 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;

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

(d) the application or non-application of the general anti-avoidance provisions of any province; nor

(e) 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
Legislative Policy and Regulatory Affairs Branch