2016 Ruling 2015-0593341R3 - 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 the loss consolidation arrangement acceptable?

Position: Yes.

Reasons: Adheres to longstanding administrative policy.

XXXXXXXXXX

XXXXXXXXXX, 2016

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-named taxpayers.

We understand that to the best of your knowledge and that of the taxpayers involved none of the issues involved in the requested ruling is:

(i) in an earlier return of a taxpayer identified in this document or of a related person;

(ii) being considered by any Tax Services Office or Taxation Centre of the Canada Revenue Agency (“CRA”) in connection with a tax return already filed;

(iii) under objection by a taxpayer identified in this document 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 not expired; or

(v) the subject of a previously issued ruling.

Our understanding of the facts and relevant transactions, including proposed transactions, is as follows:

Definitions:

(a) “Act” means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1 as amended to the date hereof;

(b) “affiliated persons” has the meaning assigned by subsection 251.1(1);

(c) “CDN Parent” means XXXXXXXXXX;

(d) “CRA” means the Canada Revenue Agency;

(e) “Daylight Loan 1” means the loan described in Paragraph 10 below;

(f) “Daylight Loan 2” means the loan described in Paragraph 11 below;

(g) “dividend rental arrangement” has the meaning assigned by subsection 248(1);

(h) “eligible dividend” has the meaning assigned by subsection 248(1) and subsection 89(1);

(i) “excepted dividend” has the meaning assigned by section 187.1;

(j) “excluded dividend” has the meaning assigned by subsection 191(1);

(k) “Lender” means XXXXXXXXXX;

(l) “GAAR” means the general anti-avoidance rule and encompasses the provisions set out in Part XVI;

(m) “Loss Utilization Arrangement” means the transactions described in Paragraphs 9 to 17 below;

(n) “Lossco” means XXXXXXXXXX;

(o) “non-capital loss” has the meaning assigned by subsections 248(1) and 111(8);

(p) “Note 1” has the meaning assigned by Paragraph 17(d);

(q) “Note 2” has the meaning assigned by Paragraph 17(d);

(r) “paid-up capital” or “PUC” has the meaning assigned by subsection 248(1) and subsection 89(1);

(s) “Paragraph” refers to a numbered paragraph in this letter;

(t) “Preferred Shares” means the Profitco 1 Preferred Shares and the Profitco 2 Preferred Shares;

(u) “Profitco 1 Preferred Shares” means the preferred shares to be issued by Lossco to Profitco 1 as more fully described in Paragraph 9;

(v) “Profitco 2 Preferred Shares” means the preferred shares to be issued by Lossco to Profitco 2 as more fully described in Paragraph 9;

(w) “Profitco 1” means XXXXXXXXXX;

(x) “Profitco 2” means XXXXXXXXXX;

(y) “Proposed Transactions” means the transactions described in Paragraphs 9 to 18;

(z) “related persons” has the meaning assigned by section 251;

(aa) “Subsidiary Loan 1” has the meaning assigned by Paragraph 10;

(bb) “Subsidiary Loan 2” has the meaning assigned by Paragraph 11;

(cc) “Subsidiary Loans” has the meaning assigned by Paragraph 11;

(dd) “subsidiary wholly-owned corporation” has the meaning assigned by subsection 248(1);

(ee) “taxable Canadian corporation” has the meaning assigned by subsections 248(1) and 89(1);

(ff) “taxable dividend” has the meaning assigned by subsections 248(1) and 89(1);

(gg) “taxable preferred share” has the meaning assigned by subsection 248(1);

(hh) “term preferred share” has the meaning assigned by subsection 248(1);

(ii) XXXXXXXXXX means XXXXXXXXXX; and

(jj) “XXXXXXXXXX Parent” means XXXXXXXXXX.

Except as otherwise noted, all statutory references in this advance income tax ruling are references to the provisions of 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.

Unless otherwise noted, all references to currency are to Canadian dollars.

Facts

1. XXXXXXXXXX Parent is a XXXXXXXXXX corporation incorporated under the laws of XXXXXXXXXX.

2. CDN Parent is a corporation incorporated under the laws of the province of XXXXXXXXXX and is a taxable Canadian corporation.

3. XXXXXXXXXX Parent and CDN Parent are indirect subsidiaries of XXXXXXXXXX, which in turn is a direct subsidiary of XXXXXXXXXX. XXXXXXXXXX is a direct subsidiary of XXXXXXXXXX, a XXXXXXXXXX parent corporation.

4. Lossco is a corporation incorporated under the laws of the province of XXXXXXXXXX and is a taxable Canadian corporation. Lossco is a subsidiary wholly-owned corporation of XXXXXXXXXX Parent. Lossco is in the business of XXXXXXXXXX. It has a XXXXXXXXXX taxation year-end. Lossco’s head office is located at XXXXXXXXXX. Lossco files its tax and information returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

5. Profitco 1 is a corporation incorporated under the laws of the province of XXXXXXXXXX and is a taxable Canadian corporation. Profitco 1 is also a subsidiary wholly-owned corporation of XXXXXXXXXX Parent. Profitco 1 is in the business of XXXXXXXXXX and has a XXXXXXXXXX taxation year-end. Profitco 1’s head office is located at XXXXXXXXXX. Profitco 1 files its tax and information returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

6. Profitco 2 is a corporation incorporated under the laws of the province of XXXXXXXXXX and is a taxable Canadian corporation. It was incorporated on XXXXXXXXXX. Profitco 2 is a subsidiary wholly-owned corporation of CDN Parent. Profitco 2 is a holding company formed to acquire a XXXXXXXXXX% interest in XXXXXXXXXX. It has a XXXXXXXXXX taxation year-end. Profitco 2’s head office is located at XXXXXXXXXX. Profitco 2 files its tax and information returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

7. Lossco currently has tax attributes and a non-capital loss carryforward balance. Its non-capital carryforward balance at the end of XXXXXXXXXX was approximately $XXXXXXXXXX. These losses were incurred in Lossco’s XXXXXXXXXX and XXXXXXXXXX taxation years. XXXXXXXXXX.

The provincial allocations of taxable income for Lossco for its XXXXXXXXXX taxation year are as follows:

Province/Territory Allocation

XXXXXXXXXX			XXXXXXXXXX%

Profitco 1’s taxable income for its taxation years ending on XXXXXXXXXX and XXXXXXXXXX was approximately $XXXXXXXXXX and $XXXXXXXXXX respectively. Profitco 1’s projected taxable income for its XXXXXXXXXX taxation year is approximately $XXXXXXXXXX.

The provincial allocations of taxable income for Profitco 1 for its XXXXXXXXXX taxation year are as follows:

Province/Territory Allocation

XXXXXXXXXX			XXXXXXXXXX%

Profitco 2 incurred a non-capital loss of $XXXXXXXXXX in XXXXXXXXXX, which it carried back to offset against taxable income of $XXXXXXXXXX in its XXXXXXXXXX taxation year. Profitco 2’s taxable income for its XXXXXXXXXX taxation year is approximately $XXXXXXXXXX. Its projected taxable income for its XXXXXXXXXX taxation year is approximately $XXXXXXXXXX.

The provincial allocations of taxable income for Profitco 2 for its XXXXXXXXXX taxation year are as follows:

Province/Territory Allocation

XXXXXXXXXX			XXXXXXXXXX%

8. Each of Lossco, Profitco 1 and Profitco 2 is a “specified financial institution” as defined in subsection 248(1) of the Act. None of Lossco, Profitco 1 or Profitco 2 is a “financial institution” as defined in subsection 190(1) of the Act.

Proposed Transactions

The following transactions will be completed in the order set out below.

9. The authorized share capital of Lossco will be amended to include non-voting, non-par value Class XXXXXXXXXX Preferred Shares (the “Profitco 1 Preferred Shares”) and Class XXXXXXXXXX Preferred Shares (the “Profitco 2 Preferred Shares”). The Preferred Shares will be redeemable in whole or in part by the issuer and retractable in whole or in part by the holder at any time for a redemption price equal to the subscription price, plus any accrued but unpaid dividends. The payment of the redemption price may be satisfied, at the issuer’s option, either by (i) payment of cash or (ii) delivery of property having a fair market value at the time of redemption equal to the aggregate redemption price, in each case together with an amount in cash equal to all accrued and unpaid dividends (whether or not declared) to but excluding the date fixed for such redemption. The legal stated capital and the fair market value of the Preferred Shares will be equal to the subscription amount paid therefor. The holders of the Preferred Shares will be entitled to cumulative dividends calculated daily by reference to the redemption price of the Preferred Shares at an expected rate equal to approximately XXXXXXXXXX%, to be confirmed prior to the completion of the Proposed Transactions. The rate of these dividends will be XXXXXXXXXX% higher than the interest rate on the Subsidiary Loans. The dividends on the Preferred Shares will be payable annually on XXXXXXXXXX, or such earlier date as the Preferred Shares are redeemed. The dividends will be designated as eligible dividends to the extent possible.

10. Lossco will borrow an amount currently estimated to be $XXXXXXXXXX on a daylight basis from a third party lender (“Daylight Loan 1”). The interest rate on Daylight Loan 1 will be at commercial, market rates. Based on financial projections and the financial statements of Lossco, Lossco represents that it will have the financial capacity to borrow these funds and that Daylight Loan 1 will not exceed its borrowing capacity. Lossco will use all of the proceeds of Daylight Loan 1 to make a series of interest-bearing loans (collectively, “Subsidiary Loan 1”) to Profitco 1. Based on financial projections and the financial statements of Lossco, Profitco 1 represents that it will have the financial capacity to borrow these funds and that Subsidiary Loan 1 will not exceed its borrowing capacity. Profitco 1 will use the proceeds of Subsidiary Loan 1 to subscribe for Preferred Shares of Lossco. The share subscriptions and Subsidiary Loan 1 will be made in series until the aggregate amount of the share subscriptions is $XXXXXXXXXX and the aggregate amount of Subsidiary Loan 1 is $XXXXXXXXXX.

11. Profitco 2 will borrow an amount currently estimated to be approximately $XXXXXXXXXX on a daylight basis from Lender (“Daylight Loan 2”). Lender is related to Profitco 2 for purposes of the Act. The interest rate on Daylight Loan 2 will be at commercial, market rates. Based on financial projections and the financial statements of Profitco 2, Profitco 2 represents that it will have the financial capacity to borrow these funds and that Daylight Loan 2 will not exceed its borrowing capacity. Profitco 2 will use all of the proceeds of Daylight Loan 2 to subscribe for Preferred Shares of Lossco. Lossco will then use the proceeds of such share subscription to make an interest-bearing loan to Profitco 2. The share subscriptions and interest-bearing loans (collectively, “Subsidiary Loan 2”) will then be made again in series until the aggregate amount of the share subscriptions is $XXXXXXXXXX and the aggregate amount of Subsidary Loan 2 is $XXXXXXXXXX. Profitco 2 will use the proceeds of the final $XXXXXXXXXX loan under Subsidiary Loan 2 to repay Daylight Loan 2. Based on financial projections and the financial statements of Profitco 2, Profitco 2 represents that it will have the financial capacity to borrow these funds and that Subsidiary Loan 2 will not exceed its borrowing capacity.

12. Each of Subsidiary Loan 1 and Subsidiary Loan 2 (collectively, the “Subsidiary Loans”) will bear interest at an estimated rate of XXXXXXXXXX% per annum and will be denominated in Canadian dollars. The interest rate on the Subsidiary Loans will be confirmed at the time the Proposed Transactions are implemented. Interest on the Subsidiary Loans will be payable annually on a specified date each year, or such earlier date as the Subsidiary Loans are repaid. Neither Profitco 1 nor Profitco 2 will acquire the Preferred Shares in the ordinary course of its business as contemplated by subsection 112(2.1) of the Act.

13. Lossco will use the subscription proceeds from the issuances of the Preferred Shares to repay Daylight Loan 1.

14. It is anticipated that Lossco will fund the annual dividend payments to be made to Profitco 1 and Profitco 2 on the Preferred Shares using cash from its own operations for so long as the Preferred Shares are outstanding. To the extent that cash from operations is not sufficient to fund the dividends, Lossco will obtain additional funds by drawing on its existing third-party credit facility.

15. On each Preferred Share payment date, Lossco will, subject to any applicable corporate law solvency tests, declare and pay all accrued but previously unpaid dividends to each of Profitco 1 and Profitco 2 in accordance with the terms of the Preferred Shares and will designate such dividends as eligible dividends pursuant to subsection 89(14) to the maximum extent possible.

16. On each interest payment date, each of Profitco 1 and Profitco 2 will pay all accrued but previously unpaid interest on the Subsidiary Loans.

17. Once it is determined that the aggregate amount of the interest income on the Subsidiary Loans is equal to the amount required to fully utilize Lossco’s non-capital losses, the following transactions will be implemented to unwind the Loss Utilization Arrangement:

a. Lossco will fund the dividend payments to be made to Profitco 1 and Profitco 2 on the Preferred Shares under Paragraph 17(b) using cash from its own operations or from its existing third-party credit facility.

b. Subject to any applicable corporate law solvency tests, Lossco will declare and pay all accrued but previously unpaid dividends to Profitco 1 and Profitco 2 in accordance with the terms of the Preferred Shares.

c. Profitco 1 and Profitco 2 will pay any accrued and unpaid interest on the Subsidiary Loans.

d. Subject to any applicable corporate law solvency tests, Lossco will redeem its issued and outstanding Preferred Shares held by Profitco 1 and Profitco 2 in exchange for promissory notes (“Note 1” and “Note 2”, respectively).

e. The principal amounts of Subsidiary Loan 1 and Note 1 will be set off against each other. Subsidiary Loan 1 and Note 1 will be cancelled as a result of the set-off.

f. The principal amounts of Subsidiary Loan 2 and Note 2 will be set off against each other. Subsidiary Loan 2 and Note 2 will be cancelled as a result of the set-off.

The transactions described in this Paragraph will result in the payment of all accrued dividends on the Preferred Shares, the payment of all accrued interest on the Subsidiary Loans, the redemption of all Preferred Shares, the repayment of the Subsidiary Loans and the repayment of Note 1 and Note 2.

18. It is estimated that the Loss Utilization Arrangement will remain in place until it is unwound on or before XXXXXXXXXX. The amount of losses transferred under the Loss Utilization Arrangement in the aggregate will not exceed Lossco’s non-capital losses as of the end of its XXXXXXXXXX taxation year. Should the Loss Utilization Arrangement transfer losses to Profitco 1 or Profitco 2 in a particular taxation year in excess of the income of such entity for such taxation year, the excess of such losses will be carried back to preceding taxation years. It is not expected that the Proposed Transactions will transfer losses to Profitco 1 in excess of Profitco 1’s income for the taxation years ending between XXXXXXXXXX and XXXXXXXXXX. It is not expected that the Proposed Transactions will transfer losses to Profitco 2 in excess of Profitco 2’s income for the taxation years ending between XXXXXXXXXX to XXXXXXXXXX.

Additional Information:

19. At no time during the implementation of the Proposed Transactions described in this letter will the Preferred Shares be:

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as a “guarantee agreement”, including any guarantee, covenant, or agreement to purchase the Preferred Shares and including the lending of funds to or the placing of amounts on deposit with, or on behalf of, Profitco 1 or Profitco 2 or a specified person in relation to either of the foregoing (as contemplated by subsection 112(2.2)) given to ensure that (i) any loss that Profitco 1 or Profitco 2 or a specified person in relation thereto may sustain by reason of the ownership, holding or disposition of the Preferred Shares or any other property is limited in any respect, or (ii) Profitco 1 or Profitco 2 or a specified person in relation to either of the foregoing will derive earnings by reason of the ownership, holding or disposition of the Preferred Shares or any other property;

(b) the subject of a dividend rental arrangement (nor will any of the dividends paid on the Preferred Shares in the course of the Proposed Transactions be received as part of a dividend rental arrangement); further, the Preferred Shares will not be the subject of a dividend rental arrangement pursuant to the amended definition of dividend rental arrangement in accordance with the Legislative Proposals to amend the Act issued on July 31, 2015, and including as described in proposed paragraphs (c) and (d) of that definition;

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

(d) issued for consideration (nor will Profitco 1 or Profitco 2 receive any other property, directly or indirectly, from an investor or any property substituted therefor) 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 would be related to Lossco (if the Act were read without reference to paragraph 251(5)(b)); or

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

20. None of the corporations involved in the Proposed Transactions is or will be a corporation described in any of paragraphs (a) to (f) of the definition of “financial intermediary corporation” in subsection 191(1).

21. The interest rates on the Subsidiary Loans are at commercial rates and the terms of the Subsidiary Loans are arm’s length terms.

22. There is no “right to reduce” the interest on the Subsidiary Loans and the interest is not otherwise “contingent” such that no portion of the interest on the Subsidiary Loans will be considered to be a “contingent amount” as defined in subsection 143.4(1) of the Act.

23. At the time of the Proposed Transactions:

a. Lossco will have the financial capacity to satisfy the applicable solvency test required to pay the dividends on the Preferred Shares, described in Paragraphs 15 and 17(b); and

b. Lossco will have the financial capacity to satisfy the applicable solvency test required to redeem the Preferred Shares as described in Paragraph 17(d).

24. Lossco, Profitco 1 and Profitco 2 are affiliated persons and are related to each other and will continue to be affiliated and related to each other throughout the Proposed Transactions.

25. None of CDN Parent, Profitco 1 or Profitco 2 will claim, at any time, a capital loss in respect of any investment in Lossco.

26. The dividends paid on the Preferred Shares to Profitco 1 and Profitco 2, as described in Paragraphs 15 and 17(b), have no purpose other than the purpose described under the heading “Purpose of the Proposed Transactions”.

27. The annual dividends paid on the Preferred Shares of the capital stock of Lossco to the Profitcos, as described in Paragraph 15, have no purpose other than the purpose described under the heading “Purpose of the Proposed Transactions”.

Purpose of the Proposed Transactions:

28. The purpose of the Proposed Transactions is to effect a tax consolidation of Lossco, Profitco 1 and Profitco 2 by:

a. having Lossco earn interest income on the Subsidiary Loans, thereby permitting Lossco to accelerate the use of its non-capital losses; and

b. having Profitco 1 and Profitco 2 incur interest expense on the Subsidiary Loans, thereby permitting Profitco 1 and Profitco 2 to reduce their respective taxable incomes.

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 each of Profitco 1 and Profitco 2 has a legal obligation to pay interest on the Subsidiary Loans, and that each of Profitco 1 and Profitco 2 continues to hold the Preferred Shares acquired from Lossco for the purpose of gaining or producing income, each of Profitco 1 and Profitco 2 will be entitled, pursuant to paragraph 20(1)(c), to deduct the lesser of (i) the interest paid or payable (depending on the method regularly followed by Profitco 1 or Profitco 2, as the case may be, in computing its income for purposes of the Act) in respect of the year on the Subsidiary Loans or (ii) a reasonable amount in respect thereof; and any resulting non-capital loss incurred by each of Profitco 1 and Profitco 2, in their respective XXXXXXXXXX taxation years will be deductible by each of Profitco 1 and Profitco 2, pursuant to paragraph 111(1)(a) in computing their taxable income for the XXXXXXXXXX preceding taxation years.

B. The dividends received by each of Profitco 1 and Profitco 2 on the Preferred Shares, as described in Paragraphs 15 and 17(b) above, will be taxable dividends, and such dividends will, pursuant to paragraph 12(1)(j), be required to be included in the computation of the income of Profitco 1 and Profitco 2, respectively.

C. The dividends received by Profitco 1 and Profitco 2 on the Preferred Shares, as described in Paragraphs 15 and 17(b) above, will be deductible, pursuant to subsection 112(1), in computing the taxable income of Profitco 1 and Profitco 2 respectively 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).

D. Part IV.1 and Part VI.1 will not apply to the dividends described in Ruling B above because the dividends will be excepted dividends pursuant to paragraph (b) of the definition of “excepted dividend” in section 187.1, as read in conjunction with paragraph 191(2)(a), and will be excluded dividends pursuant to paragraph (a) of the definition of “excluded dividend” in subsection 191(1), as read in conjunction with paragraph 191(2)(a).

E. The provisions of subsections 15(1), 56(2), 69(11) and 246(1) will not apply as a result of entering into the Proposed Transactions.

F. The provisions of subsection 55(2) will not apply to the taxable dividends, described in Paragraphs 15 and 17(b).

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

H. 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 itself, to re-determine 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 given subject to the limitations and qualifications set out in Information Circular 70-6R6 dated August 29, 2014 and are binding on the CRA provided that the Proposed Transactions are undertaken 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.

Opinions

Provided that (i) the preceding statements under the headings “Facts”, “Proposed Transactions”, “Additional Information” and “Purpose of the Proposed Transactions” constitute complete and accurate disclosure; (ii) the Proposed Transactions are undertaken in the manner described above and (iii) the Act is amended in accordance with the Legislative Proposals to amend the Act issued July 31, 2015 and other tax legislation to implement such measures, subsection 55(2) will not apply in respect of the dividends described in Paragraphs 15 and 17(b) above and subsection 112(2.3) will not preclude the deduction of such dividends.

The foregoing opinion is not a ruling and, as noted in paragraph 19(f) of Information Circular 70-6R6, is not binding on the CRA.

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 income, capital gain, taxable capital gain, recapture, 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
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch