2006 Ruling 2006-0178651R3 - In house loss utilization - Affiliated Group

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: Whether loss utilization within an affiliated group is acceptable.

Position: Yes.

Reasons: Previous positions.

XXXXXXXXXX 							2006-017865

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Subject:	XXXXXXXXXX
		Advance Income Tax Ruling Request		

This is in reply to your letter of XXXXXXXXXX, as modified by your other correspondence, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayers. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayers or any related person;

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return by the taxpayers or any related person;

(iii) under objection by the taxpayers or any 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.

The taxpayers have also represented that the proposed transactions described herein will not result in the taxpayers or any related person described herein being unable to pay its existing outstanding tax liabilities.

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

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

(c) "Acquisition Loan" has the meaning assigned by Paragraph 6;

(d) "BCA" means the XXXXXXXXXX;

(e) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7);

(f) "Daylight Loan" has the meaning assigned in Paragraph 13;

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

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

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

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

(k) "Lossco" means XXXXXXXXXX;

(l) "Lossco Demand Loan" has the meaning assigned by Paragraph 15;

(m) "majority-interest beneficiary" has the meaning assigned by subsection 251.1(3);

(n) "Newco" has the meaning assigned in Paragraph 11;

(o) "Newco Preferred Shares" has the meaning assigned in Paragraph 11;

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

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

(r) "Parent" means XXXXXXXXXX;

(s) "Profitco" means XXXXXXXXXX;

(t) "Profitco Demand Loan" has the meaning assigned by Paragraph 16;

(u) "Profitco XXXXXXXXXX Limited Partnership" means XXXXXXXXXX;

(v) "Proposed Transactions" means the proposed transactions described in Paragraphs 11 to 19;

(w) XXXXXXXXXX;

(x) XXXXXXXXXX;

(y) "related persons" has the meaning assigned by section 251;

(z) "specified financial institution" has the meaning assigned by subsection 248(1);

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

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

(cc) "Yco" means XXXXXXXXXX; and

(dd) "Yco Trust" means XXXXXXXXXX.

FACTS

1. Profitco was formed upon amalgamation on XXXXXXXXXX under the BCA. Profitco's taxation year ends on XXXXXXXXXX. The predecessor corporations to Profitco were XXXXXXXXXX which was a wholly-owned subsidiary of Lossco at the time. Profitco is a taxable Canadian corporation XXXXXXXXXX that is controlled by Parent. Profitco carries on the business of XXXXXXXXXX. Profitco deals with the XXXXXXXXXX TSO and files its federal corporate tax returns at the XXXXXXXXXX TC. Parent owns XXXXXXXXXX percent of Profitco's issued and outstanding common shares and Lossco owns the remaining XXXXXXXXXX percent of such shares. Parent controls Profitco.

2. Parent is a XXXXXXXXXX Parent deals with the XXXXXXXXXX TSO and files its federal returns at the XXXXXXXXXX TC.

3. Lossco was incorporated on XXXXXXXXXX under the BCA. Lossco's taxation year ends on XXXXXXXXXX. Lossco is a taxable Canadian corporation and a Canadian-controlled private corporation, direct control of which has been held by Yco since Lossco was incorporated. Lossco deals with the XXXXXXXXXX TSO and files its federal corporate tax returns at the XXXXXXXXXX TC.

4. Yco is a taxable Canadian corporation and a Canadian-controlled private corporation. Yco was also incorporated in XXXXXXXXXX under the BCA. Yco has a number of issued and outstanding voting preferred shares, XXXXXXXXXX% of which, are owned by Parent and XXXXXXXXXX% of which, are owned by the Yco Trust. Yco also has a number of issued and outstanding non-voting Class A special shares that are all owned by Parent. The Class A special shares owned by Parent represent most of the value in the equity of Yco.

5. XXXXXXXXXX.

Parent is the majority-interest beneficiary of the Yco Trust. XXXXXXXXXX Yco and Lossco have been affiliated persons since Yco and Lossco were incorporated.

6. Yco borrowed approximately $XXXXXXXXXX from unrelated lenders (the "Acquisition Loan") on XXXXXXXXXX. The Acquisition Loan funds were then immediately loaned by Yco to Lossco in order to finance Lossco's acquisition of all the common shares of Profitco's predecessor corporation on XXXXXXXXXX. The Acquisition Loan was refinanced between XXXXXXXXXX and XXXXXXXXXX with interest-bearing unsecured loans from Parent. Lossco and Profitco would have been amalgamated in order to match the interest expense incurred by Lossco on its interest-bearing loan owing to Yco with the business income earned by Profitco, however, such an amalgamation was not possible due to business constraints, including significant and non-addressable lender and other consent XXXXXXXXXX issues. The interest rate charged on all the interest-bearing loans from Parent to Yco to refinance the Acquisition Loan and from Yco to Lossco has been equal to commercial rates of interest that would has been charged for loans with similar terms and conditions at the time such loans were made.

7. On XXXXXXXXXX, Parent acquired its XXXXXXXXXX% of the common shares of Profitco from Lossco, which resulted in Lossco receiving proceeds of disposition equal to the fair market value of such shares. XXXXXXXXXX

8. Lossco is the sole limited partner for Profitco XXXXXXXXXX Limited Partnership, XXXXXXXXXX. Lossco had acquired its interest in the Profitco XXXXXXXXXX Limited Partnership on XXXXXXXXXX from Profitco for fair market value consideration. This limited partnership interest provides Lossco with its main source of income other than the taxable dividends paid by Profitco. XXXXXXXXXX.

9. Currently, the balance of Lossco's non-capital losses is approximately $XXXXXXXXXX. Other than some nominal general and administrative expenses, Lossco's non-capital losses have arisen as a result of interest expense on the loan from Yco. The non-capital losses of Lossco and the year of expiry are summarized as follows:

Approximate Amount of Loss		Year Incurred		Year of Expiry

	XXXXXXXXXX 				XXXXXXXXXX 			XXXXXXXXXX
	XXXXXXXXXX 				XXXXXXXXXX 			XXXXXXXXXX
	XXXXXXXXXX 				XXXXXXXXXX 			XXXXXXXXXX 

10. XXXXXXXXXX.

PROPOSED TRANSACTIONS

11. Parent will incorporate, under the BCA, a new subsidiary ("Newco"). Newco's authorized share capital will consist of an unlimited number of common shares and preferred shares ("Newco Preferred Shares"). Each common share of Newco will entitle the holder to one vote. The holders of Newco's common shares will be entitled to dividends at the discretion of Newco's directors, and will be entitled to receive the remaining property of Newco upon its winding-up or dissolution. The Newco Preferred Shares will have the following attributes:

(a) non-voting;

(b) entitled to a cumulative dividend at an annual rate equal to the interest rate on the Profitco Demand Loan plus XXXXXXXXXX per cent.

(c) redeemable at any time at the option of Newco, for an amount equal to the aggregate redemption amount plus any accrued but unpaid dividends, by Newco:

(i) paying cash equal to such amount; or

(ii) assigning the Lossco Demand Loan to Profitco and paying cash equal to any accrued and unpaid dividends.

(d) retractable at any time at the option of the holder for an amount equal to the aggregate redemption amount plus any accrued but unpaid dividends, by Newco:

(i) paying cash equal to such amount; or

(ii) assigning the Lossco Demand Loan to Profitco and paying cash equal to any unpaid dividends.

On incorporation, Newco will issue XXXXXXXXXX common shares from treasury to Parent for cash consideration of $XXXXXXXXXX.

12. XXXXXXXXXX.

13. Profitco will borrow an amount of approximately $XXXXXXXXXX on a daylight basis from Parent (the "Daylight Loan").

14. Profitco will use the proceeds of the Daylight Loan to subscribe for Newco Preferred Shares. The Newco Preferred Shares will have an aggregate redemption amount and aggregate paid-up capital equal to the principal amount of the Daylight Loan.

15. Newco will lend the proceeds from the subscription of the Newco Preferred Shares to Lossco on a demand basis (the "Lossco Demand Loan"). The Lossco Demand Loan will not bear interest. The terms of the Lossco Demand Loan will provide that if Profitco becomes the holder of the Lossco Demand Loan the Lossco Demand Loan may, at the option of either Lossco or Profitco, be set off against the Profitco Demand Loan.

16. Lossco will lend the proceeds from the Lossco Demand Loan to Profitco on a demand basis (the "Profitco Demand Loan"). The Profitco Demand Loan will bear interest at an annual rate that will be based upon Profitco's cost of capital, and such annual rate will not be in excess of the rate that would be required by a third party lender in such circumstances. The terms of the Profitco Demand Loan will also provide that if Profitco becomes the holder of the Lossco Demand Loan the Lossco Demand Loan may, at the option of either Lossco or Profitco, be set off against the Profitco Demand Loan.

To the extent that a deduction of interest by Profitco results in a non-capital loss in a particular year, Profitco will utilize such non-capital loss incurred by it before the time that Lossco's non-capital losses described in Paragraph 9 would have otherwise expired.

17. Profitco will use the proceeds from the Profitco Demand Loan to repay the Daylight Loan.

18. To the extent that, on the date annual dividends are paid by Newco on the Newco Preferred Shares, Newco does not have sufficient cash on hand, or is not able to legally pay a dividend, Parent will contribute additional funds to Newco in the form of contributed surplus on the common shares. However, it is expected that Profitco will be able to apply all of Lossco's non-capital losses against its taxable income for its taxation years ending XXXXXXXXXX and XXXXXXXXXX, such that Newco will only pay one cumulative dividend on the Newco Preferred Shares as described in Paragraph 19(b). In XXXXXXXXXX and XXXXXXXXXX, Profitco's income may include the proceeds from the sale of some of its assets for proceeds of disposition equal to their fair market value XXXXXXXXXX None of the assets to be disposed of by Profitco will have been acquired by Profitco within the XXXXXXXXXX years preceding the date of its disposition from any person with whom Profitco was not affiliated.

19. It is proposed that, on or prior to XXXXXXXXXX:

(a) Parent will contribute sufficient funds to Newco as described in Paragraph 18 equal to the amount of any cumulative accrued and unpaid dividends on the Newco Preferred Shares;

(b) Newco will pay the balance of any cumulative accrued and unpaid dividends on the Newco Preferred Shares.

(c) Profitco will pay the balance of any accrued and unpaid interest on the Profitco Demand Loan.

(d) Newco will redeem all the Newco Preferred Shares held by Profitco and settle the aggregate redemption amounts owing on such redemption by assigning the principal amount of the Lossco Demand Loan to Profitco;

(e) Profitco will repay the Profitco Demand Loan by setting off the principal amount of the Profitco Demand Loan with the principal amount of the Lossco Demand Loan, and the Lossco Demand Loan and the Profitco Demand Loan will be cancelled; and

(f) Once all of the Newco Preferred Shares held by Profitco have been redeemed, Newco will be wound up into Parent.

ADDITIONAL INFORMATION

20. The Proposed Transactions described herein will occur in the order presented unless otherwise indicated.

21. It is represented that an amount equal to the amount of the Daylight Loan represents an amount that Profitco could reasonably borrow from an arm's length financial institution with a guarantee from Parent.

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

(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).

23. None of Profitco, Lossco or Newco is or will be a specified financial institution or a financial intermediary corporation.

24. Based on its existing assets and resources, Parent will have the ability to make contributions of capital to Newco as described in Paragraphs 18 and 19(a).

PURPOSE OF THE PROPOSED TRANSACTIONS

25. The purpose of the Proposed Transactions is to consolidate profits and losses within a group of taxable Canadian corporations that are affiliated persons by enabling Lossco to earn sufficient interest income on the Profitco Demand Loan to fully utilize Lossco's non-capital losses by the end of Lossco's XXXXXXXXXX taxation year. Profitco will obtain an interest deduction to be used against its taxable income for its taxation years ending XXXXXXXXXX and XXXXXXXXXX, which is expected to include income arising from the sale of its assets during that year.

26. The purpose of Parent making capital contributions to Newco as described in Paragraphs 18 and 19(a), as opposed to having Parent 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 section XXXXXXXXXX of the BCA. If additional common shares of Newco were subscribed for and issued, the realizable value of Newco's assets (essentially the Lossco Demand Loan) after the payment of such a dividend would be less than the aggregate amount of its liabilities and stated capital of its common shares and Newco Preferred Shares, thus precluding the payment of dividends.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below.

A. The dividend received by Profitco on the Newco Preferred Shares as described in Paragraph 19(b) will be a taxable dividend that will be deductible pursuant to subsection 112(1) 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).

B. Profitco will not be subject to tax under Part IV.1 in respect of the taxable dividend it receives from Newco as described in Ruling A.

C. The taxable dividend received by Profitco as described in Ruling A will not be subject to tax under Part IV except as provided by paragraph 186(1)(b).

D. Newco will not be subject to tax under Part VI.1 in respect of the taxable dividend it pays to Profitco on the Newco Preferred Shares as described in Ruling A.

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

F. On the redemption of the Newco Preferred Shares described in Paragraph 19(d):

(a) no dividend will be deemed to have been paid by Newco and received by Profitco under subsection 84(3); and

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

G. Provided that there is no disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v) as part of a series of transactions or events that includes the Proposed Transactions, then, by virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the taxable dividend described in Ruling A. For greater certainty, the Proposed Transactions described herein, in and by themselves, will not be considered to result in any disposition or increase in interest described in any of subparagraphs 55(3)(a)(i) to (v).

H. No amount will be included in the income of Newco in respect of the contribution of capital made by Parent as described in Paragraph 19(a).

I. The set-off of the Lossco Demand Loan against the Profitco Demand Loan, described in Paragraph 19(e), will not give rise to a forgiven amount.

J. The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11) and 246(1) will not apply to the Proposed Transactions, in and by themselves.

K. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, to redetermine the consequences confirmed in the rulings given above.

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 CRA provided that the Proposed Transactions, except for Paragraph 19, which must be completed by XXXXXXXXXX, are completed 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. 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 paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein;

(b) the application or non-application of the general anti-avoidance provisions of any province;

(c) 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 truly,

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