2006 Ruling 2006-0192521R3 - 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: Loss consolidation within a corporate group

Position: The loss consolidation is acceptable

Reasons: The ruling is consistent with our positions in previous rulings and with Department of Finance policy.

XXXXXXXXXX 2006-019252

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Subject: XXXXXXXXXX
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-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:

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

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

(iii) is under objection by either of the taxpayers or any related person;

(iv) is before the courts or otherwise under appeal; and

(v) will have any impact on the ability of either of the taxpayers to pay its respective outstanding tax liabilities.

Issues similar to those involved in this ruling were the subject of advance income tax ruling 2005-016047.

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 the date of this letter and the Income Tax Regulations thereunder are referred to as the "Regulations";

(b) "agreed amount" in respect of an eligible property means the amount that the transferor and the transferee of the property agree upon in their election under subsection 85(1) in respect of that property;

(c) "BCA" means the Canada Business Corporations Act;

(d) "cost amount" has the meaning assigned by subsection 248(1) of the Act;

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

(f) XXXXXXXXXX;

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

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

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

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

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

(l) "Holdco" means XXXXXXXXXX, the corporation described in paragraphs 3 and 4 hereof;

(m) XXXXXXXXXX;

(n) XXXXXXXXXX;

(o) "Lossco" means XXXXXXXXXX, the corporation described in paragraphs 1, 2, 3, 5 and 6 hereof. Lossco's address is XXXXXXXXXX. Lossco deals with the XXXXXXXXXX TSO and files its federal income tax return at the XXXXXXXXXX TC;

(p) "mark-to-market property" has the meaning assigned by subsection 142.2(1) of the Act;

(q) "Newco" means the corporation described in paragraphs 16 and 17 hereof;

(r) "Newco Demand Note" means the demand note described in paragraph 21 hereof;

(s) "Newco Preferred Shares" means the preferred shares described in paragraphs 17 and 28 hereof;

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

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

(v) "Portfolio" means the portfolio of bonds described in paragraphs 10 to 12 hereof;

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

(x) "Profitco" means XXXXXXXXXX, the corporation described in paragraphs 7 to 9 hereof. Profitco's address is XXXXXXXXXX. Profitco deals with the XXXXXXXXXX TSO and files its federal income tax return at the XXXXXXXXXX TC;

(y) "Proposed Transactions" means the transactions described in paragraphs 16 to 25 hereof;

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

(aa) "PSA" means the purchase and sale agreement described in paragraph 19 hereof;

(ab) "redemption amount" has the meaning assigned in paragraph 17(c) hereof;

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

(ad) "specified debt obligation" ("SDO") has the meaning assigned by subsection 142.2(1) of the Act;

(ae) "specified shareholder" has the meaning assigned by subsection 248(1) of the Act;

(af) "subsidiary controlled corporation" has the meaning assigned by subsection 248(1) of the Act;

(ag) "subsidiary wholly-owned corporation" has the meaning assigned by subsection 248(1) of the Act;

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

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

(aj) "taxation year" has the meaning assigned by section 249 of the Act.

FACTS

1. Lossco was incorporated under the XXXXXXXXXX. Lossco is a taxable Canadian corporation that has a taxation year that ends on XXXXXXXXXX. Lossco is not a financial institution.

2. The authorized capital of Lossco includes XXXXXXXXXX, redeemable preference shares and class B, C and D preference shares. The redeemable preference shares and the class B, C and D preference shares are each issuable in one or more series. Currently, Lossco has a number of XXXXXXXXXX, class B preference - series A shares, class B preference - series C shares, class B preference - series D shares, class C preference - series A shares, and class C preference - series B shares issued and outstanding. XXXXXXXXXX.

3. Lossco's assets include the shares of Holdco, which is a subsidiary wholly-owned corporation of Lossco.

4. Holdco is a holding corporation that, as more specifically identified in paragraph 8 below, holds substantially all of the issued and outstanding common shares of Profitco.

5. As at the end of Lossco's fiscal year ended on XXXXXXXXXX, the balance of Lossco's non-capital losses available for carry forward was approximately $XXXXXXXXXX, which were incurred as follows:

XXXXXXXXXX

Total		    $XXXXXXXXXX 

Lossco estimates that its non-capital losses for the taxation year ending on XXXXXXXXXX will be approximately $XXXXXXXXXX. If realized, this would increase the balance of Lossco's non-capital losses available for carry forward to approximately $XXXXXXXXXX.

6. XXXXXXXXXX.

7. Profitco is a taxable Canadian corporation and a public corporation that was continued under the XXXXXXXXXX. Profitco is a financial institution but it is not a financial intermediary corporation. The taxation year of Profitco ends on XXXXXXXXXX.

8. The authorized capital of Profitco includes both common shares and preferred shares, which are issuable in one or more series. The common shares are the only shares with voting rights. Currently, Profitco has a number of common shares, non-cumulative redeemable preference shares and non-cumulative redeemable second preference shares issued and outstanding. Holdco holds XXXXXXXXXX % of the issued and outstanding common shares of Profitco XXXXXXXXXX. The other two classes of preference shares are held in combination by XXXXXXXXXX , all of whom are persons that deal at arm's length with Profitco for the purposes of the Act.

9. XXXXXXXXXX.

10. XXXXXXXXXX. Some of these assets include a portfolio of bonds (the "Portfolio") which are issued or guaranteed by the government of Canada or a province or a municipality or by a corporation. XXXXXXXXXX.

11. Each of the bonds included in the Portfolio is a specified debt obligation and is currently subject to tax in accordance with the provisions of section 142.4 as it is held by Profitco, a financial institution. For greater certainty, none of the bonds included in the Portfolio is a mark-to-market property.

12. The current estimated fair market value of the Portfolio is approximately $XXXXXXXXXX and the cost amount of each bond included in the Portfolio is less than its fair market value. On that basis, the Portfolio presently has an accrued gain of approximately $XXXXXXXXXX.

13. In addition to carrying on the XXXXXXXXXX business, Profitco is the parent company for several direct and indirect subsidiary corporations, including subsidiary wholly-owned corporations or subsidiary controlled corporations.

14. Profitco was taxable in XXXXXXXXXX and it is anticipated that it will continue to be taxable in its taxation year ending XXXXXXXXXX.

15. As Profitco is carrying on XXXXXXXXXX business in Canada, it has allocated income to each province and territory pursuant to section XXXXXXXXXX of the Regulations. The specific provincial allocations for the XXXXXXXXXX taxation year are as follows:

XXXXXXXXXX.

It is not anticipated that the allocations will change significantly for the XXXXXXXXXX taxation year.

PROPOSED TRANSACTIONS

16. Lossco will incorporate Newco under the BCA. Newco will be a taxable Canadian corporation and Newco will not be a financial intermediary corporation.

17. The authorized share capital of Newco will include a class of common shares and a class of preferred shares, referred to as the "Newco Preferred Shares", having the following attributes:

(a) non-voting;

(b) entitled to a fixed preferential non-cumulative dividend at a specified rate;

(c) redeemable at any time at the option of Newco for an amount (the "redemption amount") equal to the fair market value of the Portfolio at the time of its transfer to Newco divided by the number of Newco Preferred Shares so issued, plus any declared but unpaid dividends on such share; and

(d) retractable at any time at the option of the holder for an amount equal to its redemption amount.

18. At the time of the incorporation of Newco, Lossco will subscribe for a nominal number of Newco common shares having nominal paid-up capital and a nominal adjusted cost base to Lossco.

19. Profitco and Newco will enter into a PSA pursuant to which Profitco will agree to transfer the Portfolio to Newco for consideration consisting of Newco Preferred Shares. The PSA will not contain conditions of any kind relative to the ownership of the Portfolio by Newco. The PSA will not contemplate or require that Profitco exercise its retraction rights with respect to the Newco Preferred Shares or that Newco exercise its right to redeem the Newco Preferred Shares. The PSA will not contemplate or require that Newco be dissolved. The PSA also will not contemplate or require Newco, or any other person, to transfer the Portfolio after Newco acquires the Portfolio pursuant to the PSA. At the time that the Portfolio is transferred by Profitco to Newco, there will be no obligation, condition or requirement of any kind for Newco to do anything with the Portfolio.

20. Profitco will then transfer the Portfolio to Newco pursuant to the PSA. As sole consideration therefor, Newco will issue to Profitco a number of Newco Preferred Shares having an aggregate fair market value and an aggregate redemption amount equal to the fair market value of the Portfolio.

Profitco and Newco, will jointly elect in prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of each bond included in the Portfolio that is an eligible property. The agreed amount specified in respect of each such bond will be the cost amount thereof so that, for greater certainty, no gains will be realized by Profitco in respect of any of the transfers.

For purposes of the BCA, the amount to be added to the stated capital account maintained for the Newco Preferred Shares issued by Newco will be the aggregate of the agreed amounts in respect of such assets transferred to Newco.

21. Subsequent to the transfer of the Portfolio to Newco as described in paragraph 20, Profitco will exercise its right to retract the Newco Preferred Shares and Newco will redeem the Newco Preferred Shares at their aggregate redemption amount. As consideration therefor, Newco will issue to Profitco a non-interest-bearing demand note (the "Newco Demand Note") having a principal amount and fair market value equal to the aggregate redemption amount and fair market value of the Newco Preferred Shares.

22. Subsequent to the redemption of the Newco Preferred Shares described in paragraph 21, Newco will be wound-up pursuant to the provisions of the BCA. On the winding-up of Newco, Lossco will receive all of the property of Newco, including the Portfolio, and will assume all of the liabilities of Newco, including the Newco Demand Note. Newco will be formally dissolved upon receipt of the applicable regulatory approvals and the Certificate of Dissolution. Immediately before the winding-up of Newco, Newco will be a subsidiary wholly-owned corporation of Lossco.

23. Lossco and Profitco will enter into an agreement providing, inter alia, for the transfer of the Portfolio by Lossco to Profitco in consideration for the repayment of the Newco Demand Loan. In the event that the fair market value of the Portfolio at the time of the transfer from Lossco to Profitco is in excess of the fair market value of the Newco Demand Note, Profitco will make a cash payment to Lossco of the difference. Alternatively, if the fair market value of the Portfolio at that time is less than the fair market value of the Newco Demand Note, Lossco will make a cash payment to Profitco of the difference.

24. Lossco will report the gain that it will realize from transferring the Portfolio to Profitco on account of income in the year of the transfer.

25. Upon acquiring the Portfolio, as described in paragraph 23, Profitco will treat the Portfolio in the same manner as it had before it transferred the Portfolio to Newco as described in paragraph 20.

PURPOSE OF THE PROPOSED TRANSACTIONS

26. The purpose of the Proposed Transactions is to ensure the orderly utilization of the non-capital losses of Lossco. For financial reporting purposes, Lossco cannot continue to recognize the tax benefit associated with the non-capital losses unless Lossco is able to demonstrate that it is more likely than not to earn sufficient taxable income within the applicable loss carry forward period for tax purposes to apply the losses. The purpose of the Proposed Transactions is to enable Lossco to earn sufficient taxable income in the XXXXXXXXXX taxation year to utilize its non-capital losses and thereby permit Lossco to continue to recognize the related benefit for financial reporting purposes.

ADDITIONAL INFORMATION

27. The Proposed Transactions will occur in the order presented, with the exception of the filing of the applicable election forms, as described in paragraph 20 herein, which will be filed before the applicable due date.

28. None of the Newco Preferred Shares will, at any time during the implementation of the Proposed Transactions described herein, 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) of the Act, 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).

29. Under applicable generally accepted accounting principles, the transfers of the Portfolio, described in the Proposed Transactions, constitute related-party transactions that are not considered to be in the normal course of operations of the relevant transferor and hence will be recorded in the financial statements of the parties to the relevant transaction at the carrying amount of the Portfolio, not the exchanged amount (i.e., the fair market value of the Portfolio).

30. Profitco and Lossco have taken all steps that they deem necessary to assure themselves that these transactions fall within the ambit of the permitted related party transaction regulations of the XXXXXXXXXX.

RULINGS

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

A. Provided the appropriate joint elections are filed in prescribed form and manner within the time limits specified in subsection 85(6), and provided the particular property transferred is an eligible property, the provisions of subsection 85(1) will apply to the transfer of the specified debt obligations included in the Portfolio transferred to Newco by Profitco as described in paragraph 20 such that:

(a) the agreed amount in respect of each specified debt obligation so transferred will be deemed to be Profitco's proceeds of disposition thereof and Newco's cost thereof; and

(b) the cost to Profitco of the Newco Preferred Shares received as consideration for the transfer will be equal to the aggregate of the agreed amounts in respect of each such transfer.

For greater certainty, paragraph 85(1)(e.2) of the Act will not apply to these transfers.

B. As a result of the redemption of the Newco Preferred Shares by Newco described in paragraph 21:

(a) by virtue of paragraphs 84(3)(a) and (b), respectively, Newco will be deemed to have paid, and Profitco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid to redeem the Newco Preferred Shares exceeds the paid-up capital thereof, immediately before such redemption;

(b) the taxable dividend deemed to be received by Profitco as described in (a) above will be included in Profitco's income pursuant to subsection 82(1) and paragraph 12(1)(j), and will be deductible in computing its taxable income for the taxation year in which such dividend is deemed to have been received pursuant to subsection XXXXXXXXXX For greater certainty, none of subsections 112(2.1), (2.2), (2.3) and (2.4) will apply to deny the application of such deduction in respect of such dividend;

(c) Profitco will not be subject to Part IV.1 tax in respect of the deemed dividend received by it as described in (a) above, because such dividend will be an excepted dividend by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1; and

(d) Newco will not be subject to Part VI.1 tax in respect of the deemed dividend paid by it as described in (a) above, because such dividend will be an excluded dividend by virtue of paragraph (a) of the definition "excluded dividend" in subsection 191(1).

C. The provisions of subsection 88(1) will apply to the wind-up of Newco described in paragraph 22.

D. The provisions of subsections 15(1) and 56(2) will not apply to the Proposed Transactions, in and by themselves.

E. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, to redetermine any of the tax consequences confirmed herein.

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, other than the filing of the relevant elections, 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 Newco into Lossco as described in paragraph 22 will cause subsection 55(2) of the Act to apply to the taxable dividend referred to in Ruling B. However, we understand that 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) may not apply to the dividend described in Ruling B.

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:

(i) the GST implications of any of the Proposed Transactions;

(ii) the paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein;

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

(iv) the status of any corporation as a "financial intermediary corporation", as that term is defined in subsection 191(1), or as a "financial institution" for the purposes of subsection 142.2(1); or

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

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

(vii) 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,

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