2006 Ruling 2006-0184571R3 - Loss utilization in related companies

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 utilization in a related group of companies.

Position: The loss utilization is acceptable. Favorable rulings provided.

Reasons: The law. Fairly standard rulings that are consistent with our position in previous rulings

XXXXXXXXXX 									2006-018457

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX in which you requested advance income tax rulings on behalf of XXXXXXXXXX (together, herein called the "Applicants"). We also acknowledge all additional information in connection with your requests, both in correspondence and in our various telephone conversations.

We understand that to the best of your knowledge, and that of the Applicants, none of the issues contained herein:

(a) is in an earlier tax return of any of the Applicants or a related person;

(b) is being considered by a tax services office or taxation centre in connection with a previously filed tax return of any of the Applicants or a related person;

(c) is under objection by any of the Applicants or a related person;

(d) is before the Courts or, if a judgment has been issued, the time limit for appeal to a higher Court has expired; or

(e) is the subject of an advance income tax ruling previously issued by the Income Tax Rulings Directorate in favour of the Applicants.

Definitions

In this letter unless otherwise expressly stated:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof, and unless otherwise stated, every reference herein to a part, section, subsection, paragraph or subparagraph is a reference to the relevant provision of the Act;

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

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

(d) XXXXXXXXXX;

(e) "Daylight Loan" has the meaning set out in paragraph 10 hereof;

(f) "Holdco" means XXXXXXXXXX;

(g) "Holdco Preferred Shares" has the meaning set forth in paragraph 9 hereof;

(h) "Investment Note" has the meaning set out in paragraph 11 hereof;

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

(j) "Opco" means XXXXXXXXXX;

(k) "Opco Borrowing Capacity" has the meaning set out in paragraph 7 hereof;

(l) "Opco Subordinated Rate" has the meaning set out in paragraph 8 hereof;

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

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

(o) "taxable income" has the meaning assigned by subsection 248(1); and

(p) "ZCo" means XXXXXXXXXX, a widely held corporation incorporated and resident in the United States, the shares of which are listed for trading on the XXXXXXXXXX Stock Exchange.

Facts

1. Holdco is a taxable Canadian corporation and a private corporation, all of the shares of which are held indirectly by Zco, which acquired control of Holdco on XXXXXXXXXX. Holdco and ZCo do not deal at arm's length with each other.

2. Holdco is the holding company for several operating companies that directly or indirectly carry on the business of XXXXXXXXXX.

3. The taxation year of Holdco ends on XXXXXXXXXX. Holdco has an estimated non-capital loss of $XXXXXXXXXX (and no non-capital loss carry forward) for the period from XXXXXXXXXX to XXXXXXXXXX. In the absence of the proposed transactions, as described herein, it is estimated that Holdco would incur a non-capital loss of approximately $XXXXXXXXXX in the period ending XXXXXXXXXX.

4. Opco is a taxable Canadian corporation and a private corporation, all of the shares of which are held directly or indirectly by Holdco. The taxation year of Opco ends on XXXXXXXXXX. In the absence of the proposed transactions, as described herein, it is estimated that Opco's taxable income for its taxation year ended XXXXXXXXXX would be approximately $XXXXXXXXXX.

5. XXXXXXXXXX.

6. Holdco and Opco are each serviced by the XXXXXXXXXX Taxation Services Office and each files its tax returns at the XXXXXXXXXX Taxation Centre.

7. By letter dated XXXXXXXXXX Opco received professional advice from its bankers, based on Opco's audited financial information as at XXXXXXXXXX, that Opco would be in a position to borrow in Canadian public markets (on the basis that such borrowing be subordinated to all other debts of the company, including accounts payable) an amount up to $XXXXXXXXXX (the "Opco Borrowing Capacity"). Since that time, there has not been any material change in either Opco's aggregate debt or in its debt/equity ratio that would reduce the Opco Borrowing Capacity.

8. The weighted average interest rate on Opco's senior secured long-term debt is approximately XXXXXXXXXX%. The XXXXXXXXXX establishes a regulated rate of return on the equity of Opco, which generally falls between XXXXXXXXXX% and XXXXXXXXXX% on a post-tax basis, or approximately XXXXXXXXXX% to XXXXXXXXXX% on a pre-tax basis. A deeply subordinated debt in the quantum of the Opco Borrowing Capacity would carry a significant risk premium over the senior debt of Opco and would have a risk profile closer to equity than that of a senior debt. Therefore, Opco is of the view that a reasonable rate of interest on fully subordinated debt in the quantum of the Opco Borrowing capacity would be XXXXXXXXXX% (the "Opco Subordinated Rate").

Proposed Transactions

9. By directors' resolution Holdco will authorize the issuance of a new series of preferred shares (the "Holdco Preferred Shares") with the rights and restrictions as follows:

(a) non-voting;

(b) annual cumulative dividend rate equal to the Opco Subordinated Rate + XXXXXXXXXX%;

(c) redeemable for an amount equal to the aggregate of the amount for which the shares were issued and any unpaid dividends;

(d) retractable for an amount equal to the aggregate of the amount for which the shares were issued and any unpaid dividends;

(e) dividends and proceeds on winding up or dissolution rank ahead of any payment on shares ranking junior;

(f) on winding up or dissolution, holders will receive an amount equal to the aggregate of the amount for which the shares were issued and any unpaid dividends; and

(g) will be automatically retracted three days prior to any bankruptcy or insolvency of Holdco.

10. On or after the date of this letter, Opco will borrow funds from an arm's length financial institution on a daylight loan basis in one or more tranches (each such tranche, a "Daylight Loan"), provided that the aggregate principal amount of all Daylight Loans will not exceed the Opco Borrowing Capacity.

11. In the case of each Daylight Loan:

(a) Opco will use the proceeds of the Daylight Loan to subscribe for Holdco Preferred Shares;

(b) Holdco will use the funds from the issue of the Holdco Preferred Shares to make an interest bearing loan to Opco evidenced by a promissory note (each such note, an "Investment Note"); and

(c) Opco will use the funds borrowed under the Investment Note to repay the Daylight Loan that was used to acquire the Holdco Preferred Shares.

12. Each Investment Note:

(a) will be subordinated to all other debt of Opco;

(b) will bear interest at a rate not exceeding the Opco Subordinated Rate;

(c) will be repayable by Opco upon the earlier of (i) demand, (ii) XXXXXXXXXX and (iii) 3 days prior to an event of default;

(d) will provide Opco with a right to prepay at any time without penalty; and

(e) will provide that Opco may surrender Holdco Preferred Shares for retraction in order to obtain the funds for repayment of the note.

For greater certainty, for the purposes of subparagraph (c)(i) hereof, Holdco will demand repayment of each Investment Note no later than the day on which it is expected that the aggregate amount of interest paid and/or payable on all Investment Notes is approximately equal to the non-capital losses of Holdco described in paragraph 3 above.

13. On or before the date referred to in paragraph 12(c):

(a) Opco will pay all interest accrued and unpaid on the Investment Notes to and including the date of repayment of the Investment Notes.

(b) Holdco will pay all cumulative dividends unpaid on the Holdco Preferred Shares to and including the date of redemption of the Holdco Preferred Shares. The dividends will be funded in part with the interest income earned by Holdco on the Investment Notes.

(c) Holdco will redeem the Holdco Preferred Shares held by Opco by issuing a demand non-interest bearing promissory note (the "Redemption Note"). The principal amount of the Redemption Note will equal the redemption amount of the Holdco Preferred Shares.

(d) As the aggregate principal amounts of the Investment Notes will be equal to the principal amount of the Redemption Note, Opco will repay the Investment Notes in full by set-off with the Redemption Note and all notes will be cancelled.

Additional Information

14. Neither Holdco nor Opco is, or will be at any time during the implementation of the proposed transactions,

(a) a "specified financial institution" as defined in subsection 248(1); or

(b) a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1).

15. The Holdco Preferred Shares will not be, at any time during the implementation of the proposed transactions,

(a) the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement";

(b) a share that is issued or acquired as part of a transaction, event or series of transactions or events of the type described in subsection 112(2.5); or

(c) the subject of a "dividend rental arrangement" as defined in subsection 248(1).

16. Holdco and Opco are both governed by the BCA, which permits reciprocal shareholdings. Therefore, Opco is permitted to hold the Holdco preferred shares.

17. Opco allocates all of its income to XXXXXXXXXX. As a result of the acquisition of control of Holdco described in paragraph 1 hereof, it had 2 taxation years that ended in the XXXXXXXXXX calendar year and the combined allocation over those 2 taxation years was made significantly in favour of XXXXXXXXXX. Assuming the allocations remain consistent for the XXXXXXXXXX and XXXXXXXXXX taxation years, as a result of the proposed transactions herein there will be a reduction of a portion of the income of Opco that would otherwise be taxable in XXXXXXXXXX.

Purposes of the Proposed Transactions

18. The purposes of the proposed transactions are:

(a) to enable Holdco to earn sufficient interest income over the duration of its current taxation year in order to use its anticipated non-capital losses; and

(b) to allow Opco to deduct interest expense on borrowed money used to acquire Holdco Preferred Shares in computing its income for its current taxation year.

19. The proposed transactions are not being undertaken for the purpose of accessing any differential in provincial tax rates that may exist between various jurisdictions.

RULINGS

Provided the foregoing statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, additional information and purposes of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, we confirm the following:

A. The dividends paid on the Holdco Preferred Shares:

(i) will be taxable dividends that will, by virtue of subsection 82(1) and paragraph 12(1)(j), be included in the income of Opco in the taxation year in which they are received;

(ii) will, by virtue of subsection 112(1), be deductible in computing Opco's income for the taxation year in which they are received, and for greater certainty, such deduction will not be prohibited by any of subsections 112(2.1), (2.2), (2.3) and (2.4);

(iii) will not be subject to tax under Part IV.I or Part VI.I because each such dividend will be an excepted dividend by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1 and an excluded dividend by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1); and

(iv) will not be subject to tax under Part IV unless Holdco receives a dividend refund (within the meaning assigned by paragraph 129(1)(a)) for its taxation year in which it pays the dividends to Opco.

B. Provided that Opco has a legal obligation to pay interest on the Investment Notes and that the Holdco Preferred Shares are held for the purpose of gaining or producing income (other than income which would be exempt), in computing its income for each of its XXXXXXXXXX and XXXXXXXXXX taxation years Opco will be entitled to deduct the lesser of the interest paid or payable on the Investment Notes (depending on the method regularly followed by Opco in computing its income for purposes of the Act) in those respective taxation years or a reasonable amount in respect thereof pursuant to paragraph 20(1)(c).

C. The provisions of subsections 15(1), 56(2) and 246(1) will not apply to the proposed transactions, in and of themselves.

D. Subsection 245(2) will not apply to the proposed transactions, in and of themselves, to re-determine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 issued by the Canada Revenue Agency (the "CRA") on May 17, 2002 and are binding on the CRA provided that the transactions proposed in paragraphs 9 through 13 hereof 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 which, if enacted, could have an effect on the rulings provided herein.

COMMENTS

Nothing in this ruling should be construed as confirmation, express or implied, that the CRA:

(a) has agreed that interest paid by any corporation referred to herein on any loan is deductible in computing income under paragraph 20(1)(c) of the Act, except as specifically set out in ruling B above; or

(b) has agreed to, reviewed or has made any determination in respect of:

(i) the reasonableness of the rate of interest to be paid on any outstanding Investment Loan;

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

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

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

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

(vi) any tax consequences relating to the facts and proposed transactions described herein other than those specifically described in the rulings given above.

Yours truly,

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