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: Are losses available within the group as proposed - using preferred shares and loans among the corporations
Position: yes acceptable
Reasons: meets the technical requirements of the Act, including 20(1)(c) and is not an abuse of the Act as per Finance's technical notes to section 245. Also see CTF 2002 position and IT 533 par 32
XXXXXXXXXX 2003-005007
XXXXXXXXXX, 2004
Dear XXXXXXXXXX,
Re: Advance Income Tax Ruling
XXXXXXXXXX ("Holdco"), XXXXXXXXXX
XXXXXXXXXX ("Opco") XXXXXXXXXX
This is in reply to your letter of XXXXXXXXXX and further to telephone conversations of XXXXXXXXXX and further to additional information provided on XXXXXXXXXX, requesting an advance income tax ruling on behalf of the above named corporations. In general terms, the transactions described herein involve the use of losses within a group of affiliated corporations.
Holdco is serviced by the XXXXXXXXXX Tax Centre, in XXXXXXXXXX while the XXXXXXXXXX Tax Centre services Opco.
We understand that to the best of your knowledge and that of the taxpayers involved, none of the issues contained in the ruling requested is:
(i) in an earlier return of the taxpayers or a related person;
(ii) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayers or a related person;
(iii) under objection by the taxpayers or a 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 previous income tax ruling considered by the Income Tax Rulings Directorate.
DEFINITIONS
In this letter and in all correspondence relating hereto, the following terms have the meanings set out below, unless otherwise specified:
"Act" means the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), as amended; all statutory references herein are to provisions of the Act unless otherwise specified;
"Bank" means the XXXXXXXXXX;
"CRA" means the Canada Revenue Agency;
"Holdco 2" means XXXXXXXXXX;
XXXXXXXXXX;
"non-capital loss" has the meaning assigned by subsection 111(8) of the Act;
"Target" means XXXXXXXXXX;
"taxable Canadian corporation" has the meaning assigned in subsection 89(1) of the Act;
"XXXXXXXXXX Parent" means XXXXXXXXXX;
"XXXXXXXXXX Treaty" means the Canada-XXXXXXXXXX Tax Convention, as amended.
Our understanding of the relevant facts, proposed transactions and purpose of the proposed transactions is as follows:
FACTS
1. XXXXXXXXXX Parent is a corporation incorporated under the laws of XXXXXXXXXX and is a resident of XXXXXXXXXX for the purposes of the Act and the XXXXXXXXXX Treaty. The XXXXXXXXXX shares of XXXXXXXXXX Parent are listed on the XXXXXXXXXX Stock Exchange. XXXXXXXXXX.
2. XXXXXXXXXX Parent does not carry on any business in Canada, and does not have a permanent establishment in Canada, for the purposes of the Act or the XXXXXXXXXX Treaty.
3. Holdco is a taxable Canadian corporation incorporated under the XXXXXXXXXX . Holdco is an indirect wholly-owned subsidiary of XXXXXXXXXX Parent. Holdco merely acts as a holding company and its only material assets are the shares of Holdco 2.
4. Holdco 2 is a taxable Canadian corporation amalgamated under the XXXXXXXXXX. Holdco 2 is a wholly-owned subsidiary of Holdco. Holdco 2 merely acts as a holding company and its only material assets are the shares of Opco.
5. Opco is a taxable Canadian corporation amalgamated under the XXXXXXXXXX. Opco is a wholly-owned subsidiary of Holdco 2. Opco provides XXXXXXXXXX.
6. On XXXXXXXXXX, Holdco, directly and indirectly, acquired all of the capital stock of Target pursuant to a plan of arrangement in consideration for a combination of XXXXXXXXXX. Following the arrangement, Target amalgamated with a number of other wholly-owned subsidiaries of Holdco to form Holdco 2. The operating subsidiary of Target was XXXXXXXXXX and, following the arrangement, it amalgamated with XXXXXXXXXX. to form Opco. Prior to the arrangement, XXXXXXXXXX. was an indirect wholly-owned subsidiary of XXXXXXXXXX Parent.
7. In acquiring Target, as described in paragraph 6, Holdco issued $XXXXXXXXXX debentures (the "Debentures"), guaranteed by XXXXXXXXXX Parent, to certain shareholders of Target in exchange for their shares of Target. In addition, Holdco XXXXXXXXXX borrowed $XXXXXXXXXX from XXXXXXXXXX Parent (the "Loan") to satisfy the cash purchase price for the shares of Target. The interest rate on the Debentures was XXXXXXXXXX% per annum, payable semi-annually, and the interest rate on the Loan is XXXXXXXXXX%. As of XXXXXXXXXX, there was $XXXXXXXXXX outstanding on the Loan. The Debentures matured on XXXXXXXXXX and were repaid. The Debentures and the Loan are referred to together as the "Acquisition Debt".
8. Holdco has a taxation year-end of XXXXXXXXXX. In the taxation year ended XXXXXXXXXX, Holdco reported an aggregate non-capital loss carry-forward of $XXXXXXXXXX. These losses were realized in the following years XXXXXXXXXX. Holdco expects to generate additional non-capital losses of approximately $XXXXXXXXXX for XXXXXXXXXX and further non-capital losses in subsequent taxation years as a result of the interest payable on the Acquisition Debt.
9. Opco has a taxation year-end of XXXXXXXXXX. In the taxation year ended XXXXXXXXXX, Opco reported taxable income of $XXXXXXXXXX and non-capital loss carry-forwards of nil. Opco expects to generate taxable income of $XXXXXXXXXX for XXXXXXXXXX and further taxable income for subsequent taxation years.
10. Based on its existing assets and financial projections, Opco will have the financial capacity to pay interest on the Opco Loan (described in paragraph 14) from its own cash flow without taking into account the dividend income that it would earn on the Preferred Shares (described in paragraph 11).
PROPOSED TRANSACTIONS
11. Holdco will incorporate a new corporation ("Newco") under the XXXXXXXXXX. Newco will be a taxable Canadian corporation. Its taxation year-end will be XXXXXXXXXX. The authorized capital of Newco will consist of two classes of shares, common shares and non-voting, cumulative dividend, redeemable/retractable preferred shares (the "Preferred Shares"). The cumulative dividends payable on the Preferred Shares will be calculated at a rate equal to the then current interest rate on the Opco Loan (described in paragraph 14). The dividend rate will be determined at the time of the Proposed Transactions and subsequently at the beginning of each year. Dividends will be payable annually in arrears on the last day of every year.
12. The common shares of Newco will be issued to Holdco for $XXXXXXXXXX.
13. Holdco will borrow an amount (the "Principal Amount") on a "daylight loan" basis (the "Daylight Loan") from the Bank. The Principal Amount will be such that interest expected to be received by Holdco in XXXXXXXXXX on the Opco Loan (as described in paragraph 14) will be sufficient to offset the losses expected to be incurred by Holdco in fiscal XXXXXXXXXX as well as approximately XXXXXXXXXX of the non-capital loss carry-forwards referred to in paragraph 8. The Principal Amount of the Daylight Loan will be approximately $XXXXXXXXXX. Based on discussions with the primary lending institution of XXXXXXXXXX Parent, the management of Holdco has determined that the amount of $XXXXXXXXXX could be borrowed by Holdco on a commercially reasonable basis with a guarantee from XXXXXXXXXX parent.
14. Holdco will use the proceeds received from the Daylight Loan to make a demand loan to Opco (the "Opco Loan"). Simple interest will accrue on the Opco Loan and will be calculated annually at a rate equal to the prime lending rate of the Bank plus XXXXXXXXXX% at the time of the determination of the interest rate. The interest rate will be determined at the time of the Proposed Transactions and subsequently at the beginning of each year.
15. Opco will use the proceeds from the Opco Loan to subscribe for Preferred Shares in Newco having an aggregate redemption/retraction price equal to the Principal Amount. The Preferred Shares will have a dividend rate equal to the interest rate on the Opco Loan as determined in accordance with paragraphs 11 and 14.
16. Newco will use the proceeds resulting from the issuance of the Preferred Shares to make a demand, interest-free loan to Holdco in an amount equal to the Principal Amount (the "Newco Loan").
17. Holdco will use the proceeds from the Newco Loan to repay the Daylight Loan.
18. In every year while the Newco Loan is outstanding, Opco may pay one or more dividends to Holdco 2 and, if so paid, Holdco 2 will then pay one or more dividends to Holdco, and the aggregate of such dividends (if paid) will be at least equal to the amount of the dividends payable by Newco for that year on the Preferred Shares.
19. In every year while the Newco Loan is outstanding, Holdco will make one or more capital contributions to Newco (accounted for as contributed surplus) in an aggregate amount equal to the dividend payable by Newco for that year on the Preferred Shares. Newco will use such funds to pay Opco the dividends due for that year with respect to the Preferred Shares (the "Preferred Share Dividend").
20. Upon receipt of the Preferred Share Dividend, Opco will pay Holdco the interest due on the Opco Loan.
21. A transaction may be entered into in circumstances where the interest income on the Opco Loan is expected to be greater than the amount required to offset Holdco's expected losses for the year and non-capital losses for previous years (a "Debt Decreasing Transaction"). The need for a Debt Decreasing Transaction could arise for numerous reasons including a partial repayment of the Acquisition Debt. A Debt Decreasing Transaction will be implemented through the following steps:
(a) Holdco will borrow an amount on a daylight loan basis (the "New Daylight Loan"). Holdco will use these funds to pay down the Newco Loan.
(b) Newco will use the funds received through step (a) to redeem the Preferred Shares.
(c) Opco will use the proceeds from the redemption of the Preferred Shares to pay down the Opco Loan.
(d) Holdco will use the funds received on the repayment of the Opco Loan to pay down the New Daylight Loan.
22. When Holdco no longer needs any interest income from the Opco Loan in order to offset its expected losses for a taxation year or non-capital losses for previous years, a final Debt Decreasing Transaction, as described above, will be implemented in order to cause any remaining balance on the Opco Loan to be fully repaid. Newco will then be wound-up into Holdco.
Other representations
23. None of the losses (if any) realized by Opco as a consequence of the interest paid on the Opco Loan will be carried back by Opco to taxation years ending before the time of the acquisition of control of Target by Holdco. Further, the proposed transactions (described in paragraphs 11 to 22) are not undertaken to create a loss carry-forward period for Holdco beyond its original carry-forward period.
PURPOSE OF PROPOSED TRANSACTIONS
24. The purpose of the Proposed Transactions is to consolidate profit and losses within a related group by enabling Holdco to earn sufficient interest income on the Opco Loan as to eliminate losses that it incurred in its XXXXXXXXXX taxation years and that it would otherwise incur in its XXXXXXXXXX and subsequent taxation years. Effectively, the Proposed Transactions permit the application of the interest expense with respect to the Acquisition Debt against the income of Opco.
RULINGS GIVEN
Provided that the preceding statements constitute a complete and accurate disclosure of all relevant facts, proposed transactions and purpose of the proposed transactions, and provide the proposed transactions are completed as proposed, we rule as follows:
A. Provided that Opco has a legal obligation to pay interest on the Opco Loan and provided that the Preferred Shares of Newco continue to be held by Opco for the purpose of gaining or producing income (other than income which would be exempt), Opco will be entitled to deduct, in computing its income for a taxation year, the interest payable on the Opco Loan 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. No amount will be included in the income of Newco pursuant to paragraph 12(1)(x) of the Act in respect of the contribution of capital described in paragraph 19 above.
C. 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 rulings given.
These rulings are given subject to the general limitations and qualifications set forth in Information Circular 70-6R5 dated May 17, 2002 issued by the CRA, and are binding provided the proposed transactions other than the proposed unwind or the Debt Decreasing Transaction described in paragraphs 21 and 22 above, are completed by XXXXXXXXXX.
These rulings are based on the Act as it currently reads and do not take into account any further amendments, whether currently proposed or not to the Act.
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 amount of any non-capital loss or any other amount of any corporation referred to herein;
(c) the income tax consequence relating to the provincial income tax implications relating to the allocation of income and expenses under the proposed transactions;
(d) whether a corporation in the group is or may be a specified financial institution;
(e) whether a corporation involved in the proposed transaction has or will have entered into a "dividend rental arrangement" as defined by subsection 248(1) of the Act; or.
(f) any other tax consequence relating to the facts, proposed transactions, other information or any transactions or events, 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.
Yours truly,
XXXXXXXXXX
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
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