2004 Ruling 2004-0076801R3 - 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 utilization in a related group of companies.

Position: The loss utilization is acceptable.

Reasons: Consistent with our position in previous rulings and with Department of Finance policy.

XXXXXXXXXX
2004-007680
XXXXXXXXXX, 2004

Dear XXXXXXXXXX:

Re: XXXXXXXXXX
XXXXXXXXXX
Advance Income Tax Ruling

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers. We also acknowledge receipt of your facsimiles and emails as well as the information provided in various telephone conversations.

Throughout this letter, the following corporations will be referred to as follows:

XXXXXXXXXX Profitco
XXXXXXXXXX Lossco
XXXXXXXXXX Topco
XXXXXXXXXX Holdco
XXXXXXXXXX Numco

Profitco and Lossco file their corporate income tax returns at the XXXXXXXXXX Taxation Centre and their tax affairs are administered by the XXXXXXXXXX Tax Services Office. Profitco and Lossco are resident in Canada for the purposes of the Act.

To the best of your knowledge and that of the taxpayers, none of the issues in this ruling request is:

(i) being considered by a tax services office or taxation centre in connection with a previously filed tax return of the taxpayer or a related person;

(ii) under objection by the taxpayer or a related person; or

(iii) before the courts.

Profitco and Lossco have confirmed that the transactions described herein will not result in any taxpayer described herein being unable to pay its outstanding tax liabilities.

Unless otherwise indicated, all references to monetary amounts are in Canadian dollars.

DEFINITIONS

In this letter, unless otherwise expressly stated, the following terms have the meanings specified:

(a) "Act" means the Income Tax Act (Canada), 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) "adjusted cost base" ("ACB") has the meaning assigned by section 54;

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

(d) "BCA" means the Canada Business Corporations Act and, where applicable, its predecessor statutes;

(e) XXXXXXXXXX;

(f) XXXXXXXXXX;

(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-Sub" means the new corporation described in Paragraph 11 below;

(l) "Newco" means the new corporation described in Paragraph 22 below;

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

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

(o) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(p) "principal amount" has the meaning assigned by subsection 248(1);

(q) "Profitco-Sub" means the new corporation described in Paragraph 10 below;

(r) "proposed transactions" means the transactions described in Paragraphs 10 to 23 below;

(s) "public corporation" has the meaning assigned by subsection 89(1);

(t) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

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

(v) "subsidiary controlled corporation" has the meaning assigned by subsection 248(1);

(w) "stated capital" has the meaning assigned by section 26 of the BCA;

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

(y) "taxable dividend" has the meaning assigned by subsection 89(1).

Our understanding of the facts, proposed transaction and purpose of the proposed transaction is as follows:

FACTS

1. Topco is the corporation resulting from the amalgamation of XXXXXXXXXX, XXXXXXXXXX, which amalgamation was effective on XXXXXXXXXX. Holdco is governed by the BCA and is a public corporation and a taxable Canadian corporation.

2. Holdco is a taxable Canadian corporation that was incorporated in XXXXXXXXXX under the BCA. Holdco is a holding corporation which holds all of the common shares of Profitco. Topco owns all issued and outstanding shares of Holdco.

3. Profitco is the corporation resulting from the amalgamation of XXXXXXXXXX, which amalgamation was effective XXXXXXXXXX. Profitco is a public corporation, a taxable Canadian corporation and a subsidiary controlled corporation of Holdco. Profitco is governed by the BCA. Profitco also has outstanding preference shares, XXXXXXXXXX. All the preference shares are held by persons who are not related to Topco.

XXXXXXXXXX.

4. Numco is a taxable Canadian corporation that was incorporated in XXXXXXXXXX, under the BCA. Numco is a holding company which holds common shares of Lossco. Topco owns all the issued and outstanding shares of Numco.

5. Lossco is governed by the BCA and is a public corporation and a taxable Canadian corporation. As at XXXXXXXXXX, Topco held XXXXXXXXXX% of the common shares of Lossco directly and XXXXXXXXXX% indirectly through its wholly-owned subsidiary, Numco. The balance of the common shares of Lossco is held by the public.

Prior to XXXXXXXXXX, Lossco was engaged in the business of XXXXXXXXXX.

XXXXXXXXXX.

6. At XXXXXXXXXX, Lossco had approximately $XXXXXXXXXX of non-capital loss carry-forwards that will expire from XXXXXXXXXX to XXXXXXXXXX. Lossco also estimates that it will realize a loss of $XXXXXXXXXX in its XXXXXXXXXX taxation year. Lossco is not expected to utilize any of such losses.

7. Profitco has a XXXXXXXXXX taxation year-end and generates sufficient taxable income against which the non-capital losses of Lossco could be deducted. XXXXXXXXXX, Profitco's currently estimated federal taxable income for its XXXXXXXXXX taxation years is expected to amount to approximately $XXXXXXXXXX, respectively.

Profitco has paid regular XXXXXXXXXX common share dividends to Holdco since Holdco became Profitco's parent in XXXXXXXXXX (and previously to Topco). Taxable dividend payments by Profitco on its common shares in the XXXXXXXXXX taxation years were XXXXXXXXXX, respectively (exclusive of dividends relating to loss consolidation structures described in Paragraph 8 below). Profitco's current dividend policy is that, subject to certain cash flow constraints, it will generally pay annual dividends on its common shares of not less than XXXXXXXXXX% of the year's consolidated net income available to common shareholders as set out in the consolidated statement of operations for the year. In turn, Holdco's dividend policy is that it will generally make distributions on its common shares in an aggregate amount equal to all dividends received from Profitco and all other cash flows less principal and interest payments on Holdco's outstanding debts.

8. Topco and certain of its subsidiary corporations, including Profitco, are parties to particular tax loss consolidation transactions for which advance income tax rulings have been issued (Ruling Nos. 2003-001229 dated XXXXXXXXXX, 2003 and 2002-012381 dated XXXXXXXXXX, 2002).

9. XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. Profitco will incorporate a new corporation ("Profitco-Sub") under the BCA. Profitco-Sub will have a XXXXXXXXXX year end and will be a taxable Canadian corporation. The authorized share capital of Profitco-Sub will consist of an unlimited number of common shares without nominal or par value. Profitco will subscribe for one common share of Profitco-Sub for $XXXXXXXXXX on incorporation. Profitco-Sub will be a sole-purpose corporation. The use of Profitco-Sub is to protect Profitco's assets from the claims of creditors of Lossco.

11. Lossco will incorporate a new corporation ("Lossco-Sub") under the BCA. Lossco-Sub will have a XXXXXXXXXX year end and will be a taxable Canadian corporation. The authorized share capital of Lossco-Sub will consist of an unlimited number of common shares without nominal or par value and an unlimited number of redeemable and retractable preferred shares (the "Lossco-Sub Preferred Shares").

The Lossco-Sub Preferred Shares will be:

(a) non-participating and non-voting;

(b) entitled to an annual cumulative dividend rate, applied to the redemption amount of the shares (described in Paragraph 13 below), equal to the interest rate applicable to the Profitco-Sub Demand Loan (described in Paragraph 15 below) plus XXXXXXXXXX%. The dividend rate will be determined at the time of the implementation of the proposed transactions. The dividends accruing in a taxation year of Lossco-Sub will be payable as described in Paragraph 13 below;

(c) redeemable at any time at the option of Lossco-Sub for an amount equal to the redemption amount and any unpaid dividends, by Lossco-Sub:

(i) paying cash equal to such amount;

(ii) assigning the Lossco Demand Loan (described in Paragraph 14 below) to Profitco-Sub and paying cash equal to any unpaid dividends; or

(iii) setting-off amounts owing under the Profitco-Sub Demand Loan against the redemption amount of the Lossco-Sub Preferred Shares, in circumstances where Lossco-Sub has become the holder of the Profitco-Sub Demand Loan (described in Paragraph 14 below), and paying cash equal to any unpaid dividends; and

(d) retractable at any time at the option of the holder for an amount equal to the aggregate redemption amount and any unpaid dividends, by Lossco-Sub assigning the Lossco Demand Loan (described in Paragraph 14 below) to Profitco-Sub and paying cash equal to any unpaid dividends, unless Lossco-Sub:

(i) pays cash equal to such amount; or

(ii) sets off amounts owing under the Profitco-Sub Demand Loan against the redemption amount of the Lossco-Sub Preferred Shares, in circumstances where Lossco-Sub has become the holder of the Profitco-Sub Demand Loan (described in Paragraph 14 below), and pays cash equal to any unpaid dividends.

The terms of the Lossco Demand Loan and the Profitco Sub Demand Loan (described in Paragraph 15 below) will provide that if Profitco-Sub becomes the holder of the Lossco Demand Loan, the Lossco Demand Loan may, at the option of either Lossco or Profitco-Sub, be set off against the Profitco-Sub Demand Loan.

Lossco will subscribe for one common share of Lossco-Sub for $XXXXXXXXXX on incorporation.

12. Profitco-Sub will borrow an amount not exceeding $XXXXXXXXXX on a daylight basis from an arm's length financial institution (the "Daylight Loan").

13. Profitco-Sub will use the proceeds of the Daylight Loan to subscribe for Lossco-Sub Preferred Shares having an aggregate redemption amount and paid-up capital equal to the principal amount of the Profitco-Sub Demand Loan (described in Paragraph 15 below).

Dividends on the Lossco-Sub Preferred Shares will be paid on the same day that the interest on the Profitco-Sub Demand Loan (described in Paragraph 15 below) is paid. The dividends will be funded by capital contributions made by Lossco (described in Paragraph 17 below).

14. Lossco-Sub will lend the subscription proceeds received in Paragraph 13 above to Lossco on an interest-free demand basis (the "Lossco Demand Loan"). The terms of the Lossco Demand Loan will allow Lossco to repay the Lossco Demand Loan by assigning the Profitco-Sub Demand Loan (described in Paragraph 15 below) to Lossco-Sub.

15. Lossco will lend the proceeds from the Lossco Demand Loan to Profitco-Sub on a subordinated demand basis (the "Profitco-Sub Demand Loan"). The Profitco-Sub Demand Loan will bear interest at a rate equal to the commercial market rate applicable for such loan. The interest rate will be determined at the time the proposed transactions are implemented.

The terms of the Profitco-Sub Demand Loan will provide that repayment may be made in cash, by delivering the Lossco-Sub Preferred Shares, or by a set off with the Lossco Demand Loan (described in Paragraph 14 above).

Based on Profitco's financial projections, it would have the financial capacity to pay the interest on the Profitco-Sub Demand Loan from its own cash flow (calculated as its net accounting income before depreciation and taxes) had the loan been made directly to Profitco instead of a sole-purpose wholly-owned subsidiary. A letter from XXXXXXXXXX, dated XXXXXXXXXX, provides confirmation that Profitco's borrowing capacity is approximately $XXXXXXXXXX. Taking into account current third-party and tax loss consolidation indebtedness that will be outstanding as at the date of implementation of the proposed transactions of approximately $XXXXXXXXXX, Profitco has the ability to borrow up to an additional amount of $XXXXXXXXXX.

16. Profitco-Sub will use the proceeds from the Profitco-Sub Demand Loan to repay the Daylight Loan.

17. Lossco will agree to and will make contributions of capital to the Lossco-Sub common share capital on the same day that the interest on the Profitco-Sub Demand Loan is paid, equal to the amount of dividends to be paid by Lossco-Sub to Profitco-Sub in respect of the Lossco-Sub Preferred Shares for so long as such preferred shares are outstanding. The contributions of capital, including those contributions of capital referred to in Paragraph 20(a) below, will not be income of Lossco-Sub pursuant to generally accepted accounting principles. Lossco will, however, not be required to make such contributions of capital where Lossco-Sub is no longer paying dividends to Profitco-Sub.

18. Lossco-Sub will use the amounts received as capital contributions (described in Paragraph 17 above) to pay dividends on the Lossco-Sub Preferred Shares to Profitco-Sub, as described in Paragraph 13 above.

19. Profitco-Sub will pay interest to Lossco on the Lossco-Sub Demand Loan, as described in Paragraph 15 above.

20. Once Profitco-Sub or Lossco has decided to unwind the proposed transactions in whole or in part:

(a) Lossco will make capital contributions to the common share capital of Lossco-Sub equal to the amount of any accrued and unpaid dividends on the Lossco-Sub Preferred Shares;

(b) Lossco-Sub will declare and pay the balance of any accrued and unpaid dividends on the Lossco-Sub Preferred Shares;

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

(d) Lossco-Sub will redeem all or a portion of the Lossco-Sub Preferred Shares held by Profitco-Sub and settle the amount owing on redemption by assigning a corresponding amount of the Lossco Demand Loan to Profitco-Sub;

(e) Profitco-Sub will repay all or a portion of the Profitco-Sub Demand Loan equal to the amount of Lossco-Sub Preferred Shares redeemed under Paragraph 20(d) above by setting off the amount owing to Lossco with a corresponding amount of the Lossco Demand Loan, and such portions of the Lossco Demand Loan and the Profitco-Sub Demand Loan will be cancelled; and

(f) Once all of the Lossco-Sub Preferred Shares held by Profitco-Sub have been redeemed and all of the Lossco Demand Loan has been assigned to Profitco-Sub, as described in Paragraph 20(d) and Paragraph 20(e) above, Lossco-Sub will be wound up into Lossco pursuant to subsection 210(3) of the BCA and Profitco-Sub will be wound up into Profitco pursuant to subsection 210(3) of the BCA.

21. After Profitco-Sub has been wound up into Profitco, Profitco will dividend a portion of the tax savings from the utilization of Profitco-Sub's losses to Holdco, which will in turn dividend the amount to Topco. This dividend will be in addition to the regular quarterly dividends paid by Profitco and Holdco.

22. Lossco will incorporate a new sole-purpose company ("Newco") under the CBA. Newco will have a XXXXXXXXXX year end and will be a taxable Canadian corporation. The authorized share capital of Newco will consist of an unlimited number of common shares without nominal or par value. Lossco will subscribe for one common share of Newco for $XXXXXXXXXX on incorporation.

23. Topco will use the funds received in Paragraph 21 above to make a contribution of capital to Newco. This contribution will not be income to Newco pursuant to generally accepted accounting principles and will be recorded in Newco as contributed surplus. Newco will subsequently be wound up into Lossco.

ADDITIONAL INFORMATION

24. Profitco, Lossco, Profitco-Sub and Lossco-Sub are neither specified financial institutions nor financial intermediary corporations.

25. None of the issued shares referred to herein (including the shares to be issued as described in the proposed transactions) are or will 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).

26. Profitco and Lossco are affiliated persons.

27. Each of Lossco and Lossco-Sub will agree with Profitco that Lossco-Sub shall be a single-purpose company, shall have no other liabilities than those arising from the proposed transactions, and shall carry on (and Lossco will cause Lossco-Sub to carry on) no activities other than that contemplated by the proposed transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

28. The overall purpose of the proposed transactions is to enable Lossco to earn sufficient interest income, over a period of time, so as to utilize some or all of its non-capital losses.

29. The purpose of making capital contributions to the common share capital of Lossco-Sub, as described in Paragraph 17 above, versus subscribing for additional common shares of Lossco-Sub, is to ensure that Lossco-Sub will not be precluded from declaring dividends on the Lossco-Sub Preferred Shares pursuant to section 42 of the BCA. If additional common shares of Lossco-Sub were issued, the realizable value of Lossco-Sub's assets (the Lossco Demand Loan) after the payment of a dividend would be less than the aggregate of its liabilities and its stated capital of both common shares and Lossco-Sub Preferred Shares.

30. The purpose of using Profitco-Sub is to protect Profitco's assets from creditors of Lossco. Profitco-Sub will only be wound up into Profitco once Profitco is satisfied that Profitco-Sub has no potential liabilities that could put Profitco's assets at risk.

31. The purpose of Topco making a contribution of capital to Newco, as described in Paragraph 23 above, is to fairly compensate Lossco for the use of its losses. The purpose of using Newco and subsequently winding it up into Lossco is to avoid having an increase in the adjusted cost base of Topco's investment in the common shares of Lossco.

RULINGS GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. The dividends received by Profitco-Sub, described in Paragraphs 18 and 20(b) above, and by Holdco and Topco, as described in Paragraph 21 above, will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of the recipient for the year in which the 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) and 112(2.4).

B. Profitco-Sub will not be subject to Part IV.1 tax under section 187.2 in respect of the dividends received from Lossco-Sub, described in Paragraphs 18 and 20(b) above, by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

C. Lossco-Sub will not be subject to Part VI.1 tax under section 191.1 in respect of the dividends paid to Profitco-Sub, described in Paragraphs 18 and 20(b) above, by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

D. Provided that Profitco-Sub has a legal obligation to pay interest on the Profitco-Sub Demand Loan, described in Paragraph 15 above, and Profitco-Sub continues to hold the Lossco-Sub Preferred Shares, described in Paragraph 11 and Paragraph 13 above, Profitco-Sub 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-Sub in computing its income for purposes of the Act) in respect of the year on the Profitco-Sub Demand Loan or (ii) a reasonable amount in respect thereof.

E. No amount will be included in the income of Lossco-Sub pursuant to section 9 or paragraphs 12(1)(c) and 12(1)(x) in respect of the contributions of capital described in Paragraph 17 and Paragraph 20(a) above. No amount will be included in the income of Newco pursuant to section 9 or paragraph 12(1)(x) in respect of the contribution of capital described in Paragraph 23 above.

F. The set-off of all or any part of the Lossco Demand Loan against the corresponding amount of the Profitco-Sub Demand Loan, described in Paragraph 20(e) above, will not give rise to a forgiven amount.

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 dividends described in Ruling A above. 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. The provisions of subsection 88(1) will apply to the wind-up of Lossco-Sub, Profitco-Sub and Newco described in Paragraph 20(f) and Paragraph 23 above.

I. 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.

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

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the Canada Revenue Agency provided that the proposed transactions, excluding Paragraphs 17 to 23 above, 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

1. Nothing in this ruling should be construed as implying that the Canada Revenue Agency 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 non-capital loss, net capital loss or any other amount of any corporation referred to herein;

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

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

(e) 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
Policy and Planning Branch

??