2001 Ruling 2001-0085043 - 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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal issue:

Loss utilization arrangement within a related corporate group.

Position:		20(1)(c) and 245(2)	

Reasons:

The Agency has taken the position that corporations, within a related group, can transfer income or deductions between them using transactions that are legally effective and comply with any applicable provisions of the Income Tax Act.

XXXXXXXXXX 						2001-008504

XXXXXXXXXX, 2001

Dear XXXXXXXXXX:

Re: Advance income tax ruling
XXXXXXXXXX
XXXXXXXXXX
XXXXXXXXXX

We are writing in response your letter dated XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-named taxpayers.

Definitions

In this letter, unless otherwise indicated, the following terms have the meaning specified:

(a) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th supp.) c.1 as amended from time to time and consolidated to the date of this letter and unless otherwise expressly stated, every reference to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Act. All terms used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated;

(b) "A Inc." means XXXXXXXXXX;

(c) "B Inc." means XXXXXXXXXX;

(d) "C Ltd." means XXXXXXXXXX;

(e) "D Ltd." means XXXXXXXXXX;

(f) "F Ltd." means XXXXXXXXXX;

(g) "G Ltée" means XXXXXXXXXX;

(h) "H Ltd." means XXXXXXXXXX;

(i) "I Ltd." means XXXXXXXXXX;

(j) "J Ltd." means XXXXXXXXXX;

(k) "K Inc." means XXXXXXXXXX;

(l) "L Inc." means XXXXXXXXXX;

(m) "M Inc." means XXXXXXXXXX;

(n) "N Inc." means XXXXXXXXXX;

(o) "O Ltée" means XXXXXXXXXX;

(p) XXXXXXXXXX;

(q) "PARENT" means XXXXXXXXXX;

(r) "P Ltd." means XXXXXXXXXX;

(s) "R Ltd." means XXXXXXXXXX; and

(t) "subject corporation" has the meaning assigned by subsection 186(3).

Facts

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

1. PARENT is incorporated under XXXXXXXXXX and is a taxable Canadian corporation and a subject corporation whose shares are publicly traded on the XXXXXXXXXX Stock Exchange. PARENT is a management holding corporation, which exercises control over two major groups of corporations, I Ltd. and its subsidiaries and A Inc. and its subsidiaries.

Consolidated revenues of PARENT for the year ended XXXXXXXXXX totaled $XXXXXXXXXX with consolidated net earnings amounting to approximately $XXXXXXXXXX.

2. XXXXXXXXXX.

3. J Ltd. is a company that is a wholly-owned subsidiary of F Ltd. incorporated under XXXXXXXXXX.

4. I Ltd. is incorporated under the Canada Business Corporations Act (the "CBCA") and is a taxable Canadian corporation whose shares are publicly traded on the XXXXXXXXXX Stock Exchange and on the XXXXXXXXXX Stock Exchange. XXXXXXXXXX.

PARENT currently holds, directly or through a wholly-owned subsidiary, XXXXXXXXXX shares of I Ltd. representing approximately XXXXXXXXXX% of the outstanding participating shares and approximately XXXXXXXXXX% of the voting rights of the outstanding voting shares of I Ltd. On XXXXXXXXXX, PARENT issued $XXXXXXXXXX of exchangeable debentures maturing in XXXXXXXXXX years which may be exchanged for XXXXXXXXXX shares of I Ltd. Assuming that the debentures will be exchanged for the XXXXXXXXXX shares of I Ltd., PARENT will continue to hold XXXXXXXXXX shares of I Ltd. representing approximately XXXXXXXXXX% of the outstanding participating shares and approximately XXXXXXXXXX% of the voting rights of the outstanding voting shares of I Ltd.

Consolidated revenues of I Ltd. for the year ended XXXXXXXXXX totaled US $ XXXXXXXXXX with consolidated net earnings amounting to US $XXXXXXXXXX.

5. A Inc. is a taxable Canadian corporation that was incorporated under XXXXXXXXXX.

A Inc. carries on a XXXXXXXXXX business through the following corporations or groups of corporations:

(a) C Ltd., a controlled subsidiary of A Inc., is involved with D Ltd. and its other subsidiaries in the XXXXXXXXXX in Canada.

(b) H Ltd., a wholly-owned subsidiary of A Inc., is a XXXXXXXXXX.

(c) L Inc., a Canadian public corporation controlled by A Inc., is involved with its subsidiaries in XXXXXXXXXX.

(d) N Inc., a Canadian public corporation controlled by A Inc., is involved with its subsidiaries in the XXXXXXXXXX.

(e) M Inc., a Canadian public corporation controlled by A Inc. is involved together with its subsidiaries in XXXXXXXXXX.

(f) G Ltée is incorporated under XXXXXXXXXX and is a wholly-owned subsidiary of A Inc. G Ltée, together with its subsidiaries, offers services in XXXXXXXXXX.

(g) K Inc., a Canadian public corporation controlled by A Inc., is involved together with its subsidiary corporations in XXXXXXXXXX.

The authorized share capital of A Inc. consists of an unlimited number of common shares. PARENT currently holds, directly or through wholly-owned subsidiaries, XXXXXXXXXX common shares of A Inc., representing XXXXXXXXXX% of A Inc.'s outstanding shares. The remaining XXXXXXXXXX% of the shares of A Inc. are owned by J Ltd.

6. XXXXXXXXXX.

7. H Ltd. is a wholly-owned subsidiary of A Inc. formed under XXXXXXXXXX, and is a taxable Canadian corporation. H Ltd. owns XXXXXXXXXX% of all the outstanding shares of B Inc., which is a taxable Canadian corporation, formed under the CBCA. The remaining XXXXXXXXXX% outstanding shares of B Inc. are currently owned by J Ltd., the XXXXXXXXXX and R Ltd. H Ltd. plans to, in the future, acquire the XXXXXXXXXX% shares of B Inc. from J Ltd., the XXXXXXXXXX and R Ltd.

8. C Ltd. is a taxable Canadian corporation and was formed by an amalgamation, on XXXXXXXXXX, under the CBCA. B Inc. owns all the outstanding shares of C Ltd. XXXXXXXXXX.

In XXXXXXXXXX, C Ltd. issued US $XXXXXXXXXX Senior Subordinated Notes bearing an interest rate of XXXXXXXXXX% and due in XXXXXXXXXX ("C Ltd. Notes"). The two indentures relating to the C Ltd. Notes contain covenants that, among other things, restrict the ability of C Ltd., D Ltd. and each restricted subsidiary to incur additional indebtedness except under certain circumstances. A default in the observance or performance of any covenant of the indentures relating to C Ltd. Notes will constitute an event of default under the indentures and would enable the holders of the C Ltd. Notes to accelerate the maturity thereof. The term "indebtedness" used in the covenants contained in the indentures means any debt secured or unsecured, contingent or otherwise if and to the extent such debt appears as a liability upon the balance sheet of the debtor prepared in accordance with generally accounting principles as in effect in Canada in XXXXXXXXXX.

The fiscal period of C Ltd. ends on XXXXXXXXXX. It is expected that C Ltd. will have sufficient income for tax purposes to fully utilize the interest paid or payable on the C Ltd. Loan described in paragraph 21 below.

9. D Ltd. is a wholly-owned subsidiary of C Ltd. formed under the CBCA, and is a taxable Canadian corporation. XXXXXXXXXX.

The fiscal period of D Ltd. ends on XXXXXXXXXX. It is expected that D Ltd. will have sufficient income for tax purposes to fully utilize the deduction in respect of interest paid or payable on the D Ltd. Loan described in paragraph 21 below.

10. A Inc. intends to refinance its XXXXXXXXXX described in paragraph 6 above. After the implementation of the new financing, the total indebtedness of A Inc. is expected to amount to approximately $XXXXXXXXXX ("New A Inc. Debts"). This new financing is expected to be completed at the time of implementing the proposed transactions. The interest payments on the New A Inc. Debts will be financed substantially with dividends from A Inc.'s subsidiaries. Without giving effect to the proposed transactions, it is expected that A Inc. will generate substantial non-capital losses during the next few years caused principally by the interest expense on the New A Inc. Debts.

11. The consolidated financial statements of PARENT for its year ended XXXXXXXXXX indicate that PARENT and its subsidiaries had:

(a) assets of approximately $XXXXXXXXXX;

(b) liabilities of approximately $XXXXXXXXXX (including accounts payable, deferred taxes and arm's length borrowings); and

(c) shareholder's equity of approximately $XXXXXXXXXX which includes retained earnings and cumulative currency translation adjustments.

The arm's length borrowings of PARENT, A Inc., I Ltd. and their subsidiaries (the "A Inc. Affiliated Group") currently amount to approximately to $XXXXXXXXXX. A Inc. Affiliated Group currently has available (undrawn) credit arrangements sufficient to borrow about $XXXXXXXXXX. In addition to the undrawn credit arrangements already in place, XXXXXXXXXX. confirmed that the A Inc. Affiliated Group has an incremental arm's length borrowing capacity of about $XXXXXXXXXX.

As a result of the arrangements described herein, the A Inc. Affiliated Group is in a position to increase its current arm's length borrowings by an amount of about $XXXXXXXXXX.

There is currently no inter-company loans outstanding between related corporations within A Inc. Affiliated Group implemented for the purposes of consolidating losses within the A Inc. Affiliated Group.

12. Based on their existing assets and resources, C Ltd. and D Ltd. will have the ability to pay interest on the C Ltd. Loan and D Ltd. Loan described in paragraph 21 below without taking into account the dividend income which they would earn on A Inc. Preferred Shares (described in paragraph 22 below) resulting from the proposed transactions described herein.

13. The A Inc. Preferred Shares in the capital stock of A Inc., which will be issued as described in paragraph 23 below, will not be, at any time during the implementation of the proposed transactions described herein:

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

(ii) the subject of a dividend rental arrangement;

(iii) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or

(iv) issued for consideration that is or includes:

A) 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

B) any right of the type described in subparagraph 112(2.4)(b)(ii).

14. PARENT, A Inc., I Ltd., C Ltd. and D Ltd. are affiliated persons and are related with each other.

15. None of PARENT, A Inc., I Ltd., C Ltd. or D Ltd. is a specified financial institution nor financial intermediary corporation.

16. To the best of your knowledge, and that of the taxpayers involved, none of the issues involved in the ruling are:

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

(iii) under objection by any of the taxpayers or a related person, or

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired.

Proposed Transactions

17. Before the implementation of the transactions described in paragraphs 18 to 27 below, all of the shares of B Inc. owned by J Ltd., the XXXXXXXXXX and R Ltd. will be acquired by H Ltd. so that B Inc. will become a wholly-owned subsidiary of H Ltd., which is a wholly-owned subsidiary of A Inc.

18. XXXXXXXXXX.

19. XXXXXXXXXX.

20. A Inc. will borrow an amount of $XXXXXXXXXX on a daylight loan basis from one or more arm's length institutional lenders ("Daylight Loan").

21. A Inc. will use the proceeds received from the Daylight Loan to make a loan to C Ltd. ("C Ltd. Loan") of $XXXXXXXXXX. C Ltd. will use $XXXXXXXXXX of the proceeds of the C Ltd. Loan to make a loan to D Ltd. ("D Ltd. Loan"). The principal terms and conditions of the C Ltd. Loan and the D Ltd. Loan will be as follow:

(i) due in XXXXXXXXXX and repayable at any time, in whole or in part, at the option of the debtor;

(ii) interest payable in cash XXXXXXXXXX at a rate equal to the then current rate on the New A Inc. Debts plus XXXXXXXXXX% for the C Ltd. Loan and plus XXXXXXXXXX% for the D Ltd. Loan and, at the option of the debtor, the payment of interest could be deferred up to maturity and paid by issuing debtor common shares having a fair market value equal to the interest paid;

(iii) subordinated to all debt outstanding of the debtor; and

(iv) convertible at any time, in whole or in part, at the debtor's option into debtor common shares having a fair market value equal to the reduction of the principal amount of the loan.

Based on the above terms and conditions, the C Ltd. Loan and the D Ltd. Loan will not be considered "indebtedness" within the meaning of the term in the indentures relating to the C Ltd. Notes described in paragraph 8 above. Consequently, the implementation of the proposed transactions will not constitute an event of default under the indentures that would enable the holders of the C Ltd. Notes to accelerate the maturity. Notwithstanding paragraph 21(ii) above, the management of C Ltd. and D Ltd. have indicated their intention of paying regularly the interest payable on the C Ltd. Loan and the D Ltd. Loan.

22. A Inc. will amend its articles to provide for an unlimited number of non-voting, cumulative dividend, redeemable, retractable preferred shares with a redemption value equal to the fair market value of the consideration for which the shares are issued ("A Inc. Preferred Shares"). The cumulative dividends payable on the A Inc. Preferred Shares will be calculated daily by reference to the redemption/retraction price at a rate equal to the interest rate on the D Ltd. Loan plus a small spread. Dividends will be payable periodically to conform to the interest payments on the C Ltd. Loan and the D Ltd. Loan. The A Inc. Preferred Shares will be redeemable for cash or by delivering assets having equivalent value (including C Ltd. Loan issued under paragraph 21 above).

23. C Ltd. will use $XXXXXXXXXX of the proceeds of the C Ltd. Loan and D Ltd. will use the proceeds of the D Ltd. Loan, to subscribe for A Inc. Preferred Shares. The redemption/retraction price of the A Inc. Preferred Shares will be equal to their issue price.

24. A Inc. will use the proceeds from the issuance of the A Inc. Preferred Shares to C Ltd. and D Ltd. to repay the Daylight Loan.

25. Periodically, A Inc. will, subject to applicable solvency tests and cash flow, pay dividends to C Ltd. and D Ltd. equal, in aggregate, to the amount of the dividends payable by A Inc. at that time on the A Inc. Preferred Shares.

26. Upon receipt of the dividends on the A Inc. Preferred Shares, C Ltd. will pay A Inc. part of the interest due on the C Ltd. Loan and D Ltd. will pay C Ltd. the interest due on the D Ltd. Loan. Upon receipt of the interest on the D Ltd. Loan, C Ltd. will pay A Inc. the balance of interest due on the C Ltd. Loan.

27. In certain circumstances, including a repayment of all or a portion of the New A Inc. Debts by A Inc., the following transactions will be undertaken to reduce the amount of the C Ltd. Loan and/or the D Ltd. Loan:

(i) A Inc. will borrow an amount on a daylight loan basis from an arm's length financial institution and will use the funds to redeem A Inc. Preferred Shares held by C Ltd. and/or D Ltd.;

(ii) C Ltd. and/or D Ltd. will use the proceeds from the redemption to pay down an amount of the C Ltd. Loan and/or the D Ltd. Loan. Any amount received by C Ltd. from D Ltd. to pay down an amount on the D Ltd. Loan will be used by C Ltd. to pay down an amount on the C Ltd. Loan; and

(iii) A Inc. will use the funds received on the repayment of the C Ltd. Loan to repay the borrowings referred to in paragraph 27(i) above.

Purpose of the Proposed Transactions

28. The purpose of the proposed transactions is to effect a tax consolidation of A Inc., C Ltd. and D Ltd. by causing A Inc. to earn interest income on the C Ltd. Loan, thus permitting a netting of its interest deduction on its New A Inc. Debts and to have C Ltd. and D Ltd. incur an interest expense to reduce their taxable income.

Rulings

Provided that the above statements are accurate and constitute a complete disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions and provided further that the proposed transactions are carried out as described above, our rulings are as follows:

A. provided that C Ltd. has a legal obligation to pay interest on the C Ltd. Loan described in paragraph 21 above, in computing its income for a taxation year, C Ltd. will be entitled to deduct pursuant to paragraph 20(1)(c), the lesser of the interest paid or payable in respect of that year on the C Ltd. Loan or a reasonable amount in respect thereof to the extent that the A Inc. Preferred Shares and the D Ltd. Loan continue to be held by C Ltd. for the purpose of gaining or producing income (other than income which would be exempt);

B. provided that D Ltd. has a legal obligation to pay interest on the D Ltd. Loan described in paragraph 21 above, in computing its income for a taxation year, D Ltd. will be entitled to deduct pursuant to paragraph 20(1)(c), the lesser of the interest paid or payable in respect of that year on the D Ltd. Loan or a reasonable amount in respect thereof to the extent that the A Inc. Preferred Shares continue to be held by D Ltd. for the purpose of gaining or producing income (other than income which would be exempt);

C. the provisions of subsection 245(2) will not be applied as a result of the proposed transactions, in and by themselves, so as to redetermine the tax consequences confirmed in the above rulings.

These rulings are given subject to the general limitations and qualifications set out in Information Circular IC 70-6R4 dated January 29, 2001, and are binding on the Canada Customs and Revenue Agency provided the facts and proposed transactions described above are completed before XXXXXXXXXX. Also, these rulings are based on the Act and the Income Tax Regulations in their present form and do not take into account the effects of any proposed amendments thereto.

Comments

In the event that the payment of interest payable on the C Ltd. Loan and/or the D Ltd. Loan is deferred by the debtor, as described in paragraph 21(ii) above, unless the debtor and lender in respect of the particular loan have filed an agreement as described in paragraph 78(1)(b), paragraph 78(1)(a) will apply to the extent such interest remains unpaid at the end of the second taxation year following the taxation year in which it was incurred to include an amount in respect of such unpaid interest in the income of the debtor, in the third taxation year of the debtor, following the taxation year in which the interest expense was incurred.

Nothing in this letter should be construed as implying that the Canada Customs and Revenue Agency has agreed to any other tax consequences relating to any facts or proposed transactions referred to herein other than those as specifically described in the rulings given above.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch