2021 Ruling 2021-0898221R3 - Loss consolidation arrangement

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: Whether a loss consolidation arrangement involving a loan to buy preferred shares for the purposes of earning income would meet the CRA's requirement for acceptable loss consolidation transactions.

Position: Yes.

Reasons: Consistent with previous rulings.

XXXXXXXXXX									2021-089822

XXXXXXXXXX, 2021

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling
XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX, in which you requested an Advance Income Tax Ruling (the “Ruling”) on behalf of the above-named taxpayers. We also acknowledge the information provided in subsequent emails.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the Ruling request is:

(a) in a previously filed tax return of the taxpayers or a related person;

(b) being considered by the CRA in connection with such return of the taxpayers or a related person;

(c) under objection by the taxpayers or a related person;

(d) the subject of a current or completed court process involving the taxpayers or a related person; or

(e) the subject of a Ruling previously considered by the Directorate.

Unless specified otherwise, all statutory references herein are to provisions or parts of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof (the “Act”) and the regulations made thereunder (the “Regulations”). All references to monetary amounts are in Canadian dollars.

The Taxpayers have also confirmed that the proposed transactions described herein will not result in the Taxpayers or any person related to the Taxpayers being unable to pay any of their outstanding tax liabilities.

DEFINITIONS

“ACB” or “adjusted cost base” has the meaning assigned by section 54;

“affiliated person” has the meaning assigned by section 251.1, read without reference to
the definition of “controlled” in subsection 251.1(3);

“arm’s length” has the meaning assigned by section 251;

“BCA1” means the Business Corporations Act XXXXXXXXXX;

“BCA2” means the Business Corporations Act XXXXXXXXXX;

“BCA3” means the Business Corporations Act XXXXXXXXXX;

“CRA” means the Canada Revenue Agency;

“Daylight Loan” means the loan described in Paragraph 12;

“DRA” means “dividend rental arrangement” which has the meaning assigned by subsection 248(1);

“excepted dividend” has the meaning assigned by section 187.1;

“excluded dividend” has the meaning assigned by subsection 191(1);

“FIC” means “financial intermediary corporation” which has the meaning assigned by subsection 191(1);

“financial institution” has the meaning assigned by subsection 142.2(1);
“FMV” or “fair market value” means the highest price available in an open and unrestricted market between informed and prudent parties dealing at arm’s length and under no compulsion to act, expressed in terms of cash;

“forgiven amount” has the meaning assigned by subsections 80(1) and 80.01(1);

“GAAR” means the general anti-avoidance rule found in section 245;

“guarantee agreement” has the meaning assigned by subsection 112(2.2);

“Lossco” means XXXXXXXXXX, the corporation described in Paragraph 2;

“Lossco Note” means the note described in Paragraph 18;

“Lossco Preferred Shares” means the preferred shares described in Paragraph 14;

“Lossco Common Shares” means the common shares described in Paragraph 2;

“non-capital loss” has the meaning assigned by subsection 111(8);

“XXXXXXXXXX;

“paid-up capital” or “PUC” has the meaning assigned by subsection 89(1);

“Paragraph” means a numbered paragraph in this letter;

“private corporation” has the meaning assigned by subsections 89(1) and 248(1);

“Profitco Loan” means the loan by Lossco to Profitco described in Paragraph 13;

“Profitco” means XXXXXXXXXX, the corporation described in Paragraph 4;

“Proposed Transactions” means the transactions in Paragraphs 7 to 19;

“Pubco” means XXXXXXXXXX, a corporation incorporated and resident in the US;

“related person” has the meaning assigned by subsection 251(2);

“RFI” means “restricted financial institution” which has the meaning assigned by subsection 248(1);

“SEA” means “SFI equity arrangement” which has the meaning assigned by subsection 248(1);

“SFI” means “specified financial institution” which has the meaning assigned by subsection 248(1);

“taxable Canadian corporation” has the meaning assigned by subsections 89(1) and 248(1);

“taxable Canadian property” has the meaning assigned by subsection 248(1);

“taxable preferred shares” has the meaning assigned by subsection 248(1);

“taxable dividend” has the meaning assigned by subsections 89(1) and 248(1);

“US” means United States;

“USCo1” means XXXXXXXXXX, a corporation incorporated and resident in the US and a wholly-owned subsidiary of Pubco;

“USCo2” means XXXXXXXXXX, a corporation incorporated and resident in the US and a wholly-owned subsidiary of Pubco;

FACTS

1. Pubco, the shares of which are listed on the Stock Exchange under the symbol “XXXXXXXXXX”, indirectly controls both Lossco and Profitco. At the time of the Proposed Transactions, Pubco will indirectly control both Lossco and Profitco.

2. Lossco is a private corporation and a taxable Canadian corporation incorporated under the BCA1 on XXXXXXXXXX. Lossco has a taxation year-end of XXXXXXXXXX. It is an XXXXXXXXXX. All of the issued and outstanding common shares of Lossco, being all of the issued shares of Lossco, are held by USCo1 (the “Lossco Common Shares”). Lossco taxation centre is XXXXXXXXXX and its tax service office XXXXXXXXXX.

3. Lossco had unexpired non-capital losses carried forward of approximately $XXXXXXXXXX as of the end of its taxation year ended XXXXXXXXXX:

XXXXXXXXXX

Approximately $XXXXXXXXXX of these non-capital losses are restricted from a previous acquisition of control on XXXXXXXXXX and will not be utilized as a part of the Proposed Transactions. Absent the Proposed Transactions, the forecasted taxable income of Lossco in XXXXXXXXXX ($XXXXXXXXXX) would utilize a portion of the non-restricted non-capital loss carry-forward balance of $XXXXXXXXXX. The non-restricted non-capital loss carry-forward balance remaining after XXXXXXXXXX, considering the above forecasted income and absent the Proposed Transactions would be $XXXXXXXXXX.

By implementing the Proposed Transactions, the entire balance of the non-restricted non-capital loss carry-forward balance of $XXXXXXXXXX will be utilized in the taxation year ended XXXXXXXXXX.

4. Profitco is a private corporation and a taxable Canadian corporation and was incorporated under BCA2 on XXXXXXXXXX. Profitco has a taxation year-end of XXXXXXXXXX. Profitco is in the business of XXXXXXXXXX. All of the issued and outstanding shares of Profitco are held by USCo2. Profitco’s taxation centre is XXXXXXXXXX and its tax service office XXXXXXXXXX.

5. Profitco has generated taxable income of approximately $XXXXXXXXXX in each of its XXXXXXXXXX taxation years respectively and it is anticipated that it will continue to earn comparable taxable income in its next XXXXXXXXXX taxation years. Profitco has sufficient income to utilize all of the interest expense that will be used to either offset current taxable income or to carry back the interest expense in the form of a loss to the XXXXXXXXXX previous taxation years. Profitco estimates its taxable income to be approximately $XXXXXXXXXX in each of its XXXXXXXXXX taxation years respectively. The expected interest deductions will be approximately $XXXXXXXXXX, such that the total income would be $XXXXXXXXXX in each of its XXXXXXXXXX taxation years, respectively. Profitco does not have any existing non-capital loss carryover balance.

6. Profitco operates through permanent establishments in the Provinces of XXXXXXXXXX. Profitco has allocation factors of approximately XXXXXXXXXX% to the respective aforementioned Provinces, based on the interprovincial allocation for Profitco’s taxation year ended XXXXXXXXXX. Lossco operates through a permanent establishment in the Province of XXXXXXXXXX only.

PROPOSED TRANSACTIONS

Transfer of Lossco Common Shares from USCo1 to Profitco

7. Pubco will purchase from USCo1 the Lossco Common Shares at their FMV of US$XXXXXXXXXX.

8. Pubco will contribute the Lossco Common Shares to USCo2.

9. USCo2 will contribute the Lossco Common Shares to Profitco as a contribution of capital. The amount of the capital contribution made by USCo2 to Profitco will not be added to Profitco’s PUC.

10. The ACB of the Lossco Common Shares to Profitco after the contribution will be approximately US$XXXXXXXXXX, which is representative of the FMV of the shares at the present time, and representative of the amount paid in cash for the Lossco Common Shares on the purchase.

Change of the Corporate Status of Lossco

11. Lossco will legally continue out of XXXXXXXXXX and into XXXXXXXXXX to become a company governed by the BCA3, changing its corporate character to become an unlimited liability company.

Implementation of the structure

12. Lossco will borrow $XXXXXXXXXX from Pubco on arm’s length commercial terms customary for this type of loan (“Daylight Loan”). Lossco has the borrowing capacity to obtain the Daylight Loan. The Daylight Loan will not be guaranteed.

13. Using the proceeds of the Daylight Loan, Lossco will make an interest-bearing loan of approximately $XXXXXXXXXX to Profitco (the “Profitco Loan”), on the following conditions:

a. Simple interest will accrue on the Profitco Loan and will be calculated daily at an annual fixed rate that is equal to a commercial arm’s length rate, presently estimated to be approximately XXXXXXXXXX% per annum. The interest on the Profitco Loan will be paid on or before the last business day of each fiscal year; and

b. The Profitco Loan will be repayable on demand and will also provide that the principal amount may be satisfied at Lossco's option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the principal amount, (iii) delivery of the Lossco Preferred Shares or, (iv) way of set-off against the Lossco Note if the Lossco Note belongs to Profitco at the time of repayment.

14. Using the proceeds of the Profitco Loan, Profitco will subscribe for preferred shares of Lossco (“Lossco Preferred Shares”) for cash consideration of approximately $XXXXXXXXXX. The aggregate redemption amount, retraction amount, FMV, ACB and paid-up capital of the issued Lossco Preferred Shares will be equal to $XXXXXXXXXX. The attributes of the Lossco Preferred Shares will be the following:

a. Non-voting;

b. Non-participating;

c. Redeemable at the option of the issuer and retractable at the option of the holder, subject to applicable law, at any time for an amount equal to the cash amount for which they were issued. The payment of the redemption or retraction price may be satisfied, at the holder’s option, either by (i) payment of cash, or (ii) delivery of property having a FMV at the time of redemption equal to the aggregate redemption amount, in each case together with an amount in cash equal to all declared and unpaid dividends and any accrued dividends which have not been declared and paid up to but excluding the date fixed for such redemption or retraction;

d. The holder of the Lossco Preferred shares will be entitled to a cumulative dividend, payable annually, calculated daily and accruing by reference to the redemption amount of the Lossco Preferred Shares at a rate equal to the interest rate on the Profitco Loan plus XXXXXXXXXX% for an aggregate dividend rate of XXXXXXXXXX% per annum.

15. Using the proceeds from the issuance of the Lossco Preferred Shares, Lossco will repay the Daylight Loan.

Maintenance of the structure

16. Annually, Lossco will pay all accrued dividends on the Lossco Preferred Shares to Profitco on the last day of the calendar year. The payments will be made by Lossco using cash made available by an entity of the Pubco group of companies or using external financing on a daylight loan basis. The cash made available to Lossco by the entity or entities in the Pubco group of companies to pay the interest will not result in the increase of ACB or PUC or any other tax attribute of any property or share other than a tax attribute that is reduced when the cash is returned to such entity or entities.

17. Annually, Profitco will pay all accrued interest on the Profitco Loan to Lossco on the last day of the calendar year.

Unwind of the structure

18. At the earlier of (i) XXXXXXXXXX years after the implementation of the loss consolidation arrangement or (ii) when Lossco’s non-capital losses described in Paragraph 3 have been fully utilized, the loss consolidation arrangement will be unwound in the following order:

a. Subject to any applicable corporate law solvency tests, Lossco will declare and pay all accrued but unpaid dividends to Profitco in accordance with the terms of the Lossco Preferred Shares.

b. Profitco will pay to Lossco all accrued and unpaid interest on the Profitco Loan;

c. Subject to any applicable corporate law solvency tests, Lossco will redeem the issued and outstanding Lossco Preferred Shares held by Profitco for an amount equal to their redemption amount and FMV and will issue a non-interest bearing note (the “Lossco Note”) to Profitco in satisfaction of the redemption proceeds.

19. The principal amount and FMV of the Lossco Note will equal the principal amount and FMV of the Profitco Loan. Profitco and Lossco will enter into a set-off agreement whereby the Profitco Loan will be set-off against the Lossco Note.

ADDITIONAL INFORMATION

20. Lossco and Profitco are related persons and affiliated persons and will continue to be related and affiliated throughout the period that the loss consolidation structure is in place. The structure will be unwound in the manner described in Paragraphs 18 and 19 if any entity previously mentioned in this letter request ceases to be affiliated following an acquisition of control by a non-affiliated third party.

21. None of the corporations involved in the Proposed Transactions are, or will be, a financial institution, SFI or a RFI or a FIC. Profitco will not acquire the Lossco Preferred Shares in its ordinary course of business.

22. None of the corporations involved in the Proposed Transactions has or will have entered into a DRA, with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

23. At no time during the implementation of the Proposed Transactions described in this letter will the Lossco Preferred Shares be:

a. the subject of any undertaking that is referred to in subsection 112(2.2) as a “guarantee agreement”

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

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

d. issued for consideration (nor will Profitco receive any other property, directly or indirectly, from an investor or any property substituted therefor) 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 would be related (if the Act were read without reference to paragraph 251(5)(b)); or

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

24. The Lossco Preferred Shares will be taxable preferred shares. Dividends received by Profitco on the Lossco Preferred Shares as described in Paragraphs 16 and 18 will be excepted dividends and excluded dividends.

25. The transfer of Lossco Common Shares to Profitco will result in an addition to the contributed surplus of Profitco which cannot be converted to PUC by reason of the restriction in subsection 84(1)(c.3).

26. Profitco’s borrowing capacity exceeds the maximum amount required to complete the Proposed Transactions.

27. At the time of the Proposed Transactions, Profitco will have the solvency and liquidity to service the Profitco Loan as described in Paragraphs 17 and 18.

28. At the time of the Proposed Transactions, Lossco will have the financial capacity to satisfy the applicable solvency test and liquidity test to pay dividends on the Lossco Preferred Shares and to redeem the Lossco Preferred Shares.

29. Lossco and Profitco will undertake steps to ensure that the interest income earned by Lossco under the Proposed Transactions will not materially exceed an amount that could be fully sheltered with Lossco’s non-restricted non-capital losses. In the event that a non-capital loss is created for Profitco by the interest deducted by Profitco pursuant to paragraph 20(1)(c), in respect of the Profitco Loan, during the period in which the Proposed Transactions occur, any such non-capital loss would be carried back to a prior taxation year or carried forward to a subsequent taxation year in accordance with the provisions of section 111.

30. Pubco has not planned and does not expect that there will be an acquisition of control of Lossco or Profitco.

31. Profitco and Lossco both have independent sources of business income that exceed the annual payment of dividend/interest. Profitco and Lossco are operating companies. If needed, Lossco can obtain funds to finance the dividend payment by virtue of daylight loan or intercompany loans with an entity other than Profitco.

32. The Proposed Transactions will be legally effective.

33. The Lossco Common Shares are not taxable Canadian property.

PURPOSE OF THE PROPOSED TRANSACTIONS

34. The purpose of the Proposed Transactions is to consolidate taxable income and non-capital losses within a group of affiliated and related persons. The Proposed Transactions will enable Lossco to earn interest income on the Profitco Loan and thus will enable Lossco to effectively utilize its non-capital losses already incurred as well as the losses to be incurred.

35. The purpose of both the payment and the receipt of the dividends on the Lossco Preferred Shares as described in Paragraphs 16 and 18 is to provide a reasonable return on such shares. More specifically, none of the purposes of the dividends is to reduce the fair market value or capital gain of any share, nor to increase the total cost amounts of any properties.

36. The purpose of the Proposed Transactions is not to shift income between provinces and any such shift of income between provinces will be incidental to the Proposed Transactions.

37. The Proposed Transactions are not being undertaken to refresh non-capital losses or facilitate the use of such losses in a taxation year after the taxation year in which the losses would have otherwise expired in the hands of Lossco.

RULINGS

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

A. Provided that Profitco has a legal obligation to pay interest on the Profitco Loan and Profitco continues to hold the Lossco Preferred Shares it acquires for the purpose of gaining or producing income from property, as described in Paragraph 14, Profitco will, pursuant to paragraph 20(1)(c), be entitled to deduct, in computing its income for a taxation year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act), the lesser of:

(a) the interest paid or payable on Profitco Loan in respect of that taxation year; and

(b) a reasonable amount in respect thereof.

B. The provisions of subsections 15(1), 56(2), and 246(1) will not apply to the Proposed Transactions, in and by themselves.

C. Dividends received by Profitco on the Lossco Preferred Shares, as described in Paragraphs 16 and 18, will be taxable dividends and such dividends will, pursuant to subsection 112(1), be deductible in computing the taxable income of the recipient corporation for the year in which the dividends are received by Profitco and, for greater certainty such deduction will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4).

D. None of the dividends referred to in Paragraphs 16 and 18 will be subject to tax under Parts IV.1 or VI.1.

E. The settlement of the Profitco Loan and the Lossco Note, as described in Paragraph 19 will not give rise to any “forgiven amount”.

F. Provided that the payment and receipt of the dividends on the Lossco Preferred Shares, as described in Paragraphs 16 and 18, have no purpose other than as described in the “Purpose of the Proposed Transactions” and the Proposed Transactions are undertaken in the manner described above, subsection 55(2) will not apply to such dividends.

G. Subsection 245(2) will not be applicable as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

H. The general anti-avoidance provision of a province with which the Government of Canada has entered into a Tax Collection Agreement will not be applied, as a result of the Proposed Transactions, in and by themselves, to determine the tax consequences confirmed in the rulings given above, in respect of a taxation year in respect of which such Tax Collection Agreement is in effect.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R11 dated April 1, 2021, and are binding on the CRA provided that the Proposed Transactions described at Paragraphs 7 to 15 are completed on or before XXXXXXXXXX.

COMMENTS

Nothing in this letter should be construed as implying that the CRA 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, or the outstanding balance of various tax accounts for any of the corporate entities described herein;

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

c) the reasonableness or fair market value of any fees or expenditures referred to herein;

d) Subject to Ruling H, the application or non-application of a general anti-avoidance provision of any province; and

e) any other tax consequence relating to the Facts, Proposed Transactions, or any transaction or event taking place either prior to or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the Ruling(s) given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that includes other transactions or events that are not described in this letter.

An invoice for our fees in connection with this ruling will be forwarded to you under separate cover.

Yours sincerely,

XXXXXXXXXX
for Director
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate