2013-0516071R3 Reorganization

Principal Issues: A series of transactions is undertaken to effect the sale of a partnership interest from a Profitco to a Lossco. Does section 245 apply to this series of transactions?

Position: No.

Reasons: No this series of transactions is undertaken as a loss consolidation and does not result in an abuse and misuse of the Act as a whole.

Author: XXXXXXXXXX
Section: 55(3)(a), 34.2, 245(2)

XXXXXXXXXX
                                              2013-051607

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re:  Advance Income Tax Ruling Request
       XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers (the “Taxpayers”), as amended by your letter dated XXXXXXXXXX.  We also acknowledge the information provided in various emails and telephone conversations.

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

i.    in an earlier return of any of the Taxpayers or a related person;

ii.   being considered by a tax services office or a tax centre in connection with a tax return already filed by any of the Taxpayers or a related person;

iii.  under objection by any of 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 not expired; and

v.    the subject of a ruling previously issued by the Directorate to any of the Taxpayers or a related person.

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 all references to monetary amounts are in Canadian dollars.

DEFINITIONS:

“Act” means the Income Tax Act, R.S.C. 1985 (5th Supp.), c.1, as amended. Unless otherwise stated, all statutory references herein are to the Act;

“ACB” is the acronym for “adjusted cost base,” which has the meaning assigned by section 54;

“Amalco” has the meaning assigned in paragraph 26;

“Amalco Preferred Shares” has the meaning assigned in paragraph 26;

“Amalco Preferred Share Redemption Amount” has the meaning assigned in paragraph 26;

“Amalco Redemption Note” has the meaning assigned in paragraph 28(c);

“CRA” means Canada Revenue Agency;

“dollars” or “$” means Canadian dollars;

“EAI” is the acronym for “eligible alignment income” which has the meaning assigned in subsection 34.2(1);

“Foreign Parent 1” means XXXXXXXXXX, a XXXXXXXXXX corporation;

“Foreign Parent 2” means XXXXXXXXXX, a XXXXXXXXXX corporation;

“GPco 1” means XXXXXXXXXX, an unlimited liability company governed by the XXXXXXXXXX;

“GPco 2” means XXXXXXXXXX, an unlimited liability company governed by the XXXXXXXXXX;

“Lossco” means XXXXXXXXXX, a corporation governed by the XXXXXXXXXX;

“Lossco Preferred Shares” has the meaning assigned in paragraph 21;

“Lossco Preferred Share Redemption Amount” has the meaning assigned in paragraph 21(b);

“LP1” means XXXXXXXXXX, a partnership governed by the XXXXXXXXXX;

“LP1 Units” mean the limited partnership units of LP1;

“LP2” means XXXXXXXXXX, a partnership governed by the XXXXXXXXXX;

“LP2 Units” means the limited partnership units of LP2;

“multi-tier alignment election” has the meaning assigned by subsection 249.1(9);

“Newco” has the meaning assigned in paragraph 23;

“Profitco” means XXXXXXXXXX, a corporation governed by the XXXXXXXXXX;

“Profitco Preferred Shares” has the meaning assigned in paragraph 22;

“Profitco Preferred Share Redemption Amount” has the meaning assigned in paragraph 22(b);

“Profitco Redemption Note” has the meaning assigned in paragraph 28(d);

“QTI” is the acronym for “qualifying transitional income,” which has the meaning assigned in subsection 34.2(1);

“Subco” means XXXXXXXXXX, an unlimited liability company governed by the XXXXXXXXXX; and

“taxable Canadian corporation” has the meaning assigned in subsection 89(1).

FACTS:

1.    Lossco is resident in Canada and is a “taxable Canadian corporation” for purposes of the Act.  All of the shares of Lossco are owned by Foreign Parent 1 whose common shares are XXXXXXXXXX.  Lossco files its information returns with the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office. The authorized share capital of Lossco consists of common and preferred shares. Lossco has a XXXXXXXXXX taxation year.

2.    Lossco carries on an active business in Canada consisting primarily of XXXXXXXXXX.

3.    Profitco is resident in Canada and is a “taxable Canadian corporation” for purposes of the Act. The authorized share capital of Profitco consists of XXXXXXXXXX classes of common shares. Foreign Parent 2, a non-resident of Canada, holds all of the issued and outstanding shares of Profitco. Foreign Parent 1 indirectly owns all of the issued and outstanding shares of Foreign Parent 2. Profitco files its information returns with the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

4.    GPco 1 is resident in Canada and is a “taxable Canadian corporation” for purposes of the Act. Profitco holds all of the issued and outstanding shares of GPco 1.

5.    GPco 2 is resident in Canada and is a “taxable Canadian corporation” for purposes of the Act.  Profitco holds all of the issued and outstanding shares of GPco 2.

6.    LP1 has a XXXXXXXXXX. Prior to XXXXXXXXXX, LP1 had a XXXXXXXXXX. GPco 1 is the sole general partner of LP1 and holds a XXXXXXXXXX percent equity interest in LP1. Profitco owns all of the LP1 Units and holds a XXXXXXXXXX percent equity interest in LP1.

7.    The terms of the partnership agreement that governs LP1 provide that all income earned by LP1 in a particular fiscal period is allocated to the partners in proportion to their respective equity interests.

8.    GPco 2 is the sole general partner of LP2 and holds a XXXXXXXXXX percent equity interest in LP2. LP1 owns all of the LP2 Units and holds a XXXXXXXXXX percent equity interest in LP2. LP2 carries on an active business in Canada that consists primarily of XXXXXXXXXX.

9.    LP2 has a XXXXXXXXXX. Prior to XXXXXXXXXX, LP2 had a fiscal period that ended on XXXXXXXXXX.

10.   By virtue of subsection 249.1(11), the fiscal periods of LP1 and LP2 were aligned to XXXXXXXXXX, starting on XXXXXXXXXX. Consequently, Profitco received an income allocation from LP1 on XXXXXXXXXX that constituted EAI and was included in computing Profitco’s QTI in respect of LP1. At the end of its XXXXXXXXXX taxation year, Profitco had a positive QTI balance in respect of LP1. It is anticipated that Profitco will have a positive QTI balance in respect of LP1 on XXXXXXXXXX.

11.   On XXXXXXXXXX Profitco incorporated and became the sole shareholder of Subco. Profitco acquired its interest in Subco for cash. Subco is resident in Canada and is a “taxable Canadian corporation” for purposes of the Act.

12.   There have been no transactions with persons unrelated to either Lossco or Profitco outside the ordinary course of business which could be said to be undertaken as part of this series of transactions.

13.   XXXXXXXXXX.

14.   Lossco reported a loss for income tax purposes of $XXXXXXXXXX in its taxation year ending XXXXXXXXXX, and is forecasting taxable income of approximately $XXXXXXXXXX in its taxation year ending XXXXXXXXXX.  Thus, without taking into account the proposed transactions, Lossco would have non-capital losses carried forward of $XXXXXXXXXX after XXXXXXXXXX. 

15.   LP1 is expected to earn income of $XXXXXXXXXX for its taxation year ending XXXXXXXXXX.

16.   Neither Profitco nor Lossco is a “financial institution” as defined in subsection 190(1).

17.   Profitco’s interest in LP1 is held as a capital property.

18.   Lossco is related to Profitco by virtue of subparagraph 251(2)(c)(i) as both are controlled by Foreign Parent 1.

19.   In anticipation of the series of proposed transactions, on XXXXXXXXXX, Profitco transferred all of the LP1 Units to Subco in exchange for XXXXXXXXXX common share of Subco.  Profitco and Subco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the LP1 units so that the agreed amount will be the lesser of the ACB of Profitco in the LP1 units immediately before the transfer and the fair market value of the LP1 units immediately before the transfer.

PROPOSED TRANSACTIONS:

20.   In connection with the transfer described in paragraph 19, Subco and GPco 1 will amend the partnership agreement of LP1 to specify that Subco is the limited partner. As part of that amendment, Subco and GPco 1 will also amend the partnership agreement of LP1 to clarify that it allocates its income for income tax purposes only to those partners that are partners at the end of its fiscal period and in proportion to their respective equity interests in LP1 at that time.

21.   Prior to XXXXXXXXXX, Lossco will amend its articles of incorporation to authorize the issuance of an unlimited number of an additional class of preferred shares (the “Lossco Preferred Shares”). The terms and conditions of the Lossco Preferred Shares will provide as follows:

a.    The Lossco Preferred Shares will be non-voting.

b.    The Lossco Preferred Shares will be redeemable and retractable for an amount per share (the “Lossco Preferred Share Redemption Amount”) equal to the result obtained when the fair market value of any property transferred to Lossco as consideration for the Lossco Preferred Shares on the date of first issuance of the Lossco Preferred Shares less the amount of any non-share consideration paid, assumed or delivered by Lossco for the acquisition of such property is divided by the number of Lossco Preferred Shares issued as consideration therefor. The Lossco Preferred Share Redemption Amount will be subject to a price adjustment clause should it later be determined that the fair market value of the property transferred to Lossco is different than the amount agreed upon.

c.    Holders of the Lossco Preferred Shares will be entitled to a non-cumulative dividend equal to XXXXXXXXXX percent per month of the Lossco Preferred Share Redemption Amount.

d.    Lossco will not be entitled to pay dividends on the common and existing preferred shares until all unpaid dividends have been paid on the Lossco Preferred Shares.

e.    The Lossco Preferred Shares will have preference in all respects over the common and existing preferred shares of Lossco on a liquidation, dissolution or winding-up to the extent of the Lossco Preferred Share Redemption Amount and any dividends which have been declared but not paid.

f.    The terms of the Lossco Preferred Shares will provide that Lossco will not be entitled to declare dividends on, return capital on, or undertake reacquisitions of, the common and existing preferred shares if the result would be to impair the ability of Lossco to redeem or retract the Lossco Preferred Shares at the Lossco Preferred Share Redemption Amount.

22.   Prior to XXXXXXXXXX, Profitco will amend its articles of incorporation to authorize the issuance of an unlimited number of preferred shares (the “Profitco Preferred Shares”). The terms and conditions of the Profitco Preferred Shares will provide as follows:

a.    The Profitco Preferred Shares will be non-voting.

b.    The Profitco Preferred Shares will be redeemable and retractable for an amount per share (the “Profitco Preferred Share Redemption Amount”) equal to the result obtained when the fair market value of any property transferred to Profitco as consideration for the Profitco Preferred Shares on the date of first issuance of the Profitco Preferred Shares less the amount of any non-share consideration paid, assumed or delivered by Profitco for the acquisition of such property is divided by the number of Profitco Preferred Shares issued as consideration therefor. The Profitco Preferred Share Redemption Amount will be subject to a price adjustment clause should it later be determined that the fair market value of the property transferred to Profitco is different than the amount agreed upon.

c.    Holders of the Profitco Preferred Shares will be entitled to a non-cumulative dividend equal to XXXXXXXXXX percent per month of the Profitco Preferred Share Redemption Amount.

d.    Profitco will not be entitled to pay dividends on any class of common shares until all unpaid dividends have been paid on the Profitco Preferred Shares.

e.    The Profitco Preferred Shares will have preference in all respects over the classes of common shares of Profitco on a liquidation, dissolution or winding-up to the extent of the Profitco Preferred Share Redemption Amount and any dividends which have been declared but not paid.

f.    The terms of the Profitco Preferred Shares will provide that Profitco will not be entitled to declare dividends on, return capital on, or undertake reacquisitions of, any class of its common shares if the result would be to impair the ability of Profitco to redeem or retract the Profitco Preferred Shares at the Profitco Preferred Share Redemption Amount.

23.   Prior to XXXXXXXXXX, Lossco will incorporate and become the sole shareholder of an unlimited liability corporation (“Newco”) subsisting pursuant to the laws of a Canadian province. Lossco will acquire its interest in Newco for cash.

24.   Prior to XXXXXXXXXX, Lossco will be continued from the XXXXXXXXXX to the XXXXXXXXXX.

25.   On XXXXXXXXXX, Profitco will transfer all of its shares of Subco to Lossco in exchange for one or more Lossco Preferred Shares. Profitco and Lossco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the shares of Subco so that the agreed amount will be the lesser of the ACB of Profitco in the shares of Subco immediately before the transfer and the fair market value of those shares immediately before the transfer. It is anticipated that the fair market value of the Subco shares immediately before this transfer will be approximately $XXXXXXXXXX.

26.   During the day on XXXXXXXXXX, Lossco and Subco will amalgamate to form “Amalco” pursuant to the XXXXXXXXXX. The issued share capital of Amalco will be substantially the same as the issued share capital of Lossco prior to the amalgamation. Amalco will issue preferred shares (the “Amalco Preferred Shares”) in the same quantity and with substantially the same attributes as the Lossco Preferred Shares. The Amalco Preferred Shares will be redeemable and retractable for an amount per share (the “Amalco Preferred Share Redemption Amount”) that will be equal to the Lossco Preferred Share Redemption Amount. As a result of the amalgamation, Amalco will own all of the LP1 Units on XXXXXXXXXX. Lossco and Profitco anticipate that Subco will not contribute any capital to LP1 during the time it holds the limited partnership interest.

27.   LP2 will allocate XXXXXXXXXX percent of its income for income tax purposes for its XXXXXXXXXX fiscal period to LP1. LP1 will allocate XXXXXXXXXX percent of its income for income tax purposes for its XXXXXXXXXX fiscal period, including XXXXXXXXXX percent of the income allocated to it by LP2, to Amalco.

28.   Beginning XXXXXXXXXX, the following transactions will be undertaken to unwind the corporate structures implemented for the loss consolidation transactions:

a.    On XXXXXXXXXX, Amalco will transfer the LP1 units to Newco in exchange for one or more common shares of Newco. Amalco and Newco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the LP1 units so that the agreed amount will be the lesser of the ACB of Amalco in the LP1 units immediately before the transfer and the fair market value of the LP1 units immediately before the transfer.

b.    On XXXXXXXXXX, Amalco will transfer all of its common shares of Newco to Profitco in exchange for one or more Profitco Preferred Shares. Amalco and Profitco will jointly elect, in prescribed form and within the time referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer of the shares of Newco so that the agreed amount will be the lesser of the ACB of Amalco in the shares of Newco immediately before the transfer and the fair market value of those shares immediately before the transfer.

c.    On XXXXXXXXXX, Amalco will redeem all of the Amalco Preferred Shares held by Profitco for an amount equal to their fair market value, being the product obtained when the Amalco Preferred Share Redemption Amount is multiplied by the number of Amalco Preferred Shares so redeemed. Amalco will satisfy the redemption price by issuing and delivering to Profitco a non-interest bearing note (the “Amalco Redemption Note”) payable on demand having a principal amount and fair market value equal to the redemption price of the Amalco Preferred Shares so redeemed.  Profitco will accept such note as full payment of the redemption price.

d.    On XXXXXXXXXX, Profitco will redeem all of the Profitco Preferred Shares held by Amalco for an amount equal to their fair market value, being the product obtained when the Profitco Preferred Share Redemption Amount is multiplied by the number of Profitco Preferred Shares so redeemed. Profitco will satisfy the redemption price by issuing and delivering to Amalco a non-interest bearing note (the “Profitco Redemption Note”) payable on demand having a principal amount and fair market value equal to the redemption price of the Profitco Preferred Shares so redeemed. Amalco will accept such note as full payment of the redemption price.

e.    On XXXXXXXXXX, Profitco and Amalco will agree to offset the Amalco Redemption Note and the Profitco Redemption Note which will be equal in amount and fair market value.

f.    During the month of XXXXXXXXXX, Profitco, as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound-up into Profitco pursuant to subsection 88(1).  As a consequence, Newco’s assets, including all of its LP1 Units, will be transferred to Profitco and Profitco will assume Newco’s liabilities.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to facilitate a tax-efficient use of Lossco’s available non-capital losses within the affiliated group and enhance the overall tax efficiency of the Canadian operations of Foreign Parent 1. As stated in paragraph 14, Lossco is expected to have non-capital losses of $XXXXXXXXXX at the end of XXXXXXXXXX.  The proposed transactions should permit Lossco to utilize some or all of the non-capital losses it anticipates it will realize through XXXXXXXXXX.

RULINGS PROVIDED

Provided that

(a)   the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions,

(b)   the proposed transactions are completed in the manner described above, and

(c)   there are no other transactions which may be relevant to the rulings requested,

we rule that:

A.    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 resulting from the redemptions referred to in Paragraphs 28(c) and 28(d).  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).

B.    Provided that Profitco cannot claim an amount under subsection 34.2(11) in respect of LP1 for its taxation year ending XXXXXXXXXX, solely because it has disposed of LP1 as described in paragraph 19 above, subsection 34.2(14) will apply to deem Profitco to be a member of LP1 continuously until the end of its taxation year ending XXXXXXXXXX, for the purposes of paragraph 34.2(13)(a).

C.    Subsection 245(2) will not apply as a result of entering into 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 general limitations and qualifications set out in Information Circular 70-6R6 dated August 29, 2014, and are binding on the CRA provided that the Proposed Transactions are completed before XXXXXXXXXX.

The above rulings are based on the Act in its present form and do not take into account the effect of any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

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;

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

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

(d)   the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

(e)   the application or non-application of the general anti-avoidance provisions of any province; nor

(f)   any tax consequences relating to the Facts and Proposed Transactions described herein, other than those specifically described in the rulings given above.

Without restricting the generality of the preceding statement, nothing in this ruling should be construed as implying that the CRA has agreed to, reviewed or has made any determination with respect to whether Profitco can claim an amount under subsection 34.2(11) in respect of LP1 for its taxation year ending XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
For Director
International Division
Income Tax Rulings Directorate

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