2014-0525081R3 loss consolidation

Principal Issues: Whether a loss consolidation can be undertaken within a corporate group such that Lossco will be entitled to apply its non-capital losses against the interest income generated as part of the loss consolidation transactions and whether profitco will be entitled to deduct interest expense.

Position: Yes.

Reasons: Conforms to our requirements for such rulings.

Author: XXXXXXXXXX
Section: 20(1)(c); 245

XXXXXXXXXX

                                                      2014-052508

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”).  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:

“affiliated persons” has the meaning assigned by subsection 251.1(1);

“CBCA” means the Canada Business Corporations Act (Canada), and where applicable, its predecessor statutes;

XXXXXXXXXX;

“CRA” means the Canada Revenue Agency;

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

XXXXXXXXXX;

“Foreign Country” means XXXXXXXXXX;

“Foreign Authority” means the XXXXXXXXXX, which is the XXXXXXXXXX;

“Foreign Securities Commission” means the XXXXXXXXXX;

XXXXXXXXXX;

“Lossco” means XXXXXXXXXX;

“Lossco Loan” means the loan made by Lossco to Profitco as described in paragraph 18 below;

“Lossco Class B Preferred Shares” means shares of the capital stock of Lossco as defined in paragraph 16 below;

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

“Parent” means XXXXXXXXXX;

“Profitco” means XXXXXXXXXX;

“Proposed Transactions” means the transactions described in paragraphs 16 to 25 below;

“related” has the meaning assigned by section 251;

“Subsidiary1” means XXXXXXXXXX;

“Subsidiary1 Loan” means the loan made by Subsidiary1 to Lossco as described in paragraph 17 below;

“Subsidiary2” means XXXXXXXXXX; and

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

FACTS:

1.    Parent is a corporation incorporated under the laws of Foreign Country, a non‑resident of Canada for purposes of the Act, and a resident of Foreign Country for the purposes of the XXXXXXXXXX (the “Treaty”).  Parent is XXXXXXXXXX and XXXXXXXXXX. 

2.    XXXXXXXXXX

3.    The consolidated financial statements of Parent for its fiscal year ended XXXXXXXXXX indicate that Parent and its accounting consolidated group had:

*     total assets of approximately XXXXXXXXXX$XXXXXXXXXX;
*     total liabilities of approximately XXXXXXXXXX$XXXXXXXXXX; and
*     shareholder’s equity of approximately XXXXXXXXXX$XXXXXXXXXX.

4.    Subsidiary1 is an indirect wholly‑owned subsidiary of Parent.  Subsidiary1 is a corporation incorporated under the laws of Foreign Country, a non‑resident of Canada for purposes of the Act, and a resident of Foreign Country for purposes of the Treaty.  Subsidiary1 is XXXXXXXXXX. 

5.    Subsidiary2 is an indirect wholly-owned subsidiary of Subsidiary1.  Subsidiary2 has been a subsidiary of Subsidiary1 since XXXXXXXXXX.  Subsidiary2 is governed by the CBCA and is a taxable Canadian corporation.  Its registered address is XXXXXXXXXX.  Its taxation centre is the XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office.  Subsidiary2’s fiscal year end is XXXXXXXXXX.

6.    Profitco is a direct wholly‑owned subsidiary of Subsidiary2.  Profitco has been a subsidiary of Subsidiary2 since XXXXXXXXXX.  Profitco is governed by the CBCA and is a taxable Canadian corporation.  Its registered address is XXXXXXXXXX.  Its taxation centre is the XXXXXXXXXX Taxation Centre and its Tax Services Office is the XXXXXXXXXX Tax Services Office.  Profitco’s fiscal year‑end is XXXXXXXXXX.

7.    Profitco is a XXXXXXXXXX.  XXXXXXXXXX.  Profitco is XXXXXXXXXX. 

8.    Profitco’s taxable income for its XXXXXXXXXX prior taxation years for which tax returns have been filed with the CRA is as follows:

Taxation          Net Income              Losses Carried    XXXX    Taxable
Year Ending    For Tax Purposes   forward from                       Income
                                                        Previous                             (Loss)
                                                        Taxation Years

XXXXXXXXXX

9.    It is expected that Profitco will have taxable income of $XXXXXXXXXX for the taxation year ended XXXXXXXXXX.

10.   Profitco’s stand‑alone financial statements for its fiscal year‑end XXXXXXXXXX, indicate that Profitco has assets of $XXXXXXXXXX.

11.   In the prior XXXXXXXXXX years the provincial allocation has been as follows:

Profitco     XXXXXXXXXX
XXXX        XXXXXXXXXX
XXXX        XXXXXXXXXX
XXXX        XXXXXXXXXX
Total         100.00%

It is reasonable to expect that the provincial allocations of taxable income for the taxation years ending XXXXXXXXXX, will be comparable with prior years.

12.   Lossco was incorporated by Subsidiary1 on XXXXXXXXXX.  Its current authorized share capital consists of an unlimited number of Common shares and Class A Preferred shares. XXXXXXXXXX. 

13.   As of XXXXXXXXXX, Lossco had a balance of non‑capital loss carry-forwards of $XXXXXXXXXX, which are broken down as follows. 

Taxation year ending:   Non-capital losses carried forward:

XXXXXXXXXX              XXXXXXXXXX
Total                              XXXXXXXXXX

14.   Lossco’s financial statements for its fiscal year‑end XXXXXXXXXX, indicate that Lossco has assets of $XXXXXXXXXX.

15.   Lossco has a permanent establishment XXXXXXXXXX in the province of XXXXXXXXXX.

PROPOSED TRANSACTIONS:

16.   The authorized capital of Lossco will be amended so that it will consist of three classes of shares, namely a class of common shares and two classes of preferred shares, one of which will be non‑voting, cumulative dividend paying, redeemable, retractable preferred shares (the “Lossco Class B Preferred Shares”).  The cumulative dividends payable on the Lossco Class B Preferred Shares will be calculated as a percentage of the redemption/retraction price of the Lossco Class B Preferred Shares and will be payable at the beginning of each month.  The dividend rate will be set at XXXXXXXXXX%, which is equal to the interest rate on the Lossco Loan plus a small spread of XXXXXXXXXX%.

17.   On a particular day to be determined by Subsidiary1 and Lossco, Subsidiary1 will make the Subsidiary1 Loan to Lossco.  The Subsidiary1 Loan will be in the principal amount of $XXXXXXXXXX and will be non-interest bearing.  Subsidiary1 will obtain the funds for the Subsidiary1 Loan from its working capital. 

18.   On the same day that the Subsidiary1 Loan is made, Lossco will use the proceeds received by it from the Subsidiary1 Loan to make the Lossco Loan to Profitco.  The Lossco Loan will be in the principal amount of $XXXXXXXXXX.

19.   Interest will accrue on the Lossco Loan at a rate equal to XXXXXXXXXX% per annum, which is consistent with rates determined between arm’s length persons.  The interest on the Lossco Loan will be computed daily and will be payable at the end of each month.  Profitco will have at all times the solvency and liquidity to service the Lossco Loan.

20.   On the same day that the Lossco Loan is made, Profitco will use the proceeds received by it from the Lossco Loan to subscribe for the Lossco Class B Preferred Shares in the amount of $XXXXXXXXXX, which will have an aggregate redemption price equal to the subscription price.

21.   On the same day that Profitco subscribes for the Lossco Class B Preferred Shares, Lossco will use the total proceeds received by it from the subscription for the Lossco Class B Preferred Shares to repay the Subsidiary1 Loan.

22.   Profitco will use revenue from its business to pay interest to Lossco on the Lossco Loan when due and payable.

23.   Lossco will use revenue from its business to pay dividends to Profitco on the Lossco Class B Preferred Shares.  Dividends will be paid at the beginning of each month, subject to any applicable corporate law solvency tests. 

24.   With respect to the payment of interest and dividends, like amounts may be set off with payment of the balance owing.

25.   The following transactions will occur within XXXXXXXXXX years of Lossco making the Lossco Loan to Profitco to unwind the loss consolidation arrangement:

a.    Profitco will repay the Lossco Loan, including all accrued but unpaid interest.

b.    Lossco will redeem the Lossco Class B Preferred Shares and pay the redemption price thereof, including any accrued dividends, ensuring that the redemption price for the outstanding Lossco Class B Preferred Shares is equal to the principal amount outstanding on the Lossco Loan.

ADDITIONAL INFORMATION

26.   The Lossco Class B Preferred Shares which will be issued as described in paragraph 20 above, will not be at any time during the implementation of the proposed transactions described in paragraphs 16 to 25 above:

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;

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).

27.   At the time of the Proposed Transactions:

a.    Lossco will have the financial capacity to satisfy the applicable solvency test and liquidity test under the CBCA required to pay the dividends on the Lossco Class B Preferred Shares as described in Paragraph 23.

b.    Lossco will have the financial capacity to satisfy the applicable solvency test and liquidity test under the CBCA required to redeem the Lossco Class B Preferred Shares as described in Paragraphs 25(b).

28.   Profitco and Lossco are affiliated persons and have been related to each other since XXXXXXXXXX.

29.   Neither Profitco nor Lossco is a XXXXXXXXXX as defined in subsection XXXXXXXXXX.

30.   Neither Lossco nor Profitco is or will be XXXXXXXXXX.  Each of Profitco and Lossco is XXXXXXXXXX within the meaning assigned by subsection 248(1).  By reason only of the proposed transactions described herein, Profitco will not be considered to have acquired the Lossco Class B Preferred Shares in the ordinary course of the business carried on by it.  Lossco is not XXXXXXXXXX as defined in subsection XXXXXXXXXX or XXXXXXXXXX as defined in subsection XXXXXXXXXX. 

31.   Profitco is expected to generate interest deductions from the Lossco Loan of $XXXXXXXXXX, being $XXXXXXXXXX for its taxation year ending XXXXXXXXXX, and $XXXXXXXXXX for its taxation year ending XXXXXXXXXX.  Accordingly, for the XXXXXXXXXX taxation year, based on the estimated taxable income of $XXXXXXXXXX, Profitco will incur a $XXXXXXXXXX non-capital loss, and for the XXXXXXXXXX taxation year, based on the estimated taxable income of $XXXXXXXXXX, Profitco will incur a $XXXXXXXXXX non-capital loss.  The XXXXXXXXXX non-capital loss of $XXXXXXXXXX will be carried back and applied against taxable income in the taxation year ending XXXXXXXXXX, and the XXXXXXXXXX non-capital loss of $XXXXXXXXXX will be carried back and applied against taxable income in the taxation year ending XXXXXXXXXX.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to effect a tax consolidation of Profitco and Lossco by causing Lossco to earn interest income on the Lossco Loan, thus permitting Lossco to utilize its non‑capital loss carry-forwards, and to have Profitco incur interest expense to reduce its income for its current taxation year, and to the extent this creates non‑capital losses for Profitco, to carry‑back the non‑capital losses to reduce its taxable income from prior taxation years.

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 Profitco has a legal obligation to pay interest on the Lossco Loan, and the Lossco Class B Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income therefrom, Profitco will be entitled pursuant to paragraph 20(1)(c), to deduct in computing its income for a taxation year, the lesser of: (i) the interest paid or payable in respect of the Lossco Loan for that taxation year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act); and (ii) a reasonable amount in respect thereof.

B.    The dividends received (or deemed to be received) by Profitco in respect of the Lossco Class B Preferred Shares in a particular year will be taxable dividends that will be deductible in computing the taxable income of Profitco for the year in which the dividends are received pursuant to subsection 112(1), and for greater certainty, such deductions will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) or 112(2.4).

C.    Profitco will be entitled to carry‑back to its prior taxation years the non‑capital losses that are expected to arise as a result of the deductions described in Ruling A above, subject to any applicable restrictions in section 111.

D.    The provisions of subsections 15(1), 56(2), 69(1) and 246(1) will not apply as a result of entering into the Proposed Transactions, in and by themselves.

E.    Subsection 245(2) will not be applied 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 commenced are entered into on or 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; or

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

Yours truly,

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

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