2014-0546911C6 Q.2 Loss Consolidations

Principal Issues: CRA’s positions for issuing rulings for loss consolidation arrangements. (i) Dividend spread and independent source of income; (ii) inter-provincial loss consolidations; (iii) affiliated vs. related corporations.

Position: (i) Required; (ii) Rulings will continue to be provided, subject to provincial GAAR concerns; (iii) Rulings may be issued if the corporations are related; however, if the corporations are only affiliated (but not related), then the meaning of affiliated will be determined as described in subsection 69(11), i.e., if subsection 251.1 were read without reference to subsection 251.1(3).

Reasons: CRA’s policy positions.

Author: Ferrari, Rob
Section: 20(1)(c), 69(11), 251.1, 245(2), )

2014 CTF Annual Tax Conference
November 30 – December 2, 2014
CRA Round Table

Question 2:  Loss Consolidations

Dividend Spread and Independent Source of Income

Question

In certain loss consolidation arrangements, a profitable taxable Canadian corporation (“Profitco”) is related or affiliated to a taxable Canadian corporation that has incurred non-capital losses (“Lossco”).  Under the loss consolidation arrangement, Lossco lends money to Profitco at a reasonable stated rate of interest and Profitco in turn uses the inter-corporate debt to acquire preferred shares of Lossco.

Does the CRA require a positive spread between the dividend yield on the preferred shares acquired with inter-corporate debt and the interest rate on that debt?

Does the CRA continue to hold that in such situations the payor of the dividends must have an independent source of income to pay the dividends?

Response

In the context of loss consolidation arrangements, it is the CRA’s policy not to provide rulings without a positive spread between the interest paid and the dividends earned.

The CRA has previously commented on loss consolidation arrangements in circumstances of upstream shareholding in which a subsidiary acquired dividend paying preferred shares of the parent.  Our views on the independent source of income issue are expressed in Income Tax Technical News No. 30 (May 21, 2004), which continues to reflect the CRA's position.  In the circumstances described, “The key criteria to be met in such situations is the existence of other assets in the parent company that can generate sufficient income to pay the dividends on the preferred shares held by the subsidiary.” 

Whether the funding for the dividend payments is acceptable will depend on the circumstances and the particular loss consolidation structure.  Where taxpayers have concerns with respect to a specific situation, we encourage them to request an advance income tax ruling.

Inter-Provincial Loss Consolidation Issues

Question

The Federal Budgets in 2010 and 2012 noted the Government's intention to undertake a consultation process to consider implementing new rules for the taxation of corporate groups, which if implemented, would allow for a formal system of loss transfers or consolidated reporting.  As a result of the consultations, which included discussions with provincial and territorial officials, the 2013 Federal Budget announced it would not proceed with the implementation of a formal corporate group taxation system. 

Can the CRA provide an update on whether the 2013 Federal Budget has had an impact on issuing advance income tax rulings for loss consolidation arrangements?

Response

The 2013 Federal Budget announcement has not had an impact on the advance income tax rulings process for loss consolidations arrangements.  The CRA’s position continues to be that certain loss consolidation arrangements are in accordance with the scheme of the Act and do not usually result in a misuse or abuse for the purposes of the general anti-avoidance rules (“GAAR”).

Advance income tax rulings are generally provided for the purposes of federal “GAAR”.  We have also provided provincial GAAR rulings in respect of a province (or territory) with which the Government of Canada has entered into a tax collection agreement.

It should be noted, however, that where we consider that one of the main reasons for engaging in a loss consolidation arrangement is for the purposes of shifting income among provinces, the CRA may challenge that loss consolidation under provincial GAAR legislation.

Affiliated and Related Corporations under Loss Consolidation Arrangements

Question

Prior to 1996, the CRA’s policy permitted loss consolidation arrangements only where the corporations were related.  After April 26, 1995, the concept of "affiliated person" was introduced in section 251.1 of the Act, which was used as the criteria under certain loss restriction provisions, e.g., subsection 69(11).  As a result, the CRA’s position on loss consolidations was changed to allow loss consolidation transactions only where the corporations were affiliated.  In 2010, the CRA issued a ruling for a loss consolidation where the two corporations were related, but were not affiliated. 

Can the CRA confirm its position as to whether corporations must be affiliated, related, or both affiliated and related in a loss consolidation arrangement? 

Response

The CRA will consider ruling requests where the corporations are related and affiliated, as well as circumstances in which the corporations are related.

We will also consider loss consolidation arrangement where the corporations are affiliated but not related.  In that context, however, the meaning of affiliated will be determined on the same criteria as stipulated in subsection 69(11), which is if subsection 251.1 were read without reference to subsection 251.1(3).  In other words, where two corporations are not related, but are affiliated, the CRA would consider a loss consolidation arrangement only if the corporations are affiliated by reason of de jure control. 

The CRA is in the process of preparing Income Tax Folio S3-F6-C1, “Interest deductibility and related issues.”  We intend to add our positions on related and affiliated relationships into new Folio S3-F6-C1 with respect to loss consolidations.

Rob Ferrari
2014-054691

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