2014-0556781R3 Loss consolidation

Principal Issues: Whether Profitco can deduct the interest paid on a secured debenture issued to Lossco in return for Newco preferred shares that Lossco would transfer to it. Lossco would report the interest income on the debenture. XXXXXXXXXX.

Position: Yes.

Reasons: The proposed transactions conform to our requirements for loss consolidation transactions.

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

XXXXXXXXXX

                                                2014-055678

XXXXXXXXXX, 2014

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling
         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”). 

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:

XXXXXXXXXX;

“Act” means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof.  Unless otherwise stated, all statutory references are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

“Additional Newco Preferred Shares” has the meaning specified in paragraph 17;

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

“affiliated person” has the meaning assigned by section 251.1;

“Bco” means XXXXXXXXXX, the corporation described in paragraph 2;

“CBCA” means the Canada Business Corporations Act, R.S.C. 1995, c. C-44, as amended;

“Cco” means XXXXXXXXXX, the corporation described in paragraph 3;

“Daylight Loan” has the meaning specified in paragraph 16;

“Lossco” means XXXXXXXXXX, the corporation described in paragraph 1;

“Lossco Note 2” means the demand non-interest bearing promissory note described in paragraph 19;

“Lossco Note” means the demand non-interest bearing promissory note of $XXXXXXXXXX issued in the course of the XXXXXXXXXX;

“Newco” means XXXXXXXXXX, the corporation described in paragraph 12;

“Newco Common Shares” means the common shares described in paragraph 12;

“Newco Preferred Shares” means (i) if the interest rate on the Profitco Note 2 is XXXXXXXXXX%, the Newco Preferred Shares described in paragraph 13; and (ii) if the interest rate on Profitco Note 2 differs from XXXXXXXXXX%, a new class of preferred shares of Newco having the attributes described in paragraphs 13 (a) to (c) and entitlement to a cumulative dividend, payable quarterly, calculated daily and accruing by reference to the redemption amount of such preferred shares at a rate that is equal to the rate of interest on the Profitco Note 2, as set out in Paragraph 18, plus XXXXXXXXXX% per annum;

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

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

“Parentco” means XXXXXXXXXX, a taxable Canadian corporation and a public corporation, the common shares of which are listed on the XXXXXXXXXX under the symbol “XXXXXXXXXX”;

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

“Profitco Note” means the debenture described in paragraph 14;

“Profitco Note 2” means the debenture described in paragraph 18;

“public corporation” has the meaning assigned by subsection 89(1);

“refundable dividend tax on hand” has the meaning assigned by subsection 129(3);

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

XXXXXXXXXX;

“subject corporation” has the meaning assigned by subsection 186(3);

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

XXXXXXXXXX.

FACTS:

1.    Lossco is a taxable Canadian corporation and XXXXXXXXXX.  Parentco holds indirectly approximately XXXXXXXXXX% of the common shares of Lossco and approximately XXXXXXXXXX% of the votes attached to all issued and outstanding shares in the capital of Lossco.  Lossco has a taxation year end of XXXXXXXXXX.  The common shares of Lossco are XXXXXXXXXX.  Lossco is a XXXXXXXXXX. Lossco files its T2 returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Service Office.

2.    Bco is a taxable Canadian corporation and XXXXXXXXXX and which is controlled by Lossco, which owns directly or indirectly, approximately XXXXXXXXXX% of the issued and outstanding common shares of Bco.  Bco has a taxation year end of XXXXXXXXXX. The common shares of Bco are XXXXXXXXXX.  Bco is XXXXXXXXXX.

3.    Cco is a taxable Canadian corporation and is a wholly-owned subsidiary of Bco.  Cco has a taxation year end of XXXXXXXXXX. 

4.    Profitco is a taxable Canadian corporation and is a wholly-owned subsidiary of Cco. Profitco has a taxation year end of XXXXXXXXXX.  Profitco’s principal business activity is to XXXXXXXXXX. Profitco files its T2 returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Services Office.

5.    Lossco has non-capital losses carried forward of approximately $XXXXXXXXXX as of XXXXXXXXXX.

6.    It is anticipated that Lossco will realize an additional $XXXXXXXXXX of non-capital losses in its taxation year ending XXXXXXXXXX.

7.    The borrowing capacity of Lossco and its subsidiaries significantly exceeds the amount of $XXXXXXXXXX required to complete the Proposed Transactions described in paragraphs 15 to 23 and the maximum amount of $XXXXXXXXXX referred to in the XXXXXXXXXX.  As of XXXXXXXXXX, Lossco had a net equity value of approximately $XXXXXXXXXX and its market capitalization exceeded $XXXXXXXXXX.

8.    Profitco is anticipated to generate taxable income in each of the next XXXXXXXXXX taxation years.

9.    The borrowing capacity of Bco significantly exceeds the amount of $XXXXXXXXXX required to complete the Proposed Transactions described in paragraphs 15 to 23 and the maximum amount of $ XXXXXXXXXX referred to in the XXXXXXXXXX.

10.   Lossco operates through permanent establishments in the Provinces of XXXXXXXXXX.  Lossco has an allocation factor of approximately XXXXXXXXXX% to the Province of XXXXXXXXXX and of approximately XXXXXXXXXX% to the Province of XXXXXXXXXX, based on the interprovincial allocation for Lossco’s XXXXXXXXXX taxation year.

11.   Profitco operates through permanent establishments in XXXXXXXXXX.  Profitco has, based on the interprovincial allocation for Profitco’s XXXXXXXXXX taxation year, approximately the following allocation factors:

     XXXXXXXXXX

12.   XXXXXXXXXX, Lossco incorporated a wholly-owned subsidiary (“Newco”) under the CBCA. Newco is a taxable Canadian corporation. Newco’s share capital includes an unlimited number of common shares and an unlimited number of preferred shares (“Newco Preferred Shares”). XXXXXXXXXX. Newco files its T2 returns with the XXXXXXXXXX Taxation Centre and deals with the XXXXXXXXXX Tax Service Office.

13.   The Newco Preferred Shares have the following attributes:

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 fair market value at the time of redemption equal to the aggregate redemption amount, (iii) or by assignment, transfer and delivery of one or more of those non-interest bearing promissory notes of Lossco, having an aggregate outstanding principal amount equal to the redemption amount, or (iv) by a combination of immediately available funds and property as contemplated in items (i),(ii) and (iii) above, 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; and

d.    entitlement to a cumulative dividend, payable quarterly, calculated daily and accruing by reference to the redemption amount of Newco Preferred Shares at a rate of XXXXXXXXXX%, based on the interest rate on the Profitco Note (as described below), plus XXXXXXXXXX% per annum.

14.   Pursuant to the XXXXXXXXXX, Profitco issued to Lossco a demand interest bearing secured debenture in the principal amount of $XXXXXXXXXX, which bears interest at a stated rate of XXXXXXXXXX% (the “Profitco Note”).

PROPOSED TRANSACTIONS:

15.   If the interest rate on the Profitco Note 2 differs from XXXXXXXXXX%, articles of amendment will be filed in order to create a new class of preferred shares having the attributes described in paragraphs 13 (a) to (c) and entitlement to a cumulative dividend, payable quarterly, calculated daily and accruing by reference to the redemption amount of such preferred shares at a rate that is equal to the rate of interest of the Profitco Note 2 as set out in paragraph 18, plus XXXXXXXXXX% per annum.

16.   Lossco will borrow an amount of $XXXXXXXXXX on a “daylight loan” basis from an arm’s length financial institution or from a related entity (“Daylight Loan”). 

17.   Lossco will use the proceeds from Daylight Loan to subscribe for XXXXXXXXXX Newco Preferred Shares (“Additional Newco Preferred Shares”) for a total amount of $XXXXXXXXXX. The aggregate redemption amount, retraction amount, adjusted cost base and paid-up capital of the Additional Newco Preferred Shares issued will be equal to the subscription amount of the Additional Newco Preferred Shares. 

18.   Lossco will immediately transfer all of the Additional Newco Preferred Shares to Profitco for a purchase price of $ XXXXXXXXXX.  As the sole consideration for such transfer, Profitco will issue a secured debenture (the “Profitco Note 2”) to Lossco that will have a principal amount equal to the aggregate redemption amount of such Additional Newco Preferred Shares.  The Profitco Note 2 will bear interest that will be payable quarterly, established at XXXXXXXXXX%, and will be repayable on demand.  As security for the indebtedness evidenced by the Profitco Note 2, Profitco will grant Lossco a security interest in the Additional Newco Preferred Shares only, and not to any other assets of Profitco.  The Profitco Note 2 will also provide that the principal amount may be satisfied at Profitco’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 Additional Newco Preferred Shares or, (iv) by way of set-off against the Lossco Note 2 if the Lossco Note 2 belongs to Profitco at the time of repayment. The amount of dividends received by Profitco on the Additional Newco Preferred Shares held by Profitco will be sufficient to permit Profitco to realize a profit on its investment in the Additional Newco Preferred Shares, after the deduction of any interest on the Profitco Note 2 and its other related expenses.

19.   Newco will use the proceeds from the issuance of the Additional Newco Preferred Shares to make a non-interest bearing loan of $ XXXXXXXXXX to Lossco.  This loan will be evidenced by a demand non-interest bearing promissory note (the “Lossco Note 2”).

20.   Lossco will use the proceeds from the Lossco Note 2 to repay the Daylight Loan.

21.   The following transactions will occur in immediate sequence when jointly determined by Lossco, Profitco and Newco, but no later than XXXXXXXXXX:

a.    At least quarterly, pursuant to a capital contribution agreement, Lossco will make a contribution of capital to Newco in an amount equal to the amount of any accrued and unpaid dividends, if any, on the Additional Newco Preferred Shares.  No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the stated capital of Newco.  The amount of each contribution of capital will be recorded as contributed surplus for accounting purposes.  The contribution of capital will not be income to Newco pursuant to international financial reporting standards;

b.    Newco will pay the accrued and unpaid dividends on the Additional Newco Preferred Shares; and

c.    Profitco will pay the accrued and unpaid interest on the Profitco Note 2.

22.   The structure will be unwound in the following manner no later than XXXXXXXXXX:

a.    Newco will redeem the Additional Newco Preferred Shares held by Profitco for an amount equal to their aggregate redemption amount.

b.    As payment for the redemption of the Additional Newco Preferred shares, Newco will deliver the Lossco Note 2 to Profitco.

c.    The Lossco Note 2 and the Profitco Note 2 will be satisfied and extinguished by way of set-off. 

23.   Lossco, as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound-up into Lossco pursuant to subsection 88(1).  As a consequence, Newco’s assets will be transferred to Lossco and Lossco will assume Newco’s liabilities. 

ADDITIONAL INFORMATION

24.   Profitco, as well as all other taxpayers involved in the Proposed Transactions, are, on the basis that they are related to a corporation described in paragraphs (b) or (d) of the definition of XXXXXXXXXX pursuant to paragraph (g) of that definition.  It is, however, understood that Profitco will not acquire the Additional Newco Preferred Shares in the ordinary course of its business.

25.   None of the preferred shares to be issued as part of the Proposed Transactions is

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).

26.   XXXXXXXXXX.

27.   The interest deducted by Profitco pursuant to paragraph 20(1)(c) in respect of the Profitco Note 2 will not create a non-capital loss for Profitco during the period in which the transactions described in paragraphs 15 through 23 occur. However, Profitco could incur a non-capital loss as a result of claiming a deduction in computing taxable income under paragraph 110(1)(k) should Profitco enter into an agreement with a related party with respect to Part VI.1 tax otherwise payable by such related party, in accordance with subsection 191.3(1).  Any such resulting non-capital loss may be carried back to a prior taxation year in accordance with the rules in section 111.

28.   Dividends received by Profitco on the Additional Newco Preferred Shares as described in paragraph 21 will be excepted dividends within the meaning assigned by section 187.1 Act and excluded dividends within the meaning assigned by section 191(1).

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

PURPOSE OF THE PROPOSED TRANSACTIONS

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 Note 2 and permit Profitco to effectively utilize Lossco’s non-capital losses. 

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 Profitco Note 2 and that the Additional Newco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income, in computing its income for a taxation year, Profitco will be entitled to deduct, pursuant to paragraph 20(1)(c) of the Act, the lesser of (i) the interest on the Profitco Note 2, as described in 18 above, paid in the year or payable in respect of the year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) or (ii) a reasonable amount in respect thereof.

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

C.    No amount will be included in the income of Newco pursuant to section 9 of the Act, or paragraphs 12(1)(c) or 12(1)(x) of the Act in respect of the contributions of capital made by Lossco as described in paragraph 21 above.

D.    Dividends received by Profitco on the Additional Newco Preferred Shares, as described above, will be taxable dividends and such dividends will, pursuant to subsection 112(1) of the Act, 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) of the Act.

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

F.    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 a tax collection agreement is in effect.

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, other than those described in paragraphs 21 to 23, are completed by 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; 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

All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without the prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5.

© Her Majesty the Queen in Right of Canada, 2015

Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistribuer de l'information, sous quelque forme ou par quelque moyen que ce soit, de façon électronique, mécanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.

© Sa Majesté la Reine du Chef du Canada, 2015