2015-0569861R3 Loss consolidation arrangement

Principal Issues: Whether the LCA among the related and affiliated group is acceptable.

Position: Yes.

Reasons: The transactions fall within CRA's positions on LCAs.

Author: XXXXXXXXXX
Section: 20(1)(c), 111(5)

XXXXXXXXXX
                                                            2015-056986

XXXXXXXXXX, 2015

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling
        XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayers.  We also acknowledge the information provided in correspondence and telephone conversations concerning your request. 

To the best of your knowledge and that of the above-referenced taxpayers, none of the issues involved in this ruling is:

(i)   in an earlier return of the taxpayers or a related person;
(ii)  being considered by a Tax Service Office or Taxation Centre in connection with previously filed tax returns of the taxpayers or a related person;
(iii) under objection by 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 expired; or
(v)   the subject of a ruling previously considered by the Directorate.

You have also advised that to the best of your knowledge, and that of the taxpayers, the proposed transactions will not result in the taxpayers or any related person described herein being unable to pay its existing outstanding tax liabilities.

Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended (the “Act”), and all terms and conditions used herein that are defined in the Act have the meaning given in such definitions unless otherwise indicated.

This document is based solely on the facts described below. The documentation submitted with your request does not form part of the facts except as expressly referred to herein, and any references thereto are otherwise provided solely for the convenience of the reader.

DEFINITIONS

(a)   “Act” means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof;

(b)   “ACB” means “adjusted cost base” as defined in section 54 of the Act;

(c)   “affiliated persons” has the meaning assigned by section 251.1;

(d)   “Annual Daylight Loan” means the loan described in paragraph 13;

(e)   “FMV” means “fair market value”;

(f)   “Lossco” means XXXXXXXXXX, the corporation described in paragraphs 2 to 4;

(g)   “Lossco Preferred Shares” means the preferred shares described in paragraph 7;

(h)   “Lossco Loan” means non-interest bearing loan described in paragraph 8;

(i)   “Parentco” means XXXXXXXXXX, the corporation described in paragraph 1;

(j)   “Profitco” means XXXXXXXXXX, the corporation described in paragraphs 5 and 6;

(k)   “Profitco Note” means the demand promissory note described in paragraph 9;

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

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

(n)   “PUC” means “paid-up capital” as defined in subsection 89(1) of the Act;

(o)   "Redemption Amount" means the amount equal to the aggregate of the amount for which the Lossco Preferred Shares were issued, as further described in paragraph 7(c) below;

(p)   “related persons” has the meaning assigned by subsection 251(2) of the Act; and

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

FACTS

1.    Parentco is a taxable public corporation. Parentco became a public corporation on XXXXXXXXXX.  Parentco’s address is XXXXXXXXXX.  Parentco files its corporate tax returns with the XXXXXXXXXX Tax Centre and its corporate income tax affairs are administered by the XXXXXXXXXX Tax Service Office.

2.    Lossco is a taxable corporation controlled by a public corporation as of XXXXXXXXXX. Lossco has been a direct wholly-owned subsidiary of Parentco since XXXXXXXXXX.  Lossco’s address is XXXXXXXXXX.  Lossco files its corporate tax returns with the XXXXXXXXXX Tax Centre and its corporate income tax affairs are administered by the XXXXXXXXXX Tax Service Office.

3.    From XXXXXXXXXX forward, Lossco has had a XXXXXXXXXX year-end, except for the year-end triggered on XXXXXXXXXX that occurred on XXXXXXXXXX. 

4.    Lossco incurred the following non-capital losses for its taxation years ending in XXXXXXXXXX to XXXXXXXXXX:

XXXXXXXXXX        $XXXXXXXXXX

5.    Profitco is a taxable corporation controlled by a public corporation as of XXXXXXXXXX.  Profitco has been a direct wholly-owned subsidiary of Parentco since XXXXXXXXXX.  Profitco’s address is XXXXXXXXXX.  Profitco files its corporate tax returns with the XXXXXXXXXX Tax Centre and its corporate income tax affairs are administered by the XXXXXXXXXX Tax Service Office.

6.    Profitco has reported the following taxable income in its last three taxation years:

XXXXXXXXXX        $XXXXXXXXXX
XXXXXXXXXX        XXXXXXXXXX
XXXXXXXXXX        XXXXXXXXXX

It is expected that Profitco will continue to have taxable income in its XXXXXXXXXX and subsequent taxation years.

PROPOSED TRANSACTIONS

7.    Lossco will amend its share capital to create a series of preferred shares (the “Lossco Preferred Shares”) having 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 amount for which they were issued; and

(d)   entitled to an annual cumulative dividend on the amount for which they were issued at a rate that is expected to be XXXXXXXXXX% payable annually.

The dividend rate on the Lossco Preferred Shares will be equal to the interest rate on the Profitco Note, as described in paragraph 9 below, plus XXXXXXXXXX%.

8.    Lossco will borrow an amount, not exceeding $XXXXXXXXXX, from Parentco’s available funds, on a “daylight loan basis”, in the form of a “non-interest” bearing loan (“Lossco Loan”).  XXXXXXXXXX.  The $XXXXXXXXXX amount is within the borrowing capacity of Lossco.

9.    Lossco will use the entire proceeds received from the Lossco Loan to make a loan of an amount not exceeding $XXXXXXXXXX to Profitco (“Profitco Note”).  The Profitco Note will bear interest at an annual rate based on market conditions at the time the loan is made and is expected to be XXXXXXXXXX%, which will be a reasonable commercial rate in the circumstances. The Profitco Note will be evidenced by the issuance of a promissory note payable on demand by Profitco, to Lossco.  Interest on the Profitco Note will be payable annually.

10.   Profitco will use the entire proceeds received from the Profitco Note to subscribe for Lossco Preferred Shares having an aggregate redemption/retraction amount equal to the amount of such subscription. The PUC, the ACB and the FMV of the Lossco Preferred Shares will be equivalent to the subscription price not exceeding $XXXXXXXXXX.  Profitco will not acquire the Lossco Preferred Shares in its ordinary course of business.

11.   Lossco will use the proceeds from the Lossco Preferred Shares subscription (in paragraph 10) to reimburse the Lossco Loan to Parentco.

12.   As a result of the loss consolidation arrangement, Profitco may be in a loss position for its XXXXXXXXXX taxation year and/or its subsequent taxation years.  In such a case, Profitco will carryback the non-capital losses to reduce its taxable income in one or more of its XXXXXXXXXX preceding taxation years.

13.   The following transactions will occur annually while the Profitco Note is outstanding:

(a)   Profitco will pay interest on the Profitco Note as described in paragraph 9 to Lossco with its available cash or with funds borrowed on a “daylight loan” basis from a related entity or an arm’s length financial institution (“Annual Daylight Loan”).  The amount of the borrowed funds will be within the borrowing capacity of Profitco.

(b)   Lossco will pay the dividends on the Lossco Preferred Shares to Profitco.  It is expected that Lossco will have sufficient cash-flow from its operations (excluding any interest income or additional funding from Profitco or Parentco) to facilitate payment of the annual dividends on the Lossco Preferred Shares.

(c)   Profitco will repay the Annual Daylight Loan, if applicable.

14.   The proposed structure will be completely unwound no later than XXXXXXXXXX. The proposed structure will be unwound, either partially through separate transactions occurring at different moments in time or wholly at one particular moment, in the following manner:

(a)   Lossco will redeem all or a portion of the Lossco Preferred Shares held by Profitco at their aggregate Redemption Amount, plus any undeclared or unpaid cumulative dividends on the shares redeemed, and will issue a promissory note to Profitco in the amount of the Redemption Amount as evidence of its obligation to pay such amount;

(b)   Profitco and Lossco will agree to set-off all or the appropriate portion of the Profitco Note against the promissory note in (a) above, and this will constitute payment in full of all or the appropriate portion of the principal amount of the Profitco Note and the promissory note; and

(c)   Profitco will pay Lossco the balance of any accrued and unpaid interest on the Profitco Note.

Additional Information

15.   None of the corporations involved in the proposed transactions are a specified financial institution or a restricted financial institution as defined by subsection 248(1), or a “financial intermediary corporation” as defined in subsection 191(1) of the Act;

16.   None of the corporations involved in the proposed transactions has or will have entered into a “dividend rental arrangement” as defined by subsection 248(1) for the purposes of subsection 112(2.3) of the Act;

17.   None of the shares on which a dividend is declared or paid in the course of the proposed transactions is guaranteed in any way described in subsection 112(2.2) of the Act by a financial institution or a specified person in relation to any such institution;

18.   None of the issued preferred shares will at any time during the implementation of the proposed transactions be:

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

(b)   issued for a consideration that includes:

(i)   an obligation of the type described in subparagraph 112(2.4)(b)(i) of the Act, other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b) of the Act); or

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

19.   The proposed transactions will not, in and of themselves, result in any of the taxpayers identified in this ruling being unable to pay their outstanding tax liabilities.

20.   There has not been nor will there be any acquisitions of property or dividend paid in contemplation of the proposed transactions (except for the transactions described herein) other than transactions entered into and conducted in the normal course of business.

21.   Each of Parentco, Profitco and Lossco are affiliated persons and related persons and will continue to be affiliated and related to each other throughout the Proposed Transactions.

22.   Parentco, Profitco and Lossco have only one permanent establishment, which is in the Province of XXXXXXXXXX.  Each of Parentco, Profitco and Lossco allocate XXXXXXXXXX% of their taxable income to the Province of XXXXXXXXXX.

23.   XXXXXXXXXX.  The non-capital losses incurred by Lossco in its XXXXXXXXXX and earlier taxation years XXXXXXXXXX.  Parentco, Lossco and Profitco have XXXXXXXXXX.

Purpose of the Proposed Transactions

The purpose of the proposed transactions is to consolidate profits and losses within a related and affiliated group of corporations and to the extent that it is possible, to enable Lossco to earn interest income on Profitco Note and thus, permit Profitco to utilize Lossco’s non-capital losses.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as set forth below.

A.    Provided that Profitco has a legal obligation to pay interest on the Profitco Notes, and the Lossco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income therefrom, Profitco will be entitled to deduct, in computing its income for a taxation year, the interest paid or payable on the Profitco Note in respect of that taxation year pursuant to paragraph 20(1)(c) of the Act to the extent that such amount does not exceed a reasonable amount.

B.    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 of the Act.

C.    The provisions of subsections 15(1), 56(2), 69(4), 69(11) and 246(1) will not apply to the proposed transactions, in and by themselves.

D.    Dividends received by Profitco on the Lossco 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 ruling given.

The above rulings are given subject to the 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 by XXXXXXXXXX.  In addition, the above rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act which, if enacted, could have an effect on the rulings provided herein.

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a)   the paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein;

(b)   the amount of any non-capital loss or any other tax account of any corporation referred to herein;

(c)   the application or non-application of a general anti-avoidance provision of any province that has not entered into a tax collection agreement with the Government of Canada;

(d)   XXXXXXXXXX

(e)   any other tax consequence relating to the facts, proposed transactions or any transaction or event taking place either prior to the proposed transactions or subsequent to the proposed transactions, whether described in this letter or not.

Yours sincerely,

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

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