2015-0582101R3 loss utilization

Principal Issues: Whether a loss utilization transaction is acceptable.

Position: Yes.

Reasons: Long-standing administrative position.

Author: XXXXXXXXXX
Section: 20(1)(c), 55(2), 112(1), 245

XXXXXXXXXX                                      2015-058210

XXXXXXXXXX 2015

Dear XXXXXXXXXX:

Re:   XXXXXXXXXX
         Advance Income Tax Ruling

This is in reply to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-named taxpayers.

We understand that to the best of your knowledge and that of the taxpayers involved none of the issues involved in the requested ruling is:

(i)   in an earlier return of a taxpayer identified in this document or of a related person,

(ii)  being considered by any Tax Services Office or Taxation Centre of the Canada Revenue Agency (“CRA”) in connection with a tax return already filed,

(iii) under objection by a taxpayer identified in this document or by 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; or

(v)   the subject of a previously issued ruling. 

Our understanding of the facts and relevant transactions, including proposed transactions, is as follows:

Definitions

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

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

(c)   “CRA” means the Canada Revenue Agency;

(d)   “Daylight Loan” means the loan described in Paragraph 12 below;

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

(f)   “eligible dividend” has the meaning assigned by subsection 248(1) and subsection 89(1);

(g)   “excepted dividend” has the meaning assigned by section 187.1;

(h)   “excluded dividend” has the meaning assigned by subsection 191(1);

(i)   “GAAR” means the general anti-avoidance rule and encompasses the provisions set out in Part XVI;

(j)   “IB Loan” means the interest bearing demand loan described in Paragraph 13 below;

(k)   “Loss Utilization Arrangement” means the transactions described in Paragraphs 12 to 18 below;

(l)   “Lossco” means XXXXXXXXXX;

(m)   “Newco” means XXXXXXXXXX;

(n)   “NIB Loan” means the demand non-interest bearing loan described in Paragraph 15 below;

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

(p)   “paid-up capital” or “PUC” has the meaning assigned by subsection 248(1) and subsection 89(1);

(q)   “Paragraph” refers to a numbered paragraph in this letter;

(r)   “Preferred Shares” means the preferred shares to be issued by Newco as more fully described in Paragraph 4;

(s)   “Profitco” means XXXXXXXXXX;

(t)   “related persons” has the meaning assigned by section 251;

(u)   “taxable Canadian corporation” has the meaning assigned by subsections 248(1) and 89(1);

(v)   “taxable dividend” has the meaning assigned by subsections 248(1) and 89(1);

(w)   “taxable preferred share” has the meaning assigned by subsections 248(1); and

(x)   “term preferred share” has the meaning assigned by subsection 248(1).

Except as otherwise noted, all statutory references in this advance income tax ruling are references to the provisions of the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition unless otherwise indicated.  Unless otherwise noted, all references to currency are to Canadian dollars.

Facts

1.    Lossco is a taxable Canadian corporation, organized and existing under the laws of the province of XXXXXXXXXX, and is XXXXXXXXXX.  Lossco is principally XXXXXXXXXX company with holdings in XXXXXXXXXX. Lossco also holds investments in XXXXXXXXXX, which are treated as XXXXXXXXXX separate segments. Its reporting segments allow senior management to evaluate the operational performance and assess the overall contribution of each segment to the long-term objectives of Lossco. Each entity within the reporting segments operates with substantial autonomy, assumes profit and loss responsibility and is accountable for its own resource allocation.  Lossco carries on these activities directly and indirectly through a number of subsidiaries. Lossco has a XXXXXXXXXX taxation year-end.  Lossco’s head office is located at XXXXXXXXXX.  Lossco files its tax and information returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

2.    Profitco is a taxable Canadian corporation, incorporated in the province of XXXXXXXXXX, and is a wholly-owned subsidiary of Lossco.  Profitco owns and operates XXXXXXXXXX in XXXXXXXXXX Canadian provinces, representing XXXXXXXXXX, primarily in XXXXXXXXXX.  Profitco’s XXXXXXXXXX is comprised of assets ranging from XXXXXXXXXX in secondary and select primary Canadian markets.  XXXXXXXXXX.  Profitco has a XXXXXXXXXX taxation year-end.  Profitco’s head office is located at XXXXXXXXXX.  Profitco files its tax and information returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

3.    For greater certainty, neither Lossco nor Profitco nor any other corporation within the Lossco group is a “specified financial institution” as defined in subsection 248(1).  Neither Lossco nor Profitco is a “financial institution” as defined in subsection 190(1).

4.    Newco is a taxable Canadian corporation, incorporated in the province of XXXXXXXXXX and is a wholly-owned subsidiary of Lossco.  XXXXXXXXXX.  Newco has a XXXXXXXXXX taxation year-end.  The authorized share capital of Newco includes an unlimited number of common shares and an unlimited number of non-voting, non-par value Preferred Shares.  The holders of the Preferred Shares are entitled to fixed preferential cumulative cash dividends at a rate equal to XXXXXXXXXX% (XXXXXXXXXX% higher than the interest rate on the IB Loan) per share per annum.  The dividends on the Preferred Shares are payable quarterly commencing on XXXXXXXXXX, or such earlier date as the Preferred Shares are redeemed.  The Preferred Shares are redeemable by the issuer and retractable by the holder at any time as follows: the whole or from time to time any part of the outstanding Preferred Shares by the payment of an amount in cash for each Preferred Share so redeemed equal to $XXXXXXXXXX, being the subscription price for the Preferred Shares, plus any accrued but unpaid dividends.

5.    At XXXXXXXXXX, Lossco had non-capital losses and capital losses totalling approximately $XXXXXXXXXX and $XXXXXXXXXX respectively.  The non-capital losses were incurred in Lossco’s XXXXXXXXXX to XXXXXXXXXX taxation years.

6.    At XXXXXXXXXX, Profitco had non-capital losses totalling approximately $XXXXXXXXXX. The non-capital losses were incurred in Profitco’s XXXXXXXXXX to XXXXXXXXXX taxation years.  Profitco had XXXXXXXXXX taxable income in its taxation years ending XXXXXXXXXX and XXXXXXXXXX as a result of the utilization of loss carryforwards.

7.    The provincial allocation factor for the purpose of allocating taxable income for Lossco for its XXXXXXXXXX taxation years was XXXXXXXXXX% allocated to XXXXXXXXXX.

8.    Profitco has a permanent establishment in each of the provinces and territories listed below and, for its taxation year ending XXXXXXXXXX, its provincial/territorial income was allocated as follows:

Province/Territory           Allocation

XXXXXXXXXX              XXXXXXXXXX

9.    It is estimated that as a result of the Proposed Transactions, the following will be the amounts by which income tax in the provinces listed below will be reduced:

Province/Territory          Amount of Reduction

XXXXXXXXXX              XXXXXXXXXX

10.   XXXXXXXXXX

11.   XXXXXXXXXX

12.   Lossco has borrowed $XXXXXXXXXX (the “Daylight Loan”) on a daylight basis from a third party lender.  The interest rate on the Daylight Loan is a commercial market rate of interest.  Based on financial projections and the financial statements of Lossco, Lossco represents that it had the financial capacity to borrow these funds and that the Daylight Loan did not exceed its borrowing capacity.

13.   Lossco used all but not less than all the proceeds of the Daylight Loan to make the IB Loan totalling $XXXXXXXXXX to Profitco.  The IB Loan bears interest at a rate of XXXXXXXXXX% per annum and is denominated in Canadian dollars.  The interest on the IB Loan is paid quarterly on the XXXXXXXXXX day of each quarter commencing on XXXXXXXXXX.  It is expected that Profitco will be able to use all of the interest paid or payable on the IB Loan against taxable income generated in the current year (after taking into account the utilization of loss carryforwards from previous years) from its operations and from XXXXXXXXXX.

14.   Profitco used all the proceeds of the IB Loan to subscribe for $XXXXXXXXXX of Preferred Shares of NewCo.  The IB Loan is secured by a pledge by Profitco of the Newco Preferred Shares to Lossco.  Profitco paid an amount equal to the IB Loan to Newco in full satisfaction of the subscription price for the Preferred Shares.  For greater certainty, when considering the application of section 112, Profitco did not acquire and would not be considered to have acquired the Preferred Shares in the ordinary course of its business.  The legal stated capital and the fair market value of the Preferred Shares is equal to the subscription amount paid therefor.  The holders of Preferred Shares are entitled to fixed preferential cumulative cash dividends at a rate equal to XXXXXXXXXX (XXXXXXXXXX% higher than the interest rate on the IB Loan) per Preferred Share per annum. The dividends on the Preferred Shares are paid quarterly or on such earlier date as the Preferred Shares are redeemed. The dividends will be designated as eligible dividends. 

15.   Newco then used all the proceeds from the Preferred Share subscriptions/issuances to make the NIB Loan to Lossco.

16.   Lossco used the proceeds from cash advanced under the NIB Loan to repay the Daylight Loan to the third party lender.

Proposed Transactions

17.   On each dividend and interest payment date, the following transactions will occur in sequence while the Loss Utilization Arrangement is in place:

a.    Lossco will make a capital contribution to Newco equal to the amount of the dividend payment to be made to Profitco on the Preferred Shares for as long as the Preferred Shares are outstanding, to the extent that Newco needs funds to pay dividends on the Preferred Shares.  No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the legal stated capital of any of Newco’s issued and outstanding shares. The contribution of capital will not be reported as income for tax purposes or pursuant to generally accepted accounting principles.

b.    Subject to any applicable corporate law solvency tests, on each Preferred Share dividend payment date, Newco will declare and pay all accrued but unpaid dividends (using the funds contributed by Lossco) on its issued and outstanding Preferred Shares to Profitco in accordance with the terms of the Preferred Shares, and will designate such dividends as eligible dividends pursuant to subsection 89(14) to the maximum extent possible.

c.    On each interest payment date to the extent that there is any accrued but unpaid interest on the IB Loan, Profitco will pay such interest and may use the proceeds from the dividend payments made to it by Newco to make such interest payments.

18.   Once it is determined that the aggregate amount of the interest income on the IB Loan is equal to the amount required to fully utilize Lossco’s non-capital losses, the following transactions will be implemented to unwind the Loss Utilization Arrangement:

a.    Lossco will make a capital contribution to Newco equal to the amount of the dividend payment to be made to Profitco on the Preferred Shares under Paragraph 18(b) to the extent that Newco needs funds to pay such dividends.  No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the legal stated capital of any of Newco’s issued and outstanding shares. The contribution of capital will not be reported as income for tax purposes or pursuant to generally accepted accounting principles.

b.    Subject to any applicable corporate law solvency tests, Newco will declare and pay all accrued but unpaid dividends to Profitco in accordance with the terms of the Preferred Shares.  In the event that the Preferred Shares are redeemed between dividend payment dates, dividends accrued to the date of the winding-up will be paid pursuant to the terms of the Preferred Shares.

c.    Profitco will pay any accrued and unpaid interest on the IB Loan.

d.    Subject to any applicable corporate law solvency tests, Newco will redeem its issued and outstanding Preferred Shares held by Profitco and deliver the NIB Loan owed to it to Profitco in satisfaction of the redemption proceeds.

e.    Lossco and Profitco will enter into a set-off agreement whereby the IB Loan will be set off against the NIB Loan.

f.    Newco will be wound up into Lossco.

19.   The transactions described in Paragraph 18 above will result in, on or prior to XXXXXXXXXX, the payment of all accrued dividends on the Preferred Shares, the payment of all accrued interest on the IB Loan, the redemption of all Preferred Shares and the repayment of the NIB and IB Loans.

20.   It is estimated that the Loss Utilization Arrangement will remain in place until XXXXXXXXXX before being unwound on or before that date.  It is not expected that the Proposed Transactions will transfer losses to Profitco in excess of Profitco’s income for the taxation year ending XXXXXXXXXX (after taking into account the utilization of any existing non-capital loss carryforwards).

Additional Information

21.   At no time during the implementation of the Loss Utilization Arrangement described in this letter will the Preferred Shares be:

(a)   the subject of any undertaking that is referred to in subsection 112(2.2) as a “guarantee agreement”, including any guarantee, covenant, or agreement to purchase the Preferred Shares and including the lending of funds to or the placing of amounts on deposit with, or on behalf of, Profitco or a specified person in relation thereto (as contemplated by subsection 112(2.2)) given to ensure that (i) any loss that Profitco or a specified person in relation thereto may sustain by reason of the ownership, holding or disposition of the Preferred Shares or any other property is limited in any respect, or (ii) Profitco or a specified person in relation thereto will derive earnings by reason of the ownership, holding or disposition of the Preferred Shares or any other property;

(b)   the subject of a dividend rental arrangement (nor will any of the dividends paid on the Preferred Shares in the course of the Loss Utilization Arrangement be received as part of a dividend rental arrangement); further, the Preferred Shares will not be the subject of a dividend rental arrangement pursuant to the amended definition of dividend rental arrangement in accordance with the Draft Legislation issued by the Department of Finance (Canada) on July 31, 2015, and including as described in proposed paragraphs (c) and (d) of that definition; or

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

(d)   issued for consideration (nor will Profitco receive any other property, directly or indirectly, from an investor or any property substituted therefor) 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 would be related to Newco (if the Act were read without reference to paragraph 251(5)(b)); or

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

22.   None of the corporations involved in the Loss Utilization Arrangement is or will be a corporation described in any of paragraphs (a) to (f) of the definition of “financial intermediary corporation” in subsection 191(1).

23.   The interest rate on the IB Loan is at a commercial rate and the terms of the IB Loan are arm’s length terms.

24.   There is no “right to reduce” the interest on the IB Loan and the interest is not otherwise “contingent” such that no portion of the interest on the IB Loan will be considered to be a “contingent amount” as defined in subsection 143.4(1).

25.   At the time of the Loss Utilization Arrangement

a.    Lossco will have the ability to make the contributions of capital to Newco as described in Paragraphs 17(a) and 18(a) above;

b.    Newco will have the financial capacity to satisfy the applicable solvency test required to pay the dividends on the Preferred Shares, described in Paragraphs 17(b) and 18(b);

c.    Newco will have the financial capacity to satisfy the applicable solvency test required to redeem the Preferred Shares as described in Paragraph 18(d).

26.   Lossco, Profitco and Newco are affiliated persons and are related to each other and will continue to be affiliated and related to each other throughout the Loss Utilization Arrangement.

27.   Neither Lossco nor Profitco will claim, at any time, a capital loss in respect of any investment in Newco.

28.   Lossco will have sources of cash, other than dividends on the Preferred Shares, to fund the capital contributions to Newco.  Such sources include dividends from other subsidiaries, partnership income, interest on bank accounts, management fees and XXXXXXXXXX.

29.   The dividends paid on the Preferred Shares to Profitco, as described in Paragraphs 17(b) and 18(b), have no purpose other than the purpose described under the heading “Purpose of the Loss Utilization Arrangement”.

Purposes of the Loss Utilization Arrangement

30.   The purpose of the Loss Utilization Arrangement is to effect an intragroup loss utilization arrangement between Lossco and Profitco by:

a.    having Lossco earn interest income on the IB Loan, thereby permitting Lossco to accelerate the use of its non-capital losses; and

b.    having Profitco incur interest expense on the IB Loan, thereby permitting Profitco to reduce its taxable income.

31.   The purpose of both the payment and the receipt of the dividends on the Preferred Shares is to provide a reasonable return on the Preferred Shares and to fund the interest payments that will be due on the IB Loan.

Rulings Given

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts and proposed transactions, including the Loss Utilization Arrangement, and the purposes of the Loss Utilization Arrangement, and provided that the Loss Utilization Arrangement is completed in the manner described above, we rule as follows:

A.    Provided that Profitco has a legal obligation to pay interest on the IB Loan, and that Profitco continues to hold the Preferred Shares acquired from Newco, as described in Paragraph 14 above, for the purpose of gaining or producing income, Profitco will be entitled, pursuant to paragraph 20(1)(c), to deduct the lesser of (i) the interest paid or payable (depending on the method regularly followed by Profitco in computing its income for purposes of the Act) in respect of the year on the IB Loan or (ii) a reasonable amount in respect thereof.

B.    The dividends received by Profitco on the Preferred Shares, as described in Paragraphs 17(b) and 18(b) above, will be taxable dividends, and such dividends will, pursuant to paragraph 12(1)(j), be required to be included in the computation of Profitco’s income.  The dividends received by Profitco on the Preferred Shares, as described in Paragraphs 17(b) and 18(b) above, will be deductible, pursuant to subsection 112(1), in computing Profitco’s taxable income for the year in which the dividends are received and, for greater certainty, such deduction will not be precluded by any of subsections 112(2.2), 112(2.3) or 112(2.4).

C.    No amount will be included in the income of Newco pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital made by Lossco as described in Paragraphs 17(a) and 18(a) above.

D.    Part IV.1 and Part VI.1 will not apply to the dividends described in Paragraphs 17(b) and 18(b) above because the dividends will be excepted dividends pursuant to paragraph (b) of the definition of “excepted dividend” in section 187.1, as read in conjunction with paragraph 191(2)(a), and will be excluded dividends pursuant to paragraph (a) of the definition of “excluded dividend” in subsection 191(1), as read in conjunction with paragraph 191(2)(a).

E.    The provisions of subsections 15(1), 56(2), 69(11) and 246(1) will not apply as a result of entering into the Loss Utilization Arrangement.

F.    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 Loss Utilization Arrangement, then, by virtue of paragraph 55(3)(a), the provisions of subsection 55(2) will not apply to the taxable dividends, described in Paragraphs 17(b) and 18(b).  For greater certainty, the transactions that form part of the Loss Utilization Arrangement as 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).

G.    Subsection 245(2) will not be applied as a result of entering into the Loss Utilization Arrangement, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

H.    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 Loss Utilization Arrangement, in and by itself, to re-determine the tax consequences confirmed in the rulings given above, in respect of a taxation year in respect of which such tax collection agreement is in effect.

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.  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.

Opinions

Provided that (i) the preceding statements under the headings “Facts”, “Loss Utilization Arrangement”, “Additional Information” and “Purposes of the Loss Utilization Arrangement” constitute complete and accurate disclosure; (ii) the Loss Utilization Arrangement is undertaken in the manner described above and (iii) the Act is amended in accordance with the Draft Legislation issued by the Department of Finance (Canada) on July 31, 2015 and other tax legislation to implement such measures, subsection 55(2) will not apply in respect of the dividends described in Paragraphs 17(b) and 18(b) above and subsection 112(2.3) will not preclude the deduction of the dividends described in Paragraphs 17(b) and 18(b) above.

The foregoing opinion is not a ruling and, as noted in paragraph 19(f) of Information Circular 70-6R6, is not binding on the CRA.

Comments

Nothing in this ruling 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 amount of any income, capital gain, taxable capital gain, recapture, non-capital loss, net capital loss or any other amount of any corporation referred to herein; or

(c)   any tax consequences relating to the facts and Loss Utilization Arrangement described herein other than those specifically described in the rulings given above.

Yours truly,

XXXXXXXXXX
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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