2015-0604071R3 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                                2015-060407

XXXXXXXXXX, 2015

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling Request
XXXXXXXXXX (collectively known as the “Taxpayers”)

We are replying 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. 

We understand that to the best of your knowledge and that of the Taxpayers, none of the issues involved in this Ruling request is:

i.    in a previously filed return of the Taxpayers or a related person;

ii.   being considered by a Tax Services Office or Taxation Centre in connection with a previously filed tax return 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 expired, or

v.    the subject of an advance income tax ruling previously considered by the Income Tax Rulings 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

(a)   "affiliated persons" has the meaning assigned by subsection 251.1(1);

(b)   "Capital Contributions" is defined in Paragraph 17;

(c)   XXXXXXXXXX

(d)   "Daylight Loan" is defined in Paragraph 15;

(e)   "eligible dividend" has the meaning assigned by subsection 248(1) and subsection 89(1);

(f)   "GAAR" means the general anti-avoidance rule and encompasses the provisions of Part XVI of the Act;

(g)   "Investment Note" is defined in Paragraph 16(b); 

(h)   “Lossco” means XXXXXXXXXX;

(i)   "Lossco Dividend" is defined in Paragraph 19(b); 

(j)   "Lossco Preferred Shares" is defined in Paragraph 2; 

(k)   "Management Fees" is defined in Paragraph 9 hereof; 

(l)   "non-capital loss" has the meaning assigned by subsection 111(8);

(m)   "paid-up capital" has the meaning assigned by subsection 248(1) and subsection 89(1);

(n)   "Paragraph" refers to a numbered paragraph in this letter;

(o)   "Parent" means XXXXXXXXXX;

(p)   "Parent Loans" is defined in Paragraph 8; 

(q)   "Parent Loss Consolidation" is defined in Paragraph 8; 

(r)   “Profitco” means XXXXXXXXXX;

(s)   "Profitco Borrowing Capacity" is defined in Paragraph 13; 

(t)   "Profitco Loan" is defined in Paragraph 16(b);

(u)   "Profitco Subordinated Rate" is defined in Paragraph 14;

(v)   "Proposed Transactions" means the transactions described in Paragraphs 15 to 19;

(w)   "Redemption Amount" is defined in Paragraph 2(c);

(x)   "Redemption Note" is defined in Paragraph 19(c);

(y)   XXXXXXXXXX;

(z)   "related persons" has the meaning assigned by subsection 251(2);

(aa)  "Share Subscription" has the meaning assigned by Paragraph 16(a);

(bb)  "SisterCo" means XXXXXXXXXX;

(cc)  "SisterCo Dividends" is defined in Paragraph 9; 

(dd)  "SisterCo Preferred Shares" is defined in Paragraph 8; and

(ee)  "Support Agreement" is defined in Paragraph 17.

Facts

1.    Lossco is a taxable Canadian corporation, organized and existing under the XXXXXXXXXX, all of the issued and outstanding shares of which are owned by Parent. Lossco owns all the issued and outstanding shares of Profitco and XXXXXXXXXX other operating companies (XXXXXXXXXX).  Lossco has XXXXXXXXXX employees who provide XXXXXXXXXX to Lossco's subsidiaries (including Profitco) and to other subsidiaries of Parent. The XXXXXXXXXX provided by Lossco include XXXXXXXXXX.  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 Taxation Centre and deals with the XXXXXXXXXX Taxation Services Office.

2.    Lossco's authorized share capital includes a series of preferred shares (the "Lossco Preferred Shares"), none which are currently issued and outstanding, with the rights and restrictions as follows:

(a)   non-voting;

(b)   annual cumulative dividend rate equal to an amount to be determined on the date of issuance of such shares;

(c)   redeemable for an amount equal to the aggregate of the amount for which the share was issued and any accrued and unpaid dividends (the "Redemption Amount");

(d)   retractable for an amount equal to the Redemption Amount;

(e)   on winding up or dissolution, holders will receive an amount equal to the Redemption Amount;

(f)   dividends and proceeds on winding up or dissolution rank ahead of any payment on shares ranking junior, including the common shares; and

(g)   will be automatically retracted XXXXXXXXXX business days prior to any bankruptcy or insolvency of Lossco.

3.    Profitco is a taxable Canadian corporation, organized and existing under the XXXXXXXXXX.  Profitco is the corporation resulting from XXXXXXXXXX on XXXXXXXXXX.  XXXXXXXXXX.   Profitco's issued and outstanding share capital consists of common shares, all of which are owned by Lossco.  Profitco owns and operates a XXXXXXXXXX and its operations are 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 Taxation Centre and deals with the XXXXXXXXXX Taxation Services Office.

4.    Parent is a taxable Canadian corporation, organized and existing under the law of the province of XXXXXXXXXX, the shares of which are listed on the XXXXXXXXXX.  Parent is principally XXXXXXXXXX.  Parent carries on its business directly and indirectly through a number of subsidiaries.  Parent has a XXXXXXXXXX taxation year-end.  Parent's head office is located at XXXXXXXXXX.  Parent's Business Number is XXXXXXXXXX.  Parent files its tax and information returns at the XXXXXXXXXX Tax Centre and deals with the XXXXXXXXXX Tax Services Office.

5.    The provincial allocation factor for the purpose of allocating taxable income for Lossco for its XXXXXXXXXX taxation years was XXXXXXXXXX% allocated to XXXXXXXXXX and the projected provincial allocation factor for the purpose of allocating taxable income for Lossco for its XXXXXXXXXX taxation year is also expected to be XXXXXXXXXX% allocated to XXXXXXXXXX.

6.    The provincial allocation factor for the purpose of allocating taxable income for Profitco for its XXXXXXXXXX taxation years was XXXXXXXXXX% allocated to XXXXXXXXXX and the projected provincial allocation factor for the purpose of allocating taxable income for Profitco for its XXXXXXXXXX taxation year is also expected to be XXXXXXXXXX% allocated to XXXXXXXXXX.

7.    Lossco has no non-capital losses available to carryforward to its taxation year ending XXXXXXXXXX.  Profitco has no non-capital losses available to carryforward to carry-forward to its taxation year ending XXXXXXXXXX. 

8.    Lossco has entered into a loss consolidation arrangement with SisterCo and Parent, the purpose of which is to effect a consolidation of the non-capital losses and profits of Lossco and Parent (the "Parent Loss Consolidation").  In order to effect the Parent Loss Consolidation, Parent made XXXXXXXXXX interest-bearing loans to Lossco (the "Parent Loans") and Lossco used the proceeds of the Parent Loans to subscribe for preferred shares of SisterCo (the "SisterCo Preferred Shares").

9.    Lossco's revenues for its taxation year ending XXXXXXXXXX is estimated to include management fees in the aggregate amount of approximately $XXXXXXXXXX (the "Management Fees") (of which approximately $XXXXXXXXXX will be paid by Profitco), dividends in the aggregate amount of approximately $XXXXXXXXXX that will be paid by SisterCo on the SisterCo Preferred Shares (the "SisterCo Dividends") and dividends in the aggregate amount of approximately $XXXXXXXXXX that will be paid by Profitco. 

10.   In the absence of the Proposed Transactions, it is estimated that Profitco's taxable income for its taxation year ending XXXXXXXXXX would be approximately $XXXXXXXXXX.

11.   In the absence of the Proposed Transactions, it is estimated that Lossco would incur a non-capital loss of approximately $XXXXXXXXXX for its taxation year ending XXXXXXXXXX. 

12.   Lossco expects that it will continue to incur non-capital losses because of its obligations under the Parent Loan, interest on other loans, operating expenses, and management fees it pays to Parent. 

13.   XXXXXXXXXX, based on Profitco's audited financial information as at XXXXXXXXXX that Profitco would be in a position to borrow in the XXXXXXXXXX (on the basis that such borrowing be subordinated to all other debts of Profitco, including accounts payable) an amount up to $XXXXXXXXXX (the "Profitco Borrowing Capacity").  Since XXXXXXXXXX, there has not been any material change in Profitco's financial position that would reduce the Profitco Borrowing Capacity.

14.   XXXXXXXXXX, Profitco is of the view that a reasonable rate of interest on fully subordinated debt in the quantum of the Profitco Borrowing Capacity would be XXXXXXXXXX% (the "Profitco Subordinated Rate").

Proposed Transactions

The following transactions will be completed in the order described below. 

15.   On or after XXXXXXXXXX, Profitco will borrow funds from an arm's length financial institution on a daylight loan basis in XXXXXXXXXX tranches (each such tranche, a "Daylight Loan") in the amount of $XXXXXXXXXX. The aggregate principal amount of all Daylight Loans shall not exceed the Profitco Borrowing Capacity, which is expected to be $XXXXXXXXXX.  The interest rate on the Daylight Loans will be a commercial market rate of interest. 

16.   In the case of each Daylight Loan:

(a)   Profitco will use the proceeds of the Daylight Loan to subscribe for Lossco Preferred Shares (the "Share Subscription").  The annual cumulative dividend rate on the Lossco Preferred Shares will be set at the Profitco Subordinated Rate plus XXXXXXXXXX%.  The amount that will be added to the capital of the Lossco Preferred Shares for purposes of the XXXXXXXXXX will be equal to the amount for which such shares are issued;

(b)   Lossco will use the funds from the Share Subscription to make an interest bearing loan to Profitco (each such loan, an "Profitco Loan") evidenced by a promissory note (each such note, an "Investment Note"); and

(c)   Profitco will use the funds borrowed under the Investment Note to repay the Daylight Loan used to acquire the Lossco Preferred Shares.

17.   Parent and Lossco will enter into a support agreement (the "Support Agreement"), pursuant to which Parent and Lossco will agree that, for so long as Profitco is the holder of Lossco Preferred Shares, Parent will make contributions of capital to Lossco (the "Capital Contributions") in an amount equal to the amount of dividends on the Lossco Preferred Shares referred to in Paragraph 16(a) above and Lossco will use such Capital Contributions to pay amounts in respect of such dividends. No shares will be issued by Lossco in respect of the Capital Contributions and the Capital Contributions will not be reported as income for tax purposes or pursuant to generally accepted accounting principles. 

18.   Each Investment Note:

(a)   will be subordinated to all other debts of Profitco;

(b)   will bear interest at a rate equal to the Profitco Subordinated Rate;

(c)   will be repayable by Profitco upon the earlier of (i) demand, (ii) XXXXXXXXXX and (iii) XXXXXXXXXX days prior to an event of default including a bankruptcy or insolvency of Profitco;

(d)   will provide Profitco with a right to prepay at any time without penalty; and

(e)   will provide that Profitco may surrender Lossco Preferred Shares for retraction in order to obtain the funds for repayment of the Investment Note.

19.   On or before XXXXXXXXXX:

(a)   Pursuant to the terms of the Support Agreement, Parent will make Capital Contributions to Lossco to allow Lossco to pay amounts in respect of accrued and unpaid dividends on the Lossco Preferred Shares;

(b)   Lossco will pay the accrued dividends on the Lossco Preferred Shares held by Profitco in the amount referred to in Paragraph 16(a) above (the “Lossco Dividend”). The Lossco Dividend will be funded with the Capital Contributions.  Lossco will designate the Lossco Dividend as an eligible dividend pursuant to subsection 89(14) of the Act to the maximum extent possible;

(c)   Lossco will redeem the Lossco Preferred Shares held by Profitco for an amount equal to their Redemption Amount.  Lossco will pay the Redemption Amount to Profitco by issuing a demand non-interest bearing promissory note (the "Redemption Note"), the principal amount of which will be equal to the amount for which the Lossco Preferred Shares were issued;

(d)   Profitco will pay the balance of any accrued and unpaid interest on the Investment Notes to and including the date of repayment of the Investment Notes; and

(e)   Profitco will repay the Investment Notes in full, and Lossco will repay the Redemption Note in full, by setting off the obligations under the Investment Notes against the obligations under the Redemption Note, and all the Investment Notes and the Redemption Note will be cancelled.

Additional Information

20.   The Proposed Transactions will be legally effective.

21.   None of Parent, Lossco nor Profitco is or will be at any time during the implementation of the Proposed Transactions:

(a)   a "specified financial institution" as defined in subsection 248(1); or

(b)   a corporation described in any of paragraphs (a) to (f) of the definition of "financial intermediary corporation" in subsection 191(1).

22.   At no time during the implementation of the Proposed Transactions will the Lossco Preferred Shares be:

(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" as contemplated in subsection 112(2.3) and as defined in subsection 248(1);

(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); or

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

23.   At the time of the Proposed Transactions:

(a)   Parent will have the financial capacity, including accessing its leverage capacity, to make the Capital Contributions to Lossco as described in Paragraphs 17 and 19 above; and

(b)   Lossco will have the financial capacity to satisfy the applicable solvency test required to redeem the Lossco Preferred Shares as described in Paragraph 19 above.

24.   Parent, Lossco and Profitco are affiliated persons and related persons and will continue to be affiliated persons and related persons throughout the Proposed Transactions.

25.   Profitco will not claim, at any time, a capital loss in respect of any investment in Lossco. As a result of Capital Contributions to Lossco, Parent will not claim, at any time, a capital loss in respect of any investment in Lossco.

26.   Lossco and Profitco are both governed by the XXXXXXXXXX, section XXXXXXXXXX of which permits a subsidiary to purchase or otherwise acquire shares of a corporation of which it is a subsidiary.

26.1  The Lossco Dividend, as described in Paragraph 19(b), has no purpose other than the purposes described under the heading “Purpose of Proposed Transactions”.

Purpose of Proposed Transactions

27.   The purpose of the Proposed Transactions are:

(a)   to enable Lossco to earn sufficient interest income during its taxation year ending XXXXXXXXXX to use its anticipated non-capital losses that would arise in the absence of the Proposed Transactions; and

(b)   to allow Profitco to deduct interest expense on borrowed money used to acquire the Lossco Preferred Shares in computing its income for its taxation year ending XXXXXXXXXX.

The purpose of both the payment and the receipt of the Lossco Dividend is to provide a reasonable return on the Lossco Preferred Shares.

Rulings

28.   On the basis that the above statements are accurate and constitute complete disclosure of all the relevant Facts, Proposed Transactions and Purpose of the Proposed Transactions, we provide the following Rulings:

A.    Provided that Profitco has a legal obligation to pay interest on the Investment Notes and that the Lossco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income from property, in computing its income for a taxation year, 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 Investment Notes for that taxation year, (depending on the method regularly followed by Profitco in computing its income for purposes of the Act) and (ii) a reasonable amount in respect thereof.

B.    The Lossco Dividend received by Profitco, as described in Paragraph 19(b) above, in a particular year will be a taxable dividend that will be deductible in computing the taxable income of Profitco for the year in which such dividend is received pursuant to subsection 112(1), 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).

C.    Part IV.1 and Part VI.1 will not apply to the Lossco Dividend described in Paragraph 19(b) above because such dividend will be an excepted dividend 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 an excluded dividend pursuant to paragraph (a) of the definition of "excluded dividend" in subsection 191(1), as read in conjunction with paragraph 191(2)(a).

D.    No amount will be included in the income of Lossco pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) in respect of any Capital Contributions made by Parent as described in Paragraphs 17 and 19 above.

E.    The provisions of subsection 55(2) will not apply to the Lossco Dividend described in Paragraph 19(b) above. 

F.    The provisions of subsections 15(1), 56(2), 69(1), 69(11) and 246(1) will not apply as a result of entering into the Proposed Transactions, in and by themselves.

G.    The set-off of all of the Investment Notes against the Redemption Note, described in Paragraph 19(e) above, will not give rise to a forgiven amount under section 80.

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 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 tax collection agreement is in effect.

I.    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 and 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.

OPINIONS

Provided that (i) the preceding statements constitute a complete and accurate disclosure of all of the relevant Facts, Proposed Transactions, Additional Information and the Purpose of Proposed Transactions; (ii) the Proposed Transactions are undertaken in the manner described above; and (iii) the Act is amended in accordance with the draft legislative proposals released by the Department of Finance on July 31, 2015, subsection 55(2) will not apply in respect of the Lossco Dividend described in Paragraph 19(b) above and subsection 112(2.3) will not preclude the deduction of the Lossco Dividend described in Paragraph 19(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 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; or

(d)   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
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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