2016-0652041R3 Loss consolidation arrangement

Principal Issues: Whether the LCA is acceptable.

Position: Yes.

Reasons: The proposed transactions fall within CRA's policy position for LCA.

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

Dear XXXXXXXXXX:

Subject: 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 with your firm concerning your request.

To the best of your knowledge, and that of the taxpayers, none of the issues contained in this ruling request is:

(a) in a previously filed return of the taxpayers or a related person;

(b) being considered by a tax services office or tax centre in connection with a previously filed tax return of the taxpayers or a related person;

(c) under objection by the taxpayers or a related person;

(d) the subject of a current or completed court process involving the taxpayers or a related person; or

(e) the subject of a ruling request previously considered by the Directorate.

DEFINITIONS

(a) “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;

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

(c) “affiliated person” has the meaning assigned by subsection 251.1;

(d) “Anniversary Date” means the date of implementation of the Proposed Transactions, as described in Paragraphs 5 to 12;

(e) “arm’s length” has the meaning assigned by section 251(1);

(f) “CRA” means Canada Revenue Agency;

(g) “Credit Facility” means the Credit Agreement, as amended and restated from time to time and co-signed by Parentco allowing the co-signers to access borrowings up to an aggregate amount of XXXXXXXXXX$XXXXXXXXXX;

(h) “Daylight Loan” has the meaning specified in Paragraph 8;

(i) “CBCA” means Canada Business Corporations Act, R.S.C. 1985, c. C-44;

(j) “Newco” means the corporation described in Paragraph 5;

(k) “Newco Common Shares” means the common shares described in Paragraph 5;

(l) “Newco Preferred Shares” means the preferred shares described in Paragraphs 5 and 6;

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

(n) XXXXXXXXXX

(o) “paid-up capital” has the meaning assigned by subsection 89(1);
 
(p) “Paragraph” means a numbered paragraph in this letter;

(q) “Parentco” means XXXXXXXXXX, the corporation described in Paragraph 1;

(r) “Parentco Affiliated Group” means Parentco, Profitco and Newco;

(s) “Parentco Loan” means the non-interest-bearing loan described in Paragraph 11;

(t) “Profitco” means XXXXXXXXXX, the corporation described in Paragraph 3;

(u) “Profitco Loan” means the interest-bearing loan described in Paragraph 9;

(v) “Proposed Transactions” means the transactions described in Paragraphs 5 to 14;

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

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

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

FACTS

1. Parentco is a taxable Canadian corporation and a public corporation, existing under the CBCA, the shares of which are listed on the XXXXXXXXXX. Parentco owns all of the issued and outstanding shares of Profitco. Parentco, along with its various subsidiaries, provides XXXXXXXXXX. Parentco also offers XXXXXXXXXX. Parentco and its subsidiaries employ approximately XXXXXXXXXX people in XXXXXXXXXX offices across XXXXXXXXXX countries. Parentco is the ultimate parent of the Parentco affiliated Group. Parentco’s head office is located at XXXXXXXXXX.  Parentco’s Taxation Centre is XXXXXXXXXX, its Tax Services Office is XXXXXXXXXX and its tax account number is XXXXXXXXXX. 

2. The taxation year of Parentco ends on XXXXXXXXXX. As of XXXXXXXXXX, Parentco had non-capital losses of $XXXXXXXXXX. Parentco forecasts an additional non-capital loss will be incurred in the amount of approximately $XXXXXXXXXX for its XXXXXXXXXX tax year. The following are the actual and forecasted non-capital losses for the tax years of XXXXXXXXXX:

XXXXXXXXXX

3. Profitco is a taxable Canadian corporation. Profitco is a wholly-owned subsidiary of Parentco incorporated under the XXXXXXXXXX. Profitco’s head office is located at XXXXXXXXXX.  Profitco’s Taxation Centre is XXXXXXXXXX, its Tax Services Office is XXXXXXXXXX and its tax account number is XXXXXXXXXX.

4. The taxation year of Profitco ends on XXXXXXXXXX. It is currently expected that Profitco will be taxable in its fiscal year ending on XXXXXXXXXX and as such, will have sufficient income for tax purposes to fully utilize as a deduction the interest paid or payable on the Profitco Loan. Profitco is forecasting taxable income of approximately $XXXXXXXXXX for its fiscal year ending on XXXXXXXXXX.

PROPOSED TRANSACTIONS

5. Parentco will incorporate a new wholly-owned subsidiary (“Newco”) under the CBCA. Newco will be a taxable Canadian corporation. Newco’s share capital will include XXXXXXXXXX common shares (“Newco Common Shares”) and XXXXXXXXXX preferred shares (“Newco Preferred Shares”). Newco will not carry on any business and its activities will be limited to investing the proceeds received upon the issuance of its Newco Preferred Shares to Profitco as described in Paragraph 10 below, in the non-interest-bearing loan to Parentco as described in Paragraph 11 below.

6. The Newco Preferred Shares will 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 the 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 the Parentco Loan, 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 annually, calculated daily and accruing by reference to the redemption amount of Newco Preferred Shares at a rate equal to XXXXXXXXXX% per annum.

7. Parentco will subscribe for Newco Common Shares for nominal consideration.

8. Parentco will borrow $XXXXXXXXXX from arm’s length financial institutions on a daylight loan basis by drawing on its available Credit Facility (the “Daylight Loan”).

9. Parentco will use the proceeds of the Daylight Loan to make a $XXXXXXXXXX loan bearing interest at the rate of XXXXXXXXXX% per annum to Profitco (the “Profitco Loan”). The Profitco Loan will be payable on demand. No portion of the interest on the Profitco Loan will be a “contingent amount” as defined in subsection 143.4(1) of the Act.

10. Profitco will use the proceeds from the Profitco Loan to subscribe for Newco Preferred Shares for a total amount of $XXXXXXXXXX. The aggregate redemption amount, fair market value, adjusted cost base and paid-up capital of the Newco Preferred Shares issued will be $XXXXXXXXXX. The amount of dividends received by Profitco on the Newco Preferred Shares will be sufficient to permit Profitco to realize a profit on its investment in the Newco Preferred Shares, after the deduction of any interest on the Profitco Loan.

11. On or before XXXXXXXXXX, Newco will use the proceeds from the issuance of the Newco Preferred Shares to make a non-interest-bearing loan of $XXXXXXXXXX to Parentco (the “Parentco Loan”).

12. Parentco will use the proceeds from the Parentco Loan to repay the Daylight Loan.

13. The following transactions will occur on the Anniversary Date, or the first business day following the Anniversary Date should it fall on a non-business day, of every taxation year that the Profitco Loan is outstanding:

(a) Pursuant to a capital contribution agreement, Parentco will make a contribution of capital to Newco in an amount equal to the amount of the accrued and unpaid dividends, if any, payable on such date on the 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 or the paid-up capital of Newco at any time. 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 Generally Accepted Accounting Principles and International Financial Reporting Standards (IFRS).  Parentco will not claim, at any time, a capital loss in respect of these capital contributions to Newco;

(b) Newco will pay the accrued and unpaid dividends on the Newco Preferred Shares; and

(c) Profitco will pay the accrued and unpaid interest on the Profitco Loan.

14. At the earlier of (i) XXXXXXXXXX years from the implementation date or (ii) when Parentco’s non-capital losses described in Paragraph 2 have been utilized as described in the Proposed Transactions, the loss consolidation structure will be unwound in the following manner:

(a) Newco will redeem the Newco Preferred Shares held by Profitco for an amount equal to their aggregate redemption amount;

(b) As payment for the redemption of the Newco Preferred Shares, Newco will deliver the Parentco Loan to Profitco;

(c) The Parentco Loan and the Profitco Loan will be satisfied and extinguished by way of set-off; and

(d) Parentco, as sole shareholder of Newco immediately before the winding-up, will pass a resolution authorizing and requiring Newco to be wound up into Parentco. A general conveyance of the remaining assets of Newco and assumption of liabilities of Newco, if any, will be executed between Newco and Parentco. Newco will file articles of dissolution with the appropriate corporate registry within a reasonable time after the winding-up resolution is passed.

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) of the Act or a financial intermediary corporation as defined in subsection 191(1) of the Act.  Profitco will not acquire the Newco Preferred Shares in its ordinary course of business.

16. The Newco Preferred Shares described in Paragraph 6 will not be, at any time during the implementation of the Proposed Transactions described herein:

(a) the subject of any undertaking that is a guarantee agreement; including any guarantee, covenant or agreement to purchase the Newco Preferred Shares and including the lending of funds to or the placing of amounts on deposit with, or on behalf of, Profitco or any “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 Newco 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 Newco Preferred Shares or any other property;

(b) the subject of a dividend rental arrangement (and nor will any of the dividends paid on the Newco Preferred Shares in the course of the Proposed Transactions be received as part 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).

17. As supported by the undrawn amount on the Credit Facility, the management of Parentco confirms that the amount of the Daylight Loan is within Parentco’s borrowing capacity and would be sufficient to complete the Proposed Transactions described in Paragraphs 5 to 14.

18. Based on Parentco’s existing and anticipated assets and resources, Parentco will have the financial capacity to make the capital contributions to Newco as described in Paragraph 13.

19. On XXXXXXXXXX, Parentco entered into an arrangement agreement in connection with the acquisition of all of the issued and outstanding shares of Profitco at which time Parentco and Profitco became affiliated persons and related persons.  Parentco’s acquisition of Profitco was completed on XXXXXXXXXX.  Parentco and Profitco will continue to be affiliated and related to each other throughout the Proposed Transactions.  There has been no acquisition or deemed acquisition of control (de jure or de facto) of Parentco during the years in which Parentco incurred its non-capital losses as described in Paragraph 2.

20. Profitco and Parentco will undertake steps to ensure that the interest income earned by Parentco under the Proposed Transactions will not exceed an amount that could be fully sheltered with Parentco’s non-capital losses. Profitco expects to earn taxable income in excess of the interest expense that will arise by virtue of the implementation of the Proposed Transactions. However, it is possible that a non-capital loss may arise to Profitco as a result of the Proposed Transactions. Any such non-capital losses will be applied in accordance with the rules in section 111. For greater certainty, no losses will be carried back to a taxation year in which Parentco and Profitco were not affiliated or related persons. Further, no amount in respect of such losses will be deducted by Profitco in computing its income for any taxation year that ends more than XXXXXXXXXX taxation years after the end of Parentco’s XXXXXXXXXX taxation year (or such other period as may be prescribed from time to time under paragraph 111(1)(a), or any successor provision, for a non-capital loss incurred by Parentco in a taxation year ending on XXXXXXXXXX).

PURPOSE OF THE PROPOSED TRANSACTIONS

21. The purpose of the Proposed Transactions is to effect a tax consolidation of Profitco and Parentco by causing Parentco to earn interest income, thus permitting Parentco to utilize its non-capital loss carry forwards, and to have Profitco incur interest expense to reduce its income for its current taxation year, and to the extent this creates non-capital losses for Profitco, to carry back the non-capital losses to reduce its taxable income from prior taxation years in which Parentco and Profitco were affiliated or related persons.

22. The only purpose of both the payment and the receipt of the dividends on Newco’s Preferred Shares described in Paragraph 13 is to provide a reasonable return on the Newco Preferred Shares issued by Newco to Profitco. More specifically, none of the purposes of the dividends is to reduce the fair market value or capital gain of any share, nor to increase the total cost amounts of properties of Profitco.

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 further provided that the Proposed Transactions are completed in the manner described above and there are no other transactions which may be relevant to the rulings requested, we rule as follows:

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

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

C. Dividends received by Profitco on the 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;

D. Provided that the only purpose of both the payment and receipt of the dividends on Newco’s Preferred Shares is as described in Paragraph 22 and that the Proposed Transactions are undertaken in the manner described above, subsection 55(2) will not apply to the dividends received by Profitco on the Newco Preferred Shares as described in Paragraph 13;

E. The provisions of subsection 88(1) will apply to the winding-up of Newco into Parentco as described in Paragraph 14, such that:

a. Newco will be deemed, pursuant to paragraph 88(1)(a), to have disposed of its assets for an amount equal to the cost amount to Newco immediately before the winding-up;

b. Parentco will be deemed, pursuant to paragraph 88(1)(b), to have disposed of Newco’s common shares that it owns for proceeds of disposition equal to the greater of the amounts described in subparagraphs 88(1)(b)(i) and (ii);

c. Parentco will be deemed, pursuant to paragraph 88(1)(c), to have acquired the assets of Newco that are distributed to Parentco on the winding-up for an amount equal to the proceeds of disposition to Newco;

F. Subsection 245(2) 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; and

G. 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.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R7 dated April 22, 2016, and are binding on the CRA provided that the Proposed Transactions, as described in Paragraphs 5 to 12, are commenced by XXXXXXXXXX, and that the other Proposed Transactions are implemented as described.

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) whether there has been an acquisition or deemed acquisition of control of any of the entities described in the ruling;

(e) 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; 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 sincerely,

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

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