2018-0742641R3 Loss consolidation arrangement

Principal Issues: Whether a loss consolidation arrangement involving a loan to buy preferred shares for the purposes of earning income would meet the CRA's requirement for acceptable loss consolidation transactions. As a result of the loan, interest income would be earned by Lossco and Profitco would incur interest expenses.

Position: Yes.

Reasons: Consistent with previous rulings.

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

XXXXXXXXXX                                                                                                 2018-074264

XXXXXXXXXX 2018

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling Request
        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 (the “Taxpayers”). We also acknowledge the information provided in various emails.

To the best of your knowledge and that of the Taxpayers, none of the issues involved in the ruling request is:

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

iii.  under objection by any of the Taxpayers or a related person;

iv.   the subject of a current or completed court process involving the Taxpayers or a related person; or

v.    the subject of a ruling request previously considered by the Directorate.

The Taxpayers have also confirmed that the proposed transactions described herein will not result in the Taxpayers or any person related to the Taxpayers being unable to pay any of their outstanding tax liabilities.  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.

This document is based solely on the facts described below. Any 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

In this letter, the following terms or expressions have the meanings specified:

“affiliated” has the meaning assigned in subsection 251.1(1);

“Company Act” means XXXXXXXXXX as amended;

“Daylight Loan” means the loan described in Paragraph 13 below;

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

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

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

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

“financial intermediary corporation” has the meaning assigned by subsection 191(1);

“forgiven amount” has the meaning assigned by subsection 80(1) or 80.01(1);

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

“guarantee agreement” has the meaning assigned by subsection 112(2.2);

“Lossco” means XXXXXXXXXX, incorporated on XXXXXXXXXX pursuant to the Company Act;

“Newco” means the new corporation as described in Paragraph 12;

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

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

“Paragraph” means a numbered paragraph in this advance income tax ruling;

“principal amount” has the meaning assigned by subsection 248(1);

“Profitco” means XXXXXXXXXX, a Canadian resident corporation whose shares are wholly-owned by Lossco;

“Proposed Transactions” means the transactions described in Paragraphs 12 to 22;

XXXXXXXXXX;

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

“specified financial institution” has the meaning assigned by subsection 248(1);

“subsidiary controlled corporation” has the meaning assigned by subsection 248(1);

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

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

“taxable income” has the meaning assigned by subsection 248(1).

FACTS

1.    Lossco is XXXXXXXXXX a taxable Canadian corporation. XXXXXXXXXX. Lossco is incorporated under the Company Act. Lossco’s head office is located at XXXXXXXXXX. Lossco deals with the XXXXXXXXXX Tax Services Office and files its tax return with the XXXXXXXXXX Taxation Centre.

2.    Lossco is the corporate parent of a group of Canadian and non-Canadian corporations XXXXXXXXXX. Lossco provides XXXXXXXXXX to Lossco’s subsidiaries (including Profitco). The XXXXXXXXXX provided by Lossco include XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) and Part IV of the Income Tax Regulations, all of Lossco’s gross revenue and salaries and wages were allocated to XXXXXXXXXX in the year ended XXXXXXXXXX. The provincial allocation factor for the purpose of allocating taxable income for Lossco is expected to continue to be XXXXXXXXXX% allocable to XXXXXXXXXX during the period that is subject to the loss consolidation arrangement.

3.    Lossco owns all the shares of Profitco.

4.    Profitco is incorporated under the Company Act and is a taxable Canadian corporation. Profitco operates and owns XXXXXXXXXX% of the XXXXXXXXXX. For the purpose of the definition of “taxable income earned in a province” under subsection 124(4) and Part IV of the Income Tax Regulations, all of Profitco’s gross revenue and salaries and wages were allocated to XXXXXXXXXX in the year ended XXXXXXXXXX. The provincial allocation factor for the purpose of allocating taxable income for Profitco is expected to continue to be XXXXXXXXXX% allocable to XXXXXXXXXX during the period that is subject to the loss consolidation arrangement. Profitco’s head office is located at XXXXXXXXXX. Profitco deals with the XXXXXXXXXX Tax Services Office and files its tax return with the XXXXXXXXXX Taxation Centre.

5.    Lossco and Profitco both have a XXXXXXXXXX tax year end.

6.    Lossco and Profitco do not deal at arm’s length and are related and affiliated to one another for purposes of the Act.

7.    As at XXXXXXXXXX, Lossco had non-capital losses carried forward of $XXXXXXXXXX. Absent the Proposed Transactions, it is estimated that Lossco will generate non-capital losses of approximately $XXXXXXXXXX in the taxation year ended XXXXXXXXXX. Absent the Proposed Transactions, it is estimated that Lossco will generate non-capital losses of approximately $XXXXXXXXXX in each of the XXXXXXXXXX, and XXXXXXXXXX taxation years.

8.    As at XXXXXXXXXX, Profitco had non-capital losses carried forward of $XXXXXXXXXX and undepreciated capital cost carried forward of $XXXXXXXXXX. Based on Profitco’s current tax attributes, Profitco is not expected to pay tax in the XXXXXXXXXX and XXXXXXXXXX taxation years. Absent the Proposed Transactions, a high level estimate of Profitco’s taxable income will be $XXXXXXXXXX and $XXXXXXXXXX in the XXXXXXXXXX and XXXXXXXXXX taxation years, respectively based on XXXXXXXXXX.

9.    Lossco earned XXXXXXXXXX from wholly-owned subsidiaries of $XXXXXXXXXX in XXXXXXXXXX ($XXXXXXXXXX from Profitco and collectively $XXXXXXXXXX from XXXXXXXXXX resident corporation, and XXXXXXXXXX a Canadian incorporated subsidiary). It is expected that Lossco will earn $XXXXXXXXXX in XXXXXXXXXX from XXXXXXXXXX and XXXXXXXXXX in each of XXXXXXXXXX and XXXXXXXXXX.

10.   Lossco had a balance of cash and cash equivalents in excess of $XXXXXXXXXX in XXXXXXXXXX and XXXXXXXXXX. Lossco is expected to maintain sufficient levels of cash that would generate sufficient interest income to cover the dividend spread of XXXXXXXXXX% over the course of the loss consolidation arrangement. XXXXXXXXXX.

11.   Lossco and its subsidiaries XXXXXXXXXX. Lossco and its subsidiaries XXXXXXXXXX.

PROPOSED TRANSACTIONS

12.   Lossco will incorporate a new corporation, Newco under the Company Act. Newco will have a XXXXXXXXXX taxation year-end and will be a “taxable Canadian corporation”. The authorized share capital of Newco will consist of an unlimited number of common shares without nominal or par value (“Newco Common Shares”) and an unlimited number of redeemable and retractable preferred shares (“Newco Preferred Shares”). Lossco will subscribe for one Newco Common Share for $XXXXXXXXXX on incorporation.

13.   Lossco will borrow $XXXXXXXXXX on a daylight basis from an unrelated, arm’s length financial institution (the “Daylight Loan”) on arm’s length commercial terms customary for this type of loan.

14.   Lossco will lend the proceeds from the Daylight Loan to Profitco by making a subordinated interest-bearing loan (the “Profitco Loan”). The Profitco Loan may be settled at the option of Profitco in cash or by delivering a financial asset, at any time, without penalty. The Profitco Loan will bear a fixed interest rate of XXXXXXXXXX%, based on a comparison to the most recent arm’s length senior secured financing issued in XXXXXXXXXX. The interest will be payable annually in arrears.

Based on Profitco’s financial projections, it has the financial capacity to pay the interest on the Profitco Loan from its own cash flow (calculated as its net accounting income before depreciation and taxes).

15.   Profitco will use the proceeds of the Profitco Loan to subscribe for Preferred Shares in Newco.

The authorized Preferred Shares of Newco will have the following features:

(i)   the shares will be non-participating and non-voting;

(ii)  entitled to cumulative dividend at an annual rate equal to the interest rate on the Profitco Loan, plus one basis point. The dividend rate for the Preferred Shares of Newco will be XXXXXXXXXX%;

(iii) redeemable at any time at the option of the holder for cash or delivering a financial asset (including the Lossco Loan described in Paragraph 16) for an amount equal to the per share subscription price at which each share was issued (the “Redemption Amount”), plus any accrued but unpaid dividends, by Newco; and

(iv)  retractable at any time at the option of Newco for cash or delivering a financial asset (including the Lossco Loan issued under Paragraph 16) for an amount equal to the per share subscription price at which each share was issued (the "Redemption Amount"), plus any accrued but unpaid dividends, by Newco.

The Newco Preferred Shares may also be redeemed by setting off amounts owing under the Profitco Loan against the redemption price of the Newco Preferred Shares in circumstances where Newco becomes the holder of the Profitco Loan as described in Paragraph 14. The terms of the Lossco Loan as described in Paragraph 16 and the Profitco Loan will provide that if Profitco becomes the holder of the Lossco Loan, the Lossco Loan can, at the option of either Profitco or Lossco, be set off against the Profitco Loan.

16.   Newco will lend to Lossco the subscription proceeds received in Paragraph 15 on an interest-free demand basis (“Lossco Loan”). The terms of the Lossco Loan will allow Lossco to repay the Lossco Loan by assigning the Profitco Loan to Newco.

17.   Lossco will use the proceeds from the Lossco Loan to repay the Daylight Loan.

18.   Profitco will pay interest to Lossco on the Profitco Loan on an annual basis.

19.   Lossco will agree to and will make contributions of capital to the Common Share capital of Newco on an annual basis equal to the amount of dividends to be paid by Newco to Profitco in respect of the Newco Preferred Shares for so long as such preferred shares are outstanding.

20.   Lossco will have a source of income, independent of its investment in Profitco, sufficient to fund the amount of the capital contribution to Newco (described in Paragraph 19) in excess of the interest income received by Lossco on the Profitco Loan.

21.   Newco will use the amount received as capital contributions in Paragraph 19 to pay dividends on the Newco Preferred Shares to Profitco on an annual basis.

22.   The Proposed Transactions will unwind as follows on or before XXXXXXXXXX:

(a)   Profitco will pay the balance of any accrued and unpaid interest on the portion of the Profitco Loan settled under Paragraph 22(e);

(b)   Lossco will make capital contributions to the Newco Common Share capital equal to the amount of any accrued and unpaid dividends on the Newco Preferred Shares;

(c)   Newco will pay the balance of any accrued and unpaid dividends on the Preferred Shares held by Profitco redeemed under Paragraph 22(d);

(d)   Newco will redeem all the Newco Preferred Shares held by Profitco and settle the amount owing on redemption by assigning a corresponding amount of the Lossco Loan to Profitco;

(e)   Profitco will repay all or a portion of the Profitco Loan equal to the amount of Newco Preferred Shares redeemed under Paragraph 22(d) by setting off the amount owing to Lossco with a corresponding amount of the Lossco Loan and such portions of the Profitco Loan and the Lossco Loan will be cancelled; and

(f)   Once all of the Newco Preferred Shares held by Profitco have been redeemed and all of the Lossco Loan has been assigned to Profitco as described in Paragraph 22(d) and Paragraph 22(e), Newco will be wound up into Lossco pursuant to subsection 88(1) of the Act.

OTHER REPRESENTATIONS

23.   Lossco, Profitco and Newco are neither “specified financial institutions” nor “financial intermediary corporations”.

24.   The Newco Preferred Shares will not at any time during the implementation of the Proposed Transactions 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;

(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).

25.   Lossco, Profitco and Newco are related persons and affiliated persons for purposes of the Act and will continue to be related and affiliated persons throughout the period that the loss consolidation arrangement is in place.

26.   The payment of dividends on the Newco Preferred Shares has no purpose other than the purpose described under the heading "Purpose of the Proposed Transactions".

27.   Each of Lossco and Newco will agree with Profitco that Newco shall be a single purpose company, shall have no liabilities and shall carry on (and Lossco will cause to carry on) no business other than that contemplated by the Proposed Transactions.

28.   The Proposed Transactions will be legally effective.

PURPOSE OF THE PROPOSED TRANSACTIONS

29.   The overall purpose of the Proposed Transactions is to enable Lossco to earn sufficient interest income, over the duration of the loss consolidation arrangement, so as to utilize its accumulated non-capital losses and non-capital losses that it would otherwise incur in a taxation year.

30.   In order to undertake the Proposed Transactions in an efficient manner, it is necessary to include Newco to enable Profitco to subscribe for the Newco Preferred Shares (described in Paragraph 15). XXXXXXXXXX.

31.   The purpose of both the payment and the receipt of the dividends on the Newco Preferred Shares, as described in Paragraph 21, is to provide a reasonable return on the Newco Preferred Shares issued by Newco to Profitco. Furthermore, the purpose of the dividends is not 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 above Facts, Proposed Transactions, Other Representations and Purpose of the Proposed Transactions constitute a complete and accurate disclosure of all of the information relevant to the ruling request, 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, 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 payable in respect of the Profitco Loan for that taxation year; and (ii) a reasonable amount in respect thereof.

B.    The dividends received by Profitco, as described in Paragraph 21 and Paragraph 22(c) above will be “taxable dividends” that will, pursuant to subsection 112(1), be deductible in computing the taxable income of Profitco for the year in which the dividend is received, and, for greater certainty, such deductions will not be precluded by any of subsections 112(2.1), 112(2.2), 112(2.3) and 112(2.4).

C.    Part IV.1 of the Act will not apply to the dividends described in Paragraph 21 and Paragraph 22(c) because the dividends will be an “excepted dividend” under section 187.1 and because the dividends will be excluded dividends pursuant to paragraph (a) of the definition of “excluded dividend” in subsection 191(1).

D.    The receipt by Newco of capital contributions from Lossco as described in Paragraphs 19 and 22(b) will not be included in the income of Newco pursuant to section 9, paragraphs 12(1)(c) or 12(1)(x).

E.    Provided that the purpose of the dividends in Paragraphs 21 and 22(c) is what is described in the “Purpose of the Proposed Transactions” above and the Proposed Transactions are undertaken in the manner described above, subsection 55(2) will not apply in respect of the dividends described in Paragraphs 21 and 22(c) above.

F.    The settlement of the Profitco Loan and Lossco Loan as described in Paragraph 22(e) will not give rise to any forgiven amount under section 80.

G.    The provisions of subsections 15(1), 56(2), 69(1), 69(4), 69(11) and 246(1) will not be applied as a result of the Proposed Transactions in and by themselves.

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 70-6R7 dated April 22, 2016, and are binding on the CRA provided that the Proposed Transactions, as described in paragraphs 12 to 17 are entered into on or before XXXXXXXXXX, and the Proposed Transactions related to the payment of interest and dividends and to the windup, as described in paragraphs 18 to 22, are 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.

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 amount of any non-capital loss, net capital loss or any other amount of any corporation referred to herein;

(c)   the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions; 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 sincerely,

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

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