2018-0771891R3 Standard Loss Consolidation

Principal Issues: Whether Lossco would be entitled to apply existing non-capital losses against the interest income that would be generated as part of particular loan that would be made under the loss consolidation transaction and whether the accompanying interest expense would be deductible by Profitco.

Position: Yes.

Reasons: The proposed transactions conform to our requirements for these types of loss consolidation rulings. The proposed transactions would be legally effective and commercially realistic.

Author: XXXXXXXXXX
Section: 245; 20(1)(c); 112(1); 55(2); 88(1.1)

XXXXXXXXXX                                                                           2018-077189

XXXXXXXXXX, 2018

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling Request
         XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX, in which you requested an advance income tax ruling on behalf of the above-noted taxpayers (the “Taxpayers”). We also acknowledge the information provided in correspondence concerning your request.

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

(a)   in an earlier 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)   before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or

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

Unless otherwise stated all statutory references are to the Income Tax Act (Canada), R.S.C. 1985, c.1 (5th Supp.) as amended (the “Act”).

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

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

(b)   “affiliated person” has the meaning assigned by section 251.1;

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

(d)   “CBCA” means the Canada Business Corporations Act, R.S.C. 1995, c. C‑44, as amended;

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

(f)   “Daylight Loan” means the loan made by an arm's length financial institution to Lossco described in Paragraph 15;

(g)   “DRA” means a dividend rental arrangement, as defined by subsection 248(1);

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

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

(j)   “implementation date” means on or about XXXXXXXXXX;

(k)   “Lossco” means XXXXXXXXXX, the corporation described in Paragraph 1;

(l)   “Lossco Note” means the demand non-interest bearing promissory note described in Paragraph 18;

(m)   “Newco” means a new corporation incorporated under the CBCA which is described in Paragraph 13;

(n)   “Newco Common Shares” means the common shares of Newco described in Paragraph 13;

(o)   “Newco Preferred Shares” means the preferred shares of Newco described in Paragraph 13;

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

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

(r)   “Paragraph” means a numbered paragraph in this letter;

(s)   “Profitco” means XXXXXXXXXX, the corporation described in Paragraph 2;

(t)   “Profitco Note” means the interest bearing promissory note described in Paragraph 16;

(u)   “Proposed Transactions” means the transactions described in Paragraphs 14 to 28;

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

(w)   “refundable dividend tax on hand” has the meaning assigned by subsection 129(3);

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

(y)   “SEA” means synthetic equity arrangement, as defined by subsection 248(1);

(z)   “SFI” means a specified financial institution, as defined by subsection 248(1);

(aa)  “subject corporation” has the meaning assigned by subsection 186(3);

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

(cc)  “Tax-indifferent investor” has the meaning assigned by subsection 248(1); and

(dd)  XXXXXXXXXX.

FACTS

1.    Lossco is a taxable Canadian corporation and a public corporation, the subordinate voting shares of which are listed on the XXXXXXXXXX under the symbol “XXXXXXXXXX”. Lossco is a XXXXXXXXXX. Lossco’s registered address is XXXXXXXXXX. It files its return with the XXXXXXXXXX Tax Centre and is served by the XXXXXXXXXX Tax Services Office. Its business number is XXXXXXXXXX. Lossco’s taxation year-end is XXXXXXXXXX.

2.    Profitco is a taxable Canadian corporation and all the common shares of Profitco are held by Lossco. Profitco is a XXXXXXXXXX and XXXXXXXXXX. Profitco XXXXXXXXXX. Profitco’s registered address is XXXXXXXXXX. It files its return with the XXXXXXXXXX Tax Centre and is served by the XXXXXXXXXX Tax Services Office. Its business number is XXXXXXXXXX. Profitco’s taxation year-end is XXXXXXXXXX.

3.    Lossco has unexpired non-capital losses carried forward of approximately $XXXXXXXXXX as of the end of its taxation year ended XXXXXXXXXX.

In particular, the breakdown of these losses is as follows:

XXXXXXXXXX

4.    Absent the Proposed Transactions, it is expected that Lossco will generate non‑capital losses of $XXXXXXXXXX in the XXXXXXXXXX taxation year, $XXXXXXXXXX in the XXXXXXXXXX taxation year and $XXXXXXXXXX in the XXXXXXXXXX taxation year. These non-capital losses are expected to accumulate in Lossco and would remain unused without the implementation of the Proposed Transactions.

5.    Profitco has unexpired non-capital losses carried forward of approximately $XXXXXXXXXX as of the end of its taxation year ended XXXXXXXXXX.

In particular, the breakdown of these losses is as follows:

XXXXXXXXXX

6.    Profitco has a carried forward balance of charitable donations of approximately $XXXXXXXXXX as of the end of its taxation year ending XXXXXXXXXX.

7.    Profitco will use its tax attributes, as described in Paragraphs 5 and 6, before or concurrently to any of the losses that arise as a result of the Proposed Transactions.

8.    The borrowing capacity of Lossco and its subsidiaries significantly exceeds the maximum amount of $XXXXXXXXXX required to complete the Proposed Transactions described in Paragraphs 14 to 19.

9.    Profitco anticipates generating taxable income (before application of non-capital losses) in its taxation years ending from XXXXXXXXXX to XXXXXXXXXX of approximately $XXXXXXXXXX in aggregate.

In particular, the breakdown of Profitco’s expected taxable income prior to utilizing carried-forward losses is as follows:

XXXXXXXXXX

10.   Profitco estimates generating taxable income in the years following XXXXXXXXXX. The taxable income is anticipated to be sufficient to absorb the additional interest expense on the Profitco Note as described in Paragraph 16.

11.   Lossco operates through XXXXXXXXXX.

12.   Profitco operates through XXXXXXXXXX.

13.   On XXXXXXXXXX, Lossco incorporated a new wholly-owned subsidiary ("Newco") under the CBCA. Newco is a taxable Canadian corporation. The taxation year-end of Newco is XXXXXXXXXX. Newco's share capital includes an unlimited number of common shares ("Newco Common Shares") and an unlimited number of preferred shares ("Newco Preferred Shares"). Newco does not and will not carry on any business and its activities will be limited to investing the proceeds received from the subscription for the Newco Preferred Shares in the Lossco Note as described below in Paragraph 18.

The Newco Preferred Shares 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 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, (ii) delivery of property having a fair market value at the time of redemption equal to the aggregate redemption amount or (iii) delivery of the Lossco Note, 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, calculated daily and accruing by reference to the redemption amount of the Newco Preferred Shares, at a rate that is reasonable, based on the current prevailing market rate described in Paragraph 16 for the Profitco Note, plus 0.01% per annum.

PROPOSED TRANSACTIONS

Implementation of the structure

14.   Lossco will subscribe for Newco Common Shares for nominal consideration.

15.   Lossco will borrow $XXXXXXXXXX in one or more tranches to be determined by the company 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.

16.   Lossco will use the proceeds received from Daylight Loan to make an interest bearing loan of $XXXXXXXXXX to Profitco (“Profitco Note”), on the following conditions:

(a)   simple interest will accrue on the Profitco Note and will be calculated daily at an annual fixed rate that is reasonably equal to a commercial arm's length rate applicable in these facts and circumstances, presently estimated to be 5% per annum. The interest on the Profitco Note will be paid on or before the last business day of each calendar year;

(b)   Lossco's recourse against Profitco to obtain repayment of the Profitco Note will be limited to the Newco Preferred Shares owned by Profitco (together with all proceeds from such shares) only, and not to any other assets of Profitco, as further described in Paragraph 17. As security for the indebtedness evidenced by the Profitco Note, Profitco will grant Lossco a security interest in the Newco Preferred Shares; and

(c)   the Profitco Note will be repayable on demand and will also provide that the principal amount may be satisfied at Profitco's option, either by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the principal amount, (iii) delivery of the Newco Preferred Shares or, (iv) way of set-off against the Lossco Note if the Lossco Note belongs to Profitco at the time of repayment.

17.   Profitco will use the proceeds received from the Profitco Note to subscribe for Newco Preferred Shares having an aggregate issue price equal to the principal amount of the Profitco Note of $XXXXXXXXXX. The aggregate redemption amount, retraction amount, adjusted cost base and paid-up capital of the Newco Preferred Shares issued will be equal to the subscription amount of the Newco Preferred Shares.

18.   Newco will use the proceeds received from the issuance of the Newco Preferred Shares to make a non-interest bearing loan of $XXXXXXXXXX to Lossco (“Lossco Note”), which will be repayable on demand and which will provide that the principal amount may be satisfied by way of set-off against the Profitco Note if the Lossco Note belongs to Profitco at the time of repayment.

19.   Lossco will use the proceeds from the Lossco Note to repay the Daylight Loan amounting to $XXXXXXXXXX.

Maintenance of the structure

20.   The following transactions will occur, once a year, at or shortly before the end of each calendar year, in immediate sequence when jointly determined by Lossco, Profitco and Newco. Amounts are determined based on the effect of the implementation of the Proposed Transactions for a complete year. The amount will be prorated in the situation where the effect of the Proposed Transactions is less than a complete year:

(a)   Pursuant to a capital contribution agreement, Lossco will make a capital contribution to Newco in an amount equal to the amount of any accrued and unpaid dividends on the Newco Preferred Shares. No shares will be issued by Newco with respect to the capital contribution and no amount will be added to the stated capital of Newco. The amount of each capital contribution will be recorded as contributed surplus for accounting purposes. The capital contribution will not be income to Newco pursuant to International Financial Reporting Standards;

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

(c)   Profitco will pay to Lossco the accrued and unpaid interest on the Profitco Note.

Unwind of the structure

21.   It is expected that the structure will be unwound in the following manner no later than XXXXXXXXXX. However, Lossco, Profitco and Newco may need to postpone the dismantling of the structure no later than XXXXXXXXXX, in which case the CRA will be notified.

22.   If Newco has any accrued and unpaid dividends on the Newco Preferred Shares, Lossco will make a capital contribution to Newco in an amount of the accrued and unpaid dividends on the Newco Preferred Shares, pursuant to a capital contribution agreement. No shares will be issued by Newco with respect to the capital contribution and no amount will be added to the stated capital of Newco. XXXXXXXXXX.

23.   Newco will pay to Profitco any accrued and unpaid dividends on the Newco Preferred Shares.

24.   Profitco will pay to Lossco any accrued and unpaid interest on the Profitco Note.

25.   Newco will redeem the Newco Preferred Shares held by Profitco for an amount equal to their aggregate redemption amount.

26.   As payment for the redemption of the Newco Preferred Shares, Newco will deliver the Lossco Note to Profitco.

27.   The Profitco Note and the Lossco Note will be satisfied and extinguished by way of set-off.

28.   Lossco, as sole shareholder of Newco, will pass a resolution authorizing and requiring Newco to be wound up into Lossco pursuant to subsection 88(1). As a consequence, Newco's assets will be transferred to Lossco and Lossco will assume Newco's liabilities.

OTHER REPRESENTATIONS

29.   Lossco, Profitco and Newco will be, during the implementation of the Proposed Transactions, related persons and affiliated persons. The structure will be dismantled before the contemplated maturity in the manner described in Paragraphs 21 to 28 if any entity previously mentioned in this Paragraph ceases to be affiliated following an acquisition of control by a non-affiliated third party.

30.   All taxpayers involved in the Proposed Transactions, are, or will be, on the basis that they are related to a corporation described in paragraphs (b) or (d) of the definition of SFI, SFIs pursuant to paragraph (g) of that definition. It is however, understood that Profitco will not acquire the Newco Preferred Shares in the ordinary course of its business.

31.   None of the corporations involved in the Proposed Transactions has entered or will enter into a DRA with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

32.   None of the shares on which a dividend is declared or paid in the course of the Proposed Transactions is the subject of any undertaking that is referred to in subsection 112(2.2) as a "guarantee agreement" or is a share that is described in subsection 112(2.4).

33.   XXXXXXXXXX

34.   Dividends received by Profitco on the Newco Preferred Shares as described in Paragraphs 20 and 23 will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1).

35.   The interest deducted by Profitco pursuant to paragraph 20(1)(c) in respect of the Profitco Note may create a non-capital loss for Profitco during the period in which the Proposed Transactions occur. Any such non-capital loss would be carried back to a prior taxation year or carried forward to a subsequent taxation year in accordance with the provisions of section 111.

36.   Lossco has an independent source of income from Profitco and earns dividend income from subsidiaries other than Profitco.

37.   Profitco and Lossco are not financial institutions as defined under subsection 190(1), for purposes of Part VI tax. Newco will not be a financial institution, as defined in subsection 190(1), for purposes of Part VI tax.

38.   At the time of the Proposed Transactions, Lossco will have the financial capacity to make relevant capital contributions to Newco as described in Paragraphs 20 and 22.

39.   At the time of the Proposed Transactions, Profitco will have the solvency and liquidity to service the Profitco Note as described in Paragraph 16.

40.   The Proposed Transactions will be legally effective.

PURPOSES OF THE PROPOSED TRANSACTIONS

41.   The purpose of the Proposed Transactions is to consolidate taxable income and non-capital losses within a group of affiliated and related persons. The Proposed Transactions will enable Lossco to earn interest income on the Profitco Note and thus will enable Lossco to effectively utilize its non-capital losses already incurred.

42.   The purpose of both the payment and the receipt of the dividends on the Newco Preferred Shares as described in Paragraphs 20 and 23 is to provide a reasonable return on such shares and to fund the interest payments made by Profitco that will be due on the Profitco Note. 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 any properties.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and the purposes of the proposed transactions, 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 that:

A.    Provided that Profitco has a legal obligation to pay interest on the Profitco Note, and that Profitco continues to hold the Newco Preferred Shares 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 Profitco Note, or (ii) a reasonable amount in respect thereof.

B.    The provisions of subsections 15(1), 56(2), 69(1), 69(4) and 246(1) will not apply to the Proposed Transactions, in and by themselves.

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 Paragraph 20.

D.    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), be deductible in computing the taxable income of Profitco 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).

E.    Part IV.1 and Part VI.1 will not apply to the dividends described in Ruling D above.

F.    Provided that the only purpose of the payment and receipt of the dividends on Newco’s Preferred Shares is as described in Paragraph 42, the provisions of subsection 55(2) will not apply to the dividends, if any, referred to in Ruling D, and received by Profitco on the Newco Preferred Shares.

G.    The provisions of subsection 80(2) and subsection 80.01(2) will not apply to the set-off and cancellation of the Profitco Note against the Lossco Note described in Paragraph 27 above and will not give rise to any gain or loss.

H.    Subsection 245(2) will not be applied as a result of entering into the Proposed Transactions, in and by themselves, to redetermine 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 14 to 19, 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 20 to 28, 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 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)   the provincial income tax implications relating to the allocation of income and expenses under the Proposed Transactions;

(e)   the application or non-application of a general anti-avoidance provision of any province; and

(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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