2018-0777621R3 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                                                                                                                                        2018-077762

XXXXXXXXXX, 2019

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 involved, none of the proposed transactions or issues involved in this Ruling request are the same as or substantially similar to transactions or issues that are:

i.    in a previously filed tax return of the taxpayers or a related person and:

A.    being considered by the CRA in connection with such return;

B.    under objection by the taxpayers or a related person; or

C.    the subject of a current or completed court process involving the taxpayers or a related person; or

ii.   the subject of a Ruling request previously considered by the Income Tax Rulings 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

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

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

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

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

XXXXXXXXXX;

“CRA” means the Canada Revenue Agency;

“Daylight Loan” means the loan made by an arm's length financial institution to Lossco described in Paragraph 14;

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

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

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

XXXXXXXXXX;

“Forco 1” means XXXXXXXXXX;

“Forco 2” means XXXXXXXXXX;

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

“Lossco Note” means the demand non-interest bearing promissory note described in Paragraph 17;

“Newco” means a new corporation incorporated under the XXXXXXXXXX which is described in Paragraph 12;

“Newco Common Shares” means the common shares of Newco described in Paragraph 12;

“Newco Preferred Shares” means the preferred shares of Newco described in Paragraph 12;

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

XXXXXXXXXX;

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

“Paragraph” means a numbered paragraph in this letter;

“Parentco” means XXXXXXXXXX, XXXXXXXXXX resident corporation the common shares of which are listed on XXXXXXXXXX under the XXXXXXXXXX;

“Parentco Affiliated Group” means Parentco, Lossco and Profitco;

XXXXXXXXXX;

“Profitco” means XXXXXXXXXX, the corporation described in Paragraph 5;

“Profitco Note” means the interest bearing promissory note described in Paragraph 15;

“Proposed Transactions” means the transactions described in Paragraphs 12 to 27;

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

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

“RFI” means “restricted financial institution” which has the meaning assigned by subsection 248(1);

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

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

“subsidiary wholly-owned corporation” has the meaning assigned by subsection 248(1); and

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

FACTS

1.    Lossco is a taxable Canadian corporation and was initially incorporated under the CBCA on XXXXXXXXXX. On XXXXXXXXXX, Lossco was legally continued under 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.    The capital stock of Lossco consists solely of common shares without par value and are wholly-owned by Forco 1. Forco 1 XXXXXXXXXX and is a wholly-owned subsidiary of Forco 2. Forco 2 is a XXXXXXXXXX. Both Forco 1 and Forco 2 are indirectly-held subsidiaries of Parentco.

3.    Parentco is a XXXXXXXXXX corporation the common shares of which are listed on the XXXXXXXXXX under the XXXXXXXXXX. The shares of Parentco are widely held by the public and it is not expected that Parentco will be subject to an acquisition of control during the period covered by this loss consolidation arrangement.

4.    XXXXXXXXXX.

5.    Profitco is a taxable Canadian corporation and a subsidiary wholly-owned corporation of Forco 1. Profitco is an active corporation 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 has a taxation year-end of XXXXXXXXXX.

6.    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

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

8.    Lossco operated through permanent establishments in the provinces of XXXXXXXXXX. Lossco had the following allocation factors, based on the interprovincial allocation for Lossco’s XXXXXXXXXX taxation year:

XXXXXXXXXX%

9.    Profitco has generated taxable income of approximately $XXXXXXXXXX in each of its last XXXXXXXXXX taxation years (XXXXXXXXXX) and it is anticipated that it will continue to earn comparable taxable income in its next XXXXXXXXXX taxation years. Absent the Proposed Transactions, it is expected that Profitco will generate taxable income of $XXXXXXXXXX in the XXXXXXXXXX taxation year, XXXXXXXXXX.

10.   Profitco operates through permanent establishments in XXXXXXXXXX Canada. Profitco has the following allocation factors, based on the interprovincial allocation for Profitco’s XXXXXXXXXX taxation year:

XXXXXXXXXX%

11.   The borrowing capacity of the Parentco Affiliated Group exceeds the maximum amount of $XXXXXXXXXX required to complete the Proposed Transactions.

PROPOSED TRANSACTIONS

Implementation of the structure

12.   Lossco will incorporate a subsidiary wholly-owned corporation registered as XXXXXXXXXX (“Newco”). Newco will be a taxable Canadian corporation. The authorized capital stock of Newco will consist of an unlimited number of common shares (“Newco Common Shares”) and an unlimited number of preferred shares (“Newco Preferred Shares”). Newco will not carry on any business and its activities will be limited to acquiring the Lossco Note.

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 equal to XXXXXXXXXX% per annum.

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

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

15.   Using the proceeds of the Daylight Loan, Lossco will 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 reasonable equal to a commercial arm’s length rate applicable in these facts and circumstances, presently estimated to be XXXXXXXXXX% per annum.  The interest on the Profitco Note will be paid on or before the last business day of each fiscal 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 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 Lossco'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.

16.   Using the proceeds of the Profitco Note, Profitco will subscribe for Newco Preferred Shares for cash consideration of $XXXXXXXXXX. The aggregate redemption amount, retraction amount, adjusted cost base, and paid-up capital of the issued Newco Preferred Shares will be equal to $XXXXXXXXXX.

17.   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.

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

Maintenance of the structure

19.   It is expected that the structure will be implemented on or before XXXXXXXXXX. Although it is expected that the loss consolidation arrangement will be unwound within one year of implementation, Lossco, Profitco and Newco may collectively agree to postpone the dismantling of the structure no later than XXXXXXXXXX, in which case maintenance of the structure would take place on an annual basis.

20.   The following transactions will occur, once a year, on or before the last business day of each fiscal 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)   Profitco will pay to Lossco the accrued and unpaid interest on the Profitco Note;

(b)   Pursuant to a capital contribution agreement, Lossco will make a contribution of capital to Newco in an amount equal to the amount of any accrued and unpaid dividends, if any, on the Newco Preferred Shares, using the interest paid by Profitco on the Profitco Note and its assets and resources as well. No shares will be issued by Newco with respect to the contribution of capital and no amount will be added to the stated capital of Newco; and

(c)   Newco will pay to Profitco the accrued and unpaid dividends on the Newco Preferred Shares.

Unwind of the structure

21.   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.

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

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

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

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

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

27.   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

28.   Lossco and Profitco are related persons and affiliated persons. Lossco, Profitco and Newco will be related persons and affiliated persons and will continue to be related persons and affiliated persons throughout the period that the loss consolidation structure is in place. The structure will be dismantled in the manner described in Paragraphs 21 to 27 if any entity previously mentioned in this Paragraph ceases to be affiliated following an acquisition of control by a non‑affiliated third party.

29.   None of the corporations involved in the Proposed Transactions are, or will be, a SFI or a RFI as defined by subsection 248(1) or a FIC as defined in subsection 191(1). Profitco will not acquire the Newco Preferred Shares in its ordinary course of business.

30.   None of the corporations involved in the Proposed Transactions has or will have entered into a “dividend rental arrangement”, as defined by subsection 248(1), with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

31.   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).

32.   Dividends received by Profitco on the Newco Preferred Shares as described in Paragraphs 20 and 22 will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1).

33.   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 21.

34.   At the time of the Proposed Transactions, Profitco will have the solvency and liquidity to service the Profitco Note as described in Paragraph 15.

35.   Lossco and Profitco will undertake steps to ensure that the interest income earned by Lossco under the Proposed Transactions will not materially exceed an amount that could be fully sheltered with Lossco’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. 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.   The Proposed Transactions will be legally effective.

PURPOSES OF THE PROPOSED TRANSACTIONS

37.   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.

38.   The purpose of both the payment and the receipt of the dividends on the Newco Preferred Shares as described in Paragraphs 20 and 22 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 subsection 88(1) will apply to the winding-up of Newco into Lossco, as described in Paragraph 27 of the Proposed Transactions, 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)   Lossco 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); and

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

C.    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.

D.    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 20 and 21.

E.    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).

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

G.    Provided that the only purpose of the payment and receipt of the dividends on Newco’s Preferred Shares is as described in Paragraph 38, the provisions of subsection 55(2) will not apply to the dividends, if any, referred to in Ruling E, and received by Profitco on the Newco Preferred Shares.

H.    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 26 above and will not give rise to any gain or loss.

I.    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.

J.    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 70-6R8 dated November 1, 2018, and are binding on the CRA provided that the proposed transactions, as described in paragraphs 12 to 18, 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 27, 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)   subject to Ruling J, the application or non-application of a general anti-avoidance provision of any province;

(f)   XXXXXXXXXX; and

(g)   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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