2018-0781971R3 Loss Consolidation

Principal Issues: Whether a particular loss consolidation arrangement is acceptable and meets accepted parameters.

Position: Yes.

Reasons: Transactions fit within CRA’s policy on loss consolidations.

Author: XXXXXXXXXX
Section: 20(1)(c); 112(1); 245(2); Part IV.1 and Part VI.1

XXXXXXXXXX
                                                                                                         2018-078197
XXXXXXXXXX, 2019

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling Request
         XXXXXXXXXX

We are writing in response to your letters 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 subsequent correspondence.

We understand that, 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 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 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.

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.

This document is based solely on the facts and proposed transactions described below.  The documentation submitted with your request does not form part of the facts and proposed transactions except as expressly referred to herein, and any references thereto are otherwise provided solely for the convenience of the reader.

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 the regulations made thereunder (the “Regulations”). All references to monetary amounts are in Canadian dollars.

DEFINITIONS

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

“affiliated person” has the meaning assigned by section 251.1, read without reference to the definition of “controlled” in subsection 251.1(3);

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

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

“CRA” means Canada Revenue Agency;

“Daylight Loan” means the loan made by Ultimate Parent to Lossco as described in Paragraph 19;

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

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

“FMV” means fair market value;

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

“Group” refers to group of companies owned directly and indirectly by Ultimate Parent;

“Loan” means the interest-bearing loan to be made by Lossco to Profitco, as described in Paragraph 20;

“Loss Utilization Arrangement” means the transactions described in paragraphs 19 to 23;

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

“Lossco Note” means the non-interest bearing promissory note described in Paragraph 24(d);

“Lossco Interest Note” means the non-interest bearing promissory note described in Paragraph 16;

“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;

“Parent” means XXXXXXXXXX, the corporation described in Paragraph 2;

“Parent NIB Loan” means the non-interest bearing loan described in Paragraph 24(b);

“Preferred Shares” means the preferred shares to be issued by Lossco to Profitco as described in Paragraph 21;

“Profitco” means XXXXXXXXXX, the corporation described in Paragraph 4;

“Promissory Note” means the senior promissory note issued by Lossco to RelatedCo1, as described in Paragraph 9;

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

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

“RelatedCo1” means XXXXXXXXXX, the corporation described in paragraph 3;

“RelatedCo2” means XXXXXXXXXX, the corporation described in paragraph 11;

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

“Target” means XXXXXXXXXX, the corporation described in paragraph 6;

“taxable Canadian corporation” has the meaning assigned by subsections 248(1) and 89(1);

“taxable dividend” has the meaning assigned by subsections 248(1) and 89(1);

“taxpayers” mean the entities described on page 1 of this document;

“taxable preferred share” has the meaning assigned by subsection 248(1);

“term preferred share” has the meaning assigned by subsection 248(1); and

“Ultimate Parent” means XXXXXXXXXX, the corporation described in paragraph 1.

FACTS

1.    Ultimate Parent is a corporation incorporated under the laws of XXXXXXXXXX, the shares of which are listed on the XXXXXXXXXX. Ultimate Parent is the owner of XXXXXXXXXX (the “Group”). The Group is XXXXXXXXXX. Ultimate Parent is a non-resident of Canada.

2.    Parent is a corporation incorporated under the laws of XXXXXXXXXX. All of the shares of Parent are held indirectly by Ultimate Parent.

3.    RelatedCo1 is a corporation incorporated under the laws of XXXXXXXXXX, and is an indirect wholly-owned subsidiary of Ultimate Parent.

4.    Profitco is a corporation incorporated under the laws of XXXXXXXXXX and is a taxable Canadian corporation. All of the shares of Profitco are owned indirectly by Parent. Profitco XXXXXXXXXX. Profitco is based in XXXXXXXXXX.  Profitco files its return with the XXXXXXXXXX Tax Centre and is served by the XXXXXXXXXX Tax Services Office. Profitco has a XXXXXXXXXX taxation year-end.

5.    Lossco is a corporation incorporated under the laws of XXXXXXXXXX and is a taxable Canadian corporation.  All of the shares of Lossco are held directly by Parent. Lossco files its return with the XXXXXXXXXX Tax Centre and is served by the XXXXXXXXXX Tax Services Office. Lossco has a XXXXXXXXXX taxation year-end.

6.    Target is a taxable Canadian corporation and has a XXXXXXXXXX taxation year-end. Target XXXXXXXXXX. Target’s issued and outstanding shares consist only of Class A common shares.

7.    Lossco was incorporated on XXXXXXXXXX in order to acquire XXXXXXXXXX% of the issued and outstanding shares of Target, which at that time dealt with Lossco at arm’s length. The authorized share capital of Lossco consists of an unlimited number of common shares and an unlimited number of preferred shares having the following terms and conditions:

a.    Common shares: voting and participating;

b.    Preferred shares: non-voting, non-participating, entitled to an annual cumulative dividend on the amount for which they were issued at a rate of XXXXXXXXXX% per annum, 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 amount for which they were issued plus any accrued and unpaid dividends.

8.    On XXXXXXXXXX, Parent subscribed for additional common shares of Lossco in consideration for cash of $XXXXXXXXXX in order to partially fund the acquisition of XXXXXXXXXX% of the issued and outstanding shares of Target.

9.    On XXXXXXXXXX, Lossco borrowed $XXXXXXXXXX from RelatedCo1 evidenced by a senior promissory note for the same amount (the “Promissory Note”) to partially fund the acquisition of Target. The Promissory Note bears interest at a rate of XXXXXXXXXX% per annum payable semi-annually.

10.   On XXXXXXXXXX, Lossco used the proceeds from the share subscription and Promissory Note to fund the purchase price of $XXXXXXXXXX for XXXXXXXXXX% of the issued and outstanding shares of Target, resulting in the acquisition of control of Target by Lossco.

11.   RelatedCo2 is a corporation incorporated under the laws of XXXXXXXXXX and is an indirect wholly-owned subsidiary of Ultimate Parent. RelatedCo2 XXXXXXXXXX. For purposes of the Act, RelatedCo2 is an insurance corporation and a specified financial institution.

12.   Profitco, Lossco, Target, Parent, RelatedCo1 and RelatedCo2 are all controlled by Ultimate Parent, and are therefore related to each other pursuant to subparagraph 251(2)(c)(i).

13.   Each of Profitco and Lossco is a “specified financial institution” as defined in subsection 248(1) as each is related to a “specified financial institution” that is indirectly controlled by Ultimate Parent (i.e. RelatedCo2, an insurance corporation).

14.   The provincial allocation factor for the purpose of allocating taxable income for Profitco for XXXXXXXXXX taxation years was XXXXXXXXXX% to XXXXXXXXXX. The projected provincial allocation factor for the purpose of allocating taxable income for Profitco for XXXXXXXXXX taxation years is expected to be substantially similar to that of XXXXXXXXXX.

15.   The provincial allocation factor for the purpose of allocating taxable income for Lossco for XXXXXXXXXX taxation year is expected to be XXXXXXXXXX% to XXXXXXXXXX, pursuant to paragraph 400(2)(e.1) of the Regulations. The projected provincial allocation factor for the purpose of allocating taxable income for Lossco for its XXXXXXXXXX taxation year is expected to be the same.

16.   In XXXXXXXXXX, Lossco borrowed $XXXXXXXXXX from Profitco evidenced by a non-interest bearing promissory note for the same amount (the “Lossco Interest Note”). Lossco used the proceeds of the Lossco Interest Note to pay the accrued interest on the Promissory Note up to the first Promissory Note interest payment date.

17.   As at XXXXXXXXXX, Lossco is expected to report a non-capital loss carryforward balance of $XXXXXXXXXX, as a result of interest expense on the Promissory Note. It is anticipated that Lossco will incur $XXXXXXXXXX of non-capital losses for its taxation year ending XXXXXXXXXX.

18.   But for the Proposed Transactions, Profitco is expecting to earn taxable income of $XXXXXXXXXX for its taxation year ending XXXXXXXXXX.

PROPOSED TRANSACTIONS

Implementation of the structure

19.   On or about XXXXXXXXXX, Lossco will borrow approximately $XXXXXXXXXX from Ultimate Parent on a daylight loan basis (the “Daylight Loan”).  The Daylight Loan will be non-interest bearing. Based on financial projections of Lossco, Lossco asserts that it will have the financial capacity to borrow these funds and that the Daylight Loan will not exceed its borrowing capacity.

20.   Lossco will use the proceeds of the Daylight Loan to make a $XXXXXXXXXX loan to Profitco (the “Loan”). The Loan will bear interest at a rate of XXXXXXXXXX% per annum. The interest on the Loan will be paid annually on XXXXXXXXXX. It is expected that Profitco will be able to use all of the interest paid or payable on the Loan against taxable income generated in the current year from its operations.

21.   Profitco will use the proceeds of the Loan to subscribe for XXXXXXXXXX preferred shares of Lossco (the “Preferred Shares”) in consideration for $XXXXXXXXXX. The Loan will be secured by a pledge by Profitco of the Preferred Shares. Security under the Loan will be limited to the pledge of the Preferred Shares. For greater certainty, when considering the application of section 112, Profitco will not acquire or be considered to have acquired the Preferred Shares in the ordinary course of its business.

22.   The legal stated capital and the fair market value of the Preferred Shares will be equal to the subscription amount paid therefor. The holders of the Preferred Shares will be entitled to fixed preferential cumulative cash dividends at a rate equal to interest rate on the Loan plus XXXXXXXXXX% (the “Spread”) for an aggregate dividend rate of XXXXXXXXXX% per share per annum. The dividends on the Preferred Shares will be payable annually commencing on XXXXXXXXXX, or such earlier date as the Preferred Shares are redeemed.

23.   Lossco will use the proceeds from the Preferred Shares subscription to repay the Daylight Loan to Ultimate Parent.

Unwind of the structure

24.   Within XXXXXXXXXX after its implementation, the Loss Utilization Arrangement will be unwound in the following order:

a.    Profitco will pay any accrued interest on the Loan.

b.    Parent will make a non-interest bearing loan to Lossco equal to the amount of the Spread for the period during which the Loss Utilization Arrangement has been in place (the “Parent NIB Loan”). Parent will have sufficient assets independent of its indirect investment in Profitco to make the Parent NIB Loan. More particularly, no cash or property received by Parent, because of its indirect shareholding in Profitco, will be used to fund the Parent NIB Loan.

c.    Subject to any applicable corporate law solvency tests, Lossco will declare and pay all accrued but unpaid dividends to Profitco in accordance with the terms of the Preferred Shares.

d.    Subject to any applicable corporate law solvency tests, Lossco will redeem the issued and outstanding Preferred Shares held by Profitco for an amount equal to the Loan and issue a non-interest bearing loan (the “Lossco Note”) to Profitco in satisfaction of the redemption proceeds.

e.    Profitco and Lossco will enter into a set-off agreement whereby the Loan will be set-off against the Lossco Note.

25.   On the second Promissory Note interest payment date, Parent will make a capital contribution to Lossco equal to the amount of the accrued interest on the Promissory Note since the issuance of the Promissory Note. Lossco will pay the unpaid interest on the Promissory Note and repay the Lossco Interest Note due to Profitco.  No shares will be issued by Lossco with respect to the contribution of capital and no amount will be added to the legal stated capital of any of Lossco’s issued and outstanding shares. The contribution of capital will not be reported as income for tax purposes.

OTHER REPRESENTATIONS

26.   It is expected that for the taxation year ending XXXXXXXXXX, Profitco will earn income in excess of the interest expense arising in Profitco as a result of the Proposed Transactions.

27.   At no time during the implementation of the Loss Utilization Arrangement described in this letter will the 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 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 (nor will Profitco receive any other property, directly or indirectly, from an investor or any property substituted therefor) 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 would be related to Lossco (if the Act were read without reference to paragraph 251(5)(b)); or

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

28.   Profitco and Lossco are specified financial institutions. However, none of the Preferred Shares will be acquired by Profitco in the ordinary course of its business.

29.   The interest rate on the Loan is a commercial rate and the terms of the Loan are arm’s length terms.

30.   At the time of the Loss Utilization Arrangement:

a.    Lossco will have the financial capacity to satisfy the applicable solvency test required to pay the dividends on the Preferred Shares, described in Paragraph and 24(c);

b.    Lossco will have the financial capacity to satisfy the applicable solvency test required to redeem the Preferred Shares as described in Paragraph 24(d).

31.   Lossco and Profitco are affiliated persons and are related to each other and will continue to be affiliated and related to each other throughout the period that the Loss Utilization Arrangement is in place.

32.   Dividends paid on the Preferred Shares will have no other purpose other than described under the heading “Purpose of the Proposed Transactions”.

33.   Profitco and Lossco are not financial institutions as defined under subsection 190(1), for purposes of Part VI tax.

34.   The Proposed Transactions will be legally effective.

PURPOSE OF THE PROPOSED TRANSACTIONS

35.   Absent the Proposed Transactions, it is expected that Lossco will annually generate non-capital losses equal to the interest expense payable in respect of the Promissory Note. These non-capital losses are expected to accumulate in Lossco and would remain unused without the implementation of the Proposed Transactions.

36.   The purpose of the Proposed Transactions is to effect a tax consolidation of Profitco and Lossco by causing Lossco to earn interest income on the Loan, thus permitting Lossco to utilize its non-capital loss carry forward balance and current year losses, and to have Profitco incur interest expense to reduce its income for its current taxation year. The purpose of the tax consolidation is not to shift income between provinces and any such shift of income between provinces will be incidental to the Proposed Transactions.

37.   The purpose of both the payment and the receipt of the dividends on the Preferred Shares, as described in Paragraph 24, is to provide a reasonable return on the Preferred Shares issued by Lossco 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

(a)   the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, Proposed Transactions and the Purpose of the Proposed Transactions,

(b)   the Proposed Transactions are completed in the manner described above, and

(c) 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 Loan, and that Profitco continues to hold the 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 Loan, or (ii) a reasonable amount in respect thereof.

B.    Dividends received by Profitco on the 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).

C.    Part IV.1 and Part VI.1 will not apply to the dividends described in Ruling B because the dividends will be excepted dividends and excluded dividends.

D.    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.

E.    Provided that the only purpose of the payment and receipt of the dividends on the Preferred Shares is as described in the “Purpose of the Proposed Transactions” above, the provisions of subsection 55(2) will not apply to the dividends, if any, referred to in Ruling B, and received by Profitco on the Preferred Shares.

F.    The settlement of the Loan and the Lossco Note, as described in Paragraph 24(e) will not give rise to any “forgiven amount” for purposes of section 80.

G.    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.

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.

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 described in Paragraphs 19 to 23 above are commenced and entered into on or before XXXXXXXXXX, and the Proposed Transactions described in Paragraph 24 are entered into on or before XXXXXXXXXX.

The above Rulings are based on the law as it presently reads and do not take into account any proposed amendments to the Act and the Regulations which, if enacted, could have an effect on the Rulings provided herein.

OTHER COMMENTS

Nothing in this ruling 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;

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
Partnerships and Corporate Financing Section
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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