2019-0818291R3 Loss consolidation arrangement

Principal Issues: Whether the LCA is acceptable.

Position: Yes.

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

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

XXXXXXXXXX                                                                              2019-081829

XXXXXXXXXX, 2019

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 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, XXXXXXXXXX.

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)   XXXXXXXXXX;

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

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

(d)   “Anniversary Date” means the date of implementation of the Proposed Transactions, as described in Paragraphs 8 to 15;

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

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

(g)   “CRA” means Canada Revenue Agency;

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

(i)   “Daylight Loan” has the meaning specified in Paragraph 11;

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

(k)   “Lossco Affiliated Group” means Lossco, Profitco and Newco;

(l)   “Lossco Loan” has the meaning specified in Paragraph 14;

(m)   “Newco” means the corporation described in Paragraph 8;

(n)   “Newco Common Shares” means the common shares described in Paragraph 8;

(o)   “Newco Preferred Shares” means the preferred shares described in Paragraphs 8 and 9;

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

(q)   XXXXXXXXXX;

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

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

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

(u)   “Profitco Loan” means the interest-bearing loan described in Paragraph 12;

(v)   “Proposed Transactions” means the transactions described in Paragraphs 8 to 17;

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

2.    The taxation year of Lossco ends on XXXXXXXXXX. As of XXXXXXXXXX, Lossco had non-capital losses of $XXXXXXXXXX. The following are the actual and forecasted non-capital losses for the tax years of XXXXXXXXXX:

XXXXXXXXXX

3.    Lossco has a permanent establishment XXXXXXXXXX.

4.    XXXXXXXXXX

5.    Profitco is a taxable Canadian corporation. Profitco is a wholly-owned subsidiary of Lossco 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.

6.    The taxation year of Profitco ends on XXXXXXXXXX. Profitco taxable income for its taxation year XXXXXXXXXX is in the amount of $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 taxation year ending on XXXXXXXXXX.

7.    Based on the most recent tax return filed with the CRA, Profitco’s income is approximately XXXXXXXXXX.

PROPOSED TRANSACTIONS

8.    Lossco 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 13 below, in the non-interest-bearing loan to Lossco as described in Paragraph 14 below.

9.    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) assigning the Lossco Loan or (iii) setting-off amounts owing under the Profitco Loan in circumstances where Newco has become the holder of the Profitco 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.

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

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

12.   Lossco 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 interest is computed daily. The interest rate of XXXXXXXXXX% is an arm’s length, commercial interest rate. The Profitco Loan will be payable on demand.

13.   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.

14.   Newco will use the proceeds from the issuance of the Newco Preferred Shares to make a non-interest-bearing loan of $XXXXXXXXXX to Lossco (the “Lossco Loan”).

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

16.   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, Lossco 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.

(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.

17.   At the earlier of (i) XXXXXXXXXX years from the implementation date or (ii) when Lossco’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 Lossco Loan to Profitco;

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

(d)   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.

ADDITIONAL INFORMATION

18.   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.

19.   The Newco Preferred Shares described in Paragraph 9 will not be, at any time during the implementation of the Proposed Transactions described herein:

(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 (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).

20.   XXXXXXXXXX. Lossco and Profitco are affiliated persons and have been related persons to each other since XXXXXXXXXX. Lossco and Profitco and Newco are affiliated persons and Lossco and Profitco have been related persons to Newco since the formation of Newco.  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 16 to 17 if any entity previously mentioned in this paragraph ceases to be affiliated following an acquisition of control by a non-affiliated third party.

21.   As supported by the undrawn amount on the Credit Facility, the management of Lossco confirms that the amount of the Daylight Loan is within Lossco’s borrowing capacity and would be sufficient to complete the Proposed Transactions described in Paragraphs 8 to 17.

22.   Based on Lossco’s existing and anticipated assets and resources, Lossco will have the financial capacity to make the capital contributions to Newco as described in Paragraph 16.

23.   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 Loan may create a non-capital loss for the 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.

PURPOSE OF THE PROPOSED TRANSACTIONS

24.   The purpose of the Proposed Transactions is to effect a tax consolidation of Profitco and Lossco by causing Lossco to earn interest income, thus permitting Lossco 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 Lossco and Profitco were affiliated or related persons.

25.   The only purpose of both the payment and the receipt of the dividends on Newco’s Preferred Shares described in Paragraph 16 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), 69(1), 69(4) 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 the dividends described in Paragraph 16 is as described in Paragraphs 24 and 25, subsection 55(2) will not apply in respect of the taxable dividends in Ruling C;

E.    The provisions of subsection 88(1) will apply to the winding-up of Newco into Lossco as described in Paragraph 17, 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 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.

F.    Part VI.1 will not apply to the dividends received by Profitco on the Newco Preferred Shares as described in Paragraph 16, as the dividends will be excluded dividends;

G.    The settlement of the Profitco Loan and the Lossco Loan as described in Paragraph 17 will not give rise to any “forgiven amount” for purposes of section 80;

H.    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

I.    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 70-6R9 dated April 23, 2019, and are binding on the CRA provided that the proposed transactions, as described in paragraphs 8 to 15, 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 16 to 17, 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 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)   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

(e)   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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