2020-0865971R3 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
                                                                                                     2020-086597

XXXXXXXXXX, 2020

Dear XXXXXXXXXX:

Subject:   Advance Income Tax Ruling
                XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX and revised 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.

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

“ACB” has the meaning assigned to “adjusted cost base” 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);

“CRA” means Canada Revenue Agency;

“credit union” has the meaning assigned by subsection 137(6);

“Daylight Loan” means the loan described in Paragraph 20;

“Holdco 1” means XXXXXXXXXX;

“Holdco 2” means XXXXXXXXXX;

“Holdco 3” means XXXXXXXXXX;

“Lossco” means a Subsidiary Wholly-Owned Corporation to be formed by Holdco 1 as described in Paragraph 18;

“Lossco Loan” has the meaning specified in Paragraph 21;

“Newco” means a Subsidiary Wholly-Owned Corporation to be formed by Opco described in Paragraph 15;

“Newco Preferred Shares” means the preferred shares described in Paragraphs 15 and 16;

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

“Opco” means XXXXXXXXXX the corporation described in Paragraph 5;

“Opco Loan” means the non-interest bearing loan made to Opco as described in Paragraph 23;

“Opco’s Tax Attributes” means XXXXXXXXXX and the unused balance of Non-Capital Losses as described in Paragraph 7;

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

“Paragraph” means a numbered paragraph in this letter;

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

“Parentco Group” means XXXXXXXXXX;

“Profitco” means XXXXXXXXXX;

“Proposed Transactions” means the transactions described in Paragraphs 15 to 32;

XXXXXXXXXX;

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

XXXXXXXXXX;

“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.    Parentco is a taxable Canadian corporation and is incorporated under XXXXXXXXXX Parentco is a XXXXXXXXXX.

2.    Holdco 1 is a taxable Canadian corporation and is incorporated under the XXXXXXXXXX. Holdco 1 is a Subsidiary Wholly-Owned Corporation of Parentco.

3.    Holdco 2 is a taxable Canadian corporation governed by the XXXXXXXXXX, which is a Subsidiary Wholly-Owned Corporation of Holdco 1. XXXXXXXXXX. Holdco 2 issued and outstanding shares consist of: XXXXXXXXXX.

4.    Holdco 3 is a taxable Canadian corporation governed by the XXXXXXXXXX which is a Subsidiary Wholly-Owned Corporation of Holdco 2.  XXXXXXXXXX. Holdco 3’s issued and outstanding shares consists of: XXXXXXXXXX.

5.    Opco is a taxable Canadian corporation incorporated under the XXXXXXXXXX and is a Subsidiary Wholly-Owned Corporation of Holdco 1. Opco’s issued and outstanding shares consist of XXXXXXXXXX of Class A common shares. XXXXXXXXXX.

6.    Opco is a corporation that XXXXXXXXXX of the Parentco Group. Opco renders services to the Parentco Group such as XXXXXXXXXX.  Opco’s Head Office is located at XXXXXXXXXX. Opco’s Taxation Centre is XXXXXXXXXX, its Tax Services Office is XXXXXXXXXX and its tax account number is XXXXXXXXXX. 

7.    The taxation year of Opco ends on XXXXXXXXXX. At the end of the XXXXXXXXXX taxation year, Opco had XXXXXXXXXX. The balance of  XXXXXXXXXX unused non-capital losses generated in the course of carrying its activities were $XXXXXXXXXX at the end of XXXXXXXXXX (collectively referred to as the “Opco’s Tax Attributes”). The estimated XXXXXXXXXX non-capital losses (absent the Proposed Transactions) for the XXXXXXXXXX and XXXXXXXXXX taxation years are expected to be nil. XXXXXXXXXX. The Opco’s Tax Attributes are not restricted under subsection 111(5) or subsections 127(9.1) and (9.2). 

8.    XXXXXXXXXX:

9.    XXXXXXXXXX:

10.   For the taxation year XXXXXXXXXX, Opco had permanent establishments in XXXXXXXXXX. The allocation of the taxable income between XXXXXXXXXX%. Opco expects the XXXXXXXXXX taxable income allocation to be similar. 

11.   Profitco is a taxable Canadian corporation and is incorporated under the XXXXXXXXXX. Profitco is a Subsidiary Wholly-Owned Corporation of Holdco 3. Profitco has XXXXXXXXXX issued and outstanding Class A shares. XXXXXXXXXX. 

12.   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. 

13.   The taxation year of Profitco ends on XXXXXXXXXX. Profitco’s taxable income for its taxation year XXXXXXXXXX is in the amount of $XXXXXXXXXX. XXXXXXXXXX. Profitco is forecasting taxable income of approximately of $XXXXXXXXXX for its taxation year ending on XXXXXXXXXX, taxable income of approximately $XXXXXXXXXX for its taxation year ending on XXXXXXXXXX and taxable income of approximately $XXXXXXXXXX for its taxation years ending on XXXXXXXXXX and XXXXXXXXXX.

14.   XXXXXXXXXX.

PROPOSED TRANSACTIONS

15.   Opco will incorporate a new wholly owned subsidiary (“Newco”) under the XXXXXXXXXX.  Newco will be a taxable Canadian corporation. The taxation year-end of Newco will be XXXXXXXXXX. The activities of Newco will be limited to the activities described in the Proposed Transactions. Newco's share capital will include 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 investing the proceeds received upon the issuance of its Newco Preferred Shares to Lossco as described in Paragraph 22 below, in the non-interest-bearing loan to Opco as described in Paragraph 23 below.

16.   The Newco Preferred Shares will have the following attributes:

(a)   be without par value and non-voting;

(b)   non-participating;

(c)   redeemable and retractable for a redemption price equal to the amount contributed, which should correspond to the same amount of the Lossco Loan. The paid-up capital and the fair market value of the Newco Preferred Shares will be equal to the amount contributed; 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 the interest rate on the loan to Lossco as described in Paragraph 21 below plus XXXXXXXXXX%, in this case XXXXXXXXXX% per annum.

17.   Newco will issue common shares to Opco for a nominal amount of $XXXXXXXXXX.

18.   Holdco 1 will incorporate a new wholly owned subsidiary (“Lossco”) under the XXXXXXXXXX. Lossco will be a taxable Canadian corporation. The taxation year-end of Lossco will be XXXXXXXXXX. The activities of Lossco will be limited to the activities described in the Proposed Transactions, including the investing of the proceeds received from the loan from Opco as described in Paragraph 22 below.  The authorized share capital of Lossco will consist of an unlimited number of common shares. The common shares of Lossco will be without par value and voting. The holders of common shares will be entitled to dividends at the discretion of the directors, and will be entitled to receive the remaining property of the corporation upon its wind-up or dissolution.

19.   Lossco will issue common shares of its capital stock to Holdco 1 for a nominal amount of $XXXXXXXXXX.

20.   Opco will borrow under its existing line of credit approximately $XXXXXXXXXX from Parentco on a daylight loan basis (the "Daylight Loan") at the overnight cost of funds of XXXXXXXXXX%. Provided that the transaction is within the same day, no interest will be charged on the Daylight Loan. The interest rate is an arm’s length, commercial interest rate. The amount of the Daylight Loan will not exceed the borrowing capacity of the Parentco Group.

21.   Opco will use the proceeds of the Daylight Loan to make a loan of the same amount, $XXXXXXXXXX, bearing interest at the estimated rate of XXXXXXXXXX % per annum to Lossco (the "Lossco Loan").  Simple interest will accrue on the Lossco Loan daily. The interest rate will be based on an arm’s length, commercial interest rate. The Lossco Loan will be payable on demand and the interest on the Lossco Loan will be paid periodically.

22.   Lossco will use the proceeds from the Lossco Loan to subscribe for the 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 Lossco on the Newco Preferred Shares will be sufficient to permit Lossco to realize a profit on its investment in the Newco Preferred Shares, after the deduction of all its expenses including any interest on the Lossco Loan.

23.   Newco will use the proceeds received from the subscription of the Newco Preferred Shares in Paragraph 22 to make a non-interest-bearing loan of $XXXXXXXXXX to Opco (the “Opco Loan”). The Opco Loan will be payable on demand.

24.   Opco will use the proceeds from the Opco Loan to repay the Daylight Loan to Parentco.

25.   While the Lossco Loan is outstanding, the following transactions will occur, at least annually:

(a)   Pursuant to a capital contribution agreement, Opco 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)   Lossco will pay the accrued and unpaid interest on the Lossco Loan.

26.   On or before XXXXXXXXXX, the loss consolidation structure will be unwound in the following manner:

(a)   Opco will make a contribution of capital to Newco in an amount equal to any accrued and unpaid dividends on the Newco Preferred Shares held by Lossco.  No shares will be issued by Newco and no amount will be added to its stated capital account in respect of the contribution.  Opco will not claim any deduction in computing income in respect of any capital contributions made to Newco;

(b)   Opco will borrow an amount equal to the amount outstanding on the Interest-free Loan on a "daylight loan" basis from Parentco (the "New Daylight Loan").  Opco will use the funds of the New Daylight Loan to repay the Interest-free Loan;

(c)   Newco will use the contribution of capital from Opco described in Paragraph (a) above to pay all accrued and unpaid dividends on the Newco Preferred Shares;

(d)   Newco will use the funds received from Opco on the repayment of the Interest-free Loan described in Paragraph (b) above to redeem all the issued and outstanding Newco Preferred Shares held by Lossco;

(e)   Lossco will use most of the funds received from the redemption of the Newco Preferred Shares received in Paragraphs (c) and (d) above to repay to Opco the Lossco loan and the accrued unpaid interest thereon; and

(f)   Opco will use the funds received from Lossco on the repayment of Lossco Loan described in Paragraph (e) above to repay the New Daylight Loan. 

27.   After the transactions described in Paragraph 26 above and before XXXXXXXXXX, Holdco 1 will transfer all of its common shares of Lossco to Holdco 2 in exchange for common shares of Holdco 2. Holdco 1 and Holdco 2 will jointly elect in a prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the Lossco common shares transferred will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) (i.e., the fair market value of those shares and the nominal amount, being the ACB of such shares).  Holdco 2 will add to its stated capital account in respect of the common shares issued to Holdco 1 an amount equal to the PUC of the common shares of Lossco which will be nominal.

28.   After the transactions described in Paragraph 27 above and before XXXXXXXXXX, Holdco 2 will transfer all of its common shares of Lossco to Holdco 3 in exchange for common shares of Holdco 3. Holdco 2 and Holdco 3 will jointly elect in a prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the Lossco common shares transferred will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) (i.e., the fair market value of those shares and the nominal amount, being the ACB of such shares).  Holdco 3 will add to its stated capital account in respect of the common shares issued to Holdco 2 an amount equal to the PUC of the common shares of Lossco which will be nominal.

29.   After the transactions described in Paragraph 28 above and before XXXXXXXXXX, Holdco 3 will transfer all of its common shares of Lossco to Profitco in exchange for common shares of Profitco.  Holdco 3 and Profitco will jointly elect in a prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to the transfer. The agreed amount in respect of the Lossco common shares transferred will be an amount equal to the lesser of the amounts described in subparagraphs 85(1)(c.1)(i) and (ii) (i.e., the fair market value of those shares and the nominal amount, being the ACB of such shares).  Profitco will add to its stated capital account in respect of the common shares issued to Holdco 3 an amount equal to the PUC of the common shares of Lossco which will be nominal.

30.   Shortly after the transactions described in Paragraphs 26 to 29 above and before XXXXXXXXXX, Profitco will cause Lossco to be wound-up in such a manner that all the assets of Lossco will be acquired by Profitco and all of the liabilities, if any, of Lossco will be assumed by Profitco. It is expected that subsection 88(1) will apply to the wind-up of Lossco.  Lossco will be formally dissolved before the end of the first taxation year of Profitco commencing after the commencement of the winding-up of Lossco. Lossco will file articles of dissolution with the appropriate corporate registry within a reasonable time after the winding-up resolution is passed.

31.   Shortly after the transactions described in Paragraphs 26 to 29 above and before XXXXXXXXXX, Opco will cause Newco to be wound-up in such a manner that all the assets of Newco will be acquired by Opco and all of the liabilities, if any, of Newco will be assumed by Opco. It is expected that subsection 88(1) will apply to the wind-up of Newco. Newco will be formally dissolved before the end of the first taxation year of Opco commencing after the commencement of the winding-up of Newco. Newco will file articles of dissolution with the appropriate corporate registry within a reasonable time after the winding-up resolution is passed.

32.   XXXXXXXXXX.

ADDITIONAL INFORMATION

33.   Parentco, Holdco 1, Holdco 2, Holdco 3, Opco and Profitco are each a specified XXXXXXXXXX and a XXXXXXXXXX as defined by subsection 248(1) of the Act. Lossco and Newco, once formed, will each be a specified XXXXXXXXXX and a restricted XXXXXXXXXX as defined by subsection 248(1) of the Act. Lossco will not acquire the Newco Preferred Shares in its ordinary course of business.

34.   Lossco and Newco will not be used for any other purposes than those described in the Proposed Transactions. Opco will not claim, at any time, a capital loss in respect of its capital contribution in Lossco and Newco.  Lossco and Newco will never be insolvent.

35.   XXXXXXXXXX.

36.   The Newco Preferred Shares described in Paragraph 16 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).

37.   Opco and Profitco are affiliated persons and have been related persons to each other since their formation. Opco, Profitco, Lossco and Newco are affiliated persons and Opco and Profitco have been related persons to Newco and Lossco since the formation of Newco and Lossco. Opco, Profitco, Lossco 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 26 to 31 if any entity previously mentioned in this paragraph ceases to be affiliated following an acquisition of control by a non-affiliated third party.

38.   At the time of the Proposed Transactions:

(a)   Opco will have the financial capacity, including accessing its leverage capacity, to make the capital contributions to Newco as described in Paragraphs 25(a) and 26(a); and

(b)   Newco will have the financial capacity to satisfy the applicable solvency test required to pay the dividends on the Newco Preferred shares and to redeem the Newco Preferred shares as described in Paragraphs 25(b) and 26(c) and (d).

39.   At all times, Lossco will have the solvency and liquidity to service the Lossco Loan.

40.   Profitco and Opco 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 Opco’s non-capital losses. The interest deducted by Lossco pursuant to paragraph 20(1)(c) in respect of the Lossco Loan will create a non-capital loss for Lossco during the period in which the Proposed Transactions occur. Profitco expects to earn taxable income in excess of Lossco’s non-capital losses that will arise by virtue of the implementation of the Proposed Transactions. Any such non-capital loss will not be carried back to a prior taxation year and will be carried forward in a taxation year commencing after the commencement of the winding-up of Lossco in accordance with the provisions of subsection 88(1.1) and section 111.

41.   The Proposed Transactions will be legally effective.

PURPOSE OF THE PROPOSED TRANSACTIONS

42.   The purpose of the Proposed Transactions is to effect a tax consolidation of Opco and Profitco in order to permit Profitco to utilize the losses of Opco. Absent the Proposed Transactions, it is expected that Opco will not generate significant taxable income and the prior year non-capital losses are expected to remain unused by Opco without implementation of the Proposed Transactions.

43.   XXXXXXXXXX.

44.   The only purpose of both the payment and the receipt of the dividends on Newco’s Preferred Shares described in Paragraph 25(b) and 26(c) is to provide a reasonable return on the Newco Preferred Shares issued by Newco to Lossco. 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 Lossco.

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 Lossco has a legal obligation to pay interest on the Lossco Loan, and the Newco Preferred Shares continue to be held by Lossco for the purpose of gaining or producing income therefrom, Lossco 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 Lossco Loan for that taxation year (depending on the method regularly followed by Lossco in computing its income for the purposes of the Act); and (ii) a reasonable amount in respect thereof;

B.    In respect of the contributions of capital made by Opco as described in Paragraphs 25(a) and 26(a) above, no amount will be included in the income of Newco pursuant to section 9 or paragraphs 12(1)(c) or 12(1)(x) of the Act;

C.    Dividends received by Lossco 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 Lossco 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 requirements of paragraphs 88(1.1)(a) and (b) are satisfied, subsection 88(1.1) will apply after the winding-up of Lossco into Profitco, as described in Paragraph 30, to permit Profitco to deduct the Non-Capital Losses of Lossco in computing its taxable income for any taxation year commencing after the commencement of the winding-up, subject to the limitations in paragraph 88(1.1)(e) and section 111;

E.    Provided that the only purpose of the dividends in Paragraphs 25(b) and 26(c) is what is described in the “Purposes 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 received by Lossco as described in Paragraphs 25(b) and 26(c) above;

F.    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; and

G.    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.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R10 dated September 29, 2020, and are binding on the CRA provided that the proposed transactions, as described in paragraphs 15 to 24, are entered into on or before XXXXXXXXXX, the proposed transactions related to the payment of interest and dividends and to the windup, as described in paragraphs 25 to 31, are entered into on or before XXXXXXXXXX and the proposed transactions related to paragraph 32 and the related payment of interest and dividends and to the windup 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 ACB 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; 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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