2023-0970321R3 Loss consolidation arrangement

Principal Issues: Whether a loss consolidation arrangement involving a loan to buy preferred shares for the purposes of earning income would meet the CRA's requirement for acceptable loss consolidation transactions.

Position: Yes.

Reasons: Consistent with other loss consolidation arrangements.

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

XXXXXXXXXX                                                                         2023-097032

XXXXXXXXXX, 2023

Dear XXXXXXXXXX:

Re: Advance Income Tax Ruling Request
      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 (the “Taxpayers”).

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 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 all references to monetary amounts are in Canadian dollars.

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

In this letter, the following terms or expressions have the meanings specified:

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

“affiliated persons” 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);

“BCA” means XXXXXXXXXX;

“XXXXXXXXXX” means Parent and all of its direct and indirect wholly owned subsidiaries, including Lossco and Profitco;

“CRA” means the Canada Revenue Agency;

“Daylight Debt” means XXXXXXXXXX;

“dividend rental arrangement” has the meaning assigned by subsection 248(1);

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

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

“fair market value” means the highest price available in an open and unrestricted market between informed and prudent parties dealing at arm's length and under no compulsion to act, expressed in terms of cash;

“forgiven amount” has the meaning assigned by subsections 80(1) and 80.01(1);

“financial intermediary corporation” has the meaning assigned by subsection 191(1);

“functional currency year” has the meaning assigned by subsection 261(1);

“GAAR” means the general anti-avoidance rule found in section 245;

“guarantee agreement” has the meaning assigned by subsection 112(2.2);

“IB Debt” means the loan described in Paragraph 11;

“investment tax credit” has the meaning assigned by subsection 127(9);

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

“XXXXXXXXXX” means XXXXXXXXXX., a taxable Canadian corporation XXXXXXXXXX;

“Newco” means a corporation that will be incorporated under the BCA having its head office located at XXXXXXXXXX;

“Newco Preferred Shares” means the preferred shares to be issued by Newco described in Paragraph 13;

“NIB Debt” means the loan described in Paragraph 15;

“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 of this letter;

“Parent” means XXXXXXXXXX as referred to in Paragraph 1;

“principal amount” has the meaning assigned by subsection 248(1);

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

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

“Proposed Transactions” means the transactions described in Paragraphs 9 to 22;

XXXXXXXXXX;

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

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

“Support Agreement” means an agreement between Parent, Newco and Lossco providing Newco with a funding entitlement in an amount equal to the dividends payable on the Newco Preferred Shares and a commitment from Lossco that Newco will use the proceeds to pay such dividends;

“tax reporting currency” has the meaning assigned by subsection 261(1);

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

“taxable dividend” has the meaning assigned by subsection 89(1);

“taxation year” has the meaning in subsection 249(1);

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

“US” means United States.

FACTS

1. Parent is XXXXXXXXXX. Parent owns all of the shares of Lossco other than XXXXXXXXXX held by XXXXXXXXXX. Parent indirectly owns, through Lossco, all of the shares of Profitco other than XXXXXXXXXX held by XXXXXXXXXX.

1.1. XXXXXXXXXX.

2. Lossco is a private corporation and is a taxable Canadian corporation and was incorporated under the BCA XXXXXXXXXX. Lossco is in the business of operating XXXXXXXXXX. Lossco is also XXXXXXXXXX. Lossco’s registered address and head office address is XXXXXXXXXX.

3. If the Proposed Transactions were not undertaken in its XXXXXXXXXX taxation year, Lossco's estimated non-capital loss carry-forward at the end of its XXXXXXXXXX taxation year would be $XXXXXXXXXX. The following are the actual and estimated non-capital losses of Lossco at the taxation year ending XXXXXXXXXX:

XXXXXXXXXX

4. If the Proposed Transactions were not undertaken in its XXXXXXXXXX taxation year, Lossco has unexpired investment tax credits of $XXXXXXXXXX.

5. Profitco is a private corporation and is a taxable Canadian corporation and was incorporated XXXXXXXXXX and is currently governed under the BCA. Profitco has a taxation year-end of XXXXXXXXXX. Profitco XXXXXXXXXX. Profitco’s registered address and head office address is XXXXXXXXXX.

6. Profitco has generated taxable income of approximately of $XXXXXXXXXX and $XXXXXXXXXX in each of its XXXXXXXXXX and XXXXXXXXXX taxation years, respectively. It is expected that Profitco will generate taxable income of approximately $XXXXXXXXXX per year in the next three taxation years. Profitco has sufficient taxable income to utilize Lossco’s non-capital loss balance and investment tax credits as described in Paragraphs 3 and 4 above.

7. Profitco and Lossco operate in Canada through a permanent establishment in XXXXXXXXXX. The provincial allocation of Profitco and Lossco is XXXXXXXXXX.

8. Profitco and Lossco have as their tax reporting currency and functional currency, the Canadian dollar. Profitco or Lossco have not previously elected pursuant to subsection 261(3) to report its Canadian tax results in a functional currency other than the Canadian dollar.

PROPOSED TRANSACTIONS

Implementation of the loss consolidation arrangement

9. Lossco will incorporate Newco under the BCA. Newco will be a private corporation and a taxable Canadian corporation. Newco will have as its tax reporting currency and functional currency, the Canadian dollar. The taxation year of Newco will have a XXXXXXXXXX year-end. Lossco will subscribe for common shares of Newco for $XXXXXXXXXX per share. Newco will not carry on any business and its activities will be limited to making the NIB Debt with the proceeds received from the issuance of the Newco Preferred Shares. The authorized capital of Newco will consist of two classes of shares: common shares and Newco Preferred Shares.

10. Lossco obtains a Daylight Debt of approximately $XXXXXXXXXX.

11. Lossco will use the proceeds of the Daylight Debt to lend $XXXXXXXXXX to Profitco pursuant to a subordinated unsecured promissory loan (the “IB Debt”) under the following conditions:

i. repayable on demand, and at any time at the option of the borrower, without penalty;

ii. bearing interest at an annual rate based on market conditions at the time the credit facility is granted, and which is considered by Lossco to be a reasonable commercial rate in these circumstances. The interest rate is estimated to be approximately XXXXXXXXXX% per annum, calculated daily and payable semi-annually. The rate of interest will be finalized when the Proposed Transactions are implemented and will reflect the prevailing market rate of interest for a loan on similar terms at that time. The interest will be calculated daily and paid semi-annually; and

iii. it will also provide that the amount borrowed under the IB Debt may be satisfied, by (i) payment of cash, (ii) delivery of property having a fair market value at the time of repayment equal to the amount borrowed, or (iii) way of set-off against the NIB Debt if the NIB Debt belongs to Profitco at the time of repayment. The amount borrowed will not exceed XXXXXXXXXX borrowing capacity.

12. Profitco will use the total proceeds of $XXXXXXXXXX received from the IB Debt to subscribe for Newco Preferred Shares having an aggregate redemption amount equal to the total subscription proceeds. The full amount of the subscription proceeds will be added to the stated capital of the Newco Preferred Shares and will form part of the permanent capital of Newco. The paid-up capital of each Newco Preferred Share issued will be equal to its redemption amount. The paid-up capital, the ACB and the fair market value of the Newco Preferred Shares are $XXXXXXXXXX.

13. The terms of the Newco Preferred Shares are the following:

i. non-voting;

ii. non-participating;

iii. 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) the NIB Debt, in each case together with a payment in cash equal to the amount of all declared or accrued dividends which have not been paid up to but excluding the date fixed for such redemption or retraction; and

iv. the holder of the Newco Preferred shares will be entitled to a cumulative dividend, payable semi-annually, calculated daily and accruing by reference to the redemption amount of the Newco Preferred Shares at a rate equal to the interest rate on the IB Debt plus XXXXXXXXXX%. The aggregate dividend rate is estimated at XXXXXXXXXX% per annum.

14. Concurrently with the transaction in Paragraph 12, Parent, Newco and Lossco will enter into the Support Agreement.

15. Newco will use the proceeds received from the Newco Preferred Shares subscription to make a non-interest-bearing loan to Lossco in an amount equal to $XXXXXXXXXX (the “NIB Debt”). The NIB Debt is payable on demand.

16. Lossco commits to make a semi-annual cash contribution into Newco to fund dividends on the Newco Preferred Shares.

17. Lossco uses the proceeds of $XXXXXXXXXX received from the NIB Debt to repay the Daylight Debt.

Maintenance of the Loss Consolidation Arrangement

18. On a semi-annual basis, Lossco will make a contribution of capital to Newco in an amount equal to the accrued dividends payable at that time, by Newco, on the Newco Preferred Shares held by Profitco. 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 any class of shares of Newco, or, for greater certainty, to the paid-up capital of any class of shares of Newco.

19. Upon receipt of the contribution capital described in Paragraph 18, subject to the applicable corporate law solvency tests, Newco declares all accrued dividends and uses the contribution to pay all accrued and unpaid dividends on the Newco Preferred Shares held by Profitco in accordance with the terms of the Newco Preferred Shares.

20. Upon receipt of the payments of the dividends described in Paragraph 19, Profitco will pay all accrued and unpaid interest due and payable on the IB Debt to Lossco, pursuant to the terms of the IB Debt. The interest payments will not include any amount that is compound interest.

Unwind of the Loss Consolidation Arrangement

21. After the full amount of Lossco’s non-capital losses and investment tax credits described in Paragraphs 3 and 4 have been fully utilized, the following transactions will occur to unwind the loss consolidation arrangement:

i. Lossco will make a contribution of capital to Newco in an amount equal to the accrued dividends payable at that time, by Newco, on the Newco Preferred Shares held by Profitco. 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 any class of shares of Newco, or, for greater certainty, to the paid-up capital of any class of shares of Newco;

ii. Upon receipt of the contribution of capital described above, subject to the applicable corporate law solvency tests, Newco will pay all accrued and unpaid dividends on the Newco Preferred Shares held by Profitco in accordance with the terms of the Newco Preferred Shares;

iii. Upon receipt of the payments of the dividends described above, Profitco will pay all accrued and unpaid interest due and payable on the IB Debt to Lossco, pursuant to the terms of the IB Debt;

iv. Newco will redeem the Newco Preferred Shares held by Profitco by transferring to Profitco the NIB Debt in accordance with the terms of the Newco Preferred Shares. The NIB Debt will have a principal amount and fair market value equal to the aggregate redemption amount and fair market value of the Newco Preferred Shares redeemed; and

v. Lossco and Profitco will agree to set off the amount due under the NIB Debt against the amount due under the IB Debt as payment in full. The obligations under the NIB Debt and the IB Debt will be cancelled.

22. Immediately following completion of the transactions described in Paragraph 21, Lossco will authorise by resolution the wind-up and dissolution of Newco. Newco’s assets will be distributed to Lossco and its liabilities, if any, will be assumed by Lossco. Newco will file articles of dissolution with the appropriate Corporate Registry within a reasonable time after the winding-up resolution is passed.

ADDITIONAL INFORMATION

23. Lossco and Profitco are affiliated persons and are related persons. Newco will be an affiliated person and related person with respect to Lossco and Profitco. Lossco, Profitco and Newco will be, during the implementation of the Proposed Transactions, related persons and affiliated persons. The structure will be immediately unwound in the manner described in Paragraphs 21 to 22 if any entity previously mentioned in this Paragraph ceases to be affiliated with each other.

24. No acquisitions of control have occurred, or are anticipated to occur, as part of the series of transactions or events that includes the Proposed Transactions in respect of Parent, Lossco, Profitco or Newco.

25. At the time of the Proposed Transactions:

i. Lossco and Profitco will have the financial capacity to satisfy the applicable solvency test and liquidity test under their respective governing statutes to service any debt issued as part of the Proposed Transactions; and

ii. Newco will have the financial capacity to satisfy the applicable solvency test and liquidity test under the BCA required to pay the dividends on the Newco Preferred Shares as described in Paragraphs 19 and 21 and to redeem the Newco Preferred Shares as described in Paragraph 21.

26. None of the corporations involved in the Proposed Transactions has or will have entered into a dividend rental arrangement, with respect to any of the shares issued for the purposes of completing the Proposed Transactions.

27. The shares on which a dividend is declared or paid in the course of the Proposed Transactions, will not, at any time be:

i. the subject of any undertaking that is referred to in subsection 112(2.2) as a “guarantee agreement”;

ii. the subject of a dividend rental arrangement as that term is defined in subsection 248(1);

iii. the subject of any secured undertaking of the type described in paragraph 112(2.4)(a); or

iv. issued for consideration that includes:

a. 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

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

28. The Newco Preferred Shares will be term preferred shares.

29. Profitco and Lossco are not and at relevant times will not be specified financial institutions. Newco will not be a specified financial institution. Profitco is not and at all relevant times will not be a financial intermediary corporation. Newco will not be a financial intermediary corporation.

30. Dividends received by Profitco on the Newco Preferred Shares as described in Paragraphs 19 and 21 above of the Proposed Transactions will be excepted dividends within the meaning assigned by section 187.1 and excluded dividends within the meaning assigned by subsection 191(1).

31. The dividend paid on the Newco Preferred Shares to Profitco, as described in Paragraphs 19 and 21 above, has no other purpose than the purpose described in Paragraph 38.

32. The Proposed Transactions are not being undertaken to refresh non-capital losses or facilitate the use of such losses in a taxation year after the taxation year in which such losses would have otherwise expired in the hands of Lossco.

33. The Proposed Transactions are not intended to generate a significant loss carryforward balance in Profitco (having regard to the expected carry back of losses to prior taxation years) or interest income in Lossco in excess of amounts required to fully utlilize the loss carryovers and ITCs described in Paragraphs 3 and 4, and the taxpayers will seek to unwind the arrangements at a time that will prevent any significant loss carry-forward balance in Profitco or excess interest income in Lossco from arising.

34. The XXXXXXXXXX borrowing capacity exceeds the maximum amount required to complete the Proposed Transactions described in Paragraph 10.

35. The Proposed Transactions will be legally effective.

36. Neither Lossco nor Profitco will claim, at any time, a capital loss in respect of a disposition of any common or preferred shares of Newco.

PURPOSES OF THE PROPOSED TRANSACTIONS

37. The purpose of the Proposed Transactions is to consolidate taxable income, non-capital losses and investment tax credits within a group of affiliated and related persons. The Proposed Transactions will enable Lossco to earn interest income on the IB Debt and thus will enable Lossco to effectively utilize its non-capital losses and investment tax credits already incurred as well as any future investment tax credits or non-capital losses.

38. The purpose of both the payment and the receipt of the dividends on the Newco Preferred Shares as described in Paragraphs 19 and 21 is to provide a reasonable return on such shares and to fund the interest payments made by Profitco that will be due on the IB Debt. 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 the relevant facts, proposed transactions, and purposes of the Proposed Transactions and provided further that the Proposed Transactions are carried out as described above, we rule as follows:

A. Provided that Profitco has a legal obligation to pay interest on IB Debt and Profitco continues to hold the Newco Preferred Shares it acquires for the purpose of gaining or producing income from property, as described in Paragraph 12, Profitco will, pursuant to paragraph 20(1)(c), be entitled to deduct, in computing its income for a taxation year (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act), the lesser of: (i) the interest paid or payable on IB Debt in respect of that taxation year; 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 as a result of the Proposed Transactions in and by themselves.

C. The dividends received by Profitco on its Newco Preferred Shares, as described in Paragraphs 19 and 21, will be taxable dividends that will be deductible pursuant to subsection 112(1) in computing the taxable income of Profitco for the taxation year in which the dividends are received, 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).

D. Part IV, Part IV.1 and Part VI.1 will not apply to the dividends, described in Paragraphs 19 and 21, received by Profitco on the Newco Preferred Shares.

E. 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 C, and received by Profitco on the Newco Preferred shares.

F. The set-off and cancellation of the NIB Debt against the IB Debt described in Paragraph 21 and will not give rise to a forgiven amount or any gain or loss.

G. No amount will be included in the income of Newco pursuant to section 9, paragraphs 12(1)(c) or 12(1)(x) in respect of the contributions of capital to be made by Lossco as described in Paragraphs 18 and 21.

H. Subsection 245(2) will not be applicable as a result of the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given above.

The above rulings are given subject to the general limitations and qualifications set out in Information Circular 70-6R12 dated April 1, 2022, and are binding on the CRA provided that the Proposed Transactions, as described in Paragraphs 9 to 17, are entered into on or before XXXXXXXXXX, and the Proposed Transactions related to the payment of interest and dividends and to the wind-up, as described in Paragraphs 21 and 22, are entered into on or before XXXXXXXXXX.

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, investment tax credits or any other amount of any corporation referred to herein;

(d) subject to Ruling H, the application or non-application of a general anti-avoidance provision of any province;

(e) the application of the proposed Excessive Interest and Financing Expenses Limitation rules originally released February 4, 2022 and revised November 3, 2022 and August 4, 2023, or any amendments thereto, to the Proposed Transactions; 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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