2005 Ruling 2004-0109481R3 - Loss Consolidation

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether loss utilization within affiliated group of companies is acceptable.

Position: Yes

XXXXXXXXXX 2004-010948

XXXXXXXXXX, 2005

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("Lossco")
XXXXXXXXXX ("Profitco")
XXXXXXXXXX ("Cco")
Advance Income Tax Ruling Request

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. We also acknowledge the information provided in subsequent correspondence and various telephone conversations. You have advised us that to the best of your knowledge and that of the taxpayers involved none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayers or related persons;

(ii) being considered by a tax services office ("TSO") or taxation centre ("TC") in connection with a previously filed tax return of the taxpayers or related persons;

(iii) under objection by the taxpayers or related persons;

(iv) before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v) the subject of a ruling previously issued by the Income Tax Rulings Directorate.

DEFINITIONS

In this letter, unless otherwise specified, all monetary amounts are expressed in Canadian dollars and the following terms have the meanings specified:

(a) "Aco" means XXXXXXXXXX;

(b) "Act" means the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and, unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Act;

(c) "adjusted cost base" ("ACB") has the meaning assigned by section 54;

(d) "affiliated persons" has the meaning assigned by subsection 251.1(1);

(e) "agreed amount" in respect of a property means the amount that the transferor and the transferee of the property have agreed upon in an election under subsection 85(1);

(f) "B" means XXXXXXXXXX;

(g) "CBCA" means the Business Corporations Act (Canada) and, where applicable, its predecessor statutes;

(h) "Cco Common Shares" has the meaning assigned in paragraph 3 below;

(i) "Cco Class A Preferred Shares" has the meaning assigned in paragraph 12 below;

(j) "Cco Class B Preferred Shares" has the meaning assigned in paragraph 12 below;

(k) "Dco" means XXXXXXXXXX;

(l) "Dco Common Shares" has the meaning assigned in paragraph 4 below;

(m) "Eco" means XXXXXXXXXX;

(n) "fair market value" ("FMV") means the highest price available in an open and unrestricted market, between informed, prudent parties, acting at arm's length and under no compulsion to act, expressed in terms of cash;

(o) "Fco" means XXXXXXXXXX;

(p) "financial intermediary corporation" has the meaning assigned by subsection 191(1);

(q) "Gco" means XXXXXXXXXX;

(r) "Lossco Group" means Lossco and its wholly owned subsidiaries;

(s) "Lossco Note" has the meaning assigned in paragraph 15 below;

(t) "non-capital loss" has the meaning assigned by subsection 111(8);

(u) XXXXXXXXXX;

(v) "paid-up capital" ("PUC") has the meaning assigned by subsection 89(1);

(w) XXXXXXXXXX;

(x) XXXXXXXXXX;

(y) "related persons" has the meaning assigned by subsection 251(2);

(z) "series of transactions or events" includes the transactions or events referred to in subsection 248(10);

(aa) "specified financial institution" has the meaning assigned by subsection 248(1);

(bb) "stated capital" has the meaning assigned by XXXXXXXXXX or section 26 of the CBCA, as the case may be;

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

(dd) "taxable Canadian corporation" has the meaning assigned by subsection 89(1).

FACTS

1. Lossco is a XXXXXXXXXX taxable Canadian corporation. XXXXXXXXXX. Lossco was formed by the amalgamation of its predecessor corporation with XXXXXXXXXX, at the time a wholly-owned subsidiary of Lossco's predecessor, under the CBCA on XXXXXXXXXX. Lossco's taxation year ends on XXXXXXXXXX . Lossco files its tax returns with the XXXXXXXXXX tax centre and it deals with the XXXXXXXXXX taxation services office. Lossco's principal business address is XXXXXXXXXX. Lossco is essentially a XXXXXXXXXX.

2. Aco and B have collectively owned approximately XXXXXXXXXX of the voting common shares of Lossco, currently representing approximately XXXXXXXXXX% of the outstanding voting share capital of Lossco, and have held approximately XXXXXXXXXX% of the voting share capital since XXXXXXXXXX. B also owns all the issued non-voting common shares of Lossco which are exchangeable into voting common shares at any time. No person or group of persons has acquired control of Lossco at any relevant time.

3. Cco is a taxable Canadian corporation XXXXXXXXXX that was incorporated on XXXXXXXXXX. Cco's taxation year ends on or around XXXXXXXXXX. Cco files its tax returns with the XXXXXXXXXX tax centre and it deals with the XXXXXXXXXX taxation services office. Cco's principal business address is XXXXXXXXXX. Cco's authorized share capital consists of an unlimited number of one class of common shares ("Cco Common Shares"). Cco's issued share capital consists of one Cco Common Share that is owned by Lossco. Prior to the proposed transactions, Cco's only liability will be a $XXXXXXXXXX non-interest-bearing loan payable to Lossco and its only asset will be an investment in XXXXXXXXXX Dco Common Shares.

4. Dco is a XXXXXXXXXX taxable Canadian corporation. XXXXXXXXXX. Dco was formed on XXXXXXXXXX as a result of an amalgamation under the XXXXXXXXXX. Lossco and Cco own approximately XXXXXXXXXX% and XXXXXXXXXX%, respectively, of the common shares of Dco ("Dco Common Shares"). The Dco Common Shares are Dco's only issued and outstanding class of shares. Lossco and Cco's ACB of the Dco Common Shares is approximately $XXXXXXXXXX and $XXXXXXXXXX, respectively. Dco is a XXXXXXXXXX. Dco's taxation year ends on or around XXXXXXXXXX.

5. Dco pays regular dividends on its common shares. The declaration and payment of dividends by Dco is at the discretion of its Board of Directors who intend to maintain a stable dividend policy and, where appropriate, change the dividend on the basis of Dco's estimated earnings and projected cash requirements. During the fiscal periods XXXXXXXXXX, Dco declared $XXXXXXXXXX per common share each quarter for a yearly dividend of $XXXXXXXXXX per common share in each fiscal year.

6. Profitco is a taxable Canadian corporation XXXXXXXXXX that was formed on XXXXXXXXXX as a result of an amalgamation under the XXXXXXXXXX. Prior to Lossco's indirect acquisition of Profitco (described in paragraph 8 below), Profitco's taxation year ended on or around XXXXXXXXXX. Profitco files its tax returns with the XXXXXXXXXX tax centre and deals with the XXXXXXXXXX tax services office. Profitco's principal business address is XXXXXXXXXX. Profitco is also a XXXXXXXXXX . Profitco has or will adopt a XXXXXXXXXX taxation year-end.

7. Eco is a taxable Canadian corporation XXXXXXXXXX that was formed on XXXXXXXXXX as a result of an amalgamation under the XXXXXXXXXX. Eco owns all of the outstanding shares of Profitco.

8. Fco and Gco are both taxable Canadian corporations XXXXXXXXXX. Fco was formed on XXXXXXXXXX as a result of an amalgamation under the XXXXXXXXXX. Gco was incorporated on XXXXXXXXXX. Fco and Gco collectively owned all of the issued and outstanding shares of Eco: Fco owned all of the common shares and XXXXXXXXXX% of the Class A shares, and Gco owned XXXXXXXXXX% of the Class A shares.

9. On XXXXXXXXXX, Lossco acquired all of the shares of Fco and Gco from persons unrelated to Lossco. At that time, Lossco acquired control of Fco and Gco. Fco and Gco were wound up into Lossco on XXXXXXXXXX. Since the acquisition of control of Fco and Gco, Profitco has been a direct or indirect wholly-owned subsidiary of Lossco. All of the shares of Eco are currently owned by Lossco.

10. On XXXXXXXXXX, Lossco made a loan of $XXXXXXXXXX to Profitco, bearing interest at XXXXXXXXXX% per annum as part of refinancing Profitco's borrowings that existed with XXXXXXXXXX at the time of the acquisition of control. The interest on the original loan between Profitco and XXXXXXXXXX was XXXXXXXXXX% per annum.

11. As at XXXXXXXXXX , Lossco's non-capital losses were as follows:

Year of Expiry Amount
XXXXXXXX $ XXXXXXXX
XXXXXXXX $ XXXXXXXX
XXXXXXXX $ XXXXXXXX
XXXXXXXX $ XXXXXXXX
XXXXXXXX $ XXXXXXXX
Total $ XXXXXXXX

Lossco's taxable income in respect of its XXXXXXXXXX taxation year is sufficient to utilize the non-capital loss of $XXXXXXXXXX that would otherwise have expired in XXXXXXXXXX.

PROPOSED TRANSACTIONS

12. The articles of Cco will be amended to create an unlimited number of Class A preferred shares ("Cco Class A Preferred Shares") and an unlimited number of Class B preferred shares ("Cco Class B Preferred Shares") having the following attributes:

(a) Cco's Class A Preferred Shares will be:

(i) non-voting;

(ii) redeemable and retractable, for an amount equal to the amount for which they were issued, plus any unpaid dividends which have accumulated prior to their redemption or retraction;

(iii) entitled to annual cumulative dividends at a rate of XXXXXXXXXX% calculated on the amount for which they were issued; and

(iv) first ranking with respect to preference as to dividends and proceeds on dissolution.

(b) Cco's Class B Preferred Shares will be:

(i) non-voting;

(ii) redeemable and retractable, for an amount equal to the amount for which they were issued, plus any dividends that have been declared but not paid;

(iii) entitled to annual non-cumulative dividends at a rate of XXXXXXXXXX% calculated on the amount for which they were issued;

(iv) second ranking with respect to preference as to dividends and proceeds on dissolution; and

(v) convertible on a one-for-one basis into Cco Class A Preferred Shares.

13. Lossco will transfer at FMV all of its Dco Common Shares to Cco pursuant to the terms of a share transfer agreement. As sole consideration for the transfer, Cco will issue to Lossco

(a) Cco Class A Preferred Shares with a redemption/retraction amount of $XXXXXXXXXX;

(b) Cco Class B Preferred Shares with a redemption/retraction amount of $XXXXXXXXXX; and

(c) XXXXXXXXXX Cco Common Shares.

14. The aggregate FMV of the Cco shares described in paragraphs 13(a) through (c) above will be equal to the aggregate FMV of the Dco Common Shares so transferred to Cco. Lossco and Cco will jointly elect in prescribed form and within the time required by subsection 85(6) to have the rules in subsection 85(1) apply to Lossco's transfer of the Dco Common Shares. The agreed amount specified in the joint election for federal and XXXXXXXXXX tax purposes will be equal to Lossco's ACB of the Dco Common Shares at the time of the transfer which amount will not exceed the FMV of such Dco Common Shares.

15. Lossco will transfer at FMV all its Cco Class A Preferred Shares to Profitco. As consideration for the transfer, Profitco will issue a XXXXXXXXXX year term note with a principal amount and FMV of $XXXXXXXXXX, and bearing interest at XXXXXXXXXX% per annum (the "Lossco Note"). The interest rate charged on the Lossco Note will be approximately equal to the blended average borrowing cost of the Lossco Group at the time the proposed transactions described herein are implemented.

16. Lossco will agree with Profitco that Lossco will subscribe for additional Cco Common Shares at least annually to the extent that Cco has insufficient funds to pay the dividends on the Cco Class A Preferred Shares, as long as the Cco Class A Preferred Shares are outstanding. Based on its existing assets and resources, Lossco will have the ability to fund the additional common share subscriptions without taking into account the interest income that it will earn as a result of the proposed transactions described herein.

17. Cco will use the funds received as common share subscription proceeds together with funds received as dividends on the Dco Common Shares to pay dividends on the Cco Class A Preferred Shares to Profitco at least annually.

18. As a result of the implementation of the proposed transactions described above, Profitco will incur additional interest expense of approximately $XXXXXXXXXX on an annual basis. It is expected that Profitco will have sufficient annual income for tax purposes, after claiming discretionary deductions, to fully utilize the additional interest expense to shelter taxable income, except in its taxation year ending XXXXXXXXXX . For that taxation year, it is expected that Profitco will realize a non-capital loss that it will carry back to its taxation year ending XXXXXXXXXX. To the extent that the additional interest expense results in Profitco incurring a non-capital loss in a taxation year ending subsequent to XXXXXXXXXX, which as mentioned is not expected, such a loss will be carried back to taxation years previous to the year in which the non-capital loss was incurred and not forward to subsequent years.

SUBSEQUENT TRANSACTIONS

19. Lossco and Cco may undertake transactions materially identical to the transactions described above to consolidate losses with profitable subsidiaries other than Profitco. Lossco would generally accomplish these subsequent transactions by converting Cco Class B Preferred Shares into Cco Class A Preferred Shares, and selling the Cco Class A Preferred Shares to a profitable subsidiary in exchange for an interest bearing debt. In these subsequent transactions, Lossco may use Cco for the same function that it performs in the proposed transactions described above.

20. Lossco and Profitco will unwind the structure created by the Proposed Transactions and any structure or structures created by the transactions described in the previous paragraph no later than XXXXXXXXXX. During the course of unwinding such structures, Cco will redeem the Cco Class A Preferred Shares, the note payable to Lossco will be repaid and cancelled, and Lossco will cause Cco to wind up. For greater certainty, Lossco will not dispose of, or exchange for any other property, any Cco Common Shares prior to the time Cco is wound up.

ADDITIONAL INFORMATION

21. Profitco and Lossco are affiliated persons.

22. Neither Lossco nor Profitco has any outstanding tax liabilities that could be affected by the proposed transactions.

23. The shares in the capital stock of Cco that will be issued as described in paragraph 12 above 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) of the Act as a "guarantee agreement";

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

(c) the subject of any secured undertaking of the type of 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).

24. None of Lossco, Profitco or Cco is a specified financial institution or a financial intermediary corporation.

25. There are no significant transactions that are contemplated prior to the time of the proposed transaction and there are no transactions contemplated after the completion of the proposed transactions that are part of the series of transactions or events that includes the proposed transactions.

26. Each of Lossco and Cco will agree with Profitco that Cco will be a single purpose company, will have no liabilities other than those that existed prior to the proposed transactions and will carry on no business other than as contemplated by the proposed transactions and subsequent transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

The purpose of the proposed transactions is to allow the consolidation of profits and losses within an affiliated group of taxable Canadian corporations for taxation periods ending after Lossco's indirect acquisition of Profitco. The consolidation is achieved by allowing Lossco to earn investment income that is sheltered by its accumulated non-capital losses, and by allowing Profitco to reduce its income for tax purposes by the interest expense incurred on the Lossco Note.

RULINGS

Provided that the preceding statements constitute a complete and accurate disclosure of all of the relevant facts, proposed transactions and purpose of the proposed transactions, and provided that the proposed transactions are completed in the manner described above, our rulings are as follows:

A. Provided that a joint election under subsection 85(1) by Lossco and Cco is made in prescribed form and within the time permitted, and subject to subsection 69(11), with respect to the disposition of Dco Common Shares by Lossco to Cco, as described in paragraphs 13 and 14 above, the provisions of subsection 85(1) will apply to such disposition with the result that Lossco's proceeds of disposition and Cco's cost of the Dco Common Shares will be deemed to be the agreed amount set out in the election. The cost to Lossco of the Cco shares it receives, as described in paragraphs 13(a) through (c), will be determined in accordance with paragraphs 85(1)(g) and (h).

B. The dividends received by Profitco from Cco will be included in computing the income of Profitco pursuant to paragraph 12(1)(j) of the Act and will be deductible by Profitco in computing its taxable income pursuant to subsection 112(1) of the Act. For greater certainty, the provisions of subsections 112(2.1), (2.2), (2.3) and (2.4) of the Act will not apply to deny the subsection 112(1) deduction in respect of such dividends.

C. Profitco will not be subject to Part IV.1 tax under section 187.2 in respect of the dividends received from Cco by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

D. Cco will not be subject to Part VI.1 tax under section 191.1 in respect of the dividends it pays to Profitco by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

E. Provided that Profitco has a legal obligation to pay interest on the Lossco Note and Profitco continues to hold the Cco Class A Preferred Shares, 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 Lossco Note or (ii) a reasonable amount in respect thereof.

F. The provisions of subsections 15(1), 56(2), 56(4), 69(1), 69(4), 69(11), and 246(1) will not apply to the proposed transactions, in and by themselves.

G. Subsection 245(2) will not apply to the proposed transactions, in and by themselves, to re-determine the tax consequences confirmed herein.

The Rulings given are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the Canada Revenue Agency provided that the proposed transactions are completed before XXXXXXXXXX.

COMMENTS

Nothing in this ruling should be construed as implying that the Canada Revenue Agency has agreed to or reviewed:

(a) the determination of the adjusted cost base, paid-up capital or FMV of any shares or other property referred to herein; or

(b) any tax consequences relating to the facts and proposed transactions described herein other than those described in the rulings given above.

Yours truly,

XXXXXXXXXX
Section Manager
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch