2006 Ruling 2005-0160471R3 - Loss Utilization in an affiliated group

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: Transfer of income producing property between affiliated corporations to utilize non-capital losses. Is deemed dividend subject to 55(2)?

Position: Loss transactions are acceptable. Subsection 55(2) will apply to the deemed dividend however.

Reasons: The law.

XXXXXXXXXX 								2005-016047

XXXXXXXXXX, 2006

Dear XXXXXXXXXX:

Subject: XXXXXXXXXX
XXXXXXXXXX - Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, as modified by your other correspondence, wherein you requested an advance income tax ruling on behalf of the above-noted taxpayer. You have advised us that to the best of your knowledge and that of the taxpayer involved none of the issues involved in this ruling request are:

(i) in an earlier return of the taxpayer or any related person;

(ii) being considered by a tax services office (TSO) or taxation centre (TC) in connection with a previously filed tax return by the taxpayer or any related person;

(iii) under objection by the taxpayers or any related person;

(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.

The taxpayer has also represented that the proposed transactions described herein will not result in the taxpayer or any related person described herein being unable to pay its existing outstanding tax liabilities.

DEFINITIONS

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

(a) "Act" means the Income Tax Act, 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, and the Income Tax Regulations thereunder are referred to as the Regulations;

(b) "agreed amount" in respect of an eligible property means the amount that the transferor and the transferee of the property agree upon in their election under subsection 85(1) in respect of that property;

(c) "BCA" means the Canada Business Corporation Act;

(d) "BN" means the business number issued to the particular corporate entity by CRA;

(e) "cost amount" has the meaning assigned by subsection 248(1);

(f) "CRA" means the Canada Revenue Agency;

(g) "credit union" has the meaning assigned by subsection 137(6);

(h) "dividend rental arrangement" has the meaning assigned by subsection 248(1);

(i) "eligible property" has the meaning assigned by subsection 85(1.1);

(j) "financial institution" has the meaning assigned by subsection 142.2(1);

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

(l) "guarantee agreement" has the meaning assigned by subsection 112(2.2);

(m) "Lossco" means XXXXXXXXXX

(n) "mark-to-market property" has the meaning assigned by subsection 142.2(1);

(o) "Newco" means the corporation described in Paragraph 10;

(p) "Newco Demand Note" means the demand note described in Paragraph 12;

(q) "Newco Preferred Shares" means the preferred shares described in Paragraph 10;

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

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

(t) "Paragraph" means a numbered paragraph in this advance income tax ruling;

(u) "Portfolio" means the portfolio of bonds described in Paragraph 8;

(v) "principal amount" has the meaning assigned by subsection 248(1);

(w) "Profitco" means XXXXXXXXXX

(x) "Proposed Transactions" means the transactions described in Paragraph 10 to 15;

(y) "public corporation" has the meaning assigned by subsection 89(1);

(z) "Redemption Amount" has the meaning assigned in Paragraph 10;

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

(bb) "specified debt obligation" ("SDO") has the meaning assigned by subsection 142.2(1);

(cc) "specified shareholder" has the meaning assigned by subsection 248(1);

(dd) "subsidiary controlled corporation" has the meaning assigned by subsection 248(1);

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

(ff) "taxable Canadian corporation" has the meaning assigned by subsection 89(1);

(gg) "taxable dividend" has the meaning assigned by subsection 89(1); and

(hh) "taxation year" has the meaning assigned by section 249.

FACTS

1. Lossco was incorporated under the XXXXXXXXXX. Lossco is a taxable Canadian corporation. Lossco is not a financial intermediary corporation. The taxation year-end of Lossco is XXXXXXXXXX. Lossco deals with the XXXXXXXXXX TSO and files its federal income tax return at the XXXXXXXXXX TC.

2. The authorized capital of Lossco includes membership shares, membership participation shares, redeemable preference shares and class B, C and D preference shares. The redeemable preference shares and the class B, C and D preference shares are each issuable in one or more series. Currently, Lossco has a number of membership shares, membership participation shares, class B preference - series A, class B preference - series C, class B preference - series D, class C preference - series A, and class C preference - series B issued and outstanding. The membership shares and membership participation shares are held by XXXXXXXXXX co-operative organizations and credit unions located across Canada. The preference shares are held by co-operative organizations and credit unions, some of which do not hold membership shares and some of whom may be non-residents of Canada.

3. Lossco's assets include the shares of XXXXXXXXXX ("Holdco"), which is a subsidiary wholly-owned corporation of Lossco. Holdco is a holding corporation and is not a financial intermediary corporation.

4. As at the end of Lossco's fiscal year ended on XXXXXXXXXX, the balance of Lossco's non-capital losses to carry forward was approximately $XXXXXXXXXX, which were incurred as follows:

	XXXXXXXXXX 		XXXXXXXXXX
	XXXXXXXXXX 		XXXXXXXXXX
	XXXXXXXXXX 		XXXXXXXXXX
	XXXXXXXXXX 		XXXXXXXXXX 

	Total			XXXXXXXXXX 

Lossco estimates that its non-capital losses for the taxation year ending on XXXXXXXXXX will be approximately $XXXXXXXXXX. If realized, this would increase the balance of Lossco's non-capital losses to carry forward to approximately $XXXXXXXXXX.

5. There are no specified shareholders of Lossco.

6. Profitco is a taxable Canadian corporation continued under the XXXXXXXXXX Profitco's primary business is XXXXXXXXXX. Profitco is an XXXXXXXXXX corporation, a public corporation and a financial institution. Profitco is not a financial intermediary corporation. The taxation year of Profitco is XXXXXXXXXX. Profitco deals with the XXXXXXXXXX TSO and files its federal income tax returns at the XXXXXXXXXX TC.

7. The authorized capital of Profitco includes both common shares and preferred shares, which are issuable in one or more series. The common shares are the only shares with voting rights. Currently, Profitco has a number of common shares, Class A preference - Series A, Class A preference - Series B, Class B preference, Class D preference - Series A, Class D preference - Series B, Class D preference - Series C, Class E preference - Series A, Class F preference - Series A and Class G preference - Series A, issued and outstanding. Holdco holds all the issued and outstanding common shares of Profitco. The Class A preference shares of Profitco are traded on the XXXXXXXXXX Stock Exchange and the other classes of preference shares are held in combination by employees, credit unions, co-operatives and former policyholders of Profitco.

8. XXXXXXXXXX. Some of these assets of Profitco include a portfolio of bonds (the "Portfolio"), which are issued or guaranteed by the government of Canada or a province or a municipality or by a corporation. Each of the bonds included in the Portfolio is a specified debt obligation and, for greater certainty, none of the bonds included in the Portfolio is a mark-to-market property. The current estimated fair market value of the Portfolio is approximately $XXXXXXXXXX and the cost amount of each bond included in the Portfolio is less than its fair market value.

9. Profitco was taxable in XXXXXXXXXX and it is expected that it will continue to be taxable in its taxation year ending XXXXXXXXXX.

PROPOSED TRANSACTIONS

10. Lossco will incorporate Newco under the BCA. Newco will be a taxable Canadian corporation and Newco will not be a financial intermediary corporation. The authorized share capital of Newco will include a class of common shares and a class of preferred shares, referred to as the "Newco Preferred Shares", having the following basic attributes:

(a) non-voting;

(b) entitled to a fixed preferential non-cumulative dividend at a specified rate;

(c) redeemable at any time at the option of Newco; and

(d) retractable at any time at the option of the holder for an amount (the "Redemption Amount") equal to the fair market value of the Portfolio divided by the number of Newco Preferred Shares so issued, plus any declared but unpaid dividends on such share.

Lossco will subscribe for a nominal number of Newco common shares.

11. Profitco will transfer the Portfolio to Newco. As consideration therefor, Newco will issue to Profitco a number of Newco Preferred Shares having an aggregate fair market value and aggregate Redemption Amount equal to the fair market value of the Portfolio.

Profitco and Newco, will jointly elect in prescribed form and within the time limit referred to in subsection 85(6), to have the provisions of subsection 85(1) apply to each such transfer of property included in the Portfolio that is an eligible property. The agreed amount specified in each election will be within the limits described in subsection 85(1) and for greater certainty, no gains will be realized by Profitco in respect of any such transfers.

For purposes of the BCA, the amount to be added to the stated capital account maintained for the Newco Preferred Shares issued by Newco will be the aggregate of the agreed amounts in respect of such assets transferred to Newco.

12. Subsequent to the transfer of the Portfolio to Newco described in Paragraph 11, Profitco will exercise its right to retract the Newco Preferred Shares and Newco will redeem the Newco Preferred Shares. As consideration therefor, Newco will issue to Profitco a non-interest-bearing demand note (the "Newco Demand Note") having a principal amount and fair market value equal to the aggregate Redemption Amount and fair market value of the Newco Preferred Shares.

13. Subsequent to the redemption of the Newco Preferred Shares described in Paragraph 12, Newco will be wound-up pursuant to the provisions of the BCA. On the winding-up of Newco, Lossco will receive all of the property of Newco, including the Portfolio, and will assume all of the liabilities of Newco, including the Newco Demand Note. Newco will be formally dissolved upon receipt of the applicable regulatory approvals and the Certificate of Dissolution.

14. Lossco will repay the Newco Demand Note owing to Profitco by transferring the Portfolio to Profitco. The bonds that comprise the Portfolio will become property of Profitco following the transfer.

15. Upon acquiring the Portfolio, as described in Paragraph 14, Profitco will treat the Portfolio in the same manner as it had before it transferred the Portfolio to Newco as described in Paragraph 11.

PURPOSE OF THE PROPOSED TRANSACTIONS

16. The purpose of the Proposed Transactions is to ensure the orderly utilization of the non-capital losses of Lossco. For financial reporting purposes, Lossco cannot continue to recognize the tax benefit associated with the non-capital losses unless Lossco is able to demonstrate that it is more likely than not to earn sufficient taxable income within the applicable loss carry forward period. The purpose of the Proposed Transactions is to enable Lossco to earn sufficient taxable income in order to utilize its non-capital losses before they expire and thereby permit Lossco to continue to recognize the related benefit for financial reporting purposes.

ADDITIONAL INFORMATION

17. The Proposed Transactions will occur in the order presented unless otherwise indicated, with the exception of the filing of the applicable election forms, as described in Paragraph 11, which will be filed before the applicable due date following completion of the Proposed Transactions.

18. Newco's acquisition of the Portfolio from Profitco described in Paragraph 11 will occur pursuant to a legally enforceable and effective Agreement of Purchase and Sale ("PSA"). The PSA will not: contain conditions of any kind relative to the ownership of the Portfolio by Newco; contemplate or require that Profitco exercise its retraction rights with respect to the Newco Preferred Shares; contemplate or require Newco to exercise its right to redeem the Newco Preferred Shares; or contemplate or require Newco to be dissolved. The PSA also will not contemplate or require Newco, or any other person, to transfer the Portfolio after Newco acquires the Portfolio pursuant to the PSA. At the time that the Portfolio is transferred by Profitco to Newco, there will not be any obligation, condition or requirement of any kind for Newco to do anything with the Portfolio. After Newco's acquisition of the Portfolio from Profitco, Newco will be the only person entitled to enjoy all of the incidents of ownership of the Portfolio until Newco is wound-up into Lossco as described in Paragraph 13.

19. None of the Newco Preferred Shares is, or will be, at any time during the implementation of the Proposed Transactions described herein:

(a) the subject of any undertaking that is a guarantee arrangement;

(b) the subject 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. Under applicable generally accepted accounting principles, the transfers of the Portfolio, described in the Proposed Transactions, constitute related-party transactions that are not considered to be in the normal course of operations of the relevant transferor and hence will be recorded in the financial statements of the parties to the relevant transaction at the carrying amount of the Portfolio, not the exchanged amount (i.e., the fair market value of the Portfolio).

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 provided that the Proposed Transactions are completed in the manner described above, our rulings are as set forth below.

A. Subject to subsection 69(11), provided the appropriate jointly elections are filed in prescribed form and manner within the time limits specified in subsection 85(6) and provided the particular property so transferred is an eligible property the provisions of subsection 85(1) will apply to the transfer of the specified debt obligations included in the Portfolio transferred to Newco by Profitco as described in Paragraph 11 such that:

(a) the agreed amount in respect of each specified debt obligation so transferred will be deemed to be Profitco's proceeds of disposition thereof and Newco's cost thereof; and

(b) the cost to Profitco of the Newco Preferred Shares received as consideration for the transfer will be equal to the aggregate of the agreed amounts in respect of each such transfer.

For greater certainty, paragraph 85(1)(e.2) will not apply to these transfers.

B. As a result of the redemption of the Newco Preferred Shares by Newco described in Paragraph 12:

(a) by virtue of paragraphs 84(3)(a) and (b) respectively, Newco will be deemed to have paid, and Profitco will be deemed to have received, a taxable dividend equal to the amount by which the amount paid to redeem the Newco Preferred Shares exceeds the paid-up capital thereof, immediately before such redemption.

(b) the taxable dividend deemed to be received by Profitco in (a) above will be included in Profitco's income pursuant to paragraph 12(1)(j), and will be deductible in computing its taxable income for the taxation year in which such dividend is deemed to have been received pursuant to subsection 112(1). For greater certainty, subsections 112(2.1), (2.2), (2.3) or (2.4) will not apply to deny the application of such deduction in respect of such dividends.

(c) Profitco will not be subject to Part IV.1 tax in respect of the dividend referred to in (a) above.

(d) Newco will not be subject to Part VI.1 tax in respect of the dividend referred to in (a) above.

C. The provisions of subsection 88(1) will apply to the wind-up of Newco described in Paragraph 13.

D. The provisions of subsections 15(1) and 56(2) will not apply to the Proposed Transactions, in and by themselves.

E. Subsection 245(2) will not apply to the Proposed Transactions, in and by themselves, to redetermine any of the tax consequences confirmed herein.

The above rulings are subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on CRA provided that the Proposed Transactions are completed by 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 into law, could have an effect on the rulings provided herein.

OTHER COMMENTS

It is our view that the winding-up of Newco into Lossco as described in Paragraph 13 will cause section 55(2) to apply to the taxable dividend referred to in Ruling B. However, we understand that the Department of Finance has issued a letter dated April 21, 2005 (the "comfort letter"), indicating that it was prepared to recommend to the Minister of Finance that situations described in the comfort letter (i.e. essentially where a wholly-owned subsidiary is amalgamated with, or wound up into, its parent) should not result in a significant increase in the interest of the subsidiary solely as a result of the application of paragraphs 55(3.01)(b) and (c). If such legislation is ever enacted and is effective for the period in which these Proposed Transactions take place, it is possible that subsection 55(2) may not apply to the dividend described in Ruling B.

Unless otherwise confirmed in the above rulings, nothing in this letter should be construed as implying that the CRA has confirmed, reviewed or has made any determination in respect of:

(a) the paid-up capital of any share or the adjusted cost base or fair market value of any property referred to herein;

(b) the status of Lossco, Holdco or Newco as a financial institution for the purposes of subsection 142.2(1); or

(c) any other tax consequence relating to the facts, Proposed Transactions or any transaction or event taking place either prior to the Proposed Transactions or subsequent to the Proposed Transactions, whether described in this letter or not, other than those specifically described in the rulings given above, including whether any of the Proposed Transactions would also be included in a series of transactions or events that include other transactions or events that are not described in this letter.

Yours truly,

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