2007 Ruling 2007-0252501R3 - 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: Are the loss utilization transactions acceptable?

Position: YES

Reasons: Meets the technical requirements of the provision

XXXXXXXXXX  							2007-025250

XXXXXXXXXX , 2007

Dear XXXXXXXXXX :

Re: Advance Income Tax Ruling
XXXXXXXXXX . ("Profitco") BN XXXXXXXXXX
XXXXXXXXXX . ("Lossco") BN XXXXXXXXXX

This is in reply to your letter of XXXXXXXXXX and further to information received from XXXXXXXXXX of your office on XXXXXXXXXX, wherein you requested an advance income tax ruling on behalf of the above-named taxpayers. In general terms, the transactions described herein involve the use of losses within an affiliated group of corporations. We also acknowledge information provided during numerous telephone conversations and electronic correspondences with XXXXXXXXXX.

We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues contained in this ruling request herein are:

(i) dealt with in an earlier return of Profitco, Lossco, or a related person;

(ii) being considered by a tax services office or a taxation centre in connection with a tax return already filed by Profitco, Lossco or a related person;

(iii) under objection by Profitco, Lossco or a related person;

(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to Profitco, Lossco or a related person; nor

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

Definitions:

(a) "Act" means the Income Tax Act, R.S.C. 1985 (5th Supp.) c.1, as amended to the date hereof. Unless otherwise stated, all statutory references are to the Act and all terms and conditions used herein that are defined in the Act have the meaning given in such definition;

(b) "affiliated persons" has the meaning assigned by subsection 251.1(1) of the Act;

(c) "arm's length" has the meaning assigned by subsection 251(1) of the Act;

(d) "Canadian-controlled private corporation" has the meaning assigned by subsection 125(7) of the Act;

(e) "CBCA" means the Canada Business Corporations Act;

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

(g) "Daylight Loan" means the amount of $XXXXXXXXXX or such lesser amount to be borrowed by Profitco from an arm's length financial institution on a "daylight loan" basis and invested by Profitco in the Lossco Preferred Shares;

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

(i) "EBITDA" means earnings before interest, taxes, depreciation and amortization;

(j) "Facility" means the XXXXXXXXXX, which is owned and operated by Lossco;

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

(l) "forgiven amount" has the meaning assigned by subsection 80(1) of the Act;

(m) "Lossco" means XXXXXXXXXX;

(n) "Lossco Loan" means the demand loan made by Lossco to Profitco referred to in 22 below, bearing an annual rate of simple interest of XXXXXXXXXX % calculated daily which is not greater than the rate Profitco would pay to an arm's length lender to borrow an equivalent amount on similar terms. The interest will be payable annually, on XXXXXXXXXX or on the termination of the Lossco Loan, whichever is earlier;

(o) "Lossco Preferred Shares" means the Class B preferred shares of Lossco described in 19 below;

(p) XXXXXXXXXX;

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

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

(s) "Profitco" means XXXXXXXXXX;

(t) "Profitco Affiliated Group" means Profitco and Lossco;

(u) "Profitco Demand Note" means the demand note described in 22 below;

(v) "Proposed Transactions" means the transactions described in 19 to 24 below;

(w) "private corporation" has the meaning assigned by subsection 89(1) of the Act;

(x) "Redemption Amount" has the meaning ascribed thereto in 19(b) below;

(y) "related" has the meaning assigned by section 251 of the Act;

(z) "restricted financial institution" has the meaning assigned by subsection 248(1) of the Act;

(aa) "Shareholders' Agreement" means the Shareholders' Agreement entered into between Profitco, Xco and Lossco dated XXXXXXXXXX governing the relationship between Profitco and Xco with respect to their shareholdings in Lossco;

(bb) "specified financial institution" has the meaning assigned by subsection 248(1) of the Act;

(cc) "taxable dividend" has the meaning assigned by subsection 89(1) of the Act;

(dd) "taxation year" has the meaning assigned by section 249 of the Act;

(ee) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act; and

(ff) "Xco" means XXXXXXXXXX having its head office at XXXXXXXXXX.

Facts:

1. Profitco is a "taxable Canadian corporation" and a "Canadian-controlled private corporation" that XXXXXXXXXX is governed by the CBCA.

2. Profitco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre. Profitco's taxation year-end is XXXXXXXXXX. Profitco's mailing address is XXXXXXXXXX.

3. Profitco carries on the business of XXXXXXXXXX directly and indirectly through its XXXXXXXXXX subsidiary corporations. XXXXXXXXXX.

4. Profitco's taxable income for the year-ended XXXXXXXXXX was $XXXXXXXXXX . Its provincial allocation of income is as follows: XXXXXXXXXX.

5. Lossco is a taxable Canadian corporation and a Canadian-controlled private corporation. It is a single purpose corporation established to own and operate the Facility. Lossco itself has no subsidiaries.

6. Lossco's tax affairs are administered by the XXXXXXXXXX Tax Services Office and it files its tax returns at the XXXXXXXXXX Taxation Centre. Lossco's taxation year-end is XXXXXXXXXX.

7. Lossco's authorized share capital consists of an unlimited number of common shares without par value and XXXXXXXXXX Series A Preference Shares. There are XXXXXXXXXX common shares issued and outstanding of which XXXXXXXXXX are owned by Profitco, representing shareholder equity of $XXXXXXXXXX . The remaining XXXXXXXXXX issued and outstanding common shares of Lossco, representing XXXXXXXXXX % of its issued and outstanding shares and shareholder equity of $XXXXXXXXXX, are owned by Xco. No Series A Preference Shares are issued and outstanding.

8. As at XXXXXXXXXX, Lossco was indebted to Profitco in the amount of approximately $XXXXXXXXXX. XXXXXXXXXX. The amounts advanced by Profitco to Lossco together with the equity investment made by Profitco in Lossco in the amount of $XXXXXXXXXX were substantially used by Lossco to build the Facility. For its taxation year ending XXXXXXXXXX , Lossco projects EBITDA of $XXXXXXXXXX and a non-capital loss of $XXXXXXXXXX. The provincial allocation of income is as follows: XXXXXXXXXX.

As at the date hereof, Lossco has potential available tax shelter consisting of capital cost allowance in respect of the undepreciated capital cost of the depreciable property comprising the Facility in an aggregate amount of approximately $XXXXXXXXXX. Lossco has no other available tax shelter and, in particular, no non-capital loss carryforwards as of the date hereof.

9. Lossco is not anticipated to generate taxable income until its taxation year ended XXXXXXXXXX, due to sufficient capital cost allowance available to be claimed by it prior to the commencement of that taxation year.

10. The issued and outstanding shares of Xco are owned by XXXXXXXXXX Xco deals at arm's length with Lossco and Profitco.

11. XXXXXXXXXX.

12. XXXXXXXXXX.

13. Lossco has entered into a XXXXXXXXXX agreement with Xco XXXXXXXXXX. The XXXXXXXXXX agreement between Xco and Lossco expires at the end of the XXXXXXXXXX.

14. XXXXXXXXXX.

15. The Shareholders' Agreement provides, inter alia, that the board of directors of Lossco shall consist of XXXXXXXXXX members of which XXXXXXXXXX shall be nominated by Profitco and XXXXXXXXXX by Xco. Xco is also entitled to send an observer to board meetings, who can participate as an observer but who is not entitled to vote. The board meets XXXXXXXXXX to review the business and affairs of Lossco. The quorum for the board of directors is a majority provided the directors present include Xco's XXXXXXXXXX.

16. Board resolutions are passed by a simple majority, subject to a limited number of matters, which require unanimous approval of the shareholders, that cover fundamental changes in the business or the structure of Lossco, including redemption of Lossco shares. The fundamental changes are set out in the Shareholders' Agreement and are intended to assure Xco that Profitco cannot use its control of Lossco to disenfranchise Xco, i.e., to ensure that Lossco will remain a single purpose corporation that operates the Facility in which Xco has a XXXXXXXXXX% minority interest. For the same reason, the Shareholders' Agreement provides that each of Profitco and Lossco has a pre-emptive right to acquire its proportionate share of any new share issuance or option grants. Profitco has de jure control of Lossco notwithstanding certain provisions of the Shareholders' Agreement and, accordingly, Profitco and Lossco are related to each other and are affiliated persons.

Proposed Transactions:

17. The authorized share capital of Lossco will be modified to authorize an unlimited number of Class B preferred shares, having the following characteristics:

(a) non-voting;

(b) redeemable and retractable, subject to applicable law, at any time for an amount equal to the amount for which they were issued less any amount previously returned by way of return of capital (the "Redemption Amount") together with accrued and unpaid dividends thereon;

(c) entitled to a cumulative annual dividend of XXXXXXXXXX% on the Redemption Amount, calculated daily which rate is equal to the interest rate on the Lossco Loan to Profitco plus a spread of XXXXXXXXXX%. Subject to applicable solvency rules, dividends will be declared and paid on the Lossco Preferred Shares on XXXXXXXXXX of each year or on the date that the Lossco Preferred Shares are redeemed, whichever is earlier; and

(d) preference on dissolution over common shares in an amount equal to the Redemption Amount plus accrued and unpaid dividends thereon.

18. Xco will waive its pre-emptive right to acquire its proportionate share of Lossco Preferred Shares. Xco and Profitco will agree that the Lossco Preferred Shares can be redeemed in accordance with their terms.

19. Profitco will borrow the Daylight Loan. Profitco will use the proceeds of the Daylight Loan to subscribe for Lossco Preferred Shares having an aggregate subscription price equal to the amount of the Daylight Loan. Profitco will acquire XXXXXXXXXX Lossco Preferred Shares having a Redemption Amount of $XXXXXXXXXX per share.

20. Lossco will use the proceeds of the aggregate subscription price of its Lossco Preferred Shares to make the Lossco Loan to Profitco to be evidenced by the Profitco Demand Note.

21. Profitco will immediately use the proceeds of the Lossco Loan to repay the Daylight Loan. The loss consolidation arrangement will be unwound over time as Lossco's available tax shelter is depleted from time to time, as follows:

(a) Profitco will make repayments of principal on the Lossco Loan to Lossco;

(b) Lossco will use the funds received on the Lossco Loan repayments in paragraph (a) above to redeem a portion of the Lossco Preferred Shares (or, alternatively, to return paid-up capital of the Lossco Preferred Shares); and

(c) on or before XXXXXXXXXX , Lossco will pay any accrued and unpaid dividends on any Lossco Preferred Shares outstanding at that time and will then redeem such shares for a promissory demand note having a principal amount equal to the aggregate Redemption Amount of such Lossco Preferred Shares. Lossco will satisfy the principal amount of that promissory note by setting-off that demand promissory note against the outstanding principal amount of the Profitco Demand Note owing by Profitco to Lossco.

Additional Information:

22. Each of Profitco and Lossco confirms that the Proposed Transactions will not affect its ability to pay any of its outstanding tax liabilities.

23. The Lossco Preferred Shares, 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;

(c) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a) of the Act;

(d) issued for consideration that is or includes:

(i) an obligation of the type described in subparagraph 112(2.4)(b)(i) of the Act, other than an obligation of a corporation that is related (otherwise than by reason of a right referred to in paragraph 251(5)(b) of the Act); or

(e) any right of the type described in subparagraph 112(2.4)(b)(ii) of the Act; or a share that is issued or acquired as part of a transaction or series of transactions or events of the type described in subsection 112(2.5) of the Act.

24. Neither Profitco nor Lossco is a "specified financial institution", a "restricted financial institution" or a "financial intermediary corporation".

25. The amount of the Lossco Preferred Share subscription will not exceed the amount of monies that Lossco could reasonably be expected to be able to borrow for use in its business from an arm's length lender with a guarantee from Profitco.

26. Profitco will have the financial capacity to repay the Lossco Loan.

Purpose of the Proposed Transactions:

27. The sole purpose of the Proposed Transactions is to allow for the consolidation of profit and losses between Profitco and Lossco. The consolidation will be achieved by Lossco earning sufficient interest income, over a period not to extend beyond its taxation year ending XXXXXXXXXX , so as to utilize its available capital cost allowance and to permit Profitco to reduce its income by the interest paid by it to Lossco.

Rulings Given:

Provided that the preceding statements constitute complete and accurate disclosure of all the relevant facts, Proposed Transactions and purpose of the Proposed Transactions, and provided that the Proposed Transactions are completed in the manner described above, we rule as follows:

A. Provided that Profitco has the legal obligation to pay interest on the Lossco Loan and the Lossco Preferred Shares continue to be held by Profitco for the purpose of gaining or producing income from property, Profitco will be entitled, pursuant to paragraph 20(1)(c) of the Act, to deduct in computing its income for a taxation year, the interest paid or payable (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) on the Lossco Loan in respect of that taxation year, to the extent such amount does not exceed a reasonable amount.

B. The dividends received by Profitco on the Lossco Preferred Shares described in 17(c) above will be taxable dividends that will, pursuant to subsection 112(1) of the Act, be deductible in computing the taxable income of Profitco for the year in which the dividend is 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) of the Act.

C. Profitco will not be subject to Part IV.1 tax under section 187.2 of the Act in respect of the dividends received from Lossco on the Lossco Preferred Shares described in 19(c) above, by virtue of paragraph (b) of the definition of "excepted dividends" in section 187.1 of the Act.

D. Lossco will not be subject to Part VI.1 tax under section 191.1 of the Act in respect of the dividends paid to Profitco on the Lossco Preferred Shares described in 19(c) above, by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191.1 of the Act.

E. Provided Lossco is not entitled to a dividend refund in respect of its taxation year in which it paid the dividends on the Lossco Preferred Shares described in 19(c) above, Profitco will not be subject to Part IV tax under subsection 186(1) of the Act.

F. The set-off of the Profitco Demand Note against the corresponding amount owing by Lossco to Profitco as a result of the redemption of the Lossco Preferred Shares described in 25(c) above will not give rise to a forgiven amount, as defined in section 80 of the Act, provided that the fair market value of the Profitco Demand Note and the corresponding amount owing by Lossco to Profitco at the date of settlement is not less than their principal amount.

G. Subsection 245(2) of the Act will not be applied to the Proposed Transactions, in and by themselves, to re-determine the tax consequences confirmed in the rulings given.

The above rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5 dated May 17, 2002 and are binding on the CRA provided that the proposed transactions, excluding 24 above, 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 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 the general anti-avoidance provisions of any province; nor

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

Yours truly,

XXXXXXXXXX
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch