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: Is the loss utilization arrangement acceptable?
Position: YES
Reasons: Meets the technical requirements of the provision
XXXXXXXXXX 2008-026622
XXXXXXXXXX , 2008
Dear XXXXXXXXXX :
Re: Advance Income Tax Ruling
XXXXXXXXXX ("Lossco") BN XXXXXXXXXX
XXXXXXXXXX ("Profitco") BN XXXXXXXXXX
XXXXXXXXXX ("Xco") BN XXXXXXXXXX
This is in reply to your letter of 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 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 Lossco, Profitco, Xco 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 Lossco, Profitco, Xco or a related person;
(iii) under objection by Lossco, Profitco, Xco or a related person;
(iv) the subject of a previous ruling issued by the Income Tax Rulings Directorate to the taxpayers 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:
In this letter, the following terms have the meanings specified:
(a) "Aco" refers to XXXXXXXXXX , which is a publicly traded company with its shares listed on the XXXXXXXXXX Stock Exchange. Aco is a corporation formed under the laws of XXXXXXXXXX and a non-resident person for purposes of the Act;
(b) "Acobank" refers to XXXXXXXXXX , the majority owned retail bank operation of Aco. Acobank is a publicly traded company with shares listed on the XXXXXXXXXX Stock Exchange. Acobank's head office is located in XXXXXXXXXX and is a non-resident person for the purposes of the Act;
(c) "Act" means the Income Tax Act;
(d) "affiliated persons" has the meaning assigned by subsection 251.1(1) of the Act;
(e) "arm's length" has the meaning assigned by subsection 251(1) of the Act;
(f) "Bco" refers to XXXXXXXXXX , a corporation incorporated under the laws of XXXXXXXXXX . Bco is a wholly-owned subsidiary of ACo and is a non-resident person for purposes of the Act;
(g) "Bank" refers to an arm's length Canadian financial institution;
(h) "Cco" refers to XXXXXXXXXX ., a corporation incorporated under the laws of XXXXXXXXXX . Cco is an indirect wholly-owned subsidiary of Aco and is a non-resident person for purposes of the Act;
(i) "CBCA" and "XXXXXXXXXX " means the Canada Business Corporations Act and XXXXXXXXXX , respectively;
(j) "Common Shares" refers to the common shares issued by Xco to Lossco described in 25 below;
(k) "Lossco" means XXXXXXXXXX ;
(l) "Lossco Loan" refers to the loan described in 22 below;
(m) "FMV" means fair market value;
(n) "non-capital loss" has the meaning assigned by subsection 111(8) of the Act;
(o) "Preferred Shares" refers to the preferred shares issued by Xco which are described in 18 below which Profitco will subscribe for as described in 20 below;
(p) "Profitco" means XXXXXXXXXX .;
(q) "Proposed Transactions" means the proposed transactions described in 18 to 28 below under the heading "Proposed Transactions";
(r) "related" has the meaning assigned by section 251 of the Act;
(s) "Xco Loan" refers to the loan described in 21 below;
(t) "specified financial institution" has the meaning assigned by subsection 248(1) of the Act;
(u) "taxable Canadian corporation" has the meaning assigned by subsection 89(1) of the Act;
(v) "Xco" means XXXXXXXXXX ; and
(w) "Yco" refers to XXXXXXXXXX ., a resident of Canada that is a taxable Canadian corporation.
Facts:
1. Lossco is a resident of Canada and a taxable Canadian corporation for purposes of the Act.
2. Lossco was formed on XXXXXXXXXX as a result of an amalgamation under the CBCA. Lossco's taxation year-end is XXXXXXXXXX .
3. Lossco is a wholly-owned subsidiary of Yco, a resident of Canada and a taxable Canadian corporation for purposes of the Act.
4. Profitco is a resident of Canada and a taxable Canadian corporation for the purposes of the Act.
5. Profitco was formed under the CBCA on XXXXXXXXXX as a result of the amalgamation of XXXXXXXXXX . Profitco was formerly known as XXXXXXXXXX before its name change by articles of amendment dated XXXXXXXXXX The taxation year-end of Profitco is XXXXXXXXXX .
6. Profitco is a wholly-owned subsidiary of Bco.
7. Xco is a resident of Canada and a taxable Canadian corporation for purposes of the Act.
8. Xco was formed on XXXXXXXXXX . Xco's taxation year-end is XXXXXXXXXX .
9. Xco is a wholly-owned subsidiary of Yco. Xco is an inactive corporation.
10. Cco is the beneficial owner of XXXXXXXXXX % of the issued and outstanding shares of Yco.
11. Bco is the beneficial owner of XXXXXXXXXX % of the issued and outstanding shares of Yco.
12. Aco operates through numerous subsidiaries in XXXXXXXXXX separate divisions as follows:
XXXXXXXXXX
13. Lossco and Profitco, two of Aco's indirectly owned subsidiaries, provide XXXXXXXXXX services in Canada as part of XXXXXXXXXX .
14. Aco, Lossco, Profitco, Xco and Acobank are affiliated and related persons as defined under the provisions of the Act.
15. Since Lossco, Profitco, Xco and Acobank are related persons for purposes of the Act, Lossco, Profitco and Xco are "specified financial institutions" by virtue of paragraph (g) of the definition of "specified financial institution" in subsection 248(1) of the Act.
16. Lossco has incurred non-capital losses in previous taxation years and is expected to continue to incur additional non-capital losses.
17. Lossco's non-capital losses as disclosed in its federal income tax return for the year ended XXXXXXXXXX are as follows:
Year of expiry Amount
XXXXXXXXXX XXXXXXXXXX
Total $XXXXXXXXXX
Proposed Transactions:
18. The articles of Xco will be amended to create an unlimited number of Preferred Shares with the following attributes:
i) non-voting and non-participating;
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; and,
iii) entitled to annual cumulative dividends applied to the redemption amount of the shares, equal to the interest rate applicable to the Lossco Loan, plus XXXXXXXXXX % per annum; and first ranking with respect to preference as to dividends and proceeds on dissolution.
19. Profitco will borrow $XXXXXXXXXX on a "daylight" loan basis from the Bank. The amount of $XXXXXXXXXX has been established by the management of Profitco based on Profitco's credit facilities and Profitco's borrowing capacity.
20. Profitco will use the "daylight loan" proceeds to subscribe for Preferred Shares in Xco for an amount equal to their redemption value.
21. Xco will use the subscription proceeds to make a non-interest-bearing loan to Lossco, (the "Xco Loan"). The Xco Loan will be repayable on demand.
22. Lossco will use the proceeds from the Xco Loan to make an interest-bearing loan to Profitco, (the "Lossco Loan"). The terms of the Lossco Loan will be as follows:
a) Repayable on demand;
b) Payments of interest only; and,
c) Interest rate will be arm's length, based on estimated rate available to Profitco for borrowing of a similar amount. At current rates, the interest is estimated to be equal to XXXXXXXXXX % per annum compounded monthly.
23. Profitco will use the Lossco Loan proceeds to repay the "daylight loan" to the Bank.
24. Profitco will pay interest on the Lossco Loan on an annual basis.
25. Lossco will on an annual basis subscribe for Common Shares of Xco equal to the dividend to be paid to Profitco in respect of the Preferred Shares issued to Profitco. Lossco will fund the purchase of the Common Shares out of all available sources, including its substantial operations in the XXXXXXXXXX business.
26. Xco will include a nominal amount in its stated capital in respect of the capital contribution received for the Common Shares issued to Lossco as described in 25 above.
27. On an annual basis Xco will pay a dividend on the Preferred Shares using the proceeds received from Lossco on the issuance of Xco Common Shares to Lossco.
28. Subsequent to the utilization of the non-capital losses of Lossco, Lossco, Xco and Profitco will unwind the structure created by the Proposed Transactions as follows:
a) Profitco will repay the Lossco Loan described in 22 above,
b) Lossco will repay the Xco Loan described in 21 above,
c) Xco will redeem and cancel the Preferred Shares issued as described in 20 above, and
d) Xco will repurchase and cancel the Common Shares issued to Lossco described in 25 above for a nominal amount.
Purpose of the Proposed Transactions:
29. 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 XXXXXXXXXX . The consolidation is achieved by allowing Lossco to earn interest 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 Loan, as described above.
30. The Preferred Shares will not be, at any time during the implementation of the Proposed Transactions described herein:
i) the subject of any undertaking that is referred to in subsection 112(2.2) of the Act as a "guarantee agreement";
ii) the subject of a dividend rental arrangement as that term is defined in subsection 248(1) of the Act;
iii) the subject of any secured undertaking of the type described in paragraph 112(2.4)(a) of the Act; or
iv) issued for consideration that is or includes:
(A) 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
(B) any right of the type described in subparagraph 112(2.4)(b)(ii) of the Act.
31. The acquisition of the Preferred Shares by Profitco as described in 20 above will not occur in the ordinary course of business carried on by Profitco.
32. It is expected that Profitco will have sufficient annual income for tax purposes, before claiming discretionary deductions, to fully utilize the interest expense on the Lossco Loan.
33. Profitco and Lossco do not expect the Proposed Transactions to significantly affect the companies' respective provincial allocations. Based on historical Lossco and Profitco provincial allocations and effective rates through to XXXXXXXXXX , and computed using the XXXXXXXXXX allocations of gross revenue and salaries and wages and incorporating tax rate changes that are substantially enacted, income should not shift from significantly "higher" to "lower" tax provinces. Lossco's combined annual federal and provincial effective rates are projected to be similar to Profitco's annual federal and provincial effective rates if the Proposed Transactions are implemented.
34. Profitco and Lossco also do not expect to obtain any reduction of provincial capital taxes as a result of the Proposed Transactions. Based on a pro-forma calculation of provincial capital tax, both Lossco and Profitco have estimated an increase, on an after tax basis, in capital tax payable of approximately $XXXXXXXXXX and $XXXXXXXXXX , respectively, as a result of the Proposed Transactions.
35. Lossco will realize a capital loss on the unwinding of the structure as described in 28 above as a result of the purchase and cancellation of the Xco Common Shares it owns. However, the capital loss in respect of the disposition of the Common Shares will be denied pursuant to subsection 40(3.6) of the Act.
Rulings Given:
Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, the 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. The dividends received by Profitco from Xco as described in 27 above will be included in computing the income of Profitco pursuant to paragraph 12(1)(j) of the Act and will be taxable dividends that will, pursuant to subsection 112(1) of the Act, be deductible by Profitco in computing its taxable income for the taxation year in which dividends are received, and for greater certainty, such deduction will not be precluded by any of subsections 112(2.1), (2.2), (2.3) or (2.4) of the Act.
B. Provided the interest paid or payable by Profitco on the Lossco Loan as described in 24 above is reasonable and is paid pursuant to a legal obligation to pay interest and that the Preferred Shares of Xco continue to be held by Profitco for the purpose of producing income from property, Profitco will be entitled to deduct, in computing its income for a taxation year, pursuant to paragraph 20(1)(c) of the Act, the interest paid or payable on the Lossco Loan (depending on the method regularly followed by Profitco in computing its income for the purposes of the Act) in respect of the taxation year to the extent such amount does not exceed a reasonable amount.
C. No amount will be included in the income of Xco pursuant to paragraph 12(1)(x) or section 9 of the Act in respect of the capital contributions described in 25 and 26 above.
D. The provisions of subsection 15(1), 56(2), 69(1), 69(11) and 246(1) of the Act will not apply to the Proposed Transactions described herein, in and by themselves
E. Profitco will not be subject to Part IV.1 tax under section 187.2 of the Act in respect of the dividends received for Xco on the Preferred Shares described in 18 above, by virtue of paragraph (b) of the definition of "excepted dividends" in section 187.1 of the Act.
F. Xco 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 Preferred Shares described in 18 above, by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1) of the Act.
G. As a result of the Proposed Transactions, in and by themselves, subsection 245(2) of the Act will not be applied 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 28 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.
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
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