2007 Ruling 2007-0222921R3 - Utilization of ITCs 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: Utilization of ITCs in an affiliated group of corporations.

Position: The utilization is acceptable.

Reasons: The position is consistent with previous rulings and the policy of the Department of Finance.

XXXXXXXXXX 								2007-022292

XXXXXXXXXX, 2007

Dear XXXXXXXXXX:

Re: XXXXXXXXXX ("ACo")
XXXXXXXXXX ("BCo")
XXXXXXXXXX ("Canco")
XXXXXXXXXX ("Profitco")
(collectively referred to herein as the "taxpayers")
Advance Income Tax Ruling Request

This is in reply to your letter of XXXXXXXXXX, and your other correspondence, in which you requested an advance income tax ruling on behalf of the taxpayers. You have advised that to the best of your knowledge, and that of the responsible officers of each of the taxpayers, none of the issues involved in this Ruling is:

(i) in an earlier return of the taxpayers 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 taxpayers 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 to the taxpayers or any related person. You have also advised that to the best of your knowledge, and that of the responsible officers of each of the taxpayers, that the proposed transactions will not result in any of the taxpayers 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 of the Act, and the Income Tax Regulations thereunder are referred to as the "Regulations";

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

(c) "BCA" means Canada Business Corporations Act, and, where applicable, its predecessor statutes;

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

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

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

(g) "forgiven amount" has the meaning assigned by subsection 80(1) or 80.01(1);

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

(i) "investment tax credit" ("ITC") has the meaning assigned by subsection 127(9);

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

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

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

(m) "Proposed Transactions" means the transactions described in Paragraphs 10 to 18;

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

(o) "scientific research and experimental development" ("SR&ED") has the meaning assigned by subsection 37(7);

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

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

(r) "taxable dividend" has the meaning assigned by subsection 89(1).

FACTS

1. ACo is the corporation resulting from the amalgamation of XXXXXXXXXX. (which was originally incorporated under the BCA in XXXXXXXXXX), XXXXXXXXXX. ACo is governed by the BCA and is both a public corporation and a taxable Canadian corporation. ACo owns all of the issued and outstanding shares of BCo.

2. BCo is a taxable Canadian corporation that was incorporated in XXXXXXXXXX under the BCA. BCo is a holding corporation that holds all of the issued and outstanding shares of Canco.

3. Canco is the corporation resulting from the amalgamation of XXXXXXXXXX. Canco is governed by the BCA and is both a public corporation and a taxable Canadian corporation. XXXXXXXXXX Canco indirectly owns (through wholly-owned subsidiaries) all of the issued and outstanding shares of Profitco.

4. Profitco is the corporation resulting from the amalgamation of XXXXXXXXXX. Profitco is governed by the BCA and is a taxable Canadian corporation. XXXXXXXXXX.

5. ACo, BCo, Canco and Profitco are affiliated persons and form part of a larger group of corporations referred to as the ACo Group. Each of ACo, BCo, Canco and Profitco file their federal income tax returns at the XXXXXXXXXX TC and each such corporation deals with the XXXXXXXXXX TSO.

6. XXXXXXXXXX.

7. As at XXXXXXXXXX, Canco had approximately $XXXXXXXXXX of "undeducted" SR&ED expenditures; and approximately $XXXXXXXXXX of "unused" ITCs. Although Canco is expected to fully utilize its undeducted SR&ED expenditures in its XXXXXXXXXX taxation year (which is expected to end on XXXXXXXXXX), Canco is not expected to be able to utilize all of its unused ITCs until its XXXXXXXXXX taxation year.

8. Profitco estimates that it will generate federal taxable income of approximately $XXXXXXXXXX, respectively, for its XXXXXXXXXX taxation years. Profitco's taxable income is sufficient to generate Part I tax against which it could utilize the unused ITCs of Canco. Profitco has a XXXXXXXXXX taxation year-end.

CORPORATION INCORPORATED FOR THE PROPOSED TRANSACTIONS

9. Prior to the implementation of the Proposed Transactions, Canco will incorporate a new corporation ("Newco") under the BCA and subscribe for one common share for $XXXXXXXXXX on incorporation. Newco will be a taxable Canadian corporation and have a XXXXXXXXXX taxation year-end.

The authorized share capital of Newco will consist of one class of an unlimited number of voting and fully participating common shares and one class of an unlimited number of preferred shares that will be:

(a) non-participating and non-voting;

(b) entitled to an annual cumulative dividend, equal to the interest rate applicable to the Profitco Demand Loan described in Paragraph 12 below plus XXXXXXXXXX%, and applied to the redemption amount of the shares as described in Paragraph 12. The dividend rate will be determined at the time of implementation of the Proposed Transactions and will subsequently be determined at the beginning of each taxation year;

(c) redeemable at any time at the option of Newco for an amount equal to the aggregate of the redemption amount and any unpaid dividends, by Newco:

(i) paying cash equal to such amount;

(ii) assigning the Canco Demand Loan (described in Paragraph 13), to Profitco and paying cash equal to any unpaid dividends; or

(iii) setting-off amounts owing under the Profitco Demand Loan against the redemption amount of the Newco preferred shares in circumstances where Newco has become the holder of the Profitco Demand Loan (described in Paragraph 11), and paying cash equal to any unpaid dividends; and

(d) retractable at any time at the option of the holder for an amount equal to the aggregate of the redemption amount and any unpaid dividends, by Newco assigning the Canco Demand Loan (described in Paragraph 13), to Profitco and paying cash equal to any unpaid dividends, unless Newco:

(i) pays cash equal to such amount; or

(ii) sets off amounts owing under the Profitco Demand Loan against the redemption amount of the Newco preferred shares in circumstances where Newco has become the holder of the Profitco Demand Loan (described in Paragraph 12 below), and pays cash equal to any unpaid dividends.

The terms of the Canco Demand Loan and the Profitco Demand Loan (respectively described in Paragraphs 13 and 11), will provide that if Profitco becomes the holder of the Canco Demand Loan, the Canco Demand Loan may, at the option of either Canco or Profitco, be set off against the Profitco Demand Loan.

PROPOSED TRANSACTIONS

10. Canco will borrow an amount not to exceed $XXXXXXXXXX on a daylight basis from an arm's length financial institution (the "Daylight Loan").

11. Canco will lend the proceeds from the Daylight Loan to Profitco on a subordinated demand basis (the "Profitco Demand Loan"). The Profitco Demand Loan will bear interest at a rate equal to the commercial market rate applicable for such loan. The interest rate will be determined at the time the Proposed Transactions are implemented, and subsequently, at the beginning of each taxation year.

The terms of the Profitco Demand Loan will provide that repayment may be settled in cash or by delivering a financial asset of Profitco (including the Canco Demand Loan described in Paragraph 13).

Based on Profitco's financial projections, it has the financial capacity to pay the interest on the Profitco Demand Loan from its own cash flow (calculated as its net accounting income before depreciation and taxes). In addition, a letter from XXXXXXXXXX, provided confirmation that Profitco (with a guarantee from Canco) has the ability to borrow an additional amount of $XXXXXXXXXX in the debt capital markets.

12. Profitco will use the proceeds of the Profitco Demand Loan to subscribe for Newco preferred shares having an aggregate redemption amount and paid-up capital equal to the principal amount of the Profitco Demand Loan.

Dividends on the Newco preferred shares will be paid at least annually. The dividends will be funded by capital contributions made by Canco as described in Paragraph 16.

13. Newco will lend the subscription proceeds received in Paragraph 12 to Canco on an interest-free demand basis (the "Canco Demand Loan"). The terms of the Canco Demand Loan will allow Canco to repay the Canco Demand Loan by assigning the Profitco Demand Loan to Newco.

14. Canco will use the proceeds from the Canco Demand Loan to repay the Daylight Loan.

15. Profitco will pay interest to Canco on the Profitco Demand Loan at least annually.

16. Canco will agree to and will make contributions of capital to the Newco common share capital at least annually equal to the amount of dividends to be paid by Newco to Profitco in respect of the Newco preferred shares for so long as such preferred shares are outstanding. The contributions of capital, including those contributions of capital referred to in Paragraph 18(b), will not be income of Newco pursuant to generally accepted accounting principles. Canco will not be required to make such contributions of capital where Newco is no longer paying dividends to Profitco.

17. Newco will use the amounts received as capital contributions, as described in Paragraph 16, to pay dividends on the Newco preferred shares to Profitco at least annually.

18. Once Canco has decided to unwind the Proposed Transactions in whole or in part, at that time:

(a) Profitco will pay the balance of any accrued and unpaid interest on the Profitco Demand Loan;

(b) Canco will make capital contributions to the common share capital of Newco equal to the amount of any accrued and unpaid dividends on the Newco preferred shares;

(c) Newco will declare and pay the balance of any accrued and unpaid dividends on the Newco preferred shares;

(d) Newco will redeem all or a portion of the Newco preferred shares held by Profitco and settle the amount owing on redemption by assigning a corresponding amount of the Canco Demand Loan to Profitco;

(e) Profitco will repay all or a portion of the Profitco Demand Loan equal to the redemption amount of Newco preferred shares redeemed under Paragraph 18(d) by setting off the amount owing to Canco with a corresponding amount of the Canco Demand Loan and such portions of the Canco Demand Loan and the Profitco Demand Loan will be cancelled; and

(f) Once all of the preferred shares of Newco held by Profitco have been redeemed, Newco will be wound up into Canco pursuant to subsection 210(3) of the BCA.

ADDITIONAL INFORMATION

19. Canco, Profitco and Newco are neither specified financial institutions nor financial intermediary corporations.

20. None of the issued shares referred to herein (including the shares to be issued as described in the Proposed Transactions) are 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 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); 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).

21. Each of Canco and Newco will agree with Profitco that Newco shall be a single-purpose corporation, shall have no liabilities and shall carry on (and Canco will cause to carry on) no activities other than those contemplated by the Proposed Transactions.

PURPOSE OF THE PROPOSED TRANSACTIONS

22. The overall purpose of the Proposed Transactions is to enable Canco to earn sufficient interest income, over a period of time, in order to utilize some or all of its unused ITCs and to allow Profitco to reduce its taxable income by the equivalent interest income earned by Canco.

23. In order to undertake the Proposed Transactions in a legally effective manner, it is necessary to use Newco, as described in Paragraph 9, to enable Profitco to hold an interest in Newco preferred shares. Under section 30(1) of the BCA, Profitco is precluded from acquiring and holding shares in Canco.

24. The purpose of making capital contributions to the common share of Newco, as described in Paragraph 16, versus subscribing for additional common shares of Newco, is to ensure that Newco will not be precluded from declaring dividends on the Newco preferred shares pursuant to section 42 of the BCA. If additional common shares were issued, the realizable value of Newco's assets (the Canco Demand Loan) after the payment of a dividend would be less than the aggregate of its liabilities and its stated capital of both common shares and Newco preferred shares, thus precluding the payment of dividends.

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. The dividends received by Profitco, as described in Paragraphs 17 and 18(c) will be taxable dividends that will be deductible, pursuant to subsection 112(1), in computing the taxable income of the recipient 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) and 112(2.4).

B. Profitco will not be subject to Part IV.1 tax under section 187.2 in respect of the dividends received from Newco, described in Paragraphs 17 and 18(c), by virtue of paragraph (b) of the definition of "excepted dividend" in section 187.1.

C. Newco will not be subject to Part VI.1 tax under section 191.1 in respect of the dividends paid to Profitco, described in Paragraphs 17 and 18(c), by virtue of paragraph (a) of the definition of "excluded dividend" in subsection 191(1).

D. Provided that Profitco has a legal obligation to pay interest on the Profitco Demand Loan, described in Paragraph 11, and Profitco continues to hold the Newco preferred shares, described in Paragraphs 9 and 12, 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 Profitco Demand Loan or (ii) a reasonable amount in respect thereof.

E. 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 described in Paragraph 16 and Paragraph 18(b).

F. The set-off of all or any part of the Canco Demand Loan against the corresponding amount of the Profitco Demand Loan, described in Paragraph 18(e), will not give rise to a forgiven amount.

G. The provisions of subsection 88(1) will apply to the windup of Newco described in Paragraph 18(f).

H. The provisions of subsections 15(1), 56(2), 69(1), and 246(1) will not be applied as a result of the Proposed Transactions, in and by themselves.

I. The provisions of subsection 245(2) will not apply, as a result of the Proposed Transactions, in and by themselves, to re-determine the income 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, excluding Paragraphs 15 to 18, 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.

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 amount of any ITC and SR&ED expenditures of any corporation referred to herein;

(c) the provincial income tax implications relating to the allocation of any income, expenses under the Proposed Transactions;

(d) the application or non-application of the general anti-avoidance provisions of any province; and

(e) 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 includes any other transactions or events that are not described in this letter.

Yours truly,

XXXXXXXXXX
Manager
Corporate Reorganizations Section I
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch