Corporate Loss Utilization Transactions
A basic element of corporate tax planning is not to have one member of a corporate group pay income taxes while another is in a loss position. Transactions are undertaken to transfer income or deductions in order to avoid this result. While this issue cannot be regarded as new, it is useful to be reminded of the dos and don’ts regarding this topic.
Question 1
What are the basic parameters of loss utilization transactions, and what is the basis in law for these?
Response 1
As a starting point, all transactions that are undertaken must be legally effective and otherwise comply with the technical provisions of the Income Tax Act. Beyond this, the only technical concern is the application of the General Anti-Avoidance Rule, and particularly subsection 245(4), that is, is there a misuse or abuse. As noted in the Department of Finance’s explanatory notes for the GAAR, the transfer of income or deductions within an affiliated group of corporations would not ordinarily fall within the scope of section 245 since they usually are not considered to result in a misuse or abuse.
There is a scheme to the Act, evidenced by certain provisions, including subsections 69(11) and 111(4) to 111(5.2), that restrict the claims by corporations for losses, deductions or credits incurred by a non-affiliated corporation. However, these limitations do not apply to transactions between affiliated corporations. In addition, several other provisions of the Act, notably the stop-loss provisions, prevent the recognition of losses on transactions undertaken within a corporate group. From this we can conclude that there is a scheme to the Act recognizing and accepting certain transactions between affiliated corporations as being undertaken by the same corporate group.
Question 2
Can you provide us with a general summary of the corporate loss utilization framework?
Response 2
In general terms, we look at these transactions as a means of achieving a consolidated tax position for the group. Most of the information we require when considering a ruling request for a loss utilization transaction relates to this.
Question 3
So what information would you be looking for in particular with regard to a loss consolidation ruling?
Response 3
We will ask for three things:
1. an explicit summary of accumulated losses and taxable incomes for all relevant years for all relevant corporations and the period of time for which these corporations have been or are expected to be affiliated;
2. an analysis of any loss carrybacks to be undertaken by a formerly profitable corporation; and
3. an analysis of the possibility of losses being refreshed beyond the 7 year carryforward limit.
Question 4
There is some uncertainty in the tax community as to the continuing validity of comments in example 5 of Supplement 1 of the GAAR Information Circular 88-2. In particular, the example makes reference to borrowings in a loss consolidation transaction not exceeding what a corporation could reasonably be expected to borrow for use in its business on the basis solely of its credit from an arm’s length lender. Can you clarify the CCRA’s current views on this?
Response 4
As noted earlier, loss consolidation transactions must be legally effective. The decisions of the Supreme Court of Canada, notably in Shell 10 , reinforce this concept. However, we would not feel comfortable providing a ruling on a loss consolidation transaction that contemplates dollar amounts and time frames that are blatantly artificial. Thus, in order to be provided with a ruling, we must be able to satisfy ourselves that the transactions are plausible, and the quickest way for us to obtain such assurance is through a commitment letter.
Question 5
Another area of uncertainty relates to the C.R.B. Logging 11 case. To refresh people’s memories of this, the facts involved the indirect acquisition by a subsidiary of dividend paying preferred shares of the parent. The court ruled that there was no independent source of income from which the parent could fund the dividends, and thus the interest deductibility provisions were not met, and so the deduction for the interest was disallowed. What is the CCRA’s current view on this type of situation for loss consolidation purposes?
Response 5
While we have not reached the point where we would state that CRB Logging is no longer good law, we have provided rulings on some upstream shareholding situations. The key criteria to be met in such situations is the existence of other assets in the parent company that can generate sufficient income to pay the dividends on the preferred shares held by the subsidiary.