Principal Issues: Whether non-capital losses incurred prior to an acquisition of control can be carried forward and used by another corporation in a taxation year ended after the acquisition of control.
Position: No. In the particular situation the source of the losses was from property. As such, non-capital losses from property incurred in a taxation year ended before an acquisition of control cannot be carried forward to a taxation year ended after the acquisition of control.
Reasons: According to the law and the particular facts.
| August 16, 2011 Montreal Tax Services Office 305 René-Lévesque West Blvd., 10th floor Montréal QC H2Z 1A6 Attention: Ms. Évelyne Lamarche, CGA |
Income Tax Rulings Directorate J. Lafrenière 2011-040172 |
Request for an opinion - use of losses following an acquisition of control
This is in response to your email of April 5, 2011 in which you asked us for our opinion regarding the use of the losses of a corporation following the acquisition of its control and the successive windings up described below. This is also in response to your e-mails of May 31, 2011, as well as telephone conversations (J. Lafrenière/E. Lamarche) in which additional information and/or changes relating to this file were communicated to us.
For the purposes of our opinion, we have reviewed the following documents that you have provided to us:
- copy of a letter dated April 6, 2011 from you to XXXXXXXXXX of XXXXXXXXXX Corporation;
- copy of the financial statements of XXXXXXXXXX for the years ending XXXXXXXXXX;
- copies of extracts of income tax returns ("T2") of XXXXXXXXXX for taxation years ended on XXXXXXXXXX;
- copy of extracts of the notice of assessment of XXXXXXXXXX for the taxation year ended XXXXXXXXXX of XXXXXXXXXX;
- copy of extracts of the notice of assessment of XXXXXXXXXX for the taxation year ended XXXXXXXXXX of XXXXXXXXXX;
- copy of extracts of the notice of assessment of XXXXXXXXXX for the taxation year ended XXXXXXXXXX of XXXXXXXXXX;
- working papers illustrating the various stages of the corporate reorganization detailed below;
- copies of invoices relating to the item "Other expenses - XXXXXXXXXX acquisition", totaling $XXXXXXXXXX, as presented in the income statement of XXXXXXXXXX for its taxation year ended on XXXXXXXXXX.
It should be noted that our analysis was based solely on the review of the documents described above. You did not consider it relevant at this stage of the file that we read any other documents related to this letter.
Furthermore, and unless otherwise indicated, all statutory references are to provisions of the Income Tax Act (the “Act") or one of its provisions.
Facts
Under our understanding and based on our review of the documents listed above, the important facts relating to this file can be summarized as follows:
a) On XXXXXXXXXX, XXXXXXXXXX Corporation was incorporated under the Canada Business Corporations Act ("CBCA").
b) On the same day, XXXXXXXXXX issued one share of its capital stock to XXXXXXXXXX.
c) On XXXXXXXXXX , XXXXXXXXXX issued XXXXXXXXXX shares to XXXXXXXXXX.
d) Between XXXXXXXXXX and XXXXXXXXXX , XXXXXXXXXX invested $XXXXXXXXXX in XXXXXXXXXX in the form of equity.
e) On XXXXXXXXXX , XXXXXXXXXX acquired substantially all of the issued and outstanding common shares of the capital stock of XXXXXXXXXX for a total consideration of $XXXXXXXXXX. Thus, XXXXXXXXXX acquired de jure control of XXXXXXXXXX.
XXXXXXXXXX is a corporation incorporated XXXXXXXXXX under the CBCA.
XXXXXXXXXX had accumulated non-capital losses ("NCL") totaling $XXXXXXXXXX in the taxation years ending before the acquisition of its control by XXXXXXXXXX (i.e., $XXXXXXXXXX and $XXXXXXXXXX for the years ending XXXXXXXXXX, respectively). With respect to that last taxation year, the income statement of XXXXXXXXXX shows an amount of $XXXXXXXXXX in the "Other expenses – XXXXXXXXXXXX Acquisitions. XXXXXXXXXX.
For the taxation years concerned, the current assets of XXXXXXXXXX consisted of cash, term deposits, accounts receivable and future income tax assets. The long-term assets of XXXXXXXXXX consisted of future income tax assets, investments (i.e. shares of the capital stock of XXXXXXXXXX and a loan to an affiliated company consisting of interest only and the expenses of XXXXXXXXXX, other than the item "Other expenses - XXXXXXXXXX acquisitions" for its taxation year ended on XXXXXXXXXX referred to above, they consisted of attendance fees, professional fees and a "miscellaneous" item.
In addition, in response to question 284 of the T2s for the XXXXXXXXXX taxation years ended XXXXXXXXXX (i.e. "Specify the principal products mined, manufactured, sold, constructed, or services provided, giving the approximate percentage of the total revenue that each product or service represents"), what was written there was, respectively, "Investments - 100%" and "Holding Company - 100%".
Also, under the heading "Commercial activity and number of employees" of the XXXXXXXXXX information statement published at the Registraire des entreprises du Québec, it is stated that the type of activity of the corporation is: "Holding corporation (Holdings)", Code 7215. In addition, it is stated that the corporation has no employees in Quebec.
f) On XXXXXXXXXX, XXXXXXXXXX was wound up into XXXXXXXXXX .
g) On XXXXXXXXXX , XXXXXXXXXX reduced the paid-up capital of the common shares of its capital stock held by XXXXXXXXXX. In satisfaction of that reduction of paid-up capital, XXXXXXXXXX distributed to XXXXXXXXXX all shares of the capital stock of XXXXXXXXXX corporation.
h) On XXXXXXXXXX, XXXXXXXXXX disposed of XXXXXXXXXX to its XXXXXXXXXX shares of the capital stock of XXXXXXXXXX. In consideration of that transfer, XXXXXXXXXX issued to XXXXXXXXXX XXXXXXXXXX common shares of its capital stock.
XXXXXXXXXX is a corporation amalgamated on XXXXXXXXXX under the CBCA. XXXXXXXXXX is controlled by XXXXXXXXXX.
i) On XXXXXXXXXX, XXXXXXXXXX was wound up in XXXXXXXXXX.
Your Question respecting the Current Case
You wish to know if the NCLs incurred by XXXXXXXXXX prior to the acquisition of control by XXXXXXXXXX may be used by XXXXXXXXXX in the post-acquisition taxation years and the windings-up described above.
Our Comments respecting the Current Case
Subsection 111(5) is intended to restrict the use of NCLs and farm losses incurred by a corporation in the event of acquisition of its control.
More specifically, subsection 111(5) essentially provides that, with exceptions, where control of a corporation has been acquired by a person or group of persons, no amount in respect of its non-capital loss or farm loss for a taxation year ending before that time is deductible by the corporation for a taxation year ending after that time and no amount in respect of its non-capital loss or farm loss for a taxation year ending after that time is deductible by the corporation for a taxation year ending before that time.
The definition of a NCL in subsection 111(8) indicates that a taxpayer's NCL for a taxation year is, inter alia, the taxpayer’s loss for the year from an office, employment, business or property.
However, paragraph 111(5)(a) provides, in sum, that a corporation's NCLs and farm losses incurred prior to the acquisition of control of the corporation may be deducted in computing its taxable income for a particular year ended after the acquisition of control, if two conditions are satisfied: first, that the business was carried on by the corporation for profit or with a reasonable expectation of profit throughout the particular year (in which the loss is to be claimed); and second, that this is only to the extent of the amount of income from the business causing the loss and from any other business substantially all the income of which was derived from the sale, leasing, rental or development, as the case may be, of similar properties or the rendering of similar services.
Thus, based on the preamble to subsection 111(5), it appears to us that losses from property sustained by a corporation before the acquisition of its control are not deductible for a taxation year ending after the time of the acquisition of control.
The Act has been specifically amended to that end, as evidenced by the June 1987 Explanatory Notes of the Department of Finance issued on the amendment to subsection 111(5):
The opening words of subsection 111(5) are also amended to provide that, except as provided by paragraphs (5)(a) and (b), no amount in respect of a non-capital loss or Farm loss of a corporation for a taxation year ending before the time of an acquisition of control is deductible for a taxation year ending after that time, and no amount in respect of any such loss for a taxation year ending after that time is deductible for a taxation year ending before that time. As a result of this amendment, a loss from property or allowable business investment loss incurred by a corporation before the time of an acquisition of control may no longer be carried forward as a non-capital loss to be deducted after that time. In addition, a loss from property or allowable business investment loss incurred by the corporation after that time may no longer be carried back as a non-capital loss to be deducted in a taxation year ending before a change of control date (footnote 1). [our underlining]
Note that paragraph 88(1.1)(e) provides rules similar to those in subsection 111(5) in the context of a winding-up. Paragraph 88(1.1)(e) was amended at the same time as subsection 111(5) and the June 1987 Explanatory Notes to the Department of Finance published regarding the amendment to paragraph 88(1)(e) are similar to those in subsection 111(5) (footnote 2).
Consequently, if XXXXXXXXXX wishes to utilize the NCLs s that XXXXXXXXXX sustained before the acquisition of its control, it must first be established that those NCLs resulted from the carrying on of a business by XXXXXXXXXX.
Income or loss from a business or property is calculated in Subdivision b of Division B of Part I of the Act. Nevertheless, these are two separate sources of income for purposes of the Act.
Furthermore, the question of whether particular income constitutes income from a business or income property is a question of fact.
The term "business" is not defined in the Act. Subsection 248(1) only extends the concept of "business" for the purposes of the Act as follows:
business includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2)(c), section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment.
Traditionally, the common law has considered the concept of "business" as follows:
[...] anything which occupies the time and attention and labour of a man for the purpose of profit is business (footnote 3) .
The decision of the Supreme Court of Canada in Canadian Marconi (footnote 4) recognized that there was a rebuttable presumption in Canada that income received from or generated by an activity done in pursuit of an object set out in the corporation's constating documents is income from a business.
It should be recalled that the issue in that case was whether the interest income earned on short-term investments by the corporation constituted "active business income" for purposes of computing its "manufacturing and processing profits". As stated by Wilson J at paragraph 8 of her reasons:
It is frequently stated in both the English and Canadian case law that there is in the case of a corporate taxpayer a rebuttable presumption that income received from or generated by an activity done in pursuit of an object set out in the corporation's constating documents is income from a business. This presumption appears to have originated in a comment made by Jessel M.R. in Smith v. Anderson (1880), 15 Ch. D. 247. There, the Master of the Rolls said at pp. 260‑61:
You cannot acquire gain by means of a company except by carrying on some business or other, and I have no doubt if any one formed a company or association for the purpose of acquiring gain, he must form it for the purpose of carrying on a business by which gain is to be obtained.
...
When you come to an association or company formed for a purpose, you say at once that it is a business, because there you have that from which you would infer continuity; it is formed to do that and nothing else, and, therefore, at once you would say that the company carried on a business. So in the ordinary case of investments, a man who has money to invest, invests his money and he may occasionally sell the investments and buy others, but he is not carrying on a business. But when you have an association formed, or where an individual makes it his continuous occupation‑‑the business of his life to buy and sell securities‑‑he is called a stock‑jobber or share‑jobber, and nobody doubts for a moment that he is carrying on business. So, if a company is formed for doing the very same thing, that is for investing money belonging to persons in the purchase of stocks and shares, and changing them from time to time, either with limited or unlimited powers, I should say there can be no question that they are carrying on a business, whether you call it a business of investment or a business of dealing in securities, or, as in the case before me, both the business of investment and the business of dealing in securities.
This approach is also that of the Canada Revenue Agency ("CRA"):
If a corporation is incorporated to earn income by doing business, there is a general presumption that profits arising from its activities are derived from a business… (footnote 5).
That being said, the rebuttable presumption as to the income derived by a corporation from activities consistent with its objects has been rebutted, particularly in the case of Ben Barbary Company Limited v.M.N.R. (footnote 6)
In that case, the appellant corporation ("BBCL") owned land and operated a restaurant, a convenience store, a gas bar and a sporting goods store. BBCL sold to the son and daughter of its sole shareholder the convenience store, the gas bar, the sporting goods store and the subjacent land in exchange for a note and a mortgage, both bearing interest at 9% per annum.
BBCL considered that the interest earned on the note and the mortgage loan constituted active business income on the grounds that: (1) it was an activity within the objects listed in its constating documents; 2) its sole shareholder remained involved in the businesses sold; and (3) it was income from property that related directly or incidentally to a business that it was actively carrying on. The Minister instead considered that it was income from property.
Mogan J., after noting that the presumption applied in Canadian Marconi is rebuttable, then stated that:
In order to determine the character of income from a particular source within a private corporation, it should be possible to rely only on actual transactions and corporate conduct without reference to any objects whether declared in the charter or provided in the legislation (footnote 7) .
On the other hand, some authors consider that interest and dividends received by a corporation simply as a return on investments are prima facie income from property, unless the investments held are part of a business or the activities of the corporation, related to its investments, constitute in themselves the carrying on of a separate business. (footnote 8)
Similarly, as stated in Interpretation Bulletin IT-73R6, the CRA's position is as follows:
However, in some circumstances, a corporation's entire profits can be characterized as income from property, as might be the case where the corporation is formed for the sole purpose of holding shares of a second corporation or holding a property to be rented with limited landlord responsibilities (footnote 9).
In order to determine whether the activities of a corporation, related to its investments, constitute in themselves the carrying on of a separate business, the courts have taken into account, inter alia, the following elements: the number of transactions carried out; the size of the funds invested; the frequency of transactions; the nature of the investments as well as the number of employees assigned to the transactions; and the time they spent on investment activities. (footnote 10)
In this case, we can state that, throughout its corporate existence, XXXXXXXXXX earned interest income from a loan to an affiliated corporation. In that regard, it appears that XXXXXXXXXX did not have any employees.
Other than that loan, the only other significant asset of XXXXXXXXXX was its investment in shares of the capital stock of its subsidiary XXXXXXXXXX that did not earn any income.
Furthermore, both in its tax returns and in the documents filed with the Registraire des entreprises du Québec, XXXXXXXXXX appeared as a holding company.
Consequently, we are of the view that the NCL’s incurred by XXXXXXXXXX prior to the acquisition of control by XXXXXXXXXX were losses from property and, therefore, cannot be used by any corporation for a taxation year ending after the time of the acquisition of control of XXXXXXXXXX.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Ms. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
In the event that the representatives of the taxpayers concerned send you additional facts or representations, we will be available to study them to the extent that you consider appropriate.
If you wish additional information about this, do not hesitate to contact us.
Best regards,
Maurice Bisson, CGA
Manager
Corporate Reorganizations and Resource Industry Section
Corporate Reorganizations and Resource Industry Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained
in the original document are shown below instead:
1 Department of Finance, Explanatory Notes, S.C. 1987, c. 46 (Bill C-64).
2 Idem.
3 Smith v. Anderson (1880), 15 Ch. D. 247 at page 258 (Eng. C.A..), adopted in Canada, notably in Terminal Dock Warehouse Co. v. M.N.R., 68 DTC 5060 2 Ex. C.R. 78, aff'd 68 DTC 5316 (SCC). See also Stewart v. The Queen, [2002] 2 S.C.R. 645, 2002 SCC 46).
4 Canadian Marconi Co. v. The Queen, [1986] 2 S.C.R. 522 (SCC).
5 CRA, Interpretation Bulletin IT-73R6, "Income From an Active Business", March 25, 2002, paragraph 8.
6 89 DTC 242 (T.C.C.).
7 Idem, at page 244.
8 John Durnford, "The Distinction Between Income from Business and Income from Property, and the Concept of Carrying on Business," (1991), Vol. 39, No. 5 Canadian Tax Journal 1131-1205, pages 1165 and 1166.
9 Supra, footnote 5.
10 Supra, footnote 4, paragraph 12.