Principal Issues: Whether the CRA would accept the loss consolidations in the two situations described?
Position: The two situations do not constitute loss consolidations. The position in 2009-0332571R3 is not relevant. Subsection 50(1) may not apply.
Reasons: Conditions in subparagraph 50(1)(b)(iii) could be difficult to satisfy. Document 2009-0332571R3.
Federal Tax Roundtable, 5 October 2012
2012 APFF Conference
Question 11
Favourable change in CRA's position regarding the transfer of losses between related but unaffiliated corporations
In 2009-0332571R3, the CRA lent its approval to a reorganization leading to a consolidation of losses between corporations that were related but not affiliated.
In its summary of document 2009-0332571R3, the CRA stated that the transfer of losses between related, but not affiliated, corporations should not result in an abuse having regard to the provisions of the Act read as a whole, for the purposes of subsection 245(4), because specific provisions such as subsections 111(4) to (5.5), 256(7), 191.3(1), 112(2.4), paragraph 55(3.1)(c), section 80.04 etc. allow loss utilization transactions between related corporations, while only subsection 69(11) does not allow a rollover where property is transferred to a person other than a person that is affiliated with the transferor.
The CRA had changed its previous position regarding consolidation of losses in a group of corporations, following the announcement on April 26, 1995, of amendments to subsection 69(11), providing the requirement of being affiliated rather than related to avoid the application of that punitive provision. This change of position is referred to in Income Tax Technical News No. 9 (archived) of February 10, 1997.
The recent advance ruling is therefore a significant change in the CRA's position in the context of loss consolidations.
Question to the CRA
In light of this new position, can the CRA confirm that, generally speaking, it will accept consolidation of losses and/or corporate reorganizations in the following two situations:
Situation 1
In 2010, Son incorporated SME and invested $250,000 in common shares of SME. SME is a corporation of which Son is the sole shareholder. Son has de jure control and control in fact (as defined in subsection 256(5.1)) of SME. SME operations proved to be at a loss and SME ceased operations on September 30, 2012.
In order to qualify for a business investment loss ("BIL"), Son made an election under subsection 50(1) with respect to his SME shares in his 2012 income tax return. In January 2013, Son sold his SME shares to Holdco1, for consideration of $1. Holdco1 was a corporation all of whose shares belonged to Son's father. SME was then wound-up by Holdco1 in 2013 as described in subsection 88(1). Father has de jure control and control in fact (as defined in section 256(5.1)) of Holdco1.
Situation 2
Brother A and Brother B each hold 50% of the common shares of the capital stock of Opco, a corporation that was incorporated in 2010. They each invested $250,000 in common shares of Opco. Brother A and Brother B are a group of persons who have e de jure control and control in fact (as defined in section 256(5.1)) of Opco.
Opco's operations proved to be at a loss and Opco ceased carrying on its business on September 30, 2012. In order to qualify for a BIL, Brother B made an election under subsection 50(1) in respect of his shares of Opco in his 2012 income tax return. In January 2013, Brother B sold his Opco shares to Holdco2 for consideration of $1. Holdco2 is a corporation all of whose shares belong to his brother, Brother A. Brother A then disposed of all of his Opco shares to Holdco2 for a consideration corresponding to the FMV of his shares. Opco was then wound-up by Holdco2 in 2013 as described in subsection 88(1). Brother A has de jure control and control in fact (as defined in Section 256(5.1)) of Holdco2.
CRA Response
The proposed transactions described in document 2009-0332571R3 were different from the transactions presented in the two situations above. The former CRA position on loss consolidation arrangements was not directed at the transactions as described in the two above situations.
The situations that you submitted to us could constitute actual situations for which we cannot give a definitive opinion. The CRA does not provide confirmation regarding the application of certain provisions of the Act in respect of proposed transactions other than through advance rulings. Furthermore, when it comes to determining whether a completed transaction has received appropriate tax treatment, the determination is made first by our Tax Services Offices as a result of the review of all facts and documents. which is usually performed as part of an audit engagement. However, we can offer the following general comments, which we hope will be helpful to you.
In each of the situations described above, it is not clear that the conditions in subparagraph 50(1)(b)(iii) would be satisfied and that subsection 50(1) would be applicable. Subparagraph 50(1)(b)(iii) requires that the following conditions be met at the end of a taxation year: (A) the corporation is insolvent, (B) neither the corporation nor a corporation controlled by it carries on business, (C) the fair market value of the share is nil, and (D) it is reasonable to expect that the corporation will be dissolved or wound up and will not commence to carry on business.
The determination as to the insolvency of a person is a question of mixed fact and law that must be resolved on the basis of the relevant facts and circumstances pertaining to a particular situation (see the case of Jacques St-Onge Inc., 2001 DTC 487 (TCC)). The CRA is of the view that for the purpose of 50(1)(b)(iii)(A), it is necessary to attribute to the word "insolvent" its ordinary meaning, as this term is not defined in the ITA. A dictionary definition defines the term 'insolvent" as follows: "Being no longer able to pay one’s debts." Consequently, a corporation which has neither assets nor liabilities at the end of a taxation year (or, in any event, has no liabilities at that time) cannot generally be considered insolvent for purposes of ITA subparagraph 50(1)(b)(iii).
The condition provided in clause 50(1)(b)(iii)(C) is that the fair market value of the shares which are subject to the election under subsection 50(1) must be nil. In this regard, it appears to us that the valuation of the shares in the situations described above would normally take into account the accumulated tax losses which can eventually be deducted in the computation of a corporation's income.
If subsection 50(1) was not applicable in the two situations described above, Son and Brother B would each realize a capital loss on the sale of their shares to Holdco1 and Holdco2 respectively. It should also be considered whether paragraph 69(1)(b) would be applicable in respect of these transfers. The loss incurred by Brother A in the transfer of his shares to Holdco2 appears to be a superficial loss under subparagraph 40(2)(g)(i).
In the situations described above, it appears to us that there would be no acquisition of de jure control of SME and Opco because of the application of subparagraph 256(7)(a)(i). Consequently, it appears that the restrictions provided for in paragraphs 88(1.1)(e) and 88(1.2)(c) respecting the utilization of losses other than capital losses and net capital losses would not be applicable.
Robert Gagnon
(613) 957-9768
2012-045406