Tax II Chapter 15
Spring 2013
Notes
Chapter Fifteen Lecture Notes
Acquisition of Control Rules and Use of Corporate Losses
David Christian
Spring Term 2013
Thorsteinssons LLP
UBC Faculty of Law
______________________________________________________________________________
Notes
“All the Congress, all the accountants and tax lawyers, all the judges, and a
convention of wizards all cannot tell for sure what the income tax law says.”
Walter B. Wriston
Ordinary Rules on Use of Losses1
1.
A “non-capital loss” (ordinary business or property loss) incurred in a year
may be applied to reduce the corporation’s income for the three
immediately preceding taxation years and for the twenty subsequent
taxation years (s.111(1)(a)). A corporation's net capital loss (generally
one-half of capital losses) incurred in a year may be carried back three
years and forward indefinitely to be applied against the amount of taxable
capital gains in those years (s.111(1)(b)).
2.
The corporate “loss-utilization rules” arising on an “acquisition of control”
of the corporation are designed to prevent persons from “trading in loss
companies”. Although rules restricting the utilization of losses on an
acquisition of control had existed for many years, they had little effect on
the trading in losses. This necessitated changes in 1981, 1983, and (most
significantly) in 1987.
“Acquisition of Control”
1
I am indebted to Kellough, H., and McQuillan, P., for their discussion of these concepts in their work
TAXATION OF PRIVATE CORPORATIONS AND THEIR SHAREHOLDERS, Third Edition. Much
of this Chapter is taken from the discussion in Chapter 13 of their work.
Page 328
Tax II Chapter 15
Spring 2013
Notes
3.
We examined this concept, in part, in Chapters 2 and 3. What must be
determined in this context is whether there has been an acquisition of legal
control. Subsection 256(5.1), which deals with the concept of de facto
control, is not relevant for the purposes of the loss-limitation rules found
in section 111 and discussed below.
4.
To recap briefly, for the purposes of testing the availability of loss carryforwards under the rules in this Chapter, the word "control" means the
right of control that rests in ownership of a sufficient number of shares
(referred to as "controlling shares") to confer the majority of the voting
power in the corporation and to allow for an election of a majority of the
board of directors. Direct control of a particular corporation is the
ownership of its controlling shares; indirect control includes the ownership
of the controlling shares of an intermediary corporation that owns the
controlling shares of the particular corporation.
5.
Once it has been determined that there has been a change of control, it
must be determined whether any person or group of persons has actually
acquired control. The answer is not always clear in the case of a “group”.
Recall Chapter 3 and the notion of a “group of persons” discussed in the
case of Silicon Graphics.
Deeming Rules
6.
Subsections 256(6) and (7) contain the acquisition-of-control tests relevant
to these rules in relation to the carry-forward of tax losses. Recall s.256(6)
from Chapter 3, which applies for all purposes of the Act. The rule deems
control not to have changed if temporary control is acquired primarily for
the purpose of safeguarding a loan made to, or an investment made in, the
controlled corporation.
7.
Subsection 256(7) applies only for specific provisions of the Act,
including ss.88(1.1) and (1.2), 111, and 249(4) (all discussed below).
Subsection 256(7) specifies certain situations in which control is deemed
not to have been acquired, and also deems a change of control to have
occurred in some other circumstances.
Page 329
Tax II Chapter 15
Spring 2013
Notes
8.
Paragraph 256(7)(a) provides that where shares of a corporation were
acquired by a person, that person is deemed not to have acquired control
of the particular corporation by virtue of such share acquisition if:
•
9.
that person was “related to” the person from whom the shares were
acquired (other than by virtue of a right referred to in s.251(5)(b))
– recall Chapter 3 and the notion of “related persons”;
•
that person and the acquired corporation were related (other
than by virtue of a right referred to in s. 251(5)(b));
•
that person was an executor, administrator, or trustee of an
estate who acquired the shares by virtue of the death of any
other person; or
•
that person acquired the shares by way of a distribution
from an estate arising on the death of another person to
whom that person was related.
Note that s.256(7)(a) applies to redemptions, cancellations, and changes in
the rights, privileges, restrictions, or conditions attaching to shares as well
as to acquisitions of shares. Where any of these events occurs and the
person or group of persons that controlled the corporation after the event
was related to the corporations before the event, there is no acquisition of
control. Consider a simple example.
Page 330
Tax II Chapter 15
Spring 2013
Notes
(Before)
Father
Son
Opco
(After)
Father
Son
Sale
Opco
10.
There are two deeming rules in the context of an amalgamation. First,
s.256(7)(b)(ii) provides that where a person or group of persons controls
the amalgamated corporation, and did not control a predecessor
corporation, that person or group is treated as having acquired control of
that predecessor corporation, and of any corporation it controlled before
the amalgamation. An exception provides that this deemed acquisition of
control will not apply if, had the person or group acquired all the shares of
the predecessor before the amalgamation, the person or group would not
have acquired control of the predecessor. This ensures that s.256(7)(b)(ii)
does not deem an acquisition of control in amalgamations of corporations
in a related group of corporations.
11.
The second rule, in s.256(7)(b)(iii), deals mainly with widely-held
corporations. The rule deems control of a predecessor corporation, and of
each corporation controlled by it before the merger, to have been acquired
by a (hypothetical) person or group of persons as a result of the
amalgamation unless:
Page 331
Tax II Chapter 15
Spring 2013
Notes
•
the predecessor corporation was related, immediately before the
merger, to each other predecessor corporation – for example:
Public
Parent
amalgamate
Sub
or
•
if one person had (again, hypothetically) acquired all the shares of
the new corporation received by shareholders of the predecessor
corporation (or of another predecessor that controlled that
predecessor) on the merger in consideration for their shares of the
predecessor corporation (or the other predecessor, as the case may
be), that person would have acquired control of the new
corporation, for example:
Public A
40%
Pubco A
Public B
60%
Pubco B
amalgamate
Page 332
Tax II Chapter 15
Spring 2013
Notes
or
•
s.256(7)(b)(iii) would otherwise deem control of every predecessor
to have been acquired, in an amalgamation of two corporations and
their controlled subsidiaries, as it would, for example, if two
corporations of equal value amalgamated, with the shareholders of
each taking back half the shares of the new corporation:
Public A
Public B
50%
50%
Pubco A
Pubco B
amalgamate
12.
Paragraph 256(7)(c) deals with “reverse takeovers”. Consider this
example. A widely held public company acquires the shares of a “loss
company”. The acquisition-of-control rules for losses would clearly
apply. However, what if the public company shareholders exchange their
shares of that company for shares of the loss company? The acquisitionof-control rules would likely not have applied before enactment of
s.256(7)(c) - no “group” acquired control of the loss company. Paragraph
256(7)(c) deems an acquisition of control to occur where shareholders, if
they were hypothetically treated as one person, would have acquired
control of the loss company in this example. (As with many of the rules
designed to limit losses, these rules can also apply to transactions that are
not undertaken for the purpose of acquiring losses.)
13.
Subsection 256(8) is also best illustrated by example. Take a potential
purchaser of the shares of a corporation that discontinued a business with a
loss carry-forward available from prior years. The purchaser could
acquire effective, but not legal, control over the corporation by acquiring,
for example, an option to purchase the shares of that company. A new,
Page 333
Tax II Chapter 15
Spring 2013
Notes
profitable business might then be transferred into the corporation, the
losses utilized, and then later the option might then be exercised to take
legal control. Subsection 256(8) now deems the acquisition of any right
(for example, the option described) referred to in s.251(5)(b) with respect
to shares (discussed in Chapter 2 and 3) to be equivalent to the acquisition
of the shares if “one of the main purposes of” the acquisition of the right
was to avoid the loss limitations set out in section 111 below.
Effect of Acquisition of Control on Losses (and Other Rules)
Deemed Year-End
14.
A deemed year-end occurs when there is an acquisition of control
(s.249(4)). The deemed year-end triggers all the normal administrative
requirements of a regular year-end. Corporate tax returns must be filed,
final tax payments must be submitted, and income tax elections that are
due within a specified period of a fiscal year-end must be made. Where
the normal year-end occurs within seven days of the change of control, it
may be extended by election, thus avoiding a short taxation year.
Timing of Acquisition of Control
15.
Subsection 256(9) provides that, regardless of the time at which control is
acquired, control is deemed to have been acquired at the beginning of the
day unless the corporation elects that subsection 256(9) will not apply.
This rule can be a significant trap if the acquisition is part of a series of
staged steps in an acquisition.
Carryover of Net Capital Losses
16.
Pursuant to s.111(4), net capital losses will expire on an acquisition of
control. Post-acquisition capital losses cannot be carried back to the preacquisition period. Realized net capital losses and capital losses
unrealized immediately before an acquisition of control cannot be carried
forward. All non-depreciable capital property must be valued immediately
before an acquisition of control occurs. To the extent that such capital
property has declined in value below the original cost (ACB), the excess
Page 334
Tax II Chapter 15
Spring 2013
Notes
must be deducted from the ACB of the property, and a capital loss is
deemed to be realized (s.111(4)(c) and (d)).
17.
Under s.111(4)(e), a corporation can elect to have any capital property
(including depreciable property) that has appreciated in value deemed to
be disposed of for any amount between the ACB and the fair market value.
The property is then deemed to be reacquired at the designated amount.
The s.111(4)(e) election was designed to allow a corporation to avoid the
expiry of net capital losses on an acquisition of control to the extent of
accrued but unrealized capital gains.
Carry-over of Non-Capital Losses
18.
19.
Subsection 111(5) limits the ability of a corporation to use its non-capital
losses once control of the corporation has been acquired. The limitations
created by this subsection can be summarized as follows:
•
Only non-capital business losses are potentially available for
carry-forward. Non-capital losses that arise from property are not
available.
•
Non-capital business losses are deductible only if the business that
gave rise to the loss is carried on throughout the year in which the
deduction is claimed, and that business is carried on in that year for
profit or with a reasonable expectation of profit.
Once it is determined that a non-capital loss can be carried forward, the
loss can be used only against income from that business, and income from
any other business if substantially all of the income of the other business is
derived from the sale, leasing, rental, or development of properties or
rendering of services similar to the properties sold, leased, rented, or
developed or services rendered by that business.
Depreciable Property
20.
Subsection 111(5.1) provides that where, at any time, control of a
corporation has been acquired and the undepreciated capital cost (UCC) of
the depreciable property of a prescribed class immediately before that time
Page 335
Tax II Chapter 15
Spring 2013
Notes
would have exceeded the fair market value of all the property of that class,
the excess capital cost is deemed to have been claimed as CCA for the
taxation year ending before the acquisition of control. This calculation is
made on a class-by-class basis, not on an aggregate basis. The CCA may
increase the non-capital losses of a business, which would then be subject
to the carry-over rule above.
Effect on GRIP/LRIP
21.
When a corporation becomes or ceases to be a Canadian-controlled private
corporation in a year, the status of its GRIP and LRIP accounts will
change. A corporation that becomes a CCPC will have an addition to its
GRIP account; a corporation that ceases to be a CCPC will have an
addition to its LRIP account. Note that the timing of becoming or ceasing
to be a CCPC is not the same as the timing of an acquisition of control.
Recall paragraph 251(5)(b): if a person has a right in respect of shares of a
corporation that allows the person to acquire the shares of the corporation,
the person is deemed, for purposes of the definition of CCPC in subsection
125(7), to be in the same position in relation to control of the corporation
as if the person owned the shared. This means that a corporation may
become or cease to be a CCPC prior to the time control of a corporation is
acquired, at the time an agreement for an acquisition is made, rather than
when the transaction closes. There is no relieving rule like that in
paragraph 110.6(14)(b), which protects CCPC status for purposes of the
capital gains exemption.
Amalgamations and Liquidations (Losses)
22.
As we saw in an earlier Chapter, where two or more corporations
amalgamate, the amalgamated corporation is deemed to be a new
corporation.
Notwithstanding that a new corporation is created,
subsection 87(2.1) provides that, on an amalgamation, the net capital and
non-capital losses of the predecessor corporation flow-through to the
amalgamated corporation as if the amalgamated corporation is a
continuation of each of its predecessors. This rule applies for the ordinary
rules for carry-over of losses and the rules that apply where there is an
acquisition of control of one of the amalgamating (predecessor)
corporations as discussed above.
Page 336
Tax II Chapter 15
Spring 2013
Notes
23.
On the wind-up of a taxable Canadian corporation, ss. 88(1.1) and (1.2)
allow the effective transfer of its non-capital losses and net capital losses
to the parent company. The flow-through of losses is permitted only where
subsection 88(1) applies, i.e., immediately before the wind-up, at least 90
percent of the issued shares of each class of the subsidiary are owned by
the parent company, and all shares that were not owned by the parent were
owned by the persons with whom the parent was dealing at arm's length.
The subsidiary's loss is deemed to be the parent's loss for the parent's
taxation year in which the subsidiary's loss year ended. The subsidiary's
losses are available for the use of the parent only in its taxation year
beginning after the start of the wind-up, which is generally the date on
which the shareholders resolve to wind-up the company.
24.
Certain conditions must be met for the losses to qualify for transfer to the
parent company: (1) the losses must not have been deducted by the
subsidiary in any taxation year, and (2) the losses must otherwise have
been deductible in computing the taxable income of the subsidiary for its
first taxation year commencing after the wind-up has begun, on the
assumption that it had such a taxation year and that it had sufficient
income and/or taxable capital gains for that year.
25.
If there is an acquisition of control of the parent or the subsidiary after the
year in which the losses were sustained, the usual rule limiting the
availability of non-capital losses applies if the business transferred to the
parent is discontinued. In the case of net capital losses, any change in
control will prevent such losses from being available for the carryforward. Subsection 88(1.1) is in conformity with subsection 111(5). It
restricts the deduction by the parent of any unused non-capital losses of
the subsidiary where there has been a change of control. A non-capital
loss incurred by a subsidiary from the carrying on of a particular business
is deductible by the parent only with certain limitations where control of
the parent or subsidiary changes. The limitations are the same as those in
subsection 111(5).
Page 337