When is a Loss a Loss and When Can You Claim a Loss, Felesky Flynn LLP PricewaterhouseCoopers LLP Sean W. Hiebert, PricewaterhouseCoopers LLP Calgary, AB Introduction Losses: what s the big deal? Complexity Competing policies High value Changing landscape 2
Agenda Overview of the Loss Restriction Event (LRE) Regime vs Old Regime Old Regime LRE Regime Corporations and Trusts Impact of LRE on Non-Capital and Net Capital Losses Suspended Loss Rules Subsection 13(21.2) and certain related provisions Subsection 40(3.3), 40(3.4) and certain related provisions Historical Ruling Review and 256.1 Practicalities ATR-66 in the LRE Regime 256.1 Overview of some practical considerations 3 Old Regime: The Basics Only applied to corporations Deemed year-end Losses became restricted on an acquisition of control Same or similar business 4
Old Regime: The Basics 5 Old Regime: Planning Opportunities Structures were developed to: Shift profits or profitable businesses to losscos; or Acquire significant interests in loss trusts 6
Old Regime: Planning Opportunities 7 Old Regime: Planning Opportunities 8
Old Regime: Planning Opportunities 9 Old Regime: Planning Opportunities 10
LRE Regime: The Basics Budget 2013 Losses became restricted on a loss restriction event Corporations and trusts No longer restricted to acquisitions of control 11 LRE Regime: Corporations A corporation will undergo a LRE if: A person or group of persons exceeds 75% threshold; Immediately prior, the person or group was below 75% threshold; Person or group does not control; and Person or group does not control in order to avoid one or more specified provisions 12
LRE Regime: Corporations If a corporation undergoes a LRE, then: Deemed acquisition of control; Deemed loss of control; and Deemed lack of related and affiliated status 13 LRE Regime: Trusts A trust will undergo a LRE if: A person becomes a majority-interest beneficiary; or A group of persons becomes a majority-interest group of beneficiaries Does a person or group of persons have a beneficial interest in greater than 50% of either the income or capital of the trust? 14
LRE Regime: Trusts Various exceptions in subsection 251.2(3) for certain: Affiliated party transactions; Estate transactions; Trust variations, trust conditions and powers and equity transactions; Reorganizations; Grandfathered transactions; and Investment funds 15 LRE Regime: Trusts Additional rules: Deemed majority-interest beneficiary; Control; Affiliated = related; Anti-avoidance; Deemed acquisitions of control; and Timing 16
LRE Regime: Non-Capital Losses For pre-lre non-capital losses to be carried forward: Loss business must continue for profit or with REOP; Losses may be used against income from: The loss business; or A similar business Same test for post-lre non-capital losses to be carried back to pre-lre taxation years 17 LRE Regime: Capital Losses Pre-LRE capital losses cannot be carried forward to post-lre taxation years Post-LRE capital losses cannot be carried back to pre-lre taxation years Realization of accrued capital losses Paragraph 111(4)(e) election 18
Suspended Loss Rules 19 Suspended Loss Rules Application of 13(21.2), 40(3.3), 40(3.4) and certain related provisions Overview of Legislation Impact of LRE Regime Highlight of CRA View Doc in respect of 13(21.1) and 40(3.3)/40(3.4) 20
13(21.2) Legislation In respect of Depreciable Capital Property: Applies to individual as well as corporation, trust and partnership Accrued Terminal Loss on Property Owned or Right to Own Taxpayer or Affiliated Person 30 day period Suspended Terminal Loss = Notional Property Continued CCA Claim on Notional Property 21 40(3.3)/40(3.4) - Legislation In respect of Non- Depreciable Capital Property: Applies to corporation, trust and partnership (not individuals) Accrued Capital Loss Property Property/ Identical Property Acquired ( Substituted Property ) Taxpayer or Affiliated Person 60 day period Suspended Loss Deferred 22
13(21.2) Loss Triggering Events When is the suspended loss available? The earliest of : A. Non-affiliated person owns or right to own transferred property B. Change in Use of transferred property C. Change in Residence or tax Status of transferor D. Transferor subjected to Loss Restriction Event E. If transferor is a corporation taxable wind-up 23 40(3.3)/40(3.4)- Loss Triggering Events When is the suspended loss available? The earliest of: A. Non-affiliated person owns Substituted Property B. Change in Residence or tax Status of transferor C. Transferor subjected to Loss Restriction Event D. Deemed disposition of Substituted Property pursuant to Section 50 E. If transferor is a corporation taxable wind-up 24
Other Applicable Legislation Subsections 13(24) and 13(25) Prevent the transfer of certain tax attributes Depreciable property acquired within 12 months prior to an LRE Property was not used in a business prior to commencement of 12 month period by relevant taxpayer One consequence, property is not eligible for addition into UCC until after the LRE 25 Other Applicable Legislation Subsection 40(3.6) Applies in respect of share redemptions to an affiliated corporation Applies to corporation, trust, partnership and individual Denied loss is not suspended; rather added to cost of any remaining shares Subsection 112(3) Capital Loss reduced to extent of historical Capital Dividends Loss is permanent and not suspended Deemed $nil loss also $nil for CDA (CRA view: 2014 0540361E5) 26
Impact of LRE Regime For both 13(21.2) and 40(3.3)/40(3.4) expanded the application of a triggering event for a trust: Old Regime only - AOC rules applied to a corporation LRE Regime - applies to a corporation and trust Added complexity for triggering in LRE Regime: Section256.1: Expansion of de facto control under Old Regime to include de jure control under LRE Regime LRE Regime is more complex for corporations and a new reality and complexity for trusts. 27 13(21.2) CRA View No 2004-0091061E5 Overview of Facts: Personal Trust disposed of depreciable property with accrued loss Acquired by Affiliated Person Trust was wound up prior to expiry of 30 day period Conclusion in 2004, 13(21.2) did not apply as 13(21.2)(c) not satisfied Conclusion in Post LRE Regime, no change The impact of LRE Regime: Changed the application of a triggering event Did not impact test applied at the end of 30 day period 28
40(3.3) CRA View No 2014-0529731E5 Overview of 3 Scenarios Reaffirmation of 2 historical Administrative positions in the LRE Regime: 2003 Designate the ordering of the sale of a property 2001 Algebraic Formula to permit partial loss 29 40(3.3) CRA View No 2014-0529731E5 2001 Algebraic Formula to permit partial loss DL = (least of S, P, and B) / S L» DL: Denied Loss» S: Number of items disposed of at the time to nonaffiliated» P: Number of items bought in 60 day period» B: Number of items remaining end of period» L: Loss otherwise determined 30
40(3.3) CRA View No 2014-0529731E5 Highlight of CRA View - CRA View Doc No 2014-0529731E5 Scenario 1: No suspended loss Why? Designating the sale of the substituted property prior to end of period 2003 letter Scenario 2: Initial Loss of $100, Suspended Portion $83.33 2001 Letter Suspended Loss of $83.33 released 2003 Letter 31 40(3.3) CRA View No 2014-0529731E5 Scenario 3: Facts i. February 1: Acquire 100 Publico Shares ii. iii. iv. February 28: Acquire 50 Publico Shares (Substituted Property) March 15: $100 loss on Disposal of 60 Publico Shares to Non- Affiliated March 16: Dispose of 50 Publico shares 25 disposed of to a non-affiliated 25 disposed of to a affiliated 32
40(3.3) CRA View No 2014-0529731E5 Scenario 3: Analysis i. Strict Application, a substituted property is owned at the end of the period (March 15) by an affiliated person -> Full Denial of $100 loss on 60 shares ii. iii. Application of 2003 letter Designate Substituted Property shares sold on March 16 (i.e. 25 + 25 = 50) Application of 2001 letter Only 25 of the 50 Substituted Property Shares were sold, therefore DL = (least of S, P, and B) / S L DL = 25 / 60 x $100 DL = $41.67 33 Ruling Review and 256.1 Practicalities 34
Ruling Review and 256.1 Practicalities Losses and loss trading Continued topic of debate focal point of new legislation What is Tax equity? Why desired? treatment of losses is equalized with treatment of income obstacles to access losses are removed Consider old plans which continue to work as tax legislation changes Consider the possible unintended challenges resulting from new tax legislation 35 Review of ATR-66 NAL Transfer of Debt Followed by a Winding-up and Sale of Shares: Facts & Assumptions SellCo owns 100% of OpCo, target entity SellCo funds OpCo through intercompany advances ( Note1 ) OpCo has generated a significant NCL balance NLC s of OpCo result in lower FMV of Note1 over book value ProfitCo wishes to acquire OpCo to use NCL s (assuming LRE criteria would be achieved) 36
Review of ATR-66 NAL Transfer of Debt Followed by a Winding-up and Sale of Shares: Proposed Steps if implemented ATR-66: OpCo incorporates new SubCo SellCo sells, at FMV, Note1 to SubCo for consideration being Note2 Capital loss denied, added to ACB of Note1 SubCo wound-up into OpCo form OpCo2 37 Review of ATR-66 NAL Transfer of Debt Followed by a Winding-up and Sale of Shares: Proposed Steps if implemented ATR-66 (continued): Note1 settled without payment OpCo and SubCo SellCo completes sale of OpCo2 to ProfitCo at FMV ProfitCo amalgamates with or winds-up OpCo2 forming ProfitCo2 38
Review of ATR-66 NAL Transfer of Debt Followed by a Winding-up and Sale of Shares: Where it can go wrong: Consider the same facts and assumptions However, under the proposed steps, SubCo is not created and Note1 is sold at FMV to ProfitCo ProfitCo acquires OpCo shares and Note1 at FMV ProfitCo amalgamates with or winds-up OpCo 39 Review of ATR-66 NAL Transfer of Debt Followed by a Winding-up and Sale of Shares: Where it can go wrong (cont) : Note1 settled without payment at cost Cost of Note1 to ProfitCo < book value of Note1 to OpCo Debt forgiveness likely to result and grind losses of OpCo 40
Review of ATR-66 NAL Transfer of Debt Followed by a Winding-up and Sale of Shares: What can we do: Plan ahead of completing a transaction Due diligence tax work Assess FMV s of intercompany balances 41 256.1 Acquisition of 75% is Control (the New Rules) Trading of losses between arm s length taxpayers not embraced Existing rules limit the ability to trade losses Addressing new plans time consuming and costly to challenge Broader acquisition of control test to trigger new LRE rules 42
256.1 Acquisition of 75% is Control (the New Rules) 256.1(2) Subsection (3) applies in respect of a corporation if (a) Total FMV > 75% of the FMV of all shares; (b) shares held before the particular time a FMV < 75% of the FMV; (c) the person or group does not control the corporation at the particular time; and (d) reasonable to conclude intent was not to subvert control to avoid application of one or more specified provisions 43 256.1 Acquisition of 75% is Control (the New Rules) What are the implications: Assessment of FMV may be difficult to ascertain Publicly traded entities Thinly traded entities Private entities (limited and/or no market for trading) Will valuation process employed by CRA mirror what is employed in the market? 44
256.1 Acquisition of 75% is Control (the New Rules) Assessment of the purpose test Support purpose was not to avoid acquisition of control Consider the need to document 45 256.1 Acquisition of 75% is Control (the New Rules) Conclusion Some tried and tested plans continue to be used and do not attract the GAAR With new legislation, broadening existing concepts, we continue to move further from tax equity As tax plans evolve we can expect the same with the Act 46
CONCLUSION Tax Authorities implemented provisions they felt were required to address the perceived abuse of loss trading Suspended Loss Rules more complex related to LRE Regime, but certain administrative policies remain untouched Historical ruling of continued benefit to preserve losses, but needs proper purchaser due diligence Outlined the potential need for additional guidance for private companies in respect of Section 256.1 47