I recently had a client whose company (“PropertyCo”) had sold a property 2 weeks before making contact with me. The sale resulted in a relatively substantial amount of corporate tax. The client also had another company (“Opco”) with significant operating losses. The question was whether, by amalgamating PropertyCo and Opco, the losses of Opco could be used to offset the gain of PropertyCo, resulting in a reduced tax bill on the sale. Unfortunately, in this circumstance (and specifically because the sale had already occurred), it could not.
Sharing Losses in a Corporate Group Via Amalgamation
People often think that by amalgamating companies, losses of one company can be used to offset income or gains of another company. This is true in some circumstances, but not all.
Pursuant to section 87 of the Income Tax Act (Canada) (the “ITA”), the general rule is that the losses of the predecessor companies survive the amalgamation. What this means is that pre-existing losses of predecessors can be carried forward to offset future income of the amalgamated entity (“Amalco”). However, pre-existing losses of one predecessor corporation can not be carried back to a previous tax year in order to offset income or a gain of another predecessor company. Since the amalgamation itself deems a year end of the predecessor companies, this prevents one predecessor company from carrying back the loss to the other predecessor company.
There is, however, a scenario in which losses can be carried back through an amalgamation. Where the amalgamation is a “vertical” amalgamation (of parent and subsidiary corporation), losses of Amalco (that is, losses generated by the newly amalgamated entity) may be carried back to offset income or gains of the parent predecessor company (per section 87(2.11) of the ITA). A parallel rule applies to accomplish the same end in the context of a windup of a subsidiary corporation into the parent (per section 88 of the ITA).
The ability to shift losses among a corporate group (including via an amalgamation) is always subject to the utilization of losses rules in section 111 of the ITA. From a policy perspective, shifting losses among related corporations is permissible, but trading losses to third parties is not. Such losses may be subject to the “loss restriction event” rules.
There are other ways to reduce the tax impact of the sale. However, amalgamation did not work in this scenario.
It would have been possible to shelter the gain if some planning was done prior to the sale. PropertyCo could have transferred the property to Opco on a tax deferred rollover basis prior to the sale. Opco could then have sold the property and used its operating losses to offset a lot of the gain it would have realized from the sale.
It is always wise to try to plan in advance to use up your corporate losses if you have any (but make sure not to lose money just so that you’ll have tax losses).