31 October 2003 Internal T.I. 2003-0027217 - INCLUSION OF PROVISION - PART 1.3

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Are the accrued estimated restructuring costs at the taxpayer's year end, and amount that must be included in computing the taxpayer's capital under subsection 181.2(3)?

Position:

If the credit is a provision for accounting purposes then it is a "reserve" as defined in subsection 181(1) and included in capital under paragraph 181.2(3)(b).

Reasons:

The legislation and the facts provided. GAAP expert input needed to determine whether financial statement treatment of provision is GAAP.

								October 31, 2003

	TORONTO CENTRE TSO					HEADQUARTERS
	Verification and Enforcement				Alison Campbell
(613) 957-3496
	Attention:  Gordon MacGibbon

									2003-002721

XXXXXXXXXX
Part I.3 Reassessment Relating to Credit Account Balance XXXXXXXXXX

We are writing in reply to your memorandum of June 26, 2003, requesting our views as to whether the credit balance in the taxpayer's general ledger account XXXXXXXXXX , should be included in computing the taxpayer's capital under subsection 181.2(3) of the Income Tax Act (the "Act") for the taxation year ended December 31, 1998.

In determining whether and how much of any particular item is to be included in computing a taxpayer's capital under Part I.3 of the Act, there are essentially two criteria to be considered. First, the item must be one of the specific elements listed in subsection 181.2(3) of the Act. Second, pursuant to subsection 181(3) of the Act, what is the amount, if any, of the item that is reflected in the GAAP balance sheet of the corporation.

The Federal Court of Appeal decision in PCL Construction Management Inc. et al v The Queen (2000 DTC 2624), clarified that it is appropriate to break-down a balance sheet line item into its components to extract those components that are included in subsection 181.2(3) of the Act. At paragraph 26, the judge states "[t]he use of the words "reflected in the balance sheet" indicates a clear intention on the part of the drafter to leave it open to consider the components of a balance sheet item where some, but not all, of those components fall within the statutory definition of capital." In the information provided to us, we were told that the balance of general ledger account XXXXXXXXXX at December 31, 1998 is one of the components of the balance sheet item "Accounts Payable and Accrued Liabilities". Provided the financial statements have been prepared in accordance with GAAP, it would be our view that the amount of the credit balance in general ledger account XXXXXXXXXX that is reflected in balance sheet should be included in computing the taxpayer's capital under Part I.3 for 1998, if it is determined that the credit balance is one of the elements listed in subsection 181.2(3) of the Act.

A taxpayer must include, in computing its capital under Part I.3, the elements listed in subsection 181.2(3) of the Act. Paragraph 181.2(3)(b) of the Act, is the provision being considered as possibly requiring the credit balance to be included in computing the corporation's capital. This paragraph requires a taxpayer to include in computing its capital, "the amount of its reserves for the year, except to the extent that they were deducted in computing its income for the year under Part I". The taxpayer's T2S(1) for the 1998 taxation year does not seem to include a deduction for the amount of the credit balance and therefore, if the amount is a "reserve" for the purposes of this paragraph, it would be required to be included in computing capital for the 1998 taxation year.

The term "reserve" is defined in subsection 181(1) of the Act, for the purposes of Part I.3 to mean "the amount at the end of the year of all of the corporation's reserves, provisions and allowances (other than allowances in respect of depreciation or depletion) and, for greater certainty, includes any provision in respect of deferred taxes." Following the decision of the Federal Court of Appeal in the case of Manufacturer's Life Insurance Company vs. The Queen (2000 DTC 1600), the CCRA has accepted that in interpreting terms that primarily derive their meaning from accounting principles, such as "reserves", "provisions" and "allowances" we will look to the accounting meaning in determining whether there is an amount that must be included in computing capital for Part I.3 purposes.

The CICA Handbook (the primary source for Canadian GAAP) does not define the word "provision". However, International Accounting Standards ("IAS") and several "Accountant's Dictionaries" define a "provision" as a type of accrued liability that is in respect of expenditures that have been committed to (or are unavoidable) as at the reporting date, but are uncertain as to their timing and/or amount. While the IAS definition in section 1501 of the Handbook was removed in 2003, section 1501 of the Handbook was relevant for 1998.

While it would be appropriate for you to obtain the advice of an expert on GAAP, the setting up of an amount on the balance sheet in respect of future costs to be incurred in respect of restructuring appears to us to constitute a "provision" within the meaning noted above. Whether the off-setting debit is to an asset account or an expense item would not appear to be relevant to this determination.

Accordingly, if the taxpayer's recognition of the estimated restructuring costs provision with a corresponding debit to the subsidiary investment accounts is considered to be in accordance with GAAP, then it would be our view that the credit balance in account XXXXXXXXXX, which is reflected as part of an aggregate amount on the balance sheet, would be a "provision" for accounting purposes and therefore a "reserve" as defined in subsection 181(1) of the Act. The "provision" would be included in the taxpayer's Part I.3 capital pursuant to paragraph 181.2(3)(b) of the Act. The taxpayer is also entitled to claim an investment allowance in respect of the carrying value of its investments in the shares of other corporations pursuant to paragraph 181.2(4)(a) of the Act. Accordingly, to the extent the carrying value of its subsidiaries as reflected in the corporation's balance sheet at December 31, 1998, include the accrued estimated restructuring costs established in the provision, the taxpayer's inclusion of the "provision" in its capital would be offset by a corresponding component in the carrying value of its investment in the shares of its subsidiaries.

Should the taxpayer provide you with a submission which indicates that the setting up of the estimated restructuring costs as a credit on the balance sheet with an offsetting debit to the investment account is in accordance with GAAP and the credit is not a provision for purposes of GAAP, we would suggest that you obtain an independent opinion from an expert on GAAP.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and 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 your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

F. Lee Workman
Manager
Financial Institutions Section
Income Tax Rulings Directorate
Policy and Legislation Brach