10 March 1998 Internal T.I. 9724307 - MEMBER SHARE CAPITAL

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.

DOCUMENT TYPE:

Tax Services Office Memo - 972430

Principal Issues:

For the purpose of Part I.3 what are the proper amounts to be included in the computation of a credit unions' share capital, under subsection 181.3(3) of the Act? The regulatory financial statements require reporting the "minimum membership share capital" as equity while the excess "share deposits" are reflected as a deposit liability. However, under GAAP the both amounts are reflected as share capital.

Position:

Still a question of fact and law to be determined, on a case by case basis, under the provisions of the particular credit union legislation. In this situation, the better view based on the facts is the disputed amounts are deemed to be shares issued to members under the Credit Unions and Caisses Populaires Act of Ontario for the years in question and this was the basis for reporting these amounts as part of share capital under GAAP.

Reasons:

See above and our prior response 970048 and 971305.

			March 10, 1998

North York TSO Headquarters
Audit Division Michael Cooke
442-3-1 (613) 957-3498

Attention: Frank Fallavollita

972430

Duca Community Credit Union Limited ("Duca")

This is in reply to your memorandum to us dated September 8, 1997, in respect of your proposed reassessment of the above noted taxpayer's 1993 and 1994 taxation years for additional Part I.3 tax under subsection 181.1(1) of the Income Tax Act (the "Act"). Your proposed reassessment was based on the views expressed in our previous memoranda to you dated March 3, 1997 (#970048) and May 28, 1997 (#971305). The taxpayer's legal representative, Miller Thomson (the "taxpayer's representative"), has prepared a further submission in response to your proposed reassessment, in a letter to you dated August 19, 1997. You requested that we reconsider this matter based on the additional information contained in their August letter and, in the course of doing so, the taxpayer's representative has responded to several of our queries by way of letters dated September 24, 1997, October 21, 1997 and February 5, 1998. All the above mentioned correspondence from the taxpayer's representative will herein collectively be referred to as the "submission".

Summary of Key Facts

Duca's 1993 and 1994 audited unconsolidated financial statements were prepared in accordance with generally accepted accounting principals (herein referred to as "GAAP" and "GAAP Statements"). In the GAAP Statements Duca reported share capital of approximately $33,311,000 million for 1993 and $31,477,000 million for 1994. We understand that the GAAP Statements for each year were placed before Duca's members and accepted by Duca's board of directors as required by sections 64 and 71 of the Credit Unions and Caisses Populaires Act (Ontario) (the "CU Act").

To be a member of Duca for the taxation years in question Duca's by-laws (the "old by-laws") required each person to own at least five paid-in shares with a par value of ten dollars each (see Article 2.03 and Article 9.01 of the old by-laws - the $10 par value is also in accordance with subsection 20(1) of the CU Act). However, we have been advised that since Duca did not actually issue share certificates, each member was required to maintain a minimum balance of $50 in their "share savings account" to continue to be a member of Duca. We also understand that subject to certain time limits and notifications Duca's members were generally not otherwise prevented from withdrawing any amount of money from their share savings account (see Articles 2.07, 2.08, 2.09 and 9.03 of the old by-laws and subsection 40(3) of the CU Act).

We understand that the share capital reported by Duca on their 1993 and 1994 GAAP Statements was based on the total year end balance of each member's year end share savings account. However, based on the required share savings account minimum balance of $50 per member the total minimum share capital of Duca (the "Minimum Share Capital") was $1,333,350 for 1993 and $1,293,750 for 1994. The difference between Duca's Minimum Share Capital and their share capital reported on their GAAP Statements was $29,928,673 for 1993 and $30,183,522 for 1994 (such difference herein referred to as the "Share Deposits").

Based on the annual financial statements and other information that the management of Duca was required to include in their Annual Information Return For Ontario Credit Unions And Caissses Populaires to the Minister of Finance Credit Unions and Co-operatives (Ontario) (herein referred to as "MOFCUCO" and the "MOFCUCO REPORT" respectively) Duca reported the following:

In accordance with the Ontario Share and Deposit Insurance Corporation ("OSDIC") completion guidelines dated March 1992 (for the purpose of preparing the MOFCUCO REPORT); deposits held by members as shares which are over and above the share capital required to be held as a condition of membership were required to be reported as Share Deposits, Excluding Minimum Share Capital Required for Membership on line 91 of the financial statements included in the MOFCUCO REPORT (the "regulatory statements"). Based on these guidelines Duca reported the 1993 Share Deposits of $29,928,673 and 1994 Share Deposits of $30,183,522 as a deposit liability on line 91 of each respective years' regulatory statements. The 1993 Minimum Share Capital of $1,333,350 and the 1994 Minimum Share Capital of $1,293,750 was reported as equity on line 95 of each respective years' regulatory statements. The total of the Minimum Share Capital (i.e., line 95) and Share Deposits (i.e., line 91) reported on the regulatory statements for 1993 was $31,262,023 and 31,477,272 for 1994.

Under the heading "General Business Information" in the MOFCUCO REPORT management of Duca reported "dividends declared/paid on shares" in 1993 of $762,000 (at a rate of 3%) and in 1994 of $782,226 (also at a rate of 3%). It is our understanding that these "dividends" were paid on both the Minimum Share Capital and Share Deposits amounts each year (based on the average monthly minimum balance of the members' share savings accounts). However, in the regulatory statements these dividends were reported as an expense item for each year on line 116 (i.e., Share Deposits (Interest or Dividends)).

For Part I.3 tax purposes, Duca reported share capital of $999,300 (line 720) on their 1993 T2147 return and share capital of $1,000,000 (line 822) on their 1994 T2148 return. We understand that for Part I.3 tax purposes Duca used the Minimum Share Capital reported on their regulatory statements for each year, rather than the amount of share capital reported on their GAAP Statements as described above. At this time we wish to point out that the Minimum Share Capital that Duca reported on their regulatory statements for 1993 and 1994 does not agree to the share capital reported by Duca on its Part I.3 tax returns for those years. Moreover, the total of Minimum Share Capital and Share Deposits for 1993 do not agree to the amount of share capital reported on their 1993 GAAP Statements. However, we will not comment on these particular differences in our response.

Before 1995, the business of Duca was governed by the CU Act and each member's share savings account was insured by OSDIC (subject to the $60,000 limit) as provided under the CU Act. We also understand that under the CU Act it was possible for a credit union to issue membership share capital in excess of any minimum required for membership. After 1994, subject to certain coming into force rules, with the introduction of the Credit Unions and Caisses Populaires Act, 1994 (the "New CU Act") and the repeal of the CU Act, it became possible for a credit union to issue share capital, other than membership share capital, on an "at risk" basis and that membership share capital of a credit union would no longer be insured by OSDIC (now known as the Deposit Insurance Corporation of Ontario "DICO").

On August 3, 1995 the business operations of Duca changed and its old by-laws amended in order that they comply with the New CU Act. We understand that such changes reflected the fact that since the Minimum Share Capital of Duca would no longer be insured by DICO, to the extent a member had more than $50 in their share savings account, Duca required such excess (the "Transferred Amounts") to be automatically transferred to a separate savings account on behalf of the member that would be insured by DICO. In 1995 Duca did not report the Transferred Amounts as share capital under GAAP.

For the taxation years in question, the dispute relates solely to whether the Share Deposits that were included in Duca's share capital on its GAAP Statements for 1993 and 1994 are required to be included in Duca's computation of capital under subparagraph 181.3(3)(a)(ii) of the Act for those years (i.e., either as share capital, members' contributions or as a contributed surplus or other surplus).

The Submission

We have summarized the taxpayer's representative arguments in support of their view that the amounts in respect of Share Deposits do not represent part of the capital of Duca for the purpose of Part I.3 of the Act as follows:

1. Under Part 1 of the membership application form (the "application") that each prospective member is required to sign, the member only agrees to subscribe "...to the required number of shares" and pursuant to Article 2.03 of Duca's old by-laws it is only necessary to own five shares to be a member of Duca. Therefore they maintain that since the application does not indicate that if amounts, in excess of $50, were received and included in the member's share savings account, that such amounts would not automatically be considered to be payment on account of shares instead of deposits.

In support of this position they indicate that Article 9.02 of Duca's old by-laws states that, "Payment for shares, after the first share allotment, shall be made when subscribed for or in instalments". They submit that this requires a member to specifically state, after the first share allotment, that any additional amounts deposited in their share savings account are in fact deposited as a subscription for shares and accordingly, Article 9.04 of the old by-laws governs the general deposit of money with Duca (i.e., the Share Deposit and Minimum Share Capital monies are co-mingled in one account). They further indicate that while the CU Act refers to "deposits" and "shares" throughout its provisions and contemplates that members may make both deposits and purchase shares, the CU Act does not contain a provision which deems any payment received from a member to be a "payment on account of shares".

2. They submit that the regulatory statements prepared by Duca accurately differentiated between their permanent share capital (i.e., Minimum Share Capital) and deposit liabilities (i.e., Share Deposits) notwithstanding that both amounts were included in each member's share savings account. They also submit that where the CU Act is silent on the characterization of the amounts that comprise the balance of the members' share savings accounts, the treatment by MOFCUCO should be given weight in determining the legal nature of the amounts at issue.

3. They submit that subsection 51(3) of the New CU Act did not dictate the above noted change in Duca's 1995 GAAP Statement reporting of the Share Deposits. While they acknowledge that the enactment of the New CU Act, as noted above, ultimately affected the changes to Duca's business operations and by-laws, they maintain that if subsection 51(3) of the New CU Act was applicable to deem the Share Deposits to be deposits, rather than shares, Duca could not have made the 1995 change in GAAP Statement presentation for share capital until 1996. This, they submit, is due to the fact that under subsection 51(10) of the New CU Act the Shares Deposits would not be deemed to be deposits until one year after subsection 51(3) of the New CU Act came into force.

4. They also submit that the Department must consider the appropriate method of accounting for tax purposes. For example, based on a research study prepared by the CICA in 1984 titled, "Financial Reporting for Credit Unions - A Research Study", (herein referred to as the "1984 CICA Study") they advise that there were four different acceptable methods from which Duca could have selected to report the Share Deposit amounts under GAAP and that it was acceptable to report these amounts as deposit liabilities (see Chapter 7, paragraphs 22 to 25). They maintain that where there are two (or more) methods which may be otherwise appropriate for tax purposes, the Department should rely on the method which reflects the "truer picture" of the accounts and referred us to the decision of the federal court of appeal in The Queen v. Canderel Limited, 95 DTC 5101 in support of their position.

They also maintain that the most significant problem with the proposal to reassess Duca for these Share Deposits is that other credit unions that may have adopted a different method of GAAP reporting for such types of deposits will not be subject to the same taxation as Duca. Accordingly, they maintain that it is not appropriate to rely on such a reporting difference to the detriment of Duca since there exists a presumption in interpreting taxation statutes that parliament intends to treat all similarly situated taxpayers in a similar fashion (see Kettle River Sawmills Ltd. v. Canada 94 DTC 6086 (F.C.A.)) and that the Department's proposal to reassess must be made with this presumption in mind.

5. Finally, they submit that because Duca is prepared to have their 1993 and 1994 GAAP Statements reissued to remove the Share Deposit amounts from Total Share Capital that this should resolve this matter. They advise that management of Duca has asked, and BDO Dunwoody has agreed, to reissue the GAAP Statements for 1993 and 1994. It is their view that if the GAAP Statements are reissued the Department will have no discretion but to accept these for purposes of calculating the Part I.3 tax. However, they also maintain that Duca should not be "forced" to take this additional step.

In conclusion, it is their view that the evidence demonstrates on a balance of probabilities that the Share Deposit amounts for 1993 and 1994 do not form part of Duca's capital for the purpose of Part I.3 of the Act.

Our Views

General Comments

XXXXXXXXXX However, one should keep in mind that in discussing the generally well understood legal definitions or concepts of a "share", "share capital" or "capital", as they apply to "typical" limited liability corporations such definitions/concepts do not necessarily readily apply to corporations that are owned by its "members", such as credit unions, mutual insurance corporations or other types of co-operative corporations. Therefore, while we generally agree that the share capital of most credit unions, by nature, have characteristics that are very much akin to debt (including the fact that in many cases such share capital can be covered by deposit insurance), we cannot undermine the legislative intent of subparagraph 181.3(3)(a)(ii) of the Act by choosing to ignore what the amounts represent under the Act.

With respect, one also has to wonder why the management of Duca chose to include the Share Deposits as part of share capital under GAAP, if, as the taxpayer's representative suggests, these amounts legally represent deposit liabilities of Duca. Based on the conclusions reached in the 1984 CICA Study it would appear that classifying deposit liabilities as equity is not in accordance with their recommendations or GAAP (see Chapter 6 at paragraph 7). It is also interesting to note that of the four reporting methods identified by the CICA (see Chapter 7, paragraphs 22 to 24) none of the four methods so identified included "members deposits" in "equity" and only one of the four methods included "members shares" as part of equity. Therefore, ignoring the legal question for a moment, while we recognize that the CICA may not have identified all the possible acceptable reporting methods under GAAP in their 1984 CICA Study, it appears that the reporting method Duca used on its GAAP Statements in 1993 and 1994 may not have been a reporting method that the CICA would have recommended as being best. However, it does not necessarily follow that the reporting method used by Duca was not considered to be in accordance with GAAP at that time (see Chapter 7 at paragraph 39).

Notwithstanding the above, it has consistently been our view that unless otherwise required by the Act, it is the legal nature of a particular amount that is reflected on a corporation's balance sheet rather than its accounting classification or nomenclature under GAAP, that will ultimately determine whether the particular amount is required to be included in the computation of capital for the purposes of Part I.3 of the Act. Therefore, with respect to the taxpayer's proposal that they are prepared to have their 1993 and 1994 GAAP Statements restated to remove the Share Deposits from share capital under GAAP and reflect such amounts as deposit liabilities will not, in our view, resolve the issue.

Further, with respect as to whether the taxpayer can rely on the "truer picture" argument pursuant to Federal Court of Appeal's ("FCA's") decision in Canderel, and while they are no doubt aware that the Supreme Court very recently overturned the FCA's decision, it is our view that this particular case may not be particularly relevant for Part I.3 tax purposes anyway. This is due to the fact that paragraph 181(3)(b) of the Act provides a specific requirement for the corporation to use financial statements prepared in accordance with GAAP (unlike section 9 of the Act which does not) and that such financial statements must be presented to its shareholders. Therefore, in our view a mere restatement of a company's financial statements to change from one acceptable GAAP method to another would not, by itself, be sufficient to warrant a change in reporting for Part I.3 tax purposes and even if such restated financial statements are presented to the corporation's shareholders' the Department should not accept such financial statements for Part I.3 tax purposes since the restatement represents retroactive tax planning.

Law and Analysis

Under subparagraph 181.3(3)(a)(ii) of the Act, a financial institution, other than an insurance corporation, must include in its capital for Part I.3 purposes, inter alia,

"the amount of its capital stock (or, in the case of an institution incorporated without share capital, the amount of its members' contributions), retained earnings, contributed surplus and any other surpluses, and...".

The terms "capital stock", "members' contributions", "contributed surplus" and "other surpluses" are not defined in the Act or the CU Act; however, a "share" is defined in subsection 248(1) of the Act to include, "a share or fraction of a share of the capital stock of a corporation and, for greater certainty, ... a share of the capital of a credit union" (emphasis added). While there is also no definition in the Act for the term "share of capital" of a credit union "capital" of a credit union is defined in subsection 1(1) of the CU Act as, "the outstanding amount that has been received from members on account of shares ("capital social")".

"Deposit" is defined in subsection 1(1) of the CU Act to include all sums placed on deposit with a credit union" and pursuant to section 105(i) of the CU Act OSDIC is entitled to make by-laws concerning the definition of deposit for the purpose of deposit insurance. Under most provincial credit union acts since a member's share capital must be repaid upon the member's withdrawal from membership such share capital represents a demand type obligation (see page 168 of a CCH publication titled Canadian Credit Union Law,) and pursuant to subsection 40(3) of the CU Act and Article 2.08 of the Duca's old by-laws this appears to be the case in Duca' situation. We also note that in a brochure published by OSDIC it states at item 6 that, "OSDIC insures all "deposits" which comprises savings and chequing accounts, term deposits, guaranteed investment certificates, share deposits and share capital as well as...". Under the Glossary of Terms in the brochure OSDIC defines "share capital" as, "the dollar value of shares required for membership"; share deposit as, "Any shares in excess of the dollar value required for membership"; and a "deposit" as, All sums placed on deposit in Canadian currency with a credit union by a member or for his or her benefit, including ...share deposits and share capital". Based on the above definitions, both share deposits and share capital are defined to be deposits under the CU Act.

Therefore, it appears that for many credit unions, including Duca's for the taxation years in question, that the Share Deposits and Minimum Share Capital are considered to be deposits for the purpose of OSDIC's deposit insurance rules.

However, the purpose of subparagraph 181.3(3)(a) of the Act is to require inclusion in the computation of capital of a financial institution the amount of the particular financial institution's "equity" that is represented by capital stock, members' contributions, retained earnings, contributed surplus and any other surplus amounts. It appears to us that notwithstanding that Minimum Share Capital and Share Deposits of Duca may also be considered as deposit liabilities (for deposit insurance purposes anyway) that such amounts should not necessarily be excluded from the computation of capital under subsection 181.3(3) of the Act (subject to the underlying principle that no double counting occurs).

Paragraph 16(1)(b) of the CU Act provides that the directors of a credit union may pass by-laws not contrary to the CU Act to regulate, the allotment and recording of shares, the maximum number of shares that may be allotted to any member, the payment for shares and the withdrawal or transfer of shares. Subsection 20(2) of the CU Act provides that the subscribed capital may, subject to the by-laws, be increased by payments for shares by members, and may be diminished by withdrawal of such payments by members and subsection 20(6) of the CU Act provides that the payment on account of shares by a member and the receipt thereof by a credit union shall be deemed to be an allotment of such shares to the members. Under Article 4.04(c) of Duca's old by-laws the directors could have fixed the maximum number of shares which may be held by any member; however, we have been advised that Duca did not set a maximum number of shares which could be issued and as a result we should not automatically accept that a deposit to, or a balance in, a member's share savings account over the $50 minimum did not represent a payment on account of shares.

As noted above, the taxpayer's representative argues, based on the wording of Article 9.02 of Duca's old by-laws (see 1 above) and the membership application required to be signed by each member, that a member must actually specifically state, after the first share allotment, that any additional amounts deposited in their share savings account represent a subscription for, or a payment on account of shares. As noted in our previous memorandum, we stated that the deemed allotment of shares (under subsection 20(6) of the CU Act) did not actually require that any shares actually be issued by the credit union, nor did we agree that a member must knowingly enter into a contract to purchase such shares and the credit union must knowingly accept the consideration offered for such shares as payment on account of, or in respect of shares. While we also stated that this remained a factual question, arguably any member making such a payment and the credit union receiving it would be in a position to know what the payment is for, or how it will be treated given subsection 20(6) of the CU Act.

With this in mind we noted that paragraph 24(2)(a) of the CU Act requires every credit union to keep a register of the names and addresses of the members and the number of shares held by each member and that paragraph 28(a) of the CU Act provides that every person whose name is registered in the register of members of the credit union is entitled to a passbook or other record specifying the amount paid upon shares, deposits and loans by the person. However, when we asked whether Duca kept such records we were advised by the taxpayer's representative that Duca did not keep a separate register of members and the number of shares held by each, notwithstanding the above CU Act requirements, and that a member's "passbook" only noted the balance of their particular share savings account.

XXXXXXXXXX

As already stated, pursuant to Duca's GAAP Statements, the content of which are the responsibility of Duca's management, the entire amount of their members' share savings accounts were received on account of shares (see Note 8 to the 1993 GAAP Statements, for example). Also, while the regulatory statements required disclosure of the Share Deposits in the liability section the reporting in this manner, as noted above, was required for "...shares which are over and above the share capital required to be held as a condition of membership". Therefore, notwithstanding the regulatory statement reporting, it appears that MOFCUCO still considered these Share Deposits to be shares of the credit union.

We also understand that the directors of Duca passed a resolution to pay a dividend of 3.0% for each of the 1993 and 1994 calendar years and that such dividends were calculated on the average minimum monthly balance of the members' share savings account. Moreover, the 1993 and 1994 GAAP Statements of Duca show these amounts as dividends and even under the General Business Information section of the 1993 and 1994 MOFCUCO REPORT these payments were described as dividends, notwithstanding that such amounts were also deducted as an expense item in the regulatory statements.

As mentioned in our prior response, subsection 137(4.1) of the Act deems an amount that is paid or payable to a credit union member in respect of a share of the credit union to be paid or payable as interest by the credit union and received or receivable by the member as interest for the purpose of the Act. Subsection 137(4.2) of the Act ensures that any amount so deemed by subsection 137(4.1) of the Act to be interest, will not, notwithstanding any other provision of the Act, be considered as a dividend. Therefore, if the payment to a member of the credit union is characterized under the Act as interest one could attempt to argue that such member is not a shareholder because he is not entitled to receive a payment of a dividend since the term "shareholder" is defined in subsection 248(1) of the Act to include a member or other person entitled to receive a payment of a dividend (Note that "dividend" is defined in subsection 248(1) of the Act to include a stock dividend but is not further defined in the Act).

It is our view that such an interpretation is not possible. Subsection 137(4.1) of the Act does not apply to amounts paid or payable as or on account of a reduction in the paid-up capital, redemption, acquisition or cancellation of the share by the credit union to the extent of the paid-up capital of the share. Since the concept of paid-up capital can only apply to shares it is our view that subsection 137(4.1) of the Act only affects the tax treatment of the payment and not the underlying legal nature for which the payment was based (see the definition of "paid-up capital" in subsection 89(1) of the Act - Note that this definition includes a special rule for certain co-operative corporations and credit unions since the traditional definition of paid-up capital may be difficult to apply in the case of such shares). Since the directors of Duca passed a resolution each year to pay dividends subsection 137(4.1) of the Act would not apply to deem an amount to be interest where that amount was already considered to be legally interest.

In our previous response we also stated that it was a rebuttable presumption that the provisions of the CU Act and the New CU Act may have dictated how Duca's auditors were required to report the Minimum Share Capital and the Share Deposits under GAAP and that the change in Duca's GAAP reporting of its share capital in 1995 appeared to have been based on the fact that the Share Deposits were not otherwise converted to some other type of share capital by Duca, such that subsection 51(3) of the New CU Act applied to deem such amounts to be deposits. Based on the fact that in 1995 Duca actually required each member to transfer any amount in excess of $50 that a member had in their share saving account to a separate savings account that was insured by DICO we now agree that subsection 51(3) of the New CU Act did not dictate the above noted change in Duca's 1995 GAAP. However, since the transfer of the Share Deposits to separate savings accounts only occurred in 1995, the change in 1995 does affect the treatment of the Share Deposits for 1993 and 1994.

Conclusion

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F. Lee Workman
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation BranchXXXXXXXXXX