24 March 2010 Internal T.I. 2008-0294031I7 - Offsetting Arrears Interest with Refund Interest

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.

Principal Issues: Whether interest relief is available where refund interest is paid and arrears interest is charged.

Position: No; based on the facts.

Reasons: 1. The taxpayer had ample time and opportunities to withhold and pay the liability.
2. The Act does not allow offset of interest on Part I tax against interest on Part XIII tax.

   								March 24, 2010

Edmonton Tax Services Office				HEAD OFFICE
								Income Tax Rulings
								   Directorate
Attention: Diana Gibson					Lindsay Frank
Assistant Director, Audit Division 			(613) 948-2227

2008-029403

Request for Interest Relief

This is in reply to an email from Arun Padmanabhan, in which he sought assistance in preparing a reply to a request by XXXXXXXXXX ("the Company"), the Canadian subsidiary of a foreign parent, to offset arrears interest with refund interest accrued between 2004 and 2006. As explained below, we are of the view that none should be given.

In 2000, the Company realised a capital gain of $XXXXXXXXXX when it sold the shares it held in a public corporation, and paid Part I tax on the gain. In 2001, it reinvested all of the after-tax proceeds, plus additional capital, in shares of another company ("the Shares"). This investment was not successful. In 2003, the Company was wound up, resulting in a deemed disposition of the Shares to its foreign parent. The disposition triggered a capital loss that was carried back and claimed against the 2000 gain.

Representatives of the Company initially took the position that the Shares had no value at the time of winding up. As a result, it did not withhold or pay Part XIII tax on the distribution of the Shares to its foreign parent. When it filed its 2003 return for Part I tax, it claimed a capital loss carryback based on the full ACB of the Shares.

The CRA did not agree that the Shares had no value. This had two consequences. First, it meant that Part XIII tax was owing by the foreign parent as of the date of the wind-up. Second, it meant that the amount of loss to be carried back, and so the Part I refund due to the Company as of the first day after the end of the year of wind-up, was less than claimed. Until the valuation concerns were addressed and the tax amounts computed based on those values, debit interest accrued on the undetermined Part XIII amount and credit interest accrued on the undetermined Part I amount.

Negotiations over the value of the Shares continued for several years until 2008. On several occasions, when the CRA was satisfied that the value was at least somewhat lower than previously estimated, the Part I refund was recomputed. The foreign parent requested (for reasons dealing with its own tax situation) that cheques for these refunds be issued to it, and not used to offset the Part XIII liability. Notwithstanding this, the CRA applied a portion of the 2006 refund against the Part XIII liability. Subsequent decreases in the CRA's estimate of the value of the Shares led to refunds of both Part I and Part XIII. Eventually, in 2008 the CRA and the representatives of the Company agreed on a value of the Shares, and final reassessments and refunds were issued for both Parts.

From 2004 to 2006, credit interest on the Part I refund arising from the loss carryback and debit interest on the Part XIII liability continued to accrue. Under paragraph 12(1)(c) of the Income Tax Act (the "Act"), credit interest is taxable; under paragraph 18(1)(t), debit interest is not deductible.

Subsections 161.1(2), 220(3.1), and 221.2(2) of the Act afford a taxpayer relief in certain circumstances, but none of these provisions apply to the Company.

Subsection 220(3.1) of the Act permits the CRA to waive or cancel interest otherwise payable by a taxpayer. In this case, the only debit interest that the Company actually paid related to the finally-agreed Part XIII liability, for the time that liability was outstanding. There is no suggestion of hardship, or CRA error, or any other factor that would support relief. Furthermore, representatives of the Company could have directed the CRA to allocate to the Part XIII liability a portion of the Part I refund received in 2005. Instead, as soon as each amount was calculated and paid, they chose to take the money offshore to utilise the foreign tax credit in the return of the foreign parent.

Nor would subsection 221.2(2) apply, which authorises the CRA, at the taxpayer's request, to re-appropriate all or part of a payment from one tax account to another, and from one year to another. The tax accounts relate to amounts payable under the Act, the Excise Tax Act, the Air Travellers Security Charge Act, or the Excise Act, 2001. The effect of the re-appropriation is to eliminate or reduce interest. For subsection 221.2(2) to have effect, the taxpayer must have made a payment, which the taxpayer wishes to re-appropriate. Subsection 221.1(2) would not apply in these circumstances, as the Company did not make a payment.

Likewise, subsection 161.1(2) of the Act has no application. Pursuant to this provision, a corporation may apply for an interest offset where it is receiving refund interest and paying arrears interest simultaneously on one or more of Part I, I.3, II, IV, IV.I, VI, VI.1 and XIV. The Parts at issue in this case are I and XIII.

These legislative provisions aside, it must be borne in mind that the Canadian income tax system is a self-assessing system. In this respect, reliance is placed on the taxpayer to submit information that meets the requirements of the Act, even though the CRA is not bound to accept it. This was the case here. The Company asserted at the outset that the Shares had no value, but this assertion was not accepted, and it was only after the CRA challenged the valuation that the company agreed that there was some value, which led to rather protracted negotiations. The Company was in control of the situation from the beginning; it was not unavoidable.

Should you have any questions or require additional information on the foregoing, please do not hesitate to contact Lindsay Frank at the telephone number provided above.

Phil Jolie
Director
International and Trusts Division
Income Tax Rulings Directorate

c.c. Arun Padmanabhan
Team Leader, Audit Division
Edmonton Tax Services Office