Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues:
1. Whether the CCRA's general position, regarding the computation of safe income on hand, as presented by Mr. John R. Robertson at the Tax Conference of the Canadian Tax Foundation (see 1981 Conference Report) in respect of the acquisition of a property or an eligible capital expenditure, or a repayment on account of the principal amount of a loan, is still applicable.
2. Whether the recapture of depreciation not included in computing the taxpayer's income for the year pursuant to subsection 13(2) has an impact on the computation of safe income on hand.
Position:
Our position is still applicable.
No.
Reasons:
In accordance with the CCRA's current positions.
In accordance with the CCRA's general policy with regard to non taxable income.
XXXXXXXXXX 1999-000989
Fouad Daaboul
Attention: XXXXXXXXXX
November 16, 2000
Dear Madam/Sir,
Subject: Computing safe income on hand
This is in response to your letter of March 4, 1999, in which you asked us to confirm that the position of the Canada Customs and Revenue Agency (the “Agency”), as set out in 1981, regarding adjustments to be made in computing the post-1971 income earned or realized (the “safe income”) on hand of a private corporation remains valid in the situations described below. You referred us to that position as stated by John R. Robertson in a paper entitled
“Capital Gain Strips: A Revenue Canada Perspective of the Provisions of Section 55”, at the 1981 Conference of the Canadian Tax Foundation:
xviii) A deduction for any expense incurred or disbursement made in the period that was not allowed or not claimed as a deduction in computing income will reduce safe income. However, there will be no deduction for an expense incurred or disbursement made in respect of the acquisition of property, an eligible capital property, or a repayment on account of the principal amount of a loan.
As stated in paragraph 22 of Information Circular 70-6R3 dated December 30, 1996, it is the practice of the Canada Customs and Revenue Agency (the “Agency”) not to issue written opinions regarding proposed transactions otherwise than by way of advance income tax rulings. Furthermore, when it comes to whether a completed transaction has received appropriate tax treatment, that determination rests first with our Tax Services Offices following their review of all facts and documents, which is usually performed as part of an audit engagement. However, we can offer the following general comments that we hope may be helpful to you. These comments may not, however, fully apply to the situations you have presented to us.
We wish to reiterate that the Agency's general position is that subsection 55(2) of the Income Tax Act (the “Act”) applies to a taxable dividend received by a corporation resident in Canada in respect of which it is entitled to a deduction under, among other things, subsection 112(1), in connection with, among other things, a series of transactions one of the purposes (or results, in the case of a dividend referred to in subsection 84(3)) of which was to decrease significantly the portion of the capital gain that would have been realized on a disposition of a share at its fair market value immediately before the dividend and that could reasonably be considered to be attributable to anything other than safe income. “Safe income” is the amount of income determined under paragraph 55(5)(b), (c) or (d), as the case may be. Consequently, the safe income refers, in the case of a private corporation, to the corporation's income computed pursuant to section 3 of the Act, for each taxation year of the corporation in respect of a particular period, with the additions provided for in paragraph 55(5)(c), applicable as the case may be.
In addition, the Agency has taken the position that a corporation's safe income can contribute to a capital gain on a share only if it is on hand and available for the payment of a dividend on the share. Since the safe income is based on the income computed pursuant to section 3 of the Act as provided for in paragraph 55(5)(c) in the case of a private corporation, it is therefore necessary to adjust the safe income to take into account certain disbursements that do not reduce the corporation's income in order to determine the safe income that contributes to the capital gain on the share (the safe income on hand) for a particular period. Disbursements that generally reduce safe income on hand are dividends, income taxes, charitable donations and any expenses that are not deductible in computing a corporation's income. On the other hand, certain items not included in “safe income” may increase “safe income on hand”; for example, refundable taxes received by a corporation.
In this regard, in the scenarios you have provided to illustrate your questions, you repeatedly referred to the accounting treatment particular to an expense or disbursement; we have assumed that in each case, the income of the private corporation for a particular taxation year has been determined in accordance with section 3 of the Act and that the necessary adjustments, such as the addition of book depreciation or expenses not eligible under the Act and the capital cost allowance allowed under the Act, among others, have been made for the purposes of each situation to determine the corporation's safe income.
Since your questions mainly concern the determination of the balance of a corporation's “safe income on hand” at the end of a particular taxation year, we have assumed that, for the purposes of the definition of the term “safe income determination time” in your questions, computing a corporation's “safe income on hand” is, unless otherwise indicated, calculated at the end of the last taxation year of the corporation referred to in a particular situation.
Finally, we wish to emphasize that, in order to determine whether a dividend reduces a portion of a capital gain that could reasonably be considered to be attributable to something other than safe income, it is always useful to analyze the elements that contributed to the appreciation in the share in a particular situation and therefore indirectly confirm the balance of safe income on hand in a particular situation.
SITUATION 1
Pursuant to paragraph 14 of Interpretation Bulletin IT-143R2, Meaning of Eligible Capital Expenditures, the costs incurred by a corporation to incorporate are eligible capital expenditures. From an accounting standpoint, eligible capital expenditures may be expensed in the year they are incurred or capitalized and amortized over a period not exceeding three years, since they are not material and do not represent a future benefit to the corporation.
QUESTIONS
1) Should the position that, no adjustment should be made in computing safe income on hand in respect of a disbursement representing an eligible capital expenditure, still be followed?
2) Is it appropriate to reduce the amount of safe income on hand by an amount equal to one-quarter of the eligible capital expenditure (the “ineligible portion”) since only three-quarters of the eligible capital expenditure (the “eligible portion”) enters into computing the cumulative eligible capital (“CEC”)?
In your view, the non-eligible portion for purposes of computing CEC is a non-deductible outlay and, based on the Agency's position, any non-deductible outlay should therefore reduce the safe income on hand.
3) Is it appropriate to reduce the amount of safe income on hand by an amount corresponding to the entire cost of incorporating a corporation since this disbursement has little or no value in the eyes of a potential purchaser of the corporation's shares?
If so, you asked whether you could increase the safe income on hand, for the taxation year in which the eligible capital expenditures were incurred and for subsequent taxation years, by an amount corresponding to the deduction claimed under subparagraph 20(1)(b) in respect of those eligible capital expenditures?
As stated in paragraph 14 of Interpretation Bulletin IT-143R2, CEC includes various eligible capital expenditures in respect of a business, such as “incorporation expenses and similar expenses … if they meet the requirements of … subsection 14(5)… .”
In general, it appears to us that incorporation expenses are eligible capital expenditures and that neither the “eligible portion” nor the “non-eligible portion” of such expenses should be deducted in computing safe income on hand in a situation such as the one you have described to us.
Consequently, the Agency's position remains unchanged, namely that there is no adjustment to be made to computing safe income on hand in respect of an expense that constitutes an eligible capital expenditure.
SITUATION 2
In a technical interpretation, document no. 9517497 dated September 13, 1995, it was stated: [TaxInterpretations translation]
the costs of preparing the transactions for a reorganization aimed at restructuring the capital of a corporation are expenses of the corporation, are capital expenditures, and are eligible capital expenditures (provided the other conditions of subsection 14(5) of the Act are met);
From an accounting standpoint, reorganization costs aimed at structuring the capital of a corporation following an estate freeze may be expensed in the year or capitalized and expensed over a period not exceeding three years since they are not material and do not constitute future benefits to the corporation.
QUESTION
You asked us to comment on the same issues, as those raised in Situation 1 above, in relation to reorganization costs.
Where reorganization expenses have been incurred in connection with a reorganization whose purpose is to preserve the entity, structure or commercial organization of the business, or whose purpose is to allow the continued existence, growth and development of the business, the Agency's position is that the expenses in question could be considered to be capital expenditures incurred for the purpose of earning income from the business and therefore eligible capital expenditures (see document 9517497).
In this regard, our comments regarding incorporation expenses in Situation 1 above would generally apply with respect to reorganization expenses that constitute eligible capital expenditures.
SITUATION 3
In 1992, a corporation acquired a computer for $5,000. For accounting purposes, the acquisition cost of the computer was depreciated on a straight-line basis over two years. In 1996, the computer was scrapped.
For tax purposes, the computer was classified as Class 10 property in Schedule II of the Income Tax Regulations (the “Regulations”). The table below summarizes the capital cost allowance (the “CCA”) claimed or to be claimed under paragraph 20(1)(a) Act on this computer:
1992 1993 1994 1995 1996 1997 and after
Depreciation $2,500 $2,500
CCA $750 $1,275 $893 $625 $437 $1,020
Although the corporation disposed of the computer for nil consideration in 1996, it continues to claim CCA on its undepreciated capital cost (“UCC”) since it holds other assets in Class 10. Therefore, for the 1997 and subsequent years, the corporation's net income would be reduced by an amount of CCA equal to the cost of acquiring the computer in 1992, less the related CCA, even though the computer was destroyed in 1996.
QUESTION
In this situation, you wish to know whether you should still follow the Agency's position that no adjustment should be made in computing safe income on hand with respect to a disbursement representing the acquisition of depreciable property.
In a situation similar to the one you have described, it is our opinion that, in general, no adjustment should be made in computing a corporation's safe income on hand because of the scrapping of one of the depreciable properties in a particular class when there are other properties in that class.
The Agency's position therefore remains unchanged in that regard.
SITUATION 4
You referred us to an article in the Revue de planification fiscale et successorale published in 1992, concerning computing safe income, in which it was stated that [TaxInterpretations translation] “under paragraph 13(7)(g), the capital cost of a passenger vehicle is limited to $24,000 for the purposes of computing capital cost allowance”.
You indicated that, to your knowledge, according to the Agency, an adjustment is generally not necessary for a capital expenditure, such as, for example, the capital cost of a passenger vehicle, even if the limitation on the capital cost of the vehicle is applicable only for the purposes of computing CCA. However, an adjustment to the safe income is required following the disposition of the passenger vehicle to reflect the non-deductible portion of the loss realized on the disposition.
QUESTION
Using the following data for a corporation, you would like our opinion on the adjustments to safe income on hand to be made as a result of the disposition of the passenger vehicle, a property in Class 10.1 of Schedule II to the Regulations:
Acquisition cost at the end of 1990 ................................ $35,000
Book depreciation:
($10,500 in 1991 and $7,350 in 1992) ............................. $17,850
Proceeds of disposition the end of 1992 ......................... $15,000
Accounting loss on disposition ........................................ $2,150
Deemed capital cost at end of 1990 ............................... $24,000
Capital cost allowance:
($3,600 in 1990, $6,120 in 1991 and $2,142 in 1992)…….. $11,862
Recapture of CCA ......................................................... $3,138
For purposes of computing a corporation's safe income on hand for a particular period, the Agency's position is that, in general, a loss incurred in a taxation year during the period that was not deducted in computing the corporation's income for the year would generally be deducted in computing the corporation's safe income on hand.
In the present situation, we are of the view that, following the disposition of the passenger vehicle in the corporation's 1992 taxation year, the corporation's safe income on hand should be adjusted by reducing it by an amount equal to the excess of the acquisition cost of the vehicle in question over its deemed capital cost, i.e. an amount of $11,000, since an amount of earned income equal to that loss is no longer on hand and therefore cannot contribute to the gain on the disposition of a share of the corporation.
In addition, subsection 13(2) provides that the amount calculated, at the end of a taxation year, under subsection 13(1), as recapture of depreciation, in respect of a passenger vehicle the cost of which exceeds $20,000 or any other amount that may be fixed by regulation, is not included in computing income for the year. In addition, subsection 20(16.1) provides that subsection 20(16) (terminal loss in respect of depreciable property) does not apply to a passenger vehicle of a taxpayer the cost of which to the taxpayer exceeds $20,000 or such other amount as may be prescribed.
For the purposes of computing safe income on hand, we are of the view that an amount determined under subsection 13(2) in respect of a corporation, which is not required to be included in computing the corporation's income, has no impact on computing that corporation's safe income on hand.
Thus, in this situation, the amount calculated under subsection 13(1), $3,138, which is not included in computing the corporation's income under subsection 13(2), would have no effect on the corporation's safe income on hand for the particular period.
SITUATION 5
During its last five taxation years, a corporation incurred borrowing costs described in subparagraph 20(1)(e)(ii) and deducted those costs at a rate of 20% per year in accordance with subparagraph 20(1)(e)(iii).
For accounting purposes, borrowing costs can be expensed in the year or capitalized and expensed over a period of three to five years, since they are not material and do not represent a future benefit to the corporation.
QUESTION
Assuming that the corporation has expensed the borrowing costs from the first year (the “base year”) for accounting purposes, should any adjustments be made in computing safe income on hand in respect of those borrowing costs?
The Agency's general position is that where amounts have been expended, other than amounts expended to acquire capital property or eligible capital property, they are no longer on hand to contribute to the fair market value or an inherent gain on a share of the corporation, whether or not they are deductible in computing the corporation's income.
Thus, where borrowing costs have not been deducted by a corporation in a particular taxation year, those costs have not been deducted in computing safe income for the period and an adjustment would then be required in computing the corporation's safe income on hand for the period.
Thus, in the present situation, it is our view that the amount, if any, by which the borrowing costs incurred exceed the total of all amounts each of which was an amount deducted in a taxation year of the corporation under paragraph 20(1)(e) must be considered as a reduction in computing the corporation's safe income on hand for the particular period.
SITUATION 6
You noted that in Technical Interpretation no. 9408795 dated July 20, 1994, Revenue Canada issued the following comment regarding the implications of a capital loss in computing safe income on hand:
It is our view that losses (whether they are business, farm or capital losses) incurred in a taxation year but which have not been deducted in computing income under section 3 by the corporation, or by any corporations over which the corporation has significant influence, will generally reduce safe income on hand of the corporation because income of the corporation that has been used to finance such losses is no longer on hand to contribute to the gain inherent in a share of the corporation. Consequently, capital losses that are not deductible for tax purposes would reduce safe income on hand.
QUESTIONS
Scenario 1
You wish for confirmation that a corporation that realizes a $10,000 capital gain on the disposition of Investment X and suffers a $10,000 capital loss on the disposition of Investment Y during the same taxation year will have no adjustment to make in computing its safe income on hand at the end of the year, since the net taxable capital gain is nil for the year in question.
Scenario 2
Assuming that the $10,000 capital loss resulting from the disposition of Investment Y was incurred in a particular taxation year (the “particular year”) and that the $10,000 capital gain resulting from the disposition of Investment X was realized in the taxation year following that of the particular taxation year (the “subsequent year”) and that this capital loss and this capital gain constituted the corporation's only capital gains and losses for the particular period, should the corporation reduce its safe income on hand for the “particular year” by $10,000 or by $7,500?
You informed us that some authors claim that the amount of the allowable capital loss should reduce the amount of safe income on hand only in the year in which the loss is deducted.
Generally, where a corporation has capital losses for a taxation year that do not exceed its capital gains for the year, no adjustment would be required in computing the corporation's safe income on hand in that respect at any time for a particular period that includes that taxation year.
Furthermore, the Agency's position is that, in general, losses incurred by a corporation reduce the corporation's safe income on hand when they are incurred rather than when they are deducted in computing the corporation's taxable income since it is reasonable to consider that any loss so incurred has reduced the portion of the safe income on hand that would have contributed to a capital gain on a share of the corporation (see document 9231115).
Thus, in Scenario 1 above, since the $7,500 allowable capital loss for a taxation year would reduce the $7,500 taxable capital gain realized in the same year, no adjustment in respect of that loss would be required in computing the corporation's safe income on hand for a particular period that would include that taxation year.
On the other hand, in Scenario 2 above, it is our view that the $10,000 capital loss amount should reduce the corporation's safe income on hand for the particular period, if only the “particular year” is included in the particular period but not the “subsequent year”.
These comments are not advance income tax rulings and do not bind the Department in respect of any particular situation.
Our comments are based on the current Act and do not take into account any proposed amendments.
We apologize for the delay in responding to your request. We hope you find these comments useful.
Best regards,
Maurice Bisson, CGA
On behalf of the Director
Corporate Reorganizations and
International Operations Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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