27 July 2000 Internal T.I. 2000-0037177 - TEMPORARY AND PERMANENT WRITE DOWNS 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 Department.

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

Principal Issues: The role of the recommendations in the CICA Handbook and the Handbook of the Canadian Institute of Public Real Estate Companies Accounting Practices (CIPREC) in determining whether or not an amount written down on a corporation's balance sheet constitutes a reserve within the meaning of subsection 181(1) of the Act.

Position: The fact that a write down is made in accordance with the accounting recommendations of the CICA or of CIPREC would not, in and of itself, be determinative as to whether or not a reserve arises as a consequence of the write down.

Reasons: A permanent write down in value of a capital asset of a corporation results in a reduction of the corporation's capital for Part I.3 purposes. Where a write down is made due to a temporary impairment of an asset's value, the amount of the write down constitutes a reserve within the meaning of subsection 181(1) of the Act. The determination whether the decline in value of an asset is temporary or permanent can only be made having regard to all the facts.

		July 27, 2000

	VANCOUVER TSO	HEADQUARTERS
R. Maley
	Attention:  Larry Moi	(613-957-9226)

		2000-003717

Temporary and Permanent Write Downs - Part I.3 Tax

This is in reply to your memorandum of July 12, 2000 regarding the application of Part I.3 of the Act to assets the value of which have been written down in accordance with GAAP on a corporation's balance sheet. The four questions you have specifically raised all pertain to the role of GAAP in determining whether or not an amount written down on a corporation's balance sheet constitutes a reserve within the meaning of subsection 181(1) of the Act. Two of your questions pertain to the role, if any, of the recommendations set out in the Handbook of the Canadian Institute of Public Real Estate Companies Accounting Practices (CIPREC) in making this determination.

Before responding to your specific questions, some general comments about the application of Part I.3 and the role of GAAP in determining the amount subject to tax under Part I.3 may be helpful. Subsection 181(3) of the Act provides that, for the purposes of determining carrying values of assets, or any other amount under Part I.3, the amounts set out in the balance sheet prepared in accordance with GAAP shall be used. In other words, GAAP is used to quantify amounts subject to tax under Part I.3 of the Act. GAAP presentation does not influence what is, or isn't, in the tax base, which is defined in sections 181.2 through 181.4 of the Act. This position is supported by the decision of the Tax Court of Canada in Autobus Thomas Inc., which was affirmed on appeal.

As you have noted, the CCRA's position is that a permanent write down in value of a capital asset of a corporation results in a reduction of the corporation's capital for Part I.3 purposes. However, where a write down is made due to a temporary impairment of an asset's value, the amount of the write down constitutes a reserve within the meaning of subsection 181(1) of the Act. The fact that a write down is made in accordance with the CICA Handbook would generally not be determinative as to whether or not a reserve arises as a consequence of that write down. Similarly, the fact that a write down is made in accordance with the accounting recommendations of CIPREC would not, in and of itself, be determinative as to whether or not a reserve arises as a consequence of the write down.

This position may not be entirely clear from Rulings opinion E9311591, a severed version of which is available through CCRA Access. In that opinion, it was confirmed that a write down made pursuant to 3060.46 or 3050.20 of the CICA Handbook would not result in a reserve inclusion in a corporation's capital base. That opinion was not intended to suggest that a write down made in accordance with GAAP does not result in a reserve inclusion; rather, it merely recognizes that a write down may not be made pursuant to either of those particular sections of the CICA Handbook unless the impairment in value of the asset is permanent.

As noted in Question 36 of 1991 Round Table of the Canadian Tax Foundation, the determination as to whether the decline in value of an asset is temporary or permanent can only be made having regard to all the facts. Once it is established whether a write down was made based on an impairment in value that is permanent or temporary, the carrying value of the asset and, if applicable, the reserve resulting from the write down would be determined having regard to the relevant balances on the corporation's financial statements prepared in accordance with GAAP. If the financial statements have not been prepared in accordance with GAAP, the balances that would have been reflected on financial statements prepared in accordance with GAAP would be used.

With respect to your particular questions, we have the following comments that are made solely for the purpose of clarifying the application of Part I.3 of the Act and are not intended to constitute views as to the proper interpretation of GAAP in any given situation.

Your first question pertains to write downs made by a corporation that has established a formal plan of disposal within the meaning ascribed by section 3475 of the CICA Handbook. In our view, the compliance of a corporation with section 3475 of the CICA Handbook, or with any other section of either the CICA or CIPREC Handbook would not be relevant unless it can be demonstrated both that the write down was mandated under that particular section and that the write down could only be made in circumstances of permanent impairment. On this basis, it would appear that compliance with section 3475 of the CICA Handbook would not be a sufficient basis, in and of itself, for finding that there is no reserve in respect of the write down. The nature of the impairment in value would still need to be assessed.

Similarly, in response to your third question, it seems to us that the fact that a write down is made pursuant to section 212.2 of the CIPREC Handbook would not be sufficient, in and of itself, to negate a reserve inclusion in the capital tax base. The nature of the impairment in value would need to be assessed on a case by case basis.

In response to your second question, we would confirm that neither the accounting recommendations of CIPREC nor of the CICA in effect from time to time affects the character of any amount in the capital tax base. Proper accounting presentation may, however, affect the value of amounts included in the capital tax base pursuant to subsection 181(3) of the Act.

Finally, our understanding of your fourth question is that it is unclear whether or not the "net realizable value" within the meaning of the CIPREC Handbook is analogous to the concept "net recoverable amount" within the meaning of the CICA Handbook. As this question seems to involve purely an opinion as to the application of GAAP, we are not in a position to comment. Instead, we would reiterate that the only intent behind Rulings opinion E9311591 is to confirm that no reserve arises where an impairment in value is permanent. In our view, it should not be critical to this determination whether or not a corporation has written an amount down to net realizable value or to net recoverable amount. However, once this determination has been made, the carrying value for capital tax purposes of any amount would be based on the amounts set out on the corporation's balance sheet prepared in accordance with GAAP. If the use of net realizable value rather than the net recoverable amount is in accordance with GAAP, that balance would be used to determine the appropriate carrying values for computing the capital tax of the corporation.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. 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 LAD version, or they may request a copy severed 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 (613) 994-2898. A copy will be sent to you for delivery to the client.

F. Lee Workman
Manager
Financial Institutions
Financial Industries Division
Income Tax Rulings Directorate