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Principal Issues: Whether a financial assistance provided by a government in a particular situation and taking the form of a reimbursement of interest expenses paid by a taxpayer with respect to loans contracted for the purposes of a particular project should reduce the capital cost of depreciable property acquired in the course of the said project under subsection 13(7.1) of the Act.
Position: No.
Reasons: The financial assistance provided in the particular situation should be considered first and foremost as amounts received in respect of an outlay or expense (i.e. interest) and consequently should not be considered as an assistance received in respect of or for the acquisition of, depreciable property. Furthermore, the Department does not accept the conclusions reached by the Québec Court of Appeal in S.M.R.Q. v. Alex Couture Inc., 2001 DTC 5072 and considers that such decision is not binding upon the Department.
2001-009455
XXXXXXXXXX S. Prud'Homme
(613) 957-8975
January 2, 2002Dear Sir,
Subject: Request for Technical Interpretation - Tax Treatment of Government Financial Assistance
This is in response to your letter of July 17, 2001, in which you asked for our opinion regarding the tax treatment of financial assistance provided by Investissement-Québec (formerly known as the Société de développement industriel du Québec) in the form of a reimbursement of a portion of the interest incurred and paid by a taxpayer ("Opco") on its term debt in order to encourage the taxpayer to carry out a project to increase the productivity and production capacity of facilities (the "Project") under the "Fonds pour l'accroissement l'investissement privé et la relance l'emploi" ("FAIRE") program.
It appears to us that the situation described in your letter and summarized below could constitute an actual situation involving taxpayers. As explained in Information Circular 70-6R4, it is the practice of our Directorate not to issue written opinions regarding proposed transactions otherwise than by way of advance income tax rulings. If your situation involved a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate Tax Services Office for its opinion. However, we are able to offer the following comments which may be of assistance to you. It should be noted that the application of most of the provisions of the Income Tax Act (the "Act"), including subsection 13(7.1), requires an analysis of all the facts relating to a particular situation.
Consequently, and given that your letter only briefly describes a particular hypothetical situation and does not state certain important elements (for example, a detailed description of the Project for which financial assistance is being provided), the comments we make below may not fully apply to particular situations.
1) Particular Situation
You have presented the situation described below (the "Particular Situation") as part of your request for a technical interpretation.
a) Opco entered into an agreement (the "Agreement") with Investissement-Québec to obtain financial assistance under the FAIRE program for the Project.
b) More specifically, under the terms of the Agreement, Investissement-Québec undertook to reimburse Opco, up to a certain amount, for the interest incurred and paid by Opco on its term debt insofar as Opco carried out the Project under the FAIRE program.
c) The Project that Opco undertook to carry out is described in Schedule A to the Agreement, which Schedule has not been provided to us. However, it appears from the terms of the Agreement that this Project would consist of increasing the productivity and production capacity of certain facilities owned by Opco. You stated that the Project would consist of the expansion and modernization of Opco's business facilities and would result in the creation of new jobs and eligible capital investments. The Agreement specified that the Project should begin no later than a certain date and end no later than another certain date. In addition, the Agreement specified that the Project should include a certain minimum amount of eligible capital costs, failing which Investissement-Québec would be entitled to claim from Opco repayment of the entire contribution paid, with interest. You specified that Investissement-Québec would also be entitled to require Opco to repay the entire contribution paid if a certain number of new jobs were not maintained for a certain period.
d) Investissement-Québec's assistance relating to the cost of interest incurred and paid by Opco was to be paid over a maximum period of 10 years on the basis of eligible capital costs incurred and paid in connection with the Project. More specifically, Investissement-Québec would pay semi-annually as financial assistance an amount equal to the lesser of 10% of the eligible capital costs incurred and paid by Opco and the sum of the interest accrued and paid by Opco on its term debt during the period in question.
e) Prior to each payment of financial assistance, Opco was to provide Investissement-Québec with a copy of its most recent audited financial statements and, when required by Investissement-Québec, a certificate from the external auditors attesting to the amount of eligible capital costs incurred and paid by Opco for the Project and the amount of interest paid by Opco since the date of the last payment of financial assistance, as well as a summary report on the progress of the work and upcoming stages.
f) For the purposes of preparing Opco's financial statements, the financial assistance paid by Investissement-Québec was applied against the interest expense incurred by Opco.
g) For present purposes, we have assumed that Opco would deduct the interest incurred and paid on its term debt in computing its income, pursuant to paragraph 20(1)(c) of the Act.
2) The Issue in this Case
In your opinion, the question that arises with respect to the tax treatment of the financial assistance paid by Investissement-Québec to Opco in the form of a reimbursement of a portion of the interest incurred and paid by Opco is to determine whether this contribution should be applied against the interest expense incurred by Opco with respect to the Project or whether this contribution should reduce the capital cost of depreciable property acquired as part of the Project and not yet disposed of, pursuant to subsection 13(7.1).
3) Your Analysis of the Particular Situation
In summary, you are of the view that the financial contribution paid by Investissement-Québec to Opco should reduce the capital cost of depreciable property acquired with the proceeds of borrowings under the Project and not yet disposed of, pursuant to subsection 13(7.1). Your position in this regard is based on the following elements, among others.
First, you stated that section 9 or subsection 13(7.1) could apply in the context of the Particular Situation. You indicated that, in your opinion, profit is computed in accordance with generally accepted commercial principles, subject to the express provisions of the Act in this regard, and that generally accepted accounting principles ("GAAP") constitute a very important element of those generally accepted commercial principles. Thus, you indicated that if GAAP stipulates the reduction of carrying charges by the amount of interest repaid, it would be reasonable to believe that the tax treatment should have the same effect, unless, however, a specific provision of the Act prescribes a different result.
You are of the view that subsection 13(7.1) is a specific provision that can be an exception to section 9. That provision states that assistance from a government in respect of depreciable property or for the purpose of acquiring depreciable property, whether as a grant, subsidy or any other form, must reduce the capital cost of the depreciable property in question that has not yet disposed of by the taxpayer.
You are also of the view that the financial assistance paid by Investissement-Québec to Opco is not granted directly for job creation but rather for the purposes of the Project consisting of the acquisition of certain capital properties. According to you, job creation is therefore simply a desired effect of the investments related to the Project.
In addition, although the financial assistance is, in your opinion, clearly tied to the capital assets related to the Project, you note that this contribution nonetheless takes the form of a reimbursement of interest actually paid by Opco. You are of the opinion that it must therefore be determined whether the financial contribution paid in the Particular Situation is related more to interest on loans contracted as part of the Project or to depreciable property acquired as part of the Project.
In this regard, you stated that this issue has been the subject of litigation before the courts in the past and that the decisions in General Diesel Inc. v. M.N.R., 80 DTC 1791 (T.A.B.) and S.M.R.Q. v. Alex Couture Inc. 2001 DTC 5072 (Q.C.A.) seem to you to be the most relevant in this case.
In General Diesel Inc. the taxpayer planned, among other things, to construct a building and acquire machinery and equipment. The taxpayer had received assistance in this regard from the Société de développement industriel du Québec ("SDI"). This assistance consisted of a reimbursement of part of the interest on a $700,000 loan taken out with a financial institution by the taxpayer for the purposes of its project. More specifically, the SDI had agreed to "assume" the lesser of 40% of the annual interest paid under the above loan and certain specified amounts per year. The taxpayer applied the amount of assistance received from SDI against the capital cost of the depreciable property relating to the project, for both financial statement and tax purposes. The taxpayer also deducted the interest incurred on the loan taken out for the project, pursuant to paragraph 20(1)(c). The Minister of Revenue took the position that the assistance received from the SDI should be added to the computation of the taxpayer's income for the years in question. The court ruled that even if the assistance related to an investment project, the form of assistance used had to be considered. In this case, that form of assistance was the "assumption" or repayment of interest. However, by its very nature, interest was not part of the capital cost of a depreciable property; rather, the full amount of an interest expense incurred should be deducted in computing a taxpayer's income. Consequently, the court ruled that subsection 13(7.1) could not apply in that case.
Instead, the amount of the assistance should either be applied to reduce the amount of interest paid by the taxpayer or included in the computation of the taxpayer's income after deducting the full amount of the interest paid.
You also pointed out that the Quebec Court of Appeal ruled in Alex Couture Inc. on facts similar to those in General Diesel Inc. in connection with a provision of Quebec tax law that you consider to be identical to subsection 13(7.1). In that case, the taxpayer had received financial assistance from the SDI to help it, among other things, to finance acquisitions of depreciable property. The taxpayer's project was aimed at increasing its production capacity and cleaning up odour emissions from its plant. The financial assistance took the form of "assumption of responsibility" or repayment of part of the cost of loans in the amount of $1,600,000 taken out by the taxpayer with a financial institution to make the investments in expanding or improving. In computing its income for the year, the taxpayer deducted the interest paid during that year on the above loans and reduced the capital cost of the depreciable property relating to its project by the amount of the assistance received from the SDI, both for tax purposes and in preparing its financial statements. The Ministère du revenu du Québec rejected the tax treatment adopted by the taxpayer, claiming that the financial assistance granted by the SDI should reduce the interest expense incurred by the taxpayer in respect of the loans. The Quebec Court of Appeal ruled that the taxpayer had complied with Quebec law in its tax treatment of the grants received. The court's decision was based, among other things, on the fact that the objectives of the legislation under which the financial assistance was paid was to grant assistance for the acquisition, construction or improvement of plant or machinery and was therefore on capital account. In this case, the financial assistance was for the acquisition of property and was related to an investment project. The Court was of the view that the form of the financial assistance could not contradict its substance. The court also noted that the SDI had not truly assumed the taxpayer's obligations to the financial institution. Finally, the Quebec Court of Appeal indicated that the trial judge was right not to follow the General Diesel Inc. decision, in part because, in the Court's view, that decision did not take into account the purpose of the law for granting assistance.
4) Our Comments on the Particular Situation
We do not share your conclusion regarding the application of subsection 13(7.1) of the Act in the Particular Situation. Under the terms of the Agreement, the financial assistance granted by Investissement-Québec would be a reimbursement to Opco of a portion of the interest incurred and paid by Opco on its term debt if it carries out the Project. We are therefore of the view that the assistance received by Opco would first and foremost constitute assistance in respect of an expense that it would make or incur during a particular year (i.e., an interest expense) and would therefore not constitute assistance in respect of depreciable property or for the purpose of acquiring depreciable property. Subsection 13(7.1) would therefore not apply in the Particular Situation.
With respect to the Alex Couture Inc. decision to which you refer, it seems to us that this decision could possibly be distinguished from the Particular Situation. In fact, it appears from the facts of the Alex Couture Inc. decision that the financial assistance granted by the SDI took the form of a reimbursement of part of the cost of the loans contracted by the taxpayer to make the expansion and improvement investments. Under the terms of the documents you provided (i.e., a copy of the Agreement and its Schedule B), it appears that the financial assistance granted by Investissement-Québec took the form of a reimbursement of a portion of the interest incurred and paid on Opco's term debt, provided that the Project was carried out. However, the documents provided do not expressly indicate that the financial assistance from Investissement-Québec would consist of a reimbursement of a portion of the cost of loans that would be specifically contracted by Opco for the purpose of carrying out the Project.
Furthermore, we wish to inform you that the Directorate does not accept the conclusions of the Alex Couture Inc. decision and does not consider itself bound by that decision of the Quebec Court of Appeal.
In closing, we would like to point out that this opinion is not an advance ruling and, as stated in paragraph 22 of Information Circular 70-6R4 dated January 29, 2001, it is not binding on the Canada Customs and Revenue Agency with respect to any particular factual situation.
We apologize for the delay in responding to your request. We hope that our comments will be of assistance to you.
Best regards,
Maurice Bisson, CGA
for the Director
Corporate Reorganizations and
Resource Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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