22 January 2002 Internal T.I. 2001-0105567 - FTC & SBD - PATRONAGE DIVIDEND

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 CCRA.

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

Principal Issues: 1. Can taxpayer characterize an amount of tax withheld from a foreign source patronage dividend as being part of cost of goods purchased so as not to reduce the Small Business Deduction claimed?

Position: 1. Question of fact

Reasons:     1. The Act provides two alternatives for dealing with the amount of foreign tax withheld, either a deduction can be claimed under ss. 20(12) or the FTC under s. 126 can be claimed.  If the deduction is chosen, it must be against the business or property income to which the foreign source income relates; provided the foreign source income (patronage dividend) is active business income it may either: (i) reduce the price of goods purchased (if it represents a discount in the price of the product purchased) and the effect of 20(12) would be to increase cost of goods; or (ii) the amount received, net of taxes, would be added to income thereby also reducing the amount eligible for the small business deduction.
		January 22, 2002

	Toronto Center TSO	HEADQUARTERS
	Business Enquiries	L. Holloway
	Verification & Enforcement Division	(613)- 957-2104

	ATTENTION:  Patricia Caron
		2001-010556

Foreign Tax Credit and
Small Business Deduction override

This memorandum is in response to your faxed memorandum of October 12, 2001. The scenario presented involved a Canadian corporation who purchases supplies from the U.S. A discount for early payment is given by the supplier in the form of patronage dividends from which tax is withheld prior to payment. The Canadian corporation is entitled to a foreign tax credit in the amount of tax withheld. The Canadian corporation does not wish to reduce its income eligible for the small business deduction as any foreign tax credit claimed would otherwise do, so they are proposing to override the computer program and add the amount of foreign non-business income tax paid as a part of the cost of goods/inventory. The taxpayer claims that by adding this amount to the cost of goods instead of claiming the foreign tax credit, the amount eligible for the small business deduction would not be reduced.

Our Comments

A patronage payment referred to in IT-362R is an "allocation in proportion to patronage" and means an amount credited by the taxpayer to a customer of that year, on terms that the customer is entitled to or will receive payment of the amount, computed at a rate in proportion to patronage (i.e., the amount of business done with the customer in the taxation year) with appropriate differences in the rate for different types of goods, products or services and for different classes, grades, or qualities of such goods, products, or services. Your memorandum describes the receipt as "a discount for early payment" given by the supplier in the form of patronage dividends.

Whether or not the payments described in your memorandum are patronage dividends is a question of fact, and we have not been provided with sufficient information to make this determination. Where the amounts, as stated, represent a discount for early payment they would be relevant in computing the taxpayer's income from business and would represent a reduction in the purchase price of supplies/inventory purchased. Where on the other hand they are true patronage dividends as defined above then such a payment is not a component of the cost of goods, but rather a source of business income.

As the corporation has patronage payments coming from the U.S., it may be indicative that they are carrying on business in that country. In order for the corporation to be eligible for the small business deduction under subsection 125(1), the income of the corporation must be income from an active business carried on in Canada. The determination of whether a particular activity constitutes an active business, and in which country the business is being carried on, are also both questions of fact which cannot be determined until all of the relevant facts are known, but for purposes of your question we will assume that the corporation is not carrying on business in the U. S. Therefore, the patronage dividends otherwise relate to the taxpayer's active business carried on in Canada and any tax withheld would be foreign "non-business income tax" as that term is defined in subsection 126(7).

A corporate taxpayer has two options with respect to any non-business income taxes paid to a government of a country other than Canada. Subsection 20(12) allows a deduction, in computing income from a business or property, for foreign tax paid for the year relating to that income (i.e. from business or property). Alternatively the taxpayer may claim a foreign tax credit under section 126. In the case presented, if the corporation did not wish to claim the foreign tax credit, in respect of amounts withheld from the patronage dividends, they can certainly claim a deduction of tax paid from the business income to which the patronage dividends relate. Where such an option is chosen, the patronage dividend received, net of withholding tax would be included in the corporation's income for the year received unless, as stated in subsection 135(7), the patronage dividends represent an allocation in respect of consumer goods or services.

If, as discussed the payment represents a discount on the purchase price of inventory, the taxpayer may reduce the cost of goods/supplies purchased by the net amount received. The effect of claiming a subsection 20(12) deduction would be to increase the cost of goods (i.e. the cost of supplies purchased) as the taxpayer has suggested. However, as increasing the cost of goods would increase the cost of goods sold (unless the cost of goods to which the payments relate were not deductible in computing income from that business) and decrease the income subject to the small business deduction, we do not agree with the final statement made that in choosing this option the small business deduction would not be decreased.

If, on the other hand the payment is truly a "patronage dividend" in that it is a payment in recognition of a customer's loyalty, volume of business, etc. the net amount received would more appropriately be an income inclusion and would not affect cost of goods at all. A subsection 20(12) deduction against such income would also have the effect of decreasing the income subject to the small business deduction.

Perhaps the calculation of the "foreign tax credit option" versus the "subsection 20(12) deduction option" results in the "deduction option" being more advantageous to the taxpayer, and hence the reason for his question.

Milled Azzi, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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