21 November 2002 Internal T.I. 2002-0148037 - TRANSFER OF IMPAIRED SDO

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:

Determination of a reserve under paragraph 20(1)(l) of the Act where an affiliate transfers an impaired specified debt obligation ("SDO") to an entrant bank and elect to have subsection 142.7(7) apply to the transfer.

Position:

The cost, and therefore the amortized cost of the SDO to the entrant bank will be the fair market value thereof at the time of transfer.

Reasons: Legislation

November 21, 2002

TORONTO NORTH TSO					HEADQUARTERS
Angelo Bertolas					Alison Campbell
Banking Specialist	                  Financial Institutions Section
                                    	Industry Specialist Services	
                  				Income Tax Rulings Directorate
                                          (613)957-3496

2002-014803

Transfer of impaired loans to a Schedule III Bank

This is in reply to a memorandum, dated June 18, 2002, that was sent to us by Doug Mitchell. The memorandum deals with the continuity of reserve claims in respect of impaired specified debt obligations ("SDO's") that may be transferred from a bank's Canadian affiliate to the bank's Canadian branch operation in accordance with subsection 142.7(7). We were asked for our thoughts on the legislation as we believe it applies in these situations. Unless otherwise indicated, all sectional references in this memo refer to the Income Tax Act (Canada) R.S.C.(5th Supp.) c.1, as amended.

We agree with the analysis provided in the incoming memorandum. Under the rules in paragraph 142.7(7)(e), the affiliate will claim a 20(1)(l) reserve in its taxation year that is deemed to have ended immediately before the transfer of the SDO to the entrant bank. In computing the income of the affiliate for the taxation year that includes the transfer of the SDO, the affiliate will not include the amount of the 20(1)(l) reserve claimed in its deemed year end. The affiliate will realize a loss on the disposition of the SDO determined with reference to its fair market value which will effectively crystallize the loss in value of the SDO in the affiliate. The entrant bank will include in computing its income for the year that includes the transfer, the amount of the 20(1)(l) reserve claimed by the affiliate in the affiliate's deemed year-end.

The tax basis of the SDO to the entrant bank would be the FMV of the SDO on the transfer date (required under paragraph 142.7(7)(b)), and consequently, provided there is no further impairment of the asset, the entrant bank should not be claiming a 20(1)(l) reserve in respect of the SDO. If the SDO is further impaired, the amount of the impairment for reserving purposes should be determined with reference to the decline in value of the SDO from its amortized cost for tax purposes, as opposed to its amortized book cost. In the event that the SDO becomes further impaired after it is acquired by the entrant bank, the amount of any 20(1)(l) reserve that may be claimed would likely be limited to the taxpayer's specified percentage of a reasonable amount in respect of the amortized cost of the loan at the end of the year pursuant to subclause 20(1)(l)(ii)(D)(I), as opposed to a percentage of the GAAP reserve claimed in respect of the SDO. This is because the tax reserve amount is limited to the lesser of the specified percentage of a reasonable amount and the amount determined by the formula in subclause 20(1)(l)(ii)(D)(II). There is a definition for the amortized cost of a loan or lending asset for tax purposes in subsection 248(1) and this would supersede the accounting meaning of amortized cost for purposes of paragraph 20(1)(l).

We also agree that there may be some difficulty from a record keeping perspective, in ensuring that any 20(1)(l) reserve claim made by the entrant bank on an impaired SDO that was acquired from the affiliate, is based on the amortized cost of the SDO for tax purposes as opposed to the amortized book cost of the SDO. Consequently, it will be necessary to separately track those SDO's of the affiliate that are transferred in accordance with the rules under subsection 142.7(7), to ensure that any subsequent reserves are based on the amortized cost for tax purposes and not the amortized cost for accounting purposes. We believe that, since the affiliate must specifically identify those SDO's in respect of which a paragraph 20(1)(l) reserve is claimed and in respect of which the affiliate and entrant bank elect to have subsection 142.7(7) apply, the taxpayer and our auditors should have the starting information available to determine which assets need to be tracked.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. 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 electronic library version, or they may request a severed copy 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 (819) 994-2898. A copy will be sent to you for delivery to the client.

F. Lee Workman
Section Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch