20 November 2003 Internal T.I. 2003-0035837 - XXXXXXXXXX BANKING ARRANGEMENT

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:

The taxpayer has a XXXXXXXXXX banking arrangement in place with its bank and its subsidiaries. Its financial statements reported a net overdraft for the year. Must the overdraft be disaggregated with gross account balances used for Part I.3 purposes?

Position:

The company's asset and liability accounts subject to the XXXXXXXXXX appear to satisfy criteria for offset presentation under GAAP. Therefore, the accounts subject to the XXXXXXXXXX would reflect a single net balance for Part I.3 purposes. Accounts not subject to the XXXXXXXXXX must be disaggregated and gross balances used for Part I.3 purposes.

Reasons:

In general, the aggregate balance of a taxpayer's bank accounts must be disaggregated for Part I.3 purposes. Particular accounts may be reported on a net basis, however, where there is authority to offset asset and liability amounts under GAAP.

		November 20, 2003

	TORONTO CENTRE TSO	HEADQUARTERS
R. Maley
	Attention:  Gordon A. MacGibbon	(613) 957-9226

2003-003583

XXXXXXXXXX
Part I.3 implications, XXXXXXXXXX Banking Arrangement

This is in response to your memoranda dated August 21, and October 16, 2003. You have provided us with a copy of a document entitled "XXXXXXXXXX Banking Agreement" ("XXXXXXXXXX") made between XXXXXXXXXX ("the taxpayer"), its subsidiaries ("the subs") and the XXXXXXXXXX ("the bank"). You have requested our views on the appropriate application of Part I.3 to overdraft balances of the taxpayer for its XXXXXXXXXX taxation year having regard to the application of this agreement. You note that the taxpayer has aggregated, on its unconsolidated and unaudited financial statements for the year, the balances for all of its bank accounts, including the accounts that were subject to the XXXXXXXXXX.

The XXXXXXXXXX entitles the taxpayer and the subs to establish "transfer accounts" in respect of any operating account or group of operating accounts one of them holds with the bank. The XXXXXXXXXX also provides for the establishment of a "group account" to be held by the taxpayer. At the end of each day, the bank establishes, in each of the taxpayer's transfer accounts or a transfer account of one of the subs, a balance that offsets the balance in the related operating account(s) e.g., a sub has a $100Cr operating balance and so the bank debits its transfer account in the amount of $100 at the end of the day. The bank then reflects that transaction in the taxpayer's group account e.g., the sub's transfer balance was $100Dr, so the group account was credited with $100. Thus the group account, at the end of each day reflects the net, overall cash position of the corporate group.

You advise that the taxpayer's net overdraft position reflects the cumulative balances (both debit and credit) of all the taxpayer's bank accounts including accounts of the taxpayer subject to the XXXXXXXXXX, accounts the taxpayer holds with other financial institutions and possibly, other accounts the taxpayer holds with the bank. You wish to know whether this cumulative balance must be disaggregated, in whole or in part, for Part I.3 purposes.

Conclusions

It is not clear to us that the balance sheet provided has been prepared in accordance with GAAP. As GAAP balances are required pursuant to paragraph 181(3)(b) of the Act, we recommend that the taxpayer be asked to provide confirmation from their auditors that the balance sheet has, in fact, been prepared in accordance with GAAP.

In our view, the overdraft balance on the balance sheet must be disaggregated in computing the taxpayer's capital and investment allowance for Part I.3 purposes. However, the asset and liability accounts of the taxpayer that are subject to the XXXXXXXXXX may be offset in accordance with GAAP. In other words, the net balance of all the accounts the taxpayer holds with the bank that are subject to the XXXXXXXXXX would represent a single balance in computing the aggregate balance on the balance sheet.

The XXXXXXXXXX provides for legally valid transfers of funds held with the bank between the taxpayer and the subs. The intent of the agreement appears to be to enable the bank and the taxpayer to consolidate the taxpayer's operating accounts with those of its subs such that the taxpayer has full liability for any amount owing by the subs to the bank and full entitlement to any amount owing by the bank to the subs. The taxpayer's liability to the bank (or the bank's liability to the taxpayer) in respect of the agreement would thus be the aggregate amount of the taxpayer's transfer, group and operating accounts that are subject to the XXXXXXXXXX. We believe that section 3860 of the CICA Handbook may provide authority to offset the asset and liability accounts subject to the XXXXXXXXXX for reporting purposes.

The remaining accounts the taxpayer holds (with the bank or with other institutions) must be disaggregated and gross balances used for Part I.3 purposes unless a basis for offsetting particular debit and credit balances can be demonstrated under GAAP.

Other comments

Subsection 181(3) provides that, for the purposes of determining any amount under Part I.3, the amounts reflected in the balance sheet prepared in accordance with GAAP shall be used. The CCRA has confirmed on a number of occasions that an amount must be reflected on the balance sheet - including the notes to the balance sheet- if it is to be included in a corporation's Part I.3 capital. For example, see Rulings opinion E2001-0106227.

Where the balance reflects an aggregation of underlying amounts, the CCRA's view is that the balance sheet amount must be disaggregated for capital tax purposes. For e.g., see section 10 of IT-532. This view was confirmed by the Tax Court of Canada in PCL Construction Management Inc. 2000 DTC 2624 (TCC).

Where the balance sheet reflects a balance that was computed by offsetting asset and liability accounts, the CCRA's view is that the net amount may be used for capital tax purposes provided that the amounts are offset in accordance with GAAP. For example, see section 8 of IT-532, which acknowledges that amounts that may be legally offset may satisfy GAAP criteria for netting. Otherwise, bank balances must be disaggregated for capital tax purposes. For e.g. see rulings opinion E2001-0078917.

Section 3860 of the CICA Handbook provides as follows (a recommendation):

3860.34 A financial asset and a financial liability should be offset and the net amount reported in the balance sheet when an entity:

(a) has a legally enforceable right to set off the recognized amounts; and

(b) intends either to settle on a net basis, or to realize the asset and settle the liability simultaneously. [JAN. 1996]

In our view, the XXXXXXXXXX legally entitles the taxpayer and the bank to set off the debit and credit balances in accounts subject to the XXXXXXXXXX. An intention to settle on a net basis is also suggested by the agreement. Thus, there may be a basis for the asset and liability accounts to be offset and a net amount reported in respect of those accounts. However, to the extent that the overdraft balance at issue represents the balances of accounts not subject to the XXXXXXXXXX , gross balances must be used for Part I.3 purposes.

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
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch