20 December 2004 External T.I. 2004-0080271E5 - Capital Deduction

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.

Principal Issues: Various issues dealing with the application of subsection 181.5.

Position: Refer to document.

Reasons: The legislation

XXXXXXXXXX 								2004-008027
									Alison M. Campbell
December 20, 2004

Dear XXXXXXXXXX:

Re: Part I.3 Taxes - Capital Deduction

This is in reply to your letter of June 1, 2004, wherein you requested our views on the application of section 181.5 of the Income Tax Act (the "Act") to a specific set of complex facts. The particular situation outlined in your letter appears to relate to a factual one, involving specific taxpayers. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an Advance Income Tax Ruling. Should your situation involve specific taxpayers and completed transactions, you should submit all relevant facts and documentation to the appropriate Tax Services Office for their views. However, we are prepared to offer the following general comments that may be of assistance.

The capital deduction of a corporation is used in calculating the corporation's Part I.3 taxes payable for a taxation year in accordance with subsection 181.1(1) of the Act. The amount of a corporation's capital deduction for any particular taxation year of the corporation is dependent upon a number of factors, which are set out in section 181.5 of the Act.

Where a corporation is not related to any other corporation at any time in the corporation's taxation year, and where the taxation year ended before calendar year 2004, the corporation's capital deduction is $10,000,000. Where the taxation year ended after calendar year 2003, the corporation's capital deduction is $50,000,000. However, where a particular taxpayer corporation was related to at least one other corporation at any time in the taxpayer corporation's taxation year, subsection 181.5(1) of the Act provides that the taxpayer corporation's capital deduction for that taxation year will be nil, unless pursuant to subsection 181.5(4) of the Act, it has filed an agreement to allocate the capital deduction among all related corporations (subsection 181.5(2)) or the Minister has allocated the capital deduction among all related corporations (subsection 181.5(3)). The phrase "at any time" in subsection 181.5(1) of the Act means that the provision applies to a taxpayer corporation even if the taxpayer corporation is not related to the other corporation at the taxpayer corporation's taxation year-end.

In determining the related corporations which must share the capital deduction, subsection 181.5(2) provides that a taxpayer corporation must share the capital deduction with any other corporations to which it was related in the taxpayer corporation's taxation year where the other corporations have a year end in the calendar year at a time that they are related to the taxpayer corporation. Therefore, while a taxpayer corporation must file an allocation agreement in respect of all corporations to which it is related in the calendar year in which its taxation year ends, it will only be required to allocate the capital deduction with such corporations if they are related to the taxpayer corporation at the end of their taxation years that end in the particular calendar year. An allocation may not be required in a situation where the "other corporation" was acquired by the taxpayer corporation during the calendar year, was not related to the taxpayer corporation prior to the acquisition of control, and the first taxation year end of the acquired corporation which ends after the corporations become related is in the subsequent calendar year. Similarly, an allocation may not be required in a situation where the "other corporation" was newly created during the calendar year and will have its first taxation year-end in the subsequent calendar year.

Where two Canadian corporations are amalgamated in a calendar year and subsection 87(2) of the Act applies to the amalgamation, the corporation formed on the amalgamation will be considered a new corporation and not a continuation of either predecessor corporation for purposes of determining the capital deduction of the amalgamated corporation under section 181.5. Accordingly, the amalgamated corporation would not be considered to have been related to any other corporations prior to the time of the amalgamation. The two predecessor corporations will be deemed to have taxation years end immediately before the amalgamation and, where the predecessor corporations are related to each other or to other corporations immediately before the amalgamation, the predecessor corporations may be required to share the capital deduction for the deemed taxation year-end.

Subsection 181.5(5) of the Act will apply where a particular corporation is related to another corporation, has 2 or more taxation years ending in a calendar year and at the end of each such taxation year is related to the other corporation.

While our comments are not binding on the Agency with respect to the application of these provisions to any particular situation, we do hope that the comments will be of some assistance.

Yours truly,

F. Lee Workman
Manager
Financial Institutions Section
Income Tax Rulings Directorate
Policy and Planning Branch