19 March 2007 External T.I. 2006-0198331E5 - Texas sales and franchise taxes

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: Whether Texas sales and franchise taxes can be deducted in the year the particular assessments are raised or in the year to which the particular taxes relate.

Position: Since the Texas sales taxes are not liabilities of the taxpayer unless an assessment is issued, such sales taxes are deductible in the year in which the assessment is issued. However, the liability for the Texas franchise taxes is imposed by reference to a taxation year and accordingly can only be deducted in that year. In both cases, the taxes must satisfy the requirements in paragraph 18(1)(a) of the Act.

Reasons: Generally, expenses should be deducted in the year that they are "incurred."

XXXXXXXXXX 							2006-019833
J. Gibbons, CGA
March 19, 2007

Dear XXXXXXXXXX:

Re: Deductibility of "Texas Sales Taxes"

We are responding to your letter dated July 21, 2006, which was forwarded to us by the Calgary Tax Services Office. In your letter, you indicated that a Canadian corporation (the "Taxpayer") with a subsidiary in the U.S. was assessed Texas limited sales, excise and use taxes ("Texas sales taxes") and Texas franchise taxes in July 2005 for the period January 1, 2001 through August 15, 2002. In computing income for income tax purposes, you wish to know whether the Taxpayer can deduct such taxes in the taxation year in which the particular assessments were made (i.e., the taxation year ending July 31, 2005), notwithstanding the fact that the Taxpayer ceased to carry on business in August 2002, or, alternatively, whether the particular taxes should be deducted in the 2002 taxation year, the year to which they relate.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the applicable Tax Services Office serving the particular taxpayer. However, we have provided the following general comments.

The deductibility of expenses is always a question of fact, having regard to, among other things, whether the outlay or expense was made or incurred for the purposes of gaining or producing income (paragraph 18(1)(a) of the Income Tax Act or "Act"), whether it was capital in nature (paragraph 18(1)(b) of the Act), and whether it was reasonable in the circumstances (paragraph 67(1)(a) of the Act).

Under the accrual method of accounting, the method generally required under the Act to calculate income from a business or property, expenses should be deducted in the year they are incurred. In determining whether a so-called expense was actually incurred by taxpayer in the year, one must differentiate between a genuine liability and a contingent liability, the latter of which would be prohibited as a deduction by virtue of paragraph 18(1)(e) of the Act. In order for a genuine liability to exist, there must be an enforceable claim by the creditor with a reasonable expectation that the debt will in fact be paid by the debtor.

As we understand the operation of the Texas sales taxes, it is similar to the federal GST/HST taxes insofar as the vendor, i.e., the Taxpayer in this case, acts as an agent for the state in the collection of such taxes while the consumer remains the person liable for the taxes. Accordingly, it should be noted that it is our view that such taxes are not income to the vendor when collected nor an expense to the vendor when remitted to the particular authority. However, if a vendor fails to collect such taxes from the purchaser and is assessed afterwards by the appropriate authority for the payment of such taxes, the amount assessed would become a liability of the vendor, as well as a deductible business expense, at that time. In our view, even if a taxpayer is no longer carrying on the particular business that gave rise to the assessment, the taxpayer would not be precluded from deducting the otherwise deductible taxes. This is supported by the Federal Court of Appeal's decision in The Attorney General of Canada v. Jean-Camille Poulin, 1996 DTC 6477.

In contrast to the Texas sales taxes, liability for Texas franchise taxes does not appear to depend on the issuance of an assessment notice to the Taxpayer, but can be calculated by direct reference to the applicable statute. Accordingly, to the extent that the franchise taxes are a deductible expense for income tax purposes, a deduction would apply to the year in which the liability is ascertainable. In this regard, it should be noted that the Texas franchise taxes may, in some cases, constitute an income or profits tax that would not be deductible for income tax purposes by virtue of paragraph 18(1)(a) of the Act. However, in such cases, the taxes might qualify for a foreign tax credit under subsection 126(2) of the Act. In this regard, we have included a copy of previous correspondence from us wherein this issue is discussed at length.

We trust that the above information is helpful.

Yours truly,

Randy Hewlett
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

cc Sheri-Lee Mackinder, Calgary TSO

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