19 November 2007 Internal T.I. 2007-0232081I7 - Push-down Accounting

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 the CRA would accept certain push-down accounting journal entries in computing retained earnings and contributed surplus for purposes of subsection 18(4) of the Act.

Position: Question of fact.

Reasons: To the extent that journal entries reflect actual expenses of the Canadian corporation, the corresponding permanent reduction in retained earnings will be reflected in the computation for purposes of subsection 18(4) of the Act.

 										November 19, 2007

Ronald J. Bourque
Director									HEADQUARTERS
Technical Applications and Valuations Division			A. Seidel, CMA
Audit Professional Services Directorate				(613) 957-2058
Compliance Programs Branch

Attention:  Brett Evers							2007-023208

Push-Down Accounting and Subsection 18(4)

We are writing in response to your April 13, 2007 memorandum in which you requested our comments concerning the impact of push-down accounting entries on the computation of the interest deductibility limitation in subsection 18(4) of the Income Tax Act (the "Act").

Background

You indicate that you are currently reviewing a situation in which a Canadian corporation's parent, a US-based multi-national, was subject to a takeover by a competitor. You state that this resulted in an acquisition of control of the Canadian subsidiary. In your specific situation, the Canadian subsidiary recorded various push-down accounting entries over the course of a two year period and thereby reduced the retained earnings recorded in its financial statements. It is your view, based on the comments in Interpretation Bulletin IT-59R3, that the adjusted retained earnings should be used for the purposes of clause 18(4)(a)(ii)(A) of the Act.

Our Comments

Push-down accounting is simply a method of accounting in which the financial statements of subsidiaries are presented to reflect the costs incurred by the purchaser of a group of companies on their acquisition. The purchase price is allocated to reflect the fair market value of the various subsidiary's assets and liabilities instead of their historical costs. The purchase costs of the parent company, in this case a US resident corporation, are permanently reflected in the subsidiary's financial statements. Push-down accounting adjustments that change the historical cost of assets or liabilities to reflect fair market value are generally offset by adjustments in that corporations retained earnings or contributed surplus. This financial statement presentation is acceptable under Canadian Generally Accepted Accounting Principles (GAAP) in certain situations.

Clauses 18(4)(a)(ii)(A) and (B) of the Act refer to the "retained earnings" and "contributed surplus" of a corporation. However, these expressions are not defined in the Act. In Upper Lakes Shipping Ltd. v. The Minister of Finance (98 DTC 6264), the Court of Appeal for Ontario concluded that "the plain and ordinary meaning of these words should be taken from the language accountants speak ... tax assessors know accounting language, as do the accountants who certify corporations' financial statements". The amounts computed under Canadian GAAP are therefore the starting point for determining these amounts for purposes of subsection 18(4) of the Act. This is consistent with the CRA's stated position in paragraph 8 of Interpretation Bulletin IT-59R3, Interest on Debts Owing to Specified Non-Residents, which states that, for purposes of subsection 18(4) of the Act, a corporation's retained earnings and contributed surplus is to be determined in accordance with GAAP.

For Canadian GAAP, CICA Handbook section 1625 states that push-down accounting "may be used when all or virtually all of the equity interests in the enterprise have been acquired ... by an acquirer who controls the enterprise after the transaction". The use of push-down accounting is generally raised in Canada when there is an acquisition of all or substantially all of the shares of a publicly-traded US parent of a Canadian subsidiary and the US Parent wants to comply with the SEC requirement to reflect push-down accounting entries in the Canadian subsidiary's financial statements. However, Canadian companies are required to prepare financial statements that comply with Canadian GAAP and public companies trading on the Toronto Stock Exchange must submit such statements to the Ontario Securities Commission.

In any situation similar to the one described in your memorandum, although there may have been an acquisition of control of its US Parent, there is no change in the share ownership of the Canadian subsidiary. In such situations, it appears that CICA Handbook Section 1625 is not applicable as there has been no change in the ownership of the Canadian subsidiary. A change in control at the US-Parent level does not satisfy the requirement in CICA Handbook section 1625 that "virtually all of the equity interests in the enterprise (Canadian subsidiary) have been acquired ... by an acquirer who controls the enterprise after the transaction". Therefore, Canadian GAAP financial statements of the Canadian subsidiary should not reflect the push-down accounting entries of the US parent where there is no change in actual control of the Canadian subsidiary. We would point out that the definition of "control" in section 256 of the Act is not relevant to the determination of whether there has been a change in the ownership of a subsidiary for purposes of GAAP.

Notwithstanding the above comments, in the situation where financial statement adjustments are described as push-down accounting entries and such entries are in fact additional expenses of the Canadian subsidiary, such as additional pension liabilities or post-employment benefit liabilities, such entries would result in an actual permanent reduction in retained earnings for purposes of clause 18(4)(a)(ii)(A) of the Act.

Finally, in situations where Canadian GAAP does not accept adjustments to retained earnings and contributed surplus that pertain to push-down accounting entries from a US parent, such as an entry that simply reduces retained earnings and increases contributed surplus, it is our view that such adjustments would not be relevant in computing the retained earnings or contributed surplus of the Canadian subsidiary for purposes of clauses 18(4)(a)(ii)(A) and (B) of the Act.

Conclusion

Where there has been no change in the share ownership of a Canadian subsidiary of a US parent, any push-down accounting entries made by the US Parent, pursuant to US GAAP, would not be reflected in the retained earnings and contributed surplus of the Canadian subsidiary prepared in accordance with Canadian GAAP and would, therefore, not affect those accounts for purposes of subsection 18(4) of the Act. Any increase in actual expenses of a Canadian subsidiary, even if described as push-down accounting entries, would result in a permanent reduction in the retained earnings of the Canadian subsidiary.

We hope that our comments are of assistance. If you wish to discuss any of the above, please contact the writer.

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 copy severed 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.

Olli Laurikainen, CA
for Director
International & Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch