12 June 2007 Internal T.I. 2007-0236641I7 - Deductibility - ETA interest & penalties

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: 1. Whether an amount paid or payable as interest under Part IX of the ETA pertaining to a net amount of GST/HST that relates to a taxation year commencing prior to April 1, 2007 is deductible - where such interest accrues during periods before April 1, 2007 and after such date.

2. Whether an amount [6% penalty] paid or payable under any of paragraphs 280(1)(a), 280(1.1)(a) and 280(2)(a) of the ETA is deductible in computing income for tax purposes in respect of net amounts of GST/HST relating to a taxation year that commenced before April 1, 2007 but where the amount so paid or payable, was imposed under the ETA in a taxation year that commenced on or after April 1, 2007.

Position: 1. Interest that accrues in a taxation year that commences prior to April 1, 2007 would be deductible whereas interest that accrues in a taxation year that commences on or after April 1, 2007 would not be deductible.

2. Yes, the penalty is deductible.

Reasons: 1. With regard to paragraph 18(1)(t) of the ITA, an amount paid or payable as interest under Part IX of the ETA, which relates to a GST/HST liability that arose in the course of earning income from a business or property, and that accrued in a taxation year commencing before April 1, 2007, is deductible. An amount paid or payable as interest under Part IX of the ETA that accrued in a taxation year commencing on or after April 1, 2007 is non-deductible even where such amount relates to a net amount of GST/HST pertaining to a taxation year of the taxpayer that began before April 1, 2007.

2. With regard to the 6% penalty, an amount paid or payable under any of paragraphs 280(1)(a), 280(1.1)(a) and 280(2)(a) of the ETA, which relates to a GST/HST liability that arose in the course of earning income from business or property, and pertains to an amount of GST/HST due and outstanding before April 1, 2007, such penalty is deductible in the year but if imposed in a subsequent taxation year, may alternatively, be deducted for administrative purposes, in that subsequent year.

								June 12, 2007

	Owen Newell, CGA					HEADQUARTERS
	Manager						Income Tax Rulings
	General Operations Unit	     			Directorate
	Excise & GST/HST Rulings Directorate	Tim Fitzgerald, CGA

								2007-023664

Deductibility of interest and penalties imposed under Part IX of the Excise Tax Act

We are replying to your email of May 17, 2007 wherein you have asked for our views regarding the deductibility of interest and penalties imposed under the Excise Tax Act (the "ETA") for the purpose of computing income for tax purposes.

Your questions can be summarized as follows:

Question 1:

Where, in a taxation year that began before April 1, 2007, an amount of GST/HST was outstanding, with the result that pursuant to paragraph 280(1)(b) of the ETA, interest accrued on the outstanding amount up to April 1, 2007 and continued to accrue subsequent to that date, until eventual payment in 2008, will paragraph 18(1)(t) of the Income Tax Act (the "Act"), deny the deduction of any or all such interest paid in 2008?

Question 2:

Would the deduction of a 6% penalty imposed in 2008 on the net GST/HST due and outstanding as of March 31, 2007, be prohibited by section 67.6 of the Act?

Our Comments:

Question 1

Paragraph 18(1)(t) of the Act was amended by Bill C-13, which received Royal Assent on June 22, 2006 and now provides that in computing the income of a taxpayer from a business or property, no deduction shall be made in respect of (among other things) any amount paid or payable as interest under Part IX of the ETA. The amendment applies to taxation years that begin on or after April 1, 2007. Prior to the amendment to paragraph 18(1)(t) of the Act, an amount payable as interest under Part IX of the ETA that related to a GST/HST liability arising in the course of earning income from a business or property was deductible. It is our view that the effective date referenced in the coming into force information relating to the amendment to this paragraph is applicable to the wording "paid or payable" in the opening words of the provision. In other words, in order to be deductible, the interest must have been paid or payable in a taxation year that commenced prior to April 1, 2007.

Accordingly, an amount paid or payable as interest under Part IX of the ETA, which relates to a GST/HST liability that arose in the course of earning income from a business or property will be deductible provided that the interest accrued during a taxation year that commenced before April 1, 2007. To the extent that the interest accrued in a taxation year that commenced on or after April 1, 2007, it is non-deductible by virtue of subparagraph 18(1)(t)(ii), whether or not that accrued interest relates to a net amount of GST/HST that was due and outstanding prior to April 1, 2007.

Question 2

In 65302 British Columbia Ltd [2000] 1 C.T.C.57, the Supreme Court of Canada held that fines and penalties incurred in the ordinary course of earning income were generally deductible in computing income from a business or property, unless the underlying action or omission was so egregious or repulsive that the fine or penalty could not reasonably be considered to have had an income earning purpose.

In response to this decision, the Department of Finance introduced section 67.6 of the Act, which is applicable to fines and penalties imposed after March 22, 2004. This provision states that in computing income for tax purposes, no deduction shall be made in respect of any amount that is a fine or penalty (other than a prescribed fine or penalty) imposed under a law of a country or of a political subdivision of a country (including a state, province or territory) by any person or public body that has authority to impose the fine or penalty. Draft paragraph 7309(a) of the Income Tax Regulations provides that for the purposes of section 67.6 of the Act, an amount paid or payable under any of paragraphs 280(1)(a), 280(1.1)(a) and 280(2)(a) of the ETA is a prescribed penalty.

We should preface our response to this question by noting that section 67.6 of the Act is not an express authority to allow the deduction in computing income for tax purposes. Rather, the general rules provided in subdivision b of Division B of Part I of the Act are applicable. For fines and penalties imposed after March 22, 2004, an amount paid or payable under any of paragraphs 280(1)(a), 280(1.1)(a) and 280(2)(a) of the ETA is deductible but such an amount is deductible only to the extent that the penalty, prescribed under Draft Regulation 7309 for the purposes of section 67.6 of the Act, relates to a GST/HST liability that arose in the course of earning income from a business or property.

As you indicated in the attachment to your email of May 18, 2007 regarding the ETA, the result of the harmonization exercise is that the 6% penalty (in addition to interest) will apply to amounts due and outstanding (net GST/HST, penalty and interest) under Part IX of the ETA prior to April 1, 2007 that accrue up to March 31, 2007, at which time a new prescribed rate of interest-only will apply to the net GST/HST amount outstanding after March 31, 2007.

With respect to interest-only assessments, the deductibility for tax purposes of an amount paid or payable as interest under Part IX of the ETA is determined under paragraph 18(1)(t) of the Act. In answer to your specific question, with regard to a net GST/HST amount due and outstanding as of March 31, 2007, a 6% penalty imposed in 2008 under any of paragraphs 280(1)(a), 280(1.1)(a) and 280(2)(a) of the ETA, is deductible in the year to which the penalty relates. Alternatively, for ease of administration it may be deducted by the taxpayer in 2008, being the year in which the penalty is imposed.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada 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. Request for this latter version should be made by you to Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We trust our comments are of assistance.

Renée Shields
Section Manager
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy & Regulatory Affairs Branch