5 December 2012 External T.I. 2012-0445891E5 - Contributed Surplus and Thin Capitalization

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 amount purported to be added to corporation's contributed surplus would constitute contributed surplus for the purposes of clause 18(4)(a)(ii)(B).

Position: Unlikely.

Reasons: Does not appear that addition to contributed surplus account would conform to GAAP.

XXXXXXXXXX
2012-044589
J. MacGillivray
(613) 957-2103

Attention: XXXXXXXXXX

December 5, 2012

Dear Sir:

Re: Contributed Surplus and Subsection 18(4)

We are writing in response to your e-mail of May 2, 2012, in which you asked us to comment on whether an amount would constitute contributed surplus for the purposes of clause 18(4)(a)(ii)(B) of the Income Tax Act (Canada) (the "Act").

You have asked us to consider a scenario in which NRco, a corporation that is not resident in Canada, held all of the shares of Canco, a corporation resident in Canada. The shares of Canco were issued to NRco upon Canco's incorporation for $100 in cash. As a result, the paid-up capital of the shares of Canco was $100. Subsequently, NRco incorporated Newco, a corporation that is resident in Canada, and transferred the shares of Canco to Newco in exchange for shares of Newco. At the time of the transfer, the fair market value of the shares of Canco was $1,000. This amount was added to the stated capital account maintained in respect of the shares of Newco. Pursuant to paragraph 212.1(1)(b) of the Act, the paid-up capital of the shares of Newco was reduced by $900.

For accounting purposes, the transfer of the shares of Canco was initially recorded at fair market value, with the result that $1,000 was added to Newco's share capital account. However, the transfer should have been recorded at cost for accounting purposes. As a result, Newco's share capital account was overstated by $900. If the overstatement is corrected by deducting the share capital account by $900 and adding that amount to Newco's contributed surplus, you have asked us whether the addition to contributed surplus would be recognized for the purposes of clause 18(4)(a)(ii)(B).

Our Comments

Please note that it is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling. For more information about how to obtain a ruling, please refer to Information Circular 70-6R5, "Advance Income Tax Ruling", dated May 17, 2002. This Information Circular can be accessed on the CRA's website, http://www.cra-arc.gc.ca. We are, however, prepared to provide the following general comments, which we trust will be of some assistance.

The term "contributed surplus" is not defined in the Act. Prior to the adoption of IFRS in Canada, the CRA consistently held the longstanding view that generally accepted accounting principles ("GAAP") govern in the determination of contributed surplus of a corporation for the purposes of clause 18(4)(a)(ii)(B) (footnote 1). In applying clause 18(4)(a)(ii)(B) to a corporation that prepares its financial statements in accordance with IFRS, the CRA would also consider that an amount reflected in the corporation's equity reserves would constitute contributed surplus for the purposes of subsection 18(4) to the extent that:

(a) the amount arises on a contribution of capital by a specified non-resident shareholder of the corporation; and
(b) the amount would be categorized as contributed surplus if the corporation's financial statements had been prepared in accordance with Canadian GAAP applicable to entities that do not report under IFRS (i.e., Part II of the CICA Handbook).

Based on the limited information that you have provided in your correspondence, it is not clear to us that an overstatement of the share capital account resulting from a transaction between related parties, such as you have described, could be corrected in accordance with GAAP by adding the amount of the overstatement to the contributed surplus account. As such, we are unable to confirm whether such a correction would result in any increase to the corporation's contributed surplus account that would be included in the amount determined under clause 18(4)(a)(ii)(B).

Yours truly,

Robert Demeter
Section Manager
for Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 Interpretation Bulletin IT-59R3, Interest on Debts Owing to Specified Non-Residents (Thin Capitalization), dated September 26, 1984, at paragraph 8.