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 balance of accumulated other comprehensive income (loss) should be included in retained earnings for thin capitalization purposes under subsection 18(4)?
Reasons: In the financial statements of the taxpayer prepared under US GAAP, the balance of accumulated other comprehensive income (loss) is not included in retained earnings but rather is presented as a separate component of equity.
January 19, 2018
Leslie Bafia HEADQUARTERS
Legislative Revenue Section Income Tax Rulings Directorate
Canada Revenue Agency
Canada Building Ina Eroff
100 Metcalfe St., Suite 502 416-952-0959
Ottawa ON K1A 0L5
Re: Retained Earnings and Other Comprehensive Income
We are writing in reply to your email of September 7, 2017 in which you asked us to provide our views on whether a taxpayer’s balance of accumulated other comprehensive income (loss) (“OCI”) should be included in retained earnings and therefore in the “equity amount” of the taxpayer for thin capitalization calculation purposes under subsections 18(4) and 18(5) of the Income Tax Act (the “Act”). Unless otherwise stated, all statutory references herein are to the Act.
XXXXXXXXXX (the “Taxpayer”) is a taxable Canadian corporation. The Taxpayer is under audit for the taxation years ended XXXXXXXXXX (the “Taxation Years”).
During the Taxation Years, the Taxpayer had an interest-bearing loan (the “Loan”) owing to its parent company resident in the United States. The Taxpayer deducted the full amount of interest that accrued on the Loan in computing its income under the Act for the Taxation Years.
In connection with the Taxation Years, the Taxpayer reported an OCI debit balance (i.e. an accumulated other comprehensive loss) in its legal entity financial statements that were prepared in accordance with U.S. Generally Accepted Accounting Principles (“US GAAP”). US GAAP has consistently been used by the Taxpayer in the preparation of its financial statements, including for the purpose of computing its income under the Act. The balance sheet figures disclosed in Schedule 100 of the Taxpayer’s Canadian income tax return were US GAAP amounts. The Taxpayer does not prepare any Canadian GAAP legal entity financial statements.
The consolidated US GAAP financial statements of the Taxpayer’s U.S. parent for the Taxation Years also reported an OCI debit balance. In both the legal entity and consolidated financial statements, the OCI balance was presented as a separate component of equity and was not included in retained earnings. We understand that the Taxpayer’s OCI balance relates primarily to its pension plan.
The Taxpayer did not include the OCI debit balance in computing its retained earnings when determining its debt-to-equity ratio for the purposes of subsection 18(4).
Whether the OCI debit balance should be included in the determination of retained earnings, and thus in the “equity amount” of the Taxpayer as defined in subsection 18(5), for purposes of subsection 18(4)?
For purposes of subsection 18(4), “equity amount” of a Canadian resident corporation is defined in subsection 18(5) to include retained earnings of the corporation. The term “retained earnings” is not defined in the Act. It is our view that where a term used in the Act is not defined in the Act but rather derives its meaning primarily from accounting principles, such as retained earnings, the accounting meaning will prevail. It remains a longstanding position of the CRA (as stated in paragraph 8 of the Interpretation Bulleting IT-59R3, Interest on Debts Owing to Specified Non-Residents, dated September 26, 1984) that GAAP governs in determining retained earnings for purposes of subsection 18(4).
In our view, the amounts reflected in the legal entity financial statements of the Taxpayer prepared in accordance with US GAAP should be the starting point for determining the Taxpayer’s retained earnings for purposes of subsection 18(4), provided US GAAP has consistently been used by the Taxpayer in the preparation of its financial statements, and provided US GAAP is the basis on which the balance sheet amounts disclosed in Schedule 100 of the Taxpayer’s Canadian income tax return and other amounts reported in the income tax return have been filed. As stated in Income Tax Technical News ITTN-44 dated April 14, 2011, financial statements based on GAAP of another country with rules similar to Canadian GAAP or International Financial Reporting Standards (“IFRS”) could suffice for the purposes of computing taxable income under the Act, particularly if they were prepared for reasons other than tax returns. However, if an obscure foreign accounting rule results in a large tax change, the CRA might question its appropriateness.
We understand that under US GAAP, OCI is a component of equity that is presented separately from retained earnings and paid-in capital in a statement of financial position at the end of an accounting period. IFRS similarly requires that OCI be presented as a separate component of equity and not included in retained earnings.
As the Taxpayer’s balance of OCI is not included in the determination of retained earnings for US GAAP purposes, the OCI debit balance would not reduce the retained earnings of the Taxpayer for purposes of the definition “equity amount” in subsection 18(5) and the thin capitalization rules of subsection 18(4).
However, since the Taxpayer’s financial statements are prepared using GAAP of another country, the CRA could question the appropriateness of reporting any specific item as OCI, rather than retained earnings, where such treatment deviates from the treatment under Canadian GAAP (including IFRS) and such deviation has a significant impact on the amount of deductible interest under the thin capitalization rules.
Unless exempted, 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. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the Taxpayer. The Taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the Taxpayer.
Ann Kippen, CPA, CA
For Division Director
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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