10 February 1989 Income Tax Severed Letter 5-7307 - []

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.

XXXX

Dear Sirs: T.B. Kuss (613) 957-2128

Re: Regulation 5907(2.1) et al.

This is in reply to your letter dated September 23, 1988 and our numerous telephone conversations related thereto regarding Regulation 5907(2.1). We apologize for the lengthy delay in responding.

We have reviewed the schedule attached to your above letter and reference will be made to it as part of our comments.

The "earnings" computation for years 1, 2, 4, and 5 of your schedule are straightforward and we find no disagreement with your computations.

Regarding year 3 (the year in which asset 2 has been disposed), while we agree with the amount of earnings computed per the schedule we question the specific adjustments (and provisions of the Regulations relied upon) in arriving at that earnings amount.

In our view the following adjustments should be made in year 3. Pursuant to Regulation 5907(2.1)(c)(ii) there should be a $10 deduction to the "adjusted earnings amount" in respect of the disposition of asset 2. In our opinion there should also be an addition of $30 to the adjusted earnings amount pursuant to Regulation 5907(2.1)(a). In our view the "amount that may reasonably be regarded as having been deducted in respect of the cost" of asset 1 (the remaining asset) for year 3 would be the aggregate of the tax depreciation actually claimed in year 3 in respect of that asset ($25) and the amount credited to the portion of the undepreciated asset pool represented by the undepreciated tax cost of asset 1 ($25), as a result of the disposition of asset 2. This aggregate of $50 would be the Regulation 5907(2.1)(a)(i) amount. The Regulation 5907(2.1)(a)(ii) amount would be the $20 deducted as book depreciation, resulting in a net Regulation 5907(2.1)(a) addition of $30. The net Regulation 5907(2.1) adjustment for year 3 would therefore be a $20 addition to the adjusted earnings amount. In our view this is an appropriate result. We also feel that there is no basis (or need) for making an adjustment pursuant to Regulation 5907(2)(f) (as presented in your schedule) in order to achieve the appropriate result.

We appreciate however, that from a practical point of view it may not be reasonable or even possible (due to the inherent limitations in a corporation's accounting system) to extract the various figures contemplated by Regulation 5907(2.1) on a property by property basis. We therefore suggest the following approach which should achieve an appropriate result in most "going concern" businesses. In our view the appropriate Regulation 5907(2.1) adjustment can be determined simply by computing the net change in the difference between the aggregate net book value and the aggregate undepreciated tax cost of the affiliate's assets from one year to the next.. Using your schedule as an example, the aggregate net book value at the end of year 2 was $120 and the aggregate undepreciated tax cost was $100, for a difference of $20. At the end of year 3 the aggregate net book value was $40 and the aggregate undepreciated tax cost was zero, for a difference of $40. The net change in the above differences from year 2 to year 3 was an increase of $20, which is the appropriate Regulation 5907(2.1) adjustment.

The other issue you have requested we address involves the appropriate treatment for surplus purposes of advance corporation tax ("ACT") payable by a U.K. corporation upon the payment of a dividend.

We agree with your opinion that ACT would not be considered an income or profits tax, but a form of earnings distribution tax.

We also agree that because the ACT can be credited against the paying corporation's corporate income tax liability the ACT should not affect the surplus calculation.

You have questioned whether there is a timing issue in a situation where a large dividend is paid and the ACT thereon is in excess of the corporation's income tax liability for that year (i.e. the ACT paid will be credited against income taxes of future years). In our view the surplus computation would not be affected in such a situation. In a going concern business this credit against future income taxes would normally be an asset of value of the corporation and would be reflected in the price a purchaser would be willing to pay for that corporation's shares. We do not see any technical basis or need for matching ACT payments with corporate taxes for a particular year and adjusting the surplus accounts for the affected years accordingly.

We hope our comments are of assistance.

Yours truly,

for Director Reorganizations and Non-Resident Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch