28 May 1990 Internal T.I. 59477 F - Deduction of "Reasonable" Reserve

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.

May 28, 1990

19(1)

We are writing in reply to your letter of January 24, 1990, wherein you requested our opinion regarding the interpretation of paragraph 20(1)(n) of the Income Tax Act in the following situation:

24(1)

4.      24(1)

Discussion

The corporations believe that a reasonable reserve would be calculated as follows:

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Revenue Canada's position is contained in Interpretation Bulletin IT-152R3 wherein the reserve can be calculated as follows:

In this fact situation, this translates to:

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Were the third party purchasers assuming an existing mortgage, the denominator of the formula (Gross Selling Price) would be reduced by the amount for the mortgage.  The rationale for this adjustment is that it reflects the vendor's true equity interest in the property.  This is the treatment set out be the Department in paragraph 13 of IT-152R3.

By analogy, it is your view that the decision in The Queen V. The Ennisclare Corporation 84 DTC 6262 can be applied  24(1)

Our Comments

Paragraph 20(1)(n) provides for the deduction of a "Reasonable" reserve without indicating what would be considered "reasonable".

IT-152R3 discusses the Department's views on what constitutes a reasonable reserve for purposes of this paragraph.  The examples set out in paragraphs 12 and 13 of the IT are based on various court decisions, including the Ennisclare decision cited above.

However, what would be considered a reasonable reserve in any particular situation would involve a finding of fact after considering all the specifics of a particular transaction.  Since the situation described in your letter appears to relate to actual taxpayers and completed transactions you may wish to submit all relevant facts and documentation to the appropriate District Taxation Office for their views on this matter.

From the limited information provided in your letter, it would appear that the reserve, as computed by you, amounts to the lesser of the gross profit on the sale or the amount due after the end of the taxation year.  This would not constitute a "reasonable"  reserve as discussed in paragraph 4 of IT-152R3.

We trust our comments will be of assistance to you.

Yours truly,

for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch