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.
RE: Your Memorandum of April 28, 1981
Your memorandum requested technical interpretations with respect to an election made under subsection 93(1) of the Income Tax Act (the Act), and the calculation of earnings of a foreign affiliate from an active business, (as defined in paragraph 5907(1)(a) of the Income Tax Regulations (ITR)), as adjusted in accordance with the provisions of subsection 5907(2) of the ITR. The facts as we understand them are as follows:
Opinions Stock Relief
8. The stock relief deduction as allowed for under U.K. tax law is similar in concept to paragraph 20(1)(gg) of the Act. Essentially, the U.K. tax Act permits a corporation to deduct from its income for tax purposes the amount by which its closing inventory exceeds its opening inventory with such excess being reduced by a certain percentage of its "relevant income". (We understand that the percentage is presently 15% and that the "relevant income" pertains to earnings generated by the sale of stock-in-trade which qualifies for the calculation of the stock relief deduction.)
The existing U.K. tax law also provides that any stock relief deduction is subject to recapture if the closing inventory level falls below the opening inventory level, but only to the extent that the stock relief deduction was claimed within a period or six years immediately preceding the year in which the inventory level falls. However, the U.K. law specifically provides that stock relief claimee for 1974 and 1975 taxation years will never be recaptured. We understand that the recovery of relief to be included in computing the income would be equal to the lesser of
a) the reduction in stock value in the taxation year; and
b) the amount of unrecovered past relief allowed.
9. At the present time, we also understand that the U.K. Parliament is reconsidering the six year recapture period, and that the entire matter is somewhat up in the air.
10. It is our view that paragraph 5907(2)(b) should be applied as demonstrated by the following example:
Inventory January 1, 1979 nil
Purchases 1979 $ 6,000,000
6,000,000
Cost of goods sold 1979 4,000,000
Inventory December 31, 1979 2,000,000
Purchases 1980 12,000,000
14,000,000
Cost of goods sold 1980 13,000,000
Inventory December 31, 1980 1,000,000
Relevant Income 1979 $1,000,000
1979 stock relief deduction $2,000,000 - (15% x 1,000,000) = $1,850,000
Recovery of relief 1980 - $1,000,000
11. Factoring these amounts into paragraph 5907(2)(b) we get:
1979
Cost of goods sold 1979 $ 4,000,000
Stock relief deduction 1979 1,850,000
Amount deducted 1979 5,850,000
Purchases 1979 - 5907(2)(b)(i) $ 6,000,000
Previous years - 5907(2)(b)(ii) nil
6,000,000
Excess nil
1980
Cost of goods sold 1980 $13,000,000
Recovery of relief 1980 (1,000,000)
Amount deducted $12,000,000
Purchases of 1979 and 1980 - $18,000,000
Previous years - 5907(2)(b)(ii) 5,850,000
12,150,000
Excess nil
12. Or position is that a portion of the cost of goods sold in 1980 (i.e. $1 Million) could not be "established by the taxpayer" to have been "deducted ... in computing the earnings amount" since it was offset by the recovery relief.
In view of the above, there will never be an excess under 5907(2)(b). However, we would allow an addition to the earnings on an administrative basis where a stock relief deduction has not been added back to the earnings and ceases to be recoverable. (Otherwise, the stock relief deduction could be added again to the exempt surplus at the time of recapture.) In this regard, the onus would be on the taxpayer to demonstrate to the Department's satisfaction that the amount it wishes to add back to its earnings would not be subject to recapture under any circumstances.
Subsection 93(1) Election
13. Section 5902 of the ITR merely provides rules which impact upon the exempt surplus of a foreign affiliate in respect of a Canadian corporation, and is quite independent of any adjustment under subsection 5907(2) thereof. As to whether an amended election can be filed under subsection 93(1) of the Act, this would only be possible under the limited circumstances described in TOM 10(14)(35).4(4), which refers only to typographical or similar errors or omissions and to an error in estimating fair market values on which the election was based.
14. XXX
15. Should you have any questions or require further assistance, please feel free to call us.
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