28 January 1988 Income Tax Severed Letter 7-2293 - [Part VI Tax on Capital of Financial Institutions]

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

MEMORANDUM

DATE January 28, 1988

TO Audit Applications Division Director K.R. Warren

FROM Financial Industries Division M.J. Loveday 957-9795

SUBJECT: Part VI Tax on Capital of Financial Institutions

We are writing in reply to your memorandum of November 3, 1987 concerning three problems which arose during the audit of XXXX Unless otherwise specified all references to statutes are to the Income Tax Act ("the Act").

1. Deduction of excess of tax reserves over book reserves

The formula used by financial institutions (other than banks) for calculating the capital of a corporation for purposes of Part VI capital tax is set out in paragraph 190.12(b). Subparagraph 190.12(b)(iv) adds into the calculation the total reserves shown in the financial statements, except for two types of excluded reserves. The first exclusion allows a reasonable reserve for deferred taxes to be omitted from the capital calculation. The second exclusion exempts reserves that are permitted to be deducted in computing income for tax purposes.

The Department's view of this second exclusion under subparagraph 190.12(b)(iv) is that the amount of the reserve which is allowed as a tax deduction need not be brought into the calculation of capital. However, any excess of the amount booked for financial statement purposes over the amount allowed for tax purposes is a part of capital. There is no provision in this subparagraph to allow a deduction against other elements of capital when the tax reserve exceeds its complementary book reserve. In these cases the excess is ignored; it does not affect the calculation of a corporation's capital.

The meaning to be assigned to the word "reserve" when it is used in the Tax Act is set out in Interpretation Bulletin IT-215R . As used in the Act "reserve" has a broader interpretation than that used in current accounting guidelines. Generally "reserve" means an amount set aside that can be relied upon for future use. It should be noted that the Department does not consider accumulated depreciation to be a reserve.

As pointed out by Bob Moore of Kitchener District Office the wording of subparagraph 190.12(b)(iv) of the Act is very similar to paragraph 53(3)(c) of the Ontario Corporations Tax Act. However we do not believe that there is anything in the wording of either statute that permits the deduction of amounts claimed for income tax purposes in excess of what is reported in the financial statements.

There is some question as to whether the financial statement accounts or the tax accounts should be used as the basis for the calculation of capital. For the most part we agree with Bob Moore's assessment of the situation; that the legislation does not intend a conversion of accounts to a tax basis, and that it does not allow a deduction in the calculation of capital for tax deductible reserves in excess of book reserves.

2. Paid-up capital - whether adjusted by paragraph 89(1)(c)

The second question involved the meaning of 'paid-up capital' for purposes of subparagraph 190.12(b)(ii). The taxpayer has filed, on the assumption that the 'paid-up capital' referred to therein is the 'paid-up capital' defined for purposes of the Act in subsection 248(1) and paragraph 89(1)(c). Bob Moore suggested that the wording of paragraph 190.12(b), which states that the amounts be "computed at the end of the year on a non-consolidated basis", indicates that the 'paid-up capital' to be used in the subsection is the one shown on the financial statement.

The wording of subsection 248(1) begins with "In this Act," indicating that these definitions therein are for purposes of the entire Act. Generally, if the legislators intend to deviate from such an all- encompassing meaning, they use wording such as "notwithstanding any other provision of this Act" and also clearly state the nature of the deviation.

Accordingly, it is our view that paid-up capital is to be calculated in accordance with the Act, that is, the financial statement figure must be adjusted, if required by paragraph 89(1)(c).

3. Canadian assets of a corporation

The third part of the enquiry dealt with section 190.14 and the definition of 'Canadian assets of a corporation'. This section states that Canadian assets are the so-called 'domestic assets' that a bank would be required to report under subsection 223(1) of the Bank Act and schedule Q to that Act. The term 'domestic assets' is defined in the Superintendent of Bank's 'Manual I'. Essentially a domestic asset is one with a Canadian residence. A domestic asset is a claim or other asset of a person, corporation or other entity who is not a non-resident, regardless of the currency denomination. For this definition a non-resident is "not normally resident in Canada". Foreign branches of Canadian companies are considered non-resident; while Canadian branches of foreign companies are considered resident for this purpose. If the bank or other financial institution has no special knowledge of an asset's residence, then they rely on the mailing address to determine residency.

The Schedule Q listing of domestic asset is not only applicable to the multinational banks. A Canadian bank, or a Canadian subsidiary of a foreign bank, operating entirely within Canada will also segregate its assets, with only the Canadian-based assets being entered on Schedule Q.

In conclusion, it appears that the XXXX investments in securities of non-Canadian corporations should be excluded from their calculation of Canadian assets of a corporation. In the case of claims such as operating loans, further examination might be advisable to determine that a Canadian branch operation of a foreign corporation is not the borrowing entity. The final decision on the specific assets in question should be made with reference to Schedule Q and the related instructions, a copy of which is attached.

Thank you for bringing these issues to our attention. We hope that you will find this information of assistance in your reply to the Kitchener District Office.

Chief Financial Institutions Section Financial Industries Division Rulings Directorate

enclosure