8 July 1991 External T.I. 9035745 F - Large Corporations Tax

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.

Dear Sirs

Re: Large Corporations Tax

We are writing in response to your letter of December 4, 1990 concerning a number of issues with respect to the tax provided for under Part I.3 ("Part I.3 Tax") of the Income Tax Act ("Act").

Your first question relates to banker's acceptances and the treatment of such instruments for the purposes of Part I.3 Tax. We would confirm that it is the position of the Department that a banker's acceptance would not be included in the calculation of the capital of the drawer corporation pursuant to subsection 181.2(3) of the Act nor would such instrument be eligible for inclusion in the investment allowance of the holder corporation pursuant to any of the provisions of subsection 181.2(4) of the Act. You have noted that there is, generally, an agreement between the drawer and the accepting bank whereby the drawer agrees to provide funds to the bank in order to discharge the acceptance at maturity or, alternatively, the bank may draw on the general credit of the drawer to cover the obligation and that, in each case, a borrower/debtor relationship is created between the bank and the drawer. We would agree with this statement in the latter case, however, we would consider that the borrower/debtor relationship arises only at the time the acceptance matures and the issuing corporation actually draws upon the line of credit to compensate the bank. We would not consider the borrower/debtor relationship to arise at the time the acceptance is issued. With respect to the former alternative, we are unable to discern any borrower/debtor relationship where the issuing corporation simply agrees to provide the bank with the funds required to discharge the obligation at maturity.

You have also noted the situation in which a drawer discounts a banker's acceptance that is issued in its name for which it receives the present value of the acceptance in consideration for its promise to compensate the holder of the acceptance should the bank dishonour it. You have concluded that, in such a case, a borrower/debtor relationship is created between the drawer and the holder. We would disagree that there is any borrower/debtor relationship created in this type of case as the bank which accepted the instrument remains primarily obligated for its discharge regardless of the party who sold the instrument to the holder.

You have requested an explanation as to our conclusion that banker's acceptances are primarily obligations of a financial institution. As you noted, this interpretation is based upon section 128 of the Bills of Exchange Act which states that "the acceptor of a bill, by accepting it, engages that he will pay it according to the tenor of his acceptance".

You have also asked whether the acceptance would be included in the capital of the drawer corporation pursuant to subsection 181.2(3) of the Act where the drawer agrees to provide the bank with the funds required to discharge the acceptance at maturity. As we noted previously, we do not envision any borrower/debtor relationship in this type of arrangement.

With respect to the balance of your questions concerning banker's acceptances we would again note that it is the position of the Department, and as noted by yourself in the preamble to your discussion of banker's acceptances, that there is no debt or indebtedness created upon the issuance of such an instrument. There may be an indebtedness created at the time the acceptance is discharged upon maturity however, such a determination would be dependent upon the facts of any particular case.

Your next query deals with "commercial paper" and the eligibility of such instruments for inclusion in the investment allowance of a corporation pursuant to subsection 181.2(4) of the Act. It is the understanding of the Department that "commercial paper" is an unsecured promissory note which is issued for a specific amount with a fixed maturity date. Accordingly, we would consider that these instruments would be included in the investment allowance of a corporate holder pursuant to paragraph 181.2(4)(c) of the Act to the extent that the maker of the note is not a financial institution nor a corporation that is exempt from tax under section 149 on all of its taxable income. Similarly, the Department considers that "commercial paper" would also be included in the capital of the issuing corporation pursuant to paragraph 181.2(3)(d) of the Act.

We would note that, whereas "commercial paper" constitutes indebtedness of the issuing corporation which is represented by a note (or similar obligation), there is no indebtedness with respect to a banker "r acceptance.

You have also requested our comments as to whether "commercial paper" issued by a financing subsidiary of a bank or by a separate corporation set up as a financing vehicle for another corporation other than a financial institution would be an eligible investment for purposes of the investment allowance pursuant to paragraph 181.2(4)(c) of the Act or, in the alternative, would such corporations be considered to be financial institutions. We would advise that, for the purposes of Part I.3 Tax and subject to paragraph 181(1)(g) and section 8604 of the draft regulations to the Act a "financial institution" is a term which is defined in subsection 181(1) of the Act and would not include those types of corporations described above unless the particular corporation was itself one of those described in the provision. Accordingly, "commercial paper" issued by such corporations would constitute an asset which is eligible for inclusion in the investment allowance of the holder corporation pursuant to subsection 181.2(4) of the Act. Similarly, the capital of these particular corporations, not being financial institutions, would be determined pursuant to subsection 181.2(3) of the Act and the "commercial paper" would be included in the capital of the issuer corporation pursuant to paragraph (d) of that provision.

The next two questions asked are in respect of the write down of the value of long-term investments. We would agree that, in those situations in which there has been a permanent impairment in the value of the investment, any write down to reflect that reduced value would not be considered to be a reserve for the purpose of computing the capital of the corporation pursuant to paragraph 181.2(3)(b) of the Act. Also, for the purpose of computing the investment allowance of the corporation pursuant to subsection 181.2(4), it will be the revised carrying value of the particular investment asset subsequent to the write down which will be utilized.  If, however, a corporation reflects a possible or contingent decline in the value of an investment by way of a reduction to retained earnings and the establishment of a reserve for such possibility in the financial statements, it is the view of the Department that such an amount would constitute a reserve, within the meaning of that term in subsection 181(1) of the Act, for the purpose of computing the capital of the corporation pursuant to paragraph 181.2(3)(b) of the Act. The carrying value of the long-term investment would be determined in accordance with subsection 181(3) of the Act and would be included in the investment allowance of the corporation to the extent that the asset otherwise qualifies for inclusion.

With respect to the write down in the carrying value of depreciable or amortizable capital assets, it is our understanding that such write downs will be reflected as an adjustment to the accumulated amortization or depreciation of the asset. Accordingly, the Department considers that a write down of a depreciable or amortizable asset would not be viewed as a reserve by virtue of the exclusion for allowances in respect of depreciation in the definition of "reserve" in subsection 181(1) of the Act.

The next question posed is with respect to a bank overdraft at the year end which may be either the result of or have been increased by outstanding cheques. It is the view of the Department that, while the actual outstanding cheques do not, in themselves, constitute an indebtedness of the corporation, the resulting bank overdraft will constitute a loan or advance to the corporation at that time for the purpose of computing the capital of the corporation pursuant to paragraph 181.2(3)(c) of the Act.

With respect to the inclusion of current taxes payable in the calculation of the capital of a corporation, it is the view of the Department that such amounts constitute an "other indebtedness" of the corporation and, pursuant to paragraph 181.2(3)(f) of the Act, would be included in the calculation to the extent that the taxes payable have been outstanding in excess of 365 days. The liability for taxes payable arises as income is earned throughout the taxation year and, accordingly, a portion of the current year's taxes payable may be required to be included in the capital of a corporation in the event that the current taxation year is in excess of 365 days. Any taxes payable with respect to a proposed reassessment of a prior taxation year would be included in the calculation of the capital of the corporation as the liability for those taxes would be considered to have arisen in that prior year and, consequently, would constitute an other indebtedness of the corporation which has been outstanding in excess of 365 days as contemplated by paragraph 181.2(3)(f) of the Act.

You have also asked for our comments regarding the "netting of payables and receivables" with respect to the investment allowance of a corporation. The Department does not consider that trade accounts receivable constitute a "loan or advance to another corporation" pursuant to paragraph 181.2(4)(b) of the Act nor would they be included in any other category of items eligible for the investment allowance of a corporation. Trade accounts payable, however, will be included in the calculation of the capital of a corporation pursuant to paragraph 181.2(3)(f) to the extent that such payables have been outstanding in excess of 365 days. In those circumstances in which the "netting of payables and receivables" constitutes a payment of the trade liability and is not simply an aggregation or combination of accounts for the purpose of financial statement presentation we would consider that only the net account balance at the end of the taxation year need be considered to determine if that net amount is to be included in the capital of the corporation.

Your final query relates to foreign exchange gains and losses and the effect of such items upon the calculation of the capital of a corporation. The first situation relates to foreign exchange gains and losses arising from the translation of the financial statements of a self-sustaining foreign operation which paragraph 1650.36 of the CICA Handbook requires to be deferred and included in a separate component of shareholders' equity. The Department considers that, to the extent that the amount represents a deferred foreign exchange gain, the amount would constitute an "other surplus" of the corporation and would be included in the calculation of the capital of the corporation pursuant to paragraph 181.2(3)(a) of the Act. Conversely, to the extent that the amount represents a deferred foreign exchange loss, the amount would qualify as a "deficit deducted" in computing the shareholders' equity of the corporation at the end of the year as described in paragraph 181.2(3)(i) of the Act for the purpose of calculating the capital of the corporation.

The second situation relates to exchange gains and losses of the corporation relating to the translation of foreign currency denominated monetary items that have a fixed or ascertainable life extending beyond the end of the following fiscal year. Paragraphs 1650.23 and .24 of the CICA Handbook require these gains or losses to be recorded as a deferred charge or credit and amortized on a systematic and rational basis over the remaining life of the monetary item. It is our view that the definition of "reserve" in subsection 181(1) of the Act would include a deferred foreign exchange gain and, accordingly, the amount would be included in the calculation of the capital of the corporation pursuant to paragraph 181.2(3)(b). A deferred foreign exchange loss would not, however, reduce the amount of the capital of a corporation nor would it qualify for inclusion as a component of the investment allowance of the corporation pursuant to subsection 181.2(4) of the Act.

While we trust that our comments are of assistance to you we would also advise that they do not constitute an advance income tax ruling and are, accordingly, not binding upon the Department in respect of any particular situation.

Yours truly,

for DirectorFinancial Industries DivisionRulings Directorate