14 August 1992 External T.I. 9210015 F - Manufacturing and processing profiits

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.

Attention:  19(1)

August 14, 1992

Dear Sirs,

Re:  Manufacturing and processing profits Interest income - associated corporation

We are writing in response to your letter of March 26, 1992 in which you asked for a technical interpretation on the application of section 125.1 of the Income Tax Act (the "Act") in a particular hypothetical situation.

We are asked to assume a corporate structure where a company involved in manufacturing and processing in Canada has a wholly-owned subsidiary which is also involved in manufacturing and processing in Canada.  All debt and equity financing required by both companies is arranged by the parent company because it has better borrowing capacity.  The parent obtains both debt and equity capital; however, all injections of capital to its subsidiary are by way of interest bearing loans.

A net profit is earned by the parent company in connection with this since the funds advanced on an interest bearing basis are obtained by the parent partly by debt and partly by equity - as such, the interest income exceeds interest expense.

In computing the subsidiary's manufacturing and processing profits (M&P) deduction under section 125.1 of the Act, the interest paid to the parent company is deducted in computing its adjusted business income ("ADJUBI").

Your question is whether the parent company can include the interest income received from the subsidiary in its ADJUBI when computing its M&P deduction.

You have referred to paragraph 15 of Interpretation Bulletin IT-145R, as well as paragraph 4 of IT-73R4.  In your view, the appropriate result would be that the parent company in the above hypothetical situation would include the interest income received from the subsidiary in its ADJUBI to the extent that the subsidiary was required to reduce its ADJUBI by that amount.  You believe that paragraph 4 of IT-73R4 gives this result.

Our comments

Section 5202 of the Income Tax Regulations defines ADJUBI for purposes of determining Canadian manufacturing and processing profits, and refers to income of the corporation for the year from an active business carried on in Canada.  The definition of active business for these purposes is found in subsection 248(1) of the Act.  The definition of active business in paragraph 125(7)(a) of the Act is applicable only for purposes of section 125.  Therefore even though subsection 129(6) may deem certain income to be active business income for purposes of section 125, this definition of active business income is not valid for purposes of section 125.1 of the Act.

The wording of subsection 129(6) of the Act is such that it applies for purposes of sections 125 and 129 of the Act.  We believe that subsection 129(6) should be given its plain meaning, and since no specific reference is made thereto, it does not apply for purposes of section 125.1 of the Act.  Therefore income which is deemed to be from an active business carried on in Canada by subsection 129(6) of the Act will not be eligible for the M&P deduction.

We wish to point out that IT-145R was published June 19, 1981, at which time the definition of active business for purposes of the M&P deduction was the same as the definition of active business for purposes of the small business deduction.  The definition of active business in subsection 248(1) of the Act was amended applicable to the 1985 and subsequent taxation years.

The expressions of opinion in this letter are given in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2 and are not binding on Revenue Canada Taxation.

for DirectorReorganizations and Foreign DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch9209000 - 9209999