31 August 1992 Income Tax Severed Letter 9212795 - 12(1)(x)

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.

5-921279
P. Diguer
24(1) (613) 957-2130
Attention: 19(1)
August 31, 1992

Dear Sirs:

Re: Paragraph 12(1)(x) of the Income
Tax Act (Canada) (the "Act")

This is in reply to your letter dated April 21, 1992 in which you requested the Department's views on whether paragraph 12(1)(x) of the Act would apply to the receipt, by a Canadian corporation, of an indemnity payment from a related corporation, in a situation where both the payor and recipient are members of a related corporate group. We apologize for the delay in responding to your request.

You indicate that there is a growing tendency by foreign related companies to provide indemnifications covering potential tax-related liabilities of Canadian corporations. The indemnifications may target, for example, potential penalties, interest relating to income and withholding tax obligations and domestic income tax, all relating to whatever related party transactions are of concern.

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You are interested in the Department's view as to the Canadian tax treatment of such indemnity payments. In particular you ask:

• i) "Does the Department view these amounts as a component of taxable income of the Canadian corporation, even though the items subject to the indemnity are not themselves deductible?"
• ii) "If so, would the amount be taxed on a receivable basis, or as received, the latter in accordance with (paragraph) 12(1)(x) (of the Act)?"

iii) "Is the manner in which the indemnity is funded
relevant? For example, would the indemnity amount be
treated any differently if it was received as:
- a contribution to capital;
- an equity subscription (the Canadian corporation
would have expensed the assessed amounts);
- a payment of a receivable, which is then used to
pay the equivalent liability (the receivable and
payable would have been recorded when the
liability was assessed); or
- an unrecorded direct payment of the unrecorded
assessed liability, i.e., the Canadian
corporation would forward the assessment to the
indemnifying party for payment directly to
Revenue Canada?"

Our Comments

With regard to your first question concerning the taxation of the indemnity payments, generally, it is our view, that an indemnity payment of the type referred to above could be considered to have been received as a "reimbursement, contribution, allowance or assistance, whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of assistance, in respect of the cost of property or in respect of an outlay or expense", as contemplated by the provisions of subparagraph 12(1)(x)(iv) of the Act. However, we would like to add that an amount is only required to be included pursuant to paragraph 12(1)(x) to the extent that the amount does not reduce under subsection 12(2.2) of the Act the amount of the outlay or expense.

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It is also our view that the provisions of subsection 12(2.2) of the Act would apply to permit the reduction of the amount of the indemnity included pursuant to subparagraph 12(1)(x)(iv) of the Act (other than an outlay or expense in respect of the cost of property), provided that the taxpayer elects within the time limit specified in subsection 12(2.2) of the Act, in respect of the indemnity payments.

With regard to your second question concerning the timing of the recognition of the indemnity payment as income, it would appear that the right of a Canadian corporation to receive an indemnity payment would generally be a contingent right. Generally, it is our view that the provisions of paragraph 12(1)(x) do not apply at the time of the granting of a contingent right.

With regard to your third question concerning the method of funding the indemnity payment, you suggest that as a method of funding, the non-resident related corporation could make a contribution to the capital of the Canadian corporation or alternatively, subscribe for equity in the Canadian corporation. We note that by virtue of subparagraph 12(1)(x)(viii), paragraph 12(1)(x) only includes an amount received by a taxpayer to the extent that the amount may not be reasonably considered to be a payment made in respect of the acquisition by the payor of an interest in the taxpayer, his business or his property. The determination of whether it would be reasonable to consider that a particular payment was made for the purpose described above is a question of fact that can only be determined after a review of all the relevant facts and circumstances of a particular situation.

With regards to the two remaining examples in your third query, it is our view, subject to the application of subparagraph 12(1)(x)(viii), that the form that an indemnity payment takes, would generally not affect its inclusion in income pursuant to subparagraph 12(1)(x)(iv) of the Act. The word "amount" used in the preamble to paragraph 12(1)(x) is given a broad meaning in subsection 248(1) of the Act. It includes money, rights or things expressed in terms of money or the value in terms of money of the right or thing. Accordingly, it is our view that it could include the offsetting or the direct payment of a liability.

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We trust our comments will be of assistance.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch

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