13 May 1994 Internal T.I. 9333017 - LARGE CORPORATION TAX AND INVESTMENT TAX CREDITS

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.

Please note that the following document, although believed to be
correct at the time of issue, may not represent the current

Position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

RULINGS DIRECTORATE
CORRESPONDENCE SUMMARY

Principal Issues:

WHETHER THE BALANCE OF UNCLAIMED/NON-EXPIRED INVESTMENT TAX
CREDITS IS A DEFERRED TAX DEBIT BALANCE FOR PURPOSES OF

PARAGRAPH 181.2(3)(h).

Position TAKEN:

UNCLAIMED/UNEXPIRED INVESTMENT TAX CREDITS ARE NOT, BY
DEFINITION, DEFERRED TAX DEBITS AND THEREFORE DO NOT REDUCE
THE LARGE CORPORATION TAX BASE IN PART I.3.

Reasons FOR POSITION TAKEN:

SUBPARAGRAPH 181(3)(b)(i) GENERALLY REQUIRES THE USE OF
GAAP-DETERMINED VALUES FOR THE VARIOUS COMPONENTS OF PART
I.3 TAX. GAAP (CICA HANDBOOK SECTION 3805) RECOGNIZES TWO
METHODS (COST REDUCTION AND FLOW THROUGH) OF ACCOUNTING FOR
INVESTMENT TAX CREDITS BOTH OF WHICH DO NOT, BY DEFINITION,

RESULT IN THE RECOGNITION OF DEFERRED TAX DEBITS.

May 13, 1994

KITCHENER DISTRICT OFFICE HEAD OFFICE
Tax Avoidance Section Rulings Directorate
G.Donell
Attenttion: Dennis Watson (613) 957-8953

933301
XXXXXXXXXX

Unclaimed Investment tax credits as Deferred Tax Debits Paragraph 181.2(3)(h) of the Income Tax Act

This is in reply to your memorandum of November 4, 1993 in which you have requested our opinion regarding the above noted corporation. The corporation maintains that their capital for Part I.3 tax purposes as determined pursuant to subsection 181.2(3) of the Income Tax Act, S.C.1970-71-72, c.63 as amended consolidated to June 10, 1993 (the "Act") be reduced by the amount of unclaimed investment tax credits ("ITCs") which the taxpayer maintains represent a "deferred tax debit balance" pursuant to paragraph 181.2(3)(h) of the Act. We apologize for the delay of our response.

In your memo you state that the corporation records the ITCs in its accounting records as a deferred asset entitled "Investment Tax credit benefit", presented between current and long-term assets in the annual balance sheet. The balancing entry, a credit, reduces the related expense or asset, as the case may be.

The corporation's representatives, XXXXXXXXXX in their September 27, 1993 correspondence with the Sudbury Taxation
Centre request an adjustment to the 1989 capital of the corporation with respect to these ITCs based on their contention
that they represent deferred tax debits which would reduce the capital of the corporation pursuant to paragraph 181.2(3)(h) of the Act. This contention is based upon the definition of "deferred income taxes" contained in the Canadian Institute of Chartered Accountants (CICA) publication titled "Terminology for Accountants". That definition is quoted by them as follows:

"The accumulated difference between income taxes charged in the accounts and income taxes paid (received) or currently payable (receivable)."

The taxpayer's representatives conclude that, as ITCs will reduce taxes payable in future periods when taxable income is sufficient, the ITC's represent deferred income taxes.

Subsection 181(3) of the Act requires that amounts reflected in a corporation's balance sheet be used to determine the values to be placed upon the various components of Part I.3 tax such as capital and retained earnings to the extent that the financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP"). The CICA Handbook, which generally represents the accepted authority for the application of GAAP in Canada, in section 3805 discusses two acceptable methods of accounting for ITCs; cost-reduction and flow-through. Both methods support the recognition of the ITC as a deferred asset on the balance sheet unless a reasonable assurance of realization does not exist. We understand that this is not an issue with the taxpayer corporation under consideration.

Paragraph 181.2(3)(h) of the Act uses the words "deferred tax debit balance". The comparative accounting expression "deferred income taxes" is defined in the CICA publication Terminology for Accountants as:

"The accumulated amounts by which income taxes charged to the accounts have been increased (accumulated tax allocation credit) or decreased (accumulated tax allocation debit) as a result of timing differences."

The expression "timing differences" is defined in the same publication as follows:

"A difference between accounting income and taxable income which arises when an item of revenue, expense, gain or loss is included in the computation of accounting income in one period but is included in the computation of taxable income in another period."

Read together, the above noted definitions describe the conditions under which deferred income taxes arise. Because items of revenue, expense, gain or loss, are included in the calculation of income for accounting purposes and income for tax
purposes in different periods, unequal bases are produced upon which tax expense and tax liability are determined.

The effect upon income for accounting purposes and income for tax purposes depends upon the accounting method used to account for investment tax credits. As noted, the two methods sanctioned by the CICA Handbook are the cost reduction method and the flow through method. A review of the financial statements of this particular taxpayer would appear to indicate the use of the cost reduction method of accounting for ITCs.

The flow-through method recognizes the investment tax credits in the year they are earned by directly reducing income tax expense by "deferred investment tax credits", therefore, the tax liability will not equal the actual tax expense for accounting purposes. This difference is not, however, due to "a difference...which arises when an item of revenue, expense, gain or loss is included in the computation of accounting income in one period and included in the computation of taxable income in a
different period", but rather is due to a timing difference between years in which the payment of the tax liability will be discharged. Both the treatment of income for accounting purposes and income for tax purposes with respect to those ITC's are identical in that period. Accordingly, as the base upon which both tax expense and tax liability are calculated are identical, no deferred taxes arise.

In determining income for accounting purposes the cost reduction method, however, reduces the cost of the related asset or the amount of the related expense by the amount of the investment tax credit in the year of entitlement. For income tax purposes, the reduction of the related asset or expense occurs in a year following the year in which the ITC is claimed. Income for accounting purposes is therefore higher than income for tax purposes in the year of entitlement resulting in a deferred income tax credit. This credit results from the timing differences between accounting income and income for tax purposes and is, by definition, a deferred income tax.

The "deferred income tax entitlement" as reported on the balance sheet of this particular taxpayer would appear to be related to the discharge of a tax liability but is not "a difference...which arises when an item of revenue, expense, gain or loss is included in the computation of accounting income in one period and included in the computation of taxable income in a different period".

In conclusion, "deferred investment tax credit entitlements" would not, in our view, constitute deferred income tax debits by
definition and therefore would not reduce capital pursuant to paragraph 181.2(3)(h).

We trust that the above comments are of assistance to you.

for Director
Financial Industries Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch