6 March 1995 Internal T.I. 9412216 - ADJUSTMENTS IN THE COMPUTATION OF EXEMPT SURPLUS

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.

Principal Issues:

Whether interest on overdue taxes incurred for the purpose of gaining or producing income for the purpose of Reg. 5907(2)(j).

Position TAKEN: Yes it is.

Reasons FOR POSITION TAKEN: Result is in accordance with intent and is supported by common sense.

			March 6, 1995

	International Tax Programs Directorate		Rulings Directorate
	Lois Pollock		Olli Laurikainen
Chief, Technical Support Section		957-2116

Attention:Garry Howse

			941221

Paragraph 5907(2)(j) of the Regulations

This is in response to your memorandum dated May 5, 1994 wherein you requested our comments in reference to the application of paragraph 5907(2)(j) of the Regulations to interest paid by a foreign affiliate on overdue taxes. You indicate that representatives of the XXXXXXXXXX have raised the argument that such interest need not be deducted under paragraph 5907(2)(j) on the basis that it is not an "outlay or expense made or incurred...by the affiliate for the purpose of gaining or producing...earnings..." for the purposes of that provision.

In our view interest paid on overdue taxes must be deducted under paragraph 5907(2)(j) of the Regulations in computing the earnings of a foreign affiliate. We make the following arguments in support of this interpretation:

1) Interest on borrowings made by a foreign affiliate, where such borrowings are used to finance the working capital requirements of an active business of the affiliate would generally be considered to have been made or incurred for the purpose of gaining or producing the earnings from such active business. If a portion of such borrowings could be linked directly to an income tax payment made by the foreign affiliate, the interest would nevertheless be considered to have been incurred for the purpose of gaining or producing income. In our view there is little difference between such interest and interest incurred as a result of the late payment of tax. The interest paid in respect of a late tax payment is arguably an indirect way of partially financing the working capital requirements of a foreign affiliate for the period the taxes remain unpaid.

2) Subparagraphs 5907(2)(j)(iii) and (iv) of the Regulations restrict what would otherwise be deducted under paragraph 5907(2)(j). Clause 5907(2)(j)(iv)(C) specifically excludes "income or profits tax paid to the government of a country". The implication here is that income taxes would otherwise be deductible under paragraph 5907(2)(j) (i.e. would be considered to have been an expense made or incurred for the purpose of gaining or producing ... earnings). In our view, if income taxes are considered to have been made or incurred for the purpose of gaining or producing earnings, for the purposes of paragraph 5907(2)(j), so should interest paid on overdue taxes.

3) Paragraph 18(1)(t) of the Act was added to the Act to deny any deduction in respect of an amount payable under the Act (e.g. interest and penalties). The implication here is that such outlays would otherwise be deductible as they are incurred in the normal course of carrying on business and are therefore generally regarded as incurred for the purpose of gaining or producing income from that business.

4) As far as we are aware this issue has never been tried in the courts. However, in Premium Iron Ores v. M.N.R., 66 DTC 5281, S.C.C., the court decided that legal fees incurred in disputing a tax claim were deductible on the basis that such fees were incurred for the purpose of protecting revenue. An analogy can be drawn to our case in that interest on overdue taxes are generally incurred by a taxpayer where he takes an aggressive interpretation of the tax law in question. If the issue is eventually decided in favour of the taxing authority, he becomes liable for the said interest. That is, the interest was incurred in an attempt to protect revenue similar to the legal fees in the above tax case.

5) As you have indicated this interpretation is in harmony with the intent of subsection 5907(2) of the Regulations, to adjust the earnings computed under the foreign tax law to an amount that is more reflective of the amount that is available to the affiliate to pay dividends from such earnings.

In conclusion, it is our view that the interest paid by the XXXXXXXXXX on overdue taxes must be deducted under paragraph 5907(2)(j) of the Regulations.

for Director
Reorganizations and Foreign Division
Rulings Directorate
Policy and Legislation Branch