30 August 1995 External T.I. 9520115 - APPLICATION OF 78(1) AND 18(4)

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:

Does subsection 78(1) apply where a canco borrows from a non-resident parent?. The loan interest is not paid but capitalized pusuant to 18(2) and 18(3.1). In the same situation, does 18(4) apply ?

Position TAKEN:

1. 78(1) does not apply in any year
2. 18(4) does not apply

Reasons FOR POSITION TAKEN:

1. Deductible means capable of being deducted
2. 18(4) can only apply to amounts "otherwise deductible"

		                   952011
XXXXXXXXXX	                    C. Tremblay

Attention: XXXXXXXXXX

August 30, 1995

Dear Sirs:

Re: Application of Subsections 78(1) and 18(4) of the Income Tax Act (the "Act")

This is in reply to your letter of July 27, 1995, requesting our views with respect to the application of subsections 78(1) and 18(4) of the Act to the unpaid and accrued interest on a loan in a situation where the loan is from a related party and is used to acquire land for development.

Your enquiry appears to relate to an actual situation, and if this is the case you should contact the local Tax Services Office, provide them with all the facts and obtain their views. However, we are able to provide the following general comments which may be of assistance.

Our Comments

Generally the term "deductible" means capable of being deducted. Therefore an amount is considered to be deductible in the year it is capable of being deducted. In our view, an amount not deducted by virtue of subsection 18(2) or 18(3.1) of the Act, will not be considered to be a "deductible" outlay. Accordingly, if the taxpayer has no option as to whether or not to deduct an expense, that is, he must capitalize the outlay, the amount will not be considered to be "deductible" and section 78 of the Act will not apply.

Further to paragraph 5 of Interpretation bulletin IT 109R, an outlay or expense in respect of inventory is not considered to be a "deductible outlay or expense" for purposes of subsections 78(1) and (2) of the Act. Accordingly, section 78 would not be applied to the unpaid amount upon the subsequent sale of the inventory.

Further, in our view, subsection 18(4) of the Act can only apply to amounts "otherwise deductible" and therefore would have no application in the year inventory is eventually sold to restrict deductibility of any capitalized amounts pursuant to either subsections 18(2) or 18(3.1) of the Act.

Since section 78 of the Act does not extend to the cost of inventory, there is potential for abuse, particularly where an amount is owed to a non-resident related corporation. Whether or not GAAR would apply in a particular case would be dependent on the specific facts in the case.

We caution that our comments are of a general nature only and might very well change upon a review of all the facts and particularly after an examination of all pertinent documentation.

We trust our comments will be of assistance to you.

Yours truly,
for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch