8 July 1996 Internal T.I. 9617717 - LEVERAGED LEASES AND PREPAID PENSION - PART I.3

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:

1. Whether a non-recourse debt identified in a note to the balance sheet as part of a leveraged lease investment is to be included in computing capital for Part I.3 purposes.

2. Whether prepaid pension that has been deducted for tax purposes can be used to reduce the amount of reserves to be included in computing capital for Part I.3 purposes. In particular, should reserves be examined on an individual basis or is it the net amount of all reserves which should be considered for Part I.3 purposes?

Position:

1. Yes.

2. No reduction. Reserves should be examined on an individual basis.

Reasons:

1. We can look to the notes of financial statements to pick amounts included as part of a net figure on the balance sheet.

2. No basis in law to allow a reduction for prepaid pension. Our interpretation of paragraph 181.2(3)(b) is that it requires an item-by-item analysis of each reserve.

			July 8, 1996

	WINDSOR TAX SERVICES OFFICE   	HEADQUARTERS
J. Leigh
	Attention:  Gary Henrich            (613) 952-1505
			7-961771

XXXXXXXXXX - Large Corporations Tax

This is in reply to your request of May 16, 1996 for written confirmation of our views with respect to the treatment of leveraged leases and prepaid pension for purposes of Part I.3 of the Income Tax Act (the "Act").

Leveraged leases

We understand that XXXXXXXXXX has recorded its investment in leveraged leases as a single line item on the balance sheet with details in a note to the financial statements. The note shows a breakdown of the net figure, including the amount of non-recourse debt involved. We also understand that XXXXXXXXXX is of the view that since the amount of the debt is not reflected in its balance sheet, no amount in respect of the debt is required to be included in computing its capital for Part I.3 purposes.

Subsection 181(3) of the Act provides that in determining the carrying value of a corporation's assets or any other amount relevant for Part I.3 purposes, the amount reflected in the balance sheet of the corporation prepared in accordance with generally accepted accounting principles ("GAAP") is to be used. The generally accepted authority for GAAP in Canada, the CICA handbook states, in part, at section 1000.03 that "notes to financial statements, and supporting schedules to which the financial statements are cross-referenced, are an integral part of such statements...". Accordingly, it is our view that where an amount presented on the balance sheet reflects more than one asset, liability, reserve, surplus or an other amount, we may look to the notes to allocate or attribute such an amount to the various assets, liabilities, reserves, surpluses or other amounts which are relevant for determining capital for Part I.3 purposes.

In XXXXXXXXXX case, while the amount of the non-recourse debt is not identified as a separate item on its balance sheet, it is identified in the notes to the financial statements. Consistent with our view expressed above, we confirm that the amount of non-recourse debt should be included in computing XXXXXXXXXX capital under subsection 181.2(3) of the Act. We note that we have previously discussed this particular issue with officials from the Department of Finance and they are in agreement with our view.

Prepaid pension asset

It is our understanding that the prepaid pension asset reflected on XXXXXXXXXX balance sheet represents pension funding amounts which have been paid and which have been deducted for income tax purposes but not for accounting purposes. It is also our understanding that the amount of prepaid pension asset will eventually be charged to retained earnings. XXXXXXXXXX position is that the amount of prepaid pension asset should reduce XXXXXXXXXX capital for Part I.3 purposes. Their interpretation of paragraph 181.2(3)(b) of the Act is that it only requires a singular amount to be added to capital and therefore each individual liability need not to be separately examined to determine its treatment for Part I.3 purposes.

We disagree with XXXXXXXXXX interpretation of the law. Paragraph 181.2(3)(b) of the Act requires a corporation to include in computing capital the amount of all of its reserves that meet the definition of "reserves" in subsection 181(1) of the Act to the extent that they have not been deducted in computing income for the year under Part I of the Act. In our opinion, each reserve must be examined separately in order to determine its treatment for Part I.3 purposes. Support for our position can be found in the National Trust Company decision (96 DTC 6234) which dealt with the interpretation of former subparagraph 190.12(b)(iv) of the Act. In light of the similarities between that provision and paragraph 181.2(3)(b) of the Act, it is our view that the court's findings in that case would also be relevant in interpreting paragraph 181.2(3)(b) of the Act. In particular, the court agreed with the Department's view that subparagraph 190.12(b)(iv) of the Act necessitated a line-by-line analysis of each book reserve on the corporation's financial statement and that the corporation should examine, on an individual basis, its book reserves for the purpose of computing its capital for Part VI purposes.

In conclusion, there is no basis in section 181 of the Act to reduce the amount of retained earnings or to reduce the capital of XXXXXXXXXX otherwise computed pursuant to subsection 181.2(3) of the Act by the amount of the prepaid asset whether or not it has been deducted for income tax purposes. We would also note that the fact that the prepaid pension asset gives rise to a deferred tax credit balance which is itself included in the computation of capital is not a relevant factor in determining the proper tax treatment of the prepaid pension asset for Part I.3 purposes.

We trust that our comments will be of assistance.

Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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