3 March 1997 Internal T.I. 9700487 - CAPITAL OF A CREDIT UNION

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. Is a credit union allowed to use statutory filing financial statements for Part I.3 tax purposes, or must they use the financial statements included in their annual report and prepared in accordance with GAAP for the purpose of Part I.3?

2. For the purpose of Part I.3 what are the proper amounts in respect of the membership shares to be included in the computation of share capital under subsection 181.3(3) of the Act (i.e., are the disputed amounts really deposit liabilities)?

Position:

1. Must use GAAP statements.

2. Question of fact to be determined under the particular credit union legislation. In this case, the facts indicate that the disputed amounts are not legally deposit liabilities under the applicable credit union legislation which was the basis for them being reported as share capital in the GAAP financial statements.

Reasons: See above and our response.

		March 3, 1997

North York TSO Financial Institutions
Audit Division Section
442-3-1 Michael Cooke
(613) 957-3498
Attention: Frank Fallavollita
970048

XXXXXXXXXX

This is in reply to your memorandum to us dated January 7, 1997, wherein you requested our views on the application of subsection 181.3(3) of the Income Tax Act (the "Act") in the following fact situation.

Facts:

We understand that XXXXXXXXXX reported total share capital of approximately XXXXXXXXXX, respectively, in the audited financial statements included in their respective annual report presented to its members and prepared in accordance with generally accepted accounting principals ("GAAP" and such financial statements herein referred to as "GAAP Statements"). It is our understanding, that XXXXXXXXXX total share capital, as reported in the GAAP Statements, was comprised of share capital that is required in order to be a member of XXXXXXXXXX (referred to for the purpose of this memorandum as "membership share capital") and amounts that were included in the member's respective share savings accounts (referred to as "savings account share capital").

For Part I.3 tax purposes, XXXXXXXXXX reported its total amount of share capital for XXXXXXXXXX, respectively. It is our understanding, that for Part I.3 tax purposes, XXXXXXXXXX only included the amount of its membership share capital as share capital. We understand that XXXXXXXXXX Part I.3 filing position was based on the fact that only the membership share capital is reported as share capital in the statutory financial statements that are required to be filed with the Minister of Finance Credit Unions and Co-operatives (Ontario) (herein referred to as "MOFCUCO"). We also understand that MOFCUCO only considers membership share capital to be permanent capital of a credit union, and accordingly, XXXXXXXXXX savings account share capital is reported as a deposit liability in the statutory financial statements XXXXXXXXXX filed with MOFCUCO for XXXXXXXXXX (herein referred to as the "MOFCUCO Statements").

For XXXXXXXXXX, the taxation years in question, the business of XXXXXXXXXX was governed by the Credit Unions and Caisses Populaires Act of Ontario (the "CU Act"). Pursuant to section 1 of the CU Act, the capital of a credit union is defined to mean the outstanding amount that has been received from members on account of its shares. Subsection 20(1) of the CU Act, requires the capital of a credit union to be divided into shares with par value, as determined by the by-laws of the credit union, but the par value of each share shall in no case exceed $10. The rules that govern the by-laws of a credit union are found in section 16 of the CU Act. Under paragraph 16(1)(b) of the CU Act, the directors of the credit union may determine the allotment and recording of shares, the maximum number that may be allotted to any member, the payment for shares and the withdrawal or transfer of shares. However, subsection 20(3) of the CU Act states that no share of a credit union can be allotted until it is fully paid for in cash. Where the by-laws of a credit union provide that no share certificates are actually required to be issued or allotted, subsection 20(6) of the CU Act deems any full payment on account of shares of the credit union to be an allotment of such shares to the members.

The CU Act was repealed and replaced on March 1, 1995, subject to certain coming into force rules, with the Credit Unions and Caisses Populaires Act, 1994 (the "New CU Act"). Subsection 51(1) of the New CU Act now specifically requires that a credit union must provide for a class of shares known as membership shares and may provide for additional classes of shares. Subsection 51(3) of the New CU Act requires that any share issued before subsection 51(1) came into force (that a member held as a condition of membership), shall be deemed to be a membership share and any other share issued before that time shall, subject to subsection 51(10), be deemed to be a deposit if it has not otherwise been converted by the board into another class of shares other than membership shares. Subsection 51(10) of the New CU Act provides that a share held as a condition of membership in a credit union shall not be deemed to be a deposit until one year after subsection 51(3) comes into force.

As a result of the repeal of the CU Act and the introduction of the New CU Act, membership share capital of a credit union is no longer insured by the Deposit Insurance Corporation of Ontario ("DICO"). We understand that XXXXXXXXXX by-laws were revised, as of XXXXXXXXXX, to comply with the New CU Act. These revised by-laws of XXXXXXXXXX specify that the minimum membership share capital of

XXXXXXXXXX.

As a result of the above, your questions are as follows:

1.Is XXXXXXXXXX allowed to use the MOFCUCO Statements for Part I.3 tax purposes, or must XXXXXXXXXX use the GAAP Statements for the purposes of Part I.3?

2.If XXXXXXXXXX must use the GAAP Statements for the purposes of Part I.3, what are the proper amounts in respect of the membership shares for XXXXXXXXXX to be included in the computation of XXXXXXXXXX share capital under subsection 181.3(3) of the Act (i.e., is the savings account share capital considered to be capital or deposit liabilities)?

Our Views:

Question 1

Subsection 181(3) of the Act, which applies to determine the values and amounts to be used for the purpose of Part I.3 states,

"For the purposes of determining the carrying value of a corporation's assets or any other amount under this Part in respect of a corporation's capital, investment allowance, taxable capital or taxable capital employed in Canada for a taxation year or in respect of a partnership in which a corporation has an interest,

(a)the equity and consolidation methods of accounting shall not be used; and

(b)subject to paragraph (a) and except as otherwise provided in this Part, the amounts reflected in the balance sheet

(i)presented to the shareholders of the corporation (in the case of a corporation that is neither an insurance corporation to which subparagraph (ii) applies nor a bank) or the members of the partnership, as the case may be, or, where such a balance sheet was not prepared in accordance with generally accepted accounting principles or no such balance sheet was prepared, the amounts that would be reflected if such a balance sheet had been prepared in accordance with generally accepted accounting principles, or

(ii)accepted by the Superintendent of Financial Institutions, in the case of a bank or an insurance corporation that is required by law to report to the Superintendent, or the superintendent of insurance or other similar officer or authority of the province under whose laws the corporation is incorporated, in the case of an insurance corporation that is required by law to report to that officer or authority,

shall be used."

While a credit union may be required to prepare annual financial statements for regulatory purposes similar to those required by a bank or an insurance company, based on the specific wording of subparagraph 181(3)(b)(i) of the Act, a credit union must use the financial statements that are (or would be) presented to its shareholders (or members) and prepared in accordance with GAAP for the purpose of Part I.3 of the Act. Accordingly, it is our view that XXXXXXXXXX must use the GAAP Statements for the purpose of Part I.3 of the Act.

Question 2.

Subsection 181(3) of the Act requires that it is the amounts reported in a corporations' balance sheet (as discussed above) that must be used for the purposes of Part I.3 of the Act. However, a corporations' balance sheet presentation or classification of a particular item may not necessarily reflect its true legal nature. The Department must first determine what the particular item legally represents, and once determined, the Department will then look to GAAP (including the notes to the financial statements) to determine what amount, if any, is required to be reported in respect of that particular item for the purposes of Part I.3. Accordingly, the amounts reported as share capital by XXXXXXXXXX in its GAAP Statements are not necessarily determinative of their treatment for the purposes of Part I.3.

Under subparagraph 181.3(3)(a)(ii) of the Act, a financial institution, other than an insurance corporation must include in its capital for Part I.3 purposes, inter alia,

"the amount of its capital stock (or, in the case of an institution incorporated without share capital, the amount of its members' contributions), retained earnings, contributed surplus and any other surpluses, and..."

It is our view, that where a financial institution, such as a credit union, has in fact issued share capital, any members' contributions that do not legally form part of its share capital are generally not included in the amount of the credit unions' capital stock. However, consideration would have to be given to determine whether such contributions would be included in the particular financial institution's calculation of capital as contributed surplus or any other surplus.

While you were unable to provide us with a copy of XXXXXXXXXX by-laws that were applicable for the taxation years in question, we understand that to become a member of

XXXXXXXXXX.

In a brochure published by the Ontario Share and Deposit Insurance Corporation ("OSDIC" - now known as DICO - see your exhibit #7), the share capital of a credit union is described as the dollar value of shares required for membership and a share deposit is defined as any shares in excess of the dollar value required for membership (emphasis added). Based on subsection 20(1) of the CU Act and subsection 51(3) of the New CU Act, a credit union is allowed to have a type or class of shares other than the minimum shares required for membership. Moreover, where a credit union does not actually issue or allot shares, subsection 20(6) of the CU Act, deems any full payment on account of its shares to be an allotment of such shares to the members. Therefore, it appears to be legally possible for the savings account share capital of XXXXXXXXXX to, in fact, represent shares deemed to be allotted to its members under the provisions of the CU Act.

It is a rebuttable presumption that the provisions of the CU Act and the New CU Act may have dictated how XXXXXXXXXX auditors were required to report the membership share capital and the savings account share capital under GAAP. For example, the change in XXXXXXXXXX reporting of its share capital under GAAP in XXXXXXXXXX appears to be based on the fact that the savings account share capital was not otherwise converted to some other type of share capital by XXXXXXXXXX, such that subsection 51(3) of the New CU Act applied to deem such amounts to be deposits.

Accordingly, the following factors indicate to us that the full amount of share capital reported in XXXXXXXXXX GAAP Statements should prevail:

1.Under the CU Act, although only the membership share capital is considered permanent capital by MOFCUCO, it appears that the savings account share capital that was included in the member's respective share savings account resulted in a deemed allotment of shares to such members under the CU Act;

2.For XXXXXXXXXX, the amounts actually paid by XXXXXXXXXX as a return on the total minimum monthly balance of the member's respective share saving account (such account including both the membership share capital and the savings account share capital), are declared and paid as dividends that were approved by XXXXXXXXXX board of directors, and described as such in both XXXXXXXXXX minutes and their GAAP Statements;

3.The repeal of the CU Act in March 1995, along with the introduction of the New CU Act and XXXXXXXXXX amendment of it by-laws, indicate that the legal amount of XXXXXXXXXX share capital may have changed at that time through the operation of subsections 51(3) and 51(10) of the New CU Act, as described above. As discussed above, it is this occurrence which appears to give rise to the change in the required amount of reported share capital under GAAP. However, any change in capital that is caused as a result of the application of the New CU Act does not apply retroactively, such that XXXXXXXXXX legal share capital is not affected; and

4.While the amount of the savings account share capital may have some debt like characteristics, the treatment of the full amount received by XXXXXXXXXX as share capital appears to more properly reflect the true legal relationships for the years in question. In fact, in most of the information that describes the impact of the New CU Act to its members (much of which is prepared by XXXXXXXXXX), such information appears to reinforce the fact that the disputed amounts legally formed part of XXXXXXXXXX share capital before XXXXXXXXXX.

Aside from the MOFCUCO Statements, XXXXXXXXXX has not provided any information, or made any representation, or submission that would support their position that the legal amount of their share capital is anything other than the amount of share capital as represented on their respective XXXXXXXXXX GAAP Statements. Therefore, unless such a submission is forthcoming from XXXXXXXXXX which clearly establishes to your satisfaction (or to ours) that the XXXXXXXXXX amounts in dispute are not legally considered to be part of their share capital, we recommend that the T2148 returns of XXXXXXXXXX in respect of those years be assessed or reassessed, as the case may be, to include the full amount of share capital as reported in their respective XXXXXXXXXX GAAP Statements.

F. Lee Workman
Section Chief
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch