17 October 1997 External T.I. 9707385 - UNDEDUCTIBLE AMOUNT

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 incurred on a loan to acquire vacant land that is not deductible under ss. 18(2) would be subject to ss. 78(1) if it remained unpaid but included in the cost of the land inventory. Also, whether the base level deduction permitted under 18(2)(f) would be subject to 78(1) even though it is added to inventory.

Position:

An amount is not subject to 78(1) if it is not "deductible". Such an amount includes an amount deduction of which is denied under 18(2) or an amount that is added to the cost of inventory. Even though an amount is deductible but, on an administrative basis, is added to inventory, it will cease to be deductible for the purposes of 78(1).

Reasons:

The ambit of the respective provisions of the Act, ITs-109R2 and 153R3.

F. B. Fontaine, FCCA
XXXXXXXXXX 970738

Attention: XXXXXXXXXX

October 17, 1997

Dear Sirs:

Re: Subsections 18(2) and 78(1) of the Income Tax Act (the "Act")

This is in reply to your letter of March 17, 1997 concerning the application of subsections 18(2) and 78(1) of the Act in respect of loan interest payable by a Canadian corporation to its non-resident parent.

The particular loan was for the acquisition of vacant land to be serviced and held as inventory and then sold to an arm's length buyer. There is no revenue from the land prior to such sale. The loan interest is not deductible in accordance with subsection 18(2) of the Act and is added to the cost of inventory under subsection 10(1.1) of the Act.

The situation that you have outlined appears to be an actual fact situation. Whether or not the situation is a completed or contemplated transaction, paragraph 22 of Information Circular 70-6R3 (the "Circular") outlines the procedure to be followed in respect of such transaction. Accordingly, we are prepared to offer only the following general comments:

1.Subsection 78(1) of the Act applies in respect of a "deductible outlay or expense owing by a taxpayer....". It is our view that the term "deductible" means capable of being deducted and that an amount is deductible in a year it is capable of being deducted. Accordingly, if an amount is not a deductible outlay or expense for the purposes of the Act for any reason, subsection 78(1) will not apply, whether or not the amount remains unpaid. Such an amount would be an amount that is not deductible in computing a taxpayer's income by virtue of subsection 18(2) of the Act. Also, such an amount would be an amount that is included in the cost of inventory or capital cost of capital property, as discussed in paragraph 3 of Interpretation Bulletin, IT-109R2.

2.The entitlement to the base level deduction by a corporation under paragraph 18(2)(f) of the Act is a question of fact and would depend on whether the corporation's principal business is any of the activities described in that paragraph.

As noted above, subsection 78(1) would apply to an amount that is a deductible outlay or expense for the purposes of the Act. Such a deductible amount could be a corporation's base level deduction for a year as permitted under paragraph 18(2)(f) of the Act. An option to add such amount to the cost of inventory would not affect its deductibility. However, an amount would no longer be considered "deductible" for the purposes of subsection 78(1) of the Act where a taxpayer has added the amount to the cost or capital cost of inventory or capital property, respectively.

These comments represent an expression of our opinion. As indicated in paragraph 22 of the Circular, such an opinion is not an advance ruling and, accordingly, is not binding on Revenue Canada.

Yours truly,

for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch