28 May 1997 Internal T.I. 9713057 - MEANING OF MEMBER'S CAPITAL

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:

For the purpose of Part I.3 what are the proper amounts to be included in the computation of a credit unions' share capital, under subsection 181.3(3) of the Act, where the statutory financial statements separate the minimum membership share capital from savings account share capital (i.e., the savings account share capital is reflected as a deposit liability on the statutory statements) but under GAAP both amounts are reflected as share capital?

Position:

Still a question of fact and law to be determined, on a case by case basis, under the provisions of the particular credit union legislation. In this situation, the facts still indicate that the disputed amounts are not legally deposit liabilities under the Credit Unions and Caisses Populaires Act of Ontario for the years in question and this was the basis for these amounts being reported as part of share capital under GAAP.

Reasons:

See above and our prior response 970048.

			May 28, 1997

North York TSO Headquarters
Audit Division Michael Cooke
442-3-1 (613) 957-3498
Attention: Frank Fallavollita
971305

XXXXXXXXXX

This is in reply to your memorandum to us dated May 15, 1997, in respect of your proposed reassessment of the above noted taxpayer's XXXXXXXXXX taxation years for additional Part I.3 tax under subsection 181.1(1) of the Income Tax Act (the "Act"). Your proposed reassessment was based on the views expressed in our previous memorandum to you dated March 3, 1997 (#970048). The taxpayer's representative, XXXXXXXXXX, has prepared a submission in response to your proposed reassessment, dated May 8, 1997 (the "submission") and you request that we reconsider this matter.

Summary of Key Facts

XXXXXXXXXX reported total share capital of approximately $XXXXXXXXXX, respectively, in their audited financial statements prepared in accordance with generally accepted accounting principals ("GAAP"). However, for Part I.3 tax purposes, XXXXXXXXXX reported total share capital of $XXXXXXXXXX, respectively, based on the financial statements they filed with the Minister of Finance Credit Unions and Co-operatives (Ontario) (herein referred to as "MOFCUCO").

Before XXXXXXXXXX, the business of XXXXXXXXXX was governed by the Credit Unions and Caisses Populaires Act of Ontario (the "CU Act"). However, after XXXXXXXXXX, subject to certain coming into force rules, the business of XXXXXXXXXX was governed by the Credit Unions and Caisses Populaires Act, 1994 (the "New CU Act") as the CU Act was repealed. We understand that under both the CU Act and the New CU Act, it was (and remains) possible for a credit union to have share capital in excess of the minimum share capital otherwise required for membership.

For the years in question, the reason for a difference between GAAP and MOFCUCO reporting of share capital was that MOFCUCO only required the shares held as a condition of membership (i.e., the "minimum membership share capital") to be reported as share capital of a credit union (see the Ontario Ministry of Financial Institutions revision of Directive 1/85, dated January 20, 1988) and that any "savings account share capital" was reported to MOFCUCO as a deposit liability. In XXXXXXXXXX situation, since its minimum membership share capital was $XXXXXXXXXX per member, it was the total amount of this type of share capital that was reported as share capital to MOFCUCO and the amount of savings account share capital was reported as a deposit liability. Under GAAP, XXXXXXXXXX reported the amounts of minimum membership share capital and savings account share capital as the total amount of share capital.

The Submission

The taxpayer's representative makes the following points in their submission in support of their view that the savings account share capital does not represent share capital of XXXXXXXXXX for the purpose of Part I.3 tax:

1)Under the CU Act, they do not agree with the presumption that there was a payment on account of shares for any amount over $XXXXXXXXXX per member and that no shares in respect of such a presumption were issued. Further, they maintain that in order for someone to subscribe for shares they must knowingly enter into a contract to purchase such a share and the Credit Union must knowingly accept the consideration offered for the share in full payment;

2)The reference to the payments on the savings account share capital as dividends, rather than as interest, is a misnomer promulgated by credit unions and such amounts are similar to insurance policy dividends. Further, subsections 137(4.1) and (4.2) of the Act deems the whole payment (on a member's shares) to be interest, rather than a dividend, although the real dividend portion of such a payment is actually very small;

3)The notes to XXXXXXXXXX GAAP financial statements do not state that there has been a change in the legal amount of stated capital of XXXXXXXXXX, such that the XXXXXXXXXX comparative amounts for stated capital, as shown in XXXXXXXXXX GAAP financial statements, reflect the legal stated capital for that year (as reported to MOFCUCO). If such a change were made, the change would be of such magnitude that it would have to be disclosed in the notes to the financial statements; and

4)The amounts of "savings account share capital" more properly reflect the characteristics of debt, rather than equity.

Our Views

As noted in our previous memorandum, where a credit union (in Ontario) does not actually issue or allot shares, subsection 20(6) of the CU Act deemed any full payment on account of its shares to be an allotment of such shares to the members. This deemed allotment of shares does not actually require that any shares actually be issued by the credit union, nor do we agree that a member must knowingly enter into a contract to purchase such shares and the credit union must knowingly accept the consideration offered for such shares as payment on account of, or in respect of shares. While this remains a factual question, arguably any member making such a payment and the credit union receiving it would be in a position to know what the payment is for, or how it will be treated given subsection 20(6) of the CU Act. The simple fact is the CU Act governs the legal characterization of the payment at that time and the taxpayer's representative has not refuted the application of subsection 20(6) of the CU Act in their submission.

The taxpayer's representative also draws an analogy between dividends paid on a credit union's share capital and dividends paid on a life insurance policy, and states that such dividends, "...are really a return of premiums and I believe are not T5'd as a dividend". It is not clear to us how this analogy furthers XXXXXXXXXX cause. Life insurance policy dividends are specifically deemed by paragraph 148(2)(a) of the Act to be proceeds of disposition in respect of a disposition of an interest in the policy, to the extent that such a dividend, or portion thereof, does not otherwise automatically pay a premium or repay a policy loan under the terms of the policy.

On the other hand, subsection 137(4.1) of the Act deems an amount that is paid or payable to a credit union member in respect of a share of the credit union to be interest for the purpose of the Act, and subsection 137(4.2) of the Act ensures that any amount so deemed by subsection 137(4.1) of the Act to be interest, will not be considered as a dividend. The taxpayer's representative suggests that since only a portion of the total dividend (that is deemed to be interest by subsection 137(4.1) of the Act) which relates to the minimum membership share capital is really the "dividend component", by inference, the larger portion of the "deemed interest" that relates to the savings account share capital is not really a "dividend" and presumably, such share capital should be considered as a deposit liability.

It is our view that such an interpretation is not possible. If subsection 137(4.1) of the Act applies to deem a payment in respect of a share to be interest, that payment at law must, but for this deeming provision, be considered to represent a dividend. Stated another way, subsection 137(4.1) of the Act would not apply to deem an amount to be interest where that amount was already considered to be legally interest. The facts in XXXXXXXXXX situation indicate that both the minimum membership share capital and the savings account share capital were deposited in the same account (in respect of each member) and that "dividends" would be paid on the minimum monthly balance of this account. For example, based on XXXXXXXXXX GAAP financial statements and the other information provided to us (i.e., the minutes of the annual board of directors meeting dated XXXXXXXXXX) it appears that the annual "return" paid on the total share capital account was considered to legally represent a dividend.

In our previous response we stated that it was 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 and that the change in XXXXXXXXXX reporting of its share capital under GAAP in XXXXXXXXXX appeared to have been 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. In fact, Note 8 to the XXXXXXXXXX audited financial statements of XXXXXXXXXX states, " XXXXXXXXXX "

With respect, while we generally agree that the savings account share capital has characteristics that are indicative of debt rather than equity, we cannot disregard the provisions of the CU Act, as it applied for XXXXXXXXXX, in determining what the true legal nature of the savings account share capital was at that time. In our view, since the New CU Act does not contain a provision similar to subsection 20(6) of the CU Act, the determination of the nature of the savings account share capital after the repeal of the CU Act would be made with respect to the terms and conditions in effect with regard to this account. From this point on, we would agree that the savings account share capital is more indicative of debt which is presumably the reason that it was reported as a deposit liability under GAAP.

Conclusion

Therefore in our view, nothing in the aforementioned submission conclusively supports the position that the legal amount of XXXXXXXXXX share capital does not include the savings account share capital. Moreover, the fact that XXXXXXXXXX may be prepared to have their XXXXXXXXXX audited financial statements reissued to reflect a reduction in the total share capital for those years would not, in and of itself, resolve this matter. What we would require would be a clear representation from XXXXXXXXXX auditors that the aforementioned financial statements were originally issued in error, and therefore, were not prepared in accordance with GAAP, along with the reasons why the auditors, and the management of XXXXXXXXXX, now believe that the amounts previously reflected as share capital in those financial statements are, or were, not legally considered part of the share capital of XXXXXXXXXX. Such representations would have to specifically deal with the requirements of subsection 20(6) of the CU Act.

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