12 March 1998 Internal T.I. 9733567 - PARTS I.3 AND VI - MEANING OF "ACCEPTED"

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. Interpretation of the word “accepted” as used in subparagraph 181(3)(b)(ii).

2. Where an amount reflected in a bank’s balance sheet filed with and accepted by OSFI is incorrectly calculated, can the Department use the correct amount in computing capital for the purposes of Parts I.3 and VI?

Position:

1. Subparagraph 181(3)(b)(ii) refers to amounts reflected in the balance sheet accepted by OSFI or a similar provincial authority. The word “accepted” as used in subparagraph 181(3)(b)(ii) is not defined in the Act but its ordinary dictionary meaning would suggest that it means more than just received. To put the word “accepted” in proper context, one would need to refer to the Bank Act. Under subsection 308(4) of the Bank Act, a bank is required to prepare its financial statements in accordance with GAAP except as otherwise provided by OSFI. Further, specific procedures are to be followed when a material error or misstatement is discovered. Therefore, in order for a bank’s financial statements to be considered “accepted” by OSFI, there is the general presumption that the bank has complied with the provisions of the Bank Act that are relevant to financial statements.

2. If the error or misstatement is immaterial, it is our view that there is no basis to recompute and use the correct amount. However, if the error or misstatement is material, our understanding is that pursuant to subsection 332(3) of the Bank Act, the directors of the bank have to prepare and issue revised financial statements or otherwise notify the shareholders and OSFI of the error or misstatement. In either case, it is our view that we would be able to use the correct amount in computing capital for Parts I.3 and VI tax purposes.

Reasons: See comments above.

							March 12, 1998

	XXXXXXXXXX  TSO				HEADQUARTERS
J. Leigh
	Attention:  XXXXXXXXXX 			(613)952-1505
                  Large Case File Manager

							7-973356

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Parts I.3 and VI - Meaning of “Accepted” by the Regulatory Authority

This is in reply to your memorandum of December 18, 1997 in which you requested our views with respect to the application of subparagraph 181(3)(b)(ii) of the Income Tax Act (the “Act”) in circumstances where the financial statements filed with the Superintendent of Financial Institutions (“OSFI”) reflect an incorrect amount. This issue has arisen in connection with an audit of the above-noted financial institution.

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Subparagraphs 181.3(3)(a)(iv) and 190.13(a)(iv) of the Act provide a deduction for the amount of deferred tax debit balance in computing the capital base of a financial institution for Part I.3 and Part VI tax purposes. Accordingly, the overstatement of the Bank’s deferred tax debit balance has resulted in an understatement of the Bank’s capital base by $XXXXXXXXXX. Using Part I.3 tax rate of 0.225% and Part VI tax rate of 1.40%, the shortfall in capital taxes paid is approximately $XXXXXXXXXX. You note that while the Part I.3 tax and the Part VI tax are creditable in certain circumstances, a portion of the Part VI tax levied under subsection 190.1(1.2) of the Act is not refundable or creditable. In this case, the portion of the Part VI tax that is not refundable or creditable amounts to $XXXXXXXXXX for 1996.

In light of the above fact situation, your questions are as follows:

1. Does the word “accepted” as used in subparagraph 181(3)(b)(ii) of the Act mean a piece of paper filed with OSFI with a rubber stamp marked accepted or received or does it refer to a financial statement prepared in accordance with the accounting principles outlined in the Bank Act?

2. If the financial statements included in the report filed with OSFI do not meet the requirements of the Bank Act as the statements contain information that is not correctly stated as outlined in CICA 3470.24 and 1000.17, can the Department use the correct value or is it bound to use the value included in the report?

3. If OSFI was advised under subsection 332(3) of the Bank Act of a material error or misstatement in the financial statements, would the new information be applicable in determining the carrying value for purposes of the capital taxes?

4. What is the definition of “deferred taxes” as used in the capital taxes legislation?

5. If the definition of deferred taxes in the capital taxes legislation is identical or obtains meaning from the definition contained in CICA 3470.25, notwithstanding an audit report, can the Department ignore the incorrect calculation and reassess on the basis of what the correct value should have been at year end based on the positions taken in the T2 return filed?

6. If it is determined that the Department can recompute the value of the deferred income taxes to the actual amounts, does this require a further recompilation to what the account would be after all other audit adjustments are processed or is it just to what the position would have been based on the T2 return filed?

Our views

1. As you know, subparagraph 181(3)(b)(ii) of the Act provides that in the case of a bank or insurance corporation that is required by law to report to OSFI or a similar provincial authority, the amounts reflected in the balance sheet accepted by OSFI are to be used in determining the carrying values and other amounts under Part I.3. Subsection 190(2) of the Act provides that subsection 181(3) of the Act applies to Part VI with such modifications as the circumstances require.

In Black’s Law Dictionary, the word “accept” has several meanings, including “receive with approval”, “adopt”, “agree to”, and “means something more than to receive”. To put the word “accepted” as used in subparagraph 181(3)(b)(ii) of the Act in proper context, we would need to refer to the Bank Act. Subsection 312(1) of the Bank Act requires a bank to send to OSFI a copy of its annual financial statements. Subsection 308(4) of the Bank Act provides that, except as otherwise specified by OSFI, the annual financial statements must be prepared in accordance with generally accepted accounting principles (“GAAP”), the primary source of which is the CICA Handbook. It follows that there is the general presumption that financial statements filed with and accepted by OSFI have been prepared in accordance with GAAP with modifications as are required by OSFI. Accordingly, it is our view that in order to be considered accepted by OSFI, the Bank must have complied with the provisions of the Bank Act that are relevant to the financial statements, including subsection 332(3) of the Bank Act.

2. We note that the fact that the financial statements reflect an amount that is not correctly stated does not necessarily mean that the financial statements have not been prepared in accordance with GAAP. Such a determination would depend on whether the error or misstatement is material. With regard to materiality, CICA 1000.17 indicates that an item is material if its omission or misstatement would likely influence or change the user’s decision. It further states that materiality is a matter of professional judgment taking into account the particular circumstances. Since banks are required to file consolidated financial statements with OSFI, an item that is clearly immaterial in the context of consolidated financial statements may be viewed as material to a corporate entity within the corporate group.

Assuming that the error or misstatement in the Bank’s financial statements is material, we would then need to determine the appropriate accounting treatment under GAAP. Where it is necessary to correct an error in prior period financial statements, CICA 1506.29 recommends that the correction of the error be accounted for in the current period retroactively and that the financial statements of all prior periods presented for comparative purposes should be restated, as necessary. Our understanding is that the opening balance of Bank’s retained earnings and other affected balances in the current period financial statements should be adjusted along with a restatement of the comparative data shown in the current period financial statements. We note that there is no requirement to revise the financial statements for the period in which the error occurred.

With regard to the accounting treatment of subsequent events, if subsequent events provide additional information relating to items on the financial statements, as outlined in CICA 3820, only all such information that becomes available prior to completion of the financial statements would be used in determining whether it would be necessary to adjust the financial statements or disclosed by way of a note to the financial statements. Our understanding of the facts provided in your case is that complete information was not available to the Bank until after the completion of the financial statements. Accordingly, pursuant to CICA 3820, such information would not have to be accounted for in the Bank’s 1996 financial statements.

In circumstances where the financial statements were prepared based on the information available at the time of preparation, we would have difficulty taking the position that the financial statements were not prepared in accordance with GAAP because it is later determined based on subsequent information that an amount reflected in the financial statements was incorrect. In our view, if, having regard to CICA 1506 and 3820, it is determined that the Bank’s 1996 financial statements have been prepared in accordance with GAAP, we would be bound by the amounts reflected in the financial statements subject to any modifications as required by OSFI provided that such statements do not contain a material error.

3. As noted in your memorandum, subsection 332(1) of the Bank Act states that a director or an officer of a bank must notify the auditor of the bank of any error or misstatement of which the director or officer becomes aware in the financial statements on which the auditor has reported. Pursuant to subsection 332(2) of the Bank Act, if the auditor of the bank becomes aware of an error or misstatement that in the opinion of the auditor is material, the auditor is required to inform the directors of the bank . Subsection 332(3) of the Bank Act requires the directors to prepare and issue revised financial statements or otherwise inform the shareholders and OSFI of the error or misstatement.

Where subsection 332(3) of the Bank Act is applicable and revised financial statements are filed with OSFI or OSFI is otherwise notified of the error or misstatement, it is our view that we would be able to use the correct amount in computing capital for purposes of Part I.3 and Part VI. In the latter case, it is our position that the financial statements accepted by OSFI include adjustments disclosed under subsection 332(3) of the Bank Act whether or not new statements are in fact prepared.

We note that there is no time restriction stipulated in subsection 332(3) of the Bank Act. Therefore, it would appear that where a material error or misstatement is discovered after the preparation of the financial statements, the error or misstatement would have to be disclosed to OSFI pursuant to subsection 332(3) of the Bank Act.

In the case at hand, it is not clear to us whether the auditors of the Bank are aware of or consider the overstatement of $XXXXXXXXXX to be material. However, the handwritten comments by the Bank on the draft document included with your submission suggest that the Bank does not regard overstatement as a material item. You may wish to obtain from the Bank the auditor’s basis for determining materiality for the Bank to ensure that subsection 332(3) of the Bank Act should not have application in this situation.

4. The term “deferred taxes” is not defined in the Act. It is our view that the term “deferred taxes” as used in Part I.3 and Part VI is the amount reflected in the balance sheet prepared in accordance with GAAP and accepted by OSFI provided it does not contain a material error.

5. This question is similar to question 2 above. The language used in subparagraph 181(3)(b)(ii) of the Act does not provide the Department with the authority to ignore an incorrect amount and recompute the amount for Part I.3 and Part VI tax purposes unless it can be shown that the amount was intentionally misrepresented. As noted in our comments above, we can only use the amounts reflected in the balance sheet prepared in accordance with GAAP and accepted by OSFI provided it does not contain a material error.

6. This question is somewhat academic given our response to questions 2 and 5 above.

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We hope that our comments are of assistance.

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