30 January 1998 Internal T.I. 9800747 - PARAGRAPH 20(1)(L)

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:

The computation of a general reserve pursuant to paragraph 20(1)(l).

Position:

A general reserve is not permitted under paragraph 20(1)(l).

Reasons:

The requirements of paragraph 20(1)(l) is to allow a reserve only in respect of identified doubtful loans or lending assets.

			January 30, 1998

	TORONTO EAST TSO	HEADQUARTERS
			Michèle Trotier
	Attention:  R.L. Coker
	              Large File Case Manager
			980074

Paragraph 20(1)(l) of the Income Tax Act ("Act")

This is in reply to your memorandum dated December 31, 1997 wherein you requested our views with respect to the method used by the taxpayer to claim a reserve under paragraph 20(1)(l) of the Act for the 1994 and 1995 taxation years which we understand are presently under audit.

You are of the view that the taxpayer has included both doubtful and non-doubtful loans or lending assets in determining the reserve it claimed pursuant to paragraph 20(1)(l) of the Act since the taxpayer has used the total amount of retail receivables at year-end and multiplied this amount by a loss percentage which is referred to in your memorandum as the "lag-to-liquidation" method. We agree with your position that since the taxpayer's provision is based on its total receivables it does not follow the requirements of paragraph 20(1)(l) of the Act pursuant to which a reserve is allowed only in respect of identified doubtful loans or lending assets.

We have reviewed the information you have provided to us concerning the computation by the taxpayer of this reserve. We are of the view that the taxpayer has in fact computed a general provision which is not permitted pursuant to paragraph 20(1)(l) of the Act and you are correct in disallowing this general reserve. Pursuant to paragraph 20(1)(l) of the Act a reasonable reserve can only be computed on a doubtful loan-by-loan or lending asset-by-lending asset basis.

The Department's position as set out in paragraphs 23 and 24 of Interpretation Bulletin 442R2 is that for a loan or a lending asset to be included in a reserve for doubtful debts under paragraph 20(1)(l) of the Act there must be reasonable doubt about the collectibility of a particular debt or lending asset, having regard to such factors, among others, as the period in arrears and the debtor's financial status. In other words, this must be done on a doubtful loan-by-loan basis.

We concur with your position that the taxpayer must provide you with their ageing schedules in order to determine whether or not the taxpayer is entitled to claim a reasonable reserve pursuant to paragraph 20(1)(l) of the Act with respect to identified doubtful receivables, if any, it may hold at the end of its 1994 and 1995 taxation years. Where the taxpayer is unable or unwilling to provide you with such information and you are therefore unable to verify the amount of a reasonable reserve for purposes of paragraph 20(1)(l) of the Act, then no reserve could be allowed pursuant to paragraph 20(1)(l) of the Act.

We note that the proposed amendments to paragraph 20(1)(l) of the Act as introduced originally in Bill C-69 and recently reintroduced in Bill C-28 do not modify the fact that a reserve pursuant to paragraph 20(1)(l) of the Act is only available with respect to identified doubtful loans or lending assets. It is our understanding that Bill C-28 received its first reading on December 10, 1997 but is not yet law and that these proposals are to apply with respect to taxation years ending after February 22, 1994. Since the 1994 taxation year is under audit we thought we should make this note with respect to these proposed amendments.

We also note that section 3025 of the Handbook of the Canadian Institute of Chartered Accountants (the "Handbook") establishes accounting guidelines with respect to the accounting treatment of impaired loans. The Department of Finance ("Finance") has recently introduced proposed legislation to apply starting in 1997 which generally follows the generally accepted accounting principles ("GAAP") found in section 3025 of the Handbook. We note for your information that the coming into force of these proposed amendments with respect to impaired loans is for taxation years that end after September 1997, and also to taxation years that end after 1995 and before October 1997 where the taxpayer elects to have the proposed new paragraph 20(1)(l) of the Act apply to those taxation years. Finance in its November 1997 publication describing the legislative and regulatory proposals and explanatory notes with respect to impaired loans indicated on page 19 that for purposes of the present Act "The taxpayer may also deduct a reserve in respect of the principal amount of a loan where the collection of the principal amount is doubtful." This follows the wording of the present legislation and clearly indicates the intention of the legislator which is to allow a reserve pursuant to paragraph 20(1)(l) of the Act only in respect of identified uncollectible loans or lending assets.

The proposed legislation specifically defines a "sectoral reserve" which is not to be included in the computation of the reserve determined pursuant to paragraph 20(1)(l) of the Act. The proposed definition of a "sectoral reserve", as indicated in the proposed subsection 20(2.3) on page 8 of the above November 1997 publication by Finance, is a "reserve or an allowance for impairment for a loan that is determined on a sector-by-sector basis (including a geographic, an industrial sector or a sector of any other nature) and not on a property-by-property basis." The proposed legislation, as is the case under the current legislation, maintains that a reserve pursuant to paragraph 20(1)(l) of the Act will continue to not be available with respect to sectoral or general reserves.

In conclusion we concur with your position to deny a reserve pursuant to paragraph 20(1)(l) of the Act unless the taxpayer is able to substantiate its computation of a reasonable reserve in respect of identified doubtful receivables.

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We trust that the above information will be of some assistance. If you require to discuss further the above comments please do not hesitate to contact Michèle Trotier at 613-957-3494 or F. Lee Workman at 613-957-3497.

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