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 the business of a pawnbroker will be considered a "specified investment business." A pawnbroker ordinarily earns income by charging a fee to customers for lending them money and by selling used goods that it “acquires” from its customers.
Position: The determination of whether a business is a specified investment business is a question of fact which can only be answered by reviewing the particular facts and circumstances of each taxpayer. In the case of a pawnbroker, it is important to consider whether it is operating one or two businesses and whether the pawnbroker fees constitute interest.
Reasons: The definition of a specified investment business involves a purpose test, i.e., whether the principal purpose of a corporation is to earn income from a property. In this regard, the composition of the corporation’s revenue is likely the most important factor. That is, how much of a corporation’s income is made up of income from property. However, other factors are set out in IT-73R5.
XXXXXXXXXX J. Gibbons
5-983095
Attention: XXXXXXXXXX
January 19, 1998
Dear XXXXXXXXXX:
We are replying to your letter of November 24, 1998, in which you requested our comments concerning the tax treatment of income earned by a corporation (the “corporation”) which operates a pawnbroker business. More specifically, you ask whether such a business will be considered a “specified investment business” as defined in subsection 125(7) of the Income Tax Act.
Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. The following comments are, therefore, of a general nature only.
As a pawnbroker, the corporation advances sums of money to clients based on the value of items pawned as security. A legal contract is drawn up between the parties which specifies the particular property received by the pawnbroker, the amount advanced to the customer, and the fees charged for this service. These fees include charges for interest, warehousing, insurance, and contract administration. The customer has a certain time to repay the advance and fees and recover his or her property. If the customer does not repay within the period set out in the contract, the property is considered sold to the corporation on the first day after the termination of the contract. The property then becomes part of the corporation’s inventory of used goods, which is available for purchase by other customers. The cost of a particular item of inventory is considered to equal the advance made in respect of the particular item. The customer can recover his or her property at any point prior to the specified contract date but the pawnbroker’s fees will not be reduced.
You ask how the Department would characterize the pawnbroker fees, as described above. You have been advised that such income will be regarded as interest for purposes of the Goods and Services Tax. If the income is considered interest for income tax purposes, you ask whether the corporation will be considered to be carrying on a “specified investment business” within the meaning of subsection 125(7). For purposes of our analysis, you ask us to assume that the corporation is a “Canadian-controlled private corporation” (within the meaning of subsection 125(7)) carrying on a business in Canada, and that it employs three full-time employees. You ask us to consider the following two scenarios:
i) The pawnbroker fees earned by the corporation account for 90% of its gross revenues.
ii) The gross profit from the sale of used goods equals the gross revenue from the pawnbroker fees.
In addressing your questions, we suggest you consider whether the corporation is carrying on one business rather than two separate businesses. According to paragraph 2 of Interpretation Bulletin IT-206R, “Separate Business,” the determination of whether the carrying on of two or more simultaneous business operations by a taxpayer is the same business is dependent upon the interconnection, interlacing or interdependence and the extent of the unity of the business operations. In this respect, it would be important to note whether: (i) the pawnbroker operations and the retail operations use the same employees, (ii) the pawnbroker operations supply the inventory for the retail operations, and (iii) these operations are carried on in the same premises. In this regard, see paragraph 3 of IT-206R.
According to the definition in subsection 125(7), “a specified investment business carried on by a corporation means a business (other than a business carried on by a credit union or a business of leasing property other than real property) the ‘principal purpose’ of which is to derive income (including interest, dividends, rents and royalties) from property.” Thus, a pawnbroker must determine if its principal purpose is earning income from property. Accordingly, it is important to determine whether the pawnbroker fees will be considered income from property (which includes interest).
The income tax definition of interest is based on the judgment in Brenda J. Miller v. The Queen, 85 DTC 5354. Under this definition, an amount must satisfy three criteria to qualify as interest. That is, the amount: (i) must be calculated on a daily accrual basis, (ii) must be calculated on a principal sum or a right to a principal sum, and (iii ) must represent compensation for the use of the principal sum or the right to use the principal sum. That being said, the Pawnbrokers Act of Ontario, which appears to regulate strictly the affairs of pawnbrokers in Ontario, offers compelling evidence that the largest part of a pawnbrokers’ fees is interest. That is to say, section 28 of this statute restricts pawnbrokers’ fees to, in addition to interest, 20 cents for each pawnticket, 20 cents for a copy of the pawnticket and printed form of affidavit, and 10 cents per month per cubic foot or part thereof of storage space taken up by the pledge.
Since the corporation also sells used goods, it will be necessary to consider this source of income in determining whether the principal purpose of the corporation is to derive income from property. In the situation where the pawnbrokers fees constitute 90% of its gross revenue, it seems clear that the principal purpose of the corporation is to derive income from property. In the case where the gross profit from the sale of used goods equals the gross revenue from the pawnbroker fees, it may be more difficult to establish what the principal purpose of the corporation is. Although the composition of the corporation’s revenue, i.e., pawnbroker fees and sale of used goods, is likely the most important factor, the “purpose” test may require consideration of other factors. In this regard, we refer you to paragraph 14 of IT-73R5, which states:
The principal purpose of a corporation’s business must be determined annually after all the facts relating to that business have been considered and analyzed. Included in this evaluation should be such things as:
(i) the purpose for which the business was originally commenced;
(ii) the history and evolution of its operations, including changes in its mode of operation and purpose of existence;
(iii) the manner in which the business is conducted.
If you have a specific situation in mind, you should submit all of the facts to the applicable local tax services for their consideration.
We trust that these comments will be of assistance.
Yours truly,
J.F. Oulton, CA
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
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