22 June 1999 9833526 - VERTICAL AMALGAMATION, GOVERNMENT ASSISTANCE

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. On vertical amalgamation, whether ITC of Amalco can be carried back to reduce Part I tax of predecessor subsidiary.

2. Timing of grind by government assistance to qualified expenditures.

Position: 1. No.

2. As qualified expenditures are incurred; cannot result in negative pool.

Reasons: 1. 87(2.11)

2. Interpretation of 127(18).

		June 22, 1999

		Audit Directorate	Income Tax Rulings and
		Specialized Compliance	  Interpretations Directorate
		  Enhancement Division	B.G. Dodd
				957-8954
M. Machado, A/Manager
		Tax Incentive Audit Section
		983352

(1) Vertical Amalgamation and (2) Government Assistance

We are writing in reply to your December 18, 1998 memorandum in which you request our views on issues involving a vertical amalgamation and government assistance. These issues were referred to you by the Toronto East TSO in their December 8, 1998 memorandum.

Vertical Amalgamation

Issue

This issue involves an amalgamation of a corporation (“Parentco”) and its subsidiary (“Subco”) to form Amalco. Prior to the amalgamation, Parentco was a holding company and Subco was an operating company performing scientific research and experimental development and claiming the investment tax credit. Following the amalgamation, Amalco carried on the business formerly carried on by Subco, performed SR&ED and claimed the ITC. Amalco is now seeking to carry its ITC earned back to reduce Part I tax of Subco.

(We assume this to be an amalgamation for purposes of section 87 of the Income Tax Act (the “Act”) and further, that Subco was a “subsidiary wholly-owned corporation” of Parentco as defined in subsection 87(1.4) of the Act.)

Comments

Subsection 87(2.11) of the Act deems a new corporation formed on the amalgamation of a particular corporation and one or more of its subsidiary wholly-owned corporations to be the same corporation as, and a continuation of, the particular corporation for purposes of several provisions of the Act, including those pertaining to ITC. In this situation, the “particular corporation” would be Parentco and subsection 87(2.11) of the Act would deem the new corporation, Amalco, to be the same corporation as, and a continuation of, Parentco. As such, subsection 87(2.11) of the Act would apply to permit the ITC of Amalco to reduce the Part I tax of Parentco only, not Subco.

We note that subsection 87(2.1) of the Act provides that on an amalgamation, the new corporation, Amalco, is deemed to be the same corporation as, and a continuation of, each predecessor corporation, which would include Subco, but only for certain purposes, all of which pertain to the new corporation. Paragraph 87(2.1)(e) expressly provides that this will not affect the determination of the taxable income of, or the tax payable by, any predecessor corporation.

With respect to the TSO’s question for possible relief in this case, we note that at one time there was a proposal to amend the transitional version of subsection 87(2.11) of the Act for amalgamations occurring within a corporate group before December 20, 1991. In the case of a corporation formed through an amalgamation of two or more wholly-owned subsidiaries, this would have permitted the new corporation to carry back its losses¹ to whichever of its predecessors it chose, via an election. A similar election was to have been available in the case of a vertical amalgamation such that the losses of the new corporation could have been carried back to a predecessor subsidiary, rather than its predecessor parent. These proposals, reflected in August 1993 draft legislation, were subsequently withdrawn pursuant to a December 20, 1993 news release issued by the Minister of Finance. We take this to be suggestive of underlying tax policy in this area.

Government Assistance

Issue

The issues are twofold and relate to the position taken in our file # 9809735:

1. whether subsection 127(18) of the Act applies to net government assistance against the SR&ED qualified expenditures only where the government assistance is provided with respect to the construction of a building which will be used primarily for SR&ED, or whether it may also apply where the building will be dedicated primarily to manufacturing but in which substantial SR&ED will be performed, and

2. where the assistance (or a large portion thereof) is received and the building is constructed prior to the commencement of the SR&ED, whether the assistance which can be attributed to the SR&ED is to be netted in its entirety against the SR&ED qualified expenditures in the year such expenditures are first incurred, even if the result is a negative pool balance.

Comments

With respect to the first item, subsection 127(18) of the Act applies where the assistance “can reasonably be considered to be in respect of” SR&ED. This is a question of fact to be determined based on the specifics of any given situation. In this case where there will be substantial SR&ED performed, unless it can be established from the documentation and other relevant information that the assistance was provided solely in respect of the manufacturing activities, we tend to think that the assistance could reasonably be considered to be in respect of SR&ED. (You might also wish to refer to our memorandum to you dated April 29, 1999, copy attached, which discussed subsection 127(18) of the Act.)

With respect to the second item, where the assistance has been received in a particular year and the SR&ED is undertaken in a subsequent year, it is our view that subsection 127(18) of the Act provides that the amount of the assistance is to be applied to reduce the amount of the SR&ED qualified expenditures incurred in the subsequent year. In other words, the assistance is applied to reduce the qualified expenditures as the expenditures are incurred. It is also our view that the words in subsection 127(18) of the Act “shall be applied to reduce the taxpayer’s qualified expenditures otherwise incurred in the year”, should not be interpreted so as to produce a negative amount.² Accordingly, where the amount of assistance exceeds the amount of qualified expenditures incurred in a particular year, the amount of the excess will be applied against qualified expenditures incurred in a subsequent year.

We hope this will be of assistance.

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

Att.

¹ At the time, subsection 87(2.11) had not yet been expanded to include the ITC.

² By analogy, see Canterra Energy Ltd., 87 DTC 5019, in which the Federal Court of Appeal concluded that the word “minus” in regulation 1207 was used in its mathematical, and hence, technical sense and therefore could lead to a negative amount. The court noted, at page 5023, that the word was “not used in its non-technical sense in which, no matter what non-technical meaning is attributed to it, it is compared in all the dictionaries to which we were referred, to the word “less”. That word clearly implies a subtraction of something from the whole and does not contemplate the result being a negative amount.”

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