22 March 1999 External T.I. 9901865 - DOUBTFUL OR IMPAIRED LOANS

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: Is it possible to compute a deductible reserve for impaired loans under subparagraph 20(1)(l)(ii) by pooling loans with similar or common characteristics and applying a historical loss factor to all such impaired loans in the particular pool?

Position: Question of fact but in this case it appears not - the reserve would be considered a general reserve and may also be sectoral. It is also not clear that the reserve is computed in accordance with GAAP.

Reasons: While it may be possible to pool loans by some common characteristics and apply a historical loss factor to the particular pool to arrive at a deductible reserve under subparagraph 20(1)(l)(ii) the loss factor cannot be applied to loans that are not impaired loans. Moreover, consideration must be given to ensure that the factors used to establish the particular pool of loans or the historical loss factor do not result in the creation of a sectoral reserve.

XXXXXXXXXX 990186

Attention: XXXXXXXXXX

March 22, 1999

Dear Sirs:

Re: Doubtful or Impaired Debt Reserves

This is in reply to your letter dated January 12, 1999, wherein you are requested our comments with respect to a financial institution's computation of a reserve for doubtful or impaired debts pursuant to subparagraph 20(1)(l)(ii) of the Income Tax Act (the "Act"). Specifically, we understand that your client, a credit union, wants to know if it is possible to compute a reserve for doubtful or impaired debts under subparagraph 20(1)(l)(ii) by “pooling” its various loan receivables by type (i.e., consumer, commercial and agricultural) and multiplying the amount owing in respect of such loans by a historical loss factor applicable to that particular pool.

Your request appears to relate to a proposed transaction. Confirmation of the income tax consequences of proposed transactions involving specific taxpayers will only be provided in response to a request for an advance income tax ruling. To make such a request the advance income tax ruling must be submitted in accordance with the guidelines set out in Information Circular 70-6R3 (IC-70-6R3) dated December 30,1996, issued by Revenue Canada. However, if the situation relates to a completed transaction a request for the Department’s views must be made to your local Tax Services Office. Although we are not able to comment specifically on the situation you have provided, we can offer the following general comments.

It is a question of fact as to whether a particular financial institution's reserve for impaired loans determined in accordance with generally accepted accounting principles ("GAAP") will give rise to a deductible amount under subparagraph 20(1)(l)(ii) of the Act. In order determine the amount of an impaired loan reserve that may be deductible by a financial institution the Act requires that each loan must be specifically identified as being impaired and that impairment must be measurable on a loan by loan basis. Moreover, clause 20(1)(l)(ii)(D) of the Act provides that the taxpayer's impaired loan reserve must be based on the lesser two amounts. The first amount essentially being the total of each amount which is a reasonable amount as a reserve (other than a sectoral reserve) for the year for a loan and the second amount is 90% of the amount of the taxpayer's impaired loan reserve determined under GAAP for the year (other than a sectoral reserve) less the total specified reserve adjustment for each impaired loan.

A "sectoral reserve" is defined in subsection 20(2.3) of the Act for the purpose of clause 20(1)(l)(ii)(D) as a reserve or allowance for impairment for a loan that is determined on a sector-by-sector basis (including a geographic sector, industrial sector or a sector of any other nature) and not on a property-by-property basis (emphasis added). Accordingly the definition of a sectoral reserve is quite broad and it remains a question of fact as to whether a taxpayer's impaired loan reserve is computed on a property by property basis or on some other basis.

The term "specified reserve adjustment" is defined in subsection 20(30) of the Act for the purpose of subclause 20(1)(l)(ii)(D)(II) and based on the wording of that definition a specified reserve adjustment must be determined for each impaired loan.

Finally, while you indicated in your letter that you are aware that general reserves or sectoral reserves for impaired loans are not deductible under subparagraph 20(1)(l)(ii) of the Act it would appear from the examples of the non-specific reserves you provided that such reserves would not be deductible. This is due to the fact that impairment for this portion of the reserve has not been determined on a loan by loan basis and as a result such a reserve would be considered as a sectoral reserve. Moreover, it would be necessary to compute a specified reserve adjustment in respect of such an impaired loan reserve and in your example this does not appear to be possible.

While we trust that our comments will be of assistance to you as indicated in paragraph 22 of IC-70-6R3 this opinion is not a ruling and accordingly, it is not binding on Revenue Canada.

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

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