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:
A corporation assumed a debt repayable in the future for consideration equal to the debt's present value. Whether the amount to be included in computing the corporation's capital for Part I.3 purposes should be the amount of the consideration received plus accreting interest that is reflected in the corporation's balance sheet or the face amount of the debt that is disclosed in a note to the balance sheet.
Position:
Where a netted amount is shown on the balance sheet, the information included in the notes to the balance sheet should be used to determine with regard to the facts of the particular situation whether the amount included in the face of the balance sheet properly reflects the value of the item to be included in capital. In this case, based on the facts provided, it is our view that the amount of the consideration received plus accreting interest is the appropriate amount to include in the corporation's capital.
Reasons: See above.
December 1, 1999
CALGARY TSO HEADQUARTERS
J. Leigh
Attention: Ron Suttie (613) 952-1505
Large File Case Manager
991891
XXXXXXXXXX ("A Co") - Part I.3
This is in reply to your facsimile of July 30, 1999 concerning the treatment of A Co's long-term debt for Part I.3 purposes. As you know, A Co's representative wrote to us on July 7, 1999 in connection with this issue and we advised him that since the issue is currently under review by a tax services office, his correspondence would be referred to you. Accordingly, attached is a copy of the July 7, 1999 letter and related material.
Our understanding of the situation may be summarized as follows:
- XXXXXXXXXX ("B Co") and XXXXXXXXXX ("C Co") entered into a loan agreement dated XXXXXXXXXX which provided for a borrowing by B Co of $XXXXXXXXXX from C Co repayable in XXXXXXXXXX.
- Originally, interest was stipulated to be payable as a percentage of production revenue from XXXXXXXXXX. The interest component was subsequently eliminated.
- Under the loan agreement, $XXXXXXXXXX was also borrowed by XXXXXXXXXX ("D Co") but the Part I.3 treatment of this loan is not under review.
- In XXXXXXXXXX, A Co and XXXXXXXXXX ("E Co"), as successor to B Co, entered into an agreement conditional upon A Co acquiring D Co. Pursuant to the agreement, A Co was to receive $XXXXXXXXXX from E Co as consideration for agreeing to pay C Co $XXXXXXXXXX . The amount of $XXXXXXXXXX represents the present value of the $XXXXXXXXXX non-interest bearing obligation to C Co.
- A Co acquired D Co and in XXXXXXXXXX E Co was released from all liability under the loan agreement by C Co.
- For accounting purposes, A Co recorded the $XXXXXXXXXX as cash and as long-term debt on its balance sheet. The long-term debt is accreted by an annual interest expense calculated on a XXXXXXXXXX period using an implicit rate of XXXXXXXXXX% compounded semi-annually. The interest expense each year is recorded and capitalized as part of the carrying value of the debt so that the carrying value of the debt will accumulate to $XXXXXXXXXX by XXXXXXXXXX.
The amounts on A Co's XXXXXXXXXX consolidated balance sheet are shown in U.S dollars. Under "Long term obligations", it shows a debt of approximately $XXXXXXXXXX (U.S.) and a note to the balance sheet indicates that this debt includes a loan from C Co (comprising of the $XXXXXXXXXX to A Co and the $XXXXXXXXXX to D Co) of approximately $XXXXXXXXXX (U.S.) which is net of a discount of $XXXXXXXXXX (U.S.). The note further indicates that the balance outstanding at XXXXXXXXXX represents the present value of $XXXXXXXXXX (U.S.) repayable in XXXXXXXXXX.
For Part I.3 purposes, A Co has included the $XXXXXXXXXX plus accreted interest in computing its capital. You have proposed to reassess A Co's XXXXXXXXXX Part I.3 returns to include the full amount of the loan in A Co's capital given that A Co truly has a liability with a face amount of $XXXXXXXXXX and the "discount" is not deductible.
We understand that this issue was referred to Audit Headquarters in 1997. Based on a comment in a draft interpretation bulletin on Part I.3 that the amount of bond payable without regard to bond discount must be included in the computation of capital for Part I.3 purposes, Audit Headquarters concurred with your position that the "discount" on the long-term debt should be included in the capital of A Co for Part I.3 purposes. Revisions to the draft interpretation bulletin are currently being considered to clarify our position with respect to bond discounts.
Subsection 181(3) of the Income Tax Act (the "Act") provides that in determining the carrying value of a corporation's assets or any other amount relevant for Part I.3 purposes, the amount reflected in the balance sheet of the corporation prepared in accordance with generally accepted accounting principles is to be used. It is our view that the phrase "reflected in the balance sheet" should be interpreted to include notes to the financial statements which are considered an integral part of the financial statements. Accordingly, in a situation where an amount is netted and only the netted amount is shown on the balance sheet but a detailed breakdown is provided in the notes to the balance sheet, we are of the view that we can use the notes to determine the value of the item to be included in the corporation's capital. The information included in the notes should be used to determine with regard to the facts of the particular situation whether the amount included in the face of the balance sheet properly reflects the value of the item to be included in capital.
In A Co's case, while the long-term debt reflected in the balance sheet is a netted amount, the notes to the balance sheet disclose details pertaining to the loan from C Co including the face amount of the loan repayable in XXXXXXXXXX. In our view, the fact that A Co has a legal obligation to repay $XXXXXXXXXX in XXXXXXXXXX is an important consideration but it is not the only consideration in determining the appropriate amount to include in A Co's capital. In determining the appropriate amount to pick up, we should also consider the intent of the legislation as well as the overall impact on A Co's capital.
Our understanding is that the Department of Finance intended taxable capital to include funds available for use by a particular corporation. While this is not in itself determinative of the amount that is required to be included in capital, in this case it is our view that given only $XXXXXXXXXX was received by A Co a court would not be receptive to reliance on notes to the financial statements to include a greater amount in capital.
With regard to the effect of the loan on the other components of A Co's capital for Part I.3 purposes, we note that there appears to be little impact on A Co's retained earnings since any investment income earned on the $XXXXXXXXXX would likely be offset by the amount of interest expense for accounting purposes. The effect of amortizing the "discount" for accounting purposes is to eliminate the increase in retained earnings for the income earned on the $XXXXXXXXXX to the maturity of the loan. Accordingly, it would be appropriate to pick up the accreted interest that is reflected in the balance sheet. This is akin to picking up the amortized discount as a reserve.
We also note that E Co would have realized a gain of $XXXXXXXXXX on the assumption of the loan by A Co which would form part of E Co's retained earnings and therefore its capital for Part I.3 purposes. Accordingly, the full amount of the loan would be included in capital albeit in respect of two taxpayers.
In summary, having considered the relevant facts of this case, it is our view that the appropriate amount to include in A Co's capital for Part I.3 purposes is the $XXXXXXXXXX plus accreting interest that is reflected on A Co's balance sheet. We note that we have informally discussed this issue with the Department of Finance and Audit Headquarters and they are in general agreement with our position in this situation.
Finally, we note that the financial statements provided were prepared on a consolidated basis. While these are of assistance, for purposes of determining carry values of assets or other amounts under Part I.3, pursuant to 181(1)(a) of the Act, the consolidation method of accounting is not to be used.
For your information, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (613) 994-2898. The severed copy will be sent to you for delivery to the client.
We hope that our comments are of assistance.
Manager
Financial Institutions Section
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Attachment
cc Claude Englehart
Audit Headquarters
??
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 1999
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 1999
Email this Content