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.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 1
Application of Subsection 13(4) - Expropriation
Opco's land and plant were expropriated. Opco rebuilt factory B at another location.
Total compensation received: $1,500,000
Compensation for land and building: $1,200,000
Compensation for moving equipment: $ 300,000
Is the equipment considered to have been expropriated?
How should the $300,000 compensation be handled?
Response from the Income Tax Rulings and Interpretations Directorate
Subsection 13(4) of the Act provides that when a taxpayer receives an amount in respect of the proceeds of disposition of depreciable property, such as in the case of an expropriation, he may make an election. In order for this election to be exercised, there must have been a "disposition" as defined in subsection 13(21) of the Act.
In a case such as this, Opco does not appear to be relinquishing its right of ownership of the equipment to another person and this other person does not appear to be acquiring Opco's equipment. Opco is merely moving its equipment following the expropriation of its land and its building. Opco is compensated for moving its equipment but not for disposing of it.
In Interpretation Bulletin IT-271R, Expropriations - Time and Proceeds of Disposition, paragraphs 19 to 24 look at how to determine the amount of compensation. Paragraph 20 mentions that "The compensation award determined by the expropriating authority may take into account, in addition to the fair market value of any expropriated property, several other factors such as: (...) costs of relocation, including moving costs (...) may form part of the proceeds of disposition of the property disposed of."
Only after all the pertinent facts, documentation and relevant legislation, such as provincial expropriation legislation, have been examined can it be determined whether compensation for moving costs forms part of the proceeds of disposition.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 2
Capital Cost
Facts
A company acquires a passenger vehicle at a cost exceeding $26,000. Paragraph 13(7)(g) sets a limit on the capital cost of a passenger vehicle, i.e. the amount prescribed. The limit under this paragraph is $26,000 plus federal and provincial sales taxes.
Question
Should paragraph 13(7)(c) apply based on the capital cost set out in paragraph 13(7)(g) where (i) the use made of the vehicle by the shareholder is 60% business and 40% personal or (ii) the use made of the vehicle by the employee is 60% business and 40% personal?
Income Tax Rulings and Interpretations Directorate
Where, under subsection 15(1), a benefit resulting from personal use of a vehicle owned by a company must be included in the income of a shareholder, the capital cost of the vehicle must be apportioned annually between use for the purpose of gaining or producing income and use for other purposes, pursuant to paragraphs 13(7)(c) and (d). A capital cost allowance for depreciation may be claimed only in respect of the proportion of the cost associated with use for the purpose of gaining or producing income.
However, we are of the opinion that such a breakdown is not necessary when an employee of the company uses the vehicle, and that he must include in his income, as income from employment, the benefit resulting from personal use of the vehicle belonging to his employer. In such circumstances, we are of the view that the company is using the vehicle for the purpose of gaining or producing income during the periods when such an employee is using the vehicle for personal reasons.
As you pointed out, paragraph 13(7)(g) sets a limit on the capital cost of a passenger vehicle, i.e. the amount prescribed. The limit under this paragraph is $26,000 plus federal and provincial sales taxes. The capital cost as determined in paragraph 13(7)(g) will be used to calculate the capital cost allowance of the vehicle where the vehicle is used solely for the purpose of gaining or producing income.
If the vehicle is not used solely for the purpose of gaining or producing income (such as when a shareholder uses the vehicle for personal reasons), the amount shall be calculated in accordance with paragraph 13(7)(c), taking into account the capital cost determined in accordance with paragraph 13(7)(g). Thus, in the example given, in which the shareholder uses the vehicle for personal reasons 40% of the time, the company would be deemed to have acquired the vehicle at a capital cost equivalent to 60% of the capital cost as determined in paragraph 13(7)(g).
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 3
Undeclared income
Facts
A taxpayer has been operating a business since 1988 but has never declared his business income. The taxpayer uses capital property in his business. When purchased in 1988, this capital property cost $200,000.
The Department discovers the situation in 1997 and reassesses for the years 1995 to 1997. The taxpayer would like the cost of the capital property to be included in the capital cost of depreciable property at the beginning of 1995, because he has never deducted the capital cost allowance in respect of this depreciable property from his business income prior to 1995.
Questions
Could the Department take the position that there was a change in use of the property at the beginning of 1995, since the property was personal-use property prior to 1995?
Could the Department take the position that the business did not start up until the beginning of 1995, meaning that the property was personal-use property prior to that date and that there was a change in use at the beginning of 1995?
Should the Department issue reassessments for the years 1988 to 1994 in order to include the business income not declared during those years? The taxpayer could then claim a capital cost allowance for depreciable property in order to reduce his income for those years.
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
The question of whether the business started up prior to 1995 or whether the property began to be used in the business in 1995 is a question of fact.
A taxpayer is not required to claim capital cost allowance. If there has not been a change in use of the property, the Department would not be able to reduce the capital cost by calculating a theoretical capital cost that would take into account the depreciated value or the fair market value at the beginning of 1995. In such a case, if the years 1988 to 1994 were not reassessed, the capital cost would be $200,000 on January 1, 1995.
If the Department can take the position that the property was used personally and not as part of the business before 1995, the rules on change in use of property could be applied in 1995 with the result that the capital cost of the property would be deemed to be the amount set out in paragraph 13(7)(b). Assuming the fair market value of the depreciable property to be lower than the cost of acquisition, the taxpayer would be deemed to have acquired the depreciable property when he began to use it for the purpose of gaining or producing income at a capital cost to himself equal to the fair market value of the property at that later time.
Pursuant to subsection 220(1) of the Act, the Minister administers and enforces the Act. The point is not to determine which of the options suggested would be the most equitable for the taxpayer, but to ensure that the Act is administered. If the business started up prior to 1995 and its income was not declared because of a misrepresentation that is attributable to neglect, carelessness or wilful default, or the commission of any fraud, subsection 152(4) provides for a reassessment for 1988 and subsequent years. If the property was used for the purpose of gaining or producing income from the business effective 1988, we are of the opinion that the taxpayer could claim a capital cost allowance for this property for the years 1988 to 1994.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 4
Application of paragraph 18(1)(a) of the Act
Facts
A manufacturing business has been at the same location for 25 years. It discharges corrosive waste into the city sewers. Over time, the sewers deteriorate. Around 1983, the City gives notice to the business that it must end this practice and claims damages. It sues the business for the costs incurred in repairing the sewers. In 1996, a final decision is handed down ordering the business to repay the cost of repairs carried out by the City, as well as almost all expenses, such as legal expenses, lawyers' fees, GST and QST on repairs, interest on these amounts, and damages (exemplary?).
Questions
- Does paragraph 18(1)(a) apply in this situation, making the expenses non-deductible because they were not incurred for the purpose of gaining or producing income?
- Could we have guidelines that are easy to apply in such cases?
- Could criteria on damage to the environment be added to Interpretation Bulletin IT-104R2?
- If the company itself repairs the environmental damage on its property, is this a capital expenditure, a current expenditure, or a non-deductible expenditure?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
In order to answer this question, a distinction must be made between fines and penalties, damages, and repayment of expenses incurred in making restitution for the loss caused. Each situation is different and all the facts and documents, including the court ruling, must be analysed before determining whether or not paragraph 18(1)(a) of the Act applies.
Fines and penalties
Interpretation Bulletin IT-104R2 discusses the deductibility of fines and penalties imposed by the courts on taxpayers under federal or provincial statutes, municipal by-laws, etc...A fine or penalty is generally imposed on the offender as punishment and serves as a form of deterrent. If an examination of the facts reveals that a fine or penalty has truly been levied, we are of the opinion that the Bulletin's general principles would help in determining the required tax treatment. It would be difficult to foresee all the situations involving environment-related fines and penalties in order to produce guidelines applicable in all cases or to add environment-specific criteria to the Bulletin. Furthermore, according to this Bulletin, fines are not usually deductible.
Damages
The process of analysing a specific situation should also include consultation of Interpretation Bulletin IT-467R, which discusses the treatment of amounts paid or payable as damages in respect of a financial loss, injury or deterioration caused by a taxpayer to another person or to a business or property of another person. If an analysis of the facts reveals that there truly have been damages, we are of the opinion that the general principles of Interpretation Bulletin IT-467R would help in determining the required tax treatment for such damages. It would be difficult to foresee all the situations involving environment-related damages in order to produce guidelines applicable in all cases or to add environment-specific criteria to the Bulletin.
Costs of repairing sewers
We are of the opinion that repayment of the costs incurred by the City in repairing the sewers should receive the same tax treatment as the cost of repairing environmental damage made by the company itself. The tax treatment must take into account a number of factors, including the following:
- were the expenditures incurred voluntarily or for the purpose of discharging a legal obligation made for the purpose of restoring a site or repairing environmental damage caused directly by the operations of the business? If so, these expenditures would generally be considered a business expenditure.
- was the need to incur expenditures for the purpose of repairing environmental damage made necessary because of an ongoing condition inherent in daily operations?
- will similar expenditures be required in future if the business continues operations?
- were the expenditures incurred in order to create an enduring benefit? The question is whether the sole reason for the expenditure was to correct or repair damages caused by the operations of the business.
- were the expenditures incurred in order to increase the value of property held by the business, such as land? In this regard, the condition of land after repair work has been carried out should be compared to its condition before it was polluted.
- were the expenditures incurred in order to acquire depreciable property?
Document E9413377 contains an analysis of a particular situation.
Other expenses
In our view, the particular circumstances which gave rise to the legal expenses and interest must also be examined in order to determine whether these expenditures were incurred for the purpose of earning income.
Paragraph 11 of Interpretation Bulletin IT-467R provides the Department's position with respect to interest and to legal costs incurred for the payment of damages:
The interest element, if any, in an award for damages is considered to be a component of the damages. Such interest included with damages awarded will be deductible if the damages themselves are deductible. In a case where damages are partially deductible, the interest element will be deductible in the same ratio. Similarly, reasonable legal fees incurred in the payment of damages will be deductible in accordance with the principle expressed for interest.
You may rely on this position of the Department when deciding on the appropriate treatment for legal fees and interest in circumstances other than receipt of compensation.
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1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 7 - DEDUCTIBILITY OF INTEREST 20(1)(c)
Question 39 of the 1981 CTF Round Table, set out the Department's interpretation regarding the deductibility of interest in cases where money borrowed was used to buy common shares in a corporation. This interpretation came up again at the 1987 APFF conference, where the circumstances in which interest earned on the purchase of common shares was deductible were explained (page 480, point 3.3.1).
Today, many investors are buying common stock shares (excluded here are preferred stock shares) in mining and biotechnology research and development companies. These shares confer a potential right to profits if, one day, through research, a company strikes it rich or comes up with the magic formula that puts it on the map.
We know that, in practice, many are called, but few are chosen, and that, in almost all cases, interest charges exceed dividend income. Often, no dividend is paid out and the taxpayer eventually unloads his investment. Under the above-mentioned interpretation, the Department tends to allow interest to be deducted, since a taxpayer has a potential right to retained earnings.
1. Do you think this position is valid in cases where we are able to show that a "company has never paid out any dividends since being formed and does not plan to do so, but plans instead to reinvest its profits to finance its long-term growth [TRANS] "? This quote is taken from a prospectus sent to an investor who bought common shares in a research company.
2. Would we be justified in disallowing interest in a situation such as this where the likelihood of a breakthrough is the only reason to think that dividends might be paid, and then only after long-term funding of growth (with the profits)?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
The question of whether interest is deductible in computing income is a question of fact that can be determined only after examination of all the relevant facts. Such an examination must be done annually. In The Queen v Bronfman Trust 87 DTC 5059, Dickson C.J. of the Supreme Court of Canada ruled as follows regarding the deductibility of interest:
"Not all borrowing expenses are deductible. Interest on borrowed money used to produce tax-exempt income is not deductible. Interest on borrowed money used to buy life insurance policies is not deductible. Interest on borrowings used for non-income earning purposes, such as personal consumption or the making of capital gains is similarly not deductible."
The question of whether common shares were acquired for the purpose of earning income is a question of fact and the particular facts of each situation must be examined. As stated at a number of round tables, interest on money borrowed to acquire common shares is generally (barring exceptional circumstances) deductible, bearing in mind that the potential return to the shareholder may exceed the shareholder's borrowing costs.
For an expense to be deductible, there must be a source of income from a company or property. We are of the opinion that there is no source of income where the facts show that there is no profit or expectation of profit. Subsection 9(3) of the Act excludes capital gain from income. The increase in value of a property may therefore not be used to justify a deduction under paragraph 20(1)(c). This position was recently confirmed by the Federal Court of Appeal in Ludco Enterprises Limited et al (March 30, 1999). The Federal Court of Appeal upheld the decision of the Federal Court, Trial Division (98 DTC 6046) which concluded that the interest on money borrowed to acquire shares was not deductible because there was no expectation of profit; subsection 9(3) excludes capital gain in the determination of income from a property.
As a result, despite our above-mentioned general position, we are of the opinion that the interest on money borrowed to purchase common shares might not be deductible where there is no expectation of profit from an investment. For instance, where a company has not paid any dividends since being formed and the facts clearly show that it has no intention of so doing, there could be a good argument for concluding that there is no expectation of profit and that the interest on money borrowed to purchase common shares would not be deductible.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 8 - APPLICATION OF SUBPARAGRAPH 40(2)(g)(ii) OF THE ACT.
Under paragraph 18(1)(a) of the Act, expenses not made or incurred by a taxpayer for the purpose of gaining or producing income from a business or property cannot be deducted. It is the Department's practice, however, to allow deduction of an amount up to and including the amount of income generated by a business or property not operated with a reasonable expectation of profit.
Why doe the Department not take the same position with respect to subparagraph 40(2)(g)(ii) and paragraph 20(1)(c) of the Act?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
Paragraphs 18(1)(a) and 20(1)(c), as well as subparagraph 40(2)(g)(ii) of the Act, all use the same expression, i.e. "...for the purpose of gaining or producing income from the business or property ". An explanation of the Department's standard interpretation of this expression in these three provisions requires that the terms income and source of income be reviewed.
Meaning of income
The notion of income is increasingly the subject of comments from by the courts. In a dictum in Mark Ressources Inc. (1), Bowman J. said that income can mean gross income; Létourneau J., dissenting, in Ludco (2), held similarly.
However, as confirmed by the Supreme Court, the term income is still interpreted to mean net income or profit. In Lipson (3), Pigeon J. held that, in order for an expense to be admissible as a deduction from income, it must have been incurred in order to make a profit and not merely in order to obtain gross income. In Tonn (4), Linden J. provides an excellent analysis of the relationship between subsection 9(1) and paragraphs 18(1)(a) and 20(1)(c): references to income are references to profit, which is a net concept.
Meaning of source of income
Many decisions refer to Moldowan v. The Queen (5) to explain or define the concept of "source of income", which is the foundation of our taxation system as set out in sections 3 and 4 of the Act. Dickson J. stated as follows: "it is now accepted that in order to have a source of income the taxpayer must have a profit or a reasonable expectation of profit. Source of income, thus, is an equivalent term to business". Conversely, there is no source of income when an activity does not generate a profit or a reasonable expectation of profit.
In conclusion, where an activity does not generate a profit and offers no expectation of profit (net income), no deduction for expenses will be allowed (5) and, if there is no source of income, there is generally no gross income to include in computing income (sections 3 and 4). Let us take the case of a rented house, where expenses are well in excess of gross income and where it is concluded that there is no expectation of profit. For this reason, no expense is allowable (18(1)(a)) and gross income is not included in computing income, because it does not come from a source of income. Although the result is the same as what you describe in your question, it is not arrived at by allowing expenses up to the amount of gross income, as many think.
Important exceptions
Nevertheless, despite this general operation of the Act, section 12 is so worded (see also section 56) that the amounts mentioned therein must be considered in computing income, even if there is no profit or expectation thereof, or source of income: "shall be included in computing the income [...]such of the following amounts as are applicable ..." such as interest, dividends, etc. Sections 18, 20 and 40, on the contrary, refer to a source of income as a condition for deducting an expense or a loss." This is the legal reason why the Department includes interest on a fixed yield investment in computing income, but disallows higher interest paid on money borrowed to acquire that investment.
The interpretation of paragraphs 18(1)(a), 20(1)(c) and subparagraph 40(2)(g)(ii) is the same, setting aside certain other requirements or characteristics (such as the requirement to determine direct use in paragraph 20(1)(c), which is not present in subparagraph 40(2)(g)(ii)), discussion of which is not relevant for the purposes of answering this question.
(1) Mark Ressources Inc. v. R., 93 DTC 1004 (T.C.C.)
(2) Ludco Enterprises Limited v. Her Majesty the Queen, 99 FCJ no. 402 (F.C.A.)
The taxpayer appealed to the Supreme Court of Canada.
(3) Quebec (Deputy Minister of Revenue) v. Julius Lipson, 79 CTC 247 (S.C.C.)
(4) Enno Tonn v. Her Majesty the Queen, 96 DTC 6001 (F.C.A.)
(5) William Moldowan v. Her Majesty the Queen, 77 DTC 5213 (S.C.C.)
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1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 10
A manufacturing company (Opco) has its management company (Gesco) bill it for management fees. In computing the credit for manufacturing and processing profits (MPP), Opco did not include these management fees in the "cost of labour". When it audited Opco, Revenue Canada proposed that these fees be included in the "cost of labour", thereby substantially reducing the MPP credit. During discussions of the proposed assessment, the taxpayer raised the fact that these fees consisted of managers' salaries, overhead, and profit charged to Opco by Gesco on these fees. The taxpayer felt that only the portion of Gesco managers' salaries having to do with fees should be considered in computing OPCO's "cost of labour". Headquarters has already ruled on this in a question concerning another taxpayer, where it agreed that only the salary portion of fees needed to be included in the "cost of labour". It should be noted, however, that Revenue Canada's ruling was with reference to part (b)(iii) and not part (b)(i) of the definition of "cost of labour". A verbal request for information to Headquarters confirmed, however, that such an interpretation would also apply to part (b)(i) of the definition.
Is this still the opinion of Headquarters?
If the management fees came from a company dealing at arm's length, would the answer be the same?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
When management expenses include salaries, overhead and other items, we are of the view that the taxpayer may consider salaries alone in computing the cost of labour, as this term is defined in section 5202 of the Income Tax Regulations.
In order to qualify for this administrative relief, the taxpayer must be able to substantiate the figures. If the taxpayer is unable to do so to the satisfaction of the Department, we are of the view that the full amount of the management fees must be included in computing the cost of labour.
Our answer remains the same whether the management fees come from someone with whom the taxpayer deals at arm's length or not.
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1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 12 - APPLICATION OF PARAGRAPH 20(1)(f) OF THE ACT.
According to opinion 982822, 75% of the outlay to redeem a share purchase option is deductible under subparagraph 20(1)(f)(ii) of the Act.
However, when the outlay is high in relation to the amount borrowed, does 20(1)(f) of the Act apply, given that the result of the redemption is to prevent dilution of share ownership?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
In determining the tax treatment of an amount paid under a financing agreement, it is essential to examine the agreements signed by the parties. In addition, all the facts surrounding these agreements must be considered.
In files 982822 and 990411, it was determined that the amount paid to redeem share purchase options was part of the principal and that a deduction under paragraph 20(1)(f) of the Act was allowed. Note that in file 982822 the amount paid represented just over 50% of the amount borrowed. The quantum of the amount paid had nothing to do with the position taken in these two files.
However, this position is applicable to situations where the facts are identical to those in the two above-mentioned files and might not apply to the amount paid to redeem share purchase options in other circumstances.
In our opinion, the fact that exercising the option had the effect of diluting share ownership does not have to be taken into account in determining the tax treatment of such a redemption.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 13
An employee who is a commission salesperson may deduct, inter alia, computer rental expenses if the conditions in subparagraphs 8(1)(f)(i) to (iv) of the Act are met. If the employee buys the computer instead of renting it, why may he not deduct capital cost allowance?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
Under subsection 8(2) of the Act, only those amounts listed in section 8 of the Act may be deducted in computing a taxpayer's income for a taxation year from an office or employment. Subparagraph 8(1)(f)(v) of the Act mentions that a commission salesperson may not deduct capital costs except as provided for in paragraph 8(1)(j) of the Act. Under paragraph 8(1)(j) of the Act, a commission salesperson may deduct capital cost allowance for a motor vehicle or aircraft. We are therefore of the opinion that a commission salesperson cannot deduct capital cost allowance in respect of a computer purchased for his employment. For tax policy reasons, the legislator has decided to allow a deduction for the rental of a computer by an employee whose remuneration takes the form of commissions, but has not provided tax relief in the case where the employee buys the computer.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 14
Woodlots - Operation of a business or investment
Mr. X, aged 55, owns 100% of Gesco X, which in turns owns 75% of Opco X. The activities of Opco X have dropped off substantially in recent years, but accumulated profits are in the millions. Opco X pays a large dividend to Gesco X.
Since Mr. X now has more time to look after the assets of Gesco X and since that corporation has considerable cash assets, Mr. X decides to diversify the corporation's assets. He therefore invests in stock and starts collecting vintage cars, which he maintains and repairs himself.
Mr. X likes the outdoors and nature and he wants to begin a logging business. Mr. X obtains information about logging and registers Gesco X in the Association des producteurs forestiers du Québec. In 1995, Gesco X acquires a lot of approximately 33 acres, 28 of which are wooded with trees of little value. Shortly thereafter, Gesco X acquires a woodlot of approximately 400 acres located 150 km from his residence. The lot was acquired for approximately 20% of its real value. In 1997, Gesco X acquires another woodlot of approximately 100 acres located further away that has very recently been cleared.
Gesco X has practically no income from the woodlots and no employees. All the drainage, ditches and clearing are done by Mr. X, who must also look after stock investments and the automobile collection, in addition to spending time on his boat in Florida. The woodlots will begin producing income in 30 or 40 years.
Is Gesco X operating a logging business or are the woodlots held as an investment? If the woodlots are held as an investment, how should the expenses incurred with respect to this activity be treated for purposes of the Income Tax Act, hereinafter referred to as the "Act"?
Response from the Income Tax Rulings and Interpretations Directorate
New Interpretation Bulletin IT-373R2, Woodlots, presents the various questions that must be answered in determining the tax implications for woodlot owners and operators. These questions must be examined every year, since the facts respecting a certain activity may change.
It must first be determined whether the woodlot is a commercial woodlot or a non-commercial woodlot. For example, if the taxpayer operates the woodlot as though it were a business with a reasonable expectation of profit, it is a commercial woodlot. If, however, it is not operated with such an expectation, it is considered a non-commercial woodlot or a hobby. An analysis of relevant factors, such as the extent of planning, effort made, time spent, extent of the activity, past history, and so forth, help us make this determination. All the expenses incurred with respect to a non-commercial woodlot or hobby are not deductible by the taxpayer under paragraph 18(1)(a) or 18(1)(h) of the Act, even if the taxpayer holds this property as an investment, since the capital gain is not income from a property with the meaning of subsection 9(3) of the Act.
Where a woodlot is considered a commercial woodlot, it must then be determined whether it is operated as a farm, within the meaning of the term "farming" in subsection 248(1) of the Act. If the main focus of a business is not lumbering or logging, but is planting, nurturing and harvesting trees pursuant to a forestry management or other similar resource plan, and if significant attention is paid to manage the growth, health, quality and composition of the stands, it is generally considered a farming business.
Where the woodlot is operated as a farm, it must be determined whether, for the purposes of section 31 of the Act, farming is the taxpayer's chief source of income, as this may limit the losses that the taxpayer may deduct. In determining the chief source of income, the Courts have considered , in relation to the other source of income, three criteria, that is, time commitment, capital commitment and expectation of significant profitability. The test of simply comparing net income from each source as the test for determining the chief source of income in a taxation year is not necessarily conclusive in and by itself.
When a commercial woodlot is not operated as a farm, or if farming is the taxpayer's chief source of income, the taxpayer may deduct the losses sustained by this business from its other income.
We suggest you to consult Interpretation Bulletin IT-373R2, which contains more detailed explanations on this topic, as well as tax implications not discussed here.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 15 - APPLICATION OF SECTION 181.2
- Corporation A is a member of Limited Partnership B.
- Limited Partnership B is a member of Limited Partnership C.
- The financial year of each ends on December 31.
- Limited Partnership C made advances to Limited Partnership B totaling $10 million as of December 31.
- These advances were not considered part of Corporation's A capital subject to Part I.3 tax.
- Is it technically accurate to:
- consider Limited Partnership C advances to Limited Partnership B in computing Corporation's A capital subject to Part I.3 tax, but
- not consider these advances as part of the investment allowance?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
Capital - 181.2(3)(g)
A partnership (including a limited partnership) is not subject to Part I.3 of the Act. However, members of a partnership that are corporations ("members ") are required, under paragraph 181.2(3)(g) of the Act, to include, in computing capital, their share of certain amounts that would be included as capital of the partnership under subsection 181.2(3) as though the partnership were a corporation. This share is equal to the member's share of the partnership's income or loss for that period. The member must therefore include its share of loans and advances (except loans and advances payable to other members or to itself) in computing capital.
In your example, Corporation A must include its share of the loans and advances to Limited Partnership B from Limited Partnership C in its capital for the purposes of Part I.3. In your example, assuming that its share was 75%, Corporation A will have to include $7.75 million (75% of $10 million).
It should be noted that paragraph 181.2(3)(g) also includes in the member's capital, the capital of a partnership that is itself a member of another partnership. In effect, paragraph 181.2(3)(g) provides that "the total of all amounts ... that would be determined under this paragraph and paragraphs (b) to (d) and (f) in respect of the partnership...." [sic]. Limited Partnership B's share of the capital could also be included for the purposes of the calculation in paragraph 181.2(3)(g); however, you did not provide any fact to that effect.
Investment Allowance
When the lender is a partnership, the member will normally be entitled to an investment allowance equal to the carrying value of its share in accordance with paragraph 181.2(4)(e). Subsection 181.2(5) states that, for the purposes of subsection 181.2(4), the carrying value is deemed to be equal to the share in certain assets of the partnership as described in paragraphs 181.2(4)(a) to (d) and (f). Accordingly, these assets do not include a loan made by one partnership to another partnership. The share is calculated in the same manner as indicated above for paragraph 181.2(3)(g). In the example given, Corporation A is not a member of Limited Partnership C. It may not claim any investment allowance. This interpretation has been confirmed with the Department of Finance. In their view, it is consistent with tax policy.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 16
Syndicate of Co-owners
Ten people buy a building located in Quebec. The building consists of 10 condominiums. Each person owns one. A committee of owners runs the building. This kind of committee, which is not a corporation, is called a syndicate of co-owners.
Is the syndicate of co-owners a corporation within the meaning of the Act? If so, is it required, under paragraph 150(1)(a) of the Act, to file a T2 return?
Response from the Income Tax Rulings and Interpretations Directorate
The following is our Directorate's position with respect to your questions as provided at the federal taxation round table held during the 1995 APFF congress (Congrès 1995, Montreal, Association de Planification Fiscale et Financière, 1996, Volume 2, Table ronde sur la fiscalité fédérale, question number 7.18, pp. 34:51-53).
We are of the view that a syndicate of co-owners is a "corporation" as defined in section 248(1) of the Act.
Given the objects of a syndicate of co-owners, as set out in article 1039 of the Civil Code of Quebec, a syndicate could generally be considered to be organized for any other purpose except profit for the purposes of 149(1)(l) of the Act. The facts of each particular situation should be examined, however, in order to determine whether another purpose of a syndicate is to make a profit, which would exclude it as a "non-profit organization".
For an association to be eligible for an exemption under paragraph 149(1)(l) of the Act, none of its current or capital income may be paid to an owner or member or be used for that individual's personal gain. In this respect, articles 1071 and 1072 of the Civil Code of Quebec provide that use by a syndicate of the income from the contribution from co-owners for common expenses and for the purpose of establishing a contingency fund would not normally constitute a distribution or use of income for the personal gain of members, provided that the expenses and the contingency fund are reasonable in the circumstances.
The possibility of a distribution of income arising solely from the liquidation of a syndicate does not prevent a syndicate of co-owners from being considered a "non-profit organization".
If, however, by by-law or otherwise, income could be distributed to members of the syndicate before such liquidation, the syndicate of co-owners would no longer meet the condition in paragraph 149(1)(l) of the Act because income was payable to members, thus disqualifying the syndicate as a "non-profit organization".
Under subsection 150(1) of the Act, a "corporation" must file a return of income in prescribed form, i.e. a T2, for each taxation year. A syndicate of co-owners that is exempt from tax under paragraph 149(1)(l) of the Act and that meets one of the conditions in subsection 149(12) of the Act is also required to file a T1044 information return for the period.
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1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 18
Facts:
In order for a corporation to qualify for the Canadian Film or Video Production Tax Credit (CFPTC) under subsection 125.4 of the Income Tax Act (the "Act"), the activities of the qualified corporation in the year are primarily the carrying on through a permanent establishment in Canada of a business that is a Canadian film or video production (CFVP) business.
Questions:
For the purposes of subsection 125.4 of the Act, what criteria must be used to determine whether the activities of the qualified corporation consist primarily in the carrying on of a CFVP business?
Can a production corporation record production costs, claim the CFPTC and then transfer the production to the parent corporation? If so, who can claim the capital cost allowance after the transfer?
Responses from the Income Tax Rulings and Interpretations Directorate
"Primarily" is not defined in the Act. However, the Department considers that "primarily" means more than 50%.
In our view, in order to determine whether the activities of a corporation consist primarily in the carrying on of a business that is a CFVP business, all the facts surrounding each of the various activities undertaken by the corporation must be examined and compared. The concept of principal business is discussed in Interpretation Bulletin IT-290. Although none of the following criteria may be sufficient in or by themselves (the list is not exhaustive), they should be considered in determining which of the corporation's businesses is its principal business for the purposes of the Act:
a) the profits realised by each one of the corporation's businesses;
b) the volume and the value of the gross sales or transactions of each business;
c) the value of the assets of each business;
d) the capital employed in each business; and
e) the time, attention and efforts expended by the employees, agents or officers of the corporation in each business.
In our view, it would be possible for a production corporation to claim the CFPTC and then to transfer its production to its parent corporation if this corporation is a taxable Canadian corporation. In our view, this transfer would not, in and of itself, make it an excluded production. If, however, the production is transferred to a corporation other than a taxable Canadian corporation that is related to it, the production would become an "excluded production" and the production corporation would no longer be entitled to the CFPTC.
"Excluded production" is defined in subsection 1106(1) of the Income Tax Regulations. One of the conditions that must be met in order to avoid becoming an excluded production involves the ownership of world-wide copyright. The corporation or another taxable Canadian corporation that is related to it must usually own the world-wide copyright in the production of all commercial exploitation purposes for 25 years. Consequently, if the parent corporation is a taxable Canadian corporation, the transfer of the production in and of itself will not have an impact for the purposes of this condition.
After the property has been transferred to the parent corporation, the property would be a Class 10(x) property for the latter because the corporation would then be the exclusive world-wide copyright owner of the production. Consequently, the parent corporation should report the income and claim the capital cost allowance.
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1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 20
Application of subsection 111(4) of the Act
Control of Corporation A was acquired by a person. At that time, Corporation A held shares in a small business corporation with a fair market value below the adjusted cost base. Corporation A would have suffered a business investment loss if it had disposed of these shares to a person with whom it was dealing at arm's length.
In this situation, is Corporation A deemed to have suffered a capital loss on these shares by virtue of subsection 111(4) of the Act, and can this capital loss become a business investment loss under paragraph 39(1)(c) of the Act?
If, when the control was acquired, all the conditions in subsection 50(1) of the Act were met with respect to the shares held by Corporation A, can Corporation A claim a business investment loss with respect to these shares by making the election in subsection 50(1) of the Act?
Response from the Income Tax Rulings and Interpretations Directorate
Because control of Corporation A was acquired by a person, provision is made in paragraph 111(4)(c) of the Act, that, in computing the adjusted cost base to the corporation at and after that time of each capital property, other than a depreciable property, owned by the corporation immediately before that time, there shall be deducted the amount, if any, by which the adjusted cost base to the corporation of the property immediately before that time exceeds its fair market value immediately before that time. Paragraph 111(4)(d) of the Act provides that this amount will be deemed to be a capital loss of the corporation for the taxation year that ended immediately before that time from the disposition of the property. The amount by which the adjusted cost base of the shares owned by Corporation A exceeds the fair market value of these shares is therefore deducted in calculating the adjusted cost base of these shares at the time control is acquired and after and Corporation A is deemed to have suffered a capital loss from the disposition of these shares for the taxation year that ended immediately before control was acquired.
Paragraph 39(1)(c) of the Act provides that a taxpayer's capital loss may become a business investment loss if that loss result from a disposition of property to which subsection 50(1) of the Act applies or to a person with whom the taxpayer was dealing at arm's length.
Subsection 50(1) of the Act provides that a taxpayer can elect to be deemed to have disposed of the shares he/she owned at the end of a taxation year if one of the conditions in subparagraphs 50(1)(b)(i) to (iii) is met. The taxpayer shall be deemed to have disposed of the shares at the end of the year for proceeds equal to nil and to have reacquired them immediately after the end of the year at a cost equal to nil.
In this case, we feel that the capital loss resulting from the application of paragraph 111(4)(d) of the Act is not a loss stemming from the disposition of shares to a person with whom Corporation A was dealing at arm's length. This capital loss could therefore not become a business investment loss since the condition in subparagraph 39(1)(c)(ii) of the Act is not met.
However, if all the conditions in subsection 50(1) of the Act are met with respect to shares, we feel that the taxpayer could elect to apply the provisions of subsection 50(1) of the Act for the taxation year deemed ended before control was acquired. This election would consequently allow the capital loss stemming from this deemed disposition to become a business investment loss under paragraph 39(1)(c) of the Act using the calculation provided in this paragraph. We also feel that in this situation, the capital loss that results from the application of paragraph 111(4)(d) of the Act would not be deductible under subsection 248(28) of the Act.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 21
Re: CAPITAL GAINS DEDUCTION AND CUMULATIVE NET INVESTMENT LOSS
QUESTION
Does a benefit calculated under paragraph 80.4(2) or an amount taxed under subsection 15(1) of the Act affect the CNIL?
REPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
We feel that any amount included in income under subsection 15(1), because of subsection 15(9) and paragraph 80.4(2), or any other benefit mentioned therein, will reduce the CNIL.
An amount included in income under subsection 15(1) of the Act constitutes income from a property for the purposes of calculating the CNIL. Subsection 15(1) is part of Subdivision b of Division B of the Act which covers income from a business or property.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 22
Re: Application of paragraph 69(1)(b) of the Act
The preamble to paragraph 69(1)(b) in the French version of the Act differs from the English version. According to the French version, the paragraph can be applied when the taxpayer disposes of a property, while according to the English version, the paragraph can be applied when the taxpayer disposes of "anything", which is translated by "quoi que ce soit". At first glance, it seems that the English version is broader than the French.
QUESTION
Since both versions are of equal value, which version should be used? Are there any plans to make any changes to ensure that both versions are comparable?
REPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATION DIRECTORATE
"Anything" means "any kind of thing" and we feel that the English and French versions of paragraph 69(1)(b) of the Act are comparable. Further, the English and French versions of paragraph 4 of Interpretation Bulletin IT-405 show a similar application of paragraph 69(1)(b).
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 23
Application of section 67.1 of the Act
Interpretation Bulletin IT-518R, Food, Beverages and Entertainment Expenses, interprets the expression "food and beverages" found in section 67.1 of the Act in a broad manner. Does that mean that the 50% limitation in subsection 67.1(1) of the Act applies every time this type of expense is found, except when one of the exceptions applies? For example, does this limitation apply when expenses are incurred to purchase bottles of liquor that will be given to clients, although they are not consumed immediately?
According to paragraph 14 of IT-518R, meals and beverages served, and entertainment provided while travelling on an airplane, train or bus, are not subject to the 50% limitation if the cost of meals, beverages and entertainment are included in the travel fee. Why does it specify that this exception does not apply to food, beverages and entertainment provided while travelling by ship, boat or ferry, which are therefore subject to the 50% limitation?
Response from the Income Tax Rulings and Interpretations Directorate
Subsection 67.1(1) of the Act provides that, for the purposes of this Act, other than sections 62 (moving expenses), 63 (child care expenses) and 118.2 (medical expense credit), an amount paid or payable in respect of the human consumption of food or beverages or the enjoyment of entertainment shall be deemed to be 50% of the lesser of the amount actually paid or payable in respect thereof and an amount in respect thereof that would be reasonable in the circumstances. Exceptions to this rule are set out in subsection 67.1(2) of the Act.
Reference is made in the English version of subsection 67.1(1) of the Act to "an amount paid or payable in respect of the human consumption of food or beverages ...". As indicated in Nowegijick v. Her Majesty The Queen, 83 DTC 5041 (SCC), the expression "in respect of" has a very wide scope, and we feel that because this expression is used in subsection 67.1(1), this subsection can apply to all meal-, beverage- and entertainment-related expenses.
Provision is made in paragraph 17 of IT-518R that the 50% limitation applies to the cost of food or beverages for human consumption, including any related expenses such as taxes and tips. The cost of a restaurant gift certificate is considered to be an expense for food or beverages and is subject to this limitation. We feel that this limitation also applies to expenses incurred to purchase bottles of liquor that will be given to clients, although they will not be consumed immediately, because this liquor is for human consumption.
Subsection 67.1(4) of the Act provides, for the application section 67.1 of the Act, that no amount paid or payable for travel on an airplane, train or bus shall be considered to be in respect of food, beverages or entertainment consumed or enjoyed while travelling thereon. Consequently, the meals and beverages served while travelling on these means of transportation and entertainment provided are not subject to the 50% limitation, provided these costs are included in the travel fee.
Since no mention is made in subsection 67.1(4) of the Act of the amount paid or payable for travel on a ship, boat or ferry, we feel that it is possible in certain situations that a portion of the amount paid to travel on one of these means of transportation relates to food, beverages or entertainment consumed or enjoyed during the trip. If so, we feel that the 50% limitation applies to this portion of the expense. According to the Department of Finance, subsection 67.1(4) of the Act does not include other means of transportation, such as, for example, a cruise, since in these situations a large portion of the amount paid or payable for the trip is usually considered to be in respect of food, beverages and entertainment consumed or enjoyed during the trip, as opposed to a trip on an airplane, train or bus, where, in most cases, a minimal portion of the amount paid or payable relates to these components.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 24
RE: CALCULATING THE ACB
When an investor acquires flow-through shares, as defined in subsection 66(15) of the Income Tax Act (the "Act"), the investor is deemed to have acquired them at a cost of nil under subsection 66.3(3) of the Act.
If, further to an audit, the Department decreases or disallows the exploration expense deduction, for example, because the expenses were not incurred, the adjusted cost base of the shares is not changed to take into account the fact that the deduction was disallowed.
If an investor acquires what is believed to be flow-through shares and it is subsequently determined that these shares are not flow-through shares, the exploration expense deduction will be zero. Since the share is not a flow-through share, its cost is not deemed to be nil.
A share may not be a flow-through share if it is an excluded share as defined in sections 6202 and 6202.1 of the Income Tax Regulations.
Shouldn't the adjusted cost base of the shares in both situations be corrected?
Responses from the Income Tax Rulings and Interpretation Directorate
There is no provision in the Act to increase the adjusted cost base of shares in the first situation described above. Determining whether the adjusted cost base of shares should be changed under specific circumstances is a tax policy issue, which is the responsibility of the Department of Finance. The Department of Finance has not found it necessary to amend the Act in order to require an adjustment to a taxpayer's adjusted cost base of flow-through shares in this situation. Consequently, the cost remains nil and the adjusted cost base of the shares will not change.
In the second situation, the cost of the shares will not be deemed to be nil.
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1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 27
Subsections 69(1) and (4) of the Act
Émile holds more than 50% of the shares of a corporation involved in the construction industry in the province of Quebec. The corporation hires 20 employees, but does not sell materials. It earns 10 to 15% profit on most of its contracts. However, it charges 5% in administrative costs and 5% in profit on some contracts. The corporation uses this method to invoice certain clients (other than Émile), whether it deals with them at arm's length or not.
The corporation has, on a few occasions, carried out work at Émile's residence. No part of this residence is leased to or used by the corporation. The materials purchased from various suppliers are delivered to Émile's residence. Employees of the corporation install some of these materials, and the rest is installed by sub-contractors.
The corporation periodically invoices Émile for work performed during the period. The only information disclosed on the invoices is the amount to pay and the period involved. Since this work seems to have been invoiced at cost or less, an assessment is going to be established under subsection 15(1) of the Act with respect to Émile.
The question now is, to what extent do subsections 69(1) and (4) of the Act apply to the corporation?
Response from the Income Tax Rulings and Interpretations Directorate
We feel that a transaction through which a corporation confers a benefit on a shareholder can result in the application of both subsection 15(1) of the Act with respect to the shareholder, and the application of subsection 69(1) or (4) of the Act with respect to the corporation (see document E72399). In Gee-Gee Investments Limited v. MNR, 94 DTC 1419, and Dailley Recreational Services Limited and Birginia M. Dailley v. MNR, 85 DTC 134, the Tax Court of Canada concluded that the transactions involved the application of paragraph 69(1)(b) of the Act to the corporation and subsection 15(1) of the Act to its shareholder.
Subparagraph 69(1)(b)(i) of the Act presumes, except as expressly otherwise provided in the Act, that where a taxpayer disposes of anything to a person with whom the taxpayer was not dealing at arm's length for less than the fair market value thereof, the taxpayer shall be deemed to have received proceeds of disposition therefor equal to that fair market value.
Further, provision is made in subsection 69(4) of the Act to add the amount that exceeds the fair market value of a property to the corporation's income that the corporation received when the sale of this property would have increased the corporation's income or reduced a loss of the corporation. Please note, that for the purposes of the application of subsection 69(4) of the Act, it must be shown that the property actually was "appropriated", and not just "disposed" of.
In the foregoing situation, if the corporation is only an agent, and it does not purchase the materials delivered to Émile's residence, paragraph 69(1)(b) of the Act would not apply because the corporation would not have disposed of any property. The same would be true for subsection 69(4) of the Act. We feel that in this particular case, the services provided would not represent property that had been "appropriated", or property that had been "disposed of".
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 28 - DEDUCTIBILITY OF A PAYMENT
The Supreme Court of Canada ruled in favour of Canderel Limited (98 DTC 6100) with respect to the year in which an inducement payment is deductible. The Appeals Directorate Decision 95-32R establishes the Department's position for other objections or appeals. Three conditions are mentioned in it under which payments are deducted in the year in which they were made. The Department also continues to accept that our analysis begins with a review of the Act and generally accepted accounting principles (GAAP).
Is the outcome of this case and the directive going to greatly change the way we establish our assessments?
RESPONSE FROM THE INCOME TAX RULINGS
AND INTERPRETATIONS DIRECTORATE
The Department's position in this regard was set out at the 1998 APFF Round Table and in Income Tax Technical News No. 16 of March 8, 1999.
The Supreme Court set out six principles for calculating profit for the purposes of the Act that must be applied to each specific case in order to determine whether income was calculated according to the current legal framework and whether this income provides an accurate picture of the taxpayer's profit for the year in question.
The six principles are:
1. The determination of profit is a question of law;
2. Profit is determined by setting against the revenues from the business for that year the expenses incurred in earning said income;
3. In seeking to ascertain profit, the goal is to obtain an accurate picture of the taxpayer's profit for the given year;
4. The taxpayer is free to adopt any method which is not inconsistent with the provisions of the Income Tax Act, established case law principles or "rules of law" and well-accepted business principles;
5. Well-accepted business principles, which include but are not limited to the formal codification found in GAAP, are not rules of law but interpretative aids on a case-by-case basis, depending on the facts of the taxpayer's financial situation; and
6. On reassessment, once the taxpayer has shown that he has provided an accurate picture of income for the year, which is consistent with the Act, the case law, and well-accepted business principles, the onus shifts to the Minister to show either that the figure provided does not represent an accurate picture, or that another method of computation would provide a more accurate picture.
It is therefore the Department's responsibility in future to prove that the method it uses to calculate income for tax purposes provides a more accurate picture of income than the taxpayer's method. If the proof can be interpreted equally well in both ways, the taxpayer will prevail, and the payment will be more often deemed a running expense.
It is important to note that the Department does not consider GAAPs as the starting point. The Department does not want to place more emphasis on GAAPs than recommended by the Supreme Court. It is reasonable, in our opinion, to recognize well-accepted business principles, such as GAAPs, as interpretative aids that must be used in each individual situation with a view to obtaining the most accurate picture possible of profit.
The decisions in the Canderel and Toronto College Park cases do not mean that all tenant inducement payments will be deductible in the year in which they were paid. When the facts are identical to those in Canderel or Toronto College Park, particularly in situations where the expenses gave rise to sufficient running expenses, the Department agrees that tenant inducement payments are deductible as "running expenses". It could, however, decide in situations that differ from the Canderel case, namely when the expense was incurred with the specific purpose of producing an identifiable future income, to apply the matching principle with respect to the deductibility of inducement payments. This issue can only be resolved after examining each specific situation.
Taxpayers who have already filed their returns based on the Department's previous position, adjustment requests submitted to create refunds or to take the Supreme Court decision into account will not be processed. This is in keeping with the Department's policy set out in paragraph 4 (e) of Information Circular 75-7R3.
The issue as to whether taxpayers who filed their returns in 1995 and 1996 based on the Department's previous position can, in 1997, claim, based on the Supreme Court decision, the unamortized amount of the inducement payment, will depend on the particular facts of a given situation. When the facts are identical to those in the Canderel (or Toronto College Park) case and the payments are considered running expenses that would have been deductible in the year in which they were incurred, it is acceptable to deduct from the return for the current year, the unamortized amount of the inducement payments.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 29 - APPLICATION OF SUBSECTION 20(4) OF THE ACT
Mr. X disposed of a building and a lot in 1994 for $200,000, which represents the balance of the mortgage to be paid. Mr. X claims a capital loss on the lot and a terminal loss on the building, since its total cost was $250,000.
Mr. Y, the buyer, assumes the mortgage, but the bank requires as a condition that
Mr. X remain the guarantor of the mortgage. Mr. Y goes bankrupt in 1997 and the bank forecloses. The balance of the mortgage is $190,000, but the fair market value of the property is $150,000. The bank requires Mr. X to pay the $40,000 difference, since he is the original and sole guarantor of the mortgage.
Mr.X. claims that the $40,000 he had to pay the bank becomes an uncollectible portion of the proceeds of disposition of the building and he would like to apply subsection 20(4) of the Act for the applicable portion of the building.
Can Mr. X use subsection 20(4) of the Act or any other section of the Act to deduct an amount as a terminal loss instead of a capital loss for the building in 1997?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
In order to determine the tax treatment of an amount paid as mentioned above, the legal circumstances surrounding the payment must be established. Consequently, the contract of sale and the mortgage must be examined to establish which articles of the Quebec Civil Code are applicable.
Based on how the question is formulated, it seems that novation was effected on the mortgage as provided for in articles 1660 to 1666 of the Quebec Civil Code. The vendor provided a surety at the same time.
Novation is a legal transaction which consists in substituting a new debt for an existing debt, which differs from the former debt. Novation may be effected when a new debtor is substituted for a former debtor. Two separate legal transactions are therefore involved in novation: the existing debt is extinguished and a new debt is substituted for the former debt.
Pursuant to subsection 20(4) of the Act, an amount may be deducted in computing the taxpayer's income for the year when an amount that is owing to a taxpayer as or on account of the proceeds of disposition of depreciable property (other than a timber resource property or a passenger vehicle which costs more than $20,000) of the taxpayer of a prescribed class is established by the taxpayer to have become a bad debt in a taxation year.
When a taxpayer guarantees a new mortgage when a depreciable property is sold, it is our view that no amount is owed to the taxpayer on account of to the proceeds of disposition. Consequently, when the taxpayer carries out the guarantee, and acquires a debt equal to the payment, subsection 20(4) of the Act is not applicable.
It is our view that the loss incurred as a result of acquiring the debt by guaranteeing the mortgage could be deemed nil under paragraph 40(2)(g)(ii) of the Act if the facts of the particular case do not lead one to believe that the guarantee was acquired by the taxpayer to earn or derive income from business or property.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 30
RE: APPLICATION OF PARAGRAPH 18(1)(r)
FACTS
Based on paragraph 18(1)(r) of the Act and section 7306 of the Regulations, since
January 1, 1997, a taxpayer cannot deduct more than $0.35 a kilometre for the first 5,000 kilometres, and $0.29 for the excess kilometres.
If a corporation pays, for example, $0.40 a kilometre, it will receive an Input Tax Credit (GST) and an Input Tax Rebate (QST) totalling $0.05. The net amount that it will claim in its financial statements will be $0.35.
QUESTION
Since the amount paid as an allowance is $0.40 a kilometre, should the excess $0.05 be disallowed?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
We are of the view that the excess $0.05 is not deductible. Although the taxpayer records only $0.35 in his/her financial statements, this amount is the excess of the allowance paid, that is, $0.40 in GST refunds and QST rebates, which are, in fact, income. The amount paid or payable for the purposes of the Act remains $0.40.
Provision is made in paragraph 67.1(1) of the Act that the amount paid or payable in respect of meals, beverages and entertainment shall be deemed to be 50% of the lesser of the amount actually paid or payable or an amount in respect thereof that would be reasonable. If the cost of meals including $7.00 in GST is $107.00, the amount subject to the 50% limitation is $107.00, that is, the amount paid regardless of the GST refund and QST rebates that can be received.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
QUESTION 31 - SALE OF ACCOUNTS RECEIVABLE - "FACTORING"
When a corporation sells its accounts receivable at a discount to a financial institution or an entity whose main activity consists in managing and collecting receivables (factoring corporation), it incurs a loss.
What is the Department's position on the treatment of the loss: capital loss or financing costs? There are various repercussions involved in both treatments (i.e. "off balance sheet financing", capital tax, Part I.3 tax). Could you elaborate on the repercussions?
Is there a difference in terms of tax treatment if the sale at a discount occurs only once for a list of fixed accounts receivable versus a corporation that continuously sells its accounts receivable for financing purposes?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
As mentioned in paragraph 1 of Interpretation Bulletin IT-442R, a loss incurred on the sale of accounts receivable is usually deductible by the taxpayer as a general business expense, provided that the disposition of the debt occurs in the ordinary course of business. Generally, it is our view that the sale of accounts receivable, other than as part of the selling of a business, is income since this transaction occurs in the ordinary course of the taxpayer's business. This position is supported by The E.C.E. Group. Ltd. v. M.N.R., 92 DTC 2019.
Consequently, when it is established that accounts receivable have been sold under a factoring contract, the discount represents a deductible general business expense. This discount cannot be the financing costs, since it was not incurred in the course of a borrowing of money.
The same treatment is applicable when it is established that the taxpayer actually sold its accounts receivable as part of the securitization (1) of accounts receivable. It is a question of corporate law and of fact whether accounts receivable were sold or a loan guaranteed by accounts receivable.
Securitization is the creation of marketable securities, which are guaranteed by various types of assets, including accounts receivable. In the typical securitization of the sale and purchase of accounts receivable, the business sells its accounts receivable to a collateralized security entity that finances the acquisition by issuing marketable securities on capital markets. The vendor immediately receives the proceeds of the sale less a discount and a deduction from the selling price. The deduction from the selling price is paid to the vendor based on the losses on the accounts receivable and must be part of the selling price. Consequently, the deduction from the selling price should not usually create a tax loss at the time when the accounts receivable are sold.
Based on Millford Development Limited v. Her Majesty The Queen, 93 DTC 5052, it is our view that the frequency with which accounts receivable are sold should not, in and of itself, change the nature of the discount on the sale of accounts receivable.
With respect to Part I.3 tax, provision is made in subsection 181(3) of the Act that the carrying value of an amount under this Part in respect of a corporation's capital is that presented to the shareholders of the corporation where such a balance sheet was prepared in accordance with generally accepted auditing principles. The true nature (legal nature) of the amount is, however, the instrumental factor in determining its nature for the purposes of Part I.3, not how an amount is presented for accounting purposes.
If a corporation sells its accounts receivable under a factoring or securitization contract and uses the proceeds to reduce its debts, it is using an acceptable method to minimize its Part I.3 tax.
(1) A very informative document on securitization is available on Page 23:1 and subsequent pages of the Canadian Tax Foundation's 1992 Conference Report.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 32
Application of paragraph 6(1)(a)
An audit of a corporation shows that no benefit is included on employees' T4s for subsidized meals from the corporation's cafeteria. These meals were prepared by a caterer and charged to the corporation. Employees do not reimburse any amount for the meals. The employer refuses to include a benefit on the employees' T4s. It says that it cannot accurately determine which of its employees eats in its cafeteria.
Is there a benefit to be included on employees' T4s? If so, how should it be calculated?
Response from the Income Tax Rulings and Interpretations Directorate
In general, the fact that an employer pays a third party for the costs of an employee's meal means that a taxable benefit must be included under paragraph 6(1)(a) of the Act in calculating this employee's income. If the employer pays the caterer for the total cost of an employee's meal, the taxable benefit for the employee will be the amount the employer pays the caterer for this meal. If the employee reimburses a portion of the cost of his/her meal, this amount will reduce the value of the benefit to be included in the employee's income.
According to the administrative practice set out in paragraph 28 of Interpretation Bulletin IT-470R, Employees' Fringe Benefits, subsidized meals provided to employees will not be considered to confer a taxable benefit provided the employee is required to pay a reasonable charge. A reasonable charge is generally defined as one that covers the cost of the food, its preparation and service. This administrative practice applies only when the cafeteria is operated by the employer.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Questions 33 and 36
A taxpayer purchases a triplex in 1987. He must spend $40,000 on work because of a hidden defect. He capitalizes $13,000 and claims $27,000 as a maintenance and repair expense in 1988.
He institutes legal proceedings against the vendor for hidden defect. In 1996, the latter is ordered to pay the taxpayer $80,000 as follows:
$40,000 Capital cost
$37,000 Refund of interest
$3,000 Refund of expenses
The vendor is also ordered in the ruling to pay interest on the $80,000 from the date of the ruling to the date of the payment.
What tax treatment should this amount received in 1996 be given, and which section or section(s) govern each of its components?
Response from the Income Tax Rulings and Interpretations Directorate
The reimbursement of current expenses is usually income during the year in which it was received under section 9 of the Act. Failing section 9, the provisions of paragraph 12(1)(x) of the Act could apply, depending on the circumstances.
Paragraph 9 of Interpretation Bulletin IT-365, Damages, sets out the Department's position on the reimbursement of capital expenses. Mention is made in it that where the amount of compensation relates to a particular asset that was not disposed of, the amount will serve to reduce the cost of that asset to the taxpayer. The provisions of paragraph 12(1)(x) of the Act could also apply, depending on the circumstances, and the amount received could be included in the taxpayer's income. An election provided for in subsection 13(7.4) allows the taxpayer to reduce the cost by an amount elected under that subsection in respect of that property. If the property was disposed of, provision is made in paragraph 9 of Interpretation Bulletin IT-365 that the amount received will be considered proceeds of disposition of that asset.
In all cases, it is important to establish the reasons why the recipient received the payment. Therefore, the clauses of the contract between the parties, the provisions of a settlement or ruling or any other relevant fact must be taken into account when analyzing each case. Depending on the circumstances, certain court decisions should be considered, such as Mohawk Oil Ltd (92 DTC 6135) and Westcoast Energy Inc. (92 DTC 6253).
If the purchaser received an amount to waive his/her right to take legal proceedings against the vendor, it is our opinion that the amount received could constitute the proceeds of disposition of this right. Business income or capital gains could therefore result from it.
The interest the purchaser receives for the period following the date of the ruling will be taxable under paragraph 12(1)(c) of the Act.
1999 ROUND TABLE
Annual Conference of Quebec Region Technical Advisers
Question 34
Expenses incurred to purify a corporation's assets
When a corporation incurs expenses for the sole purpose of allowing a shareholder to crystallize his/her capital gains deduction provided for in subsection 110.6 of the Act, the amount of these expenses is not deductible. This amount also represents a benefit the corporation conferred on the shareholder for the purposes of subsection 15(1) of the Act. What if the corporation incurs expenses in order to purify its assets, and as a result of this purification, some of its shareholders would eventually be able to benefit from the deduction provided for in subsection 110.6 of the Act?
Response from the Income Tax Rulings and Interpretations Directorate
Under paragraph 18(1)(a) of the Act, expenses shall not be deducted that were not incurred for the purpose of gaining or producing income from a business or property. Further, expenses that were not incurred for the purpose of gaining or producing income from a business are not "eligible capital expenditures" as defined in subsection 14(5) of the Act. However, the portion of these expenses that can reasonably have been incurred in connection with the corporation's business may be deductible or capitalized, depending on the case.
When determining the value of the benefit for the purposes of subsection 15(1) of the Act, the portion of these expenses that can reasonably have been incurred in connection with the corporation's business must also be disregarded. The value of the benefit that the corporation conferred on the shareholder for the purposes of subsection 15(1) of the Act, is not always equal to the amount of the deduction disallowed to the corporation. The exact value of the benefit can only be determined after all the relevant facts have been examined in detail. For example, this value may be nil in the case of a shareholder who has already deducted the maximum capital gains deduction provided for in paragraph 110.6(4) of the Act.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 35
According to paragraph 23 of Interpretation Bulletin IT-143R2 - Meaning of eligible capital expenditure, in order for legal and accounting fees to be considered eligible capital expenditures when an abortive attempt is made to acquire the shares of a corporation, the taxpayer must demonstrate that he proposed to make the business of the corporation part of a similar business which the taxpayer already operated.
Should the word "part" be interpreted as meaning that the taxpayer planned to amalgamate with the corporation or to wind-it up?
RESPONSE FROM THE INCOME TAX RULINGS AND INTERPRETATIONS DIRECTORATE
The Department has not specified how the business should form part of the taxpayer in order for legal and accounting fees to be eligible capital expenditures. If a taxpayer planned to amalgamate with a corporation or if a winding-up was planned, it is our opinion that the corporation would form "part" of the business of the taxpayer as required under paragraph 23 of the Bulletin. If the corporation that the taxpayer planned to acquire was going to be part of a similar business of the taxpayer under circumstances other than those of an amalgamation or a winding up, it is our opinion that the Department could accept that the legal and accounting fees qualify as eligible capital expenditures.
The taxpayer must be able to demonstrate how they planned to make the corporation "part" of a similar business of the taxpayer. The Department will then take all the relevant facts into account when analysing the case.
As indicated in paragraph 18 of Interpretation Bulletin IT-259R3 - Exchange of Property, the term similar business must be interpreted in a reasonably broad manner.
1999 ROUND TABLE - ANNUAL CONFERENCE OF QUEBEC REGION TECHNICAL ADVISERS
Question 37
Application of paragraph 12(1)(a) of the Act
Based on Kenneth B.S. Robertson Ltd. v. Minister of National Revenue, 2 DTC 655, an amount received must possess the essential qualities of income, namely, that the recipient's should have an absolute right to it and be under no restriction, contractual or otherwise, as to its disposition, use or enjoyment. It appears, however, that an amount received for a service to be provided or for goods to be delivered is, in most cases, subject to a security clause that the client can exercise under certain conditions, and be reimbursed thereunder all or part of the amount if the goods or service do not satisfy the client or meet certain requirements.
Does a security clause such as that mentioned above constitute a restriction affecting the disposition, use or enjoyment of the amount? Does an amount affected by such a security clause have to be included in the taxpayer's income under paragraph 12(1)(a) of the Act?
Response from the Income Tax Rulings and Interpretations Directorate
An amount is an income inclusion under paragraph 12(1)(a) of the Act if it is received on account of services not rendered, goods not delivered or if it may be regarded as not having been earned in the year or a previous year.
This usually could occur in situations where an amount should be reimbursed to a client for services not rendered or goods not delivered. An amount is, however, considered earned if the taxpayer was under no restriction, contractual or otherwise, as to its disposition, use or enjoyment, or if the taxpayer has the absolute and unconditional right to this amount. This amount must be reported as income under section 9 of the Act. These concepts were raised in Her Majesty The Queen v. Foothills Pipe Lines (Yukon) Ltd., 90 DTC 6607, Westcoast Petroleum Ltd. v. Her Majesty The Queen, 89 DTC 5153 and Burrard Yarrows Corporation v. Her Majesty The Queen, 86 DTC 6459, and the courts deemed that the amounts involved constituted income for the purposes of section 9 of the Act.
Provision can be made in contracts for the client to undertake to pay a security deposit in order to guarantee that he/she will respect his/her commitments. If the latter withdraws, the beneficiary (vendor, manufacturer) will keep the deposit. Otherwise, the beneficiary, is obligated to reimburse the deposit. In Minister of National Revenue v. Atlantic Engine Rebuilders Limited, 67 DTC 5155, the Supreme Court ruled that this type of deposit could not constitute income for the purposes of the Act because the deposits could not be regarded as forming part of the corporation's profits and because it was part of its assets for which the beneficiary has a corresponding contingent liability equal in amount.
The question as to whether an amount is earned in a given situation is a question of fact to be determined with all the facts and circumstances. We feel, however, that the possibility of having to reimburse an amount under a security clause would not be sufficient in and of itself to indicate that the amount in question is not earned.
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