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.
Principal Issues: (a) Are the taxpayers restricted financial institutions ("RFI") within the meaning of paragraph (e) of the definition in subsection 248(1)?
(b) Are the taxpayers financial institutions ("FI") as defined in subsection 142.2(1)?
(c) Whether the income from the conditional sales agreements ("CSAs") and the leases ("Leases") constitute income from specified debt obligations ("SDO")?
(d) Whether the costs of an SDO would include allocated costs (the "LOCs")?
Position: (a) Yes, both A Co and Leaseco are RFIs.
(b) Yes, both A Co and Leaseco are FIs.
(c)
(i) A Co, yes, provided a CSA is a conditional sales agreement.
(ii) Leaseco, perhaps no, provided the Lease is described in paragraph 142.2(1)(c) and (d) of the SDO Definition.
(d) No, perhaps.
Reasons: (a) Factual determination.
A Co is an RFI pursuant to paragraph 248(1)(e) and (e.1) of the RFI Definition. Leaseco is controlled by A Co, an RFI and accordingly Leaseco is also an RFI pursuant to paragraph 248(1)(f) of the RFI Definition.
(b) As an RFI, A Co is also an FI pursuant to subparagraph 142.2(1)(a)(i) of the FI Definition. Leaseco is controlled by A Co, an FI and accordingly, Leaseco is also an FI pursuant to subparagraph 142.2(1)(a)(iii) of the FI Definition.
(c)
A Co
Generally, a conditional sales agreement is an SDO and thus income received on a conditional sales agreement represents income from an SDO. However, it is a question of fact as to whether a CSA is a conditional sales agreement and as we have not examined any documents we are no able to make this determination. However, if a CSA is a conditional sales agreement it is likely an SDO and as such any income received by A Co on a CSA would represent income from an SDO.
Leaseco
It is a question of fact as to whether a Lease would constitute an indebtedness or a debt obligation described in paragraphs 142.2(1)(a) and (b) of the SDO Definition. If paragraph 142.2(a) or (b) applies, it must then be determined if the Lease is exempted pursuant to paragraphs 142.2(1)(c) and (d) of the SDO Definition.
(d) If it is determined that the CSAs and the Leases are SDOs for purposes of the Act and that the LOCs are not referable to any particular CSA or Lease, as the case may be, they should not, as stated in the Technical Interpretation, be amortized over the term of the obligation but rather, they should be regarded as running costs that are fully deductible in the year incurred for income tax purposes.
March 24, 2005
XXXXXXXXXX TSO HEADQUARTERS
Technical Applications and P. Diguer CGA
Valuations Division (613) 957-8953
Attention: XXXXXXXXXX
2005-011592
: XXXXXXXXXX ("A Co"
XXXXXXXXXX ("Leaseco")
This is in response to your e-mail ("Request") dated February 14, 2005 in which you request our views in regard to the above referenced taxpayers proposed change in the method of reporting of expenses incurred in connection with the acquisition of certain properties for purposes of the Income Tax Act (Canada) (the "Act").
Our understanding of the situation is as follows.
Facts
1. A Co is a taxable Canadian corporation and is a wholly owned subsidiary of XXXXXXXXXX, a corporation incorporated under the laws of the United States. A Co's taxation year-end is XXXXXXXXXX.
A Co's principal business activities include:
(i) the raising of capital for the XXXXXXXXXX ("Opco Group");
(ii) the financing of XXXXXXXXXX ("Opco XXXXXXXXXX") manufactured by XXXXXXXXXX ("Opco") and held for sale ("Opco XXXXXXXXXX Inventory") by Opco XXXXXXXXXX ("Opco XXXXXXXXXX"); and
(iii) the purchase of what are referred to as conditional sales agreements ("CSA") from Opco XXXXXXXXXX. The CSA's are purchased from Opco XXXXXXXXXX following the sale and financing of Opco XXXXXXXXXX to consumers. Generally, CSAs run for periods of between XXXXXXXXXX and XXXXXXXXXX years. A Co services and collects on the purchased CSA's.
The CSA activity is the largest of A Co's business activities. XXXXXXXXXX.
2. Leaseco is a taxable Canadian corporation and is a wholly owned subsidiary of A Co. Leaseco's taxation year-end is XXXXXXXXXX.
Leaseco's principal business activity is the servicing and collecting on leases of Opco XXXXXXXXXX to consumers ("Leases") purchased by Leaseco from Opco XXXXXXXXXX. Generally, Leases run for periods of between XXXXXXXXXX and XXXXXXXXXX years. Leaseco sells the XXXXXXXXXX.
3. A Co and Leaseco incur expenses in connection with the acquisition of the CSAs and Leases, respectively and these expenses are referred to as loan originating costs ("LOCs"). A Co's and Leaseco's LOCs include direct costs related to system charges, salaries and wages, and the costs associated with the processing of CSAs and Leases and credit decision costs (i.e. outside credit reports).
The direct costs mentioned above are pooled and each of A Co and Leaseco then divide the pooled amount by the number of CSAs or Leases, as the case may be, to determine a dollar amount attributable to each contract. Currently, LOCs are estimated to be $XXXXXXXXXX (the "Per Contract LOC") for each new CSA and Lease purchased. A Co and Leaseco set up the Per Contract LOC amount as an asset with a corresponding credit to origination costs on the income statement. At XXXXXXXXXX the unamortized LOCs on A Co's and Leaseco's balance sheet was $XXXXXXXXXX and $XXXXXXXXXX, respectively.
4. For accounting purposes, both A Co and Leaseco currently amortize LOCs over the life of the CSA or Lease, as the case may be, as an expense deducted from income. CSAs are amortized on an actuarial basis whereas Leases are amortized on a straight line basis.
You advise that this accounting treatment is consistent with AcG-4 issued by the CICA and FASB 91 and that according to these accounting pronouncements, only costs directly associated with the acquisition of contracts should be amortized.
5 In computing income for purposes of the Act, LOCs are treated by A Co and Leaseco in the same manner as for accounting purposes. In this regard, both A Co and Leaseco currently amortize LOCs over the life of the CSA or Lease, as the case may be, as an expense deducted from income.
6. A Co and Leaseco wish to change their respective treatment of LOC's in computing income for purposes of the Act. In A Co's and Leaseco's view, LOCs are general business expenses incurred in the operation of their respective businesses and accordingly should be deductible as incurred in computing income for tax purposes (the "LOC Change"). As such, following the implementation of the LOC Change by A Co and Leaseco the timing of deductions for LOC's will differ for accounting and for tax purposes.
7. Changes to both A Co and Leaseco electronic data processing systems ("EDP Systems") are required in order to track the LOCs for the LOC Change. The EDP System changes required by A Co will be relatively quick and easy to accomplish. However, EDP System changes required by Leaseco will take considerably more time to accomplish.
As such, A Co wishes to implement the LOC Change effective XXXXXXXXXX (i.e. its XXXXXXXXXX taxation year). However, Leaseco will defer implementation until EDP System changes are completed. You have not provided any indication as to whether Leaseco has set a tentative date for the implementation of the LOC Change.
8. A Co and Leaseco propose the following treatment of LOC's for taxation years ended before implementation of the LOC Change. Unamortized LOCs on the balance sheet prior to the LOC Change will continue to be deducted in a manner consistent with the accounting treatment. LOCs incurred after the proposed change will be deductible for tax purposes as incurred. In subsequent years an adjustment will be necessary to add back any accounting amortization related to LOCs incurred after the change. In addition, LOCs will have to be tracked during the transition period of CSAs and Leases that are securitized by A Co and Leaseco, respectively.
9. Before proceeding with the implementation of the LOC Change, both A Co and Leaseco are seeking CRA's views in regards to this matter.
10. In a technical interpretation ("Technical Interpretation") document1 dated March 30, 1999, issued by the Income Tax Rulings Directorate, involving a set of circumstances similar2 to the situation described above, it was determined that the LOCs in that particular set of circumstances were not referable to any particular item of revenue in the year of payment or in any subsequent year. Rather, it was determined that the LOCs were incurred in running the business as a whole and that there were sufficient current benefits to the payor to justify their treatment as running expenses. The CRA concluded that, in that particular set of circumstances, the LOCs should not be amortized over the terms of the obligation but rather that they should be regarded as running expenses that are fully deductible in the year incurred for income tax purposes.
You ask:
(a) Are A Co and Leaseco restricted financial institutions ("RFI") within the meaning of paragraph (e) of the definition in subsection 248(1)?
(b) Are A Co and Leasco financial institutions ("FI") as defined in subsection 142.2(1)?
(c) Whether the CSAs and the Leases are conditional sales contracts and hence the income from the CSAs and Leases constitute income from specified debt obligations ("SDO")?
(d) Whether the costs of an SDO would include allocated costs (the LOCs)?
In your view:
(a) A Co and Leaseco are RFIs. However, you state that A Co would not be considered an RFI within the meaning of 248(1)(e) of the definition since the court decision in General Motors Acceptance Corporation of Canada v. The Queen3 , "established that a conditional sales agreement is not a loan as the judge determined that there was no lender borrower relationship between the taxpayer and the consumers. Therefore 248(1)(e) did not apply." However, A Co is nevertheless an RFI pursuant to paragraph 248(1)(e.1).
(b) A Co and Leaseco are each an FI.
(c) Yes, income from the CSAs and Leases acquired by A Co and Leaseco, respectively, constitute income from an SDO.
(d) No.
We have not examined any CSAs, Leases or other documents relating to the transactions described above and our understanding of the facts are restricted to the information disclosed in your referral and described above. Accordingly, our comments below in regards to certain issues are of a general nature.
Our comments below follow the ordering of your queries as set out in your e-mail.
(a) RFI
We agree that based upon the information provided in your referral both A Co and Leaseco are RFIs.
In this regard, the determination of whether a taxpayer is an entity that is a "restricted financial institution" ("RFI") within the meaning of that term as defined in subsection 248(1) of the Act (the "RFI Definition") is a question of fact.
A Co and Leaseco will be considered as RFIs' if they are corporations described in any of paragraphs (a) to (f) of the RFI Definition.
A Co
248(1)(e) of the RFI Definition
Pursuant to paragraph (e) of the RFI Definition, an RFI includes a corporation:
... whose principal business is the lending of money to persons with whom the corporation is dealing at arm's length or the purchasing of debt obligations issued by such persons or a combination thereof...
(our emphasis added)
Thus, an RFI includes a corporation whose principal business is either:
(a) The lending of money at arm's length; or
(b) the purchasing of debt obligations issued by arm's length persons.
XXXXXXXXXX
You appear to conclude that absent a lender-borrower relationship a CSA acquired by A Co is not a loan. We agree that A Co is not lending money such that it would not meet the condition described in (a) above.
However, in our view, A Co would likely meet the condition described in (b) above (i.e. purchasing of debt obligations) such that A Co would be an RFI pursuant to paragraph 248(1)(e) of the RFI Definition. We opine that A Co is "likely" an RFI, because we have not examined a CSA and accordingly are unable to state with certainty that a CSA is a conditional sales agreement, to which the comments below apply.
In this regard, the term "debt obligation" is not defined in the Act. According to Creditor - Debtor Law in Canada, Dunlop 2nd Ed. 1995, there is no all-encompassing definition of "debt" and defining this term or the term "debt obligation" is not an easy task. While the text states that the meaning of the word "debt" is changing over time, the most commonly accepted meaning or use of the word "debt" is to describe an obligation to pay a sum certain or readily reducible to certainty. In Beament Estate v. M.N.R4 , the court noted that the term "debt" is not defined in the Act and thus takes its ordinary meaning which is a sum payable in respect of liquidated money demand, recoverable by action. At the 1984 Canadian Tax Foundation conference,5 the CRA stated that, "generally speaking, a "debt obligation" is considered to arise whenever a binding liability is created and the principal amount of the liability can be quantified."
In our view, amounts owing under the terms of a conditional sales agreements are generally "debt obligations" within the ordinary meaning of this term.6 As such, provided that the CSAs are conditional sales agreements, it is our view that A Co is a corporation whose principal business is purchasing of debt obligations and accordingly, would be, in our view, an RFI pursuant to paragraph 248(1)(e) of the RFI Definition.
248(1)(e.1) of the RFI Definition
Additionally, we agree that paragraphs 248(1)(e.1) would likely also apply with respect to A Co.
In this regard, pursuant to paragraph (e.1) of the RFI Definition, a corporation described in paragraph (g) of the definition of a "financial institution" ("Part I.3 FI") in subsection 181(1) of the Act is also an RFI.
A Co and Leaseco will be considered Part I.3 FIs if they are corporations described in any of paragraphs (a) to (g) of the meaning of the term Part I.3 FI as defined in subsection 181(1) of the Act (the "Part I.3 FI Definition").
Pursuant to paragraph (g) of the Part I.3 FI Definition, a prescribed corporation, listed in section 8604 of the Income Tax Regulations (the "Regulations") is a Part I.3 FI.
Pursuant to subsection 8604(e) of the Regulations, A Co is a Part I.3 FI. As such, A Co is also an RFI pursuant to paragraph 248(1)(e.1) of the RFI Definition.
Leaseco
Leaseco is not a corporation listed in subsection 8604 of the Regulations and as such is not a prescribed corporation described in paragraph 248(1)(e.1) of the RFI Definition.
However, Leaseco is controlled by A Co and is therefore an RFI pursuant to paragraph 248(1)(f) of the RFI Definition.
Draft amendments
If A Co and Leaseco are RFIs under the Act in its present form, they will continue to be RFIs under the draft amendments ("Draft Amendments") to the Income Tax Regulations dated December 20, 2002 (repealing Regulation 8604) and corresponding draft amendments to the Income Tax Act dated February 27, 2004 (see the draft schedule following subsection 260 of the Act), both applicable after December 19, 2002 provided the pending amendments are enacted substantially as described in the Draft Amendments.
(b) FI
We agree that based upon the information provided in your referral both A Co and Leaseco are FIs.
In this regard, A Co and Leaseco will be considered as FIs if they are corporations described in any of paragraphs 142.2(1)(a) to (e) of the definition of a "financial institution" (the "FI Definition").
A Co
A corporation that is an RFI referred to in paragraphs 248(1)(a) to (e.1) of the RFI Definition is considered an FI pursuant to subparagraph 142.2(1)(a)(i) of the FI Definition. Given our view that A Co is an RFI pursuant to paragraphs 248(1)(e) and 248(1)(e.1) of the RFI Definition, it follows that A Co is also an FI pursuant to subparagraph 142.2(1)(a)(i) of the FI Definition.
Leaseco
A corporation that is controlled by an FI, other than in narrow circumstances described therein, is considered an FI pursuant to subparagraph 142.2(1)(a)(i) of the FI Definition. Leaseco is controlled by A Co, an FI, and accordingly, Leaseco is an FI pursuant to subparagraph 142.2(1)(a)(iii) of the FI Definition.
(c) SDO
As noted in the Technical Interpretation,7 the intent of the SDO rules is to require the taxpayer to include the total expected economic return from the SDO over the term of the SDO. If the cost of the SDO is increased by the allocated costs, the accrued return to be included in the income of the taxpayer will decrease.
A Co
Our general position with respect to income from conditional sales agreements as set out in the Technical Interpretation remain unchanged. In this regard, provided that the CSAs are conditional sales agreements, it is our view that, the obligation under a CSA assigned to A Co can arguably fall under paragraph (a) or (b) of the SDO definition as defined below. Accordingly, unless one of the exclusions described in paragraph (c) or (d) of the SDO definition is applicable, it is our view that the obligation under the CSA constitutes an SDO with the result that A Co would have to compute its income from the CSA in accordance with the SDO rules. Where a taxpayer that is an FI holds an SDO, subject to subsections 142.3(3) and (4) of the Act, subsection 142.3(1) of the Act provides that the amounts to be included or deducted in computing income are the prescribed amounts in respect of the SDO.
Leaseco
The determination of whether a lease receivable, for example a Lease as described above, is an SDO within the meaning of that term as defined in subsection 142.2(1) of the Act (the "SDO Definition") is a question of fact.
In this regard, it is a question of fact as to whether a Lease would constitute an indebtedness or a debt obligation described in paragraphs 142.2(1)(a) and (b) of the SDO Definition.
XXXXXXXXXX
Paragraphs 142.2(1)(c) and (d) of the SDO Definition exempt certain types of indebtedness from the SDO rules. For example, paragraph (c) excludes, inter alia, "prescribed properties". XXXXXXXXXX. In this regard, prescribed properties for purposes of paragraph (c) of the definition of SDO are defined in Regulation 9004 which reads as follows:
... a direct financing lease, or any other financing arrangement, of a taxpayer that is reported as a loan in the taxpayer's financial statement for the year prepared in accordance with generally accepted accounting principles and an amount is deductible under paragraph 20(1)(a) of the Act in respect of the property that is the subject of the lease or arrangement in computing the taxpayer's income for the year.
XXXXXXXXXX
Thus, it remains to be determined whether the specific facts in the present case support a finding that the Leases are SDOs for purposes of the Act.
(d) LOC
Our general position with respect to LOCs incurred in running a business of acquiring, servicing and collecting on conditional sales agreement as set out in the Technical Interpretation remain unchanged.
In this regard, it must first be determined that the CSAs are conditional sales agreements and the Leases are SDOs for purposes of the Act. It must then be determined that the LOCs are not referable to any particular CSA or Lease, as the case may be. Such a determination is a question of fact. If it is determined that the costs are not directly associated with a particular CSA or Lease, as the case may be, they should not, as stated in the Technical Interpretation,9 be amortized over the term of the obligation but rather, they should be regarded as running costs that are fully deductible in the year incurred for income tax purposes.
We would be willing to consider this matter further in the event that the taxpayer provides additional information.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. 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 the electronic library version, or they may request a severed copy using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
If you have any questions concerning this matter please feel free to contact us.
Steve Tevlin
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch
ENDNOTES
1 Document No. 9904437.
2 i.e. a corporation with a business similar to A Co and the acquisition of conditional sales contracts from XXXXXXXXXX . However, the fact situation described in this document did not include a corporation with a business similar to that of Leaseco (i.e. the business of acquiring and servicing XXXXXXXXXX leases).
3 2000 DTC 1844 (TCC).
4 69 DTC 5016 (SCC).
5 Question No. 12
6 See Fingold v. MNR, 92 DTC 2393 (TCC); Beament supra 4 above and civil law definition of "obligation".
7 At page 8.
8 XXXXXXXXXX
9 At page 10.
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, 2005
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, 2005
Email this Content