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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues:
1. Should the calculation in subsection 18(4) be made using the average of the all of the calendar months that end in the year, even if there is no debt or equity outstanding in a particular month?
2. Does the term "beginning of a calendar month" in subparagraph 18(4)(a)(ii) mean the end of the previous month, or any time on the first day of the month?
3. If debt is repaid at the first instance in a month, will the debt be included in the computation of "outstanding debts to specified non-residents" in subparagraph 18(4)(a)(i)?
4. In determining the amount of PUC and contributed surplus at the beginning of a month for purposes of subsection 18(4), will we apply our position in paragraph 9 of IT-474R so that in the absence of a specified time, an amalgamation takes place at the earliest moment on a date?
Position:
1. Yes
2. Neither
3. No
4. Yes
Reasons:
1. The provision appears to contemplate that the averages be computed using all of the calendar months in the year.
2. The term "beginning of a calendar month" means the earliest moment on the first day of the month.
3. If the debt is extinguished at the earliest possible moment in a month, it can't be said to exist prior to that time in the month.
4. Section 87 intends to provide a rollover in an amalgamation that qualifies, and it would be reasonable to apply this position for the thin capitalization rules.
XXXXXXXXXX 2002-013698
S. E. Thomson
September 9, 2002
Dear XXXXXXXXXX:
Re: Interpretation of thin capitalization terms
This is in reply to your letter of April 23, 2002 and your subsequent emails in which you ask for our interpretation of certain terms contained in subsection 18(4) of the Income Tax Act (the "Act"). In your letter, you have set out the following three questions:
1. Should the calculation in subsection 18(4) of the Act be made using all of the calendar months that end in a year, even if there is no "outstanding debts to specified non-residents", "contributed surplus" and "paid-up capital" outstanding in a particular month? If so, this will result in a lower monthly average of those items, which will have an effect on the corporation's interest deduction (i.e., the amount of interest expense denied under subsection 18(4)) of the Act.
2. Does the term "beginning of a calendar month" in subparagraph 18(4)(a)(ii) of the Act mean the equity has to be in place at the end of the previous month? If contributed surplus or paid-up capital is injected at any time on the first day of the month, will we consider it have been outstanding at the beginning of the calendar month for purposes of the calculation in subsection 18(4) of the Act?
3. If debt is repaid at the first instance in a month, will the debt be included in the computation of "outstanding debts to specified non-residents" in subparagraph 18(4)(a)(i) of the Act for that month?
In addition, you set out several examples, and ask for our comments thereon.
In a subsequent email, you ask the following question:
4. In determining the amount of PUC and contributed surplus at the beginning of a month for purposes of subsection 18(4) of the Act, will we apply our position in paragraph 9 of IT-474R so that in the absence of a specified time, an amalgamation takes place at the earliest moment on a date? You are concerned about the following scenario:
Canco 1 and Canco 2 are wholly-owned subsidiaries of Non-Residentco. Canco1 and Canco 2 amalgamate into Amalco on the first day of the calendar month. Because of the hours of operation of various government bodies that approve or effect the amalgamation, it may be practically difficult to prove that an amalgamation occurred at the first moment in time on a day. Even though the debt to equity ratio for Amalco is within the 2:1 ratio immediately after the amalgamation, Amalco may be disallowed a deduction in respect of part of its interest expense under subsection 18(4) for the year if for the first month after amalgamation, Amalco is considered to have no PUC or contributed surplus at the "beginning" of the month.
Although you have asked for our technical interpretation on certain hypothetical situations, it appears that your request involves a transaction or series of transactions contemplated by a specific taxpayer. We refer you to Information Circular 70-6R5 Advance Income Tax Rulings, which is available at our website at www.ccra-adrc.gc.ca. Although we are precluded from commenting on a proposed transaction except in the context of an advance income tax ruling, we are able to offer the following comments on the general application of subsection 18(4) which may or may not apply to your situation. As such, these comments are not binding on the Canada Customs and Revenue Agency.
1. For purposes of the calculation in subsection 18(4) of the Act, we are of the opinion that all of the calendar months that end in a particular year should be taken into account when averaging the "outstanding debts to specified non-residents", "contributed surplus" and "paid-up capital" in that subsection, even if there were no outstanding debts to specified non-residents outstanding at any time in the particular month, or if the contributed surplus or paid-up capital were nil at the beginning of the particular month.
2. We are of the view that the phrase "the beginning of a calendar month" in subparagraph 18(4)(a)(ii) of the Act is a reference to the earliest moment of the particular calendar month. Therefore, an advance of equity on the first day of the month can be included in calculating a corporation's debt to equity ratio as long as the advance is made at the earliest moment on that day. However, an advance made at any other time on the first day would not be included in the corporation's debt to equity ratio until the next month. As a corollary, we note that it is not necessary for an advance of equity to have been made prior to the end of the previous month in order to be effective for thin capitalization purposes.
3. In our view, if the debt is extinguished at the earliest possible moment in a calendar month, then it is extinguished at that time, and can't be said to exist prior to that time in the month. Therefore, the extinguished debt would not be included in the calculation of "outstanding debts to specified non-residents" for that particular month.
4. Paragraph 9 of IT-474R Amalgamations of Canadian Corporations provides that, in the absence of a specified time in the certificate of amalgamation, the time of an amalgamation is the earliest moment on the date of amalgamation. In our view, if the position in paragraph 9 otherwise applies to the amalgamation, it would apply for the application of subsection 18(4). That is, we would consider the amalgamation to have occurred at the earliest moment on the day, and therefore, if the amalgamation took place on the first day of the calendar month, Amalco will have PUC and contributed surplus at the "beginning" of the month for purposes of subsection 18(4).
We trust that our comments have been of assistance.
Yours truly,
Olli Laurikainen
for Director
International & Trusts Division
Income Tax Rulings Directorate
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