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: Whether subparagraph 18(9)(a)(iii) of the Act applies to a premium paid in year 1 for product liability insurance that provides lifetime coverage against liability for products manufactured and sold in year 1.
Position: Yes
Reasons: The product liability insurance premium paid in year 1 guarantees coverage against liability arising from goods manufactured in year 1 for the life of the good. Since the year 1 premium provides coverage in respect of a period after the end of year 1, subparagraph 18(9)(a)(iii) of the Act would apply.
XXXXXXXXXX 2002-016978
Shaun Harkin, CMA
January 30, 2003
Dear XXXXXXXXXX:
Re: Technical Interpretation Request: Subparagraph 18(9)(a)(iii)
This is in reply to your letter of October 21, 2002 wherein you asked us if subparagraph 18(9)(a)(iii) of the Income Tax Act (the "Act") would apply in the following hypothetical situation:
1. At the commencement of year 1, XYZ Ltd. purchases a product liability insurance policy from an Insurer. This insurance policy is a standard "occurrence basis" policy which covers XYZ Ltd. for any product liability arising from goods that it manufactures in year 1.
2. In year 1, XYZ Ltd. manufactures its products and sells them to its customers. All goods manufactured in year 1 are sold in the year and all the revenue from these sales is recorded in year 1.
3. XYZ Ltd. does not renew its policy with the Insurer for year 2.
4. In year 3, product that was purchased in year 1 by Customer A from XYZ Ltd. fails causing Customer A to incur significant monetary losses.
5. In year 4, after reviewing the cause of the failure, Customer A determines that the failure was due to defective product sold to it by XYZ Ltd. in year 1.
6. In year 5, Customer A files a lawsuit against XYZ Ltd. to recover the monetary losses that it incurred as a result of the product failure in year 3.
7. In year 6, the lawsuit is settled out of court and Customer A receives compensation for its losses. These losses are fully covered by the Insurer as the product was manufactured in year 1 and such losses were covered under XYZ Ltd.'s product liability insurance purchased in year 1.
Specifically, you asked us if subparagraph 18(9)(a)(iii) of the Act would limit XYZ Ltd.'s insurance premium deduction in year 1? If yes, over what period of time should the insurance premium be taken into account in determining XYZ Ltd.'s income?
Written confirmation of the tax consequences inherent in a particular transaction or series of transactions are given by this Directorate only where the transaction(s) are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R5. Notwithstanding the foregoing, we are prepared to provide the following comments.
Subparagraph 18(9)(a)(iii) of the Act states:
Notwithstanding any other provision of this Act,
(a) in computing a taxpayer's income for a taxation year from a business or property (other than income from a business computed in accordance with the method authorized by subsection 28(1)), no deduction shall be made in respect of an outlay or expense to the extent that it can reasonably be regarded as having been made or incurred...
(iii) as consideration for insurance in respect of a period after the end of the year,...
The product liability insurance, purchased by XYZ Ltd. in year 1, insures XYZ Ltd. against liability arising from goods that it manufactures in year 1 for the life of those goods. Thus, the year 1 insurance premium paid by XYZ Ltd. provides it with benefits that extend over the life of the goods manufactured in year 1. Since the year 1 premium paid by XYZ Ltd. represents consideration for insurance in respect of a period after the end of year 1, we are of the view that the premium is a prepaid expense and that subparagraph 18(9)(a)(iii) of the Act would apply. Based on the facts, the amount that XYZ Ltd. would be entitled to deduct in any particular year would be calculated by taking into consideration expected claims against XYZ Ltd. over the life of the goods manufactured in year 1. However, given the difficulty in making this determination, we would likely allow XYZ Ltd. to amortize the year 1 premium equally over the average expected life of the goods manufactured in year 1.
The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Customs and Revenue Agency. Our practice is to make this disclaimer in all instances in which we provide an opinion.
We trust the above comments are of assistance.
Yours truly,
Daryl Boychuk, LL.B
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
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