7 October 1991 Income Tax Severed Letter - Indexed Deferral Plan

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.

STATEMENT OF PRINCIPAL ISSUES

XXX has requested a technical interpretation on the application of s. 20(1)(c), 12(1)(x) and 245(3) to loans made to farm producers by the XXX and under which the payment and interest terms have been modified by a program referred to as the Indexed Deferral Plan. A review of the documents submitted with the request indicate that under the plan a loan would operate as follows:

• 1. The farmer signs a promissory note for the principal amount of the loan with interest at 20% per annum. Interest is payable in the first period from the date of the promissory note until a specified date which ends the first period. Principal and interest is payable thereafter in equal consecutive annual instalments with each such instalment being applied firstly in payment of interest and secondly in reduction of the principal amount. If default is made in the payment of interest, then compound interest is payable at the same rate. If default is made on the payment of any instalment then the whole balance of principal plus accrued interest becomes due.
• 2. The farmer also signs an Interest Reduction Agreement which reduces the interest rate to 9% per annum as long as he remains the only beneficial owner of the security pledged. (The promissory note and the Interest Reduction Agreement are referred to as the "Existing Agreement").
• 3. The farmer also signs an Indexed Deferral Plan Loan Amendment Agreement (the "IDP Agreement") which permits partial payment deferrals based on ADC's opinion of price fluctuations of certain products or commodities of farm enterprises (the "Plan Index").
4. The terms of the IDP Agreement are:
• a) The payments which are due and payable under the Existing Agreement by the borrower during the period from and including April 1, 1988 to and including March 31, 1991 are to be varied in accordance with the IDP Agreement, subject to the limits provided therein.
• a) There are four "Plan Periods", i.e., the Initial Plan Period from April 1, 1988 to September 30, 1988, the Second Plan Period from October 1, 1988 to September 30, 1989, the Third Plan Period from October 1, 1989 to September 30, 1990 and the Fourth Plan Period from October 1, 1990 to March 31, 1991.
• b) At the time of execution of the IDP Agreement the parties establish and agree to an amount called the Initial Deferral Amount.
• c) The obligation of the Initial Deferral Amount is deferred to the end of the Initial Plan Period.
• d) If the Plan Index for the Second Plan Period is less than 1 then the obligation to pay the Initial Deferral Amount is further deferred until the end of the Second Plan Period and in addition the obligation to pay a portion of the payments required for the Second Plan Period is also deferred until the end of the Second Plan Period, such deferred portion being calculated by multiplying the payment originally required by 1 minus the Plan Index for the Second Plan Period.

If the Plan Index is equal or greater than 1 then there is no deferral of the payments required for the Second Plan Period and, based on a formula, part or all of the Initial Deferral Amount may become payable.

• e) Deferrals in the Third and the Final Plan Periods operate as described in d) above.
• f) No amount of the deferrals accrues interest unless it becomes payable.
• g) Where payments of deferred amounts are required to be made in a later period the maximum of all payments in the period cannot exceed the instalment payments under the original agreement multiplied by the Plan Index for the particular period.
h) All deferred amounts become due and payable on the earlier of March 31, 1991 or the maturity date of the existing agreement and interest will accrue on the amount that is due and payable from that date.
• i) The IDP agreement notes that it is the intention of the parties to agree upon and enter into an arrangement for payment of the remaining deferred amounts over a period of time after the date referred to in h) above and for the waiver of interest on the deferred amounts that are further deferred past that date. If the farmer does not enter into an agreement after that date, then the deferred amounts will bear interest and become payable on the date referred to in h).
• j) If the farmer pays the deferred amount it appears that the ADC will according to the IDP Agreement "refund" such a sum as an "overpayment".

It should also be noted that the dates referred to in the documents indicate that the technical interpretations requested relate to completed transactions. Therefore, we can only provide general comments on the sections mentioned and refer the XXX to the District Offices located in XXX pursuant to paragraph 21 of IC 70-6R2 [Information Circular 70-6R2].

ISSUE: Are the amounts to be refunded as an overpayment deductible pursuant to paragraph 20(1)(c)?

Essentially, the IDP Agreement is an agreement to vary the installment payments on existing loan agreements. The installments vary based on a commodity index. In effect, a portion of the installment payments are or could be deferred. However, an examination of the agreement indicates that the deferred amounts are to be paid in the future. They become due and payable on the earlier of March 31, 1991 or the maturity date of the existing agreement and interest then accrues on the deferred amount from that date, i.e., there is no contingency or forgiveness of the payments. According to the agreement if the deferred amounts are paid, such "overpayments" are "refunded". The installment payments are blended, i.e., they are to pay interest first and then principal.

It would appear that, in the case of a farmer who reports his income on an accrual basis, the full amount of the interest in respect of the year could be deducted pursuant to paragraph 20(1)(c). The deferred portion of the interest is payable in respect of the year although it is not due until a later year. An amount is considered to be payable if there is an absolute and unconditional legal obligation to pay the amount even though payment may not be due until a later date. See, for example, J. L. Guay Ltee v. MNR, [[1971] C.T.C. 686] 71 DTC 5423 (FCTD), aff'd [[1973] C.T.C. 506] 73 DTC 5373 (FCA), aff'd [[1975] C.T.C. 97] 75 DTC 5094 (SCC) and The Queen v. Ken & Ray's Collins Bay Supermarket Ltd., [[1975] C.T.C. 504] 75 DTC 5346 (FCTD). The phrase "in respect of the year" was considered in MNR v. Midwest Abrasive Co. of Canada Ltd., [[1973] C.T.C. 548] 73 DTC 5429 (FCTD) and Fernwood Construction of Canada Ltd. v. MNR, [[1985] 1 C.T.C. 2289] 85 DTC 257 (TCC).

In the case of a farmer who elects to report his income on a "cash basis" pursuant to subsection 28(1), only the interest paid in the year would be deductible pursuant to subsection 20(1). If an amount paid as interest is to be refunded, such amount is not considered to be paid for purposes of paragraph 20(1)(c) and would, therefore, not be deductible. As stated in Q.28(1) of the Revenue Canada Round Table at page 49:15 of the 1985 Conference Report of the Canadian Tax Foundation, a payment that is conditional upon its repayment would not be accepted as a bona fide payment.

ISSUE: Should the refunded amounts be included in income pursuant to subparagraph 12(1)(x)?

To the extent it has not been included in computing a taxpayer's income, paragraph 12(1)(x) of the Act requires the inclusion in income of any amount received in the year by a taxpayer, in the course of earning income from a business or property, from a government, municipality or other public authority where the amount can reasonably be considered to have been received as a reimbursement, contribution, allowance or assistance, whether as a grant, subsidy forgivable loan deduction from tax allowance or any other form of assistance in respect of the cost of property or in respect of any outlay or expense.

The December 6, 1990, memorandum to Current Amendments regarding the Quebec Mining Tax Credit for Losses (7-901535) notes that XXX The memorandum continues with the statement that "expense" in subparagraph 12(1)(x)(iv) of the Act refers to a deductible expense is supported by the May 23, 1986 budget papers of the Department of Finance which allude to a "deductible expense" in describing the budget proposal to include reimbursements and inducements in income for tax purposes. It also refers to the April 3, 1987 Department of Finance letter regarding the Alberta Royalty Tax Credit which states that "paragraph 12(1)(x) of the Act is not intended to apply to assistance received by taxpayer in respect of non-deductible Crown Charges". In the conclusion of the memorandum we have taken the position that "expense" in subparagraph 12(1)(x)(iv) refers to a deductible expenses. Therefore, if a refundable amount of interest is not deductible for the purposes of paragraph 20(1)(c) it would not be considered a reimbursement in respect of an expense for purposes of subparagraph 12(1)(x)(iv).

With regard to refunds of principal payments, a September 19, 1990 letter to Industry, Science and Technology Canada (902190) states that the Department considers that a government loan which is unconditionally repayable would ordinarily be excluded from paragraph 12(1)(x). An examination of the IDP Agreement indicates that a refund of the principal payments was required to either.

• a) be repaid on the earlier of March 31, 1991 or the maturity date of the existing agreements, or
• b) be repaid over time pursuant to a new agreement.

Whether the deferred principal is unconditionally repayable will be a question of fact and will depend on whether it is repaid as required in a) above or on the terms of the new agreement, referred to in b) above.