Section 78

Subsection 78(1) - Unpaid amounts

Cases

Canada v. Dow Chemical Canada Inc., 2008 DTC 6544, 2008 FCA 231

The taxpayer ("Amalco") was formed on the amalgamation of two corporations, one of which ("UCCI") had previously incurred interest-bearing indebtedness to a financing affiliate within the Union Carbide group of companies and the other of which ("DCCI") was a Canadian subsidiary within the Dow group of companies that dealt at arm's length with UCCI and the financing affiliate up to the time of acquisition of control of that group by the Dow group of companies. The interest in question was incurred in the 2000 taxation year of UCCI, the next taxation year of UCCI ended in 2001 with the acquisition of its control by the Dow group, and its next taxation year ended in 2001 with its amalgamation.

In finding that s. 78(1) applied to Amalco, Noël, J.A. rejected [at para. 31] the submission of the taxpayer "that Amalco should be viewed as having incurred the obligation back in 2000, but without regard to the non-arm's length relationship that prevailed at that time" after having noted [at para. 30] that under s. 87(7)(d) "an amalgamated corporation stands in the shoes of its predecessor insofar as previously incurred debts are concerned as of the time when they were incurred".

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 87 - Subsection 87(7) 193

Minister of National Revenue v. Shofar Investment Corporation, 79 DTC 5347, [1979] CTC 433, [1980] 1 S.C.R. 350

The cost of an item of inventory is not "a deductible outlay or expense" within the meaning of what now is s. 78(1). The predecessor of s. 78(1) accordingly did not apply to a non-arm's length sale of land inventory for a consideration to be paid over a 7-year period.

See Also

Dow Chemical Canada Inc. v. The Queen, 2007 DTC 1701, 2007 TCC 668

The taxpayer was formed on the amalgamation of two corporations, one of which ("UCCI") had previously incurred interest-bearing indebtedness to a financing affiliate within the Union Carbide group of companies and the other of which ("DCCI") was a Canadian subsidiary within the Dow group of companies that dealt at arm's length with UCCI and the financing affiliate. The U.S. parent of the taxpayer ("Dow") had acquired control of the U.S. parent of UCCI, and the amalgamation then occurred.

Mogan, D.J. found that s. 78(1) did not apply to the interest on such debt as the taxpayer was not related to UCCI or the financing affiliate in fact or by any deeming rule during the calendar year in which such interest was incurred.

Redclay Holdings Ltd. v. The Queen, 96 DTC 1207 (TCC)

In rejecting a submission that s. 78(1) should be interpreted as applying to deny an expense (in this case, alleged interest expense) to a taxpayer only where the taxpayer computes its income on an accrual basis and the creditor to whom the expense is owed is subject to tax on a cash basis rather than an accrual basis, Rip TCJ. found that the wording of s. 78(1) was unambiguous and, therefore, there was no basis for limiting its application in the suggested manner.

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 20 - Subsection 20(1) - Paragraph 20(1)(c) interest not payable if contingent cash flow 192

Administrative Policy

30 August 1995 T.I. 952011 (C.T.O. "Application of 78(1) and 18(4)")

"An amount not deducted by virtue of subsection 18(2) or 18(3.1) of the Act, would not be considered to be a 'deductible' outlay."

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(4) 36

IT-109R2 "Unpaid Amounts" 23 April 1993

15. (a) Debtor and Creditor on the Accrual Basis

Generally, where an unpaid amount exists between a debtor and creditor who are not dealing at arm's length and both taxpayers account for income on the accrual basis, subsection 78(1) will not be invoked. An exception occurs where the unpaid amount in question appears to be part of a tax avoidance scheme...for example...

  • claiming a reserve under paragraph 20(1)(l) or (n), or a deduction under paragraph 20(1)(p), or
  • deferring tax under Part XIII of the Act where the creditor is a non-resident.

(b) Payment by Promissory Note

For the purposes of section 78, an ordinary promissory note is regarded as a promise to pay a debt at a later date, and not as payment of the debt on the date on which the note was issued. This is so unless the agreement between the parties clearly indicates that the note was accepted as absolute payment

27 March 1992 External T.I. 5-920554 -

S.78(1) does not apply to amounts that are non-deductible by virtue of s. 18(2).

17 January 1992 T.I. (Tax Window, No. 15, p. 11, ¶1704)

The application of s. 80 to a prior year would not be a technical impediment to the application of s. 78 to a later year.

91 CPTJ - Q.31

RC is no longer of the view that section 78 applies to unpaid interest which has been capitalized as CEE.

17 September 1991 T.I. (Tax Window, No. 9, p. 3, ¶1453)

Where a corporation defers payment of interest payable to a controlling shareholder and no agreement was filed, s. 78(1) requires the interest to be included in the corporation's income even if the shareholder was required by s. 12(4) to recognize the accrued interest.

28 May 1991 T.I. (Tax Window, No. 3, p. 29, ¶1267)

Because compound interest is not eductible until paid, s. 78 does not apply to compound interest.

90 C.P.T.J. - Q.37

Where a taxpayer has elected under s. 21 to include interest expense otherwise incurred as CEE and the interest remains unpaid at the end of the second taxation year following the year in which the interest was incurred and the debt was owed to a non-arm's length party, s. 78 will require the taxpayer to include the unpaid amount of such interest in his income for the third taxation year, although the CEE pool will not be affected by the application of s. 78.

2 May 1990 T.I. (October 1990 Access Letter, ¶1467)

s. 78 can apply to a deductible outlay or expense incurred by a partnership. The agreement under s. 78(1)(b) which is filed on behalf of the partnership must be filed on or before the earliest day on which a return is required to be filed by any of the partners in respect of the taxation year that includes the last day of the third taxation year of the partnership following the taxation year of the partnership in which the outlay or expense was incurred.

11 April 1990 T.I. (September 1990 Access Letter, ¶1422)

Where on December 1984, the taxpayer accrues $10,000 in interest owing to a non-arm's length creditor, the amount is still owing at the end of December 1986, and no election under s. 78 is filed on December 31, 1987, and on December 31, 1989 the creditor forgives the debt, then s. 78(1) will take precedence over s. 9, i.e., the amount of $10,000 will be included in the taxpayer's income in 1987 and not in 1989. S.80 will not apply by virtue of s. 80(1)(f).

89 C.P.T.J. - Q26

The phrase "in respect of" has a wide meaning. Accordingly, subsection 78(1) applies to interest which has been capitalized under s. 21.

88 C.R. - Q.3

Where the filing of a prescribed agreement on the due date of December 31, 1989 gives rise to a deemed payment of interest to a non-resident on July 1, 1989, RC will not assess penalties or interest if the withholding tax provided for under s. 215(1) is paid by the subsidiary to the Receiver General by January 15, 1990.

81 C.R. - Q.11

RC will apply s. 78(1) to deductible amounts owing to a non-resident even where such amounts would not be subject to withholding tax when paid and credited.

Articles

Brahmst, "Non-Arm's Length Expenses and Section 78", Practice Notes, Canadian Current Tax, April 1991, p. P33

Discussion of application of s. 78 where there have been back-to-back loans within a financial institution group before the loan to the ultimate borrower who now is in financial difficulty.

Paragraph 78(1)(b)

Subparagraph 78(1)(b)(ii)

Administrative Policy

15 May 2019 IFA Roundtable Q. 4, 2019-0798721C6 - 78(1)(b)(ii) deemed loan & thin capitalization

deemed s. 78(1)(b)(ii) loan is not also deemed to bear interest

The thin cap rules apply to “outstanding debts to specified non-residents”, whose definition specifies that there is deductible interest paid or payable on them. Where the Canadian debtor and the non-resident creditor make an s. 78(1)(b)(ii) agreement to deem the amount of simple interest owing by the one to the other to be a loan, CRA generally considers that the amount of the deemed loan would not be an outstanding debt to a specified non-resident for the purposes of ss. 18(4) and (5) until the compound interest is paid and thereby becomes deductible under s. 20(1)(d).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 18 - Subsection 18(5) - Outstanding Debts to Specified Non-Residents - Paragraph (a) - Subparagraph (a)(ii) unpaid simple interest that is deemed to be a loan by s. 78(1)(b)(ii) generally is not outstanding debts to specified non-residents 160

Subsection 78(4) - Unpaid remuneration and other amounts

See Also

WPH Mechanical Services Ltd. v. The Queen, 2007 DTC 263, 2006 TCC 677

It was found that bonuses declared payable by the taxpayer to its two directors were paid by it within the 180 day period referred to in s. 78(4) pursuant to a demand loan agreement (notwithstanding that the directors did not report the portion of the demand loan that was not paid in cash until the subsequent year as employment income until that subsequent year).

Locations of other summaries Wordcount
Tax Topics - General Concepts - Payment & Receipt payment by demand loan 62

Administrative Policy

6 November 2012 External T.I. 2012-0452531E5 - Satisfactory Evidence of Payment

In response to a question as to whether "a demand note payable, which is accepted as absolute payment of salary owing to an employee, constitutes satisfactory evidence of the payment of that salary," CRA stated:

An ordinary promissory note is generally regarded as a promise to pay a debt at a later date, and not as payment of the debt on the date on which the note was issued. However, an amount may be considered to be "paid" by a promissory note if an agreement between the parties clearly indicates that the note was accepted as absolute payment.

Respecting whether the remuneration was paid within the 180-day period provided by s. 78(4), CRA stated:

The best evidence of payment is that the related payroll withholdings were remitted on time....Other evidence that would corroborate the payment of the wages would include the issuance of a T4 slip to the employee, the reporting of the income by the employee....

Locations of other summaries Wordcount
Tax Topics - General Concepts - Payment & Receipt promissory note accepted as payment 98

2 October 2012 External T.I. 2012-0446671E5 F - Subsection 78(4)

s. 78(4) inapplicable where payment made on 180th day

In response to a query as to whether the repayment deadline in s. 78(4) is satisfied when the repayment is made on the 180th day, CRA stated (TaxInterpretations translation) that:

[A] payment on the 180th day after the end of a taxation year avoids the application of subsection 78(4).

Consequently, in a situation as described above where a payment is made by a corporation on the 180th day after the end of its taxation year, subsection 78(4) would not apply.

7 August 1992 T.I. 921752 (May 1993 Access Letter, p. 198, ¶C76-066, (Tax Window, No. 23, p. 5, ¶2140)

Because the function of a journal entry is to record a transaction rather than to make it legally effective, the reclassification of a shareholder's loan into remuneration payable by a journal entry would not be considered to be payment of the remuneration.

87 C.R. - Q.19

"Other remuneration" refers to amounts which would be included under s. 5, and does not include a retiring allowance.

87 C.R. - Q.32

The best evidence of payment is that the related payroll withholdings were remitted on time.