Principal Issues: Whether a particular transaction constitutes a "payment" for purposes of subsection 135(4).
Position: Yes, in this particular situation.
Reasons: Question of fact
May 24, 2011
XXXXXXXXXX TSO HEADQUARTERS Audit Income Tax Rulings Directorate Attention: XXXXXXXXXX Sylvie Danis Team Leader (613) 957-3496
2011-039677
Payment of Patronage Dividends by Cooperatives
This is in reply to your memo dated February 10, 2011. You have asked us to consider whether a particular transaction would constitute a "payment" as defined in subsection 135(4) of the Income Tax Act (the "Act").
XXXXXXXXXX You advise that when they issue a patronage dividend, they are basically paying a stock dividend and simply issuing new shares to their members as way of payment of the dividend after removing an amount for source deductions. At issue is whether the transactions and the by-laws fit under (b) of the definition of "payment" which provides for payment to be effected by a set-off of obligations. You are of the view that the use of the past tense in "issued" means these should be shares that were issued prior to the payment of the dividend and not applicable to the shares issued as the dividend.
You have provided the by-laws of XXXXXXXXXX for our consideration. This particular taxpayer's by-laws include, among others, the following rules:
XXXXXXXXXX
Our Comments
Subsection 135(1) of the Act allows a deduction in computing a taxpayer's income for a taxation year where the taxpayer has made a payment pursuant to allocations in proportion to patronage to its customers within the year or within 12 months thereafter. For the purposes of section 135 of the Act, the term "payment" is defined in subsection 135(4) of the Act to include three different ways of effecting payment.
In particular, pursuant to paragraph (b) of the definition of "payment" in subsection 135(4) of the Act, a "payment" includes "the application by the taxpayer of an amount to a member's liability to the taxpayer (including, without restricting the generality of the foregoing, an amount applied in fulfilment of an obligation of the member to make a loan to the taxpayer and an amount applied on account of payment for shares issued to a member) pursuant to a by-law of the taxpayer, pursuant to statutory authority or at the request of the member".
According to paragraph 10(b) of Interpretation Bulletin IT-362R, Patronage Dividends, the set-off of obligations must be authorized by a member in writing, or effected by the provisions of a by-law of the taxpayer in respect of members only, except that no formal authorization is required by the taxpayer to apply an amount to a trade debt of any member. As stated in paragraph 11 of IT-362R, there must be an obligation on the member to make a loan, purchase shares or pay a debt to the taxpayer, and an obligation on the taxpayer to pay the patronage dividend, before payment may be effected by set-off of obligations.
Based on our review of the by-laws provided, it appears these by-laws provide for a payment to be effected by a set-off of obligations as described in IT-362R. The fact that the shares may not be issued prior to the payment of the dividend does not, in and of itself, cause the transactions not to constitute payment. The enumerated set-off mechanisms in paragraph (b) of the definition of "payment" are prefaced by the words "including, without restricting the generality of the foregoing." These words clearly indicate that the enumerated set-off mechanisms are only examples of the ways in which payment of a patronage allocation may take place. Accordingly, in our view, the issue of additional membership shares by the taxpayer to a member in satisfaction of patronage dividends would constitute a payment within the meaning of paragraph (b) of the definition of "payment" in subsection 135(4) of the Act since such issue results from the member's liability to purchase such shares pursuant to the by-laws of the taxpayer. We note that this position is consistent with a previous interpretation issued by this Directorate involving similar circumstances (see document E9505687).
We trust that these comments will be of assistance. Should your client request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for a severed copy to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
Jenie Leigh
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch