Principal Issues: 1. Whether the term "retained earnings" in paragraph 181.2(3)(a) refers to the definition of retained earnings in Section 3251 of CPA Canada Handbook - Accounting (Part II Accounting Standards for Private Enterprises (ASPE))?
2. Whether the adjustments to retained earnings resulting from the fair value adjustments in accordance with Section 1500 of CPA Canada Handbook - Accounting (Part II ASPE) should be considered in computing the taxpayer's capital pursuant to subsection 181.2(3)?
Position: 1. The accounting meaning of retained earnings under ASPE should be used for the purpose of paragraph 181.2(3)(a) for a taxpayer that follows the ASPE.
2. Yes, provided that the accounting treatment of the adjustments are in accordance with ASPE.
Reasons: 1. Subparagraph 181(3)(b)(i) refers to the amount reflected on the balance sheet that is prepared in accordance with GAAP. ASPE is part of GAAP in Canada. Where a term in Part I.3 (such as retained earnings) derives its meaning from accounting principles, the accounting meaning has to be used. 2. Paragraph 181.2(3)(a) specifically mentions retained earnings to be added in computing capital.
XXXXXXXXXX 2016-066378 Lucie Allaire, LL.B CPA, CGA, D. Fisc. May 2, 2017
Dear Sir,
Subject: Meaning of “retained earnings”
This letter is in response to your August 30, 2016 e-mail in which you inquired as to the meaning of retained earnings for the purposes of paragraph 181.2(3)(a) of the Income Tax Act (the "Act").
Unless otherwise indicated, all legislative references are to the provisions of the Act.
In particular, you described the situation of a corporation that, since January 1, 2011, used accounting standards for private enterprises ("ASPEs") (Part II of the CPA Canada Accounting Handbook). On the initial application of ASPE, the corporation revalued its principal assets to their fair value. In accordance with Section 1500, First-Time Adoption, of the ASPE, the corporation recognized the adjustment, resulting from the revaluation of its assets to fair value, in its retained earnings presented in its opening balance sheet, as if ASPE had always applied. You indicated that this adjustment resulted in an increase in retained earnings.
Your questions
You asked whether the term "retained earnings" in paragraph 181.2(3)(a) refers to the definition of retained earnings in Section 3251, Equity, ASPE.
In addition, you asked whether the adjustment to retained earnings of the corporation arising from the revaluation of its assets to fair value at the time of adoption of the ASPE is to be considered for the purposes of paragraph 181.2(3)(a).
Our Comments
This technical interpretation provides general comments on the provisions of the Act and related legislation, where referenced. It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R7, Advance Income Tax Rulings and Technical Interpretations.
Subject to paragraph 181(3)(a) and except as otherwise provided in Part I.3, subparagraph 181(3)(b)(i) requires that the amounts to be used in determining any amount under Part I.3 relating to the capital of a corporation for a taxation year are those reflected in the balance sheet presented to the shareholders of the corporation. If such a balance sheet is not prepared in accordance with generally accepted accounting principles ("GAAP"), that subparagraph provides that the amounts to be used are those that would be reflected if such a balance sheet had been prepared in accordance with those principles.
As ASPE partially replaced former Canadian GAAP, the reference to GAAP in subparagraph 181(3)(b)(i) is considered a reference to ASPE.
We have already indicated that the accounting treatment of retained earnings must be used to determine retained earnings for purposes of paragraph 181.2(3)(a). Therefore, if an entity adopts ASPE, the term retained earnings for the purposes of paragraph 181.2(3)(a) will be defined in accordance with ASPE.
We are therefore of the view that the retained earnings determined in accordance with ASPE are included in the capital of the corporation under paragraph 181.2(3)(a).
Finally, in the situation described, the adjustment to the retained earnings of the corporation as a result of the revaluation of its assets will be taken into account for the purposes of paragraph 181.2(3)(a) to the extent that the presentation of such adjustment conforms with ASPE.
We hope that our comments will be of assistance.
Louise J. Roy, CPA, CGA
Manager
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch