Principal Issues: Whether subsection 17(1) would apply where interest at a reasonable rate is charged but a deduction is claimed under paragraph 20(1)(l) for the receivable in respect of such interest?
Position: Probably no, depending on a particular situation.
Reasons: Interest has been included in computing the corporation's income as described in subparagraph 17(1)(b)(i), notwithstanding the claim for the paragraph 20(1)(l) deduction.
XXXXXXXXXX 2004-009354 S. Leung, CA Attention: XXXXXXXXXX
March 29, 2006
Dear Sir:
Re: Section 17 and paragraph 20(1)(l) of the Income Tax Act (the "Act")
We are writing in reply to your email transmission in which you requested our view as to whether section 17 of the Act would apply to the situation described below where a reserve is claimed under paragraph 20(1)(l) of the Act in respect of a receivable in respect of interest on a loan.
The situation described in your email transmission is as follows. A Canadian corporation ("Canco") lends money to a related U.S. corporation ("USco") and interest is charged on the loan. At the end of the year, because of the financial problems encountered by USco, a portion of the loan and interest receivable on the loan are doubtful of collection. You enquired whether in circumstances where a reserve under paragraph 20(1)(l) was claimed in respect of the interest receivable that has been included in computing Canco's income for the year, section 17 would nevertheless apply because there would be no net income inclusion in Canco with respect to such interest.
Our Comments
The situation outlined in your email appears to relate to an actual situation involving identifiable taxpayers. Accordingly, the applicable Tax Services Office should be consulted with respect to the income tax liabilities of such taxpayers. However, we can offer the following general comments.
In the following analysis, we assume the following:
(i) Subsection 12(4.1) does not apply because Canco is not a financial institution within the meaning assigned in subsection 142.2(1) of the Act nor a taxpayer whose ordinary business includes the lending of money;
(ii) A reasonable rate of interest is charged on the loan and the loan is outstanding for more than one year; and
(iii) Subsections 15(1), 15(2) and 80.4(2) are not applicable.
Subsection 17(1) of the Act in part reads as follows:
"Where at any time in a taxation year of a corporation resident in Canada, a non-resident person owes an amount to the corporation, that amount has been or remains outstanding for more than a year and the total amount under paragraph (b) for the year is less than the amount of interest that would be included in computing the corporation's income for the year in respect of the amount owing if that interest were computed at a reasonable rate for the period in the year during which the amount was owing, the corporation shall include an amount in computing its income for the year equal to the amount, if any, by which
(a) the amount of interest that would be included in computing the corporation's income for the year in respect of the amount owing if that amount were computed at the prescribed rate for the period in the year during which the amount was owing
exceeds
(b) the total of all amounts each of which is
(i) an amount included in computing the corporation's income for the year as, on account of, in lieu of or in satisfaction of, interest in respect of the amount owing,
(ii) ..., or
(iii) ..."
In the situation described above, in computing the income for a taxation year of Canco, subsection 12(3) of the Act would apply to include the interest in respect of the loan that accrues to Canco to the end of the year, or becomes receivable or is received by Canco before the end of the year, to the extent that the interest was not included in computing its income for a preceding taxation year. As a result of the application of subsection 12(3), an amount would be included in computing Canco's income on account of interest in respect of the loan as described in subparagraph 17(1)(b)(i) of the Act. As it is assumed that the interest charged by Canco is reasonable, subsection 17(1) would not apply.
Where the receivable in respect of the interest is doubtful of collection, Canco can claim a reserve under paragraph 20(1)(l) of the Act. The claiming of such reserve would not trigger the application of subsection 17(1) because the amount of such interest was included in computing Canco's income under subsection 12(3) and as such it is an amount described in subparagraph 17(1)(b)(i), even though such inclusion is offset by the deduction under paragraph 20(1)(l).
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, the opinions expressed in this letter are not rulings and are consequently not binding on the Canada Revenue Agency.
Yours truly,
Olli Laurikainen, CA
Manager
for Division Director
International and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch