Principal Issues: Application of subsection 15(1) in two specific fact situations.
Position: See response.
Reasons: The law.
XXXXXXXXXX 2007-022410
March 9, 2007
Dear XXXXXXXXXX:
Re: Subsection 15(1) of the Income Tax Act (the "Act")
As we discussed on March 6, 2007 (Cooke/XXXXXXXXXX), we are writing in response to your facsimile inquiry of February 22, 2007, to Mr. Wayne Adams, Director General, Income Tax Rulings Directorate, wherein you requested our views regarding two situations described below.
Situation 1
The corporation's bookkeeper incorrectly records $100,000 in cash received by a corporation as follows:
DR: Cash $100,000
CR: Shareholder Loan Account $100,000
The correct entry should have been:
DR: Cash $100,000
CR: Sales $100,000
As a result, the corporation failed to report the $100,000 as income when it filed its T2 corporate income tax return for the year. As a result of an audit by the Canada Revenue Agency ("CRA"), the error was discovered and the corporation was assessed for the $100,000 in unreported income. CRA agreed not to assess the shareholder for a benefit under subsection 15(1) since the shareholder never actually received any portion of the $100,000 that was incorrectly credited to the shareholder's loan account.
In this situation, you conclude that the following correcting journal entry is required:
DR: Shareholder Loan Account $100,000
CR: Retained Earnings $100,000
Situation 2
The facts are exactly the same as described in Situation 1 except that CRA assesses the shareholder for a benefit of $100,000 under subsection 15(1) even though the shareholder has still not actually received any funds from the corporation. The assessment under subsection 15(1) is not appealed by the shareholder.
In this situation, you conclude that no correcting journal entry to the shareholder loan account is required.
Your request appears to relate to a completed transaction. Confirmation of the income tax consequences of completed transactions involving specific taxpayers must be made to your local Tax Services Office. We can, however, provide the following comments.
We generally agree with your conclusions in both situations.
Situation 1
The corporation should reverse the erroneous credit that was posted to the shareholder's loan account (and credit sales/retained earnings) since this reflects the true intention and legal result of the transactions.
Situation 2
As you know, where an honest bookkeeping error has been made and the shareholder has not actually receive any funds from the corporation, generally CRA would not assess a benefit under subsection 15(1).
However, since you have asked us to assume that a benefit has been assessed under subsection 15(1) in Situation 2, even though the shareholder has not actually received any funds from the corporation, generally in these types of circumstances CRA would not require the corporation to reduce the credit to the shareholder loan account until the shareholder actually withdraws such funds from the corporation. This is because the amount is considered to be "tax paid" and we would not tax such amount twice.
It is our understanding that our above views are consistent with the views expressed by Mr. Claude Englehart, Director, Technical Applications & Valuations Division, in his letter to you dated August 29, 2006 and those of the Minister in her letter to you dated January 16, 2007.
Other Comments
As you know, a taxpayer is required to keep adequate books and records under the Act. Normally, a corporation is required to prepare its books and records following generally accepted commercial accounting practices for these purposes. However, even where a corporation fails to maintain adequate books and records, the income tax consequences of a taxpayer's transactions can only be determined by ascertaining the true legal relationships that have been created by such transactions and by applying the specific rules in the Act to these transactions. Thus, whether a "correcting" journal entry is made or not by a corporation such action would not be determinative, in and by itself, of the income tax consequences of the actual transactions entered into by the corporation.
Our comments are provided in accordance with the practice outlined in paragraph 22 of IC-70-6R5.
Yours truly,
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch