Dear Sirs:
Re: Tax on Large Corporations
We are writing in response to your letters of May 6 and May 7, 1991 concerning the above noted subject which were forwarded to this division for reply by way of the Winnipeg Taxation Centre and the Saskatoon District Office.
Your first question deals with paragraph 181(3)(a) of the Income Tax Act (the "Act") which denies the use of the equity or consolidation methods of accounting for the purpose of determining the carrying value of a corporation's assets or any other amount in respect of a corporation's capital, investment allowance, taxable capital or taxable capital employed in Canada in a taxation year or in respect of a partnership in which the corporation has an interest. As noted by yourself, this prohibition results, by the process of elimination, in the use of the cost method of accounting.
With respect to the calculation of the taxable capital of a corporation pursuant to subsection 181.2(2) of the Act, we would agree that the cost and the equity methods of accounting for an investment in the shares of a corporation will usually yield an identical result notwithstanding that each method will yield different results for the two components of that calculation being the capital and the investment allowance of the corporation as determined pursuant to subsections 181.2(3) and 181.2(4) respectively.
You have also requested our comments with respect to the calculation of the capital of a corporate partner pursuant to subsection 181.2(3) of the Act and, more specifically, whether the undistributed earnings of the partnership are to be included in the retained earnings of the corporate partner for such the purpose of such calculation. In view of the prohibition in subsection 181(3) of the Act regarding the use of the equity or consolidation methods of accounting for an interest in a partnership, we would consider that only the distributed earnings of the partnership are to be included in the retained earnings of the corporate partner. As you noted, paragraph 181.2(3)(g) of the Act requires the corporate partner to include its proportionate share of the reserves, loans and advances and other indebtedness of a partnership in which it holds an interest but is silent with respect to the earnings of that partnership.
In those circumstances in which the year-end of the partnership does not correspond with the year-end of the corporate partner and income from the year-end of the partnership is accrued to the year end of the partner, we would again consider that only the distributed earnings of the partner would be required to be included in the retained earnings of the corporate partner for the purposes of the calculation of the capital of that corporation pursuant to subsection 181.2(3) of the Act.
The next two questions posed deal with partnerships and the treatment of certain assets and liabilities of the partnership in the calculation of the capital and the investment allowance of the corporate partners.
In the first example provided, the partnership holds a bond issued by a corporate partner. The bond has a carrying value of $1,000,000 to the partnership and the particular partner is entitled to a one-third share of the partnership income. The corporate partner which issued the bond would include the full amount of $1,000,000 in the calculation of its capital pursuant to paragraph 181.2(3)(d) of the Act as indebtedness of the corporation at the end of the year represented by a bond. No amount would be included in the capital of any other corporate partners as there is no amount of indebtedness of the partnership as described in paragraph 181.2(3)(g). Pursuant to paragraph 181.2(4)(e) and by virtue of subsection 181.2(5) of the Act, each corporate partner, including the issuer of the bond, would include their proportionate share of the carrying value of the bond in the calculation the investment allowance. In the case of the particular partner which had issued the bond, the amount to be included in the calculation of its investment allowance pursuant to paragraph 181.2(4)(e) as determined by subsection 181.2(5) would be one-third of $1,000,000.
The second example provided considers the case of a partnership which has a mortgage outstanding in the amount of $1,000,000 which mortgage is held by a corporation which has a one-third interest in that partnership. In determining the capital of a corporate partner, paragraph 181.2(3)(g) of the Act provides that each partner include in that calculation its proportionate share of, inter alia, the amount of all indebtedness of the partnership represented by mortgages other than such amounts owing to be particular corporate partner or to other partners which are corporation. Consequently, no amount in respect of the outstanding partnership mortgage would be included in the calculation of the capital of any of the corporate partners by virtue of the exclusionary phrase in paragraph 181.2(3)(g) of the Act, With respect to the investment allowance of the particular corporation which holds the partnership mortgage in the above example, we would consider that no amount would be included in the calculation of the investment allowance of that corporation pursuant to paragraph 181.2(4)(c) of the Act as the asset is not a mortgage of another corporation as is required by that provision. Further, the amount would not be included in the calculation of the investment allowance of that corporate partner nor that of any other corporate partner pursuant to paragraph 181.2(4)(e) by virtue of subsection 181.2(5) which refers solely to the carrying value of an asset of the partnership.
While we trust that our comments are of assistance to you we would also advise that they do not constitute an advance income tax ruling and are, accordingly, not binding upon the Department in respect of any particular situation.
Yours truly,
for DirectorFinancial Industries DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch