Dear Sirs:
This is in reply to your letter dated February 5, 1991, wherein you requested our opinion concerning the calculation of a corporation's capital pursuant to subsection 181.2(3) of the Income tax Act ("Act") when it has an interest in a partnership. You have asked, more specifically, whether undistributed earnings of such a partnership are to be included in the retained earnings of the corporation for the purpose of paragraph 181.2(3) of the Act.
In our view, as subsection 181(3) of the Act specifically prohibits the usage of both the equity and the consolidation methods of accounting with respect to an interest in a partnership held by a corporation, only the distributed earnings of the partnership would be included in the corporation's capital for purposes of the Part I.3 of the Act. As you pointed out, paragraph 181.2(3)(g) of the Act requires the corporation to include its proportionate share of all 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 the same partnership. There is no basis at law at this time requiring the inclusion of the undistributed earnings of the partnership.
You have also asked whether an adjustment should be made to the retained earnings amount otherwise required to be included in the corporation's capital pursuant to paragraph 181.2(3)(a) of the Act to reflect a reduction of the income taxes charged against the retained earnings for accounting purposes where only the undistributed earnings of the partnership are included in the corporation's capital pursuant to subsection 181.2(3) an opposed to the full earnings. The amount of the retained earnings to be included in the corporation's capital would be determined pursuant to subsection 181(3) of the Act and since the equity method cannot be utilized the accounting income would be reduced by the amount of the undistributed earnings and the income taxes charged against the retained earnings should be adjusted accordingly.
While we trust that our comments are of assistance to you, they do not constitute an advance income tax ruling and are, therefore, not binding upon the Department in respect of a particular situation.
Yours truly,
ChiefFinancial Industries DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch