| December 17, 1990 | |
| MONTREAL DISTRICT OFFICE | HEAD OFFICE |
| Financial Industries Division | |
| Attention: Larry Dankoff | B.G. Dodd |
| Banking Industry | (613) 957-9769 |
| Specialist | |
| 900355 | |
| 24(1) |
SUBJECT: Deduction under subsection 26(2) of the Income Tax Act
This is in reply to your round trip memorandum dated April 6, 1990 requesting our comments on a submission by 24(1) regarding the deduction allowed under subsection 26(2) of the Income Tax Act (the "Act") as it applied to 24(1).
The submission relates to the Department's position that amounts deducted by 24(1) under subsection 26(2) of the Act must be allocated in computing foreign source income for purposes of the foreign tax credit in section 126 of the Act. 24(1) continues to disagree in principle with this position; however, 24(1) argues that if such an allocation must nevertheless be made, because the subsection 26(2) deduction is discretionary, 24(1) may claim less than the maximum permissible amount in sofar as computing its foreign income is concerned. In particular, 24(1) is asking that it be permitted to reduce the amount of its subsection 26(2) deduction to the extent that the (Department's proposed additional) allocation to the foreign branches would reduce 24(1) foreign tax credits under subsection 126(2) of the Act.
We understand that your response to 24(1) was that any reduction to the subsection 26(2) deduction must be allocated proportionately to all sources of income of 24(1) including domestic sources and that a reduction in the amount claimed cannot be allocated to any specific source of income.
The Department's general views on the determination of income from sources in a foreign country are set out in paragraphs 35 to 41 of IT-270R. Paragraph 37 in particular expresses the view that (subject to specified exceptions which are not relevant here) each permissible deduction in arriving a taxpayer's total net income (i.e. the "bottom line" in the section 3 calculation) is theoretically allowable in whole or in part to a territorial source of income.
Following the reasoning in IT-270R, it is our view that the subsection 26(2) deduction is determined and taken for purposes of arriving at total net income. Any discretion available to the taxpayer as to quantum is exercised in that context. Once the deduction has been so established and section 126 is applicable, it is then a matter of allocating it to the relevant territorial sources of income pursuant to subsection 4(3) and paragraph 4(1)(b) of the Act. As such, it is our view that once the subsection 26(2) deduction for the year has been established and (properly) allocated to territorial sources, any subsequent change as to the quantum thereof should be allocated proportionately to the relevant sources.
In addition, the deduction permitted under subsection 26(2) of the Act for prudential reserves is determined by reference to the amount of "eligible loans" which include loans booked in 24(1) foreign branches. The available deduction was determined in accordance with OSFI's rules which as we understand them, do not give 24(1) the option of determining which loans it wants and does not want to include in eligible loans. Therefore as each dollar of eligible loan contributes equally to the deduction under subsection 26(2), it is our view that the only reasonable basis for allocating the actual deduction taken is on a prorata basis.
24(1) 21(1)(b)
We trust this will be of assistance.
for DirectorFinancial and Industries DivisionRulings Directorate
c.c. E. H. Gauthier, DirectorSpecial Audits Division
STATEMENT OF PRINCIPAL ISSUE
| File: 900355 | B. Dodd |
In determining income from a particular place, under paragraph 4(1)(b), for purposes of the foreign tax credit under subsection 126(2), may a taxpayer claim or allocate to the foreign jurisdiction less than the maximum permissible deduction under subsection 26(2).
Note:
24(1)
Position Taken
No. The discretion permitted to the taxpayer is to be exercised in determining overall amount of the 26(2) deduction before allocating to various sources. Once allocated properly, which would be done with respect to the amount of eligible loans in each country, it is our view that any change must take place on a prorata basis among all sources.
Note:
The issue is relevant in the context of subsection 26(2) as it read prior to the tax reform amendments in and around 1987/88.