| June 14, 1989 | |
| Rémi St Louis | Specialty Ruling |
| Revue de la Vérification | D. Turner |
| Section 148 | (613) 957-2094 |
| B.D. Montréal | |
| F. Tirabasso | File No. 7-3910 |
Subject: Subsection 18(3.1) of the Income Tax Act (the "Act")
We are writing in reply to your memorandum of April 19, 1989, wherein you requested our comments on interest costs relating to construction of a building, where the building is partly owned by a life insurance corporation.
Facts
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- 24(1)
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- 24(1)
District Office Comments
You propose to refuse the offset of interest expense against interest revenue by 24(1) and to capitalize the interest amounts as part of the capital cost of the building. You base your proposal on the following:
1) As 24(1) principal activity is not real estate and construction it is not exempt from the application of subsections 18(3.1) to 18(3.7) of the Act. These subsections require construction period interest to be capitalized.
2) The interest cost to 24(1) is identifiable.
3) The recent addition of subsection 138(4.4) of the Act appears to address the issue of interest on construction undertaken by insurance companies.
Standard's Comments
24(1) states that the loan structure used was to facilitate the tracking of participation in the project. The reality of the situation was funded by 24(1) internally and as such the only loan to be recognized for taxation purposes is that portion owed to 24(1) which is 15% of the total loan. They fail to see how it is possible for one taxpayer to be both a debt and a creditor to itself.
Our Comments
In our opinion, 24(1) position is correct and its portion of the interest need not be capitalized as part of the cost of the building. Our opinion is based on the following:
1) Subsection 138(4.4) of the Act does not apply prior to 1987. In addition, were it to apply, it determines the amount to be capitalized based on a prescribed formula which is not related to interest actually paid. The reason for the addition of subsection 138(4.4) of the Act has no bearing on pre-1987 transactions and if it did, would tend to indicate a lack of authority to capitalize such amounts prior to its inclusion in the Act.
2) Both 24(1) were acting as agents of 24(1). As such all transactions undertaken are to be considered as transactions of 24(1) The payments of interest by 24(1) were in fact payments by 24(1) to itself for purposes of its own accounting system. In our opinion, since a taxpayer cannot create revenue or expenses for taxation purposes by using an internal accounting system which causes it to make payments to itself, the revenues and expenses created must be netted in the determination of taxable income. Many internal transfers between various branches or departments of a company are separate identifiable transactions and may relate to one department selling an item to the other department, however in calculating the taxable income of the company these transactions must be netted or reversed.
We trust our comments will be of assistance to you.
Acting ChiefMerchandising Manufacturing and Construction Section Small Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch