Jan 23 1985
HEAD OFFICE Corporate Rulings Directorate P.K. Tang 995-1787
RE: Subsection 12(3) of the Income Tax Act Reporting of Income by a Pawnbroker
This is in reply to your memo of November 15, 1984 concerning the problem of reporting interest income by XXXX (the "Taxpayer"), a registered pawnbroker operating in Ontario under the Ontario Pawnbrokers Act.
The issue at hand is whether or not the Taxpayer should include, in computing its income in a taxation year, any interest on its pawn loans accrued to it to the end of the year. The Taxpayer reports interest income only in the year when the interest is received.
We have received the Taxpayer's agreement in defense of its cash basis of reporting and your office's position of the matter. Our comments are as follows:
1. We do not agree with the Taxpayer's argument that the pawn transaction does not constitute a loan simply because at the end of its transaction year it is not known whether or not the customer will redeem the article pawned. In a pawn transactionm the pawnbroker has made a loan to the pawner but taken the article pawned as a pledge for the repayment of the loan. In our view, it is not relevant whether or not the customer later redeems his article. If the customer did not redeem the article it would become the absolute property of the pawnbroker as repayment for the loan and the interest owing. Under the Ontario Pawnbroker's Act, a pawnbroker is a person who carries on the business of taking by way of pawn of pledge any article for repayment of money lent. On the pawnticket, which constitutes a contract between the pawnbroker and its customer, it is stated, as a condition for the loan, that "the loan may be renewed by payment of interest" and the "loan may be paid by installments". It also provides for a charge of "2% per month for all loans plus ticket charge and storage" (underlines are our). Further, the intention of a loan can also be found in the reminder letter sent by the pawnbroker to its customer when the loan becomes past due.
Whether or not this is a loan, per se, is not the determination factor, in our view, however. Subsection 12(3) of the Income Tax Act (the Act) refers to a "debt obligation" and in our view there is no doubt that there is a "debt obligation" until such time as the amount is paid by the pawner or the Taxpayer extinguishes the obligation by taking title to the property pledged as security.
2. The Taxpayer argued that it has no legal right to enforce payment of the interest at the end of its fiscal year. Most debt obligations have specific terms relating to the dates on which interest is due and payable and the creditor cannot enforce payment except in accordance with those terms. This does not mean that interest does not accrue or that the amount acrrued is not required to be included in income. In the case of pawnbrokers, the terms appear to be set forth in the Pawnbrokers Act which provides that the interest and principal may be paid at any time by the pawner, but the pawnbroker can only "enforce payment" of interest and principal after one year by taking title to the property pawned but as indicated this does not mean interest does not accrue or that accrued interest is not required to be recognized for tax purposes.
3. Under the provisions of subsection 12(3) of the Act a corporation must include in computing its income for a taxation year any interest on a debt obligation that accrued to it to the end of the year. In a pawn transaction, the interest amount is accrued at 2% per month on the amount lent by the pawnbroker. Hence, at the end of the taxation year in which the object is pawned the interest amount accrued must be included in computing the income of the Taxpayer regardless of the fact that such interest amount is not due or payable at that time.
4. XXXX
As we understand the situation the objection to the XXXX reassessment was allowed on the basis of the law as it read at that time that the Taxpayer's principal business was not the making of loans rather than on the question of accrual of interest income. Hence, the Taxpayer's objection of the reassessment should not affect the application of subsection 12(3) of the Act in subsequent years. Pursuant to the provisions of its subsection at this time a taxpayer must include, in computing its income for its taxation year,
(a) all interest accrued to it to the end of the year,
(b) all interest that became receivable by it before the end of the year, or
(c) all interest that was received by it before the end of the year,
to the extent that it was not included in computing its income for a preceeding year. Therefore, it is our opinion that the Taxpayer cannot claim a deduction for an accrual at the beginning of the year unless it has included the amount in its income for a proceeding year.
We hope the above will be of assistance to you.
Chief Services, Public Utilities and Exempt Corporations Section Specialty Corporations Rulings Division Legislation Branch