Pending Canadian income tax issues.

• Author: Berwick, Hugh D.

Pending Canadian Income Tax Issues

1. BACKGROUND

   Tax Executives Institute welcomes the opportunity to present the following comments on several pending tax issues, which will be discussed with representatives of the Department of Finance during TEI's November 19, 1990, liaison meeting. In the meantime, if you have any questions about these comments, please do not hesitate to call either Donald K. Cornborough, TEI's Vice President for Canadian Affairs, at (604) 372-2217 or Hugh D. Berwick, chair of the Institute's Canadian Income Tax Committee, at (514) 848-8235.

   TEI is an international organization of approximately 4,500 professionals who are responsible -- in an executive, administrative, or managerial capacity -- for the tax affairs of the corporation and other businesses that employ them. TEI's members represent almost 2,000 of the leading corporations in Canada and the United States. (1)

2. INCOME TAX ISSUES

   1. Deductibility of Interest

      On November 24, 1989, a revised Notice of Ways and Means extended the application of the June 2, 1987, tax rules for deductibility of interest to all borrowings made before 1991. With less than two months left before 1991, taxpayers require certainty.

      Has the Department of Finance completed its review of the rules concerning the deductibility of interest and other financing costs? Specifically, has the Department developed a position concerning the CBA/CICA Joint Committee Recommendations of August 20, 1990, including the proposal to broaden section 20(1)(c) to permit a deduction for all interest normally expensed in accordance with good commercial accounting practice? Will Finance be in a position to make its recommendations public before the end of the year?

   2. Currency Swaps and Hedging

      We understand that the Department of Finance and Revenue Canada have each been reviewing the government's policy regarding "swap and hedging" transactions. During the liaison meeting, we request a status report on the project, including some estimate of when any changes will be made known to the public.

   3. Deductibility of Interest on

      Income Taxes

      The nondeductibility of interest on income tax underpayments is a significant issue for taxpayers because of high interest rates, new forms of tax, and the ever-increasing complexity of taxation legislation. The prohibition against an income tax deduction for interest paid on income tax underpayments operates as a penalty. Since the interest paid cannot be taken as a deduction for income tax purposes, the effective rate of interest paid is nearly double the prescribed rate; thus, today the rate is in the neighborhood of 27 percent for corporations with income not subject to the Small Business Deduction. At the same time, credit interest paid on refunds remains fully taxable.

      This situation creates many distortions and anomalies. A most glaring anomaly is the not infrequent situation in which a taxpayer both receives credit interest and pays arrears or instalment interest relating to the same period of time.

      The economic realities of this situation are that the government has a deposit on which it is paying interest, and at the same time, there is a liability of the same taxpayer on whic interest ins accruing; the actual amount due or refundable is the net of these positions. While the interest amounts may offest, the taxse payable on the non-deductible interest paid will exacerbate the burden of the interest expense.

      The cause of arrears interest may ver well be out of the taxpayer's control. It may arise as a result of forecasting variances tht wer not foreseeable. Other causes may be administrative or interpretative or interpretative changes affecting legislation years after returns have been filed or simple, good faith errors or omissions. Some jurisdictions, such as Ontario, address this problem by not adjusting instalment requirements for subsequent reassessments.

      The introduction of the Large Corporations Tax and the Federal Capital Tax, each with their own instalment and final payment requirements, have further complicated the administrative burden associated with the remittance of taxes.

      TEI submits that existing penalties under the Income Tax Act are sufficient to deal with any abuses that might arise. There is no need for an "automatic" penalty by operation of the Act's interest provisions.

   4. Low-or Non-Interest Bearing

      Loans

      Subparagraph 40(2)(g)(ii) of the Income Tax Act disallows recognition of a capital loss on debt unless the debt was acquired by the taxpayer for the purpose of gaining or producing income from business or property (other than exempt income) or as consideration for the disposition of capital property to a person with whom the taxpayer is dealing at arm's length.

      In many cases, corporations invest in subsidiary companies by way of loans rather than capital stock for convenience rather than anything else. TEI submits that where a low-or non-interest bearing loans to a subsidiary forms part of the capitalization of the subsidiary, any loss incurred on the disposition of the debt should be recognized as a capital loss. We invite your response to this proposal.

   5. Interest Deductibility -- Interpretation

      Bulletin It-445

      TEI is also concerend that taxpayers who seemingly fall within Revenue Canada's policy for deductibility of interest may be denied the deduction. Such a result occured in David Scott v. MNR, 89 DTC 218, where an indvidual taxpayer borrowed funds at interest and then lent the funds interest-free to his company. The court declined to adopt the policy enunciated in Interpretation Bulletin IT-445 on the ground that the policy would permit an "undue tax advantage" to accrue to the taxpayer.

      In respect of the situations outlined in Interpretation Bulletin IT-445, TEI recommends that the legislation be amended to take cognizance of REvenue Canada's stated policies and include a closely worded definition of what would not be regarded as an "undue" taxadvantage.

   6. Prepaid Interest

      Effective after 1984, proposed subsection 18(9.1) of the Income Tax Act requires that "prepaid interest" be deducted during the period over which a debt obligation would have remained outstanding. It appears, however, that the recipient of such "prepaid interest" will be taxable in the year of receipt. Please comment on the apparent discrepancy between the timing of when the payor claims a deduction and when the payee reports the income.

   7. Large Corporation Capital Tax

      Instalments

      The separate instalment requirement outlined in the proposed section 181.7 of the Income Tax Act (as set forth in Bill C-28) may impose...