Capital Tax - Paid-Up Capital Inclusions - Shareholders' Equity Accounts

Bulletin 3012
Published: March 2004
Content last reviewed: November 2010
ISBN: 0-7794-2160-4 (PDF)

Publication Archived

Notice to the reader: Capital Tax was fully eliminated on July 1, 2010. It was eliminated effective January 1, 2007 for Ontario corporations primarily engaged in manufacturing or resource activities.

This publication was archived and kept for historical purposes. Use caution when you refer to it, since it reflects the law in force at the time it was released and may no longer apply.

References: subsections 62(4), 62(5), 62(7), and 63(2), and clauses 61(1)(a), 61(1)(b) and 61(1)(c)

Application

This bulletin replaces portions of Interpretation Bulletins L-8R and L-9R originally published on August 15, 1980 and is updated for current legislative references and information from former Information Bulletins 2720, 2726 and 2730.

The bulletin sets out the policy of the Corporations Tax Branch for the inclusions in paid-up capital (PUC). It is provided as a guide to taxpayers and is not intended as a substitute for the legislation. References to legislation are to the provisions of the Corporations Tax Act (Ontario) (CTA) and its Regulations unless otherwise noted.

The bulletin applies to corporations that compute PUC under sections 61 and 62. These corporations are:

  • incorporated in Canada and have a permanent establishment in Ontario, or
  • incorporated outside Canada (non-resident) but carry on their business entirely in Canada.

The bulletin does not apply to:

  • financial institutions computing adjusted taxable PUC under section 62.1,
  • corporations incorporated outside Canada (non-resident) that must compute PUC under subsection 63(1),
  • corporations exempt from capital tax under subsection 71(1), or
  • small business corporations exempt from capital tax under subsection 6 (1).

Table of Contents

  1. This bulletin discusses the components of paid-up capital (PUC) usually associated with the shareholders' equity section of the balance sheet. The following chart shows where the components of PUC are discussed in this and other interpretation bulletins:
    Component of PUC See

    Share Capital (Paid-up Capital Stock)

    Paragraphs 3 - 10

    Retained Earnings (Earned Surplus)

    Paragraphs 11-13

    Contributed Surplus (Capital Surplus)

    Paragraphs 14 - 15

    Any Other Surplus

    Paragraphs 16 - 33

    Reserves

    Paragraphs 34 - 41

    Liabilities:

    • loans and advances
    • lien notes
    • bank loans and indebtedness
    • bankers' acceptances
    • liabilities for income tax, and
    • bonds, debentures and mortgages.

    Interpretation Bulletin 3013R

    Deferred Credits

    Interpretation Bulletin 3013R

    Partnership PUC

    Interpretation Bulletin 3017R

The Meaning of Paid-up Capital - Subsection 61 (1)

  1. PUC for the purpose of capital tax is a wider concept than just the paid-up capital stock or share capital of a corporation described in its articles of incorporation, letters patent or charter. PUC is essentially all the capital of the corporation, as set out by subsection 61(1).

Share Capital (Paid-up Capital Stock)

The Meaning of Share Capital - Clause 61(1)(a)

  1. A corporation must include its "paid-up capital stock" in PUC, in accordance with clause 61(1)(a). Paid-up capital stock, which is termed "share capital" in this bulletin, is the dollar amount of the issued share capital of the corporation, as shown on its balance sheet prepared in accordance with generally accepted accounting principles (GAAP).

Items Included in Share Capital

  1. Share capital includes the value given to all types of issued shares, including:
    • common shares
    • preferred shares, and
    • special category shares.
  2. The following amounts must be included:
    • the value of shares issued for intangibles such as trademarks and patents, and
    • premiums received from shareholders on the issue of shares and recorded as share capital.

Items Excluded from Share Capital

  1. The following amounts are excluded from share capital:
    • subscriptions receivable from shareholders on shares issued to them but not fully paid for, and
    • discounts allowed to shareholders on the issue of shares.

High-Low Preferred Shares

  1. High-low preferred shares are shares that have a redemption amount greater than their legal stated capital. They are often used for income tax purposes in estate freezes. GAAP now requires highlow preferred shares to be presented on the balance sheet as a liability rather than as share capital. Also, they must be presented at their settlement amount, which is usually the (higher) redemption amount, and not at the legal stated capital amount.
  2. The increase in the liability is offset by a decrease in shareholders' equity, either by a direct charge to retained earnings or by reporting a separate negative equity account.
  3. The liability on the balance sheet must be included in PUC under clause 6 (1)(d). The decrease to shareholders' equity is permitted by administrative concession to reduce PUC. The net effect of these adjustments is that only the legal stated capital amount for the shares is included in PUC.

Non-Share Corporations

  1. A corporation that is incorporated without share capital must include in PUC all capital contributed to the corporation by its members.

Retained Earnings (Earned Surplus)

Meaning of Retained Earnings - Clause 61(1)(b)

  1. This bulletin uses the term "retained earnings" in place of the legislated term "earned surplus" in clause 61(1)(b). Retained earnings as shown on a corporation's balance sheet prepared in accordance with GAAP must be included in PUC.
  2. A deficit (negative retained earnings) may, by administrative concession, be deducted from PUC.

Unpaid Dividends - Clause 62(5)(b)

  1. Dividends payable must be included in PUC as "any other surplus" in accordance with clause 62(5)(b) when they:
    • are payable to shareholders not at arm's length with the corporation
    • were unpaid at the prior taxation year-end, and
    • remain unpaid at the end of the current taxation year.

Contributed Surplus (Capital Surplus)

Meaning of Contributed Surplus - Clause 61(1)(b)

  1. This bulletin uses "contributed surplus" instead of the legislated term "capital surplus" in clause 61(1)(b). Contributed surplus as shown on a corporation's balance sheet prepared in accordance with GAAP must be included in PUC.

Examples of Contributed Surplus

  1. Contributed surplus includes donations and contributions of capital made to the corporation by any person. Some examples of contributed surplus are:
    • premiums received on shares issued that are not recorded as share capital
    • any portion of the proceeds of the issue of shares without par value that is not recorded as share capital
    • proceeds arising from donated shares
    • credits arising from the redemption or conversion of shares at less than the amount recorded as share capital, and
    • any other contributions by shareholders in excess of the amount recorded as share capital.

Any Other Surplus

Legislated Items Included in "Any Other Surplus"

  1. "Any other surplus" is a legislated term under clause 61(1)(b) and subsections 62(4), 62(5) and 62(7). It includes:
    • certain unpaid dividends, as explained in paragraph 13
    • income for tax purposes that has not been recorded in the financial statements explained in paragraphs 18 and 19,
    • certain unpaid expenses, explained in paragraph 20
    • certain write-downs of assets, explained in paragraphs 21 to 24, and
    • the write-up of an asset above its cost, except for the appraisal increase of a fixed asset, explained in paragraph 33.

Other Items Included in "Any Other Surplus"

  1. Any other item of surplus recorded in the books or on the financial statements, that is not already included in PUC as contributed surplus (capital surplus), retained earnings (earned surplus) or a reserve, must be included in "any other surplus".

Income for Tax Purposes Not Booked - Subsection 62(4)

  1. Pursuant to subsection 62(4), any amount that is income for income tax purposes under the CTA but has not been recorded as income in the financial statements of the corporation, is required to be included in PUC as "any other surplus".
  2. However, the rule in paragraph 18 does not apply to the following:
    • the addition to income for certain management fees and royalties under subsections 11(5) and 11(6)
    • Crown charges that are required to be included in income by paragraph 12(1)(o) of the Income Tax Act (Canada) (ITA)
    • income of a shareholder for a benefit conferred under subsection 15(1) of the ITA
    • income of a shareholder for certain loans received under subsection 1 (2) of the ITA, and
    • deemed interest income on a loan to a non-resident person under subsection 17(1) of the ITA.

Unpaid Expenses - Subsection 62(5)

  1. An expense must be included in PUC as "any other surplus", pursuant to subsection 62(5), when the expense:
    • is owed to a person who is not at arm's length to the corporation
    • has been deducted for income tax purposes under the CTA, and
    • remains unpaid at the end of the taxation year following the year it was incurred.

Assets Written - Down for Book but not Tax - Clause 62(7)(b)

  1. When a corporation writes down an asset in its books of account for an amount that differs from the deduction claimed for income tax purposes under the CTA, the corporation must make an adjustment to its PUC.
  2. Where an asset write-down has been charged against income in the books of the corporation but is not deductible, or has not been deducted, for income tax purposes under the CTA, the write-down must be included in "any other surplus" pursuant to clause 62(7 (b). Consequently, where the booked write-down exceeds the income tax deduction claimed, the excess book write-down must be included in PUC.
  3. Conversely, by administrative concession, where the deduction claimed for income tax purposes under the CTA exceeds the related write-down booked, the excess tax deduction may be deducted from PUC.
  4. The above adjustments to PUC must be made on a cumulative annual basis to reflect the accumulated differences between the write-down booked (e.g., depreciation) and the tax deduction claimed (e.g., capital cost allowance).

Example: Depreciation Expense versus Capital Cost Allowance

  1. For example, a corporation may have booked accumulated depreciation expense of $1,000,000 whereas the total capital cost allowance (CCA) deducted for income tax purposes under the CTA may amount to only $900,000. The difference of $100,000 must be added to PUC. The same $100,000 must also be added to "total assets" in computing the investment allowance.
  2. Conversely, the corporation may have claimed CCA totaling $1,000,000 but only booked $800,000 in accumulated depreciation expense. The difference of $200,000 is permitted by administrative concession to be deducted from PUC, and from "total assets" in computing the investment allowance.

NBV/UCC Shortcut

  1. As a shortcut to determine the accumulated differences, corporations may take the difference between the undepreciated capital cost (UCC) of fixed assets and their net book value (NBV).
  2. In so doing, however, extraneous items that may distort a proper comparison must first be removed. For example, land (non-depreciable), assets that are not "available for use" for CCA purposes, and appraisal increments relating to fixed assets must be deducted from NBV before comparing NBV with UCC.
  3. The NBV/UCC shortcut is not appropriate for a corporation to which assets have been transferred under section 85 of the ITA. The NBV/UCC shortcut does not provide a proper comparison of the accumulated depreciation expense and cumulative CCA claimed by the corporation for those assets. For more information, see Interpretation Bulletin 3019.

Examples of Asset Write-Downs

  1. Examples of write-downs of assets that require an adjustment to PUC, when they are not deductible or have not been deducted for income tax purposes under the CTA, are:
    • a provision for depreciation, amortization, or depletion of an asset
    • the amortization or write-down of goodwill
    • an allowance for doubtful accounts
    • a provision for obsolescence, and
    • a reduction to realizable value.

Income Tax Incentives do not Reduce PUC

  1. An income tax incentive that provides a deduction from income in excess of the original cost of the expenditure will not affect the PUC of a corporation. As the tax incentive is never booked in the accounts, it must not be deducted from PUC. Moreover, there is no authority in the CTA for such a deduction.
  2. For example, the following Ontario income tax incentives and deductions under sections 12 to 13.5 and clause 11(10)(b) do not reduce PUC:
    • research and development super allowance
    • current cost adjustment
    • Ontario new technology tax incentive gross-up deduction
    • workplace child care tax incentive
    • workplace accessibility tax incentive
    • Ontario school bus safety tax incentive and related gross-up deduction
    • educational technology tax incentive, and
    • resource allowances for mining and oil & gas corporations.

Assets Written-Up - Clause 62(7)(a)

  1. Where an asset is carried on the books or balance sheet of a corporation at an amount in excess of the cost of the asset, such as when shares in a subsidiary are reported on the equity basis, clause 62(7)(a) requires the amount in excess of cost to be included in "any other surplus". As described more fully in Interpretation Bulletin 3015, the excess carrying amount is also included in "total assets" and "cost of investments" for purposes of calculating the investment allowance. These adjustments do not apply to the appraisal increase of a fixed asset.

Reserves

The Meaning of Reserve

  1. "Reserve" is generally considered to mean an amount set aside for future use, expense, loss, or claim. It includes an amount appropriated from retained earnings or other surplus.

Reserves Not Deductible for Income Tax: Contingent and Similar Reserves

  1. Reserves recorded by a corporation must be included in PUC in accordance with clause 61(1)(c) where they:
    • are not deductible in computing income for income tax purposes under the CTA, or
    • are deductible but have not been deducted in computing income for income tax purposes under the CTA.
  2. Examples of reserves that must be included in PUC include:
    • a contingent reserve for damages
    • a reserve for future result of lawsuit
    • a sinking fund reserve, and
    • an appropriation of retained earnings or other surplus account for the future decline in value of an asset.

Reserves Deductible for Income Tax

  1. Reserves, other than the special reserves described in paragraph 40 below, booked in the accounts that are deductible and have been deducted for income tax purposes under the CTA, are not included in PUC. An example is the reserve for guarantees under paragraph 20(1)(l.1) of the ITA.

Book versus Income Tax Reserves

  1. When a reserve, other than the special reserves described in paragraph 40 below, is booked in the accounts for an amount exceeding the amount that has been deducted in computing income for income tax purposes under the CTA, the excess booked reserve must be included in PUC.
  2. Conversely, when a reserve, other than the special reserves described in paragraph 40 below, is booked in the accounts for an amount less than the amount that has been deducted in computing income for income tax purposes under the CTA, the excess amount deducted for income tax purposes is permitted by administrative concession to reduce PUC.

Special Reserves

  1. Three reserves that are deductible in computing income for income tax purposes under the CTA are required by clause 61(1)(c) to be included in PUC when they are recorded in the accounts of the corporation. The reserves are:
    • the reserve for amounts not due until a later year under paragraph 20(1)(n) of the ITA
    • the reserve for a capital gain where proceeds of disposition are receivable after the end of taxation year under sub-paragraph40(1)(a)(iii) of the ITA, and
    • the reserve for a capital gain where proceeds of disposition are receivable after the end of the taxation year, under the "replacement property rules", under sub-paragraph 44(1)(e)(iii) of the ITA.

Appropriated Retained Earnings

  1. All appropriations of retained earnings must be included in PUC. They represent either "earned surplus", "capital surplus" or a "reserve" under the CTA.
 
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