Capital Tax - Paid-up Capital Inclusions - Liabilities and Deferred Credits

Bulletin 3013
Published: March 2004
Content last reviewed: November 2010
ISBN: 0-7794-2408-5 (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 61(2), 61(8), 61(9), 62(5) and 63(2) and clause 61(1)(d). subsections 701(1), (2) and (3) of Regulation 183.

Application

This bulletin replaces portions of Interpretation Bulletins L-8R and L-9R which were originally published on August 15, 1980 and is updated for current legislative references and information contained in former Information Bulletin 2739.

The bulletin sets out the policy of the Corporations Tax Branch for liabilities and deferred credits that are to be included in paid-up capital (PUC). It is provided as a guide to taxpayers and is not intended as a substitute for the relevant 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 all corporations except:

  • financial institutions computing adjusted taxable PUC under section 62.1
  • corporations exempt from capital tax under subsection 71(1), and
  • small business corporations exempt from capital tax under subsection 68(1).

Overview of inclusion in PUC

  1. This bulletin discusses liabilities and deferred credits that are included in paid-up capital (PUC). The following chart shows where the inclusions in PUC are discussed in this and in other interpretation bulletins:

Inclusion in PUC

  • Loans and Advances: see paragraphs 4 to 17
  • Current Accounts Payable: see paragraphs 18 to 21
  • Deferred Revenue and Other Prescribed Items: see paragraphs 22 to 25
  • Income Tax Liabilities and Assets: see paragraphs 26 and 27
  • Long-Term Debt: see paragraphs 28 to 39
  • Corporate Beneficiaries of Trusts: see paragraphs 40 and 41
  • Shareholders' Equity accounts, including share capital, retained earnings, contributed surplus, any other surplus, and reserves: see Interpretation Bulletin 3012
  • Obligations under Leases: see paragraphs 21 and 22.
  • Partnership PUC: see Interpretation Bulletin 3017

Legislation

  1. Clause 61(1)(d) requires all liabilities and deferred credits, except current accounts payable described in subsection 61(2) and items prescribed in section 701 of Regulation 183, to be included in PUC.

Legal Obligations

  1. A liability recorded under generally accepted accounting principles (GAAP) that is a legal obligation of the corporation is included in PUC as a "liability" under clause 61(1)(d). A liability under GAAP that is not a legal obligation of the corporation is not a liability for capital tax purposes. However, where the amount has been charged against income, retained earnings or another surplus account, it is considered to be a "reserve" which may be included in PUC under clause 61(1)(c). Reserves are discussed more fully in Interpretation Bulletin 3012R.

Loans and Advances

Examples of Loans and Advances

  1. Loans and advances payable by a corporation must be included in its PUC pursuant to clause 61(1)(d). Loans and advances include both sums loaned and credit(s) advanced to the corporation. Examples of loans and advances to be included in PUC are:
    • all short or long-term loans of cash from any source, whether from a bank, trust, finance or loan corporation, shareholder, or any other person
    • bankers' acceptances
    • lien notes payable
    • amounts owing even if cash was not advanced, such as credit extended to a corporation for the purchase of fixed assets or shares
    • trade accounts payable to an arm's length corporation that have been outstanding for 365 or more days at the year-end, and
    • trade accounts payable, owing to a corporation that is not at arm's length, that have been outstanding for 120 or more days at the year-end.

Bank Indebteness and Loans

  1. Bank indebtedness recorded on the balance sheet which represents the excess of outstanding cheques over funds on deposit at a financial institution is not considered to be a loan. However, the portion of the recorded bank indebtedness representing the actual overdraft balance for each account as shown on the statement from the financial institution, is considered to be a loan and must be included in PUC.
  2. All current and operating accounts, whether at one or more financial institutions, may be combined in determining whether a corporation is in a net cash or overdraft position as shown on the statement(s) from the financial institution(s). Loans and term deposits are not to be combined with these accounts.
  3. An amount that is required to be on deposit with a financial institution as security for a loan from the financial institution, may be netted against the amount of the loan. "Total assets" for purposes of the investment allowance would then also be reduced, unless the deposit has already been netted with the loan on the balance sheet of the corporation.

Bankers' Acceptances

  1. Bankers' acceptances are drafts or bills of exchange that have been drawn by a creditor (usually a supplier of goods), that are payable at maturity by a debtor (usually the purchaser of goods), and that have been "accepted" by the financial institution of the debtor. In accepting the draft, the financial institution guarantees that payment will be made at maturity.
  2. Bankers' acceptances, regardless of their term, purpose or balance sheet presentation, are treated as loans payable and must be included in the PUC of the debtor corporation.
  3. Where the amount is outstanding beyond the term of the bankers' acceptance, it must be included in the debtor's PUC as a bank loan.

Loans and Advances from Shareholders

  1. All loans and advances from the shareholders of the corporation must be included in PUC, regardless of whether the shareholders are at arm's length with the corporation. Loans and advances include cash advances and credits made available by shareholders, whether directly or indirectly. An example of an indirect advance of cash by a shareholder is the advance of funds from a trust which is administered by the shareholder on behalf of his/her family.

Netting Loans and Advances / Receivable/Payable

  1. A taxpayer corporation is permitted, by administrative concession, to reduce PUC by netting a loan or advance receivable with the corresponding loan or advance payable where all the following conditions are satisfied:
    • the receivable and the payable are of the same nature
    • they are due to, and from, the same corporation
    • that corporation is related to the taxpayer corporation, and
    • the receivable otherwise qualifies as an eligible investment.
  2. Where the taxpayer corporation satisfies the above criteria, it must also reduce its eligible investments and total assets for purposes of the investment allowance.
  3. For example:
    • A subsidiary corporation owes its parent corporation $1,000,000 which was advanced to the subsidiary as a loan to cover capital equipment acquisitions over the next 12 months.
    • At the same time, the subsidiary advanced $200,000 to its parent corporation as a temporary measure to overcome a cash shortage.
    • Both advances are due within a year, are non-interest bearing and are issued without security.

The advances are permitted to be netted. Consequently, only $800,000 would be included in the subsidiary's PUC, the $200,000 advance to the parent would not be claimed as an eligible investment, and total assets for purposes of the investment allowance would be reduced by $200,000.

Lien Notes

  1. Lien notes represent debt obligations which are secured by a corporation's property. Examples include lien notes used:
    • by corporations to acquire fixed assets such as machinery and equipment, and
    • by automotive and farm equipment dealers to acquire inventories of new vehicles and farm equipment.
  2. The full amount of all lien notes must be included in PUC, irrespective of their presentation on the balance sheet as a current account payable, other current liability or long-term liability.
  3. Unrecorded lien notes that are legal obligations of the corporation must also be included in PUC. For example, lien notes pertaining to goods-in-transit at the year-end must be added to PUC. In addition, the goods-in-transit must be added to total assets for purposes of the investment allowance.

Current Accounts Payable

Current Accounts Payable Excluded from PUC - Subsection 61(2)

  1. Under subsection 61(2), current trade accounts payable for the purchase of goods or services that have been outstanding for less than 365 days at the year-end, or less than 120 days if due to a related corporation, are excluded from PUC. The following current liabilities, not normally considered to be current trade accounts payable, are also excluded from PUC by subsection 61(2):
    • employee source deductions
    • salaries and wages payable
    • current income taxes payable, and
    • cheques issued and outstanding in excess of funds on deposit at a financial institution.
  2. In addition to current income taxes payable, corporations are permitted, by administrative concession, to exclude from PUC other types of current taxes payable, such as GST, capital tax, provincial sales tax, property tax and business tax.
  3. The current portion of long-term debt is not included in the extended meaning of "current accounts payable" under subsection 61(2) and consequently must be included in PUC.
  4. An unpaid amount, other than accounts payable referred to in subsection 61(2), is defined by subsection 62(5) to be "any other surplus" and must be included in PUC where the amount:
    • is owed to a person who is not at arm's length to the corporation
    • has been deducted for income tax purposes and
    • was incurred in a preceding taxation year.

Deferred Revenue and Other Prescribed Items

Prescribed Exclusions from PUC - Section 701 of Regulation 183

  1. Subsection 701(1) of Regulation 183 prescribes liabilities and deferred credits that are excluded from PUC. In brief, the excluded items are:
    • accrued (not legally due) interest, other than interest capitalized to the principal of a loan, that has accrued for 365 days or less at the year-end
    • interest owing to a related person that has been legally due and payable for less than 120 days at the year-end
    • interest owing to an arm's length person that has been legally due and payable for less than 365 days at the year-end
    • dividends declared during the year and unpaid at the year-end, and
    • deferred revenue, deferred credits and lease obligations that would not be included in capital for purposes of the large corporations tax (LCT) under subsection 181.2(3) of the Income Tax Act (Canada), irrespective of whether the corporation is subject to the LCT.
  2. Conversely, deferred revenue, deferred credits and lease obligations are included in PUC where they:
    • are included in the corporation's capital for purposes of the LCT, or
    • would be included in the corporation's capital if the corporation were subject to the LCT.

Preventing Double Inclusions in PUC

  1. Subsection 701(2) of Regulation 183 provides that an amount will not be included in PUC as a result of subsection 701(1) where that amount is required to be and is included in PUC under another provision of the CTA. This prevents an amount being included in PUC twice.

Ensuring Consistency with CTA.

  1. Subsection 701(3) of Regulation 183 provides that an amount cannot be excluded from PUC as a result of subsection 701(1) where that amount is required to be included in PUC by another provision of the CTA other than clause 61(1)(d). This ensures that the CTA takes precedence over the regulation in the case of any inconsistency.

Income Tax Liabilities and Assets

Current and Future Income Tax Liabilities

  1. Current liabilities for income taxes, representing taxes due to be paid within the next fiscal year, should be excluded from PUC. The liability for future income taxes (or the former deferred income tax credit) recorded under GAAP must be included in PUC.

Future Income Tax Asset (Deferred Tax Debit)

  1. By administrative concession, a corporation is permitted to deduct from PUC a future income tax asset (or a former deferred income tax debit). Total assets for purposes of the investment allowance would then also be reduced.

Long-Term Debt

Bonds, Mortgages and Debentures

  1. All long-term debt of a corporation, including the current portion of long-term debt, must be included in PUC. Some common forms of long-term debt are bonds, bond mortgages, debentures, income bonds, income debentures and mortgages.

Discounts and Premiums on Issuing Debt

  1. Generally, the amount of capital received by a corporation as a result of issuing, assuming or undertaking debt is the amount to be included in PUC.
  2. Where a corporation issues debt for a discount, the excess of the face value of the debt over the proceeds received on the issue is not included in PUC. Accordingly, the portion of any unamortized discount which has not been netted with the face value of the debt on the balance sheet may be deducted from the face value of the debt otherwise included in PUC. The amortization of the discount reduces PUC through retained earnings. A separate adjustment to PUC is not required for any difference from the income tax deduction allowed.
  3. Where a debt obligation is issued for a premium, the excess of the proceeds received over the face value of the debt must be included in PUC.

Premiums on Redeeming Debt

  1. For accounting purposes, a premium payable and related expenses may be added to the carrying value of debt where, for example, a premium is required to be paid in accordance with a debt instrument to debt holders at the maturity of the debt. The premium and related expenses payable are permitted to be excluded from PUC to the extent that they have not already been charged to expense for accounting purposes.
  2. The amount charged to expense for accounting purposes reduces PUC through retained earnings. A separate adjustment to PUC is not required where the (cumulative) expense for accounting purposes differs from the (cumulative) deduction allowed in computing income for income tax purposes.

Mortgage Advance Receivable

  1. A mortgage advance receivable may be recorded as an asset when part of a mortgage loan is yet to be received from the lender but the full mortgage loan payable has been recorded as a liability. Where the mortgage debt has not already been reduced, the receivable should be deducted from PUC, eligible investments and total assets for purposes of the investment allowance.

Deferred Foreign Exchange Gains and Losses

  1. Under GAAP, long-term debt payable in a foreign currency should be presented on the balance sheet in Canadian funds translated at the rate of exchange in effect at the year-end. A foreign exchange gain or loss results when the year-end exchange rate differs from the exchange rate that prevailed when the debt was issued. In accordance with GAAP, the gain or loss should be deferred and amortized over the remaining term of the debt.
  2. Foreign currency denominated debt is included in PUC at the year-end value recorded under GAAP. A deferred foreign exchange gain relating to the debt is also included in PUC.
  3. A deferred foreign exchange loss relating to the debt is permitted, by administrative concession, to reduce PUC and total assets for purposes of the investment allowance.
  4. The amortized gain or loss recorded in the income statement is included in PUC through retained earnings. A separate adjustment to PUC is not required for any difference between the accounting and tax treatment of the amortized gain or loss.
  5. The net result of paragraphs 35 to 38 is to include the debt (or remaining debt) in PUC at the rate of exchange prevailing when the debt was issued. From another perspective, the net result is to include in PUC the Canadian funds received on issue of the debt (or received for the portion of the debt still outstanding at the year-end).

PUC Added from a Trust-Subsections 61(8) and 61(9)

  1. A corporation that is a beneficiary of a trust must include in PUC its beneficial share of the liabilities and deferred credits of the trust other than current accounts payable and prescribed items. The liabilities, deferred credits, current accounts payable and prescribed items are determined for the trust as though it were a corporation. Accordingly, the sections of this bulletin dealing with these items are applicable to a trust. As an example of an inclusion in PUC, a mortgage liability of a trust would be attributed to a corporation in proportion to the beneficial interest of the corporation in the trust.
  2. Subsection 61(9) provides that a corporation must include in PUC its beneficial share of the accounts payable of the trust which are owed to corporations related to the trust, and those which are owed to corporations related to the taxpayer corporation, where the accounts payable are outstanding for 120 days or more at the year-end of the trust.
 
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