Capital Tax - Deductions from Paid-Up Capital

Bulletin 3015
Published: March 2004
Content last reviewed: November 2010
ISBN: 0-7794-2180-9 (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(1), 62(1.1), 62(1.2), 62(1.3), 62(2), 62(3), 62(4), 62(7)

Application

This bulletin replaces Interpretation Bulletin Number L-10R originally published August 15, 1980 and is updated for comments contained in previous Information Bulletins 2739 and 2752 and Interpretation Bulletin L-16.

The bulletin sets out the policy of the Corporations Tax Branch (Branch). It is provided as a guide to taxpayers and is not intended as a substitute for the relevant legislation. Any references to legislation are to the provisions of the Corporations Tax Act (Ontario) (CTA) and its Regulations, unless otherwise noted.

The information in this bulletin does not apply to financial institutions. For information on the capital tax of financial institutions, refer to Tax Legislation Bulletin 98-1, dated February 1998.

Overview

  1. Subsection 62(1) allows a corporation to claim various items as deductions from paid-up capital in calculating taxable paid-up capital. These deductions are discussed as follows:

    Deductions from Paid-up capital in calculating taxable paid-up capital

    Topic Paragraph
    Investment Allowance
    General, Calculation 2 to 4
    Cost of Investments 5 to 8
    Rules Which Apply to All Investments 9 to 11
    Types of Investments
    (cash deposits, investments in financial institutions, loans or advances, commercial paper, accounts receivable, leased, assets and investments in mutual fund trusts)
    12 to 23
    Total Assets (as adjusted) & Paid-up Capital (as adjusted) 24 to 32
    Other Deductions from Paid-up Capital
    Discount on shares 33
    Deferred Canadian and Ontario Mining Exploration & Development Expenses 34, 35 & 42
    Renounced Canadian Mining Exploration & Development Expenses 36 to 42
    Undeducted scientific research and experimental development (SR&ED) or Ontario New Technology Tax Incentive (ONTTI) amounts 43

General Rules

General

  1. The Investment Allowance is a deduction from paid-up capital which is granted to minimize double-taxation that might result when the eligible investments are included in the paid-up capital of the issuing corporations.

Calculation

  1. Clause 62(1)(c) provides that a corporation computes its investment allowance as a proportion of paid-up capital (as adjusted), calculated as:

    [(Cost of "Eligible Investments" In Other Corporations) / (Total Assets (as adjusted))] x Paid-up Capital (as adjusted)

  1. Paragraph 62(1.2)1 limits the investment allowance deduction to a maximum of the cost of eligible investments.

Cost of Investments

  1. The investment allowance is based on the "cost of investments". Cost generally means the purchase price or the amount expended.
  2. Where an investment is carried in the corporation's books of account or on its balance sheet in excess of the cost of the investment, such as when shares in a subsidiary are reported on the equity basis, clause 62(7)(a) requires the investment allowance to be calculated on the higher amount.
  3. Where an investment has been written down and the write-down is not deductible for tax purposes, clause 62(7)(b) includes the amount of the write down in paid-up capital as "any other surplus", and in the calculation of the investment allowance as part of "cost of investments" and "total assets".
  4. Where an investment has been written down for accounting purposes and the write-down is deductible and has been deducted for tax purposes, clause 62(7)(c) recognizes this write-down for capital tax purposes. Accordingly, no additional adjustment is made to paid-up capital, cost of investments and total assets.

Rules Which Apply to All Investments in Other Corporations

  1. Generally, investments in other corporations qualify for the investment allowance deduction. Subsection 62(1.1) provides that an investment in another corporation is:
    • an investment by the corporation in shares issued by the other corporation
    • an investment by the corporation in bonds, lien notes and similar obligations issued by the other corporation, or
    • a loan or advance to the other corporation.
  2. An investment in a corporation that is not subject to capital tax referred to in subsection 71(1) does not qualify as an eligible investment. For example, an investment in a credit union, family farm or family fishing corporation, registered charity or a government-owned corporation would not qualify. However, an investment in a taxable prescribed Crown corporation listed in section 401 of Regulation 183 would qualify as an eligible investment.
  3. Where an investment is made less than 120 days before the year end of the corporation as part of a "series of investments and repayments or redemptions" in a related corporation that has a different year end from the year end of the corporation claiming the eligible investment, paragraph 62(1.2)10 and subsection 62(1.3) may restrict or deny the deduction.

Types of Investments

Cash Deposits

  1. Paragraph 62(1.2) 2 provides that cash on deposit with any corporation authorized to accept deposits from the public is not an eligible investment.
  2. A cash deposit paid for goods to be delivered or services to be rendered after the end of the corporation's year end qualifies as an eligible investment if it otherwise qualifies for inclusion in the federal investment allowance under paragraph 181.2(4)(b) of the Income Tax Act (ITA), or would qualify for inclusion, if the corporation were subject to Part I.3 tax under the ITA.

Investments in Financial Institutions

  1. Investments in financial institutions qualify as eligible investments under paragraph 62(1.2)4 if the investment represents:
    • shares of Canadian or foreign financial institutions
    • long-term debt of Canadian or foreign financial institutions which meets the criteria in subsection 181(1) of the ITA, or
    • bankers' acceptances issued and held for at least 120 days before the end of the corporation's taxation year.
  2. For Ontario tax purposes, a financial institution is defined as a corporation that at any time during the taxation year is:
    • a bank
    • authorized under the laws of Canada or a province to carry on the business of offering its services as a trustee to the public
    • authorized under the laws of Canada or a province to accept deposits from the public, and carries on the business of lending money on the security of real estate or investing in mortgages on real estate
    • a mortgage investment corporation
    • a registered securities dealer
    • a credit union, or
    • a corporation prescribed by the regulations (section 703 of Regulation 183).
  3. Term deposits issued by banks and (guaranteed) investment certificates of trust companies are not eligible investments irrespective of their term.

Loans or Advances

  1. Subject to the restrictions discussed in paragraph 18 below, loans or advances to other corporations generally qualify for the investment allowance deduction. For a discussion of what constitutes a loan or advance to be included in paid-up capital, refer to Interpretation Bulletin 3013.
  2. Loans and advances to corporations will not qualify as eligible investments for purposes of the investment allowance if they are:
    • made to a corporation exempt from Ontario capital tax (see paragraph 10 above)
    • part of a series of investments and repayments or redemptions (see paragraph 11)
    • made to a financial institution and it is not long-term debt which meets the criteria in subsection 181(1) of the ITA (see paragraphs 14 and 15)
    • guaranteed by a related financial institution unless the loan or advance is issued for a term of and held for at least 120 days prior to the year end, or
    • to a related corporation which has its head office outside Canada unless the loan or advance is outstanding for at least 120 days prior to the year end.

Commercial Paper

  1. Commercial paper must be issued for a term of 120 days or more and held for at least 120 days prior to the year-end of the investor to qualify as an eligible investment. Commercial paper which is issued without a specified term must be held for 120 days or more prior to the year-end of the investor to qualify.
  2. Commercial paper issued by a financial institution does not qualify for the investment allowance, regardless of the term and holding period.

Accounts Receivable

  1. Trade accounts receivable from a related corporation must be outstanding for at least 120 days prior to the taxpayer's year end to qualify as an eligible investment. Trade accounts receivable from an arms' length corporation must be outstanding for at least 365 days prior to the taxpayer's year end to qualify.

Leased Assets

  1. Special rules apply to the computation of paid-up capital and eligible investments where a corporation is a lessor or lessee.

Investments in Mutual Fund Trusts

  1. Units in a mutual fund trust do not qualify as an investment for the investment allowance deduction. There is no provision which allows a corporate beneficiary of a mutual fund trust to claim investment allowance on its share of the trust's eligible investments.

Total Assets (as adjusted)

Introduction

  1. Total assets used in the denominator of the fraction of the Investment Allowance formula discussed in paragraph 3 are total assets on the balance sheet, adjusted, if necessary, for the following inclusions and deductions.

Amounts Included in Total Assets (as adjusted)

  1. When a corporation has an investment in a partnership, it must add its share of the partnership assets to its total assets and deduct the amount shown in its financial statements as its investment in the partnership, pursuant to subsection 62(3). The corporation's share of the partnership assets is calculated using the corporation's profit-sharing percentage in the partnership.
  2. As discussed in paragraph 7, where assets are written-down and the write down is not deductible for income tax purposes, subsection 62(7) requires that the difference between the amount carried in the books and the cost amount be included in total assets for purposes of determining the investment allowance.
  3. Corporations occasionally net obligations due to or from related corporations on their financial statements. This has the impact of reducing the corporation's total assets on its balance sheet. For capital tax purposes, netting is allowed only to the extent that the amounts netted are from the same company and of the same nature. When this is not the case, total assets should be increased by the impact of any netting. Netting may also impact the amount of loans and advances to be added to eligible investments and paid-up capital. The impact of netting on paid-up capital is discussed further in paragraphs 11 to 13 of Interpretation Bulletin 3013.

Amounts Excluded or Deducted from Total Assets (as adjusted)

  1. Pursuant to subsection 62(7), for the purposes of calculating the investment allowance, except for certain tax reserves referred to in paragraph 29, total assets is reduced for the following items:
    • asset write-downs deducted for tax in excess of amounts booked (e.g., the excess of net book value over undepreciated capital cost (NBV/UCC difference)).
    • the excess of book value over cost resulting from an appraisal surplus of the corporation's fixed assets.
  2. The following income tax reserves under the ITA do not reduce total assets for capital tax purposes:
    • deferred profit reserve [paragraph 20(1)(n)], and
    • capital gains reserve [subparagraphs 40(1)(a)(iii) and 44(1)(e)(iii)].
  3. Total assets for investment allowance purposes is also reduced by the following deductions from paid-up capital:
clause deduction from paid-up capital discussed in paragraph(s)
62(1)(b) discount on issue of share capital 33
62(1)(d) deferred mining exploration & development expenses 34, 35, 42
62(1)(e) renounced mining exploration & development expenses 36-42
62(1)(f) scientific research & development expenses (SR&ED) deductible but not deducted 43
62(1)(f) any Ontario New Technology Tax Incentive (ONTTI) deductible but not deducted 43
  1. The above reductions are available only to the extent the corresponding expenditures were not written off to income for financial statement purposes.

Paid-up Capital (as adjusted)

  1. Paid-up capital (as adjusted) for purposes of the investment allowance formula discussed in paragraph 3 is determined by reducing paid-up capital by the amounts referred to in paragraph 30.

Other Deductions from Paid-up Capital

Discount on Shares

  1. Clause 62(1)(b) allows a corporation to deduct from paid-up capital the amount of the discount on the issue or sale of shares of the corporation, to the extent that the discount has not otherwise reduced the amount of share capital or retained earnings included in paid-up capital.

Deferred Canadian and Ontario Mining Exploration and Development Expenses - Clause 62(1)(d)

  1. Mining corporations accumulate expenses incurred by them in exploration and development activities in Canada. These deferred expenses may be carried forward and deducted from income in computing income taxes in future years. Subject to the exception noted in paragraph 42 below, the following undeducted amounts may be deducted from paid-up capital for capital tax purposes:
    • Canadian exploration and development expenses (CEDE)
    • Canadian exploration expenses (CEE)
    • Canadian development expenses (CDE), and
    • Ontario exploration and development expenses (OEDE).
  2. As an example, assume a mining corporation incurred CEDE of $1,000,000 which has been treated as follows:
    • $400,000 written off in the profit and loss statement with the balance of $600,000 shown as deferred expenses (asset) on the balance sheet
    • $200,000 deducted from income for income tax purposes with the balance of $800,000 available to reduce future income taxes.
    Paid-up capital would be adjusted as follows:

    add $200,000
    - the difference between the write-off for book purposes ($400,000) and the write-off for tax purposes ($200,000)

    deduct $800,000
    - the balance of the deferred expenses available for future income tax purposes.

    The net result of the above is a reduction to paid-up capital of $600,000. This would be in addition to the $400,000 already written off in the books and reducing surplus. In effect, paid-up capital has been reduced by $1,000,000, the full amount of the exploration and development expenses. As noted in paragraph 30 above, a similar deduction is made to total assets.

Renounced Mining Expenses

  1. Subject to the exception noted in paragraph 42, clause 62(1)(e) allows a deduction from paid-up capital for CEE and CDE renounced to individuals under section 66 of the ITA.
  2. Where a joint exploration corporation renounces CEE or CDE in favour of a shareholder corporation rather than to an individual, the deduction from paid-up capital provided by clause 62(1)(e) for renounced expenditures does not apply to the joint exploration corporation.
  3. However, the Corporations Tax Branch administratively deems the renounced CEE or CDE to have been incurred by the shareholder company for capital tax purposes. Accordingly, the joint exploration corporation may reduce total assets by the renounced portion of any CEE or CDE reflected in its assets for accounting purposes. The shareholder corporation must add to total assets the renounced CEE or CDE that it has not recorded for accounting purposes.
  4. The joint exploration company must also make the following adjustments to total assets and paidup capital:
    • deduct the balance of any CEE or CDE deferred for tax purposes (pursuant to clause 62(1)(d), as discussed in paragraphs 34 and 35 above), and
    • deduct the cumulative amount of CEE or CDE written off for tax purposes in excess of the cumulative amount (if any) of CEE or CDE deducted for accounting purposes. Conversely, the excess of the cumulative amounts deducted for accounting over the cumulative amounts deducted for tax purposes is added to paid-up capital and total assets.
  5. In addition to the adjustment to total assets noted in paragraph 38, the shareholder corporation must also make the following adjustments to total assets and paid-up capital in respect of CEE or CDE renounced by the joint exploration company, or CEDE, CEE, CDE or OEDE incurred directly:
    • deduct the balance of any of the above mining expenditures deferred for tax purposes (pursuant to clause 62(1)(d), as discussed in paragraph 34 and 35 above), and
    • deduct the cumulative amount of any of the above mining expenditures written off for tax in excess of the cumulative amount (if any) of mining expenditures deducted for accounting purposes. Conversely, any excess of amounts deducted for accounting over amount deducted for tax is added to paid-up capital.
  6. The adjustments outlined in paragraphs 37 to 40 also apply to a junior mining corporation that issues flow through shares and renounces resource expenditures to its investors.

Exception: Oil and Gas Expenses

  1. Pursuant to the definition of minerals in subsection 62(2), the deductions under clauses 62(1)(d) and 62(1)(e) for deferred and renounced mining expenses are not allowed for expenses incurred in exploring for or developing petroleum, natural gas or related hydrocarbons, bituminous sands, oil sands or oil shale.

Undeducted SR&ED and ONTTI Costs

  1. Clause 62(1)(f) allows a deduction from paid-up capital for SR&ED and ONTTI amounts deductible but not deducted in the current or any prior year, to the extent that these amounts have not been deducted in the corporation's financial statements.
 
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