2018-0746351I7 Retained earnings under IFRS

Principal Issues: 1. Can a taxpayer use fair value accounting under IFRS for thin cap purposes, despite the comments in our document 2013-0512551I7? 2. Can a taxpayer use IFRS for thin cap, even if it is voluntary? 3. Can a taxpayer use IFRS for thin cap purposes, and U.S. GAAP for shareholder reporting purposes?

Position: 1. Yes. 2. Yes. 3. Possibly.

Reasons: 1. The subject of document 2013-0512551I7 was the partnership income of a corporate partner, not IFRS retained earnings based on fair value reporting. CRA's position is the same as expressed in ITTN 42. 2. IFRS is an acceptable accounting standard even where it is not mandatory. 3. Accounting methods used for financial statements should generally be consistent between income tax purposes and shareholder presentation. However, each case will have to be considered on its merits.

Author: Graham, Kanwal
Section: 18(4)

                                                                                           October 29, 2018

Kerri Hanley, CPA, CA                                                        HEADQUARTERS
Senior Technical Applications Officer                             Income Tax Rulings
Legislative Application Section                                         Directorate
Large Business Audit Division                                           K. Graham
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Directorate

                                                                                            2018-074635

    Retained Earnings under IFRS

We refer to your email enquiries regarding the effect of converting to International Financial Reporting Standards (“IFRS”) on the application of the thin capitalization rules (“thin cap”) in subsections 18(4) and 18(5) of the Income Tax Act (the “Act”).

You are currently considering a case in which a multi-national entity’s Canadian subsidiary has voluntarily adopted IFRS for the purpose of preparing its Canadian income tax returns. In this regard, you have requested our response to three questions:

1. Can a taxpayer use fair value accounting under IFRS for thin cap purposes, despite the comments in our document 2013-0512551I7?

2. Can a taxpayer use IFRS for thin cap, even if it is voluntary?

3. Can a taxpayer use IFRS for thin cap purposes, and U.S. GAAP for shareholder reporting purposes?

Our Comments

1. Can a taxpayer use fair value accounting under IFRS for thin cap purposes, despite the comments in our document 2013-0512551I7?

In document 2013-0512551I7, the CRA stated that a corporation’s retained earnings are to be determined in accordance with generally accepted accounting principles (“GAAP”) but may not include unrealized appraisal surpluses. However, the subject of 2013-0512551I7 was the partnership income of a corporate partner, not IFRS retained earnings based on fair value reporting.

On May 31, 2010, CRA published Income Tax Technical News (“ITTN”) 42, for the purpose of providing guidance on how IFRS would affect entities’ tax reporting. The CRA stated that where IFRS financial statements are used by a particular entity, it is our position that references to GAAP in the Act can be read as references to IFRS and all references to GAAP in any Agency publication can also be read as references to IFRS for those entities that report under IFRS. In regard to thin cap, CRA maintained that retained earnings are to be computed under GAAP, and when a taxpayer files under IFRS, we would expect retained earnings to be computed using IFRS. This continues to be the CRA’s position.

Therefore, where a taxpayer prepares financial statements using IFRS, and the retained earnings includes amounts that reflect the fair value of certain investments due to the use of IFRS, we would accept that amount as retained earnings for purposes of the thin cap rules.

2. Can a taxpayer use IFRS for thin cap, even if it is voluntary?

Under Canadian GAAP, IFRS became mandatory for publicly accountable enterprises (“PAEs”) effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2011. A corporation that is not a PAE may voluntarily use IFRS for financial accounting purposes; otherwise, it must use Accounting Standards for Private Enterprises (“ASPE”).

You are concerned whether the voluntary adoption of IFRS results in an appropriate measure of financial information, including retained earnings, for purposes of the thin cap rules, given that a taxpayer may be been able to significantly increase the reported retained earnings by adopting IFRS.

The CRA’s position, as stated in ITTN 42, is that when a taxpayer files under IFRS, we would expect retained earnings to be computed using IFRS for thin cap purposes. In our view, retained earnings computed using IFRS is acceptable for thin cap purposes, whether or not the adoption of IFRS is mandatory or voluntary.

3. Can a taxpayer use IFRS for thin cap purposes, and U.S. GAAP for shareholder reporting purposes?

We understand that you are considering a case in which a Canadian taxpayer, that is a member of a multi-national group of companies, prepares financial statements for Canadian tax purposes (including thin cap calculations) using IFRS. The taxpayer also prepares financial statements using U.S. GAAP, which are used for consolidation purposes by the U.S. parent of the taxpayer.

The CRA has previously stated that consistency is expected from the taxpayers to avoid the use of financial statements as a tax planning tool, and this continues to be our view. That is, for purposes of the thin cap rules, the accounting method followed by a taxpayer in preparing financial statements for presentation to its shareholders is generally expected to be consistent with the method followed in preparing financial statements for income tax purposes.

A multinational entity, however, may be required to prepare financial statements using different accounting methods in order to be compliant with the GAAP for each particular country in which financial statements are required to be prepared. As such, it is feasible that a Canadian taxpayer which is part of a multi-national group of companies, who prepares financial statements for income tax purposes under Canadian GAAP (IFRS or ASPE), will also prepare financial statements using another accounting method for purposes of consolidation by a parent entity located in another country, which has a different GAAP. Absent objectionable tax planning or abusive tax avoidance, this may be acceptable, but each particular situation would need to be considered on a case-by-case basis.

Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period.

We trust our comments are of assistance.

Yours truly,



Sherry E. Thomson, CPA, CGA
Acting Section Manager
for Division Director
International Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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