Mortgage Investment Corporations Affected by IFRS 9 Uncertainty
A change in the International Financial Reporting Standards (IFRS) has
created an unexpected tax exposure relating to loan loss allowances for
mortgage investment corporations (MICs). MICs comply with IFRS and, as a
result, were required to adopt IFRS 9—Financial Instruments for years
beginning on or after January 1, 2018. The standard represents a shift
away from an incurred business model to an anticipated business model.
As explained in more detail in "IFRS 9: Financial Instruments" (Canadian Tax Highlights
, June 2018), the new model for impairment assessment in IFRS 9 is as follows:
- Stage 1 includes financial instruments that have not had a
significant increase in credit risk since initial recognition or that
have low credit risk at the reporting date.
- Stage 2 includes financial instruments that have had a significant
increase in credit risk since initial recognition but that do not have
objective evidence of impairment.
- Stage 3 includes financial assets that have objective evidence of impairment at the reporting date.
The connection to tax liability operates through the loan-loss
provisions of paragraph 20(1)(l). In particular, subclause
20(1)(l)(ii)(D)(II) provides that, for a financial institution or a
taxpayer whose ordinary business includes money lending, a reserve
claimed on loans identified as being impaired is essentially the lesser
of a reasonable amount and 90 percent of the financial statement reserve
as determined under GAAP. A MIC is affected by this rule because an
integral part of its business is earning profits from lending money.
As explained in the Canadian Tax Highlights
article, there is
uncertainty as to whether the financial statement reserve referred to
above includes only loans that fit the description of stage 3, or
whether the reserve also includes loans that fit the descriptions of
stage 1 or stage 2.
MICs are among the taxpayers that adopted IFRS 9 and are therefore
affected by the uncertainty described above. However, most MICs are not
aware of the impact that the accounting change may have on their tax
exposure. In part, this is probably because the definition of "financial
institution" in section 142.2 specifically excludes MICs; however,
paragraph 20(1)(l) is not restricted to financial institutions. Also,
section 130.1 provides that taxable dividends paid by a MIC may be
deducted in determining its taxable income, and that these taxable
dividends are deemed to be received by the shareholder as interest.
Thus, it is typically the intention of a MIC to distribute 100 percent
of its income as the return to its investors, with the effect being that
the MIC pays no tax. This may no longer be possible if a narrow
interpretation is taken of the financial statement reserve, such that
only stage 3 amounts are considered eligible for the paragraph 20(1)(l)
Guidance on this issue from the CRA would be helpful, particularly since
(as noted above) the new standard has been in effect since 2018. If CRA
guidance were to suggest that a narrow interpretation is appropriate,
then the Department of Finance may have to decide whether its intention
is that, as a practical matter, MICs generally do not pay tax.
Geoff Chen and Phil Ross
Grant Thornton LLP, Vancouver