Tax Angles The ins and outs of CNIL

The phone ring sounded urgent. I picked it up. It was Harry Speers. “Barry, do your guys know what they’re doing?” Now Harry is a bit of a joker but this sounded semi-serious. “Why do you ask, Harry?”

“Because I’ve received an assessment on my 1989 return that you prepared. They want more money. It seems to have something to do with the capital gains exemption.”

I was surprised to hear this.

First, because this was a very quick assessment of a relatively complicated return;

Second, because taxpayers are normally given an opportunity to discuss proposed tax increases before an assessment is issued, except in cases of computational error; and,

Third, because I knew Harry’s capital gains exemption had been carefully worked out.

“Send me a copy of the assessment, Harry, and I’ll get back to you.”

The explanation for the tax increase was in the usual cryptic computer generated style.

“Capital gains exemption claimed has been reduced by cumulative net investment loss. Cumulative net investment loss includes 50% of resource expense claimed.”

I suspected I knew what the problem was. In spite of what the tax forms say, cumulative net investment loss (CNIL) does not necessarily include 50% of resource expenses claimed.

In particular, you do not take into account claims in respect of resource expenses — allocated to a partner by a partnership for a partnership’s fiscal period that ended prior to Dec. 15, 1987, or incurred pursuant to an “old style” flow-through share agreement (this includes all pre-1986 agreements and most 1986 agreements).

Since all resource expenses are not 100% deductible in the year incurred, many people are making a current claim for resource expenses that were incurred prior to 1987. If they just follow the tax forms, they may understate the amount of available capital gains exemption.

I opened up Harry’s tax return file. Sure enough, he had participated in an oil and gas shelter in 1986, and had been allocated both Canadian exploration expense (CEE) and Canadian development expense (CDE). The CEE had all been deducted in 1986, but the claim for CDE was limited to 30% of the undeducted expenditure. Claims in respect of the undeducted balances of CDE were then made in 1987, 1988 and 1989.

A few quick calculations showed it was 50% of these 1988 and 1989 claims that accounted for the CNIL change as assessed. It was apparent the desk assessor had not reviewed the whole return, since there was a schedule that segregated those resource claims that must be added CNIL and that were excluded.

I was happy to call George to tell him that of course we knew what we were doing. The good news is that Revenue Canada was wrong. The bad news is that it will take some time and effort to get the assessment corrected. George agreed I should call the district office and arrange a meeting after they’ve obtained the files from the data centre. If this takes too long, it may be necessary to file a protective notice of objection.

I wonder how many more calls I’ll get on this subject? Maybe business will pick up.006 Barry Dent is a tax partner in the Ernst & Young Mining Industry Group.