For non-arm’s length persons (related persons), where a deductible expense is unpaid at the end of the second taxation year following the year of accrual, the amount must be added back to income at the beginning of the third taxation year. Alternatively, a joint agreement (Form T2047) may be filed with the creditor and the borrower, deeming the amount to have been paid by the borrower on the first day of the third taxation year following the taxation year in which the expense was incurred. The agreement also allows for a loan to be made for an equal amount. The intent of this rule is to ensure that the payer does not receive a deduction when the payee obtains an unreasonable deferral of tax on the unpaid amount. For example, suppose that Angie rents property to a corporation that she controls. At the end of the year, the corporation accrues rent expense, but Angie, who is on a cash basis of accounting, does not need to report the income until received. Absent section 78, Angie could defer reporting this income indefinitely, while the corporation would receive a deduction for the amount accrued.
Unpaid remuneration, including bonuses, salaries, retiring allowances, pension benefits or other remuneration owing to employees, must be paid no later than 180 days after the end of the taxation year to be deductible. If the remuneration is paid after 180 days the employer may only deduct the remuneration in the taxation year the remuneration is paid to the employee.
Other Prohibited Deductions
Paragraph 18(1)(e)-Reserves for contingent liabilities or a sinking fund.
Paragraph 18(1)(f)-Amortization of discounted bonds issued.
Paragraph 18(1)(g)-Payments on income bonds based on profits of the business.
Paragraph 18(1)(n)-Political contributions-a limited tax credit is provided in subsection127(3).
Again, it is important to determine if any deduction denied under section 18 is available in an alternative or regulated form in section 20 or in any other related provisions.
Review Check 5-7 illustrates the application of some of the restrictions provided for in sections 18 and 67.1.