4 February 2005 External T.I. 2004-0101781E5 - Revenue Recognition

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Whether amounts invoiced in the current taxation year, but not paid, for services to be performed in the subsequent taxation year, are included in income for the current taxation year.

Position: No.

Reasons: The amounts invoiced are not received, paragraph 12(1)(a), receivable, paragraph 12(1)(b), or earned, subsections 9(1) and 12(2). Therefore such amounts are not included in computing income.

2004-010178
XXXXXXXXXX A. Seidel, CMA
(613) 957-2058
February 4, 2005

Dear XXXXXXXXXX:

Re: Paragraphs 12(1)(a) and (b) of the Income Tax Act

This is in reply to your letter dated October 26, 2004, in which you requested our comments with respect to the application of paragraphs 12(1)(a) and (b) of the Income Tax Act (the "Act").

You describe a situation in which a taxpayer invoices clients for services to be provided in the subsequent fiscal period of the taxpayer. Some of the clients pay the invoice in the current fiscal period of the taxpayer and some clients pay the invoice in the year in which the services will actually be provided. You query whether, in the latter situation, the taxpayer must include an amount in income in the fiscal period in which the client is invoiced.

The particular circumstances in your letter on which you have asked for our views appear to be a factual situation involving a specific taxpayer. To the extent that you require confirmation of the tax consequences of proposed transactions involving a specific taxpayer, we bring to your attention Information Circular 70-6R5, Advance Income Tax Ruling ("IC 70-6R5"). As explained in IC 70-6R5, it is not this Directorate's practice to comment on proposed transactions involving specific facts other than in the form of an advance income tax ruling. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate district tax services office for their views. However, we are prepared to offer the following general comments which may be of assistance.

In general, both sections 9 and 12 of the Act have the effect of bringing amounts into income. Section 9 of the Act sets out the principle that a taxpayer must include, in computing its income from a business, the profit therefrom for the year. Section 12 of the Act sets out specific amounts that must be included in computing such income.

Pursuant to paragraph 12(1)(a) of the Act, an amount received in the year for services not rendered or goods not delivered is included in the income of a taxpayer in the year in which it is received. A taxpayer may, however, claim a reasonable reserve under paragraph 20(1)(m) of the Act.

Ellis Vision Incorporated v. Her Majesty the Queen, 2004 DTC 2024 (TCC), considered the issue of when paragraph 12(1)(a) of the Act could apply. Rip, J. concluded that notwithstanding the fact that an amount may be included in income under subsection 9(1) of the Act, such amount may nonetheless be described in paragraph 12(1)(a) of the Act if it is received on account of a service, that in the main, has not been rendered before the end of the year, has not been earned in the year of receipt or is an amount for the use of a chattel that was paid in advance. Rip, J. concluded that a taxpayer is entitled to a reasonable reserve in respect of such amounts under paragraph 20(1)(m) of the Act. To be an amount described in paragraph 12(1)(a) of the Act, the amount must be received by the taxpayer, which would not be the case in the situation where the client has not paid the invoice.

Generally speaking, paragraph 12(1)(b) of the act applies to require taxpayers to include in income "amounts receivable" in respect of property sold or services rendered in the course of a business in a particular taxation year, even though the amount is not due until a subsequent taxation year.

Minister of National Revenue v. John Colford Contracting Company Limited, 60 DTC 1131 (Ex.Ct.), considered the issue of when paragraph 12(1)(b) of the Act would apply. Kearney, J. concluded that an "amount receivable" should be interpreted as meaning an amount which the intended recipient has a clearly legal, though not necessarily immediate right to receive. In the situation described above, paragraph 12(1)(b) of the Act would not apply if the taxpayer has not sold any property or rendered any services to the client and has, therefore, no legal right to receive an amount from the client.

Subsection 12(2) of the Act provides that paragraphs 12(1)(a) and 12(1)(b) of the Act were enacted for greater certainty, and should "...not be construed as implying that any amount not referred to in those paragraphs is not to be included in computing income from a business for a taxation year whether it is received or receivable in the year or not".

Maritime Telegraph and Telephone Company, Limited v. Her Majesty the Queen, 92 DTC 6191 (FCA), considered the issue of when subsection 12(2) of the Act applies. The principal issue considered was whether subsection 9(1) of the Act applied to amounts that were earned but not received or receivable. MacGuigan, J.A. stated that, "[I]n my opinion, s. 12(1) operates so as to expand s. 9(1)'s ambit of inclusion. Obviously, at the boundary line of inclusion there may logically be some exclusions, but the joint thrust of s. 9 and s. 12(1) is to include, not exclude, and s. 12(2) has the effect of ensuring, at the very least, that nothing clearly included in s. 9 is henceforth excluded". In the situation described above, subsection 12(2) of the Act would not apply since the taxpayer has not earned the amount invoiced.

Accordingly, in situations where a taxpayer has invoiced a client in respect of services to be rendered or goods to be delivered in the subsequent taxation year of the taxpayer, but the taxpayer has not received payment of such invoice, it is our view that, for purposes of section 9 and paragraph 12(1)(b) of the Act, no amount is included in computing the income of the taxpayer for the fiscal period in which the invoice was sent. Further, if no amount has been received by the taxpayer, paragraph 12(1)(a) of the Act would not apply. Finally, notwithstanding that subsection 12(2) of the Act makes it clear that paragraph 12(1)(a) and paragraph 12(1)(b) of the Act are not to be construed as implying that amounts not referred to therein are not to be included in computing income, it is our view that subsection 12(2) of the Act would not apply to a situation where no amount is received, receivable or earned by a taxpayer.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch