25 September 2003 External T.I. 2003-0022405 - CONTINGENT LIABILITY INCOME INCLUSION

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

1) Is a returnable membership fee that is only returnable when a fixed number of membership fees are sold included in income and is the event a contingency.

Position TAKEN:

1) Question of fact and it depends on whether there is "Quality of Income"

2) Question of fact however it appears that the event is a contingency.

REASON FOR POSITION:

Quality of income cases and 18(1)(e)

								2003-002240
XXXXXXXXXX 							C. Tremblay, CMA
(613) 957-2139
September 25, 2003

Dear XXXXXXXXXX:

Re: Technical Interpretation - Contingent Liability

This is in reply to your letter of May 30, 2003, in which you request our views on whether certain amounts received by a corporation are income in the year of receipt and whether there also exists a "contingent liability" as described in paragraph 18(1)(e) of the Income Tax Act (the "Act").

You describe a situation involving a Canadian controlled private corporation operating a business of providing various XXXXXXXXXX facilities to members. In addition to annual fees, members are currently charged a one-time non-refundable initiation fee for the right to become a member. This initiation fee is included in income in the year it is due. The corporation is proposing to build a new facility XXXXXXXXXX and it is requesting current members to pay a refundable membership fee (RM) which will be the same amount as what future members will be charged as a non-refundable initiation fee to participate in the new activity. It is intended that RMs will be repaid without interest from the proceeds of initiation fees from new members once the facility is operational. In the event, that the corporation does not build the new facility, the RMs will be repaid immediately. It is intended that only XXXXXXXXXX RMs will be issued and they will be repaid from initiation proceeds when total membership exceeds XXXXXXXXXX. There will be no obligation to repay the RMs if membership does not exceed XXXXXXXXXX.

Our comments:

The particular circumstances in your letter on which you have asked for our views are a factual situation. As explained in Information Circular 70-6R5 issued by Canada Customs and Revenue Agency ("CCRA"), it is not this Directorate's practice to comment on proposed transactions involving specific taxpayers other than in the form of an advance income tax ruling. If you wish to obtain a binding commitment with respect to an actual case similar to that outlined in your letter, an advance income tax ruling application should be submitted. Although we are unable to provide any binding assurance with respect to the interpretations requested, we do provide the following general comments for your information.

It is a question of fact whether the amounts in issue are income for income tax purposes. Based on Kenneth B. S. Robertson Ltd. v. Minister of National Revenue (2 DTC 655), an amount received must possess the essential qualities of income, namely that the recipient should have an absolute right to it and be under no restriction, contractual or otherwise as to its disposition or enjoyment. Whether RMs have the "quality of income" and whether the corporation has an absolute right to the RMs and is under no restriction, contractual or otherwise, as to its disposition or enjoyment are questions of fact.

Generally, a reserve may be deducted under paragraph 20(1)(m) of the Act where amounts received have been included in income under paragraph 12(1)(a) of the Act in respect of goods or services that will have to be delivered or rendered after the end of the year or amounts that may have to be repaid. In a situation where in addition to annual membership fees, an initiation fee is paid to the corporation, the corporation would have to show that it was under some definite restriction as to the disposition, use or enjoyment of such funds before a reserve under paragraph 20(1)(m) of the Act could be claimed. This could involve a commitment to refund the amount of the fee in the event the member leaves or dies within a certain time period. In a situation where there is no service left to be rendered, the corporation reports the income under section 9 of the Act and no reserve is allowed under paragraph 20(1)(m) of the Act.

As stated in paragraph 9 of IT-215R " In order that an expense which is unpaid at the end of a taxation year may be deductible for tax purposes, the liability so created in respect of that expense must constitute a genuine liability of that taxpayer in that taxation year. In order for a genuine liability to exist, there must be an enforceable claim by the creditor for an ascertained amount. More generally, an amount which is due and payable at the end of a taxation year, can only constitute an allowable deduction in the year which it become ascertainable and unconditional."

A contingency involves an event, which may or may not occur and the contingent liability is a liability, which depends for its existence upon an event, which may or may not happen. In our view, a contingent liability is one which is not now fixed and absolute, but which shall become so in case of the occurrence of some future and uncertain event; if the event does not occur, the amount will never become payable.

Accordingly, in our view, where an amount received has the "quality of income", the amount is income in the year and a contingent liability may exist under paragraph 18(1)(e) of the Act with respect to a potential refund of that amount. When the future event occurs, (for example, in your situation, when the corporation sells XXXXXXXXXX memberships) there will be a genuine requirement for repayment. Therefore, in our view, only at the time when the liability becomes absolute and legally enforceable, is the payer corporation entitled to deduct the amount as an expense.

While we hope our comments are of assistance to you they do not address all of the potential income tax implications nor do they constitute an advance income tax ruling and therefore are not binding on the Canada Customs and Revenue Agency.

Yours truly,

Steve Tevlin
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch