18 March 2004 External T.I. 2004-0064741E5 - Contract Termination Payments

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: The taxable status of an amount received in respect of the termination of a business contract.

Position: Question of fact. The general position of the Canada Revenue Agency regarding the taxable status of amounts received in respect of non-performance under business contracts is outlined in Interpretation Bulletin IT-365R, Damages, Settlements and Similar Receipts. It must be determined whether the amount received by the taxpayer is considered on account of income or capital.

Reasons: Generally, where the amount is intended to compensate the taxpayer for lost profit, that amount will be considered on account of income and must be included in the taxpayer's business income pursuant to subsection 9(1) of the Income Tax Act (the "Act"). Where the amount relates to a particular asset that is sold, destroyed or abandoned as a consequence of the non-performance, that amount will be considered proceeds of disposition for purposes of determining the gain on the asset. Where the amount received does not relate to a particular asset and the effect of the non-performance is the destruction or material crippling of the whole structure of the profit-making apparatus of the taxpayer's business, that amount will be considered an "eligible capital amount" for purposes of determining the taxpayer's income inclusion under subsection 14(1) of the Act.

Randy Hewlett, B.Comm.

XXXXXXXXXX 613-957-8973
2004-006474
March 18, 2004

Dear XXXXXXXXXX:

Re: Contract Termination Payments

We are writing in response to your letter of February 27, 2003, wherein you asked for our opinion on the above-noted issue as it pertains to payments received by a taxpayer under the terms of an agreement that terminated a business contract.

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following general comments.

The general position of the Canada Revenue Agency regarding the taxable status of amounts received in respect of non-performance under business contracts, is outlined in Interpretation Bulletin IT-365R, Damages, Settlements and Similar Receipts. It will always be a question of fact whether the amount received by a taxpayer is considered on account of income or capital.

Generally, where the amount is intended to compensate the taxpayer for lost profit, that amount will be considered on account of income and must be included in the taxpayer's business income pursuant to subsection 9(1) of the Income Tax Act (the "Act"). Where the amount relates to a particular asset that is sold, destroyed or abandoned as a consequence of non-performance, that amount will be considered proceeds of disposition for purposes of determining the gain on the asset. Where the amount received does not relate to a particular asset and the effect of non-performance is the destruction or material crippling of the whole structure of the profit-making apparatus of the taxpayer's business, that amount will likely be considered an "eligible capital amount" for purposes of determining the taxpayer's income inclusion under subsection 14(1) of the Act. For more information regarding the tax consequences resulting from a disposition of an eligible capital property, see Interpretation Bulletin IT-386R Eligible Capital Amounts.

The documents referred to above may be found on our web site at www.ccra.gc.ca. We trust our comments will be of assistance to you.

Yours truly,

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