13 December 2007 External T.I. 2007-0228811E5 - Holdbacks Receivable

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: Does the non-arm's length relationship between Canco and USco affect Canco's ability to exclude the amount of holdbacks receivable from USco as described in paragraph 3 of IT-92R2?

Position: Not necessarily - question of fact.

Reasons: Must determine based on actual facts on a case-by-case basis.

XXXXXXXXXX 							Michael Cooke
								2007-022881
December 13, 2007

Dear XXXXXXXXXX :

Re: Holdbacks Receivable on Progress Billings

We are writing in response to your letter dated March 21, 2007, concerning the above-noted issue.

In your letter you indicated that your client is a taxable Canadian corporation ("Canco") that is in the business of manufacturing XXXXXXXXXX for commercial and institutional customers in Canada. You indicate that Canco essentially follows the general rules for reporting income as described in paragraph 3 of IT-92R2. Specifically, Canco progress bills its customers and reports such amounts in its income less a deduction for any "holdback receivable" under the terms of the particular contract. However, once Canco's customer receives certification (via architect or engineer) that the work under the particular contract has satisfactorily been performed the amount of any holdback receivable is then included in Canco's income.

You also indicate that Canco is related to a US corporation ("USco") by way of common parent ownership. USco sells and installs XXXXXXXXXX for commercial and institutional customers in the US; however, USco subcontracts the manufacturing of these XXXXXXXXXX to Canco. USco also reports its income for US income tax purposes in the same manner as Canco (i.e. it progress bills its customers and deducts the amount of any holdback receivable from its income until the customer receives certification that the work has satisfactorily been performed). USco also holds back an appropriate amount from the amounts that are progress billed to it by Canco until the entire job is completed.

Your question is whether the non-arm's length relationship between Canco and USco affects Canco's ability to exclude from income the amount of holdbacks receivable from USco.

Our Comments

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, "Advanced Income Tax Rulings", dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Revenue Agency ("CRA"). All publications referred to herein can be accessed on the CRA website at the following address: http://www.cra-arc.gc.ca/tax/technical/incometax/menu-e.html.

Paragraph 12(1)(b) of the Act requires a taxpayer to include in income for the year any amount that becomes receivable in respect of services rendered in the course of a business in the year, even when the amount or any part thereof is not due until a subsequent year. Generally speaking, "receivable" means that there is a legal right to enforce payment. Where a contract provides for a holdback pending architect or engineer approval or expiry of a lien period, the amount held back is not considered receivable until such condition is met.

The non-arm's length nature of the relationship does not, in and by itself, affect the computation of a taxpayer's income as described above, including the taxpayer's ability to deduct the amount of a holdback receivable. However, as in all non-arm's length situations, the CRA would need to consider whether, based on the particular facts and circumstances and/or the terms of the particular contract, if any, between the two non-arm's length parties, the income tax treatment of the particular transactions reflect their true legal nature. As such, while the appropriateness of a deduction by Canco of holdbacks receivable from USco remains a question of fact, if Canco's only obligation to USco is to provide it with completed XXXXXXXXXX, once Canco has fulfilled this obligation it would not be appropriate for Canco to deduct a holdback receivable simply because USco has not fulfilled its contractual obligation with its US customer to install such XXXXXXXXXX.

We trust that these comments will be of assistance to you.

Yours truly,

Renée Shields,
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch