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: What is the appropriate tax treatment to be afforded compensation received in respect a "signing bonus" paid by a XXXXXXXXXX company in connection with an agreement which grants an easement and settles related damage claims
Position: The signing bonus constitutes an inducement pursuant to the express terms of the agreement. If the amount were not otherwise taxable under section 9, the signing bonus is taxable under pp. 12(1)(x).
Reasons: The tax treatment of compensation should be determined with reference to the purpose for which the amount was paid
August 31, 2010
XXXXXXXXXX HEADQUARTERS
Technical Advisor Income Tax Rulings
Audit Division Directorate
XXXXXXXXXX TSO James Atkinson CGA
(519) 457-4832
2009-035053
Tax Treatment of Signing Bonuses
This is in response to your memorandum dated XXXXXXXXXX concerning the tax treatment of amounts received, that were described as signing bonuses ("Signing Bonuses") in connection with the granting of an easement. XXXXXXXXXX.
XXXXXXXXXX
Facts
With respect to the specific transaction undertaken between XXXXXXXXXX, based on the representations and documents you have submitted, our understanding of the facts is as follows:
1. XXXXXXXXXX
2. XXXXXXXXXX is an individual who carries on a farming business XXXXXXXXXX
3. Pursuant to the terms of the Agreement, various forms of compensation have been provided to XXXXXXXXXX, which you have categorized as pertaining to the following:
a) Easement - The Agreement provides that XXXXXXXXXX will pay XXXXXXXXXX the greater of XXXXXXXXXX% of the fair market value ("FMV") of the easement and the amount arrived at by using $XXXXXXXXXX per acre for the land subject to the easement. The FMV determined by XXXXXXXXXX considers the current use of the land, and neighboring lands, zoning laws, economic considerations, recent sales and other relevant factors.
b) Temporary Workspace Rights - The Agreement provides that XXXXXXXXXX will pay XXXXXXXXXX as compensation on a per acre basis for temporary workspace an amount that is XXXXXXXXXX% of the value used on a per acre basis to compute the easement consideration.
c) Crop Loss - The Agreement provides that XXXXXXXXXX will pay XXXXXXXXXX compensation for crop loss. In respect of cultivated lands, $XXXXXXXXXX per acre amount will be paid where construction of the XXXXXXXXXX takes XXXXXXXXXX.
d) Nuisance & Inconvenience (Disturbance) - The Agreement provides that XXXXXXXXXX will pay XXXXXXXXXX compensation for other losses and damage of any nature or kind, based on a XXXXXXXXXX amount of $XXXXXXXXXX.
4. XXXXXXXXXX
a) Signing Bonus #1 - XXXXXXXXXX received a signing bonus of $XXXXXXXXXX per XXXXXXXXXX of disturbance across his land XXXXXXXXXX.
b) Signing Bonus #2 - XXXXXXXXXX received a signing bonus of $XXXXXXXXXX per XXXXXXXXXX provided all applicable agreements relating to the granting of the easement were signed prior to XXXXXXXXXX.
5. XXXXXXXXXX
6. XXXXXXXXXX
7. XXXXXXXXXX
8. XXXXXXXXXX
9. XXXXXXXXXX
10. You have advised that XXXXXXXXXX has reported the compensation received in respect of the Temporary Workspace Rights, Crop Loss and Disturbance as being on account of income XXXXXXXXXX. XXXXXXXXXX reported as a taxable capital gain one-half the compensation received in respect of the easement as the proceeds of disposition of qualified farm property on schedule 3 of their XXXXXXXXXX T1s. XXXXXXXXXX reported as a taxable capital gain one-half the total compensation received in respect of the Signing Bonuses, separately, as the proceeds of disposition of an unidentified qualified farm property on schedule 3 of their XXXXXXXXXX T1s. XXXXXXXXXX claimed a capital gains deduction pursuant to subsection 110.6(2) of the Income Tax Act (the "Act") to completely eliminate the taxable capital gains in respect of the easement and Signing Bonuses as described above.
11. XXXXXXXXXX
TSO Position
XXXXXXXXXX
The determination of whether or not a particular amount is on account of income or capital is a question of fact, which must be resolved based on the facts and circumstances of the case under review.
The transaction that is at the heart of the Agreement between XXXXXXXXXX is the granting of an easement. The activities undertaken by XXXXXXXXXX in connection with the XXXXXXXXXX construction create an interference and disturbance to XXXXXXXXXX vested rights and enjoyment of XXXXXXXXXX properties. This attracts a claim for compensation, together with incidental losses and damages, particularly as it may pertain to any business operations carried on upon the property by XXXXXXXXXX.
Amounts payable in respect of the settlement of XXXXXXXXXX claims in connection with the granting of an easement are usually structured in a settlement agreement under various heads of compensation. The tax consequences resulting from receipt of the various heads of compensation identified in the Agreement are, in our view, as follows.
Easement
The granting of an easement is considered a disposition of property. As discussed in IT-264R, Part Dispositions, compensation received in respect of such a disposition is considered "proceeds of disposition" ("POD") as that term is defined in section 54 of the Act. A reasonable portion of the adjusted cost base ("ACB") of the whole property attributable to the part disposed of is required to be allocated to the disposition pursuant to section 43 of the Act. Accordingly, a taxable capital gain may arise.
An administrative position is described in IT-264R, which provides that the CRA will accept an amount equal to the proceeds from such a disposition as being the reasonable portion of the ACB of the whole property attributable to the part disposed of provided that: (a) the area or the portion of the property that was expropriated or in respect of which an easement was granted is not more than 20% of the area of the total property, and (b) the amount of the compensation received is not more than 20% of the amount of the adjusted cost base of the property. Whether or not these conditions are met in any particular case is a question of fact and must be determined on a case by case basis.
Provided that the whole property to which the easement pertains meets the definition of "qualified farm property" under subsection 110.6(1) of the Act, XXXXXXXXXX may be entitled to claim the capital gains deduction under subsection 110.6(2) in respect of a capital gain realized upon the disposition of the easement.
Temporary Workspace Rights
Compensation received in respect of the provision for temporary workspace provided to XXXXXXXXXX to facilitate XXXXXXXXXX construction is akin to rent for the use of the land and is included in computing XXXXXXXXXX net profit from the farming business under subsection 9(l) of the Act.
Crop Loss and Disturbance
As a general rule, compensation received in the course of carrying on a business or earning income from a property will be either on income or capital account for income tax purposes, the determination of which is always question of fact. (Bellingham v. Canada, [1996] 1 F.C. 613 (C.A.)).
The characterization of compensation for damages depends on the character of the item or subject matter in respect of which the compensation is payable pursuant to the application of the surrogatum principle. (Tsiaprailis v. R., [2005] 1 S.C.R. 113).
Compensation for damages in respect of crop loss replaces the lost revenues of a farming business and is therefore in computing XXXXXXXXXX net profit from the farming business under subsection 9(1) of the Act.
Compensation for Disturbance is, pursuant to the Agreement, intended to compensate for such matters as XXXXXXXXXX and "all other loss and damage of any nature and or kind whatsoever as a result of the construction of the XXXXXXXXXX, (with the exception of personal injury and damage to personal property)." Such compensation relates to lost profits from business activities, whether as a consequence of revenues foregone or additional expenses that XXXXXXXXXX may have to incur and is therefore included in computing XXXXXXXXXX net profit from the farming business under subsection 9(1) of the Act. (Goff Construction Limited v The Queen, 2009 DTC 5061 (T.C.C.); aff'd. 2009 FCA 60.)
XXXXXXXXXX
Signing Bonuses
Regarding the tax treatment of the Signing Bonuses, we have considered the application of section 9, paragraph 12(1)(x), proposed section 56.4, and the allocation of the Signing Bonuses pursuant to section 68 to the various other items settled under the Agreement. In our view, XXXXXXXXXX the Signing Bonuses should be included in computing income under section 9 or in the alternative under paragraph 12(1)(x). XXXXXXXXXX.
Section 9 of the Act
The tax treatment of the bonus compensation depends upon the purpose for which the compensation is received. The word "bonus" and phrase "signing bonus" are not defined in the Act or in the Regulations. The word "bonus" imports an extra or additional payment by way of an inducement or reward for some undertaking or effort. (The Great Western Garment Co Ltd., 49 DTC 526, (SCC); Estey (dissenting), at 360-61.) The phrase signing bonus suggests that it is compensation earned for the mere act of signing a contract. Based on US jurisprudence, a signing bonus arises from a unilateral contract representing one party's promise to pay money in consideration for another party's signature on a contract. (Alabama Football, Inc. v. Greenwood, 452 F.Supp. 1191 (W.D. Pa. 1978)).
The best evidence of the purpose for which the Signing Bonus compensation was paid is to be found in the wording of the Agreement, which evidences the legal relationships established by the parties and the contractual requirement for payment. These legal relationships should be respected absent a contrary provision in the Act or a finding that they are a sham. (Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622).
Moreover, the actual apportionment of consideration made by parties dealing at arm's in the course of a transaction that is not a mere sham or subterfuge should be respected where such apportionment appears reasonable in the circumstances. (The Queen v. Golden, [1986] 1 S.C.R. 209).
The Agreement indicates that the signing bonuses payable are inducements because they are intended to be an incentive for early signing of the documents and are not compensation for easement, temporary workspace, consent or damages.
XXXXXXXXXX
[Emphasis added.]
In Supermarché Ste-Croix Inc. v. The Queen, 95 DTC 871 (T.C.C.), the Court described an inducement payment as an amount granted in consideration of an obligation on the recipient's part. The wording of the Agreement, in our view, factually establishes that the Signing Bonuses were paid as inducements.
An inducement such as a signing bonus received by a taxpayer in the course of carrying on a business is income pursuant to subsection 9(1) according to the principles enunciated by the Supreme Court of Canada in Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147, concerning the computation of profit, unless the inducement is of a capital nature because it can be viewed as consideration for the disposition of a capital property by the taxpayer. Based upon the terms of the Agreement, the signing bonuses received by XXXXXXXXXX were not allocable to the disposition of any capital property or right, and accordingly, they are to be included in computing XXXXXXXXXX net profit from the farming business pursuant to subsection 9(1) of the Act.
Paragraph 12(1)(x) of the Act
If for some reason subsection 9(1) of the Act were found not to apply to include the Signing Bonuses in income, in our view, paragraph 12(1)(x) of the Act would specifically provide for their inclusion in income.
Paragraph 12(1)(x) of the Act provides that inducements received by a taxpayer in the course of earning income from a business or property must be included in income to the extent that the amounts have not otherwise been included in income or reduced the cost of a property or the amount of an outlay or expense.
The Signing Bonuses can reasonably be considered to represent an inducement for the purposes of paragraph 12(1)(x)(iii) of the Act as XXXXXXXXXX was obliged to act in a certain manner, by signing the Agreement prior to XXXXXXXXXX, as consideration thereof. If subsection 9(1) of the Act were otherwise found not to apply to the Signing Bonuses, the Signing Bonuses would be brought into income pursuant to clause 12(1)(x)(i)(A) and subparagraph 12(1)(x)(iii).
Proposed Subsection 56.4(2) of the Act
It would be premature to apply section 56.4 to the Signing Bonuses since the section has not been enacted but it is still proposed law. Nevertheless, the comments below are made on the basis that section 56.4 were enacted in the identical form as presently proposed.
Proposed section 56.4 applies to restrictive covenants and reflects changes to the income tax law proposed by the Minister of Finance on October 7, 2003 (release 2003-049), on July 18, 2005 (release 2005-049), and on July 16, 2010 (release 2010-068). Subject to certain exceptions, these provisions apply to amounts received or receivable by a taxpayer after October 7, 2003.
We note that the definition of "restrictive covenant" in proposed subsection 56.4(1) of the Act is broadly worded as follows:
""restrictive covenant", of a taxpayer, means an agreement entered into, an undertaking made, or a waiver of an advantage or right by the taxpayer (other than an agreement or undertaking for the disposition of the taxpayer's property or except where the obligation being satisfied is in respect of a right to property or services that the taxpayer acquired for less than its fair market value for the satisfaction of an obligation described in section 49.1 that is not a disposition), whether legally enforceable or not, that affects, or is intended to affect, in any way whatever, the acquisition or provision of property or services by the taxpayer or by another taxpayer that does not deal at arm's length with the taxpayer."
The new rules in proposed section 56.4 of the Act do not merely address non-competition agreements or other covenants granted in the course of carrying on a business: the definition of a "restrictive covenant" is broad enough to include an "agreement entered into, an undertaking made or a waiver of an advantage or right by the taxpayer
whether legally enforceable or not." Therefore, the definition's scope is much broader and encompasses more than simply an agreement not to compete.
Proposed subsection 56.4(2) of the Act provides for a full income inclusion in a taxation year of amounts in respect of a restrictive covenant that are received or receivable in the taxation year by the taxpayer, subject to the exceptions found in proposed subsection 56.4(3) for amounts caught by other tax provisions (sections 5 and 6, the description of parameter E in the definition of cumulative eligible capital in subsection 14(5), or generally as part of the disposition of an eligible interest in a partnership or corporation).
In view of the broad definition of restrictive covenant, we have considered the possibility that the signing bonus compensation might, by default, be allocable to the covenants provided by XXXXXXXXXX to XXXXXXXXXX as described in Fact #9. If such were the case, then the signing bonus compensation would be included in income under proposed subsection 56.4(2) (unless the exceptions are applicable).
We note however, that proposed section 56.4 has yet to be enacted; and, in accordance with Audit Communiqué AD-07-02, Assessing/Reassessing Practice Related to Proposed Legislation, April 19, 2007 and Section 12.3.0 of the Audit Manual, the CRA will not require a taxpayer to file on the basis of proposed legislation, if is not beneficial. However, we do not believe that this poses a problem because we have already concluded that the signing bonus compensation is taxable under subsection 9(1), or in the alternative, paragraph 12(1)(x).
XXXXXXXXXX
Capital Gains Deduction Qualified Farm Property
As regards XXXXXXXXXX capital gains deduction under subsection 110.6(2) in respect of the disposition of QFP, we note that QFP, as defined under subsection 110.6(1), refers to capital property used in the course of carrying on a farming business in Canada and consists of only four types of property:
- real or immovable property,
- a share of the capital stock of a family farm corporation,
- an interest in a family farm partnership, and
- eligible capital property.
Based on the information provided, the only property that may qualify as QFP is the easement.
We trust these comments are of assistance.
S. Parnanzone
Manager
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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