8 December 2010 External T.I. 2010-0375921E5 - Subsection 20(24)

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: In the hypothetical fact situation provided, the correct tax treatment for an amount paid by the vendor of a service business to compensate the purchaser for assuming obligations for which the vendor has received deferred revenues included into income under 12(1)(a), where: (1) A joint subsection 20(24) election is made. (2) No subsection 20(24) election is made.

Position: (1) The amount paid may be deducted by the vendor under subsection 20(24) and must be added to the purchaser's income under 12(1)(a). (2) The amount paid must be included in the purchaser's income under 9(1) or 12(1)(x).

Reasons: (1) Wording of the applicable legislation. (2) The amount paid is considered as an amount paid to the purchaser to reduce future expenses with respect to the obligation to provide services beyond the end of the vendor's taxation year.

XXXXXXXXXX
									2010-037592
									T. Posadovsky, CMA

December 8, 2010

Dear XXXXXXXXXX :

Re: Election under Subsection 20(24) of the Income Tax Act

We are writing in reply to your correspondence dated July 23, 2010, concerning various issues in respect of a sale/purchase of a service business and the election under subsection 20(24) of the Income Tax Act. We apologize for the delay in responding.

Unless otherwise expressly stated, every reference herein to the "Act" or to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Income Tax Act (Canada), R.S.C. 1985 (5th Supp.) c.1, as amended.

In your letter, you describe a hypothetical situation in which a corporation resident in Canada (the "Vendor") agrees to sell its XXXXXXXXXX business to another resident corporation (the "Purchaser"). In accordance with paragraph 12(1)(a) of the Act, the Vendor has collected and included into income pre-paid XXXXXXXXXX fees and XXXXXXXXXX fees representing services that will not be rendered to customers until after the end of the corporation's taxation year. The Vendor has agreed to refund a proportionate amount of fees in the event that the XXXXXXXXXX cancels the agreement within a certain time period. At the time of sale, the business assets have a fair market value of $1,000 and the amount of the deferred revenue is $400. The Purchaser agrees to assume the Vendor's commitments and the parties agree to a $400 offset against the asset purchase price of $1,000, resulting in a $600 net cash outlay for the Purchaser.

You wish to know the correct tax treatment in the above scenario where an election under subsection 20(24) of the Act is filed and where such an election is not filed.

Our Comments

Written confirmation of the tax implications inherent in a particular transaction 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. Should your situation involve a specific taxpayer and a completed transaction, you should submit all relevant facts and documentation to the appropriate tax services office for their views. However, we are prepared to offer the following general comments that may be of assistance.

Paragraph 12(1)(a) of the Act requires a taxpayer to include in income from a business or property for a taxation year any amount received in the year that is on account of services not yet rendered or goods not yet delivered before the end of the year.

With some exceptions, a taxpayer is generally entitled to deduct a reasonable reserve under paragraph 20(1)(m) of the Act for amounts described in paragraph 12(1)(a) that have been included in computing a taxpayer's income from a business for the year or a previous year.

Whether a prepayment in respect of account of services not yet rendered or goods not yet delivered before the end of the year should be included into a taxpayer's income pursuant to paragraph 12(1)(a) rather than subsection 9(1) of the Act is a question of fact. Only an examination of all the facts and circumstances surrounding a particular situation will determine the correct treatment and such a determination must be made on a case-by-case basis. More information on this determination is available in Income Tax - Technical News No. 30 available on our website at www.cra-arc.gc.ca/E/pub/tp/itnews-30/README.html.

Subsection 20(24) Election

In reference to the above hypothetical situation and in accordance with the comments provided in Interpretation Bulletin IT-154R Special Reserves, where the Vendor has:

• included in income for a taxation year an amount that is on account of goods not delivered or services that will not be rendered before the end of the year, under paragraph 12(1)(a) the Act, and
• paid to the Purchaser a reasonable amount for undertaking to provide such goods and services,

the Vendor and Purchaser may jointly elect under subsection 20(24) to effectively transfer the deferred revenue to the Purchaser. The following rules will apply:

1) The Vendor may claim a deduction for the reasonable payment under paragraph 20(24)(a) of the Act (in this case $400);

2) Paragraph 20(24)(b) of the Act deems the payment to be an amount described in paragraph 12(1)(a) for the Purchaser, for the respective taxation year in which the payment is received;

3) The purchaser is entitled to claim a reserve under paragraph 20(1)(m) of the Act, to the extent that the reserve reflects a reasonable amount in respect of goods or services that it is reasonably anticipated would have to be delivered or rendered after the end of that year; and

4) No amount is deductible under paragraph 20(1)(m) or (m.1) of the Act in respect of the deferred revenue in computing the Vendor's income for its taxation year in which the payment was made, or in any subsequent taxation year.

Subject to Part I of the Act, the costs incurred by the Purchaser at the time the obligations associated with the deferred revenue are performed, will be deductible business expenses of the Purchaser when computing its profit or loss for purposes of section 9 of the Act.

Manner of Election

An election under subsection 20(24) of the Act must be made in the manner described in subsection 20(25). There is no prescribed form, but the election must be made by notifying the Minister in writing by the earlier of the return filing deadline of the Vendor and the Purchaser for the year the payment is made.

Note that the subsection 20(24) election is in the list of permitted late elections set out in section 600 of the Income Tax Regulations. As such, the CRA may exercise its discretion under subsection 220(3.2) of the Act to allow or disallow the filing of a late election. Information Circular IC07-1, Taxpayer Relief Provisions, provides guidelines for accepting late, amended, or revoked elections. The request must be made within a 10-year time limit and may be subject to a penalty.

No Subsection 20(24) Election Made

Where no election is filed under subsection 20(24) of the Act, it is a question of fact whether the transaction is on account of income or of capital. In the hypothetical situation described above and where the Vendor pays the Purchaser a reasonable amount
for undertaking to provide goods and services in respect of the deferred revenue, the following tax treatment would be acceptable:

1) The Vendor may not claim a paragraph 20(1)(m) reserve for the $400 previously included in income under paragraph 12(1)(a) of the Act. This is because the Vendor no longer has the means to satisfy any obligation to deliver goods or services after the end of the year - the Purchaser has agreed to assume all obligations.

2) Any payment made to the Purchaser for the assumption of such obligations (in this case, the $400 offset against the purchase price) is not deductible to the Vendor. Further, the Vendor may not claim a deduction under paragraph 20(1)(m.2) because no payments have been returned to customers.

3) The Purchaser is not entitled to claim a reserve under paragraph 20(1)(m) because it did not include in its business income under paragraph 12(1)(a) any amount which related to the obligation to deliver the goods or render the services in question.

4) The $400 offset received by the Purchaser must be included in the Purchaser's income by virtue of either subsection 9(1) or paragraph 12(1)(x) of the Act. This amount could be considered an amount paid to the Purchaser to reduce the future expenses with respect to the services yet to be provided.

5) Since the Vendor and Purchaser did not claim a reserve under paragraph 20(1)(m) in the taxation year in which the business is transferred, neither will be required to include an amount in calculating business income for the immediately following taxation year under subparagraph 12(1)(e)(i).

Subject to Part I of the Act, the costs incurred by the Purchaser at the time the obligations associated with the deferred revenue are performed, will be deductible business expenses of the Purchaser when computing its profit or loss for purposes of section 9 of the Act.

12(1)(x) Income Inclusion

In the case where an income inclusion under paragraph 12(1)(x) of the Act would be appropriate, you asked whether an election to reduce the cost of the depreciable property purchased under subsection 13(7.4) is available to the Purchaser.

Subsection 13(7.4) of the Act permits a taxpayer to elect to reduce the capital cost of depreciable property by the amount of a related inducement, contribution, reimbursement or allowance that would otherwise be included in income under paragraph 12(1)(x). In the hypothetical situation presented, the income inclusion is in respect of the Purchaser's assumption of the deferred revenue and a corresponding obligation to provide services. Consequently, no reduction to the cost of depreciable property would be available.

Please note that this opinion is not a ruling and consequently, is not binding on the CRA in respect of any particular situation. However, we trust that our comments will nonetheless be helpful.

Yours truly,

Guy Goulet CA, M.Fisc.
for Director
Ontario Corporate Tax Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch