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This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: Franchisees would submit an application to have a chance to receive an amount of money from their franchisor. That amount would have to be used for a specified purpose. Other conditions would have to be fulfilled by the franchisee to receive the amount. What are the tax consequences with respect to the amount earned for the franchisee chosen to receive that amount?
Position: In such a situation, subsection 52(4) of the Act would not apply. General comments on subsection 9(1) and paragraph 12(1)(x) of the Act.
Reasons: The event organized by the franchisor would not be considered as being a lottery for the reasons below. The amount would be received by the franchisee in the course of carrying on its business. An analysis of all the relevant facts would be required to reach a definitive conclusion with respect to the specific tax consequences in a particular situation.
XXXXXXXXXX
2011-042536
Sylvie Labarre, CA
March 12, 2012
Dear Madam,
Subject: Contest of a franchisor
This is in response to your e-mail of October 21, 2011 in which you requested our opinion regarding the tax treatment of a prize won by a corporation (the "Corporation") for its participation in the following contest.
The Corporation is a corporation that carries on business under a commercial banner. Many taxpayers carry on their business under the same banner. The issuer of the banner (the "Franchisor") has organized a contest among the taxpayers operating under its banner. The contest allows the winner to receive a maximum amount of $XXXXXXXXXX which must be used for XXXXXXXXXX. XXXXXXXXXX.
To participate in the Franchisor's contest, the Corporation must submit an application.
You wish to know what the appropriate tax treatment would be if the Corporation wins the prize.
Our Comments
We are of the view that the contest organized by the Franchisor would not constitute a lottery as interpreted in paragraph 3 of the Interpretation Bulletin. In fact, we are of the view that the organized contest would not be a game of chance for distributing prizes by lot or chance among persons who have purchased a ticket or a right to the chance.
In the present situation, the fact of having to submit an application to be eligible to win the prize would seem to indicate that the prize could be awarded on merit, which would exclude the contest from the meaning of "lottery".
In addition, the contest appears to be limited to taxpayers who carry on their business under the same banner as the Corporation. Where participation in a contest or draw is so limited, we are of the view that the contest or draw would not constitute a lottery for the purposes of subsection 52(4) of the Income Tax Act (The “Act”).
Furthermore, we are of the view that the contest organized by the Franchisor would not constitute a lottery or a game of chance since the winner would have other conditions to satisfy in order to receive the prize, such as purchasing from a specific supplier, or having to make specific renovations for an amount at least equal to the prize.
Subject to a review of all relevant facts in this situation, it appears to us that the amount that would be awarded to a winner would be a kind of non-government assistance received by the winner in the course of the carrying on of a business (assistance that would be paid by the Franchisor in the context of its business). It would then be necessary to determine whether the winner should include the amount of the prize in its business income in accordance with subsection 9(1) or whether such amount would instead be part of an amount referred to in paragraph 12(1)(x).
Subsection 9(1) provides no definition of "profit". Recognized business principles (including accounting principles) are usually used in determining what constitutes profit for a taxation year unless the Act provides for a specific provision or unless there are principles that are derived from jurisprudence or established rules of law that are different.
We are of the view that the concepts set out in paragraph 2 of Interpretation Bulletin IT-273R2 with respect to government assistance could also apply to non-government assistance. The part of paragraph 2 of that bulletin that could apply to your situation is as follows:
2. When assistance is received in the course of earning income from a business or property, the application of well-accepted business principles for the purpose of calculating profit or loss under section 9 commonly requires the cost of an asset or the amount of an expense to be reduced by any reimbursement or similar payment that relates to the acquisition of the asset or the expense incurred. … If the application of well-accepted business principles relating to the calculation of profit or loss for the purpose of section 9 does not require the government assistance to be included in income, or to reduce the cost or capital cost of a property or the amount deductible as an expense, a specific provision of the Income Tax Act, such as paragraph 12(1)(t), 12(1)(x), 12(1)(x.1) or 28(1)(d) (which refers to amounts deferred under section 80.3), or subparagraph 56(1)(a)(vi), may apply to require the amount to be included in income.
If the amount earned was for the purpose of reimbursing expenses attributable to income, we are of the view that it should be included in computing the taxpayer's business income in accordance with subsection 9(1) in the taxation year in which such amount would be realized, provided that such amount is free from conditions or restrictions as to its use.
As stated in paragraph 2 of Interpretation Bulletin IT-273R2, if the application of well-accepted business principles relating to the calculation of profit or loss for the purpose of section 9 does not require the government assistance to be included in income, or to reduce the cost or capital cost of a property or the amount deductible as an expense, paragraph 12(1)(x) should be analyzed to determine what the appropriate tax treatment would be for the amount earned.
It appears to us that in the situation you submitted to us, the amount would be received by the Corporation in the course of deriving business income from a person who pays the amount in the course of earning income from a business or property, in order to achieve a benefit or advantage for itself or for persons with whom the payer does not deal at arm’s length. In addition, we are of the view that it would be reasonable to consider the amount as received
- as an inducement, whether as a grant, allowance, or any other form of inducement; or
- as a refund, reimbursement, contribution or allowance or as assistance, whether as a grant or any other form of assistance, in respect of
(A) an amount included in, or deducted as, the cost of property, or
(B) an outlay or expense.
However, there are certain exclusions to the application of paragraph 12(1)(x) of the Act. They are found in subparagraphs 12(1)(x)(v) to (viii). If none of these exclusions apply, the Corporation should include, in computing its income from the business, the amount received from the Franchisor in the taxation year in which the amount is received. Of the exclusions set out in subparagraphs 12(1)(x)(v) to (viii), there is one for where the amount was already included in computing income (for example, if the amount was included under subsection 9(1)) or where the amount reduces the cost or capital cost of the property (for example, under subsection 13(7.4)) or the amount of the outlay or expense (for example, under subsection 12(2.2)).
If certain conditions are satisfied, subsection 13(7.4) is an election that may be made to reduce the capital cost of depreciable property acquired through an amount of assistance that would otherwise be included in income in accordance with paragraph 12(1)(x) to defer the tax consequences of including an amount in computing income under paragraph 12(1)(x).
Subsection 12(2.2) is an election that may be made to reduce the amount of an expense for which a taxpayer received an amount of assistance that would otherwise be included in income in pursuant to paragraph 12(1)(x).
These comments do not constitute advance income tax rulings and are not binding on the Canada Revenue Agency with respect to a particular situation.
Best regards,
Stéphane Prud'Homme, Notary, M. Fisc.
Manager
Reorganizations Section III
Reorganizations Division
Income Tax Rulings Directorate
Legislative Policy
and Regulatory Affairs Branch
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