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: To consider whether the proposed tax treatment in respect of the taxpayer's XXXXXXXXXX program is appropriate. In particular, whether for income tax purposes, the taxpayer can deduct an amount associated with XXXXXXXXXX earned by cardholders under the XXXXXXXXXX program on an accrual basis (i.e., as XXXXXXXXXX are earned) rather than as XXXXXXXXXX are redeemed, consistent with the treatment which is permitted for accounting purposes under IFRS.
Position: Mixed question of fact and law, however, in our view no.
Reasons: No cost in respect of unredeemed XXXXXXXXXX can be considered to have been “incurred” because until they are redeemed pursuant to the cardholder agreement, they do not create an absolute and unconditional liability for purposes of paragraph 18(1)(a) of the Act.
XXXXXXXXXX 2022-092789
Christina Foggia, CPA, CA
October 25, 2023
Dear XXXXXXXXXX:
Re: XXXXXXXXXX Program – Deductibility of Expenses
This is in reply to your correspondence of February 22, 2022, wherein you requested our views concerning the appropriate tax treatment of XXXXXXXXXX provided to cardholders under the company’s (“taxpayer”) XXXXXXXXXX program (“XXXXXXXXXX program”).
You explained that for accounting purposes in accordance with International Financial Reporting Standards (“IFRS”), the taxpayer is permitted to deduct the estimated future cost of XXXXXXXXXX provided under the XXXXXXXXXX program (“the XXXXXXXXXX expense”) on an accrual basis (i.e., when XXXXXXXXXX are earned by cardholders). (footnote 1) On the other hand, for income tax purposes, the taxpayer deducts the XXXXXXXXXX expense as XXXXXXXXXX are redeemed by cardholders. Ultimately, the question is whether it is appropriate for income tax purposes for the taxpayer to deduct the XXXXXXXXXX expense as the XXXXXXXXXX are earned by cardholders, in order to align the income tax treatment of the XXXXXXXXXX expense with the accounting treatment.
BACKGROUND
In the situation you described, the taxpayer, a corporation resident in Canada, operates a XXXXXXXXXX program that is offered to cardholders to encourage them to use the taxpayer’s credit card. Pursuant to the terms and conditions of the agreement entered into between the cardholder and the taxpayer (“cardholder agreement”), cardholders earn XXXXXXXXXX based on the dollar amount of eligible purchases charged to their credit card. (footnote 2) A cardholder has the option to redeem XXXXXXXXXX for various XXXXXXXXXX which, amongst others, includes XXXXXXXXXX.
For the taxpayer to fulfil its obligations under the XXXXXXXXXX program, it has entered into agreements with both a related-party and various third parties (“participant”) to participate in the XXXXXXXXXX program and supply XXXXXXXXXX. Following a cardholder’s request to redeem XXXXXXXXXX for a XXXXXXXXXX (“redemption request”), the taxpayer pays the participant an agreed upon amount for the XXXXXXXXXX as set out in the applicable participant agreement. XXXXXXXXXX earned under the XXXXXXXXXX program expire only in very limited circumstances.
OUR COMMENTS
This technical interpretation provides general comments about the provisions of the Income Tax Act (“Act”) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R12, Advance Income Tax Rulings and Technical Interpretations.
Subsection 9(1) of the Act provides that a taxpayer’s income for a taxation year from a business or property is its profit therefrom for the year. However, the Act does not provide a definition of the term “profit.” The Supreme Court of Canada (“SCC”) examined the concept of profit in the decision of Canderel Ltd v. Canada, [1998] 1 S.C.R. 147 (“Canderel”), and summarized the principles relevant to the computation of profit under section 9. The principles state, among other things, that in ascertaining profit, the goal is to obtain an accurate picture of the taxpayer’s profit for the given year, and that the taxpayer is free to adopt any method which is not inconsistent with: (a) the provisions of the Act; (b) established case law principles or “rules of law;” and (c) well-accepted business principles. However, the SCC also added that well-accepted business principles, including those formally codified in generally accepted accounting principles (“GAAP”), are not rules of law but interpretive aids. This means that the treatment of a transaction under GAAP is not necessarily determinative of its treatment under tax law.
In the situation described, while the taxpayer’s proposed treatment to deduct the XXXXXXXXXX expense as XXXXXXXXXX are earned (i.e., accrual basis) appears to be consistent with well-accepted business principles, which includes GAAP, the SCC in Canderel was clear that to ascertain profit for tax purposes, the proposed income tax treatment cannot contravene any provisions of the Act or established case law principles.
Paragraph 18(1)(a) of the Act provides that in computing the income of a taxpayer from a business or property, no deduction shall be made in respect of an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property. It is a mixed question of fact and law in any situation whether the conditions of paragraph 18(1)(a) are met. Such a determination can only be made after a review of all the facts and circumstances of the taxpayer’s situation. Based on the information that you have provided, we have the following comments.
The meaning of “incurred” as used in paragraph 18(1)(a) of the Act has been considered by the courts on a number of occasions over the years. As a result, several case law principles (i.e., rules of law) have been established that are relevant to the determination of whether an expense has been incurred and whether a legal obligation exists for purposes of paragraph 18(1)(a). In particular, the courts have held that an expense will not be considered to have been incurred unless the taxpayer has an obligation to pay money to someone. (footnote 3) For instance, in the Federal Court of Appeal (“FCA”) decision of The Queen v Burnco Industries Ltd et al., [1984] 2 FC 218, the FCA stated that,
“In our opinion, an expense, within the meaning of paragraph 18(1)(a) of the Income Tax Act, is an obligation to pay a sum of money. An expense cannot be said to be incurred by a taxpayer who is under no obligation to pay money to anyone….an obligation to do something which may in the future entail the necessity of paying money is not an expense.”
Moreover, in General Motors of Canada Ltd v. The Queen, 2004 FCA 370, the FCA determined that an amount representing an overtime balance, which the taxpayer accrued to a special contingency fund, was not deductible because no absolute liability or identifiable debt had been incurred and, “correspondingly, there [was] also no identifiable creditor who could make a legally enforceable claim against General Motors…”
Lastly, the courts have held that a legal obligation to pay under contract does not exist until all contractual preconditions to which the payment relates are fulfilled. (footnote 4) For instance, in paragraph 9 of the Wawang Forest Products Ltd. et al. v, The Queen, 2001 FCA 80 decision, the FCA stated that,
“Generally, a taxpayer incurs an expense when it has a legal obligation to pay a sum of money. In most situations, the legal obligation exists upon the fulfilment of the contractual obligations to which the payment relates. Whether the payment of the obligation is required at that moment or in a subsequent year is irrelevant.”
In the situation presented, the terms of the cardholder agreement require that at the time that a cardholder makes an eligible purchase on their credit card, the taxpayer is required to assign a specified number of XXXXXXXXXX to a cardholder, however, it does not require them to provide a cardholder with a XXXXXXXXXX at that time. So, while XXXXXXXXXX awarded under the XXXXXXXXXX program provide a cardholder with the option and means to redeem XXXXXXXXXX cardholder’s entitlement to a specific XXXXXXXXXX is dependent, amongst others, on a redemption request being made. It is upon the occurrence of this event that a cardholder selects the particular XXXXXXXXXX for which they will redeem their XXXXXXXXXX, and both the amount of the XXXXXXXXXX, and the participant who will supply the XXXXXXXXXX (and therefore, the party who the taxpayer will ultimately be required to pay an amount to) are known. Thus, when applying the previously cited case law principles to the situation at hand, it is our view that no expense is considered to have been incurred at the time that XXXXXXXXXX are earned by cardholders, since, at that time, there is no identifiable debt owing to an identifiable creditor who can make a legally enforceable claim against the taxpayer in respect of the XXXXXXXXXX. Although the taxpayer has an obligation to do something which may in the future entail the necessity of paying money – to observe the terms of the cardholder agreement when a cardholder redeems XXXXXXXXXX pursuant to the agreement – the obligation itself is not an expense. Concluding otherwise would lead to inappropriate results in many situations, given that it is common commercial practice for parties to contract for the provision of goods or services, the fulfillment of which necessitates expenses to be incurred in the future. Accordingly, in our view, in the situation presented, it does not appear that the XXXXXXXXXX has been incurred for purposes of paragraph 18(1)(a) of the Act until XXXXXXXXXX are redeemed by a cardholder.
In summary, it is our view that while the Taxpayer’s method of accounting for the expense associated with unredeemed XXXXXXXXXX may meet some of the requirements noted in Canderel to ascertain profit for the year, it is inconsistent with principles established under case law and the provisions of the Act, namely paragraph 18(1)(a). More specifically, no cost in respect of unredeemed XXXXXXXXXX can be considered to have been “incurred” because until the XXXXXXXXXX are redeemed pursuant to the cardholder agreement, they do not create an absolute and unconditional liability for purposes of paragraph 18(1)(a). Accordingly, in our view, a deduction of the XXXXXXXXXX expense on an accrual basis is not an appropriate treatment for income tax purposes.
We trust our comments will be of assistance.
Yours truly,
Pam Burnley CPA, CA
Manager
Business and Capital Transactions
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 As confirmed by you, in accordance with IFRS IAS 37.10 and 37.86.
2 The earn rates vary depending on the type of credit card held and the type of purchases made by the cardholder.
3 For instance, see the FCA decisions of The Queen v Burnco Industries Ltd et al., [1984] 2 FC 218 and Northwood Pulp and Timber Ltd. v The Queen, [1999] 1 CTC 53.
4 For instance, see the Federal Court of Appeal decisions of J.L. Guay Ltée. v. MNR, [1971] FC 237, and Wawang Forest Products Ltd. et al. v. The Queen, 2001 FCA 80
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