12 October 1988 Income Tax Severed Letter 7-2973 - [Advance Payments Received sot Unapproved Milestone Billings]

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.

October 12, 1988

HEAD OFFICE Specialty Rulings Directorate E. Mikhail Tel. (613) 957-2088 SUBJECT: XXXX Advance Payments Received sot Unapproved Milestone Billings

This is in reply to your memorandum of June 17, 1988 in which you inquired about the proper income tax treatment to be accorded to the recognition as income of advance payments and certain milestone billings for the taxation years.

XXXX case of Burrard Yarrows Corporation v. Her Majesty The Queen, 86 DTC 6459, upheld in June 1988 by the Federal Court of Appeal. It is our understanding that no leave to appeal the decision to the Supreme Court was requested. Accordingly, we do agree with the contractor's conclusion that the contract is one for the sale of materials and rendering of services. The contractor

XXXX

Our understanding of the facts and problems as they relate to advance payments received and approved milestone billings and our comments thereon are as follows:

Advance Payments Received

Facts and Problem

XXXX

You wondered whether the contractor is entitled to deduct the full amount included in income under paragraph 12(1)(a) as a reasonable reserve in respect of services that it is reasonably anticipated will have to be rendered after the end of the year under subparagraph 20(1)(m)(ii).

Our Comments

It is our view that each advance payment is an "amount received" by the contractor "in the course of a business" that is on account of services not rendered at the time it is received.

XXXX

However, subparagraph 12(1)(a)(i), as it applies to your situation, only catches amounts received on account of services not rendered before the end of the year which if the service had been rendered before the end of the year would be in the nature of income. Amounts received on account of services rendered in the year of receipt and before year-end are included in income under subsection 9(1) and not subparagraph 12(1)(a)(i) (Burrard Yarrows case).

XXXX

It is our view that these terms of the contracts

XXXX

Having an absolute right to a portion of the advance payment means the contractor's right is under no restriction, contractual or otherwise, as to its disposition, use or enjoyment (Kenneth B.S. Robertson Ltd. v. M.N.R., Ex. CR., 2 DTC 655). When these conditions are fulfilled it is clear the portion of the advance payment received is on account of services rendered and subject to income inclusion under subsection 9(1). Conversely, advance payments received in the year and included in income under subparagraph 12(1)(a)(i) cover situations where the services are to be rendered after the end of the year and where the services were rendered before the end of the year and the certificate could not be issued and the claim could not be submitted until after the end of the year under the terms of the contract.

Our view that the advance payments would be in the nature of income if the services had been rendered is not affected by the terms of the contract XXXX. Since these events are contingent liabilities they are ignored in this context. A case on point is Brown v. Helvering (1933) 291 US. 193, a decision by the Supreme Court of the United States. In that case, Mr. Justice Brandeis dealing with the question whether commission income received and subject to a contingent liability, namely the repayment of the commission should the contract be cancelled, would tarnish the income, made the following statement ".... the mere fact that some portion of it [namely the commission income received] might have to be refunded in some future year in the event of cancellation or reinsurance did not affect its quality as income... . When received, the .... right to it was absolute. It was under no restriction, contractual or otherwise, as to its disposition, use or enjoyment "[italics mine]. This case has been cited by the Canadian Judiciary.

It is our view that for purposes of subparagraph 20(1)(m)(ii), a reasonable reserve in respect of services that it is reasonably anticipated will have to be rendered after the end of the year XXXX

Unapproved Milestone Billings

Facts and Problem

XXXX

Our Comments

XXXX

It is our view that the phrase "amount receivables" In-paragraph 2)(b) means an amount fixed by agreement (M.N.R. v. Benaby Realties Limited, 67 DTC 5275) to which the contractor has "a legal, though not necessarily immediate right to receive it" (M.N.R. v. Colford Contracting Co. Ltd., 60 DTC 1131). The intent of paragraph 12(1)(b) is to include in a taxpayer's income "receivables" in respect of services that would because of undue delay in billing otherwise not be included in income under subsection 9(1). Paragraph 12(1)(b) deems the amount that could have been, claimed and approved to be deemed to have become receivable on XXXX Since these claims are included in income under paragraph 12(1)(b) they are not eligible for a reserve under paragraph 20(1)(m).

We trust our comments will help you finalize your reassessment. If any additional questions arise, please feel free to call us.

Original Signed by Original signé par

T. HARRIS

Chief Merchandising, Manufacturing Construction Section Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch