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.
August 20, 1992
Toronto District Office Manufacturing, Partnerships
Basic File Audit Division and Trusts Division
Section 142-1-2 Franklyn S. Gillman
(613) 957-9768
Attention: Douglas S. Polson
5-921716
24(1) Contractors Progress Billings This is in reply to your memorandum dated May 29, 1992, wherein you requested our opinion regarding the timing being used by 24(1), to include progress billings in their income. You explained in your above mentioned memorandum that the company deducts as a reserve, 100% of certain progress billings, claiming that the amount is not a receivable for tax purposes. They contend that they are following the method the Department prescribes with regards to progress billings set out in paragraph 3 of Interpretation Bulletin IT-92R2. It was your opinion that the company was applying a sentence found in paragraph 3 of Interpretation Bulletin IT-92R2 out of context with a result which in your opinion was incorrect, unintended and leaves considerable room for manipulation of the timing of the company's contract income.
Your explanation was as follows: The Taxpayer indicates that they are following the method for calculating this reserve as is set out in paragraph 3 of Interpretation Bulletin IT-92R2 which states:
- The amount of a progress billing, less the holdback if any, becomes receivable and must be included in the contractor's income at the time when the purchaser or the purchaser's architect or engineer approves the progress bill for payment.
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Toronto D.0 disagrees with the taxpayer's treatment of the progress billings receivable for income tax purposes. It is your opinion that the progress billings receivable should be included in income for income tax purposes. 24(1) progress billings do not require approval by an architect nor an engineer. Under these circumstances, you consider that the taxpayer's method of reporting its contract income is such that it leaves considerable room for the manipulation of the timing of the taxpayer's contract income. You feel 24(1) should be following the method set out by paragraph 3 of Interpretation Bulletin IT-92R2 which reads as follows:
- In less formal situations where no construction contract exists or where the terms of a contract do not require formal approval of progress billings by the purchaser's architect or engineer before payment, the amount thereof, net of holdbacks if any, will be considered to be receivable and includable in the contractor's income as of the date such billings are made.
You stated that it was your experience that subcontractors normally do not avail themselves of a 100% deduction for progress billings. It is more typical to see a subcontractor claim a deduction for "holdbacks" only, which usually amounts to 10% or 15% of the progress billing amount.
You further went on to state that the case M.N.R vs Colford Contracting Co. Ltd. [[1960] C.T.C. 178] 60 DTC 1131, found that in the provinces of Ontario and Quebec, the legal right to collect a progress bill will come into existence upon the issuance of the engineer's or architect's certificate (where this is required by the contract), which by contract normally provides the contractor with the authority to bill for work completed up to that point in time.
In view of the differing opinions between 24(1) and your office concerning the propriety of deducting progress billings, you asked that we review the situation. You specifically requested that our reply address the following issues. The Taxpayer claims that the existence of a formal contract automatically gives them the right to follow the method they quoted above from paragraph 3 of Interpretation Bulletin IT-92R2. Your position is that the Taxpayer does not follow the formal contract situation which 24(1) claims to follow because they do not require the formal approval of the progress billings by an architect or engineer as stated in the said Interpretation Bulletin and therefore they should be following the less formal method set out in Interpretation Bulletin IT-92R2. You asked "Which method in this situation is correct?". In addition you stated that "...this Bulletin sets out two different situations. In the first situation the purchaser or the purchaser's architect or engineer can approve a progress billing and in the second situation only the purchaser's architect or engineer can approve a progress billing". You requested that we comment on this difference. Additionally, you requested us to comment on what documentation there should be in the subcontractor's files to signify when the billings are to become receivable?
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Our Comments
Pursuant to our telephone conversation (Gillman/Polson) on Wednesday, July 8,1992, we advised that due to the material you supplied, we are unable to accommodate your request regarding the existence of a written agreement and the application of the agreement to the method being used for progress billings. It was agreed during the above mentioned telephone conversation that you shall be making this determination and what you required from us was an explanation as to the practical application of paragraph 3 of Interpretation Bulletin IT-92R2.
Interpretation Bulletin IT-92R2, outlines the Department's position as to how contractors and sub-contractors are to report their income. The Bulletin has been prepared by taking into consideration the principle jurisprudence in this area, that being;
Wilson and Wilson Limited v. M.N.R [[1960] C.T.C. 1] 60 DTC 1018
- Exchequer Court
M.N.R. v. John Colford Contracting Co. Ltd. [[1962] C.T.C. 546] 62 DTC
1338 - SCC
J.L. Guay Limited v. M.N.R. [[1973] C.T.C. 506] 73 DTC
5373 - FCA
The Supreme Court of Canada concurred with the judgement of the Exchequer Court in the Colford case and dismissed the Appellant's appeal without giving any written reasons. At the lower court level it was found that to constitute an amount receivable "... it was not enough to have a precarious right to receive the amount in question, but he must have a clear legal, though not necessarily immediate, right to receive it". Further on Kearney J. combines the above statement with "...collectable whether or not due..." to connote entitlement. Generally a receivable means when a legal right exists to enforce payment. If this exists then the amount will possess the quality needed to constitute income.
What must be determined is whether the amount is a receivable. Where a contract exists between the parties, the terms of the contract would determine at what point in time the contractor/sub-contractor would have a clearly legal right to receive an amount. This point was well established in the Colford case. Each contract under scrutiny must be examined in its entirety to determine whether according to the law, the clause requiring approval is a condition precedent that is binding on the parties. If this is the case then only once the specified approval is given will the amount take on the quality of a receivable and be taken into income in that year whether received or not. If on the other hand a binding condition precedent does not exist, the general law on the definition of receivable will determine when the amount is receivable which generally occurs when the invoice is issued. Therefore as soon as an amount takes on the quality of a receivable it will be taken into income.
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It is important that progress billings not be confused with holdbacks. In the above cited Guay case, the Federal Court of Appeal affirmed the judgement of the Honourable Camil Noël, A.C.J. of the Federal Court Trial Division, where it was held that a holdback would not be receivable until the engineer or architect, as the case may be, issued a certificate of acceptance. The court pointed out that up until the time the certificate is issued the amount in question is not a receivable because it is not certain that the amount of the holdback would be paid in full. The amount is subject to a contingency whose outcome can not be predicted until the condition is met. Should the certificate not be issued, then the amounts withheld are not only uncertain as to quantum if partial damages result from poorly done work, but nothing will ever will become due or payable if damages exceed the amounts withheld.
It is our view that an architect's or engineer's certificate, or third party documentation submitted to support billings for work completed to date, is prima facie evidence that the work was in fact completed in accordance with what was agreed to by the parties. It is our view that immediately after the architect or engineer has certified the contractor's invoice, the amount so certified whether during the contract or at the completion thereof, would constitute an "amount receivable" by the taxpayer. In addition, it is important to note that the amount receivable by the contractor would be the amount calculated and certified by the architect or engineer. (See the first 2 sentences of paragraph 3 of IT-92R2). It is not a requirement that the certificate be a "formal" certificate, nor is it required that a certificate be given by the contractor's engineer or architect. On the contrary, in accordance with normal commercial practice it is the customer who requires the certificate in order to make the payment under the terms of the particular contract. The term "certificate" should be given its normal dictionary definition, i.e., a document containing a certified statement.
In those cases where no third party documentation is available, or necessary, and the taxpayer has issued progress billings in respect of work completed in the fiscal year end, those amounts are due and receivable and the taxpayer is entitled to the amount billed.
It should be noted that IT-92R2 applies to a particular contract in situations where the "contractor" is engaged in the construction of a structure for the supply of work and materials. Title to such work and materials must vest in the customer as they are put in place. Chief Merchandising, Manufacturing, Partnerships and Trusts Section Manufacturing Industries, Partnerships, and Trusts Division Rulings Directorate
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