5 April 1994 Internal T.I. 9331007 - COMPLETION METHOD

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

			April 5, 1994

Calgary District Office Manufacturing Industries,
Business Audit Partnerships and Trusts
Group 441-2-2 Division
F. B. Fontaine
Don Murray, Technical Advisor (613) 957-8953

		                             933100

Building Contractor's Revenue Recognition

This is in reply to your memorandum dated October 13, 1993 concerning the above-captioned subject. We regret the delay in responding.

The situation that you have outlined is as follows:

1.A contractor reports his income on the "completion method" pursuant to the administrative guidelines in paragraph 12 of Interpretation Bulletin IT-92R2.

2.Sales are recognized at the time of possession by the homeowner.

3.Due to the timing of the year end, seasonal work may not be completed, e.g. pouring of the driveway, landscaping, deck construction, or small items may have to be completed within the house. The cost of these items would not total more than 5% to 10% of the total construction cost.

You query whether the house would be considered completed in accordance with paragraph 12 of the Bulletin or whether completion would be deferred until the next fiscal period. Also, you raised other issues including what section of the Income Tax Act (the "Act") that brings completion method revenue into income and made assumptions on the basis that paragraph 12(1)(a) of the Act would, or would not, apply. Based on these assumptions you are concerned whether paragraphs 20(1)(m) and 18(1)(e) of the Act would apply to deny a reserve and a deduction for completion costs as being "contingent", respectively.

Our comments are as follows:

(A)Since you have made no comments to the contrary, we have assumed that the contractor was not a builder who constructed buildings on his own land, that the Bulletin has application in the circumstances and that, other than the specific queries raised, you are satisfied that the completion method is otherwise applicable.

(B)Based on 2. and your query regarding deferral of completion to the following year as mentioned above, it would appear that, notwithstanding the unfinished work, the contract price was received and included in computing income of the contractor within two years of commencement of the contract and that possession of the building was taken by the owner within that time.

(C)Paragraph 12 of the Bulletin requires that under the completion method the whole revenue, i.e. the contract price, (including holdbacks) must be brought into income for the year in which the contract work is completed within the two-year period. The Bulletin suggests that the contract would be considered completed upon (i) acceptance of the project by the owner but for minor adjustments for incompleted work or (ii) actual occupancy by the owner.

(D)Prior to giving up possession of the building by the contractor, we would have thought that under the residential building code, the building would have to be substantially completed. Therefore, taking possession of the building by the owner would be tantamount to acceptance of the building and also would tend to support that any adjustments for incompleted work would be minor. While it is a question of fact whether work outstanding under a contract at a particular time can be considered to be minor, it would be difficult to argue that 5% to 10% of construction cost is a major or substantial part of a contract. Accordingly, it would appear that the contract would be considered "completed" for the purposes of the completion method.

(E)The completion method of reporting income for tax purposes was accepted only as a matter of convenience for both the Department and contractors. The completion method is an administrative position and where it is adopted by a taxpayer, the rules as stated in the Bulletin will apply.

(F)As stated in (C) above, under the completion method the whole revenue must be brought into income when the contract is completed. Such revenue would be considered to be included in computing income for tax purposes under subsection 9(1) of the Act. Accordingly, since it is accepted that under the completion method revenue is reported on completion of the contract, the Department will not apply paragraphs 12(1)(a) and 20(1)(m) of the Act to any portion of the revenue. (See paragraph 5 of the Bulletin which provides that paragraphs 12(1)(a) and 20(1)(m) be applied under the general rules for reporting income). Similarly, since costs, and more specifically direct costs, are required to be deducted (also pursuant to subsection 9(1)) in the year in which the contract is completed and income is recognized, there would be matching of costs and revenue and no portion of such costs would be considered "contingent" for the purposes of paragraph 18(1)(e) of the Act.

(G)Paragraph 18(1)(e) denies the deduction of an amount to a taxpayer that is a "contingent liability". The term is defined in paragraph 3 of IT-215R as "a legal obligation that may arise out of present circumstances providing certain developments occur". If our understanding of the situation is correct, it is our view that at any time during the contract, there was always a legal obligation by the contractor to carry out any of the unfinished work described in 3. above and no further developments would be necessary to create such an obligation after the end of the two-year period.

(H)Based on our perusal of the Burnco Industries case (84 DTC 6348) that you mentioned with regard to the application of paragraph 18(1)(e), we would conclude that the case was decided on whether an expense was incurred by a taxpayer for the purposes of paragraph 18(1)(a) and not whether an amount was a contingent liability for the purposes of paragraph 18(1)(e) of the Act.

We hope our comments will be helpful to you.

for Director
Manufacturing Industries,
Partnerships and Trusts Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch