7 June 1995 Internal T.I. 9506157 - ACCRUED VACATION PAY

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.

Principal Issues:

Whether the taxpayer can have a deduction for accrued vacation pay where no accrued vacation pay was recorded for the purposes of its financial statements and the deduction was claimed by an adjustment on the T2S1?

Position TAKEN:

Yes if presents a truer picture and the taxpayer has a legal obligation to pay the vacation earned.

Reasons FOR POSITION TAKEN:

The position of the Department is that the profit for tax purposes must be established using the method that presents the truer picture of the profit. Moreover, there must be a legal obligation (see 7-922084 and 7-921979).

			June 7, 1995

LONDON TAX SERVICES HEADQUARTERS
Robert Gagnon
Attention: B.S. Deacon (613) 957-8953
Large File Case Manager
7-950615

XXXXXXXXXX

We are writing in response to your memorandum of February 27, 1995, concerning the deductibility of accrued vacation pay.

Facts

1.XXXXXXXXXX has claimed deductions for accrued vacation pay in computing its income for its taxation years 1986 to 1991. No accrued liability in respect of accrued vacation pay were recorded for the purposes of the financial statements of XXXXXXXXXX. The deductions for accrued vacation pay were claimed by XXXXXXXXXX by adjustments on its T2S1 for each taxation years.

2.XXXXXXXXXX had a policy on vacation during its taxation years 1986 to 1991. A copy of XXXXXXXXXX policy was attached with your request.

3.You have requested XXXXXXXXXX to provide adequate support in respect of the deductions for accrued vacation pay. The deductions claimed by XXXXXXXXXX were based on estimates.

4.You have proposed to disallow the deduction in respect of accrued vacation pay on the basis that the accrual has understated the income for the taxation years, that there is no provision in the Income Tax Act to allow the deduction and the deduction is based on estimates not actual amounts.

Our Opinion

The position of the Department is to allow a deduction to a taxpayer in respect of accrued vacation pay for a taxation year where the taxpayer has a legal obligation before the end of the year to pay the vacation earned by its employees and the liability is quantifiable. The amount recorded as accrued vacation must not be an estimate but should be set up on an employee by employee basis in accordance with their present salaries and individual entitlements. The amount deducted as accrued vacation pay by XXXXXXXXXX can be disallowed if the taxpayer is unable to prove the amount of the liability.

However, the above position has been established in respect of situations where the accrued liability was recorded for the purposes of the financial statements.

The position of the Department in respect of the method of accounting for profit is to the effect that the profit for purposes of section 9 of the Act must be established in compliance with generally accepted accounting principles, unless the Act contains express contrary provisions, taking into account the method which presents the truer picture of the taxpayer's income and which matches revenue and expenditures.

In some cases, a taxpayer may select from among a number of accounting methods, each one being equally valid. The position of the Department is that the profit for tax purposes should in that case be established using the method that presents the truer picture of the profit and the best revenue/expenditure matching and it is not necessary that there must be conformity between the financial statements and the income tax returns. This position is based on the decisions West Kootenay Power and Light Company Limited 92 DTC 6023 (FCA) and Maritime Telegraph and Telephone Company Limited 92 DTC 6191 (FCA).

In the decision West Kootenay Power and Light Company Limited, the Federal Court of Appeal rejected as a rule of law the requirement that there must always be conformity between tax and accounting. The critical passage of the decision reads:

"In my view, it would be undesirable to establish an absolute requirement that there must always be conformity between financial statements and tax returns, and I am satisfied that the cases do not do so. The approved principle is that whichever method presents the "truer picture" of a taxpayer's revenue, which more fairly and accurately portrays income, and which "matches" revenue and expenditures, if one method does, is the one that must be followed.

The result often will not be different from what it would be using a consistency principle, but the "truer picture" or "matching approach" is not absolute in its effect, and require a close look at the facts of a taxpayer's situation."

In our view, you could allow the deductions claimed by XXXXXXXXXX in respect of accrued vacation pay if such deductions would permit to present a truer picture of the taxpayer's income or more accurately match revenue and expenditures for the relevant taxation years, and if the requirements in the first paragraph of our opinion are satisfied.

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch