12 February 1998 External T.I. 9800185 - DEPOSITS - INCLUSION INTO INCOME

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:

Inclusion under 12(1)(a) ITA of deposits received and related reserve under 20(1)(m) ITA.

Position:

Deposits are not income under 12(1)(a) ITA.

Reasons:

When an amount is paid as a deposit, it cannot be regarded as profit or gain to the holder until the circumstances under which it may be retained by him to his own use have arisen and, until such time, it is not taxable income in his hands, for it lacks the essential quality of income, namely that the recipient should have an absolute right to it and be under no restriction, contractual or otherwise, as to its disposition, use or enjoyment. (Kenneth B. S. Robertson Limited v. M.N.R., 2 DTC 655)

									980018
XXXXXXXXXX							N. Mondou, M.Fisc.

Attention: XXXXXXXXXX

February 12, 1998

Dear Sir:

Re: Paragraphs 12(1)(a) and 20(1)(m) of the Income Tax Act

We are replying to your letter dated December 19, 1997 in which you request a technical interpretation of paragraphs 12(1)(a) and 20(1)(m) of the Income Tax Act ("ITA").

Facts

We understand from your letter that a contractor sells complex machines to third parties. These machines may take a number of weeks to install, a number of months to complete adjustments distinct to each customer, and finally weeks to train the purchaser's staff. It is only after the purchaser approves the entire process that the machine is accepted. Under the contract, the purchaser has the right to decline acceptance of the machine if it does not meet the required specifications.

The significant commitment by the vendor requires the purchaser to indicate his intention by depositing with the vendor funds equal to the purchase price, less 10% that is payable upon acceptance. The vendor is obligated to refund the funds on deposit if the purchaser fails to accept the product.

For accounting purposes, standard practice in the particular industry dictates that recognition of the sale occurs at acceptance. This practice has been developed by the industry due to the uncertainty that the machine will be accepted, as the machines are relatively recently developed and are not yet accepted in the market place. As a result, acceptance may be quite some time after the actual machine has been delivered.

Our comments

Although you have asked for a technical interpretation, the fact situation which you set out is quite specific and it appears that it may relate to definite contemplated transactions. Assurance as to the tax consequences of contemplated transactions can only be given in response to a request for an advance income tax ruling, submitted in the manner set out in Information Circular 70-6R3. We do, however, provide the following comments for your information.

Section 9 of the ITA provides that, subject to the specific provisions of Part I of the ITA, a taxpayer's income for a taxation year from a business or property is the taxpayer's profit from that business or property for the year. Except where a specific provision of Part I of the ITA applies, this "profit" must be computed in accordance with ordinary commercial principles that best reflect the true income of the taxpayer for the year.

One of the overriding provision is paragraph 12(1)(a) of the ITA. This paragraph generally provides that any amount that is received in a taxation year by a taxpayer in the course of a business, that is on account of services not rendered or goods not delivered before the end of the year or that, for any other reason, may be regarded as not having been earned in the year or a previous year, must be included in computing the taxpayer's income from the business for the year.

The Courts have considered paragraph 12(1)(a) of the ITA with respect to the issue of whether amounts received by taxpayers on account of goods sold have the quality of income. In this respect, they have held that deposits that are contingently received are not to be included in the computation of the business income of a taxpayer. The test in this respect is whether the funds have become the absolute property of the vendor. In other words, where a taxpayer holds funds subject to specific and unfulfilled conditions and the taxpayer's right to retain and apply them to his or her own use has not yet accrued, the amount so held are not to be included into income.

The facts that you disclosed in your letter appear to indicate that the amounts received by the taxpayer do not have the quality of income in that, if the purchaser does not accept the product, the vendor is obligated to refund the amounts received from the purchaser. Accordingly, in our view, the amounts received by the vendor would not have to be included in income under paragraph 12(1)(a) of the ITA. Hence, subsection 20(1)(m) of the ITA would not apply.

We trust that these comments are of assistance but caution you that they do not constitute an advance income tax ruling and, accordingly, are not binding on the Department with respect to any particular transactions.

Yours truly,

C. Chouinard
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch