1 June 1998 Internal T.I. 9808836 - EARNED METHOD - REPORTING 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:

1. Method of reporting income by a Utility Corporation. - Whether Earned or Billed Basis?

2. If earned basis whether amounts earned in prior year but included in current year’s income required to be rolled back to prior year'?

Position:

1. Earned basis.

2. No.

Reasons:

1. Earned basis produces the "truer or more accurate picture".

2. No requirement in the Act to roll back the amounts earned in the prior year but reported in the current year.

							June 1, 1998

	Lorraine Tremblay				HEADQUARTERS
	Director					Wm. P. Guglich
	Income Tax Appeals Division			(613) 957-2102
	Attention: Derek W. Baines
							980883

XXXXXXXXXX

This is in reply to your memorandum of April 3, 1998, regarding the above taxpayer who has not included in income amounts earned but not billed and has expensed amounts for tax purposes which were capitalized for financial statement purposes.

EARNED BUT UNBILLED AMOUNTS

In both West Kootenay Power and Light Company Limited v. Her Majesty, 92 DTC 6023 and Maritime Telegraph and Telephone Company Limited v. Her Majesty, 92 DTC 6191, it was held by the Federal Court of Appeal that in computing income for tax purposes the method which presents the "truer picture” should be used. In both cases that method was the one that recognized as income all revenues earned whether billed or not.

The issue of what profit is for the computation of income, for purposes of subsection 9(1) of the Act, was dealt with in the recent Supreme Court decisions in Toronto College Park Limited, 98 DTC 6088, Ikea Ltd., 98 DTC 6092 and Canderel Limited, 98 DTC 6100.

XXXXXXXXXX

The principles established by the Supreme Court regarding the computation of income were summarized as follows in Canderel on page 6110.

(1) The determination of profit is a question of law.

(2) The profit of a business for a taxation year is to be determined by setting against the revenues from the business for that year the expenses incurred in earning said income.⁽¹⁾

(3) In seeking to ascertain profit the goal is to obtain an accurate picture of the taxpayer's profit for the given year.

(4) In ascertaining profit the taxpayer is free to adopt any method which is consistent with:

(a) the provisions of the Income Tax Act;

(b) established case law principles or "rules of law", and

(c) well-accepted business principles.

(5) Well-accepted business principles, which include but are not limited to the formal codification found in G.A.A.P., are not rules of law but interpretative aids. To the extent that they may influence the calculation of income, they will do so only on a case-by-case basis, depending on the facts of the taxpayer's financial situation.

(6) On reassessment, once the taxpayer has shown that he has provided an accurate picture of income for the year, which is consistent with the Act, the case law, and well-accepted business principles, the onus shifts to the Minister to show either that the figure provided does not represent an accurate picture, or that another method of computation would provide a more accurate picture.” (Emphasis in original.)

The Supreme Court in Canderel, cited with approval the West Kootenay, Maritime Tel & Tel “truer picture” principle. Therefore, in the present case including the earned but unbilled amounts in income would present the truer or more accurate picture of XXXXXXXXXX profit for the year. As stated in principle 2 in Canderel the taxpayer, in computing the profit for the year, would be entitled to deduct expenses incurred to earn the amounts included in income for the taxation year.

Subsection 9(1) refers to "the year" and "taxation year", the year being the taxation year. Subsection 249(1) defines taxation year as: “in the case of a corporation, a fiscal period”. Subsection 249.1(1) (formerly 248(1 )) restricts the duration of the fiscal period to not more than 53 weeks. Including 54 weeks of revenue in a taxation year would not have any basis in law.

XXXXXXXXXX. In the present case there are no extenuating circumstances and the taxpayer has not requested a change in its fiscal period. In our view, the decision in La Capitale, Compagnie D’Assurance Générale v. Her Majesty, 95 DTC 5587 does not support a 54 week taxation year. On the contrary, Pinard, J. on page 5590 suggests that paragraph 12(1)(b) of the Act requires that the amounts receivable to be included in income must be associated with services rendered (insurance protection provided) “in the year”.

Including the earned but unbilled amounts in XXXXXXXXXX income for the current year without rolling back the prior year’s earned income should not be viewed as creating a 54 week fiscal period. The fiscal period is not being changed or extended. We are simply including unreported earned amounts in income for the current taxation year. Whether we should also roll back the prior year’s earned income reported in the current year is a separate issue. Based on the decision in West Kootenay and Maritime Tel & Tel and the criteria described in Canderel there is not much doubt that the earned but unbilled amounts must be included in the current year’s income.

As to the rolling back issue this was considered in a similar fact situation (i.e., income had been deferred and a roll-back would have created a permanent revenue loss) in Casey Realty Limited and Chignecto Holdings Limited v. M.N.R., 91 DTC 1354. The court held that the Act does not provide any remedial provision under which the prior year’s amounts included in the current year could be excluded from the current year's reported income. Note that subsection 4(4) as it read for the years in question would not apply in this situation since the inclusion of the billed income relating to goods sold in a prior year is not included in computing income for the year "in accordance with or because of any other provision of this Part". The decision in Casey Realty can be distinguished from the obiter comments in Stevenson & Hunt Insurance Brokers Ltd. v. Her Majesty, 93 DTC 5125. In Stevenson Hunt there would have been no permanent revenue loss resulting from a roll-back while in Casey Realty there would have been a permanent revenue loss.

CAPITALIZE OR EXPENSE?

As discussed in our telephone conversation of April 27, 1998 (Baines/Guglich) your memorandum does not provide any details regarding the outlays or costs capitalized for financial purposes but expensed for tax purposes nor is there any explanation of XXXXXXXXXX rationale for the different treatment. We therefore cannot comment. Comments regarding “capitalized general expenses” incurred by XXXXXXXXXX were provided in our January 4, 1979, memorandum (document # EC1802) to the St. John's District Office. We would be pleased to revisit the issue if you wish to submit details respecting the specific outlays or costs.

We trust our comments will be of assistance.

Roy C. Shultis
Director General
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
ENDNOTES

⁽¹⁾ M.N.R. v. Irwin, (1964) S.C.R. 662, at p. 64: and Associated Investors of Canada Ltd. v. M.N.R., (1967) 2 Ex. C.R. 96 at p. 102.

- 3 -