1 June 2010 External T.I. 2009-0349561E5 - Gift Certificates - Timing of Income Recognition

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.

Principal Issues: The timing of the income recognition on the sale of gift cards by related businesses and whether a reserve under paragraph 20(1)(m) can be claimed. Also if the gift cards sold by one taxpayer can be used by the customer at a related business what are the implications?

Position:
While income should be recognized at the date of sale of the gift card the ultimate determination of income or income for income tax purposes remains a question of fact.

Reasons:
The law.

XXXXXXXXXX 							2009-034956
								Michael Cooke, C.A.
June 1, 2010

Dear XXXXXXXXXX :

Re: Gift Certificates - Timing of Income Recognition

We are writing in response to your letter of November 26, 2009, wherein you requested our comments regarding the timing of recognition of income from the sale of gift certificates.

Briefly, as indicated in your letter, two related corporations ("Aco" and "Bco") allow their customers to use gift cards sold by either corporation at any retail store owned by Aco or Bco. Where this has occurred, an inter-company payable/receivable is set up by Aco and Bco and the amount of the net payable/receivable is settled monthly by way of cash payment.

Comments:

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of a request for an advance income tax ruling submitted in the manner set out in Information Circular 70-6R5, Advanced Income Tax Rulings, dated May 17, 2002. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on the internet at http://www.cra-arc.gc.ca. Where the particular transactions are complete, the inquiry should be addressed to the relevant tax services office, a list of which is available on the "Contact Us" page of the CRA website. Although we cannot comment on your specific situation, we are prepared to provide the following comments in respect of the issues that you raised. Please note, however, that these comments are of a general nature only and are not binding on the CRA.

Generally speaking, the business income of a taxpayer arising from the sale of gift certificates should be recognized at the date of sale of the gift certificate pursuant to subparagraph 12(1)(a)(i) of the Income Tax Act (the "Act") and, where applicable, a reasonable reserve might be available pursuant to subparagraph 20(1)(m)(i) of the Act. While the determination of what is considered a reasonable reserve can only be made after considering all of the facts and circumstances surrounding a particular situation, where subsection 20(6) of the Act is not applicable, in our view a reasonable reserve would represent the amount of the taxpayer's outstanding gift certificates at the end of the year less a percentage for gift certificates which (on the basis of past experience) will never be redeemed by their holders.

In the situation described in your letter, it is our view that if for example, Bco accepts gift cards sold by Aco as payment for its merchandise; Bco should recognize all of its revenue from such a sale at that time pursuant to subsection 9(1) of the Act, assuming the goods have been delivered and the sale is otherwise complete. For accounting purposes, in such circumstances we generally understand that Bco would debit the Aco inter-company account for the full face value amount of the Aco gift cards "redeemed" and credit its sales revenue for the full amount of the sale. In respect of Aco, we generally understand that Aco would debit sales revenue (or some other contra-revenue or reserve account) and credit the Bco inter-company account for the same amount. For tax purposes, any reserve that Aco might have claimed pursuant to paragraph 20(1)(m) of the Act in respect of such gift cards would be added back into its income pursuant to paragraph 12(1)(e) of the Act and no new reserve would be claimed by Aco for any gift cards that were otherwise redeemed by Bco. In your view, the net effect is that Aco's computation of income or profit for income tax purposes will be the truer picture as required by the courts in the particular circumstances.

While a mixed question of fact and law that can only be determined once all the relevant information has been considered, we are inclined to agree with your view that Aco's computation of income or profit for income tax purposes in the above-described circumstances is consistent with the rules in the Act.

We trust that these comments will be of assistance.

Renée Shields
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch