30 March 1993 Income Tax Severed Letter 9303550 - Contractor Income—Accounts Receivable

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.

1993 EDMONTON DISTRICT OFFICE INFORMATION SESSION Re: Receivable QUESTION #2

A Canadian company (Canco) obtains contracts for the sale of large turbines and compressors. The turbines and compressors are purchased by Canco from a related U.S. company. Canco does not modify or add value to such turbines and compressors, although it installs and tests them this service is billed separately. Canco does not have a legal right to enforce payment from its customer until certain contract conditions "milestones" are met. For accounting purposes, revenues and costs are matched and recognized according to internal policy and generally accepted accounting principles (GAAP). Is the narrow concept of "receivable" as outlined in IT-92R2 pursuant to jurisprudence applicable to Canco?

RESPONSE #2

Yes, the concept of "receivable" as outlined in IT-92R2 pursuant to jurisprudence is applicable to Canco. The determination of income of a contractor under section 9 of the Act is not necessarily based on GAAP, but, rather it is based on whether the amount received or receivable by the contractor has the quality of income—his right to it is absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment, which is a question of fact to be determined in each case. In the case at hand, Canco does not have a legal right to enforce payment from its customer on the progress billing until certain contract conditions "milestones" are met. Such billing does not have the quality of income and thus is not required to be included in the income of Canco under section 9 of the Act. However, if Canco has received the amounts in respect of such billing, it should include such amounts in its income under paragraph 12(1)(a) of the Act and it may be entitled to a reserve under 20(1)(m) of the Act.

Peter Lee March 30, 1993 7-930355

               Statement of Principal Issues

Re:   Income Recognition                         Peter Lee
      Accounts Receivable                        March 29, 1993
      Progress Billings                          7-930355

Background

                          XXXXXXXXXX

Issues

1. Whether income of a contractor must be determined in accordance with GAAP (without considering the legal concept of income) for the purpose of section 9 of the Act.

2. Whether the unapproved or uncertified progress billings of a contractor should be brought into the contractor's income under section 9 or paragraph 12(1)(a) of the Act.

Analysis and Positions Taken

1a. Urie, J.A. commented in the case of Foothills Pipe Lines (Yukon) Ltd., 90 DTC 6607 (FCA), at page 6612:

             A considerable body of jurisprudence has
             developed certain principles applicable in
             determining whether or not sums of money received
             by a taxpayer are to be considered as income in
             the tax period when received or are to be
             recorded as a liability or in some other way.

At the same page, Urie, J.A. quoted his own comments in the case of Neonex International Ltd., 78 DTC 6339 (FCA), at page 6348:

             There is no doubt that the proper treatment of
             revenue and expenses in the calculation of
             profits for income tax purposes with a view to
             obtaining an accurate reflection of the taxable
             income of a taxpayer, is not necessarily based on
             generally accepted accounting principles. 
             Whether it is so based or not is a question law
             for determination by the Court having regard to
             those principles (see M.N.R. v. Anaconda
             American Brass Ltd., 
55 DTC 1220 (Privy
             Council); see also Associated Investors of
             Canada Ltd. v. M.N.R., 
67 DTC 5096 (Ex.
             Ct.)).

At the same page, Urie, J.A. also commented:

             ... as matter of law, amounts become taxable
             income in the year of receipt provided the
             amounts received exhibit the nature and quality
             of income at that time.  As was observed in this
             Court in Commonwealth Construction Company
             Limited v. Queen, 
84 DTC 6420 (FCA), the
             phrase "quality of income" appears in the
             Judgment of the Exchequer Court of Canada in
             Kenneth B.S. Robertson Limited v. M.N.R.,

2 DTC 655, when Thorson P. said at pages 660 and
             661:

             ... for the question remains whether all of the
             amounts received by the appellant during any year
             were received as income or became such during the
             year.  Did such amounts have, at the time of
             their receipt, or acquire, during the year of
             their receipt, the quality of income, to use the
             phrase of Mr. Justice Brandeis in Brown v.
             Helvering, 291 U.S. 193.  In my judgment, the
             language used by him, to which I have already
             referred, lays down an important test as to
             whether an amount received by a taxpayer has the
             quality of income.  Is his right to it absolute
             and under no restriction, contractual or
             otherwise, as to its disposition, use or
             enjoyment?  To put it in another way, can an
             amount in a taxpayer's hands be regarded as an
             item of profit or gain from his business, as long
             as he holds it subject to specific and
             unfulfilled conditions and his right to retain it
             and apply it to his own use has not yet accrued,
             and may never accrue?

1b. Kearney J. commented at pages 1134 and 1135 in the case of John Colford Contracting Company Limited, 60 DTC 1131 (Ex. Ct.), affirmed without written reasons, 62 DTC 1338 (SCC):

             As "amount receivable" or "receivable" is not
             defined in the Act, I think one should endeavour
             to find its ordinary meaning in the field in
             which it is employed... I think it is not enough
             that the so-called recipient have a precarious
             right to receive the amount in question, but he
             must have a clearly legal, though not necessarily
             immediate, right to receive it... This leads to a
             consideration of whether, legally speaking each
             of the holdbacks in the instant case possessed
             the quality required to bring it within the
             meaning of a receivable.  Speaking of the quality
             required to constitute income, the learned
             president of this Court stated in Kenneth B.S.
             Robertson Limited v. M.N.R., 
2 DTC 655... Did
             such amounts have... the quality of income...
             (see 1a above)

The above-noted principle of quality of income has also been applied in the cases of J.L. Guay Ltée, 71 DTC 5423 (FCTD), affd 73 DTC 5373 (FCA), and Burrard Yarrows Corporation, 86 DTC 6459 (FCTD), affd 88 DTC 6352 (FCA) (the case is also known as Versatile Pacific Shipyards Inc.).

1c. Based upon the above-noted analysis, we opine that the determination of income of a contractor under section 9 of the Act is not necessarily based on GAAP, but, rather it is based on whether the amount received or receivable by the contractor has the quality of income - his right to it is absolute and under no restriction, contractual or otherwise, as to its disposition, use or enjoyment, which is a question of facts to be determined in each case.

2a. In a situation wherein an approval or certification of the work covered by a progress billing of a contractor is required under a contract, it is our opinion that the unapproved or uncertified progress billings of the contractor (as in the case at hand) do not have the quality of income because the amount of the work provided by the contractor has not been ascertained and confirmed by both parties of the contract and, hence, the contractor's right to them is not absolute (i.e., such billings are more or less like advances to the contractor). Accordingly, based upon our analysis in 1 above, the amounts of such billings should not be included in the income of the contractor under section 9 of the Act. However, if the contractor has received the amounts in respect of such billings, he should include in his income under paragraph 12(1)(a) of the Act and he will also be entitled to a reserve under 20(1)(m) of the Act (see paragraph 5 of IT-92R2 ).

2b. Our position as stated in 2a above does not contradict the decisions of the Federal Court of Appeal in the cases of West Kootenay Power and Light Company Limited and Maritime Telegraph and Telephone Company, Limited. MacGuigan, J.A. concluded at page 6031 in the former case:

             I must therefore conclude that the appellant had
             a clear legal right to payment: the amounts in
             question were sufficiently ascertainable to be
             receivables even though not yet billed or due,
             and therefore had to be included in income for
             the year then ending...

MacGuigan, J.A. also said at page 6194 in the later case:

             The appellant's earned revenues to the end of
             each taxation year were receivables in law, and
             therefore income for the ending year... The
             receivables already being recognized as profit
             under s. 9(1), s. 12(2) requires that status be
             maintained.

In both cases, it was decided that the companies had a clear legal right to payments in respect of the services provided by them (even though the amounts had not been billed) because such services had been recorded on a timely basis and readily quantified. Whereas, in the case at hand, there is no clear legal right to payments in respect of the unapproved or uncertified progress billings of a contractor because the work in respect of such billings have not been ascertained and confirmed by both parties of the contract.