12 November 2003 External T.I. 2002-0121835 - 85(1) - Holdbacks Payable

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 CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues:

Where in a sale by a contractor of its construction contract to a corporate purchaser under subsection 85(1) of the Income Tax Act, whether the assumption by the purchaser of the contractor's holdbacks payable as part of the purchase and sale transaction should form part of the agreed amount, where at the time of such assumption, the contractor's holdbacks payable were conditional on the issuance by an architect or engineer of a certificate of acceptance with respect to the contract?

Position:

The fair market value of the contractor's holdbacks payable at the time they were assumed should form part of the agreed amount.

Reasons:

The assumption by the purchaser of the contractor's holdbacks payable would constitute non-share consideration received by the contractor.

									2002-012183
XXXXXXXXXX 								Daniel Wong
(613) 954-4949
November 12, 2003

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Subsection 85(1) of the Income Tax Act ("Act")

This is in reply to your letter of February 6, 2002 wherein you indicated that a builder had a contract with an owner to build a building. The builder hired subcontractors to construct the building ("work"). Pursuant to an agreement between the builder and its subcontractors, the builder withheld a certain percentage ("builder's holdbacks") of the amount payable to its subcontractors. The purpose of the builder's holdbacks was to cover the payment of any damages that the builder might incur from the subcontractors' failure to perform, or their faulty performance of, the work. Consequently, the builder would not release its holdbacks to its subcontractors until an architect or engineer had issued a certificate of acceptance with respect to the work. The builder also had holdbacks receivable from the owner with respect to the contract.

You indicated that the builder had transferred its holdbacks receivable and the contract to a corporation under subsection 85(1). As part of the consideration for the transfer, the corporation assumed the builder's holdbacks. At the time of the assumption by the corporation of the builder's holdbacks, no architect or engineer had issued a certificate of acceptance with respect to the work. You requested our opinion as to whether the builder's holdbacks (that were assumed by the corporation) would constitute non-share consideration given by the corporation to the builder with respect to the transfer under subsection 85(1).

COMMENTS

In your letter, you outlined what appears to be an actual fact situation related to transactions and events that have taken place. The review of such situations is generally the responsibility of the local taxation services offices and, as outlined in paragraph 22 of Information Circular 70-6R5, it is not our practice to provide specific opinions on factual situations otherwise than in the context of an advance income tax ruling. In any event, a request cannot be considered for a ruling when the transactions are completed or where the issues involved are primarily questions of fact. Nevertheless, we are prepared to provide the following comments that we hope will be of assistance to you.

At the time the builder's holdbacks were assumed by the corporation, they were contingent liabilities, as the builder's legal obligation to pay them was conditional on the issuance by an architect or engineer of a certificate of acceptance with respect to the work and no such certificate had been issued at that time. Consequently, the builder's holdbacks would not be due and payable at law (see J. L. Guay Ltée v. M.N.R., 71 DTC 5423 (F.C.T.D.), affirmed 73 DTC 5373 (F.C.A), affirmed 75 DTC 5094 (SCC); Newfoundland Light & Power Co. Ltd. v. The Queen, 90 DTC 6166 (FCA)).

In our view, the fair market value of the builder's holdbacks at the time they were assumed should form part of the agreed amount with respect to the transfer, as such assumption by the corporation would constitute non-share consideration given by the corporation to the builder for the purposes of subsection 85(1).

However, the fact that the corporation assumed the builder's holdbacks would not, in and by itself, make the builder's holdbacks become due and payable at law. Consequently, the builder would not be entitled to deduct its holdbacks in computing its income from the contract by virtue of paragraph 18(1)(e) for the relevant taxation year.

The above comments represent our general views with respect to the subject matter of your letter and are provided in accordance with paragraph 22 of Information Circular 70-6R5.

Yours truly,

David Palamar
Corporate Reorganizations Section II Manager
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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