7 March 1991 Income Tax Severed Letter - Life Estates Sales

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.

Subject: XXX Life Estate Sales

We are writing in reply to your memorandum of August 14, 1990 wherein you requested our views on XXX We regret that other workload prevented an earlier response to your query. Our understanding of the facts is as follows:

Facts

XXX

Our Opinion

A transaction entered into on the basis of documentation similar to the sample life estate sale submitted with your memorandum clearly would involve a sale by the partnership of a life estate in a condominium unit and not a lease arrangement. We are not aware of any legal basis for the treatment of a life estate sale as a lease for purposes of the Act.

The question to be resolved is the proper treatment of the receipt of the life estate sale proceeds for purposes of the Act. It is our view that, on the receipt side, generally accepted accounting principles ("GAAP") are not necessarily the determining factor in computing income for tax purposes. The more appropriate test is whether the amount received has the quality of income. This principle is derived from Robertson Ltd v. MNR [[1944] C.T.C. 75] 2 DTC 655 (Ex. Ct.) wherein Mr. Justice Thorson stated:

. . . 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 to Mr. Justice Brandeis in Brown v. Helvering (supra). 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 restriction, contractual or otherwise, as to its disposition, use or enjoyment? To put it 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?

Robertson dealt with the tax treatment of advance fees which were to be "held as a deposit". Mr. Justice Thorson decided in the appellant's favor, as there was no certainty that the advance fees would be retained by the appellant and because their use was governed by contract.

Brown v. Helvering 291 U.S. 193, referred to by Thorson J. in the above quoted excerpt from Robertson, was a decision of the Supreme Court of the United States, dealing with the appropriate tax treatment of overriding commissions received by insurance agents. These commissions were subject to repayment if the policies of insurance to which they related were cancelled. Mr. Justice Brandeis, in delivering the opinion of the Supreme Court of the United States said at page 199:

The overriding commissions were gross income of the year in which they were receivable. As to each such commission there arose the obligation - a contingent liability - to return a proportionate part in case of cancellation. But the mere fact that some portion of it might have to be refunded in some future year in the event of cancellation or reinsurance did not affect its quality as income . . . . When received, the general agent's right to it was absolute. It was under no restriction, contractual or otherwise, as to its disposition, use or enjoyment.

The Brown v. Helvering case is distinguishable from the Robertson case in that in the latter case, the use of the advance fee is governed by contract whereas in the former case there is no restriction as to the use of the commission.

The "quality of income" test has been adopted in other Canadian cases including:

• (1) The Queen v. Foothills Pipe Lines (Yukon) Ltd, [[1990] 2 C.T.C. 448] 90 DTC 6607 (FCA);
• (2) Northern and Central Gas Corporation v. The Queen, [[1985] 1 C.T.C. 192] 85 DTC 5144 (FCTD);
• (3) The Queen v. Imperial General Properties Limited, [[1985] 1 C.T.C. 40] 85 DTC 5045 (FCA);
• (4) MNR v. Atlantic Engine Rebuilders Ltd., [[1967] C.T.C. 230] 67 DTC 5155 (SCC); and
• (5) Dominion Taxicab Association v MNR, [[1954] C.T.C. 34] 54 DTC 1020 (SCC).

Based on your understanding of the facts as set out above, it is our opinion XXX

If, however, after your review you conclude that there are additional facts, not referred to herein, which would establish that entitlement to the sale proceeds was subject to restrictions and therefore not fully earned in the year of receipt, it is our view that any unearned portion of the payments should be included in income under paragraph 12(1)(a) of the Act. No reserve would be permitted under subparagraph 20(1)(m)(iii) of the Act, as amounts received for the sale of property would not generally be in respect of ". . . periods for which rent or other amounts for the possession or use of land or chattels have been paid in advance. . . ." However, paragraph 20(1)(m.2) of the Act provides a deduction for a repayment by a taxpayer of an amount required by paragraph 12(1)(a) of the Act to be included in income for the year or a preceding year. It should be noted that under this alternative treatment XXX would not have a cost of sales with respect to the disposition of the life estate as transactions in which amounts are received by a taxpayer that "may be regarded as not having been earned in the year or a previous year" do not affect inventory accounts.

Should you have questions concerning this memorandum, please contract T. Murphy.