7 September 1991 Income Tax Severed Letter - Determination of Income by Health Clubs

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: Determination of Income by Health Clubs

This is in reply to your telephone enquiry of July 4, 1991 concerning the matching of revenue to expenses by Health Clubs. In particular you asked if the Department had a policy on revenue recognition by such clubs where substantial fees were collected from members up front in payment for lifetime memberships. These clubs would in fact incur high set up costs, which they would expense, while deferring revenue recognition declaring that the revenue was unearned, and claiming a reserve under 20(1)(m) of the Act.

This question has been previously addressed in the Rulings Directorate with respect to a membership fee charged for use of a recreational park called XXX. We have enclosed a copy of our response to the Appeals and Referrals Division concerning this subject for your reference.

Our position with respect to the claiming of a reserve under paragraph 20(1)(m) of the Act was recently reaffirmed in a draft response to Canadian Tax Foundation. Under paragraph 12(1)(a) of the Act an amount is included in income only if it is "on account of services not rendered" or "may be regarded as not having been earned in the year or a previous year." However, an amount is considered earned and is not in respect of services not rendered if the taxpayer's right to the amount is under no restriction, contractual or otherwise, as to its disposition, use and enjoyment, or the taxpayer's right to the amount is absolute and unconditional. A reserve under paragraph 20(1)(m) may only be claimed in respect of paragraph 12(1)(a) included income.

Where in addition to annual membership fees, a one-time initial fee is paid to a health club for a new membership, the club would have to show that it was in fact under some definite restriction as to the disposition, use or enjoyment of such funds before a reserve under paragraph 20(1)(m) could be claimed. This could involve a commitment to refund a proportionate amount of the fee in the event the members leaves within a certain time period. Generally the annual membership fees cover merely represents a cost to the new member for the use of facilities paid for by previous members. Where this is the case, or where the club is endeavouring to build up a fund for future contingencies such fees should be reported as income under section 9 of the Act.

The Audit Applications Division had not addressed this issue in the context of applying to Health Clubs, however, they had in fact responded to a similar question asked by your District Office in respect of time sharing vacation property arrangements. We enclose a copy of this response for your records.

Alternatively, you may argue that the expenses incurred up front, in order to advertise and promote the sale of health club memberships cannot be written-off in the year they are incurred. These expenses, in accordance with section 9 of the Act, GAAP, and the matching principle, should be amortized for income tax purposes over the membership period if the taxpayer agrees that the expenditures were laid out to earn income from operations in future years as well as for the current year. This opinion is consistent with the comments set out in paragraphs 5 and 7 of IT-471R dated July 15, 1982, entitled "Prepaid Expenses and Deferred Charges".