Timing

A Canadian-controlled private corporation (“CCPC”) is granted an option to acquire shares of an arm’s length CCPC. The option will only vest upon completion of a medical research project in which it is engaged in the course of its business. Such vesting occurs at the end of the third year, and the corporation exercises its option to purchase the shares at the beginning of the fourth year.

Regarding the timing of the recognition of any business income, CRA stated:

Generally speaking, where stock options are granted to a taxpayer as payment for consulting services rendered, the FMV of the underlying shares on this date over the aggregate of the exercise price of the option should be included in the taxpayer’s business income, pursuant to subsection 9(1). … [W]here it can be determined … that the option is granted in consideration for services that are to be rendered after the time of grant and upon the fulfillment of a condition or contingency, the income should instead be recognized when the services are rendered, the amount is quantifiable and the rights are unrestricted.

… [Here] the vesting of the option is linked to the completion of the long-term research project. As such, it may be difficult to conclude that the income is earned before the vesting date under the particular arrangement. … [G]enerally, it is at the time where the services have been rendered and the contingency has been fulfilled, that the FMV of the underlying share over the aggregate of the exercise price of the option should be included in income under subsection 9(1). …

… Where the facts indicate that the incremental value represents part of the consideration received by the taxpayer for consulting services rendered, the incremental value should generally be treated as business income for purposes of the Act.

The estate of the deceased annuitant of an RRSP was fully settled without the executor (his surviving wife and the sole beneficiary) being aware of the RRSP. Later, the RRSP became unclaimed property and the Quebec Commission for dealing with unclaimed property (the “DPBNR”) instructed the RRSP issuer to liquidate the RRSP and remit the proceeds in cash to it. In a subsequent taxation year, the surviving spouse claimed and received the amount from the DPBNR as the sole estate beneficiary.

CRA found that the amount paid to the surviving spouse was to be included in her income under the surrogatum principle as being in lieu of a payment received under s. 146(8). In finding that the income inclusion occurred in the year of receipt of the payment by her (when she had been identified) rather than in the year of receipt by the DPBNR, CRA stated:

[A]t the time the DPBNR (as administrator) received a benefit under an RRSP on behalf of an unidentified beneficiary (the beneficial owner), the beneficial owner was unknown and could not be identified. However, it is [its] longstanding position … that the CRA must … rely on the facts as they exist at the end of the taxation year. …

To the extent that, at the end of a particular taxation year in which the DPBNR received a benefit under an RRSP, the beneficial owner was not identified with certainty, the facts as they existed at the end of the particular taxation year did not permit the benefit to be included in computing a taxpayer's income. The fact that the identity of the beneficial owner is clarified in a subsequent year does not change the facts as they existed at the end of the particular taxation year. Consequently, an amount received in a particular taxation year by the DPBNR on behalf of a beneficial owner and paid in a subsequent year to the same beneficial owner, once identified, is not required to be included in computing the beneficial owner's income in the particular taxation year.

Where a book publisher’s customers could return unsold books, it could not deduct a reserve from the profit required to be recognized by it on its sales. In contrast:

In a consignment sale situation or a sale under a "true" return of unsold goods clause, the taxpayer is not required to recognize, for tax purposes, the income from the sale of the goods before title passes to the purchaser.

Canco, which was wholly-owned by its Canadian Parent, entered into “Dividend Bond Locks” and “Interest Bond Locks” (collectively, the “Bond Locks”) with third-party counterparties. The Dividend Bond Locks were said by Canco to hedge against an increase in the dividend rate on preferred shares issued by Parent which provided for periodic resetting of the dividend rates thereon. Canco had to make a payment on the termination of the Dividend Bond Locks. The terms of the Interest Bond Locks were similar, except that they related to Debentures of Parent. Their settlement also was at a loss.

After finding that the losses realized by Canco were on income account, Headquarter went on to address the timing of their deduction:

[T]he benefits of the Bond Locks are primarily related to the interest stream on the Debentures and the dividend stream on the…Preferred Shares. The taxpayer does not seem to have made any representations that the Bond Locks provided any immediate benefits [unlike Canderel]. Accordingly… there is a good case to be made that amortization is appropriate… .

The taxpayer has asked that the CRA confirm that if losses on the Bond Locks are amortized, then gains should be amortized as well. However…Ikea specifically states that there is no possibility of an amortization of income.

In order to enhance customer retention, a manufacturer agrees with its independent distributors to disburse $1,000,000 to them over two years if the distributors agree to follow a specified program of excellence over a period of eight years, and to pay damages if they fail to do so. Under Canadian accounting principles, a distributor must include the amounts received as revenue over the eight-year period. Should this treatment also be followed for s. 9 purposes? After discussing Canderel, CRA stated:

Ikea Ltd. v. The Queen [f.n. [1998] 1 S.C.R. 198]… confirmed the importance of the realization principle under which amounts received or realized by a taxpayer – free of conditions or restrictions as to their use – are taxable in the years in which they are realized subject to any contrary provision in the Income Tax Act or other rules of law.

…[I]f it is determined that the $1,000,000 that the manufacturing corporation is obligated to disburse over two years (the “sum”) was, for the distributor corporation, free of conditions or restrictions respecting its use from the commencement of the contract, the sum could be included in the income of the distributor corporation in such taxation year [of commencement] under the terms of subsection 9(1).

Furthermore, an examination of the relevant documentation and the applicable private law would be necessary in order to determine if the damages clause…constitutes by itself a condition restricting the use of the sum by the distributor corporation.

A corporation rents a property under an emphyteutic lease for a lump sum. Is it able to amortize that amount over the period stipulated in the deed constituting the emphyteusis? CRA responded (TaxInterpretations translation):

[A]t civil law, an emphyteusis is not a lease, but instead a division of the property rights [citing Gatineau v. Canada, 2013 FC 439]. Consequently, the taxation rules applicable to a lease do not apply… .

If the emphyteusis is made for consideration, the sum so provided, whether payable in a lump sum or by instalments, is considered as proceeds of disposition of the proceeds of disposition of a right of emphyteusis or of part or all of the property subject to the emphyteusis. In other words, the grant of an emphyteusis constitutes the disposition of property for income tax purposes. …[Accordingly] the sum received on the grant of an emphyteusis cannot be amortized over the term because the emphyteusis is not considered as a lease and the sum received is proceeds of disposition. However, by virtue of subsection 40(1)…a taxpayer can claim a reserve…

2012-047210 no longer reflects the CRA position… .

Corporation G and Corporation D, who were affiliated corporations, were the licensor and licensee of a licence to manufacture and sell a product in most world markets in return for a royalty calculated on net sales. In order for Corporation G to utilize non-capital losses which otherwise would have expired, Corporation D made a lump sum payment (the "Payment"), which was agreed to be an advance on any royalties arising from future sales of Product A, but with the Payment not, under any circumstances, being refundable by Corporation G.

The Directorate noted that the Payment appeared not to be a royalty as it did “not appear to be subject to any contingency,” but that it was “integral to the business of Corporation G and…business income to it.”

The Directorate indicated that the Payment (following Ellis Vision ) “could be considered as an amount paid in advance for the use of chattels,” in which case it would be included in income under s. 12(1)(a). However, “given that the Payment received by Corporation G does not contain any condition or limitation as to its use, an argument could be made that the Payment could also become within subsection 9(1).” It was not necessary for CRA to “resolve the issue of which of these two provisions prevails because Corporation G does not wish to benefit from a deduction under paragraph 20(1)(m).”

The purchaser under a major supply agreement negotiated a "signing bonus" of $5 million (payable equally in the first and second year) in conisderation for agreeing with the supplier to puchase the raw materail under the six-year agreement, and with damages payable on specified events of non-performance. CRA did not specifically address the treatment to the supplier and purchaser and instead provide a general overview of the Canderel and Ikea principles.

Publico determined to grant stock options to its directors and consultants, as a result of which a private corporation ("Corporation"), that had provided consulting services, was entitled to receive a grant of options. However, such options instead were granted directly to an individual sole shareholder of Corporation, who subsequently exercised and sold the acquired Publico shares, reporting a capital gain.

Before considering the application of ss. 56(4) or 56(2) to Corporation, the Directorate first addressed what would have been the tax consequences had the options been granted directly to Corporation, and stated:

[G]iven that the terms of Publico stock options must provide that they cannot be assigned or transferred, it was necessary for Corporation itself to exercise its options to acquire the shares of the capital stock of Publico. It therefore appears to us that the tax consequences for Corporation would normally be those arising from the exercise of those options. …

As to the nature of the income that would have arisen to Corporation at the time of the exercise of the options, we are of the view that this is consideration for the services that were to be rendered by Corporation to Publico. … Consequently, the income generated on the exercise of options granted by Publico would normally be added to the Corporation's business income under subsection 9(1).

In accordance with Destacamento and Demeterio, CRA found several bases on which a self-employed taxpayer's life insurance sales commissions must be included in income the years they are earned, notwithstanding that the taxpayer would be obligated to return ("chargeback") some or all of a commission if a customer cancelled a policy within the first twelve months:

• The commissions "have the quality of income in the year of receipt" and should be included pursuant to s. 9.
• Even if the commissions are unearned, they must be included in the year received (s. 12(1)(a)) or to offset amounts advanced in respect of life insurance contracts (s. 32(1)(a)).

Chargebacks would be deductible from income, assuming the chargebacks were incurred for the purpose of earning income from a business.

CRA takes the position that renovation of buildings or work on water supply and sewage systems is not a "construction activity" under IT-92R2, and, therefore, the completion method is not available for such contracts. Where only some of the contracts performed by contractors are covered by IT-92R2, they may use the completion method described in para. 12 of IT-92R2 only in respect of the construction contracts.

Interest rate swap transactions were entered into between a controlled foreign affiliate of the taxpayer ("BCo") and a foreign financial institution specializing in derivative contracts ("FCo"). There was a fixed coupon swap of FCo computed and paid every six months at a fixed notional interest rate on a US-dollar notional principal and a second arm payable by BCo on (presumably the same) US dollar notional principal at the prevailing US six-month LIBOR rate but payable every X years.

CRA rejected the taxpayer's position that a net amount payable or receivable by the taxpayer under this composite swap position should be computed on an annual basis, thereby resulting in current deductions of a net loss on an accrual basis. After referring to the realization principle, CRA stated:

...a gain could only be realized and a loss could only be incurred upon the termination of the swaps at the specified termination date. Only on the termination date would the taxpayer have the absolute right to receive, or the legal obligation to pay, the cash settlement. Only on the termination date could the cash settlement amount be ascertained.

A taxpayer who owns two properties that allow the earning of rental income, and pays a real estate agent commissions (based on a percentage of the rents for the initial term) for finding tenants to occupy a newly-built rental building. After noting that Cummings found “that the payment of fees to a real estate broker for finding tenants and entering into new leases is generally a current expense” and that Canderel found that “in order to obtain a better or a more accurate picture of the landlord's profit, the lease incentive payments were current expenses that were deductible in the year, and which were not subject to the matching principle because they brought significant and numerous benefits immediately in the year of payment,” CRA stated:

[A]ssuming, of course, that this remuneration represents an expense of a current nature … the remuneration would be deductible in the years in which it is paid. That approach would provide a fairer picture of the taxpayer's profit.

All the condo owners in a condo complex that was used only in a high-end commercial accommodation business leased their units to a manager for a share equalling 50% of the aggregate rental income (but with the municipal taxes and condominium fees for common services continuing to be borne by the co-owners directly).

After the manager ceased operations, the syndicate of co-owners took over the operation of the condominium complex, but because there was no working capital, the syndicate retained for a period of 120 days all the revenues generated by the operation of the condominium complex. Now, the syndicate of co-owners has raised a special assessment, corresponding to the amount of the overdue rental income, to serve as working capital for the operation of the commercial accommodation business. Is this special assessment of the taxpayer (one of the co-owners, and amounting in the taxpayer’s case to $7,000) deductible in computing income?

After noting that under this arrangement, the taxpayer had paid $7,000 by way of “compensation” (i.e., set-off), stated:

[N]o deduction or capitalization of the expense is allowed before the amount is expended by the syndicate of co-owners. … [P]repaid expenses or expenses that are paid before they are actually incurred are not deductible in computing a taxpayer's income.

Under a "gilt lock" hedge, the taxpayer, between the time of deciding to issue the bonds and the time of actually issuing them would hedge against the change in price of the bonds in order to lock in its effective interest cost. For accounting purposes, it was permitted to amortize the payment made or received under such hedge over the term of the borrowing as an adjustment to the interest rate cost. This treatment also would be appropriate for tax purposes.

The smoothing of rent expenses generally required by GAAP is not permitted in computing income for tax purposes.

In response to a query regarding a client's ability to deduct expenses in a taxation year subsequent to the one in which they were incurred, CRA discussed Canderel and the matching principle, and then stated:

Where an expense creates both immediate benefits and future income, we generally take the view that the expense should be deducted in the year it is incurred.

Finally, you indicated that the purpose of the deferral of expenses to a subsequent taxation year is to avoid an assessment to your client based on the absence of a source of income. We confirm that the Act does not permit the deferral of expenses for such purposes.

A corporation terminated a contractual services agreement and paid compensation to the other party equivalent to the present value of the amounts that would otherwise have been payable to that party for the balance of the term.

After referring to the statement in IT-467R2, para. 16 that “[w]here amounts originally payable under a contract would have been eligible for deduction from income had they been paid, amounts paid to terminate and settle that contract will also generally be eligible for deduction from income,” and noting that Canderel established that “the matching principle will not apply where an expense cannot be associated with specific income,” CRA stated:

Although the tax treatment of the amount of the compensation can only be determined following an analysis of all the relevant facts and circumstances, assuming that it is an expense of a current nature, we are of the view that the payment of the amount will generate several immediate benefits for your corporation. To this end, we are of the view that deducting the amount in the year in which it is paid would give a more accurate picture of your corporation's profit for the year in question.

A taxpayer was required under GAAP to level out the rental payments receivable by it under an operating lease so that the rental income accrued to it evenly over the lease term. In finding that this approach was not acceptable under s. 9, CRA referred to the realization principle established inter alia under Ikea, and stated:

[I]t is our view that generally it is the amounts received or receivable as rent under a lease that are included in the lessor's income for tax purposes. Whether an amount received constitutes income or whether an amount is receivable in a particular situation is a question of fact that can only be determined after examining the terms of the agreements between the parties.

In our view, under the rules of law derived from the case law for computing a taxpayer's income for a taxation year, the inclusion of an amount of rent based on a theoretical or notional value determined in accordance with GAAP under C.I.C.A. Section 3065, paragraph .55 would generally not be an acceptable method.

Regarding a payment made by a landowner to a related corporation as an inducement to enter into a contract granting a right of emphyteusis, CRA noted that Befega, 72 DTC 6170 found that expenses incurred in connection with an emphyteusis were capital expenditures, that were not deductible in computing income because they were made not only once and for all but also to provide an enduring benefit to the business, and then reiterated its position (based on Canderel) that it is necessary to determine whether a tenant inducement payment was incurred for the specific purpose of producing an identifiable item of income so as to engage the application of the matching principle or whether it gave rise to sufficient current benefits to be treated as a current expense in the year of payment.

A taxpayer, injured in an automobile accident in 1994, received in 2004 a sum from the Quebec auto insurer (the “SAAQ”) to reimburse him for the amounts that he had paid to his wife for her personal care of him over the previous 10 years. CRA stated:

[T]he determination by the SAAQ to reimburse the taxpayer was made only in 2004 and the taxpayer's wife could not possibly have known whether she would receive an amount from the taxpayer while the taxpayer was waiting for the SAAQ to determine the amount. The entire amount determined in 2004 must therefore be included in the wife's 2004 income computation.

"Where [commodity] options that are sold are on income account and the taxpayer is not a mutual fund trust (where the mark-to-market approach is permitted), the premium received will be included in income when it is received pursuant to section 9 of the Act, provided that the recipient is absolutely entitled to the amount (that is, the amount has the 'quality of income' when received, irrespective of whether the option has been exercised). Where a taxpayer pays a premium to obtain an option that will be held on income account, the amount paid will form part of the cost of the taxpayer's inventory. Although this position does not provide symmetry and may result in timing differences in computing income, the Act does not provide another result."

An open-end unit trust invests the proceeds of a public offering in a note of a bank and then enters into a total-return swap with the Bank respecting a bond index (some of the components of which correspond to bonds held by the bank). Under the Swap, the Trust agrees to make quarterly payments to the Bank equal to the interest received on the note, minus X% of the assets of the Trust.

The income of the Trust includes the interest accruing to it on the note, and is reduced by the quarterly payments made in each taxation year to the Bank. The return under the Swap based on the bond index is not included until maturity.

upfront fees received on interest/currency swaps likely were includible in income under s. 9 (so that no reserve under s. 20(1)(m) was available) on the basis that that had been legally earned, as the taxpayer was not required to provide any further services or deliver any goods.

Where a stock option is granted to a business supplier, the fair market value of the option will be included in the supplier's income at the time it is granted, and at the time of exercise the difference between the fair market value of the shares, and the aggregate of the exercise price and the amount previously included in the income, will be included in income at that time.

At different times in year 1, a speculator entered into two separate futures contract, each with an arm's length third party. Under the first contract, he bought a predetermined number of U.S. dollars for delivery in year 2, and under the second contract he sold the same predetermined amount of U.S. dollars at a different preset price.

In response to a suggestion that the speculator should be able to recognize in year 1 the net economic loss because it became predetermined at that time, the Department indicated that generally a loss is only recognized when realized unless an application of the principals in Canderel would suggest a different approach to determining income.

The correspondent noted that under the GAAP that prevailed in 2008 (contained in Section 3855 of the CICA Handbook) taxpayers whose financial liabilities were incurred for trading purposes were required to revalue those liabilities at fair value, and referred in particular to situations where such liabilities were revalued at a year end as a result of a change in prevailing interest rates.

CRA indicated that the income or loss arising for accounting purposes from such annual adjustments due to fluctuations in interest rates would not be recognized for purposes of the Act. Although CRA accepted the Canadian General Electric case, that "decision does not apply to the revaluation of a debt due to interest, credit or other adjustments." Furthermore, s. 18(1)(e) "specifically denies a deduction for reserves and contingent liabilities."

premiums received for the issue of bonds (presumably on income account) were to be included in income at the time of issue under s. 9 rather than s. 12(1)(a) "as the premiums represent consideration for the issuance of the obligations and are received regardless of the period of time that the debt is outstanding." Therefore, under the Robertson test, the taxpayer's right to the premiums is "absolute and under no restriction," so that the amortization treatment available under GAAP was not applicable for income tax purposes. However, even if the bond premiums were instead included in income under s. 12(1)(a), a reserve under s. 20(1)(m) would not be available, so that the full amount again would be income in the year of issue.

In the business of providing services with respect to property of another person, revenue is recognized when the fee for the service is billed or is able to be billed.

"Where a rental agreement provides for a rent-free period and there is no legal obligation on the part of the tenant to pay rent in respect of that period, there is no income to be recognized by the landlord."

A federal sales tax refund that is received in respect of a prior year is to be included in income in the year of receipt rather than in the prior year. The Johnson case (94 DTC 6125) failed to consider the "no relation back" principle established in the Benaby Realties (67 DTC 5275) and Vaughan Construction (70 DTC 6368) cases.

Re whether a taxpayer that manufactures on a made-to-order basis and that, for accounting purposes, recognizes a percentage of income as each invoice is rendered to the customer, must follow the same basis of income recognition for tax purposes.

A contractor that has entered into contacts that are to be completed within two years of the date of commencement and that comprise various segments or parts is permitted to use the completion method.

Generally, where a contractor reasonably has estimated that a contract will be completed within 24 months from its commencement, but due to unforeseeable and uncontrollable circumstances such as labour problems, unusual weather, etc., the completion date does not occur until after the two-year period, the contractor should continue to use the completion method to report its income from its contract. Where the reason for the delayed completion is change orders which are not treated as separate contracts, RC may challenge the use of the completion method for the contract.

It is RC's understanding that the issuer of mortgage-backed securities administers the pooled mortgages and is entitled as payment for services to a servicing fee equal to the difference between the amount of interest accrued on the pooled mortgages and the amount of interest payable to the holders of mortgage-backed securities at the rate specified on the mortgage-backed securities certificate. RC considers that a requirement for accounting purposes to add the present value of the net interest spread to the proceeds from the sale of the mortgages pursuant to the accounting guidelines of OSFI is not relevant for income tax purposes, and that the issuer can include the servicing fee in its income as it becomes entitled to the difference between the amount of the interest accrued on the pooled mortgages, and the amount of interest payable to the holder of the mortgage-backed securities.

RC will permit a film limited partnership to report its revenue (including revenue subject to a revenue guarantee) on a cash basis (on the authority of Boosey and Hawkes (Canada) Ltd. 84 DTC 1728 (TCC)), if the cash basis truly reflects the income position of the taxpayer and provided that the flow of cash from the viewers through the distributors and sub-distributors or others to the limited partnership is not artificially dammed. In the case of a TV series, timing of the inclusion in income of the limited partnership of amounts received by the distributor will depend upon the agreements between the parties and the weight or relevance that a court will give to any conditions included in those agreements.

Where a put of a partnership interest is exercisable before income will be receivable by the partnership in an amount equal to the revenue guarantee, RC will examine their arrangement to determine whether the revenue flow to the partnership is artificially dammed.

Gold loans of gold producers should be revalued annually at the close of the borrower's tax year, with the resulting gain or loss included in computing its income for the year.

Where a non-resident trust which has made the election under s. 216(1) receives a lump sum as payment of the entire three-year rent for Canadian premises owned by it, the entire amount must be included in its income in the year of receipt with no deduction as a reserve for prepaid rent.

Where a construction contract originally is for less than two years, so that the completion method of revenue recognition is available, but a change order extends the original contract, the change order should be treated as a separate contract. If this is not done, RC may insist that the progress method be used with respect to the entire contract.

Under the completed contract method, the receipt of the final approval of the engineer or architect indicates that the contract has been completed.