2015-0618601E5 Earned or Unearned Revenue

Principal Issues: Is the payment received by the taxpayer included in income the fiscal year it was received, or can it be deferred as unearned revenue and amortized over the duration of the contract?

Position: Included in income in the year received.

Reasons: There is no reserve available to the taxpayer under the Act for amounts included in income pursuant to subsection 56.4(2) or paragraph 12(1)(x).

Author: Posadovsky, Tom
Section: 12(1)(x); 56.4; 18(1)(e)

XXXXXXXXXX|
                                                2015-061860
                                                T. Posadovsky

February 16, 2016

Dear XXXXXXXXXX,

Re:  Amount received for a supplier loyalty agreement

We are writing in response to your correspondence concerning the tax treatment of a payment received by a taxpayer in consideration for entering into a supplier loyalty agreement.

Briefly, you indicate that your client (the “Taxpayer”) entered into a contract (the “Agreement”) with a major supplier (“ACo”) and received a lump-sum payment (the “Payment”).  If the Taxpayer breaches the contract during the first 5 years, damages equal to the Payment plus interest are payable to ACo.  However, if there is a breach of contract in the last 10 years, then the damages payable to ACo will be a prorated amount based on the remaining number of years over 10, plus interest.

You indicated that the amount of the Payment should be included in the Taxpayer’s income for income tax purposes; however the amount should be included on an amortized basis over the life of the Agreement which is consistent with its accounting treatment.  You do not believe that there is any provision in the Income Tax Act (the “Act”) that would prevent such treatment.

Our Comments

This technical interpretation provides general comments about the provisions of the Act and related legislation (where referenced).  It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination.  The income tax treatment of a particular transaction proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings and Technical Interpretations.  Where a particular transaction has already been completed, a review of the relevant facts and circumstances surrounding the situation would be required.  Such a review would normally be conducted by the applicable Tax Services Office during the course of an income tax audit which, if undertaken, would be carried out after the particular taxpayer has prepared and filed its income tax return for the year.  Notwithstanding the foregoing, we are prepared to provide the following comments.

In calculating income for income tax purposes for a tax year, the courts have held that a taxpayer is free to adopt any method that shows a truer picture of income provided such method is not inconsistent with the provisions of the Act, established case law principles, and well-accepted business principles.

While a determination of the Taxpayer’s income remains a mixed question of fact and law, it is our view that in the situation you describe, the Payment appears to be in respect of a “restrictive covenant” as that term is defined in subsection 56.4(1) of the Act.  This is because it appears to affect, in any way whatever, the acquisition or provision of property or services by the Taxpayer.  Where this is the case, the amount in respect of the restrictive covenant is required to be brought into income when received or receivable pursuant to subsection 56.4(2) of the Act unless a specific exception applies.  However, if the amount is not in respect of a restrictive covenant, the Payment appears to be an amount otherwise described in paragraph 12(1)(x) of the Act as an inducement or as assistance.  Amounts described in paragraph 12(1)(x) are included in income when they are received.  In this instance, the accounting practice of deferring and amortizing such income would be inconsistent with the provisions of the Act and is specifically prohibited under paragraph 18(1)(e) of the Act.

We trust that our comments will be of assistance.

Yours truly,

Michael Cooke, CPA, CA
Manager
Business Income and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate

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