2020-0855831E5 CEWS - qualifying revenue

Principal Issues: (1) Is revenue of an eligible entity determined under the percentage of completion method considered qualifying revenue under subsection 125.7(1)? (2) Are unrealized gains/losses of investments arising from mark-to-market adjustments to the carrying amount of the investments under accounting practices included in qualifying revenue?

Position: (1) Likely yes. (2) Unrealized gains/losses arising from mark-to-market valuation adjustment to investments are not included in qualifying revenue.

Reasons: (1) The services performed under a contract generally give rise to an inflow of cash, receivables or other consideration in the qualifying period. (2) Unrealized gains/losses arising from mark-to-market valuation adjustment to investments do not give rise to an inflow of cash, receivables or other consideration.

Author: Naufal, Bob
Section: 125.7(1)

XXXXXXXXXX                                                                Bob Naufal
                                                                                        2020-085583
September 21, 2020

Dear XXXXXXXXXX:

Re: Canada Emergency Wage Subsidy (CEWS) – Qualifying Revenue

We are writing in response to your email dated July 13, 2020 requesting our views on the definition of “qualifying revenue” of an eligible entity in subsection 125.7(1) of the Income Tax Act (Act) in the following two situations:

(a)   “over time” (or “percentage of completion”) revenue recognition that is common in, for example, the construction industry, and

(b)   Mark-to-market accounting used by the investment industry.

You advise that under “percentage of completion” revenue recognition, the eligible entity recognizes revenue based on costs incurred with respect to a particular project during the particular period (i.e. calendar month) and adds to that the anticipated profit margin on the particular contract.  You would like to confirm that if this is the normal accounting practice of the eligible entity, that if, for example, the revenue dropped by more than 30% in April 2020 compared to April 2019 (i.e. because construction projects were shutdown), that the eligible entity would qualify for Period 2 for CEWS.

Furthermore, you advise that with mark-to-market accounting, the eligible entity determines its profit or loss each period based on the value of its investments at the end of the particular period. In this regard, you have asked whether investment and brokerage firms who use mark-to-market accounting can qualify for CEWS on the basis that the value of their portfolio of investments dropped by more than 30% -- in particular, comparing their portfolio values in January/February 2020 to March and April of 2020.

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 particular transactions 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 70-6R9, Advance Income Tax Rulings and Technical Interpretations.

In general terms, the CEWS is available to any qualifying entity that experiences a decline in qualifying revenue in a current reference period when compared to a prior reference period.

The term “qualifying revenue” is defined in subsection 125.7(1) , in part, as follows:

““qualifying revenue”, of an eligible entity for a prior reference period or a current reference period, means the inflow of cash, receivables or other consideration arising in the course of the ordinary activities of the eligible entity — generally from the sale of goods, the rendering of services and the use by others of resources of the eligible entity — in Canada in the particular period, …”.

Subsection 125.7(4) provides that for the purposes of the definition “qualifying revenue” in subsection 125.7(1), the qualifying revenue of an eligible entity is to be determined in accordance with its normal accounting practices, subject to certain specified exceptions and elections available to the eligible entity, such as determining revenue on a consolidated basis and elections pertaining to operations from a joint venture.

It is our understanding that the term “revenue” under normal accounting practices generally requires the satisfaction of certain performance obligations, such as the sale of goods or the performance of services that would typically result in a corresponding inflow of cash, accounts receivables or other consideration.

In the first situation described above, it is our understanding that, under normal accounting practices, “percentage of completion” is a method that reports revenue of a service contract over a period of time (i.e., performance obligations under the contract have been satisfied on an ongoing basis by the entity). Moreover, the services performed under the contract by an entity typically give rise to an inflow of cash, receivables or other consideration over the term of the service contract. Accordingly, it is our view that the revenue reported by the entity under the percentage of completion method would generally be considered “qualifying revenue” as defined in subsection 125.7(1) of the Act.

In the second situation described above, it is our understanding that under normal accounting practices mark-to-market adjustments are made by an entity to the carrying value of certain investments that reflect the change in market value of the investment. Moreover, the corresponding unrealized gains or losses on the investment arising from the valuation adjustments, are typically reflected in an entity’s financial statements either through profit or loss or statement of other comprehensive income. However, in our view, the mark-to-market valuation adjustment to the carrying value of the investment does not give rise to an “inflow of cash, receivables or other consideration”. Accordingly, in our view, the unrealized gains/losses reflected in an entity’s financial statements arising from mark-to-market adjustments to the carrying value of an investment, where the entity continues to hold the investment, are not considered qualifying revenue as that term is defined in subsection 125.7(1) of the Act.

We trust our comment will be of assistance.

Yours truly,

Bob Naufal
Manager
Financial Institutions Section
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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