Principal Issues: [TaxInterpretations translation] The auditor presented us with a situation where the application of subsection 9(1) and paragraph 12(1)(a) in taxing the corporation's income may be ambiguous. In addition, the corporation is deducting expenses that have not yet been incurred.
Position: Based on the information submitted by the auditor, we believe that paragraph 12(1)(a) applies. Thus, a reasonable reserve under paragraph 20(1)(m) can be claimed. As for expenses deducted before they are incurred, they are not eligible.
Reasons: Application of the Act.
January 29, 2010
XXXXXXXXXX Tax Services Office Headquarters Income Tax Rulings Directorate Attention: XXXXXXXXX Pierre-Luc Meunier
2009-033954
Interpretation of subsection 9(1) and paragraph 12(1)(a) of the Income Tax Act
This is further to your email of September 3, 2009, in which you asked for our opinion on the application of the above provisions.
Unless otherwise indicated, all legislative references herein are to the provisions of the Income Tax Act (the "Act").
Specifically, you described a situation where Corporation A is involved in the distribution, warehousing, handling, and packaging of goods ("goods processing"). The corporation's main customer is a Canadian company that specializes in the creation of XXXXXXXXXX. Corporation A, after warehousing the goods, distributes them to large retail companies.
Corporation A invoices and receives revenue currently for goods processing services to be rendered in the following six to 12 months. Corporation A estimates that the merchandise remains in its warehouses, on average, for four months. However, it is possible for it to remain in Corporation A's warehouses for 12 months or more.
Furthermore, Corporation A deducts as expense an amount for estimated costs payable. This item consists mainly of an estimate of the rent and labour costs that it could eventually incur to meet its obligations to its customers.
Therefore, you wish to know which of subsection 9(1) or paragraph 12(1)(a) should apply to the advance payments received by the business. You also wish to know if the business can deduct anticipated expenses that have not yet been incurred at the time they are deducted.
Our Comments
The goods processing services to be performed after the end of the year appear to us to be of sufficient importance that the prepayments cannot be included in computing income from a business under subsection 9(1).
On the other hand, since Corporation A received advance payments in respect of goods processing services to be performed after the end of the taxation year, these amounts come within paragraph 12(1)(a) and must therefore be included in computing income from a business in the taxation year in which they are received.
Since the amounts are subject to paragraph 12(1)(a), Corporation A would be entitled to claim the reserve permitted by paragraph 20(1)(m). The reserve should be reasonable, based on the taxpayer's past experience or other factors and on the services to be rendered after the end of the year.
With respect to expenses claimed as "estimated costs", the terms of paragraphs 18(1)(a) and (e) generally do not allow for any deduction or allowance on account of obligations that Corporation A may eventually incur. The language used by Parliament is clear: only expenses made or incurred by the taxpayer for the purpose of earning income from a business can be considered while, at the same time, taking into account the other limitations imposed by the Act.
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance.
François Bordeleau, LL.B.
Manager
Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate.