On March 16, 2011, Finance released broadly worded draft income tax proposals relating to contingent amounts not otherwise caught under the general limitation in paragraph 18(1)(e). In particular, these proposals were intended to address the Federal Court of
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Income Tax Technical News No. 25, dated October 30, 2002.
Appeal decision, Collins v. The Queen, 2010 FCA 12, in which the Court held that the taxpayers could deduct interest expenses as they accrued even though the taxpayers had a right to reduce the amount payable in respect of the interest expenses. The Court indicated that it was not the interest amounts payable that were contingent; instead, it was the issue of whether the taxpayers would exercise their right to reduce the amount they were required to pay that was contingent. In response, under new subsection 143.4(2), the amount of a taxpayer’s expenditure, that is otherwise deductible for the purposes of the Act or that otherwise forms part of a capital property to the taxpayer, is reduced by the amount, if any, by which the total amounts each of which is a “contingent amount” of the taxpayer in respect of the expenditure exceeds the total of all amounts each of which is an amount paid by the taxpayer to obtain a “right to reduce” an amount in respect of the expenditure.
A “contingent amount58” is broadly defined to include an amount of a taxpayer at any time
(other than a time at which the taxpayer is a bankrupt) to the extent that the taxpayer, or another taxpayer that does not deal at arm’s length with the taxpayer, has a right to reduce the amount at that time. In a letter to Finance dated November 7, 2011, The Joint Committee recommended that the definition be narrowed by changing “includes” to “means”.
“Right to reduce59” an amount in respect of an expenditure at any time is also broadly defined to mean a right to reduce or eliminate the amount including, for greater certainty, a right to reduce that is contingent upon the occurrence of an event, or in any other way, if it is reasonable to conclude, having regard to all the circumstances, that the right will become exercisable. Discussions with Finance officials indicated that it is Finance’s view that generally any change to a taxpayer’s obligation should be caught (including
automatic contractual adjustments and adjustments from legal proceedings). The Joint Committee expressed concern that the intended broad application of the “right to reduce” definition goes "well beyond the sort of situation at issue" in the Collins case, and could apply to any expenditure adjustment.
In addition, the Joint Committee is concerned with the “reasonable to conclude” aspect of the proposed definition of "right to reduce". Finance’s intention is understood to require a taxpayer to review all circumstances in which an adjustment may be required and then to determine whether, in the particular taxation year, it is reasonable to conclude that an adjustment will be made at a future time. The Joint Committee considers that the uncertainty and additional work required under the proposal is not necessary to address Finance's concerns. Further, the draft legislation and explanatory notes do not provide any guidance on what sort of level of probability is associated with a “reasonable to conclude” outcome.
If the taxpayer subsequently pays all or a portion of the contingent amount, the taxpayer is considered to have incurred the previously reduced expenditure to the extent it was paid. The amount paid is considered to be incurred in the year paid for the same purpose and to have the same character as the expenditure that was previously reduced60.
If a taxpayer, or a person with whom the taxpayer does not deal at arm’s length, has a right to reduce in respect of an expenditure in a year subsequent to the taxation year in which the expenditure occurred, the taxpayer is deemed to have received a “subsequent contingent amount” included in income under paragraph 12(1)(x)61. This only applies if
the original expenditure was not otherwise subject to a reduction under subsections 143.4(2) or 143.4(4). The “subsequent contingent amount” is equal to the amount by which the amount in respect of an expenditure may be reduced under the right to reduce
58 Proposed subsection 143.4(1). 59 Proposed subsection 143.4(1). 60 Proposed subsection 143.4(3). 61 Proposed subsection 143.4(4).
exceeds the amount paid to obtain such right62. However, if it is reasonable to conclude
that one of the purposes of having the right to reduce an amount in respect of an expenditure after the end of the taxation year in which an expenditure is incurred was to avoid a reduction under subsection 143.4(2) of the Act, there is an anti-avoidance rule that would apply to deem the right to reduce to exist in the taxation year in which the expenditure arose63 (i.e., 143.4(2) would reduce the amount of the expenditure instead of
an income inclusion under paragraph 12(1)(x)).
Further amendments also provide the Minister of National Revenue the authority to make assessments, determinations and redeterminations that are necessary to give effect to new section 143.4 notwithstanding that the taxation year in question is otherwise statute- barred from assessment64.
A taxpayer includes a partnership for purposes of this new section65.
New section 143.4 applies in respect of taxation years ending on or after March 16, 2011. As of the date hereof, the draft legislation has not yet been included in a bill.
KPMG Observations
The impact of proposed section 143.4 should be considered when the purchaser of real property has deferred consideration payable to the vendor which may be reduced if certain performance targets are not achieved (i.e. net operating income guarantees).