INCOME TAX IMPLICATIONS OF PRIZES & AWARDS
HOW TO VALUE THEM FOR INCOME TAX PURPOSES?
In a previous blog post, we wrote about the GST/HST implications of prizes and awards for direct sellers. In this post, we turn to the income tax consequences, a topic that often causes confusion for Independent Sales Contractors (“ISCs”). Understanding how these awards are treated for tax purposes is important as missteps can lead to unintended reporting errors or even overstating tax liabilities.
Background on Reporting Income
Just like all other Canadians, ISCs must report their taxable income and pay the appropriate amount of tax to the Canada Revenue Agency (the “CRA”). The taxable income of an ISC is determined under Subdivision b of Division B of the Income Tax Act (the “ITA”), and includes the taxpayer’s “profit” from his or her business. Although “profit” is not defined in the ITA, generally ISCs must take into consideration all income received from business (whether sales, commissions, bonuses, etc.), including prizes, awards, and gifts received from operating a direct selling business. This often includes vacation/incentive trips, free merchandise, or the use of a car.
In situations where an award is required to be included in income, the ISC must determine how to value the award. Most direct sellers attempt to assist the ISC in valuing awards by providing the ISC with the “retail value” of the award. However, what constitutes the correct value to report for income tax purposes may not always be easy to determine.
Fair Market Value
While essentially all of the CRA’s administrative materials on valuing prizes/awards arise in the employer/employee situation, they can still serve as useful guidance in a direct seller – ISC relationship.
The value to assign to proper non-cash prizes and awards is one important issue. In general, the CRA position is that one should use the “fair market value”, which is the price that can be obtained in an open market between two individuals dealing at arm’s length.
While the starting point of the “fair market value” might be the regular retail selling price, there are exceptional cases where the “fair market value” might be less because the prize/award/non-monetary compensation is subject to terms and conditions that impact its value (e.g., restrictions on when a free trip may be redeemed).
For another example, in Wisla v. The Queen (heard under the informal procedure) the Tax Court held that the fair market vale of a commemorative gold ring costing $562 given to an employee was only $76.16 (it’s scrap value) because the ring had a corporate logo on it which negatively impacted its value. This approach could arguably apply to other prizes/awards given to ISCs that have the direct seller’s logo on them.
Determining value of prizes and awards for income tax purposes is not straightforward and may lead to overstating tax liabilities.
Expert legal advice is strongly recommended.
Similarly, certain awards, such as plaques, trophies, or other mementos of nominal value for which there is no market may effectively have no fair market value.
Takeaways
Determining the correct value of prizes and awards for income tax purposes is rarely straightforward. While direct sellers may provide the ISC with retail value, this information may be provided for marketing/motivational reason and does not necessarily serve as the appropriate value for income tax purposes. Because this determination can be complex, seeking expert legal advice is strongly recommended.
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