If you have a professional corporation then the new work in progress tax rules will likely affect you!
Professional corporations are typically set up and used by accountants, lawyers, dentists, doctors, veterinarians and chiropractors. Instead of running their business as a sole proprietor, everything happens under an incorporated entity.
Work in progress (WIP) includes any work that has been completed, but has not yet been billed to the client. Often professionals in these areas of work cannot bill their clients until the work is complete, which could mean weeks, months or even years before the work is billed.
With the implementation of the new rules proposed in the 2017 federal budget, professional corporations are no longer allowed to elect to exclude the value of WIP from business income.
Under the old rules, professionals could elect to exclude the value of any WIP at year end from their corporate income for the year. This meant that you could defer tax on that work until it was completed, but still deduct the costs related to that WIP in the current year. Under this method, professionals would also value their WIP at regular bill out rates. Therefore any revenue would not be taxed until it was actually billed. This had a huge impact on professionals as it allowed for increased cash flow while the work was being performed.
How will your corporation be affected?
Professional corporations that previously deferred their WIP will be allowed five years to transition to the new rules. WIP will need to be included in income using one of the following options:
Option 1: For tax years beginning after March 21, 2017
- Year 1 – 20% of the lower of cost and fair market value of work in progress will need to be added to income
- Year 2 – 40% of the same calculation
- Year 3 – 60% of the same calculation
- Year 4 – 80% of the same calculation
- Year 5 – 100% of the same calculation
Option 2:
- Using fair market value of work in progress
After this transition period is over, the full amount of WIP will need to be included in income.
Valuing Work in Progress
It is difficult to know what portion of overhead and other costs such as office supplies and indirect salaries should be included. While this requires a considerable amount of judgement, it is important to remember that you must demonstrate that your income levels have been accurately reflected. CRA has indicated that they will accept either direct or absorption costing methods.
Sometimes contingency fee arrangements arise where your income will be dependent on the outcome of the scenario. The Canada Revenue Agency has indicated that professionals should use the amount of the fee that is reasonably expected to be receivable. If it is not possible to determine an amount, the value of the WIP will be nil.
If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.
Thanks to Stephanie Kwan of KWB Chartered Professional Accountants for providing this content.
