2017 Federal Budget Eliminates WIP Deduction for Professionals
As many of you may be aware, it is common practice for designated professionals (accountants, lawyers, doctors, dentists, etc.) to deduct their work in progress (“WIP”) in the calculation of taxable income. This implies that in general, all labour related costs with work not invoiced yet will be deducted for the purpose of taxable income. However, no associated revenue will be recognized, perhaps until the following year or so, when it is eventually invoiced.
Therefore, there is a mismatch of when revenue is recognized vis-a-via when the costs are actually incurred. The fact that professionals recognize costs before the revenue does not appeal to the CRA. For that reason, this correction was proposed in the 2017 Budget.
Federal Budget 2017 proposed to amend the Income Tax Act (Canada) to eliminate the provision which allows for the deduction of WIP when calculating taxable income. With this change, all designated professionals will now need to recognize as revenue WIP in the calculation of income for tax purposes at the lower of cost and fair market value (“FMV”) in the first fiscal year that begins after Budget Day (March 22, 2017).
It’s important to note that for accounting purposes, WIP is often recorded using billing rates. Therefore, further analysis may be needed in order to determine the lower of cost and FMV of WIP correctly to be recognized in the tax returns.
On September 8, 2017 the Department of Finance released draft of legislation for public comment which included additional relief for WIP of professionals. When the original budget was announced, it provided for a 2-year phase-in period for the new rules allowing professional to reduce some of the upfront impact of the charges. The September draft legislation now contemplates a 5-year phase-in period. The changes will come into effect for tax years beginning after March 22, 2017, in which most of the cases will be impacted for the year ending December 31, 2018.
The transition over the 5-year is as follows:
- 20% of the lower of cost or FMV of WIP to income
- 40% of the lower of cost or FMV of WIP to income
- 60% of the lower of cost or FMV of WIP to income
- 80 % of the lower of cost or FMV of WIP to income
- 100% – full amount of WIP should be included in income
In summary, the new tax update no longer allows designated professionals to claim a deduction for WIP when calculating taxable income. All designated professionals will now be required to include the lower of cost and FMV of WIP in income for tax purposes. Consequently, this change is likely to result in additional taxes payable for the 2018 and transitional years.
For more information on how these changes may affect your professional practice, please contact Filomena Silveira, CPA, CGA, LPA at 416-628-7016 (Toronto) or 905-361-8698 (Mississauga).
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