Lawyers are decrying a proposed change to the Income Tax Act, which they say could greatly affect lawyers’ cash flow.
Critiques have continued to pile up after the release of the 2017 budget, where the federal government has proposed to eliminate billed-basis accounting, which allows lawyers and some other professionals to exclude the value of work in progress from their income.
This lets lawyers defer paying taxes on work until it is billed.
Lawyers say the change could be burdensome for lawyers who might not have the cash flow to pay tax on work for which they have not billed their clients.
“It’s pretty devastating,” says Leigh Taylor, a tax lawyer with Leigh Somerville Taylor PC in Toronto. She says the change doesn’t mean more tax for lawyers, but it does mean they must pay tax earlier.
Taylor says the change also means lawyers will have to take a meaningful look at their revenue recognition policies and will likely have to bill clients more frequently.
“If you had [work in progress] at the end of a calendar year that [wasn’t] billed until the next, tax is now going to be payable in a year, even though you might not have the cash flow to pay the tax, which is unfortunate,” she says.
News of the change was contained in the federal budget in March.
It stated that billed-basis accounting would be eliminated, which lawyers say will mean abolishing s. 34(a) of the Income Tax Act that allowed for the deferral.
The section was first enacted because it is difficult to value work in progress, as lawyers do not necessarily know what they are going to bill until they have enough information to render a bill, Taylor says.
The change will impact most lawyers next year, as it will take effect in the tax year that starts after the budget.
But concerns have continued to mount, with the Canadian Bar Association recently sending a submission to the federal government asking for further legislative guidance about the change, a de minimis test and longer transition period.
Tax lawyer Brandon Siegal says going forward lawyers are going to need to make sure to have their accounting systems set up to value work in progress to ensure it is reported.
He says this change will mean lawyers will end up having to pay 13 months’ worth of income tax in one shot.
Lawyers are going to need to plan for it and create a work-in-progress fund.
“There was this hopeful benefit of always kicking the can down the road by one year. That’s gone.”
Siegal says that as lawyers and professional corporations are required to have a calendar year end under the Income Tax Act, the first year will be the one that starts on Jan. 1, 2018.
Those that incorporated after the budget was released on March 22, 2017, however, will be caught this year.
David Stevens, a partner with Gowling WLG, says the change will be particularly problematic for practice areas such as personal injury but also technically difficult for a significant portion of the profession as well.
“It’s significant and somewhat troubling,” he says.
Siegal says it is not clear how work in progress will be assessed for contingency work, as it may or may not be billable in the end.
The Canada Revenue Agency, however, issued guidance at the end of April, saying no amount is receivable by the lawyer until the right to collect the amount is established.
Lawyers say the rationale for the elimination of billed-basis accounting is likely that work in progress should not be deducted while associated expenses are deducted, and that professionals should be given a deferral that is not available to other taxpayers.
The federal government has said there will be a transitional period to phase in the elimination of billed-basis accounting.
For the first taxation year that starts after the budget was released, 50 per cent of “the lesser of the cost and the fair market value of work in progress will be taken into account for the purposes of determining the value of inventory held by the business,” and for each year after, the full amount will be taken into account, according to a document on the budget’s tax measures.
In its submission, the CBA said the proposed transition period is not adequate for long established practices that have work-in-progress balances, which have built up over years.
The CBA has asked that the government consider a transition of five to seven years.
A spokesman for the Ministry of Finance declined to comment on the issue.