What are the tax changes regarding work in progress for professionals?
In previous years, under a provision in the Income Tax Act, professionals did not pay tax on work in progress (WIP). Instead it was deferred as unearned income until the work had been completed and invoiced. The 2017 budget has proposed to do away with this provision for WIP of professionals for tax years beginning after March 22, 2017.
The removal of this provision will likely result in an unexpected tax bill for most professionals. To help soften the tax impact for these professionals, draft legislation was released in September 2017 which allows for transitional relief. Professionals can choose to phase-in their WIP earnings over 5 years by adding their WIP into taxable income at 20% each year until the full amount is included in taxable income in the fifth year.
WIP can be valued at either the fair market value or the lower of cost and fair market value. As WIP for professionals is typically based on charge-out rates or fair market value, professionals will have the option of declaring their WIP at cost instead. Presumably, cost would be the lower value and would therefore result in less taxes. However, there is no legislative guidance on how to cost WIP for professionals.
Professionals will have to determine an appropriate costing method that most accurately reflects their direct expenses, a portion of overhead and typical profit margins. The method chosen must be documented and reasonably supported in case of an audit. Once a costing method has been chosen, it should be applied consistently year on year.
Professionals who bill on a contingency fee arrangement will not be required to include these fees into taxable income until the right for the professional to collect an amount from the client has been established.
If you would like more information about the tax changes on work in progress for professionals, please get in touch below.