Evidence of meeting #121 for Finance in the 42nd Parliament, 1st session. (The original version is on Parliament’s site, as are the minutes.) The winning word was year.
A video is available from Parliament.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
When you say “inventory”, you're talking about a service that's being delivered, correct?
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
That's right.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Okay, so you're equating inventory on a store's shelf to a service of a lawyer.
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
That's right. Your work in progress, your performed but unbilled hours, are treated for tax purposes essentially as inventory.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
If someone does a lot of work and doesn't get anything for it, shouldn't they be able to write that off? There are expenses all along the way. Filing papers, that's something the lawyer receives no remuneration for. Are they going to be able to lower their tax burden under this new section, or is this expected to be added on when they'll be paying more?
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
In the abstract, you can elect to choose a fair market value or the lower of cost or market method for valuing inventory.
Where you have a lawyer who's incurred expenses, costs in order to earn their revenue, the lawyer can measure that file under work in progress, in respect to that file, at the lower of its cost and fair market value. I believe in your example it was $10,000 of work in progress at the end of the year. Let's say they have $10,000 of work in progress at the end of the year, and they have incurred $6,000 of costs, for example, to pay an associate on the file or whatever is properly allocable to it. They would value, for tax purposes, at the lower of their costs and fair market value, so the costs, which would be generally deductible, would offset the income from the work in progress. But that's just in an abstract case.
I recognize you'll have more than one file in a practice, which brings us to the second point, which is that it essentially represents a deferral. Think of it in the simplest case, where you perform services in one year and then bill in the next. Let's say, to make the example simple, you have just that one item worth $10,000. Under the billed-basis system, where you get it included in your inventory when you send out the bill, you could add the costs in the first year but then you'd have an income inclusion in the second year, where the first year's income was deferred to. You will pick that up in the second year.
In that year, if you take on another file with a contingent amount to be paid after the end of the year, so you bill at the end of the year. Let's say that's of comparable size of $10,000, then you wouldn't bill for that in the current year, your second year, you would bill it in the third year. If you look at the tax results in the second year, you have $10,000 that has been deferred from the previous year, and then $10,000 deferred into the next year. You can see that you end up in roughly the same place as if you had, at least in respect of that year, been taxed on an accrual basis.
If you're deferring income from year to year every year, and certainly taken across the industry, it's primarily a deferral benefit where one inclusion from a previous year would ordinarily tend to offset, to varying degrees, income deferred to a following year. You have that averaging out as well that mitigates the impact of the change.
To summarize and answer your question, first, if you have a real contingency, perhaps it's not included under the case law and general rules. Second, if it is going to be subject on an accrual basis, there's the option to use the lower of cost or market method. Third, if you have a number of files, where some are billed and some aren't, over time you would expect the other deferrals to even out.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Okay, so if a lawyer decides to base his or her own practice specifically on contingency fees, and there's no income in a year, they're expected to pay tax for what they provided.
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
That's a situation where a lawyer has no revenues in the year.
Conservative
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
Right, and you say it's on a contingency basis.
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
As I said, there is case law to the effect that if there's real uncertainty about whether you'll get it or not, then it might not be included in the year.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
How do you define what's a winning case?
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
You go to the case law in the Canada Revenue Agency—
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Are they going to tell you if you have a winning case?
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
For the criteria to help you determine if your case is sufficiently likely to result in income...but also you could have a valuation of the lower of cost or market.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Okay, so if we're going to treat things like inventory, if I was a grocer, and I had inventory that would go bad, technically I can write that off. I don't have to pay tax on stuff that has gone bad. Is that correct?
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
That's right.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
If I get a case on contingency that goes bad, I have to pay tax on it because I'm not going to know that the case has gone bad until I've reached a conclusion, which due to our court system.... We don't have the fastest system in the world. I know in Vancouver they actually closed family chambers for a day because they didn't have any judges.
People, by the way, still had to pay their lawyers. Of course if they're on contingency, I guess the lawyer would have to pay tax for that day.
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
To answer your question, there are a few things I think that are implied in that. You say that a lawyer paid tax in one year and then after the end of the year determined the amount to be uncollectible or a bad outcome. In the first year, they would have had to have made the determination that it would likely result in income. Again, it's the same sort of determination as an engineering firm that gets paid at the end of the project. It's the world that they're already in, but for lawyers, of course, you win or lose—it's binary—court cases sometimes.
If you made that determination, you include it in your income in year one. Then you would have a writedown in year two and you'd have a deduction or a loss in that year.
Conservative
Dan Albas Conservative Central Okanagan—Similkameen—Nicola, BC
Again, there are so many circumstances. For example, you take someone's case and it's an elderly person who has been struck by a car and can't afford to pay you. You go to try to get them some money. In a year or two down the line when their court case finally comes up, they die. It may be natural causes or maybe it's because of ill health. What does the lawyer do in those kinds of cases? Where they have paid taxes, do they get to apply for it back?
It's lost time, which, by the way, to a professional is very expensive.
What I think may end up happening is that many lawyers might say, particularly in more rural areas, they just don't take cases anymore on contingency, because they don't have the client base to subsidize them, to subsidize these extra taxes.
I'm very concerned, Mr. Chair, that this is going to have serious impacts.
I'm not making this up. First of all, I did work in a law office for about a year and a half. I got to know clients, and I got to know how things don't work out the way that we try to arrange life. Life is very messy. The second thing, though, is that I've actually been contacted by people in B.C., members of the bar, who say exactly that. The big firms in the big cities will subsidize these cases because they know that every one out of 10 may win big, but for the smaller firms in the rural areas, people will not be able to access justice.
I really am disappointed with this provision.
I have other things I'd like to talk about, but we'll go to someone else.
Liberal
The Chair Liberal Wayne Easter
We'll come back to you a little later.
We'll move on to Mr. Dusseault and then Ms. O'Connell.
Mr. Dusseault, go ahead.
Pierre-Luc Dusseault NDP Sherbrooke, QC
Thank you, Mr. Chair.
Thank you to the witnesses for being with us today and providing us with these explanations.
I always say that, in Canada, ignorance of the law is no excuse. All Canadians are expected to understand the Income Tax Act so that they can respect it. For that reason, I think that, with each opportunity, we should strive to simplify it, rather than make it more complicated.
That said, I am mainly interested in clause 16. I'm referring essentially to the department's explanatory notes. The provision deals with pension income splitting and makes changes to the retirement income security benefit payable under the Canadian Forces Members and Veterans Re-establishment and Compensation Act.
Could you explain the changes in greater detail? If I understand correctly, the provisions limit the ability to split income. Is that correct?
Senior Legislative Chief, Legislative Review, Tax Legislation Division, Tax Policy Branch, Department of Finance
This is a technical amendment that had been released in September 2016 for comment. My colleague Pierre is just more of a pension expert than I am, but this is a technical tax amendment.
It essentially allows couples to be able to split the retirement income security benefit under part 2 of the Canadian Forces Members and Veterans Re-establishment and Compensation Act for the purposes of pension income splitting rules, and the existing registered pension plan limits. It's an enhancement to previously announced, or previously enacted, rules to provide for proper income splitting, or proper splitting of pension income in the context of this retirement income security benefit.
NDP
Pierre-Luc Dusseault NDP Sherbrooke, QC
In that case, it is meant to clarify the situation involving pensions payable under the Canadian Forces Members and Veterans Re-establishment and Compensation Act.
I'll leave it at that, for now, Mr. Chair.