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  • Charles Rotenberg

Taxation of Professionals' Work in Progress

Rotenberg Consulting Taxing Work In Progress

“We have to know that a large percentage of small businesses are actually just ways for wealthier Canadians to save on their taxes and we want to reward the people who are actually creating jobs.”

Justin Trudeau, The Globe and Mail November 27th, 2015

It should come as no surprise that our Prime Minister, who has never operated a business of any kind, but has made use of companies to shelter his own income, continues to attack businesses, large and small.

In the 2016 Budget, there was a change in the way small businesses are taxed on their active business income, the very companies “who are actually creating jobs”. By using an elephant gun approach to attack companies that may have related shareholders, even if they have always dealt on a commercial arm’s length basis, the Liberals have effectively raised tax rates for many small companies by 10%. For details, see my August, 2016 Newsletter on Small Business Deduction Planning.

The 2017 Budget contained relatively little of substance, in terms of tax changes. However, for professionals practising as accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors, there was a very significant, and potentially very expensive change, as the Liberals continue to scramble for money to keep up with Trudeau’s generous international spending.

Work In Progress

For the purpose of computing income, the inventory of a business is included at the lesser of its Fair Market Value or its cost. Work in progress (WIP) of a business that is a profession is the inventory of that business. For professionals, WIP is, essentially, a measure of unbilled time and the cost of supplies incurred on a particular matter.

Since 1972 most businesses have had to report their income on an accrual basis, not on a cash basis. However, a Department of Finance commentary at the time stated, with respect to professionals, that “because of the difficulty in valuing unbilled time, the legislation provides that work in progress need not be brought into income unless the taxpayer chooses to do so.” Accordingly, professionals practising in the listed professions have had the option to exclude their year end WIP in computing their income. That is about to change, even though the difficulty in valuing unbilled time has not.

For taxation years beginning after March 21st, 2017, the listed professionals (accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors) will be required to include their WIP at the lower of its cost or its fair market value in computing their income for tax purposes. To ease the transition, in the first year of the change, taxpayers can exclude one-half of their WIP. In subsequent years the full amount of WIP must be included.

As a matter of tax policy, the change makes some sense. Since the expenses, including unbilled time, related to a particular matter are generally deducted in the year in which they occur, the change will “match” those expenses with the revenue to which they relate.

Tracking actual expenses – couriers, photocopies, filing fees, etc. are easy to measure. But including them in income and then deducting them as expenses, makes these costs irrelevant in terms of having to include them as part of WIP.

However, valuing unbilled time is much more difficult. If one wanted to include WIP at fair market value, it would also be easy to calculate – if I have unbilled time on a file of 6 hours at $500 per hour and an associate has unbilled time of 10 hours at $300 per hour, the fair market value of the WIP is $6,000, which is the amount that would reasonably be recoverable when the file is billed.

But, how do you calculate the cost of that WIP? Presumably I could calculate the salary that I pay to an associate assuming an expected number of billable hours over the course of a year. So, if I pay an associate $50,000 and he or she is expected to bill 1,250 hours, the cost of their WIP is $40 per hour.

The problem is in calculating the cost of my WIP. If I am a sole practitioner, or a partner in a firm, I cannot pay myself a salary – my earnings are based on the net income at the end of the year. So, if there is no salary, is there a cost to my WIP? Would I be expected to apply a reasonable margin to apply to my billing rate in order to determine the notional cost of that WIP?

If I operate my practice through a professional corporation I could pay myself a salary. Presumably, then, the corporation could calculate the number of billable hours based on what I have billed in past years and determine a cost per hour in a similar fashion to the calculation for an associate.

But, what if I don’t pay myself a salary? What if I take all of my compensation by way of dividends based on the net income of the corporation at the end of the year? If there is no salary paid, then, arguably, there is no cost to be determined. In that case, the lower of cost or fair market value would be nil.

Contingency Fees

The real hardship in this change will be for firms that bill on a contingency basis. A law firm might take on a personal injury action on contingency, ultimately receiving, say, 30% of the settlement amount. These matters can take years to be resolved. In the meantime, even if we don’t include any WIP for the partners of the firm, all time spent by associate lawyers, law clerks, students, etc. will have a determinable cost. With the change in rules, the law firm will be expected to include the cost of that WIP on an annual basis, even though the firm might not earn any revenue for 2 or 3, or more, years. And, ultimately, the fees will be based on the damages received, not on an hourly basis. The firm could have included, and paid tax on, hundreds of thousands of dollars of WIP and the revenue could be significantly less than the hours expended. So taxes will have been paid on amounts that will never be received. And, even if the revenue is eventually received, taxes may have been paid on the cost of the WIP years before the income is received.

Retirement Planning

Many professionals have elected, on an annual basis, to exclude their WIP. Effectively, this pushes the taxation of unbilled time forward a year by including the previous year’s WIP and backing out the WIP from the current year. Ultimately, after retirement, there will be a year of reckoning, where the WIP from the last pre-retirement year will be included with no current year’s deduction, but this allows a professional to do some planning to include the final year’s WIP in the first year of retirement when, presumably, his or her income will be reduced.

In some ways, this was a final bastion for those of us old enough to remember block averaging, forward averaging and income averaging annuity contracts.

Although the repeal of the election to exclude WIP doesn’t increase tax in actual terms, it certainly accelerates the payment of tax.


There is little question that this change is nothing more or less than an attempt at a massive tax grab that could potentially cause severe cash flow problems for professionals, particularly lawyers and accountants. For some reason, the health care professionals do a much better job of collecting fees as they are incurred – either through OHIP, private insurance, or direct payment. When was the last time any of us left the dentist or the vet without leaving payment for the services we have received.

For lawyers and accountants, particularly those who work on either contingency files or simply large files that can span a period of years, having to include WIP in income annually will require the payment of taxes well in advance of the collection of the revenue to which those taxes relate. And, it could easily require payment of taxes on amounts that will never be collected.

There are a number of things to consider to ameliorate the impact of this change.

Tracing WIP

Many small firms do not even track their WIP on a regular basis. It will certainly be necessary for all professionals to track WIP on their files on an annual basis. This may involve new accounting systems and will certainly involve additional work, but is necessary.

Proprietorship or Partnership

As mentioned above, it is well accepted that a proprietor or partner cannot be paid a salary. Arguably, then, there is no cost associated with the WIP of the proprietor or partner. This does not, however, eliminate the WIP of employed associates, clerks, students, etc.


For those professionals who have still not incorporated, now is definitely the time. As an unincorporated professional, all of your practice income, now including your WIP, will be included in your personal income at your personal marginal tax rate – as high as 53% in Ontario.

If your practice is incorporated, the income will be taxed at 15% on the first $500,000 of income and 26.5% on any excess income.

The incorporation will not solve the problem of the inclusion of the WIP related to employees, but at least that WIP will be taxed at a much lower rate. This alone represents a significant reduction in the tax payable.

WIP Reserves

Most of us are familiar with maintaining reserves with respect to accounts receivable for those receivables that may not be collectible. However, for most professional firms, unbilled time and disbursements are usually the largest current asset. If all of your files are billed strictly based on time and out of pocket expenses, and you are lucky enough to be able to collect all of the time and expenses charged to your files then you may not need to worry about WIP reserves. However, if you have fixed price files or you do not always collect 100% of the time and expenses charged to a file then you need to consider WIP reserves. Even if you will collect 100%, but the matter may not be collected in the same year that all of the time and expenses are incurred, then a realistic reserve may help reduce the cash flow problem caused by having to include your WIP.


This is simply one more instance where the Liberals are attacking business, raising tax rates, making the system even more complex and dramatically increasing costs of compliance.

Mr. Trudeau and his Liberal government continues to be bad for business, but good for the business of those of us in the tax world.

I would be pleased to be of assistance in planning to deal with this tax increase. If all of your projects are contracted as time and materials work and you are lucky enough to be able to collect all of the time and expenses charged to your projects then you do not need to worry about WIP reserves. However, if you have fixed price projects or you do not always collect 100% of the time and expenses charged to a project then you should be considering the use of WIP reserves.


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