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Update on Taxation of Professionals' Work in Progress - Contingency Fees

May 3, 2017

 

A couple of weeks ago I wrote about the changes to the way that certain professionals will be taxed on their Work in Progress (WIP).

 

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.  

 

There are certain issues as to how one values WIP as a proprietor or partner. But it is clear that the cost of WIP will at least include the costs incurred by employed professionals and support staff.

 

The biggest area of concern was for those in the legal profession who 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. 

 

The Canada Revenue Agency how now clarified the new rules as they relate to contingency fees.  

 

"Under the terms of a contingency fee arrangement, all or a portion of a designated professional's fees may only become known and billable at some time after the taxation year in which the professional provided services under the arrangement (e.g., where, under the terms of a written contingency fee agreement between a personal injury lawyer and a client, legal fees are only billable by the lawyer on a periodic basis as amounts are received by the client under a negotiated settlement or a court judgment). Until such time, there is often no liability on the professional's client to pay any fee; consequently, no amount is receivable by the professional until the right to collect the amount is established. Under these circumstances, for purposes of determining the value of the professional's work in progress at the end of the year, no amount would normally be recognized. As a result, the proposed change to eliminate the ability of designated professionals to elect to use billed-basis accounting is not expected to have any impact on these types of contingency fee arrangements where the terms and conditions of such arrangements are bona fide."

 

"Where a designated professional incurs expenses to earn income under a contingency fee arrangement, and the terms of the arrangement provide that the client has no risk or obligation to the professional in respect of those expenses unless and until some successful outcome is obtained in the future, the expenses would be deductible by the professional in computing business income for the taxation year in which they were incurred, assuming no other provision of the Income Tax Act would prohibit the deduction."

 

The entire document posted by the CRA can be found here.

 

I'm happy to be able to share some good news for a change.

 

- Chuck

 

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