27 August 2004 External T.I. 2004-0079061E5 - Bankruptcy - work in progress

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Can a self-employed professional elect under section 34 of the Act for work in progress in a post-bankruptcy return?

Position: Yes, provided that the professional is carrying on a business that is a professional practice.

Reasons: Not prohibited in the legislation.

2004-007906
XXXXXXXXXX Bob Naufal, CMA
(613) 957-2744
August 27, 2004

Dear XXXXXXXXXX:

Section 34 and bankruptcy

We are writing in response to your facsimile of June 1, 2004, whereby you asked us if a bankrupt individual can elect under section 34 of the Income Tax Act (the "Act") to exclude, in computing income, an amount in respect of work in progress in the individual's post-bankruptcy return.

Our Comments

Subsection 128(2) of the Act deals with the income tax consequences on the bankruptcy of an individual. In general terms, when an individual becomes bankrupt, the calendar year in which the bankruptcy occurs is divided into two taxation years. One taxation year runs from January 1 to the day before the bankruptcy (pre-bankruptcy period), and the other begins on the day of bankruptcy and runs to December 31 (post-bankruptcy period). Accordingly, an individual will normally file two income tax returns for that calendar year, a pre-bankruptcy return and post-bankruptcy return. Moreover the trustee in a bankruptcy must file an income tax return (in-bankruptcy return) for any calendar year in which an individual is bankrupt, prepared on the basis that the only income of the individual was the income arising from the dealings in the estate of the bankrupt or in the carrying on of the business of the bankrupt.

Depending on the type of business involved and the degree to which the debts of that business contributed to the bankruptcy, a bankrupt individual may either continue to carry on a business that was operated prior to the bankruptcy or cease to carry on such business when the trustee assumes control of the business assets. If the individual continues to carry on the business after the date of the bankruptcy, the individual would normally report the business income or loss in the post-bankruptcy return under paragraph 128(2)(f) of the Act. The determination of whether an individual is carrying on a business is a question of fact.

In general terms, section 34 of the Act allows a taxpayer, carrying on a business in a taxation year that is a professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor, to elect to exclude, in computing income, an amount in respect of work in progress at the end of the taxation year. Under paragraph 34(b) of the Act, if a professional so elects under section 34 of the Act, the election is binding for all subsequent taxation years unless the professional obtains concurrence from the Minister to revoke the election. Work in progress of a professional practice is considered inventory by virtue of subsection 10(5) of the Act.

While subsection 128(2) of the Act contains restrictions on certain deductions that a bankrupt individual may claim, the subsection does not prohibit deductions respecting inventory or work in progress adjustments. Accordingly, a bankrupt individual, who has not previously made an election under section 34 of the Act, may elect under this provision to exclude an amount in respect of work in progress in the individual's post-bankruptcy return, provided that the individual is carrying on a business that is a professional practice, as described above.

The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R5, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Revenue Agency. Our practice is to make this disclaimer in all instances in which we provide an opinion.

We trust our comments will be of some assistance.

Yours truly,

Wayne Antle, CGA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate