26 November 1996 Internal T.I. 9625286 - DEC 1995 INCOME RESERVE AND BANKRUPTCY OF A PROFESSIONAL

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

in which of the bankruptcy returns is the prior yr "December 31, 1995 income" reserve included in income? & does the change in fiscal period legislation affect Dept's Dec 91 policy to permit a change in fiscal period to coincide with the bankruptcy?

Position:

December 31, 1995 income reserve included in pre-bankruptcy return
question on policy referred to Client Assistance Directorate

Reasons:

reserves are included in income in the immediately following taxation year even if no fiscal period ends in that taxation year

							November 26, 1996

	Winnipeg Tax Services Office	Headquarters
	Client Assistance			A. Humenuk
							957-8953
	Attention: Debbie Anderson
							962528

Change of Fiscal Period in the year of Bankruptcy

We are replying to your memorandum of July 16, 1996 in which you ask for clarification of how the business income of a professional who continues to carry on business after an assignment into bankruptcy as well as how any related reserve under section 34.2 of the Income Tax Act (the Act) should be reported for the year of bankruptcy.

As you state in your memorandum, the income for a fiscal period which straddles the date of assignment into bankruptcy is included in income for the taxation year described in paragraph 128(2)(d) of the Act which commences with the date of the bankruptcy (and includes the date upon which the fiscal period ends) unless the Department approves a change in fiscal period. When the individual continues to carry on the business following the assignment into bankruptcy, it is the individual who is required to report the income or loss on the return which is required to be filed under paragraph 128(2)(f) of the Act (referred to in your memorandum as the post-bankruptcy return).

With respect to the requirement to include in income the amount of any reserve deducted under subsection 34.2(4) of the Act in the taxation year which ended immediately before the calendar year in which the individual became bankrupt, you asked whether there is any provision which would allow the reserve to be prorated between the pre-bankruptcy and post-bankruptcy returns. Based on our conversation with Tim Camp of your office on September 5, 1996, it is our understanding that this question is premised on the assumption that the reserve described in subsection 34.2(4) would be included in income on the post-bankruptcy return rather than the pre-bankruptcy return.

Under subsection 34.2(5) of the Act, the amount of any "December 31, 1995 income" reserve claimed in one taxation year under subsection 34.2(4) must be included in income in the immediately following taxation year. In the year of bankruptcy, an individual has two taxation years, one of which is deemed by paragraph 128(2)(d) of the Act to end on the day immediately before the date of bankruptcy and a pre-bankruptcy return is required for that taxation year. Since that is the taxation year which immediately follows the taxation year in which a reserve under subsection 34.2(4) of the Act has been claimed, the amount of any "December 31, 1995 income" reserve claimed in the calendar year before the bankruptcy is included as business income on the pre-bankruptcy return even if no other business income is included on that return.

Since subsection 34.2(6) of the Act prohibits a deduction for any reserve in computing an individual's income for a taxation year which ends in the calendar year in which the individual becomes a bankrupt, no amount may be deducted as a reserve under subsection 34.2(4) for the pre-bankruptcy or post-bankruptcy return. As a result, the full amount of any "December 31, 1995 income" reserve is included in income on the pre-bankruptcy return, even though the fiscal year of the business straddles the date of assignment into bankruptcy and the business income earned during the year of bankruptcy is included on the post-bankruptcy return.

It is our understanding that the policy set out in the memorandum to all tax centres and tax service offices dated February 7, 1991 is still in effect. If you have any further questions concerning the policy, please contact Monique Hayes in the T1/T3 Processing Division of Individual Returns and Payments Processing Directorate.

John F. Oulton
Section Chief
Business, Property & Personal Section
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch