ARCHIVED - Election by Professionals to Exclude Work in Progress from Income

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NO: IT-457R

DATE: July 15, 1988

SUBJECT: INCOME TAX ACT
Election by Professionals to Exclude Work in Progress from Income

REFERENCE: Section 34 (also section 23, subsections 10(5), 70(2), 85(1), (2) and (3), 96(3), 97(1) and (2), 98(2), (3), (5) and (6) and paragraphs 12(1)(a) and (b) and the definitions of "cost amount" and "inventory" in subsection 248(1))

Application

This bulletin cancels and replaces IT-457 dated September 8, 1980 and the Special Release thereto dated May 4, 1984. The comments herein apply only for the 1985 and subsequent taxation years. Where it is necessary to determine the application of section 34 for taxation years prior to 1985, please refer to the law itself as it read for those years. Current revisions are designated by vertical lines.

Information Circular 79-2 dated February 22, 1979 is also cancelled and replaced by this bulletin.

Summary

The law provides special rules for computing the income of taxpayers carrying on designated professional businesses. These rules permit taxpayers to elect to exclude, in computing income from such a business, the amount of work in progress at the end of the year.

The commentary below explains these rules and includes a discussion of the meaning of the terms "designated professional business" and "work in progress" as well as other matters related to an election under section 34.

Discussion and Interpretation

1. A taxpayer carrying on a business that is the professional practice of an accountant, dentist, lawyer (including a notary in the province of Quebec), medical doctor, veterinarian or chiropractor (referred to in this bulletin as a "designated professional business") is taxable on the income from that business as determined according to the rules set out in section 34 (the professional business method). The taxpayer may be a corporation or an individual practising either alone or as a member of a partnership. The criteria for determining whether a corporation is carrying on a professional business are discussed in IT-189R "Corporations Used by Practising Members of Professions".

2. Under the professional business method, provision is made for a taxpayer to elect not to include in income for a taxation year from each designated professional business an amount in respect of work in progress at the end of the year. Where a taxpayer is a member of a partnership, subsection 96(3) provides that a valid election not to include work in progress can be made only by the partnership, i.e., it must be made or executed on behalf of all partners by one partner authorized to act for the partnership. Once this has been done, all other partners are deemed to have made a valid election and are bound by it. Where one member of a partnership is itself a partnership, the election must be made or executed as set out in IT-413 "Partnership as "Person" or "Taxpayer" for subsection 97(2)".

3. Where a taxpayer carries on a designated professional business but derives a portion of income from sources other than the rendering of professional services, the Department considers that all of the taxpayer's work in progress would qualify for the election under paragraph 34(a), if the income from those other sources is either incidental or accessory to the main income from carrying on the profession, or if the other sources are of an auxiliary nature to the main source of income. Where a taxpayer carries on more than one business, paragraph 34(a) applies only to businesses that are designated professional businesses.

4. The members of a partnership who carry on a business that is not a designated professional business cannot elect under paragraph 34(a) in respect of that business even if the partners are qualified to carry on a designated professional business.

Timing and Form of Election

5. The time for making an election not to include work in progress is upon filing the return of income for the year for which the election is made. It is the Department's view that the phrase "his return of income... for the year" in paragraph 34(a) refers to the original return for that year and that, in order to be valid, the election must be made when filing that return, even though the return may have been filed late. An election filed with an amended return for the year will be considered invalid and will not be recognized. However, this will not affect the right of the taxpayer to make an election when filing the return for a subsequent year, although in no case can a valid election made in one year apply retroactively to previous years.

6. Paragraph 34(a) does not require a special form to be used for making an election. The election in respect of the particular designated professional business(es) may be made by either attaching a letter to the taxpayer's return of income stating that the election has been made in respect of that business, or clearly indicating in the financial statements or in an income reconciliation submitted with the return that the election has been made. Where a taxpayer is electing on behalf of the members of a partnership the taxpayer should either attach a letter to the return of income stating that the taxpayer has the authority to elect for the partnership or include a note to that effect in the financial statements.

7. Paragraph 34(b) provides that once a taxpayer has made an election not to include an amount in respect of work in progress of a particular designated professional business in income for a taxation year, work in progress of that business may not be included in income for subsequent years unless the election is revoked with the concurrence of, and upon such terms and conditions as are specified by, the Minister. That concurrence will be given if the taxpayer can demonstrate that the requested change results in a more appropriate method of accounting for work in progress, that the change is reasonable in the circumstances and that it does not result in any undue tax advantage. Where the concurrence has been obtained and the election is revoked, the value to be attached to the work in progress at the beginning of the year for the purposes of computing income for the year on the accrual method will be nil. Although the Act does not preclude a taxpayer from making another election under paragraph 34(a) for any year following the year for which the first election was revoked, the Department is not likely to accede to a request for revoking that second election.

Election in Force when Business Ceases or Partner Withdraws or Dies

8. Where an individual or a corporation carried on a designated professional business alone or in a partnership and the business ceases to exist, an election made by the individual, corporation or the partnership under paragraph 34(a), and in force at the time of dissolution, ceases to be in force immediately thereafter. In the case of a partnership, if all or some of the former members form a new partnership, they will normally be required to make a new election under paragraph 34(a) if they do not wish to include work in progress in income at the end of the first or a subsequent taxation year of the new partnership. The same rule applies also in the case of a former sole proprietor or a former partner who commences to carry on alone a new professional practice.

9. An exception to the foregoing arises where all or some of the former members of a Canadian partnership continue to carry on the partnership's designated professional business as a new Canadian partnership and the provisions of subsection 98(6) are met, or where the designated professional business which was formerly carried on by a Canadian partnership is carried on alone by one of the former partners and the provisions of subsection 98(5) are met. In these circumstances, it is the Department's view that the election made under paragraph 34(a) continues to be valid for the new partnership or for the former partner carrying on the business of the former partnership as the case may be.

10. As a consequence of the application of provincial law or the partnership agreement, a partnership may or may not cease to exist when a partner retires or dies. If the partnership does not cease to exist, the election made under paragraph 34(a) continues to be valid for the remaining partners. If the partnership does cease to exist, the comments in 8 and 9 above will apply.

Meaning of "Work in Progress"

11. The term "work in progress" is not defined in the Act and therefore must be given its ordinary meaning which it has in business usage, i.e., partly finished goods or services which are in the process of completion and have not reached the stage where the taxpayer is required to include an amount in income pursuant to paragraph 12(1)(b). When an election under paragraph 34(a) is not in force, work in progress of a designated professional business must be included in computing a taxpayer's income. The amount to be included will be determined on the basis of the expenses incurred that relate to services performed for which an amount has not become receivable or on the basis of what the billing for those same services would have been (including a profit element) if it had been rendered, depending on the method regularly followed in valuing this work in accordance with allowable inventory valuation principles (see IT-473 "Inventory Valuation").

12. Subsection 10(5) provides that work in progress of a business that is a profession is inventory. This status will not change if an election is made under paragraph 34(a). Where an election under paragraph 34(a) is in force at the time a sole proprietor, partnership or corporation disposes of or ceases to carry on a designated professional business or a part of that business and, at that time or some time thereafter, part or all of the work in progress in respect of which the election had been made is sold, subsection 23(3) provides that this work in progress is to be considered inventory notwithstanding that its value had previously not been taken into account in the annual determination of income. The circumstances in which section 23 applies are discussed in IT-287R "Sale of Inventory".

Work in Progress at Time of Death of Sole Proprietor or Partner

13. Where a sole proprietor carrying on a designated professional business has, at the time of death, work in progress the amount of which had not been included in the computation of income for a taxation year because of an election under paragraph 34(a), the work in progress is a right or thing the value of which is required, under subsection 70(2), to be included in computing the taxpayer's income for the year of death or, if transferred to a beneficiary within the prescribed period, to be included in the beneficiary's income under subsection 70(3), when realized or disposed of. Where a partner or a former partner dies possessed of a right to partnership income based on the value of the partnership's work in progress at the time of death in respect of which an election under paragraph 34(a) is in force, see the comments in IT-278R "Death of a Partner or a Retired Partner".

Transfers of Work in Progress

14. "Property" includes the work in progress of a taxpayer who carries on a designated professional business and this is also the case where the taxpayer has previously elected not to take into account any amount in respect thereof in the annual determination of income. Such work in progress is therefore, as is any other property, subject to the rules of the Act dealing with transfers of property discussed in the following paragraphs. In the case of a partnership, any such property is property of the partnership rather than the property of each partner.

15. Unless subsection 85(3), 98(3) or (5) applies, subsection 98(2) provides that a transfer of property (in this case, work in progress in respect of which an election under paragraph 34(a) is in force) from a partnership to a partner (e.g., on withdrawal) or to all partners (e.g., on the dissolution of the partnership) is deemed to have been made at fair market value.

16. When a partner withdraws from a continuing partnership which has work in progress in respect of which an election under paragraph 34(a) is in force, the partnership may:

17. Subsections 97(1) and (2) apply to a transfer of work in progress to a designated professional business that is a partnership (whether newly formed or existing) by a taxpayer who, immediately after the transfer, was a member of that partnership. The taxpayer may be a sole proprietor carrying on or having carried on a professional practice or a partner who had ceased to be a member of another professional partnership. Under the provisions of subsection 97(1), the value of work in progress is to be transferred at fair market value. However, in the case of a Canadian partnership the elective provisions of subsection 97(2) permit it to be transferred at an "agreed amount" which cannot exceed the fair market value of the work in progress and cannot be less than the consideration received by the transferor, but may be any amount between fair market value and nil (inclusive) when no consideration is received by the transferor. A newly formed partnership may then make an election under paragraph 34(a) not to include in income the work in progress at the end of its first or a subsequent taxation year.

18. The rules governing a transfer of inventory by an individual or a corporation to a Canadian corporation carrying on a designated professional business are set out in subsection 85(1) and those governing such transfer by a partnership are set out in subsection 85(2) (see also IT-378R "Winding-up of a Partnership"). Under the elective provisions of subsection 85(1), work in progress may be transferred at an agreed amount within specified limits which are discussed in IT-291R "Transfer of Property to a Corporation under Subsection 85(1)". One of the specified limits is its "cost amount". The "cost amount", as defined in subsection 248(1), of work in progress in respect of which an election under paragraph 34(a) has been made is nil.

19. The Act does not contain any special provisions governing the merger of partnerships. However, in the case of a Canadian partnership the effect of a merger can be accomplished by utilizing the "roll-out, roll-in" provisions of subsections 98(3) and 97(2). Where Canadian partnerships using these provisions have previously elected under section 34 not to include work in progress in computing income, each former Canadian partnership may "roll-out" its work in progress at a "cost amount" of nil (see 18 above). Furthermore, each partner of the former Canadian partnerships may "roll-in" work in progress into the new (merged) Canadian partnership at an agreed amount of nil. The new Canadian partnership may elect under paragraph 34(a) not to include in income the work in progress at the end of its first or a subsequent taxation year.

General

20. There are no longer any special rules in section 34 concerning the time of recognition of income; accordingly, the provisions of paragraphs 12(1)(a) and (b) are applicable.

Date modified:

2002-09-06