2019-0798481C6 STEP 2019 - Q8 - Contingency Fees WIP

Principal Issues: How should the value of a professional's work in progress be determined where the work is performed on a contingency basis?

Position: See response.

Reasons: Previous positions.

Author: Trop, Shiri
Section: 10(1), 10(4)(a), 10(5)

2019 STEP CRA Roundtable – June 7, 2019

QUESTION 8. CRA’s Views on Contingency Fees and WIP

As a result of recent changes to the taxation of WIP for certain professionals, the CRA has published the following statement as it relates to contingency fee arrangements made by certain professionals under FAQ #5 at https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/federal-government-budgets/budget-2017-building-a-strong-middle-class/billed-basis-accounting.html :

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.

While this position is very generous for the professional that has entered into a contingent fee arrangement, we question whether this position is correct.  Specifically paragraph 10(4)(a) of the Act states:

work in progress at the end of a taxation year of a business that is a profession means the amount that can reasonably be expected to become receivable in respect thereof after the end of the year;

Accordingly, the amount of WIP that a professional is required to value is the amount that can reasonably be expected to become receivable after the end of the year.  It would not seem unreasonable that a professional should be able to value its contingent fee files to determine what amounts could reasonably be expected to become receivable after the end of the year.  Can the CRA reconcile its administrative position to the law?

CRA Response:

In computing income from a business, a taxpayer must generally take their work in process (WIP) into account.  Subsection 10(5) of the Income Tax Act (the Act) provides that WIP of a business that is a profession is inventory. Consequently, under subsection 10(1) of the Act, inventories of WIP shall be valued at the end of the year at the cost at which the taxpayer acquired the WIP or the fair market value (FMV) of the WIP at the end of the year, whichever is lower, or in a prescribed manner.

Paragraph 10(4)(a) of the Act provides, with certain exceptions, that the FMV of WIP at the end of a taxation year of a business that is a profession means the amount that can reasonably be expected to become receivable in respect thereof after the end of the year.

When a designated professional, as part of an agreement, undertakes to provide services in exchange for contingency fees, sometimes, a portion or all of these fees cannot be known or determined until after an event or a time occurring after the taxation year during which the designated professional provided the services under the terms of the agreement. In this situation, at the end of the taxation year, the FMV of such WIP of the designated professional would be nil. However, in certain situations, it is possible, at the end of the year, to establish an amount that can reasonably be expected to become receivable in respect of this WIP after the end of the taxation year. In this case, the CRA’s view is that the FMV of this WIP should correspond to this amount.

Shiri Trop
2019-079848

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