Change in the WIP Rules

JANUARY 2, 2018

On September 8th, 2017, in a whirlwind of various legislative proposals released by the government, the government released its proposal for the future of “Billed-basis Accounting”. Currently, professional practices only include in income billed amounts. Their work in progress, or “WIP”, for short, would be excluded until the clients were actually billed. Effective January 1, 2024, this will no longer be the case and professional practices will have to include WIP into their income, in the year that the work is performed, not when the invoice has been billed.

Who is affected?

This impacts the professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor.

What is the transition period?

The transition period commences the first tax year that begins after March 21st, 2017.

The income inclusion for each year in the transition period is the value of the WIP (defined below) at the end of that given year based on the following:

· Year 1 – 20% of the WIP at the end of the year

· Year 2 – 40% of the WIP at the end of the year

· Year 3 – 60% of the WIP at the end of the year

· Year 4 – 80% of the WIP at the end of the year

· Year 5 and onwards – 100% of the WIP at the end of the year

If your year end is December 31st – the transition commences for the 2018 year end. For the 2018 year end you would include 20% of the WIP in your income. It continues until in 2022 (Year 5 in this example) you are including 100% and you will continue to do so in the years after.

This transition period is available for those that chose NOT to include WIP in the last tax year that began before March 22, 2017.

What is the value of the WIP?

WIP is valued at the lower of cost and fair market value. While the government has not released any new information on how they define “cost” in this situation, they did issue guidance in 1989 where they defined cost as follows:

· The cost of WIP means the total of the laid-down cost of materials, the cost of direct labour (including benefits) and the applicable share of overhead expense properly chargeable to production;

· Either direct costing (allocates variable overheads to inventory) or absorption costing (allocates variable and fixed overheads to inventory) are acceptable but the method used should be the one that gives the truer picture of the taxpayer’s income;

· Prime cost, a method where no overhead is allocated, is unacceptable;

· A taxpayer is not required to include in WIP any fixed or indirect overhead costs, such as rental, secretarial and general office expenses, or any imputation of the cost of the partner’s or proprietor’s time.

While this provides a start in computing the cost, it is not a binding definition nor is it a complete one. There is a lot of flexibility in how cost is determined and we are hoping that the government releases further clarification on its definition of cost prior to the transition period.