Business Income Review

Sole Proprietor and Corporation

Business Income
In Bus 484 we will mostly focus on corporate business income, but we will
sometimes also discuss personal business income.
Regardless of the vehicle that is used to earn the business income, the same
underlying concepts apply.

Business Income
For the purpose of the example we will cover today, we will use the corporate tax
calculation steps.
1)
2)
3)
4)
5)

Net Income per Financial Statements

Net Income for Tax Purposes (NIFT)
Taxable Income (TI)
Taxes Payable
Taxes Owing (Refund)

As we are just calculating NIFT and TI today, we dont have to worry about the
corporate tax rate.
We will review the corporate tax rate and the corporate tax calculation in more
detail next class.

Business Income
Consists of the following:
Revenue / Income:
Sole Proprietor cash or accrual accounting
Corporation accrual accounting

Expenses

Must be incurred in order to earn income.

Must be reasonable.
Expenses incurred that benefit the shareholder or owner are not deductible.
Meals and entertainment expenses that involve employees or shareholders are 50%
deductible.
Golf Dues are 0% deductible.
Sole Proprietor can use cash or accrual accounting
Corporation must use accrual accounting
If accrual accounting is used, then income tax reserves can be utilized.
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Business Income vs. Capital

Gains

When a business disposes of property the transaction can either be treated as

business income or as a capital transactions (i.e. capital gain/loss).

In order to determine this CRA would look at the following:

Businesss intention for the asset (used to produce product or service, or used to resell it).
How often does the business buy and sell this type of asset.
Did the business do any supplemental work on the property to increase its re-sale
value.
What is the businesss objectives in their articles of incorporation

This distinction is important as business income is 100% taxed, where as capital

gains are 50% taxed.
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Reserves
Businesses operate on an accrual basis unless they qualify for a reserve that is
allowable under the income tax act:

ITA 20(1)(m) Reserve for undelivered goods and services

ITA 20(1)(n) Reserve for unpaid amounts

ITA 20(1)(l) Reserve for bad debts

Reserves

A reserve is a deduction for a future event.

General Rules:
Reserves are only deductible for tax if they are specifically mentioned in ITA
20. Meaning a business can only use reserves that are specifically
mentioned in the Income Tax Act (ITA).
If a reserve is deducted from income in 2013, it is then added to income in
2014.
Why? The business is allowed to remove amounts from income in 2013 and not
be taxed on them as they technically dont meet income criteria for tax in 2013. In
2014 when they meet income criteria for tax they will be included in income.
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Reserves Undelivered Good

Example #1:
During 2013 Kovac Inc. had sales of $300,000, with $40,000 for goods to be
delivered next year (2014).
During 2014, the remaining $40,000 of the goods were delivered.
The entire $300,000 was included in the businesss Net Income.
Note this reserve does not factor in if the entire $300,000 was received or not in
2013.

Reserves Undelivered Good

Example #1 Solution:
The first question to ask yourself if how much of this revenue met revenue
recognition criteria?
The business has only earned $260,000 of the $300,000.
The business was also most likely only paid $260,000but this doesnt affect if the
reserve for undelivered goods can be applied or not.

Reserves Uncollected Amounts

Example #2:
During 2013 Kovac Inc., sold an item for $300,000 but had a payment plan with the
purchaser to receive payment in three $100,000 instalments in 2013, 2014, and
2015.

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Reserves Uncollected Amounts

Example #2 Solution:
2013 - include $300,000 in income for tax and then deduct $200,000 from income
for tax. Therefore a net of $100,000 is included.
2014 - include $100,000 in income for tax.
2015 - include $100,000 in income for tax.

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Reserves Uncollected Amounts

Example #2 Solution:

Income
2013 income for taxes
2013 income uncollected

$300,000
($200,000)

2014 income collected

$100,000

2015 income collected

$100,000

Actual net income for tax for 2013, 2014 & 2015

$300,000

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Reserves Uncollected Amounts

Your are probable asking yourself how is this different than regular accounts
receivable?
The main difference is regular A/R has an agreed upon payment date of between
30 to 60 days.
Whereas the terms of this type of transaction have payment terms that stretch way
beyond normal A/R terms.
The reserve also has a max of 3 years, meaning all the income associated with the
event that caused the reserve must be included in NIFT within 3 years of the initial
transaction.

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Reserves Bad Debts

Example #3:
This reserve follows the same logic as the revenue reserve, but
In 2013 a year-end deduction is permitted for anticipated bad debts.
In 2014, the actual bad debt is deducted.
In 2014 the old reserve is included in business income and then a new reserve is
established and deducted.

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Reserves Bad Debts

Example #3: (continued)
At Dec 31, 2013, Kovac Inc. estimates that $2,000 of its $50,000 accounts
receivable will be uncollectible.
During 2014, write-offs of accounts receivable total $2,200.
On Dec 31, 2014, it is estimated that $2,500 of the $62,500 accounts receivable
will be un-collectible.

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Reserves Bad Debts

Example #3 Solution:
2013 - deduct $2,000 from income for tax (2013 estimate for 2014 tax year).
2014 - add $2,000 to income for tax (2013 estimate for 2014 tax year).
2014 - deduct $2,200 from income for tax (2013 actual).
2014 - deduct $2,500 from income for tax (2014 estimate for the 2015 tax year)

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Reserves Bad Debts

Example #3 Solution:
Income
Allowance expensed in 2013 for tax
Allowance added back to income in 2013 for
tax

($2,000)
$2,000

Actual write-off 2013

($2,200)

Actual net expense for tax for 2013 & 2014

($2,200)

The 2014 estimate of $2,500 will also be deductable for Income

Tax in 2015
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Reserves
Many times reserves wont even come into effect because of accounting rules:

Reserve for undelivered goods and services

The business cant record the revenue as the product sale would not have met
revenue recognition criteria (i.e. product has yet to be delivered).
This reserve would only occur for a sole proprietor that operates on the cash
basis of accounting.

ITA 20(1)(n) Reserve for unpaid amounts

This reserve could occur anytime, as businesses often go into transactions
where they know they wont be paid under typical A/R terms.

ITA 20(1)(l) Reserve for bad debts

Usually a $0 effect, as the reserve is the same as the accounting expense.
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Example #1 Business Income

Determine the Corporations Net Income for Tax and Taxable Income for 2013:
Co-op Inc.
Income Statement
For the Year Ended December 31, 2013
Grocery sales
Investment income
Gain on the sale of an asset
Dividend income
Total Income

500,000
30,000
10,000
40,000
580,000

Cost of goods sold

Salaries and wages
Administrative expenses
Depreciation expense
Interest expense
Total expenses

250,000
100,000
10,000
30,000
5,000
395,000

Income before income taxes

Income taxes

185,000
46,250

Net income

138,750

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Example #1 Business Income

Additional Information Provided:

CCA - $25,000

Non-capital loss carry forward of $30,000 from 2012.

The $46,250 consists of $44,000 in tax installments to CRA and $2,250 in interest
and penalties paid to CRA.

Included in the administrative expense was $2,000 of meals incurred during

business meetings with clients.

The gain relates to the sale of building that had the following value:
POD - $400,000
NBV - $390,000

UCC - $385,000
ACB - $396,000

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Example #1 Business Income

Solution NIFT:
Net Income for Tax
Net Income per F/S
Additions:
+ Depreciation expense
+ Income taxes
+ Taxable capital gain ($400,000 - $396,000) * 50%
+ Recapture ($396,000 - $385,000)
+ 50% of meals ($2,000 * 50%)
Deductions:
- CCA expense
- Capital gain

138,750

30,000
46,250
2,000
11,000
1,000

90,250

(25,000)
(10,000)

(35,000)

NIFT

194,000
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Example #1 Business Income

Solution Taxable Income:

Taxable Income
NIFT
Deduct:
- Dividend income
- Non-capital loss carry forward

194,000

TI

(40,000)
(30,000)
124,000

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Business Income Review

This review and example should have been pretty straight forward.

If you are struggling with any of the concepts we covered, be sure to revert to the
help section on UofR Courses. The help section has all the slides from Bus 384.

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Corporate Taxes

So far we have covered the first 3 steps:

1)
2)
3)
4)
5)

Net Income per Financial Statements

Net Income for Tax Purposes (NIFT)
Taxable Income (TI)
Taxes Payable
Taxes Owing (Refund)

In the next class we will do a review of Step #4 Taxes Payable and Step #5
Taxes Owing of the corporate tax calculation.

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