Business Income & capital gains/losses
42 Why do we need to reconcile accounting/business income to taxable income? What are some common reconciling items?
Jatin Gupta
Businesses often follow Generally Accepted Accounting Principles (GAAP) while preparing their own financial statements. The Income Tax Act, however, has a different set of rules for determining business income. The difference between these two sets of rules (GAAP vs ITA) requires us to reconcile business income for accounting to business income for tax purposes when preparing tax returns.
The reconciliation typically starts with accounting business income and then adjusts for all the differences between GAAP and the ITA. Most of the ITA rules for businesses can be found in Sections 9 to 37 of the ITA but some key criteria for business deductions are as follows:
18(1)(a) – States that you are only allowed deductions for expenses that were incurred for the purpose of generating income
20(1) – States that regardless of Section 18, if an item is listed in Section 20 it is deductible.
The relationship between these two sections can be seen in the treatment of accounting deprecation and Capital Cost Allowance (“CCA” – tax depreciation). 18(1)(b) of the ITA states that accounting depreciation is not deductible while 20(1)(a) says that you can deduct CCA. So, to reconcile these amounts you would start with your accounting business income, add back the accounting depreciation and deduct CCA. This revised amount would be your business income for tax purposes.
For Example, say your accounting income was $500,000 and includes $75,000 in depreciation. Your CCA is $85,000. The reconciliation of these amounts to determine business income for tax purposes would be as follows:
|
Business income for Accounting Purposes |
$500,000 |
|
Add: -Depreciation ITA 18 (1) (b) |
$75,000 |
|
Less: – CCA ITA 20 (1) (a) |
($85,000) |
|
Business Income for Tax Purposes |
$490,000 |
Here are some of the more common reconciling items look out for:
| Particulars | Examples | Citations |
| Deductions Generally Non- deductible/ Restricted | ||
| General limitation | ITA 18 (1) (a) | |
| Accounting depreciation and amortization expenses | ITA 18 (1) (b) | |
| Recreational facilities and club dues | ITA 18 (1) (l) | |
| Deductions Allowed Generally | ||
| Capital Cost Allowance | ITA 20 (1) (a) | |
| Expenses re financing | ITA 20 (1) (e) | |
| Bad debts | ITA 20 (1) (p) | |
| Meals and Entertainment | ITA 67.1 (1) | |
Interactive Activity:
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References and Resources
ITA 18(1), 20(1), 67.1(1)
March 2019
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