• Last Updated:
  • Sep 2nd, 2014 12:51 am
[OP]
Newbie
Nov 18, 2010
9 posts
BC

Corporate Taxes and Year-End

I have been working with my father for a few years and learning the ropes on running the business. One aspect of the business which doesn't seem accurate to me is his year end tax returns.

He does his year end tax returns by giving the accountant all of his company bank statements at the end of the year from which his accountant calculates the income and balance statements. Since his accountant does the company year-end based solely on the bank statements, his corporate profits show as 0 each year and consequently, the retained earnings are also 0 and he has never paid corporate taxes and he claims that most companies operate like this. Do other companies operate their year end statements like this? This is a business that buys, stocks and sells inventory. The inventory amount is increasing by a small amount each year so assuming all of the other numbers remain static, the increase in inventory should equal his current earnings and therefore, he would have to pay corporate tax on that amount correct? Please let me know if my understanding is inaccurate.

Thanks!
10 replies
Member
Aug 17, 2011
448 posts
139 upvotes
CALGARY
Likely what is happening is the accountant is "bonus-ing down" any taxable income in the corp via an accrued bonus payable at year end to your father. The result is that the taxable income for the corporation is nil for the year, and as such the taxes payable are nil. However, there is no free lunch: your father winds up paying personal income tax on the bonus received instead.

The scenario isn't necessarily good or bad, just one way of handling corporate tax filings.
[OP]
Newbie
Nov 18, 2010
9 posts
BC
Theoretically, if he was paid the same amount from year to year but the inventory increased, would the value of the increased inventory be taxable as earnings for the company? Do other companies declare that increased value on their tax returns as income and pay taxes on it?
Member
Aug 17, 2011
448 posts
139 upvotes
CALGARY
I'm not sure I completely understand the question, but if I've read this correctly, no, a yearly increase in inventory volume is not taxable. Revenue is only generated through the actual sale of inventory (revenue item), and not through the purchase of inventory (asset item.)

Without seeing the actual statements though I can only guess at what's going on.
[OP]
Newbie
Nov 18, 2010
9 posts
BC
What I mean is, if this is your income statement:
Revenue $1000
COGS $400
Expenses $200
Profit $400 <--- this profit is used to increase your inventory

Balance sheet
Starting Inventory $500
Ending Inventory $900


So, does that $400 count as profit and is corporate taxable? Or is it not taxable since you don't actually take out that $400 as cash and it stays in the company?
Member
Aug 17, 2011
448 posts
139 upvotes
CALGARY
Grem,

Thanks for the example. In the scenario you've given, the $400 would be considered income, and would be taxable to the corporation. Whether or not that $400 sits in the corporation as cash, or the cash is used to purchase inventory, it does not have an effect on the taxability of that income.
[OP]
Newbie
Nov 18, 2010
9 posts
BC
Thanks for your help Hansol. That's how I interpret how taxes work.

This is of course if the company is using accrual bookkeeping though. Is anyone using cash basis for their company using the same scenario but at a larger scale (such as a $2 million dollar revenue company)? As the cash is tied up in inventory, it does not show as income for the company. Is this a scenario that someone is using cash basis for? Is that legal?
Deal Addict
Aug 28, 2007
1851 posts
245 upvotes
Calgary
Whether the business is using cash basis or accrual basis will not directly affect the taxability of income, but just the timing of the record-keeping. You seem to be hung up on inventory, which Hansol pointed out is a Balance Sheet entry and not directly related to the Income Statement. You say " his accountant does the company year-end based solely on the bank statements" is a little simplistic. I expect your father is also providing expense receipts, and that is probably where the accountant is reducing the net earnings to negligible amounts each year. You did put the expense category in your example, but seem to overlook it in favour of the inventory situation. I may be naïve but I expect your Dad is not a crook, he is simply handing over his "shoebox of paper" to the accountant and the accountant does a particularly good job with it. Now, if you said he was doing his own taxes I'd be concerned too. However, having a good accountant that may be pushing the envelope isn't the same as income tax fraud.
[OP]
Newbie
Nov 18, 2010
9 posts
BC
Yeah that was another question I had too.

Where would I find the rules regarding cash basis vs accrual basis regarding what is required for Canada? I see that cash basis can be used in the US up to $5million revenue but I don't see anything like that in Canada. Also, I do think cash basis does help to defer taxes but you're thinking it doesn't? Can you help explain that? Thanks!
Member
Aug 17, 2011
448 posts
139 upvotes
CALGARY
Basically, unless you're a farmer, cash basis isn't allowed for tax purposes.

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