The Role of Accounting in Tax Law
M. A. Denega *
An interesting effect of the development of Canadian income tax
legislation is the mutual respect and cooperation which has been
generated between the accounting and law professions over the years.
Relationships between lawyers and accountants have become increasin-
gly more harmonious and each profession has recognized the vital
role played by the other in the income tax field. The old adage that
“Necessity is the Mother of Invention” can perhaps be properly
applied to an analysis of the interrelationships which have develo-
ped between these two professions – the “necessity” being the need
to provide the utmost of competent service to clients and the “invent-
ion” being the combining of skills of the two professions to provide
such services.
The spirit of cooperation between lawyers and accountants is not
one of just peaceful co-existence, nor is it by any means a mere
acknowledgement by each profession that the other has some rights
to practice in the tax field. Quite the contrary is the case. For exam-
ple, there has been an active participation and collaboration of out-
standing practitioners from both professions in carrying on the work
of the Canadian Tax Foundation. The Foundation may be described
as an independent tax research organization whose purpose is to
provide the tax-paying public and the governments of Canada with
the benefit of expert and impartial research into problems of taxation
and government finance. Its Governors are nominated jointly each
year by the Canadian Bar Association and the Canadian Institute
of Chartered Accountants. Thus the Foundation provides a clear illus-
tration of the united efforts of lawyers and accountants to furnish
the general public with the benefit of many years of specialized
training and practical experience.
The friendly association between the two professions is further
enhanced by the implied understanding between them that each will
stay within the field in which it is competent to practice. As is so
often the case in dealing with clients on tax matters, the affairs of
the client will require both legal and accounting advice. Practising
accountants readily refer their clients to solicitors when the clients’
Member of the Institute of Chartered Accountants of Alberta and applicant
for membership in the Institute of Chartered Accountants of Quebec.
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THE ROLE OF ACCOUNTING IN TAX LAW
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problems touch on legal matters on which the accountant is not com-
petent to advise, and it has also been the experience that lawyers
likewise will direct their clients to seek accounting advice when the
circumstances warrant it.
Another good example of joint effort by accountant and lawyer
is the filing of Notices of Objection to the Minister of National
Revenue and the filing of Notices of Appeal to the Tax Appeal Board
or the Exchequer Court. In dealing with a Notice of Objection, for
instance, the accountant will frequently prepare a synopsis of facts
which he feels should be presented in the appeal. Since he is familiar
with the financial affairs of his client, the accountant is usually the
person in the best position to furnish all the relevant data which
are vital to a successful appeal. However, having ascertained the
salient facts for such an appeal, the accountant will then suggest to
his client that this Notice of Objection be reviewed by a solicitor.
Being a legal document the Notice of Objection should under no cir-
cumstances be prepared solely by an accountant.
When an appeal is being heard by the courts, it is best to remember
that accountants are not competent to plead cases for their clients;
this is an act which is wisely the exclusive prerogative of the tax-
payer’s legal counsel. In certain provinces, cases before the Tax
Appeal Board may be pleaded by accountants or the appellant may
act on his own behalf; while such permission may be granted to
accountants it is preferable that they should not make use of this
privilege. The Exchequer Court, on the other hand, permits only
lawyers to defend taxpayers’ cases heard before it. The’accountant
can, however, and often does, function as counsel to the lawyer. Here
again, the accountant, being readily conversant with his client’s
financial affairs, can supply the lawyer with information which
often means the difference between winning and losing a case.
Accountants may also be called upon to serve as witnesses in tax
cases. They may merely supply or authenticate information without
any explicit expression of an opinion or they may testify as expert
witnesses where they are asked to express opinions based on their
professional judgment and their appraisal of given information.
Given the broad context of the mutual relationship between prac-
tising lawyers and accountants in matters of income tax law, a careful
analysis of the role played by each profession is necessary before
we can fully comprehend the need for the existence of each profession
in this field. A description of the role played by lawyers is of course
better left to be done by lawyers themselves since only they are com-
petent to make such an analysis. On the other hand, the role of
accountants can perhaps be best understood by a focus on four differ-
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ent aspects of their income tax practice: first, the rules gcverning
the accountants’ practice in this field; secondly, the role of accounting
in defining the income concept under our tax legislation; thirdly, an
outline of some of the anomalies which presently exist in our tax
law; and, finally, a comment on the accountants’ suggestions to rem-
edy the existing anomalies.
I. Rules Governing Accountants in Income Tax Practice.
First, it may be useful to understand the “terms of reference”
within which Chartered Accountants conduct their public practice.
In the province of Quebec, practising Chartered Accountants are
governed by the Quebec Institute whose main object is to maintain
the status of its members; promote the efficiency and usefulness of
its members; and regulate their discipline and professional conduct.
In this connection it has embodied certain restrictions in its Rules
of Professional Conduct which provide, in part, as follows:
“1. Professional competence.
While the attached rules contain no specific provisions relating to the
maintenance of adequate standards of competence by members of the
Institute, members are reminded that under the general heading “Spirit
of the Profession” they are required at all times to maintain the standards
of competence which
the Institute and its members have established.
If a member signs or in any way associates himself with any statement,
exhibit, schedule or any form of accountancy report, whether for publication
or not, which is prepared in a manner which might tend to be misleading
or in any way to disguise the actual situation, or if a member expresses an
opinion on financial statements examined by him when he has failed to
obtain sufficient information to warrant such expression of opinion, he
may expose himself to a civil claim based on negligence, incompetence or
misrepresentation. The determination of guilt in such cases is obviously the
responsibility of the courts. Nevertheless, where such guilt is established,
or where, in the opinion of Council, the actions of the member have tended
to bring the profession to disrepute, the member may be subject to the
disciplinary procedures of the Institute”.
It is interesting to note that the Quebec Bar Act 1 grants to account-
ants the right to give tax advice to clients and to prepare certain
types of documentation. This permission is clearly set out in Article 6
and provides as follows:
“6. 1. Nothing in the foregoing article forbids accountants referred to
in Chapters 47 and 89 of 10 George VI, 1946, and amendments thereto,
within the limits of said laws and amendments, to give advices and consulta-
tions on all questions of a financial, administrative or fiscal nature, to
prepare and submit to whom it might concern plans of financial or fiscal
administration, organization and reorganization, to prepare and submit sur-
1 2-3 Eliz. II, S.Q. 1953-54, ch. 59.
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THE ROLE OF ACCOUNTING IN TAX LAW
119
veys, statements and declarations of the same nature, including tax state-
ments of all kinds, to discuss with all persons having authority in the matter
all and every kind of tax assessments and also to prepare and give Notices
of Appeal to the Minister of Finance of Canada and to discuss with him
or the officers of his department of the merits of the assessments imposed
upon their clients with respect to income tax.”
Given the general rules which govern practising accountants, we
readily come to the conclusion that accountants have been given cer-
tain rights in the income tax field. Why ? Have they usurped these
rights by default or is accounting itself vital to tax law ? This question
can be best answered by an analysis of the very heart of our income
tax legislation – the concept of income.
II. Role of Accounting in Defining the Concept of Income
A study of the income concept must emphasize the function of
accounting in the determination of income. The measurement of in-
come is the foundation stone upon which all of our tax legislation
is built. While there are many sections of the Income Tax Act 2 dealing
with the computation of income, an analysis of only several of these
sections will provide a basic understanding of the meaning of “in-
come”. These sections are the following:
See. 12(1) (a).
“Sec. 4. Subject to the other provisions of this Part, income for a tax-
ation year from a business or property is the profit therefrom for the year.
In computing income, no deduction shall be made in
respect of an outlay or expense except to the extent that it was made or
incurred by the taxpayer for the purpose of gaining or producing income
from property or a business of the taxpayer.
Sec. 12(1) (b).
In computing income, no deduction shall be made in
respect of an outlay, loss or replacement of capital, a payment on account
of capital or an allowance in respect of depreciation, obsolescence or depletion
except as expressly permitted by this Part.”
Undoubtedly, a layman not conversant with the provisions of our
income taxing statute would consider the wording and meaning of
Section 4 to be perfectly clear and unequivocal. He would appear to
be justified in doing so since the key word, “profit”, would be
assumed to have the same meaning to everyone. Unfortunately, such
is not the case. There is no unanimity of opinion on the determination
of a profit and consequently we must have a closer look at the
principles which govern its calculation.
Since the Income Tax Act does not provide a definition of a “prof-
it” one must refer to the courts and prior jurisprudence to find-some
guidelines. In this respect the courts have held that ordinary generally
2 R.S.C. 1952, ch. 148.
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accepted principles of commercial trading and accounting 9ractice
will govern in determining income unless there is specific provision
in the Act to the contrary. To avoid confusion, it should be noted
that the words “profit” and “income” are synonymous from an
accounting viewpoint. However, having determined “income” as
defined by accountants it is then necessary to make certain adjust,
ments to that income to arrive at “income” as defined by the Income
Tax Act. Hence, in accordance with Section 4, the accountant’s ver-
sion of income after being ajusted in accordance with certain specific
provisions of the Act, becomes the income for tax purposes.
In Publishers Guild of Canada Limited v. M.N.R. 3 Thorson, J.,
puts accounting principles and expert accounting evidence into their
proper perspective and emphasizes the important role they play in
income tax law.
He says, at pages 16-17:
“At this stage it would, I think, be appropriate to make some remarks
of a general nature regarding the role of accountancy experts in income
tax cases. The accounting profession is not a static one and the system of
accounting which accountants should apply to the accounts of the business in
which they are called upon to act are not immutable. A system of accounting
that would be appropriate to one kind of business is not necessarily appro-
priate to a different kind. Only an arbitrary minded person would contend
that there is only one system of universal applicability. No reasonable person
would do so. But while accountants devise changes in systems of accounting
to meet the changing conditions in the business world and new ways of
conducting business, their guidiig principle must always be the same.
Accounting is really the recording in figures, instead of words, of the
financial implications of the transactions of the business to which it is
applied. The accountant
is thus the narrator of the transactions, his
narrative being in the form of figures instead of words. His narrative
should be such as to disclose to persons understanding his language of
figures the true position of his client’s business at any given time or for
any given period. The accountant cannot fulfil the duty thus required of
him unless he has carefully considered the manner in which his client
carries on his business and has applied to it the system of accounting
that is appropriate to it and most nearly accurately reflects its financial
position including its income position, at the time or for the period required.
But the court must not abdicate to accountants the function of determin-
ing the income tax liability of a taxpayer. That must be decided by the
court in conformity with the government income tax law. If the law does
not prohibit the use of a particular system of accounting, then the opinion
of accountancy experts that it is an accepted system and is appropriate to
the taxpayer’s business and most clearly reflects his income position should
prevail with the court if the reasons for the opinion commend themselves
to it.”
3 [1957J C.T.C. 1.
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If accountants are charged with the responsibility of determining
profit, what, then, is their definition of the term ?
Such a definition is found in Accounting Terminology published
by the Canadian Institute of Chartered Accountants. It reads as fol-
lows :
“Profit. – This term is used in several different senses. Usually it refers
to the gain resulting from business operations and indicates the excess of
revenue over expense. From the accountant’s viewpoint, the measurement of
profit calls for the maintenance of “money” capital. From the economist’s
viewpoint, profit arises only after “real” capital has been maintained and
consequently represents a measure of the increase in value. ‘Income’ is some-
times used as a synonym.”
Inasmuch as the above definition can be condensed to state that
profit is simply the excess of revenue over expenses, it is necessary
to explore further afield for the definitions of revenue and expenses.
The Accounting Terminology we find, gives us the following defini-
tions :
“Revenue – The gross proceeds of sale of goods and services including
the gross yield of investments, generally after deducting returns, allowances
and discounts. The revenue from disposition of assets other than stock-in-
trade is generally considered to be the proceeds in excess of costs or book
value rather than gross proceeds.”
“Expense – 1. A general term applied to the costs of carrying on a business.
2. A cost incurred in the process of earning the revenue attributed to
a period, including those costs not assignable to any particular revenue but
incurred during the period in the course of ordinary operations and not
assignable to the operations of a future period or periods.”
While the definition of a profit has a wide coverage, it is well
established that for income tax purposes it does not include gains
realised on the disposal of capital assets. To the extent that the
meaning of revenue has a fairly uniform interpretation for accounting
as well as for income tax purposes, the conflicts which arise between
the taxpayer and the taxing authorities in this area are less numerous
than those arising in the area of expense deductibility.
It is in the broad area of expense deductibility where we run
into limitations as to the nature of the items which may be deducted
in computing income for tax purposes. The Income Tax Act enumerates
to a small degree those items which must be included in income and
those expenses which are deductible in arriving at income, but never-
theless, one may be awestruck by the realization that there are count-
Iass thousands of items which are not specifically provided for in the
Act. Accordingly, one would have to look at the general provisions
of the Act relating to the computation of income in order to determine
the rules governing the deductibility of these unspecified items.
122
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Such a review of the general limitations of the Act brings us face
to face with Sections 12(1) (a) and 12(1) (b) and forces us to look
once again to court judgments for an interpretation of their meaning.
Translated into accounting terminology the remarks made in court
cases dealing with these specific interpretations have been summarized
by A. W. Gilmour 4 into the following set of rules :
1. The net income of the business should first be computed in accordance
with ordinary principles of commercial trading or well accepted principles
of business and accounting practice.
2.
In computing income, any expense incurred is inherently deductible
as long as the expenditure was made in accordance with the ordinary
principles of commercial trading or well accepted principles of business
practice. If the expense does not meet this general test, it is not deductible
in computing income in accordance with ordinary principles of commercial
trading.
3. Finally, expenses which can be shown to have been incurred in accord-
ance with ordinary principles of commercial trading, should be examined to
ascertain if they conflict with any of the specific prohibitions contained in
Section 12 of the Act.
It should be emphasized that in order to qualify as a deduction
under Section 12 (1) (a), an expense must have been incurred for the
purpose of gaining or producing income. It is not necessary that in-
come be produced but only that the expense was for the purpofe of
gaining or producing income. In Imperial Oil Limited V. M.N.R.
Thorson J., states at page 371:
“The view that an item of expenditure is not deductible unless it can
be shown that it earned some income is quite erroneous. It is never necessary
to show a causal connection between an expenditure and a receipt.”
At issue in the Imperial Oil case was the conflict between the Min-
ister’s interpretation of the deduction provisions of the Income War
Tax Act 6 and the broader business and accounting concepts of
expenses which were necessary to earn income. The court held that
the deductibility of disbursements or expenses is to be determined
according to the ordinary principles of commercial trading or well
accepted principles of business and accounting practice unless their
deductibility is prohibited by reason of their coming within the
express terms of the excluding provisions of the Act.
The basic principle recognized in the Imperial Oil case echoed the
findings of earlier cases. In one of these, Dominion Natural Gas V.
M.N.R. 7 Maclean, J., states at pages 147 and 148:
4 A. W. Gilmour, Income Tax Handbook, 1964-65, p. 161 et seq.
5 [1947] C.T.C. 353.
6 R.S.C. 1927, ch. 97.
7 [1940-41] C.T.C. 144.
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THE ROLE OF ACCOUNTING IN TAX LAW
123
it
is permissible when
“The generally recognized rule as regards trade expenses is that a deduct-
ion
is justifiable on business and accountancy
principles, but this principle is subject to certain specific statutory provisions
which prohibit the allowance of certain expenses as deductions in computing
the net profit or gain to be assessed. To the extent that ordinary business
and accounting principles are not invaded by the Statute they prevail.”
While the previous cases were heard under the Income War Tax
Act, subsequent rulings by the Income Tax Appeal Board and the
Exchequer Court of Canada have upheld that this principle is also
applicable under the Income Tax Act. On this topic perhaps the lead-
ing case under the present Act is The Royal Trust Company V.
M.N.R.,8. The judgment in this case sets out in clear terms the condi-
tions under which an expense is deductible under the Act and is
summed up on page 44:
The essential limitation in the exception expressed in Section 12(1) (a)
is that the outlay or expense should have been made by the taxpayer “for
the purpose” of gaining or producing income “from the business”. It is the
purpose of the outlay or expense that is emphasized but the purpose must
be that of gaining or producing income “from the business” in which the
taxpayer is engaged. If these conditions are met the fact that there may
be no resulting income does not prevent the deductibility of the amount of
the outlay or expense. Thus, in a case under the Income Tax Act if an outlay
or expense is made or incurred by a taxpayer in accordance with the
principles of commercial trading or accepted business practice and it is made
or incurred for the purpose of gaining or producing income from his business
its amount is deductible for income tax purposes.”
It
is interesting to note a remark made in the Royal Trust case
by the learned President of the Exchequer Court in referring to his
earlier judgment in the Imperial Oil case:
“… -My only present observation is that I should have omitted the
reference to accounting practice which I made in that case.”
Accordingly, he has in effect ruled that the prime test of an ex-
pense deductibility is determined according to the sound principles
of commercial trading and business practice for the particular business
under review.
The learned President’s remark regarding the omission of the
reference to accounting practice should not be construed as restricting
the importance of accounting practice in determining business profits.
Indeed, it is superfluous to state that the expense must have been made
in accordance with good accounting practice. Accounting is but a
tool of business.
is the process of recording, classifying, sum-
marizing and interpreting in a significant manner, transactions and
events of a financial nature. It records such transactions and events
“after the fact”. Thus, it follows the route taken by the business
It
8 [1957] C.T.C. 32.
124
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which it is recording. If the business carries on its trading operations
in accordance with sound commercial practices, it is the responsibility
of accountants to effect proper accounting for the business operations.
It is a well recognised accounting principle that costs must match
revenues and inherent in this principle is the taxing concept that a
cost must be incurred for the purpose of earning income in order
to be deductible in arriving at income.
Accountants have for many years been following the principle
which the courts have slowly acknowledged. The accountants have the
responsibility of recording the millions of business transactions in
this country in the day to day routine. With minor exceptions, they
faithfully follow the long established accounting principle that costs
must match revenues. If this were not so, disorder of an unlimited
magnitude would result. No one, not the taxing authorities, not the
taxpayer and not the judiciary, would ever hope to unscramble the
chaos.
Turning now to Section 12(1) (b), we must first of all relate it
to Section 12(1) (a) which, as already outlined, limits the deductib-
ility of expenditures to only those which are made or incurred for
the purpose of gaining or producing income. Section 12(1) (b)
provides a restriction on this deductibility by stating that no deduct-
ion can be made for “capital”
items unless they are “expressly
permitted” by Part I of the Act.
As mentioned earlier, it is an established principle that gains
realized on the disposal of capital assets are not included in the
determination of “income” for income tax purposes and accordingly
no tax is exigible on them. This principle is consistent with the one
followed in Section 12(1) (b) in that no allowance is granted for
capital losses or expenditures. Thus, capital gains and losses are
ignored in computing income for income tax purposes. However, the
Act does give recognition to the role played by capital assets in
determining income by permitting the deduction of allowances on the
capital cost of depreciable property, depletion allowances on the capital
cost of natural resources and certain expenses of borrowing money
and issuing shares. Nevertheless, the rule is basically that no
deduction is permitted for capital expenses.
The distinction between “capital” receipts and expenditures and
“current” receipts and expenditures is not an easy one. A large
number of the tax cases heard by our judiciary deal with the conflict
as to whether an item is of an income or of a capital nature. Through
the years many attempts have been made by the courts to distinguish
between capital and revenue expenditures. The problem is complicated
by the fact that an expenditure may be considered a “current” item
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THE ROLE OF ACCOUNTING IN TAX LAW
125
under normal business practice but may be considered a “capital”
item for income tax purposes.
A capital expenditure can perhaps be most simply defined as one
which brings into existence an asset or one that protects an asset
already in existence. A detailed distinction has been made between
capital expenditure and revenue expenditure by Robert R. Thompson,
a chartered accountant and a former professor at McGill University,
in his modestly titled book 120 Graduated Exercises in Bookkeeping 9.
“Capital expenditure is that –
(1) Which is incurred for the purpose of creating or acquiring the Fixed
Assets by means of which the business is to be carried on; and
(2) That expenditure on Fixed Assets, which is incurred for the purpose
of increasing the earning capacity of the business.
Examples:
(1) Purchase of a Factory.
(2) Expenditure on Improvements to the Factory.
Revenue Expenditure is that which is incurred for the purpose of:
(1) Carrying on the business; and
(2) Maintaining the Fixed Assets in a state of working efficiency.
Examples:
(1) Office salaries, rent, depreciation.
(2) Repairs and renewals to machinery.
In British Columbia Electric Railway Company Limited v. M.N.R.O
the Supreme Court of Canada considered earlier attempts by the
courts to define the nature of capital items. Two of these attempts
are referred to on page 26:
“In Vallambrosa Lumber Company V. Farmer (1910), 5 T.C. 529, Lord
Dunedin said in part (p. 536):
‘I don’t say that this consideration is absolutely final or determinative,
but in a rough way I think it is not a bad criterion of what is capital
expenditure as against what is income expenditure to say that capital expend-
iture is a thing that is going to be spent once and for all, and income
expenditure is a thing that is going to recur every year’.
In Atherton V. British Insulated and Helsby Cables Ltd. (1925), 10 T.C.
155, Lord Cave said (p. 192) that:
‘when an expenditure is made, not only once and for all, but with a view
to bringing into existence an asset or an advantage for the enduring benefit
of a trade, I think that there is a very good reason (in the absence of
special circumstances leading to an opposite conclusion) for treating such
expenditure as properly attributable not to revenue but to capital.’.”
Ill. Some Existing Anomalies in Income Tax Law.
One may ask “what are the traps in which an unsuspecting tax-
payer may find himself if he is not knowledgeable about the above
9 Robert R. Thompson, 120 Graduated Exercises in Bookkeeping, 1936, p. 16.
10 [1958J C.T.C. 21.
McGiLL LAW JOURNAL
[Vol. 11
legislation and the courts’ interpretation of that legislation’? What
are the anomalies which exist under our present legislation?
It could be concluded from what has been said thus far that an
expenditure is either “current” and allowed as an immediate tax
deduction or “capital” and subject to amortization against income of
the current and future incomes. Unfortunately, however, this is not
so. For there is a third category – an infinite abyss – a category of
“nothings”.
“Nothings” have been defined by tax practitioners as legitimate
business expenditures for which there is no tax relief. There is no
inimediate deduction allowed. There is no deduction for amortizations
against future income. Some of these “nothings” are obvious from a
close study of our Act and the supporting regulations. Others, how-
ever, have been declared by the tax courts in cases heard by them
since inception of our income tax legislation. Most of them have been
found to be of a nature of “capital” cost for which a write-off is
not allowed by statute.
A classified list of nothings, originally prepared in Tax Review 11,
is reproduced below. (Some of these items, i.e. 1(c) and 8(e) have
been permitted as deductions by subsequent changes to the Act.).
1. Legal expenses
(a) To fight an eviction notice.
(b) To fight competition.
(c) To contest income tax assessments.
(d) To obtain lower import duty.
(e) To defend a franchise.
2. Contracts and Rights, sums expended.
(a) To acquire a newsprint contract.
(b) To obtain a permit to export natural gas from the United States.
(c) To obtain transfer of a liquor licence and licence for public com-
mercial vehicles.
(d) To acquire a patent application.
(e) To make a franchise payment in connection with a bus service.
(f) To acquire a right to drill for oil.
(g) To obtain admission to the Bar.
(h) To acquire a sugar quota.
3. Damages, Cancellations, etc.
(a) Charter cancellation.
(b) Surrender of lease.
(c) Brokerage transaction.
(d) Compensation on leasehold.
(e) Deposit on block of timber.
(f) Non-competition agreement.
11 Canadian Chartered Accountant, November, 1957, p. 461 et seq. and Decem-
ber, 1957, p. 559 et seq.
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4. Losses on Loans, Advances, etc.
(a) Accommodation loans to customers.
(b) Loss under guarantee of advances.
(c) Losses on logging advances.
(d) Shares in lieu of debt.
(e) Sales of notes.
(f) Partner’s income tax.
(g) Loan to company.
(h) Loss on oil company shares.
5. Financial Expenditures.
(a) Bond discount.
(b) Premium on redemption.
(c) Bonus to obtain mortgage.
(d) Premium to discharge mortgage.
(e) Cost of guarantee of bank loans.
6. Acquisition of Business, etc.
(a) Expense before incorporation.
(b) Expenses before commencement of business.
(c) Expenses to obtain agency.
(d) Receivables of retired partner.
(e) Debts of predecessor.
7. Sundry Assets.
(a) Land for new building.
(b) Expenses of golf course.
(c) Breaking farm land.
(d) Goodwill.
(e) Trade mark registration.
(f) Sulphur drilling coats.
8. Miscellaneous Expenses.
(a) Terminal audit.
(b) Expenses of subsidiary company.
(c) Transfer fees – a stock exchange membership.
(d) Misappropriation by manager.
(e) Post graduate studies.
(f) Political contributions.
(g) Partners’ life insurance.
(h) Wife as partner.
(i)
(j) Fines and penaltier.
Interest on income tax.
This list gives some indication of the nature of these outcast items.
One can gather from the updating summary prepared by Gwyneth
McGregor 12 that the composition of subsequent additions to this list
of “nothings” has continued in much the same pattern as before. To
say that this situation is appalling is presenting the case very mildly,
indeed !
r-‘ More Ado About Nothizgs, Canadian Tax Journal, July-August, 1964, p. 268.
McGILL LAW JOURNAL
r-rol, 11
Many of the expenses which are disallowed under the Act are
nevertheless recognized by accountants as bona fide deductions in
arriving at an enterprise’s profit. In most instances, practising ac-
countants will report that profit and loss statements with deductions
of this nature are drawn up in accordance with generally accepted
accounting principles. Because accountants have been given wide lat,
itude of freedom in developing principles, standards and procedures
by which income is determined and because they have been pains-
takingly diligent
in policing their development, should not the
statutory concept of income parallel the concept of income which
has been developed by sound commercial and accounting practices ?
IV. Some Suggested Remedies to Existing Anomalies.
This question – whether the Income Tax Act should give cog-
nizance, in defining business income, to “generally accepted account-
ing principles” – has been under considerable study in the past. The
problem, however, always seems to settle at the accounting profes-
sion’s inability to agree with any unity as to what constitutes such
principles.
The accounting profession in Canada and the United States has
been undergoing some deep soul searching in attempting to idQntify
generally accepted accounting principles. There are conflicts amongst
accountants themselves, since accounting matters are largely inter-
pretations, and in varying degrees are arbitrary and subjective. Even
though practising accountants have committed themselves in their
audit reports to the existence of generally accepted accounting prin-
ciples, they have not been able to enumerate a definitive list of such
principles. It may well be that the reference to generally accepted
principles in the draft of the 1948 revision of the Income Tax Act
was finally dropped because of the great uncertainty as to their
precise definition.
The Accounting and Auditing Research Committee of the Canadian
Institute of Chartered Accountants considered this problem and gave
its majority conclusion in an appendix to the Institute’s brief to the
Royal Commission on Taxation. The committee came to the conclusion
that it would be undesirable for our Income Tax Act to refer to
“generally accepted accounting principles” since this would possibly
restrict the development of accounting principles and practice. If tax
legislation and jurisprudence did not develop in the same general
direction as accounting theory, then it is reasonable to conclude that
accounting practice would tend to follow the course set by our laws
rather than develop free from their influence.
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THE ROLE OF ACCOUNTING IN TAX LAW
129
Of major concern to the Committee also was the effect that the
reference to generally accepted accounting principles would have in
the determination of income for income tax purposes. Because of the
diversity in accounting principles and the even greater diversity in
accounting practices, it was felt that reference to generally accepted
accounting principles would create a considerable amount of uncer-
tainty. It would then follow that in the absence of judicial decisions
the income tax statutes would have to provide specific provisions to
clarify the uncertainty.
While it has been concluded by accountants that the Income Tax
Act should make no reference to generally accepted accounting prin-
ciples it is nevertheless apparent to them, to lawyers and to business-
men that there are generally accepted practices in determining profit
from a business but these are presently not recognised for tax pur-
poses. Perhaps the main area where this is so is in the category of
expense deductibility. Other areas where generally accepted business
and accounting practices differ from the stand taken in the Income
Tax Act include: the LIFO method of inventory evaluation; allow-
ances for doubtful accounts; reserves and prepaid and deferred
charges. It is hoped that the coming revision to our tax system r6-
sulting from the findings of the Royal Commission on Taxation will
correct the obvious inequity resulting from the non-deductibility of
legitimate business expenditures.
Certain quarters have suggested that the present anomaly in the
Act with respect to non-deductible expenditures could be eliminated
by providing that all capital expenditures incurred for the purpose
of earning income could be deducted in arriving at taxable income.
Such a remedy, while being startling, yet simple, is not to be recom-
mended. It would result in such wide inequities in the taxing of busi-
ness enterprises that tbere would immediately arise a great clamour
for exempting and relieving provisions to cover the inequities. Thus,
the patch-work, which is so typical of our present tax legislation,
would start all over again.
There would appear to be one logical solution to the problem. Tax-
payers could be given the tax relief they deserve by providing for
the creation of a new capital cost class which would include capital
expenditures incurred for the purpose of gaining or producing in-
come, but which do not fall into an already existing capital cost class.
An arbitrary class rate of say, 10%, could be used to provide for the
systematic and orderly amortization of the cosL against income. Some
quarters suggest that if such a proposal were adopted, capital expend-
itures falling into the categories of land, goodwill and investments,
should not be permitted as additions to the new capital cost class.
McGILL LAW JOURNAL
P-o1 II
While such a recommendation is based on sound arguments, ‘, a might
perhaps go one step further and provide for the systematic am-
ortization of these three items as well. Any “recaptured depreciation”
on the eventual disposition of these assets would of course be subject
to the same rules of taxation as is presently the case.
Given the role which accounting plays in the development of our
income tax legislation and in its interpretation, one might come to
the conclusion that accountants could be justified if they adopted a
prima-donna attitude to the effect that the tax field was theirs and
theirs alone. Fortunately this is not the case, for even where they
have many years of experience in tax work they have not assumed the
responsibility for giving legal opinion.
Given the broad background of the role played by accountants in
the area of tax law, we can readily conclude that they have an onerous
responsibility to the taxpaying public and to government to provide
the optimum level professional skills and services. With this aim in
mind it should be concluded that accountants as well as lawyers, if
they are to fulfill their function, must constantly strive for new know-
ledge in tax matters and be ever alert to the problems of their clients,
their professions and the public.
