Last month, I wrote about the federal budget tabled on March 22 and the elimination of billed-basis accounting. This will force lawyers to recognize work in progress as income in the year it is done. The repercussions could be devastating for small law firms with a large number of contingency files and insufficient cash flow to pay the associated taxes.
Canada Revenue Agency’s position
The Canada Revenue Agency, in an update to its website on April 28, stated that the elimination of billed-basis accounting is not expected to affect contingency fee arrangements, where the terms and conditions of such arrangements are bona fide. The CRA explains that, under contingency fee arrangements, there is no obligation for the client to pay any fee until a certain time and, therefore, no amount is receivable until the professional’s right to collect a fee is triggered. The CRA is of the position that WIP would not normally be recognized under these circumstances.
Expenses under such arrangements can continue to be deducted in the year that they are incurred. However, the client must have no risk or obligation to the professional for those expenses unless and until some successful outcome is obtained in the future.
There is still no update, however, on whether the proposed elimination of billed-basis accounting remains on the table. While the impact on small firms is unlikely to move the needle, lawyers across the country, including the Canadian Bar Association, have raised concerns about how the changes negatively affect access to justice. Minister of Finance Bill Morneau has acknowledged these concerns, and discussions are ongoing.
Do you have a bona fide contingency fee arrangement?
For the time being, non-contingency fee arrangements remain affected by the elimination of billed-basis accounting. As such, lawyers are encouraged to talk to their accountants to prepare for the changes. Those using contingency fee arrangements may need to revisit their retainer agreements.
The update to the CRA website is brief, but it explains what the CRA would consider a bona fide contingency fee arrangement and makes reference to written contingency fee agreements. Given the CRA’s position, having a written contingency fee agreement is all the more important. Whether it is in the Solicitor’s Act in Ontario, the Law Society Rules in British Columbia or the Alberta Rules of Court, jurisdictions across Canada already require contingency fee agreements to be in writing.
While not having a contingency fee agreement in writing could breach local rules, it may also prompt the CRA to question whether the agreement qualifies as a bona fide contingency fee arrangement. The phrase “bona fide arrangement” is used numerous times in the Income Tax Act, though it is not defined.
Black’s Law Dictionary defines “bona fide” as “in or with good faith; honestly, openly, and sincerely; without deceit or fraud.” Tax court cases, such as Deckelbaum v. M.N.R., have warned that the term should be approached with great caution: “The more so when the term ‘arrangement’ in this relevant section is qualified by the flashing red light ‘bona fide’ — a term which, simply because it lacks precision, should be approached with the greatest of caution.”
In Tolhoek v. Canada, the tax court stated that although “there may be differences between ‘arrangements’ and ‘contracts,’ I believe that you either have a meaningful, binding agreement between parties that means something to them or you do not. If the evidence does not support the existence of a legally binding agreement, then ultimately it is going to be on a collision course with the limited-recourse debt rules.”
Provided that the agreement is in writing, the intent to enter into an agreement should (hopefully) be obvious. However, we have all heard of cases where the scope of a retainer agreement is challenged. Furthermore, the intent that the payment be contingent in nature may not be clear. Under such circumstances, the CRA may take the position that the arrangement is not a bona fide one.
In light of the recent federal budget and the CRA’s position, lawyers should revisit the wording of their contingency fee agreements to ensure that the entitlement to collect fees is contingent on a clearly defined event. In litigation matters, this could be the completion of a procedural step, settlement or court judgment. In estates, the contingency may be the sale of the deceased’s real property, obtaining a grant of probate or the issuance of a clearance certificate. Whatever the case may be, there must be no doubt as to the contingent nature of the lawyer entitlement to fees.
While the CRA’s position is welcome news for small and large firms, discussions with the minister of Finance continue, and it is possible that the legislation itself could change. The first Budget Implementation Act, introduced on April 11, did not include the elimination of billed-basis accounting. The second bill is expected this fall. Thus, there is still time to amplify the concerns over this issue. It is encouraging to know that our voices are being heard thus far and steps to protect access to justice have been taken.