Business and Investment Income: Tax Accounting
| Author | Vern Krishna |
| Pages | 93-114 |
CHAPTER
6
BUSINESS
AND
INVESTMENT
INCOME:
TAX
ACCOUNTING
A.
INTRODUCTION
Before
we
embark
on an
examination
of the
rules
for the
computation
of
income,
let us
look
at the
general framework
of
accounting applicable
to
income
tax
law. Although
tax
rules
often
vary
from
accounting
rules,
the
starting point
for the
measurement
of
business
and
investment
income
is
always
the
accounting measure
of
income
or
gain.
A
taxpayer's income
for a
taxation year
from
a
business
or
property
is her
profit
therefrom
for the
year.1
The
Income
Tax Act
imposes
a tax
on
profit
or
realized gain.
The
term"profit"
means
net
profit
—
that
is,
the
amount that remains
from
revenues
after
the
deduction
of
expenses
incurred
for the
purpose
of
earning
the
revenues.2
Accounting
is
concerned with
the
measurement
of
income. Thus,
as
a
starting
point,"profit"
is
computed
in
accordance with accounting
and
commercial principles.
For
most purposes,
the
accounting measure
of
income
for
financial statement purposes
is
quite adequate
for the
mea-
surement
of
income
for tax
purposes. There are, however, important pol-
icy
reasons
why
income
for
financial
statement purposes
may not
always
be
suitable
for tax
purposes.
As we saw in
chapter
1,
tax law is
concerned
1
Income
Tax
Act, R.S.C. 1985 (5th Supp.),
c. 1,
subs.
9(1)
[ITA].
2
Montreal
Light,
Heat
&
Power Consolidated
v.
M.N.R.;
(1941),
[1940-41]
C.T.C.
217,
2
D.T.C.
506
(Ex.
Ct),
aff'd
[1942] C.T.C.
1, 2
D.T.C.
535
(S.C.C.),
aff'd
[1944]
C.T.C.
94, 2
D.T.C.
654
(EC.).
93
94
INCOME
TAX LAW
with more than
the
raising
of
revenues
for
government operations.
It is
also
used
as an
instrument
for
social
and
economic engineering
— for
example,
to
promote economic growth, employment,
and
cultural pur-
poses. Thus,
the
measure
of
income
for tax
purposes sometimes varies
from
accounting
principles
or
normal commercial practice.
One
should
be
mindful
of the
fact
that taxpayers have
a
different
incentive
in
report-
ing
income
for tax
purposes
from
that
in
reporting income
for
financial
statements. Hence,
tax
accounting
often
controls more rigidly those seg-
ments
of
measurement that call
for the
exercise
of
judgment.
In
this chapter
we
start with
the
basic rules
for the
preparation
of
accounting statements,
the
measurement
of
profit
for
accounting pur-
poses,
and the
assumptions
and
conventions that underline these rules.
We
will also
see how tax law
adapts
and
varies generally accepted account-
ing
principles
(GAAP)
to
meet
tax
objectives
and to
control
tax
avoidance.
B.
ACCOUNTING
STATEMENTS
The
two
most common accounting statements
are the
balance sheet
and
the
income statement.
A
balance sheet
reflects
as at a
particular date
the
condition
of a
business
as it may be
judged
by a
statement
of
what
the
business owns
(assets)
and a
statement
of its
obligations
(liabilities).
Hence,
a
balance
sheet answers
two
questions:
What assets does
the
business own?
How
did it
finance
its
assets?
There
are two
sources
of
business
financing: capital
and
debt.
The
owner
may
contribute capital
to the
business,
and the
business
may
bor-
row
money
or
purchase
goods
on
credit. Thus,
the
liabilities
side
of a
balance
sheet
is
divided into
two
parts:
a
statement
of
indebtedness
to
outsiders
and a
statement
of the
owner's equity.
The
traditional balance sheet equation,
A = L + E
(assets
=
liabilities
+
owner's equity),
reflects
the
segments
of a
balance sheet that provide
answers
to
three questions:
What does
a
business
own and
what
is its
value?
How
much
of the
business
is
financed
by
creditors?
How
much
of the
business
is
financed
by its
owners?
As
its
name implies,
a
balance sheet always balances. This
is an
immutable rule because everything that
an
entity owns (assets) must
be
financed
either
by its
owners
or by its
creditors. There
is no
other
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