Using tax deferral strategies to improve cash flows
The Bank of Canada recently increased interest rates for the first time in 7 years, and when doing so, indicated that the Canadian economy is approaching full capacity. Economists are already speculating on when the next rate increase will take place. What we know with certainty now, however, is that borrowing rates increase as the interest rates go up, and this will have an impact on corporate profitability across the board.
With a strong global and local economy in recent years, business profits have been rising steadily, particularly in the food and beverage sector. As a result, tax payments to the federal and provincial governments have also increased. When we meet with business owners to finalize their annual corporate income tax returns, they are often surprised that over and above the increase in the current year’s taxes owing, their corporate monthly or quarterly tax instalments have also increased. For some food and beverage companies, this often leads to increased bank debt to finance the current year’s taxes payable and the next year’s instalments.
There are many ways to use tax deferral strategies to not only reduce the current year tax payable, but to leverage the ripple effect of reducing next year’s tax payments, as well. When a company uses bank debt to finance payment of tax liabilities, this improved cash flow reduces interest costs and improves overall profitability.
While the government has recently announced proposed legislation to close perceived “tax loopholes”, there are still a number of ways to reduce current year taxable income, and thereby improve ongoing cash flow.
Accelerating tax deductions
There are a number of tax deductions that many companies tend to either overlook or ignore altogether. They are unrealized losses on the balance sheet.
For example, doubtful accounts (potential bad debts) and obsolete inventory are unrealized losses. If you have a general reserve for these items in your accounting records (for example, 2% of sales), they are not tax deductible. However, if you can identify specific obsolete inventory items or accounts that may be bad debts, you can claim tax deductible reserves for them. So, take the time to review individual receivable accounts and inventory items to identify if these opportunities exist in your business. These deductions can be claimed even if the general reserves are not adjusted for financial statement purposes.
The sale or disposition of an asset, resulting in either a capital or income loss, is another example of an unrealized loss that could translate to an immediate tax deduction. For example, if it has been your policy to recognize foreign exchange gains and losses when realized (sold or disposed of), check to see if there are any losses that can be realized before year end. You may be able to claim the foreign currency loss by selling the foreign currency.
Another opportunity to accelerate deductions is to ensure that all newly acquired assets are put into use before year-end. Capital cost allowance (depreciation for tax purposes) cannot be claimed on assets that are not available for use. This rule was introduced many years ago to counter taxpayers that would purchase assets immediately before year-end for the tax deduction.
Claiming allowable reserves, selling assets at a loss, and putting assets in use can be done at the end of the year. Other techniques like making life insurance premiums tax deductible or accelerating the deduction for leasehold improvements require advance planning.
Life insurance premiums are not tax deductible unless the policy is required as collateral by a lender. So, when renewing the terms of your loan, it may be possible to have the lender add the requirement for insurance, thus making the cost of the life insurance deductible.
Leasehold improvements are deductible over the lesser of the term of the lease plus its first renewal term, or five years. So, when entering into a new lease, consider structuring the terms in order to accelerate the tax deductions for leasehold improvements. For example, rather than enter into a five-year lease with an option to renew for another five years, enter into a four-year lease with an option to renew for another year and then another five years. This will allow you to deduct the leasehold improvements over a five-year period rather than a ten-year period, thereby realizing the deductions faster.
Reducing income inclusions
Income inclusions can be reduced by delaying the shipment of goods or the provision of services into the next tax year. Of course, you will want to ensure that your customers are not negatively impacted by this strategy. You want to defer your revenue, not lose it.
This is, by no means, an exhaustive list of strategies by which a company can defer income tax. There are many other ways to achieve this desired result. Some are more aggressive than others, but you should always seek professional tax advice to ensure that you fully understand your options and their implications.