How is unbilled work in progress taxed when I sell a professional practice?

Lawyers, accountants, dentists and other professionals often finish a year with hours worked but not yet billed. When the practice is sold, that unbilled work has a value, and its tax treatment differs from the treatment of the goodwill sitting beside it. This page explains the general rule in the Income Tax Act and where the allocation of the sale price comes in.

Why unbilled work counts as inventory

The Act defines inventory as property whose cost or value is relevant in computing income from a business, and it adds that work in progress of a business that is a profession is, for greater certainty, inventory. For valuing inventory at year end, the Act sets the fair market value of such work at the amount that can reasonably be expected to become receivable after the year ends. Section 23(1) then deems inventory sold on or after disposing of or ceasing to carry on a business to have been sold in the course of carrying on the business, so the price allocated to it is generally taxed as business income rather than as a capital gain.

How the sale price is split

The CRA notes that a sales agreement may set a price for each asset, a value for the inventory and, where applicable, an amount for goodwill. In a professional practice those lines matter, because unbilled work, equipment and goodwill are each handled under different rules. A buyer and seller can disagree about the split, and an amount assigned to work in progress that does not reflect what is realistically collectable can raise questions later. For the broader picture, see our guide to selling a professional practice in Canada.

If a professional corporation owns the practice

Many professionals practise through a corporation. The Act defines a professional corporation as one that carries on the practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor, and the CRA requires resident corporations, with a few exceptions such as registered charities, to file a corporation income tax return every tax year. Whether the corporation sells its assets, including unbilled work, or its owners sell their shares changes what is being priced and who reports the income. Who may own a practice is a separate question, covered in our page on whether a non-professional can own a practice.

Questions to put to your accountant

• How was the unbilled amount measured at the last year-end, and does it match the figure in the sale agreement?
• Is the practice sold as assets or as shares, and who reports the income?
• What part of the price is assigned to inventory, and what part to goodwill and equipment?