One of the critical steps in the preparation of the T2 Corporation Income Tax Return is the calculation of net income for tax purposes which differs from net income for accounting purposes. The calculation of net income of a corporation for accounting purposes is based on GAAP, whereas, the calculation of net income for tax purposes is based on income tax law.
In order to reconcile the difference between net income for accounting purposes and net income for taxation purposes, a corporation is required to prepare a reconciliation schedule (Schedule 1 - T2SCH1 Net Income (Loss) for Income Tax Purposes) demonstrating the conversion process. In this blog we will discuss the differences between the calculation of net income for accounting and taxation purposes.
The starting point for the conversion process is the accounting income which is entered on the top of the page in Line A – Net income (loss) after taxes and extraordinary items from line 9999 of Schedule 125. Now we need to reconcile the “Permanent” and “Timing” differences from the figure in Line A.
Timing differences, which are temporary in nature, are differences between accounting and taxable income that arise when the timing of including item of revenue and expenses in computation of accounting income and time of inclusion in computation of taxable income does not coincide. They are temporary since they originate in one period and reverse in one or more periods. One example of timing difference is the difference between depreciation and Capital Cost Allowance (CCA). Depreciation and CCA are both defined as the usage costs of capital assets during their lifetime/period but the timing and usage rates varies between both methods. In case of depreciation alone, it can be calculated either in “Straight Line” or “Sum-of-Years Digits Depreciation” methods. The Act and related regulations specify the method for capital cost allowance calculation and the maximum amount of such allowances that may be deducted in a year. However, a taxpayer can deduct less than maximum amount allowed under capital cost allowance.
Let’s look at an example. John purchased a car for $20,000 on January 1, 2023. Assuming depreciation period of 5 years (20% per annum). What will be his depreciation under straight-line method and CCA for years 1-3?
Depreciation Expense:Permanent differences, are differences between accounting and taxable income that arises when some items of revenue and expenses are included in computation of accounting income whereas the same are not included in computation of taxable income. Some of the expenses, which are shown on income statement, may not be deductible for income tax purposes and must be added back on Schedule 1.
For example, a corporation incurred $10,000 in meal expenses in 2022 and booked the expenses at full amount as “Meal and Entertainment Expenses”. However, for taxation purposes the maximum amount that can be claimed for food, beverages, and entertainment expenses is 50% of the lesser of the following amounts:
In this case, 50% of $10,000 or $5,000 will be added to income on Line 121 of Schedule 1.
The following are the common additions and deduction from Accounting Net Income to arrive at Net Income for Tax Purposes:
Additions to Accounting Income:For further information please contact Softron at 1-877-SOFTRON or visit www.softrontax.com
Posted on 29 June 2023