Calculation of CEWS eligibility using the cash basis of accounting

On April 11, 2020 the federal government of Canada passed legislation on the Canadian Emergency Wage Subsidy (CEWS). This program, in response to the COVID-19 pandemic, will allow certain qualifying employers to apply for a government subsidy towards payroll costs which would generally offset 75 per cent of each employee’s pre-crisis remuneration up to a maximum benefit of $847 per week.

Baker Tilly has published a couple of excellent articles following the many changes of the CEWS program since it was introduced on April 1, available here and here.

As noted in these articles, to be eligible for CEWS, an employer must have had a minimum drop of “qualifying revenue” in the period of application as compared to the prior reference period. For example, a 15 per cent drop in revenue in March 2020 (as compared to March 2019 or an average of January and February 2020) is needed to be eligible in the first period. Subsequent application periods (e.g., April and May) would require a 30 per cent drop.

However, once qualified for one period (e.g., March) you would automatically qualify for the very next period (e.g., April) without meeting the revenue drop requirement for that month.

The CEWS legislation identifies “qualifying revenue” as being earned in Canada from arm’s length sources and would exclude revenue from extraordinary items and amounts on account of capital as well as government subsidies (like the CEWS itself). The legislation further defines “qualifying revenue” as the inflow of cash, receivables or other consideration arising in the course of the ordinary activities generally from the sale of goods, the rendering of services and the use by others of resources of the eligible entity.

Another very important thing to note is that the CEWS legislation also gives the eligible employer the option of calculating “qualifying revenue” using either the accrual basis or cash basis.

Businesses should be familiar with the accrual basis of calculating revenue as that is how all of them (aside from some farmers and fishermen) need to report it for income tax purposes. For example, if a business sold and delivered $10,000 worth of goods before year-end but did not receive the cash payment until the following year, it would still have to record the $10,000 as income for tax purposes because it was “receivable” at year end.

Under the cash basis, the same transaction above would result in no income as the $10,000 would not have been received in cash yet. Clearly this could allow many more employers to qualify for CEWS if, for example, they had a lot of revenue tied up in accounts receivable that has not been paid yet due to the COVID-19 crisis.

On the surface, it appears that calculating revenue using the cash method would be very simple. Employers would just have to add up all cash income that is deposited in the bank account each month. However, the timing of cash receipts can be a bit more complicated than that.

The CEWS legislation directs us to subsection 28(1) of the Income Tax Act as to how cash revenue should be calculated. This subsection was originally written for fishing and farming businesses which are the only businesses eligible to report their income on the cash basis for tax purposes.

CRA Interpretation Bulletin IT-433R has an excellent summary of subsection 28 (1) regarding what is to be included when the cash method of accounting is used. A portion of this Interpretation Bulletin has been reproduced below and should be used as a guideline when calculating CEWS eligibility on the cash basis. It may come as a surprise that certain items, such as cheques in the mail, commodities paid in lieu of cash and payments made by offsetting debts, are still considered to be cash receipts for the purpose of this calculation.

Due to the complexities and potential pitfalls involved, we encourage you to contact your Baker Tilly office for guidance on whether or not you should elect to use the cash method of accounting when calculating “qualifying revenue” for purposes of meeting the CEWS criteria. Once you elect to use the cash basis of accounting for one period, you must use this method for all periods.

Please see below for a reproduction of the “Meaning of Received” section of IT-433R:

“3. When computing income using the cash method paragraph 28(1)(a) requires that amounts be included in income when received or when deemed by the Act to be received. The meaning of the term received is not necessarily limited to those situations where the income was actually received in cash. Received has a broader meaning, and an amount may be said to have been received by the taxpayer at the time when, for example,

1. it was received by a person authorized to receive it on behalf of the taxpayer
2. it was offset against an amount owing by the taxpayer
3. it was paid or transferred to a third party pursuant to the direction of or with the concurrence of the taxpayer (this may be implicit)
4. a security or other right or a certificate of indebtedness or other evidence of indebtedness was received in payment or part payment of a pre-existing debt of an income nature. For further explanation see the current versions of IT-77, Securities in Satisfaction of an Income Debt and IT-184, Deferred Cash Purchase Tickets Issued for Grain
5. a commodity is accepted in lieu of cash.

4. A payment made to a taxpayer by first class mail or its equivalent is deemed by virtue of subsection 248(7) to be received by the taxpayer on the date of its mailing. An item entrusted to a courier service for prompt delivery is considered equivalent to first class mail.

Receipt of a Cheque

5. The value of a cheque that is received by a taxpayer who uses the cash method to compute income is considered to be income at the time the cheque is received from a person who was indebted to the taxpayer provided the following conditions are applicable:

1. the debt is payable at the time the taxpayer receives the cheque,
2. the debt is of such a nature that it would be income of the taxpayer if it were paid in cash,
3. the cheque does not have any conditions attached to it such as, for example, postdating or an arrangement that the cheque is not to be used for a specific time, and
4. the cheque is honoured on presentation for payment.

Where a debt is not payable at the time a taxpayer receives a cheque, the value of the cheque is considered to be income at the earlier of:

5. the time the cheque is cashed or otherwise negotiated, and
6. the time the debt becomes payable.

6. Normally, a post-dated cheque will be accepted as security for a debt without extinguishing the original debt. Where such a debt is an income debt then payable, the value of the post-dated cheque will be brought into income at the earlier of the date that the cheque is payable and the date the cheque is negotiated. In the event that the debt is not payable at the time the post-dated cheque is payable, the value of the cheque will be brought into income at the earlier of the date that the debt becomes payable and the date that the cheque is negotiated. On the other hand, where a postdated cheque is accepted in absolute payment of debt, the value of the postdated cheque is normally considered to be income at the time it is received subject to a subsequent adjustment if it is not honoured on subsequent presentation for payment. In this situation, the taxpayer accepts the post-dated cheque as full payment of the debt and as such accepts it at the risk of it being dishonoured with the only recourse being an action against the maker of the cheque for failure to honour the cheque.”

Notwithstanding the above, even when calculating eligibility using these guidelines you should still be cautious of the CEWS anti-avoidance measures and penalties. The legislation specifically mentions that penalties will apply if “employers enter into transactions or participate in events (or a series of transactions or events) or take action (or fail to take action) that has the effect of reducing their revenue and it is reasonable to conclude that one of the main purposes of the transaction, event or action is to meet the Required Revenue Reduction.”

Using the cash method offers a greater opportunity to be tripped-up by these penalty provisions because of the additional options available to management on recognizing revenue. It is not known to the extent CRA will pursue these but, if found off-side, the result would be the repayment of the CEWS and penalties ranging from 25 per cent to 50 per cent of the subsidy received.