Expenses deductible when paid

What it means

Expenses deductible only when paid are costs that, under the Income Tax Act, become tax-deductible expenses only in the tax period in which they are actually paid. Even though a company using double-entry accounting records them as expenses on an accruals basis, for tax they are recognised only once paid.

The law lists these expenses specifically. They include contractual penalties, late-payment fees and default interest, brokerage commissions, rent paid to individuals, fees for advisory and certain other services from individuals, and some contributions and membership fees.

The rule prevents a company from reducing its tax base with an expense it may never pay, and ensures the recipient is not taxed on income never received. It aligns the payer’s deduction with the taxable income of the individual recipient, who generally pays tax only on receipt.

How it works in practice

At year-end we go through clients’ unpaid invoices and pick out those that fall into this category. In the tax return we add them back to the tax base, and in the year they are paid we deduct them. Without this adjustment, the tax base would be understated.

This mainly affects rent for an office or warehouse from a private individual, commissions to sales agents and fees for services from individuals, which are often not paid by year-end. It is best to track such items throughout the year rather than hunting for them at closing.

For contractual penalties and default interest, the rule also works the other way: a creditor booking them as income is taxed only on receipt where the law so provides. The tax return therefore adjusts both income and expenses depending on whether they were paid.

What to watch out for

The most common mistake is forgetting the adjustment and deducting such unpaid expenses immediately. In an audit, the tax authority increases the tax base, assesses the difference and imposes a penalty, even though the adjustment is simple if remembered.

The opposite error is also common: the deduction is not made in the year of payment, so the expense is never claimed and tax is overpaid unnecessarily. Records carried between years must therefore be accurate and consistent.