Tax Tip Thursday

It is really strange how things come in groups.  Strangely enough I have had multiple conversations with clients about barter transactions over the last few weeks.

So….

Barter in Business — A Good Deal or a Tax Trap?

Barter is simply exchanging goods or services without paying—or without paying entirely—in cash.

For example, an accountant prepares a photographer’s tax return, and the photographer provides the accountant with new professional headshots. A restaurant gives a radio station gift certificates in exchange for advertising. A contractor renovates a website designer’s office, and the designer builds the contractor a new website.

No money—or very little money—may change hands. But here is the important point: as far as your financial records and the Canada Revenue Agency are concerned, a barter transaction is generally still a business transaction.

The absence of cash does not mean the absence of income—or tax.

Advantages

Bartering can help a business conserve cash. This can be especially useful for a new business or for a business going through a temporary cash-flow squeeze. If you need marketing services and you can pay for them using your own excess inventory or available time, you may be able to obtain something valuable without draining your bank account.

Bartering can also put unused capacity to work.

Suppose a hotel has empty rooms during a slow period. The cost of allowing a marketing consultant to use one of those rooms may be relatively small. If the consultant provides useful marketing services in return, the hotel may receive more value from that empty room than it would have received by leaving it vacant.

Personally I have found the best use of barter is from advertising.  It allows you to turn your barter dollars into future cash sales!

Disadvantages

There can be disadvantages to a barter transaction as well.  Make sure you are getting our money’s worth!

There are 3 parts of the transaction to consider.

1. the value of the goods or services and whether it is a good sale for you.
2. The margin associated with the transaction. If you are trading a desk for advertising, you have to remember the desk had a real cost to it and that becomes a hit to cashflow.
3. The taxes associated with the transaction – you will still have to deal with HST and or Income tax.

The one good thing from the tax perspective is that if you selling business goods or services and receiving business goods or services of the same value, net net, you will have no HST or Income tax impact.

The second disadvantage is that barter does not pay the bills.

Your landlord, bank, employees and utility companies normally expect money. A business can appear busy and profitable while still experiencing a serious cash-flow problem if too much of its revenue is being received in goods or services.

You may also end up accepting something you do not really need simply because the other party cannot pay you. That is not conserving cash—it may simply be replacing a good sale with a poor purchase.

You want to make sure you are generally only dealing with excess capacity and not cutting into your cashflow.  I have seen large businesses fail, because they did to much barter and were not able to sustain their cash flow requirements.

Accounting and Taxes

The CRA’s general position is that when a business exchanges its goods or services through barter, the value of what it provides must normally be included in business income.

The transaction should generally be recorded at its fair market value: the amount the goods or services would reasonably sell for between independent parties in the open market.

Let’s use a simple example.

A bookkeeper normally charges $1,000 to perform a particular service. Instead of receiving cash, the bookkeeper accepts $1,000 of business advertising.

Revenue $1000, Expense $1000 – no HST or tax impact.

But that does not mean every barter transaction has no tax effect.

What if the business receives a personal vacation instead of advertising? The $1,000 of bookkeeping revenue may still be taxable, but the personal vacation is not deductible.

If both businesses are entitled to full input tax credits, each may recover the HST charged by the other. But both sides still need proper invoices and must record the transaction correctly on their GST/HST returns.

Problems can arise if only one party is registered, if one of the supplies is exempt, or if the item received is not used entirely in commercial activities. A business can even find itself owing HST to the CRA despite receiving no cash with which to pay it.

That is one of the biggest hidden risks of barter: you can create a tax obligation without creating the cash needed to satisfy it.

Documentation is therefore essential.

Treat barter exactly like a cash transaction. Prepare a written agreement and have each business issue an invoice describing what was provided, its fair market value and any applicable GST or HST.

Keep evidence supporting the value. That could include your usual price list, comparable sales, estimates or previous customer invoices.

And record both sides of the transaction in your accounting system. Do not simply leave it out because no payment passed through the bank account.

Barter conducted through an organized barter exchange also has tax consequences. Receiving trade credits or barter units does not automatically make the income non-taxable. Special GST/HST rules may apply to designated barter-exchange networks, so those arrangements should be reviewed carefully.

The bottom line is that barter can be useful when it conserves cash, uses excess capacity, moves unwanted inventory or creates a worthwhile new business relationship.

But a good barter deal should pass three tests:

1. Would you have purchased what you are receiving if you had to pay cash?
2. Is the value of what you are receiving reasonably equal to the value of what you are providing?
3. Have you accounted for the income, the expense and the applicable GST or HST correctly?

If the answer to any of those questions is no, the barter arrangement may not be the deal it first appeared to be.

Barter may eliminate the cash payment, but it does not eliminate the sale, the bookkeeping or the tax consequences.

As I often remind business owners: the CRA accepts many forms of payment—but unfortunately, your leftover inventory usually is not one of them.

Its tax treatment is based on the CRA’s current guidance on barter as business income and GST/HST for barter transactions.

If you need help understanding the best ways to make use of barter, come speak to our team! You can reach us at 905 862 2727 to make an appointment or you can google The Mad Accountant and you can make an appointment through my website.  Make An Appointment today!

Disclaimer:

This article provides information of a general nature only. It is only current at the posting date. It is not updated and it may no longer be current. It does not provide legal or tax advice nor can it or should it be relied upon. All tax situations are specific to each individual. If you have specific tax questions you should book an appointment for a 1 on 1 consultation.