The Tax Treatment of Advance Receipts

Abstract

Under the present income tax, some advance receipts are neither taxable on receipt nor deductible on repayment, while others are taxable when received and deductible when repaid or paid for. From a purely theoretical perspective, it remains unclear why different sets of rules apply in different cases. For example, if the fact of unrestricted control over the payment compels the conclusion that it is income, then most advance receipts, including loan proceeds, should be included in income immediately. Conversely, if the presence of an offsetting liability compels the conclusion that the payment is not (yet) income, then most advance receipts, including amounts received for future services, should not be taxed unless and until they are secured to the taxpayer without obligation.

This paper argues that confusion in this area stems from a misunderstanding of the role that the income concept plays and should play in guiding the proper rules for advance receipts, and from an inapposite application of consumption and wealth tax concepts in the income tax context. If practical questions of tax administration were not salient, advance payments under the income tax would be included as and when secured to the taxpayer without offsetting obligation, without regard to the time of receipt of the funds. By contrast, under a consumption tax the focus would be on the control and use of funds for personal or non-personal reasons. Control and use, however, do not play a significant role under the income tax.

The actual rules under the income tax sometimes diverge from those that would apply under a theoretically correct income tax. In most cases, the divergences reflect an appropriate attempt to accommodate the effort to tax true income to the practicalities of tax administration. If it is unlikely the amounts will become true economic income, a general presumption of non-taxation on receipt and non-deduction on return is appropriate, subject to adjustment if the presumption turns out to be false. If it is likely the amounts will become true economic income, the opposite presumption may be appropriate, again subject to adjustment if proved incorrect. Intermediate cases present problems of judgment that must be addressed from the perspective of effective administration of the tax law.

Keywords: taxation, income, timing, administration

JEL Classification: H2, H20, K34