The CRA defines a business as “an activity that you conduct for profit or a reasonable expectation of profit”.
The profit test is used by the CRA to determine whether or not a person is actually running a business. The test asks, “Was the activity conducted with an actual expectation of profit?” and “Was that expectation of profit reasonable?” Only a person (or legal entity) operating a business can claim business expenses or business tax credits on their income tax or GST return. If the business does not pass the profit test, then all credits and expenses will be disallowed.
Criteria that the CRA uses to determine whether or not you are running a business:
- The profit and loss of the business in past years.
- The amount of gross income if any reported over several years.
- The length of time in which the business can be reasonably expected to be showing a profit, relevant to the nature of the activity.
- The extent of the activity related to businesses of a similar nature and size in the same locality.
- The amount of time spent on the activity.
- The qualifications of the business owner, including training, experience and education including eligibility for membership of a professional association.
- The individual’s intended course of action for the business to make a profit, for example preparing a business plan.
- That the business has enough capital to make it capable of showing a profit after depreciation, and the individual has the resources available to allow the business to develop and expand. This includes the ability to secure financing to make the business viable.
- That a degree of effort is spent in promoting and marketing the product or services supplied by the individual. This includes the registration of a trading name and opening and maintaining books and records.
- The type of expenses claimed and how relevant and reasonable they are to the activity, and if this expenditure will help the business to make a profit.
- The nature of the goods or services provided is such that a market exists or can be developed and there is potential for profit.
For more information see the CRA's P-176R – Application of Profit Test to Carrying on a Business