Do You Know Why the CRA Uses a Profit Test for Business?

By Randall Orser | Business Income Taxes , Small Business

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

What is Income Splitting and How Can it Reduce Your Tax Bill?

By Randall Orser | Business Income Taxes , Small Business

Income splitting is the transfer of income from a person in a higher tax bracket to a family member in a lower tax bracket.  The more you earn the higher your income tax bracket so “transferring” some of your income to a person whose income is lower than yours will result in having to pay much less tax.

The Family Tax Cut that allowed individuals to split their income with a spouse up to a tax credit of $2000 is no longer available, but businesses can use income splitting strategies still available to them.

There are two ways in which you can split your business income: 

  • By paying some of it in salary or wages to a family member 
  • Transferring some to family members in the form of dividends

Paying salary or wages to a family member means that you actually hire your spouse or children as employees and pay them from your business income thereby reducing your net income.  For example, if you earn $75,000 and pay your spouse $30,000 this reduces your income to $45,000 which is a lower tax bracket, and your spouse will be taxed even less as $30,000 is even lesser tax bracket, resulting in double tax savings for you both.  As great as this sounds there are strict rules on income splitting which involve hiring members of the family as employees.  

  • They must have duties to carry out the same as any other employee.  As with any other employee you must keep employee records to prove that your family member actually worked in the business.
  • You have to pay your family member the same wage as you would pay anyone else to do the same job.  You cannot overpay them for the job they do, the rate must be the same as other employees earn in the same industry.

Income splitting by Dividends is another way to pay your spouse or children, but you can only do this if your business is incorporated.  This tax strategy is very flexible in that the value of the dividends and those receiving them can vary from year to year.  Your corporation must be set up so that your spouse and children are shareholders then dividends can be distributed between them.  You can also structure your corporation so that there are non-voting share classes for family members so that they can receive dividends but not vote on decisions made relating to the company. 

For the 2018 tax year, the rules on split income received through dividends is changing.  For more information go to Revenue Canada guidance on split income rules for adults.  


Self Employed? Do You Know What Your Tax Obligations Are?

By Randall Orser | Business Income Taxes , Sales Taxes , Small Business

While self-employment comes with some great benefits, such as a flexible work schedule and freedom to select your work projects, you also have big responsibilities, when it comes to tax time. You are totally responsible for reporting your income and filing and paying your taxes.

It’s a good idea to get familiar with the CRA required self-employment tax forms. When you understand what you have to do, you can organize your finances, keep great records, and make tax filing much easier.

Do you need to file self-employment taxes? You are considered by the CRA to be self-employed if your business is one of the following: 

  • A sole proprietorship
  • An unincorporated partnership
  • An unincorporated limited liability partnership
  • An unincorporated general partnership

Your business income is then part of your personal tax return which means that you will pay the personal income tax rate rather than the corporate rate if your business was incorporated.  

Do you need a T4A?  Unlike when you are employed and receive a T4 from your employer, if you are self-employed as an independent contractor then your clients should send you a T4A slip which will include the dollar amount for each job you do for them.  To figure out your income you need to add the amounts from each slip.

However, you will not always get a T4A especially if you are selling goods direct to customers, they will not give you one. You will then be responsible for keeping accurate records of all of your income from receipts, invoices and any other proof of income.  It is a good idea to use a program such as Quickbooks to keep track and you can run a report to find out your total income for the year.

What is a form T2125 for?  This a Statement of Business or Professional activities which helps you to calculate your gross income as well as your business expenses which you deduct from your income to lower your taxable income.  On the T2125 you will have to provide the following information:

  • Information about your business including a description of your products and services.
  • Income from internet activities such as affiliate sales or ad traffic revenue.
  • Business or professional income.
  • The amount of GST you paid 
  • Costs incurred while making and selling your goods
  • Business expenses
  • Expenses paid for while running your business from home
  • Information about your business partners if you are in a partnership

Once you have completed form T2125 you will know your gross and net income for the year which you will enter on your T1 form. If you run a few businesses, then you will need to fill out a T2125 for each of them.

When Do You Need to Pay GST?  If your business makes more than $30,000 per year then you are required to register for a GST number and collect GST from your customers.  You will submit a GST return either monthly, quarterly, or annually.  

Tax Deadlines  If you are self-employed you will have until June 15th to file your tax return instead of the April 30th deadline.  However, you should still pay any taxes you owe by April 30th.  If you are employed in addition to running your own business, then you will have to file your T1 return by April 30th. Your clients have until the last day of February to send you any T4A slips.

 

What is CRA ReFile and How Does it Work?

By Randall Orser | Personal Income Tax

The CRA ReFile service allows you to send online adjustments for income tax and benefits returns using certified Netfile software and Efile software.  You or your tax service provider can send adjustments for 2018, 2017, 2016, and 2015.

Advantages of ReFile:

  • You will know how much you owe or what your refund is much quicker than making adjustments on paper.
  • It saves you money on postage and you use less paper
  • It is good for the environment as you use less paper
  • It is really easy to do

You must use ReFile with the same certified Netfile software that you used to file your income tax and benefit return.  If you filed a paper copy of your return then you will need to mail a paper form             T1-ADJ - T1Adjustment Request to the CRA.

You Cannot Use ReFile when:

  • You are amending an election, or you want to make an election for example on the Disposition of Property by a Taxpayer to a Taxable Canadian Corporation, (transferring eligible property to the corporation for consideration such as shares of any class in that corporation).
  • You are applying for child and family benefits.
  • You are allocating a refund to other CRA accounts.
  • You are applying for the disability tax credit.
  • You have a reassessment in progress.
  • You have a first return that has not been assessed – check on your MyAccount or have a notice of assessment paper copy to show that your return has been assessed.
  • You have to pay taxes in other provinces or territories.
  • Your first return was filed by the CRA as a 152(7) assessment.

You cannot use ReFile to make changes to personal information you need to use MyAccount to make the following changes:

  • Marital status
  • Address
  • Direct deposit details
  • Email address

The ReFile system only allows you to make nine adjustments per year.  If you go over that then you will get an automated response saying the limit has been reached and you will then have to file a paper request.

 

How Can You Claim Expenses on a Business Loss?

By Randall Orser | Business Income Taxes , Small Business

If you are a sole proprietor or partner and file your income taxes on a T1 you need to fill out a Statement of Business or Professional activities on a T2125.  Should your business expenses exceed your business income then you will record a business loss on this form.

"Using" this business loss depends on whether or not you have other income.  If you do you can use the income from your business to offset your other income. This is an advantage for people who work full time and have a side business as you can write off business losses against your regular income.  If you don’t have other income your business loss will not be a tax advantage for you.

Using Your Business Loss in a Different Tax Year  If you have personal income you can offset your business loss up to three years back or seven years forward from the year of your business loss, therefore it can make sense to use your business loss to offset a larger tax bill in the future or the past.

Beware! you Cannot Write off Business Losses Forever  According to the CRA your business should have a “reasonable expectation of making a profit” and will eventually generate more income, reduce losses and become more profitable.  If you continue to write off business expenses for a number of years, then the CRA will decide that you decide that your business does not meet this expectation and will deny your claim for business losses in the current year and will assess your losses in previous years.  See Canada Revenue Agency Profit Test.

Your Business Must be Legitimate  Your business must be seen to be “clearly commercial in nature”.  If you have a full-time job and start a side business, you must have customers and revenue. Otherwise your business expense claims may be denied by the CRA if they decide that your business is not a sufficiently commercial operation.

Incorporation  If your business is incorporated you cannot use business losses from the corporation to offset your other income, except in some cases where investment losses result may from share dispositions or debt. 

Claim Reasonable Expenses  To avoid raising red flags which may result in a CRA audit you should always be reasonable with your expense claims.

From an article by Susan Ward

What are Input Tax Credits?

By Randall Orser | Business Income Taxes , Personal Income Tax , Small Business

Input Tax Credits are the amount that your business paid, or the allowable portion of the GST you paid.  They allow you to recover GST you paid out on business purchases or expenses.  You must be registered for the GST to use Input Tax Credits.  Once you have done this you need to start keeping track of the GST you have paid and enter it into your bookkeeping system.  As with all expenses you need to keep all your receipts to support your claims.

What qualifies as Input Tax Credit?

Some of the expenses that you can claim as Input Tax Credits include:

  • Rent
  • Equipment Rentals
  • Advertising expenses such as business cards, ads and flyers
  • Accounting, legal and other professional fees
  • Home office and motor vehicle expenses
  • Office expenses including postage, computers, pens etc.
  • Travel including hotels, airfare, car rentals

These capital expenses also qualify:

  • Capital property
  • Machinery and vehicles
  • Furniture and appliances
  • Improvements to capital property

You can only claim Input Tax Credits for anything related to your business not for personal expenses.  The purchase or expense must also be what the CRA deems reasonable in nature as well as cost.  You cannot claim Input Tax Credits on:

  • Taxable goods and services bought or imported to provide exempt goods and services
  • Some capital property
  • Memberships or dues to any club whose main purpose is for recreation – this includes fitness clubs, golf clubs and hunting and fishing clubs unless the membership is bought to resell in 

For more information a full list is available on the CRA website

What Happens if You File Your Income Tax Return Late

By Randall Orser | Personal Income Tax

Are you procrastinating about filing your tax return? Wondering what will happen if you file late?  Well what happens will depend on whether you have to pay this year or whether you will get a refund.

Late Filing Penalties:

Those who file individual tax returns late and have a balance owing to the CRA will be subject to a late filing penalty: 

  • 5% of your balance owing, plus
  • An additional 1% of your balance owing for each month your return is late up to a maximum of 12 months

If you have already been charged a late penalty in any of the three previous years, then your penalties for the current year will increase to:

  • 10% of your balance owing, plus
  • 2% of your balance owing for each month your return is late up to a maximum of 20 months

So, to save yourself money you need to file on time by the 30thof April.

Exceptional Circumstances That Can Result in Late Filing:

If you are filing late due to circumstances beyond your control, then the CRA may waive the late filing penalty and interest for more information see IC07-1: Taxpayer Relief Provisions. The CRA will considers the following exceptional circumstances:

  • If you have suffered a serious illness or accident
  • You in emotional distress from a divorce or death of a family member
  • You have suffered a disaster such as a flood, fire, or earthquake
  • If you are filing by mail and there is a disruption of service due to a mail strike

You may also be able to avoid penalties when your delay in filing is a result of action by the CRA such as:

  • Processing errors by the CRA
  • Incomplete or incorrect information on the return which has to be corrected or where the CRA asks for additional information
  • A CRA delay in processing which results in a late assessment of your balance owing
  • Delays caused as a result of reviews, audits, objections or appeals

Financial Hardship:

The CRA can also cancel all or some of your penalties and interest if your inability to pay is due to financial hardship caused by loss of employment, loss of business income, medical bills etc.  If you are unable to pay you will need to provide the CRA with detailed financial information including statements of assets, income, liabilities and expenses. 

If you are unable to pay the amount that you owe on your taxes by the filing deadline you should still file your return on time to avoid late filing penalties.  

From an article by Susan Ward

How to File Your Income Tax Return Electronically

By Randall Orser | Personal Income Tax

Out of more than 25 million tax returns filed each year over two-thirds are filed electronically.  This number is going to grow as the CRA is encouraging people to go paperless 

There are two ways to file your return electronically. If you do your own return you can file through Netfile.  If you have your return done for you or you do one for others you need to submit those returns through Efile Online.  

It is important to keep your personal information up to date with the CRA for the best results when filing electronically.  It is a good idea to set up a MyAccount on line with the CRA so that you can check the status of your return as well as sign up for direct deposits of your tax refund and GST payments. 

Service Canada’s My Service Canada Account or MSCA gives you access to your employment insurance, old age security and Canada pension plan information.  It will also give you access to electronic versions of your T4’s for these services.

Netfile only processes tax returns from the current year, so if you are filing for previous years or wish to make amendments to previous returns you will need paper copies of the relevant tax return forms.   You also cannot use Netfile if you have declared bankruptcy or if you have income from a different province to the one where you live.

When you file electronically you need to collect all your T4’s and T5’s which show your employment and investment income.  You should also have last year’s notice of assessment which shows your RRSP limits and deductions you can carry forward.  You will also need all receipts that support claims for deductions and tax credits such as medical expenses and children’s activities.  You need to keep all your receipts in case you have a future review or audit. 

You will need to use certified software such as TurboTax to prepare your return which will also guide you through the Netfile process.  

For more information about filing with Netfile see https://www.canada.ca/en/revenue-agency/services/e-services/e-services-individuals/netfile-overview.html

From an article from Turbo Tax

Tax Strategies to Reduce Small Business Income Tax

By Randall Orser | Small Business

Are you the owner of a small business that is a sole proprietorship or a partnership and you file your taxes using a T1 Personal Income Tax Return? Here is a list of small business tax strategies that you can apply to your return this year to lower your income tax bill.

  • Always collect receipts for business related activities – it’s amazing how quickly those receipts for parking to meet a client, or having coffee or lunch with a client, mailing letters and picking up coffee for the office can add up especially over a year. Make sure you record and keep all business-related receipts.  The CRA does not normally accept credit card statements as proof of expenditures– you need to keep your original receipts in case you are audited.
  • Manage your RRSP and TFSA contributions – these are both good income tax deductions for small business owners.  As the tax savings are based upon your marginal rate tax it is a good idea to carry forward any allowable tax deductions to subsequent years when you are making a higher income.  A Tax-Free Savings Account allows you to shelter savings and investment income from taxes. If you are maxed out on your RRSP contributions this is a good choice to put tax free cash or investments.
  • Maximize your non-capital losses – When your expenses exceed your income in any year you can use this loss to decrease your income tax bill.  Non-capital losses can be used to offset other personal income in any given tax year and can be carried back three years or carried forward for up to seven years. It makes sense to figure out when it will be to your biggest tax savings advantage to use your non-capital loss. It could be to recover back taxes already paid or to offset a future larger tax bill.  For more information see: Claiming Expenses on a Business Loss on Canadian Taxes
  • Maximize your charitable income tax credits – charitable donations earn you tax credits but those over $200 give you more credit as they are assessed at a higher rate.  Before you donate more of your income be aware that non-registered Canadian charities, American charities, and political parties do not count as charitable income tax donations.
  • Maximize your Capital Cost Allowance – in Canada small businesses deduct the cost of depreciable property over a period of years.  However, some business owners may not be aware of this and that they don’t have to claim in the year that it is purchased.  You can actually use it in a future year to offset a large tax bill rather than in a year when you have little taxable income.  You should also make sure to buy and sell your assets at the right time. New assets before the end of your fiscal year and sell old assets after the current fiscal year.  Lastly be aware of the 50% rule - in the year that you acquire an asset you are only able to claim 50% and sometimes under the “available for use” rule you cannot claim until the second year after you acquired an asset.  Two links for further information – Learn about calculating and claiming Capital Cost Allowance and How to Claim CCA on a Vehicle Bought for Business Use.
  • Split your income – By transferring some of your higher marginal rate income to a family member with a lower income you can reduce the marginal tax rate on your income.  For example, employing your wife or child in your business and paying them $10,000 per year would mean that they pay very little tax and you will decrease your income for tax by $10,000.  You do however have to make sure that you keep accurate records for their employment as you would any other employee.
  • Take full advantage of all income tax deductions available to home-based businesses– for more information see Business Use of Home Deduction and 6 Home-Based Business Tax Deductions you Don’t Want to Miss.
  • Incorporate your business – Incorporating a business has tax advantages such as the Small Business Tax Deduction where the income of Canadian held corporations is taxed at a special reduced rate.  However, incorporation is only effective if your business has grown enough to make it worthwhile as you need significant income to offset the costs of incorporation and you need to leave enough of your business earnings in the corporation to benefit from corporate tax deferral.  See Should You Incorporate Your Small Business for further information.

Now you can start to think about tax planning and strategies to reduce your tax bill

From an article by Susan Ward

10 Red Flags That Can Trigger a CRA Audit For Your Small Business

By Randall Orser | Small Business

All businesses dread getting a letter notifying them that they are subject to a CRA audit.  Business returns are especially scrutinized by the CRA and it is impossible to avoid an audit. However, here are 10 red flags you should pay attention to which will increase your risk for an audit.

  1. Revenue Discrepancies – your revenue will be compared across all tax forms. The revenue declared on your GST forms will be compared to that on your income tax form, your spouse’s return, and information on tax returns provided by employers, financial institutions, and other third parties.  If they don’t match, then it’s a sure-fire way to attract a CRA audit.
  2. Declaring Income That is Far Below or Above the Norm for Your Industry Will Draw Attention.  The CRA knows what the income and profit margin for your industry should be and will compare your return to what is the norm.
  3. Deducting Large Business Expenses – being able to deduct business expenses is a big tax advantage of running a small business.  However, expenses for advertising, promotions, meals and entertainment, travel, miscellaneous, and interest expenses will be scrutinized by the CRA.  Claiming large deductions in any of these areas can attract attention. 
  4. Claiming the Home Office Deduction – if you qualify for the home office deduction it is a great deal as you can deduct a percentage of your rent, real estate taxes, utilities, phone, insurance etc.  However, you must only use this work space in your home to earn income and to meet with clients regularly.  If you are not doing so then you should not claim this deduction.
  5. Claiming 100% Business Use of a Vehicle – this is a big red flag for the CRA as they know that it is very rare for an individual to use their vehicle 100% of the time for business.  It is also a very easy expense for auditors to disallow as few people keep the required logbook to actually record their mileage.
  6. Changes in Shareholder Loans and Large Balances – changes in shareholder loans or balances are red flags to the CRA.  They look for personal expenses recorded as business expenses and loans taken from the company.
  7. Running a Cash-intensive business – businesses that deal in a lot of cash such restaurants, hair salons, bars or other retail have the opportunity to take cash and not report all of their taxable income so you should expect extra scrutiny from the CRA.
  8. Reporting Several Years of Business Losses in a Row – is likely to earn you an audit especially when those losses are used to offset other incomes.  The CRA expects all businesses to have a reasonable expectation of profit and the CRA’s idea of that may differ from yours.
  9. Making Large Charitable Donations – the CRA knows what taxpayers at your income level usually give to charity so if your donation exceeds that amount it can cause a red flag to pop up.
  10. Not Following the Rules for Employing Your Spouse or Child in Your Business – this type of income splitting is legitimate, but businesses not following the rules may become a target for the CRA.

In addition to these red flag triggers individuals who claim self-employment status are also liable to scrutiny from the CRA especially if you do not follow the self-employment rules.  Although the CRA does conduct a certain number of audits each year just to check compliance, you can somewhat control your chances of being chosen if you pay attention to these red flags.  In any case it is prudent to keep meticulous bookkeeping so that you have all the information to support your tax claims.

For more information see:  The Tax Advantages of Self-Employment and Independent Contractor vs Employee: Which One Are You?

From an article by Susan Ward