Income Tax and Self-Employment

As stated in my related article “3 Main Components of a Basic Tax Return”, if you are reporting income from self-employment in Canada, you must provide an income and expense statement which contains your total income for the year, a breakdown of operating expenses, and your net income or loss.


This article is directed to owners of small businesses and provides information about the income and expense statement and business operating expenses.

This information and additional details can be found in the Canada Revenue Agency (CRA) information booklet entitled “Business and Professional Income”, or on their website: www.cra.gc.ca.

Gross Income

Your gross income is your total sales, commissions, or fees.

Adjusted Gross Income

Your adjusted gross income is your gross income, less goods and services tax and provincial sales tax (GST and PST) or harmonized sales tax (HST) (if included in sales) and less any returns, allowances and discounts (if included in sales).

Gross Profit

Your gross profit is your adjusted gross income, less cost of goods sold (if applicable). Cost of goods sold includes:
1) inventory costs which are calculated as follows: opening inventory plus purchases during the year, minus closing inventory.
2) Direct wage costs which is the remuneration you paid to employees who work directly in the manufacture of your goods.
3) Subcontracts

Net Income

Your net income or loss is your gross profit, less business expenses. There are a number of operating expenses which can be incurred by your business during the year, including the following:

Tax Write-Offs for Self-Employed

1) Advertising
2) Meals and entertainment (generally limited to 50 %)
3) Bad debts
4) Insurance
5) Interest (paid on business-related loans)
6) Business tax, fees, licenses, dues, memberships and subscriptions
7) Office expenses
8) Supplies
9) Legal, accounting and other professional fees
10) Management and administration fees
11) Rent
12) Maintenance and repairs
13) Salaries, wages and benefits
14) Property taxes
15) Travel
16) Telephone and utilities
17) Fuel costs (other than vehicle)
18) Delivery and freight
19) Motor vehicle expenses (excluding CCA)
20) Allowance on eligible capital property (such as goodwill or a franchise)
21) Capital cost allowance (CCA) – see next section for description
22) Business-use-of-home expenses
23) Other expenses

The total of all these expenses is deducted from your gross profit to determine your net income or loss.

Capital Cost Allowance (CCA)

When you acquire an asset for use in your business, such as a vehicle, building, furniture, or equipment, you cannot deduct the full cost of the asset as an expense when calculating your net business income for the year. However, since these assets usually depreciate in value and wear out over time, you can deduct their cost over a period of several years. The deduction for this is called capital cost allowance (CCA).

There are specific rules which apply when claiming CCA and a detailed method of calculation. The rate of CCA, which is a percentage of the cost of the asset, varies depending on the type of asset involved. There are a number of asset classes, and the class in which an asset is included determines the CCA rate. For example, most motor vehicles are included in class 10, which allows a CCA rate of 30 % per year.

Refer to the CRA information booklet entitled “Business and Professional Income” or go to the CRA website: www.cra.gc.ca for additional details when claiming the CCA expense.

Record Maintenance

In order to simplify your task at year end, i.e. preparation for your income and expense statement and filing of your income tax return, it is essential that you maintain good records. This includes accurate recording of all income and expenses on an ongoing basis, as well as efficient filing and storage of all business-related documents, including invoices and receipts. It is recommended that you maintain separate files for each business expense.

The traditional “shoe box” filing method, often used by small businesses, is no longer practical. Invoices and receipts for a whole year were stuffed into a box and delivered to the bookkeeper, who had to sift through them and find the information required to complete the income and expense statement. This method is deficient for two reasons:

1) The excessive cost due to the time required on the part of the bookkeeper or accountant and their staff

2) The lack of current information available to the business owner/operator regarding the status of their business. In other words, there is no way of knowing how the business is doing at any given time, whether it is profitable or losing money, what operating changes are required, etc.

Conclusion

Operating a small business in today’s economy can be extremely challenging and demanding, due to increasing costs, competition, regulation, and customer expectations. However, the financial benefits derived from a successful small business, and the independence it affords, can be very rewarding. I hope that this article will enhance your entrepreneurial experience by providing information that clarifies and facilitates the often onerous task of income tax preparation.

Related: Please see the articles “Income Tax – The Agony and the Ecstasy” and “3 Main Components of a Basic Tax Return“.

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