For Canadian taxpayers looking to setup a small business the issue of taxes can be daunting. This article seeks to provide some of the basic concepts and issues to help guide new businesses to stay compliant with their Canadian tax obligations.
Form of Business
One of the most crucial choices that a small business makes is the form of organization they create. There are three common business forms in Canada: sole proprietorship, corporation, and partnership. Each form carries with it different benefits and issues that should be considered when starting a business. This article, however, is only concerned with the different effects that the form of organization may have on tax obligations. For a more in depth look at these forms of organization see our previous article here.
General Tax Accounting
The accrual method is the main tax accounting method in Canada. Most businesses follow it with only a few exceptions, such as farmers and fishers who can elect to use the cash method. The accrual method requires income to be reported in the fiscal period that it is earned, no matter when the income is received. Similarly, allowable expenses in the fiscal period are reported as they are incurred, regardless of whether they are paid for in that period.
Business vs Capital Income
In Canada, distinguishing between business income and capital gains for tax purposes is vital. Business income arises from profit-oriented activities, while capital gains stem from property sales, including investment income. The classification can be intricate, with factors like property nature, ownership duration, transaction frequency, work involvement, sale circumstances, and the taxpayer's motive playing key roles. Business income is fully taxable, with losses deductible against non-capital income and the ability to carry losses forward a limited amount of time. In contrast, only 50% of capital gains or losses are taxable or deductible, with the option to carry losses indefinitely. For further information please see our article here. You can also learn about small business capital gain exemptions.
Tax Year for Income Tax Purposes
Regardless of the form your business takes, you will have to report your business income on an annual basis. For sole proprietorships, professional corporations that are members of a partnership, and partnerships in which at least one member is an individual, professional corporation or another affected partnership, your business income is generally reported on a calendar-year basis. This can be changed for sole proprietors or for members in partnerships where all the members are individuals to a non-calendar-year fiscal period through form T1139, Reconciliation of Business Income for Tax Purposes. Whereas, a corporation's tax year is its fiscal period, which cannot be longer than 53 weeks. New corporations can choose any tax year-end as long as its not more than 53 weeks from the date the corporation was incorporated. The corporation has to file its income tax return within six months of the end of its fiscal period. An additional consideration should be given to how your fiscal period-end for income tax purposes may affect your GST/HST reporting periods, as well as your filing and remitting due dates, if you are a GST/HST registrant. Be sure to learn how to file GST and HST returns for your small business in Canada.
Capital Cost Allowance (CCA)
In your business activities, you might acquire depreciable property. This includes property, such as a building, furniture, or equipment, that may wear out or become obsolete over time. You cannot deduct the full cost of this depreciable property when you calculate your net business or professional income for the year in which you acquired the property, rather the ITA allows you to deduct their cost over a period of several years. This yearly deduction is called the capital cost allowance (CCA). CCA is usually calculated using the declining balance method, where the CCA rate is applied against the remaining balance each year. For the first year you acquire a depreciable property, you can usually claim CCA only on one-half of the net additions to a class. Certain properties, like land and living things, are ineligible for CCA. Additionally, CCA claims may lead to recapture or terminal loss when disposing of property.
There are various small businesses deductions in Canada as listed in the Income Tax Act ("Tax Act"). These deductions, which fall under section 8 of the Tax Act, deals with business-related deductions and no deductions are permitted except those specifically enumerated in the Tax Act. There are five available for small businesses.
- Home Office Expense Deductions: Small business owners who operate from a dedicated home office may qualify for a home office deduction. This deduction covers expenses related to rent, utilities, and maintenance, based on the percentage of the home office's square footage. The CRA's guidelines are usually followed, but consulting with a Canadian tax lawyer is advisable for specific cases.
- Assistant and Cleaning Expense Deductions: Expenses for an assistant's salary are deductible if required by an employment contract. Additionally, cleaning expenses related to the home office can also be deducted.
- Travel Expenses Deductions: While commuting expenses between home and the primary place of work are generally not deductible, travel expenses for business purposes can be claimed if the home office is the base of operations.
- Deductibility of Supplies: Purchases of equipment, machinery, and supplies necessary for business operations can be deducted. Some assets may need to be depreciated over time.
- Deductibility of Meals: Meal expenses while traveling for business purposes are deductible if you are away from your usual place of business for at least 12 hours. The deduction is generally limited to 50% of the actual cost incurred. Meals during business meetings or entertaining clients can also be deductible, subject to restrictions.
For any deduction that is claimed it is crucial to maintain detailed records and receipts for all expenses, including meal expenses, to support deduction claims in case of a CRA tax review or audit. For further information on these deductions see our article here.
Employees and Payroll
Canadian employers are responsible when it comes to payroll for withholding taxes of employees. Thus, employers are required to register for a payroll program account with the Canada Revenue Agency (CRA). Employers are responsible for correctly classifying employees and independent contractors. Employers must withhold certain amounts from employee pay, including Canada Pension Plan (CPP) contributions, Employment Insurance (EI) premiums, and income tax. The classification is a legal matter, and it's essential to make the right determination.
Remitter Type and Deadline
Remitter type is determined by your average monthly withholding amount from two calendar years ago and affects your remitting frequency and due dates. The due dates apply to remitting periods and nil remittances (for seasonal workers or no employees). Different remitter types have different payment due dates, based on their average monthly withholding amount and compliance record. Remitter types include quarterly remitters, new small employers, regular remitters, and accelerated remitters. Special situations such as having no employees or only seasonal workers (nil remittance) or making a final remittance have specific due dates. Depending on the category, employers are required to remit payroll deductions to the CRA online payroll on specific due dates. For example, regular remitters remit on the 15th day of the month after paying employees. The amounts withheld from employee pay are held in trust for the government and should be remitted promptly. Failure to withhold and remit payroll taxes is a common issue that can lead to problems with tax authorities.
Generally, a taxpayer must register for a GST/HST account if he/she makes taxable sales, leases, or other supplies in Canada and he/she is not a small supplier. For most businesses, the small supplier limit is $30,000 over four consecutive calendar quarters. If you do not exceed this threshold, then you do not have to register, although you can choose to register voluntarily if you make taxable supplies. If you exceed the $30,000 threshold in a single calendar quarter, you are no longer a small supplier and must register for the GST/HST and your effective date of registration is the day that caused you to exceed $30,000. If you exceed the $30,000 threshold over the previous four (or fewer) consecutive calendar quarters (but not in a single quarter), you are no longer a small supplier at the end of the month following the quarter when you exceeded $30,000. You must register for the GST/HST, and your effective date of registration is set at the beginning of the following month.
When to Remit
The reporting and remittance requirements for GST (Goods and Services Tax) and HST (Harmonized Sales Tax) in Canada is based on annual revenue. Businesses with annual revenue of $1,500,000 or less are required to report and remit GST/HST annually. The annual reporting period typically ends three months after the business' fiscal year's end. Between an annual revenue of $1,500,000 and $6,000,000, businesses are required to be reporting quarterly. The GST/HST return and remittance should be completed within one month after the end of each reporting period. Businesses with more than $6,000,000in annual revenue must report and remit GST/HST monthly. The return and remittances are also due within one month after the end of the reporting period.
Individual business owners with business income for income tax purposes, who file annual GST/HST returns, and have a December 31 fiscal year-end, are required to make their GST/HST payment by April 30th. However, they have until June 15th to file their GST/HST return. Small Suppliers are generally not required to register for and collect/remit GST/HST. Voluntary registration is possible.
Input Tax Credit
Input Tax Credits (ITCs) allows GST/HST registrants to recover the taxes they have paid on their purchases and expenses related to their commercial activities. To claim ITCs, your purchases and expenses must be related to your commercial activities. Expenses or purchases must be reasonable in quality, nature, and cost for your business. If you're a new registrant, you may be able to claim ITCs for GST/HST paid on property and inventory you had on hand when you registered. ITCs can typically be claimed for common business expenses and purchases. Most registrants have four years to claim ITCs, however certain financial institutions and businesses have a two-year limit.
You need specific information on invoices, receipts, contracts, or other business documents to support your ITC claims. Requirements vary depending on the total sales amount, including supplier's business name, invoice date, amount paid, GST/HST indications, business numbers, buyer's information, property or service description, and payment terms. In some situations, the documentation requirements may be reduced.
Tax residence is an important aspect that differs whether the business is a separate entity, like a corporation, or not, like a sole proprietor. If your business is run as a non-separate entity, then there would be no separate tax return and the business taxation would be part of the taxes of the owner or partner. Residence of a corporation, however, can be more complicated and is determined based on common-law principles and statutory provisions. For a corporation to be a small business corporation in Canada it can either be incorporated in Canada or resident in Canada from a specific date. For a non-Canadian Inc. Corporation to become a resident involves examining the central management and control of a corporation. This involves looking at with factors like where principal business is conducted, the location of records, and director residence considered. Deeming provisions also exist for corporations incorporated in Canada after a certain date or those carrying on business in Canada. Changes in the residence of the shareholders residence can affect a corporation's residence, which can have consequences involving departure taxes.
Withholding tax is a tax paid to a government by the payer of the income as opposed to the recipient of the income. Thus, if your business is making payments to non-residents, then it may need to withhold taxes. The withholding tax is set at a flat rate of 25% of the payment made to a non-resident. Canada, however, has signed tax treaties with many other countries which typically reduce the rate of withholding tax on certain payments. If you are uncertain whether the payee is a Canadian taxpayer, then it would be advisable to retain some form of verification whether they are or not. For more information on withholding taxes see our article here.
Small Business Deduction (SBD)
The SBD is a tax credit under Section 125 of the ITA provides a favorable tax rate to certain Canadian corporations. The standard federal corporate tax rate is 38%, but the SBD reduces it to 28% by providing a 10% abatement for income earned in a Canadian province. The SBD offers an even lower rate for certain businesses. To qualify for the SBD, a corporation must be a Canadian-Controlled Private Corporation, earn active business income, and share the SBD with associated corporations. Active business income includes income from any business, except specified investment businesses or personal service businesses. For a fuller explanation on SBD see our article here.
Get Professional Advice
Consult with a knowledgeable Canadian tax lawyer to ensure your business complies with tax laws and is maximizing small business tax benefits. This checklist provides a starting point for managing tax issues for small businesses; however, this is nonetheless a generalized overview of the tax system. For tax planning and proper legal determinations essential it is prudent to consult with a Canadian tax professional for personalized guidance based on the specific business situation.
How do I know if I need a tax lawyer or tax accountant for the tax issues I am facing in starting a business?
The decision as to when to retain a Canadian tax lawyer in Toronto and when an accountant depends on the exact nature of the tax help needed. While there is overlap between what an accountant and lawyer do, there are also areas where a one professional should be the one sought out for help. If you are unsure as to what is appropriate in your case, then contact us and we will provide you with tax help or refer you to an accountant. If you wish to read more about circumstances where a lawyer or accountant may appropriate see our article here.
What Personal Expenses Can I Run Through My Business?
While other expenses can be claimed, taxpayers are prohibited from claiming personal expenses as business expenses. Doing so could result in major legal consequences as it would likely constitute tax evasion and make the taxpayer liable for significant financial penalties and potential imprisonment. A Canadian tax lawyer would be able to assist you in determining and calculating appropriate expenses to be cleared.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.