5 Important Tax Deductions for Every Small Business in Canada

These business deductions are the only ones permitted in the Income Tax Act

Running a small business comes with its own set of challenges, not least of which is managing taxes. However, understanding and utilizing the various tax deductions available to small businesses can help entrepreneurs save money and optimize their financial returns. There are certain deductions listed in the Income Tax Act (ITA) of which small business owners should be aware when computing net taxes payable.

Section 8 of the Income tax act deals with business-related deductions. This section authorizes a number of deductions in respect to employment income. Section 8(2) contains a general limitation, which states that no deductions are permitted except those specifically enumerated in the Income Tax Act. This prevents people from making a “but for” argument in their deductions, i.e: but for this expense, I would not be able to do my job so it should be deductible.

Home Office Expense Deductions

If you operate your small business from a dedicated workspace in your home, you may qualify for the home office deduction. To be eligible for a small business deduction, your home office must be used primarily (more than 50%) as a place of business or regularly and continuously used to meet customers and clients. You can deduct employee expenses such as a portion of your rent, utilities, and maintenance costs, based on the square footage of your office space. When a home office deduction is available, the question of the appropriate amount of the deduction arises. In general, a deductible amount should be based on a reasonable allocation of costs attributable to the home office.

The most common method of allocation is to determine the amount of space occupied by the office compared to the total usable area of the home. A proportionate amount of the expenses are then taken as a business deduction. If you are an employee, this CRA publication lists the home office expenses that can be claimed. This specific CRA publication can be relied upon since the permitted deductions are listed in the Income Tax Act, and the Act does not allow for deductions other than those specifically listed. In general, the correct tax treatment is determined by looking to the relevant provisions in the Canadian Income Tax Act. This means that while CRA publications can be looked to for guidance, the publications are not legally binding and they do not consider the tax treatments of each taxpayer’s specific situation.

In addition, while the CRA is responsible for enforcing and administering the Income Tax Act, it’s not responsible for interpreting the Income Tax Act. As such, to interpret the law as written in the Income Tax Act one must look to the binding authority in the case law or consult with a Canadian tax lawyer. Even though the CRA itself is not bound by its own publications, they nearly always follow their own guidelines.

Assistant and Cleaning Expense Deductions

The expenses for the salary of an assistant are deductible under S.8(1)(i)(ii), as long as the payment to the assistant is required by an employment contract. Additionally, cleaning expenses for the home office are also deductible.

Travel Expenses Deductions

Expenses incurred by taxpayers to travel between home and the work location are generally considered to be personal or living expenses. In effect, the choice where to live is considered a personal consumption decision and commuting expenses are not deductible. However, if you use a vehicle for business purposes, you can deduct expenses related to its use in certain situations, counting them as tax deductions for travel expenses. Commuting expenses between a place of work and home office may be allowed if the base of the operation is the taxpayer’s house per the Exchequer Court of Canada’s ruling in Cumming[1]. In Ricketts[2], the taxpayer attempted to deduct motor vehicle expenses for travelling to his place of work. The House of Lords held that he was travelling to his primary place of work, and so s.8(1)(h.1) could not be used to deduct motor vehicle expenses. The House of Lords explained that expenses incurred by a taxpayer in commuting to and from his home to his place of work were not expenses incurred in the course of the taxpayer’s performance of his duties but rather expenses incurred in order to allow him to perform his duties.  Paragraph 8(1)(h.1) can only be used when the motor vehicle expenses are related travel for work purposes where the destination is not the ordinary place of business.

Deductibility of Supplies

Purchases of equipment, machinery, and supplies necessary for your business operations can be deducted. This includes office furniture, computers, printers, software, and other tools essential to your trade. However, certain items may have different treatment for tax purposes. For instance, certain assets may need to be depreciated over time rather than deducted in their entirety in a single year. It is recommended to consult with a top tax lawyer in Toronto to determine the correct treatment for tax purposes.

Deductibility of Meals

If you are traveling for business purposes, you can deduct reasonable meal expenses while you are away from your usual place of business for at least 12 hours. This includes meals consumed during business trips or overnight stays. The deduction is generally limited to 50% of the actual cost incurred. Meal expenses incurred while conducting business meetings or entertaining clients can also be deductible. This includes meals purchased in a restaurant or provided during conferences or seminars. Again, the deduction is typically limited to 50% of the actual cost. If you provide meals to your employees as part of their employment contract, the cost of these meals can be deductible. However, there are specific conditions and restrictions associated with this deduction, so it’s advisable to consult with a knowledgeable Canadian tax lawyer for guidance.

Additionally, it’s important to maintain detailed records and receipts for all meal expenses to substantiate the business purpose of the expenditure. Documentation should include the date, location, individuals present, and the business purpose of the meal. Keeping accurate records is crucial to support your deduction claims in case of a CRA tax review or audit.

Pro Tax Tip: The CRA has the power to question the reasonableness of any deduction

Section 67 allows the CRA to challenge a taxpayer’s business deduction on the grounds that it was unreasonable. Section 67 states that all deductions from any source, including an office or employment, must be reasonable in the circumstances to be deductible. This means that although an expense might otherwise be deductible according to the ITA, if the expense is deemed too excessive to the point that it is unreasonable, the CRA can disallow the deduction. For this reason, it is important to maintain proper documentation and records when deducting expenses, especially more costly expenses and when those expenses might not be easily understood as reasonable from the perspective of a third party. If you are unsure whether an expense is reasonable, it is advisable to consult with a top Canadian tax lawyer.

FAQ

Are the deductions for employees and independent contractors the same?

No. As an employee, your deductions are generally more limited in scope than expenses deductible by independent contractors. It’s important to note that the classification of a worker as an employee or an independent contractor is a fact-specific analysis. If you are unsure whether you are an independent contractor or employee, it is recommended to consult with an expert Canadian tax lawyer.

Can business deductions be carried over if not used up in the same year incurred?

Business losses can be used to reduce taxable income from the same business in future years. They can be deducted against other sources of income, such as employment income, in certain circumstances. Losses in a specific taxation year can be carried forwards or backwards If they cannot be fully deducted in that same year. These losses can be carried back three years or forward twenty years according to the Income Tax Act. Business owners have the flexibility to decide when to apply their carried-over losses against taxable income in future years. It is up to the business owner or the experienced Canadian tax professional to determine the most advantageous timing for utilizing the losses. Consider the profitability of your business and the potential tax implications when deciding to apply carried-over losses. In some cases, it might be beneficial to strategically time the use of losses to maximize their impact on reducing tax liability.

[1] Dr Ronald K Cumming v Minister of National Revenue, 67 DTC 5312

[2] Ricketts v. Colquhoun, [1926] AC