Tax Guide: Canadian Small Business Tax Preparation in Canada

‍Whether this is your first or fiftieth tax season as an unincorporated small-business owner, there’s plenty to learn about the ins-and-outs of the Canadian tax system.

Items like location, legal structure, and employee base will impact what you’re required to collect and remit.  As a startup, e-commerce business, or professional service, you’ll want to have an idea of the relevant deadlines and forms. To prepare you, we’re going to cover some of the most common documents, deductions, and processes to keep in mind for the year ahead.

Business Tax Types

You’ll be required to report different tax forms depending on your business structure. As an unincorporated small business or sole proprietorship, you'll be required to file a traditional T1 personal income tax form alongside a T2125 statement of business or professional activities. T1 tax returns for self-employed individuals (including form T2125) must be filed by June 15. However, most tax professionals recommend that individuals file their taxes before the regular April 30 deadline, because you’ll be charged interest on any taxes you owe starting April 30.

Logically, the next question you might ask than is how to tell if you're a sole proprietor or partnership. If you made any income outside of your regular employment income (i.e. the regular salary and wages your employer pays you) and you don’t run an incorporated business, the CRA will probably recognize you as a sole proprietor or member of a partnership.

Note that the law doesn’t consider sole proprietorships or partnerships to be individual legal entities, so they’re not taxed as such. Instead, sole proprietors and partners report their income on their individual T1 tax return.

The CRA will typically look at four major factors to determine what kind of relationship an individual has with their employer:

1. Control over how and where you work
2. Tools and equipment
3. Financial risk
4. Opportunity for profit

If your employer sets your hours, decides when and where you work, controls how your work is done, sets your salary and supervises you, you’re an employee, and you shouldn’t use T2125 to report your income.

If you control your hours, decide when and how you carry out your work, provide your own equipment, assume most of the business costs associated with the work, and you incur a profit or a loss, you’re a sole proprietor or partner, and you should use T2125.

That said, you’ll begin to rely quite heavily on deductions to reduce the amount taxable.

Business Tax Deductions

Deductions are a bright spot in the tax filing process. Throughout a given year, your business and team will incur various expenses as a part of operations. These expenses are used to reduce taxable income. Although the deductions available depend on your business structure, there are several core items worth noting:

1. Business-Use-of-Home - Deduct the use of a workspace in your home, including maintenance, utilities, taxes, and mortgage interest. The amount claimable is calculated by determining the space used for business purposes and assessing the total time spent working there.
2. Supplies - Deduct the cost of items used indirectly to provide your goods or services. For example, cleaning supplies for a plumber.
3. Capital Cost Allowance - Depreciate business-related assets and equipment over time. Although somewhat complex, it’s a core piece of a successful tax season. Here’s more on how to use the CCA correctly.
4. Meals and Entertainment - Deduct up to 50% of the money spent on meals and entertainment as a means of generating business income.
5. Business Vehicle - Deduct the expenses incurred to run a motor vehicle for business purposes.
6. Professional Services - Deduct fees incurred for external professional advice or services, such as consulting, accounting, or legal.
7. Travel - Travel expenses incurred to earn business income. This category includes transportation, hotel, and meals.
8. Rent - Deduct the rent paid for business-use properties.
9. Payroll & Employee Benefits- Deduct gross salaries and any other benefits paid to employees.
10. Insurance - Deduct all regular insurance premiums related to business buildings, machinery, and equipment.
11. Interest on Loans - Deduct interest incurred on money borrowed for business purposes or to acquire business property.

For a complete list of business deductions, check out the government’s Business Expense Guide.

You’re going to want to pay special attention to recordkeeping in order to claim deductions and avoid issues with the CRA successfully. Documenting transactions will ensure that you have a complete story if an audit were ever to arise.

Preparing Your Business Tax Return

With a new understanding of tax types and deduction sources, it’s time to decide how you will file the business’s return. The two most common approaches will be contacting an accountant to get their professional support or completing the return solo with online tax software. Both come with unique pros and cons:

1. An Accountant is going to be your ideal solution come tax time. Not only will they ensure that the return is done correctly, but they’ll maximize your tax savings along the way. Although more expensive than the self-serve online alternative, the time savings and minimized frustration justify the cost.
2. An online Tax Software will provide you with the tools you need to navigate tax time solo. Although not as supportive as a tax professional, modern software does an excellent job of ensuring you cover your bases. With tools like TurboTax and Wealthsimple Tax, you can feel confident that you’re covering all of your input, deductions, and tax-saving opportunities.

The foundation for this year's tax season began the moment last year's tax season ended. It’s critical that your business keep documents, receipts, records, and relevant files organized throughout the year to ensure that chaos doesn’t ensue come tax time. Whether you accomplish this with in-house systems or the help of an expert bookkeeping service, the key to success is clarity.

Next Steps

With that, you should now feel confident in tackling the tax season ahead. As your business evolves, so will its complexity. Pay attention to the work involved in your return and the insights gathered along the way.

If you’re finding that too much time and effort is being spent on the process, it may be worth looking for professional accounting support next year. If your books are a complete disaster, with scattered documents and files, you may benefit from enlisting the help of a professional bookkeeping team. If the business structure you’re operating under appears to be outgrown, it may be worth having the incorporation discussion.

If there’s anything you’re still unsure about, don't hesitate to get in touch with our team.