Are you a small Canadian business owner? Then you know how much work it takes to build up your company, especially in the early days. And you want to keep more profit by reducing your income taxes as much as possible legally.
Fortunately, there are ways to do just that. This guide provides a list of the best strategies for keeping more money out of the taxman’s hands and in your business. Keep reading to find out how to save tax in Canada legally.
10 Ways to Reduce Your Small Business Income Tax
When you run a business, it’s vital to arrange your finances in such a way that your tax burden is lowered as much as possible. With proper tax planning, you don’t just reduce your tax liability but save for your future business goals. This makes tax saving one of the most crucial financial planning tools for your business.
- Maximize Your RRSPs
Like death, taxes are certain. However, there are credits and deductions you can take advantage of to maximize your rebate or refund.
One such method is to contribute to your Registered Retirement Savings Plan (RRSP) each year. These contributions are tax-deductible, so you can save on your taxes upon filing a personal return and enjoy tax-free growth on your savings.
Warning: Make sure that your RRSP contributions never exceed the limit. Otherwise you’ll be subject to a 1% penalty for every month the over-contribution remains.
- Deduct Employment Expenses
Are you an employee who wants to save on your taxes? Then you can take advantage of deductions on your employment expenses. If your employer needs you to pay expenses in order to earn your employment income, you can calculate the deductible expenses using this guide. Certain expenses, like deductions on your return, are included in employment-related expenses, which also consist of office expenses, supplies and vehicle expenses.
To claim these employment expenses when filing income tax return, you need to obtain a completed T2200 tax form from your employer. This is also known as a Declaration of Conditions of Employment. Everything about your duties, expenses, travel and commission, and whether you need to work from home for a certain period is recorded in this form.
Employment expenses are only deductible if you’re required to pay for them as a condition of employment, but your employer doesn’t reimburse you. Remember that you don’t need to immediately submit this form to the Canada Revenue Agency (CRA), but you should keep it with you in case they audit you.
- Borrow Money to Invest
Investments are taxable. However, with the right planning, you can get more money on your tax returns. Of course, dividend investments such as stocks have certain tax advantages over other investment types, such as bonds and term deposits.
Thanks to the Dividend Tax Credit, this can be a tax savings investment for individuals. In Canada, only half of your capital gains from these investments are taxed. While your interest income is fully taxable, dividends from reliable sources, such as shares in Canadian public companies or mutual funds, can be beneficial for you. Therefore, with the right financial plan and careful investing, you can make more money in the stock market.
But to do this you must borrow money from reliable sources. Doing so with the intention of investment increases your purchasing power as well as your stock portfolio size. When you invest this money to buy stocks, bonds and mutual funds, the interest you earn is tax-deductible and increases your tax savings.
- Buy Your Home Tax-Free
What many first-time homebuyers don’t know is that they can partially access their RRSP savings when buying a home. Implementing the Home Buyers Plan is a great way to use money from your RRSP to buy a new home without paying taxes.
It works like this. You are exempted from taxes when you withdraw part of your RRSP to make the down payment on your house purchase. However, $25,000 is the limit to how much you can borrow. The keyword here is ‘borrow’, as you have to repay the amount you withdraw from your fund in the next 15 years in equal yearly payments. But it would help if you made the first compulsory repayment in the second year after you buy the home.
- Claim Medical Expenses
Another strategy to obtain a tax credit is to file your return for the medical expenses you pay annually. Everything from payments to a medical practitioner, the cost of prescription drugs and specific medical devices to medical premiums paid to your insurance company can be included.
To make a claim, you need to have all your medical receipts in case of a CRA audit. However, not every type of medical expense qualifies, and there is a limit on the costs over which you can claim medical expenses. This minimum amount, also known as the ‘threshold’, for 2019 is either 3% of your net income or $2268, whichever is less.
To maximize the amount you can claim, one clever option is to combine the medical expenses of your children, spouse and other family members into one person’s tax return.
- Start a Business
By owning a business, you can deduct tax-related expenses and your net income is increased in the process.
There are many innovative ways to expand your business or start a new one. These include using your personal car for business purposes, maintaining a home office and claiming its expenditure, and having salaried friends and relatives working as an employee in your side business.
While it is true that your tax bill will be lessened through a side business, this technique does not apply to everyone. Consider a side business that can give the maximum ROI to truly see a significant difference in your bank balance by saving your tax returns. A net increase is only possible when the side business has minimum investment, maximum profit and significantly high tax returns.
- Make New Investments to Gain Tax Breaks
While planning an investment, keep its effect on your tax in mind.
An investment like stocks is a preferential tax break for both capital gains and dividends. On the other hand, any fixed-income investment, like a fixed deposit, is not beneficial for your taxes as the changing rate of inflation can cost you money.
Many people have a tax-protected retirement portfolio and income portfolio. If you have these, keep a smaller percentage of your fixed-income investment in the taxable portfolio to get a better tax return.
- File Your Taxes on Time
By paying your taxes before they’re due, you avoid late fees, which can be significant, depending on your business type and how long you delay payment.
Self-employed people have until June 15 of the fiscal year to submit their taxes. However, if you owe the CRA, pay by April 30. Failing to do so makes you liable for a hefty fine. For business owners eligible to submit their taxes by June 15, not doing so will lead to a 5% late penalty and 1% interest every full month thereafter up to a maximum of 12 months.
- Keep Diligent Records
To maximize your claim, you’ll need the relevant evidence. This is only possible if you maintain a diligent record of every expense, payment, bill and any other financial document associated with the business.
If your payslips and receipts are mostly in hard copies, scan and document them digitally; in this way you reduce the liability of lost hard copies. Maintain separate files for the different types of bills your business incurs. Take a similar approach with the digital versions by storing them in separate folders. Thorough documentation is particularly helpful for small businesses, which often don’t have dedicated bookkeepers and accountants. These proofs are necessary when filing for claims.
- Reduce Home Office Expenses
Some business owners operating from home neglect to calculate the utility costs for running their home office. Money spent on internet, stamps, repair, maintenance and accessories may not be much individually but can add up to a significant amount you can claim when filing your income tax. The CRA will need the accurate percentage calculation of your home space allocated for the business to determine the claim amount. This will include the rent, mortgage interest, utilities and other expenses related to the business.
There are legal ways to save a significant amount on your small Canadian business tax returns and, as a result, increase your overall income. Just implement the tips outlined here so you can start maximizing your profits by next year.