If you operate a small business in Canada, you’re probably aware of how essential it is to file a business income tax return.
However, not all entrepreneurs know about business taxes or have an experienced accountant to offer advice. This can lead to costly mistakes and unnecessary stress, especially for startups.
If this is the first year you’ll be filing an income tax return as a small business owner, there’s a lot you need to know.
From maximizing income tax deductions to calculating taxable income, here’s a guide to help you understand small business taxes in Canada.
A Comprehensive Guide to Small Business Taxes in Canada
Operating a business without knowing about business taxes can land you in trouble. If you want to identify potential tax advantages and protect yourself from the consequences of tax evasion, read this blog to learn about small business taxes in Canada.
Income Tax Returns Depend on Your Business Structure
The first thing you should understand is that the tax return you need to file depends on your business structure. For example, if you’re the sole proprietor, you will file your income tax return using Form T2125 Statement of Business and Professional Activities. That figure is then carried forward to line 135 of your personal T1 Income Tax and Benefit Return. Partnerships are also treated as sole proprietorship businesses where each partner claims the percentage of business income and expenses equal to their profit-sharing ratio.
However, if you operate a small incorporated company, your business income will be reported on a T2 corporate income tax return. This is because technically an incorporated company is a separate legal entity.
Small Business Tax Deductions Can Reduce Your Taxable Income
As a small business owner, you must consider tax deductions to reduce your taxable income. These write-offs are often ignored which can influence the amount of income tax you’re paying. Some of the most common deductions are:
- Home-office expenses (like mortgage interest on your residence, property taxes, home insurance and utilities)
- Vehicle expenses (like toll charges, parking fees, repairs and maintenance, lease payments, fuel and vehicle registration fee)
- Office rent (the copy of lease agreement and rent receipts are required)
- Accounting and legal fees (including the fees paid to your accountant for preparing your income tax return)
- Meals and entertainment (50% of the amount is tax deductible, except for certain circumstances like staff events and parties where 100% of the cost can be deducted)
- Insurance (like business property insurance and general business liability insurance)
- Advertising (expenses incurred on television, radio, magazine, radio and online advertising can be deducted fully or partially)
- Capital assets (these include the ones that can depreciate, like furniture and fixtures, computers, equipment and more)
Tax Deductions and Tax Credits Are Not the Same
Many small business owners confuse tax credits with tax deductions and don’t take them into consideration when filing an income tax return. However, they’re not the same.
The basic difference is that the former is directly reduced from the amount of tax you owe, giving you a dollar-for-dollar reduction of your tax liability, whereas the latter is reduced from your taxable income.
We’ve already explained tax deductions. Here are some of the tax credits you can claim.
- Canada Caregiver Credit – A sole proprietor or partner is eligible for this if they support a spouse, common-law partner or dependent with a physical or mental impairment. This credit only applies to those impaired people whose net income is below $23,046.
- Apprenticeship Job Creation Tax Credit – This is an attempt by the federal government to create long-term jobs by encouraging employers to hire apprentices. A business can earn a tax credit up to 10% of the salaries and wages paid to eligible apprentices. The amount should not exceed $2,000.
- Cost of Qualified Property Tax Credit – This tax credit can be earned by doing designated activities on or with their property in Nova Scotia, Newfoundland, Labrador, New Brunswick, Prince Edward Island and other prescribed regions. The designated activities include manufacturing or processing products for sale or lease, logging, farming, fishing, processing or drilling ore, exploring, or operating a gas or oil well.
- Research and Development Investment Tax Credit and Refund – If your business is engaged in qualifying research and development, you are entitled to a cash refund over a three-year period from revenue worth up to 25% of your R&D expenditure.
Income Taxes Differ for Residents and Non-Residents
There’s a difference between residents and non-residents of Canada operating business in the country when it comes to income tax calculation. While Canadian residents are subject to tax on worldwide income, non-residents are taxed on their income sources within the country.
|Note: As per the Income Tax Act of Canada, you’re considered a resident of Canada if you keep significant ties here while living or travelling outside the country. These significant ties include having a home, a spouse or common-law partner or dependants in Canada.|
You’re considered a non-resident if you normally, routinely or customarily live in another country or do not have significant ties in Canada. This includes if you’ve lived outside the country throughout the tax year or have stayed in Canada for fewer than 183 days in the tax year.
If you’re a non-resident operating a business in Canada, you’ll be taxable for the following types of income:
- Income from an office or employment in the country
- Income from a business carried on in the country
- Passive income received from Canadian residents (for example, rent, dividends, and royalties)
- Capital gains on property disposition
If you’re a resident business owner in Canada, you’re subject to be taxed on your worldwide income, regardless of where it’s earned or received.
Late Filing of Income Tax Return Is Penalized
Every business owner must file their corporate income tax within six months of the end of the fiscal year. For example, if the end of your tax year is March 31st, you should file an income tax return by September 30th.
For late income tax filing, the Canada Revenue Agency (CRA) will charge you a penalty of 5% on your fiscal year’s balance owing along with 1% of your balance owing for each full month your return is late. It can be charged a maximum of up to 12 months. The penalty can be higher if the CRA charged a late-filing penalty on a return for any of the three previous years.
You can avoid paying this penalty by filing your return on time, even if you cannot pay the full amount owing by the due date.
Net Income and Gross Income Are Different
Filing an income tax return is a technical process, thus making it important to know the meaning of technical terms, especially the types of income. Many business owners confuse gross and net income, but they are not interchangeable.
Your gross income is all the income you receive that isn’t explicitly exempt from taxation. It includes income from all your sources before allowable deductions. Wages, salaries, and dividends are also part of your gross income. Your net income is calculated by subtracting your total expenses from your total revenues.
When filing an income tax return, you use your net income. Don’t make the mistake of using gross income.
Your Corporate Tax Rate Depends On Your Province
If you don’t have an experienced in-house or remote accountant, you may not know that your small business tax rate depends in which province your business is located.
Apart from the 15% federal tax paid by incorporated companies, you have to pay business income tax at the provincial level as well. Generally, there are two tax rates. The lower one applies on income eligible for the federal small business deduction whereas the higher rate is applied on any other income generated by the business. For example, in Ontario, the lower rate is 3.2% and the higher rate is 11.5%, going into effect from January 1, 2020. Click here to learn about various provincial tax rates.
We hope this post has helped you understand small business taxes in Canada. Remember that filing income tax returns can be made easier with the right knowledge. Not understanding the filing process, technical terms or tax rates can land you in trouble. That’s why it’s advisable to get in touch with an accountant if your small business doesn’t have one so you can concentrate on your core business activities. They will help calculate your taxable income, complete and file your income tax return, guide you on maximizing your tax deductions and minimize errors.