This article will help you understand:

• the taxes that you pay as a sole proprietor, partnership or corporation;
• how you calculate what taxes you owe
• what counts as a valid business expense
• your record keeping requirements, and
• additional taxes that you should be aware of.

It is your responsibility to obtain full information on your tax obligations. The Canada Revenue Agency (CRA) website provides in-depth coverage of business tax obligations.

What taxes am I responsible for?

Taxes are paid differently depending on the legal status of your business. Both sole proprietorships and partnerships report their net income on the owners' personal tax returns, while corporations file a corporate tax return.

Sole proprietors report their company's net business profit (or loss) under the Self-Employment Income section of their personal tax returns.

You must report the gross and net income for your business and file either a Statement of Business Activities or a Statement of Professional Activities form. The main difference between the two is that some professional activities may differ from other types of businesses activities.

Partnerships are owned by two or more individuals and have more in common with a sole proprietorship than a corporation. The partnership does not pay income tax or file a tax return. Instead each partner reports his or her share of the partnership's net income or loss. This applies whether you received your share of the income in cash or as a credit to a capital account in the partnership.

Partners also file either a Statement of Business Activities or a Statement of Professional Activities form.

A corporation is a separate legal entity. All its business transactions are entered into and conducted separately from its owners. It therefore pays tax on the income it generates and files its own income tax return.

Corporations use the T2 return form, even if the company has zero taxes payable as in the case of non-profit organizations, tax-exempt corporations and inactive corporations. For full explanation on the items on the T2 return, consult the T2 Corporation Income Tax Guide (T4012).

Corporate filings are complex and assistance from a tax professional is recommended.

How do I calculate my net profit (or loss)?

To calculate your net profit (or loss) and complete your tax return you need to have detailed records of:

• all business related income
• all expenses, and
• all of the company's assets.

Next: subtract the cost of goods sold and expenses you incurred in the fiscal year (whether or not you paid them in that period) from the income you earned in that fiscal year (even if you do not receive it during this year).

This is known as the accrual method, where income and expenses are reported for the year in which work is done, regardless of whether payables and receivables for the job are actually paid in that year.

A fiscal year is always a 12 month period. Most but not all businesses will have a December 31^st year end, in which case their fiscal year is based on the calendar year.

Businesses that have a non-calendar fiscal year must do special adjustments to bring their income and expenses in line with the applicable calendar year. In this case, use the Canada Revenue Agency's guide Reconciliation of Business Income for Tax Purposes to help you calculate your business income on your annual tax return.

The accrual method is generally used by sole proprietors, self-employed individuals and partnerships to report their income.

Self-employed commission sales agents typically use the cash-method to report their income. Basically the cash-method equation is: income in year received minus expenses in the year they are paid.

What are valid businesses expenses?

The Canadian Revenue Agency defines a business expense as a cost you incur for the sole purpose of earning business income.

But before you start deducting away, keep two things in mind.

1. There are two types of expenses:
   • current expenses such as your telephone bills, office supplies, and
   • capital expenses such as the computer your purchased and the property you own and use for business purposes.

   Capital expenses can be confusing to new business owners. Since these expenses are property, which has long term value, you cannot apply money spent to purchase these assets against your business income. Instead, you calculate a depreciation expense at the end of each fiscal year using formulas set by Canada Revenue Agency. This is commonly known as the Capital Costs Allowance (CCA).

2. Not all expenses are created equal.

   For example, you can deduct 100% for the cost of fuel used in your business but only 50% of meals and entertainment or a reasonable amount in these circumstances, whichever is less.

   You can also deduct GST/HST incurred for these expenses. However, you can't deduct personal expenses (such as the purchase of business clothing) or expenses incurred to purchase capital property.

   You can deduct 100% of advertising expenses provided that your ads target a Canadian market and that 80% or more of the non-advertising content is original editorial content. If you advertise to a Canadian audience with a foreign broadcaster you cannot deduct any of your advertising expenses.

To help you better understand expenses, refer to the handy chart in chapter 3 of the Business and Professional Income Guide on the CRA website.

What records do I need to keep?

The same rule applies to income, expenses and your books and records – keep all books and records for a minimum of six years.

Good records will help you run your business more effectively and they will be critical if you are ever audited. You need to keep records of all income that you receive. You must also keep receipts for all of your business related expenses, including:

• receipts
• sale invoices
• purchase invoices
• vouchers
• banking information
• directors and shareholders minutes
• general ledger
• special contracts
• agreements

For shared expenses, such as heating expenses for a home-based business or fuel expenses when a car is used personally and for business, you must be able to prove what portion of the expense applied to the business. For a shared vehicle you can use the Kilometre Method (KM method) -- where you log each trip and note whether it was business or personal -- to track this shared expense.

Electronic record keeping
In addition to traditional record keeping on paper you now have the option of keeping your records electronically. If you choose the e-route, check out the CRA website https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/ic05-1.html to make sure your records comply with CRA requirements.

To simplify your accounting system for your business, consider purchasing accounting software. Drop by your favourite computer store to check out the software best suited for your business.

Payroll & other taxes

Any business that hires employees has additional tax and documentation requirements. You must:

• keep track of the hours worked,
• deduct and remit 'source deductions', which are the employee and employer portions of the federal tax, employment insurance and Canada pension plan for all your employees
• you may be required to register for Worker's Compensation, and
• when an employee leaves you must issue a Record of Employment in a specified timeframe

The goods and services tax/harmonized sales tax (GST/HST) is the other tax that all businesses must consider. If your annual income from clients worldwide exceeds $30,000 in four consecutive quarters or in a single quarter you must register for the GST/HST.

You can register for the GST/HST even if you are not required to do so. This can be an advantage is you are starting a business and expect to have some significant start-up expenses, as you can only use the GST/HST portion of those expenses as Input Tax Credits (ITCs) if you were a GST/HST registrant before the purchase was made.

For more information on GST/HST requirements, see GST Basics on CanadaOne:
https://www.canadaone.com/ezine/oct03/gst.html.

Finally, you may want to consider employing an accountant or bookkeeper to help you set-up your books. Getting an early start will simplify your life.

In this article:

The Canada Revenue Agency (CRA) website:
http://www.cra-arc.gc.ca