Is your business really a business, or just a hobby? In order to claim business tax credits or take advantage of small business tax deductions, you must be able to demonstrate that you engage in activities with the express intention of earning a profit. The Canada Revenue Agency (CRA) uses a profit test to determine if your activities as an individual qualify you as a business for tax purposes. Even if your business isn’t yet profitable, you must show you have a reasonable expectation of profit at a certain point. The CRA offers clear guidance on how to pass the profit test. It’s important to make a good case for your business in order to reap the tax advantages while you work toward profitability.
Profitability Time Frame
In evaluating your business, the CRA analyzes your activities over several years. The length of time may vary, giving consideration to the length of time it typically takes to show a profit in your line of business. An individual apple farmer, for example, may require years for crops to establish and bear fruit, whereas a strawberry farmer could conceivably bring crops to market in the first year. In some cases, your expectation of profit may extend into the distant future and even posthumously (such as artists).
The CRA considers how much time you spend on the business activity overall, both in terms of hours per week and years invested. It helps if you can demonstrate a significant time investment in your business. The CRA compares your time investment relative to your other pursuits. A full-time business venture is more likely to qualify than a part-time side project.
Education and Qualifications
Relevant education and qualifications can reinforce your claim as a business. For example, if you’re an amateur author setting out to write a book of nonfiction, you’re more likely to qualify if you can point to a degree or experience in the field. Your membership in a trade or professional association (such as a writers guild), or evidence that you receive public assistance for your activities (such as farming subsidies), can improve your chances of passing the CRA’s profit test as well.
Investments and Promotions
The clearest way you can pass the test is to actually produce a profit. A profit and loss statement can help show the amount of profit you earn. If your business is not yet profitable, you can demonstrate your expectation of profit by investing in your business such as purchasing equipment, land, facilities, and other assets. For artists and writers, it’s a good idea to show the expectation of profit through publicly promoting, publishing, and exhibiting your work. It also helps if you secure representation through an agent or a publisher.
Additional Tips for Passing the CRA Profit Test
Beyond how you operate and invest in your business, there are other ways you can improve your odds with the CRA’s profit test:
- Create a business plan that clearly details your efforts to turn a profit.
- Maintain clear accounting record books of your income, purchases, operating expenses, and depreciation.
- Register your business with your provincial government. The CRA offers an online Business Registration service to set up your business with the CRA and refer you to local registries.
Failing to pass the CRA’s profit test denies you the benefits of Canada’s tax deductions and credits for businesses. Follow these guidelines and tips to get every advantage as your grow your business towards profitability. As a small business owner, it’s beneficial to track how much time and money you’re spending on your company to determine if it’s profitable. Using an accounting system such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.