The Canada Revenue Agency uses the profit test to determine if your activities as an individual qualify you as a business for tax purposes. If you fail this test, you cannot claim tax credits for your business or deduct business expenses, which can significantly raise the amount of taxes you pay on your income. To qualify, you must demonstrate you have a reasonable expectation of profit, even if your business isn’t yet profitable. The CRA offers clear guidance on how to pass this test.
Determining the Time Frame for Profitability
As of Sept. 30, 1998, 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 for artists, so its important to make your case for your business so you can reap the tax advantages while you work towards profitability. The CRA also 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 as well. 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. If you are an amateur author setting out to write a book of non-fiction, you are more likely to qualify if you can point to a degree or experience in the field, for example. If you are eligible to join a trade or professional association, such as a writers guild, or receive public assistance for your activities, such as farming subsidies, this can improve your case as well.
Invest in and Promote Your Business
Of course, the clearest way you can pass this test is to actually produce a profit. Even if your business is not yet profitable, you can demonstrate your expectation of profit by investing in your business through purchasing equipment, land, facilities, and other capital. For artists and writers, you can demonstrate your 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 Test
Beyond how you operate and invest in your business, there are other ways you can improve your odds with the CRA 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 a Business Registration Online service to set up your business with the CRA and refer you to local registries.*Review Form P-176R for a full list of criteria for the profit test.
Failing to pass the CRA 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.