You and I both know that paying taxes is an inevitable part of our life. One of the easiest ways to reduce tax for your company is by claiming business expense as a deduction. We will discuss the rules that qualify a business expense as an eligible deduction and some of the common types of expense your company will likely incurs when running a business.
What qualifies as a Business Expense?
From the Canada Revenue Agency (CRA)’s perspective, business expense is any reasonable current expense your company incur in order to earn business income. To qualify for a deduction, each expense must meet the following four conditions:
1. It must be reasonable
A reasonable current expense can be defined as an expense in line with what the business’ day-to-day activities are. For example, it would be unreasonable for a restaurant owner to claim a substantial amount of home office expense if the business operation takes place at the restaurant. However, it would be totally reasonable for an architect with a home office to claim home office expense as a deduction.
2. It must be directly related to your business
If you drive a vehicle that is used for both your business and personal activities, you need to separate and allocate the proportion of the vehicle mileage that relate to business versus personal. You can only claim a deduction for expenses that relate to business use.
3. It cannot be a personal expense
Personal expenses cannot be claimed as a deduction. One of the areas that CRA is likely to audit is business owners attempting to claim personal expense on the business tax return. If these expenses are denied, your company will be required to repay the tax along with additional interest and penalties.
4. It must be supported
You must have receipts, proof of purchase, or some other form of support for each business expense you claim. The general rule of thumb is that you cannot claim an expense if you don’t have the receipt to support it. You may not be audited in the following year after your company file its tax return. However, you are required to retain all supporting documents for six years as the CRA has the right to audit a previous year’s tax return.
Common Business Expenses
Now that you are familiar with the rules of business deduction, here is a list of the common business expenses that will help your company reduce its overall tax liability.
Meals and Entertainment
If you take a client out to dinner for the purpose of earning business income, or if you take a prospective client to an entertainment event as part of the client acquisition process, your business can claim 50% of the costs as business deduction. The CRA is aware that business owners are including personal meals and entertainment which are not legitimate business expense. Business owners should be cautioned on the repercussion of claiming expenses that do not qualify for business deduction.
Many small business owners have a home office for convenience and to reduce rent costs. If you work from a home office, you are eligible to claim a portion of the home expense as business deduction. These may include, but are not limited to, mortgage interest, utilities, property taxes, repairs and maintenance, and home insurance. The portion that you can claim and write-off is generally determined by the square footage of the home office over the total square footage of your home. For example, if your home office is 300 sq. ft. and the total size of your home is 3000 sq. ft., you would generally be entitled to claim 10% of home related expense.
Vehicle expenses are common for small businesses. Depending on the nature of your business, vehicle expense may account for a significant portion of your overall business expense. Some of the expenses may include lease payments, fuel, insurance, parking, toll, repairs and maintenance, and finance interest charges. The portion that you are entitled to claim is determined by the business mileage over the total mileage driven. If 5,000 km were driven for business purposes and 20,000 km were driven in the year, you would generally be entitled to claim 25% of vehicle expense.
Almost all small businesses incur some type of professional fees depending on the business needs. At the inception of the business, incorporation costs of up to $3,000 can be claimed as business expense. Accounting fees are required by every business for recurring services such as bookkeeping, financial statements, payroll, and income tax return preparation. Legal fees are paid for shareholder agreements, corporate resolutions, and annual corporate return. These professional fees can be netted against the company’s business income to reduce its overall tax liability.
The four types of business expense discussed form the starting point of what you could deduct when running a business. Depending on the industry of your business, there will likely be other types of expense that can be deducted. For any questions regarding the eligibility of an expense, consult with your accountant to take advantage of every possible opportunity to legitimately reduce your company’s taxes.