If you’ve joined the ranks of the self-employed, you’re in good company. According to Statistics Canada, about 2.9 million Canadians run their own businesses—roughly 15% of the population—and that number continues to grow. With self-employment comes a different relationship with the Canada Revenue Agency (CRA). To keep that relationship smooth, you must maintain accurate records and be prepared to make several periodic remittances during the year. From GST/HST to payroll remittances for staff (including Canada Pension Plan contributions and Employment Insurance premiums) and your own income tax instalments, the responsibility to assess and pay what’s owed falls squarely on you. This guide summarizes the key obligations every Canadian small-business owner should know.
File on time
Filing your tax return on time is mandatory. For most individuals, the annual deadline is April 30 (or the next business day if April 30 falls on a weekend or holiday). Unincorporated business owners have until June 15 to file, but if you owe taxes you’ll be charged interest starting April 30—so it’s usually best to file by the standard deadline. Corporations must file their returns no later than six months after the end of their fiscal year.
Your burden of proof
As a business owner, you are responsible for keeping thorough records of income, expenses and asset purchases. If record-keeping isn’t your strength, get professional help—this is not the area to cut corners. You should keep both personal and business records available in case of a CRA review. Relevant documents include journals, invoices, receipts, contracts, bank statements, mortgage papers and credit card statements, plus any adjustments made to your business accounts for tax purposes. The CRA may also request records relating to family members, corporations, partnerships or trusts connected to the business. In short, once you start a business the CRA could scrutinize not only your business records but also related household and affiliated financial documents.
Paying family members
If you hire a family member—related by blood, marriage (including common-law) or adoption—put a formal employment or subcontracting agreement in place. For an employment agreement, be prepared to demonstrate that the contract mirrors what you would offer to an unrelated worker, that the pay is reasonable, and that the terms and conditions of employment (hours, workplace, duties and importance of the role) are clearly documented. These steps help substantiate the legitimacy of the compensation if the CRA examines the arrangement.
Employee or subcontractor?
Whether a worker is an employee or an independent contractor for CRA purposes depends on several factors:
- Control/independence. The more control the payer has over what the worker does, where it’s done and when it’s done, the more likely the worker is an employee and subject to source deductions.
- Ownership of tools and assets. If the payer supplies the tools and equipment, the worker is more likely to be an employee. Independent contractors generally supply their own tools and supplies.
- Assumption of risk. Is the worker financially responsible for business risk, investments or losses? If not, the person is less likely to be self-employed.
- Hiring others. Can the worker subcontract or hire assistants and manage payments to them? If the worker has that control and financial liability under a contract, they are more likely to be self-employed.
Making source deductions
If you have an employer-employee relationship with someone you hire, you must withhold statutory deductions at source for income tax, Canada Pension Plan (CPP) and Employment Insurance (EI), where applicable. EI may not apply to certain related persons, which also means those workers would not be entitled to EI benefits if employment ends. Determining insurability and withholding obligations hinges on properly classifying the worker. For EI-insurable employment, it helps to show that the same employment terms apply to related and unrelated employees. Written employment contracts that are used consistently are vital evidence.
Failing to make required source deductions can trigger significant penalties: in addition to remitting the missed amount, penalties typically include 10% of the amount not remitted plus interest, with higher penalties for repeat offences. Accurate classification of workers—employee versus subcontractor—is therefore important to avoid costly mistakes.
The TOSI rules
The Tax on Split Income (TOSI) rules, effective since January 1, 2018, target income-splitting through private family businesses. Under TOSI, certain distributions—typically dividends—paid to family members who are not sufficiently active in the business can be taxed at the top marginal rates. This places the burden of proof on the recipient family member to show they qualify for an exclusion. Note that TOSI applies to split income such as dividends, and does not apply to employment income.
TOSI rules apply to family members unless they meet specific exclusions. Examples of common exclusions include:
- Family members aged 18 or older who worked in the business an average of 20 hours per week during the current tax year or in any of the five preceding years.
- Family members aged 25 to 64 who hold at least 10% of the company’s voting shares and of the fair market value of the company.
- Spouses aged 65 or older, who may receive dividends without triggering the top-rate taxation for non-active owners.
Given these rules, paying employment income to family members can make more sense in some cases—provided the employment criteria are genuinely met and the compensation is reasonable relative to market rates and to the family member’s contribution.
Mixed-use expenses
Expenses that have a personal component cannot be fully deducted for tax purposes. Common examples include home-office costs and vehicle expenses. For a home workspace, clearly designate and measure the area used for business and claim only the portion of total home expenses that corresponds to that space—typically calculated by dividing the workspace square footage by the home’s total square footage.
For vehicle expenses, keep a detailed log to establish a base year (a full 12-month period) showing the proportion of kilometres driven for business. In subsequent years, if your driving patterns don’t change by more than 10% from the base year, you can keep a representative log for three months rather than for the whole year. Total vehicle expenses are then multiplied by the business-kilometres proportion to determine the deductible business portion.
Claiming assets
Capital assets used in a business are depreciated over time and grouped into asset classes with specific rates and rules. When an asset has a useful life beyond one year, its purchase cost is recorded and depreciated according to the applicable class, prorated to the portion of business use. This depreciation deduction is called Capital Cost Allowance (CCA) and is optional: you can choose not to claim CCA in a given year if deferring the deduction will better offset future income. CCA can create a business loss for tax purposes (but not for rental properties).
If you sell an asset for more than the undepreciated capital cost, the CCA previously claimed may be recaptured and added back to income. If the sale price exceeds the original cost, a capital gain may also arise—common with real estate. Conversely, if you claimed less CCA than allowed and the asset’s pool is depleted on disposition, a terminal loss can be claimed to offset income.
Business losses
Losses from a sole proprietorship can be used to reduce other income for the current year, carried back up to three years, or carried forward up to 20 years—making losses potentially valuable for tax planning. However, the CRA expects a genuine profit motive; your business must be a commercial activity pursued with the intent to make a profit rather than a hobby. For GST/HST purposes, the threshold is different: it’s enough that the activities could compete with profit-driven enterprises.
Working with a qualified bookkeeper and tax professional is highly advisable for small-business owners. Professional support improves after-tax outcomes, helps you take advantage of legitimate deductions and planning opportunities, and reduces the risk of expensive CRA audits.
Evelyn Jacks is the author of many books on tax filing and planning and is president of a financial education institute that trains bookkeeping, tax and financial advisers.
Read more on taxes:
- Who pays the tax on dividends earned in a joint account?
- Tax basics for newly separated parents
- When your investment partners don’t play by the CRA’s rules
- Do teenagers need to file a tax return if they work part-time?