As a newcomer, there are many advantages to becoming an entrepreneur or small business owner in Canada. Whether you’re buying an existing Canadian venture or starting a new business, you’ll have the opportunity to scale your business, create a sustainable source of income, and be your own boss.
However, like with employment income, income from your small business venture is subject to taxation. If you’re new to the Canadian business environment, you may be unfamiliar with the tax laws that apply to small businesses and self-employed individuals. This article will give you an overview of how taxes work for small business owners in Canada and address some common questions that newcomers have about entrepreneurship income tax.
In this article:
What does being a small business owner mean?
Any activity or undertaking, including, but not limited to, a profession, trade, or manufacturing venture, that you carry on for profit falls under the definition of a business. In Canada, you don’t need a physical store or even employees to run a small business.
You can choose to focus on your self-employment venture full-time or part-time while holding a regular job. As a newcomer, if you undertake any freelancing activity or side gigs in your spare time, such as ride-share driving, dog walking, food delivery, consulting, content writing, etc., you qualify as a small business owner.
As long as the intent behind your undertaking is to make a profit, it will be termed a business, regardless of whether it is actually profitable.
What taxes do I need to pay if I’m running a small business?
As a small business owner, you’ll pay income tax on the profits you generate from your business. In Canada, you’re required to pay income tax both at the federal and provincial or territorial level.
Depending on business, you may also be required to collect Goods and Services Tax (GST) or Harmonized Sales Tax (HST) from your customers and remit it to the CRA, in addition to your income income tax. You are not required to register for GST/HST if your business revenue over four consecutive quarters is less than $30,000 CAD. However, if you make taxable sales, leases, or other supplies in Canada, you’re allowed to voluntarily register for GST/HST even if you don’t meet the minimum threshold.
As a small business owner, it’s also important to keep in mind that you’ll likely have to start paying taxes by quarterly instalments after your first year.
Does my business structure affect my tax returns?
The taxes you pay will depend on your business structure. Most small businesses start off as sole proprietorships or partnerships. These structures are not incorporated and you must report your business income on the T2125 form along with your T1 personal income tax return. If you’re an independent contractor or freelancer, the applicable tax rates will be the same as the personal income tax brackets.
If you’ve incorporated your business, you’ll need to file a Corporation Tax return or T2. There can be a significant tax advantage in incorporating your small business. You should learn more about the pros and cons of each business structure before making a decision.
The basic federal tax rate for corporations is 38 per cent of your taxable income, or 28 per cent after federal tax abatement. However, Canadian-controlled small businesses are eligible for small business deduction (SBD) on income from business carried out in Canada, which effectively reduces the federal tax rate to nine per cent.
Provinces or territories typically have a lower and higher income tax rate for corporations, of which the lower one applies to income eligible for small business deduction. The provincial and territorial tax rates are revised each year and as of January 1, 2021, the lower tax rates vary between zero to three per cent.
|| Note: In Quebec and Alberta, provincial taxes are not a part of the federal tax return and need to be filed separately.
What does the self-employed income tax return include?
If your business is not incorporated and you’re filing small business taxes as part of your personal income tax, you’ll need to fill a T2125 tax form to report your self-employment and professional income.
The T2125 form is split into different sections, each covering different aspects of your business. Some of the key sections include:
- General business identification: This includes your name, business name, address, industry code, and if applicable, the partnership number and your share of partnership. You’ll also need to include the fiscal period for which you’re filing the tax return. The fiscal period for sole proprietorships and partnerships is typically the same as the calendar year, but you can choose to opt for an alternative period.
- Details of other partners: These sections will include details of all your business partners, if applicable, including their partnership percentage and share of profit or loss from the business.
- Business income: This includes gross sales, commissions, or fees, minus any GST/HST or provincial sales tax collected, returns, discounts, etc. You’ll also need to subtract the cost of goods sold, including opening inventory, purchases made during the year, wages paid, and subcontracting costs, if any, in this section. This will give you the gross profit or loss made by your business.
- Net profit and business expenses: In this section, you’ll deduct your business expenses from the gross profit or loss to calculate net profit (or loss) for taxation purposes.
What counts as a business expense?
Only expenses incurred for business purposes can be listed as business expenses for claiming tax deductions. Some eligible business expenses include advertising, meals and entertainment, insurance, office expenses, professional fees, rent and maintenance, property taxes, salaries and benefits, utilities, travel expenses, motor vehicle expenses, capital cost allowance, and business-use-of-home expenses.
Note: Salaries and benefits drawn by the business owner or partners in unincorporated businesses don’t count as business expenses and are not tax deductible. If you’ve incorporated your company, be sure to compare the tax implications of drawing a salary for yourself versus reinvesting the money in your business, as you’ll need to pay businesses taxes on your organization’s overall profits and then pay personal income tax on your salary.
Do I need to file a tax return if my small business didn’t make a profit?
Regardless of whether your small business is profitable, you still need to file a tax return. As an entrepreneur, it may take some time for your business to get established and start making a profit. If you’ve made a net loss in a given fiscal period, you might be able to apply that loss to your other income to offset your total tax liability.
Keeping business accounting records
All businesses and self-employed persons are required to keep business accounting records and supporting documents for a minimum of six years after the end of the relevant tax year.
You should keep all financial documents pertaining to your business, even if you’re not required to attach them with your tax return. This is a compliance requirement and will be helpful in case the CRA audits your tax return and asks you to prove your claims of deductions, credits, or income.
As a small business owner, proper record-keeping helps you track how your business is performing and estimate your tax liability. You should also keep records of your expenses and receipts so you can claim tax deductions, wherever applicable. Set aside time each week to organize and label your expenses and track your income. Be sure to review your business financial situation frequently or hire a financial expert to manage your accounts.
What documents do I need to keep as part of my business records?
While the CRA doesn’t specify the documents businesses or entrepreneurs are required to keep, some essential accounting documents you should have in your records include sales invoices, purchase invoices, cash register receipts, formal contracts, credit card receipts, delivery slips, deposit slips, cheques, bank statements, tax returns, and general financial correspondence.
In addition, accountants’ working papers that were used to determine the obligations and entitlements with respect to taxes are considered part of the books and records of the taxpayer and must be made available to the CRA upon request.
How do I manage my business finances?
While you may be an expert in your business, you may not necessarily have an in-depth understanding of Canadian tax regulations. Luckily, there are tools and experts you can turn to for help.
There are several softwares on the market that make it easier to manage your small business finances and keep track of your income and expenses, such as QuickBooks Self-employed. You can also file self-employed income tax using software such as H&R Block software, TurboTax, Freshbooks, Ufile, or TaxTron.
Depending on the size of your business, you may also want to consider hiring an accountant, bookkeeper, or professional organization to look after your finances on an ongoing or periodic basis, such as for tax season.
Whether or not you’re in-charge of your business’s finances, it’s important that you review your business’s financial reports regularly to oversee how it is performing, to adapt your business plans, and ensure you’re meeting your goals.
Penalties for failure to pay taxes on your small business income
In Canada, there are severe penalties for tax evasion and late payment of small business taxes. If the CRA determines that you’ve knowingly falsified or made omissions in your tax return, you can be charged a penalty of $100, or 50 per cent of understated tax or overstated tax credits, whichever is higher. Serious cases of tax evasion can also result in criminal convictions, large fines, and even jail time.
If you file your tax return after the due date and have a balance owing, you will be charged a late-filing penalty. The late-filing penalty will be 5% of your balance owing for the tax year, plus an additional 1% for each full month you file after the due date, to a maximum of 12 months. If you’ve already been charged with late payment in the past three years, the penalties will be much higher.
As a small business owner in Canada, a portion of your business revenue will go towards paying income tax. Whether you’re in the process of writing your business plan or have already established your business, it’s important for you to understand the taxes that apply to you, the process of filing tax returns, and tax deductions you might be able to claim. This overview gives you the basic information you need to understand self-employment taxes.