A Guide to Income Tax in Canada for Small Businesses

A couple completing their small business income tax return at their kitchen table

It’s that time of year again, so we’ve posted this guide to help small business owners as they prepare to file their taxes. Keep reading for valuable information you need to get you started on completing a return for your business. There’s a lot of ground to cover, so let’s get to it!

Yes, Your Side Hustle is a Business

Simply put, almost any activity that generates revenue is considered a business, whether it’s profitable or not. Not to be confused with income earned from capital gains, business income more commonly refers to business activities or work you do for yourself and includes work you do as a sub-contractor, even if it’s full-time for one company. If you are not technically an employee, you are considered to be self-employed. Other examples include:

  • Work as a professional or consultant, e.g., a small business accountant in Toronto, a lawyer, graphic designer, etc.
  • Tradespeople such as plumbers, electricians, painters etc.
  • Private daycare services.
  • Driving for a ridesharing platform.
  • Dropshipping and selling via online marketplaces.
  • Renting out a living space to permanent tenants and short-term rentals.
  • Dog walking.
  • Food delivery.

If you run a sole proprietorship in Canada and use your legal name without adding anything to it as the name of your business, you don’t need to register your business with your province.

How Business Structure Affects Your Taxes

Businesses in Canada usually fall into one of three business structures:

  • Sole proprietorship. This is the easiest and most basic business structure and is usually best for self-employed individuals. It provides no legal separation between you and your business, leaving you personally liable for debts and lawsuits incurred by the business.
  • Partnership. This is a business co-owned by two or more people and is as easy to set up as a sole proprietorship but also doesn’t provide much personal protection.
  • Corporation. This structure offers the most protection for owners and it can leverage many tax breaks but it requires lots of legal paperwork to set up.

The taxes you pay will depend on your business structure. Most small businesses start off as sole proprietorships or partnerships.

Preparing your taxes if you’re self-employed, a sole proprietor or partner in a small business is like preparing your personal taxes. You complete a T1 personal income tax return however, you must also fill out a Form T2125 Statement of Business or Professional Activities, which you use to report your business income and expenses. You must also find and include your industry code with your T2125. You then use the business’s profit, or loss, as your personal income for the year.

*Note: If your partnership has more than $2 million in worldwide absolute revenues plus absolute expenses for the year, or if it has more than $5 million in worldwide assets, you must file a Form T5013.

If you’re preparing taxes for an incorporated business, you’ll need to file a T2 Corporate Tax return for the business and a T1 personal income tax return for yourself.

My Business Didn’t Make Money, Do I Still Need to File a Return?

Unlike your personal taxes you must still file a return for your business even if you will not owe taxes, your business lost money or you were in school/it was a part-time business.

Aside from staying on the right side of the CRA, filing a return for your small business for a year it experienced a loss or negligible profits as a self-employed individual, sole proprietorship or a partnership can reduce your total income, thereby reducing your tax amounts owing or resulting in a refund. Filing a return also allows you to claim:

  • The GST/HST credit.
  • Canada Child Benefit.
  • Provincial tax benefits.
  • Tax refunds for instalment or source deductions.
  • Refundable medical expense supplement.
  • Canada Pension Plan or Employment Insurance (EI) premium overpayments.

Also, filing your tax return creates the contribution room in your RRSP. For incorporated businesses, you may be allowed to roll a loss into a future year.

Business partners discussing matters while referring to a laptop

What Types of Income is My Small Business Required to Pay Taxes On?

As a small business owner, you report the sources and the total of revenues for your business, subtract its expenses and pay income tax on the profits your business generates. In Canada, you’re required to file both federal and provincial/territorial returns.

Sources of income includes all business revenue as well as:

  • Amounts paid to your that were previously written off as bad debt.
  • Rental income.
  • Vacations, awards, gift cards/certificates.
  • Barter transactions.

Many businesses also receive funding through grants and subsidies, especially during COVID-19, to increase income or reduce expenses. Most of these are reported as income, however, if you received a subsidy for hiring or training more workers, for example, it would be used to reduce your wage expense by the amount of the subsidy. Consult a professional that provides small business accounting services if you have filing questions or are wondering which government programs and subsidies your business can qualify for.

What Expenses Can Canadian Small Businesses Claim?

Small businesses incur several expenses during the course of operations and most of them are deductible. There are also expenses that can only be deducted by specific types of businesses.

 This is when retaining a small business tax accountant really pays off. Not only do their expertise in business accounting and tax law help you avoid incorrectly claiming expenses, but there are many expenses small business owners can claim that they aren’t aware of.

Common deductible business expenses include:

  • Advertising
  • Bad debts
  • Business start-up costs
  • Business tax, fees, licenses, and dues
  • Business-use-of-home expenses
  • Capital cost allowance
  • Insurance
  • Interest and bank charges
  • Fees, penalties, or bonuses paid for a loan
  • Legal, accounting, and other professional fees
  • Maintenance and repairs
  • Management and administration fees
  • Meals and entertainment (allowable part only)
  • Office expenses
  • Property taxes
  • Rent
  • Salaries, wages, and benefits (including employer’s contributions)
  • Supplies
  • Telephone and utilities
  • Travel

It’s crucial that you keep all your purchase invoices, receipts and other financial documents in case you are asked to provide them by the CRA. Check the CRA page on keeping records to know the criteria your records must meet. If you can’t provide proper records, those deductions will be disallowed and your return will likely be re-assessed, resulting in a higher payable tax amount. 

Also, accountants’ worksheets used to calculate tax obligations and entitlements are considered part of the books and records of the small business and must be made available to the CRA upon request.

Small Business Income Tax & GST/HST

Most businesses must charge their customers Goods and Services Tax (GST) or Harmonized Sales Tax (HST) for the goods and services they provide.

Once your revenue exceeds $30,000 over four consecutive quarters in a calendar year, you are required to register for GST/HST, start collecting it on your sales and remit those funds to the CRA. You can also voluntarily register for GST/HST if you don’t meet the minimum threshold or feel that you might during the course of the year.

Depending on the amount of taxes you are required to pay and GST/HST your business collects, you may have to start paying taxes and remitting GST/HST in quarterly instalments.

What Is the Average Small Business Tax Rate in Ontario?

The basic federal tax rate for corporations is 38% of its taxable income, or 28% 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 reduces their 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.

Find out more on how we help with corporate tax.