Filing a tax return for your business in Canada

09 December 2021 by National Bank
A man and a woman in an office looking at a laptop.

Taxes for incorporated businesses are different from taxes for individuals. Even if you don’t plan on doing everything yourself, it’s a good idea as an entrepreneur to learn the basics of the different tax calculations for incorporated businesses in Canada. Here are some business tax tips from our experts.

How does the return for my incorporated business differ from my individual return?

You have to file a separate tax return for your business

An incorporated business is a separate entity in the eyes of the tax authorities—it’s considered to be a corporate body. The business must therefore file its own income tax return, independent of its owners’ return. 

In Canada:

A business must complete and submit a T2 form to the federal government 

In addition to this basic form, there are appendices that allow you to calculate exactly what needs to be paid in taxes. 

These appendices are used to: 

  • Detail income and expenses 
  • Generate tax calculations for the business to determine the tax attributes for the fiscal year just ended  

In Quebec: 

In Quebec, you must also complete the CO-17 form. This form is a summary of business income and expenses for the fiscal year. 

Businesses set the beginning and end of their own fiscal year 

While individuals must file their tax returns according to dates set by the government, businesses set the beginning of their fiscal year themselves, depending on what works for them. Some will choose a quieter moment in the year, to ensure more time to devote to administrative tasks. Businesses must produce and submit the documents within 6 months of the end of their fiscal year, even if they generally have only 2 months to pay their taxes.

How is business income taxed?

All business income must be declared. Income can be grouped into two main categories, each of which is taxed differently: 

  • Active business income, such as sales and fees for services.  
  • Passive income, i.e., income generated by investments and property, such as rent from a rental property. 

Determine your deductible expenses

The basic principle for deducting a business expense is that it must be used to earn income. For example, purchasing the machinery used to make your product is an eligible expense. Life insurance, on the other hand, is not. 

It’s important to deduct each expense in the right category to get the net results for each type of income.

  • What you can deduct from active income: The cost of goods, salaries and office expenses are examples of deductible operating expenses. You can even deduct the professional fees charged to file your business tax return.
  • What you can deduct from passive income: Management fees and interest paid on a loan used to acquire an investment are among the expenses that can be deducted. 

Calculate amortization of your capital expenditures

There are current expenses and there are capital expenses. Capital expenses are assets that have a longer life span, but diminish in value over time, such as a car or a computer. Also included in this category are big-ticket expenditures like repairs or renovations to improve the condition of an asset. Instead of deducting the total cost of acquiring the asset at the time of purchase, you need to calculate its amortization. 

Note: The amortization of an asset must be calculated according to predefined percentages and the category of asset. The longer the normal life span of an asset, the lower its amortization rate. 

For example: The amortization rate for a car is 30% per year, which essentially means that a car loses 30% of its value every year. Its value gradually decreases without ever reaching 0. Be sure to note that the “half-rate rule” applies in the first year. 

This means that if you buy a car for $30,000, you can deduct 15% (the half-rate) from your taxes in the first year, which works out to $4,500. 

In the second year, you can deduct 30% of the remaining $25,500, or $7,650. 

Calculate deductions for vehicles 

There is a distinction between the tax treatment of a company-owned vehicle and that of a personal vehicle used for business purposes. 

The primary factor in determining whether it is better for a vehicle to be company-owned or personally owned is its use for business purposes. That said, the amortization, maintenance costs, and the value of the vehicle are also important considerations. 

A financial advisor or accountant can help you calculate which option is best for you. 

Company vehicle

For a vehicle exclusively reserved for company use, the calculation is simple: all expenses are deductible, including gas, repairs, maintenance, payments and amortization. 

Personal vehicle 

When a vehicle is owned by an individual and used for business, the company can pay an allowance for its use in the form of an expense account. This expense is calculated based on mileage and is deductible for the company. It is not taxable for the individual. Expenses reimbursed cannot exceed a maximum amount per kilometre.

Personal and company vehicle

For a company vehicle that is sometimes driven for personal use, a mileage log must be kept to determine the percentage of personal versus company use. The company can then deduct the company use percentage from the total expenses. The remainder, the personal portion, is non-deductible and is also considered a taxable benefit for the individual. This personal use portion and associated expenses must be reported on the user’s T4 slip (RL-1 in Quebec).  

Calculate expenses related to working from home

For an expense to qualify as a work-from-home expense, the business must pay it directly. This could be rent paid to the homeowner for the use of space, for example. 

If you use part of your home to perform work for your incorporated business, the business could pay you rent. Depending on your situation, this option would reduce taxable income of your business by allowing you to deduct the value of the rent paid. 

Good to know: Depending on the amount of rent paid, sales taxes may apply. The shareholder will have to add this rent to their personal income but will be able to deduct certain expenses (taxes, interest charges, electricity, etc.) based on the proportion of the home that is used as a workspace. 

How does the taxation of incorporated businesses work?

The basic principle is simple: all eligible expenses are subtracted from total income to arrive at the taxable amount. When planning a company’s tax strategy, it is important to understand that tax rates can vary depending on the type of income, the amount of taxable income and the business limit. 

In the case of business income derived from active operations such as the sale of products or services, there are two possible rates: 

  • A lower rate for taxable income below the business limit 
  • A higher rate for taxable income that exceeds the business limit 

The business limit is generally $500,000, but certain tax rules may reduce that amount. 

Tax rates may vary by industry as governments sometimes want to encourage economic activity in certain industries. The number of hours worked by a company’s employees during the year can also cause the tax rate to fluctuate. 

In the case of passive income derived from income and gains on investments or property, there is only one fixed rate. It is higher than the rate for active income and is similar to the personal tax rate that a high-income individual would have paid on the same passive income.

What can you do throughout the year to make tax time easier?

Careful bookkeeping is one key way to make life easier for the people crunching the numbers. 

We recommend:

  • Tracking income and expenses on a regular basis  
  • Keeping digital records where possible 

Good to know: There are several tax software programs available at a range of price points. 

Tracking income and expenses 

It is mandatory to keep supporting documentation such as mileage logs, invoices, or purchase orders for 6 years. 

Filing income tax returns for an incorporated business is required, so make sure your records are up to date and turn to our experts for help. We’re here to answer your questions.

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