Let’s learn about deductions, what is generally deductible, what some common deductions are, and requirements for retaining documentation to support your deductions.
Deductions
One of the greatest means you have as a self-employed individual to reduce your tax burden is to ensure you understand what you may be entitled to deduct against your income. A “deduction” reduces your income upon which personal tax is then calculated. The lower your income, the lower your overall tax burden.
What is Deductible?
At a conceptual level, any expense you are incurring for the purposes of earning business income is generally deductible for tax purposes. There are, of course, always exceptions. Notable ones include only 50% of meals and entertainment being deductible for tax purposes, green fees or membership fees in a golf club are not deductible at all, and items purchased that are capital in nature (think: equipment) are only deductible in accordance with the CRA’s prescribed capital cost allowance rates.
Common Deductions
- Advertising and promotion
- Meals and entertainment (generally 50% deductible)
- Insurance
- Interest and bank charges
- Licenses, memberships, dues
- Office expenses
- Office stationery and supplies
- Professional fees (including legal and accounting)
- Management and administration fees (brokerage transaction fees)
- Rent or home off ice
- Repairs and maintenance
- Salaries, wages and benefits
- Travel/vehicle expenses
- Capital cost allowance (on capital assets)
Organization
You’ll want to make sure that you have a system in place to keep track of the above business expenses as you are incurring them, including keeping copies of the supporting receipts and invoices.
Why do you need to keep receipts, you might ask?
Well, in Canada, we operate on a self-reporting income tax system. This means that you report your income and expenses to the Canada Revenue Agency. The Canada Revenue Agency will generally assess your return based upon what you file. Their agents will then spend time “reviewing”/requesting supporting documentation from a sample of taxpayers across the country which serves to maintain the integrity of our self-reporting tax system.
Pre-assessment Reviews
Sometimes prior to assessing the return, the Canada Revenue Agency will conduct a “pre-assessment” review to request that you provide supporting documentation for an item reported in your return. You generally have 30 days to reply to a pre-assessment review.
Post-assessment Reviews
Sometimes the Canada Revenue Agency will perform a “post-assessment” review to request supporting documentation for an item reported in your return after the have already assessed your return. This again helps the government to ensure the integrity of the tax system as a whole.
How Long to Keep Documents?
Tax returns filed by individuals become “statute-barred” after 3 years from the date of mailing of the Canada Revenue Agency’s original “Notice of Assessment”. However, there are many exceptions to these rules.
You are required to maintain supporting documents for a period of 6 years from the end of the last tax year they relate to. This requirement is actually legislated under subsection 230(4) of the Income Tax Act. The law does also provide for possible prosecution where records are destroyed without the CRA’s written permission.
How To Keep Records
While paper has been traditional for many years, you are legislatively permitted to keep records electronically, provided they are retained in an electronically readable format.
Regardless of how you decide to keep your records, you will want to ensure that you have mechanisms in place to ensure their safety (for example, if paper, you may want to keep them in a dry, fire-proof area that minimizes possible fading. If electronic, you’ll want to ensure that there is a backup mechanism in case of hard-drive failure).
Electronic Recordkeeping Applications
Common applications for storing electronic records include Dext and Hubdoc. These two applications make it easy to capture and store data electronically and are also designed to integrate into sophisticated cloud accounting software (such as Xero, Quickbooks Online).
Final Thoughts on Organization
To help substantiate an expense if ever reviewed by CRA, it is recommended that you maintain a description of how the expense related to your business generating activities. For example, for a meal receipt, you may wish to summarize names of who was in attendance and the purpose of the meeting (for example, “Emily Mantle and John Doe – year-end meeting”).
