When the Entrepreneur and Tax Man Meet - LawNow Magazine

When the Entrepreneur and Tax Man Meet

Starting a business can be exciting, but also incredibly nerve-wracking.  While tax considerations are often a low priority, some commonly overlooked issues can cause significant headaches. Below we discuss some key general considerations.  Specific advice from a tax professional is prudent.

Business or Personal Venture?

Disputing the CRA’s assessment is very difficult without proper records.

Determining if and when a business has commenced can be a confusing matter.  In some cases, it may be obvious.  In others, not so much.  To determine whether one is carrying on a business, the Canada Revenue Agency (“CRA”) looks to a number of factors, including: the individual’s intended course of action, the historical performance of the undertaking, the potential for future profits, the education and training of the individual, and business risk management/minimization.

If the operation is considered a business, income or loss must be reported on the tax return. CRA often questions start-up losses.  A written business plan showing how the operation will generate future income can be helpful.

Business Structure

The next step is to determine the legal form of the business.  Typically, one of three structures are selected:

  • A Sole Proprietorship is the simplest structure. The owner just starts running the business and reports all earnings and expenses on their personal tax return.  The business does not have a separate legal status and the owner assumes all risks personally.
  • A Partnership is an association or relationship between two or more persons who join together to carry on a business in common, with a view to profit. Each partner contributes money, labour, skills or property, and in turn, is entitled to their share of the profit or loss.  Certain partnerships are subject to tax filing requirements.  While most partnerships are usually governed by a written agreement, they can be formed by a simple verbal agreement.  Some partnerships, with proper structures and legal filings, may limit the partners’ business risk to contributions to the partnership.
  • A Corporation is a separate legal entity which is established by filing articles of incorporation with the appropriate jurisdiction. The owner transfers money or property into the corporation in exchange for shares.  While shareholders enjoy significant protection from corporate debts and risks, its directors could still be liable for some corporate debts such as GST/HST, and payroll withholdings (including EI and CPP).

Regardless of the type of business, however, all earnings must be reported. The Canadian tax system is structured so that, generally, regardless of whether income is earned through a proprietorship, partnership or corporation, the net tax liability is approximately equal.  While proprietorships and partnerships are subject to one level of tax, corporate earnings are subject to two: corporate tax, and personal tax when the after corporate tax income is distributed to the shareholders as dividends.  As corporate tax rates (especially for smaller businesses) are generally lower than personal rates, more cash can be kept in the corporation to reinvest in the business.  However, when the owner withdraws those funds personally, they will be subject to personal tax.  Essentially, operating through a corporation permits some tax deferral and greater control over the timing of personal tax.

It is also possible to operate a business as a proprietorship or partnership for a number of years and then transition to a corporation.

GST/HST and Other Indirect Tax Considerations

A common question of new businesses is whether they should be charging GST/HST (and PST in particular jurisdictions) on their sales.  Unfortunately, the answer is not always simple.

It is also possible to operate a business as a proprietorship or partnership for a number of years and then transition to a corporation.

Generally, if a business’ total revenue from taxable supplies (sales) exceeds $30,000 in a calendar quarter, or over four consecutive quarters combined, they are required to register for, collect and remit GST/HST. Special rules require taxis, commercial ride-sharing and limousine services to register, collect and remit regardless of the quantum of their earnings. The reporting and remittance frequency (ranging from monthly to annual filings) depends on the business’s annual taxable supplies.  The provision of certain products and services may not be subject to GST/HST (such as many health, medical, and dental services performed by licensed physicians or dentists).

Some, but not all, businesses may be able to recover GST/HST paid on expenses incurred in commercial activities as input tax credits (ITCs).  A business required to register which does not do so in a timely fashion may lose ITCs on prior expenses.

If registered for GST/HST, a business should ensure that their receipts properly disclose the supplier’s name, total amount paid/payable, and date of invoice.  For purchases greater than $30, GST/HST charged and on what items, and the supplier’s business number are also required.  Additional information is required for purchases greater than $150.

Depending on one’s industry and operations there may be other federal duties, excise taxes, and charges. British Columbia, Manitoba, and Saskatchewan all have provincial sales tax (“PST”), which may require businesses operating in those jurisdictions to register for, collect and remit PST. Québec is subject to a Québec sales tax (“QST”) regime.

Workers and Payroll

Businesses need to decide whether to engage independent contractors, employees, or both.  Structuring these arrangements, and determining such status is challenging, fraught with error, and subject to considerable interpretation.

The Canadian tax system is structured so that, generally, regardless of whether income is earned through a proprietorship, partnership or corporation, the net tax liability is approximately equal.  Employers are required to pay CPP, EI, and also deduct and remit income tax in respect of employees.  Employers who do not properly do so can be responsible for their and the employee’s liability for a number of years, in addition to penalties and interest.  For assistance on properly determining withholdings for an employee, see the CRA’s Payroll Deductions Online Calculator.

Such payroll amounts are not required for contractors.  However, if a contractor’s terms and conditions of engagement are similar to that of an employee, the CRA may look beyond the contract and require the business to make these payments anyways.  This can result in a significant surprise liability that may cripple an organization.

Income Tax Filing

Canada has a self-reporting tax system. Income tax filings depend on the type of business structure used.  Proprietors report earnings on their personal tax returns, while partners report their share of the partnership’s profit or loss on their tax returns.  Corporations file separate corporate tax returns, with dividends they pay being reported on the shareholders’ personal tax returns.  Regardless of the type of business, however, all earnings must be reported.  Costs incurred to earn business income are generally deductible, provided they are reasonable, not capital in nature, and have no personal element.  Special rules apply when determining whether certain amounts are deductible for tax purposes, and are beyond the scope of this article.

Once a tax return is filed, the CRA will issue an assessment which essentially states that they have accepted the self-reported amounts, at least initially.  If a business disagrees with a CRA assessment, there are a number of dispute resolution mechanisms.

A taxpayer realizing they have made an error in past disclosures may make a voluntary disclosure application which will enable the person to get back on side while limiting certain penalties, interest and risk of criminal prosecution.  Eligibility for this program is being tightened March 1, 2018.

Record Retention

Records of business earnings and expenses must generally be kept for six years from the end of the year to which they relate.  Records relating to capital expenditures must generally be retained for six years after the year that the property is disposed of.  Records can be kept in paper or electronic format (provided it is accessible and readable).  Disputing the CRA’s assessment is very difficult without proper records.

CRA Administration

Businesses obtain a business number by registering with CRA.  The business number is used to register for various program accounts, such as GST/HST, payroll, and corporate tax.

Business owners can get online access to CRA tax information by registering for My Business Account.  Online access provides the ability to file returns, obtain various account balances, submit enquiries, update business and direct deposit information, and much more.  Gaining access can take a few weeks, so starting the process early is best.

CRA provides various other types of support, such as:

The Government also provides considerable tax incentives for those who are involved in scientific research and development.  This may include costs a business incurs to develop or improve an existing product or service. Further details can be found online.

The above note a few key tax considerations that a business starting operations should consider. By addressing these early, significant challenges can be avoided, providing business owners space and capacity to establish and grow their business.

Authors:

Caitlin Butler
Caitlin L. Butler, CPA, CA is a designated accountant splitting her time between Vancouver, British Columbia and Edmonton, Alberta. She is a member of the Video Tax News editorial board and is a co-writer and presenter of the Video Tax News National Personal Tax and Corporate Tax update courses.
 


A Publication of CPLEA

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