Navigating the confusing world of tax filing is often quite daunting for small business owners. The sheer number of questions, myths, and advice regarding tax filing is enough to overwhelm any founder. This article focuses on clarifying common questions that entrepreneurs usually have.
Q1. Do small businesses have to pay taxes even if they’re making losses?
Small businesses in Ontario are required to file tax returns, even if they are operating at a loss. However, if the business is not generating any income, there may be no taxes owed. In fact, reporting losses can be beneficial to your company and might help you save on taxes in the early years. It also has the added benefit of avoiding any fines and penalties from the CRA.
Q2. What are the different taxes a start-up needs to consider?
Start-ups in Ontario may be required to pay federal income tax, provincial income tax, payroll taxes (Canada Pension Plan and Employment Insurance premiums), sales tax (Harmonized Sales Tax), and excise tax (if applicable). The specific taxes that a start-up must pay will depend on the type of business, the size of your team and operations, and the location of your business.
Q3. What is the deadline to file taxes?
Although there is some difference in the deadline to file taxes depending on your business structure, the federal and provincial taxes are filed together. Sole proprietorships are required to file taxes along with their personal income taxes every year by April 30th. On the other hand, corporations are required to file taxes 6 months after their year-end. Corporations have the discretion of choosing their year-end, typically December 31st, but their first year must be within 365 of incorporation.
Q4. Are there any differences in taxes depending on your business structure (incorporation, sole proprietorship, partnership)?
If the small business is a sole proprietorship or partnership, the business’s income and expenses are reported on the owner’s or partners’ personal tax returns. In this case, business income is reported on Form T2125 alongside your Personal Income tax return. Again, losses can be used to offset future profits or carried back to offset previous profits. Contractors or freelancers are taxed at the same rate as the personal income tax rate.
If the small business is incorporated, it is required to file a Corporate Tax return (T2) each year. The return will show the business’s income and expenses, and any losses incurred can be used to offset future profits or carried back to offset previous profits. At the federal level, the basic rate is 38% of your taxable income, which changes to 28% after federal tax abatement. Furthermore, Canadian-controlled private corporations that are eligible for the small business deduction have a net tax rate of 9%, on their first $500,000 in net income every year. At the provincial or territorial level, there are two rates of income tax, a lower rate and a higher rate, which varies based on the province or territory. The lower limit applies to income eligible for the Small Business Deduction at a business limit and the higher rate applies to all other income. For instance, in Ontario, the lower rate is 3.2% and the higher rate is 11.5% at a business limit of $500,000.
Q5. What is the Small Business Deduction (SBD)?
A Canadian-controlled private corporation (CCPC) is eligible to reduce their corporate income federal tax to a net tax rate of 9%. The business limit for a taxation year is $500,000. The SBD is calculated as 19% of the lesser of the business’s:
- Income from active business carried on in Canada, excluding certain income and exceeding certain losses
- Taxable income
- Business limit.
Q6. Why must I keep a track of my expenses?
It’s important for small businesses to keep accurate records of their income and expenses, even if they are operating at a loss, to ensure that they are complying with tax laws and to help them make informed business decisions. A well-managed expense record system will help you claim tax deductions for certain business expenses. It is equally as important to categorize your expenses properly to avoid any comingling between personal and business’s accounting. It is important to note that the CRA expects businesses to retain supporting documents for 6 years in case the CRA asks you to provide them later on.
Q7. What are some common documents that you may need to file taxes?
While specific documents depend on the type of business structure and your source of income, there are some common documents that you may need to file taxes. These are as follows:
- Business Number (BN): Every start-up operating in Canada needs a Business Number (BN), which is a unique identifier assigned by the CRA. Start-ups can register for a BN online through the CRA website. In the case of a sole proprietorship, this will continue to their personal SIN.
- Income Tax Return: Start-ups must file an income tax return with the CRA each year, reporting their business income and expenses. The type of income tax return required depends on the business structure. For example, if the start-up is a sole proprietorship, it will need to file a T1 General Income Tax and Benefit Return along with a T2125 business form attached. If the start-up is a corporation, it will need to file a T2 Corporation Income Tax Return , which is completely separate from your personal T1 tax filing.
- Payroll Taxes: If the start-up has employees, they must withhold and remit payroll taxes, including Canada Pension Plan (CPP) contributions, Employment Insurance (EI) premiums, and income tax deductions. Start-ups must also file T4 slips for each employee, reporting their employment income and deductions.
- Other Forms: Depending on the start-up’s activities, they may also need to file other forms with the CRA, such as:
- Sales records for all revenue receipts
- Record for all business expenses
- Profit and loss statement
- Balance sheet (for corporations only)
- List and ownership breakdown of shareholders (for corporations only)
- List of any assets and a Capital Cost Allowance form
- Receipts and record of personal assets and expenses used for business.
Q8. When must I register for HST/GST?
Businesses which earn more than $30,000 in goods or service revenue over four consecutive quarters are required to register for an HST/GST account and collect HST/GST on their taxable goods and services. To find out if you need to register for an HST/GST account, a good practice would be to compare your revenue against the threshold every quarter. If you do cross that threshold, you have 30 days to register for an account and must start collecting HST right away. It is important to note that if you receive other sources of money, such as donations or grants, they do not count towards the $30,000 threshold. You can also choose to register for HST/GST, even if you’re not required to do so because you do not meet the threshold (i.e., you’re making less than $30,000 in sales).
Another important element to note here is that HST does not apply the same way to all products. The rate that needs to be charged depends on different factors such as the type of supply, the place of supply as well as who the supply is made to. For example, products are considered essential in Canada have a 0% HST. However, if you’re supplying to different provinces or countries, the HST rate may vary. Before issuing an invoicing or making a sale, ensure which rules apply to you. The Government of Canada’s website had an HST/GST calculator as well as the set of rules which can be found at this link: CRA—GST/HST calculator
Q9. What is the difference between a T4 slip and a T4A?
The main difference between a T4 and a T4A is the type of income being reported on the tax slip.
A T4 slip is used to report employment income received by an employee, which includes salary, wages, tips, bonuses, and other forms of compensation paid by an employer to an employee. The T4 slip also reports the amounts of income tax, Canada Pension Plan (CPP) contributions, and Employment Insurance (EI) premiums deducted from the employee’s pay.
On the other hand, a T4A slip is used to report income that is not considered employment income, such as fee for service contractors, pension income, and certain types of government benefits. For example, a T4A slip may be issued to report rental income, scholarships, or bursaries. The T4A slip does not report any income tax, CPP contributions, or EI premiums deducted, as these types of income are typically not subject to these deductions.
In summary, while both the T4 and T4A slips are used to report income for tax purposes, the T4 reports employment income earned by an employee, while the T4A reports income earned outside of employment.
Q10. What are some common forms that I need to know about?
- T1 General Income Tax and Benefit Return: This form is used by sole proprietors to report their business income and expenses, as well as their personal income and deductions.
- T2 Corporation Income Tax Return: This form is used by corporations to report their business income and expenses.
- GST/HST Return: Start-ups that are registered for the Goods and Services Tax/Harmonized Sales Tax (GST/HST) must file a return for each reporting period to report the amount of tax collected and paid.
- T4 Slip: This form is used to report employment income, deductions, and contributions for each employee.
- T5013 Partnership Information Return: This form is used by partnerships to report their business income and expenses.
- T2125 Statement of Business or Professional Activities: This form is used to report income and expenses for a sole proprietorship or partnership.
- T3 Trust Income Tax and Information Return: This form is used by trusts to report their income and expenses.
Lastly, while entrepreneurs can certainly do their own taxes, they can also choose to hire a professional such as a Certified Professional Accountant (CPA), to ensure that a business is complying with all applicable tax laws and help you minimize taxes payable, as well as to avoid any fines and penalties.