Business Information

Tutorial and a Guide for Small Businesses

Business Information

 
 

The Essentials a Business Owner Should Know:

 

Are you starting a new small business in Canada? Are you operating one already? Then this guide is for you.  Many activities of a small business are subject to different forms of taxation.  This guide will help you with each of these, and will explain how to plan for taxes, keep records, and make and report payments.

It will also explain the different kinds of business structures, GST / HST, excise taxes, payroll deductions, income tax reporting and payment.

  1. Setting up your business
  2. Goods and Services Tax (GST) and Harmonized Sales Tax (HST)
  3. Payroll deduction and remittances
  4. Income Tax

Section 1: Setting up your business

 

Let’s start with business structure.  There are three kinds: sole proprietorship, partnership, and corporation.  The type of structure you choose has a significant effect on the way you report your income and the type of tax returns you complete each year.  One of your most important concerns will be your liability for business debts.

Sole proprietorship

            A sole proprietorship is an unincorporated business that is owned by one person.  It is the simplest kind of business structure.  The owner of sole proprietorship has sole responsibility for making decisions, receives all the profits, claims all losses, and does not have a separate legal status for the business.

If you are a sole proprietor, you pay personal income tax on all revenue generated by your business.   You also assume all the risks of the business.  The risks extend even to your personal property and assets.   As a sole proprietor, you have to register for the good and services tax / harmonized sales tax (GST / HST) if your worldwide annual taxable revenues are more than $30,000.

If you operate more than one business and you have legal ownership of each, it is your responsibility to register them for GST / HST.  One registration will cover all of your business.

It is easy to set up a sole proprietorship.  Simply operate as an individual or as a registered, unincorporated business.  If you operate as an individual, just bill your customers or clients in your own name.  If you operate under a registered business name, bill your clients and customers in the business’s name.  If your business has a name other than your own, you will need to separate bank account to process cheques payable to your business.

How does a sole proprietor pay taxes?                                                                             

            A sole proprietorship pays taxes by reporting income (or loss) on a personal income tax and benefit return (T1).  If you are a sole proprietor, you must file a personal income tax return if you:

  • have to pay tax for the year;
  • disposed of a capital property or had a taxable capital gain in the year;
  • are required to make Canada Pension Plan / Quebec Pension Plan (CPP / QPP) payments on self-employment earnings. 

When you file your income tax and benefit return, you must include financial statements or one or more of the following forms.

  • Form T2125, Statement of business and professional activities;
  • Form T2042, Statement of farming activities;
  • Form T2121, Statement of fishing activities.

 

Partnership                                                                                                                  

            A partnership is an association or relationship between two or more individuals join together to carry on a trade or business.  Each partner contributes money, labour, property, or skills to the partnership.  In return, each partner is entitled to a share of the profits (or losses) in the business.  The business profits (or losses) are usually divided among the partners based on the partnership agreement.

How does a partnership pay taxes?

            A partnership by itself does not pay income tax on its operating results and does not file an annual income tax return.  Instead, each partner includes a share of the partnership income (or loss) on a personal income tax return.  You do this whether or not you actually received your share in money or in credit to your partnership’s capital account.

            A partnership must also register for GST / HST if its taxable worldwide annual income is more than $30,000.

            Computer – generated version of one of these forms:

  • Form T2124, Statement of business or professional activities;
  • Form T2024, Statement of farming activities;
  • Form T2121, Statement of fishing activities.

 

Something to keep in mind is that for both sole proprietorship and partnership the business fiscal year end is always December 31.  Although you have until June 30 to file your income tax, if you owe taxes it must be paid by April 30, four months after December 31.  Note: if you know you owe taxes, pay a lump some to Canada Revenue Agency (CRA) by April30. CRA will require you to pay instalment payments during the year.

Corporation                                                                                                        

            A corporation is a separate legal entity.  It can enter into contracts and own property in its own name, separately from its owners.  A corporation may have some of the following features.

  • It is a separate legal entity with a perpetual existence.
  • It can generally raise larger amounts of capital more easily than sole proprietorship or partnership.
  • The shareholders cannot claim any loss the corporation sustains.

 

When forming a corporation, the owners transfer money, property, or services to the corporation in exchange
for shares.  The owners are referred to as shareholders.
                                                                                                                                               
You can buy and sell shares in a corporation without affecting the corporation’s existence.  A corporation continues to exist unless it winds up, amalgamates, or surrenders its charter for reasons such as bankruptcy.

            Since a corporation has a separate legal existence, it has to pay tax on its income, and therefore must file its own income tax return. It must also register for GST / HST if its taxable worldwide annual revenues are more than $30,000.

How does a corporation pay taxes?

            A corporation must file a corporate income tax return (T2) within six months of the end of every tax year, even if it does not owe taxes.  It also has to attach a complete financial statement and the necessary schedules to the T2 return.  One thing to keep in mind is that, although you have 6 months to file your corporate tax (T2) but if you owe taxes you must pay within 3 months. Ex: if your corporate year end is March 31, the deadline to file your (T2) is September 30.  But if you owe corporate taxes you must pay it by June 30, three months after the fiscal year end of March 31.  CRA will require the corporation to pay instalment payments during the year.

The Business Number (BN)                                                                                        

Your first step for starting a business is to register for the business number (BN).  The BN is a numbering system that simplifies and streamlines the way businesses operate.  It is based on an idea of one business, one number.  Eventually as your business grows and you need to charge GST / HST or employ labour, you need to register for those programs as well.

          The BN consists of two parts: the registration number and the account identifier. They are as follows:

  • RT – GST / HST (for sole proprietorship and partnership)
  • RP – payroll deductions
  • RC – corporate income tax ( for corporations)
  • RM – import / export

 

The BN has 15 digits:

  • 9 numbers to identify the business;
  • 2 letters for the type of accounts; and
  • 4 numbers for the account reference.

 

For example, your BN might look like this:

            12345 6789   (Registration Number)    RP0001 (Account Identifier)

            If you have more than one account (GST / HST for example), your account number will be as follows:

            12345 678 RT0002 or RT0003 and so on.

 

Keeping records                                                                                                          

5 reasons why keeping records can benefit you?

  • Good records can help you identify the sources of your income.  You may receive cash or property from many different places.  If you do not have records showing your income sources, you may not be able to prove that some sources are non-business or non-taxable.
  • Well-kept records can mean tax savings.  Good records serve as a reminder of deductible expenses.  If you do not record your transactions, you may forget some of your expenses when you prepare your income tax or GST / HST returns. 
  • Well-kept records will help you in decision making and taking your business forward.  Having a proper filing system and hiring a bookkeeping to look after your day to day transactions will give you sound financial statements you can rely on and make confident decisions for your business. 
  • Your records will keep you better informed about the financial position of your business.

You need good records to establish your profit and loss, and the value of your business.  Information from good records can also tell you what is happening in your business and why.  The successful use of records can show you trends in your business, let you compare performance in different years, and help you prepare budgets and forecasts.

  • Proper records may help you get loans from banks and other creditors.  Creditors need accurate information about your current financial position before they give you a loan.  You cannot give them this information if you do not keep organized records.  Also, good records show potential creditors that you know what is going on with your business.

What records should you keep?

            Make sure you keep orderly records of all income you receive and expenses paid out.  Invoices to clients and cancelled cheques indicating outlays of money such as:

  • salaries and wages
  • operating expenses such as rent, advertising, supplies and capital expenditures
  • miscellaneous items such as charitable donations
  • import and export documents
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Section 2:  Goods and Services Tax (GST) or Harmonized sales tax (HST)

What is GST / HST?

            Goods and services tax (GST) is a tax that applies at a rate of 5% to the supply of most goods and services in Canada.  Three participating provinces (Nova Scotia, New Brunswick, and Newfoundland and Labrador) harmonized their provincial sales (PST) with GST to create the harmonized sales tax (HST). HST applies to the same goods and services as GST, but at a rate of 13%.  Of this, 5% is the federal part of 8% is the provincial tax.

The registrants collect GST / HST on their taxable supplies.  Anther words, every time a business owner purchases products GST / HST are charged on that product.  And every time a business owner sells goods to customers they charge GST / HST on the sale of that product.  Now, if the GST / HST collected on your sales more than paid on the product purchased, the business owner owes the difference to CRA.  If it is the reverse the business owner can claim a refund.
Who registers for GST / HST?

            If you provide taxable goods and services and your worldwide income is more than $30,000 in the last four consecutive calendar quarters, you need to register for GST / HST. 

Small Supplier                                                                                                                                  

            You are a small supplier if you are a sole proprietor, partnership, or corporation with total taxable income (before expenses) from all your businesses of $30,000 or less in the last four consecutive calendar quarters you do not need to register for GST / HST.

Voluntary registration

            If you are a small supplier you can choose to register voluntarily, even if you are not legally required to do so.  If you register voluntarily, you have to charge GST / HST on all your sales and you can claim the input tax credit (ITC) you paid.  Generally, you have to stay registered for at least one year before you can ask to cancel your registration.  If you cancel your registration, you may have to remit part of the ITCs you claimed on certain properties you have on hand, such as inventory and capital property.

            To register for GST, simply go to the home page and download the form in PDF format.

Filing and remitting due dates

            If your reporting period is monthly or quarterly, you have to file your GST / HST return and remit any amount owing no later than one month after the end of your reporting period.

            For example: if you are a quarterly filer, and the quarter is January1 to March 31, the amount owing is due by April 30.

            If you are an annual filer, you usually have to file your return and remit any amount owing no later than three months after the end of your fiscal year. As an annual filer, you may also have to pay quarterly instalments.  If so, they are due no later than one month after the last fiscal quarter.

            For example: if you are a sole proprietorship or partnership your fiscal year end is Dec31.  The instalment payments are as follows:

  • January 1 to March 31 is due by April30
  • April 1 to June 30 is due by July 31
  • July 1 to September 30 is due by October 31
  • October to December 31 is due by January 31

 

If you are a corporation and your fiscal year end if March 31, the instalment payments are as follows:

  • March 1 to May 31 is due by June 30
  • June 1 to August 31 is due by September 30
  • September 1 to November 30 is due by December 31
  • December 1 to February 28 is due by March 31

 

Input tax credit (ITC)

ITC is the GST / HST you pay on the product purchased for commercial use.  All businesses have to buy supplies, gas for vehicle, telephone, utilities, advertising, etc to run their businesses.  The GST / HST on those invoices or receipts are the ITCs.  These ITCs are than put against the GST / HST collected on the sales. There is an exception.  Since there is no GST / HST collected on residential rent, there can not be any ITC claimed for expenses incurred for small repairs and maintenance or utility bills paid by the land lord.

Stop filing GST / HST returns temporarily                                                                                   

            As a registrant, you must file your returns for each reporting period, even if you do not have to remit any net tax.  However, if you operate a seasonal or part-time business, you may be eligible to stop filing GST / HST returns for the reporting periods.

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Section 3: Payroll deductions and remittances

            If you are an employer, you must make regular deductions from your employee’s wages.  You need to register for a payroll number if you:

  • pay salaries and wages
  • pay tips and gratuities
  • pay bonuses and vacation pay
  • provide benefits and allowances to employees
  • need to deduct and remit amounts from other types of remuneration (such as pension)

If you need a payroll account and you already have a BN, you only need to add a payroll deductions account to
your existing BN.  However, if you don’t have a BN, you must request one and register for a payroll account before your fist remittance due date.

What to deduct from your employees wages

            You’re responsible for deducting Canada Pension Plan (CPP) or Quebec Pension Plan (QPP) contribution, Employment Insurance (EI) premiums, and income Tax from your employees’ wages.  You are also responsible for remitting this money to CRA at regular intervals, usually on or before the 15th day of the month following the month in which you deduct it.

            For example, if you make your deductions from an employees’ wages on May 10, you than have to remit the money to CRA on or before June 15th.  If June 15th falls on a Saturday, Sunday, or holiday the remittance is due on the next business day.

How to calculate deductions

            There are many software programs available for payroll deductions.  The one used by Accomp Services and is recognized by CRA is Simply Accounting by Sage.  It has a very strong payroll module to handle all types of payroll

remunerations and deductions.  You can also log onto Payroll Deductions Online Calculator (PDOC) available on CRA web site at www.cra.gc.ca.

            The deductions for CPP, EI and Income Tax may vary from year to year.  Make sure your software is up to date for most recent deductions update. 

See below for sample of a pay cheque and deductions                                                                                

Employee’s Name:                  Margo Jones
Employee’s Name:                  Accomp Services
Pay periods:                           Semi-monthly (24 pay periods a year)
Pay period ending date:           2009-08-31
Province of employment:          British Columbia
Federal amount from TD1:        Claim code 1 (Minimum - $10,375.00)
Provincial amount from TD1:      Claim Code 1 (Minimum - $9,373.00)

 

Income

Salary or wages for the pay period                                                     1,650.00         
Vacation pay 4% of 1,650.00                                                                66.00
Total income                                                                                  1,716.00

Deductions

Federal and provincial income tax                                                        237.56
CPP deductions                                                                                 77.72
EI deductions                                                                                   29.69
Total deductions                                                                             344.97

Net Amount paid to employee                                                           1,371.03 (1,716.00 – 344.97) 

See below for sample of how to calculate for source deductions remittance:

Employee portion of deductions                                Employer portion of deductions

CPP                   77.72                                          77.72 (employer must match same)
EI                     29.69                                          41.57 (employer must match 1.4%)
Income Tax      237.56                                           (Employer does not contribute)

Total payable to CRA is (77.72+77.72+29.69+41.57+237.56) = 464.26

 

How to complete T4 and T4 summary

            You have to fill out and give your employees their copies of the T4 slips no later than the end of February following the calendar year to which the slip relates.  For example, the T4 generated for calendar year 2009 is due by February 2010.

The T4 summary is a report showing total deductions for the calendar year withheld from all employees including the employer’s portion.  And the total remitted to CRA.  Any short fall must be paid by the due date for February.

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Section 4: Income Tax

            This section introduces you to the process of reporting earnings and paying tax on your business’s profits.  It will explain how to account for what your business earns, and what kinds of income you have to report.  It also tells you what expenses you are allowed to deduct.

Accounting for your earnings

            Generally, you have to report business income (other than farming and fishing) using the accrual method of accounting.  Farmers or fishers may use the cash method or the accrual method, but not a combination of both.

The accrual method 

            Under the accrual method, you have to report income in the fiscal period you earn it, regardless of when you received payment.  Similarly, you deduct allowable expenses in the fiscal period in which you incur them, whether or not you pay for them in that period.  Incur usually meals you either paid or will have to pay the expenses.

The cash method

            Under the cash method, you report income in the year in which it is received (whether in cash, property, or services) and you deduct allowable expenses as they are paid in the year in which you actually pay them. 

How to keep sales and expense journals

            You should keep a day-to-day record of your receipts and expenses.  A book with columns and separate pages for income and expenses is good for this.  Keep this record along with your duplicate deposit slips, bank statements, cancelled cheques and receipts.  This will support your expenditure claims.  This is the manual way of keeping your books.  There are software programs available to do your bookkeeping more accurately and with ease. 

Fiscal year

            You have to report your business income on an annual basis.  For sole proprietorship and partnership your business income is generally reported on a calendar-year basis.  A corporation’s tax year is its fiscal period.  A fiscal period cannot be longer than 53 weeks (371 days).  A new corporation may choose any tax year-end as long as its first tax year does not exceed 53 weeks from the date it was either incorporated or formed as a result of an amalgamation. 

            The corporation has to file its income tax return within six months of the end of its fiscal period.  When the fiscal year ends on the last day of the month, the return is due on or before the last day of the sixth following month.  When the fiscal year ends on a day other than the last day of the month, the return is due on or before the same day of the sixth following month.

 

Income

            This part gives you an overview of the business income that you should account for in your records.

Types of income

            Business income includes money you earn from a profession, a trade, manufacturer or any other activity you carry on for profit and there is evidence to support that intention. 

Expenses and cost of goods sold                                                                                                              
            The following expense categories are the most common types used in business, so it should be easy for you to set up your accounting records. 

Inventory and cost of goods sold

            To match expenses with income, you need to prepare an annual inventory.  This is usually a list of goods held for sale.  If you are a manufacturer, this includes raw materials as well as packaging material and supplies, work-in-progress (goods and services that you have not yet completed at the end of your fiscal period), and finished goods that you have on hand.  However, if you have a professional practice and you are an accountant, dentist, lawyer, medical doctor, notary, Veterinarian, or chiropractor, you may elect to exclude your work-in-progress when you determine inventory.

How to value your inventory

            The value you place on the items in your inventory is important in determining your income.  For income tax purposes, the two acceptable methods of valuing your inventory are by determining.

  • The fair market value of your entire inventory (use either the price you would pay to replace an item, or the amount you would get if you sold an item)
  • The value of individual items (or classes of items, if specific items are not readily distinguishable) in the inventory, at either their cost or their fair market value.

 

Once you choose a method of inventory valuation, you must continue to use this method in subsequent years.

Expenses

Accounting and legal fees

            You can deduct the fees you incurred for external professional advice or services, including consulting fees.

Advertising

            You can deduct expenses for advertising, including ads in newspapers, television and radio stations.  You can also include any amount you paid as finder’s fee as well as business cards and brochures.

Business tax, fees, licences, and dues

You can deduct any annual licence fees and business taxes you incur to run your business.  You can also deduct annual dues or fees to keep your membership in a trade or commercial association.  However, you cannot deduct club membership dues (including initiation fees) where the main purpose of the club is to provide dining, recreational, or sporting facilities for its members.

Insurance

            You can deduct all regular commercial insurance premiums you incur on any building, machinery, and equipment that you use for your business.

Interest and bank charges   

            You can deduct the interest you incur on money you borrow to run your business.  However there is a limit on the interest you can deduct on money you borrow to buy a passenger vehicle.  The amount of interest deducted should be equal to the amount of vehicle usage for business.  Example:  If you use the vehicle 75% to run your business and 25% for personal usage, the amount of interest deducted is 75% of the total yearly interest you paid.

Maintenance and repair

            You can deduct the cost of labour and materials for any minor repairs or maintenance done to property you use to earn income.  However, you cannot deduct the value of your own labour.  You can not deduct costs you incur for repairs that are capital in nature.  However, you may be able to claim capital cost allowance on the repaired property.  A capital expense generally gives a lasting benefit or advantage.  Example:  The cost of putting vinyl siding on the exterior walls of a wooden house is a capital expense and should be added to the capital property and be depreciated on a yearly basis.

Meals and entertainment

            The maximum part you can claim for food, beverages, and entertainment expenses is 50% of either the amount you incur or an amount that is reasonable in the circumstances, whichever is less.  The 50% limit also applies to the cost of your meals when you travel or go to a convention, conference, or similar event.  

Motor vehicle expense

            You can deduct expenses you incur to run a motor vehicle that you use to earn business income.  However, several factures can affect your deduction.   The kind of vehicle you own can affect the expenses you deduct.  For income tax purposes, there are two types of vehicle.

  • Motor Vehicle – Any automotive vehicle designed or adapted for use on highways and streets.  A motor vehicle does not include a trolley bus or a vehicle designed or adapted to be operated only on rails.
  • Automobile – This is a motor vehicle designed or adapted primarily to carry people on highways and streets.   It seats a driver and no more than eight passengers.  An automobile does not include an ambulance, police and fire emergency-response vehicles, taxi and buses.

Most cars, station wagons, vans and some pick-up trucks are considered passenger vehicles.  If you own or
lease a passenger vehicle, there may be a limit on the amounts you can deduct for capital cost allowance, interest, and leasing costs.

            To get the full benefit of your claim for each vehicle, keep a record of the total kilometres you drove, and the kilometres you drove to earn business income.  For each business trip, list the date, destination, purpose, and the number of kilometres you drove.

What kind of vehicle expenses can you deduct?

  • oil and fuel
  • maintenance and repair
  • insurance, licence and registration fees,
  • capital cost allowance

Office supplies

You can deduct the cost of office expenses, which include small items such as pens, pencils, paper clips, stationary, and stamps.  Office expenses do not include such items as calculators, filing cabinets, chairs, and desks, which are capital items.

Follow the above guideline and your business operations will run smoothly.  If ever in doubt about a certain item to be expensed you can always refer to CRA web site at www.cra.gc.ca.

Thank you for reading this guide.  I hope it has helped you and put you on a path to have a successful business.

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