How to Determine the Deductibility of Business Expenses?

The determination of the deductibility of certain business expenses for taxation purposes has often boggled the mind of numerous business owners. To appropriately determine the deductibility of a business expense, the first and foremost procedure is to determine whether the expense is of a personal or business nature. In accordance to paragraph 18(1)(a) of the Income Tax Act, business expenses that are eligible for a deduction are only  limited to those that are incurred “for the purpose of gaining on producing income from [a] business or property”. ¹ In addition, paragraph 18(1)(h) further states that personal expenses are not eligible for a deduction with the exception of travel expenses incurred in the course of generating business income. ² In other words, deductible business expenses are only limited to expenses incurred for the purpose of income-generating activities while personal expenses are deemed non-eligible deductions.

Moreover, it is important to note that business expenses that qualify for a deduction must be reasonable in amount. While this criterion is rather subjective in nature, the general rule for determining the reasonableness of a business expense relates to the question: Provided the circumstances, would an ordinary person in the course of business not pay such an amount? ³ If the answer to the question is yes, then the amount is likely to be unreasonable. For example, cleaning services for the purpose of property maintenance is considered a legitimate business expense incurred for income-generating purposes. A business owner may also decide to employ a family member to perform these services once a week for three hours while paying that individual a salary for the service performed. In this case, the amount paid must be reasonable taking into consideration the prevailing market rate for such services – offering a wage of $100 an hour may seem unreasonable provided that the average rate for cleaning services in a certain jurisdiction is equivalent to $25 an hour.

What Expenses Qualify for a Tax Deduction?

As a general rule, personal and living expenses are prohibited from tax deductions as only expenses that are incurred for the purpose of generating business income are eligible for deductions. The list below is comprised of business expenses that are generally eligible for a deduction&nbsp⁴:

• Accounting, legal, and other professional fees
• Advertising and marketing expenses
• Business tax, fees, licenses and dues
• Insurance expenses
• Bank charges and interest expense
• Repair and maintenance expenses
• Office expenses
• Meals and entertainment (limited to 50%)
• Employee wages, salaries and benefits
• Business start-up costs
• Motor vehicle expenses
• Business supplies
• Home office expenses
• Rent
• Telecommunication expenses
• Utility fees
• Property taxes
• Private health insurance premiums
• Bad debt

What Expenses Do Not Qualify for a Tax Deduction?

In contrary to the above listed deductible business expenses, the following list below outlines some common non-deductible business expenses ⁵ :

• Value of your own labour (i.e., repairing your own doors)
• Capital assets (i.e., furniture, office equipment)
• Capital expenses (i.e., repair and maintenance of floor or windows)
• Commuting costs (i.e., home to workplace)
• Penalties and fines
• Golf club dues and gym memberships
• Life insurance premiums

What the CRA Looks for During Business Audits

In order to verify the legitimacy of business expenses, the CRA conducts regular business audits of the expenses incurred in a business. In particular, the CRA will be on the look out for personal expenses claimed as business expenses, with red flags including ⁶ :

• Purchases made that appear irrelevant to the performance of ordinary business activities
• Purchase invoices addressed to the taxpayer or their related parties
• The shipment/delivery address on the invoice is the taxpayer’s own residence
• Credit card transactions made for personal purchases

Tips to Track Business Expenses

To facilitate the recordkeeping process for business expenses, it is important to develop good habits to track these expenses. First of all, it is mandatory to keep all records associated with your business expenses, including but not limited to receipts, invoices, monthly bank and credit card statements, as well as a record of each automobile used for business purposes. Below are some tips to help make the recordkeeping process simpler and more efficient:
 TIP 1: Always ask for a receipt for all purchases made. When possible, label the receipts with
relevant information such as the expense category and the purpose of the cost incurred.
 TIP 2: Keep personal and business expenses separate. Open a separate business account and credit card and use these for the sole purpose of business expenses.
 TIP 3: For motor vehicles used for both personal and business purposes, keep a mileage log of the total kilometers driven for business purposes as well as the date, purpose, destination of the trip. In addition, record the odometer at the start and end of the year and keep a separate mileage log for each vehicle if you use more than one vehicle for business travel.

¹ J. Andre Rachert, "Proving Business Expenses: Checklists and Commentary," in 2012 British Columbia Tax Conference (Toronto: Canadian Tax Foundation, 2012), 11:1-26.
² J. Andre Rachert, "Proving Business Expenses: Checklists and Commentary," in 2012 British Columbia Tax Conference (Toronto: Canadian Tax Foundation, 2012), 11:1-26.
³ Hugh Neilson, "Deductibility of Expenses," in 2013 Prairie Provinces Tax Conference (Toronto: Canadian Tax Foundation, 2013), 14:1-21.

⁴ https://www.canada.ca/en/revenue-agency/services/tax/businesses/small-businesses-self-employed-income/business-income-tax-reporting/business-expenses/types-operating-expenses.html

⁵ https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/sole-proprietorships-partnerships/business-expenses.html

⁶ J. Andre Rachert, "Proving Business Expenses: Checklists and Commentary," in 2012 British Columbia Tax Conference (Toronto: Canadian Tax Foundation, 2012), 11:1-26.