Chapter 4 Income from Business: General Concepts and Rules

What is an adventure or concern in the nature of trade?

When a taxpayer buys property for resale, even if resale is not their normal business. Any profit or loss is treated as business income or loss.

Why does it matter if a transaction is business income or capital?

Business income is fully taxable, business losses can offset other income, and capital transactions get preferential tax treatment.

How do you tell if something is business income or capital?

• If the asset was bought for resale, it is usually business income.

• If it was bought for long-term benefit, it is usually capital.

What is the main question when deciding income vs capital gain?

Did the taxpayer intend to use the asset like inventory or like a capital asset?

What is the secondary intention test/question for income vs capital?

Did they buy it mainly as capital, but also have a backup plan to sell it for profit?

What are badges of trade?

Clues used to decide if a transaction is business income or capital, such as:

• frequency of transactions, length of ownership, work done to improve the asset, reason for sale, relation to business, and nature of the asset.

What does number/frequency of transactions suggest?

A large number of similar transactions may suggest business income.

What does length of ownership suggest?

A shorter ownership period may suggest business income.

What does supplemental work on the property suggest?

Work done to increase the property’s value may suggest business income.

What does the reason for selling suggest?

An unsolicited offer or needing money may argue against business income.

What is the basic rule for calculating business income?

Business income is the profit from the business for the year.

How is business income calculated for tax purposes?

Start with accounting net income, then adjust for income inclusions, denied expenses, allowed deductions, and capital gains/losses.

Is GAAP used for business income?

Yes. GAAP is a starting point, but tax rules override GAAP when the Income Tax Act has different rules.

What are major GAAP concepts related to business income?

Revenue recognition, accrual, matching, and conservatism.

What are common differences between GAAP and tax rules?

• Amortization/depreciation

• allocations

• permanent differences

• non-arm’s length transactions

• reasonableness

For tax purposes, what do you do with book amortization and CCA?

Add back accounting amortization and deduct CCA instead.

What does “gain = deduct, loss = add back” mean?

Book capital gains are deducted from accounting income, and book capital losses are added back when calculating business income for tax purposes.

What are examples of income inclusions for tax purposes?

• Future services

• accounts receivable

• bad debts recovered

• interest

• dividends

• partnership income

• barter transactions

• inducement payments

How are barter transactions treated?

They are included in income at fair market value.

How can inducement payments be treated?

They can be included in income when received or elected to reduce the cost of the property acquired.

What are the main Section 18 expense deduction tests?

• Income earning test

• capital test

• reserve test

• reasonableness test

• personal expense test

What is the income earning test?

An expense is only deductible if it was made to earn business income.

What is the capital test?

Capital outlays are not deductible unless the Act specifically allows them.

What is the reserve test?

Reserves are not deductible unless the Act specifically allows them.

What is the personal expense test?

Personal expenses are not deductible.

What is the reasonableness test?

Expenses must be reasonable in the circumstances to be deductible.

What expenses are specifically denied or restricted?

• Recreational facilities/club dues

• political contributions

• unpaid remuneration not paid within 180 days

• automobile allowances

• automobile costs

• some interest/lease limits

When are home office expenses deductible for a business?

When the workspace is the principal place of business, or it is used only for business and regularly for meeting clients

What is the general rule for meals and entertainment?

Only 50% is deductible, unless a specific exception applies.

What is Section 20 used for?

Section 20 lists specific expenses that are allowed even though general rules may deny them.

What are examples of expenses permitted under Section 20?

• CCA

• interest on borrowed money used to earn income

• share/borrowing issue costs deducted over five years

• certain reserves

What happens to a reserve deducted this year?

It must be added back into income next year, and then a new reserve may be claimed if allowed.

What are examples of deductible reserves?

• Doubtful debts

• goods not delivered/services not rendered

• certain warranty reserves

• instalment sales contract reserves

How do sole proprietorships and corporations report business income?

• Sole proprietorships usually report on a calendar-year basis.

• Corporations report based on their fiscal period (due 6 months after).

What are the two types of registered pension plans?

Defined benefit plans and money purchase plans.

When are employer contributions to an RPP deductible?

Employer contributions to an RPP are deductible only if they are paid within 120 days after the taxation year-end.