Running a business is great but it comes with many risks. One risk that many don’t even consider is whether their business will pass the Canada Revenue Agency’s REOP test. This is one idea I share in this week’s newsletter. Enjoy this issue and please remember to share this with everyone in your network:
1. Are You Really In Business?
Many individuals run their businesses as sole proprietors. As a result, any profit or loss from the business is reported in their personal tax return. If you report a business loss, you can use the loss to reduce income from other sources and consequently reduce your taxes. It’s not surprising therefore, that many employed individuals who earn regular T4 income, use their side business to generate losses to reduce their employment income. The question is are you really in business if you regularly report losses year after year? CRA (Canada Revenue Agency) has a test for businesses run by individuals called the Reasonable Expectation Of Profit (REOP) test. If you report losses and benefit from these losses in terms of lower taxes year after year, it is likely that CRA will apply this test. And if you fail the test, all your expenses will be denied and you will have to repay taxes plus accrued interest. Without going into the legal definitions in the Tax Act on what constitutes a business, the important point to note is that CRA will use facts as a basis for determining whether an individual has a reasonable expectation of profit as an objective, facts based on the activities actually undertaken by the individual. A subjective profit motive is not sufficient; there must be an objective profit expectation based on an analysis of the activity using certain criteria. Below are just a few examples of these criteria:
■ The profit and loss experience in past years;
■ The length of time over which a profit could reasonably be expected to be shown must be relevant to the nature of the activity. For example, in the case of a tree farm, the relevant time period might be longer than a vegetable farm;
■ The extent of activity in relation to that of businesses of a comparable nature and size in the same locality;
■ The amount of time spent on the activity in question;
■ The individual’s qualifications, such as experience, training and education, including his/her eligibility for membership in a professional association;
■ The individual’s intended course of action, as evidenced by his/her efforts showing an intention to make a profit (e.g., the preparation of a business plan);
■ The degree of effort in promoting and marketing the products or services supplied by the individual as, for example, the registration of a trading name and the opening and maintaining books and records;
■ The type of expenditures claimed and their relevance and reasonableness to the activity (i.e., will the expenditure enhance the ability to make a profit); and
■ The nature of the product or service supplied, such that it has a profit potential (i.e., a market exists or can be developed).
In applying the test, note that no particular factor is more important than the other and no one factor can determine whether or not an activity is carried on with a reasonable expectation of profit. CRA will typically consider the relevant criteria together in making a determination. So, use these factors to assess your business to see if your business can pass the REOP test.
2. Tax Deduction vs. Tax Credit – What’s The Difference?
While a few people may be familiar with tax credits and tax deductions, most people don’t understand the difference between these two terms. More importantly, I find that taxpayers don’t always take advantage of the various tax credits and deductions that are available to reduce their income taxes. As a result, they end up keeping less of their money. So what are the differences between a tax credit and a tax deduction, and why does it matter? A tax deduction (or “write-off”) reduces your taxable income, on which your federal tax is calculated. If you’re paying some taxes, a deduction is worth about 25% to 50% of your taxable income depending on your tax bracket. A tax credit, on the other hand, is a direct reduction in tax; $100 of a credit such as the credit for political contributions is worth exactly $100 to you. If you want further details on this and how you can take advantage of the tax code to accumulate both tax-free and tax-efficient wealth, then I encourage you to get a copy of my book, Tax-Efficient Wealth.
3. Are You Willing To Be Uncomfortable?
Each week, I get a short newsletter in my inbox from James Clear, author of Atomic Habits (If you’ve not read this book, I highly recommend it. You will love it!). Below is one of his ideas this week…
“Are you willing to be uncomfortable for 5 minutes?
Exercising is easier once you’ve started the workout.
Conversation is easier once you’re already talking.
Writing is easier once you’re in the middle of it.
But many rewards in life will elude you if you’re not willing to be a little uncomfortable at first.”
This reminds me of the discomfort I strongly felt when I thought about starting the 75 HARD challenge earlier this month. Now, after successfully completing 13 days of the challenge, in some ways it is easier but truly, in other ways, it is challenging. What is certain is the rewards. So, how are you willing to be uncomfortable this week and in the coming weeks?
Consider subscribing to James Clear’s weekly emails as he shares a lot of good nuggets to motivate you as you try new things and new habits. Check it out here.
4. Do You Rent Or Own Your Home?
It is not very common to find people who own investment real estate and rent a space as their primary residence. I know at least 3 friends and clients who do this. Most people who own investment real estate also own their primary residence. There are many reasons why renting will make financial sense. The biggest is obviously the lower cost of renting compared to owning, particularly in a market like Toronto. Personally, I am biased towards owning for two key reasons. First, it forces you to save and second, you don’t pay capital gains taxes on the sale of your home. However, with house prices so high in the Greater Toronto Area, renting may be a better option only if you save the difference and reinvest it, preferably in an investment real estate. Some experts have suggested that if the value of the house is more than 15 times the value of the annual rent, you should consider renting. For example, let’s say you have a house valued at $650,000 and you can rent the same house or a similar house for $3,000 per month or $36,000 per year. In this case, you can consider renting as the value of the house ($650,000) is more than 15 times the value of the annual rent (15 x $36,000 = $540,000). What do you think? Do you currently rent or own your primary residence? If you rent, why?
5. Extended Repayment Deadline for CEBA
This week, the government announced that the repayment deadline for CEBA loans to qualify for partial loan forgiveness is being extended from December 31, 2022, to December 31, 2023, for all eligible borrowers in good standing. Repayment on or before the new deadline of December 31, 2023, will result in loan forgiveness of up to a third of the value of the loans (meaning up to $20,000).
The repayment deadline to qualify for partial forgiveness for CEBA-equivalent lending through the Regional Relief and Recovery Fund is also extended to December 31, 2023. This is great news for many businesses that are still struggling as a result of the ongoing COVID-19 concerns.
