Tax Strategies to Help Your Ontario Small Business Thrive
Running a successful small business in Ontario comes with its fair share of responsibilities. Having an effective tax plan is a key component to the longevity and success of a small business, and yet it is often overlooked.
Whether small business owners are focused on managing day-to-day operations or keeping customers satisfied, strategic tax planning helps businesses manage long-term financial goals, maintain cash flow, and take advantage of available deductions and credits. Thinking about your taxes is not just for tax season.
Understanding Ontario and federal tax rules allows small businesses to thrive, whether the business is incorporated, a sole proprietorship, or just starting out.
Strategic tax planning is the process of arranging your financial affairs in a way that reduces your overall tax liability. To gain a better understanding of what strategic tax planning is, check out our Strategic Tax Planning: Maximizing Wealth blog.
Business Structure and Tax Implications
The legal structure of a small business significantly affects its income tax obligations. Structures such as incorporation, sole proprietorship, or partnership each carry distinct tax requirements. Deciding which structure is right for your small business depends on your long-term objectives, income potential, and tolerance for legal and financial risk.
The simplest structure is a sole proprietorship. In a sole proprietorship, business income is taxed at the individual’s personal income tax rate. This structure leaves the owner with full liability, as there is little to no separation between personal and business assets; the owner assumes full responsibility for all business debts and obligations, including income tax.
In a partnership, each partner reports their share of business income on their own tax return. Partnerships allow two or more individuals to share profits and losses, offering flexibility in income allocation. However, partnerships require clear agreements and careful planning to address liability concerns.
Another structure is incorporating. An advantage of incorporating your small business is that it provides distinction between the individual and the corporation, allowing for limited liability on the business’s debts and obligations. Incorporation also allows businesses to claim the small business deduction.
Small Business Deduction
Canadian-controlled private corporations can use the small business deduction to pay tax at a lower rate on up to $500,000 of active business income earned in Canada. The small business deduction is designed to support small businesses, encourage local economic growth, and compensate for the lack of other benefits available to entrepreneurs.
To qualify for the small business deduction, the corporation must earn active business income and must not be classified as a specified investment business or a personal services business.
Tax Deductions for Business Expenses
Maximizing eligible tax deductions is one of the most effective strategies available to small business owners. Section 18(1)(a) of the Income Tax Act establishes that businesses may deduct expenses “made or incurred by the taxpayer for the purpose of gaining or producing income.” The amount that can be deducted in a given year depends upon whether the expense is current or capital in nature.
Deductible expenses can include:
- Office supplies
- Professional fees
- Motor vehicle expenses
- Rental and utilities expenses
- Travel expenses
- Home office expenses
For a full list of business expenses, check out the Canada Revenue Agency (“CRA”) business expenses page. To benefit from these deductions, keeping detailed and accurate records of all business-related expenditures is essential. This facilitates accurate tax filing and prepares a small business for a potential CRA audit.
Understanding Tax Credits for Small Business Owners
Like income tax deductions, income tax credits are an important part of Canada’s taxation system. They can directly reduce the amount of income tax owing, while deductions only reduce taxable income. Gaining an understanding of the different types of credits available to small businesses enables business owners to benefit from them.
There are three main types of tax credits:
- Unlimited non-refundable tax credits
- Refundable tax credits
- Non-refundable tax credits at a defined rate
Examples of income tax credits available to Ontario businesses include Clean Technology Investment Credits. Sustainability is an increasing priority in Canada, and investing in clean technology can be a smart tax planning strategy for Ontario small businesses. Some of these credits include the Clean Technology ITC, Clean Technology Manufacturing ITC, Carbon Capture, Utilization and Storage ITC, Clean Hydrogen ITC, and Clean Electricity ITC. These credits allow incorporated small businesses to invest in meaningful projects that help reduce emissions in manufacturing and industrial processes. Taking advantage of these credits can help Ontario businesses position themselves for long-term growth in a cleaner, more sustainable economy while potentially reducing income tax payable.
Disclaimer
This article provides information of a general nature only. It does not provide legal advice nor should it be relied upon. All tax situations are specific to their individual facts and may differ from the situations described in this article. If you have specific legal questions, you should consult a lawyer.
Bhavika Chadha