Wondering how a Business Income for an Individual in Canada  – You may earn income outside of employment—whether full-time or as a side hustle—as a contractor, consultant, or self-employed individual. In Canada, you do not need to register your business (incorporate) to earn income from a business if you operate as a sole proprietorship.

According to CRA, business income is income you earned from a profession, trade, a manufacturing or undertaking of any kind, an adventure or concern like trade, or any activity you carry on for profit, and there is evidence to support your intention. This simply means any income you generate from activities like running a business, offering services, selling products or any other work with the intention of earning profit is considered as business income.

Individuals who earn income from a business—whether as a sole proprietor, independent contractor, or self-employed professional—are required to report this income on their personal tax return. The business income is taxed under the rules set out in the Income Tax Act (ITA). Therefore, it is essential to understand what business income is, how to track both income and expenses, and which expenses can be claimed to stay compliant and reduce tax payable on your business earnings.

At MJ Professional, we will cover everything – from determining whether you are carrying on a business to complete Statement of Business or Professional Activities (T2125), identifying allowable expenses, and managing capital cost allowance ((CCA and advising on HST/GST requirements.

What Is a Sole Proprietorship in Canada, and How Does It Differ from a Corporation?

A sole proprietorship is the simplest form of business that you can run without incorporating (unincorporated business). Legally, there is no separation between you and your business- your business and you are considered the same entity for tax purpose. This means income you earned from running the business under this structure must be reported on your personal tax return (T1). In contrast, Corporation is separate legal entity incorporated under Canada Business Corporation Act (CBCA). Since it is a separate legal entity, its income is reported separately on T2 return.

Things to consider for a sole proprietor:

1. You will be personally liable for any debt or obligation of your business.
2. Business income must be reported using form T2125 on your personal tax return (T1).
3. You can deduct eligible business expenses in determining your net business income, which is tax at your personal tax rate.
4. You must register for HST/GST if your business income is more than $30,000 in any 12-month period.

 

Should I incorporate my self-employed business in Canada?

Before making final decision on incorporating your self-employed business, you should understand the advantages and disadvantages of incorporation. There is no one size that fits the answer and depends on the specific situation.

Advantages of incorporating your business

1. Tax deferral and planning – If your business earns active income below $500,000, it qualifies for the small business rate which is 9% federally plus approximately 3-5% provinces rate (depending on province of operation). You can defer personal taxes by leaving profits in the corporation, paying only the lower corporate tax rate, and withdrawing funds as needed through salary or dividends.
2. Limited liability- if no personal guarantee is given, your personal assets are generally protected from business debt or legal actions.
3. Enhance credibility and access to capital – Corporations are often viewed more favorably by investors and lenders when seeking funding. You can also raise capital by issuing shares.
4. Lifetime Capital Gain Exemption (LCGE) – If your corporation Qualifies as Small Business Corporation (QSBC), you may be eligible for LCGE and shelter up to $1.25 million (2025 limit) in capital gain from sale of your corporation shares.

For more information about the LCGE and how it might apply to you, please contact our team.

5. Income Splitting – you can split income by paying your family member salary or dividend. However, in certain cases, issuing dividends to family members may trigger the Tax on Split Income (TOSI) rules. TOSI is designed to restrict income splitting and often applies when dividends are paid to your family members who are not actively involved in the business. These rules are complex, and several exceptions are available.

Please consult one of our tax experts for guidance if you believe TOSI may apply to your situation.

Disadvantages of incorporating your business

1. Cost and complexity – there are costs associated with incorporating your business as well as annual filing requirements. You must file a corporate tax return (T2) every year, and you will likely need to pay for bookkeeping and accounting services.
2. Loss of deduction – As a sole proprietor or self-employed individual, all business income or loss flows directly through your personal tax return. Loss on business can lower your taxable income, saving taxes that otherwise you would owe. A corporation is a separate legal entity, so business losses are retained within the corporation and do not flow through to your personal tax return.
3. TOSI rule- The Tax on Split Income (TOSI) rules limit your ability to pay dividends to family members unless they are actively involved in the business. This may significantly reduce your ability to split income with family members.
4. Double taxation – If not structured properly, you may end up paying tax at both the corporate and personal level when withdrawing funds from the corporation.

It is a good idea to start thinking about incorporating your sole proprietorship or self-employed business when your net income exceeds $80,000 – $100,000 and you do not need funds for personal use. Incorporating allows you to defer taxes on this income as you will be paying taxes at a corporate level which is significantly lower than personal level.

However, you may want to wait if your business income is low or not consistent, or you need all business income for your personal needs. Also, if you wish to contribute to the Registered Retirement Saving Plan (RRSP), you should not incorporate your business as business income increases your RRSP contribution room.

How can I transfer my self-employed business into an incorporated business

The Canada Revenue Agency (CRA) considers any transfer of assets from your self-employed business to an incorporated business as a deemed disposition. This may result in capital gains tax being triggered at your personal level. However, the CRA allows you to transfer your self-employed business without triggering immediate tax on capital gains under section 85 rollover.

Another way to transfer your self-employed business assets to a corporation is by selling them to the corporation at fair market value (FMV). However, this approach will trigger immediate tax consequences on any capital gains realized from the sale. This option may be used if you have non-capital loss carryforwards from prior years on your personal return which can be used to offset the gain triggered by selling assets to the corporation or want a clean start with minimal paperwork.

How Section 85 rollover works

Steps to use the sections 85 rollover:

 This is a high-level overview only. The actual transfer of a sole proprietorship to a corporation is significantly more complex and must consider various legal, tax, and financial factors. We strongly recommend consulting a qualified tax advisor or legal professional to ensure the process is done correctly and efficiently.

1. Incorporate your new corporation – register with federal/provincial, choose a name, structure your business and issue common shares.
2. Prepare a section 85 rollover agreement – Legal agreement to transfer assets from you to the corporation in exchange of common shares. You can elect any amount between cost and fair market value of the assets, which will be your deemed proceeds of disposition. You must receive common shares in exchange of assets.
3. File CRA form T2057 – basically this is to document the rollover and defer any taxes on transferred assets. The due date to file this form is later of your personal tax return due date or the corporation’s income tax return due date.
   30. You’re an individual (sole proprietor), and your personal tax year ends December 31, your return is due April 30.
   31. The corporation has a year-end of, say, June 30, its return is due six months later, by December 31.
4. Transfer your assets to corporation – physically or legally transfer your business assets to the new corporation, update contracts, bank account and other account. Everything you transferred should be under your new business

Please contact us before making final decision on incorporating your business.

How business income for individuals is reported and taxed in Canada

In Canada, income earned through self-employment, a sole proprietorship, or a partnership is reported and taxed on your personal tax return, along with other sources of income such as employment and investments. There are no separate filing requirements; instead, it is reported on your T1 personal tax return using form T2125, which is the Statement of Business or Professional Activities. T2125 form is used to calculate your net business income using all your business/professional income and expenses. You will pay tax on net business income after deducting eligible expenses from all business/professional income you earned.

These are the most common sources of Business Income for an Individual in Canada

• Consulting income
• Commission income – real estate agents, insurance brokers sale representatives etc.
• professional income – self-employed doctors, lawyers, accountant, dentist etc.
• contract income/ Gig work – tradespeople, delivery drivers, independent contractors, income earned from Uber, Lyft, Skip the dish etc.
• Online business income – youtubers, selling products on Amazon marketplace etc.
• Home based services – childcare, personal training cleaning etc.
• Rental related services – Airbnb (depends on involvement in generating income)

What Expenses Can be Deducted from Business Income in Canada

The starting point for determining which expenses you can deduct from your business income is whether those expenses were directly related to or necessary for earning business income. Also, the expenses that you are claiming must be reasonable. In the CRA’s view reasonable expenses are those that a prudent businessperson would incur in similar circumstances, for example, paying your spouse or child an unreasonably high salary is not reasonable. Moreover, CRA imposes some restrictions on the deductibility of expenses such as meals and entertainment, capital expenses, vehicle lease costs, luxury vehicle used in business etc. Therefore, it is crucial to ensure only expenses allowed by CRA are included in your business expenses.

What happens if the CRA does not allow expenses claimed on reported business income?

The cost of claiming disallowed expenses on your business income can be significantly higher than the immediate benefit you received when filing taxes. If the CRA reviews your return, the following consequences may occur:

• Increase your taxable income – If the CRA disallows your business expenses, they are added back to your business income, resulting in higher net income. Higher net income results in higher income taxes you owe. For example, you reported $20,000 business income and $10,000 expenses. Later, the CRA disallowed $2,000 of expenses – your taxable income becomes $12,000 instead of $10,000. You need to pay additional tax on the $2,000 according to your marginal income tax rate.
• Interest – the CRA will charge you interest on additional tax you owed due to reassessment. Interest is compounded daily starting from the original due date, which is June 15 in the tax year you filed your personal income tax return.
• Penalties – Penalties may apply in certain circumstances such as
  • Gross negligence penalties – if the CRA believes you knowingly claimed false or unreasonable expenses, the penalty is 50% of the understated tax or amount of taxable benefit you received.
  • Failure to report income – if you repeatedly made error or omission, the CRA may charge you penalty even if it was not intentional.
• Loss of other personal benefits – Since disallowed expenses increase your net income for tax purposes, The CRA may reduce or eliminate your benefits such as GST/HST credit, Ontario Trillium Benefit, Canada Childcare Benefit (CCB) and other income-tested benefits.

What happens if the CRA audits my return?

If the CRA reviews and disallows your business expenses, it may audit or reassess your prior year returns. The CRA can reassess your return up to 3 years return from the date of the notice of assessment, or beyond if there is a suspicion of fraud, negligence, or misrepresentation. Moreover, disallowed expenses in the current year may increase the likelihood of future audits.

The CRA will provide you with reasons for the disallowed expenses in the Notice of Reassessment or audit letter. If you are not satisfied with the CRA’s reason, you can file the Notice of Objection. You will have 90 days to file an objection from the date of Notice of Reassessment.

At MJ Professionals, we ensure that only deductible expenses are claimed on your tax return to avoid these issues. We will also assist you in the event of CRA audit or review including filing Notice of Objection if necessary.

Business expenses that you can claim

It is very important to ensure your personal expenses are not included on your personal tax return. As explained above, consciousness can be severe, causing extra headaches and cost to resolve. The common expenses that you can claim on your business income are as follows:

• Advertising– Generally, advertising expenses you paid in Canada are deductible expenses if they were incurred for the business purposes. There is a restriction when foreign print or broadcasting is used for advertising. CRA does not allow advertising expenses as your business expenses if you use foreign print or broadcasting and the advertising is directed primarily to the Canadian market. Advertising expenses are deductible if the advertising is directed to a non-Canadian market.
• Meals and entertainment – meals and entertainment include expenses for food, drink, taking a client for lunch etc. The CRA imposes restrictions on how much you can claim as your business expenses. Generally, only 50% of meals and entertainment expenses related to business are deductible. However, if you have employees and you provide meals for all employees (e.g. party or events), you can deduct 100% as expense but limited to 6 events per year. No personal meals and entertainment-related expenses can be claimed.
• Bad debts – Bad debts refer to amounts owed to you by your customer or clients that were already included in your business income but are no longer collectible. You can deduct uncollectible amounts as a business expense in the year become uncollectible. The following must be considered before taking bad debts as business expense.
  • Bad debt amount must have been included in your business income in current year or prior years.
  • Bad debt is related to your business, not personal.
  • The debt must be uncollectible during the year. You must have made reasonable efforts to collect. It is a good idea to have documentation that shows effort to collect, reason for writing off and amount included in your business income in current or previous years.

• Insurance – Insurance premiums can be deducted as business expenses if they are directly related to earning business income (e.g. commercial liability insurance, property insurance errors or omissions insurance, cyber security insurance). However, not all types of insurance are deductible. Non-deductible insurance includes personal life insurance and personal health insurance.

Some insurance premiums are partially deductible, based on used for business purposes (e.g. auto insurance if the vehicle is used for both business and personal, home insurance if a portion of home is used as a home office).

 

• Interest and bank charges – Any interest you pay on money borrowed for business purposes is deductible, but not the principal (e.g., interest on a line of credit or a loan for purchasing business equipment). If a portion of home is used for business, you can claim interest on your home mortgage based on portion used for business. Penalties paid for early loan payment are generally not deductible, unless you can directly relate them to a business purpose. Bank charges are also deductible if they are related to earning business expenses, for example, monthly account fees, transaction fees, or overdraft charges, business taxes, licenses, and membershi fees. 
• Office expenses – Office expenses generally refer to small supplies you require to run your business. These expenses are deductible if directly related to business. Deductible expenses include pen, paper, postage, files, folder etc. No capital nature expenses are deductible such as desks, chairs, computers, printers etc. However, you can claim Capital Cost Allowance (CCA) on the expense if they are in capital nature based on the applicable CCA class rate.
• Professional fees (including legal and accounting) – Professional fees are deductible as business expense if they are directly related to earning business income. Deductible expenses include accounting fees, legal fees, consulting fees, professional association dues, license fees. However, certain expenses are not deductible including legal fees for personal matters, accounting fees for preparing personal tax return, membership dues for golf club. The CRA strictly disallows golf club membership and other recreational due regardless of the purpose or intent behind these expenses.
• Management and administration fees – This expense refers to fees paid for managing and administering your business. If these expenses are directly related to earning business income, you can claim these expenses against your business income. Deductible management and administrative fees may include payments to management companies overseeing your business operation, bookkeeping services, billing service, office support or third-party contractors providing administrative support. You may also pay your spouse or other family members, but fees are deductible only if actual work was performed and fees paid at fair market value.

 To be deductible, fees paid must be reasonable in amount incurred for business purposes, not personal nature. They must also be supported by invoices, contracts, or agreements.

 

• Rent – If rent is paid for business purposes, it can be deducted from your business income. Deductible rent expenses may include rent paid for a commercial office or workplace only used for business, storage space used for your inventory or supplies, equipment leased or rented, computers or tools used in business.

 Rent paid for personal use, excessive rent paid to related parties and the full home office rent are not deductible. Only the portion of home rent used for business use is deductible.

 Rent paid amount must be reasonable and well supported by proper documentation, such as lease agreement, receipts.

 

• Repairs and maintenance – Routine or minor repairs to business property, equipment or vehicles are deductible form your business income. To be deductible, it must be directly related to earning business income. However, you may not be able to deduct major improvements or renovation, since the CRA considers them capital in nature. The CRA allows this expense to be deducted through Capital Cost Allowance (CCA). CRA has specific CCA rates for different assets. see the full list of CCA rate and class of assets may be applicable to you. For reference, visit CRA website

 

• Salary, wages and benefits– Amount paid to yourself, your family member, subcontractors or any other people to operate your business are generally deductible. However, if you pay salary to a family member, it must be reasonable and for the actual work performed for the business. The CRA may disallow excessive wages paid to family members or related parties. It is good practice to keep proper documentation such as employment agreements, time sheets and records of the work performed.

 You must also issue T4 for the gross salary you paid and be responsible for payroll remittance such as CPP, EI and income tax withheld. If you hired a subcontractor or self-employed individuals to help your business, you are required to issue T4A slip for the amount paid. T4 and T4A must be submitted to the CRA by you by the end of February, with copies provided to the respective employees and subcontractors. To determine how much CPP, EI and tax to deduct from employees’ salaries, you can use the payroll deduction calculators and tools provided by the CRA. 

 

• Property taxes – If you work as self-employed or sole proprietor, you can deduct property taxes paid for commercial properties as well as a portion of property taxes related to your residential property if you use part of your home as a workspace for business purposes. You can deduct a portion of property taxes for your residential property for the use of home office for your business if;
  • The workplace is your principal place of business

Or

• You use space exclusively and on a continuous basis meeting your client or customers.

 

Deductible portion = (Workspace area ÷ Total home area) × Annual property taxes

 

• Travel expenses – Travel expenses directly related to earning business income are deductible for tax purposes such as transportation, meals and lodging, vehicle rental, parking, tolls, baggage fees, conference or trade show. Travel expenses for personal use such as travel expenses related to vacation, fines and penalties (parking, speeding tickets) are not deductible. All travel expenses must be reasonable and well-documented, as the CRA often audits these expenses if they seem excessive.
• Utilities – Utilities expenses used to earn business income are deductible for tax purposes such as electricity, heating, internet, telephone, waste disposal etc. However, if you paid for utilities related to your home office and meet the criteria outlined above, you can deduct a portion of your utilities including heat, electricity, water, internet, maintenance fees (such as condo fees).

 

• Delivery, freight expenses – Expenses related to delivery and freight are deductible if incurred to earn business income including shipping cost, freight cost paid to import supplies and inventories, courier charges, postal charges, cost of packaging material for delivery. This expense must be reasonable and well supported with receipts or invoices. If you use your personal vehicle for delivery, only the portion used for business is deductible, and you need to keep mileage log for support.
• Motor vehicle expenses other than CCA – If you are a sole proprietor or self-employed individual and used your vehicle to earn business income, you can deduct operating expenses related to your vehicle, excluding Capital Cost Allowances (CCA), which is calculated separately as explained in the next section.

Deductible operating expenses for business-use vehicles include fuel, maintenance and repair, parking fees, license plate fees, registration charges, interest paid on car loan, tolls, insurance, lease cost (for leased vehicles).

Only business-related portions of these expenses are deductible, and you must maintain a detailed record of both business and personal kilometers driven (a mileage log is required). However, any fines and penalties such as parking and speeding tickets are not deductible. A vehicle used to commute between home and work is considered for personal use and is therefore not deductible – unless you are travelling directly to meet clients or customers.

• Capital cost allowances (CCA)- Capital Cost Allowance (CCA) allows a sole -proprietors or self-employed individuals to deduct the cost of depreciable assets used in business over several years. Capital Cost Allowance (CCA) is the tax term for depreciation. The CCA system does not allow you to deduct the full cost of your depreciable assets in the year of purchase, rather you deduct a portion of the cost each year based on a prescribed CRA rate. Most common depreciable properties used in business are as follows.
  • Motor vehicle used for business
  • Computer and software
  • Tools and machinery
  • Buildings used for business
  • Leasehold improvements (any cost you incurred on leased properties)
  • Office furniture

Each type of asset falls into a CCA class with a specific rate (e.g., Class 10 for general motor vehicles at 30%, Class 50 for computer equipment at 55%). When you sell or dispose of these assets, Undepreciated Capital Cost (UCC), which is the value of assets that has not yet been claimed as deduction, may have to be adjusted or recognize recapture or terminal loss. Recapture is a negative balance remained at the end of year of sale or disposal calculated as follows:

Recapture= UCC- lesser of cost and Proceeds of Disposition

Generally, recapture occurs when proceeds exceed UCC and treated as business income. terminal loss occurs when proceeds are less than UCC, which is deductible from business income.

• Other expenses: Other expenses refer to any legitimate expenses that do not fall under the above but are incurred to earning business income. These expenses include software fees, website development, loan set up fees, subcontracting payment.

Need help determining deductible expenses, Business Income for an Individual in Canada?

Contact our team — we’re here to ensure your tax return is accurate and maximizes all allowable deductions.