Many Canadians have a passion that they enjoy outside of their work life. This may include baking, woodworking, art, or collectibles. This hobby may begin to generate income for the lucky few. Determining whether this income is from a business or a hobby has significant implications for your tax return.
A general rule in the Income Tax Act is that expenses are only deductible to the extent that they are incurred to gain or produce income from a business or property. This is commonly referred to as “reasonable expectation of profit”. Canada Revenue Agency will assess whether your activity has a reasonable expectation of profit to determine whether it is a business or hobby. Factors commonly assessed in this determination include the profit or loss in recent years, your training or expertise in the area, your intended course of action, and the capability of the venture to turn a profit after deducting capital cost allowance. These factors need to be assessed based on the facts and circumstances in each particular situation.
Business income will be reportable, and deductions allowed, if you are running your endeavour in a business-like manner even if there is a personal element included. Factors that may support this include the amount of time devoted to the venture, advertising and marketing activities, and financing activities. In the early years of a business venture, it is common to report losses and these losses can be claimed against other sources of income on your tax return, such as employment or investment income. These losses generally will not be questioned by Canada Revenue Agency if you can provide sufficient support that you are incurring the expenses in pursuit of income from a business. If the activity continues to incur losses year after year, the likelihood of Canada Revenue Agency challenging the losses increases. It is possible they will deem the losses to be from a hobby and the amounts will not be deductible against other sources of income. Proper documentation regarding the factors listed above is critical if the amounts reported are challenged.
If you earn income from a hobby activity, it will be considered a gain from the sale of personal-use property. Gains from the sale of personal-use property are only taxable if the total proceeds of disposition exceed $1,000. This is due to a deeming provision which deems the adjusted cost base of personal-use property to be no less than $1,000. Therefore, if the total revenue from your hobby is less than $1,000 in any given year, you will not be subject to tax even if you earned a profit. You will be subject to tax on the sale of personal-use property if the revenue exceeds $1,000. Losses on the sale of personal-use property are disallowed.
The rules regarding business or hobby income are not clearly defined. Careful analysis is required to assess whether your activity is commercial in nature, or if it is an activity primarily undertaken for personal reasons such as enjoyment or entertainment.
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