Chapter 4 - Income from Business Flashcards
What is the difference between net income for accounting purposes and net income for tax purposes?
Net income in accounting follows generally accepted accounting principles (GAAP) whereas net income for tax purposes follows the income tax act (ITA)
There are some items deducted in computing net income from accounting that need to be added back for tax purposes, some things added that need to be taken away, and some things that can stay as they are
What are the methods we can use to value inventory under ITA subsection 10(1)?
- Lower of cost and market (LCM) for each item
- Free market value for all items
We use the system that provides lower inventory valuation to minimize tax and maximize COGS
What are the 2 ways inventory can be identified for valuation purposes to calculate COGS?
- Specific identification identifies specific items that were sold and includes the invoice price plus duties, freight, insurance, labour, allocated overhead
- First-in-first-out (FIFO) is used is specific identification cannot be applied. We make the simplifying assumption that the earliest acquired items are being sold
What are some of the main expenses specifically disallowed under subsection 18(1)?
- Expenses incurred not for earning business income
- Capital expenditures
- Expenses incurred for earning tax exempt income
- Reserves and contingent liabilities
- Personal expenses
- Political contributions
- ITA payments like taxes, interest, and penalties
- Payments on discounted bonds
- Use of recreational facilities and club membership fees
When are food, beverage, and entertainment costs 100% deductible instead of 50% deductible?
- If you are a restaurant, airline, or hotel where you provide meals to customers in the course of business
- Meals and entertainment primarily intended to benefit a registered charity
- Meals and entertainment provided to all employees at occasional events (max 6 per year)
What home office expenses are deductible for sole proprietors/business that aren’t available for employees?
- Mortgage interest
- CCA on a computer
How are incorporation expenses deductible under paragraph 20(1)(a)?
- The first $5,000 are fully deductible
- Remaining amounts are capitalized to CCA class 14.1
What expense is specifically permitted under paragraph 20(1)(c)?
Interest on funds borrowed to earn business income
When is accrued (unpaid) remuneration deductible as a business expense?
Only if the amount will be paid within 180 days after the tax year ends.
When are life insurance premiums deductible as a business expense?
If the policy is assigned as collateral for a loan used to earn business income
What are the rules for deducting expenses of issuing shares or borrowing money?
- Expenses are permitted as a deduction spread equally over 5 years
- Refinancing costs such as costs to restructure a debt are included
- Advertising costs, filing fees, legal fees, transfer fees, commissions, etc are all deductible
What reserves are specifically deductible under subsection 20(1)?
- Reserve for doubtful debts
- Reserve for goods not delivered and services not rendered
- Reserve for manufacturer’s warranty for amounts payable to a third-party insurer
- Reserve for an amount not due until a later year under an installment sales contract
When must reserves be added back to income?
All reserves deducted in one year must be added back to income in the following year but new reserves can be deducted again if still justified
What are the rules for deducting a reserve for an amount not due until a later year for an installment sales contract?
- The sale must have occurred within 36 months before the end of the tax year
- The reserve is calculated as profit*(unpaid amount/sale price)
What is the limitation on deductions for employer contributions to an RPP or a DPSP?
Limited to the lesser of:
1. 18% of the employee’s income for the year
2. A specified annual limit ($31,560 for Feb 29, 2024)
