Sole Proprietorship: Tax

A sole proprietorship is not a taxpayer separate from its owner. The net income of the business is computed under section 9 of the Income Tax Act as income from a business or profession, reported by the proprietor on Form T2125, and taxed at the proprietor's personal graduated federal and provincial or territorial rates together with all other income of the individual. This page sets out the computation of business income, the principal deduction rules, losses, CPP and instalment obligations, filing deadlines, GST/HST and provincial sales tax, and provincial considerations.

COMPUTATION OF BUSINESS INCOME

• Profit is determined in accordance with well-accepted business principles, generally consistent with generally accepted accounting principles, subject to the specific provisions of the Act.

• Income must be computed on the accrual basis (cash basis only for farming and fishing), and the fiscal period of an individual's business ends on December 31 unless an alternative year-end is elected under section 249.1.

• Amounts received for goods or services to be provided in a future year may be included in income and offset by a reserve under paragraph 20(1)(m).

• Income includes the fair market value of goods withdrawn for personal use and of barter transactions.

DEDUCTIBILITY OF EXPENSES

• General limitation: an outlay is deductible only to the extent it was made or incurred for the purpose of gaining or producing income from the business (paragraph 18(1)(a)).

• Personal or living expenses are not deductible (paragraph 18(1)(h)).

• Capital expenditures are not deductible currently (paragraph 18(1)(b)); they are recovered through capital cost allowance.

• All expenses must be reasonable in the circumstances (section 67).

• Meals and entertainment are limited to 50% of the lesser of the amount paid and a reasonable amount (section 67.1).

• Business-use-of-home expenses are restricted by subsection 18(12): the space must be the principal place of business or used exclusively and regularly to meet clients, and the deduction may not create or increase a loss.

• Automobile expenses are limited to the business-use proportion and to the prescribed ceilings for passenger vehicles; a logbook is required.

• Interest on money borrowed for business purposes is deductible under paragraph 20(1)(c).

• Prepaid expenses are deductible only in the year to which they relate (subsection 18(9)).

• Convention expenses are deductible for no more than two conventions per year held by a business or professional organisation within its territorial scope.

• Salaries paid to a spouse or child are deductible only where the services are rendered and the amount is reasonable.

CAPITAL COST ALLOWANCE

• Depreciable property is allocated to prescribed classes in Schedule II of the Income Tax Regulations, each with a prescribed rate, principally on a declining-balance basis.

• Commonly used classes: Class 1 (buildings, 4%); Class 8 (furniture, equipment, and machinery not otherwise classified, 20%); Class 10 (motor vehicles and general-purpose equipment, 30%); Class 10.1 (passenger vehicles above the prescribed cost ceiling, 30%, one vehicle per class); Class 12 (tools and software under the prescribed value, 100%); Class 14.1 (goodwill and other intangible property formerly eligible capital property, 5%); Class 50 (computer hardware and systems software, 55%).

• The half-year rule limits the first-year claim to one-half of the normal amount, except where enhanced first-year allowances apply under the accelerated investment incentive or other prescribed measures.

• CCA is discretionary: any amount up to the maximum may be claimed, and claims may be reduced to preserve other deductions or credits.

• On disposition, recapture (where proceeds exceed undepreciated capital cost) is fully included in income, and a terminal loss (where the class has no remaining property and an undepreciated balance) is deductible.

LOSSES

• A business loss is first applied against the proprietor's other income for the year, including employment and investment income.

• Any unused amount becomes a non-capital loss, which may be carried back three years (Form T1A) or forward twenty years.

• Losses from farming that is not the chief source of income are restricted farm losses, subject to annual limits.

• A loss is deductible only where the activity is a business carried on for profit, not a personal pursuit or hobby.

PERSONAL TAX, CPP, AND INSTALMENTS

• Net business income is added to other income and taxed at the proprietor's marginal federal rate (14% to 33% in 2026) plus the provincial or territorial rate of the province of residence on December 31.

• Canada Pension Plan contributions on self-employment earnings at 11.9% (base and first additional) and 8% (CPP2), calculated on Schedule 8; one-half of the base contribution is deductible and one-half creates a non-refundable credit, while enhanced contributions are fully deductible.

• Instalments are required quarterly where net tax owing exceeds $3,000 ($1,800 in Quebec) in the current year and either of the two preceding years.

• Optional EI special benefits premiums are payable on Schedule 13 where the proprietor has registered.

FILING AND PAYMENT DEADLINES

• T1 return with Form T2125: June 15 of the following year for self-employed individuals and their spouses or common-law partners.

• Balance of tax owing: April 30 of the following year. Interest accrues on unpaid amounts from May 1.

• T4 slips for employees: last day of February.

• GST/HST return: annual filers with a December 31 fiscal year-end file by June 15 and pay by April 30; quarterly and monthly filers file and pay one month after the end of each reporting period.

GST/HST

• Registration is mandatory once taxable supplies (worldwide, including those of associated persons) exceed $30,000 in a single calendar quarter or over four consecutive calendar quarters.

• Reporting period: annual where annual taxable supplies are $1,500,000 or less; quarterly where they exceed $1,500,000 up to $6,000,000; monthly where they exceed $6,000,000. Voluntary election of a shorter period is permitted.

• Input tax credits may be claimed for GST/HST paid on purchases used in commercial activities, supported by documentation meeting the $100 and $500 thresholds.

• The quick method is available to eligible registrants with annual taxable supplies not exceeding $400,000.

• Rates: 5% GST in Alberta and the territories; 13% HST in Ontario; 14% in Nova Scotia; 15% in New Brunswick, Prince Edward Island, and Newfoundland and Labrador; 5% GST plus provincial sales tax in British Columbia (7% PST), Saskatchewan (6% PST), and Manitoba (7% RST); 5% GST plus 9.975% QST in Quebec.

PROVINCIAL AND TERRITORIAL CONSIDERATIONS

• Quebec: the proprietor files the TP-1 return with Form TP-80, pays Quebec income tax, QPP, and QPIP premiums, and may be liable for a Health Services Fund contribution on business and other non-employment income above a threshold, calculated on Schedule F. QST registration with Revenu Québec is required at the same $30,000 threshold.

• British Columbia: PST registration with the Ministry of Finance is required for businesses that sell taxable goods or services in British Columbia, subject to small seller exceptions.

• Saskatchewan: PST vendor licence required for sales of taxable goods and services.

• Manitoba: RST registration required where taxable sales exceed the small trader threshold.

• Ontario and the Atlantic provinces: provincial sales tax is harmonised and administered by the CRA through the HST account.

• All provinces and territories: personal income tax at provincial rates and credits; certain provinces offer small business and regional tax credits, and municipalities may levy business licence fees.

• Alberta, Yukon, the Northwest Territories, and Nunavut: no provincial sales tax.

INCORPORATION OF A SOLE PROPRIETORSHIP

• Business assets may be transferred to a taxable Canadian corporation on a tax-deferred basis under subsection 85(1), by filing Form T2057 with an elected amount between the tax cost and fair market value of each property.

• Considerations include the deferral available at the small business rate, the cost of maintaining a corporation, the loss of the ability to deduct business losses against personal income, access to the lifetime capital gains exemption on qualified small business corporation shares, and liability protection.

• GST/HST may be relieved on the transfer by a joint election under section 167 of the Excise Tax Act.

SOURCES

• Income Tax Act, ss. 9, 18, 20, 67, 67.1, 85, 111, 249.1; Income Tax Regulations, Schedule II.

• Canada Revenue Agency, Guide T4002 Self-employed Business, Professional, Commission, Farming, and Fishing Income.

• Canada Revenue Agency, Guide RC4022 General Information for GST/HST Registrants.

• Revenu Québec, Guide to Filing the Income Tax Return (TP-1.G) and Form TP-80.