BUSINESS VS HOBBY

Not every activity that brings in money is a business. Whether an activity is a business determines whether its income is taxable and, just as importantly, whether its losses can be deducted against other income such as employment income. This page sets out the legal test, the factors the CRA and the courts look at, the special limit on farming losses, and how gains on items sold from a hobby are treated.

THE LEGAL TEST

• Stewart v. Canada (2002): the Supreme Court of Canada held that the question is whether the taxpayer is carrying on the activity in pursuit of profit or as a personal endeavour. The old "reasonable expectation of profit" test is no longer applied on its own.

• Commercial activities: where an activity has no personal or hobby element, such as a consulting practice or a retail store, it is a business, and there is no need to examine the expectation of profit. A loss from it is a business loss.

• Activities with a personal element: where the activity could be a hobby, such as art, photography, crafts, horse breeding, collecting or music, the taxpayer must show it is carried on in a sufficiently commercial manner to be a source of income.

FACTORS THAT POINT TO A BUSINESS

• Profit and loss history: profits in some years, or losses that are shrinking as the business grows.

• Business plan: a written plan, budgets and a realistic path to profit.

• Time and effort: regular, substantial time spent on the activity, with a structured schedule.

• Training and expertise: qualifications or experience in the field, or advice sought from experts.

• Commercial practices: a separate bank account, proper books, invoices, marketing, a registered business name, GST/HST registration where required, and pricing set to make money.

• Response to losses: changes made to cut costs or raise revenue when the activity loses money.

• Capability to make a profit: a scale of operations that could reasonably produce one.

FACTORS THAT POINT TO A HOBBY

• Losses year after year: with no realistic prospect of a profit and no change in approach.

• Personal enjoyment as the driver: the activity would be pursued whether or not it made money.

• Personal use: the assets, such as a boat, horse or cottage, are used largely by the owner and family.

• Informal operation: no records, no separation of personal and business money, and sales mainly to friends and family.

• Losses that shelter other income: the main effect of the activity is to reduce tax on a salary or pension.

CONSEQUENCES

• If it is a business: all income is taxable, reasonable expenses are deductible, and a net loss can be deducted against other income in the year and carried over under the normal rules.

• If it is a hobby: the income is not business income, and the expenses and losses cannot be deducted. Previously claimed losses can be reassessed and denied, with interest.

• Start-up years: losses in the first few years of a genuine business are normal and do not, by themselves, make it a hobby, as long as it is run commercially.

RESTRICTED FARM LOSSES

• When it applies: where a person farms in pursuit of profit, but farming is not their chief source of income, either alone or combined with another main source.

• Annual limit: the deductible farm loss is capped at $17,500, being the first $2,500 of the loss plus half of the next $30,000.

• Carryover: the restricted part of the loss can be carried back 3 years and forward 20 years, but only against farming income.

SELLING ITEMS FROM A HOBBY

• Personal-use property: items such as furniture, cars and boats. A gain is a capital gain, but a loss is not deductible. Cost and proceeds are each deemed to be at least $1,000.

• Listed personal property: art, jewellery, rare books, stamps and coins. A gain is a capital gain, and a loss can be deducted only against gains on other listed personal property, carried back 3 years or forward 7 years.

• Regular selling: buying and reselling items frequently, with a view to profit, can turn the activity into a business, so the full profit becomes business income rather than a capital gain.

WORKED EXAMPLE

An engineer earning a $110,000 salary sells her landscape photographs.

• As a hobby: she sells a few prints a year to friends, keeps no books and has lost $6,000 a year for five years on equipment and travel. The CRA is likely to deny the losses, and her salary is taxed in full.

• As a business: she has a business plan, a website, a separate bank account, gallery contracts and steadily growing sales. Early losses are deductible against her salary, and later profits are taxable.

KEY POINTS

• Pursuit of profit: the test is whether the activity is commercial, not whether it currently makes money.

• Personal element matters: hobby-type activities need clear evidence of commercial operation.

• Farm losses: capped at $17,500 a year where farming is not the chief source of income.

• Hobby sales: taxed as capital gains on personal-use or listed personal property, with restricted losses.

SOURCES

• Supreme Court of Canada: Stewart v. Canada, 2002 SCC 46.

• Income Tax Act: sections 3, 9, 31, 41 and 46.

• Canada Revenue Agency: Guide T4002, Business or hobby; Income Tax Folio S4-F11-C1, Meaning of Farming and Farming Business.