Defining “Net Income” For A Business

by Tax Guy - Burlington Accountant on March 13, 2009 Print This Post Print This Post

Question: So simple of a question it doesn’t appear to be in any glossary I have found. What is the definition of taxable income with respect to a corporation in Ontario?

The concept and definition of income is an interesting question in the context of income tax. The Income Tax Act does not specifically define income but contains some general principals for calculating net income for tax purposes. These principals are the same for both a business and an individual, although businesses have access to greater number of deductions from income.

Calculate Net Income For Tax Purposes First

Before we can calculate taxable income for a business we must first determine net income from a business.

Simply stated, net income from a business is the profit derived from carrying on a business. Again in very simple terms, the net income from a business for tax purposes begins with the financial statement net income before tax. From there we must then adjust this value to arrive at the net income for tax purposes as follows:

  • Financial Statement Net Income Before Tax
  • Plus: Accounting Amortization Expense
  • Plus: Contingencies and Reserves
  • Plus: Estimated Expenses
  • Plus: Gains and Losses on the Sale of Assets
  • Less: Capital Cost Allowance (Tax Depreciation Expense)
  • Less: Allowable Tax Reserves
  • Equals: Net Income For Tax Purposes

Certain deductions are not permitted to arrive at net income for tax purposes as you see above. Other deductions that are also not permitted in the calculation of net income may be included in calculating taxable income. The basic calculation of net income is the same for both business and individuals and the deductions to arrive at taxable income differ, and that is why there is this distinction.

For individuals, these additional deductions and inclusions to arrive at taxable income include such things as home relocation loans and stock option deductions. For corporations these deductions include dividends received from other taxable Canadian corporation and charitable donations.

Accounting Income vs Income for Tax Purposes

I apologize for my lack of understanding of some trivial parts here; trust you understand. Financial Statement Net Income – I am confused with the use of the term Net here. By this, you mean total income for the business? If so, starting here and adding (subtracting) expenses, amortization expense, etc. and then subtracting (adding) capital cost allowance to arrive at taxable income would make sense to me.

Your clarification is appreciated, as is this service. I have had accountants threaten to bill me to answer this very question. Thank you from a non-accountant who needs to understand this little tidbit.

The term net income refers to the revenue collected or sales less the direct expenses related generating the sales. For example, assume a consulting business collects $10,000 from clients and pays out $1,500 in client entertainment expenses, and $2,000 for telephone expenses. The net income of this business is $6,500. This is the financial statement net income because we have not made any tax adjustments.

In this case, there is only one item that needs to be adjusted to arrive at net income for tax purposes: Entertainment expenses. Under the tax rules, only 50% of entertainment expenses can be deducted. Therefore, net income for tax purposes is $7,250.

Yes, it does help; thanks! Using my own example, just to be sure:

 

Gross sales $50,000
Expenses (materials, labour, utilities, lease payments, etc.) 15,000
Net income 35,000
Amortization Expense 5,000
Capital Cost Allowance 2,500
Taxable income 27,500

 

Again sorry for being such a hassle, but i appreciate your help a great deal.

I really don’t mind answering these questions.

Your financial statement net income before tax is $30,000 (amortization is deducted). This is your accounting net income before tax. (50,000 -15,000 -5,000).

Your net income for tax purposes is $32,500. Amortization is added back and CCA is deducted. Your taxable income in this case would equal your net income for tax purposes. (50,000 – 15,000 – 2,500).

Do you know where I might find a list of items that I can write off or is it more general in that you can write off almost anything, if it is necessary to generate the revenue you’re writing it off against? Supplies, salaries and wages, benefits, materials, advertising expenses, etc.

A Handy Reference Guide

There is no list. Deductions may be taken if they are for the purpose of earning income from a business or property. If you are looking for an excellent general reference guide for taxation that has a number of illustrative examples, I suggest Byrd & Chen’s Canadian Tax Principles, 2008-2009 Edition. You can pick up a copy at chapters.indigo.ca. If you join their iRewards program you can save a little more off the cover price. And of course the cost of the book is tax deductible if purchased for business purposes.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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{ 4 comments }

Amir March 16, 2009 at 9:58 pm

Im not too sure about the calculation of taxable income. Can you deduct both Ammortization expense and CCA? Is not only one deductable?

Tax Guy March 18, 2009 at 8:52 am

Only CCA is tax deductible. You need to add back amortization.

Marianne March 6, 2011 at 9:21 am

I lent my company $1,500 on start up. At the end of the first year, it owes me $2,800. When I am preparing my first T2 and get to the “Opening Balance Sheet” Sch 101. Do I show the $1,500 as Cash and Due to Shareholder?

Also, the company has an account payable at the end of the year which I am showing on Line 201 of Schedule 1. Am I able to show the $1,500 loan I made to the company somewhere on Schedule 1? I’m thinking maybe Line 300?

Thanks for all the info. You have a great website.

Tax Guy March 8, 2011 at 6:17 am

The $1,500 is a loan and is either a current debt or long-term due to shareholder. This amount is not an expense to the company. Accounts payable is an expense that is payable but has not yet been paid. I’m not sure how the $1,500 changed to $2,800. Normally interest would have to be a reasonable amount.

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