Business and Property Deductions
Author | Vern Krishna |
Profession | Professor of Common Law, University of Ottawa Barrister at Law |
Pages | 185-256 |
185
CHAPTER 8
buSIneSS and
properT y dedu cT IonS
A. DEDUCTIONS
1) General Comment
We saw earlier that income from an office or employment is taxable on
a gross basis. In contr ast, income from business and property is tax able
on a net basis. Thus, we need to determine which expenses are deduct-
ible from business and property revenues in order to ca lculate net profit
for tax purposes.
The calculation of net profit is a question of law. Nevertheless, we start
by looking to the tax payer’s financial statement s. We determine net profit
according to commercial and accounting pri nciples to the extent that they
do not conflict with the Act or judicial decisions. The court in R oy al Tr u st
explained the scheme for the deductibility of expenses as follows:
Thus, it may be stated categorically that in a case under the Income
Tax Act the first matter to be determined in deciding whether an out-
lay or expense is outside the prohibition of . . . [paragraph 18(1)(a)]
of the Act is whether it was made or incurred by the taxpayer in ac-
cordance with the ordinary pri nciples of commercial tr ading or well
accepted principles of business practice. If it was not, that is the end
of the matter. But if it was, then the outl ay or expense is properly de-
ductible unless it falls outside the expressed exception of . . . [para-
graph 18(1)(a)] and, therefore, within its prohibition.1
1 Royal Trust Co v MNR (1957), 57 DTC 1055 at 1060 (Ex Ct).
Income Tax L aw186
Figure 8.1 Overview of Structure
Computation of “profit” under section
Expense deductible by commercial principles?
Yes
Yes
Yes
Yes
No
No
No
No
Deductible unless prohibitedNot deductible unless spe cifically
authorized
Prohibited?
e.g., ss , , ., ., .Authorized?
No deduction unless specifi cally
authorized
Deductible
Deductible
No deduction
No deduction
Specific authorization? s.
Business a nd Property Deductions187
2) General Rules
To be deductible from revenue, in computing net profit, an expenditure
must satisfy six basic tests. It must:
• Be incurred for the purpose of earning income;
• Be of an income nature and not a capital expenditure;
• Be reasonable in amount;
• Not be a personal expenditure;
• Not be expressly prohibited by the Act; and
• Not constitute “abusive” tax avoidance.
Apart from these six tests, there is no blanket public policy prohibition
on the deductibility of expenses.2
The above criteria serve purposes that are different from those that
generally accepted accounting and commercial principles serve. For
example, the requirement that an expenditure should be reasonable
in amount is not an accounting rule, but a constraint to protect the
government’s taxable base. The prohibition against the deductibility of
expenses t hat the statute specifically proscribes allows the legislator to
use it to foster socio-economic and public policies. The anti-abuse rule
is intended as a broad “catch-all” clause for expenses that the legislator
did not proscribe more specifically.
3) Purpose of Expenditure
An expenditure is deductible as an expense in computing income only
if one incurs it for the purpose of earning income.3 It is the purpose,
and not the result, of the expenditure that determines deductibility.
Thus, an expense for the purpose of earning income from a business
is deductible, regardless of whether it actually produces income. For
example, if a taxpayer incurs advertising expenses for the purpose of
promoting sales, failure of the advertising program to stimulate sales
does not disqualify the expenditure as a deductible expense.4
3 Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA], para 18(1)(a). This rule does
little more tha n reinforce subs 9(1), which states th at the income from a
business or prop erty is the profit therefrom. To const itute an “expense,” the
taxpayer mu st be under an obligation to pay money to someone. A n obligation
to do something t hat may entail an expe nditure in the future is not a n expense;
see Canada v Burnco In dustries Ltd, [1984] CTC 337 (FCA).
4 See BC Electric Railway Co v MNR, [1958] CTC 21 (SCC) [BC Electric Railway]
(payments m ade by taxpayer to enable it to become m ore profitable not deduct-
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