Introduction
For many people who engage in some form of activities as hobbies while being employed or engaged in business on a full time basis the question of whether the income is taxable or the related expenses tax deductible arises. People generally have hobbies like photography, dog-raising, painting, singing etc. for recreational purposes; some of these hobbies transition into side businesses hence the need to figure out if your activity counts as a business because of the thin line that exists between a hobby and a business.
Who is this for?
Individual Taxpayers
Self-employed individuals.
Hobbyists
Keep reading if you’re…
Not sure if you are engaged in a hobby or a side business
Unsure if your expenses are deductible from income for tax purposes
TLDR
Determining whether your hobby is actually a business actually goes just beyond the definition. The Canada Revenue Agency (CRA) defines a business as something done in the pursuit of profit. Hobbies are not always an activity that you do for profit hence the difficulty in distinguishing a hobby from a business arises because essentially there is a personal element involved in carrying out hobbies. What you consider to be a hobby may be a business in the eyes of the Canada Revenue Agency (CRA).
THE DIFFERENCE BETWEEN BUSINESS AND HOBBY
As against the key element of profit required to qualify as a business, the CRA defines a hobby as an activity that is generally undertaken for pleasure, entertainment or enjoyment, rather than for business or profit reasons. But if a hobby is pursued in a sufficiently commercial and businesslike way, it can be considered a business activity and will be taxed as such.[1]
Based on the definition above, if a hobby irrespective of the size ends up generating profit it is assumed that the hobby is a venture with an expectation of profit and categorized as a business. However, if the hobby results in a loss then reasonable expectation of profit does not exist.
For people with income from a regular job, the net loss from a hobby can be deducted from the total income resulting in a lower tax bill. However, there are limits: you cannot continue to write off losses from your hobby year after year without the CRA using the profit test to see whether or not your activities are conducted with a “reasonable expectation of profit”[2]. If the activity is considered to be a personal endeavour or hobby, then the expenses are limited to income earned and losses are recognized or can’t be carried back or forward, as in the case of a business venture.
PROFIT TEST: HOBBY or BUSINESS
Generally, the following criteria should be considered when determining whether an activity engaged in by an individual has a reasonable expectation of profit:
The profit and loss experience in past years;
The amount of gross income, if any, reported over several years;
The length of time over which a profit could reasonably be expected to be shown must be relevant to the nature of the activity. For example, in the case of a tree farm, the relevant time period might be longer than a vegetable farm;
The extent of activity in relation to that of businesses of a comparable nature and size in the same locality;
The amount of time spent on the activity in question;
The individual’s qualifications, such as experience, training and education, including his/her eligibility for membership in a professional association;
The qualification of the individual for public assistance given to those who are carrying on a business in that field of activity;
The individual’s intended course of action, as evidenced by his/her efforts showing an intention to make a profit (e.g., the preparation of a business plan);
The capability of the venture to show a profit after charging depreciation, and the development of the operation and commitments for future expansion according to the individual’s available resources. This includes the ability to secure proper and reasonable financing in order to make the venture a viable business capable of showing a profit;
The degree of effort in promoting and marketing the products or services supplied by the individual as, for example, the registration of a trading name and the opening and maintaining books and records;
The type of expenditures claimed and their relevance and reasonableness to the activity (i.e., will the expenditure enhance the ability to make a profit); and
The nature of the product or service supplied, such that it has a profit potential (i.e., a market exists or can be developed).[3]
TO REPORT or NOT TO REPORT
The Application of Profit Test to Carrying on a Business listed above provides great clarity for concerns about reporting hobby income on your tax return. A hobby that takes on substantial time commitments similar to that of a part-time job is likely a business, especially when income exceeds expenses and this should inform how your earnings are classified.
The CRA also looks at the financial resources you commit to your hobby. Is it strictly a labor of love that you invest a few dollars into, or are you borrowing money to finance the operation? In the case of the latter, the CRA considers such activity to be a sign of expansion where the expectation of turning a profit is evident. In this case, you may want to report proceeds on the T2125.[4]
THE TAX ADVANTAGE
For every hobby that has attained all the elements of a business, there are tax advantages you are entitled to; which are the same as those deductions that any other Canadian small business enjoys.
Even though it is tough to predict from inception whether a hobby would end up being profitable or not, It is advised that a separate record of income generated and incurred expenses on the hobby should be kept so that the future tax benefits can be enjoyed if that transition is made. The availability of historical records will make it possible to claim losses once the hobby becomes a regular activity with income and or losses being made more frequently.
REFERENCES
[1] https://www.canada.ca/en/revenue-agency/programs/about-canada-revenue-agency-cra/compliance/digital-currency/cryptocurrency-guide.html
[2] https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/p-176r/application-profit-test-carrying-on-a-business-revised-sept-30-1998.html
[3] https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/p-176r/application-profit-test-carrying-on-a-business-revised-sept-30-1998.html
[4] https://quickbooks.intuit.com/ca/resources/self-employed/the-difference-between-a-business-and-a-hobby/?cid=ppc_G_b_CA_.QBSE_CA_DSA_SBC_G_S_FY19.__txt&gclid=CjwKCAiAkan9BRAqEiwAP9X6UY8i_ddW6dWy7MM5mOHxzhGq3FM93GNxX6aR_3ifeR3uHfzd1q-37xoC0z0QAvD_BwE&gclsrc=aw.ds
