I feel like I’m always surprised when it’s a new month. I mean, I don’t know why it surprises me so much as time just goes by, but here we are in October. Can you believe it? The month of spice lattes and pumpkin pie and Halloween candy and getting the sweaters out. Although I live in Puerto Vallarta, so it’s not really sweater weather yet! But today I want to talk about the definition of what is the CRA’s definition of an expense, so that we are super clear on that!
The CRA says that you can write expenses off to your business, which means that you’re buying something and using it as a business expense. According to the CRA, you can write something off as long as you have a reasonable expectation of profit. Now, what does that mean? Because that is an interesting, interesting expression. So, there are three words that we need to talk about: Reasonable, Expectation and Profit.
Let’s start with profit. That’s the easy one, right? Profit is when you have your income, you have your expenses, and then at the end of the day, what’s left over when you subtract the one from the other is your profit. And profit is what we’re all going for, right? That’s what we pay ourselves from. That’s why we run our businesses or why we should be running our businesses. They’re not hobbies, they’re ways of making money for us, so you’re trying to build up that profit. And of course, along the way, there are lots of expenses that pop up that you need to use in order to build your business. How are you going to use your money in order to further your business?
And that’s where these other two words come in. You have a reasonable expectation of profit. When you buy something, when you purchase something, you’re expecting that that thing, that purchase that you’re making is going to bring you a profit.
So we come to expectation. This is a bit tricky because it doesn’t mean that your expense actually makes you a profit, it just means that you’re expecting it to help you make a profit. For example, hiring a bookkeeper – hiring a bookkeeper is not going to increase your top line, right? It’s not like you’re selling bookkeeping services, so that’s not going to increase your top line. However, hiring a bookkeeper gives you more time to do the things that you need to do in order to make a profit. So the expectation is that by hiring a bookkeeper, you’re actually going to have more time to make more money.
Therefore, you have an expectation of making a profit off of hiring someone. An easier example is something like running an ad, a Facebook ad, for example. When you create a Facebook ad, you have an expectation that that Facebook ad is going to be seen by people who are then going to spend money on your service or your product. And so the idea of expectation is that you, as a reasonable business owner, expect that whatever you’re purchasing is going to bring you some kind of return either in time or so that you can build your business and create a profit.
WHAT DOES THAT MEAN?
And the last word, of course, is reasonable. What does that mean? Reasonable simply means just that it is judged by you, as a reasonable person, to be something that you can justify to bring you a profit. I think a really good example here is going out, taking somebody out for dinner. Entertainment costs are a big thing in business, and you have the right to take people out and entertain them in order to create a business relationship so that maybe they will become one of your clients. And the reasonable part of this comes in when you look at what you’re actually selling – what are you selling to this person? If you’re selling a ten dollar product and you’re expecting this person to become your client and you take them out for oysters and champagne, then it’s not really reasonable that you’re going to turn a profit on that. If you’re selling them a $40,000 coaching package, for example, then it definitely seems more reasonable that you would take them out for oysters and champagne. I’m not saying that’s what you should do, but it is more reasonable that the expense will generate a lot more profit for you.
In Canada, one of the things about our tax system is that at the end of the day, you are responsible for telling the CRA: this is how much money I’ve made and these are my expenses. And they are expecting you, as a reasonable business owner, to generate a profit and use your expenses to generate a profit. But the CRA doesn’t check, they don’t actually go through unless there’s an audit. They don’t go through all of the different pieces and look at them with a fine tooth comb unless you’re audited. And then in that audit, they will ask these questions: is this generating a profit? what was the expectation when you purchased this? and was it reasonable? So for every expense that you have, is there a reasonable expectation of profit? Can you answer that question for the expenses that are going through your business?