What Is the Difference Between a Hobby and a Business? 0

Posted On November 15, 2022, by Admin

We all have hobbies that help us unwind from work and keep us entertained. However, for some, those hobbies also provide an additional source of income. This might seem like a plus, but it comes with a catch in the form of taxes. It all depends on whether the CRA considers your side hustle a business.

If you’re unsure whether your hobby qualifies as a business according to the CRA, stay tuned. This article will detail the ways you can differentiate between the two and explain how to proceed in either case.

How the CRA Differentiates Between a Hobby and a Business?

The Canada Revenue Agency once used a well-known test to determine whether an activity is a hobby or a business under the Income Tax Act. The test was known as the reasonable expectation of profit or REOP test. Here are the main criteria it comprised:

• Profits and losses in the past year — The CRA looked at how much a taxpayer had invested in this activity, how much profit the activity generated, and what losses occurred.
• Intentions — The taxpayer’s intentions are one of the most important and ambiguous factors the CRA’s test examined. They’d ask whether the taxpayer pursued this hobby intending to turn a profit or solely for their personal enjoyment.
• Training and qualifications — Another factor of the REOP test was the training and qualification the taxpayer had to successfully run a business. They could indicate that the taxpayer might’ve planned to earn a living from the hobby.
• Capability of venture to show a profit — The CRA also considered whether the activity could make a profit after the capital cost allowance was charged.

The REOP test was used to assess the commercial nature of activities for a number of years. However, the Supreme Court of Canada’s rulings in two cases — Steward vs. Canada and Walls vs. Canada — helped overturn its application. The court stated that the mentioned cases proved the REOP is no longer a viable instrument in establishing whether an activity constitutes a source of income and suggested adopting a new approach.

The new approach includes two stages. Firstly, the CRA must determine if the activity resulting in income is conducted for profit or personal endeavour. The agency only proceeds with the second stage if the taxpayer’s activity isn’t undertaken for personal endeavour. The second stage includes determining whether the source of income comes from a business or a property under the Income Tax Act.

This approach stands only if the activity resulting in a source of income has a personal element. If there’s a personal element to the activity, the CRA will assess whether the activity is “sufficiently commercial,” that is, whether the taxpayer has intentions to turn a profit from this activity and whether they’ve behaved in a way that would support these claims.

So, a personal element in an activity does not exclude it from being a business. Personal enjoyment and commerciality can both exist within the same activity. However, the commerciality of the activity has to overshadow the personal element for it to be deemed a business.

Confusion About What Constitutes a Business in Canada

The rise of the internet has brought about a flood of new hobbies and ways to make them profitable. A great example is platform economies — sites and mobile apps that use the internet to connect buyers and sellers. They’ve created some confusion around what the CRA considers taxable. Let’s look at some of the most prominent examples:

• Gig economies — Gig economy is a labour market based on freelance work or short-term contracts. Here, companies use internet platforms or mobile apps to find and hire freelancers or independent contractors to work on their projects. These workers are usually considered self-employed, and the money they make falls under the category of income under the Income Tax Act.
• Sharing economies — Sharing economy is a system where people share personal assets to generate additional income. For instance, they may rent out their property, vehicles, machinery, or equipment to make a profit. According to the CRA, these types of earnings are also considered taxable income.
• Peer-to-peer economies — Peer-to-peer economy is a business model where people buy and sell goods and services from one person to another without an intermediary. Examples include Etsy, eBay, Posh Mark, and so on. CRA will consider your profits from this activity an income if you’re buying items to resell them at a higher price.
• Social media — Plenty of people are turning a profit from product placements, endorsements, or promotions on their social media profiles. This type of earning most often falls under advertising revenue and is subject to taxation.

Do I Need To Charge GST/HST On My Side Hussle?

If your side hustle Business/Hobby generates sales of $30,000 or more (before expenses) within a calendar quarter or over four consecutive quarters (not necessarily a calendar year), you will have to register for a GST/HST number, as you are no longer a “small supplier” according to the CRA. It’s a good idea to get your number before you reach $30,000, or you may find yourself paying GST/HST out of pocket or facing fines. And if you wait, you’ll have to start charging your existing clients or customers 5% to 15% tax (depending on their province) once you do hit $30,000, so you may as well get them in the habit of paying that extra cost early on.

Reporting Hobby Income to the CRA

If a hobby constitutes a business according to the above-described assessments, you’re obliged to declare and report it to the CRA. It doesn’t matter whether your income is not big or how you’ve come by it. The CRA will be searching for anyone trying to evade taxes and audit their activity.

You should report your hobby income as a part of your T1 income tax return on Form T2125 — Statement of Business or Professional Activities. This form is included in the income tax return package. Once you do so, you’ll be entitled to income tax deductions. These include business use-of-home, motor vehicle, entertainment, and many other expenses. Your overall tax burden may be reduced significantly due to this advantage.

Those still unsure whether their hobby profits are taxable can reach out to the CRA. The agency runs a Rulings Program and a Voluntary Disclosure Program (for prior years) where you can submit all relevant documents concerning your activity and generated income. They’ll help you assess the situation and proceed accordingly.

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This blog is not meant to provide specific advice or opinions regarding the topic(s)  discussed above. Should you have a question about your specific situation, please discuss it with your GBA advisor.

GBA LLP is a full-service accounting firm in the Greater Toronto Area, but we primarily service all of Ontario as well as the rest of Canada virtually, except Quebec. Our team of over 30, provides Audits and Reviews of financial statements, and Compilations of  financial information, as well as corporate tax returns.  We provide specialized corporate tax and succession planning for small and medium businesses, in addition to general advisory services.

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