Generally speaking, all expenses incurred for the purpose of generating income are deductible, subject to several limitations.
For example, if you spend $5 to buy flour to make cookies, and you sell the cookies to a local bakery for $10, you shouldn’t pay tax on the $10 you make. Rather, you are entitled to deduct the $5 you spent on the flour as the cost of goods sold from the proceeds of $10 and only pay tax on the difference.
Therefore, if you can prove that the money you spent is for the purpose of making money, (you gotta spend money to make money, right?) you usually can deduct the expenses from your revenue as the cost of doing business.
However, this rule is subject to several limitations. One of the most contentious limitations is meal and entertainment expenses.
For many small businesses that sell services rather than goods, client retention is important. Therefore, many business owners and executives are required to wine and dine their clients. While this sort of expense seems a legitimate deduction claim from taxable income, it has been subject to great abuse.
For example, rather than taking a client out for lunch, the business owner may decide to treat his or her spouse to a fancy meal then try to claim the cost as a business expense. Or, rather than staying at home for dinner, the business owner may decide to go out every day and deduct the expense from his or her taxable income.
Therefore, a special rule on meal and entertainment expenses was put in place: only 50% of the amount spent on meals and entertainment for the purpose of generating income is deductible.
While this rule may seem straight forward, it has been the constant subject of fierce litigation between the taxpayers and the CRA because it catches a wide range of expenses, from office coffee to lobster dinner. The 50% rule applies regardless of whether the taxpayer enjoys the benefit of the meal or entertainment. For example, a real estate agent who gives out baseball game tickets can only claim 50% of the ticket price as an expense.
Moreover, expenses not incurred for the purpose of generating income are not eligible. Hence, you go out to lunch by yourself, it’s not deductible. You should bring a client instead.
