How to categorize business expenses: a practical guide

Why categories matter

A bank statement lists payments. A category list tells you what the business spends money on. Without it you cannot see that advertising doubled, that bank charges are creeping up, or that a few subscriptions add up to a real cost. At tax time, your accountant or the form you complete will group costs by type, so labels applied during the year save sorting later.

Categories are not a tax claim in themselves. They are a filing system. The claim depends on whether the expense meets the rules, which the categories help you check one type at a time.

Build a short category list

The CRA’s business expenses page lists the more common headings: advertising, bad debts, business taxes, fees, licences and dues, delivery and freight, insurance, interest and bank charges, legal, accounting and other professional fees, maintenance and repairs, management and administration fees, meals and entertainment, motor vehicle expenses, office expenses, rent, salaries and wages, supplies, telephone and utilities, and travel.

Start from that list and delete what you never use. A short list is usually enough for a small business. In accounting software this list sits inside your chart of accounts. Resist adding a new category for every odd purchase; ten categories used consistently are more useful than forty used loosely. Add a separate category only when you will actually want to see that total, for example software subscriptions if they are a large cost.

Decide with three questions

For each purchase, ask what it was, why you bought it and who benefited. What it was gives you the category. Why you bought it tests whether it relates to earning income. The CRA says that, as a rule, you can deduct any reasonable current expense you incur to earn income, and that you cannot deduct personal expenses. Who benefited catches personal and shared costs.

If you cannot answer the second question, do not guess. Put the item on a question list for your accountant. A groceries purchase, a restaurant bill and a large store purchase could each be business or personal depending on context, and the merchant name alone will not tell you.

Expenses that need a decision

Meals and entertainment are the most common trap. The CRA says the maximum you can claim for food, beverages and entertainment is generally 50% of the lesser of what you spent and an amount that is reasonable in the circumstances, with some exceptions. Record meals in their own category so the limit can be applied, and note who attended and why.

Vehicle costs, a home workspace, a phone and internet usually combine business and personal use. The CRA says to enter only the business part of an expense. Claim the business share, keep the basis for it, such as a logbook or a measured workspace, and record the full amounts in the books if your accountant asks for them that way. Our articles on vehicle expenses, home office costs and meals each go further.

Small office items such as pens, paper and stamps are office expenses, while the CRA treats items such as calculators, filing cabinets, chairs and desks as capital items. Which brings up the next point.

Current expenses versus capital purchases

A current expense is used up in running the business. A capital purchase, such as equipment, furniture or a vehicle, lasts and is generally claimed over time through capital cost allowance rather than deducted at once. The CRA states that you cannot claim expenses you incur to buy capital property, although you can deduct reasonable current expenses.

In your books, give larger durable purchases their own asset category instead of dropping them into supplies. Repairs follow a similar split: the CRA allows minor repairs and maintenance, but not repairs that are capital in nature. When a purchase is large or unclear, ask before categorizing it, because the choice affects the timing of the deduction.

Items that are not ordinary expenses

Several things that leave your bank account are not business expenses at all. The CRA says salaries or drawings paid to you or your partners are not deductible, and that interest on money borrowed for personal purposes or to pay overdue income taxes is not deductible. For incorporated businesses, money taken by an owner has its own treatment, which is why it belongs in an owner or shareholder account rather than an expense category.

Other items to keep out of expense categories are transfers between your own accounts, loan proceeds and the principal part of loan repayments, GST/HST you can claim back, and refunds. Treat each as its own type of transaction. Interest and bank charges, by contrast, can be expenses, so split a loan payment into its parts.

GST/HST and the expense amount

If you are a GST/HST registrant, you generally recover the tax you pay on business purchases through input tax credits. The CRA says that when you claim an ITC, you reduce the related expense by the credit. In practice, record the tax in a separate GST/HST receivable account so the expense category shows the net amount.

To claim a credit you need sufficient documentary evidence before filing, and some expenses are restricted. For example, the CRA says that memberships in clubs whose main purpose is recreation, dining or sporting facilities do not qualify for credits, and income tax deductions for such dues are also not allowed. If you use the quick method, you generally cannot claim credits on operating expenses, so your treatment differs.

Keep the support and review monthly

Keep a receipt or invoice for every expense, with a short note of the business purpose when it is not obvious. The CRA expects records to be kept generally for at least six years from the end of the last tax year they relate to, and electronic copies are fine if they are clear and readable.

Once a month, scan each category total for surprises, review the uncategorized items and ask whether any category is hiding two different things. If you run more than one business, keep separate records for each. Bring your category list, the question list and any large purchases to your accountant before year end, so the labels are settled before the return is prepared.