Reasonable Expectation of Profit
Author: Brad Howland
First Posted: October, 2000
Losses occur when your costs – such as equipment, salaries, travel, supplies, and other expenses – exceed your income. Losses usually mean that things are not going well. However, from a tax point of view, the nice thing is that you can write them off against any other income you receive that year.
Not only that, if the loss exceeds your combined income in the current year, you can carry it back up to three years, write it off against past income, and get a refund for tax paid at that time. If it still isn't used up, you can carry it forward to future years.
If you are claiming losses on your self-employed music business, and writing them off against other sources of income, there is a chance that you will hear from the tax department. Don't let that stop you! If your expenses are legitimate, and you have the receipts to back them up, you shouldn't be afraid to claim them and create a loss.
Revenue Canada uses the concept of "reasonable expectation of profit" to decide if a loss is justified. With most businesses, the general rule is that losses are acceptable for 2-3 years, then they are expected to turn a profit. However, the situation for artists and musicians is different. The department feels that "continuous losses for many years are not alone sufficient to establish that there is no reasonable expectation of profit. All the facts and circumstances surrounding the reasonable expectation of profit will be evaluated." (Hogg, R.D. and M.G. Mallin. Preparing Your Income Tax Returns. (1993): p. 255). This position arose out of a series of cases in the eighties in which Revenue Canada challenged the expenses of artists and writers, without success.
As Mike Grenby put it, "your best approach remains an aggressive but well-documented approach within the law."
Remember, you can't operate a business that continually loses money. If you have losses for 5 years in a row, Revenue Canada will probably decide that your music endeavors are a hobby, not a business, and your business expenses will be disallowed.