Understanding how to properly handle business expenses is a fundamental part of managing a company’s finances. According to tax regulations, businesses can deduct certain expenses from their gross income. This process is crucial because it reduces the amount of income that is subject to tax, ultimately lowering the business’s overall tax liability.
RMC 81-2025 provides guidance on the essential rules that determine whether an expense is deductible, helping new business owners and professionals navigate their tax obligations with clarity.
For any expense to be considered for a tax deduction, it must first meet two fundamental criteria: it must be “ordinary” and “necessary.” These terms have specific meanings in the context of tax law, and both conditions must be satisfied.
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Ordinary Expense |
Necessary Expense |
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An expense that is “normal, usual and customary in the type of business conducted by the taxpayer.” |
An expense that is “appropriate and helpful for the development of the taxpayer’s business.” |
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This does not mean the expense must be incurred frequently, but that it is a common and accepted one within your industry. However, it must also meet the “test of reasonableness.” An expense that is extravagant or inordinately large may not be considered ordinary, even if it is for a common business purpose. |
This means the expense must be essential or integral to earning income. While it doesn’t need to be absolutely indispensable, it must be directly helpful in operating and growing the business. |
Meeting the “ordinary and necessary” test is the first and most critical step, but several other requirements must also be fulfilled for an expense to be successfully claimed.
In addition to being ordinary and necessary, a deductible expense must satisfy three other crucial conditions related to its timing, relevance, and proof.
1. Timing: Paid or Incurred within the Taxable Year – An expense must be claimed in the same taxable year that the corresponding income was earned. This rule ensures that income is accurately matched with the expenses that helped generate it within the same accounting period, providing a clear picture of the business’s net income for that year.
2. Relevance: Directly Connected to Your Business – There must be a direct link between the expense and the business activity. The expense must be directly attributable to the “development, management, operation and/or conduct of the trade, business or exercise of a profession.” This means that personal expenses or costs related to generating passive income—such as from interest, royalties, dividends, and capital gains—cannot be deducted from your active business income. The expense must be tied to the core operations of the business.
3. Proof: The Critical Need for Substantiation Simply stating that an expense was ordinary and necessary is not enough. The responsibility falls on the taxpayer to prove that the expense is legitimate and that the claim is valid.
The mere allegation of the taxpayer that an item of expense is ordinary and necessary does not justify its deduction.
To meet this requirement, the taxpayer must be able to substantiate the expense with clear evidence. This proof can include official documents such as: official invoices, vouchers, records and other pertinent papers. Without this documentation, a deduction claim may be disallowed.
Before you claim any expense, run it through this quick checklist. This will help you ensure your deductions are compliant with the key requirements.
1. Is it Ordinary and Necessary? (Is this a normal, reasonable, and helpful expense for my type of business?)
2. Is it for This Taxable Year? (Did I pay or incur this expense in the same year as the income it helped create?)
3. Is it truly a Business Expense? (Is there a direct connection between this expense and my business operations?)
4. Do I Have Proof? (Do I have an official invoice, voucher, or other record to substantiate this claim?)
5. Conclusion: Claim with Confidence
Deducting business expenses is a powerful tool for managing your tax obligations, but it must be done correctly. The core principle is that any claimed expense must be ordinary, necessary, timely, directly related to your business, and—most importantly—supported by solid evidence. By understanding these rules and keeping meticulous records, you can claim your deductions with confidence, ensuring you are accurately and fairly reflecting your business’s taxable income. Developing a consistent habit of digitizing and organizing your receipts as you receive them is the single best way to ensure you can claim every rightful deduction with confidence.
