There are major differences between income tax rules and financial accounting rules.
However, in one area, there is significant overlap. That area is the computation of business income or profit.
Thus, for income tax purposes, in most cases the basic rule is that you start with the net income or profit for financial accounting purposes. But, since there are still some differences between the tax and accounting rules, you make adjustments based on those differences. For example, if an amount is deductible for accounting purposes but not deductible for tax purposes, you add back that amount when converting the accounting business income to income for tax purposes. Or if an amount is deductible for tax purposes but not accounting purposes, then you deduct that amount when converting from accounting to income for tax purposes.
A few of the differences between business income for tax purposes and accounting purposes include:
- Depreciation or amortization for accounting purposes is not allowed for tax purposes. Instead, you use the capital cost allowance provisions under the Income Tax Act.
- For meals and entertainment expenses incurred for business purposes, in most cases only 50% of the expenses are deductible for tax purposes. There is no similar rule for accounting purposes.
- Government fines and penalties, even if incurred in the course of your business, are not deductible for tax purposes.
- For motor vehicle expenses, there are arbitrary dollar limits for tax purposes.
- Landscaping and site investigation costs are deductible in full in the year they are paid for tax purposes. For accounting purposes, they are sometimes amortized, depending on the facts.
- For tax purposes, you cannot deduct amounts paid for the use of a golf club, or membership fees paid to a recreational club.
- If a corporation issues new shares or debt, its financing costs (e.g. investment bank and legal fees) are amortized over five years for tax purposes. There is no similar rule for accounting purposes.