Tax Primer 2: Preparing a Business Plan

Introduction

Over the past couple of years, Revenue Canada has been looking carefully at the tax returns of self-employed individuals, some of whom are artists and cultural workers. This review has led to increasing numbers in the cultural community facing the audit process at the same time as Revenue Canada officials struggle with the unique circumstances of artists' work.

The Department views the self-employed individual as a small business and recognizes that it may take time for a small business to show a profit. During the start up period of such a business, the tax payer can deduct from other income business losses they incur. The cultural sector is distinctive in its nature as it pertains to "reasonable expectation of profit" and Revenue Canada recognizes that as a professional artist you do not perceive yourself as involved in a business activity. However, this should not be construed as giving an artist carte blanche at tax time, and it behoves self-employed members of the cultural sector to abide by the rules written by the federal government. The CCA and others continue the work of representing the interests and concerns of artists and cultural workers with Revenue Canada .

It is to the advantage of self-employed artists and cultural workers to develop a business plan in the event of an audit in order to demonstrate the seriousness of your business. A business plan is simply an overview of who you are and what you do, your vision, goals and objectives and how you plan to realize them. It describes the past, present and future of your artistic venture. It should be approximately 3-4 pages long, written in a clear and factual manner. It should demonstrate to Revenue Canada that you are well aware of the costs and expenses of running a business, and that you understand the strengths, weaknesses, threats and opportunities inherent in so doing. The bottom line for Revenue Canada is that you anticipate some profit in the foreseeable future and that your expectation is realistic.

A thoughtful and realistic business plan is an essential tool but it can take time to put together. It is recommended you write one that can be updated on an annual basis, even if you are not facing an audit; it is useful when applying to a financial institution for financing, when seeking grants or new partners, or when considering the pros and cons of expansion.

Depending on the size and nature of your business, you might require the professional services of a lawyer and/or an accountant in drawing up your business plan. Your local bank should also be able to provide professional services. Scotiabank offers complimentary business planning software (Scotiabusiness Plan Writer) through its branches. The Royal Bank's web site (www.royalbank.com) has a program (BigIdea) to help small businesses and entrepreneurs organize their finances and business plans which can be downloaded directly to your computer. The Business Development Bank of Canada advertises strategic planning services for small businesses and offers a kit to help draw up a business plan.

The following components are merely suggestions for inclusion in your business plan. Depending on the size and nature of your artistic endeavour, not all the points will be relevant.

Components of a Business Plan

1. Executive Summary
Preface your document with a concise Executive Summary giving a brief overview of the business, its history and where it is going - something that captures the essence of the business in question. If you have a mission statement, add it here.

Every business is different and therefore the business plan should be modified and developed to suit the needs of the entrepreneur and the organization.
The Entrepreneurship Centre, Ottawa

2. Who you are

a description of yourself, what you do, and how long you have been doing it
your professional/artistic associations and qualifications (attach a résumé for greater detail)
highlight your unique skills and talents, strengths and weaknesses
list all work-related activities, volunteer or otherwise, in which you are involved
list all continuing education you undertake related to your work

In order to protect your legitimate expense claims when filing an income tax return, you must be prepared to demonstrate that you are a professional artist and not a hobbyist.
R Scott Ware, CARFAC Sask Newsletter, March 1997

3. How your business is organized

type of enterprise (its name, what you produce or what service you offer, do you work on commission or employ staff)
location (where you are located, the advantages to being located there) history of your business (when it started, what stage it is in - R&D, start up, etc.)
how much time you spend on your artistic endeavour (if you earn income from another source, you must prove to Revenue Canada 's satisfaction that you are a professional artist and not a hobbyist)
legal form of business (sole proprietorship, corporation, etc)
list of business advisors, if any (manager, agent, dealer, lawyer, accountant, instructor, mentor, etc.)

4. What you produce

description of your art/product/service
is your work unique and what makes it so
what is your pricing strategy
what are your product's or service's competitive advantages
what is the anticipated growth in development/production for the coming years

A good business plan will not enhance the success of a poor idea but a poor business plan ... will do nothing other than militate against the success of a good idea.
Start Your Own Business: The Canadian Entrepreneur's Guide by Peter D Cook

5. For whom

who is your primary market (eg: tourists, gift shops, other businesses, producers, galleries, magazines, etc.)
how large is the market for your work and is it expanding or shrinking
where is it located (local, provincial, national, international) how are you actively promoting the sale of your work (list everything you do to get your name out there, cooperative advertising ventures, networking, etc. - this is important information in separating professionals from hobbyists)
how much money do you allocate to marketing/advertising your service or product
how do you distribute your work

6. And why - Do your homework
Use as much data as you can glean from professional associations, StatsCan, libraries, the Internet, trade journals, etc.

is there a specific niche market today, or do you foresee one in the future, for what you do
what is its size and is it growing or declining
have you done any specific market research related to marketing your work

... provide SMART statements for your banker, auditor or interested reader. All information provided should be Specific, Measurable, Achievable, Realistic, and Trackable to clearly define your goals.
R Scott Ware, CARFAC Sask Newsletter, March 1997

7. What is the competition - Know your competition, but don't knock it

what does the competition produce
why is your work better/different
is there room in the marketplace for everyone

A business plan will repeat the same or similar facts over and over again, but within financial, organizational or production contexts.
R Scott Ware, CARFAC Sask Newsletter, March 1997

8. Financial situation - Again, do your homework

give an indication of your past financial track record
state the present situation, what funding you currently have
what are your funds currently used for (supplies, development, expansion, marketing, etc.), provide a budget
what are your funding requirements for the future and your projected financial return (5 year forecast - this is where Revenue Canada wants an indication that you have a reasonable expectation of profit)
what will future funds be used for (capital expenses, debt retirement, increased marketing/promotion, acquisition of rights, expansion of business, new equipment, etc).
provide a cash forecast if possible (a monthly forecast for a startup business, a quarterly forecast for one operating 2-3 years, or an annual forecast for a business over 3 years old)
are your losses decreasing over time; if not, why not

The concept of profit is critical in determining whether a taxpayer's artistic activity or literary undertaking constitutes the carrying on of a business or is merely the furtherance of a hobby or interest of the taxpayer that is of a personal nature. Generally, any undertaking or activity of a taxpayer that results in profits or has a reasonable prospect of profits would be viewed as the carrying on of a business.
IT-504R2, INCOME TAX ACT Visual Artists and Writers

9. Future goals
Revenue Canada requires an indication that you have a "reasonable expectation of profit", that you anticipate showing a profit in the future (if you are not currently doing so). A statement to the effect that you are a modern day Van Gogh whose work will be accepted commercially only after your death will not suffice; a statement that your work is avant garde, uses new technologies, and probably will not attract general critical attention or acclaim for another 10 years might receive a more sympathetic hearing. (Remember, computer artists would have been on the cutting edge 10 years or so ago ...) Ensure you indicate:

where you plan to be in the future in your artistic development
that your plan is realistic
what strategies you have for improved and increased promotion of your work
whether you will be spending more time or less time in pursuit of your profession in future years

The nature of art and literature is such that a considerable period of time may pass before an artist or writer becomes established and profitable.
IT-504R2, INCOME TAX ACT Visual Artists and Writers

10. Support documents
Attach supporting documents to substantiate claims made in the business plan. These include résumés of key people including yourself, references, photos/ slides/examples of the artistic endeavour in question, professional awards or citations, published reviews of your work, etc. Include anything you believe will add to your business plan and your credibility.

Reasons Why Small Businesses Fail

Failure to establish goals and objectives;
Underestimating the public;
Inadequate financial planning;
Absence of critical business skills;
Inability to change;
Failure to communicate the plan.

Extract from Business Plans for Dummies , Paul Tiffany PhD and Steven D Peterson PhD