Deducting Fines and Penalties for Business Owners

Fines and penalties are often an inevitable part of owning a business. On some occasions, such as the early repayment of a loan, you might even choose to pay them voluntarily. While fines and penalties are generally not deductible, they are considered a business expense and may be deducted in certain circumstances.

There are a number of different types of fines and penalties that a business can incur as part of its operations.

For tax purposes, they are broadly classified as follows:

• Judicial or imposed by a court of law for the breach of a public law
• Statutory or arising directly as a result of the application of a law
• Levied by professional and similar organization
• Levied by trade organizations and similar bodies on its members
• Levied under private contracts.

The tax treatment of a fine or penalty varies according to which category it belongs to.

Generally, a fine or penalty imposed under a federal, provincial, municipal or foreign law by any person or public body that has the necessary authority is not considered deductible. However, there are a number of significant exceptions to this general rule.

The law does not prohibit the deduction of fines and penalties in the following situations:

• Penalties paid under a private contract, such as early-repayment penalties for loans or a penalty charged for late performance in a construction contract
• Interest charges, including interest arising on fines or penalties
• Amounts not characterized as a fine or penalty under the legislation imposing the particular amount
• Fines or penalties imposed before March 23, 2004

To be considered deductible, the fine or penalty must also be a business expense and logically connected to the operations of the business.

To deduct a penalty, you must include it in the regular computation of your business income, similar to any other expense. This penalty will be part of your Statement of Business or Professional Activities and included in your income tax return.

If the payment is not made as part of the day-to-day operations of the business but instead as part of the acquisition of capital property, the fine or penalty may be considered part of the acquisition cost. If this is the case, it will be added to the property’s capital cost. Additionally, it may be eligible for deduction as part of the capital cost allowance of the property.

Note that the rules regarding the deduction of fines and penalties may vary provincially. Therefore, the provincial treatment of an amount paid may be different from how it is treated federally. It’s important to be informed and look at the rules concerning your particular province of residence when preparing your tax returns.