Expense reports carry recoverable tax that most companies simply never claim. The recovery mechanism differs depending on how you pay staff, and choosing the wrong one either forfeits money or creates an assessment. Reimbursements and allowances run on separate provisions, and claiming input tax credits on either depends on conditions most expense policies never mention. This guide sets out both routes, the arithmetic behind each, and where they break. It assumes you are already registered, which our guide to HST for small business covers from the beginning.
Key Takeaways
- Receipts decide the label: no receipts means an allowance, receipts mean a reimbursement.
- Section 174 deems you to have paid tax equal to a fraction of the payment.
- Section 175 passes through the tax your employee actually paid.
- Both routes need at least 90 per cent of the underlying purchases to be taxable.
- Meals and entertainment lose half the credit under section 236.
Allowance or Reimbursement: The Distinction CRA Cares About
An allowance is a predetermined sum handed to a worker without any accounting for how it is spent. The employee keeps whatever is left over. A reimbursement repays a specific amount actually spent, supported by a receipt, and any surplus never exists. Put another way, the money goes out up front for expenses to be incurred, while a reimbursement follows for costs your staff already incur.
| Feature | Allowance | Reimbursement |
|---|---|---|
| Receipts required | No | Yes |
| Amount | Fixed in advance | Whatever was spent |
| Recovery provision | ETA section 174 | ETA section 175 |
| Amount you recover | Tax fraction of the payment | Actual tax, or a factor |
| Risk of a taxable benefit | High if not reasonable | Low |
What you call the payment does not settle the question. A monthly sum described as an allowance but adjusted every month against submitted receipts is considered a reimbursement in substance, and the Canada Revenue Agency will treat it that way. CRA considers the payment made rather than the label on the payroll code, so a fixed sum later reconciled to receipts is considered to be a reimbursement whatever your policy says. Choose one design deliberately and apply it consistently, because the treatment of allowances differs from the treatment of repayments, and the two claims cannot be mixed on the same expense.
How an Allowance Turns Into an Input Tax Credit
Section 174 of the Excise Tax Act (ETA) lets you claim an input tax credit as if you had bought the goods yourself. It reaches beyond payroll, because the same rule covers an allowance paid to an employee, to a member of a partnership, and to volunteers of a charity or public institution. Four conditions have to hold. The supplies for which an allowance is paid must be acquired in Canada, or relate to the use of a motor vehicle in Canada, in relation to the activities of the person paying it. All or substantially all of those supplies, meaning 90 per cent or more, must be taxable supplies other than zero-rated ones. And the allowance is deductible for income tax purposes, was reasonable, and was treated as reasonable when you paid it. The employer that pays the allowance claims the credit, provided the allowance clears all four.
Meet them and you are deemed to have received a supply and deemed to have paid tax equal to the tax fraction of the payment. That fraction recovers the GST and the federal part of the HST, plus the provincial part where a participating province is involved. In Ontario the fraction is 13/113. Where the purchases were made in a non-participating province it is 5/105, and where they straddle two or more participating provinces you use the lowest of those provincial rates on top of the 5 per cent federal portion. The Agency’s memorandum on allowances works through the variations, and it is the best single source of information on allowances for anyone drafting a policy.
What it recovers. A $600 monthly car allowance paid to an Ontario employee produces a credit of $600 × 13/113, or $69.03 a month. Across a year that is $828.32 for one employee, and $8,283 for a team of ten. The 90 per cent test is what quietly kills this claim, so where the allowance is intended to cover both parking and residential rent it fails outright, since one of those is an exempt supply.
Expense allowances of other kinds work the same way. A travel or motor vehicle payment is the common case, and a per kilometre allowance is the version the Agency scrutinises hardest. Allowances are generally included in the employee’s income unless an exception applies, so settle the benefit treatment before you price the credit.
Claiming the GST on a Reimbursement: Two Methods
Section 175 works differently. Where you repay an employee for expenses incurred on your behalf, you are deemed to have received the supply and to have paid the tax paid by the employee, limited by the amount reimbursed and by the extent the purchase relates to your commercial activity. The employee must have incurred the expense directly, because the section reaches expenses incurred by the employee rather than costs the company settled itself. Reimbursements paid to employees, to partners and to a charity’s volunteers all qualify on the same test. Two methods calculate it.
- Actual. Add up the tax shown on the receipts and claim it. Precise, and slow.
- Factor. Apply an administrative fraction to the total repaid, without unpicking every line.
The factor method is available where all or substantially all of the expenses being repaid are taxable and not zero-rated. The fractions are 4/104 where the 5 per cent federal rate applies, 12/112 in a 13 per cent province, and 14/114 in a 15 per cent province. Nova Scotia is the odd one out: after its rate cut, CRA prescribes a 13/113 factor where the repayment is made on or after 1 April 2025. Reimburse an Ontario employee $369 of receipted expenses and the credit is $369 × 12/112, or $39.54. Québec adds a parallel calculation under the QST, and the rules concerning the GST and QST are administered together by Revenu Québec on its own fractions. Provinces running a separate provincial sales tax outside the harmonized system give you nothing to recover on that portion.
Timing matters as much as method. The claim arises at the time the reimbursement is paid, not when the employee bought the item, so a December purchase repaid in January belongs to the January return. Where you repay an employee for an expense incurred on a project, test the supplies for which the reimbursement is made rather than the project as a whole. Nothing is claimable in respect of a reimbursement paid for expenses incurred outside Canada, because no Canadian tax was charged in the first place.
Three conditions ride along with it. Use one method consistently through the fiscal year. Keep the receipts anyway, because the factor simplifies the arithmetic and not the documentation. And remember section 236, which recaptures half the credit on food, beverages and entertainment expenses, mirroring the restriction in section 67.1 of the ITA.
The requirements for claiming input tax are the same whichever route you take, and the rules for claiming input tax credits do not change because the amount is small. A charity or public institution follows a parallel path, since it may claim input tax credits or public service bodies’ rebates depending on the activity. Claim an ITC only where the underlying purchase supported a commercial activity.
When an Allowance Becomes a Taxable Benefit for Income Tax
Paragraph 6(1)(b) of the Income Tax Act (ITA) puts these payments into an employee’s income unless a specific exception applies. Canada has no fringe benefits tax as such, so the amount given for expenses simply lands in income where no exception covers it. Motor vehicle allowances computed solely by reference to kilometres driven are the exception most employers rely on.
So a flat monthly car payment that ignores distance is a taxable benefit, belongs on the T4, and costs the employee real money. It also eliminates the section 174 claim, because the deeming rule reaches only a reasonable payment that is deductible for tax purposes. Where the allowance does not meet that standard, the employer has no deemed tax to recover, and the employee is not entitled to treat the amount as tax-free. Two further design errors have the same effect: paying an amount unconnected to actual costs, and paying a per-kilometre rate while separately covering fuel and insurance already included in the allowance.
Per-Kilometre Allowances and the Reasonableness Test
The prescribed limits in section 7306 of the Income Tax Regulations set the ceiling for your own deduction. A motor vehicle allowance is reasonable where the allowance is based solely on business kilometres at a rate near those limits. For 2026 the rates are 73 cents for the first 5,000 business kilometres and 67 cents after that, with an extra 4 cents in the territories. Confirm the figure against the Agency’s current table of automobile allowance rates before you set a policy, because the limits are reset every January.
What a full year looks like. An Ontario employee logs 18,000 business kilometres in 2026. At the prescribed rates that is $3,650 for the first 5,000 and $8,710 for the remaining 13,000, so $12,360 in total. Your credit is $12,360 × 13/113, or $1,421.95, on top of deducting the payment itself.
None of that survives without a log. The employee records date, destination, purpose and distance, and the employer keeps it. Employers that pay these allowances monthly should reconcile the log once a year, because an allowance for travel that drifts away from real distance stops being reasonable. Allowances paid to employees across several provinces need the fraction that matches where the purchases happened. Owner-managers weighing a personal vehicle against a company-owned one should read this alongside our guide to buying or leasing a car in a corporation, because the allowance route often wins on tax once the standby charge is priced in.
Where Allowances and Reimbursements Go Wrong in a CRA Audit
In our audit representation work, expense reports are where reviews often begin, because they test a company’s controls faster than any other file. The recurring failures are these:
- Claiming on payments covering exempt costs, which breaks the 90 per cent test.
- Applying a domestic factor to foreign travel, where no Canadian tax was ever charged.
- Switching between the actual and factor methods inside one fiscal year.
- Missing the 50 per cent recapture on meals and client entertainment.
- Claiming on payments to a shareholder who holds no employment role.
- Grossing up the payment as though it were tax-exclusive, when the fraction already treats it as tax-included.
- Keeping no kilometre log, which collapses the reasonableness argument and the credit together.
- Paying a blanket work-from-home stipend, which rarely satisfies the conditions that home office expenses must meet.
If a review letter has already landed, our CRA representation team deals with these files regularly, and the outcome usually turns on documentation rather than argument.
Allowances and Reimbursements: Questions Employers Ask
What is the difference between an allowance and a reimbursement?
An allowance is a set amount paid without receipts, and the employee keeps any unspent portion. A reimbursement repays a documented amount actually spent. The distinction decides which provision gives you the credit and whether the payment lands on the employee’s T4.
Do you charge GST on reimbursable expenses billed to a client?
Usually yes. Costs you recover from a client normally form part of the consideration for your own supply, so they take on the tax status of that supply. Genuine agency disbursements, incurred as the client’s agent, are the narrow exception and need to be documented as such.
Are reimbursements subject to GST?
No tax is charged on the payment itself, because repaying an employee is not a supply. What section 175 does instead is let the employer claim the tax the employee already paid to the original vendor, to the extent of the repayment.
How do I know if an allowance counts as reasonable?
For vehicles, it must be based solely on business kilometres at a rate near the prescribed limits, with no separate payment covering the same operating costs. For other expenses, compare the payment against the employee’s actual expenses. Persistent surpluses signal remuneration rather than cost recovery.
Can I claim the tax on an employee’s meal expense?
Yes, at half. Section 236 recaptures 50 per cent of the credit on food, beverages and entertainment, matching the limit in the ITA, and the recapture applies whether you paid an allowance or repaid a receipt.
The Bottom Line
Every expense report is a small tax recovery waiting to be documented properly.
- Decide whether each payment is an allowance or a reimbursement, and write the policy down.
- Apply the correct fraction, and treat every payment as tax-included.
- Test the 90 per cent condition before claiming anything.
- Halve the credit on meals and entertainment.
- Require kilometre logs and keep receipts even under the factor method.
Multi-province teams complicate this further, since the fraction follows where the purchase happened rather than where payroll sits, which connects directly to the place of supply rules. If your expense policy has never been tested against any of this, our corporate tax advisory team can price the recovery you are missing. Get in touch with a year of expense reports and we will show you the number.
