The profit test refers to the business definition used by the Canada Revenue Agency and is used to determine whether or not a person who claims to be operating a business actually is.
Only a person (or legal entity) actually operating a business can claim business expenses or business tax credits, so if a person claims to be operating a business on his or her Canadian income tax return or GST/HST return and that business does not pass the profit test, all of the claimed business expenses and relevant tax credits would be disallowed - creating a hefty tax bill.
The Canada Revenue Agency defines a business as "an activity that you conduct for profit or with a reasonable expectation of profit".
The profit test asks, "Was the activity conducted with an actual expectation of profit?" and "Was that expectation of profit reasonable?"
The Canada Revenue Agency's P-176R - Application of Profit Test to Carrying on a Business explains the issue further and provides examples of how the profit test has been applied in particular past cases.
The Canada Revenue Agency recognizes that the issue of reasonable expectation of profit "is likely to arise more often" with some types of activities people try to engage in for profit; both farming operations and artists and writers are discussed in depth in the Policy Statement just linked.
