Inventory and Cost of Goods Sold on the T2125: A Guide for Canadian Sellers

Why Inventory Is Not an Immediate Expense

A common T2125 question from Etsy, Shopify, craft, and resale businesses is: Can I deduct everything I bought for inventory this year? Usually, not if some of those goods remain unsold at year-end.

Inventory is used to calculate cost of goods sold (COGS). Instead of deducting every product purchase immediately, the T2125 matches the cost of items sold to the revenue earned from selling them. Unsold goods remain closing inventory and carry into the next fiscal period.

This matters for anyone who sells physical products, including makers, resellers, and manufacturers. A service-only freelancer with no saleable goods will usually have no inventory section to complete.

What Counts as Inventory?

Inventory can include:

Do not confuse inventory with equipment. A laptop, printer, display shelf, or manufacturing machine used for several years is generally a capital asset, not merchandise held for sale. Ordinary operating items that are not incorporated into saleable goods may belong in a T2125 expense category instead.

The T2125 Cost of Goods Sold Formula

Part 3D of Form T2125 calculates COGS broadly as:

Opening inventory + purchases + direct wage costs + subcontracts + other direct costs − closing inventory = cost of goods sold

Purchases are entered net of returns, allowances, and discounts. Opening inventory is generally the prior year's closing inventory. For a brand-new business with no inventory brought in, opening inventory may be zero.

Example: you start with no inventory, buy $3,000 of materials, and still hold $1,200 of those materials and finished goods at year-end. With no other direct costs, COGS is $1,800, not $3,000. The remaining $1,200 becomes next year's opening inventory.

Value Inventory at Cost, Not Retail Price

A frequent mistake is counting unsold products at their expected selling price. Inventory valuation is based on permitted tax methods, not the revenue you hope to earn.

The CRA generally permits you to value individual inventory items—or classes of similar items—at the lower of cost and fair market value, or to value the entire inventory at fair market value. Once you choose a method, use it consistently in later years. Cost should reflect what you paid and applicable direct costs, supported by supplier invoices and production records.

If damaged, obsolete, or unsaleable stock has fallen in value, document why. Do not write inventory down simply because sales were slower than expected.

Count What You Have at Year-End

Perform and retain a physical inventory count at your fiscal year-end, usually December 31 for an individual sole proprietor. Your records should show:

Reconcile the count with purchases and sales. Platform deposits alone cannot prove how much inventory was sold or remains on hand.

Avoid GST/HST Double-Counting

If you are GST/HST registered and claim input tax credits, calculate inventory and purchases without the recoverable tax. If you do not claim an ITC, the tax may form part of the cost. Keep the treatment consistent with your GST/HST return and T2125 records.

Track Product Costs With ClaimHero

ClaimHero is a free Canadian T2125 expense tracker for sole proprietors. Record inventory purchases, supplier details, and business notes throughout the year, then use your year-end count to calculate COGS in tax software or with your accountant. Clean purchase records make the inventory adjustment far easier—and prevent unsold stock from being deducted twice.