Most Etsy sellers overpay on taxes because they report gross revenue as profit. If you sold $50,000 worth of handmade products last year and spent $35,000 on materials, packaging, and supplies, your taxable income isn’t $50,000. It’s $15,000. The difference is Cost of Goods Sold (COGS), and it’s the single biggest tax lever you have as a product seller in Canada.
What is COGS
COGS is the direct cost of making or acquiring the products you sold. The CRA formula is straightforward:
Opening inventory + Purchases during the year - Closing inventory = Cost of Goods Sold
You report it on Form T2125 (Statement of Business or Professional Activities), Part 4, the same form you use to report all your self-employed income.
If you started the year with $5,000 in beads, wire, and findings, bought another $33,000 throughout the year, and had $3,000 left at year end, your COGS is $35,000. That $35,000 comes straight off your gross revenue before the CRA calculates what you owe.
Why COGS matters more than you think
COGS reduces your taxable income dollar-for-dollar. Every $1 in legitimate COGS is $1 less in taxable income. For an Etsy seller in Ontario earning $50,000 gross with a combined federal and provincial marginal rate around 29%, properly claiming $35,000 in COGS could save you roughly $10,000 in taxes compared to reporting the full $50,000 as income.
The mistake most sellers make is treating their Etsy deposit as profit. Etsy already takes fees off the top, so it feels like what lands in your bank account is “what you made.” But that ignores the thousands you spent on materials, and the CRA doesn’t automatically know about those costs. You have to claim them.
CRA-accepted valuation methods
When you count your inventory at year end, you need to assign a dollar value to it. The CRA accepts two methods:
Fair market value (replacement cost): what it would cost you to buy the same materials today. If you bought silver wire at $40/metre last March but the price has risen to $48/metre, you’d value your remaining stock at $48/metre.
Actual cost: what you actually paid. This is simpler and what most Etsy sellers use.
You must use the same method consistently from year to year. The CRA doesn’t let you switch back and forth to cherry-pick whichever gives you a lower tax bill. Pick one. For most handmade sellers, actual cost is the easiest to document and defend.
What counts as COGS
Not everything you spend on your business qualifies as COGS. Only costs directly tied to creating your product count.
| Included in COGS | NOT included in COGS |
|---|---|
| Raw materials (yarn, beads, leather, fabric, wood) | Your own labour or time |
| Components and findings (clasps, zippers, buttons) | Etsy listing fees and transaction fees |
| Packaging integral to the product (gift boxes, custom bags) | Marketing and advertising costs |
| Shipping costs to get materials to you | Shipping costs to the customer |
| Subcontractor labour (someone you pay to help make products) | Home office expenses |
| Labels and tags attached to the product | Tools and equipment (these are capital expenses, depreciated via CCA) |
The items on the right aren’t wasted. They’re still deductible, just in different sections of your T2125. Etsy fees, advertising, and shipping to customers go under “Other expenses.” Tools and equipment get depreciated over time. For more on what you can deduct as a self-employed person, see our freelance tax guide.
Inventory tracking that satisfies the CRA
The CRA expects you to do a physical inventory count at the end of each fiscal year (December 31 for most sole proprietors). You don’t need a fancy system, but you do need documentation:
- Count everything on hand: raw materials, work-in-progress, and finished goods you haven’t sold yet
- Assign a value using your chosen method (actual cost or fair market value)
- Keep the records. A dated spreadsheet with item descriptions, quantities, and unit costs is sufficient
- Save your purchase receipts. Every materials order, supplier invoice, and craft store receipt backs up your COGS claim
If the CRA asks questions, they want to see a clear trail from your purchase receipts to your inventory count to your T2125. The sellers who get into trouble are the ones who guess at year end instead of counting.
A real example: handmade jewelry
Say you sell handmade earrings and necklaces on Etsy. Here’s how a typical year might look:
| Amount | |
|---|---|
| Etsy gross revenue | $50,000 |
| Opening inventory (Jan 1) | $4,000 |
| Materials purchased during the year | $34,000 |
| Closing inventory (Dec 31) | $3,000 |
| COGS (4,000 + 34,000 - 3,000) | $35,000 |
| Gross profit | $15,000 |
From that $15,000, you’d still deduct other business expenses: Etsy fees, shipping to customers, home office, and so on. Your actual taxable business income could be even lower.
Without claiming COGS, you’d be paying tax on $50,000 instead of $15,000. At a 29% marginal rate, that’s roughly $10,000 in unnecessary tax.
Don’t forget GST/HST
If your total revenue (before COGS) exceeds $30,000 in any 12-month period, you’re required to register for and collect GST/HST. This catches a lot of Etsy sellers off guard. The threshold is based on gross revenue, not profit. A seller with $50,000 in sales and $35,000 in COGS still crossed the threshold at $50,000.
The upside: once registered, you can claim Input Tax Credits (ITCs) on the GST/HST you paid on your materials and supplies. That’s money back in your pocket.
How Accountly helps
Tracking materials purchases, doing year-end inventory counts, and calculating COGS by hand gets tedious fast, especially when you’re juggling dozens of SKUs and multiple suppliers. Accountly tracks your inventory and auto-calculates COGS for your T2125, so you’re not scrambling with spreadsheets every December.
FAQ
How do I calculate cost of goods sold for handmade products in Canada?
Use the CRA formula: opening inventory + purchases during the year - closing inventory = COGS. Only include direct material costs, components, and packaging integral to the product. Report it on Form T2125, Part 4.
Can I include my own labour in COGS as a sole proprietor?
No. As a sole proprietor, your own time and labour are not a deductible expense. Only materials, supplies, and payments to subcontractors count toward COGS. Your “pay” is whatever profit the business generates after expenses.
What happens if I don’t track inventory for my Etsy shop?
You’re likely overpaying on taxes. Without an inventory count, you can’t calculate COGS, which means you’re reporting your full gross revenue as income. You’re also at risk if the CRA audits you, since they expect product-based businesses to maintain inventory records.
Do Etsy fees count as cost of goods sold?
No. Etsy listing fees, transaction fees, payment processing fees, and advertising fees are not COGS. They’re deductible as “Other expenses” on your T2125, so you still get the deduction, just in a different line.
Should I use actual cost or fair market value for inventory?
Most Etsy sellers should use actual cost. It’s simpler, easier to document, and less likely to trigger CRA questions. Fair market value works if your material costs fluctuate significantly and you want to reflect current replacement costs. Whichever you choose, stick with it year over year.
Do I need to count inventory if I sell digital products on Etsy?
No. Digital products like printables, templates, and SVG files have no physical inventory and no material costs. COGS generally doesn’t apply. Your deductions will come from software, equipment, and other business expenses instead. Check our gig worker platform guide for more on Etsy-specific deductions.
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