The essential Tax Law in Canada

These are the highlights if you want to know more about the essential Tax Law in Canada. This entry was drafted by HazloLaw Business Lawyers. Link to E-Iure Network.

This collaboration is a brief step-by-step guidance. In no case it can be considered as legal advice. If you want -or need – legal advice, ask for a lawyer or a law firm. In that case HazloLaw Business Lawyers is an excellent option in Canada.

In Canada, corporations may be subject to both federal and provincial income taxes. Unlike individuals, which are subject to progressive tax rates, corporations are subject to flat rates of tax. The tax rate payable by a corporation depends on the type of corporation and the source of its income. The federal income tax payable by a corporation pursuant to the Income Tax Act (Canada) (the “Tax Act”) is comprised of the basic federal corporate rate and the federal corporate surtax. Currently, the basic federal corporate rate is 38% minus a provincial abatement of 10%. However, this abatement only applies where a corporation earns income that is attributable to any province in Canada. In 2017, the basic federal rate after applying the provincial abatement is reduced to a net rate of 15%, but only on certain income, and excludes income earned from a personal service business or from a corporation that is, throughout the year, an investment corporation or a mutual fund corporation, as defined in the Tax Act. Financial institutions and insurance corporations with permanent establishments in Canada that have taxable capital employed in Canada in excess of $1 billion are subject to a capital tax at a single tax rate of 1.25%.

In Ontario, a provincial tax of 11.5% is imposed under the Corporations Tax Act (Ontario) on corporations carrying on business through a permanent establishment in the province. A corporation will have a permanent establishment in a province if it has a fixed place of business there. It may also have a permanent establishment in certain other circumstances, such as when it carries on business through an employee or agent, or uses substantial machinery or equipment in a province.

Corporate Residence

The application of Canadian income tax is based on a taxpayer’s residence. Tax residency under the Tax Act is a question of fact and is established based on the location of the “central management and control” of the corporation. Moreover, the Tax Act provides for deeming rules whereby a corporation may be deemed resident in Canada. For instance, a Canadian subsidiary incorporated in Canada after April 26, 1965, or prior to that date if it carried on business or was resident in Canada at any time thereafter, is considered to be resident in Canada for tax purposes and is taxed in Canada on its world-wide income regardless of where such income is earned. The subsidiary is subject to Canadian federal income tax as well as provincial income tax in any province in which the company maintains a permanent establishment.

A non-resident corporation which carries on business in Canada is subject to Canadian income tax on the portion of its world-wide income earned in Canada. However, Canada has entered into numerous tax treaties which may affect the foregoing principle, for example by providing that the business profits of corporations resident in a treaty country are only subject to tax in Canada if they are attributable to a permanent establishment in Canada. The application of branch taxes is usually subject to modification in Canada’s international tax agreements.

Other Taxes

a) Sales taxes

Sales taxes are imposed by federal legislation and also by all provincial governments with the exception of Alberta.

Since 1991, Canada has had a value-added sales tax on goods and services (“GST”), which is provided for in the Excise Tax Act (Canada). GST is imposed at a rate of 5% on the consideration paid in respect of virtually all goods and services provided in Canada. Generally, the tax is paid by the purchase of the good or service to the vendor, who collects the tax on behalf of the government. The vendor is entitled to claim a credit for the GST paid by the purchaser in respect of the GST paid by the vendor itself on goods or services acquired for the conduct of the vendor’s commercial activity in Canada. The difference between the total amount collected by the vendor from its clients and the total amount paid by the vendor to it suppliers is remitted to the tax authorities. In the case of goods imported into Canada, the GST is paid to the taxing authority directly, based on the duty-paid value of the goods, with an off-setting credit available to a registered importer in respect of the GST paid, provided the goods are used by the importer for a commercial activity in Canada.

No GST is paid on basic groceries, prescription drugs, medical and educational services and residential rents.

Some provinces such as Ontario have chosen to harmonize their sales taxes with the GST, resulting in a combined sales tax referred to as the harmonized sales tax (the “HST”). For example, the HST is levied on supplies made in the province of Ontario at a rate of 13%, consisting of an 8% Ontario component and a 5% federal component.

b) Excise taxes

The Excise Tax Act (Canada) provides for excise taxes on four products imported into or manufactured in Canada: beer, wine, alcohol and tobacco. Most of these taxes are ad valorem, meaning that they are imposed on the value of the good as opposed to their quantity or volume.

Branch Income

It is possible for a foreign enterprise to do business in Canada without incorporating a company in Canada by operating through a “branch operation”. In such case, the enterprise would be required to register as an extra-provincial corporation in Ontario and any other province in which it carries on business. Depending on the nature of the activities undertaken, such registration may be required even if the corporation does not have a permanent establishment for income tax purposes.

A non-resident corporation that carries on business in Canada is generally subject to corporate income tax at the same rates as similarly situated Canadian resident corporations (as discussed above). In addition a non-incorporated branch may also be subject to an additional 25% branch tax (subject to potential rate reduction under a bilateral tax treaty) imposed by the federal government. This tax is imposed on the portion of the branch’s net after-tax Canadian income that is not re-invested in the Canadian business. This tax measure is intended to eliminate the more favourable tax treatment of branches relative to that of subsidiaries by effectively taking the place of the 25% withholding tax which is levied on dividends paid by a Canadian subsidiary to its non-resident parent. The branch tax may be more onerous though in that it is payable in the year in which income is earned regardless of whether the income is in fact distributed to the parent in that year. Withholding tax, on the other hand, is only payable when a dividend is paid, such that the tax can be postponed until actual payment.

Income Determination

The Tax Act provides that a taxpayer’s income from a busi­ness or property is the profit from that source for the taxation year. “Profit” is to be computed initially using applicable general commercial and accounting norms, but is subject to many specific adjustments under the Act.

Deductions

Generally, in order to be deductible, expenses must be incurred in the year for the purpose of gaining or producing income from business or property and they must be reasonable in the circumstances. In general, only current expenses are deductible in computing taxable income. Capital expenditures are not generally deductible, but an amount representing depreciation may be deducted pursuant to the capital cost allowance regime contained in the Tax Act and the Income Tax Regulations.

Inter-Corporate Loans

Particular consideration should be given to loan transactions between a non-resident parent company and its Canadian subsidiary and to interest charged with respect to such loans. The Tax Act generally disallows the deduction of interest payable by a Canadian subsidiary on debts owed to specified non-resident persons, to the extent that the ratio of such debt to the subsidiary’s equity exceeds 1.5:1. A “specified non-resident” is any non-resident who owns, or is related to a person who owns either 25% or more of the voting shares of the Canadian-resident corporation, or 25% or more of the fair market value of all of the issued and outstanding shares of the capital stock of the corporation. Special rules apply to debts owed to partnerships of which the Canadian-resident corporation is a member and debts owed to non-resident corporations and trusts that carry on business in Canada.

Inter-Company Dividends

Generally, dividends received by corporate shareholders are included in income but are deducted when calculating taxable income. This deduction prevents tax from being paid many times over on the same amount. Dividends will only be taxed in the hands of the ultimate shareholder who is an individual. However, this treatment is reserved to dividends paid by taxable Canadian corporations or by corporations residing in Canada which are controlled by the corporate shareholder. The Tax Act generally imposes a 25 per cent withholding tax on dividends paid by a Canadian subsidiary to its non-resident shareholder, subject to potential rate reduction under a bilateral tax treaty.

Tax Incentives

A Canadian-controlled private corporations (“CCPC”) is entitled to claim a small business deduction on active business income (ABI) earned in Canada. A CCPC generally includes a private corporation resident in Canada that is not controlled by one or more non-residents and/or public corporations. The small business deduction is a reduced rate of tax that is available on active business income earned by a CCPC, but only on the first $500,000 of active business income. Such incentive is reduced on a declining basis when a CCPC’s taxable capital reaches $10 million, and is eliminated when taxable capital reaches $15 million.

Generous tax incentives also exist to encourage investment in research and development activities. For example, a scientific research and experimental development investment tax credit is available on qualified capital and non-capital expenditures. This credit can reduce tax payable or even result in a tax refund. CCPCs may be eligible for the credit at a rate of 35% on the first $3 million dollars of annual eligible expenditures and 15% thereafter. Other Canadian companies are eligible for a 15% credit. To be eligible, the research and development activities must be carried on in Canada. To claim the credit, the taxpayer will require extensive supporting documentation meticulously showing the various steps, results and conclusions achieved in order to prove that a scientific advancement has taken place.

Withholding Taxes

Canada imposes withholding tax at the rate of 25% (reduced by most bilateral tax treaties) on various types of “passive” income received by non-residents from Canadian sources. Withholding tax applies to, among others, management or administration fees, interests, dividends, rents and royalties paid by a resident of Canada to a non-resident. There are certain circumstances where a non-resident may be deemed by the Tax Act to be resident in Canada and thus subject to withholding tax on payments made by it to another non-resident.

The Canadian tax system is a self reporting and self assessing system which imposes the obligation on individuals, corporations and trusts to file an income tax return on all taxable amounts for the preceding fiscal year. Individuals are required to file their tax returns each year by April 30, or by June 15 if the individual received business income. Corporations are required to file their income tax returns within six (6) months of their fiscal year-end.

Income tax in Ontario is administered federally; therefore a separate provincial income tax return is not required.

The Tax Act confers upon the Minister of National Revenue a number of powers such as that to require persons to provide information to facilitate the administration or enforcement of the legislation. Typically, the Minister can use special execution measures and enjoys super-priorities vis-à-vis other creditors of a taxpayer who is in default of the Tax Act. The Minister of National Revenue has a duty to examine a taxpayer’s income tax return in order to determine whether or not there is applicable tax, interest or penalties due. A notice of assessment is then sent confirming the amount of tax owing or the amount of the tax refund due to the taxpayer. In the absence of fraud or misrepresentation attributable to neglect, carelessness or wilful default, the Minister of National Revenue may not reassess (issue a revised assessment) after three years (or four years in certain cases) has passed since the original notice of assessment was mailed.