Canada operates under a self-assessment system. Subject to a few exceptions, taxpayers have to report certain information in their tax returns in order to allow the Government to compute their income taxes payable for the year.
Following is an overview of federal income taxation in Canada for individuals. Each province or territory also imposes its own income tax.
Residence is an important concept because residents of Canada are taxable on their worldwide income, whereas non-residents are taxable only on income from a source in Canada (i.e. employment in Canada, business carried on in Canada or disposition of “taxable Canadian property”).
- Are you resident in Canada? Whether an individual is resident in Canada is based on a number of factors. The goal is to assess the individual’s ties to Canada. The stronger the ties, the stronger the indication that the individual is resident in Canada. For a look at some of the factors that are considered when determining residency, go to the CRA’s website: Determining Your Residency Status. It is important to note that the factors mentioned by the CRA are not exhaustive and that each case must be assessed on its own merit.
- Are you resident in a province or territory? As opposed to residence in Canada, the rule for determining whether a person is resident in a province or territory is more straightforward. An individual is resident of the province or territory where he is factually resident at the end of the year. See the CRA’s website: Your Province or Territory of Residence.
2) Types of Income
The Act recognizes different types of income:
- Income from employment
- Income from office
- Income from business
- Income from property
- Capital gain
- Other income
Income from Office or Employment
As opposed to the terms “employment” and “employee,” which are not defined in the Act, the terms “office” and “officer” are specifically defined. “Office” is defined to mean “the position of an individual entitling the individual to a fixed or ascertainable stipend or remuneration,” such as a judicial office, the office of a minister of the Crown, the office of a member of the Senate or House of Commons of Canada, etc. An “officer” is a person holding such office.
The Act differentiates between an officer and an employee on the basis that the officer is not subject to the same constraints as the employee, although the officer also receives a fixed or ascertainable stipend or remuneration.
Although the Act differentiates between office and employment, the tax consequences of holding an office or being employed are for the most part similar.
What is considered office or employment income?
Generally, expenses related to an individual’s employment are not deductible, unless specifically allowed under the Act.
Income from Business
Income from business if self-explanatory. However, there are instances where the line between employment and self-employment can be blurry. When is a person employed (working for someone else) and when is he carrying on his own business (working for himself)?
When there is a dispute as to the status of a worker, the central question that needs to be answered is “whether the person who has been engaged to provide the services is performing them as a person in business on his own account.” The case law has come up with a series of criteria to help in this determination, such as control, ownership of tools, risk of loss, chance of profits, etc. Generally, the difference between an employee and someone who is self-employed is that the employee has to work within the constraints fixed by his employer, whereas someone who is self-employed enjoys much more flexibility because, being his own boss, he gets to make the rules. While an employee enjoys less flexibility, he is not exposed to the same risks as someone who is self-employed. With changes in the workforce and the level of sophistication of today’s workers, it becomes harder and harder to draw a clear line in some cases.
Although an individual’s status as employee or self-employed is fact-specific, the CRA gives some guidance here: Employee or Self-employed?
Advantages and disadvantages of being an employee vs. being self-employed/ independent contractor:
|Employee||Self-Employed/ Independent Contractor|
|Access to employment insurance, but requirement to pay EI premiums.||No access to employment insurance, but also no need to pay EI premiums.|
|Only required to pay 50% of CPP (QPP for Quebec). The other 50% is paid by the employer.||Required to pay 100% of CPP (QPP for Quebec).|
|Employment expenses generally not deductible, unless specifically provided for in the Act.||Business expenses incurred to earn income generally deductible, unless otherwise provided for in the Act.|
Income from Property
Income from property can generally be understood as income deriving from the ownership of property. For example, monthly rent from leasing a unit is property income. Other examples of property income include interests, dividends and royalties.
The main difference between property income and business income is that a person should not need to spend a lot of time or labor to earn property income. In contrast to earning “passive” property income, a person would need to “carry on” a business, which requires more “active” involvement.
However, similar to business income, expenses incurred to earn property income are generally deductible unless otherwise stated in the Act, the rationale being that a person should only be taxed on his profits.
A capital gain is realized when a person disposes of property at a profit. A capital gain is different from property income because a capital gain is realized upon the disposition of property, whereas property income is earned from the ownership of property.
One attractive feature about capital gains is that only 50% of the gain is taxed (“taxable capital gain”), as opposed to income, which is taxed at 100%.
It may happen that a person receives income that does not fit under any of the previous headings. When this happens, the income is referred to as “other income,” and is not taxable under the Act. An example that is often cited when referring to other income is proceeds from gambling or lottery winnings.
3) Tax Computation
Following is a broad overview of how tax is calculated under the Act. It is not meant to be comprehensive. It is only intended to give an appreciation of where things fit.
* The CRA lists on its website the deductions, credits and expenses available to individuals, as well as at what stage those apply: All Deductions, Credits, and Expenses [“CRA Summary”].
In general terms, a taxpayer’s income is calculated by adding the taxpayer’s net income (after deductions) from the various sources and subtracting [the losses incurred by the taxpayer from these sources + deductions allowed under “subdivision e” of the Act (see the CRA Summary)].
Or, as the Act puts it:
|+ / –||Description|
|Add||The taxpayer’s net income (after deductions) from office, employment, property and business for the year.|
|Add||The “taxable capital gain” (50% of the capital gain) realized by the taxpayer, after subtracting any allowable capital losses of the taxpayer for the year.|
|Subtract||Deductions allowed under “subdivision e” of the Act for the year. See the CRA Summary.|
|Subtract||The taxpayer’s losses, if any, from office, employment, property or business for the year.|
Once the taxpayer’s income has been determined for the year, the next step is to determine his taxable income. Generally, a taxpayer’s taxable income for a taxation year is his income for the year taking into account the adjustments provided for under “Division C” of the Act. See the CRA Summary.
Once the taxable income is calculated, the next step is to apply the corresponding tax rate to that income. Since Canada has a progressive tax system, the tax rates increase with the individual’s income bracket. The table below shows the federal tax brackets and tax rates for 2016:
|Taxable Income||Tax Rate|
|Over $45,282 and up to $90,563||20.5%|
|Over $90,563 and up to $140,388||26%|
|Over $140,388 and up to $200,000||29%|
Against this amount of tax otherwise payable we can then subtract tax credits. See the CRA Summary.
Tax Deductions vs. Tax Credits
Tax deductions refer to amounts that are deducted from income or taxable income, before tax is calculated.
Tax credits refer to amounts that a taxpayer can deduct from his tax otherwise payable. In other words, as opposed to a tax deduction, which is applied against income or taxable income, a tax credit is applied against the amount of tax otherwise payable. There are two types of tax credits: refundable tax credits and non-refundable tax credits. See the CRA Summary.
4) Tax Administration
The Canada Revenue Agency is the federal agency in charge of administering the tax system in Canada. Through various agreements, it also administers provincial and territorial taxes, except for Quebec.
Last updated: November 2, 2016