Direct taxation of businessesi Tax on profitsDetermination of taxable profit
Canadian-resident corporations are taxed on their worldwide income from all sources, including business, property and capital gains. Income from business or property is the profit from such activities calculated in accordance with 'well accepted principles of business (or accounting) practice', adjusted as permitted or required by the tax legislation. As a practical matter, most corporations start with income as determined under generally accepted accounting principles (GAAP), although those principles are not determinative.
The tax legislation mandates certain adjustments. For example, the rates at which assets are depreciated for accounting purposes will differ from the rates at which capital cost allowance (tax depreciation) may be deducted in computing income for tax purposes.
Corporations may choose any taxation year, but no taxation year can exceed 53 weeks. Moreover, once selected, the taxation year cannot be changed unless the Canada Revenue Agency (CRA) agrees. However, certain events will result in a deemed taxation year-end (e.g., an acquisition of control) following which a different taxation year may be selected.
The most common adjustments to accounting profits to compute income for tax purposes are described below.Expenses
To be deductible for tax purposes, an expense must be reasonable, not on account of capital (except to the extent expressly permitted), not contingent and incurred for the purpose of earning income.
Certain expenses that might satisfy those tests nonetheless may be prohibited from being deducted. For example, no deduction is permitted in respect of stock option benefits conferred on employees. Business entertainment expenses are only partially deductible. Costs related to vacant land held for development generally must be capitalised. On the other hand, certain expenses that might be considered capital expenditures are deductible (albeit over time), including costs incurred to issue shares or borrow money.Depreciation (capital cost allowance (CCA))
Depreciation taken in computing accounting profits must be added to income for tax purposes. Canada has a CCA system for depreciating assets such as buildings, machinery and equipment; properties of a similar nature are typically included in the same pool for CCA purposes. With few exceptions, property is depreciated for tax purposes on a declining balance basis at rates that range from 4 to 100 per cent.
CCA is recaptured in income if a depreciated asset is disposed of for an amount in excess of the balance of the pool to which it belongs. A fully deductible loss arises if the last asset in the pool is disposed of and an undeducted pool balance remains.Capital and income
Capital gains may arise on the disposition of capital property (including depreciable property, where the proceeds exceed the original cost). Only 50 per cent of a capital gain (a taxable capital gain) is included in income. Capital losses may be realised on the disposition of non-depreciable capital property, and 50 per cent of such a loss (allowable capital loss) is deductible but only against taxable capital gains.
Private corporations add the untaxed half (net of 50 per cent of any capital losses) to a special account (capital dividend account), the balance of which may be paid to its Canadian-resident shareholders as a tax-free dividend. In addition, taxable capital gains realised by a Canadian-controlled private corporation (CCPC) are included in investment income, which is subject to a special higher rate of tax that is refundable when the CCPC pays dividends.Losses
Losses are generally categorised as net capital losses or non-capital losses. Net capital losses (being one-half of a capital loss not deducted in the year realised) may be carried back for three taxation years and carried forward indefinitely, but generally are only deductible against taxable capital gains realised in those years.
Non-capital losses may be carried back for three taxation years and may be carried forward for up to 20 taxation years. Non-capital losses generally may be deducted against taxable capital gains or income from other sources.
Immediately prior to an acquisition of control, a corporation has a deemed taxation year end, and accrued losses on most assets are deemed realised in that year. Thereafter, losses become restricted. Net capital losses, as well as any non-capital losses incurred in the course of earning income from property (rather than from a business), will expire unless used in the taxation year ending with the acquisition of control. Non-capital losses incurred in the course of carrying on a business may be carried forward for deduction in subsequent taxation years only if the loss business is carried on for profit or with a reasonable expectation of profit throughout the taxation year in which the loss is to be deducted. In such a case, the loss is deductible against income (but not taxable capital gains) from the loss business or certain 'similar' businesses. Similar rules apply to the carry-back of losses from post-acquisition of control taxation years to pre-acquisition of control taxation years.
To temper the effect of these restrictions, in the taxation year ending with the acquisition of control, a corporation may elect to 'step up' the tax cost of capital property (including depreciable property) it owns to fair market value by deeming a disposition of such property for the amount it designates (not in excess of fair market value), thereby generating income or taxable capital gains against which the pre-acquisition of control losses may be deducted.
The rules relating to acquisitions of control extend to trusts – the loss restriction event being tied to changes in beneficiaries. However, trusts do not benefit from the elective step-up provisions.Rates
Income tax is imposed by both the federal government and the provinces in which a business has a PE. The combined federal and provincial rate on business income ranges from 26 to 31 per cent. A CCPC enjoys a preferential tax rate of 10.5 to 18.5 per cent (depending on the relevant province or provinces) on active business income less than a specified threshold (generally C$500,000). While CCPCs are also liable for a higher rate of tax on investment income (49.7 to 54.7 per cent), a portion of that tax is refunded when dividends are paid by the CCPC. Effective 1 January 2018, the federal small business tax rate will be further reduced to 10 per cent and then to 9 per cent effective 1 January 2019.AdministrationTax returns for corporations
Canada has a self-assessment system of taxation. Although each of the provinces assesses provincial income taxes, the federal government administers the provincial income taxes on behalf of most provinces. A corporation must file an income tax return for each taxation year, due within six months after the taxation year-end. Most corporations with gross revenue in excess of C$1 million must file returns electronically.
The typical taxation year is 12 months, but a corporation is deemed to have a taxation year-end immediately before an amalgamation, an acquisition of control of the corporation, or the corporation ceasing to qualify as, or becoming, a CCPC.
Corporations must pay monthly instalments on account of income taxes (quarterly for small CCPCs), and must pay the balance due by the end of the second month following the taxation year-end (third month for small CCPCs). While not all corporate taxpayers are audited, any taxpayer may be selected for audit. Large corporations rated as high risk (by industry, record, etc.) typically are audited annually.
The normal period for reassessing a corporation is four years (three years for CCPCs) after the initial assessment, but longer periods are permitted for certain types of income, if misrepresentations are made, for transactions with non-arm's length non-residents, and to accommodate loss carry-backs and similar adjustments. A corporation that disagrees with an assessment or reassessment may object (generally within 90 days). If the objection is upheld, the taxpayer may take the dispute to the Tax Court of Canada, from which an appeal to the Federal Court of Appeal is available, as of right. Thereafter, the appeal may be heard (with leave) by the Supreme Court of Canada.
Canada does not have a real time audit procedure, but taxpayers may seek advance tax rulings (discussed below). The CRA has a number of well-established published administrative practices that generally may be relied on by the public.Tax grouping
Canada does not accommodate consolidated income tax returns, and, thus, each taxpayer must compute its own income (or loss). However, closely connected corporations must share certain tax benefits (e.g., the C$500,000 low-rate threshold for a CCPC must be shared among associated CCPCs).
Following a study of a formal loss transfer system or consolidated tax reporting regime for corporate groups, the government announced that moving forward with a formal system is not a priority. While loss trading is generally precluded, well-accepted techniques may be used to move losses within an affiliated corporate group.ii Other relevant taxesTaxes on goods and services
Canada has a federal goods and services tax (GST) – a value added tax – levied at a rate of 5 per cent. Although the GST is imposed widely, input tax credits are intended to ensure that intermediaries receive a credit for the GST they pay so that the GST is borne only by the final user in the supply chain. Most provinces have adopted a harmonised sales tax (HST) based on the GST, administered for those provinces (other than Quebec, which has its own tax administration) by the federal government.
Of the non-participating provinces, Alberta does not impose a sales tax, and British Columbia, Manitoba and Saskatchewan levy and administer their own retail sales tax.
Property imported into Canada may be subject to customs or excise duties as well as GST and HST, although Canada is party to several free trade agreements.Property taxes
Many provinces (and some municipalities) levy a separate tax on the transfer of land within the province (municipality). Municipalities typically levy annual property taxes on owners of real property, based on the assessed value of commercial and residential real property.Income tax and social security contributions
Personal income tax rates imposed by provinces and the federal government are higher than corporate rates. The rates are progressive, increasing as income levels rise, but individuals with very low income may pay no income tax. The highest combined personal income tax rates in Canada exceed 53 per cent.
Employers are required to deduct tax at source from remuneration paid to employees and remit the tax on behalf of the employee. In addition to federal and provincial income tax, individuals and their employers are required to make contributions to the federal public pension and employment insurance programmes. Employers are subject to provincial social security levies that vary among the provinces.