Canada’s tax rules are complex and subject to change. The information contained herein is not, and is not intended, to be a comprehensive overview of Canada’s tax system.
Canada’s federal income tax system for businesses and individuals is governed by the federal Income Tax Act (Canada) (“ITA”) and its regulations. Businesses operating in Canada might also be affected by sales tax, payroll tax, and other federal, provincial and territorial tax laws, and by the administrative policies and assessing practices of the Canada Revenue Agency (“CRA”). The CRA is a federal governmental agency that, among other things, administers all federal tax laws, and many provincial and territorial tax laws. In this blog post, we provide an overview of the key Canadian tax rules that both Canadian and foreign businesses need to be mindful of when setting up their business in Canada.
Taxation of Residents in Canada
Residency is a key concept in the Canadian tax system. For example, a resident of Canada is subject to income tax on its worldwide income, whereas a non-resident is generally only taxed on income having a Canadian source. Consequently, an understanding of when a person is, or is deemed to be, a resident for Canadian tax purposes can be crucial in assessing Canadian tax matters. The following rules generally apply for determining residency for the purposes of the ITA, subject to the overriding provisions of an applicable tax treaty.
Corporation: A corporation incorporated in Canada after April 26, 1965 is deemed to be resident in Canada. A corporation may also be resident in Canada if its central management and control is located in Canada.
Individual: Generally, an individual who regularly or normally lives in Canada is considered a resident for Canadian tax purposes. In addition, an individual who sojourns in Canada for 183 days or more during any particular year is deemed a resident of Canada for that year.
Trust: A trust is generally considered a resident of Canada where the central management and control of the trust is exercised. In addition, certain trusts having a resident contributor or a resident beneficiary are deemed to be a resident of Canada.
Taxation of Non-Residents of Canada
As discussed above, generally a non-resident of Canada is subject to Canadian tax only on its Canadian-source income. The most common forms of income tax imposed on a non-resident include (subject to the overriding provisions of an applicable tax treaty):
– Withholding tax on passive income (such as dividend, interest or royalties) paid by a resident of Canada to the non-resident;
– Income tax on income earned from a business carried on in Canada, including a special “branch tax” on non-resident businesses carrying on business in Canada;
– Capital gains tax realized on the disposition of “taxable Canadian property”, which includes, among other things:
- Real property and resource property situated in Canada; and
- A share of a corporation, or an interest in a trust or partnership, 50% or more of the value of which was, directly or indirectly, attributable to real property or resource property situated in Canada in the previous 60-month period;
– Income tax on employment performed in Canada.
The federal Goods and Services Tax (“GST”) generally applies to the supply of goods and services made in, or imported into, Canada. The rate of the tax is 5%. Although the GST applies at each stage of production, it is levied on consumers (a “middleman” is generally entitled to recoup GST/HST that it pays by claiming an input tax credit). GST on taxable imported goods and services is payable by the importer of record, while exported goods and services are generally zero-rated (GST technically applies, but at a rate of 0%). A non-resident who carries on business in Canada that involves making taxable supplies must register under the GST/HST legislation and charge and collect GST/HST.
In addition to the GST, each province in Canada (other than Alberta) levies a sales tax on most sales of tangible personal property and certain specified enumerated services within the particular province. British Columbia, Saskatchewan and Manitoba each levy their own sales tax. Newfoundland and Labrador, Nova Scotia, New Brunswick, Prince Edward Island and Ontario have harmonized their respective provincial sales taxes with the GST to form the Harmonized Sales Tax (“HST”). Quebec levies the Quebec Sales Tax, which is applied and administered separately from the GST, but it is generally similar to the GST regime.
A non-resident’s liability for Canadian tax can be reduced or eliminated pursuant to a bilateral tax treaty between Canada and the non-resident’s country of residence. To date, Canada has entered into over 80 income tax treaties with other jurisdictions. Generally, the treaties provide that the business profits of a non-resident of Canada are not subject to tax under the ITA except to the extent that such profits are attributable to a permanent establishment of the non-resident in Canada. Canada’s tax treaties also generally reduce the statutory withholding tax and branch tax rates. While tax treaties do not bind the provinces, the provinces generally adhere to the provisions of the treaties.
Individuals or companies doing business in Canada, or those seeking to do business in Canada are strongly urged to obtain Canadian tax advice to ensure that their business is structured and operated in a tax-efficient manner. This includes incorporating the right entities prior to establishing business activities in Canada.