Everything You Need to Know About the Tax System in Canada
We all pay taxes to various government agencies in our day-to-day lives, but very few people really understand how taxes work. Most people simply want to know what they owe, pay, and move on with their lives.
But do you know that you can save yourself a lot of trouble in the form of penalties, interests, and more by simply understanding how your country’s tax system works?
In Canada, there are multiple taxes regulated by government agencies at all levels of government. But sadly, very little is always done by them to educate the citizens about the tax system in Canada.
This is why we decided to craft this guide to explain in the simplest terms possible the tax system in Canada. We’ll also share with you the types of taxes in Canada and how they work, as well as other important information you need to know about this tax system.
There’s no doubt that taxes can weigh down on anyone who has little knowledge about them; thankfully, we’re here to try and fix that so you view taxes like any other expense in your life contributed for a greater good.
The truth is, the Canadian tax system is not that complicated; let’s start with the basics.
The Tax System in Canada
The tax system in Canada is mainly regulated by the Federal Income Tax Act; however, other laws such as sales tax and corporate tax also contribute immensely to the country’s tax system.
The general view of the tax regime is that residents are required to pay taxes on all incomes they generate globally while non-residents only pay taxes on incomes derived from activities within Canada.
Non-residents who were available in Canada during a certain tax year will be required to pay taxes for that period even after they leave. Similarly, all taxable properties disposed of by non-residents are also subject to taxes. Additionally, non-residents carrying on business activities with a certain province will be required to pay taxes in relation to the set laws in that province.
Important note: If a non-resident earns an income that is not subjectable to the ordinary income tax, withholding tax (at a rate of 25%) may still apply to the earnings unless otherwise stated by a tax treaty. Such incomes may include dividends, management fees, royalties, and interest. However, individuals who earn an interest expense at an arm’s length with the payer are exempted from withholding tax.
For corporations, their taxes will be evaluated based on the presence of their offices and central management and control during a certain tax year. Essentially, the law provides that all corporations registered in Canada after 1965 are said to be residents for tax purposes.
As at the time of this writing, Canada had over 80 treaties with various countries around the world. The treaties are aimed at streamlining the taxation of residents of the respective states. They also help to reduce the withholding tax rate as well as profits made by branches in other jurisdictions.
And if you’re a resident of either Canada or the US, you’ll be happy to know that there was an amendment to Canada-US Tax Convention that scrapped withholding tax on interest earned and paid. This means that as a citizen of either country, any amounts received as interest from an investment or payments made to cater for an interest expense will fully be tax-free.
Types of Taxes in Canada
The type of tax is subjected to depend on your source of income; generally, there are four types of taxable income in Canada:
- Employment Income
- Business Income
- Property Income
- Capital Gains Income
Let’s look at each individually.
This is the most common type of taxed income, and it applies to individuals only. This type of income attracts income tax, which results from earnings from wages and salary paid to an employee by an employer.
For tax purposes, employment income includes any other benefits received from an employer including gifts, mileage allowance, vacation, and more. The tax code allows very few deductions to be made from this income source, with only a few exemptions for the sales team.
Under tax laws, income derived by the business from trading activities is separated from the salary of its owner. This means that a business income is separated from employment income for tax purposes.
The phrase ‘business income’ is used to describe a wide range of earnings; the earnings could be as a result of an individual business, a partnership, or a corporation’s trading activities.
Unlike the employment income, this income type allows for a number of deductions prior to computing the payable tax.
This income attracts property taxes on earnings such as rent received, interest from investments, dividends received, and more
Income from property is almost similar to business income; however, it differs in the sense that only specific expenses can be deducted from the gross income. A common deduction usually relates to the interest paid for the loan taken to develop the property.
It’s important to note that the law has provisions to restrict one from avoiding more taxes by transferring a property to a spouse or a child.
Capital Gains Income
Capital Gains are the amount that is received when capital assets such as stocks are sold; this income is taxed differently depending on the transaction in question. Generally, all capital assets that are sold at a price higher than they were bought, the difference is considered to be capital gains. At the time, only 50% of such gains are brought to tax. However, losses resulting from disposing of capital assets are not taxed. This is to say, if you bought an asset at $1,000 and sell it at $900, the amount will not be subjected to capital gains tax.
Now that we’ve looked at the income that is taxable, let’s look at what’s actually not taxable in Canada.
Income that is Not Taxed in Canada
As per the Canada Revenue Agency (CRA) laws, certain income earned is not subjected to taxes and, as such, you don’t have to report them as income.
- Winnings from Lottery
- GST/HST (goods and services tax/harmonized sales tax) credits
- Child assistance payments received
- Canada Child Tax benefits and benefits from related provincial and territorial programs
- Sums received as compensation for personal injuries
- Gifts from non-employment activities and inheritances
- Most amounts received from a tax-free savings account (TFSA)
- Most amounts received from a life insurance policy after someone’s death
There you have it; next time you receive an income from any of these sources, now you know you’re spared from taxes.
How Do Taxes Work in Canada?
Basically, the CRA requires every eligible person (both natural and artificial) to present taxes on all qualified incomes. Taxes are regulated by the federal and provincial laws.
The Canadian tax system is progressive in nature; this means that as your income increases, so do your tax rates. So, as your tax bracket moves up, it makes sense to be prudent to try and take advantage of acceptable deductions such as credits to help you reduce your tax burden. Each new financial year, the government provides the tax brackets that are subject to changes; be sure to check out the most updated tax rates each time you evaluate your returns.
Deductions and Credits – Is There a Difference?
Deduction: A tax deduction is an amount taken from your taxable income for purposes of reducing the net taxable amount. Consider this example:
Alex, a US citizen, earned a total income of $47,000 during a certain period in Canada. He had also received an interest income of $2,000 (which is already included in his aggregate income). Since the US and Canada have a treaty that exempts its citizens from paying taxes on interest received, Alex will end up with a net taxable income of $ 45,000 (47,000 – 2,000). If Alex has other deductions, he can still go ahead and reduce his taxable income further. In the end, he will end up paying a lower tax rate.
Another advantage of deductions is that they can move you from one tax bracket to the other. For instance, Alex’s $47,00 falls in the 20.5% tax bracket of the federal taxes; however, after the deduction, his taxes fall in the 25% tax bracket. That’s a whopping 5.5% in federal tax savings!
There are numerous other deductions that taxpayers can take advantage of (well, legally I mean) including losses incurred, childcare expenses, professional dues, and more.
Credit: Tax credits are another common way of reducing someone’s tax burden. However, the source of this amount and that of a deduction are the distinguishing factors; unlike deductions, tax credits are granted by government agencies charged with managing certain taxes. For instance, the CRA can issue a tax credit to an individual who volunteers to present a tax for an income that had not yet been under the government’s tax radar.
In this case, a tax credit can be issued as a reward for good citizenship. If you’re awarded a tax credit, you will be able to apply it when filing your taxes to be able to reduce what you owe by the credit amount. You can think of tax credits as prepaid taxes that allow you to deduct what is no longer owed.
These two concepts are very important if you’re going to take advantage of legal ways of reducing your taxes.
Some credits are actually refundable while others can only be used up in the tax system to reduce your tax burden.
Refundable tax credits are sums that are actually a credit to your bank account by the government after an evaluation of your returns for a certain period. For this reason, you can only receive your credit after you file your returns.
The non-refundable tax credit is the most common ones; they are amounts that are not refunded in hard cash, but are used to reduce your taxes. Our explanation above typically describes a non-refundable tax credit.
Now that we understand how the tax system works, let’s understand how to file your tax returns.
How to File Your Returns
Basically, there are three ways of filing your taxes:
- On paper
- By phone
This is the most common way of filing your taxes. According to the CRA records, more than 90% of taxpayers filed their returns online in the 2017 financial year; this was attributed to the fact that most people find online platforms to be fast, convenient, and secure.
Filing your returns online is easy; the CRA has a list of recommended online solutions to help you get through the process without much trouble.
All you need to do is to sign up for an account if you don’t have one and fill in the details in simple steps.
The CRA also allows individuals to file their returns on paper; the 2017 Income Tax and Benefits Guide and forms book for individuals can be mailed to persons who request for that or it can be downloaded from their website. If you’re going to request it to be posted to you, please note that it could up to 10 days for the mail to arrive. Individuals who require the returns form to be mailed to them can request so over the phone or via email.
Eligible individuals are allowed by the CRA to file their returns over the phone; the session is normally occasioned by a series of questions, including your personal identification details, sources of income, any advanced tax payments, and more.
Through the File My Return program, Canadians with low incomes can be able to have their taxes filed over the phone.
Who Should File a Tax Return?
Growing up, I believed that no adults were spared from the tax man’s wrath; well, as you would imagine, I wasn’t entirely right. And here’s why…
Under the Canadian tax laws, you are mandated to file a return only if any of the below applies to you:
- Tax authorities request that you file a return
- You have to pay tax on income earned during the previous calendar year
- You have a taxable capital gain or are reporting a capital gains reserve that you claimed on your previous year’s return
- You sold or otherwise disposed of property, such as corporate shares or real estate
- You are contributing to the Canada Pension Plan (CPP)
- You have to pay back a portion of your Old Age Security or Employment Insurance benefits
- You and your spouse or common-law partner choose to split pension income in the previous year
- You have not repaid the money you withdrew from your RRSP under a qualified plan, such as the Home Buyers’ Plan
- You paid Employment Insurance premiums on self-employment and other eligible earnings
- Both you and your spouse or common-law partner chooses to split pension income in the previous year
- You received Working Income Tax Benefit (WITB) advance payments in the previous year
There you have it; if you don’t fit any of these conditions, you may not be liable to taxes in Canada. Of course, there are some exceptions in which individuals can be exempted from all the above conditions; they say if you know who you’re not, then it shouldn’t be hard to know who you are.
Well, any luck not meeting the requirement of the above holy grail?
The law requires each taxpayer to file returns and pay up what is owed by 30 April of the year that follows. So, for this year’s taxes, you will have up to 30 April 2019 to get your taxes in order after this year closes. However, currently, businesses are allowed to file their returns latest by 15 June of the following year. Notice that I have to use the word file only and not together with pay; this means that as much as businesses may be allowed up to the 15 July to file their previous year’s returns, they are required to still pay up the owed amounts by the 30 April.
I hope you now fully understand the tax system in Canada; whether you’re an immigrant or a resident, you should have a high level of understanding of what is required of you as far as taxes are concerned.
Lastly, let me know if you have any comments or suggestions in this regard in the comments sections.