Dual Citizenship In Canada

Canada Tax System: How it works

Venturing into the Canadian wilderness, one might expect to learn about moose, maple syrup, and mountains. Yet, there’s another quintessentially Canadian experience to explore—the tax system.

This guide will navigate you through the forest of tax brackets, deductions, and credits, with the precision of a Mountie on duty.

Whether you’re a longtime resident or new to the Great White North, understanding Canada’s tax system is crucial for everyone’s financial health.

Let’s dive in!

Who Pays Tax In Canada?

The major determinant of Canadian income tax liability is an individual’s residence status. An individual resident in Canada is taxable on worldwide income. Non-residents are taxed on Canadian-source income only.

Tax returns are due by 30 April following the tax year-end, which is 31 December. There are no provisions for extensions to this deadline. 

Late-filing penalties and interest are generally based upon unpaid taxes, although penalties can also be assessed on certain late-filed information forms.

The Canadian tax system is a self-assessment system. 

Individuals are required to determine their liability for income taxes and file the required returns for any taxation year in which taxes are payable. 

Individuals file their tax returns; spouses do not file jointly.

A non-resident employee is required to file a Canadian income tax return by 30 April following the tax year to report compensation and compute the tax, or claim an exemption under an income tax treaty. 

The income taxes withheld are applied as a credit in calculating the final tax liability for the year. 

To facilitate filing a return, the employee must apply to the CRA for a Canadian Social Insurance Number or if they are not eligible for a Social Insurance Number, an Individual Tax Number. 

A return is recommended even if the income is exempt from taxation under the provisions of an income tax treaty. 

What Is Income Tax?

For almost every dollar you earn, you must pay a portion in taxes.

It wasn’t always this way. Before World War I, Canada was a tax-free haven. 

Unlike England and the United States, Canada prided itself on its “no federal taxes” policy and used it to attract desperately needed skilled immigrants, investors, and capitalists. 

The government made money mostly by selling off natural resources and charging high customs fees on imported goods.

But in 1917, Finance Minister Sir William Thomas White implemented the Income Tax Act to pay for World War I and asked that it should be reviewed after the war. 

Canada has had an income tax ever since.

While income tax may seem natural and inevitable to us today, it was met with resistance at the time and considered a significant burden.

When income taxes were first introduced, in 1917, single people had a personal exemption of $29,757 in today’s dollars, while married people had an exemption of $59,514. 

Over those amounts, they were taxed at just 4%.

Now, married and single people have identical federal personal exemptions, at around $15,000. 

The top federal tax rate is 33%, and when we add in provincial tax rates, the total marginal tax rate now reaches 54.8%.

But we pay it without (much) complaint because it’s the price of living in a prosperous nation.

As Oliver Wendell Holmes, the 19th-century U.S. Supreme Court Justice, said, “I hate paying taxes. But I love the civilization they give me.”

The Canada Revenue Agency (CRA) collects this money to pay for the government’s operating expenses and delivery of services. 

Taxes are the reason we have hospitals, high schools, the military, the police force, libraries, roads, prisons, and the CBC. 

The government redistributes much of these taxes to low-income families and vulnerable Canadians in the form of child benefits, employment insurance, old age security, and social assistance.

How Income Tax Works In Canada

You’re required to report your income to the CRA annually by filing paperwork known as a tax return. In this return, you must list all your income sources and note your eligibility for tax deductions or tax credits.

The tax system is based on trust. Although the CRA does know about some of your income, they mostly rely on citizens to self-report their total income accurately.

The CRA recommends you file a return even if you do not earn any money. If you don’t file your taxes, you may miss out on free money. Some payouts you may be eligible for include:

  • Canada Child Benefit
  • GST/HST credit
  • Guaranteed income supplement

The Deadline To Pay Your Income Taxes

The deadline to pay taxes, for those who earn enough to do so, can be confusing because the date you must pay does not always line up with the date that you must file.

Employed individuals have the same payment and file date: April 30 (if this falls on a weekend, the tax deadline is the next business day). 

That’s because their taxes usually get taken off at the source, on each paycheque, so their tax calculation is simpler.

Self-employed individuals must pay any taxes owed in a tax year by April 30, but they have until June 15 to file their return.

The CRA charges a fee for late filers — 5% of your balance owed plus an additional 1% for each month late (to a maximum of 12 months).

What Are Income Tax Rates In Canada?

Canada has a graduated or progressive tax system, which means the more you earn, the more you pay.

Under this system, money is divided into income brackets which determine the applicable tax rate. 

A common mistake is to assume that all income is charged at the rate of its highest tax bracket. 

We are charged progressively, which means that first, you pay the rate in the lowest bracket and only pay the higher rate on each additional dollar. 

This is also called your marginal tax rate.

For example, if you earn $1, you’ll pay 10%.

But on the second dollar, you’ll have to pay 20%. And on the third dollar, you’ll be on the hook for 30%. 

But you never have to pay 30% of $3. Instead, you pay a total of just $0.60, which works out to an average tax rate of just 20%.

Some find this graduated system fair, while others believe it burdens hard workers, penalises success, and discourages prosperity.

Corporations are the exception to this system, however. They pay a flat tax instead of a graduated tax. 

The corporate income tax, a flat tax for small business Canadian-controlled private corporations, for example, maxes out at 12.20% (9% federal income tax rate plus up to an additional 3.20% provincially/territorially, no matter how much they earn).

Graduated tax rates can be confusing because the income tax brackets don’t depend just on the amount earned — they also depend on where the money comes from. 

Plus, each province has a completely different tax bracket. You must add the two together to come up with the total rate.

Some Canadians are surprised to learn that not all income is treated equally. 

The government typically gives a tax break to money earned from selling an investment — 50% of the capital gains are taxed at the marginal tax rate which applies to their taxable income. 

And to encourage jobs and development, small Canadian corporations have extremely low tax rates. The highest tax rates are the personal income tax rates applied to wages and salaries.

The CRA differentiates between these six types of income sources:

  1. Other income (including employment and interest)
  2. Capital gains
  3. Eligible dividends (from large, public Canadian corporations)
  4. Ineligible dividends (from small Canadian corporations)
  5. General corporate income
  6. Small business corporate income

For example, let’s say you made $55,000 in employment income and you live in Ontario. That’s in the second tax bracket both federally and provincially. 

The federal government charges you 15% on the first $53,359 you made, and then 20.5% on the remaining amount. 

Ontario charges 5.05% on the first $49,231 and 9.15% on the remaining amount. That’s what we mean when we say that the more you make, the more you pay.

Dividend money is considered to have already done its duty since it comes from after-tax corporate profit. 

Instead, you might also be eligible to receive a dividend tax credit, which is a nonrefundable tax credit meant to offset the effect of double taxing.

Income That’s Not Taxable

Luckily, not all income is taxable. Here are some examples of income that is not taxed in Canada:

  • Most lottery winnings
  • Most inheritances and gifts
  • Canada Child Benefit payments
  • GST/HST credit payments
  • Payouts from a life insurance policy
  • School scholarships
  • Withdrawals from a Tax-Free Savings Account (TFSA)
  • Strike pay from a union

How To Reduce Your Income Tax?

Paying what you owe in income taxes is a civic duty. But there’s no reason to pay a penny more than is required.

Finding ways to reduce your taxable income is not only legal but financially responsible. 

Strategies to do so range from the simple and the common — maximise deductions — to the elaborate and esoteric — like buying flow-through shares.

Many tax preparation programs can help you find the deductions and credits you qualify for. 

For truly complex and unique situations, a good accountant will be the best person to help find the optimal tax efficiencies in your particular situation.

But here are a few ideas:

  • Change up your income sources: Our government gives some types of income preferential treatment. Employment income and interest bear the heaviest burden, while capital gains and dividends are barely touched. 

Instead of relying on a job and stashing funds in a savings account, many people try investing. 

If you can manage, over the long term, to transfer surplus income from your salary into an investment portfolio, you will be able to shelter much of your funds from taxes.

  • Move from sole-proprietorship to incorporation: If you’re a freelancer or have a small business, consider switching from a sole-proprietorship to a corporation. 

While incorporating comes with heavier compliance requirements and a trickier tax return, it could drop your tax rate significantly.

In Ontario, for example, high earners would go from a marginal tax rate of 46.16% to just 12.2%. 

That’s only inside the corporation of course — once you transfer the funds and pay yourself a salary or dividend, you’ll have to pay income taxes at regular marginal tax rates. 

This strategy will only save you on taxes if you make enough to be able to retain income inside the corporation. 

Speak with a professional accountant to see if your small business can benefit from this tactic.

  • Defer taxes: There’s a concept in financial planning that states that money today is always better than money tomorrow. 

So if there’s a way to put off paying taxes until tomorrow, you should always take advantage of that opportunity. 

That’s because money can grow over time, and the more money you have, the faster it can grow. Paying taxes impedes this process. 

The most obvious way to defer taxes is to stash funds and invest inside your Registered Retirement Savings Plan (RRSP). 

The money can grow sheltered from taxes until you withdraw funds in retirement. 

While eventually, you’ll have to pay the piper, your marginal tax rate will hopefully be lower than it was in your prime working years. 

You can do the same in your TFSA. Although you’re contributing with after-tax funds, the money, once inside, will also be able to grow free, away from the long reach of the CRA. 

A newly introduced tax deferral option is the First Home Savings Account (FHSA), which allows you to save up to $40,000 for the purchase of your first home.

Like the TFSA, the money, once inside the FHSA, can grow tax-free.

For investors and small business owners, a common way to defer taxes is to leave money inside a corporation for as long as possible.

If you own an investment property, you can write off the depreciation every year, which delays paying taxes until you sell the property.

As you can see, there’s still quite a bit of wiggle room in the tax code to postpone your tax obligations and put your money to better use.

  • Maximise all deductions: Deductions work by lowering your income, hopefully by enough to kick you down a tax bracket. 

Credits work by lowering your tax payable, hopefully down to zero. Typical tax deductions include union dues, RRSP contributions, childcare expenses, and capital losses. 

Typical tax credits include charitable donations, medical expenses, caregiver amounts, and the Canada Workers Benefit.

How To Pay Income Tax Online?

With income sources such as employment income, income tax is deducted from your income and remitted to the CRA throughout the year. 

With other sources such as self-employment income, income tax is required to be paid quarterly to the CRA. 

If after preparing and filing your tax return and all income has been accounted for it’s determined that you still owe some tax money, you have to pay that amount owed to the CRA by the payment deadline, April 30 of the following year.

You can file your tax return longhand, the old-fashioned paper way, or through a free or paid service online. Some Canadians choose to outsource the work to an accountant.

You can pay tax by mailing a cheque, or by walking into any major bank with a cheque.

If you prefer to pay online, you have three options:

  1. Pay through online banking. Simply set up the CRA as a bill payee.
  2. Pay directly at the CRA with a debit card through “My Payment.”
  3. Use a third-party service to pay with a credit card or PayPal.

Are There Tax Treaties And Double Tax Relief?

Foreign tax relief – Foreign taxes paid are generally allowed as credits

If a resident expat receives foreign-source income that has been subject to foreign tax, foreign tax credit relief may be provided in Canada to reduce the effects of double taxation.

The foreign tax credit is computed on a country-by-country basis and may be taken only to the extent of Canadian tax payable on the net foreign income from the country.

Provincial foreign tax credit relief for non-business foreign income taxes is also provided. 

The provincial tax credit is generally limited to the lesser of the provincial taxes payable on the income and any foreign tax paid exceeding the amount of tax allowed as a credit and deduction for federal income tax purposes.

Double tax treaties – Canada has negotiated double tax treaties with most major industrialised nations and many developing nations. 

All treaties negotiated after 1971 generally follow the provisions of the model treaty developed by the Organization for Economic Cooperation and Development (OECD). 

Many treaties currently in force were negotiated before 1972 and may vary significantly from the OECD model treaty.

Double tax treaties have been entered into with circa 95 countries as of 2017.

What Are The Tax Rules On Residency?

The tax statutes do not contain a specific definition of “residence.” Accordingly, the residence of an individual is determined by such matters as the location of the following:

  • Dwelling places
  • Spouse
  • Dependents
  • Personal property
  • Economic interests
  • Social ties

However, a non-resident individual who stays temporarily in Canada for 183 days or longer in a calendar year is deemed to be a resident of Canada for the entire year, unless he or she is determined to have non-resident status under a tax treaty. 

This provision applies only to an individual who would otherwise be considered a non-resident.

Not to an individual who purposely takes up residence in Canada or to an existing resident who ceases to be a resident after moving away from Canada. 

These latter individuals may be treated as part-year residents.

In the year that an individual becomes a Canadian resident, that individual is considered a part-year resident and is subject to tax in Canada on worldwide income for the portion of the year he or she is resident in Canada. 

A part-year resident is also subject to Canadian tax on any Canadian-source income received during the non-residence period.

Do You Have To Pay Estate And Gift Tax?

Canadian succession law does not include estate or gift tax. However, provincial probate fees may apply at rates that vary depending on the province.

Finally on this point, do not assume that just because you’ve expatriated to live in Canada that your estate will not be liable to inheritance tax (IHT) in your old home nation, or any nation where you hold assets.  

For example, those domiciled in Britain remain liable for IHT on their worldwide estate.

If you are concerned about mitigating your IHT liability, we can introduce you to a UK inheritance tax specialist who will be able to guide whether you can reduce your exposure to inheritance tax.

Do I Have To Pay Capital Gains Tax?

Fifty percent of the year’s capital gains are included in taxable income, to the extent that the amount exceeds 50% of capital losses for the year. 

This includes capital gains on real estate and personal property, regardless of whether used in a trade or business and on shares held for personal investment. 

Special rules apply, affecting expat taxes, and determining the nature of the gain or loss on the sale of depreciable property.

The adjusted cost basis of identical shares must be averaged to determine the capital gain or loss on a disposition of such shares if the individual has acquired shares of a particular corporation at different dates.

Capital gains derived from the sale of a principal residence are generally exempt from tax. Capital losses incurred on the sale of a principal residence may not be used to reduce income for the year. 

In general, capital losses from personal-use assets are not allowed.

Capital losses – Except for allowable business investment losses, capital losses not utilised in the year realised are deductible only against net capital gains realised in another year. 

Unused capital losses may be carried back to any of the three preceding years or may be carried forward indefinitely.

Do Expats Get A State Pension?

Canada has an extensive social security system that confers benefits for disability, death, family allowances, medical care, old age, sickness, and unemployment. 

These programs are funded mainly through wage and salary deductions and employer contributions.

An employee’s responsibility is made up of two parts: Canada Pension Plan (CPP) and Employment Insurance (EI).

Fifteen per cent of the contributions made by an employee to CPP or EI are creditable against that individual’s federal income tax liability. 

The contributions are also creditable for provincial tax purposes.

The Canada Pension Plan (CPP) provides contributors and their families with partial replacement of earnings in the case of retirement, disability or death.

Almost all individuals who work in Canada outside Quebec contribute to the CPP.  

In Quebec, the Québec Pension Plan (QPP) provides similar benefits to the CPP. 

Canada Pension Plan (CPP) contributions –

  • CPP must be deducted from an individual’s remuneration if the individual is employed in Canada (other than in the province of Québec), between the ages of 18 and 70, and receiving pensionable earnings.
  • The employer is responsible for withholding and remitting the individual portion and remitting the matching employer portion to the tax authorities. 
  • The maximum employee and employer contribution for 2016 is CAD2,544 each.

Individuals working in Québec contribute to the Québec Pension Plan (QPP) instead of the CPP program.

The maximum employee and employer QPP contribution for 2016 is CAD2,737 each.

If the employee is transferred from a country that has a social security agreement with Québec and/or the rest of Canada, the employer may request a certificate of coverage from the other country to exempt the compensation from CPP and/or QPP.

Your CPP retirement pension does not start automatically. You must apply for it. Before you apply, you must:

  • be at least a month past your 59th birthday;
  • have worked in Canada and made at least one valid contribution to the CPP; and
  • want your CPP retirement pension payments to begin within 12 months.

How Does A Tax Deduction Work In Canada?

In addition to TFSAs and RRSPs, there are other ways to reduce your taxes. These are called tax deductions.

Some of the key tax deductions are:

  • Child care expenses: You can deduct the cost of daycare and camps for your children. These can be costly so be sure to keep receipts and add them to your tax return.
  • Tuition: Students can deduct tuition fees and living costs up to a certain amount. 

However, since most students earn little money, they don’t usually need this deduction and can transfer it to a parent. 

Post-secondary education is expensive so be sure to take advantage of this deduction.

  • Moving expenses: If you are moving out of the area to take a job, you can deduct moving costs. Sorry, you can’t deduct this if you are just moving across town.
  • Support payments paid to your spouse: If you are separated and making payments to your spouse for alimony or child support, these payments may be deductible

There are specific legal requirements so check the rules to see if you are eligible.

Conclusion

As we emerge from the thicket of information on Canada’s tax system, you’re now better prepared to face the tax season with knowledge and confidence.

Like navigating the vast landscapes of Canada, understanding taxes takes patience and a bit of guidance.

Armed with the insights from this guide, you’re ready to approach your taxes with the wisdom of a wise old maple tree—steadily, surely, and with deep roots in understanding. Remember, in the world of taxes, being well-informed is your best defense.

Happy filing!

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