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CANADA
Taxation of Nonresident Entities
Taxation of Groups of Companies
Corporate Assessments and Payments
Personal Assessments and Payments
Canada, the world's second largest country, with a total area of 9.98 million square kilometers (3.85 million square miles), occupies most of the northern half of North America. It has a population of approximately 27.8 million. Canada is a federal state comprising ten provinces (Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland, Nova Scotia, Ontario, Prince Edward Island, Québec, and Saskatchewan) and two territories (the Northwest Territories and Yukon). Canada is a parliamentary democracy with a bicameral parliament. It is a completely independent state within the British Commonwealth of Nations, the head of state, the Queen, being represented by a governor-general.
Deloitte & Touche, the Deloitte Touche Tohmatsu International member
firm in Canada, is the second largest public accounting firm in the country, with over 590
partners and approximately 2,500 staff members in sixty-three Canadian centers. In
Québec, the firm operates as Samson Bélair/Deloitte & Touche and is the leading firm
in the province. Deloitte & Touche and Samson Bélair/Deloitte & Touche provide a
full spectrum of audit, tax, and consulting services to over 65,000 clients in Canada,
including 98 of Canada's Financial Post's 500 top industrial companies and 26 of the top
100 financial institutions. The firm's clients include global entities, as well as small
and owner-managed companies.
Audit Services: Marc Paradis, Toronto (Wellington Street)
International Services: Ruben Rosen, Toronto (King Street)
Management Consulting Services: Robert V. Brouillard, Toronto
(Wellington Street)
Tax Services: John A. Stacey, Toronto (Wellington Street)
Telephone-Wellington Street: +1 (416) 601-5650
Telecopier-Wellington Street: +1 (416) 601-5991
Telephone-King Street: +1 (416) 599-5399
Telecopier-King Street: +1 (416) 599-9009
Forms of Business Organization. The three principal forms of
business organization are corporations or limited companies, branches or divisions of a
foreign parent, and partnerships. Other forms include joint ventures, trusts, and sole
proprietorships. Foreign investors generally favor corporations over branches, based on a
comparison of the tax treatments of branches and subsidiaries.
Partnerships and sole proprietorships have a number of disadvantages and are seldom used
by foreign investors. Joint ventures, licensing arrangements, and trusts also are used
only occasionally.
The tax treatment of the various entities differs. Corporations are subject to corporate income tax. Branches are treated in substantially the same manner. The taxable income accruing to a partnership, however, is computed as if the partnership were a separate entity, but the individual partners are taxed on their respective shares of the partnership income. Trusts are separate taxable entities, but they are taxed in basically the same manner as individuals. The major difference between a partnership and a joint venture is that, in a partnership, the investor owns a partnership interest, which is generally a capital asset, but a joint venturer directly owns his or her portion of the business assets of the joint venture. A joint venturer reports a proportionate share of revenue and expenses without the need to take into account the actions of co-participants.
Exchange Controls. Canada has no exchange controls or currency
restrictions. Canadian and foreign currency may be moved freely into or out of Canada and
may be purchased or sold without limit through most banks, although reporting requirements
are imposed for large amounts being transferred to the United States. Several Canadian
banks now permit customers to maintain US dollar bank accounts, but this practice has not
generally been extended to other currencies. Foreign nationals and nonresident
corporations may maintain Canadian dollar bank accounts in Canada without restriction.
There are also no restrictions on the repatriation of profits.
Local Participation Requirements. Federal legislation restricts the
level of foreign ownership for specified regulated activities, including broadcasting,
life insurance, and some banking and financial activities. Some of these limitations are
currently under review. Some provinces also limit the business activities of foreign
investors in specified sectors.
Investment Incentives. Some of the main nontax incentive programs
are as follows:
* The Federal Business Development Bank encourages the establishment and development of
small and medium-sized companies by providing loans, equity capital, and management
assistance.
* The Federal Export Development Corporation facilitates the export trade by providing insurance and bank guarantee services to Canadian exporters and credits for foreign buyers.
* Industry, Science and Technology Canada provides loans, loan guarantees or credit insurance, and grants or subsidies, primarily to small and medium-sized enterprises in disadvantaged regions of Ontario and Québec.
* The Atlantic Canada Opportunities Agency provides loan guarantees, interest rate subsidies, and other support for initial establishment, expansion, modernization, and innovation of enterprises engaged in industry, commerce, or tourism in New Brunswick, Newfoundland, Nova Scotia, and Prince Edward Island.
* The Western Economic Diversification Office provides investors in Alberta, British Columbia, Manitoba, and Saskatchewan with loans aimed at developing new products, markets, or technologies; enhancing productivity; or reducing imports.
* The Small Business Loans Act sanctions federal assistance to new or existing businesses with sales under $Cdn 5 million by providing loans of up to $Cdn 250,000 for the purchase of equipment, land, or buildings on favorable interest terms.
* Under the Manufacturing Productivity Improvement Program, the federal government subsidizes for a maximum of five years up to 50% of the cost of specified consulting services and up to 25% of the cost of new production machinery for manufacturing or processing firms in central Québec.
* The costs of feasibility studies abroad and the financial risks of competing in new foreign markets are shared by various federal government agencies under the Industrial Cooperation Program and the Program for Export Market Development.
* Under the federal job strategy programs, administered by Employment and Immigration Canada, costs of approved training plans may be subsidized.
* A variety of federal and provincial programs offer technical information and financial assistance for industrial and technological research projects.
Tax incentives include federal -- and often provincial -- corporate income tax rate
reductions. These reductions are available to Canadian-controlled private corporations on
their Canadian-source profits and to Canadian corporations and branches, whether or not
Canadian controlled and whatever their size, that undertake manufacturing
or processing perations in Canada. In addition, Manitoba, Newfoundland, Nova
Scotia, Québec, and Saskatchewan provide a full or partial tax holiday from provincial
corporate income tax on taxable business income for the first two or three years for new
CCPCs incorporated in those provinces.
Investment tax credits (ITCs) may be earned for a number of qualifying expenditures,
including qualified Canadian exploration expenditure, expenditure on scientific research,
and certain types of expenditure in specified areas of Canada. ITCs may be deducted from
federal tax otherwise payable or in certain circumstances may be refunded.
Accelerated federal -- and sometimes provincial -- rates of capital cost allowance (tax
depreciation) are permitted for certain classes of depreciable property. Eligible
scientific research costs may be wholly deducted in the year in which they are incurred.
Under federal government legislation, Vancouver, British Columbia, and Montréal, Québec,
have been accorded International Banking Centre (IBC) status. Prescribed financial
institutions may earn tax-exempt income by carrying on qualifying activities in these two
cities. For deposit-taking institutions, such activities are the acceptance of deposits
from and the making of loans to nonresidents; profits from these activities are exempt as
long as the total of the institution's eligible deposits is equal to at least 96% of its
eligible loans on each business day throughout the year. Eligible deposits are deposits
from arm's-length nonresidents and qualifying deposits from other institutions' IBC
business. Eligible loans are (with conditions) loans to arm's-length nonresident
borrowers, loans acquired from non-arm's-length foreign banks that meet these criteria,
and qualifying IBC deposits made by the IBC with another arm's-length prescribed financial
institution. If eligible deposits are less than 96% of eligible loans, a proration formula
is used to reduce the amount of income exempt from federal tax. No withholding taxes are
deductible from interest payments on eligible deposits.
Québec and British Columbia provide provincial tax incentives to qualifying institutions
carrying on eligible activities in Montréal (International Financial Centres-IFCs) and
Vancouver (International Financial Businesses-IFBs), respectively. Profits from eligible
IFC activities are exempt from Québec corporate income tax. An IFC is also exempt from
paying capital tax on its paid-up capital. Employees of IFCs are entitled to tax benefits;
for example, an employee who was a nonresident before taking employment with the IFC is
completely exempt from personal income tax for two years and thereafter may receive a
tax-free allowance of up to 50% of his or her total salary. An employee who is a Canadian
resident is also entitled to the tax-free allowance of up to 50% of his or her total
salary, but not to the two-year exemption. In British Columbia, provincial tax refunds may
be available to registered financial institutions for income earned from carrying on
eligible IFB activities, as well as to certain specialists and eligible employees with
respect to their income earned while employed by an IFB.
Both the federal government and the provinces levy corporate income taxes on the worldwide income of resident corporations. Resident corporations are basically classified for tax purposes as either public or private, though some may be neither. In general, a public corporation is one that has a class of shares listed on a Canadian stock exchange, and a private corporation is one that neither is itself a public corporation nor is controlled by a public corporation. Most Canadian subsidiaries of foreign corporations are therefore private corporations, even though the parent may be a public corporation in its own jurisdiction.
A private corporation is classified as a Canadian-controlled private
corporation (CCPC) if it is not controlled by nonresidents, by one or more public
corporations, or by any combination of nonresidents and public corporations. A CCPC may be
eligible for a reduced rate of tax on some of active business
income and a refund of a portion of the taxes paid
on investment income.
Corporate Income Tax Rates. Corporations are subject to a number of
different tax rates, depending on their status, the nature of their income, and the
province in which they carry on business.
Federal rates. The current rate of federal income tax (Part I tax)
on corporations is 38%. However, it is reduced by 10% for income that is also taxable in a
province. This abatement is not available for taxable income attributable to permanent
establishments outside Canada.
CCPCs are permitted a further tax rate reduction, known as the small
business deduction, of 16%, but only in relation to the first $Cdn 200,000 of income
derived from carrying on active business in Canada. Corporations associated with one
another are considered jointly, each receiving an allocated portion of the $Cdn 200,000
limit.
Profits derived from manufacturing and processing activities in Canada that have not
benefited from the small business deduction are eligible for the manufacturing and
processing deduction, a 7% tax rate reduction. The profits eligible are determined under a
complex formula.
A corporate surtax of 3% applies to the basic federal tax, net of the 10%
provincial abatement but before the small business or manufacturing and processing
deduction. Click to see federal corporate income tax
rates outlined after the deduction of the 10% abatement for income earned in a province
but before the corporate surtax.
Twenty percent of the corporate income tax that a CCPC pays on its
investment income (including capital gains but not Canadian dividends that may be deducted
in computing taxable income) is earmarked Part I refundable tax or refundable dividend tax
on hand (RDTOH). When the CCPC pays a taxable dividend to its shareholders, a refund of
RDTOH is made, equal to the lesser of the RDTOH balance or 25% of the actual dividend
paid. This procedure mitigates the effects of taxing both the corporation and recipient
shareholder.
Although most dividends are excluded from the taxable income of Canadian
corporations, a special tax (Part IV tax) is charged at the rate of 25% when private
corporations, wherever they are controlled, receive dividends from portfolio investments
(usually holdings of under 10%) in other Canadian corporations. Part IV tax paid is added
to a private corporation's RDTOH balance. Accordingly, when the corporation later pays an
ordinary dividend to its shareholders, it receives a dividend refund equal to the lesser
of the actual RDTOH balance or one-quarter of the dividend paid. If a corporation ceases
to be a private corporation, it loses its entitlement to recover the RDTOH balance.
In the case of resident corporations controlled by foreigners, the
refundable dividend tax regime applies only when taxable dividends are received on which
they must pay the special refundable dividend tax.
The 1994 federal budget proposed to increase this Part IV tax from 25% to
33.33%. The dividend refund related to this tax is proposed to increase to one-third of
the dividend paid. These changes are intended to be effective 1 January 1995.
Federal large corporations tax.
Introduced to ensure that all large corporations in Canada pay some federal tax, large
corporations tax is levied at the rate of 0.2% on capital in excess of $Cdn 10 million
used in Canada by resident and nonresident companies. Related companies must be considered
jointly and qualify for only one $Cdn 10 million limit. The capital base is similar to
that used for capital taxes in a number of the provinces.
Provincial rates. Provincial
corporate income tax rates vary from province to province. When a corporation
maintains permanent establishments in more than one province, income is allocated to
provinces under a formula that involves averaging both the gross revenue and the
remuneration payable by those permanent establishments and applying the averages to
taxable income. In most provinces, a reduced rate of provincial tax applies to the
proportion of total income that is eligible for the federal small business deduction or
manufacturing and processing deduction.
Taxable Income. The Income Tax Act (ITA) does not specifically
define taxable income, but statutory provisions impose Part I tax on employment income;
business profits; income from property (interest, dividends, rent, and royalties); and 75%
of capital gains and grant relief for losses arising.
Inventory valuation. Inventories may generally be valued at the
lower of cost or market value. The last-in, first-out (LIFO) method is not acceptable for
determining cost. The basis of valuation selected by the taxpayer for accounting purposes
is normally used to determine inventory values for tax purposes and, once established,
should be followed consistently from year to year. Inventory value at the end of one year
must be used as the opening value in the following year.
Foreign exchange. Foreign exchange gains and losses related to
current trading activities are treated as being on an income account and should generally
be recognized for tax purposes on an accruals basis, particularly if they are reflected in
computing accounting income. The method used must be consistent with the financial
statements and consistent from year to year. Exchange gains and losses of a capital nature
are considered capital gains and losses; they are normally recognized for tax purposes
only when realized.
Income from property. Most income from property (passive income),
including foreign-source income for which a foreign tax credit may be allowed, is taxed on
an accruals basis. Dividends, however, are normally taxed on the basis of the sums
received. As an exception, dividends earned by controlled foreign affiliates may be
attributed to and taxed in the hands of Canadian shareholders, in which case there is no
further charge when the sums earned are actually distributed to the Canadian shareholders.
Dividends received by a taxable corporation from another corporation
resident in Canada or from a foreign affiliate are generally excluded from the recipient's
taxable income, but the exclusion may be denied if the dividend is, because of the type of
share involved, regarded as tantamount to the return on a debt obligation. In the case of
dividends from foreign affiliates, the recipient and related parties must usually hold at
least 10% of the equity capital in the affiliate for the exclusion to apply. Dividends
from unaffiliated foreign corporations are included in taxable income but are eligible for
foreign tax credit treatment.
The exclusion of dividends from taxable income is effected by initially
adding them to income from other sources and then granting a deduction. This method can
affect, for example, the base on which the 20% limitation on charitable donations is
computed, that base being the net income before any dividends are excluded.
These rules merely exclude dividends from Part I tax. Under Part IV of the
ITA, a refundable tax of 25% on dividends may then be imposed on private corporation. (This rate would rise to 33.33% effective 1 January 1995 under
proposed legislation.)
Stock dividends. Stock dividends are taxable, generally to the
extent of the paid-up capital increase. The amount of the dividend is added to the cost
base of the shares for capital gains purposes.
Capital gains. Three-fourths of the capital gains realized are
included in taxable income and taxed at the normal rates. The ITA defines a capital gain
as the difference between the proceeds of disposition and the tax cost of capital
property. The tax cost is also known as the adjusted cost base (ACB). The proceeds of
disposition are normally the amount of consideration that the taxpayer is entitled to
receive, but when a taxpayer transfers property in a non-arm's-length transaction for no
proceeds or for a price that is less than market value, the tax authorities generally deem
the taxpayer to have received proceeds equal to the market value. Adjustments under the
deeming provisions are generally one-sided since the provisions do not allow the
purchaser's cost base to be increased to market value except in the case of gifts.
As a rule, the ACB of property sold is its historical cost. The cost of
improvements and additions to an asset is generally added to its ACB, as is the cost of
acquisition. Any outlay or expenditure incurred in connection with the disposal of an
asset is deductible in arriving at the taxable gain. Indexing of costs or discounting of
gains is not permitted. When taxpayers dispose of part of a group of identical properties,
the average cost method is used to determine the cost of both the shares sold and the
shares retained.
When a capital gain is realized, a reasonable amount may be deducted as a
reserve if some or all of the proceeds are not receivable until after the end of the tax
year. At least one-fifth of the gain must be included in the income of each year on a
cumulative basis.
Deductions. To be deductible, an expense must be incurred for the
purpose of earning income, must be reasonable in the circumstances, and must not be of a
capital nature.
Depreciation. In place of the accounting depreciation charge on
capital assets provided in the financial statements, Canadian federal tax law permits the
deduction of a capital cost allowance (CCA). CCA rules in the provinces are based on
federal rules, but there are important differences in Alberta, Québec, and Ontario.
Depreciable property for tax purposes excludes inventory, land, animals,
and plant life. The capital cost of an asset is usually its historical cost. Canadian tax
law does not provide for inflation accounting. Depreciable properties are grouped in a
series of classes, each with its own annual rate of CCA.
Costs within a class are pooled, and the appropriate rate is applied to the undepreciated
expenditure as of the end of the tax year. For most classes, rates are applied on the
declining-balance basis, but the straight-line basis is used for a few.
Accelerated allowances are available for various resource extraction
properties and offshore drilling platforms, which are depreciable at 25% on a
declining-balance basis. An allowance is available to cover the income from a new mine or
major mine expansion. Accelerated allowances are also available for energy-efficient
equipment and retailer's point-of-sale equipment.
The CCA regulations address the fact that some equipment becomes
technologically obsolete before being fully depreciated for tax purposes. Taxpayers can
elect to include one or more qualifying assets in a separate class for the first five
years of its useful life. The CCA rate is unchanged, but if the asset depreciates more
quickly than the CCA rate of write-off and is disposed of within five years, a terminal
loss could be claimed. Eligible assets include general-purpose electronic data processing
equipment and systems software, computer software, photocopiers, and electronic
communications equipment acquired after 26 April 1993, provided that each asset has a
capital cost of at least $Cdn 1,000.
Allowances are not mandatory. Each year the taxpayer may claim any amount
up to the maximum. The amount claimed need not relate to the depreciation shown in
financial statements. In the year in which a depreciable asset is acquired, the maximum
allowance is generally limited to 50% of the normal allowance. For most classes, this
restriction applies to the excess (if any) of the acquisition costs over disposal proceeds
during the year.
The proceeds of disposing of depreciable property, up to the original cost,
are deducted from the undepreciated capital cost remaining in the class to which the asset
belonged. If the result is a negative balance at the end of the tax year, the balance must
be included in taxable income as a recapture of allowances given. When a building that has
been used for business purposes is disposed of voluntarily, a one-year replacement period
is allowed, provided that the replacement property is acquired for a similar use and is
located in Canada. When no assets remain in a particular class at the end of a tax year
but there is an undepreciated positive balance for that class, the balance must be
deducted from income as a terminal loss.
Most incentive grants and other forms of government assistance -- including
ITCs -- received in connection with the acquisition of a capital property are excluded
from taxable income. Instead, they reduce the cost of the asset for CCA purposes.
Intangibles. Most intangibles (including
copyrights) that have a fixed expiration date are treated as depreciable property, and
their cost may be written off on a straight-line basis over the life of the asset.
Intangibles of an indefinite life, including goodwill, generally qualify for allowances
under the eligible capital property rules. Three-quarters of the cost may be amortized at
the rate of 7% on a declining-balance basis. The costs of all eligible capital property
are included in a pool, and when property is sold, three-quarters of the proceeds are
credited to the cumulative balance in the pool. If a negative balance is produced at the
end of a tax year, that balance must be included in taxable income.
If a taxpayer so chooses, patents and patent rights acquired after 26 April
1993 can be included in a new 25% declining-balance CCA class.
Expenditure on scientific research. Relief is given for expenditure
on scientific research and development (R&D) related to a business carried on by the
taxpayer. Activities covered include research, product development, and the testing of
prototypes. They exclude quality control or routine testing; market research; style
changes; and the commercial production of a new or improved material, device, or product.
Both current and capital expenditure on R&D carried out in Canada may
be deducted in full either in the current year or in a later year. A capital expenditure
made with respect to the acquisition of most buildings and used for R&D is eligible
neither for the 100% deduction nor for ITCs. The entire
amount of current expenditure on R&D carried on outside Canada must be deducted in the
year concerned, and there are no special provisions granting accelerated relief for
capital expenditure on R&D carried on outside Canada. However, capital assets
purchased abroad qualify for relief if the asset is to be used for R&D in Canada. Most
expenditure on R&D in Canada qualifies for ITCs, which reduce the amount deductible as
R&D expenditure.
Taxes. As a rule, taxes other than those on income are deductible if
they relate to the earning of income, including municipal property taxes and provincial
capital taxes. The 3% federal surtax may be credited against the large corporations tax.
Any surtax liability for the current year in excess of the large corporations tax
liability for the current year may be credited against excess large corporations tax for
the three preceding and seven subsequent tax years. Foreign taxes on
foreign-source income are deductible if they do not qualify for foreign tax credit
treatment. When foreign taxes suffered on business income cannot be credited in full in
the current year, the excess may be carried back for three years and forward for up to
seven years. Foreign taxes on nonbusiness income are not, however, eligible for carryover;
any part that cannot be used for foreign tax credit in the current year may instead be
deducted in computing taxable income. Taxpayers whose federal tax liability is
insufficient to allow them to use their business or nonbusiness foreign tax credits in
full have the further option of adding an amount to income to increase their federal tax.
The amount added is regarded as a noncommittal loss that may be applied against the
taxable income of other years.
Formation and start-up costs. Costs incurred in forming and starting
up a business are generally deductible if they are incurred after the commencement
of business activities. Expenses incurred before the start of business activities are not
normally allowed as deductions but may qualify as eligible capital property. (See Intangibles) Interest and
royalties. Interest is deductible if it is payable under a legal obligation on
borrowed money used to earn income from a business or to acquire property for the
purpose of producing income. Interest paid on a debt that does not stipulate a rate of
interest -- or interest paid in excess of the agreed-upon rate -- does not qualify for a
deduction. Royalty payments are subject to the general rules governing the deductibility
of expenditure.
Bad and doubtful debts. A full deduction is allowed for debts of an
income nature that become bad in a tax year. Debts of a capital nature that become
bad are generally accorded capital loss treatment. A taxpayer is allowed to deduct a
reasonable amount as a reserve for doubtful debts if the debts arise in the ordinary
course of business from income-producing transactions.
Other reserves. Payments received related to goods or services that
will not be delivered until a later tax year may be excluded from income by creating
a reserve. Prepaid rent is normally apportioned on a per diem basis. Deposits received on
returnable containers other than bottles may also be reserved. Reserves are allowed (with
conditions) for installment sales and for the portion of a capital gain attributable to
sales proceeds not due until after the end of the current tax year. Special rules on
deferred income reserves apply to insurance corporations, financial institutions, and
contractors.
Charitable contributions. Donations made to charities registered in
Canada or to approved foreign organizations and universities are deductible up to
20% of a taxpayer's income for the year. Excess contributions may be carried forward as a
deduction for up to five years. The 20% limit does not apply with respect to gifts to the
federal and provincial governments or gifts of certified cultural property.
Advertising, entertainment, and convention expenses. Reasonable
advertising expenses are deductible. If an advertising expenditure results in the
acquisition of a tangible asset with a useful value beyond the current year, the cost must
be capitalized but may be depreciated.
Normally, no deduction is permitted for the cost of using or maintaining a
yacht, camp, lodge, or golf course, nor for membership fees or dues in any club
whose main purpose is to provide dining, recreational, or supporting activities for the
members.
Reasonable amounts for food and beverages consumed and entertainment
enjoyed are deductible up to 50% of the outlay. This 50% limitation does not apply
when meals or recreational events are provided by an employer for the benefit of all
employees; when the primary purpose of incurring various entertainment costs is to benefit
a registered charity; or when the cost is incurred by a restaurant, hotel, or airline that
provides meals and beverages to customers in the ordinary course of business.
The costs of attending a conference or convention held by a business or
professional organization are normally deductible, but if there is no breakdown for
the food, beverages, and entertainment components in a fee for a conference or similar
event, their cost (which is subject to the 50% limitation) is deemed to be $Cdn 50 per
day.
Legal expenses. Legal expenses incurred in connection with the
acquisition of a capital asset are considered to be part of the cost of that asset.
Legal expenses incurred in connection with the incorporation of a business are regarded as
eligible capital property. Legal expenses incurred in connection with an income tax appeal
are deductible. Sometimes a deduction is allowed for legal expenses incurred in borrowing
money. (See Intangibles)
Dividends. In general, dividends paid out of profits are not
deductible.
Health insurance, pension, and profit-sharing plans. Employers may deduct
payments that they make in sharing with employees the cost of health insurance plan
premiums, up to specified limits. Employer's contributions to deferred profit-sharing
plans are deductible within limits.
Tax Treatment of Losses.
Losses, other than capital losses, may be carried back for three years and forward
for up to seven years and may be set off against taxable income from all sources in the
year of claim. Three-quarters of the excess of capital losses over capital gains for a
year may be carried back for three years or forward indefinitely, generally for setoff
only against the net taxable gains in those years.
Taxation of Nonresident Entities
If a nonresident entity has a permanent establishment in Canada and is carrying on business in Canada, any income arising from its Canadian business activities is generally subject to tax in Canada in a manner similar to income of a resident entity. A permanent establishment means a fixed place of business, including a branch, office, factory, or warehouse. A nonresident entity that does not have a permanent establishment as such may nevertheless be subject to tax if it has an employee or agent in Canada who has the authority to contract on behalf of the entity or who maintains a stock of goods from which he or she regularly fills orders. A nonresident entity that does not have a permanent establishment in Canada may be subject to withholding taxes on income received from Canada.
The after-tax profits of a branch may be subject to a special federal tax
in lieu of the withholding tax that normally applies to dividends distributed to
nonresident shareholders. This additional branch tax, which is levied at the same time as
the corporate income taxes, is intended to tax accumulated earnings, but the tax base
includes an investment allowance for the cost of investing in Canadian property. The rate
is generally 25%, subject to any reduction available under a double tax treaty. There is
no provincial equivalent to this tax.
Taxation of Groups of Companies
Consolidated tax returns for groups of related companies are not permitted. Unused losses may, as a rule, be claimed only by the corporation that incurred them, but there are exceptions in the case of a corporate reorganization. There is no general provision allowing assets to be transferred tax free between members of a group, but a number of special "rollover" provisions can have that effect in specified circumstances, including one that permits capital property to be transferred to a corporation without an immediate charge to tax when the consideration for the transfer includes at least some shares in the transferee. This provision does not just apply to groups. Another special provision allows tax-free transfers of partnership assets.
Rules regarding the payment of dividends free of tax are described in the
section on "Taxation of Resident Entities."
Thin capitalization rules limit the deductibility of interest paid by
foreign-owned Canadian subsidiaries when the aggregate of loan capital received from
specified nonresident shareholders exceeds three times the Canadian borrowing
corporation's equity capital. A specified shareholder is mainly one that either alone or
with related persons owns at least 25% of the shares of any class in the Canadian
corporation, but proposed legislation would define the term as a person that alone or
together with related persons owns (1) 25% or more of the voting shares or (2) 25% of the
fair market value of all issued and outstanding shares.
A number of rules, affecting both corporations and individuals, govern
transactions that are not at arm's length, including those between related parties.
The basic rule is that such transactions must occur at fair market value; otherwise,
penalties may be imposed, including one-sided adjustments. In the case of payments between
closely related corporations, the character of the payer's deduction may be attributed to
the recipient's income.
Subject to the provisions of double tax treaties, Canadian branches of foreign corporations are taxed in substantially the same way as Canadian domestic corporations. Although a branch cannot pay interest and royalties to itself, it can allocate these amounts to a head office, and the payments are regarded as deductible under the same rules as those applying to Canadian corporations. The branch tax is levied at 25%, the same rate as the dividend withholding tax rate, and may be reduced by a double tax treaty to the maximum withholding tax rate applicable to dividends under that treaty.
Nevertheless, a corporate subsidiary is generally preferable to a branch
when tax and limited liability considerations are taken into account, especially as some
government assistance programs and tax incentives are available only to Canadian
corporations. Dealing with lending institutions may also be easier if the business is
incorporated. However, if the Canadian operation is expected to remain unprofitable for a
number of years, tax considerations may warrant forming a branch and later converting the
branch into a subsidiary.
Incorporating a branch as a Canadian-registered subsidiary company
(typically accomplished by having the foreign corporation transfer the assets used in its
Canadian branch operations to a wholly owned Canadian subsidiary) may result in a branch
tax liability. However, it may be possible to defer any potential liability if the
transfer is structured to take advantage of a rollover provision in the ITA.
Corporate Assessments and Payments
A corporation may select any year-end, but usually the tax year coincides with the period selected for financial statement purposes. Once adopted, a year-end may be changed only with the agreement of the tax authorities.
A corporation liable for tax in Canada must file a federal income tax
return and, if required, provincial tax returns for jurisdictions in which it has
permanent establishments no later than six months following the end of the tax year.
Provincial income tax returns are required in Alberta, Ontario, and Québec; provincial
capital tax returns are required in many of the provinces. A copy of a corporation's
financial statements must accompany its tax return.
The system is basically one of self-assessment since returns require a
computation of the tax payable to be included and since tax in excess of the amounts
withheld at source from some types of income must be paid without assessment. An
assessment notice is usually issued within six months of a return being filed and is based
on a provisional examination of the return and the statements and schedules attached.
After a more detailed review, the tax authorities may decide to issue a reassessment. As a
rule, the law allows a reassessment within three years following the date of the original
assessment -- six years if the reassessment results from non-arm's-length transactions
between the taxpayer and a nonresident. The tax authorities may reassess amounts on the
return at any time if fraud or misrepresentation is proved.
During the current year, corporations are required to make monthly payments
of the estimated tax (including large corporations tax) due. The estimate may be based on
the preceding year's tax. Any balance of tax payable must be paid within two or three
months following the end of the tax year. Any overpayment of tax is refunded. Interest on
overpaid tax, including that paid on installments, is regarded as taxable income.
Penalties are levied for a number of tax offenses, including fraud,
evasion, willful misrepresentation, negligence in completing returns, the late filing of
returns, and failure to remit taxes withheld from payments to employees and nonresidents.
When the failure to file a return results in an underpayment of tax, a penalty is levied
that is equal to 5% of the underpaid tax, plus 1% for each month (maximum twelve) in which
the tax remains underpaid. Repeated failures may give rise to a basic 10% penalty, plus a
2% charge for each month (maximum twenty). When a false statement or omission amounting to
gross negligence results in an underpayment of tax, a penalty is levied equal to the
greater of $Cdn 100 and 50% of the amount underpaid. Penalty interest is levied for late
or inadequate installment payments and for unpaid balances, including balances charged in
assessments and reassessments.
Penalties and interest payments are not normally deductible. However,
interest paid on an assessment or reassessment of provincial capital tax is deductible.
Interest on sales tax re-assessments is deductible, but fines and penalties generally are
not. Excise tax penalties may be deductible.
Individuals resident in Canada are liable for income tax on their worldwide income. (See Capital Gains). Nonresidents are liable on Canadian-source income (including income from employment in Canada and income from carrying on a business in Canada) and on capital gains derived from taxable Canadian property as defined in this section.
Residence has been held in law to denote the jurisdiction in which a person
regularly, normally, and customarily lives and is determined based on the facts of each
case, including ownership of a home in Canada, whether other members of the individual's
family reside there, and membership in clubs and associations in Canada. Individuals
present in Canada for periods totaling 183 days or more may be deemed resident even if
they are not considered ordinarily resident. The acquisition of permanent resident status
for immigration purposes is a significant factor. Citizenship has little or no relevance
to the question of residence for tax purposes.
Individuals becoming resident are generally deemed to have acquired all
property, other than taxable Canadian property, owned at that time at a cost equal to the
current fair market value. Individuals ceasing to be resident are regarded as having
disposed of their property, other than taxable Canadian property, at its current fair
market value. Taxable Canadian property is defined as including:
* Real property situated in Canada.
* Most capital property used in carrying on a business in Canada.
* Shares of a corporation (other than a public corporation) resident in Canada.
* Shares of a public corporation if, within the five years preceding disposal, the nonresident and persons with which the nonresident did not deal at arm's length owned at least 25% of any class of capital stock of the corporation.
* An interest in a partnership if, at any time during the twelve months preceding disposal of the interest, the fair market value of taxable Canadian property held by the partnership constituted 50% or more of the fair market value of all the partnership property.
* A capital interest in a trust (other than a unit trust) resident in Canada.
* A unit of a unit trust (other than a mutual fund trust) resident in Canada.
* A unit of a mutual fund trust if, at any time during the five years immediately preceding the disposal, the nonresident and persons with which the nonresident did not deal at arm's length owned at least 25% of the issued units of the trust.
* Property deemed to be taxable Canadian property. For example, the owner of the property may make an election to that effect when he or she ceases to be resident in Canada. Security has to be provided to Revenue Canada to cover taxes that would otherwise be payable.
Personal Income Tax Rates. Personal income tax is levied by both the federal and
provincial governments. Provincial income tax is in most provinces calculated as a
percentage of federal income tax payable and is collected by the federal government on
behalf of the province. For provincial income tax purposes, business income is apportioned
between the provinces when individuals carry on business through permanent establishments
in more than one province. Other income, however, is generally considered to have been
earned in the province in which the individual resides at the end of the tax year,
regardless of where it has actually been earned.
Federal rates. The federal personal income tax rate brackets and credits are
indexed annually. Rates are progressive. In
addition, a federal surtax is levied at 3% and applied to the federal income tax payable
after taking into account any credits. When the federal income tax, after deducting
credits but before adding the surtax, exceeds $Cdn 12,500, an additional surtax is levied
equal to 5% of the federal tax in excess of $Cdn 12,500.
When individuals deduct significant tax preference items, such as the tax-free portion of
capital gains, pension and registered retirement savings plans contributions, and various
tax-shelter deductions available to some types of investment vehicles, alternative
calculations are made under minimum tax provisions. Taxable income is recalculated by
adding back the preferences and deducting the amount added in grossing up Canadian
dividends, one-third of allowable business investment losses, and a basic exemption of
$Cdn 40,000. The federal minimum tax rate of 17% is then applied to the recalculated
taxable income, and the resulting figure is compared with the federal income tax (net of
some tax credits) calculated under the ordinary rules. The greater of the two becomes the
tax payable and forms the basis for the additional surtax. Further tax paid as a result of
the recalculation under the minimum tax provisions may be recovered as a credit against
taxes payable in the following seven years to the extent that the federal tax payable
under the ordinary rules exceeds the recalculated minimum tax in those years.
Except for income subject to withholding tax, the
Canadian-source income of nonresidents is taxed in substantially the same way as that of
residents, but if income is not considered to have been earned in a province, an
additional federal tax is levied on the basic federal tax payable on that income at the
rate of 52% instead of provincial tax.
Provincial rates. The provincial personal income
tax rates are applied to the federal tax payable. Québec charges its provincial
tax separately, applying a graduated scale of rates ranging from 16% to 24% (excluding
surtax). Québec's tax base closely parallels the federal tax base. The tax chargeable is
slightly higher than that in other provinces. As a partial offset, Québec taxpayers are
entitled to a 16.5% federal tax credit.
Treatment of Families. Individuals are taxed separately; there are no provisions
for the submission of a joint return. Tax credits are given to individuals supporting
spouses if the income of the spouse does not exceed specified amounts.
A number of attribution rules inhibit the splitting of income between members of a family
to take advantage of Canada's progressive tax rates. For example, an individual who makes
a loan to his or her spouse or children may be taxable on any income attributable to the
loan. In general, when an individual transfers property to a spouse, any income or capital
gain associated with the property continues to be taxed in the hands of the transferor. In
the case of transfers to children, income (but not generally capital gains) may be
attributed to the transferor.
Taxable Income. Taxable income is computed in the same way as it is for
corporations. The net income from all sources has to be determined, and tax adjustments
have to be made, including tax exemptions and deductions.
Employment income. Employment income includes salaries, wages, and benefits
received. Taxable benefits include various stock options, automobiles, and allowances
provided by an employer, and any portion of health insurance plan premiums paid by an
employer. Benefits not regarded as taxable include employers' contributions to deferred
profit-sharing plans.
In computing net income from employment, deductions are allowed for specified traveling
expenses and for contributions to registered pension or superannuation plans (within
limits). Residents of the northern regions of Canada are entitled to hardship deductions.
Business income. Business income is computed substantially in the same way as it is
for corporations, using the accruals basis. Individuals conducting an unincorporated
business may select a fiscal period that ends on any date. The basis of the tax charge for
a given tax year is the fiscal period ending in that year.
Income from property. Income from property
includes interest, rent, and dividends and is normally taxed on the basis of amounts
received; however, rents and some forms of interest are charged on the accruals basis.
Individuals in receipt of dividends from Canadian corporations are required to include in
their taxable income 125% of the dividends received and are granted a credit for federal
tax purposes equal to 13.33% of the grossed-up sum (16.67% of the actual dividends
received). The credit represents the corporate income tax assumed to have been paid by the
Canadian corporation on its own profits. For most provinces, the provincial tax is based
on the same calculations. In Québec, dividends are grossed up to 125% and a credit of
8.87% of the grossed-up dividend is allowed.
Capital gains. Income includes 75% of capital gains, net
of capital losses, under rules similar to those for companies. Individuals may claim an
exemption for a gain realized on the disposal of their principal residence.
Resident individuals may also be entitled to a lifetime capital gains deduction. The limit
is $Cdn 500,000 if the gains are derived from the sale of qualifying small business
corporation shares. Normally, shares qualify if they are shares of a CCPC, most of whose
assets are used in an active business carried on primarily in Canada either by the
corporation itself or by a corporation under its control. Gains on farm property may also
qualify for the deduction.
If a significant part of the gain on the sale of shares other than ordinary common shares
arose because either dividends were not paid or unreasonably low dividends were paid, the
shareholder may be prohibited from using the lifetime exemption.
Miscellaneous income. Miscellaneous income includes pension, annuity, and alimony
payments, the proceeds of some life insurance policies, and research grants.
Deductions and Reliefs. Deductions from income in general include personal moving
expenses, child care expenses (up to set limits), alimony and maintenance payments,
carrying charges and interest expenses, and contributions to registered retirement savings
plans-RRSPs (up to set limits). As a rule, home ownership expenses such as mortgage
interest, insurance, and property taxes are not deductible, but if an individual rents out
a dwelling or maintains a business office in a dwelling, some of these expenses may be
deductible.
Federal tax credits for 1994 include a basic credit of $Cdn 1,098, a credit of $Cdn 915
for a married taxpayer with limitations based on the spouse's income, a credit of $Cdn 269
for each person eighteen years old or over dependent by reason of mental or physical
infirmity with limitations based on the dependent's income, a credit of $Cdn 592 for a
taxpayer sixty-five years old or over, a credit of $Cdn 720 for a taxpayer with a mental
or physical impairment, and a basic goods and services tax credit of $Cdn 199.
A Canadian resident employed by a Canadian employer or a foreign affiliate of a Canadian
employer on a foreign assignment related to a resource, construction, installation,
agricultural, or engineering project may qualify for the overseas employment tax credit.
The amount of the credit is generally equal to the portion of the employee's tax otherwise
payable that is the lesser of $Cdn 80,000 or 80% of the net overseas income (taxable in
Canada), divided by the total net income for the year.
Charitable donations that do not exceed 20% of net income are eligible for tax credits.
There is no ceiling on donations that involve a gift to the Crown or a gift of cultural
property. The federal tax credit is calculated as 17% of the first $Cdn 200, plus 29% of
any eligible donation in excess of $Cdn 200.
Medical expenses that exceed $Cdn 1,614 or 3% of the taxpayer's net income (whichever is
less) qualify for a federal tax credit calculated as 17% of the eligible sum. The first
$Cdn 1,000 of qualifying pension income is eligible for a federal tax credit amounting to
17% of the eligible sum. A tuition tax credit is allowed, equal to 17% of specified
postsecondary tuition fees. An education credit may also be claimed that amounts to 17% of
$Cdn 80 per month for each month of full-time enrollment in a qualifying program at an
approved institution. Contributions under the Canada Pension Plan (or Québec's pension
plan) and unemployment insurance premiums qualify for a tax credit of 17%.
A taxpayer may transfer the following credits to a spouse if he or she is unable to use
them: those for individuals age sixty-five or over, for pension income, for tuition and
education fees, and for dependents with mental or physical infirmities. Education and
tuition fee credits may be transferred (within limits) to a supporting person, such as a
parent, if the student is unable to use the credit.
Losses. Individuals may carry over both net capital losses and noncapital losses to
reduce the taxable income of other years. Rules are similar to those described for
corporations in the section on "Tax Treatment of
Losses."
Losses on the disposal of shares in and debts of small business corporations may qualify
for special treatment as business investment losses. Small business corporations are
basically CCPCs whose assets are used in an active business carried on primarily in Canada
or whose assets comprise shares in a small business corporation. Three-fourths of
qualifying losses are treated as noncapital losses and may, without limitation, be set off
against an individual's income from other sources. Any unused portion may be carried
forward under the normal rules relating to noncapital losses. A loss that cannot be used
in the carryforward period is treated as a net capital loss available for an indefinite
carryforward against future capital gains. Business investment losses treated as
noncapital losses are reduced to the extent that a capital gains exemption was allowed in
a previous year. Any such reduction in a business investment loss is treated as a capital
loss.
Personal Assessments & Payments
The rules for returns, assessments, and payments of individuals closely parallel the rules for returns, assessments, and payments for corporations, except that the tax year is normally the calendar year ended 31 December. A taxpayer must file a federal return -- and, if applicable, a return for the province of Québec -- by 30 April in the year following the tax year.
An individual must pay quarterly installments if the difference between tax
payable and amounts withheld at source is greater than $Cdn 2,000 in both the current year
and either of the two preceding years. Installments are due on or before 15 March, 15
June, 15 September, and 15 December. Installments are based on the lesser of the estimated
tax for the current year and the tax for the previous year. Any further tax chargeable
must be paid by the date for filing the tax return. Payments of employment income to both
residents and nonresidents (unless exempted by a tax treaty) are subject to employer
withholding.
Late and deficient installment payments are subject to severe interest
charges and penalties. Other overdue taxes are also subject to interest charges. Interest
is calculated on a daily basis using a rate that is set quarterly. Penalties are levied
for the late filing of returns.
Most payments to Canadian residents are not subject to withholding tax. In contrast, most income paid or credited to nonresidents is subject to final withholding tax (nonresident withholding tax) at prescribed rates. Tax treaties may reduce these rates.
Dividends. Dividends paid to a nonresident shareholder are subject
to a 25% withholding tax. The dividend tax credit
available to Canadian resident individuals in receipt of Canadian-source dividends is not
available to nonresidents. Loans and other debts owed to a corporation by its shareholders
(including foreign corporations) or by related persons may, in some circumstances, be
treated as income of the debtor if not repaid within specified time limits. When the
debtor is a nonresident, such deemed income is regarded as a dividend.
Interest. Most forms of interest paid to nonresidents are subject to
withholding tax at 25%. Canada unilaterally exempts some interest payments, including
interest on loan instruments issued or guaranteed by the government of Canada, provinces,
municipalities, or government agencies; interest on specific kinds of arm's-length
intercompany loans when the borrower cannot under any circumstances be obliged to repay
more than 25% of the principal within the first five years; and interest on foreign
currency deposits with Canadian banks.
Rents, Royalties, and Similar Payments. Rents, royalties, and
similar payments are subject to the 25% nonresident withholding tax. There is no
withholding tax on the production or reproduction of any literary, dramatic, musical, or
artistic work (other than a motion picture film or a film or videotape for use in
connection with television).
Disposals of Taxable Canadian Property. The purchaser of taxable
Canadian property must withhold tax at the rate of 33.33% from the purchase price and
remit that tax to the tax authorities. If the nonresident transferor renders a special
notice to the tax authorities either before disposing of taxable Canadian property or
within ten days of its disposal, the tax authorities normally issue a clearance
certificate and enable the purchaser to reduce the withholding to 33.33% of the capital
gain rather than the sales proceeds, assuming that no capital cost allowance has been
claimed. The tax liability is finalized when the nonresident files a formal tax return.
Although the withholding of tax is normally required even when gains are exempt under a
double tax treaty, if tax withheld and accounted for by a purchaser exceeds the tax
payable, the overpayment is refunded. If further tax is payable, it must be paid when a
return is filed.
Other Payments. A final 25% withholding tax generally applies to
payments to nonresidents of the following types of income: management or administration
fees and charges, estate or trust income, timber royalties, alimony and other support
payments, patronage dividends, superannuation and pension benefits, retirement allowances,
supplementary unemployment benefit plan payments, payments out of various deferred income
plans, income-averaging annuity contract payments, and the taxable portion of other
annuity payments.
Alternative Taxation of Nonresidents. Although nonresident
withholding tax is normally regarded as final, nonresidents may in some instances (for
example, rent receivable from Canadian real estate) elect to file Canadian tax returns.
Instead of nonresident withholding tax being deducted from the gross rent, it may
(provided that the nonresident files a return within six months after the tax year) be
paid on the net rent after the deduction of expenses incurred in earning the rent,
including property taxes, insurance, mortgage interest, and repairs. However, no tax
credits may be claimed for personal amounts. The recipient is treated as a resident whose
only income is Canadian rental income, which means, for example, that rental losses cannot
be set off against other Canadian-source income. If tax has been withheld from the gross
rentals, any excess over the tax calculated by the alternative method is refundable.
Other payments qualifying for the alternative method include alimony,
pensions, retirement allowances, payments out of registered retirement savings plans,
registered retirement income funds, and deferred profit-sharing plans.
Rates Under Double Tax Treaties. Click
to see withholding tax rates on payments to residents of countries that have tax treaties
with Canada. Tax treaties may modify the tax treatment accorded to particular
types of income as well as the withholding tax rate.
Capital Taxes. A number of the provinces levy annual capital taxes on the paid-up capital of corporations that have permanent establishments in the province. The rules governing taxability, the tax base, and tax rates vary from one province to another, but for some corporations the charge can be considerable. In several provinces, capital tax is only levied on banks and other types of financial institutions.
The federal government levies a capital tax on large financial institutions and life
insurance companies. Like the large corporations tax,
the capital tax is a form of corporate minimum tax. Corporations that are liable may
deduct the federal capital tax payable from the corporate income tax payable for the year.
To the extent that the capital tax cannot be set off against the corporate income tax in
the current year, it may be carried back three years and forward seven years. Click to see provincial and federal capital tax rates.
Goods and Services Tax. Goods and services tax (GST) is a tax on the consumption of
most goods and services, including imports. It is levied at each stage of commercial
activity, but a refundable credit is allowed to businesses engaged in commercial
activities registered for the GST so that they may recover the GST incurred on their
business expenditure. Thus, GST is ultimately imposed on the consumer because input tax
credits are available at every level other than the consumer level.
Goods and services are classified for GST purposes as taxable at 7% or 0% or as tax
exempt. Businesses making taxable supplies may claim an input tax credit for tax paid on
purchases relating to the provision of such supplies. Businesses supplying goods and
services that are exempt from tax are not regarded as engaged in a commercial activity.
Consequently, they are not entitled to claim input tax credits.
Tax-exempt goods and services include long-term and some short-term residential rents; the
resale of used dwellings; day care services; legal aid services; health and dental
services; educational services; goods and services provided by charities, nonprofit and
public-sector organizations, and the government; and domestic financial services. Taxable
at 0% are prescription drugs and medical supplies, basic groceries, exports, and financial
services related to deposits outside Canada or to loans for use outside Canada.
Provincial Sales Tax. Most provinces levy sales tax at the end-consumer level on
sales of tangible goods, with exemptions for food and other items. Rates vary from
province to province but generally are between 7% and 12%.
Social Security Contributions and Payroll Taxes. Contributions to the federal
unemployment plan are 4.2% of employee wages for the employer, up to a maximum
contribution of $Cdn 1,780.00, and 3% for the employee, up to a maximum contribution of
$Cdn 1,271.40. Contributions to retirement pensions under the Canada Pension Plan or its
Québec equivalent are 2.7% of employee wages for both the employer and the employee, up
to a maximum contribution of $Cdn 850.50. For self-employed individuals, the rate is 5%
and the maximum contribution $Cdn 1,701.00. Contributions to health insurance plans and
workers' compensation funds are also payable; amounts vary depending on the province.
Land Transfer Taxes. Stamp or capital issue duties are not levied in Canada, but
land transfer taxes are levied on transfers of real estate in most provinces. The basic
charge on a disposal of land is generally a small percentage of the value of the
consideration passing, but in the case of some transfers to nonresidents, a much higher
rate (for example, 20%) may apply.
Municipal Taxes. Most municipalities levy taxes at varying rates on real estate,
including land, commercial buildings, and residential property. Municipalities also charge
taxes for local improvements. Local license fees are often charged, but there is no trade
or business license tax as such.
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