Canadian Income Taxation Ch03

CHAPTER 3:
Liability for Tax, Income Determination, and

Administration
Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved.

1
Liability for Tax and Income Determination
I. Sources of Canadian Tax Law

II. Liability for Tax
III. Determination of Income
IV. Administration of the Income Tax System
Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 2

I. Sources of Canadian Tax Law
There are three separate sources that govern income

tax law in Canada:
1. Statute law:
a. Federal Tax system The Income Tax Act and Regulations
b. Separate Provincial income tax acts
2. Common law
3. International tax conventions

Common Law
Is an integral source of tax law.

CRA often views a transaction differently than the taxpayer.
Disputes are settled in the Canadian court system.
Sufficient jurisprudence helps define and interpret

tax laws.
Jurisprudence is now the primary source of definitions and
interpretations in the Canadian tax system.

International Tax Conventions
Reciprocal tax treaties with foreign countries in order

to:
a) rationalize and define the jurisdictional authority; and,
b) avoid the incidence of double taxation.
Tax conventions are designed to limit the right of one
jurisdiction to tax income.
Treaties takes precedence over Income Tax Act (the
Act)

Sources of Canadian Tax Law
Federal tax law is the responsibility of the Department of

Finance.
Assessing and collecting tax is the responsibility of

Canada Revenue Agency (CRA).

Interpretation Bulletins and Information
Circulars
In order to assess tax, CRA must interpret the law.
CRA publishes its interpretation of the tax laws in two
forms:
- Interpretation Bulletins
- Information Circulars
The interpretations published by CRA are not law and

can be disputed through the court system.

II. Liability for Tax
ITA 2(1) - Federal and provincial income taxes are imposed on:
1. Individuals
2. Corporations
3. Trusts
Individuals Corporations Trusts
Employment Income Business Income Employment Income

Business Income Property Income Business Income
Property Income Capital Gains Property Income
Capital Gains Capital Gains
Other i.e. pension Other i.e. pension

Corporations
An artificial person
Has same legal rights and responsibilities as an
individual.
The affairs of the corporation are separate from its
shareholders.
For tax purposes, corporate profits earned or losses
incurred belong to the corporation.

Resident Individuals and Corporations
Residency is the primary factor in determining how an

entity is taxed in Canada.
Subject to tax if considered resident in Canada.
Residents subject to tax on worldwide income.
Non-resident entities are only taxable on income earned
in Canada.

Individuals - Residency
The concept of residency is not defined in the Act.

must maintain a continuing state of relationship with the
country.
Residence for tax purposes is not:
the same as domicile, or
Citizenship.

Residence is based on the legal or economic links an

individual has with Canada.
question of fact whether one is resident or not, and

each case is judged on its own special circumstances.
Residency is determined on a year to year basis.

Factors to consider in determining residency:
Amount of time spent in Canada on a regular basis;

Motives for being present or absent;
Maintenance of a dwelling place in Canada
Origin and background of the individual;
General mode and routine of ones life; and
Existence of social and financial connections with
Canada.

ITA 114 - Part-time Resident

Subject to tax in Canada on worldwide income earned
while resident.
Once residency ceases only subject to tax on Canadian
source income.

Corporations
ITA 250(1) - Corporations incorporated in Canada are

residents of Canada
subject to tax on world income.
Foreign corporation may be Canadian resident if
central management and control is exercised from within
Canada.

Dual Jurisdictions
May be subject to tax in a foreign jurisdiction if they carry

on business outside of Canada.
The treaty may limit Canadas right to tax.
May be subject to taxation in both jurisdictions; if so the
Act generally allows a foreign tax credit.

Non-Resident Individuals and Corporations
Non-residents of Canada are taxable on specific

activities.
Taxed in Canada on net income arising while non-
resident if:
carries on business in Canada (through a Permanent
Establishment);
disposes of Taxable Canadian property; or,
is employed in Canada.

Tax on Canadian Source Income
Withholding Tax
Tax on amounts originating in Canada but paid to a non-
resident.
ITA 212 - General rate is set at 25% by the Act.
Most tax treaties have reduced the rate to 5%, 10%, or 15% on
most types of revenues.

Tax on Canadian Source Income
Major types of payments subject to withholding tax

are:
Interest (only to non-arms length)
US/Canada treaty - amounts paid to arms length no longer subject to
withholding
Dividends
Rents
Royalties
Pension benefits
Certain management and administration fees

III. Determination of Income
Each entity is required to pay tax on its taxable

income in each taxation year.
What is taxable income?
The Act provides a framework to help determine:
Income from each category of income, and
Deduction from income in each category.
Taxable Income = Net Income Special reductions

Types of Income
An entitys world income is derived from five basic

sources:
1. Employment income
2. Business income
3. Property income
4. Capital gains and losses
5. Other specific sources
Income is determined by applying basic principles
specific to the particular category.

The Taxation Year
ITA 249.1 - Corporate taxpayers can choose the taxation

year.
Once chosen, it cannot change it without concurrence is
given by CRA.
A taxation year cannot exceed 53 weeks.
May be less than 12 months.
Exception is Professional Corps fiscal year must
coincide with calendar year.
ITA 249(1) Individual tax year = calendar year.

Formula for Determining Net Income for Tax
Purposes
Segment A includes income net of deductions only positive net
income
Employment +
Business Income +
Property Income +
Other items +
Subtotal 1 (must be positive or Zero) + or 0

Segment A
Each of the income items should be reported at their net

amount. Example:
Business Income = Gross Revenue Expenses
Each category of income may have more than one

source within it.
Includes only positive net income.
Any source resulting in net loss are deducted in segment
D.

Segment B
Segment B deals with capital property.
Increase Subtotal 1 by
Taxable Capital Gains +
Exceeds
Allowable Capital losses - + or 0
Subtotal 2 (must be positive or Zero) + or 0
Means that Capital losses in the year can offset capital gains.

Segment C
Reduce Subtotal 2 by:
Other items Deductions -
Subtotal 3 + or 0

Segment C
Other items of deduction are subtracted at this

point:
RRSP contributions
Moving expenses etc.
These items can be offset against any form of income.
These deductions cannot exceed the total of income
included in segments A and B.

Segment D
Reduce (but not exceed) subtotal 3 by
Employment losses -
Business losses -
Property losses -
Allowable business investment losses - - or 0
Total net income for tax purposes (must + or 0
be positive or zero)

Segment D
Includes losses incurred from:

employment,
business,
property, and
allowable business investment losses.
These losses can offset all forms of income previously
included.
Losses can only reduce income for the year to zero.

Taxable Income
Net income for tax purposes is reduced by limited

number of specified reductions to arrive at taxable
income.
The items that reduce net income for tax purposes to
taxable income are different for individuals and
corporations.

Reductions Applicable to Individuals
Unused losses of other years.
Employee stock option deductions.
Capital gain deduction on certain property.

Reductions Applicable to Corporations
Charitable donations.
Unused losses of other years.
Dividends from Canadian corporations.
Dividends from foreign affiliates.

IV. Administration of the Income Tax
System
Filing Returns:
Every taxpayer must file an income tax return.
Filing deadline is different for each of these entities.
ITA 150(1)(a) - Corporations due 6 months after taxation
year.
ITA 150(1)(d) - Individuals:
April 30 for most recent calendar year, or
June 15 if individual (or spouse) carries on a business.
ITA 150(1)(b) - Deceased Individuals due the later of:
6 months from date of death, or
Normal filing deadline (April 30 or June 15)
ITA 150(1)(d) Trusts 90 days after fiscal year-end.

Assessments
After filing a return, CRA is required to assess it within

a reasonable time.
Means CRA will scrutinize the calculations

Assessments
CRA has the right to reassess returns at a later time,

subject to limitations:
individuals, trusts and CCPCs - reassessed within three years
of original assessment.
For public corporations extended to four years.
Unless:
taxpayer has made any:
misrepresentation that is attributable to neglect, carelessness, or wilful
default, or
has committed any fraud in filing the return or supplying information.

Objection and Appeal
Taxpayers can appeal an assessment they do not

agree with:
The first step is to file a formal notice of objection.
Unsatisfactory results of this first appeal may be
appealed to the Tax Court of Canada.
Still not satisfied then appeal to:
the Federal Court of Canada, and
perhaps to the Supreme Court of Canada.

Payment of Tax Individuals
ITA 153 (1) - Pay tax on certain income when received:

Ex: Employers are required to withhold and remit tax to CRA
on employees behalf.
Other types of income, payments must be made on an
instalment basis.

Payment of Tax Individuals
ITA 156.1(2) - Instalment are required whenever federal

tax owing exceeds $3,000 for both:
the current year and
either of the past two taxation years.
Instalments are due quarterly, beginning on March 15.
The balance of taxes payable is due on April 30.

Payment of Tax Corporations
Instalment payments are the primary method of remitting

corporate tax.
ITA 157(2.1) - A corporation must make 12 instalments
per year.
Monthly instalments are equal to 1/12 of prior years tax
owing, unless:
Current year taxes estimated to be lower than prior year.

Payment of Tax Corporations
ITA 157(1)(b)Balance owing is due two months after

taxation year-end.
Extended to three months for a CCPC whose:
taxable income does not exceed the $500,000 annual business
limit,
if during the year or previous year a small business deduction
was claimed, and
Have taxable capital employed in Canada of $10,000,000 or
less.

Payment of Tax Interest
CRA charges interest on any tax that is due and payable

but not paid.
Interest is charged on late or deficient tax instalments.
ITA 161(1) Interest rate prescribed by the regulations
and is adjusted quarterly.
Not deductible for tax purposes.

Penalties and Offences
ITA 162(1) - Failure to file an annual return:

5% of the tax unpaid for the year, plus 1% for each month after
the due date, to a maximum of 12 months.
ITA 162(2) - Repeated failures to file an annual return:
10% on a second or further late filing.
increased by 2% for each month after the due date, for a
maximum of 20 months.

Penalties and Offences
ITA 163(1) - Failure to report an item of income:

Lessor of:
10% of the unreported income if the failure to report occurs more than
once in a three-year period and
50 percent of the amount of tax relating to the understatement of
income
ITA 163(2) - Knowingly making a false statement or
omission:
50% of the tax owing on the excluded or understated amount.

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CHAPTER 3:

Liability for Tax, Income Determination, and

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved.

I. Sources of Canadian Tax Law

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 2

There are three separate sources that govern income

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 3

Is an integral source of tax law.

Sufficient jurisprudence helps define and interpret

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 4

Reciprocal tax treaties with foreign countries in order

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 5

Federal tax law is the responsibility of the Department of

Assessing and collecting tax is the responsibility of

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 6

The interpretations published by CRA are not law and

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 7

Employment Income Business Income Employment Income

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 8

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 9

Residency is the primary factor in determining how an

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 10

The concept of residency is not defined in the Act.

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 11

Residence is based on the legal or economic links an

question of fact whether one is resident or not, and

Residency is determined on a year to year basis.

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 12

Factors to consider in determining residency:

Amount of time spent in Canada on a regular basis;

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 13

ITA 114 - Part-time Resident

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 14

ITA 250(1) - Corporations incorporated in Canada are

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 15

May be subject to tax in a foreign jurisdiction if they carry

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 16

Non-residents of Canada are taxable on specific

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 17

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 18

Major types of payments subject to withholding tax

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 19

Each entity is required to pay tax on its taxable

Taxable Income = Net Income Special reductions

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 20

An entitys world income is derived from five basic

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 21

ITA 249.1 - Corporate taxpayers can choose the taxation

ITA 249(1) Individual tax year = calendar year.

Copyright 2016 McGraw-Hill Ryerson, Limited. All rights reserved. 22

Subtotal 1 (must be positive or Zero) + or 0

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Each of the income items should be reported at their net

Each category of income may have more than one

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Segment B deals with capital property.

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Reduce Subtotal 2 by:

Other items Deductions -

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Other items of deduction are subtracted at this

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Reduce (but not exceed) subtotal 3 by

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