In Canada, there are various types of taxes that are levied, particularly income taxes and sales taxes, which are imposed both at the federal and provincial level.
Individuals that are residents of Canada are taxed on their worldwide income, whereas non-residents are subject to Canadian taxation on the following sources of income; the sale of taxable Canadian property; carrying on a business in Canada; and through employment in Canada.
Under Canada’s tax treaties, business profits are generally only taxable in Canada to the extent that the non -resident has a “permanent establishment” in Canada. A permanent establishment generally means a fixed place of business in Canada through which the business of the entity is wholly or partly carried on. A Corporation operating in Canada without a permanent establishment may be required to file a treaty based corporate tax return.
Although each province has also enacted provincial income tax legislation, only Alberta and Quebec administer their own corporate income taxes. Moreover, only Quebec administers its own individual income taxes. All the other provinces rely upon the federal government to collect taxes on their behalf.
Corporate income taxes are imposed both by the federal government and the provinces. Active business income by a corporation is taxed at a rate of 15% at the federal level. The provinces then levy taxes and the rates range from as low as 11% in British Columbia to as high 16% in Nova Scotia and Prince Edward Island.
Preferential tax rates are given to qualifying small business corporations, which are “Canadian Controlled Private Corporations” that earn active business income on their first $500,000 of profits. Canadian controlled private corporations are corporations which are privately held and controlled (50% or more) by Canadian residents. Taxes are imposed at a rate of 11% federally and range from 0% to 8% throughout the provinces.
Investment income earned by a Canadian Controlled Private Corporation is taxed at 34.7% at the federal level and ranges from 11% to 16% at the provincial level. A portion of the federal tax is refundable to the corporation when a dividend is paid to the shareholders.
Investment income earned by any other corporation is taxed at a 15% federal rate and 11% to 16% provincial rate.
Generally, dividends received by Canadian individual residents from corporation’s resident in Canada are subject to preferential tax rates apart from other sources of income. This is a result of the “integration” principle to provide for close parity between income earned directly by an individual and income earned by an individual shareholder through a corporation.
Dividends received by a corporation resident in Canada from another corporation resident in Canada are included in, and then fully deductible from, the recipient’s income. Dividends paid between two Canadian resident corporations are generally tax-free subject to certain exceptions. Dividends received by corporation’s resident in Canada from corporations not resident in Canada are fully included in the recipient’s income without a corresponding deduction, unless such dividends are paid out of the active business income of a non-resident corporation that is a “foreign affiliate” of the Canadian resident corporation that is resident in a specified treaty jurisdiction.
Dividends paid to non-residents shareholders are subject to income tax withholdings (see ‘Withholding Taxes’ section).
A non-resident corporation that carries on business in Canada through a branch must pay Canadian income tax on income earned in Canada. Generally, however, Canada’s tax treaties provide that a corporation’s business profits will only be subject to Canadian income tax to the extent that they are attributable to a Canadian permanent establishment.
In addition to Canadian federal and provincial income tax, a non-resident corporation carrying on business in Canada through a Canadian branch is subject to a branch tax. The branch tax is 25 per cent of after-tax income that is not reinvested in Canada. Where the rate of withholding tax on dividends is reduced by a tax treaty, the rate of the branch tax is often reduced to the same rate. In addition, a tax treaty may exempt the first $500,000 of a non-resident corporation’s income from branch tax.
Personal income taxes are based on progressive tax rates and brackets. The federal income tax rates range from 15% to 33%. For 2017, the highest marginal tax bracket applies when income exceeds $200,000.
Provincial tax rates and brackets vary from one province to another. The top marginal rates for federal and provincial taxes combined range from 44.5% in Nunavut to 54.0% in Nova Scotia.
There also exists what is known as the “basic personal exemption”, where the first $11,474 of income is not subject to taxation at the federal level.The amounts of the basic exemption differ throughout the provinces.
The gains resulting from the sale of capital property is subject to taxation at 50%. In other words, only 50% of the gain is included in computing a taxpayer’s income.
In similar fashion, one half of capital losses are deductible. Capital losses may only be deducted against capital gains.
Property taxes on real property are an important source of revenue in Canada, particularly for municipalities. Many provinces also levy transfer taxes on the purchase of land and impose various other taxes on mines, timber property and similar properties.
Canada imposes a goods and services tax (“GST”) on the consumption of goods and services in Canada. Some of Canada’s provinces have chosen to harmonize their sales taxes with the federal GST (referred to as Harmonized Sales Tax -HST). While GST or HST is collected by all registered businesses at each stage in the production or marketing of goods and services, the burden of the tax is ultimately borne by the consumer.
Businesses collect tax on their sales and claim a credit, referred to as an input tax credit, for any tax paid on their purchases. While most sales of goods and services are subject to GST, some goods and services are exempt or zero-rated.
The federal GST rate is 5 percent. In provinces which have harmonized their taxes, the combined HST tax rate varies from 13 percent to 15 percent. Other provinces that have not harmonized their sales taxes, such as Quebec, levy an additional 9.975 percent sales tax in addition to the GST.
GST also applies to imports of goods and is usually paid by the importer. The GST is payable on the duty-paid value of goods, meaning the value for customs purposes, plus applicable customs duty.
Non-resident corporations with a permanent establishment in Canada are considered to be resident in Canada for GST/HST purposes, and may be required to register for and collect GST/HST on all taxable supplies of property and services made through the permanent establishment.
Canada has entered into over 80 tax treaties with countries throughout the world. The treaties are in place to eliminate the double taxation of income that may arise. The tax treaties generally provide that business profits of a nonresident of Canada are not subject to tax in Canada, except to the extent that profits are attributable to a permanent establishment of the non-resident in Canada. The tax treaties usually reduce both the withholding tax rates imposed under Canadian law and the branch-profits tax rate.
Canada generally follows the OECD transfer pricing guidelines. Canadian taxpayers are taxed on their transactions with non-arm’s-length non-residents based on terms similar to those that would have applied had the parties been dealing at arm’s length. Canadian taxpayers that transact with non-arm’s-length nonresidents are also required to prepare and retain certain documentation. Failure to do so may result in significant penalties if the terms of their transactions are ultimately held not to be arm’s-length terms. These rules apply to related persons and to parties who, as a matter of fact, do not deal with each other at arm’s length.