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Taxation System - Federal Tax Law Canada | Federal Income Tax Lawyers
Introduction to the Canadian Taxation System
The Federal and Provincial governments of Canada levy taxes upon all tax-paying entities in order to finance various public sector needs. In the taxation system’s creation, there was an attempt to produce a neutral, efficient, fair and equitable system. To this end, both governments employ a combination of flat and progressive tax rates. A flat tax rate is one that applies to all taxpayers equally, regardless of their consumption or income levels (such as the 6% Goods & Sales Tax). Progressive taxation is based on the principle that people with higher income levels should be required to pay more tax than those with lower income levels. Thus, the tax rate increases as the taxpayer’s income increases.
Authority over Income Tax
The Constitution Act, 1867, divides the power to tax between the Federal and Provincial governments. The Federal Parliament obtains the authority to levy tax from s. 91(3) of the Constitution Act, 1867, which states that the federal government may raise money “by any Mode or System of Taxation”. Section 92(2) of the Constitution Act, 1867, grants the Provincial Legislatures the power to impose a direct tax in order to raise “Revenue for Provincial Purposes”. The Income Tax Act (‘Act’) is the primary source of tax law in Canada. In addition to the Act, there are several other sources of tax law, these are: Income Tax Regulations, bilateral international tax treaties, Income Tax Application Rules, and case law.
Administration of Income Tax Law
The Department of Finance, the Department of Justice and the Canada Revenue Agency all hold a unique place in the income tax law system. The Department of Finance drafts tax legislation and develops tax policies in accordance with the national goals of Canada’s taxation system. The Department of Justice handles litigation arising in income tax cases. The Canada Revenue Agency (‘CRA’) is responsible for the administration and enforcement of the Income Tax Act. The CRA has approximately thirty offices across Canada; these have been created to deal with public inquiries, to collect taxes, audit income tax returns and to investigate tax compliance.
It is the responsibility of the courts to decide important issues in income tax law. There are several courts in Canada that deal with tax issues. The Tax Court of Canada is the court of first instance, all tax appeals commence here. Applicants may make further appeals to the Federal Court of Appeal. Finally, leave to appeal may be sought from the Supreme Court of Canada.
Who is Taxed?
Residency, rather than citizenship, is the primary basis for determining who is taxable in the Canadian tax system. Residency establishes the individual or corporate tax liability of a taxpayer. To facilitate this system, the Income Tax Act divides taxpayers into residents, non-residents and part-year residents. A resident of Canada must pay tax on all worldwide income, regardless of where the income is earned. Non-residents are only required to pay taxes on the income they earn in Canada, while part-year residents
  1. Constitution Act, 1867 (U.K.), 30 & 31 Vict., c. 3, s. 91(3), reprinted in R.S.C. 1985, App. II, No. 5.
  2. Constitution Act, 1867 (U.K.), 30 & 31 Vict., c. 3, s. 92(2), reprinted in R.S.C. 1985, App. II, No. 5.
are required to pay tax on income earned globally while they are residents of Canada and on Canadian income earned while they are non-residents. An example of a part-year resident is someone who immigrated to or emigrated from Canada, part way through the year.
The Canada Revenue Agency may use a common law, statutory or treaty analysis to determine residency. Common law analysis uses a highly flexible approach, identifying personal links to Canada, to establish residency. Numerous cases have established a long list of criteria that a court takes into account when considering the question of residency. Section 250(1) of the Income Tax Act also delineates a long list of criteria a court may use in determining residency. Sometimes, an individual can be resident in more than one country, and is thus subject to more than one taxation system. Bilateral tax agreements seek to minimize double taxation in such cases. The OECD Model Double Taxation Convention serves as a base for Canadian tax treaties and sets out model guidelines for solving international double taxation issues.
The government taxes corporations in a manner similar to individuals. Resident corporations pay tax on worldwide income while non-resident corporations only pay tax on Canadian income. Similar to individuals, either the common law, statutory law or treaties determine residency for corporations. Section 250(4) of the Income Tax Act outlines the residency requirements for corporations.
Residency for the purposes of provincial income tax is easier to establish. An individual is a provincial resident if he or she resides in the province on December 31st of the taxed year. Corporate residency is established in the province where the corporation maintains a permanent establishment.
For non-residents, the Act distinguishes between active income (Part I of the Income Tax Act) and passive income (Part XIII of the Income Tax Act).
Active income can be any of the following: money earned on employment in Canada, money earned while carrying on business in Canada or money earned from the disposition of taxable Canadian property. The presence of bilateral tax treaties complicates non-resident tax analysis. Residence and non-residence laws of various countries, in addition to international tax treaties, are some of the instruments which require analysis in non-resident tax disputes.
Part I of the Act also exempts certain entities from taxation. Some of these entities include diplomats and their families, municipal authorities, registered charitable organizations, labour organizations, not-for-profit organizations, and registered pension funds.
What is Taxed?
In Canadian tax law, ‘income’ is a fluid concept and its precise definition attracts much debate. Different jurisdictions each have unique definitions. Because of the complexities involved in calculating exactly what falls under the category of ‘income’, taxpayers may require professional assistance when encountering unusual items in their tax returns.
The CRA classifies income according to its source. Depending on the source, income falls into a certain category where it is subject to a unique set of tax rules. Some common categories of sources include: office, employment, business, property, and capital gains. For efficiency purposes, the Income Tax Act also recognizes unnamed categories of income. A taxpayer’s total taxable income is the sum of all categories of income.
Income tax authorities do not consider gifts and inheritances to be sources of taxable income. Similarly, windfall gains (such as gambling winnings or valuable findings) do not incur income tax due to their unplanned, unexpected and irregular nature.
Filing Tax Returns
In Canada, each taxpayer is responsible for self-assessing his or her income on an annual basis. To facilitate the process, the Government of Canada provides tax returns that taxpayers must fill out and file with the government. Subsection 150(1) of the Income Tax Act requires individual’s to file tax returns either by April 30th of the following year, or where the individual or his spouse carries on a business – June 15th of the following year. However, like many sections of the Income Tax Act, there are exceptions to certain individuals having to file returns. Basically, those exceptions are (i) the individual did not have tax payable for the year; or (ii) the individual did not have a taxable capital gain or dispose of capital property (i.e. stocks, mutual fund units, etc.) in the year.
Corporations have slightly different timing and filing requirements. Aside from registered charities, corporations must file tax returns on an annual basis irrespective of whether actual tax payable was accrued. Each organization must file its tax forms within six months of the end of its fiscal year. In addition to government forms, the corporation must also submit financial statements and supporting schedules to the appropriate administrators. Similar to individual citizen tax returns, misleading or non-accurate filings result in severe civil or criminal charges.
After this period, the taxpayer receives a Notice of Assessment, stating the amount that the taxpayer must pay to the government. Taxpayers have the right to disagree with the government if they believe they were incorrectly assessed for what tax amount they should pay. In such a case, taxpayers have ninety days to file an objection notice with the Chief of Appeals for any taxation centre of the CRA. Special rules regarding limitation periods apply to corporations with such grievances.
If the taxpayer cannot resolve the objection with the CRA, the taxpayer may launch an appeal to the Tax Court of Canada. The Tax Court has two separate procedures to deal with appeals made by taxpayers:
1.Informal Procedure - The taxpayer may elect to use this procedure if the aggregate of all tax amounts does not exceed $12,000 or the amount of any loss in issue does not exceed $24,000. The taxpayer must submit the appeal in writing, setting out the reasons for the appeal. The government must submit a reply within sixty days after the filing of the appeal. The entire process usually finishes within seven months.
2.General Procedure - The taxpayer may elect to undergo a more formal procedure with the use of lawyers if the disputed amount involves federal tax in excess of $12,000. Because there is no time frame involved in the use of a General Procedure, the entire process may take longer to complete.
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