How Canadian Income Tax is Calculated?

by Tax Guy - Burlington Accountant on January 4, 2011 Print This Post Print This Post

The Canadian Income Tax Act contains ordering rules and general principles for calculating net income for tax purposes and taxable income. The accumulation of income and deductions must follow a chronological order and is summarized as follows:

1. Calculate total income

  • Income from employment + Income from property + Income from a business + Other income
  • Plus “net” capital gains (Capital gains less capital losses)*
  • Less deductions such as RRSPs, RPP, union or professional dues, child care expenses, moving expenses.
Tax paperwork

By iowa_spirit_walker via Flickr

2. Calculate net income for tax purposes

3. Calculate taxable income

Taxable income is the income in which federal and provincial taxes will be calculated from.

  • Deduct personal deductions such as home relocation loan deduction, stock option deduction, non-capital and net capital losses from prior years, and capital gains deductions.

4. Calculate federal taxes

  • Basic federal tax = Taxable income x federal tax rates
  • Less: Tax credits (basic personal amount, spousal credit, medical expense credit, tuition fees, donations, transit pass and other tax credits.

5. Calculate provincial taxes

  • Calculated in much the same manner as federal taxes and credits (except for Quebec).

The balance owing or refund due is the federal tax less federal tax credits plus provincial taxes less provincial credits plus any provincial surtaxes less amounts deducted from pay cheques or paid in installments.

* Capital losses may only reduce capital gains to zero. Any remaining capital net capital loss may be carried back three years or forward indefinitely against net capital gains.
Tax software is always a good choice to calculate your taxes and often can help you find hidden credits or deductions. If you have renal income or investments try TurboTax Premier or TurboTax Canada Business Tax Software if you are self-employed or have a corporation.

About The Tax Guy...

Dean Paley CGA CFP is a Burlington accountant and financial planner who services individuals and business owners locally, nationally and internationally. Dean has appeared in the National Post, Toronto Star and Metro News.

To find out more, visit Dean's website Dean Paley CGA CFP or connect via Twitter @DeanPaleyCGACFP.

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A. Freeman June 14, 2012 at 4:12 pm

I could not find any articles on tax evasion, so hopefully this query fits here. Is the below transaction sophisticated tax planning or tax evasion?

A Canadian Company (CanCo) has a European subsidiary (EuroCo), which has $50million in retained earnings and nominal share capital.

CanCo forms a Barbadian subsidiary (BarCo) under preferred-tax legislation and sells EuroCo to BarCo.

EuroCo declares a dividend of $50million to BarCo, on which BarCo pays nominal tax under the preferred-tax legislation.

BarCo, in turn, declares a dividend of $50million to CanCo, which is tax exempt under the Canada-Barbados Tax Treaty.

Tax Guy June 14, 2012 at 5:00 pm

The answer depends on a number of factors not limited to where the corporation was established. Often the tax residence of a corporation is where the controlling management and high level decisions are made. I would assume that the Canadian corporation would be responsible for moving down this path and thus it would all still be subject to Canadian tax law.

One would assume that anyone with that level of retained earnings would not rely on the internet for tax advice!

Amazed June 15, 2012 at 11:52 am

I presume that a Canadian corporation should not be legally/properly able to simply flow income earned/accumulated in foreign jurisdiction A through foreign jurisdiction B and apply the more advantageous treaty benefits of jurisdiction B to those earnings.

Tax Guy June 15, 2012 at 12:05 pm

What exactly is the Canadian company attempting to achieve here?

Amazed June 15, 2012 at 12:52 pm

I am not sure, not being part of the inner circle. From looking on, it appears to be an attempt to apply the advantageous treaty benefits of jurisdiction B to income that was earned/accumulated in jurisdiction A. I think there is a “look through” provision that will disallow the application of the tax treaty benefits of jurisdiction B in this way, should there be full disclosure. Thank you for the exchange.

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