Introduction to Canada

Canada is the world’s second-largest country in area (9 970 610 sq. km) second only to the Russian Federation Canada with 10 provinces and 3 territories is a constitutional monarchy and a federal state with a democratic parliament. The Parliament of Canada, in Ottawa, consists of the House of Commons, whose members are elected, and the Senate, whose members are appointed. Election of the members of parliament is held every four years.

The population of Canada as in 1996 was over 30 million. There is a concentration of a large majority of Canadians, about 77 percent, who live in cities and towns. According to the 1991 census, more than four-fifths of Canadians are Christians, 47% of which are Catholics and Protestants about 36%. Other religions include Judaism, Islam, Hinduism, Sikhism and Buddhism. About 12.5% have no religious affiliation. The Official Languages Act makes French and English the official languages of Canada Other spoken languages include Chinese, Italian, German, and Polish etc. The leading industries in Canada are in the business of automobile manufacturing, pulp and paper, iron and steel work, machinery and equipment manufacturing, mining, extraction of fossil fuels, forestry and agriculture. Canada’s leading exports are automobile vehicles and parts, machinery and equipment, high-technology products, oil, natural gas, metals, and forest and farm products.

Canada’s leading exports are automobile vehicles and parts, machinery and equipment, high-technology products, oil, natural gas, metals, and forest and farm products.

1. History of tax revenues

When Canada became independent in 1867, the British North America Act was passed with a motive to create a centralized federal government with scope of unlimited revenue gathering abilities. The federal government was responsible to execute with the high cost programmes such as defence and the construction of major infrastructure projects such as railways. The provincial governments were given limited taxation power. They were only empowered with imposition of direct taxes such as sales and income tax. Provincial governments were made responsible for health care and education, which were not high revenue earners. In the initial stages, the main sources of federal government revenue were the tariffs on trade with excise taxes. The provincial governments earned a major portion of their revenues from licence permits and transfers of funds from the federal government. The first corporate taxes were introduced at the end of the nineteenth century. In the year 1917, a tax on income was introduced as a temporary measure to fund the First World War. The Second World War led to dramatic change in the tax system. The percentage of Canadian government revenue from indirect taxes fell from 90% in 1913 to less than 40% by 1946. The income tax has since become a permanent feature of the Canadian tax system and direct taxes has since provided the greatest bulk of government funding. Currently, approximately 70% of the Canadian government’s income comes from taxation, the rest from tariffs, fees, and investments.

2. Tax system

Canada taxes are highly progressive as the high income residents pay a significantly higher percentage than the low income residents. Both, the federal and provincial governments impose income taxes on individuals, which is a significant source of revenue for the government contributing to more than 40% of the total tax revenue. A major portion of the income tax is charged by the federal government while the provincial governments charge a lower sum. Where income is earned in the form of a capital gain, only half of the gain is included in income for tax purposes; the other half is not taxed. Canada levies personal income tax on the worldwide income of individuals resident in Canada and on certain types of Canadian source income earned by non-resident individuals. The amount of income tax that an individual must pay is based on the amount of their taxable income for the taxation year.

3. Personal income taxes

Both, the federal and provincial governments, impose personal income taxes. Hence, taxes are imposed at two levels, first at the central or federal level and then based on the taxable income arrived at federal level, the provincial governments impose a tax. The federal government defines taxable income in the Income-tax Act. Personal income tax is levied on the taxable income as per the rate schedule contained in the Act. All the provinces and territories impose a provincial or territorial tax, which is calculated as a percentage of the taxable income as defined by the federal Act. The federal government collects personal income taxes for all provinces except the province of Quebec.

1. Federal personal income tax system

Under the Income-tax Act, residents of Canada are liable for tax on their income from all sources, both domestic and foreign. For Canadian residents, income earned from employment, business (self-employment or unincorporated businesses), and property (interest, dividends, etc.) is subject to tax. Only a few types of receipts are not included in the taxable income. Gifts, inheritances, and lottery winnings are not included in taxable income. Also, the federal child tax benefit is a non-taxable payment to parents. There are also certain exemptions granted under the Act, such as veterans’ disability pensions. Certain other items, such as workers’ compensation payments under a government scheme and some social assistance payments, must be declared by the tax-payer as income but they are exempt from tax.

2. Provincial personal income tax systems

The federal government determines its personal income tax as per the rate schedule included in the Federal Income-tax Act. All the provinces and territories also levy tax by applying their rate schedule to taxable income. The nine provinces and three territories that have collection agreements with the federal government to use the federal determination of taxable income. However, Quebec, which collects its own tax, uses its own definition of taxable income. The tax abatement for Quebec is expressed as a percentage of basic federal tax.

4. Liability for tax

Under section 2 of the Canadian Income-tax Act, tax is required to be paid by every person who has been resident in Canada in any given taxation year on his taxable income. Canadian residents are taxable in Canada on their world income. This includes income or capital gains earned overseas, such as through the rental or sale of a foreign property. Failure to report such income is tax evasion and is punishable by a fine or even a jail term.

5. Concept of “Tax-payer”

Just as in India, a person assessable to tax is called an Assessee, in Canada, the person responsible to pay tax in Canada is called a Tax-payer.

6. Concept of “Taxation Year”

In Indian tax system, the period for which an assessee is responsible to pay his taxes is called an assessment year running from April 1 to March 31. In Canada, “taxation year” of a person means the period determined under the federal Act as the person’s taxation year. The taxation year for individuals is a calendar year. Corporations are taxed on a fiscal-year basis rather than a calendar-year basis. Therefore, any rate changes made at any point in the calendar year are usually prorated over the fiscal year.

7. Assessment system

The Canadian income tax system is a self-assessment regime. Tax-payers assess their tax liability by filing a return with the Canada Revenue Agency (CRA) within the prescribed filing deadline. CRA assesses the return based on the information it has obtained from employers and financial companies. It may correct it for obvious errors.

8. Appeals

A tax-payer who disagrees with CRA’s assessment of a particular return or is aggrieved by the assessment of its return, may appeal the assessment. The appeal process starts with a formal objection by the tax-payer to the CRA assessment. The objection so filed, must explain, in writing, the reasons for the appeal. The reasons so provided must be supported by detailed related facts. The objection so filed, is subjected to a review process by the appeals branch of CRA. An appealed assessment may either be confirmed, vacated or varied by the CRA. If the assessment is confirmed or varied, the tax-payer has a right to further appeal the decision to the Tax Court of Canada. A further appeal lies from a decision of the Tax Court to the Federal Court of Appeal.

The decision of the Federal Court of appeal is final.

9. Tax administration

In Canada, taxes are imposed and administered by both, the federal as well as the provincial governments. Canadian federal income taxes, both personal and corporate are levied under the provisions of the Income-tax Act Canada’s federal income tax system is administered by the Canada Revenue Agency (CRA). Provincial and territorial income taxes are levied under various provincial statutes. The federal and provincial governments have entered into agreements which are called “Tax Collection Agreements” under which, the CRA collects and remits taxes to the provinces: Provincial personal income taxes are collected by the CRA on behalf of all provinces except Quebec, so that individuals outside of Quebec file only one set of tax forms each year for their federal and provincial income taxes. Tax collection agreements enable different governments to levy taxes through a single administration and collection agency. The federal government collects personal income taxes on behalf of all provinces and territories except Quebec. “Agreeing provinces”; i.e., all provinces and territories except Quebec must use the federal definition of “taxable income” as the basis for their taxation. This means that they are not allowed to provide deductions in calculating the income on which tax is based. Federal taxes are collected by the CRA. Canada Revenue Agency collects personal income taxes for agreeing provinces/territories and remits the revenues to the respective governments Provincial and territorial governments provide both non-refundable tax credits and refundable tax credits to tax-payers for certain expenses. They may also apply surtaxes and offer low-income tax reductions.The provincial/territorial tax forms are distributed with the federal tax forms, and the taxpayer need make only one payment — to CRA — for both types of tax. Similarly, if a tax-payer is to receive a refund, he or she receives one cheque or bank transfer for the combined federal and provincial/territorial tax refund. Corporate income taxes are collected by the CRA for all provinces and territories except Ontario, Quebec and Alberta. Provinces and territories subject to a tax collection agreement must use the federal definition of “taxable income,”; i.e., they are not allowed to provide deductions in calculating taxable income. These provinces and territories may provide tax credits to companies, often in order to provide incentives for certain activities such as mining exploration, film production, and job creation. The provinces of Ontario, Quebec and Alberta collect their own corporate income taxes, and therefore may develop their own definitions of taxable income. In practice, these provinces rarely deviate from the federal tax base in order to maintain simplicity for tax-payers.

10. Integration of corporate and personal income taxes

In Canada, corporate income is subject to corporate income tax and on distribution as dividends to individuals, personal income tax. The personal income tax system, through the gross-up and dividend tax credit (DTC) mechanisms, currently provides recognition for corporate taxes, based on a 20 per cent notional federal-provincial rate, to taxable individuals resident in Canada.

11. Types of income

1. Employment income

Employment income includes salaries, wages, commissions, employment benefits, and living allowances. A few deductions, such as child-care expenses (to a specified maximum), are allowed against employment income.

2. Business and property income

The computation of income from a business or property is generally uniform whether it is earned by a sole proprietorship, partnership, corporation, or any other form of organization. Major sources of income from property include interest, dividends, rentals, and royalties and other production payments. Those with business or property income may deduct expenses incurred to earn that income, whether it is earned by an individual, a sole proprietorship, or a partnership. Sole proprietorships and partnerships are not themselves taxable entities. Instead, individuals who are sole proprietors and members of partnerships are subject to personal income tax on their respective shares of the profits of the enterprise. Corporations are separate taxable entities subject to most of the same rules for determining taxable income.

3. Other sources of income

The other principal sources of income are

• Capital gains

• Pension

• Retirement benefits

• Child tax benefits (not taxable)

• Employment insurance benefits

• Capital gains on disposition of a capital asset.

Since 1972, part of an individual’s net capital gains has been included as income from other sources. This inclusion is subject to an exemption on the first $ 100,000 of net capital gains earned between 1984 and 1994, with an enlarged exemption of $ 500,000 for gains from the sale of farm property or shares of incorporated small businesses. Gains accruing after February 1992 to real estate not used in an active business do not qualify for the $ 100,000 personal life-time capital gains exemption. Capital gains accruing after February 24, 1994 do not qualify for the $ 100,000 capital gains exemption. The $ 500,000 capital gains exemption for farmers and incorporated small businesses remains unaffected.

12. Alternative Minimum Tax

The Alternative Minimum Tax (AMT) is payable if it exceeds tax calculated in the normal manner. First, adjusted taxable income is calculated. It differs from regular taxable income in that some deductions and a number of tax incentives are not applicable. Adjusted taxable income includes 80 per cent of capital gains and losses not eligible for the capital gains exemption rather than the one-half that is included for regular tax purposes. As well, the actual amount of taxable Canadian dividends (rather than the grossed-up amount) is reported as income, but no dividend tax credit is allowed. A basic $ 40,000 exemption is subtracted from adjusted taxable income and a tax rate of 16 per cent is applied to the remainder. The federal AMT is this amount minus the basic minimum tax credit and any foreign tax credit. The basic minimum tax equals the sum of personal, spousal, charitable donation, education, disability, EI, and CPP non-refundable tax credits for the year. No other tax credits are deductible. Federal and provincial surtaxes are payable on the AMT in the same manner as on regular tax. The excess of AMT over regular tax can be carried forward for up to seven years to reduce regular tax payable to the extent that regular tax exceeds AMT.

13. Deferred Income

The Income-tax Act includes special provisions that further social policy objectives such as saving for retirement or a university education and profit sharing. These measures are provided through deferred income plans, registered pension plans (RPPs), registered retirement savings plans (RRSPs), employee benefit plans, employees’ profit-sharing plans, and registered education savings plans (RESPs). Although the tax treatment of these plans is not uniform, contributions into a plan by an employee and his or her employer (usually subject to an annual maximum) generally are deductible in calculating income, income accumulating in the plan is tax-sheltered, and benefits from the plan are taxable at the time of receipt. Contributions to RESPs are not deductible, but the income within the plan is not taxed on a current basis, and the benefits, when received, are taxable to the recipient, rather than the contributor.

14. Computation of taxable income

Section 3 provides the rules for determination of the total taxable income of a person, as per which, the following must be taken into consideration;

The total of the tax-payer’s income for the year from all sources like each office, employment, business and property, whether the source of it is within or outside of Canada must be added except income earned from sale or disposal of a property; i.e., capital gains. The total aggregate income added as such is called total income. This income is then reduced by the allowable deductions and exemptions under the Act to arrive at the net income which is further reduced by some more items to arrive at the total taxable income for the tax-payer during the relevant taxation year.

1. Tax calculation

An individual tax-payer must report his or her total income for the year. Certain deductions are allowed in determining net income, such as deductions for contributions to Registered Retirement Savings Plans, union and professional dues, child care expenses, and business investment losses. Net income is used for determining several income-tested social benefits provided by the federal and provincial/territorial governments. Further deductions are allowed in determining taxable income, such as capital losses, half of capital gains included in income, and a special deduction for residents of northern Canada. Deductions permit certain amounts to be excluded from taxation altogether.

Tax payable before credits is determined using four tax brackets and tax rates. Non-refundable tax credits are then deducted from tax payable before credits for various items such as a basic personal amount, dependents, Canada/Quebec Pension Plan contributions, Employment Insurance premiums, disabilities, tuition and education and medical expenses. These credits are calculated by multiplying the credit amount (e.g., the basic personal amount of $ 8,648 in 2005) by the lowest tax rate. This mechanism is designed to provide equal benefit to tax-payers regardless of the rate at which they pay tax.

A non-refundable tax credit for charitable donations is calculated at the lowest tax rate for the first $ 200 in a year, and at the highest tax rate for the portion in excess of $ 200. This tax credit is designed to encourage more generous charitable giving.

Certain other tax credits are provided to recognize tax already paid so that the income is not taxed twice: The dividend tax credit provides recognition of tax paid at the corporate level on income distributed from a Canadian corporation to individual shareholders; and the foreign tax credit recognizes tax paid to a foreign government on income earned in a foreign country.

2. Total income

To calculate Total Income, the following are added,

• Income from employment and commissions

• Old Age Security pension

• Canada Pension Plan or Quebec Pension Plan benefits

• Other pensions or superannuation

• Employment insurance and other benefits

• Grossed-up Canadian dividends

• Interest and other investment income

• Net income from partnerships

• Net rental income

• Current year taxable capital gains in excess of current year allowable capital losses

• Taxable support payments received

• Registered Retirement Savings Plan (RRSP) income

• Net income from self-employment (business, professional, commission, farming, and fishing)

• Workers’ compensation benefits

• Social assistance payments

• Net federal supplements

3. Net income

To calculate Net Income, the following items are deducted from Total Income:

• Registered pension plan deduction

• RRSP deduction

• Saskatchewan pension plan deduction

• Annual union, professional, or like dues

• Child care expenses

• Disability supports deduction

• Allowable business investment losses

• Moving expenses

• Deductible support payments

• Carrying charges and interest expense

• Deduction for CPP or QPP contributions on self-employment and other earnings

• Exploration and development expenses

• Other employment expenses

• Clergy residence deduction

4. Other deductions

There are certain other deductions which are,

• Repayment of certain amounts (other than salary and wages) that were included in income in the current year or a previous year

• Repayment of EI benefits

• Deductible legal fees

• Depletion allowances

• Unused RRSP contributions refunded to the tax-payer or the spouse in the current year (and included in Total Income)

• Excess registered pension plan transfers withdrawn from an RRSP or RRIF, and included in Total Income

• Capital cost allowance on a Canadian certified feature film or production

• Social benefits repayment

5. Taxable income

To calculate Taxable Income, the following items are deductible from Net Income:

• Canadian Forces personnel and police deduction

• Employee home relocation loan deduction

• Security options deductions

• Allowable other payments deduction a re workers' compensation benefits, social assistance payments, and net federal supplements

• Limited partnership losses of other years

• Non-capital losses of other years

• Net capital losses of other years

• Capital gains deduction

• Northern residents deductions

6. Additional deductions

The following are additional deductions:

• Foreign income exempt under a tax treaty (if included in Total Income)

• 15% of U.S. social security benefits included in Total Income as other pensions or superannuation

• Earned income and pension benefits given to a religious order

• Qualifying adult basic education tuition assistance, if included in Total Income

• Net employment income from prescribed international organizations

7. Exempt income

The following types of income are not taxed in Canada

• gifts and inheritances;

• lottery winnings;

• winnings from betting or gambling for simple recreation or enjoyment;

• strike pay;

• compensation paid by a province or territory to a victim of a criminal act or a motor vehicle accident*;

• certain civil and military service pensions;

• income from certain international organisations of which Canada is a member, such as the United Nations and its agencies;

• war disability pensions;

• RCMP pensions or compensation paid in respect of injury, disability, or death*;

• income of First Nations, if situated on a reserve;

• capital gain on the sale of a tax-payer’s principal residence;

• provincial child tax credits or benefits and Québec family allowances;

• the goods and services tax or harmonized sales tax credit (GST/HST credit); and

• the Canada Child Tax Benefit.

The method by which these forms of income are not taxed can vary significantly, which may have tax and other implications; some forms of income are not declared, while others are declared and then immediately deducted in full. In certain cases, the deduction may require off-setting income, while in other cases, the deduction may be used without corresponding income. Income which is declared and then deducted, for example, may create room for future Registered Retirement Savings Plan deductions.

Deductions which are not directly linked to non-taxable income exist, which reduce overall taxable income. A key example is Registered Retirement Savings Plan (RRSP) contributions, which is a form of tax-deferred savings account (income tax is paid only at withdrawal, and no interim tax is payable on account earnings).

8. Tax incentives

Certain incentives are provided by way of deductions or credits to further governmental objectives (for example, enhancement of research and development activities). Dividends from taxable Canadian corporations are treated differently from other sources of income from property. To integrate partially the taxation of corporations and their shareholders, dividend income received from taxable Canadian corporations is grossed up before being included in an individual’s taxable income. A dividend tax credit is then provided to reflect the fact that dividends are paid out of income that has already been taxed at the corporate level.

1. Tax credits and deductions
   
   Provincial and territorial governments provide both non-refundable tax credits and refundable tax credits to tax-payers for certain expenses. They may also apply surtaxes and offer low-income tax reductions.
    

2. Federal tax credits and deductions
   
   Certain deductions can be used by all tax-payers to reduce income subject to tax. The main deductions are child care expenses, contributions to registered pension and retirement savings plans, moving expenses for employees changing jobs, union dues, professional membership dues, and a restricted list of expenses incurred in connection with employment. A location-based deduction is allowed to offset the cost of living in northern Canada.
   
   The current system uses non-refundable tax credits to recognize basic living expenses and personal and family circumstances. The credits reflect the assumption that a certain amount of income should be effectively exempt from tax at the first rate of 16 per cent. These credits are subtracted from basic federal tax, with a maximum benefit of lowering basic federal tax to zero.
   
   A number of federal tax credits, including the investment tax credit, foreign tax credit, and federal political contribution tax credit, are available to both corporations and individuals. Certain unused credits and deductions can be transferred to a spouse or other supporting individual.
    

3. Dividend tax credit
   
   The dividend tax credit is one of the principal tools for integrating the personal and corporate income tax systems. Dividends received from taxable Canadian corporations are grossed up by 25 per cent before being included in an individual’s taxable income. The dividend tax credit then reduces an individual’s basic federal tax by 13 1 ?3 per cent of the grossed-up dividend income.
   
   The provinces also provide a dividend tax credit, at varying rates, that reduces provincial tax payable.
    

4. Sales tax credit
   
   A refundable sales tax credit (applied after the calculation of basic federal tax) provides relief from the federal goods and services tax (GST) for low-income families and individuals. For the period July 2005 to June 2006, the credit provides $ 227 per adult and $ 120 per dependant under 19, with a supplementary credit for single adults that is phased in at a rate of 2 percent of net income in excess of $ 7,253, to a maximum of $ 120. The total credit is reduced by 5 percent of net family income over $ 29,123 in 2004.

15. Tax payable by non-resident persons

As per section 2 (1)(3) of the Canadian Income Tax Act, a person who is not taxable under the Act, by virtue of being a non-resident for a taxation year is taxable on income arising in Canada, which includes income from personal services performed in Canada, business carried on through a permanent establishment in Canada, and capital gains on the disposal of taxable Canadian property Individuals and corporations not resident in Canada are liable for federal income tax at the regular rates on income from employment in Canada and from carrying on business here, as well as on one-half of capital gains (since October 17, 2000) on the disposal of taxable Canadian property. Other forms of income, such as dividends, interest, rents, management fees, alimony, and royalties when paid or credited to non-resident persons, are subject to special withholding taxes under part XIII of the Income-tax Act. These taxes, which must be withheld by the payer, are levied on the gross amount of the payments. The general rate of withholding tax on investment income paid to non-residents is 25 per cent unless reduced by treaty. The federal government will lower the withholding tax rate on dividends to 5 per cent for any country willing to treat dividends flowing into Canada in a similar manner. Unless the rate is reduced by treaty, non-resident corporations carrying on business in Canada are also subject to an additional tax (branch tax) of 25 per cent on after-tax earnings minus an allowance for increases in capital investment. The purpose of the tax is to equalize, at least roughly, the tax burden on Canadian branches and Canadian subsidiaries of foreign corporations:

16. International taxation

Canadian individuals and corporations pay income taxes based on their worldwide income. They are protected against double taxation through the foreign tax credit, which allows tax-payers to deduct from their Canadian income tax otherwise payable the income tax paid in other countries. A citizen who is currently not a resident of Canada may petition the CRA to change his status so that income from outside Canada is not taxed.

17. Income tax rates

1. Canadian federal personal income tax rates

Canadian federal income tax is calculated based on taxable income, then non-refundable tax credits are deducted to determine the net amount payable. The marginal tax rates (the rate of tax on the next dollar of income) in the 2005 federal rate schedule were 16 per cent on the first $ 35,595 of taxable income to 29 percent on taxable income over $ 115,739 For 2006, every tax-payer can earn taxable income of $ 8,839 ($ 8,648 for 2005) before paying any federal tax. The basic personal tax credit is calculated by multiplying the lowest tax rate by the basic personal amount. The 2006 tax credit is 15.25% x $ 8,839 = $ 1,348 (2005 is 15% x $ 8,648 = $1,297). The lowest federal tax rate was increased from 15% to 15.25% for 2006, and certain tax credits were revised.

FEDERAL PERSONAL INCOME TAX RATES

	2006 Marginal Tax Rates			2005 Taxable Income	2005 Marginal Tax Rates
2006 Taxable Income	Other Income	Capital Gains	Eligible Canadian Dividends		Other Income	Capital Gains	Canadian Dividends
First $ 36,378	15.25%	7.63%	-5.39%	First $ 35,595	15.00%	7.50%	2.08%
Over $ 36,378 up to $72,756	22.00%	11.00%	4.40%	Over $ 35,595 up to $71,190	22.00%	11.00%	10.83%
Over $ 72,756 up to $118,285	26.00%	13.00%	10.20%	Over $ 71,190 up to $115,739	26.00%	13.00%	15.83%
Over $ 118,285	29.00%	14.50%	14.55%	Over $ 115,739	29.00%	14.50%	19.58%
Federal Basic Personal Amount
2006	Tax Rate	2005	Tax Rate
$8,839	15.25%	$8,648	15.00%

The rates for 2006 use the enhanced dividend tax credit. Marginal tax rate for dividends is for actual dividends received (not grossed-up amount).

18. Corporate Taxes

Companies and corporations pay tax on profit income and on capital. These make up a relatively small portion of total tax revenue. Tax is paid on corporate income at the corporate level before it is distributed to individual shareholders as dividend A tax credit is provided to individuals who receive dividend to reflect the tax paid at the corporate level. This credit does not eliminate double taxation of this income completely, however, resulting in a higher level of tax on dividend income than other types of income. Where income is earned in the form of a capital gain only half of the gain is included in come for tax purposes; the other half is not taxed.

Corporate taxes include taxes on corporate income in Canada and other taxes and levies paid by corporations to the various levels of government in Canada. These include capital and insurance premium taxes; payroll levies (e.g., employment insurance, Canada Pension Plan, Quebec Pension Plan and Workers' Compensation); property taxes; and indirect taxes, such as goods and services tax (GST), and sales and excise taxes, levied on business inputs. Corporations are subject to tax in Canada on their worldwide income if they are resident in Canada for Canadian tax purposes. As per section 115 of the Canadian Income-tax Act, corporations not resident in Canada are subject to Canadian tax on certain types of Canadian source income . The taxes payable by a Canadian resident corporation may be impacted by the type of corporation that is, a Canadian-controlled private corporation or, a private corporation or a public corporation:

1. Federal corporate income tax system

The federal corporate income tax, like the personal income tax, is imposed under the Income-tax Act. The principles defining the scope of the tax parallel to those that apply to individual income tax-payers, and net income or profit received by Canadians is often defined by the Act without reference to individuals or corporations. There are limits on the amount of some expenditures that may be deducted; others may not be deducted at all. In order to further government policy objectives, certain incentives are provided by way of a deduction from income or a credit against tax payable. Both the corporate and personal income tax systems contain elements intended to improve integration between the two systems. A perfectly integrated system would be neutral in the amount of tax levied on income flowing through a corporation to shareholders and on the same income earned directly by shareholders. The principal tool for integration in the personal income tax is the dividend gross-up and tax credit. Canadian corporations are allowed to exclude from taxation dividends received from other Canadian corporations, on the assumption that the first company has already paid tax on them. Special rules are in effect for preferred shares as part of the current federal-provincial fiscal arrangements; the federal government provides a tax credit for taxable corporation income earned in a province or territory to make room for the provinces to levy their own corporate income tax. As long as the provincial government applies the federal definition of corporation taxable income, the federal government will collect the tax on the province’s behalf, as a provincially imposed tax. All provinces and territories impose corporate income taxes. Quebec, Ontario, and Alberta currently administer their own provincial corporate income taxes, although their tax bases are not radically different from the federal base. The federal government collects the provincial corporate income tax in all other provinces and the territories. A corporation is subject to provincial income tax in each province in which it has a permanent establishment. If a corporation has a permanent establishment in more than one province, its taxable income is allocated among the provinces according to formulas agreed upon by the federal and all the provincial and territorial governments. Currently, provincial payroll and capital taxes are deductible when calculating income for the federal corporate tax, but provincial corporate income taxes are not. This situation has created an incentive for provincial governments to impose payroll and capital taxes instead of income taxes. Through a series of announcements beginning in 1992, the federal government has repeatedly delayed the implementation of a proposal to limit the deductibility of these taxes when calculating income for federal tax purposes. Interim measures now in effect deny, at least until the end of 2005, the deductibility of any increases in provincial payroll and capital taxes, whether through rate increases, base changes, or the introduction of new taxes. An exemption was introduced for the three provinces that have harmonized their retail sales taxes with the goods and services tax (GST).

2. Tax credits

Investment tax credits, which reduce tax otherwise payable, are available for certain investments and qualifying expenditures. Credits of 20 or 35 per cent can be claimed for expenditures on scientific research and experimental development carried on anywhere in Canada. Unclaimed balances may be carried forward or backward for limited periods.

3. Federal corporate income tax rates

Tax rates

The federal corporate income tax rate structure is a basic rate of 38 per cent with a reduction of 7 percentage points available for income other than that from investments or natural resources, and further reductions for manufacturing and processing (M &P) income earned in Canada, the first $ 300,000 of active business income of Canadian-controlled private corporations (CCPCs), and income earned in a province—10 percentage points. A general 4 per cent surtax (equal to 1.12 per cent of taxable income) is imposed on federal corporate income taxes.

Selected years	2005	2006
General business .........	21%	21%
Manufacturing and processing	21%	21%
Natural resources .........	25%	25%
Investment income ........	28%	28%
Small business .......	12%	12%

Corporations can also take advantage of tax credits for federal political contributions, charitable donations, and gifts to Canada and the provinces, as well as tax credits to offset the double taxation of foreign-source income. The federal government also provides a credit for logging taxes paid. A refundable Canadian film credit is available for 25 per cent of salaries and wages paid while making an eligible Canadian film.

4. Provincial corporate income tax systems
   
   All provinces have at least two rates for corporate income. A lower rate is levied on corporate income that qualifies for the federal small business deduction (except in Quebec, which no longer offers a small business rate) and a higher general rate (or rates) on other corporate income. Since the federal government raised the threshold at which the low rate disappears, all provinces have followed. A number of provinces have committed to raising their thresholds even further in future years. The general rate is applicable to all other corporate income; however, several provinces have a preferred rate. Quebec, Ontario, and Alberta operate their own corporate tax systems.
    

5. Provincial corporate income tax rates on small businesses, effective July 1, 2005

   Province/territory	Rate per cent	Threshold  begins dollars
   Newfoundland and Labrador	500%	30000000%
   Prince Edward Island	650%	30000000%
   Nova Scotia	500%	35000000%
   New Brunswick	2	450,000
   Quebec	8.9	300,000
   Ontario	5.5	400,000
   Manitoba	5	400,000
   Saskatchewan	5	300,000
   Alberta	3	400,000
   British Columbia	4.5	400,000
   Northwest Territories	4	300,000
   Nunavut	4	300,000
   Yukon	4	300,000

6. Corporate minimum tax (CMT)
   
   The corporate minimum tax applies to corporations with annual gross revenues in excess of $ 10 million or total assets in excess of $ 5 million. The tax is paid to the extent that CMT liability exceeds regular income tax liability. The tax is based on a company’s financial-statement income computed according to GAAP, but the financial statement cannot be prepared on a consolidated basis. The tax is imposed on the portion of a corporation’s CMT base that is allocated to Ontario, at a rate of 4 per cent.
    

7. Capital taxes

1. Federal capital taxes

An annual tax of 1.25 per cent of paid-up capital over $200 million employed in Canada, as defined, is payable by financial institutions. All corporations are subject to an annual tax (large corporations tax or LCT) of 0.175 percent of paid-up capital in excess of $ 10 million. This tax is not deductible for income tax purposes but is reduced by any current year corporate income surtax payable. Surtax incurred in any of the three previous or seven subsequent taxation years may also be carried over to reduce current year LCT liability.

2. Provincial capital taxes

Nova Scotia, New Brunswick, Quebec, Ontario, Manitoba, and Saskatchewan impose a general tax on the paid-up capital of corporations. British Columbia eliminated its general capital tax effective September 1, 2002. All of the provinces except Alberta levy a tax on the paid-up capital of banks and loan and trust companies. Each province defines its paid-up capital base somewhat differently, but most are moving to harmonize their legislation with the federal capital tax system. As well, the definition of paid-up capital is different for financial institutions and other corporations. In general, paid-up capital includes the amount received by a company on its issued share capital as well as its contributed surplus, retained earnings, long-term debt, short-term debt of a capital nature, and all reserve funds except those for depreciation, depletion and doubtful debts. Limited allowances are made for goodwill and investment. Governmental corporations (for example, municipalities) and charitable organizations are generally exempt from capital taxation. Nova Scotia levies a general capital tax at a rate of 0.275 percent on corporations with taxable capital in excess of $ 10 million. Where taxable capital is less than $ 10 million, the applicable rate is 0.58 percent, and a capital deduction of $5 million is allowed. Financial institution capital tax is levied at 3 percent of taxable capital over $ 500,000. Trust and loan companies with head offices in the province are eligible for an enhanced capital deduction of $ 10 million.

19. Indirect Taxes

1. Sales tax

The federal government levies a multi-stage sales tax of 6% on goods and services that is called the Goods and Services Tax (GST), and, in some provinces, the Harmonised Sales Tax (HST). The GST/HST is similar to a value-added Tax. All provincial governments except Alberta levy sales taxes as well. The provincial sales taxes of Nova Scotia, New Brunswick and Newfoundland and Labrador are harmonized with the GST. That is, a rate of 14% HST (15% prior to 1 July 2006) is charged instead of separate PST and GST. Both Quebec and Prince Edward Island apply provincial sales tax to the sum of price and GST. The territories of Nunavut, Yukon and Northwest Territories do not charge provincial sales tax.

Provincial and federal sales tax rates at the retail level on goods and some services are as follows:

Alberta	0 + 6% = 6%
British Columbia	7% + 6% = 13%
Manitoba.	7% + 6% = 13%
Ontario	8% + 6% = 14%
Prince Edward Island	10% + 6% = 16.6% (Provincial SalesTax
(PST) applied to price
+ GST)
Quebec	7.5% + 6% = 13.95% (PST applied to price
+ GST)
Saskatchewan	5% + 6% = 11%

2. Property taxes

The municipal level of government is funded largely by property taxes on residential, industrial and commercial properties. These account for about ten per cent of total taxation in Canada.

3. Excise taxes

Both the federal and provincial governments impose excise taxes on inelastic goods such as cigarettes, gasoline, alcohol, and for vehicle air conditioners. A great bulk of the retail price of cigarettes and alcohol are excise taxes. The vehicle air conditioner tax is currently set at $ 100 per air conditioning unit. Canada has some of the highest rates of taxes on cigarettes and alcohol in the world. These are sometimes referred to by Canadians as "sin-taxes".

4. Payroll taxes

Ontario levies a payroll tax on employers, the "Employer Health Tax", of 1.95% of payroll. Eligible employers are exempt on the first $ 400,000 of payroll. This tax was designed to replace revenues lost when health insurance premiums, which were often paid by employers for their employees, were eliminated in 1989. Quebec levies a similar tax called the "Health Services Fund". For those who are employees, the amount is paid by employers as part of payroll. For those who are not employees such as pensioners and self-employed individuals, the amount is paid by the tax-payer.

5. Goods and Services Tax

The tax is a 6% charge (previously 7% before July 1, 2006) on the sale of all goods and services, except certain essentials such as groceries, residential rent, and medical services, and services such as financial services. The tax is levied on each sale. Businesses that purchase goods and services as inputs can claim "input tax credits" (i.e., they deduct from the amount of GST they have collected the amount of GST that they have paid). This avoids "cascading" (i.e., the application of the GST on the same good or service several times as it passes from business to business on its way to the final consumer). In this way, the tax is effectively borne by the final consumer. Exported goods are exempt, while individuals with low incomes can receive a GST rebate calculated in conjunction with their income tax. In 1997, the provinces of Nova Scotia, New Brunswick, and Newfoundland and Labrador and the Government of Canada merged their respective sales taxes into the Harmonized Sales Tax (HST). In those provinces, the HST rate is 14% (previously 15% before July 1, 2006). HST is administered by the federal government, with revenues divided among participating governments according to a formula. All other provinces continue to impose a separate sales tax at the retail level only, with the exception of Alberta, which does not have a provincial sales tax. In PEI and Quebec, the provincial taxes include the GST in their base. The three territories of Canada (Yukon, Northwest Territories and Nunavut) do not have territorial sales taxes. The government of Quebec administers both the federal GST and the provincial QST. It is the only province to administer the federal tax.

Untaxed items

For tax-free i.e., "zero-rated" sales, vendors do not charge GST. However, they are still able to recover any GST paid on purchases used in making the tax-free good or service. This effectively removes all tax from these goods and services. Tax-free items include basic groceries, prescription drugs and medical devices. Exports are also zero-rated. For tax-exempt sales, vendors do not charge tax on their sales. By the same token, however, they are not entitled to credits for the GST paid on inputs bought for the purposes of making the exempt good or service. Tax-exempt items include residential rents, health and dental care, educational services, day-care services, legal aid services and financial services.