Salaries, wages, commissions, directors' fees, and all other remuneration received by an officer or employee are included in income from employment. Canadian residents are taxable on worldwide income, whether remitted in Canada or not. Most fringe benefits (e.g. interest-free or low-interest loans) received or enjoyed in connection with employment are also taxed as employment income. Foreigners working temporarily or permanently in Canada are eligible for special concessions for employment at a special work site or remote location. The rules exempt from tax most amounts received as allowances for board and lodging, as well as transportation between the special work site and the employee's principal place of residence.
Employer contributions to a registered pension plan or deferred profit sharing plan will be taxed when the employee receives a distribution from the plan.
A non-resident of Canada is subject to a 25% WHT on plan withdrawals. The plan administrator is responsible for withholding and remitting this tax. However, a non-resident individual can elect to have the withdrawal taxed at graduated rates. In certain circumstances, this election enables the taxpayer to withdraw the funds tax-free up to an annual threshold, which is usually the personal tax credit for the year. The 25% rate may also be reduced under the provisions of an income tax treaty.
Employee Profit Sharing Plans (EPSPs)
A 'specified employee' (generally an employee who has a significant interest in, or does not deal at arm’s length with, the employer) is subject to a special tax on the portion of an employer’s EPSP contribution, allocated by the trustee to the employee, that exceeds 20% of the employee’s salary received in the year from the employer. The tax rate will equal the top combined marginal rate of the province or territory in which the employee resides (except for Quebec residents, for whom the tax rate will equal the top federal marginal tax rate, which is 33%).
Employees who exercise options to acquire shares of their employer corporation (or a related corporation) will be considered in receipt of a benefit in the year of exercise, based on the difference between the market value of the shares on the date of purchase and the total price paid to acquire the options and the shares themselves. In most cases, 50% of this benefit (25% for Quebec tax purposes, except for options of small- or medium-sized businesses conducting innovative activities, and for options granted after 21 February 2017, in shares of public corporations with at least CAD 10 million payroll in Quebec) is deductible from taxable income. As a result, only half of this benefit (75% for Quebec tax purposes if none of the above exceptions apply) is included in income.
Employees who cash out their stock option rights will be eligible for the stock option deduction only if their employer makes an election to forgo deducting the cash payment from its income. The cost of the shares to the employee for capital gains purposes is the market value of the shares on the day the option is exercised. Any capital gain or loss accruing after the date of exercise will arise only on the ultimate disposition of the shares. An exception is provided for stock options of Canadian-controlled private corporations (CCPCs) granted to employees of CCPCs, which are not subject to tax until the employee disposes of the underlying shares.
Draft legislative proposals limit the use of the current employee stock option tax regime and move towards aligning the tax treatment of stock options with the United States for employees of large, long-established, mature firms. The draft legislative proposals:
- impose a CAD 200,000 annual vesting limit (based on the value of an option's underlying shares at the date of grant) on options that can qualify for the 50% employee stock option deduction, and
- introduce an employer deduction for the amount of stock option benefits that exceeds the new annual vesting limit, subject to certain conditions.
The proposed rules will not apply to Canadian-controlled private corporations, or employers that will be specified in the Income Tax Regulations.
Business income for self-employed individuals includes most income earned from any activity that is intended to be carried on for profit. Evidence must exist to support this intention. It does not include employment income.
Loss relief is available for self-employed individuals. Business losses from self-employment can be offset against income from the self-employment. Business losses can be carried back for a period of three years and carried forward for a period of 20 years.
For taxation years beginning before 22 March 2017, taxpayers in certain designated professions (accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors) could elect to exclude the value of work in progress (WIP) in computing their income. This election effectively allowed these taxpayers to defer tax by deducting costs associated with work in progress in advance of the matching revenue inclusion.
For taxation years beginning after 21 March 2017, taxpayers who had previously elected to exclude WIP in calculating taxable income can no longer deduct the cost of WIP, subject to a transitional period (the lower of the cost and fair market value of the WIP is gradually included in income over five years). If no election was previously made, there is no deduction available for the cost of WIP.
Half of a capital gain constitutes a taxable capital gain, which is included in the individual's income and taxed at ordinary rates.
No special concessions are available to short-term residents with respect to the taxation of capital gains. However, a step-up in the cost base is available to new residents of Canada, which may reduce the amount of capital gains otherwise subject to tax.
The purchaser of taxable Canadian property is generally required to withhold tax from the proceeds paid to a non-resident vendor, unless the non-resident vendor has obtained a clearance certificate.
Taxable Canadian property of a taxpayer includes, among other things:
- Real estate situated in Canada.
- Both capital and non-capital property used in carrying on a business in Canada.
- In general, shares in a corporation that are listed on a stock exchange if, at any time in the preceding 60 months:
- 25% or more of the shares of the corporation are owned by the taxpayer or persons related to the taxpayer, and
- more than 50% of the fair market value of the shares is derived from real property situated in Canada, Canadian resource properties, and timber resource properties.
- In general, shares in a corporation that are not listed on a stock exchange if, at any time in the preceding 60 months, more than 50% of the fair market value of the shares is derived directly or indirectly from property similar to that described above for shares of a public corporation.
However, in specific situations the disposition by a non-resident of a share or other interest that is not described above may be subject to Canadian tax (e.g. when a share is deemed to be taxable Canadian property).
Capital gains reserve
When capital property is sold at a profit in the year or in a previous year, a reserve can be claimed on any proceeds that are not due until after the year end. The reserve equals the portion of the gain related to the sale proceeds that are not due until after the end of the year. The reserve mechanism can be used to spread gains over a maximum of five years on most types of capital property. Amounts brought into income each year under the reserve mechanism are treated as capital gains. A reserve cannot be claimed if the taxpayer was not resident in Canada at the end of the year or at any time in the immediately preceding year.
Capital gain on sale of residence
A gain realised on the sale of an individual's home (principal residence) is exempt from tax in most instances. A loss is not deductible. Generally, a capital gain realised on the sale of a principal residence will be fully exempt from tax only if the taxpayer has been resident in Canada and has occupied the home during all the years of ownership (or all years except one, known as the 'one-plus' rule, which is intended to ensure that an individual who, in the same year, disposes of a home and acquires a replacement residence is not precluded from designating both properties as a principal residence). Only one principal residence per family unit in a tax year is eligible for this treatment.
Special rules permit resident taxpayers who temporarily rent their home to others to elect to continue to treat it as a principal residence for a further period. Generally, the period is up to four years, but it can be extended if the taxpayer is temporarily transferred by the employer and eventually returns to the same residence.
Individuals who sell their principal residence must report the sale (i.e. date of acquisition, proceeds of disposition, and a description of the property) and the principal residence designation on their income tax returns to claim the full principal residence exemption.
The 'one-plus' rule (see above) is eliminated if the purchaser of Canadian residential real estate was not resident in Canada during the year the property was purchased. As a result, non-residents who acquire residential properties in Canada can no longer claim a portion of the principal residence exemption to shelter gains on a later sale.
Assessments and reassessments
The CRA can reassess tax, after the end of the normal reassessment period (three years after the date of the initial notice of assessment, for most taxpayers), on a gain from the disposition of real or immovable property if the taxpayer does not initially report the disposition.
Capital gains exemption
A lifetime capital gains exemption (LCGE) allows a Canadian-resident individual to realise, tax free:
- up to CAD 883,384 for 2020 (indexed thereafter) in capital gains on the disposition of shares of a qualifying small business corporation, and
- up to CAD 1 million for dispositions of qualified farm and fishing properties.
An individual resident in Canada for only part of the year may be eligible to claim the exemption if that individual was a resident of Canada throughout the immediately preceding or following year.
Mutual fund trusts: Allocation to redeemers methodology
When a mutual fund trust unitholder redeems its units, the trust often must dispose of investments to fund the redemption, recognising accrued gains in the trust. Although a 'capital gains refund' mechanism is available under the Canadian Income Tax Act to prevent potential 'double taxation' that could result, the mechanism does not always work well. Accordingly, the mutual fund trusts often use the 'allocation to redeemers methodology' to match the capital gains realised by the mutual fund trust on its investments to pay for the redemption with the capital gains realised by the redeeming unithholders on their units. The methodology allows a mutual fund trust to allocate capital gains realised by it to a redeeming unitholder and claim a corresponding deduction. The allocated capital gains are included in computing the redeeming unitholder's income, but its redemption proceeds are reduced by that amount.
Certain mutual fund trusts have been using the allocation to redeemers methodology:
- to allocate capital gains to redeeming unitholders that exceed the capital gains that would otherwise have been realised by these unitholders on the redemption of their units, resulting in a deferral benefit to the remaining unitholders (the deferral benefit), and
- to allow the mutual fund trust to convert the returns on an investment that would have the character of ordinary income to capital gains for their remaining unitholders, which is possible when the redeeming unitholders hold their units on income account, but others on capital account (the character conversion benefit).
For taxation years of mutual fund trusts beginning after 18 March 2019, draft legislative proposals introduce new rules to deny a mutual fund trust a deduction to address:
- the deferral benefit on the portion of an allocation made to a unitholder on a redemption of a unit of the mutual fund trust that exceeds the capital gain that the unitholder would otherwise have realised on the redemption under certain conditions*, and will require mutual fund trusts to use 'reasonable efforts' to determine the unitholder's cost amount, and
- the character conversion benefit in respect of an allocation made to a unitholder on a redemption if:
- the allocated amount is ordinary income, and
- the unitholder's redemption proceeds are reduced by the allocation.
* For mutual fund trusts listed on a designated stock exchange in Canada and in continuous distribution, the effective date of the first denied deduction is deferred to taxation years beginning after 19 March 2020.
For 2020, non-eligible and eligible dividends from Canadian corporations are grossed up by 15% and 38%, respectively, for inclusion in income. A federal tax credit can then be claimed for 9.03% (non-eligible) or 15.02% (eligible) of the grossed-up dividend, in addition to a provincial or territorial tax credit.
Eligible dividends must be designated as such by the payer. Dividends generally will be eligible dividends if the corporation that pays them is resident in Canada and either is a public corporation or is not a CCPC. However, these corporations will pay non-eligible dividends in certain cases (e.g. if they received non-eligible dividends). Dividends from CCPCs will be eligible or non-eligible depending on the source of the dividends paid.
A non-resident's Canadian-source dividends are subject to WHT of 25%. That income is not subject to graduated rates. The 25% WHT, which is deducted at source, may be reduced under an income tax treaty to rates ranging from 5% to 20%.
Interest income is taxed as ordinary income, regardless of whether or not the interest is derived from a source in Canada. Accrued interest income on most debt obligations must be reported annually.
A non-resident's Canadian-source interest (except for most interest paid to arm's-length non-residents) is subject to WHT of 25%. That income is not subject to graduated rates. The 25% WHT, which is deducted at source, may be reduced under an income tax treaty to rates ranging from 0% to 18%.
Rental income is generally taxed as ordinary income.
A non-resident's Canadian-source rental income is subject to WHT of 25%. For real estate rentals that do not constitute income from carrying on a business, a non-resident can elect to be taxed on the net income from these sources at the graduated tax rates that apply to residents. However, the availability of personal and other tax credits to individuals electing to file on this basis is restricted. Any excess tax withheld is refundable to the non-resident. If an election is made, the non-resident can also file an undertaking that results in WHT being levied on only the net income from these sources.
Individuals working temporarily in Canada often have rental income from renting out their foreign home while in Canada. Deductions for expenses incurred to maintain the foreign house are allowed in determining the portion of rental income subject to the graduated tax. Canadian tax law, however, limits the amount of capital cost allowance (i.e. tax depreciation) that can be deducted to the amount required to reduce the rental income to zero. This ensures that a rental loss cannot be created by claiming capital cost allowance. If rental expenses, except for capital cost allowance, exceed rental income, the loss generally may be offset against the individual's other income, provided certain conditions are satisfied. The deductibility of rental losses against other income may be restricted if there is no reasonable expectation of a profit from the rental property.
Foreign accrual property income (FAPI)
Individuals resident in Canada are taxed on certain investment income (FAPI) of controlled foreign affiliates as it is earned, whether or not distributed. A grossed-up deduction is available for foreign income or profits taxes and WHTs paid in respect of the income. A foreign corporation is considered to be a foreign affiliate of a Canadian individual if the Canadian individual owns, directly or indirectly, at least 1% of any class of the outstanding shares of the foreign corporation and the Canadian individual, alone or together with related persons, owns, directly or indirectly, at least 10% of any class of the outstanding shares of that foreign corporation. The foreign affiliate will be a controlled foreign affiliate if certain conditions are met (e.g. more than 50% of the voting shares are owned, directly or indirectly, by a combination of the Canadian individual, persons dealing at non-arm’s length with the Canadian individual, a limited number of Canadian resident shareholders, and persons dealing at non-arm’s length with such Canadian resident shareholders).
Non-resident trusts (NRTs)
An NRT will generally be deemed to be resident for Canadian tax purposes if (i) it has Canadian resident contributors or (ii) certain former Canadian residents have contributed to an NRT that has Canadian resident beneficiaries. However, an election can be filed to deem the creation of a separate notional trust for tax purposes, referred to as a ‘non-resident portion trust’. Canadian tax will apply only to the income or gains from the properties held by the trust that are not included in the non-resident portion trust. Properties included in the non-resident portion trust are those that have not been contributed directly or indirectly by a Canadian resident or certain former Canadian residents (or property substituted for those properties or income derived from those properties). Many direct or indirect transfers or loans of property or services can be deemed to be contributions to an NRT.
An NRT will also be deemed to be resident in Canada if a Canadian-resident taxpayer transfers or lends property to the trust (regardless of the consideration received) and the property held by the trust may revert to the taxpayer, pass to persons to be determined by the taxpayer, or be disposed of only with the taxpayer’s consent.
Offshore investment funds
The offshore investment fund rules affect Canadian residents that have an interest as a beneficiary in these funds. If the rules apply, the taxpayer will be required to include in its income an amount generally determined as the taxpayer’s cost of the investment multiplied by a prescribed income percentage (i.e. the prescribed rate of interest plus 2%) less any income received from the investment. Also, for certain non-discretionary trust funds in which a Canadian-resident person, and persons that do not deal at arm's length with the person, have interests in aggregate of 10% or more of the total fair market value of the total interests in the trusts, the trust is deemed to be a controlled foreign affiliate of the Canadian beneficiary and is thereby subject to the Canadian FAPI rules (discussed above).
Few income items are specifically exempt from personal income tax in Canada.