Chapter 7: Basics of Taxation Flashcards
What are the 6 most common reasons for collecting taxes?
- Source of government revenue
- Regulatory measures
- Moral suasion
- Redistribution of wealth
- Economic incentive or disincentive
- Information gathering
What are “sin taxes”?
A form of moral suasion. Tax measures to discourage certain behaviours such as taxes on gasoline, alcohol, and tobacco.
What are the two types of income tax systems?
Progressive tax system and flat tax system.
How do progressive tax systems work?
A lower amount of tax is imposed on lower income earners, and tax rates increase as income levels increase.
What are regressive taxes?
Cause a lower income earner to pay more tax than a higher earner. This is seldom done by design, but can occur if taxes are poorly implemented.
What are consumption taxes?
Include sales tax, charged at the point of purchase. Goods and Service Tax (GST) and Harmonized Sales Tax (HST) are two common examples in Canada.
How are consumption taxes seen to reduce economic activity?
Like flat taxes, they seem to penalize low income earners as high income earners and low income earners pay the same amount on the purchase of goods.
What are excise taxes?
Generally charged selectively on certain types of services or commodities such as airline travel, gasoline, and alcohol. In the case of gasoline, the tax is paid by the seller, but the cost is usually passed on to the end consumer.
What are inheritance taxes?
Although not applicable in Canada, these are taxes that are assessed on amounts inherited.
What are estate taxes?
Taxes paid based on the value of a deceased person’s estate at the time of death, often only applied to estates with relatively high values. Canada does not assess estate taxes, though the US does and the top estate tax rate in the US is 40%. Probate can be considered a form of estate tax although in Canada, the highest probate fee is only 1.695% in Nova Scotia.
What is land transfer tax?
Tax assessed on the party receiving the transfer of land when property is transferred from one owner to another.
Which provinces assess a land transfer tax?
No federal land transfer tax. All provinces except Alberta and Saskatchewan and rural Nova Scotians.
What is property tax?
One of the oldest forms of taxation. Assessed against the value of real property owned.
What is payroll tax?
Assessed against employers who have a certain number of employees or who pay a certain amount of remuneration. Sometimes levied against employees directly. Often used to fund unemployment insurance. Fairly rare in Canada, except some provinces assess payroll tax on employers who exceed thresholds for amount of payroll or number of employees.
What is capital tax?
A tax based on the amount of capital (similar to property tax) normally not assessed on individuals. Common for banks and insurers to pay tax based on their holdings of capital.
What is investment tax?
Tax assessed on financial transactions such as stock purchases, designed to create a degree of regulation of the financial services industry. Not assessed in Canada.
What are user fees?
Fees or taxes assessed when certain services are accessed. These include garbage collection, driver’s license fee, business permits, probate fees, etc. Some provinces assess it as a fee, some as a tax (little difference between the two).
Which type of tax is considered an indirect tax and why?
Excise taxes as they are taxed to the importer or manufacturer, not the consumer, even though they increase the eventual consumer’s costs. Indirect as the consumer ends up paying a tax without being made directly aware of it.
What is tax avoidance?
When a taxpayer reduces their burden while still working within the strict interpretation of the rules. “Using loopholes”
What is GAAR?
The General Anti-Avoidance Rule which can be invoked by the CRA when it appears that a taxpayer has re-arranged their affairs to avoid taxes.
What is tax deferral?
Earning income now, but paying tax on it in the future.
What is the definition of income splitting?
Earning a source of income, but having another taxpayer pay tax on it.
When was the first income tax instituted in Canada and why?
In 1917 due to the high cost of World War 1. Was supposed to be temporary but high government debt compelled the government to make it permanent in 1922.
On which basis do jurisdictions tax on?
Net income, which is income from all sources reduced by certain deductions.
How is provincial tax handled in common-law provinces?
In provinces such as Quebec, two separate returns are filed - one federal, one provincial - each with their own separate calculation.
What is the surtax on income tax?
Effectively a tax on tax payable for higher income earners. Only PEI and Ontario apply a surtax to personal income.
What does Section 85(1) of the Act refer to?
Subsection 1 of section 85 of the Income Tax Act.
What does Part I of the Act deal with?
Almost all information related to taxation of individual and corporate taxpayers. Sections 2 through 180.
What does Part IV of the Act deal with?
Passive dividend income earned by corporations.
What does Part X of the Act deal with?
DPSPs. Subdivided into X.1, X.2, etc.
What does Part XI of the Act deal with?
RDSPs. XI.01 deals with taxes in respect to TFSAs.
How many parts and sections of the Act are there (at the time of writing)?
17 Parts and 270 sections.
What is the difference between a married couple and common-law couple under the Income Tax Act?
No difference. A legally married couple is just one that has been married under the Marriage Act.
What defines a common-law couple for the purposes of the Income Tax Act?
Any couple that has lived together in a conjugal relationship for at least 12 months or lie together and are parents of the same child/raise a child together.
What defines separation under the Income Tax Act?
End of a marriage or common-law couple defined by 90 days of being separated.
What is a sham separation?
When a couple separates for tax purposes only. CRA has been known to challenge the separated status of some taxpayers in some cases.
What does the Income Tax Act define as a “child”?
Legal children, children dependent on the taxpayer under 19 years old, child of the taxpayer’s spouse or common-law partner, spouse of the child of a taxpayer.
What does a “person” refer to under the Income Tax Act?
Can be an individual (flesh and blood person) or a corporation.
What are the 2 other types of taxpaying entities beyond individuals and corporations?
Trusts and partnerships.
When does a partnership become a taxable entity in its own right?
If there are more than 5 partners.
How are partnerships taxed?
Nearly identical to the taxation of individuals.
On which bases are Canadian taxpayers taxed?
On the joint bases of residency and location of income.
How are non-residents of Canada taxed in Canada?
To the extent that there is Canadian-resident income, most likely from carrying on business or investment activity in Canada.
Who enforces the Income Tax Act?
The Department of Finance is responsible for the review and implementation of most tax measures, with other Departments often providing recommendations.
What is the CRA’s role?
The CRA’s responsibility is only administrative.
When does the government pass their Budget?
Usually in about February. Sometimes use a Fall “mini budget” known as the Fall Economic Statement.
What informal methods (aside from the Budget) can be used to implement income tax measures?
A “mini budget” known as the Fall Economic Statement or economic policy notes.
Who does jurisdiction fall to once income tax legislation has passed?
Department of Justice.
What are the CRA’s functions?
Processing tax returns, providing information to assist taxpayers in filing their taxes, ensuring taxpayers have paid tax in accordance with legislation and regulations.
When are the filing and payment deadlines for employed individuals?
April 30
When are the filing and payment deadlines for self-employed individuals (and their spouses)?
Filing by June 15, payment by April 30
When are the filing and payment deadlines for deceased taxpayers?
Same as for a living taxpayer except no less than 180 days after death.
When are the filing and payment deadlines for an Inter Vivos trust?
April 30
When are the filing and payment deadlines for a Testamentary Trust?
90 days after the trust’s year end.
When are the filing and payment deadlines for corporations?
Filing 180 days after the corp’s year-end, payment 60 to 90 days after the corp’s year end.
When are the filing and payment deadlines for partnerships with fewer than 5 partners?
Partners report all income and losses personally. No return is necessary for the partnership.
When are the filing and payment deadlines for partnerships with more than 5 partners?
File a return by March 31. Partners report all income and losses personally.
Why is it beneficial for a child (under 18) to file an income tax return if they have income?
To build their RRSP contribution room.
Which types of returns do individuals and corporations file?
Individuals - T1 General
Corporations - T2 General
+ any relevant Schedules
What does a “voluntary tax system” imply?
The onus is on the taxpayer to file a tax return.
How long does the CRA have to file a Notice of Reassessment?
4 years from the filing date, although an auditor can request an additional 4 years beyond that.
How long does the Act require taxpayers to retain records for?
6 years after the end of the tax year in question.
What happens if a taxpayer disagrees with a Reassessment?
Normally given 90 days or one year after the date the original return was due to file an objection.
What occurs if a taxpayer files an objection to a Reassessment?
The CRA has an Appeals Division. If the taxpayer and CRA are unable to agree, the taxpayer has 90 days to appeal to the Tax Court of Canada which is part of the Department of Justice. Once a matter has concluded at the Tax Court, a taxpayer can appeal to the Federal Court of Appeal. Some taxpayers have even appealed to the Supreme Court of Canada.
How does the CRA release their interpretations of the Income Tax Act?
In the form of Information Bulletins (now Tax Folios), Information Circulars, Pamphlets, Rulings, etc.
These documents do not have the force of law and CRA’s interpretations may be incorrect.
How much can be tax planners/preparers be held liable for if they help create schemes for inappropriate tax savings for clients?
A penalty for $1000 or up to the amount that the scheme created savings to the client (such as $50,000 in penalties for $50,000 in tax savings).
How much can be tax planners/preparers be held civilly liable for if they help create schemes for inappropriate tax savings for clients?
$1000 or the lesser of $100,000 plus the taxpayer’s savings and the penalty the taxpayer would have to pay.
In which provinces does the CRA not collect provincial taxes?
Quebec - Revenu Quebec
Alberta - Finance Department (corporate provincial taxes)
How much interest accrues on late amounts owing to the CRA?
Interest rate based on the prescribed rate of interest + 4%.
What is the prescribed rate of interest?
Based on the 90-day Government of Canada T-bill for the first month of the prior quarter.
If the average T-Bill rate in January is 0.87%, February is 1.04%, March is 1.09%, what will the prescribed rate for the second quarter of 2021 be?
1%. Take the T-bill rate in the first month of the prior quarter and round up to the next highest round number. Would be 2% if the January rate was instead 1.04%.
How much would a taxpayer owe in interest if they paid 214 days late and owed $1,000 of taxes? The prescribed rate in this situation is 2%.
$35.71 of interest. P/Y & C/Y = 12 (compounds monthly) I/Y = 6% (2% + 4%) xP/Y = 214/365 PMT = 0 PV = 1000
What penalties are associated with filing taxes late?
Interest accrues.
Initial 5% penalty of the balance owing.
1% of the balance owing each month for a maximum of 12 months.
Interest will be assessed on the penalties at the prescribed rate.
Does interest accumulate on penalties for filing income taxes late?
Yes, at the prescribed rate (not +4%).
What happens to repeat late filers?
If a taxpayer has late filing for any of the 3 prior years and files late in the current year, the penalty is raised to 10% up front and 2% per month to a maximum of 12 months (24%).
What are the taxpayer relief provisions?
The CRA can waive penalties for up to 10 preceding years in exceptional circumstances (such as if a taxpayer was dealing with illness)
Which items should be dealt with first if in arrears with the CRA?
CPP and GST/HST items before ordinary taxes.
What are the penalties for unreported income?
The least of:
10% of the unreported income or
50% of the difference between the understated tax (or falsely claimed benefits) and the amount of tax withheld related to the unreported income
What are the penalties for gross negligence and when do they apply?
For taxpayers who willfully evade taxes, usually repeat offenders. Based on the greater of…
$100 or
50% of the tax benefit gained
What is the Voluntary Disclosure Program (VDP)?
Gross negligence penalties and failure to pay penalties can be waived if a taxpayer discloses their transgression (with the assistant of a competent tax professional) before the CRA catches them.
What are tax credits calculated on?
Taxable income. Applied to reduce taxes once tax has been calculated on net income.
When are taxpayers required to remit instalments?
Quarterly instalments will be required if a taxpayer has owed more than $3,000 in two consecutive years.
In which months do quarterly installments need to be paid?
15th of March, June, September, and December.
What is line 23600?
Net Income
Why are deductions from net income not widely available?
These tend to correspond to specific scenarios.
Summarize the 13-step process for calculating taxes.
- Calculate total income
- Deductions from total income
- Calculate net income
- Deductions from net income
- Calculate taxable income
- Calculate federal tax
- Apply NRTxCr
- Certain deductions and additions to basic federal tax
- Calculate provincial tax
- Apply NRTxCr (Provincial)
- Calculate total of Fed and Prov tax
- Calculate credits
- Refund or balance due
What are the 4 sources of total income?
- Employment income
- Self-employment income
- Investment income
- Interest income
What are the 3 distinct types of dividends?
- Foreign dividends
- Eligible dividends (Canadian publicly-traded company or private income with dividend income from GRIP pool in excess of $500K)
- Ineligible dividends (privately owned Canadian corps out of income below $500K threshold)
How are different dividends taxed?
No preferential tax treatment on foreign dividends.
Eligible dividends are grossed up by 38% and taxpayer is taxed on the grossed up amount. A fed tax credit is provided at 15.02% of the taxed up amount. A prov tax credit is also provided.
Ineligible dividends are grossed up by 15%, with a tax credit of roughly 9% of the grossed up amount.
What is the primary benefit of taking dividend income over salary income?
Allows the business owner to not have to pay CPP premiums. There can also be some income-splitting benefits.
How does dividend income impact someone collecting OAS benefits or the Canada Child Benefit?
The dividend gross-up increases the taxpayer’s net income, but the credit does not reduce net income. Can impact income-tested benefits.
How are GICs taxed?
On an accrual basis, meaning tax is paid as interest is accrued each year, not when it is collected at maturity. There are no tax deferral benefits.
The only tax deferral benefit is that the investor earns interest in one year that is not taxed until the following year as interest is deemed on December 31 of the following year.
Example: if you invest in a GIC in June 2021, no interest will be deemed for 2021, interest will be deemed on December 31, 2022.
What are sources of other income?
OAS benefits CPP benefits Pension, Annuity, RRIF income Pension income splitting EI benefits Income from reg. plans Support payments received Workers comp benefits Social assistance payments Net federal supplements
What are sources of income that may be received on a tax-free basis?
- Most insurance benefits
- Winnings (if not pro gambler)
- Return of Capital
- Inheritances
- Certain transfers and property rollovers
- Gifts
What are examples of deductions from net income?
- Northern residents deductions
- Capital gains deduction
- Stock options deductions
- Canadian forces personnel and police deduction
What is line 260?
Taxable income
What is a surtax?
In Ontario, 20% surtax is payable if provincial tax payable is in excess of $4,874 (starts at taxable income of $79,505). 36% surtax (total of 56%) if provincial tax payable is in excess of $6,237 (starts at taxable income of $93,655).
The surtax raises the provincial marginal tax rate. For example, if the marginal rate was 15%, a 20% surtax will raise it to 18% (15% x 1.20).
Should you use marginal or average tax when calculating after-tax investment returns?
Marginal.
How do we calculate the average tax rate?
Calculate the tax payable, then divide it by the income earned.
Are federal tax credits matched at the provincial level?
Many are.
How does the pension income tax credit work?
$2,000 credit for pension income (over age 65) at 15% creates a $300 tax savings on federal tax. Provincial tax is reduced further at the provincial tax credit rate.
What is the 2021 basic personal amount?
$13,808 federal, $10,880 Ontario
What is the basic personal amount reduction?
Basic personal amount reduced by $0.0145708 for every dollar of income in excess of $151,978 (second highest federal tax bracket)
Can the basic personal amount be transferred?
Yes, can be transferred to spouse or common-law partner or Eligible Dependent if one individual is not making enough income to use the full credit.
Which tax credits are offered at higher rates than the minimum?
- Charitable donations credit
- Contributions to political parties
- Dividend credit
- Alternative minimum tax carry-forward
- Labour-sponsored funds credit
- Foreign credit
- Investment credit
Are tax refunds taxable?
No, but any interest payable on a refund to a taxpayer is taxable.
Which type of credit (fed or prov) is the Canada Employment Amount?
Federal.
How much is the Ontario dividend tax credit?
10%. Federal is 15.02%.
Does the Ontario dividend tax credit reduce provincial tax payable for surtax purposes?
No.
What is a T1213?
Request to Reduce Tax Deductions at Source
