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Income Tax and You – A Start
By Kris Matthews
Q: I’ve been told there are
different kinds of income tax.
Is this true?
Can you tell me more?
- Deanna P., Winnipeg
The Federal Income Tax Act (ITA) is an interesting piece of
work if you have the muscles to hold it, the eyesight to manage
the fine print, and the genius intelligence to interpret it. It’s
hefty and hardly recognizable as being in either of Canada’s
two official languages.
The ITA started out as the Income Tax War Measures Act
(I think that was back in 1917). We had a copy – a skinny
waif that hid among the paperbacks on a shelf. Thick paper
and large print made it easy to read. Now it’s an overweight
periodical – thick, with tiny print on thin paper.
The idea is simple: earn income and then pay taxes. The
execution is complex. The ITA has cousins, the Provincial
Income Tax Acts, which are different enough to complicate
life. In some provinces such as Alberta some persons are
required to file two tax returns. In other provinces, they
file one.
Three types of ‘person’ to tax
Did you notice the term ‘persons’ above? To me a person
has a head, a body and the ability to think and speak. To
the Canada Revenue Agency (CRA) there are three types of
person: there’s the ‘you or me’ (an individual); the limited
company; and finally there’s the estate or trust. Each has its
own specific rules.
You’ll note that a partnership and proprietorship are not
persons – they are extensions of us as individuals. We have
to report partnership or proprietorship income personally.
The next part is easy: what do they tax? Income – it is
an Income Tax Act. However, it gets harder when we try
to define what income is. (We’ll deal with that in
another article.)
Let’s talk a bit more about these ‘persons’. A person can be
a resident or a non-resident of Canada. Residency is a pretty
common sense idea – someone or something who/which
ordinarily lives in Canada.
How residency factors in
Residency is a question of fact which simply means that every
case is theoretically judged on its own circumstances. Usually
it’s obvious and the rules are well set for most cases. Only on
an odd occasion does residency become an issue.
Residents of Canada – all three types of person – are taxed
on their world income. All very logical: if we ordinarily live
in Canada, we pay taxes on any income we earn anywhere.
The rules are more complicated for companies and trusts.
They may have a presence in several countries but the same
ideas prevail.
Non-residents are taxed only on income earned in Canada.
If we do not live here, then we pay taxes only on income we
earn here. That again seems very logical.
The U.S. has a different logic. It taxes residents and it taxes
U.S. citizens on their world income. A Canadian resident
in the U.S. pays taxes in the U.S. on world income and
pays Canadian taxes only on income earned in Canada.
An American resident in Canada pays taxes here on world
income but is also subject to tax in the U.S. on all income.
The U.S.-Canada Tax Treaty tries to minimize double taxes
but it’s not always successful because there are fundamental
differences in how the two Tax Acts work.
Residency is important to the CRA as many of the tax dodges
you’ve read about exploit this difference – they move income
to offshore trusts or foreign companies to be taxed where
taxes are nil or lower. It’s an ongoing battle. It’s not clear how
many billions of dollars Canadians have stashed overseas to
avoid paying taxes in Canada but the figure is huge for most
major countries. More and more these countries co-operate
to force financial institutions in tax havens to reveal account
holders.
14 MOMpreneur ® � July/August 2010