Canada’s Income Tax Act: A Comprehensive Walk-Through

Michael Pignatelli
Oct 19, 2021

Disclaimer: Please note this article is not financial advice. The purpose of our blog is purely educational, so please consult a professional accountant or financial advisor before making any financial decision.

Do you have a small business in Canada, or are you planning to start one? If so, then it's your responsibility to know about the Income Tax Act. 

This blog post will introduce you to the basics of the act and how it affects businesses in Canada.  

What Is the Income Tax Act in Canada?

The Income Tax Act in Canada is legislation passed by Parliament that dictates what Canadians must do with the income and assets they earn during tax years. Income includes any revenue or profits earned from investments or employment.

The Income Tax Act is a comprehensive guide to understanding everything you need to know about Canada's tax system. It covers the various deductions and credits available and their impacts on Canadian citizens, including those living abroad and those who are not habitual residents of Canada.

It is also an invaluable resource for any Canadian looking for information on their taxes or wondering how it can affect them or their company. Knowing about the Income Tax Act and its regulations is important so that you can easily understand these complex issues.

Short History of the Act

The federal tax was first introduced in 1916, followed by the personal income tax in 1917. Both of these taxes were imposed as temporary financial measures during World War I.

The Income Tax Act remains one of the oldest acts still in force among Commonwealth countries and one of the longest-standing statutes, having undergone more than 50 amendments since its introduction. It continues to be updated periodically to meet new challenges facing Canadians today.

Do You Have to Pay Income Tax?

Yes, you have to pay income tax in Canada. Income tax starts with the federal tax and then carries on down from there.

Everything that you earn in a year is subject to the income tax laws of the country. Thus, it's important to keep track of your earnings throughout the year so that you can understand better how much money you need to allocate for taxes. 

Under this act, everyone who is a Canadian citizen or a resident of Canada must file a tax return. People who are under 18 or live outside of Canada for one or more years in a row are exempted. 

Income Taxes

The Basics You Need to Know About the Income Tax Act Regulations

The act includes a table of contents and the array of changes made to this act since its original enactment. 

It contains the following parts:

  • Income Tax
  • Estate Tax
  • Sales Tax
  • Excise Tax
  • Corporations Tax
  • Employers' Contributions to Social Insurance
  • Pay As You Earn (PAYE) System
  • Special Taxes and Fees

Furthermore, it also contains a miscellaneous collection of provisions, including laws passed by Parliament not related to any other act. These are dealt with only in the context of the Income Tax Act.

You should also know that it has regulations attached to it as soon as the government makes them available (usually after receiving royal assent). It is a guide to help you understand and follow Canada's income tax laws.

What Is Taxable Income?

A person's taxable income is the total of all income amounts. The income includes salaries, wages, bonuses, commissions, tips, dividends, gratuities, or allowances.

The following are included in this definition:

  • Salaries and wages from employment
  • Retirement benefits received, including Employment Insurance (EI) benefits
  • Bursaries, project grants, and scholarships received in connection with your employment or business
  • Annuities or other periodic payments not exceeding $2000 annually received from life income funds, pension plans, and retirement funds
  • Gains on securities transactions, the disposition of eligible capital property, and certain forward contracts, options, and futures
  • Home relocation loan deduction

Types of Taxable Income

Taxable income has three types: capital gains, employment income, and business or professional income. These income types are not taxed at the same rate.

Capital Gains

The first type is capital gains, which is the amount you receive on investment when you sell it for more than its purchase price. You need to declare a capital gain in the year you made the sale.

If you realize a capital gain, 50% of that becomes part of your income and is thus taxable. Thus, Canada has no fixed tax rate for capital gains. The amount of tax you have to pay will vary depending on your income tax bracket at the federal and provincial levels.

Employment Income

Income from employment is determined by adding up all of your income earned through working for a business, self-employment, and commissions. Any allowable deductions such as moving expenses and childcare expenses are then subtracted. 

Business Income

The third taxable income type is business income, which includes all of the income you receive from running a business or practicing a profession in Canada. The sources of income are determined by the kind of business or profession you’re doing.

You must keep original copies of the documents that support your income declarations. These records include the following:

  • sales invoices
  • cash register tapes
  • receipts
  • bank deposit slips
  • fee statements
  • contracts

The cost of goods sold is an allowable deduction, even though it's technically part of the income you receive from running a merchandising business. Since it’s necessary to buy those goods to run such a business, this expense typically counts as an allowable deduction. 

Other items that you need to deduct to determine your taxable business income include advertising expenses, bad debts, insurance, rent, repair and maintenance fees, employee salaries and benefits, utilities, and freight costs. 

A Brief Overview of Tax Credits

The two types of tax credits are refundable and nonrefundable.

Refundable tax credits are subtracted from your income tax payable, and if there is still a difference, you will receive that as a refund. For example, if you have to pay $5000 in income tax and you're entitled to a refundable tax credit of $5500, your tax payable becomes $0 and you will get a $500 refund.

On the other hand, nonrefundable tax credits only lower your tax up to $0, and you won’t receive the leftover. 

What Are RRSPs and TFSAs?

When you hear about the RRSP (Registered Retirement Savings Plan) and TFSA (Tax-Free Savings Account), they’re usually associated with retirement savings because both types of accounts are geared toward that goal. However, you need to have earned income to contribute to your RRSP or TFSA because you cannot put money into an account that is not yours or your spouse’s.

Cashing out money from your RRSP or TFSA to live on can be tricky. If you withdraw money before you turn 65, it might affect the Guaranteed Income Supplement and/or Old Age Security benefits that you will receive.

RRSP

RRSP is a tax-deferred registered savings account that allows Canadians to set some of their income aside for retirement. RRSP contributions are deductible from your taxable income in the year they are made, but withdrawals are fully taxed as ordinary income.

The money you put into your RRSP is usually not taxed. After you turn 71, though, you must begin taking money out of your plan. 

The amount of money you take out from the plan you've selected will be added to your taxable income. Thus, it’s best to take it out gradually so that you don’t have to pay a lot of taxes all at once. How much money you withdraw from your plan every year depends on the amount of taxable income you expect to earn.

TFSA

TFSA, on the other hand, is a type of registered account that allows Canadians to save money tax-free throughout their lifetime. Any income, gains, or losses in a TFSA are not taxed so long as the funds remain in the account. Furthermore, they won't be taxed if used for the owner’s qualifying purpose.

Just like RRSP, the money you contribute to your TFSA is not taxed. You can withdraw money from your TFSA anytime, and you won’t pay any tax on it. The downside to this is that you can only contribute up to your TFSA contribution room, which is the same as the maximum amount you can withdraw in a year.

How to Compute Your Income Tax

How to Compute Your Income Tax

Canada has a marginal or graduated income tax system. It means your income is taxed at different rates, depending on how much you earn. If you have a low income, you will pay a low tax rate.

From your total income, you’ll subtract federal and provincial nonrefundable tax credits, as well as any deductions or other amounts that have reduced your income. These calculations are done so that they become the lowest taxable income possible.

Then, you multiply them to the applicable tax rate according to your tax bracket. Below are Canada’s federal tax rates for 2021.

Tax RateIncome Bracket
15%$49,020
20.5%Over $49,020 to $98,040
26%Over $98,040 to $151,978
29%Over $151,978 to $216,511
33%$216,512 and above

After calculating your federal tax, you need to determine your provincial tax rate. The rates differ per province. Check out the Canadian government’s website for more information.

Get Expert Accounting Services

As a Canadian taxpayer, you have to know what taxable income is under Canadian law. We hope that this has been a helpful guide to the Income Tax Act. But if things are still confusing, it’s best to consult with a Canadian tax professional. 

Need assistance? You can count on us at Unloop

As your accounting service provider, you can trust us with your business. We will automate your accounting and have your financial statements ready in time for tax season!

To get started, call us at 877-421-7270, and one of our professionals will assist you the soonest!

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