Employment Income
Salaries, wages, commissions, directors’ fees, and all other forms of remuneration received by an officer or employee are included in employment income. Canadian residents are taxed on their worldwide income, regardless of where it is received. Most fringe benefits, such as interest-free or low-interest loans received in connection with employment, are also taxed as employment income. Foreigners working temporarily or permanently in Canada may receive tax concessions for employment at special work sites or remote locations, exempting most allowances for board and lodging, and transportation between the work site and the employee’s principal residence.
Employer contributions to a registered pension plan or deferred profit-sharing plan are taxed when the employee receives a distribution from the plan.
Non-residents of Canada are subject to a 25% withholding tax (WHT) on plan withdrawals, which the plan administrator must withhold and remit. Non-residents can opt to have the withdrawal taxed at graduated rates, which may allow tax-free withdrawals up to an annual threshold based on the personal tax credit. The 25% rate may be reduced under an income tax treaty.
Employee Profit Sharing Plans (EPSPs)
A ‘specified employee’ (an employee with a significant interest in, or not dealing at arm’s length with, the employer) is subject to a special tax on the portion of the employer’s EPSP contribution that exceeds 20% of the employee’s salary from the employer. This tax is at the top combined marginal rate of the employee’s province or territory of residence, except for Quebec residents, where it equals the top federal marginal tax rate of 33%
Equity Compensation
When employees exercise options to acquire shares of their employer corporation (or a related corporation), they receive a benefit based on the difference between the market value of the shares on the purchase date and the total price paid for the options and shares. Generally, 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 February 21, 2017, in shares of public corporations with at least CAD 10 million payroll in Quebec) is deductible from taxable income. Consequently, only half of this benefit (75% for Quebec tax purposes if no exceptions apply) is included in income.
Employees who cash out their stock options can claim the stock option deduction only if their employer opts to forgo deducting the cash payment from its income. For capital gains purposes, the cost of the shares to the employee is the market value on the exercise date. Any capital gain or loss accrues only upon the ultimate sale of the shares. However, for stock options of Canadian-controlled private corporations (CCPCs) granted to CCPC employees, taxation is deferred until the employee disposes of the shares.
Changes effective July 1, 2021, align the employee stock option tax regime with U.S. treatment for employees of large, mature firms. For stock options granted after June 30, 2021:
- A CAD 200,000 annual vesting limit (based on the value of the underlying shares at the grant date) is imposed on options qualifying for the 50% employee stock option deduction.
- An employer deduction for the amount of stock option benefits exceeding the new annual vesting limit is introduced, subject to certain conditions.
These rules do not apply to options granted by CCPCs or non-CCPC employers with consolidated group revenue of CAD 500 million or less.
Business Income
For self-employed individuals, business income encompasses most income earned from activities intended for profit, excluding employment income. There must be evidence to support the profit intention.
Loss Relief:
- Business losses from self-employment can be used to offset self-employment income.
- Business losses can be carried back for three years and carried forward for 20 years.
New Legislation for Residential Properties:
- For properties sold after December 31, 2022, profits from selling properties owned for less than 12 months are taxed as business income, with some exceptions.
- The principal residence exemption is disallowed for these short-term dispositions.
Billed-Basis Accounting
For taxation years starting before March 22, 2017, professionals in certain fields (accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors) could elect to exclude the value of work in progress (WIP) from their income calculations. This allowed them to defer tax by deducting the costs associated with WIP before including the matching revenue.
For taxation years beginning after March 21, 2017, those who previously elected to exclude WIP can no longer deduct the cost of WIP. There is a transitional period where the lower of the cost and fair market value of WIP is gradually included in income over five years. If no prior election was made, no deduction for the cost of WIP is available.
Capital Gains
Taxable Capital Gains:
- Half of a capital gain is considered taxable and included in an individual’s income, taxed at ordinary rates.
- No special concessions are available to short-term residents for capital gains taxation.
- New residents of Canada can benefit from a step-up in the cost base, potentially reducing the taxable capital gains.
Withholding Tax for Non-Residents:
- Purchasers of taxable Canadian property must withhold tax from proceeds paid to non-resident vendors unless a clearance certificate is obtained.
Taxable Canadian Property Includes:
- Real estate located in Canada.
- Capital and non-capital property used in a Canadian business.
- Shares in a publicly listed corporation if, within the past 60 months, the taxpayer (or related persons) owned at least 25% of the shares, and over 50% of the shares’ fair market value was derived from Canadian real estate, resource properties, or timber resource properties.
- Shares in a private corporation if, within the past 60 months, more than 50% of the shares’ fair market value came from similar property.
Capital Gains Reserve:
- When capital property is sold at a profit, a reserve can be claimed on proceeds not due until after year-end, spreading gains over up to five years.
- 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 a Canadian resident at the end of the year or in the immediately preceding year.
Principal Residence Exemption:
- Gains on the sale of a principal residence are typically exempt from tax; losses are not deductible.
- To be fully exempt, the taxpayer must have been a Canadian resident and occupied the home during all ownership years, except one (‘one-plus’ rule).
- Only one principal residence per family unit per tax year is eligible for this treatment.
- Temporarily rented homes can continue to be treated as principal residences for up to four years, extendable if the taxpayer is temporarily transferred by an employer and returns to the same residence.
- Sales must be reported to claim the exemption, detailing the acquisition date, proceeds, and property description.
- Non-residents who acquire Canadian residential properties cannot claim a portion of the principal residence exemption upon sale.
Property Flipping:
- For properties sold after December 31, 2022, profits from properties owned for less than 12 months are taxed as business income, with some exceptions.
- This rule also applies to profits from assigning purchase rights if the assignment occurs within 12 months of acquisition.
Assessments and Reassessments:
- The CRA can reassess tax after the normal reassessment period (three years) for unreported property dispositions.
Lifetime Capital Gains Exemption (LCGE):
- Up to CAD 971,190 (indexed annually) for gains on qualifying small business corporation shares.
- Up to CAD 1 million for gains on qualified farm and fishing properties.
- Part-year residents may claim the exemption if resident throughout the immediately preceding or following year.
Mutual Fund Trusts: Allocation to Redeemers Methodology:
- To avoid double taxation, trusts may use the ‘allocation to redeemers (ATR)’ methodology.
- New rules, effective for taxation years starting after March 18, 2019, address deferral and character conversion benefits, denying certain deductions.
- Effective dates were deferred for exchange-traded funds (ETFs) to taxation years beginning after December 15, 2021.
Dividend Income
In 2023, dividends from Canadian corporations undergo specific tax treatments. Non-eligible dividends are increased by 15%, while eligible dividends are augmented by 38% before being included in income. Taxpayers can claim a federal tax credit equivalent to 9.03% of non-eligible dividends and 15.02% of eligible dividends. Additional provincial or territorial tax credits may apply.
Eligibility for eligible dividends is determined by the payer. Generally, dividends from Canadian resident corporations, particularly public corporations or those not classified as Canadian Controlled Private Corporations (CCPCs), are considered eligible. However, certain circumstances may result in non-eligible dividends, such as when corporations receive non-eligible dividends.
For non-residents, Canadian-source dividends are subject to a 25% withholding tax (WHT), deducted at the source. This WHT may be reduced under an income tax treaty, with rates ranging from 5% to 20%.
Taxation of Interest Income
Interest income, irrespective of its source, is taxed as ordinary income in Canada. Accrued interest on most debt obligations must be reported annually.
For non-residents, Canadian-source interest income (excluding most interest paid to arm’s-length non-residents) is subject to a 25% withholding tax (WHT). This WHT is deducted at the source and is not subject to graduated rates. However, under income tax treaties, the 25% WHT can be reduced to rates ranging from 0% to 18%.
Rental Income
Rental income is generally treated as ordinary income for tax purposes. For non-residents, Canadian-source rental income is subject to a 25% withholding tax (WHT). However, non-residents can opt to be taxed on the net income from these rentals at graduated tax rates similar to those for residents. This election restricts the availability of personal and other tax credits but allows for a refund of any excess tax withheld. Additionally, non-residents making this election can file an undertaking to have WHT applied only to net income.
For individuals temporarily working in Canada who rent out their foreign home, expenses related to maintaining the property are deductible when calculating taxable rental income. Canadian tax law limits capital cost allowance (tax depreciation) deductions to ensure rental income is not reduced below zero, preventing the creation of a rental loss through depreciation claims. If rental expenses exceed rental income (excluding depreciation), the loss can generally offset other income, assuming there is a reasonable expectation of profit from the rental property. However, if there is no reasonable expectation of profit, the ability to deduct rental losses against other income may be restricted.
Non-Resident Trusts (NRTs)
Non-resident trusts (NRTs) are considered resident for Canadian tax purposes if they have Canadian resident contributors or if certain former Canadian residents have contributed to them with Canadian resident beneficiaries. However, an election can establish a separate notional trust, known as a ‘non-resident portion trust,’ for tax purposes. Canadian tax applies only to income or gains from properties not included in this portion trust, which excludes properties contributed by Canadian residents or certain former residents, along with substituted properties or income derived from them.
Additionally, an NRT is deemed resident in Canada if a Canadian-resident taxpayer transfers or lends property to the trust, regardless of consideration received, and if the trust’s property may revert to the taxpayer, pass to persons determined by the taxpayer, or be disposed of only with the taxpayer’s consent.
Offshore Investment Funds
Offshore investment fund rules impact Canadian residents with a beneficiary interest in these funds. When these rules apply, the taxpayer must include in their income an amount calculated as the investment’s cost multiplied by a prescribed income percentage (typically the prescribed rate of interest plus 2%), minus any income received from the investment.
Additionally, certain non-discretionary trust funds, where a Canadian-resident person and related parties hold aggregate interests of 10% or more, are deemed controlled foreign affiliates of the Canadian beneficiary. Consequently, they are subject to Canadian Foreign Accrual Property Income (FAPI) rules, as discussed earlier.
Exempt Income
Canada provides exemptions from personal income tax for specific income items.
