Are you looking into how tax law works in Canada? This article will answer some of the most common questions that people have. It was written by a tax lawyer in Toronto.
Tax laws are mostly federal, so the information applies to all of Canada.
How are stocks taxed in Canada?
Stocks in Canada are generally taxable in two ways:
First, the difference between the purchase price and the selling price of a stock is taxable as a capital gain.
Only half of the capital gain is added to the taxpayer’s income for the year, which means it’s taxed at half the rate income is normally taxed.
Typically, the liability for tax is only created when the stock is sold, meaning the capital gain has been realized.
For example, a taxpayer could own a stock for 10 years without selling, and only when they sell the stock in the final year would they be liable for taxation.
As an exception to this general rule, there are numerous deeming rules in the Income Tax Act which may deem the stock to be sold without the stock actually being sold.
For example, when contributing a stock to a RRSP which has unrealized gain, the Income Tax Act deems the stock to have been sold, triggering the requirement to recognize the capital gain and pay tax.
Second, any distributions paid from the stock will also be taxable in Canada, such as a dividend.
Dividends must be reported annually, and the calculation of dividend tax is a bit more complicated.
Canada relies on a tax integration mechanism to determine the dividend taxes owed. The idea is that income earned by an individual vs an individual and corporation should be roughly the same.
As a company pays tax at the corporate level, a dividend tax credit is provided to compensate the individual for the tax already paid by the corporation.
As a result, the effective tax rate on dividends is lower than the tax rate of ordinary earned income. For some taxpayers with lower taxable income, this may even allow them to receive dividends tax-free.
How is cryptocurrency taxed in Canada?
Cryptocurrency is generally only taxable when it is disposed of, such as by selling it on an exchange or using it to purchase goods or services.
The difference between the purchase price and disposition proceeds can be taxable as either business income or as a capital gain. The distinction is important.
If it is considered “business income” it is taxable as earned income, whereas if it is a “capital gain” it is taxed at half that amount.
There is a legal test to determine if the ownership of cryptocurrency constituted business income, and the assessment should be made on a case-by-case basis.
Even if it seems obvious for the taxpayer that their activity does not constitute a “business”, this may not be the case.
The CRA has warned that in some instances even a single cryptocurrency transaction can be considered a business.
For a taxpayer who only holds a small amount of Bitcoin while working an unrelated full-time job, it is less likely that their activity will constitute business activity.
Alternatively, for a taxpayer who relies on the proceeds from cryptocurrency trading to fund their living expenses, it is more likely to be considered as business income by the CRA.
A tax lawyer can help you if it is not clear if the proceeds from cryptocurrency should be taxable as business income or as a capital gain.
How do taxes work for married couples?
Generally, Canada imposes taxes on the individual level, rather than as a family unit (with exceptions, such as the child tax benefit which is calculated based on the family income).
This means that if there is one higher-earning spouse, they must pay tax at the higher tax bracket, and the taxable income cannot be transferred to the lower-earning spouse to pay less tax overall.
A considerable number of methods to split income under the Income Tax Act will result in “attribution rules” which will deem the income to be that of the higher-earning spouse and taxed accordingly.
There are still methods in Canada that can be used to split income between the spouses and reduce the overall tax liability for the family. A tax lawyer can advise you on the remaining permitted income-splitting tax strategies.
For example, a tax lawyer can help set up a spousal loan tax strategy.
A spousal loan would allow a taxpayer to transfer investment income that would otherwise be taxable at a higher tax rate to that of their lower-tax rate spouse.
How do taxes work in Ontario?
The Ontario tax system is integrated with the federal tax system. This means that when you file their federal tax return, you are also filing the return required for Ontario.
The Ontario tax system includes both additional taxes and tax benefits specific only to residents of Ontario.
For example, the top federal tax rate is 33% for individuals in Canada, which increases to 53.53% once Ontario income taxes are included.
Ontario has one of the highest combined tax rates in Canada, only beaten by Nova Scotia (54%).
If setting up a business in Canada, it may be preferable to set the business up in a province with lower taxes.
This will need to be balanced with the needs of the business, and it may not always be practical to move the business once established to optimize taxes.
How does Canada tax offshore investments?
Canada taxes residents on worldwide income.
If you own offshore investments, you will need to declare any source of taxable income when filing your tax return, such as capital gains from selling an offshore investment.
You may be able to receive a tax credit for any taxes paid to the foreign country, which would reduce the Canadian tax liability.
The exact amount of credit will depend on the details of the tax treaty between the two countries (if one exists). A tax lawyer can provide guidance to the extent a tax credit applies.
Additionally, if you have not previously disclosed foreign assets, you should consider the voluntary disclosure program, which can allow you to receive leniency and avoid other penalties from the CRA.
A tax lawyer can ensure the correct information is provided to the CRA, to meet the precise requirements of the voluntary disclosure program.
What to do about taxes on death?
In Canada, all assets of a taxpayer are deemed to have been sold on death, which can trigger substantial capital gains. Additionally, the full amount in a retirement plan such as an RRSP or RRIF is taxable as income.
However, as always with tax, there are numerous exceptions to these rules.
Often a taxpayer will pay the most tax in their final year.
If there is a concern that you will have a significant tax liability on death, it is wise to speak with a tax lawyer to utilize tax planning opportunities to limit tax on death.
There are several methods to transfer assets to a spouse or even another family member which can defer paying tax on death.
Sometimes when dealing with an estate, the executor may discover the deceased did not file several previous years’ tax returns.
It will be the responsibility of the legal representative to file not only the tax return for the year of death but also the missing tax years.
Before distributing assets to beneficiaries from the estate, a clearance certificate should be obtained from the CRA that will confirm that the estate tax liability has been paid in full.
Failure to obtain a clearance certificate can result in the legal representative of the estate being personally responsible for the tax debts of the estate.
While receiving proceeds from an estate, it can also be a good time to review any tax planning arrangements going forward.
As assets may be transferred to a beneficiary, there may be more tax-efficient methods to hold the assets.
What to do when the CRA audits you?
The first thing to do is to identify what type of audit you will be subjected to.
The most common type is a field audit, where a CRA agent will visit the place of business or residence. Alternatively, they may conduct an office audit, which takes place in a CRA office.
During a field audit, the CRA agent will look through your financial records. It is up to the CRA agent and their supervisor in how deep they will search.
They will also look around the business to see if there are any discrepancies.
Receiving expert advice from a tax lawyer will be beneficial if you are being audited.
They can tell you what specific questions should or should not be answered, along with what documents you are obligated to provide to the CRA agent.
They can also ensure that the CRA does not infringe on your rights as a taxpayer.
What to do when the CRA freezes your account?
The CRA will only freeze an account as a last resort. This likely means that the CRA has already been sending letters demanding payment, which you may have ignored or have been unable to pay.
The first thing to do is to determine why the account is frozen.
It may be possible to get the CRA to agree for a payment plan if there is tax debt that cannot be paid in full – which can remove the freeze on the account.
A payment plan would allow you to repay the tax debt in more manageable regular payments over a longer period.
A tax lawyer can help you reach a payment plan arrangement with the CRA.
Receiving advice from a lawyer is important if you have other assets such as a business or home.
The CRA will generally want to see that you have exhausted all other avenues such as selling assets or seeking a bank loan before obtaining a payment plan.
To prevent an account from being frozen in the first place, you can also be proactive to obtain a payment plan with the CRA.
What to do if CRA makes a mistake?
If you think the CRA has made a mistake in assessing their tax return, there is an appeals process that can be used to get the CRA to correct their mistake.
Within 90 days of receiving the notice of assessment (or other notice), you must file a notice of objection.
Although not guaranteed, there is the possibility that you can receive a one-year time extension to file the notice of objection, if for example, the delay was a result of extraordinary circumstances beyond your control.
It is possible to file a notice of assessment without a tax lawyer, but it can be recommended especially if you are unsure of the process or the legal grounds for your case.
After submitting the notice of assessment, the CRA may reassess the return and correct the mistake.
If the mistake has still not been corrected, you can appeal further to the Tax Court of Canada. In most cases, a tax lawyer is not required to appeal to the Tax Court.
A tax lawyer is recommended because they will be familiar with the legal processes and can best present your argument in court.
A tax lawyer will be able to determine the likelihood of success at tax court.
If they can create a convincing argument to support your case that would likely win at Tax Court, the Department of Justice lawyers may accept an offer to settle the case without going to trial.