Tax season is just around the corner. How many of us really know our tax system?
How does our tax system work?
In Canada, we have a progressive tax system. This means that the more money you earn, the more taxes you could pay. As explained by the Canada Revenue Agency (CRA), many of the services and benefits we enjoy as Canadians are made possible through taxes. We pay taxes on our income and on most goods and services we purchase in Canada. The government collects these taxes to pay for such things as roads and highways, hospitals, education, health care, national defence, police and fire services, parks and playgrounds, libraries, garbage collection, and many other programs and services.
Tax revenue also helps government redistribute wealth by funding social programs such as Old Age Security, Canada child tax benefit, universal child care benefit and working income tax benefit.
How are taxes calculated?
Individuals and families, businesses and charities are required to declare their income annually (or more frequently when directed), and pay any applicable taxes. Taxes are calculated based on the level of income, deductions permitted and credits. Individuals and families complete an annual tax return following instructions issued by the CRA and the provinces.
Businesses and employers are required by law to issue statements to individuals for income earned through employment. An example of this is a T4 Statement of Remuneration Paid (slip) issued to a student who worked at a pizzeria part-time and earned $15,000. Interest, except when earned in a Tax-Free Savings Account (TFSA), and dividend income are also included in calculating income.
GST and HST
GST is applicable to most goods and services in Canada. HST applies to the same goods and services as the GST and is collected in provinces that have harmonized their provincial sales tax with the GST. Businesses generally must file returns on a regular basis, collect the tax on taxable supplies they make in Canada and remit any resulting net tax owing.
Individuals, families, and businesses may legally reduce the taxes payable on their income by making the most of the eligible deductions and credits permitted by the federal and provincial governments. Currently individuals may qualify for a basic personal exemption, a spousal exemption and tax credits for items such as tuition, education and textbook amounts, housing costs, charitable donations and medical expenses. There are also credits for GST, with eligibility determined by the CRA.
Provincial/territorial income tax
You have to calculate and pay provincial or territorial income tax in addition to your federal income tax. These are usually included with the annual returns filed to the CRA. You may be entitled to provincial or territorial credits above and beyond your federal credits. Provinces and territories develop their own tax laws and policies. However, the CRA collects and administers the individual income taxes for these governments, except for the province of Quebec.
Splitting pension income
Subject to residency and living arrangements specified by the CRA, spouses or common-law partners are permitted to split the eligible pension income earned by the pensioner. This split essentially reduces the income of the pensioner by allocating part of the pension to the pensioner’s spouse or partner. Note that Old Age Security payments, Canada Pension Plan and Quebec Pension Plan cannot be split. Both spouses or partners have to jointly elect and agree to the split. If one of the spouses or partners has higher income than the other, they may reduce their taxable income by allocating part of their pension to the lower earning partner. The maximum amount that may be split is 50 per cent of the eligible pension income.
It is very important to keep copies of all receipts with respect to income and certain expenses in order to prepare and support income reported and to claim eligible deductions from the CRA and provincial governments. For example, receipts for public transportation passes, tuition fees receipts and receipts for contributions to Registered Retirement Savings Plans (RRSPs) can all add up to significant deductions or credits. Accountants, tax specialists and advisors are available to assist in this process and in the filing of returns.
The CRA issues a notice of assessment after processing your tax return. The information in the notice of assessment is an important basis for next year’s return. The CRA has issued a Taxpayer Bill of Rights Guide, which applies to anyone who pays taxes. I strongly recommend contacting the CRA to resolve key issues or questions prior to finalizing a tax return. The CRA also issues advance income tax rulings and technical interpretations.
Later this month, I’ll explain what RRSPs and TFSAs are, and how they can be used to reduce income taxes and assist in retirement planning.
Keep the conversation going
Do you have any questions on tax? Post a comment below.
The views and opinions expressed in this article are those of the author and do not necessarily reflect that of Chartered Professional Accountants of Canada (CPA Canada).