Understanding Canadian Income Tax

The Canadian Tax system in its entirely can be very complex. Fortunately, the basic income tax that relates to the majority of Canadians is relatively straightforward as long as we take the time needed to learn the terminology and the rules.

Throughout the next series of blog we’ll discuss;

  1. The basic concept of Canadian personal income tax
  2. Average Tax bracket vs. Marginal tax bracket
  3. Reducing you Taxes: Tax deductions, Refundable and Non-Refundable Tax Credits

Hopefully, after this you’ll have a better knowledge of the Canadian Income tax system.

After-Tax vs Before-Tax Savings
Tax planning is an important component of financial planning

In comparison, every dollar of reduced taxes (after-tax) savings puts more money in your pocket. Because the after-tax saving is ready to be spend whereas the next dollar earned (Before-Tax) saving still has to be tax.

The basic concept of Canadian personal income tax

Canadians are tax on worldwide income based on a progressive system. Which means, the higher income earner pays an exponentially more taxes. The amount of tax is based on, your taxable income for the year minus any allowable deductions and credits.

As of 2001, the Canada Revenue Agency (CRA) introduced TONI (Tax-on-Income) method for calculating the provincial personal income tax based on taxable income. The TONI method enables each province to determine a separate tax rate and a separate personal tax credit. The federal and the provincial/territorial tax is calculated separately. However, the calculation is completed on the same tax return, except for Quebec. Canada uses the self-reporting tax system. The income tax must be filed by April 30th or June 15th for Self-employed individuals and their spouses (Common-law partners). Any balance owing must be paid by April 30th regardless of the filing due date.

All rules, calculations and definitions pertaining to the Canadian Federal Income tax is in law by Income Tax Act. The three main governmental ministries involved in the Canadian Income tax are:

The Finance Department –  Responsible for drafting and revising the Income Tax Act.
Canada Revenue Agency – Responsible for administrating the Act and collecting the taxes owed by the taxpayers.
Department of Justice – Handles the litigation between Taxpayer and CRA, when legal disputes occur.

We all work hard for our money, therefore, we prefer to pay to lowest amount of tax possible.  It is, however, important to distinguish the difference between what is accepted and legal (Tax Planning) from the Canada Revenue Agencies (CRA) perspective to what is illegal (Tax evasion).  Tax evasion is a criminal offence.

Keep in mind, rules and regulations change, especially, the tax credit limits. When the time comes for filling out your income tax I feel it is best to leave it to an expert.  Although, there are many software available in the market that can do a very good job, I rather spent the money to consult a professional accountant.

In the next blog, we’ll discuss:

  • The Federal and Provincial Tax Brackets; and
  • The difference between Average Tax Rate vs. Marginal Tax Rate.