Chapter 1

Introduction to Federal
Taxation in Canada

2013 Taxation year


The following topics are not covered in this course:
Alternative concepts of income Slide 24

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Learning Objectives
Understand different tax bases that are used by government to levy
taxes
Know the different entities that are subject to paying federal income
taxes
Understand the difference between Federal and Provincial income
taxes
Describe the general structure of the Income Tax Act
Describe sources of income tax information
Understand the charging provision (ITA 2)
Calculate Net Income for Tax Purposes (ITA 3)
Explain the difference between Net and Taxable income
Explain the concept of tax planning
Provide examples of tax avoidance, reduction, deferral and income
splitting
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The Canadian Tax System
Tax bases can vary widely, and many different bases are
used to determine taxation in Canada:
Income Tax on income of certain entities
Property Tax on ownership of goods
Consumption or Sales Tax on consumption or use of a certain
good or service
Value Added Tax on the increase in value of a good or service
during production
Tariffs or Customs Duties on the import or export of goods
Transfer tax on the change in ownership of goods
User tax for using a publically owned asset
Capital tax on the invested capital of a corporation
Head tax on the existence of a particular group of individuals
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Tax Bases
The federal government in Canada uses many of these tax
bases. Following taxes are examples of taxes charged by
the Canadian Federal Government:
Goods and Services Tax
Income tax on individuals, corporations and trusts
Alcoholic Beverages tax
Special transaction taxes
Gasoline tax
The most significant portion of the federal governments
revenues is the income tax on individuals, followed by that
on corporations and then the Goods and Services Tax.
These taxes are the focus of this course
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Taxable Entities
Three types of entities are required to pay Federal
income taxes, and must file a tax return annually in order
to calculate the tax they owe:
Individuals (human beings)
Corporations
Trusts
The income tax act refers to all of these entities as
persons.
Unincorporated businesses such as partnerships and
proprietorships are not taxable entities
The income of unincorporated businesses is included in the
income of the individual proprietor, or the partner
Partners can be individuals, corporations or trusts
Complete Exercise One-1 on page 3
5
Taxable Entities for GST
Purposes
When it comes to GST, there are four
types of entities:
Individuals
Corporations
Trusts
Others (Including partnerships,
unincorporated businesses and charities)
Complete Exercise One-2 on Page 3
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Provincial Taxation
Each province in Canada also imposes
taxes on income earned in the province
and residents of the province
The provinces levy their own personal and
corporate income taxes and sales taxes
This course will focus on taxation at the
Federal level, however there will be times
that provincial taxes will have to be
considered
Complete Exercise One-3 on page 4
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Tax Policy Concepts
Tax legislation is used to do more than just
generate revenue for the government. It also:
Allocates resources between different public goods
Influences choices: e.g., taxes on alcohol and
cigarettes
Redistributes income and wealth
Stabilizes the economy
Allocates resources between different levels of
government (fiscal federalism)
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Taxation and Income Levels
Proportional taxes: a constant rate at all levels of income
Theoretically, this is how corporations are taxed
Regressive taxes: lower effective rates of tax for higher
income taxpayers
Sales taxes are considered to be regressive
Less complex
Doesnt kill the motivation to pay taxes
Discourages tax evasion
Fair when income fluctuates (Ex. Unemployed vs. Employed)
Fairer to one income families
Less pressure for concessions
Complete Exercise One-4 on Page 6
Complete Self-Study Problem One-1 on Page 32

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Taxation and Income Levels
Progressive taxes: higher rates are applied to higher
levels of income
This is how the personal income tax system is designed to
function
The arguments for this type of system are that it is more
equitable and provides more stability in after-tax income levels
Arguments against are: complexity, discriminatory, discourages
employment and investing, pressure to give concessions,
evasion more likely, may reduce total revenue

Complete Self-Study Problem One-2 on Page 32

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Qualitative Characteristics of Tax
Systems
Desirable qualities include:
Fairness or equity: people in similar economic situations should
pay similar amounts of tax
Neutrality: tax system should not interfere with decision making
Adequacy: should meet funding requirements of government
Elasticity: should be able to be adjusted for changes in economic
conditions easily
Simplicity: easy to follow the rules
Certainty: taxpayers should know how much to pay, when and
how it was calculated
Balance between sectors: All sectors of the economy should
contribute
International competitiveness: Should keep Canadian
businesses in Canada
Complete Self Study Problem One-3 on Page 32
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Evaluation of Canadian System
Equity: There are situations where high income
individuals pay little or no tax and low income individuals
pay a high rate of tax
Heavy reliance on personal taxation, much less on
corporate
Problems with stability of revenues
Complexity is incredible! You will experience this
yourself over the next few months!!
Administration is difficult due to complexity
International competitiveness has been a problem in the
past, however this has been improving in recent years.
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Income Tax Reference Material
Most important source
The Income Tax Act is the basis for all decisions
made related to the amount of income tax
payable by any person
So, why dont we use that for this course?
Because the language is legalistic and technical. It
is very difficult to understand.
You may however want to use it as a reference. It
can be accessed at:
http://laws-lois.justice.gc.ca/eng/acts/I-3.3/
For Windows users, it is also available on the CD-ROM
provided with the text book.
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Income Tax Act
Basic Structure
Parts I to XVII, more than 17, because of parts like X.1
Within each part, there are Divisions A to J
There are Subdivisions within Divisions
Each subdivision contains sections 1-260, but there are
more than 260 sections, because of sections like 12.1
Subsection (1), (2), (3)
Paragraph (a), (b)
Subparagraph (i), (ii), (iii)
Clause (A), (B)
Sub clause (I), (II), (III),
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Parts
Part I is the largest section (about 70% of
the Act). This will be the focus of the
course.
Other parts cover a variety of taxes that
apply in special situations, as well as parts
that contain rules about administration,
enforcement and interpretation
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Part One
Eleven Divisions:
A Liability for Tax
B Computation of Income
Subdivision a Income or Loss from Office or Employment
Subdivision b Income or Loss from a Business or Property
Subdivision c Taxable Capital Gains and Allowable Capital
Losses
Subdivision d Other Sources of Income
Subdivision e Deductions in computing income
Subdivision f Rules related to computation of income
Subdivision g Amounts not included in computing income
Subdivision h Corporations resident in Canada and their
shareholders
Subdivision i Shareholders of corporations not resident in
Canada
Subdivision j Partnerships and their members
Subdivision k Trusts and their beneficiaries
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Part One
Eleven Divisions (continued):
C Computation of Taxable Income
D Taxable Income Earned in Canada by
Non-Residents
E Computation of tax
Subdivision a Rules applicable to individuals
Subdivision a.1 Child tax benefit
Subdivision b Rules applicable to corporations
Subdivision c Rules applicable to all taxpayers
E.1 Minimum tax
F Special rules applicable to certain
circumstances (bankruptcies, co-operatives)
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Part One
Eleven Divisions (continued):
G Deferred and other Special Income
Arrangements
H Exemptions
I Returns, Assessments, Payments and
Appeals
J Appeals to the Tax Court of Canada and
the Federal Court.
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Other Legislation
Income Tax Application Rules, 1971
Transitional rules resulting from major reform in 1971. Still
significant in some situations.
Income Tax Regulations
This is where you find amounts prescribed under the Act, such
as interest rates, Capital Cost Allowance rates and classes
International Tax Agreements
Currently exist with 92 countries. Attempt to avoid double
taxation and prevent evasion.
Draft Legislation
Legislation that has not been approved by parliament may still
be applicable to tax returns for a particular year.
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Other Sources of Information
1. CRA Publications
Interpretation Bulletins: Give CRA interpretations of various
sections of the law, and announce significant changes in
departmental interpretation, effective dates.
IT Folios: CRA is replacing IT Bulletins with Folios
Information Circulars: Provide information regarding procedural
matters and report administrative developments
Income Tax Technical News
News releases, Tax tips, Fact Sheets
Guides and Pamphlets: non technical information
Advance Tax Rulings and Technical Interpretations: Can
be requested by taxpayers involved in complex transactions, for a
fee
2. Court decisions
3. Electronic Library Resources
4. CRA Website (http://www.cra-arc.gc.ca/)
Complete Self Study Problem One-4 on Page 32
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Liability for Income Tax
A charging provision specifies who is liable to
pay a particular tax. This is the charging
provision for Part I tax, which is commonly
known as Income Tax.
The basis for Canadian taxation is residency,
based on the following charging provision:
ITA 2(1) An income tax shall be paid, as required by
this Act, on the taxable income for each taxation
year of every person resident in Canada at any time
during the year.
Bolded terms above require further definition
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Section 2(1) Charging Provision
Taxation of Residents
Taxable income
Defined in ITA 2(2) The taxable income of a taxpayer for a
taxation year is the taxpayers income for the year plus the
additions and minus the deductions permitted by Division C.
Taxation year
Defined for corporations in ITA 249(1)(a) to be the fiscal year
(less than 53 weeks)
Defined for individuals in ITA 249(1)(b) to be the calendar year
Person
Refers to individuals, corporations and trusts. The act generally
uses the word individual to refer to actual people.
Resident
The definition of this term will be covered in detail in this chapter.
In the US, taxes are based on citizenship over residency
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Section 2(3) Charging Provision
Taxation of Non-Residents
ITA 2(3) - Non-residents who were employed in Canada, carried on
business in Canada, or disposed of taxable Canadian property,
during a year or the previous year are subject to tax on their taxable
income, calculated under Division D.
Under Part 1 of the Act, non residents are taxed on income from:
Employment working as an employee in Canada, regardless of
location of employers business
Business producing or manufacturing products in Canada
Dispositions of Taxable Canadian Property for example, the sale of
land in Canada, capital property used by a Canadian business, shares
of a CCPC, some partnership interests
Property income of non-residents is taxed under Part XIII of the Act,
which requires a 25% flat rate of tax on this type of income paid to
non-residents.
The taxation of non-residents will be covered in detail in MOS 4462.
Complete Exercise One-5 on page 20
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Alternative Concepts of Income
Economists concept (Not very specific)
Income = rents, profits and wages, net of any related expenses
Has not, in the past, generally included capital gains or other
similar increases in net worth
More recently, these other types of income are included so that
income includes all increases in net economic power during the
relevant measurement period
Accountants concept:
Net income is determined based on GAAP, which is generally
based on historical costs, with some more recent willingness to
include things at fair value
Match expenses and recognize revenue
Tax Act concept:
Has its own set of complex rules to determine NET INCOME
FOR TAX PURPOSES (NIFTP)
Includes: Employment Income, Business Income, Property
Income, Net Taxable Capital Gains, Other Inclusions/Deductions


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The Tax View of Income
There are four different types of income, with different
rules and tax rates. They are:
Income from office or employment (Rarely a loss)
Business Income
Property Income
Capital Gains and Losses
Income from office or employment is calculated on a
cash basis
Business and property income calculation starts with an
accrual income statement, and makes adjustments to
net income per financial statements. For example:
Amortization not deductible, capital cost allowance is
Capital gains only 50% taxable
Capital gains/losses are calculated as per the Act.
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Division B Computation of Net
Income
This is the computation of Net Income for Tax
Purposes (NIFTP)
Three subdivisions in Div B provide rules for 3
(4) different types of income or loss:
Income or loss from office or employment (Subdiv a)
Income or loss from business and (property) (Subdiv b)
Taxable capital gains and losses (Subdiv c)
The rest of Division B deals with miscellaneous
types of income (Subdiv d) and deductions
(Subdiv e)
Additional subdivisions deal with the
determination of NIFTP in a variety of special
situations. (Subdiv f thru k)
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Division B Computation of Net
Income
ITA 3(a) Worldwide income from employment,
business, property and all other non capital sources
(Other types of income included are: pension income,
spousal support received, social assistance
payments)
PLUS
ITA 3(b) The amount (if any) by which taxable capital
gains (TCG) exceeds allowable capital losses (ACL)
LESS
ITA 3(c) Deductions permitted under Div B, Subdiv e.
This number can be positive or nil; not negative.
(RRSP, moving expenses, spousal support, child care, etc.)
LESS
ITA 3(d) Losses from employment, business, property
and allowable business investment losses.
If losses exceed the amount in 3(c), amount will be
nil, not negative.
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Section 3 Ordering Provision
S. 3(a) Includes positive amounts of income
from employment, business, property and other
miscellaneous amounts listed in Subdivision d.
S. 3(b) Amount if any that taxable capital gains
(50% of gain amount) exceeds allowable capital
losses (50% of loss amount)
Will be a positive number
This establishes an important rule, that in calculating
NIFTP, the current years allowable capital losses can
only be deducted against taxable capital gains
recognized in the current year.
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Section 3 Ordering Provision
Note that if the balance forward from 3(a)
and (b) is negative, it becomes nil, and
NIFTP is therefore nil. There is no need to
consider 3(c) or (d)
S. 3(c) These amounts are items like
RRSP contributions, spousal support, child
care expenses, moving expenses. They
generally must be used in the year they
were paid.
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Section 3 Ordering Provision
If amounts deducted under 3(c) bring NIFTP to a
negative number, then NIFTP is nil, and the
calculation is complete.
S. 3(d) Current year losses other than
allowable capital losses (ACL)
These losses might include:
Business losses, property losses, employment losses,
allowable business investment losses (a special type of
ACL), and farm losses subject to some restrictions
NIFTP must not be negative.
Losses that a taxpayer cannot use in the year can be
carried back or forward to other years

Complete Exercise One-6, One-7 and One-8 on Pages 26-27
Complete Self Study Problems One-5, One-6 and One-7 on Pages 32-33
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Tax Planning Principles
1. Avoid tax whenever possible
$750,000 capital gains exemption
Employee benefits, discounts
More complex methods
2. Defer tax whenever possible
RRSP contributions, RPP contributions
Capital cost allowance of some properties
Methods available to most taxpayers
3. Split income within family if possible
Aim for all members to have approximately equal taxable
income.
Not available to all, many rules to prevent
4. Pay on time
Complete Exercise One-9 and One-10 on page 30
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Final Steps
Do the assigned problems on the course outline
Review the key terms on page 30 of the text. The
glossary (at the back of your study guide, and on the
CD-ROM) can be used for terms you do not understand.
Review the learning objectives at the beginning of these
slides for any that you dont feel you have learned,
review the related material in these slides, and the text.
Do the practice exam that is on the CD-ROM that came
with the textbook (for this chapter only, it is printed and is
in the study guide).
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