Every year, Canadians face a familiar burden: filing their taxes. Startups are no exception. Navigating taxes as a startup in Canada doesn’t have to be overwhelming. The key is to approach the process strategically. First, consult a qualified tax lawyer who can provide tailored guidance on tax considerations relevant to businesses. Second, take advantage of the many deductions and tax incentives available to startups, which can significantly support capital growth over time.
This post offers a simplified overview of where startups can find tax-related information. It is important to note that this blog post does not constitute legal or financial advice. Tax law is one of the most complex legal regimes in Canada, and errors in filing can lead to severe consequences. However, this guide serves as a jumping off point for startups looking to better understand how to manage their tax obligations effectively.
Does my startup have to pay taxes?
General obligations
Different types of businesses have varying tax obligations. This blog post focuses onstartups; however, not all startups have the same legal form. Corporations, partnerships and sole proprietorships have different tax filing expectations.
Sole proprietorships and partnerships do not constitute legal entities separate from their owners or partners, respectively. Consequently, sole proprietors and partners are generally liable for tax imposed on income earned by the underlying business.
In contrast, incorporated startups are subject to different rules. Unlike partnerships and sole proprietorships, where income, losses and the resultant tax obligations pass through to the owners, corporations have a separate legal personality and are subject to tax on income earned by the corporation, which carries on business as a separate legal entity. As the corporation distributes this income to individuals — in the form of dividends, salary, etc. — the individual recipients are generally then subject to an additional level of tax on this income in their hands (although note that salary payments are generally deductible by the corporation, and there exists a complex dividend tax credit and refund mechanism to eliminate double taxation of dividends). The taxation of corporate income and corporate distributions can be quite complex and consulting a qualified advisor is strongly recommended before deciding to incorporate your business.
To reiterate, both the corporation and its individual shareholders and employees are generally subject to tax on income earned through the corporation and must file separate tax returns. In a partnership, tax is paid directly by the partners, whereas in a corporation, the company covers its tax obligations using corporate funds.
Corporations should take proactive steps to prepare for tax compliance. A fundamental but essential consideration is maintaining accurate financial records. This includes tracking payroll, revenue, expenses, and any fees paid for services. Corporations are bound to pay payroll taxes as well as sales taxes on taxable supplies made by the corporation. However, these topics are complex and beyond the scope of this post. Hiring a qualified tax advisor early on can help ensure proper financial management and compliance with tax obligations.
Who has to pay tax?
Subsection 2(1) of the Income Tax Act states that “every person resident in Canada at any time in the year” must pay tax on their taxable income each year. Corporations are considered persons for purposes of the Income Tax Act, as are individuals (but notpartnerships, for most purposes—as stated above, partners are generally liable for tax on income earned by the partnership). Non-resident persons are also subject to tax on certain items of income earned in Canada. Generally, every corporation resident in Canada or that has earned certain Canadian-source income must file an income tax return within six months of the corporation’s taxation year-end, whether or not the corporation has earned any income.[1]
Residency requirements
A corporation’s residency determines how it is taxed in Canada. Businesses incorporated in Canada after April 26, 1965, are automatically considered Canadian residents for tax purposes. For corporations incorporated outside Canada, residency depends on where the company’s key decision-makers, typically the board of directors, manage and control the business. Since this is assessed on a case-by-case basis and the applicable legal tests can be complicated, consulting a tax lawyer is essential.
Both Canadian and foreign corporations may be taxed in Canada if they are conducting business in the country or earn certain Canadian-source income. Canadian-resident corporations are taxed on their worldwide income, including business profits, property income, and capital gains. Non-resident corporations, on the other hand, are only taxed on income earned in Canada, which includes both active business income, such as sales profits, and passive income, such as dividends, interest, rent, royalties, and capital gains from the sale of certain types of property. Note that for non-resident persons, Canada has entered into a number of tax treaties with other countries that may reduce or eliminate Canadian tax that would otherwise be owing. Non-residents should strongly consider consulting a tax advisor specializing in international tax issues.
Filing your taxes
Filing – startups
One of the first tasks for anew company is to register for a business number. This is the corporation’s equivalent to a social insurance number. In order to set up the business number, a company can start the process online here. The corporation should be prepared with the following information in order to set up this number:
- Shareholder information;
- Your major business activities;
- Any relevant payroll;
- Any import or export activities; and
- Your in corporation number.
Note also that corporations carryingon an active business may be required to register for a GST/HST number as well.
This can be done after registering for a business number at this site. In order to do so, you will need information such as the registration date for your business, the date of your fiscal year-end, your annual total revenue and any other information about your business that you used to register for the business number.
Corporations have the option to choose the date of their fiscal year—i.e. the fiscal year does not need to
align with the calendar year. This helps with tax planning and alignment of business needs. For most small businesses in Canada, a tax return is due six months after the year-end date, but for corporations, tax must generally be paid in monthly or quarterly instalments, depending on the size and type of corporation.
Failure to file a return or payinstalments or other amounts owing related to taxes may result in penalties and interest being charged. Another important process is filing payroll deductions. When employers pay their employees, they are required to withhold: (1) pension plan contributions, (2) employment insurance premiums, (3) federal income tax, and (4) provincial income tax. This withholding relates to the province or territory of residence of the corporation. Companies are required to report and register themselves with the CRA and assess potential withholdings based on the calendar here.
Filing– provincial concerns
Québec administers and collects its own personal andcorporate income taxes under the Taxation Act (the QTA) through aseparate provincial tax department (Revenu Québec). Corporations should be sure to determine whether or not they are conducting business in Québec or whether or not they would need to register to carry on business in Québec. They would then be subject to taxation under the QTA and would need to file additional returns on that basis.
Corporate versus personal tax rates
Corporate and personal income taxes differ primarily in their application and structure. Personal income tax is imposed on individuals’ earnings, typically using a progressive rate system where higher incomes are taxed at higher rates. In contrast, corporate income tax applies to a company's profits, usually at a flat rate, but with different rates applying to different sources of income. The Canadian corporate tax rate structure is complex, and incorporated startups should consider consulting a tax advisor. Note also that businesses, whether carried on by an individual or a corporation, can generally deduct business expenses in determining taxable income.
Expenses and deductions
Regular expenses
All corporations or startups will have expenses that should be deducted in computing taxable income, and that they will need to keep track of in order to file a tax return. Corporations should consider simply that they may need to pay taxes every year. Therefore, money should be set aside for this purpose. Additionally, they will need to keep track of their sales tax paid depending on the startup, their payroll, other employee benefits, and whether they hire contractors. Contractors and employees have different tax expectations, and this is something to bring up with a qualified accountant or lawyer when filing taxes each year.
GST/HST
Not every startup will need to collectand remit GST/HST. If you provide taxable property and services in Canada and your total taxable revenues exceed $30,000 in any calendar year, you need to register for the GST/HST. Income tax will also be calculated for the profits you earn. The CRA offers Liaison Officer Services for new companies and provides them with free tax help as they are starting.
Canadian-controlled private corporations
The Income Tax Act provides certainadvantageous tax incentives to Canadian-controlled private corporations (or CCPCs), including reduced rates on specified amounts and types of business income. In order to qualify as such, a corporation must be incorporated or resident in Canada and must not be controlled directly or indirectly by non-residents, public corporations or any combination of the two. The determination of control can be quite complicated, and startups should consider consulting a tax lawyer if they have any non-resident directors or non-resident or public corporation shareholders.
Why is CCPC status important? Because CCPCs have access to the small business deduction, which allows eligible CCPCs to pay a lower tax rate on the first $500,000 of their active business income. Instead of the standard corporate tax rates, qualifying businesses are eligible to pay 9% federal tax on their income.[2] The small business deduction is generally limited to CCPCs with less than $10
million in taxable capital and applies only to active business income.
The general federal corporate tax rate in Canada is 15%,with provincial corporate tax rates ranging from 11.5% to 16%, for a combined rate of 26.5% to 31%. Note however that these rates can vary, including where the corporation earns different types of income, and as mentioned above, there is a complicated refundable tax system that applies to dividends.
Sources
The Income Tax Act (ITA)
Corporation Income Tax from the Government of Canada Website
Corporation Income Tax Return from the Government of Canada Website
Tax Summaries from PwC
Guide to Doing Business in Canada:Taxation fromGowling WLG
Canadian Tax Compliance: What Startups Need to Knowfrom MaRS
Business Registration Online from the Canada Revenue Agency
The Basics of Employer Payroll Deductions from BDC
Small Business Deduction Rules from the Government of Canada Website
[1] Althoughnote that the penalty for failing to file is computed by reference to the
amount of tax payable for the year in question, which, where the corporation
has no taxable income, would be nil.
[2] Provincial corporate tax rates where the small business deduction applies range from 0% to 3.2%, for a combined rate of 9% to 12.2%.
This blog is authoredby students at McGill University’s Faculty of Law. The information here by no means constitutes legal advice. Tax law is extremely complex and difficult to tackle on one’s own—for that reason, every startup should confer with a qualified lawyer before finalizing their business’ tax plans and should hire staff, such as an accountant, to ensure that taxes are paid correctly each filing year.