Corporate Income Tax Rules of General Application

Determination of Business Income

The Income Tax Act (ITA) defines a taxpayer’s business income for any given year as the "profit" from that taxpayer’s business in that year. However, the term "profit" is not defined in the ITA. The common law provides that "profit" is to be determined by calculating the difference between receipts attributable to a taxpayer’s business and the expense of earning those receipts. Generally, the only allowable deductions from income are expenses that:

  • are incurred for the purpose of earning business income;

  • are not on account of capital; and

  • are reasonable in the circumstances.

Deductibility of Expenses

Generally, only current expenses are deductible in computing taxable income. Capital expenditures may be deducted pursuant to the Capital Cost Allowance (CCA) regime, which is discussed briefly below. Restrictions apply on the deductibility of certain business expenses (e.g., only 50% of meals and entertainment expenses are deductible) while other expenses (such as reserves or estimated expenses) may not be deductible at all, unless specifically allowed by the ITA.

Generally, interest is deductible only to the extent that it was paid on a debt incurred for the purpose of earning income from business or property. The "thin capitalization" rules further restrict the interest deduction that a corporation resident in Canada can claim on debt owing to a "specified non-resident" – generally a non-resident shareholder holding at least 25% of a corporation’s voting shares or value, or anyone not at arm’s length with such a shareholder. In that case, non-residents can only deduct interest related to the portion of the debt that does not exceed two times their contributed capital.

Capital Cost Allowance

The ITA explicitly disallows the deduction of capital expenditures other than those specifically permitted under the Capital Cost Allowance (CCA) system. The CCA system requires the pooling of depreciable assets into various classes provided in the ITA Regulations. CCA may be claimed annually against the undepreciated capital cost (UCC) balance of each class at the rate prescribed by the ITA Regulations, generally on a declining balance basis. The rate at which any of the CCA classes is depreciated does not necessarily reflect the useful life of assets included in that class.

In most cases, the amount deductible in the first year that an asset is acquired is subject to the "half-year" convention, which means that only one-half of the amount that would be deductible at the normal CCA rate of that asset class can be claimed. In addition, CCA may only be claimed on an asset at the earlier of the time when this asset is available for use and the second year of its acquisition. CCA is a discretionary deduction that can be carried forward indefinitely.

When a depreciable property is sold, the proceeds of disposition can be deducted from the UCC of the asset class up to an amount not exceeding the acquisition cost. A resulting negative balance of the UCC is taxable as income, while the portion of proceeds of disposition exceeding the acquisition cost is taxable as a capital gain (50% of which is included as taxable income). A resulting positive balance, where no asset remains in the CCA class, may be deducted from income as a terminal loss.

Loss Carry-Overs

Corporations that incur losses from business are able to use these losses to reduce their taxable income. A non-capital loss (a loss resulting from a company's operations) can be carried back 3 years and carried forward 20 years to reduce a corporation's taxable income. A net capital loss (a loss resulting from the sale of a capital asset) may be used only to shelter capital gains and, for this purpose, can be carried back 3 years and forward indefinitely.

Investment Tax Credits

An investment tax credit of 10% is available for capital investments in the Atlantic provinces and in the Gaspé region of Quebec. An investment tax credit is also available for investment in qualified scientific research (20% of public corporations and up to 35% for Canadian-controlled private corporations). Finally, a temporary investment tax credit of 15% is provided to individual purchasers of flow-through shares where the funds are spent on specified "grass-roots" mineral exploration expenses.

Unused investment tax credits can be carried forward (20 years) or backward (3 years) to reduce the taxes payable.

Large Corporations Tax

A Large Corporations Tax, which was levied on taxable capital in Canada, was eliminated as of January 1, 2006.

Withholding Taxes

Payments made to non-residents are subject to a withholding tax, which is determined according to the type of payment (management fees, interest, dividends, royalties and rents) and the country of the recipient. These rates are determined by tax treaties that Canada has established with other countries and are intended to prevent double taxation of foreign income. For example, payments to residents of Spain are subject to withholding taxes of 15% for interest and dividend payments and 10% for royalty payments. A withholding tax of 5% is imposed on dividends paid or credited by a Canadian corporation to a U.S. corporation in the case where the U.S. corporation holds 10% or more of the Canadian corporation’s voting shares. In all other cases, the withholding tax rate applicable to dividends is 15%. The withholding tax on interest and royalties under the Canada-U.S. Tax Treaty is 10%.