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Provincial Tax Laws 

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Profession > Tax Strategy

Provincial Tax Laws

Be aware of the multitude of differences between provincial and federal tax legislation.


Last tax season a colleague of mine was quite perplexed when preparing a client’s personal tax return. The client had paid American income taxes on income from a U.S.-based business. No matter how he tried, the accountant couldn’t get the tax preparation software to allow a provincial foreign tax credit for the U.S. taxes paid in excess of those recovered via the federal foreign tax credit. He’d seen that provincial credit hundreds of times in tax returns and was totally frustrated by the fact that it wasn’t being generated.     

The solution to the accountant’s dilemma was actually rather simple, but it involved an awareness of the authority provinces have over taxable income. The lack of awareness is not uncommon with practising accountants, who tend to be centred on the specifics of federal tax. Some simply aren’t aware that provinces have a separate Income Tax Act (applying to individuals), and may also have a Corporations Tax Act and/or a Capital Tax Act.

Individual Taxpayers

Provinces can tax individual income, but not business income earned through a permanent establishment located outside the province. In this case, the taxpayer pays provincial tax on the business income to the other province instead of the province of residence. Where the business is located outside Canada, a 48 per cent federal surtax applies in lieu of provincial tax.

Once my colleague substituted the federal surtax for the provincial tax – tax the province had no right to – the excess American taxes were fully recovered through the federal foreign tax credit.

This multi-jurisdictional approach does not mean the taxpayer files more than one T1 return (unless in Quebec). Rather, the provincial (or additional federal) tax liability is allocated based on the relationship of business income to net income. Where this allocation applies, form T2203 is used.

It’s important to note that this approach only applies to business income and not to rental income (crop share, for example, is considered rental income). Also, it’s key to understand what constitutes a permanent establishment. That is set out in Regulation 2600(2) and includes, among other situations, a fixed place of business such as an office, a branch, a mine, an oil well, a farm, a timberland, a factory, a workshop, or a warehouse.   

Corporate Taxpayers

The provincial right to tax business income also applies to corporate taxpayers. Assume a corporation has branch sales offices in Alberta and Manitoba in addition to its main operation in Ontario. The business income needs to be allocated between Ontario and the two branch provinces, and Regulation 402(3) provides the mechanics to do so. Two things should be appreciated:

  1. A permanent establishment is defined differently (though similarly) for corporations than it is for individuals – see Regulation 400(2), and;
  2. The allocation is calculated differently and in a more complex way than the method noted above for my colleague’s personal tax client because, in this case, there is business income attributable to permanent establishments in more than one province.

Pursuant to Regulation 402(3), the taxable income allocation is based on the average of the relationships of (a) gross revenue attributable to the jurisdiction to total gross revenue, and (b) salaries/wages paid in the jurisdiction to total salaries/wages paid. This is illustrated in the table.

Regulations 402(4) to 402(8) provide a series of rules addressing where gross revenue is attributable in more complex situations. A similar allocation (Regulation 2603(3)) also applies to individuals who have permanent business establishments in more than one province, although that would normally be a very rare situation. 

I’d be remiss if I didn’t mention that particular industries – insurance, banking, trust and loan, railways, grain elevators, airlines, pipelines, ships, and bus/truck operators – each have unique allocation methods. These, too, are found in the Regulations to the federal Income Tax Act.

Given that tax rates and tax credits can vary considerably between provinces, the correct allocation of taxable income is crucial. Familiarity with these allocations and with the specific workings of provincial tax legislation is an ever-increasing burden on accountants – and one that will continue to grow.

Province Wages
($)
Wage
Ratio (%)
Gross
Revenue ($)
Revenue
Ratio (%)
Taxable
Income
Allocated (%)

Manitoba
15,000
15
100,000
10
12.5
Alberta
30,000
30
200,000
20
25
Ontario
55,000
55
700,000
70
62.5

Total
100,000
1,000,000
100

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