HERE'S EVERYTHING YOU NEED TO KNOW ABOUT PAYING TAX BY INSTALMENT THIS YEAR
This month, the Canada Revenue Agency sent out instalment reminders to taxpayers who are required to pay quarterly tax instalments, reminding them of the first and second instalment deadlines for 2021. The first instalment is due in a couple of weeks on March 15, 2021, with the second due on June 15, 2021. According to the CRA, approximately 1.8 million individuals are required to pay income tax by instalments annually.
Under the Income Tax Act, quarterly tax instalments are required for this tax year if your “net tax owing” for 2021 will be more than $3,000 ($1,800 for Quebec tax filers) and was also greater than $3,000 ($1,800 for Quebec) in either 2020 or 2019.
The definition of net tax owing is somewhat complex, but essentially refers to your net federal and provincial taxes, less income tax withheld at source, plus any Canada Pension Plan contributions and Employment Insurance premiums on self-employment earnings (if applicable), as well as adjustments for certain other credits and social benefit repayments.
There are three options that may be used to determine how much you need to pay each quarter: the no-calculation option, prior-year option and current-year option. Individuals can choose the option that results in the lowest payments.
Under the no-calculation option, the CRA calculated your March 2021 and June 2021 instalments based on 25 per cent of the net tax owing on your 2019 assessed return. The Sept. 15 and Dec. 15, 2021 instalments will then be calculated based on the net tax owing from your soon-tobe-filed 2020 return (due April 30, or June 15 for self-employed and their spouse or partner), less the March and June instalments already paid.
By contrast, the prior-year option bases the calculation solely on last year's (2020) income. The 2021 instalments are based on your 2020 tax owing and you simply need to pay a quarter of the amount on each instalment date. This option is best if your 2021 income, deductions and credits will be similar to 2020, but significantly different than 2019, perhaps because you sold a vacation property back in 2019 and reported a large capital gain (which wasn't sheltered by the principal residence exemption.)
Finally, under the current-year method, you simply base your 2021 instalments on the amount of estimated tax you think you will owe for this year and you pay one quarter of the estimated amount on each instalment date. This option is useful if your 2021 income will be significantly less than 2020. For example, if you are self-employed and your income has dropped significantly due to COVID, you can make 2021 instalments based on your estimated lower income this year.
Provided you make the required instalments and they are remitted on time, no interest or penalties will be assessed.
Thinking of ignoring the instalment reminder you just received? The government could charge your instalment interest and, in some cases, an instalment penalty. Instalment interest is compounded daily at the prescribed interest rate, which is currently five per cent for overdue taxes. The instalment interest clock starts ticking from the day your instalment was due until the date it is paid (or, if unpaid, until April 30, 2022.) Fortunately, the government chooses the instalment option that results in the least amount of interest.
An instalment penalty may also apply if the instalment interest is more than $1,000. The penalty is calculated by subtracting from the instalment interest the greater of either $1,000 or 25 per cent of the instalment interest calculated if no instalment payments had been made for the year. Half of this difference is the amount of the penalty.
A tax case decided last month demonstrates what can happen if you ignore the instalment reminder from the CRA. The case came before a three-judge panel of the Federal Court of Appeal, which heard the case by online video conference. The taxpayer was appealing a prior judgment of the Tax Court of Canada which had dismissed his appeal concerning $599.24 of arrears interest the taxpayer was charged for the failure to make tax instalment payments for the 2016 tax year.
The taxpayer worked in Egypt for a non-canadian petroleum company but was still considered a resident of Canada for tax purposes the year 2016. He chose not make any Canadian tax instalment payments for the year.
The taxpayer argued that he should not be required to make Canadian instalment payments because source deductions were taken by his employer on account of his tax liability in Egypt. The taxpayer wanted the court to reimburse him for the arrears interest charged.
The taxpayer attempted to seek relief using an article of the Canada-egypt tax treaty, which states that “The nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals of that other State in the same circumstances are or may be subjected.”
The taxpayer interpreted this provision to mean that the CRA was required to take into account source deductions taken with respect to tax in Egypt in calculating the instalment payments that were then required to be paid in Canada.
The appellate court disagreed and found that the treaty provision being invoked did not apply to the taxpayer's case. It ruled that instalments were, indeed required, and, as the lower Tax Court found, any source deductions taken for tax in Egypt do not affect the instalments that were required under the Canadian Income Tax Act. The court therefore upheld the arrears interest charged for failing to make the required tax instalments when due.