In order to be taxable, the Canadian income tax system requires income to be allocated to a “source” either contained in the Income Tax Act or recognized by the courts.
Section 3 of the Income Tax Act provides the starting point from which Canadians calculate their personal income tax. It requires a taxpayer to determine all sources of income that they have inside and outside of Canada. This includes income from each office, employment, business, and property.
Section 56 of the Act supplements s. 3 and provides other sources of income to be included in finding tax payable. That is, pension benefits, employment insurance benefits, amounts received out of a registered retirement savings plans, retirement allowances, as well as scholarships and nurseries.
Capital property involves a unique calculation in terms of assessing your income. A taxpayer only includes half of their proceeds when they sell property, other than personal property, in their total income. However, they include all of their income which comes from using that property. So, if you own a truck for the purpose of making deliveries, then you include all of your income from the contracts for those deliveries. This can be characterized as income from a business source. If you turn around and sell the truck, you only recognize half of that gain for tax purposes. This is the distinction between capital property and income generated from capital property.
Section 4 of the Act completes the process of determining a Canadian’s tax payable. Once the taxpayer’s sources of income have been established, the Act provides that one can deduct permitted amounts from each office, employment, business, and property. In other words, all of the losses from each source for a year are subtracted from all of the gains of that source.
For instance, your truck in the previous example needed repairs that cost $5,000 and therefore before adding the $50,000 of income from contracts for delivery to your larger pool of income (or losses), you are permitted to subtract $5,000 from $50,000. After this process unfolds for each source of income, the sources are then combined which lands a taxpayer on their total income, or tax payable. Tax payable for a given year is then remitted to the Canadian Government.
An important aspect of this regime is that if a source of income or a deduction is not recognized by the Act, then it need not be added to your income or cannot be deducted. A deduction can also cause a net loss for a year on that source. A taxpayer can count this loss against all other aggregated sources of income (or losses). However, losses from selling capital property, otherwise referred to as a capital loss, can only be counted against capital gains.
The process of assessing what is income and what is deductible has been the subject of many tax disputes in Canada considered in our courts system.
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