How Do Corporate Tax Instalments Work?

You’ve just finished filing your corporate tax return and footing a tax bill which you’re not thrilled about. Just as you’re about to breathe a sigh of relief until next year, you get a friendly notice from the CRA asking for another hand-out. What’s the deal?

Before you purchase a ticket to the Caymans and invest in a fake moustache, it’s important to understand how tax instalments work.

The idea behind instalments is to smooth out your tax bill by paying throughout the year instead of one big lump sum at the end.

Let’s assume you’re an employee who earns $48,000.  Instead of a $4,000 cheque each month, you receive $3,000 where the difference (and a little bit more) goes off to the CRA for CPP, EI and income tax. At the end of the year you calculate the difference between the amount of tax you actually paid and the amount of tax you should have paid on your tax return. If done correctly, assuming you have few deductions, your tax return should be close to nil.

You could probably imagine what would happen if the CRA simply taxed everyone at the end of the year in one lump sum - it certainly wouldn’t make April a better time of year.

The idea behind source deductions is to ensure that the CRA receive their cash first so they’re not left empty handed at the end of the year. While not everyone will agree with the concept of source deductions, it does force people to manage their spending habits in relation to their after-tax earnings so they’re not left with a tax bill they can’t pay at tax time.

Corporate tax instalments are based on the same idea. While they ensure the CRA get their share throughout the year, they are also a means of cash flow planning so you can manage your company’s burn rate without a surprise tax bill at year-end.

How are instalments calculated?

While there are a few methods to calculate instalments, one of the common ones is based on your previous corporate tax bill. Assuming you’re making quarterly instalments, if your tax bill was $10,000 in year one, you’ll be making instalments of $2,500 throughout year two.  

If your tax bill is $10,000 again in year two, you won’t have any additional tax to pay at year end.

What happens if your tax bill is different at year-end?

The CRA doesn’t expect you to know exactly how much tax you’ll need to pay next year. If in our example above your tax bill comes to $20,000 in year two, you’ll need to pay an additional $10,000 at year end.

If you had a poor second year and your tax bill is $5,000, you’ll get a refund of $5,000.

If you’re not sure how much tax you’ll be paying at year-end, why bother paying instalments?

As you may have expected, the CRA doesn’t make instalments optional and imposes interest when not received on time.  However, the catch is that interest is only charged when tax is actually due.

If you choose not to pay the $2,500 per quarter of tax instalments and your tax bill comes to $10,000 again in the second year, you’ll need to pay some additional interest charges for not making the instalments. On the other hand, if your tax bill comes to zero, the CRA will waive any interest charges once you file your return.

So should you be making instalments?

That really depends on your cash flow situation and your forecast for next year.  If you’re having a successful second year and you have the cash available, you may as well make the instalment payments to avoid any interest charges.

However, if you think you’ll need the cash and will have a poorer year this year, you may want to skip the payments and see how the year goes.In general, if you had corporate income tax to pay last year, the CRA will require you to make instalments throughout the next year.

Whether you make those instalments or not should depend on your cash flow and predictions for the year ahead. So, next time you receive your instalment notice, relax and make an informed decision.