Income Tax vs Payroll Tax In Canada

By Sean Stevenson – Latest Revision February 28th, 2021

What Is Income Tax Compared To Payroll Tax?

Income tax and payroll tax in Canada deal with deductions, taxation, and remittances. 

Canadian employers have specific tax responsibilities that fall under unique categories.  Whereas, the larger grouping of payroll taxes represents an umbrella of considerations that must also be deducted.

In tandem, both payroll tax and income tax represent taxation responsibilities.  These are required to be fulfilled under Canadian law.  Failure to adhere to payment schedules for CPP, EI, remittances, and income tax, can result in significant penalties if left unfulfilled.

Understanding Payroll Tax And Income Tax

In the case of a business paying its employees, income tax represents a deduction that must be taken out of each pay cheque.  This means that every time an employee receives their due payment, their employer must automatically withhold the required deductions.

The required deductions that employers must account for from each pay check are as follows:

  • Withholding income tax.
  • Employment Insurance (EI) premiums.
  • Canadian Pension Plan (CPP) contributions.
  • Along with any additional provincial employer taxation (also known as source deductions).

Payroll tax represents a larger umbrella.  Payroll taxation is made up of income taxes, federal taxes, and provincial taxes.

Income Tax vs Payroll Tax

PRO TIP:  Don’t hesitate to call the CRA for additional information at 1 (800) 959-8281.  Any business seeking to discuss payroll taxes with the CRA should use the key phrases “employer deductions and remittances.”  Ask specifically what is required of you, and the CRA will give you a precise answer.  It is also recommended to make use of an accountant, who will have detailed knowledge of proper regulations and procedures in Canadian taxation law.

Tax Responsibilities of Canadian Employers

If you are an employer in Canada, it falls to you to withhold the appropriate income tax deductions during each pay cycle.  These deductions vary based on your location in either a province or territory.  Moreover, you must also remember to account for federal income taxation.

If you are employing contractors, then you are not responsible for accounting for any deductions.  It would be the responsibility of the contractor company’s management to deal with their own payroll taxation.

Income Tax vs Payroll Tax for Sole Proprietors

The rules for sole proprietorship differ slightly.  The taxation principles that must be considered are as follows:

  • Personal and business income taxes (federal and provincial).
  • Canada Pension Plan/Quebec Pension Plan payments (CPP/QPP).
  • Self-employment taxes.
  • Goods and services tax/harmonized sales tax (GST/HST).
  • Optional employment insurance (EI) payments.

In the case of sole proprietorship, both business and personal income fall under the same category.

When filing your taxes, use Form T2125 Statement of Business and Professional Activities, along with your personal T1.

It is important to note that you will still be required to pay both federal and provincial income taxes.

How Should Withheld Funds Be Used?

As a Canadian employer, you may be wondering what to do with the withheld funds. 

The short answer is to not use them for anything except paying the government.  Using withheld funds as a “loan” or bridge amount is erroneous to say the least. 

It’s far safer (and legal) to ensure the funds are remitted (paid) to the government as soon as possible.  This is done through the CRA on a consistent (monthly or quarterly) basis.

Once you have established your withholding (payment) schedule with the CRA, you may consider automating it with the use of software.  However, some business owners opt to do so manually.

Regardless, in either event you are fully responsible to ensure that the funds are accurately calculated and remitted on time.

As a remind, failure to meet your withholding schedule can result in steep penalties, including hefty fines and even jail time.

How To Calculate Income Tax and Payroll Tax

The CRA’s payroll deduction tables and your employee’s TD1 forms are what determine the amount of income tax required to be withheld.  Apply this to each pay cycle.

Using the payroll deduction tables will allow you to oversee the exact amount of federal and provincial/territorial income tax required during each pay cycle.  However, if you are an employer in Quebec, it should be noted that these tables do not include your income tax calculations.

The payroll deduction tables also include the amounts required for EI premiums and CPP contributions. 

An employee’s federal and provincial TD1 form will describe the deductions in detail.  These are both their own unique and separate forms.

NOTE:  As of January 1, 2019, there has been an increase in the contributions required for CPP.

Who Is The CRA?

Originally formed in November 1999, the CRA is responsible for administering taxation laws for the Government of Canada.  The CRA itself is an acronym for the Canada Revenue Agency.  They are headquartered in Ottawa Ontario in the famous Connaught Building.

Additional duties of the CRA include:

  • Collecting taxes.
  • Administering tax policy and rule of law.
  • Delivering benefit programs.
  • Applying tax credits where applicable.
  • Overseeing registration of charities in Canada.
Income Tax vs Payroll Tax

How Does The CRA Find My Business?

Every business is required to register with the CRA for tax purposes.  During this process you will be issued a unique 9-digit business account number, which you can then use to register for a payroll deductions account.

Your 9-digist business account number, and the registration process itself, are what the CRA records in detail.  This allows them to identify both you and your business.

To register with the Canada Revenue Agency for provincial or other federal programs, click here.

How Does The CRA Categorize Income Tax and Payroll Tax?

In Canada, the CRA groups your income tax and payroll tax together.  You can find an authoritative guide to payroll deductions and remittances here.

It should also be noted that making use of software for payroll deductions and contributions is highly advised.  Not only will it ensure accuracy when determining the exact withholding amounts, it will also make the entire process much easier.

Payroll Taxes Vs Income Taxes – The Difference

For Canadian employers, there is a clear distinction between payroll taxes and income taxes.  Namely, as an employer who deal with payroll, you will have to account for provincial/territorial tax requirements, along with CPP and EI.

Income taxation is all about withholding the predetermined amounts from an employee pay cheque.  However, the caveat is that EI and CPP also require employer contributions.  This works as follows:

  • For CPP –  The employer is required to match the exact amount deducted from each employee’s pay.
  • For EI  –  The employer pays 1.4 times that amount that was withheld from the employee’s pay.

Reporting Income Taxes And Payroll Taxes

How often you need to send your information to the CRA depends on the amount being withheld.  However, the frequency is typically monthly, twice a month, or quarterly.

Should you have no deductions to report for a single month or an entire quarter, you are still required to file a nil report.

What Is YTD?

In payroll jargon, YTD is an acronym that stands for year to date.  This would represent the total amount paid in payroll taxes during a single fiscal year.

It is crucial to ensure accuracy when accounting for your YTD amounts.  This will prevent you paying too much or too little on your total payroll taxation amount.

By law, employers must complete and file a summary of their T4 report.  This should clearly display all payroll taxation related to business operations.  Moreover, a T4 must be provided to all employees no later than the final business day of February.

Issuance of a Record of Employment

In the event that an employee is let go or is deprived of income for a period of time, an ROE must be issued.  This provides context for taxation purposes, ensuring that the correct amounts of EI contributions are being reciprocated.

Should an employer switch payroll companies, an ROE must also be issued.  This will cover the time during which the new system is adopted and provide a record for future reference.

Changing Payroll Systems

If you are ever changing your payroll system in any way, you must ensure your YTD numbers remain accurate.

Always account for the entire fiscal year accurately, by keeping your records pristine and up to date.  This is especially important during transition periods where important data can potentially be compromised or lost.

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