Corporate Income Tax, Small Business

We Owe How Much? … OUCH!

Manage cash flow better by projecting future tax liabilities.

Unforeseen circumstances often leave owner-managers short of the cash needed to pay federal and provincial taxes. Unfortunately, many owner-managers consider unpaid tax bills to be the same as unpaid trade credit. They are not. Unpaid taxes can cause a lot of problems. Ensuring funds are available to pay obligations to the Canada Revenue Agency (CRA) should be a top priority for any business, whether incorporated or a sole proprietorship.

calculatorWithholding Taxes

Every self-employed business owner or owner-manager is obligated to collect HST as well as deductions for employment insurance, Canada Pension Plan, and income taxes. These amounts are collected “in trust” from the employee or client on the understanding that the funds will be remitted to the CRA on their behalf. In theory, the business should just collect the money and set it aside in a separate account until the required filing date. However, it is often all too tempting to use the “in trust” funds as working capital and assume sufficient cash flow will be generated when accounts receivable are collected or additional cash sales occur. This may be fine in theory, but in practice, the necessary funds are rarely available. For a corporation, it is particularly important to note that directors could be held personally liable for the unpaid “in trust” taxes.

Income Tax Payable

Income tax payable at the end of the year, whether for corporate tax or income tax owing on self-employed earnings, is another area that is problematic for many. The major issue for most businesses is that they are unable to project the amount of taxable income that will be earned by year end and thus cannot anticipate the amount of income tax owed. As a result, when taxes are due, there may be insufficient funds available to make the payment.

To make matters worse, many corporations are required to pay the taxes owing within two or three months of the corporate year end. Owner-managed businesses may have difficulty finalizing their year ends and providing such information to their CPA in a timely manner. Thus, year-end taxes and the instalment could be owing at practically the same time. This creates incredible cash flow issues for corporations that have a large corporate tax liability at the end of the fiscal year and then have to make a large instalment payment.

The reverse can also occur. A taxpayer remits large amounts in instalment payments throughout the year based on the prior year’s tax liability only to discover at the end of the current fiscal year that the corporation made little profit or suffered a loss and therefore owed much less than the sum of the instalment payments already made. In such instances, the CRA may owe the business thousands of dollars that could have been used within the business but is not refunded until the actual filing of the tax returns.

The CRA Holds All the Cards

The CRA determines when taxes should be paid. If instalment payments are not paid, the business must endure non-deductible interest for late payment. On the other hand, if the instalment payments are made and the business does not have a tax liability, the CRA has held onto funds that could have alleviated cash flow. The CRA pays interest on overpayments, but only on the amount of tax owing at the time of filing, not on the entire amount of the overpayments. Also, the CRA charges taxpayers arrears interest at 6% while the interest rate on taxpayer overpayments are only calculated at 2%.

Business owners need money on hand to pay tax instalments.

Take Charge

Business owners need to have sufficient funds on hand to make payments when due. To minimize the risk of insufficient funds, management must take into account not only the withholding tax requirement but also the need to minimize instalment payments and/or interest charges on the funds needed to make the corporate tax instalments.

The following procedures provide a way to anticipate future obligations:

  1. After your CPA has provided the corporate income tax return for the last fiscal year, ask them to provide and review a printout of the required instalment payment amounts and due dates. If your profits are expected to be about the same in the coming year, those amounts will approximate the instalment amounts required.
  2. Project the anticipated monthly or quarterly profits from the first of the new fiscal year. Since most administrative costs are usually constant from year to year, the task is reduced to projecting sales, estimating the cost of goods sold, and determining the gross margin at the monthly or quarterly interval. Once the estimated gross margin is known, simply deducting the administration cost should provide a reasonable estimated profit before income taxes.
  3. Review these projections with your CPA. Input regarding potential bonuses and capital cost allowances combined with knowledge of corporate tax rates will provide better insight into the probable tax liability for the end of the fiscal year. By default, this information will determine the instalment amounts required.

The process of deriving this information will be of value to your business by:

  • ensuring a better understanding of your business cycle
  • providing insight into periodic profits and losses and thus any potential income tax liability
  • projecting the estimated HST/ITCs and withholding taxes that will be due
  • providing indicators of when cash flow may be tight
  • reducing the uncertainty as to the amount of income tax instalments and thereby providing a reasonable payment schedule for corporate income tax
  • lessening the impact of non-deductible interest and/or penalties on amounts due but unpayable because
    of inadequate cash flow
  • reducing the probability of scrutiny by the CRA because of late payments

The Present Guides the Future

If management makes reviewing financial statements an integral part of their work cycle, not only will they benefit the future by understanding the present, they will also be better able to sleep at night knowing their cash flow needs are under control.

 


The preceding article is reprinted from the July 2018 newsletter Business Matters with the permission of the Chartered Professional Accountants of Canada.  Business Matters is a bi-monthly newsletter, the full version of which can be obtained on request. 

This post deals with a number of complex issues in a concise manner; it is recommended that accounting, legal or other appropriate professional advice should be sought before acting upon any of the information contained therein.

Although every reasonable effort has been made to ensure the accuracy of the information contained in this article, no individual or organization involved in either the preparation or distribution of this letter accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.

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