One of the most frequent questions I get from clients is whether or not they should pay tax installments. Although this sounds like a simple enough question, the answer is rarely straight forward and depends on your individual situation.
Are you liable for tax instalments?
Quarterly instalment payments may be required on personal tax and HST accounts. Monthly or quarterly instalments may be required on corporate tax accounts. Most Canadian taxpayers are liable for instalment payments if their taxes payable on any of these accounts was $3,000 or more in the prior year. Where it gets confusing, is that the amount you are liable to pay is the lesser of the taxes owing from the prior year and the taxes you will owe for the current year. On the date that your instalment payments are due, you may have no idea of what your tax liability for the current year will be. If you expect that your tax liability will be equal to or higher than the prior year, then instalment payments are due. If however you expect your taxes to be lower, you could be making payments in excess of what is required and the Canada Revenue Agency (CRA) will not pay any interest on these amounts.
Will the CRA tell me how much to pay?
For personal tax, the CRA will send you one instalment reminder for amounts due on March 15th and June 15th, and a second instalment reminder for amounts due on September 15th and December 15th. The amounts in the first reminder will be based on your taxes payable for the second preceding tax year, because the CRA will not have processed your tax return for the preceding year. The second reminder will then make up the difference, so that the total of the two reminders will equal the taxes payable from the preceding year. Keep in mind however, that if your taxes payable for the current year will be less than $3,000 you have no payment requirements. A fairly common situation can arise where a taxpayer incurs a one-time capital gain on the sale of a property or investments that results in a large tax liability. The CRA will send instalment reminders based on the tax you paid in that year, but if you have no similar gains in the current year, you likely do not owe anything.
For corporate tax and HST, the CRA will not send you any instalment reminders. They expect that business owners know the rules, and can calculate the required instalments on their own, or with the help of their accountants.
What happens if I do not make instalment payments?
If you do not make sufficient instalment payments, then the CRA will charge you interest on the shortfall. The current rate of interest charged is 6% per annum. If the interest calculated exceeds $1,000, then you may be liable for additional penalty interest that can bring the effective total interest rate charged to 8.25%. The CRA will never make any collection efforts on installment payments, because as mentioned above, they do not know if you actually owe anything at all until you file your tax return for the year. That being said, they have started a test program of automated call reminders for personal tax instalments that in the current environment of scam calls, was a bad idea in my opinion.
So should I pay?
Now that you have a better idea of the requirements, it will be easier for you to make an informed decision. If you are unsure of what your current tax liability will be, and are someone who hates paying the CRA interest under any circumstances, then you should pay the required instalments. On the other hand, you may make the informed decision that you have more pressing needs for your available cash (or credit facility) and that you are willing to pay the 6% interest to the government when they assess your return. One other thing to keep in mind for business owners. The interest you pay to the CRA is not tax deductible, wheras if you borrow funds from your bank to make payments, this would be tax deductible. If you are a corporation however, at today’s low small business corporate tax rates this does not make a big difference. If you are paying more than 6.8% for deductible interest, you are better off with the non-deductible interest at 6% (based on Ontario combined corporate tax rates of 12.5%).