As interest rates rise in Canada, taxpayers may face higher charges on their notice of assessments. Failing to make required instalment payments throughout the year could catch some people off‑guard, especially in light of higher interest rates. Here, we outline the calculations behind instalment interest and penalties, along with the costly consequences of not meeting payment requirements.

Application of instalment interest and penalties

Let’s begin with the conditions where instalment interest and penalties are payable. The Canada Revenue Agency (“CRA”) charges instalment interest when all of the following apply:

1. The taxpayer is required to pay instalments in the taxation year;
2. The taxpayer received an instalment reminder showing the amount payable; and
3. The instalment payments were either not made or not made in full, or were paid late

Calculation of instalment interest and penalties

Instalment interest

Instalment interest is charged on all late or insufficient instalment payments. It is compounded daily at the prescribed interest rate and calculated as follows:

A ⁠–⁠ B ⁠=⁠ C, where:
A ⁠=⁠ Interest on each required instalment not paid

• This is calculated from the day the payment was due until the taxpayer’s balance due date, using the instalment payment calculation option resulting in the least amount of interest.

B ⁠=⁠ Interest on each instalment the taxpayer paid

• This is calculated starting from the later of the date the instalment payment was made or Jan. 1, up to the taxpayer’s balance due date.

C ⁠=⁠ The taxpayer’s interest charge

• The taxpayer’s instalment interest owing is the difference between A and B.

Instalment penalties

The CRA charges instalment penalties when instalment interest for the taxation year exceeds $1,000. Instalment penalties are calculated first by determining which of the following amounts are higher:

1. A flat rate of $1,000
2. 25 per cent of instalment interest the taxpayer would pay if they did not make instalment payments for the taxation year

Next, the higher of these amounts is subtracted from the taxpayer’s actual instalment interest charges for the taxation year, then divided by two to determine the taxpayer’s instalment penalties.

10‑year history of interest rates

The prescribed interest rates used to calculate instalment interest over the past 10 years are as follows:

Example

Let’s assume a taxpayer has a $5,000 quarterly instalment requirement starting in January 2023. The following example calculates the amount of interest and penalties owed by this taxpayer as of April 30, 2024, assuming no instalment payments are made.

Instalment interest

The interest on unpaid instalments is calculated in the following table:

Notes:

1. The number of days outstanding is calculated as the number of days each total balance is outstanding, with the final balance outstanding until the taxpayer’s balance due date ⁠–⁠ April 30, 2024.
2. Interest is compounded daily at nine per cent divided by 365, equaling 0.0246575 per cent.

Instalment interest would be as follows:
A ⁠=⁠ $1,400.63 (from table above)
B ⁠=⁠ $0 (taxpayer made no instalment payments)
C ⁠=⁠ $1,400.63 ($1,400.63 minus $0)
The instalment interest owed by the taxpayer is $1,400.63.

Instalment penalties

First, it must be determined which amount is higher:

1. $1,000
2. $400.63 ($1,400.63 x 25 per cent)

Instalment penalties are then calculated as follows:

Here, the taxpayer owes $1,400.63 in instalment interest and $200.31 in instalment penalties on the overdue payments.

Now, to demonstrate the full impact of an interest rate increase, the above example will be recalculated using a five per cent interest rate.

Instalment interest

Interest is compounded daily, calculated at a rate of five per cent divided by 365, equaling 0.0136986 per cent, per day. At an interest rate of five per cent, the instalment interest owed by the taxpayer would be $764.81.

A ⁠=⁠ $764.81
B ⁠=⁠ $0
C ⁠=⁠ $764.81

Instalment penalties

Since the taxpayer’s instalment interest has not accumulated beyond $1,000, no instalment penalties are charged. At a five per cent interest rate, the taxpayer owes $764.81 in instalment interest and $0 in instalment penalties. The difference between the instalment interest and penalties charged at interest rates of 9 per cent and 5 per cent is summarized as follows:

If you have any specific questions or concerns regarding the impact of inflation and rising rates on your tax instalment payment obligations, simply contact your Baker Tilly advisor.

References:

Canada Revenue Agency. Required tax instalments for individuals Interest and penalty charges. Government of Canada, 24 Jan. 2023.

Canada Revenue Agency. When the CRA charges interest and penalties. Government of Canada, 13 Mar. 2023.

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Bryan Whalen
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