During down periods in the economy, cash management can become a critical issue for many small businesses. Highly leveraged yet profitable businesses may have difficulty obtaining additional financing on short notice. In these situations, one strategy for short-term internal financing that is often overlooked is the opportunity to reduce tax instalments.
Tax instalments for a particular year typically are based on the prior year's taxes payable. If the net income after the previous year end, and presumably the expected taxes payable for the current year, have fallen, it can be crippling from a cash flow perspective to pay higher instalment amounts. The solution to this problem is to understand and apply the relevant rules in order to optimize the instalments paid to the Receiver General.
Below are several ways of achieving an optimal tax instalment regime to maximize cash flow without incurring interest charges (or penalties) on late instalments.
Deferring tax instalments
Not surprisingly, it is advantageous to defer tax instalments for as long as possible. The general rule for corporate instalments is that they must be paid on a monthly basis. However, Canadian Controlled Private Corporations (CCPCs) may qualify for quarterly instalments if they satisfy three requirements:
- a perfect compliance history;
- have claimed a small business deduction for the current or previous tax year; and
- have less than $500,000 in taxable income and $10 million or less in taxable capital employed in Canada for the tax year (together with all associated corporations for the current or previous year).
Achieving a "perfect compliance history" requires that all GST/HST filings and remittances, source deduction withholdings, and corporate tax filings and remittances were made on time in the twelve months prior to the most recent instalment due date. Switching from monthly to quarterly remittances will result in a deferral of two months every quarter. Consult your Collins Barrow advisor for assistance in making this change.
Reducing tax instalments
Instalment payment requirements may also be reduced to align with the expected tax payable for the current year. Generally speaking, the default calculation for tax instalments takes one-twelfth (for monthly filers) or one-quarter (for quarterly filers) of the previous year's tax payable. This method is used commonly because, regardless of the income levels in the current year, no interest will be charged on any instalment shortfalls that result in tax payable.
There is, however, another option. A taxpayer may pay one-twelfth (for monthly filers) or one-quarter (for quarterly filers) of the estimated current year's tax payable. The risk with this option is that the CRA will charge interest (and possible penalties) where the actual tax due for the year exceeds the estimated amount. It is thus imperative that the estimate be accurate. A Collins Barrow advisor can help in this regard.
The CRA will assess a return using the option that results in the least amount payable by instalments. If income has fallen off in the current period and a budgeted estimate of the tax payable can be computed, significant savings may be realized.
Filing on time
It is important for eligible small CCPCs to ensure the correct instalments are filed on time to avoid unnecessary interest and penalties, and to maintain the quarterly filer status. Instalment payments are due on the last day of every complete month of the tax year, or the last day of every complete quarter for eligible small CCPCs. Interest accrues on unpaid balances at the CRA's prescribed rate (currently 5%) compounded daily from the balance due date to the date of payment. Penalties may also apply when instalment interest exceeds $1,000.
Contact your Collins Barrow advisor for more information.
Cody Marson, CA, is an Associate Partner in the Edmonton office of Collins Barrow.
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