It’s a good idea to regularly review the method your corporation uses to make tax instalments to ensure you aren’t accidentally making overpayments. By using the most advantageous method to calculate the instalments you pay to the tax authorities, you can reduce your instalments and increase cash flow for your business.
Generally, corporations are required to pay monthly income tax instalments if their total taxes payable for the current or preceding taxation year are more than $3,000. Corporations usually calculate and pay monthly instalments in one of three ways:
Option 1 – Pay 1/12th of your estimated tax liability for the current year;
Option 2 – Pay 1/12th of the preceding year’s tax liability (first instalment base);
Option 3 – For the first two months, pay 1/12th of the second preceding year’s tax liability and for the remaining 10 months, pay 1/10th of the difference between the first instalment base and the first two payments.
Many corporations simply pay monthly instalments based on the previous year’s results (Option 2), but this could prove costly in some situations. For example, although the total amount of the instalments under Option 2 and 3 will be the same for the year, your corporation may realize a cash flow advantage by paying reduced instalments for the first two months of the current tax year (i.e., Option 3) if your taxable income from last year was higher than it was two years ago.
You might also consider other options where your corporation’s taxable income is projected to be lower in this year than in last year. For example, if your company had taxable income of $1.2 million in each of the last two taxation years (and total tax of $324,000 each year), but you expect a significant drop in this year’s income so that tax payable will only be $60,000, using Option 1 would require you to pay monthly instalments of $5,000. However, under Options 2 and 3 you would pay monthly instalments of $27,000—a difference of approximately $22,000 per month in additional cash flow.
There are also special rules that apply to Canadian-controlled private corporations, which can further improve cash flow by paying their instalments on a quarterly basis. However, to qualify for quarterly payments, your company must meet all of the following conditions:
• your corporation’s income (together with associated companies) for the current taxation year or previous taxation year must not exceed the small business limit of $500,000;
• your corporation claimed a small business deduction for either the current or previous taxation year;
• your corporation’s taxable capital (together with associated companies) does not exceed $10 million for the current or previous taxation year;
• your company has no tax compliance irregularities during the preceding 12 months.
These Canadian-controlled private corporations can calculate their quarterly instalments conceptually using the same three options:
Option 1 – Pay 1/4th of the estimated tax liability for the current year;
Option 2 – Pay 1/4th of the preceding year’s tax liability (first instalment base);
Option 3 – Pay 1/4th of the second preceding year’s tax liability (second instalment base) for the first instalment and, for the remaining three payments, 1/3rd of the difference between the first instalment base and the first payment.
Don’t forget, however, that if you underestimate your tax liability for the current year and make instalments using Option 1, the CRA will charge you interest on the difference, which will not be deductible to the company. If you overpay instalments, your company will get a refund at the time you file your corporate tax return for the taxation year. However, when cash is tight, most corporations prefer to have the money in their hands rather than have it sitting with the tax authorities, especially since overpaid instalments don’t usually earn any interest.
As they say, “cash is king,” and considering your tax payment instalment options can sometimes help ease the pain a bit, especially if your company is experiencing lower income than in prior years due to, for example, a business downturn.