From Net Income to Taxable Income

• Author: Vern Krishna
• Profession: Professor of Common Law, University of Ottawa Barrister at Law
• Pages: 342-367

342

CHA PTER 12

FROM NET INCOME TO

TAX ABLE INCOME

A. GENER AL COMMENT

Up to this point, we have looked at the rules for calcu lating net income.

Now, we look at the rules th at determine “taxable income,” which is the

base to which we apply tax rates.1 In the next chapter we w ill review

the computation of the tax payable on taxable income.

Taxpayers are taxable on their t axable income. Canadian residents

are taxable on their worldwide taxable income for the year.2 Subject

to treaty provisions, non-residents a re taxable only on their Canadi an

source taxable income during a ta xation year.3 The tax payable by a

taxpayer is equ al to his tax base multiplied by the appropriate ta x rates.

Taxable income is net income, as adjusted for social policy, and

economic and equity considerations. Thus, taxable income moves us a

further step away from the concept of economic net income.

Equally important, we use the concept of taxable income to amel-

iorate the adverse effects of calculating taxes on a calendar yea r or f‌ifty-

two week basis by permitting for carryover of losses.

There are two controversial issues in designing an appropriate

structure to determine the taxable base:

1 Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA], subs 2(2); Div C (ss. 110–14.2).

2 Ibid, subs 2(1).

3 Ibid, subs 2(3). A non-resident’s taxable income is det ermined by reference to

the rules i n Div D (ss 115–16).

From Net Income to Taxable Income 343

1) What relief, if any, should we provide for individual and personal

circu mst ances?

2) Should the relief take t he form of a deduction from income or a

credit against taxes payable?

1) “Taxable Income”

“Taxable income” is the mathematical measure of the t axable base. A

resident’s “taxable income” is her net income plus or minus the adjust-

ments in Division C of the Income Tax Act.

We saw earlier that income for tax purposes is a taxpayer’s net real-

ized economic gains from a source recogni zed in law. However, income,

which for tax purposes represents the net realized i ncrement in wealth,

is not always the best measure of a taxpayer’s ability to pay tax. We

now look at some of the adjustments that the tax system makes for

individual circum stances. Also, we see, once again, how the system

affects behaviour by providing incentives for particular act ivities — for

example, ch aritable g iving.

Taxable income is a fairer measure of a taxpayer’s ability to pay tax

than net income. In the case of ind ividuals, for example, it is easy to

see that tax payers who have the same amount of net realized income

may not have equal capacity to pay t ax. For example, consider two in-

dividuals, each of whom ear ns $50,000: an unmarried person with no

dependants and a mar ried person with a fam ily of six, one of whom is

seriously ill and require s expensive care. The individuals have di fferent

capacity to pay tax.

Should we allow the individual with substantial f‌inanci al respon-

sibilities a measure of tax relief to ease the burden of his responsibil-

ities? Should the amount of relief be related to his income, or should

it be a blanket amount, regardless of the pa rticular circum stances? If

relief is income-tested, should we test it by reference to the individual’s

income or her family income? How do we determine “family” for the

purposes of income testi ng? These are diff‌icult and, sometimes, contro-

versial questions for which we do not have absolute answers. Neverthe-

less, they are questions t hat require rigorous analysis.

2) Deduction or Credit?

The f‌irst policy issue is whether we should provide relief for persons in

different f‌inancial circumstances th rough tax deductions or tax credits.

A tax deduction is a reduction of income in computing taxable income.

The net saving from a deduction is the amount deducted, multipl ied by