Income tax
What income tax is, the types in Canada, and how to calculate it with examples.
Published Thursday 23 July 2026
Table of contents
Key takeaways
- Income tax is a levy on earnings that the Canada Revenue Agency (CRA) collects to fund public services and infrastructure.
- Canada layers federal income tax with provincial or territorial tax, and the federal personal system is graduated, so the rate rises as income rises.
- Businesses pay income tax on their net profit and file their returns with the CRA.
- The type of income tax you pay depends on your structure: personal, sole proprietor or partnership, or corporation.
Income tax (definition)
Income tax is a government levy on the earnings of individuals and businesses. In Canada, the Canada Revenue Agency (CRA) collects income tax to fund public services and infrastructure.
Individuals and businesses submit returns that declare their taxable income, then pay tax based on the amount they earn.
Three types of income tax
The type of income tax you or your business pays depends on how you're set up. The 3 main types are personal, sole proprietor or partnership, and corporate.
Personal income tax
Individuals pay personal income tax on their earnings. In Canada, this system is graduated, so the rate rises as income rises.
Business income tax for sole proprietors and partnerships
Sole proprietors report business profit or loss on their personal return and pay personal income tax on the combined amount. Partnerships generally file a separate information return as well, which the CRA checks against each partner's personal return.
Business income tax for corporations
Corporations pay income tax on their net profit as a separate legal entity. Any salaries or dividends the corporation pays its owners are then taxed as part of each recipient's personal income tax.
Income tax in Canada: federal and provincial
Income tax in Canada comes in 2 layers. The CRA collects federal income tax, and each province and territory adds its own income tax on top (Quebec administers its own provincial tax separately).
The federal personal system is graduated, or progressive, so higher portions of income are taxed at higher rates. You can read more on the CRA personal income tax overview, and see how rates apply to small businesses in the Xero guide to small business tax rates.
Income tax rates
The federal system is graduated, and provincial or territorial rates layer on top. Because rates change every year, it's best to check the official CRA sources rather than rely on a fixed figure.
How to calculate income tax
You can work out income tax by applying the relevant tax rate to your taxable income. The basic formula is:
Income tax = Taxable income x Tax rate
With a graduated system you may need to apply several rates across different brackets, as the progressive example below shows.
Example flat rate income tax calculation
Here's how the formula works when a single flat rate applies to all taxable income.
A company with revenue of $240,000 and expenses of $140,000 pays a flat rate tax of 20%.
Taxable income (revenue minus expenses) x Tax rate
($240,000 minus $140,000) x (20/100)
= $100,000 x 0.2
= $20,000
The company owes $20,000 in income tax. If it distributes after-tax profit to its owners, they'll declare that income on their personal returns too.
Example progressive income tax calculation
This example uses simplified, hypothetical brackets for illustration only, and does not reflect actual Canadian tax rates. It shows how tax adds up when income falls across several brackets.
An individual earns $70,000 in wages and $30,000 in profit from a sole proprietor business, for total income of $100,000. Using these hypothetical brackets, this person would pay:
- 0% on the first $30,000
- 33% on the next $50,000
- 40% on the final $20,000
($30,000 x 0) + ($50,000 x 0.33) + ($20,000 x 0.4)
= $0 + $16,500 + $8,000
= $24,500
This individual owes $24,500 in income tax.
Reporting and paying business income tax
Businesses pay income tax on their net profit (before taxes) and file their returns with the CRA. When you file, you report revenue and expenses, and you may be asked to provide the matching invoices and receipts.
You may also need to prepay tax in installments through the year to avoid a large end-of-year bill, often based on projected earnings or the previous year's profit.
Keep your records and supporting documents for 6 years, as set out in the CRA guidance on how long to keep your records.
What info does a business need to calculate income tax?
To calculate income tax, you'll pull together a few key pieces of financial information. The main inputs are:
- Revenue and expenses, found on the income statement (also known as a P&L)
- Depreciation claimed on assets owned by the business
- Tax credits, if applicable, which reduce the tax owed
Xero's accounting software can simplify this by capturing transaction data, automating depreciation calculations, and generating financial reports. It's also a good idea to get support from a tax professional, and you can find one in the Xero advisor directory.
Simplify income tax with Xero
Staying on top of income tax is easier when your revenue, expenses, and reports live in one place. Xero brings your finances together so you can prepare for tax time with less manual admin.
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FAQs on income tax
Here are answers to some frequently asked questions about income tax in Canada.
When is income tax due in Canada?
For most individuals, income tax is due by 30 April. If you're self-employed, you have until 15 June to file, but any tax you owe is still due by 30 April.
What is the difference between federal and provincial income tax?
Federal income tax is collected by the CRA and applies across Canada, while provincial and territorial tax is charged on top by each province or territory. Quebec administers its own provincial income tax separately.
How do sole proprietors pay income tax?
Sole proprietors report their business profit or loss on their personal tax return and pay personal income tax on the combined total. They may also need to make installment payments through the year.
What happens if you file or pay income tax late?
The CRA can charge a late-filing penalty on the balance owing plus interest on any unpaid tax. Filing on time, even when you can't pay in full, helps you avoid the late-filing penalty.
How can you reduce the income tax you owe?
You can lower the tax you owe by claiming eligible deductions, such as business expenses, and applying available tax credits. A tax professional can help you find the ones that fit your situation.
Related terms
Learn more about income tax
Handy resources
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.