How does my corporation’s income get split between provinces for tax?

The formula: average your revenue share and your payroll share

The general allocation rule is deliberately mechanical. For each province with a permanent establishment, compute two ratios: gross revenue reasonably attributable to the permanent establishments in that province over total gross revenue, and salaries and wages paid to employees of those establishments over total salaries and wages. Average the two percentages, and that average, applied to taxable income, is the province's share. If a corporation has no revenue at all, or no payroll at all, the formula falls back to the single factor it does have.

Notice what the formula ignores. It does not care where the corporation is incorporated, where the head office thinks the profit was really earned, or which province's work was more profitable; a low-margin branch and a high-margin branch with the same revenue and payroll pull the same allocation. It applies to taxable income as one pool, after all deductions, so there is no tracing of specific expenses to specific provinces. That bluntness is the point: it removes argument, at the price of occasionally rough justice.

The threshold question, whether you have a permanent establishment in a second province at all, comes before any of this arithmetic, and it is its own test with its own traps, covered in whether working in another province creates corporate tax there. No second establishment means no allocation: every dollar is taxed in your home province and Schedule 5 never enters the return.

A worked example

Take a Mississauga company with an Ontario head office and an Alberta branch, $8,000,000 of gross revenue, $2,000,000 of salaries and wages, and $600,000 of taxable income. The books trace $2,400,000 of revenue to the Alberta establishment and $400,000 of payroll to the people who work from it. The allocation runs like this:

Each province then taxes its slice under its own rules and rates, so the corporation's blended provincial rate is a weighted mix rather than Ontario's alone. Provincial small business rates follow the same slices: a CCPC's income eligible for the small business deduction gets each province's small rate only on the portion allocated there, so in this example Ontario's 3.2% small business rate applies to the Ontario share and Alberta's small rate to its own. When provinces' rates differ, the allocation percentage is worth real money in both directions, which is why auditors on both sides of a border take an interest in the same two ratios.

Notice also how the two factors pulled in different directions: Alberta produced 30% of revenue but holds 20% of payroll, and the averaging split the difference. That pattern, a province that sells more than it staffs, or staffs more than it sells, is the normal case, and it means neither your sales report nor your org chart alone predicts the tax result.

How revenue gets traced to a province

The revenue factor depends on attribution rules, and they are destination-leaning but establishment-limited. Broadly: revenue from goods goes to the province of the permanent establishment where the customer's order is filled, generally the destination province if you have an establishment there. But revenue can only be attributed to provinces where you actually have a permanent establishment, so sales into a province where you have none flow back to the establishment that made or negotiated the sale. Ship from Ontario to customers in six provinces with establishments only in Ontario and Alberta, and all of that revenue lands in those two columns, not six.

Service revenue follows a similar logic, attributed broadly to the establishment where the services are rendered, falling back to the establishment from which the work was negotiated when they are rendered somewhere you have no establishment. The practical discipline is a revenue-by-establishment working paper: a documented, consistent method for tracing sales to establishments, applied the same way every year. Auditors challenge inconsistency and improvisation far more often than they challenge a reasonable method applied steadily.

Gross revenue also means gross operating revenue, not everything on the income statement; items like interest on the operating float or one-off asset dispositions need a deliberate decision about inclusion, made once and applied consistently. When the method genuinely could go two ways, the difference between them is your provincial rate spread applied to the swing, which tells you exactly how much analysis the question deserves.

The payroll factor, and why contractors distort it

The wages factor counts salaries and wages paid to employees of each establishment, which raises two practical questions: who is an employee, and which establishment are they "of". Subcontractors are not employees, so a branch that runs on contractors shows almost no payroll in its province and the wages factor quietly shifts income toward the provinces where actual employees sit, often the Ontario head office. Companies are sometimes startled that an eight-figure out-of-province operation allocates modestly because it is staffed by subs; that is the formula working as written, not an error, though there are special rules that can deem amounts paid under certain arrangements to be wages for this purpose, central paymaster rules being the notable one for corporate groups that pay everyone from a single entity.

Assigning people to establishments follows where they work from, not where HR sits or where the paycheque is issued. Field staff attached to a branch belong to the branch; head-office functions belong to head office; mobile and remote workers need a documented, defensible assignment. This is a different question from the province-of-employment rules that drive payroll withholding, and the two can legitimately differ for the same person, so borrowing the T4 province for Schedule 5 without thought is a common shortcut that fails review.

A caution before anyone gets clever: the underlying facts are legitimate levers, where you actually locate people and how you actually structure operations, but relabelling without substance is not. The same books feed both provinces' audits, and a wages assignment invented for tax reads as such immediately. If the footprint itself is worth restructuring, that is a real conversation with real numbers, which is where our Corporate Tax work starts rather than ends.

Filing it: Schedule 5, the separate provincial returns, and corrections

The allocation is filed once federally and repeated wherever a province self-administers. Schedule 5 carries the percentages and each province's tax on the T2; Alberta and Quebec each require their own corporate return computing tax on the same allocation. The returns must agree, because a mismatch means some income is taxed twice, or escapes a province until it notices, and both endings involve interest. Special formulas replace the general two-factor rule for certain industries, transportation companies, banks and insurers among them, so a trucking operation should not expect the arithmetic above to be its arithmetic.

When an allocation was wrong, or Schedule 5 was never filed despite a second establishment, the fix is corrections: amending the federal schedule and any provincial returns for the open years, consistently, before a province's desk audit forces it. Provinces do compare notes with CRA, allocation reviews are a standard provincial audit program, and the corporation that corrects first controls the story and usually most of the cost. Late or missing provincial filings carry their own penalties and daily interest, and each administration keeps its own instalment account, so a changed allocation ripples into instalments too. This is bread-and-butter CRA support and corporate compliance work for an Ontario CPA: establish the right percentages, file the corrections in every affected place at once, and reset the calendar so it stays fixed.

Two supporting habits keep the file audit-ready. Retention: keep the revenue-tracing and payroll-assignment working papers for six years from the end of the year they support, because the percentages are only as defensible as the paper behind them. And an annual re-run: the allocation is a yearly computation, not a setting, so put it on the compliance calendar alongside everything else the multi-province footprint requires, the full sweep of which lives in what a multi-province business should review for tax compliance. When a file changes accountants, onboarding should include reperforming the prior year's allocation, since inherited percentages are wrong more often than inherited balances.

What changes the answer for your corporation

What your allocation looks like, and how much attention it needs, turns on a short list of facts:

• Where you actually have permanent establishments, since the formula only ever splits between provinces that have one
• How revenue traces to each establishment, including sales into provinces where you have none, which flow back to the establishment that made them
• Employees versus subcontractors at each location, because only employee payroll moves the wages factor
• Whether Alberta or Quebec is involved, adding a separate return that must mirror the federal percentages
• Whether an industry-specific formula applies, as it does for transportation, banks and insurers
• The rate spread between your provinces, which prices every percentage point the working papers move

If your company files in more than one province and nobody has reperformed the allocation recently, that is a working-paper afternoon that occasionally finds real money, in either direction. A free 15-minute discovery call tells you whether yours is worth the look.

Source: CRA — T2 Schedule 5, Tax Calculation Supplementary (provincial and territorial allocation).