The Integration of Corporate and Individual Taxation

At the beginning of this chapter, a review of the primary relationship between a

corporation and its shareholder(s) established that corporations, as separate legal
entities, are taxed on their profits separate from the shareholders. The review
further established that although after-tax corporate profits can be shifted freely
to corporate shareholders, the ultimate shareholder of a corporation is the
individual, who is taxed a second time when after-tax corporate profits are
distributed as dividends. This two-tiered system creates the possibility of some
double taxation. In order to fully understand the impact of corporate taxation on
financial decisions, we need to establish the degree to which double taxation, if
any, results from the two-tiered structure.
The effect of double taxation is modified by the dividend tax credit, which the
individual can apply to reduce the personal tax on dividends received from Canadian
corporations. This reduction represents a credit for all or a portion of the
corporate taxes paid on the income represented by the dividend. In Chapter 7, we
established that the dividend tax credit attempts to reduce double taxation by
reducing personal taxes and assumes that the corporate tax rate is approximately
either 27.5% or 13%. Exhibit 11-8 and  Exhibit 11-9 show that the corporate tax
rate is not, in fact, always 27.5% or 13%.
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By applying the corporate rates in Exhibit 11-8 and the individual tax rates on
dividends in Exhibit 10-7 (see Chapter 10), we can determine the extent of double
taxation on the flow of corporate income to shareholders. Remember, there are two
categories of dividends—eligible and non-eligible—each having a different dividend
tax credit. The table below illustrates what happens when a public corporation pays
its after-tax profits to an individual shareholder who is in the top marginal tax
bracket. The same table also demonstrates that business income earned by a public
corporation and then transferred to its shareholder will incur a combined tax rate
of 53%; if the same business income were earned directly by the individual, a tax
rate of only 50% would apply.

We can apply the same calculation to a Canadian-controlled private corporation that

earns business income subject to the small business deduction (see the table
below). In this example, because the corporate tax rate is only 13%, the dividend
tax credit eliminates the element of double taxation. However, noted that annual
business income in excess of $500,000 is subject to a higher rate of corporate tax;
consequently, that income is subject to double taxation, much like income from
public corporations.

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The amount of double taxation is an important component in the calculation of the
long-term return on investment in corporations, as is the timing of that taxation.
In a public corporation, double taxation on returns to the owner is automatic; in a
Canadian-controlled private corporation, it may or may not occur depending on the
nature of the income (see Chapter 13). In either case, the combination of corporate
tax and tax on distributions to shareholders has an impact on dividend policy,
capital (debt/equity) structures, and the form of business organization (see
Chapters 12 and 13).
Consider, for example, the impact of double taxation on a public corporation that
must choose between two alternatives for raising capital: acquiring additional debt
or issuing preferred shares bearing a fixed dividend rate. If the going interest
rate for corporate debt were 10%, an individual investor in the top tax bracket
would receive a net return of 5% after tax
In order to receive an after-tax return of 5% on a dividend, the dividend rate
would have to be
To provide the same after-tax return to an investor, the corporation can issue
debt that bears interest at 10% or preferred shares with a dividend rate of 7.7%.
Because the interest is deductible from corporate income, the corporation could
invest the borrowed funds at 10% in order to generate enough income to pay out 10%
interest. However, for the preferred shares, the dividend is not deductible and an
element of double taxation occurs. Therefore, given that the corporate tax rate is
27%, the corporation would have to generate a return of about 10.5% with the equity
capital in order to have sufficient funds to pay a dividend of

This example demonstrates the effect that double taxation has on the cost of equity
capital and compares it with the cost of debt in public corporations. (We make a
more detailed review of corporate financing in Chapter 21.) We can apply similar
analyses to Canadian-controlled private corporations. Note that in private
corporations, the corporation/shareholder relationship is much stronger because
there are only a few shareholders. In such circumstances, the shareholder can
reduce the impact of double taxation by also acting as creditor and provide debt
capital to the corporation in return for interest or lease assets to the
corporation in return for rents. Such circumstances avoid double taxation because
interest and rents are deducted from corporate income (see Chapter 12).
These sample integration calculations have applied tax rates using a fictitious
provincial tax rate. When we use actual provincial tax rates, the element of double
tax for public corporations (and business income of Canadian-controlled private
corporations with no small business deduction) varies widely by province.
Similarly, business income eligible for the small business deduction often results
in over-integration, providing overall tax savings when income is passed through a
corporation. The following table outlines the integration cost/saving rates by
province/territory for 2022.