This action might not be possible to undo. Are you sure you want to continue?
The following pages of this document will be provided for exam purposes: Pages: 20, 23, 26, 28, 29, 32, 36, 37, 38, 39, 42, 49, 57, 58, 59, 60, 64, 70.
Subsection 2(1) Corporations are included in the definition of a "person" and therefore are taxable entities Corporations file T2s The T2s(1) is used to reconcile net business income for accounting purposes to net business income for tax purposes The T2s(7) is used to identify the different sources of income: Business Income or Loss Canadian and Foreign Investment Income (Loss) (eg.: Capital gains (loss), interest, rent, royalties, foreign dividends) Taxable Dividends received from taxable Canadian Corporations In order to codify and standardize the filing of tax returns, Canada Revenue Agency has developed a "General Index of Financial Information (GIFI). Each
B/S and I/S item must be matched to a GIFI index reference number.
COMPUTATION OF CORPORATE TAXES
Step 1: Calculation of Net Income for Tax Purposes Step 2: Calculate deductions from Net Income to arrive at Taxable Income Step 3: Calculation of Corporate Tax Federal and Provincial
COMPUTATION OF NET INCOME
3(a)Income from a business Income from property Other income (relating mainly to individuals) 3(b) Taxable capital gains (including net taxable gain from disposition of listed personal property) Less: Allowable capital losses Less: allowable business investment losses 3(c)Other deduction (relating mainly to individuals) 3(d) Loss from a business Loss from property Allowable business investment loss Net income of the corporation for the year + + + +
+ (-) + + + +
Note: Corporations have no employment income or loss
The T2s1 is used to reconcile income from a business: Accounting → Tax
PERSONAL SERVICE BUSINESS
ss125 (7) These rules were introduced to remove the tax advantages that high income earning individuals would benefit from becoming "incorporated employees" Employer → Employee
Employee shareholder) (Specified
↓ 10 % or + Employer Note: → Corporation
If the business employs throughout the year more than 5 full-time employees, then the business is not considered a "personal
PERSONAL SERVICE BUSINESS TAX IMPLICATIONS
All tax advantages of becoming a Corporation are denied other than those that would have been available to the employee in the first place if he or she had not incorporated.
COMPUTATION OF TAXABLE INCOME
Net income for the year Less: A) Section 110 Part VI.1 tax x 3 (preferred shares) B) Section 110.1 Charitable gifts (also Crown gifts and
+ + + + +
C) Sections 112 and 113 Taxable dividends received from 112(1)(a) - taxable Canadian corporation 112(1)(b)- controlled corporation resident in Canada 112(2) - non-resident corporation carrying on a business in Canada (subject to special rules) 113(1) - foreign affiliate corporation (subject to special rules) D) Section 111 Non-capital loss carryover Capital loss carryover Farm loss carryover
Add: E) Section 110.5 Additions for foreign tax deductions Taxable income for the year
Restricted farm loss carryover Limited partnership loss carryover
Note that for Corporations, charitable donations are not tax credits but rather deductions in calculating taxable income. The deduction is limited to 75% of net income with a 5 year carryover provision. Certain favourable rules apply to certain types of donations: Gifts of capital property Gifts of securities Ecological gifts Cultural gifts
Individual ↓ Corporation 1 ↓ Corporation 2 ↓ Corporation 3 ↓ Corporation 4 Corp. #4 earns $100,000 of business income, pays $ 20,000 of taxes and pays the $80,000 remaining as a dividend to Corp. #3. If Corp. #3 did not get to deduct the $80,000 in calculating taxable income, the same income would be taxed a second time (Double taxation).
With multi-level organizations, the same income could be taxed 2, 3, 4... times.
ACQUISITION OF CONTROL
These rules were introduce to prevent the acquisition of certain Companies for tax reasons In the past, Companies were being acquired for their embedded losses so that the acquiring Company could use these loss carryovers to reduce its own taxes For these reasons, CRA introduced its "Acquisition of Control" rules
ACQUISITION OF CONTROL
Where acquisition of control is acquired ss249 (4) deems the current taxation year to have ended immediately before the acquisition of control and a new taxation year will be deemed to have begun Example: ABC Corporation has a December 31 year end. On April 6th, Mr. A, the major shareholder owning 52% of the voting shares, sells 20% of his shares to Company XYZ. Company XYZ previously held 40% of the shares of ABC Corp.
AOC Jan 1st Result: April 6th Dec 31st
The current taxation year ends on April 5th and a new taxation year begins on April 6th. The Company may choose a new year-end or stick with Dec 31st
GENERAL EFFECTS OF THE DEEMED YEAR-END
Financial statements and other reports must be prepared for the year ended Inventory must be counted CCA, SBD, and other deductions must be prorated Company will use up one of its loss carryover years Corporate instalments must be calculated Tax return must be filed
ACQUISITION OF CONTROL AND EFFECTS ON LOSSES
Net Capital Losses Net capital losses occurring before the AOC are lost and cannot be carried forward to future years Net capital losses occurring after the AOC will not be allowed to be carried backwards to any year commencing before the AOC Non Capital Losses & Farm Losses These losses continue to be deductible in a taxation year after an acquisition of control but only: If the corporation carries on the business in which the losses were incurred, for profit or with a reasonable expectation of profit, throughout the year in which the corporation seeks to make a deduction; and To the extent of total income earned by the corporation from carrying on that business or a similar business
Similar rules apply when carrying back losses that
occur after the AOC to years preceding the AOC
Any accrued losses on assets owned by the Corporation at the time of the AOC will be deemed to be realized immediately prior to the AOC Non-Depreciable Property If an accrued loss exists on non-depreciable property [ACB > FMV], then the ACB must be reduced to the FMV. The amount by which the ACB was reduced is considered to be a capital loss Depreciable Property If the UCC of a class exceeds the total of: the FMV of all assets in the class
Then the excess is considered a non-capital loss for the year Eligible Capital Property If the CEC exceeds 3/4 x FMV of the property, similar
rules apply as depreciable property.
SPECIAL ELECTION VIA PARA 111(4)(e)
If the corporation has any capital property in which there is an accrued capital gain, the corporation may elect to recognize the accrued gain so as to reduce any net capital losses or non-capital losses The taxpayer can choose the proceeds of disposition which can range between the following amounts: 1.The ACB of the property 2.The FMV of the property
ALLOCATION OF TAXABLE INCOME
An individual is taxed in the Province in which he/she resided on December 31st Corporations, on the other hand, are taxed in the Province in which it has a "permanent establishment" When a Corporation has several permanent establishments in different Provinces (Countries) the total taxable income must be allocated to the different "permanent establishments"
ALLOCATION OF TAXABLE INCOME
Step 1 - Determine the Permanent Establishments [Reg. 400(2)] Ontario Quebec Manitoba Germany P.E. - Office, branch, oil well, farm, factory workshop, warehouse Step 2 - 1. 2. 3. 4. Determine the % of gross revenue attributed to each P.E. Determine the % of salaries & wages attributed to each P.E. Calculate the average % Multiply % by taxable income
ALLOCATION OF TAXABLE INCOME EXAMPLE
Taxable Income = $6,000 Gross Rev Ontario Quebec Manitob a German y Total
% 10 20 60 10 10 0
Salary & W
% 40 20 30 10 10 0
Ave % 25 20 45 10 100
1,000 2,000 6,000 1,000
800 400 600 200
Ontario Quebec Manitoba Germany
T.I. 6,000 6,000 6,000 6,000
x x x x
% 25 20 45 10
= = = =
1,500 1,200 2,700 600 6,000
TYPES OF CORPORATIONS
Canadian Corporation Resident in Canada
private co. [s.89(1)(f)] • not controlled by a: - non-resident - public company
controlled by a public company
CALCULATION OF TAX
Taxable Income x Tax Rate (38% since 1988) Plus: s123.3 Less: Income earned in a province - s124 General tax reduction s123.4 Small business deduction - s125 Manufacturing and processing profits Foreign tax credit - s126 Political contribution tax credit - s127 (3) Investment tax credit - s127 (5) and s127.1 Deduction of Part VI.1 tax – s125.2 Surtax - s123.2 (Will be repealed in 2008) Refundable tax on investment income -
CORPORATE TAX RATES
Basic rate Federal tax abatement (10.00) 4% surtax Effective tax rate 2007 38.00% 28.00 1.12 29.12%
GENERAL TAX REDUCTION s123.4
A general tax reduction applies to certain types of corporations on certain types of income. Basic rate Federal tax abatement 4% Surtax General tax reduction Effective federal tax rate 2007 38% 28 1.12 (10)
Excluded Corporations -Mutual funds, mortgage investment and non-resident owned investment corporations. Excluded Income Income from natural resources or manufacturing and processing. Also excluded is active business income earned by CCPCs that is subject to the small business deduction and investment income.
*Note: The general rate reduction will change as follows: 2008: 7.5%; 2009: 8%; 2010: 9%; 2011:9.5%.
SMALL BUSINESS DEDUCTION (SBD)
Available to CCPC's with active business income (ABI) - ss125 (7) The SBD is currently 16% of the least of: ABI carried on in Canada Taxable income not sheltered by the foreign tax credits calculated as follows: Taxable income minus: - 10/3 times the non-business foreign tax credit (without reference to the ART or GRR) And - 3 times the business foreign tax credit (without reference to the GRR) The corporation's business limit for the year (2007: $400,000)
Note that the $400,000 business limit for the year must be allocated among associated corporations Association is defined in ss256 (1)
Active Business Income ITA s125 (7)
This section of the Act defines active business income as follows: “Active business carried on by a corporation” means any business carried on by the corporation other than a specified investment business or a personal services business and includes an adventure in the nature of trade. Note: Some exceptions are made for “incidental property income” as well as property income received from an associated Company that has deducted the payments in calculating its own active business income.
TAX RATES - SBD
Basic rate Federal tax abatement 4% surtax SBD on ABI Effective tax rate 2007 38.00% (10.00) 28.00 1.12 *(16.00) 13.12%
*Note: The small business deduction is scheduled to increase as follows: 2008: 16.5%; 2009: 17%.
Elimination of the Small Business Deduction for Large CCPCs
In order to limit certain large CCPCs from benefiting from the SBD, the annual business limit will be reduced for certain CCPCs. Annual Business Limit Reduction = A * B/$11,250 Where: A is the amount of the corporation’s annual business limit for the year ($400,000 for 2007, or less if it is shared with associated corporations). B is .225 percent of the excess of the corporation’s Taxable Capital Employed in Canada (TCEC) as determined for the previous year under ITA s181.2 of the Large Corporations Tax legislation, over $10 million.
ABI $400,000 $400,001 and less and over 38.00% 38.00% (10.00) 28.00 1.12 29.12 (16.00) -13.12% (10.00) 28.00 1.12 29.12 -(7.00) 22.12%
Basic rate Federal tax abatement 4% surtax SBD on ABI General tax reduction Effective federal tax rate
GENERAL TAX REDUCTION FOR Non-CCPC
Taxable Income - 100/7 x M&P Tax Credit Total x 7% = General Tax Reduction for Non-CCPCs
GENERAL TAX REDUCTION FOR CCPC
Taxable Income -100/7 x M&P Tax Credit -SBD Base - Aggregate Investment Income Total X 7% = General Tax Reduction for CCPCs
DEDUCTION FOR MANUFACTURING AND PROCESSING PROFITS
This deduction is calculated as 7% of the corporation's M&P profit not eligible for the small business deduction In order to qualify for the deduction, at least 10% of a corporation's gross revenue for the year from all active business, must be from the sale or leasing of goods that are manufactured or processed The following types of businesses are excluded from the M&P deduction: Farming and Fishing Construction Various Resource Activities
TAX RATES - M&P
Basic rate Federal tax abatement 4% surtax M&P Effective tax rate 38.00% (10.00) 28.00 1.12 (7.00) 22.12%
Note: The effective tax rate for income subject to the M&P tax credit is equal to that subject to the general tax reduction. This means that for federal tax purposes M&P income is no longer treated more beneficially than other types of business income. Some provinces will still treat M&P income more beneficially than other types of income.
M&P DEDUCTION - CALCULATION
The equations for calculating the M&P deduction are as follows: M&P deduction M&P profits = M&P rate x Adjusted
In computing the M&P profits an allocation is performed based on the relative cost of capital and labor employed in manufacturing and processing:
M&P profits = ADJUBI labor] x [cost of M&P capital + cost of M&P [cost of capital + cost of labor]
Adjusted business income – Reg 5202 Cost of M&P capital = 100/85 x 10% x the Capital cost of Manufacturing depreciable property Cost of M&P labor = 100/75 x Cost of labor use for M&P Cost of capital = 10% x the Capital cost of all depreciable property Cost of labor = total of all salaries & wages
Adjusted M&P profits = The lesser of: A) M&P profits - SBD base B) Taxable income - SBD base - 3 times the business
foreign tax credit (without reference to the GRR) If a CCPC, the aggregate investment income
M&P DEDUCTION - EXAMPLE
Manufacturing an Processing Deduction Facts: $ ABI, net of active business losses 4,000,000 Total cost of depreciable property used for M&P activities 9,000,000 Total cost of all depreciable property 12,000,000 Total cost of labor used in M&P activities 600,000 Total cost of all labor 700,000 Taxable income 3,400,000 SBD base 400,000 M&P rate 7%
Solution: Cost of Capital 1,200,000 Cost of Labour = 12,000,000 x 10% = = = 700,000
Cost of M&P capital = 100/85 x (9,000,000 x 10%) = 1,058,823 Cost of M&P labor = = 800,000* 100/75 x 600,000
*(However, the total cost of labour cannot exceed $ 700,000) M&P profits 700,000) 700,000) = $3,702,785 Adjusted M&P profits = The lesser of: A) 3,702,785 - 400,000 $ 3,302,785 B) 3,400,000 - 400,000 = $4,000,000 x (1,058,823 + +
3,000,000* = 7 % x 3,000,000 =
M&P deduction $ 210,000
FOREIGN TAX CREDIT
s126 This credit is available to both individuals and corporations The calculation is done on a country-per-country basis There are two different credit calculations: - one for foreign business income and - one for foreign non-business income
FOREIGN NON-BUSINESS INCOME TAX CREDIT
ss126(1) The lesser of:
a) b) the income tax paid to a foreign country gross foreign income Less: - expenses incurred for the purpose of gaining that income - amount exempted under a tax treaty x Basic corporate tax net income Less: - 10% federal tax abatement Less: - capital losses carried over and - general rate - deductible dividends under sections reduction 112 and 113 Add: - additions under section 110.5 Add: - surtax - 6 2/3 tax(ART)
FOREIGN BUSINESS INCOME TAX CREDIT
ss126 (2) & ss126 (2.1) The lesser of:
a) b) the income tax paid to a foreign country gross foreign income Less: - expenses incurred for the purpose of gaining that income - amount exempted under a tax treaty net income
tax Add: - surtax tax Less: - general rate Less: - capital losses carried over and reduction - deductible dividends under sections 112 and 113 Add: - additions under section 110.5 c) basic corporate tax plus the surtax and less the general rate reduction less the non-business foreign tax credit allowed under subsection 126(1)
Note: Foreign taxes paid on foreign business income in excess of the credit allowed can be carried back 3 years or forward 7.
CIRCULAR CALCULATION PROBLEM I
NB-FTC ----> ART and GRR ART and GRR ----> SBD SBD ----> NB-FTC (non-business foreign tax credit) Solution: 1. 2. 3. 4. Calculate the NB-FTC without reference to the ART or the GRR. With this preliminary NB- FTC calculate the SBD. Calculate the ART and GRR using the SBD calculated in Step 2. Recalculate the actual NB-FTC using the ART and GRR calculated in Step 3.
CIRCULAR CALCULATION PROBLEM II
GRR -----> SBD SBD -----> B-FTC (business foreign tax credit) B-FTC -----> GRR (general rate reduction) Solution: 1. 2. 3. 4. Calculate the B-FTC without reference to the GRR. With the preliminary B-FTC calculate the SBD. Calculate the GRR using the SBD obtained in step 2. Recalculate the actual B-FTC using the GRR obtained in step 3.
ADDITIONS UNDER SECTION 110.5
An addition can be made to a taxpayer's taxable income in order to increase the amount claimed under the foreign tax credit The amount added is also added to the corporation's non-capital losses in order to be carried over to other taxation years according to the normal rules.
FOREIGN TAX DEDUCTION
In circumstances where the ability to claim a foreign tax credit on non-business income is limited, the taxpayer can deduct the foreign tax paid under ss20(12) Example: A corporation has calculated its net income for the year to be $100,000 of which $40,000 is foreign non-business income. The corporation has also calculated its corporate tax otherwise payable to be $35,000. The corporation paid $20,000 of foreign taxes on its foreign income
Solution: Non-business Foreign Tax Credit: lesser of: A) 20,000 B) 40,000 x 100,000 35,000 =
Portion deductible under ss20(12): $20,000 -14,000 = $6,000
POLITICAL CONTRIBUTION TAX CREDIT
Deduction 75% of contributions 300 plus 50% of contributions over $ 400
1 to $ 400 401 to $ 750 751 to $ 1,275 1,276 and over
475 plus 33-1/3% of contributions over $ 750
650 maximum deduction
INVESTMENT TAX CREDIT
A tax credit given to all taxpayers incurring certain types of expenses or acquiring certain types of assets used in certain types of businesses or activities Qualified Property New depreciable property that is a building, machinery or equipment The property must be acquired to be used in Canada primarily for the purpose of manufacturing and processing goods, operating an oil or gas well, extracting minerals, logging, farming or fishing, and storing grain
Research and Development The ITC also applies to qualified R&D expenditures
Salary and Wages to an Eligible Apprentice Cost of Creating Childcare Spaces
Investment Tax Credit - Rates
Type of Expenditure Salaries and Wages of Eligible Apprentices 10% (Limited to $2,000 per Apprentice) Cost of Creating Child Care Spaces 25% (Limited to $10,000 per space)
Qualified Property In Atlantic Provinces and Gaspe 10% Prescribed Offshore Regions (East Coast) 10% Rest of Canada Nil Scientific Research and Experimental Development Incurred by Any Taxpayer 20% Incurred by some CCPCs 35%
The ITC received will reduce the capital cost of the asset in the year following the year in which the ITC was received This is done to prevent a circular calculation: To calculate the ITC, we must calculate the income taxes payable To calculate income taxes payable, we must calculate CCA To calculate CCA, we must first deduct government assistance (ie. ITC) from the capital cost of the asset
DEDUCTION AND CARRYOVER
The amount allowed to be deducted is the lesser of: the ITC at the end of the year federal income tax payable
Any amount not used in the year can be carried back 3 years and forward 20 years
ITC - REFUND
Certain taxpayers cannot benefit from the ITC since they have no taxes payable against which the credit can be deducted Revenue Canada therefore allows a refund of a portion of the ITC: 100% of unused ITC on expenditures up to $700,000 current R&D
40% of the unused credit applicable to other qualifying acquisitions
PART IV TAX - INTRODUCTION
Mr. A holds shares of various companies Mr. A (50% tax rate)
Mr. B has set-up a holding corporation to hold his investments Mr. B (50%) Holding Corp (No part 1 tax)
Solution: A part IV tax will be charged on dividends received. This tax will be refunded to the Corporation once the dividend is paid out
PART IV TAX - RATES
After June 30th, 1995 Tax rate Refund rate 33 1/3% 1/3 of dividend paid
Note: Part IV tax is only assessed on dividends received by private corporations.
PART IV TAX - EXAMPLE
ABC Corp earns $100,000. After paying part I taxes of $20,000 it declares and pays a dividend of $ 80,000
Holding Corp: Part IV tax on the dividend received: Dividend received Part IV tax 33 1/3% Note: 80,000 (26,667) $ 53,333
When holding corp pays a dividend to Mr. A, for every $3 of dividend paid $1 of the part IV tax will be refunded
Holding Corp will therefore be able to pay an $ 80,000 dividend to Mr. A (53,333 + 26,667) Mr. A Dividend 80,000 x 5/4 100,000 Taxes paid (50%) (50,000) DTC [(2/3 of 20,000) x 1.5] Total taxes payable Amount received Taxes paid 50,000 20,000 $ 30,000 80,000 30,000 $ 50,000
How much would Mr. A have after taxes had he
received $100,000 of income directly?
PART IV TAX - CONTINUED
ss186(1): Part IV tax is applicable to: Taxable dividends received from Canadian Corporations not connected to the receiving corporation Taxable dividends received affiliates not connected to corporation from foreign the receiving
and also to: Taxable dividends received from connected Corporations to the extent that the payer corporation receives a dividend refund A company is connected to the payer Corporation if: 1. It controls the Company or 2. It owns 10% or more of the voting
shares of the Company as well as 10% of the value of the shares
Corp A 100% Corp B 5% Corp Cs Corp A will only pay Part IV tax on the dividend to the extent that Corp B received a Part IV dividend refund For example:
Dividend Part IV tax of $33.33
If Corporation A received a dividend of $100 and Corporation B got a refund of $33.33 then corporation A will be liable for Part IV tax on the full $100 received. (33.33 x 3 = 100) If Corporation A received a dividend of $80 and Corporation B got a refund of $13.33, only $40 of the dividend is subject to Part IV tax. (13.33 x 3 = 40) If Corporation A received a dividend of $60 and Corporation B got no refund, then none of the dividend received by Corporation A is subject to
Part IV tax.
PART IV TAX EXAMPLE
Company P 55% Company S Company S pays a dividend of $60,000 and gets a Part IV dividend refund of $15,000. How much of the dividend received by Company P will be subject to Part IV tax? Solution: Company P will receive $33,000 as a dividend of which only $24,750 will be subject of Part IV tax: 15,000 x 3 = $45,000
45,000 x 55% = $24,750
ELECTION ON CERTAIN LOSSES
Part IV tax may be reduced by non-capital losses and farm losses as long as these losses have been used to first reduce taxable income to nil Net income Part IV tax Non capital losses Farm losses Solution: Net income Non-capital losses Part IV tax Non-capital losses Farm losses Part IV tax Note:
20,000 10,000 25,000 3,000
20,000 20,000 $ 0 10,000 3,000 2,000 5,000
This is usually done only if non-capital losses or farm losses are about to expire since you are using your losses to reduce a refundable tax. If these losses are not about to expire,
they should not be used in this manner but rather they should be used to reduce Part I tax
INVESTMENT INCOME AND REFUNDABLE PORTION OF PART I TAX
Due to the significant differences in the tax rates for investment income between corporations and individuals, a tax deferral could be obtained by earning investment income through a Corporation To prevent this deferral, a system was developed that will tax investment income at a high rate within the Company and will refund a portion of the tax once the income is taken out of the Company in the form of a dividend. The Corporation must be a Canadian-Controlled Private Corporation throughout the year to obtain a dividend refund on investment income Tax Rates for investment income: Basic Rate 38.0% Federal tax abatement (10.00) 28.00 Surtax + 4% 1.12 29.12 * Special tax 6 2/3% 6.67 35.79 Refundable portion of Part I Tax (20.00) Refund of Special Tax (6.67)
Effective fed. tax
* An additional 6 2/3% tax applies on investment income earned by CCPCs since July 1, 1995.
ADDITIONAL REFUNDABLE TAX (ART) ON INVESTMENT INCOME EARNED BY CCPCs
6 2/3% times the lesser of: i) ii) *Aggregate investment income Taxable income - SBD base
*Aggregate investment income: Sum of A) Taxable Capital GainLosses Carryovers Allowable Net Capital Capital Losses
B) Income from property -Losses from property (Excluding dividends deducted in calculating taxable income)
REFUNDABLE PORTION OF PART I TAX
Paragraph 129(3)(a) "Refundable portion of Part I tax", is the lesser of the following amounts: 26 2/3% of aggregate investment income less: foreign non-business tax credit Less 9 1/3% of foreign investment income; 26 2/3% of the excess, if any, of taxable income over: the amount on which the small business deduction was computed 25/9 times the foreign non-business tax credit 3 times the foreign business tax credit Part I tax payable for the year without taking into account the surtax For part I tax to be refundable, the
corporation must be a CCPC throughout the year.
REFUNDABLE DIVIDEND TAX ON HAND [RDTOH]
ss129(3) This account is used to keep track of how much of the refundable Part I tax and special tax on investment income and the Part IV tax on dividends received is available to be refunded once a dividend is paid RDTOH Last year’s closing balance - Last year dividend refund +Refundable portion of Part I tax on investment income 26 2/3% (20% + 6 2/3%) +Part IV tax on dividends (33 1/3%) RDTOH Ending Balance available to be
For every $3 of dividend paid, 1 dollar of the RDTOH will be refunded A Corporation is entitled to a dividend refund in respect of taxable dividends paid by it while it is a private corporation
CAPITAL DIVIDEND ACCOUNT
Allows private corporations to distribute on a taxfree basis, certain capital gains that would not have been taxable had the amounts been received directly by an individual Conceptually, this account is made up of the following basic items: (a) the non-taxable portion of capital gains (b) the non-deductible portion of capital losses + (c) the non-taxable portion of gains on the sale of eligible capital property + (d) proceeds arising from certain life insurance policies received by the corporation + (e) capital dividends received from another corporation (f) capital dividends paid
ss83(2) To pay a tax-free dividend out of the CDA, a corporation (private), must make the proper election (Form T2054)
SALARY VS DIVIDENDS
Salaries are deductible in calculating net income while dividends are not Dividends are taxed at a lower rate in the hands of an individual as compared to salary
We must therefore decide whether to pay higher personal rates (salary) and have the corporation deduct the amount in calculating net income OR Receiving a dividend taxed at a lower personal rate and having the corporation pay taxes on the amount As a rule of thumb, one should reduce the corporation's income down to $400,000 through bonuses and salaries Dividend Low Rate 400,000 450,000 Salary High Rate 50,000
PART I.3 TAX - LARGE CORPORATIONS TAX (LCT)
This tax was levied on a corporation's taxable capital employed in Canada (TCEC) in excess of $50 million While the phase out of this tax was scheduled to end in 2008, the May, 2006 budget proposes to accelerate the phase out and eliminate this tax as of January 1, 2006.
Definition of Taxable Capital for the LCT
Contributed share capital + Retained earnings + Loans, advances, bonds, and mortgages + Other payables (A/P, W/P) if outstanding for 365 days or more before the Corporation’s year end + FIT liabilities FIT assets + Deferred X-change gains Deferred X-change losses Investment Allowance
Note: 1. The above capital is reduced by an “Investment Allowance” for investments in other Corporations, Including debt and equity. 2. The above capital must be multiplied by the % employed in Canada
Type of Corporation
Canadian-Controlled Other Private Private YES YES YES NO
Liability PART I tax Small business Deduction
Public YES NO
Manufacturing and processing profits deduction YES YES (except income subject to S.B.D.) Surtax Special refundable tax of 6 2/3% Refundable portion of PART I tax PART IV tax YES YES YES YES YES NO NO YES
YES NO NO NO (except in limitedcases)
Paid Up Capital (Tax Basis Contributed Capital)
PUC should be based on legal stated capital as determined under the legislation governing the particular corporation (Canada Business Corporations Act or relevant provincial legislation). As Contributed capital under GAAP is also based on legal stated capital, the initial PUC for shares issued will be equal to contributed capital under GAAP. However, there will be adjustments to PUC that have no equivalent under GAAP. The importance of PUC lies in the fact that it is a capital contribution and does not reflect accumulated earnings of the corporation. Because of this, it can be distributed to shareholders as a return of capital without tax consequences for either the corporation, or the shareholder. PUC is applied on an average per share basis to each class of shares.
Taxation of Dividends
Dividends received by shareholders are classified as either “eligible dividends” or “non-eligible dividends”. Eligible dividends are grossed up by 45% and a federal dividend credit equal to 11/18 of the gross-up is available in calculating taxes payable. Non-eligible dividends are grossed up by 25% and a federal dividend credit equal to 2/3 of the gross-up is available in calculating taxes payable. CCPCs generally pay a low rate of taxes due to the SBD and the refundable tax on investment income. This is why most dividends paid out by CCPCs usually do not benefit from the more generous treatment given to eligible dividends. It is however possible that some of the CCPC’s income is not subject to the low rate of tax and the payment of this income to its shareholder’s should be given the preferential tax treatment. To keep track of the company’s income that was subject to the higher rate of tax, the CCPC will maintain a “GRIP” (General Rate Income Pool). To the extent there is a balance in the GRIP account, a CCPC can declare dividends that can be designated as eligible. Non-CCPCs, in general, pay taxes at the full rate and therefore the default treatment is to consider dividends paid out by these corporations as being eligible. If a non-CCPC does earn income that was subject to the lower rate of taxes, then it will have to pay this income
out in the form of a non-eligible dividend. To keep track of this income, the company will have to maintain a LRIP (Low Rate Income Pool). Any dividend paid in the year must first come out of the LRIP and therefore will not benefit from the preferential treatment given to eligible dividends.
Since corporations can return the PUC of their shares to shareholders on a tax-free basis, companies are often tempted to artificially increase the PUC of their shares. Various provisions in the Act will create a deemed dividend when the PUC of shares is artificially increased or when distributions occur which exceed the PUC of the shares: ITA 84 (1) Deemed Dividend on Increase of PUC ITA 84(2) Deemed Dividend on Winding Up or Reorganization of a Business ITA 84(3) Deemed Dividend on Redemption, Acquisition or Cancellation of Shares ITA 84(4) Deemed Dividend on Reduction of PUC When such deemed dividends are received by an individual, they are treated in the same manner as
cash dividends and are subject to the usual gross up and tax credit procedures.
PRE-1972 CAPITAL SURPLUS ON HAND (CSOH)
This balance reflects capital gains and capital losses that accrued prior to 1972, but were realized subsequent to that date. From the point of view of the corporation disposing of such assets, the median rule will prevent taxation of this type of gain at the corporate level. However, the corporation still has the funds from the disposition and, in the absence of a special provision for such amounts, their distribution would result in a taxable dividend to shareholders. To prevent this from happening, such gains and losses are accumulated in a Pre-1972 CSOH balance. This balance can be paid out to shareholders on a tax free basis when a corporation is being wound up.
Ordering of Tax Calculation 1 Basic tax (38%) 2 Federal Abatement (10%) 3 Surtax (28% * 4%) 4 Non-Business Foreign Tax Credit 5 Business Foreign Tax Credit 6 Small Business Deduction (16%) 7 Additional Refundable Tax on Investment Income (6 2/3%) 8 Manufacturing and Processing Deduction (7%) 9 General Rate Reduction - GRR (7%) 10 Others ie Political Contributions Investment Tax Credits
This action might not be possible to undo. Are you sure you want to continue?
We've moved you to where you read on your other device.
Get the full title to continue reading from where you left off, or restart the preview.