Corporate Taxation and Management Decisions

Chapter 15
Corporate Taxation And

Management Decisions
The Decision To Incorporate
Tax Reduction
Tax Deferral
Income Splitting
Other Considerations
2011, Clarence Byrd Inc.
2
Incorporation:
Other Advantages
Limited Liability
Shareholders liability to creditors
limited to amounts invested
For smaller corporations, personal
guarantees almost always required to
obtain significant financing
Protection from other types of liabilities
(e.g., product liability)

3
Incorporation:
Other Advantages
Lifetime capital gains deduction
Flexibility on timing and
character of income
Foreign taxes
Estate planning
4
Incorporation:
Disadvantages

Loss deductions
Tax credits
Charitable donations
(deduction, not credit)
Cost of maintaining corporation
Winding-up procedures
5
Tax Reduction
See Paragraph 15-66 (Based on
$100,000 of income)
Save $1,100 for CCPC with SBD
Neutral with respect to dividends
All other cases involve tax cost
$2,830 for public company
$2,830 for CCPC on non-eligible income
$3,190 for CCPC investment income
6
Tax Deferral
See Paragraph 15-66
Neutral on non-eligible dividends
Prepay
CCPC investment income
Eligible dividends subject to Part IV
Deferral in other cases
$15,500 for public company or CCPC without
SBD
$30,000 for CCPC earning ABI
7
CCPC Income > Small Business Limit
The Problem
If over $500,000 ABI
Flow through rate can be near
50%
The Solution
Bonusing Down
8
Imperfections In
Integration System
Provincial dividend tax credits non-eligible dividends
DTC 1/3 (33-1/3%) Gross Up Favours use of corporation
DTC < 1/3 (33-1/3%) Gross Up Favours not incorporating
Actual range (2011): 5.0% to 40.0%
9
Imperfections In
Integration System
Provincial dividend tax credits eligible dividends
DTC 10/23 (43.5%) Gross Up Favours use of corporation
DTC < 10/23 (43.5%) Gross Up Favours not incorporating
Actual range: 22.0 to 41.3%
10
Imperfections In
Integration System
Different federal/provincial
combined tax rates
Combined rates for CCPC on ABI
range from 12% to 19%
As all rates are less than 20%,
they favour incorporation
11
Tax Free Dividends
Basic Concepts
$1 Non-Eligible Dividend Received
$1.25 Increase In Taxable Income
[($1)(125%)]
Individuals In Lowest Federal Tax Bracket
Taxes Are $0.1875 [($1.25)(15%)]
Federal Dividend Tax Credit = $0.1667
[($0.25)(2/3)]

12
Tax Free Dividends
Tax on first $1 of
non-eligible dividends
is $0.0208
($.1875 - $.1667)

First $1 of non-eligible
dividends uses up
available credits of
$0.1387
($.0208 $.15)
13
Use Of Tax Credits
$1 of salary uses $1 of credits
$1 of non-eligible dividends
uses $0.1387 of credits
Dividends are better until
credits are used
14
Amounts Available Tax Free
Single Individual
$41,418 Non-Eligible
$ 57,178 Eligible
With Dependent
Spouse
$55,955 Non-Eligible
$69,623 Eligible
15
Amounts Available Tax Free
Dont forget the
alternative minimum
tax (AMT)
16
Income Splitting
Splitting income a very
powerful tool
Corporations very effective
here
Few limits for spouses and
adult children
Problems with minor children
(tax on split income)
17
Shareholder Benefits
The owner-manager
environment
Not arms length
Few constraints on use of
corporate resources
Sometimes difficult to separate
business and personal use
Travel
Automobiles
18
Automobiles
Standby charge
Operating cost benefit
See Chapter 3, Employment Income
19
Benefits other than loans
Included in shareholders
income
Not deductible for
corporation
Should be avoided!
20
Loans - ITA 15(2)
General Requirements
Principal amount must be added
to shareholders income
No imputed interest under
ITA 80.4(2)
Can be deducted under
ITA 20(1)(j) when it is repaid
21
Shareholder Loans
Exceptions
Corporation In Lending
Business: ITA 15(2.3)
Loan repaid prior to second
balance sheet date of
corporation
Not Specified Shareholder
If not in income imputed
interest under ITA 80.4(2)
22
Shareholder Loans
Exceptions
Loans To
Shareholder/Employee:
ITA 15(2.4)
To acquire personal residence
To acquire shares of the company
To acquire an automobile to be
used in employment duties
23
Management Compensation
General Principle: Salary is Benchmark
Fully taxable to shareholder
Fully deductible to corporation
24
Management Compensation
Tax effective solutions
RPPs
DPSPs
Private health care
Stock options
25
Salary Vs. Dividends
26
Example: Ms. Olney has $100,000 of corporate income and is
subject to a tax rate of 45 percent

SALARY: No corporates taxes personal taxes of $45,000 retention
of $55,000. Like direct receipt of income.

Dividends: Retention will depend on type of corporation and type of
income (see Paragraph 15-66 of text). Better retention only in the
case of a CCPC earning active business income.
Salary vs. Dividends
Provincial rates and credits
Tax rates on individuals are not an issue
High dividend tax credit rates encourage the
use of dividends
High corporate tax rates encourage the use of
salary
27
Income splitting
Some family members
with no income
Can receive substantial
amounts of tax free
earnings
28
RRSP Contributions (2011)
$22,450 18% = $124,722 =
required 2010 earned income
Dividends Earned Income
RRSP
CPP
29
Cumulative net investment
loss (CNIL)
CNIL reduces available lifetime
capital gains deduction
Receipt of dividends reduces CNIL
Added costs of salary
CPP and EI premiums
Payroll taxes (in some provinces)
30
Added benefits of salary
CPP and EI tax credits
Canada employment credit
Corporate tax payable
If distributions exceed income
No tax savings with salary
31
Dividends - Problem
Problem
- All Dividend Approach
Use up tax credits at a slow rate
May leave unused tax credits
Solution
Pay a lesser amount of dividends
Sufficient additional salary to
absorb tax credits
32
Basic Data
Corporate Taxable Income = $29,500
Combined Corporate Tax On ABI = 16%
Provincial Tax On First $41,544 Of Personal
Taxable Income = 10%
Individual Has Combined Tax Credits Of $3,920
Provincial Dividend Tax Credit = 1/3 Of Gross Up
33
All Salary
No Corporate Tax Payable
Salary Received = $29,500
Taxes At 25% (15% + 10%) ($7,375)
Personal Tax Credits 3,920
Tax Payable ($3,455)
After Tax Cash Retained $26,045
34
All Dividends
Maximum Dividend
Corporate Income $29,500
Corporate Tax At 16% ( 4,720)
Available For Dividends $24,780
Taxable Dividends
Dividends Received $24,780
Gross Up (25%) 6,195
Taxable $30,975

35
All Dividends
Personal Taxes On Dividends
Tax At 25 Percent [(25%)($30,975)] $7,744
Personal Tax Credits ( 3,920)
Dividend Tax Credit (Equal Gross Up) ( 6,195)
Tax Payable (Negative $2,371) Nil
After Tax Cash Retained
Tax Payable Nil
Cash Retained $24,780
36
All Dividends
The All Dividend Approach Leaves $2,371
In Unused Personal Tax Credits

A Combination Of Salary And Dividends
May Provide A Better After Tax Retention

37
Dividend/Salary Combination
Consider:
For Each $1,000 Of Additional Salary Paid
Dividends Are Reduced $840.00 [($1,000)(1.00 - .16)]
Increase In Salary $1,000.00
Decrease In Dividends ( 840.00)
Decrease In Gross Up ( 210.00)
Change In Taxable Income ($ 50.00)
38
Decrease In Dividend Tax Credit $210.00
Each $1,000 Increase In Salary Results In An Increase
Of Tax Payable Of $197.50 [$210.00 (25%)($50)]
Each $1 Increase In Salary Increases Tax Payable By
$0.1975.
To Use Up $2,371 In Credits, Need Additional Salary Of
$12,005 ($2,371/$0.1975)
39
Pre-Salary Taxable Income $29,500
Salary ( 12,005)
Corporate Taxable Income $17,495
Corporate Tax At 16 Percent ( 2,799)
Available For Dividends $14,696

40
Gross Up (25%) 3,674
Taxable Dividends $18,370
Salary 12,005
Taxable Income $30,375
41
Personal Tax At [(25%)($30,375)] $7,594
Personal Tax Credits ( 3,920)
Dividend Tax Credit (Gross Up) ( 3,674)
Personal Tax Payable Nil

42
Salary Received 12,005
Personal Tax Payable Nil
After Tax Retention $26,701
43
All Salary Approach $26,045
All Dividend $24,780
Dividend/Salary $26,701
44
Conclusions
All Dividends
Ineffective
Doesnt use all credits
Need minimum salary of
$12,005 to use credits (in
this example)
45
Conclusions
Combination salary/dividend
improves on all dividend and
all salary
Reflects the fact that the 16
percent corporate rate is
below the 20 percent rate built
into the dividend gross up and
tax credit procedures.
46
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Chapter 15

Corporate Taxation And

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