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Chapter 16

Integration, Refundable Taxes,


And Special Incentives For
Corporations
Integration

I get the same after tax


amount by either route!!!

Corporation

© 2007, Clarence Byrd Inc. 2


Dividend Gross Up And Tax
Credit
 Eligible Dividends
 45 Percent Gross
Up
 11/18 Of Gross Up
Tax Credit
 Non-Eligible
Dividends
 25 Percent Gross UP
 2/3 Of Gross Up Tax
Credit

© 2007, Clarence Byrd Inc. 3


If you haven’t covered this material recently
– Review the dividend gross up and tax
credit procedures in Chapter 9.

© 2007, Clarence Byrd Inc. 4


Integration Assumptions
 Combined
Federal/Provincial
Corporate Tax Rates
 Eligible Dividends = 31.03
%
 Non-Eligible Dividends =
20%
 Provincial Dividend Tax
Credit
 Eligible Dividends = 7/18
 Non-Eligible Dividends = 1/3
© 2007, Clarence Byrd Inc. 5
Actual Corporate Rates
 Public companies (pay eligible
dividend)
 Low: 32 percent in Quebec
 High 38.1 percent in PEI and Nova Scotia

 Too high for integration

 CCPCs (pay non-eligible dividends)


 Low: 16.1 percent in Alberta
 High: 21.1 percent in Quebec

 On average – integration works


© 2007, Clarence Byrd Inc. 6
Actual Dividend Tax
Credit
 Lowest:
21 percent of gross
up
 Highest:
39 percent of gross
up
 Effectiveness of
integration
depends on
province
© 2007, Clarence Byrd Inc. 7
Tax Basis Shareholders’
Equity
 Paid Up Capital
(PUC)
 Based On Legal
Stated Capital
 ITA 89(1)
 Similar To
Contributed Capital
in Accounting

© 2007, Clarence Byrd Inc. 8


Tax Basis Shareholders’
Equity
 Retained Earnings
 Pre-1972 Capital Surplus On
Hand
 Capital Gains Accrued Before
1972
 Realized After 1971
 Surplus Nothings
 Capital Dividend Account
 Post-1971 Undistributed
Surplus
 Treatment Of RDTOH (an
asset from a tax© 2007,
point of
Clarence Byrd Inc. 9
Paid Up Capital
 Importance
 An investment of after tax
funds
 Can be distributed tax free
 Note: PUC is not equal to ACB
 Defined
 Legal Capital (as per
corporate law)
 Limited number of
adjustments

© 2007, Clarence Byrd Inc. 10


Paid Up Capital

Example: J & J issues 1,000 shares of stock on January 1,


2007 for $10,000 ($10 Per Share) and an additional 3,000
shares on December 31, 2008 for $60,000 ($20 Per Share).
1/1/07: PUC = ACB = $10 Per Share
31/12/08: PUC = $70,000 ÷ 4,000 = $17.50 Per Share
-Individual buying on December 31, 2008
PUC = $17.50
ACB = $20.00

© 2007, Clarence Byrd Inc. 11


Capital Dividend Account
 General Idea
 Like RDTOH - A Tracking
Mechanism

 Private Companies Only

 With election, balance


can be distributed tax
free

© 2007, Clarence Byrd Inc. 12


Capital Dividend Account
 Components
 Untaxed Portion Of Net
Capital Gains
 Capital Dividends Received
 Untaxed Portion Of CEC
Gains
 Untaxed Life Insurance
Proceeds
 Reduced By Capital
Dividends Paid

© 2007, Clarence Byrd Inc. 13


Use Of Corporate Surplus
 Cash Dividends
 Reduces Post-1971
Undistributed Surplus
 Subject To Gross Up
And Tax Credit
Procedures
 Not Deductible To The
Corporation

© 2007, Clarence Byrd Inc. 14


Use Of Corporate Surplus
Stock Dividends
Common Stock (100,000 Shares) $1,000,000
Retained Earnings 4,000,000
Total Shareholders’ Equity $5,000,000

A 10 percent stock dividend is declared (FMV = $70)

Transfer To PUC - [(100,000)(10%)($70)] = $700,000

© 2007, Clarence Byrd Inc. 15


Use Of Corporate Surplus
Stock Dividends
Common Stock (110,000 Shares) $1,700,000
Retained Earnings 3,300,000
Total Shareholders’ Equity $5,000,000

Holder of 100 shares at $60 gets 10 new shares at $70


Taxable Dividend = $700
ACB = ($6,000 + $700)/110 = $60.90

© 2007, Clarence Byrd Inc. 16


Dividends In Kind
Example:
Distribute An Investment With A Cost Of $1
Million And A FMV Of $1.5 Million.

Recipient: Taxable Dividend Of $1.5 Million

Payor: Disposition At $1.5 Million, Capital


Gain Of $500,000

© 2007, Clarence Byrd Inc. 17


ITA 84(1) Deemed
Dividend
 General Idea
 PUC Increase In Excess Of
Net Asset Increase
 Creates Added Tax Free
Distribution
 ITA 53(1)(b) - Addition To
ACB Of Shares
 Exceptions
 Stock Dividends
 Shifts Between Classes
 Conversion Of Contributed
Surplus

© 2007, Clarence Byrd Inc. 18


ITA 84(2) Deemed
Dividends
 With winding-up under ITA 88(2):
 ITA 84(2) Deemed Dividend Equals The Excess
Of The Amount Distributed Over PUC

© 2007, Clarence Byrd Inc. 19


Components Of 84(2)
Dividend
 ITA 88(2)(b)
 Indicates That ITA 84(2)
Deemed Dividend Is Made
Up Of:
 Capital Dividend (If
Elected)
 Distribution Of Pre-1972
CSOH [Deemed Not To
Be A Dividend By
88(2)(b)(ii)]
 Residual Is A Taxable
Dividend
© 2007, Clarence Byrd Inc. 20
ITA 83(2) Capital
Dividend
 All Dividends Are Taxed If No
Election
 Election (Form T2054) Allows
Any Dividend To Be Treated
As A Capital Dividend (If
Balance Available In Capital
Dividend Account)
 Penalty For Excess Election
 Does Not Reduce ACB Of Shares
 Does Not Reduce PUC Of Shares

© 2007, Clarence Byrd Inc. 21


ITA 84(3) Deemed
Dividend
 On Redemption, Acquisition
By Corporation, Or
Cancellation Of Shares
 General Idea: If Payment To
Shareholder Exceeds PUC, The
Excess Is A Deemed Dividend
 If Payment Exceeds ACB, The
Excess Is A Capital Gain
 Remove ITA 84(3) Deemed
Dividend From POD under ITA
54

© 2007, Clarence Byrd Inc. 22


ITA 84(3) Example

Mr. Jones owns all 5,000 shares of L&L Ltd. The shares have a PUC
of $75,000 and his ACB is $40,000. One-half of the shares are
redeemed for $55,000.
Redemption Price $55,000
PUC [(1/2)($75,000)] ( 37,500)
ITA 84(3) Deemed Dividend $17,500

© 2007, Clarence Byrd Inc. 23


ITA 84(3) Example (Cont)

Redemption Price $55,000


84(3) Dividend ( 17,500)
POD $37,500
ACB ( 20,000)
Capital Gain $17,500

© 2007, Clarence Byrd Inc. 24


ITA 84(4) Deemed
Dividends
 A Liquidating Dividend
Involving a PUC
Reduction
 If Amount Distributed
Exceeds PUC, The Excess
Is A Deemed Dividend

© 2007, Clarence Byrd Inc. 25


ITA 84(4) Example

Company distributes $80 per share. The shares have a PUC Of


$60 Per Share.
• ITA 84(4) Deemed Dividend Of $20 Per Share
• PUC Down By $60 To Nil
• ACB Down By $60

© 2007, Clarence Byrd Inc. 26


ITA 84(4.1) Example

• If Public Company
• Entire distribution is treated as deemed dividend
• Exception if there is a redemption, acquisition, or
cancellation of shares

© 2007, Clarence Byrd Inc. 27


© 2007, Clarence Byrd Inc. 28
ITA 129(4) - Aggregate
Investment Income Defined
 Includes:
 Net Taxable Capital Gains For The Year,
Reduced By Any Net Capital Loss Carry
Overs Deducted
 Interest
 Rents
 Royalties
 Excludes:
 Dividends Deductible In Computing
Taxable Income

© 2007, Clarence Byrd Inc. 29


Additional Refundable Tax
On Investment Income
(ART)
 Amount Payable Is 6-2/3% Of
Lesser Of:
 The Corporation’s Aggregate
Investment Income
 The Amount, If Any, By Which
The Corporation’s Taxable
Income Exceeds The Amount
Eligible For The Small Business
Deduction

© 2007, Clarence Byrd Inc. 30


Refundable Part I Tax
The Problem

 Excessive Tax Rates On Flow


Through Of A CCPC’s Investment
Income
 With ART, Taxed At Federal Rate Of Just
Under 36% [(38% - 10%)(104%) + 6-
2/3%].
 Add Provincial Rates Of 11.5% To 17%

 Total Tax Rate Varies Between 47% And


53%
© 2007, Clarence Byrd Inc. 31
Refundable Part I Tax
The Problem

$100,000 Of Individual
Investment
Shareholder
Income

© 2007, Clarence Byrd Inc. 32


Refundable Part I Tax
The Solution

 When Corporation
Distributes Its After
Tax Income As
Dividends, Part Of
Tax Is Refunded
 Refund Equal To $1
For Each $3 Of
Dividends Paid

© 2007, Clarence Byrd Inc. 33


Example – Part I Refund
Corporate Income $100,000
Taxes At 46-2/3% 46,667
Balance Before $53,333
Refund
Refund 26,667
Maximum Dividend $ 80,000

$26,667 = [(1/3)($80,000)]

© 2007, Clarence Byrd Inc. 34


Refundable Part IV Tax
The Problem

$100,000
Investment
Income

© 2007, Clarence Byrd Inc. 35


Refundable Part IV Tax:
Liability For
 Private Corporations
 Subject Corporations
 A Corporation (Other Than A
Private Corporation) Resident In
Canada And Controlled By, Or
For The Benefit Of, An Individual
Or Related Group
 For The Purposes Of Part IV Tax,
Treated As A Private Corporation

© 2007, Clarence Byrd Inc. 36


Refundable Part IV Tax
Assessment And Refund

 Assessed At A Rate
Of 33-1/3%

 Refunded At A Rate
Of $1 For Each $3
Of Dividends Paid

© 2007, Clarence Byrd Inc. 37


Part IV Refundable Tax
Where Applied
 Dividend Is Received From An
Unconnected Company
(Portfolio Dividend)
 Dividend Is Received From A
Connected Company, And
The Company Paying The
Dividend Received A Refund
As The Result Of The
Payment

© 2007, Clarence Byrd Inc. 38


Part IV Refundable Tax

 Connected Corporations
 Control (> 50%), or
 Greater Than:
 10% Of Voting, And
 10% FMV Of All

© 2007, Clarence Byrd Inc. 39


Part IV Refundable Tax
 Reduce Part IV With Non-
Capital Losses
 However, Uses A Potential
Permanent Reduction In Taxes
To Reduce Tax Payable That
Would Ultimately Be Refunded

© 2007, Clarence Byrd Inc. 40


Keeping Score:
Refundable Dividend Tax
On Hand
 Components
 Opening Balance
 Refundable Part I Tax
 Part IV Tax
 Dividend Refund
 Closing Balance

© 2007, Clarence Byrd Inc. 41


Refundable Portion Of
Part I Tax
 RDTOH Definition Limits To The
Least Of:
 ITA 129(3)(a)(i) – Investment
Income Limit
 ITA 129(3)(a)(ii) – Taxable Income
Limit
 ITA 129(3)(a)(iii) – Tax Payable Limit

© 2007, Clarence Byrd Inc. 42


ITA 129 (3)(a)(i)
 Determined By Formula A-B,
Where
 A Is 26-2/3% Of Aggregate
Investment Income

 B Is The Amount, If Any, By


Which The Non-Business FTC
Exceeds 9-1/3% Of Foreign
Income

© 2007, Clarence Byrd Inc. 43


ITA 129(3)(a)(ii)
 26-2/3% Of The Amount, If
Any, By Which Taxable
Income Exceeds The Total
Of:
 Amount Eligible For The Small
Business Deduction

 25/9 Of Non-Business FTC

 3 Times Business FTC

© 2007, Clarence Byrd Inc. 44


ITA 129(3)(a)(iii)
 Tax Payable Under
Part I Determined
Without Corporate
Surtax

© 2007, Clarence Byrd Inc. 45


Dividend Refund
 Equal To The Lesser Of:
 Balance In RDTOH Account At
The Year End

 1/3 Of All Dividends Subject


To Tax Paid During The Year

© 2007, Clarence Byrd Inc. 46


Example Basic Data
 Fortune Ltd. is a
Canadian controlled
private corporation.
Based on the formula in
ITR 402, 90 percent of
the Company’s income is
earned in a province.
The following information
is available for the year
ending December 31,
2007:
© 2007, Clarence Byrd Inc. 47
Basic Data
Canadian Source Investment Income
(Includes $25,000 In Taxable Capital Gains)
$100,000
Gross Foreign Investment Income (15 Percent Withheld)
20,000
Gross Foreign Business Income (15 Percent Withheld)
10,000
Active Business Income (No Associated Companies)
150,000
Portfolio Dividends Received
30,000
Net Income For Tax Purposes
$310,000
Portfolio Dividends ( 30,000)
Net Capital Loss From Preceding Year Deducted
( 15,000) © 2007, Clarence Byrd Inc. 48
Basic Data
 RDTOH - December 31, 2006
$110,000
 Dividend Refund For 2006
20,000
 Taxable Dividends Paid During 2007
40,000
 Aggregate investment income for
Fortune Ltd. is equal to $105,000
($100,000 + $20,000 - $15,000).
© 2007, Clarence Byrd Inc. 49
Part I Tax Payable
Base Amount Of Part I Tax [(38%)($265,000)]
$100,700
Surtax [(4%)(28%)($265,000)]
2,968
ART: Equal To The Lesser Of:
[(6-2/3%)($265,000 - $150,000)] = $7,667
[(6-2/3%)($100,000 + $20,000 - $15,000)] = $7,000
7,000
Federal Tax Abatement [(10%)(90%)($265,000)]
( 23,850)
Foreign Non-Business Tax Credit ( 3,000)
Foreign Business Tax Credit
( 1,500)

© 2007, Clarence Byrd Inc. 50


Small Business
Deduction
 The small business deduction would be equal to 16 percent
of the least of:
1. Active Business Income
$150,000
2. Taxable Income
$265,000
Deduct:
[(10/3)($3,000 Non-Business FTC)]
( 10,000)
[(3)($1,500 Business FTC)] ( 4,500)
Total $250,500
3. Annual Business Limit
$400,000
The least of these figures is $150,000, providing for a small
business deduction of $24,000 [(16%)($150,000)].
© 2007, Clarence Byrd Inc. 51
Part I Tax Payable
Base Amount Of Part I Tax [(38%)($265,000)]
$100,700
Surtax [(4%)(28%)($265,000)]
2,968
ART: Equal To The Lesser Of:
[(6-2/3%)($265,000 - $150,000)] = $7,667
[(6-2/3%)($100,000 + $20,000 - $15,000)] = $7,000
7,000
Federal Tax Abatement [(10%)(90%)($265,000)]
( 23,850)
Foreign Non-Business Tax Credit ( 3,000)
Foreign Business Tax Credit
( 1,500)
Small Business Deduction ( 24,000)

© 2007, Clarence Byrd Inc. 52


General Rate Reduction
The general rate reduction under ITA 123.4(2)
would be calculated as follows:
Taxable Income $265,000
Amount Eligible For SBD
( 150,000)
Aggregate Investment Income
($100,000 + $20,000 - $15,000)
( 105,000)
Full Rate Taxable Income $
10,000
Rate 7%
ITA 123.4(2) Reduction $ 700
© 2007, Clarence Byrd Inc. 53
Part I Tax Payable
Base Amount Of Part I Tax [(38%)($265,000)]
$100,700
Surtax [(4%)(28%)($265,000)]
2,968
ART: Equal To The Lesser Of:
[(6-2/3%)($265,000 - $150,000)] = $7,667
[(6-2/3%)($100,000 + $20,000 - $15,000)] = $7,000
7,000
Federal Tax Abatement [(10%)(90%)($265,000)]
( 23,850)
Foreign Non-Business Tax Credit ( 3,000)
Foreign Business Tax Credit
( 1,500)
Small Business Deduction ( 24,000)
General Rate Reduction For CCPCs (
700)
© 2007, Clarence Byrd Inc. 54
Part I Tax Payable $ 57,618
Part I Refundable
26-2/3% Of Aggregate Investment Income
[(26-2/3%)($105,000)]
$28,000
Deduct Excess Of:
Foreign Non-Business Tax Credit $3,000
Over 9-1/3% Of Foreign Investment
Income [(9-1/3%)($20,000)] ( 1,867)
( 1,133)
ITA 129(3)(a)(i) $26,867

© 2007, Clarence Byrd Inc. 55


Part I Refundable
Taxable Income $265,000
Deduct:
Amount Eligible For SBD ($150,000)
[(25/9)($3,000 Non-Business FTC)] ( 8,333)
[(3)($1,500 Business FTC)] ( 4,500)
( 162,833)
Total $102,167
Rate 26-2/3%
ITA 129(3)(a)(ii) $ 27,245

© 2007, Clarence Byrd Inc. 56


Part I Refundable
 ITA 129(3)(a)(iii) Adjusted Part I
Tax Payable ($57,618 - $2,968)
$ 54,650

 The refundable portion of Part I tax is


equal to $26,867, which is the least of the
preceding three amounts

© 2007, Clarence Byrd Inc. 57


RDTOH Balance
 The Part IV tax would be $10,000, one-third of the
$30,000 in portfolio dividends received. Given
this, the balance in the RDTOH account at the
end of the year is as follows:
RDTOH - End Of Preceding Year $110,000
Deduct: Dividend Refund For
The Preceding Year ( 20,000) $
90,000

Refundable Portion Of Part I Tax $ 26,867


Part IV Tax Payable
[(33-1/3%)($30,000)] 10,000
36,867
RDTOH - December 31, 2007
$126,867 © 2007, Clarence Byrd Inc. 58
Dividend Refund
 The dividend refund for the year
would be $13,333, the lesser of:
 One-Third Of Taxable Dividends
Paid ($40,000 ÷ 3)
$13,333
 RDTOH Balance

December 31, 2007


$126,867

© 2007, Clarence Byrd Inc. 59


Federal Tax Payable
Using the preceding information, the total
federal Tax Payable for Fortune Ltd. is
calculated as follows:
Part I Tax Payable
$57,618
Part IV Tax Payable 10,000
Dividend Refund
( 13,333)
Federal Tax Payable $54,285
© 2007, Clarence Byrd Inc. 60
Eligible Dividends
 Any dividend that is
designated as such.
 Qualifies for enhanced 45
percent gross up.
 Receives dividend tax
credit of 11/18 of the gross
up.
 Reduces maximum federal
rate on dividends to about
15 percent.
© 2007, Clarence Byrd Inc. 61
Tax On Excessive
Election
 For CCPC – A designation that
exceeds General Rate Income Pool
(GRIP).
 For Public Company – A designation
that leaves a positive Low Rate
Income Pool (LRIP).
 Excess taxed at 20 percent.
 If artificial manipulation – Tax at 30
percent on the entire dividend (not
just excess) © 2007, Clarence Byrd Inc. 62
Basic Approach
 CCPCs  Public Companies
 Income eligible for  Most income taxed
SBD at general rates
 Investment income  Assume most
eligible for refund dividends are
 Assume most eligible
dividends are non-  Exceptions in LRIP
eligible
 Exceptions in GRIP

© 2007, Clarence Byrd Inc. 63


CCPCs and their GRIP
GRIP = C + [(68%)(D – E – F)] + G + H - I
C = GRIP at end of preceding year
D = Taxable Income for the year
E = Amount eligible for SBD for the year
F = Aggregate investment income for the
year
G = Eligible dividends received during the
year
H = Adjustments for amalgamations and
wind ups © 2007, Clarence Byrd Inc. 64
Designation By CCPC
 To the extent of the
GRIP balance:

 Dividends can be
designated as eligible.

© 2007, Clarence Byrd Inc. 65


Non-CCPCs and their
LRIP
LRIP = (A + B + C + D + F) – (G + H)

A = LRIP at end of preceding year


B = Non-eligible dividends received for the year
C = Additions for corporate reorganizations
D = Adjustment if CCPC in some preceding year
E = Adjustment if credit union in some preceding
year
F = Adjustment if investment company in some
preceding year
G = Non-eligible dividends paid during the year
H = Excess election during year
© 2007, Clarence Byrd Inc. 66
Non-Eligible Dividends:
Non-CCPC
 Dividend paid when
there is a positive LRIP
balance:

 Should be non-eligible.

 If designated – will be
subject to tax on excess
designation.

© 2007, Clarence Byrd Inc. 67


© 2007, Clarence Byrd Inc. 68