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CORPORATIONS

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.
INTRODUCTION

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

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B/S and I/S item must be matched to a GIFI index
reference number.

3
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 Federal and Provincial


Corporate Tax

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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

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The T2s1 is used to reconcile income from a
business:
Accounting → Tax

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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
(Specified
shareholder)

↓ 10 % or +

Employer → Corporation

Note: If the business employs throughout the year


more than 5 full-time employees, then the
business is not considered a "personal

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service business"

8
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.

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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 -
cultural gifts) +
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

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Restricted farm loss carryover +
Limited partnership loss carryover +
Add:
E) Section 110.5
Additions for foreign tax deductions
Taxable income for the year

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CHARITABLE DONATIONS

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

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DIVIDENDS

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).

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With multi-level organizations, the same income
could be taxed 2, 3, 4... times.

14
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

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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
st

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 April 6th Dec 31st

Result: 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

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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

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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

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occur after the AOC to years preceding the AOC

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ACCRUED LOSSES

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

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rules apply as depreciable property.

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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

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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"

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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. Determine the % of gross revenue


attributed to each P.E.

2. Determine the % of salaries & wages


attributed to each P.E.

3. Calculate the average %

4. Multiply % by taxable income

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ALLOCATION OF TAXABLE
INCOME EXAMPLE

Taxable Income = $6,000

Gross % Salary & W % Ave %


Rev
Ontario 1,000
$
10 800
$
40 25
Quebec 2,000 20 400 20 20
Manitob 6,000 60 600 30 45
a
German 1,000 10 200 10 10
y
Total $
10,00 10 $
2,000 10 100
0 0 0

T.I. %
Ontario 6,000 x 25 = 1,500
Quebec 6,000 x 20 = 1,200
Manitoba 6,000 x 45 = 2,700
Germany 6,000 x 10 = 600
6,000

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TYPES OF CORPORATIONS

Canadian
Corporation
Resident in Canada

CCPC Other Public


[s.125(7)(a)] [s.89(1)(g)]

• private co.
[s.89(1)(f)]
• not controlled by • controlled by
a: a public • publicly listed
- non-resident company
- public
company

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CALCULATION OF TAX

Taxable Income x Tax Rate (38% since 1988)

Plus: Surtax - s123.2 (Will be repealed in 2008)


Refundable tax on investment income -
s123.3

Less: Income earned in a province - s124


General tax reduction s123.4
Small business deduction - s125
Manufacturing and processing profits -
s125.1
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

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CORPORATE TAX RATES
2007
Basic rate 38.00%
Federal tax abatement
(10.00)
28.00
4% surtax 1.12
Effective tax rate 29.12%

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GENERAL TAX REDUCTION s123.4

A general tax reduction applies to certain types of


corporations on certain types of income.

2007
Basic rate 38%
Federal tax
abatement (10)
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4% Surtax 1.12
General tax
reduction (7.0)*
Effective federal
tax rate 22.12%

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.

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*Note: The general rate reduction will change as
follows:
2008: 7.5%; 2009: 8%; 2010: 9%; 2011:9.5%.

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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)

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*
Note that the $400,000 business limit for the
year must be allocated among associated
corporations

Association is defined in ss256 (1)

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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.

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TAX RATES - SBD
2007
Basic rate 38.00%
Federal tax abatement (10.00)
28.00
4% surtax 1.12
SBD on ABI *(16.00)
Effective tax rate 13.12%

*Note: The small business deduction is scheduled to


increase as follows: 2008: 16.5%; 2009: 17%.

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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.

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TAX RATES

ABI
$400,000 $400,001
and less and over
Basic rate 38.00% 38.00%
Federal tax
abatement (10.00) (10.00)
28.00 28.00
4% surtax 1.12 1.12
29.12 29.12

SBD on ABI (16.00) --


General tax
reduction -- (7.00)

Effective federal
tax rate 13.12% 22.12%

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GENERAL TAX REDUCTION FOR
Non-CCPC

Taxable Income

- 100/7 x M&P Tax Credit


Total
x 7%

= General Tax Reduction for Non-CCPCs

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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

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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

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TAX RATES - M&P

Basic rate 38.00%


Federal tax abatement (10.00)
28.00
4% surtax 1.12
M&P (7.00)
Effective tax rate 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.

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M&P DEDUCTION - CALCULATION
The equations for calculating the M&P deduction are
as follows:

M&P deduction = M&P rate x Adjusted


M&P profits

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 x [cost of M&P capital + cost of M&P
labor]
[cost of capital + cost of labor]

ADJUBI =
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

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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

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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%

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Solution:

Cost of Capital = 12,000,000 x 10% =


1,200,000

Cost of Labour = = 700,000

Cost of M&P capital = 100/85 x (9,000,000


x 10%) =
1,058,823

Cost of M&P labor = 100/75 x 600,000


= 800,000*

*(However, the total cost of labour cannot exceed


$
700,000)

M&P profits = $4,000,000 x (1,058,823 +


700,000)
(1,200,000 +
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 =

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3,000,000*
$

M&P deduction = 7 % x 3,000,000 =


$
210,000

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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

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FOREIGN NON-BUSINESS
INCOME TAX CREDIT

ss126(1)

The lesser of:


a) the income tax paid to a foreign country

b) 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)

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FOREIGN BUSINESS
INCOME TAX CREDIT

ss126 (2) & ss126 (2.1)

The lesser of:


a) the income tax paid to a foreign country

b) 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 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.

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CIRCULAR CALCULATION PROBLEM
I

NB-FTC ----> ART and GRR


ART and GRR ----> SBD
SBD ----> NB-FTC (non-business foreign tax credit)

Solution:

1. Calculate the NB-FTC without reference to the


ART or the GRR.

2. With this preliminary NB- FTC calculate the SBD.

3. Calculate the ART and GRR using the SBD


calculated in Step 2.

4. Recalculate the actual NB-FTC using the ART and


GRR calculated in Step 3.

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CIRCULAR CALCULATION PROBLEM
II

GRR -----> SBD


SBD -----> B-FTC (business foreign tax credit)
B-FTC -----> GRR (general rate reduction)

Solution:

1. Calculate the B-FTC without reference to the


GRR.

2. With the preliminary B-FTC calculate the SBD.

3. Calculate the GRR using the SBD obtained in


step 2.

4. Recalculate the actual B-FTC using the GRR


obtained in step 3.

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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.

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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 35,000 = 14,000*


$

100,000

Portion deductible under ss20(12): $20,000 -14,000


= $6,000

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POLITICAL CONTRIBUTION
TAX CREDIT

ss127(3)

Amount Contributed Deduction


$
1 to $ 400 75% of contributions

$
401 to $ 750 $
300 plus 50% of
contributions over $ 400
$
751 to $ 1,275 $
475 plus 33-1/3% of
contributions over $ 750
$
1,276 and over $
650 maximum
deduction

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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

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Investment Tax Credit - Rates

Type of Expenditure Rate

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%

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CAPITAL COST

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

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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

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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 current R&D


expenditures up to $700,000

 40% of the unused credit applicable to other


qualifying acquisitions

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PART IV TAX - INTRODUCTION

Mr. A holds shares of various companies

Mr. A (50% tax rate)

ABC Corp 123 Corp XYZ Corp

Mr. B has set-up a holding corporation to hold his


investments

Mr. B (50%)

Holding Corp (No part 1 tax)

ABC Corp 123 Corp XYZ Corp

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

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PART IV TAX - RATES

After June 30th, 1995

Tax rate 33 1/3%

Refund rate 1/3 of dividend paid

Note: Part IV tax is only assessed on dividends


received by private corporations.

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PART IV TAX - EXAMPLE

Mr. A

Holding Corporation

ABC Corporation

ABC Corp earns $100,000. After paying part I taxes


of $20,000 it declares and pays a dividend of
$
80,000

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Holding Corp:

Part IV tax on the dividend received:

Dividend received 80,000


Part IV tax 33 1/3% (26,667)
$
53,333

Note: 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)
50,000
DTC [(2/3 of 20,000) x 1.5] 20,000
Total taxes payable $
30,000

Amount received 80,000


Taxes paid 30,000
$
50,000

How much would Mr. A have after taxes had he

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received $100,000 of income directly?

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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 from foreign


affiliates not connected to the receiving
corporation

and also to:

 Taxable dividends received from connected


Corporations to the extent that the payer
corporation receives a dividend refund

Note: A company is connected to the payer


Corporation if:

1. It controls the Company

or

2. It owns 10% or more of the voting

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shares of the Company as well as 10%
of the value of the shares

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Corp A

100% Dividend

Corp B Part IV tax of $33.33

5%
$
100 dividend
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:

 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

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Part IV tax.

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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


$

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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 20,000


$

Part IV tax 10,000

Non capital losses 25,000

Farm losses 3,000

Solution:

Net income 20,000


$

Non-capital losses 20,000


$
0

Part IV tax 10,000


$

Non-capital losses 5,000


Farm losses 3,000
Part IV tax $
2,000

Note: 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,

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they should not be used in this manner but
rather they should be used to reduce Part I
tax

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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)

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Effective fed. tax 9.12

* An additional 6 2/3% tax applies on investment


income earned by CCPCs since July 1, 1995.

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ADDITIONAL REFUNDABLE TAX
(ART) ON INVESTMENT INCOME
EARNED BY CCPCs

6 2/3% times the lesser of:

i) *Aggregate investment income

ii) Taxable income - SBD base

*Aggregate investment income:

Sum of

A) Taxable Capital Gain- Allowable Capital


Losses
- Net Capital Losses
Carryovers

B) Income from property -Losses from property


(Excluding dividends deducted in
calculating taxable income)

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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

Note: For part I tax to be refundable, the

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corporation must be
a CCPC throughout the year.

75
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


refunded

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

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CAPITAL DIVIDEND ACCOUNT

Allows private corporations to distribute on a tax-


free 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

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DISTRIBUTION

ss83(2)

To pay a tax-free dividend out of the CDA, a


corporation (private), must make the proper election
(Form T2054)

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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 Salary

Low Rate High Rate

400,000 50,000

450,000

79
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.

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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

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SUMMARY

Type of Corporation

Canadian-Controlled Other
Liability Private Private Public

PART I tax YES YES YES

Small business
Deduction YES NO NO

Manufacturing and
processing profits
deduction YES YES YES
(except income subject
to S.B.D.)

Surtax YES YES YES

Special refundable
tax of 6 2/3% YES NO NO

Refundable portion of
PART I tax YES NO NO

PART IV tax YES YES NO


(except in
limitedcases)

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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.

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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

84
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.
DEEMED 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

85
cash dividends and are subject to the usual gross up
and tax credit procedures.

86
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.

87
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

88

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