Tax II

Research Assignment

Compiled by:
Arjun Sawhney
102562332
Tax II
March 19, 2007
Prof. Jones
PART A:

♦ Active business income:

According to the tax act, the current definition of active

business income is” “active business carried on by a corporation”, which means
any business carried on by the corporation other than a specified investment
business or a personal services business and includes an adventure or concern
in the nature of the trade.” Active business income does not let in rental and
investment income and the aggregate tax rate, provincially and federally is 16%-
22% on the first $300,000. However, this only applies to a Canadian Controlled
Private Corporation (CCPC). Another major factor, which must be looked in
whether, the active business income earned in a treaty country or non-treaty
country. If in treaty, the income derived is called surplus and will be received tax
free, however, if it is generated in a non-treaty country, the income will be
subjected to tax as per non-resident withholding taxes. This is very advantageous
to a CCPC, where they get to pay a much lower tax rate rather than normal tax
rates for both, provincially and federally. The easy way to remember about an
active business income is by saying “If not work, no pay”. Our physical abilities
determine whether we are able to earn it or not. The most common examples of
this type of income are salary or wages, professional fees and income of a small
business owner.

♦ Specified investment business income:

Specified investment business income means to generate

the income from a business whose main purpose is to produce income from
property, for example, royalties, rents, interest etc but does not include a
business where the firm hires five full time employees. This type of income is
strictly excludes real property i.e. leasing of building, financial services etc
because they are an active business income generators. When a person
receives an investment income in the corporation, that person pays tax on its
corporate file and personal file as well. To avoid that, the government introduced
what is called refundable tax, which allows receiving a portion of a tax when
dividends are received. Individual can get refund up to 20% because the
corporation pays that 20% initially, to void the double taxation among each
other’s. The corporations are taxed at a high rate to begin with also to avoid
double taxation. All this is done is to keep off the individuals of using a
corporation to defer tax on their investment income. The most common examples
of specified investment business income are interests, dividends, rents and
royalties.
♦ Personal service business income:

A personal service income is received by a person who

provides services to the corporations and organizations, where which he would
be considered to be an employee. To check whether the individual meets the
criteria for employee is to verify using employee and self-employed analytical
thinking. There are four tests that can be made: results test, unrelated clients,
business premises and employment tests. Results test which says that if the 80%
rule is not met, then the rules will not apply and income will be earned in PSB.
Unrelated client is only applied to those who actually have clients and earns less
than 80% of the PSB. Business premises is when the income is paid to the
company rather than directly to you, it considered to be a personal service. And
lastly, employment test is where when 80% of yours personal service income
comes from each client. A corporation, who claims to be a PSB, cannot claim
SBD for that year. Except salaries and wages, nothing else can be deducted. In
terms for services, expenses like legal expense and negotiating expense can be
deducted. The common types of personal service businesses are contractors and
engineers.

PART B:
Federal rates:

♦ Active business income: effective Jan 1, 2006

General corporate rate = 38%

Less: fed abatement = 10%
Surtax = 0%
SBD = 0%
Less: rate deduction = 7.5%
Total = 20.5%

♦ Specified investment business income: effective Jan 1, 2006

General corporate rate = 38%

Less: fed abatement = 10%
Surtax = 0%
SBD = 0%
Add: refundable tax = 6.7%
Total = 34.7%

♦ Personal service business income: effective Jan 1, 2006

$0-$36,378 = 15.25%
$36,379-$72,756 = 22%
$72,757-$118,285 = 26%
$118,286 and more = 29%

PART C:

Quote:

The “Corporation association rules” in the income tax act which apply in the
taxation of Canadian controlled small businesses are a necessary elements of
taxation in Canada.

The reason for this rule is to take advantage of certain boundaries and ranges for
the investment tax credit. Associated corporation not only means just the
corporations, it also means between individuals and corporation as well. In terms
of individuals, only those qualify who are related by blood, marriage or adoption.
Aunts, uncles, nieces, nephews and cousins are strictly not related. In associated
rules, one corporation has control over the other one and this is the key to
understand the relationship between them. The majority of number of voting
shares gives the power to a corporation. Three different types of test can be met
to find out whether the individual is related or not: control test, related test and
cross ownership test. I agree with this type of rule because of tax purposes.
When a corporation controls another corporation, they may not be a necessary
element but many tax advantages can be achieved. Nevertheless, as mentioned
not only the tests have to be made, but also the criteria. One of the two parties
will have to control the corporation either directly or indirectly, the controller must
be a related person and that person must own a minimum of 25% of voting
shares. By having those rules in placed, no other person can take advantage of
tax benefits, as they are quite strict. If a corporation shows a valid reason for non-
tax reasons to be a separate entity, it qualifies to be a deemed association. The
primary purpose is to foreclose the income splitting of a business into different
corporations. As per the controller, he or she is entitled equal to the percentage
of ownership. For example, if corporation A owns 76% of corporation B,
corporation A is only qualified to receive up to 76% from corporation B, whether
in profits or dividends. As corporations are associated for full accounting cycle,
they must include their worldwide income. There is a negative side to it as well.
Corporations are connected with each other and so their database. It is very
complex to track every single database and to transmit to each other. Asides
from accounting, there is a tax incentive to it and I strongly agree with this rule for
taxation in Canada.