CHAPTER 21:

Tax Aspects of Corporate

Financing

Prepared by

Kristie Dewald
University of Alberta
Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Education Limited

Tax Aspects of Corporate Financing

I.
II.
III.

Debt versus Equity

Tax Treatment of Financing Charges
Leasing An Alternative to Debt Financing

I.

Debt versus Equity

A. Cost of Corporate Debt and Equity

Cost of Debt:
Payment of interest,
Fully deductible by the corporation
Shifts income directly to the taxpayer avoids double tax.

Cost of Equity:
Payment of dividends,
Not deductible - paid from after-tax corporate income.
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B. Tax Treatment to Investors

Interest income on debt is taxed at normal rates
applicable to individuals and corporations,
Dividend income is taxed at normal rates.
Less the dividend tax credit

Capital gains are taxed at a 50% inclusion rates.

The tax treatment of each type of return may vary
depending on the nature of the investor.

C. Preferred Share Financing

Preferred shares - severely constrained owing to the nondeductibility of dividend payments.
Corporations must earn substantially higher dividend rate
in order to meet their preferred share commitments.
Preferred share financing may be subject to a further tax
burden under Part VI.1 of the Act.

C. Preferred Share Financing

Canadian corporations - special tax on preferred share
dividends in excess of $500,000.
payable by the payer rather than the recipient.

The rate of tax varies depending on the nature of the

preferred shares:
In most cases the tax on excess dividends is 40%.
Tax is fully recoverable against the normal income tax.

Preferred Share Special Tax

Purpose is to prevent non-taxable corporations from
paying dividends to other public corporations that receive
the dividends on a tax free basis.
The special tax creates a risk for all large corporations
issuing preferred shares.
Payer corporation may not have other tax payable on which to
use the special tax again.

A viable alternative to debt financing in spite of the tax

burden.

II. Tax Treatment of Financing Charges

A. Expenses Incurred to Issue Shares or Borrow Money
Certain Financing Costs are incurred in the process of
developing and issuing securities.
These financing costs are of a capital nature:
they provide a long-term benefit over the life of the
securities.

Deducted for tax purposes over 5 years at a rate of 1/5

per year.

B. Securities Issued at a
Discount or Premium
Debt and equity securities can be issued at amounts
greater than or less than their stated amount.
A result of the change in economic conditions.

A premium or discount on equity issues has no tax impact

on the issuing corporation.
Debt securities - tax treatment of a premium or discount
affects the after-tax cost of such securities.

Issuing Debt Securities

at a Discount
Borrowing corporation receives an amount that is less
than it is obliged to repay.
Tax treatment depends on the amount of the discount:
Shallow discount - discount </= 3%; the full amount is
deductible when it is repaid.
Deep discount - discount > 3%; only one-half of the discount
is deductible when it is repaid.

A discount tends to increase the cost of financing.

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Issuing Debt Securities at a Premium

Borrowing corporation receives a price greater than the
securitys stated amount.
Tax treatment to issuing corporation is extremely
favourable.
Unless the issuing corporation is in the business of lending
money, the premium is not taxable.

Issuing debt securities at a premium will usually reduce

the after-tax cost of financing.

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Tax Treatment of Discounts and Premiums to

the Investor
If investor is in a position to negotiate the terms of the
loan:
the premium or discount is treated as income and
is fully taxable when the debt is repaid.

Public Issued security - the tax treatment varies:

Investors business - the gain or loss is fully taxable at the time
the debt is repaid.
Not in the business of acquiring securities - the gain or loss is
considered to be a capital gain or loss.

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III. Leasing An Alternative to Debt

Financing
A. Types of Leases
Financial lease provides the lessee with the right to use
the asset for a long period of time;
usually for most of its useful life.

Operating leases are usually short-term

used to obtain the use of short-lived, lower-cost assets.

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B. Tax Treatment of Financial Leases

Annual rental payments are fully deductible in arriving at
net income for tax.
Tax rules offer a second option relating to the tax
treatment for leased equipment.
Under certain conditions can treat a lease contract as if
purchased:
Lessee can forgo rent payment and claim CCA and an imputed
interest deduction.

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