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Chapter 15

Taxable Income And Tax


Payable For Corporations
Computation Of Net
Income – Schedule 1
 Accounting Net Income

 Additions

 Deductions

 Net Income For Tax


Purposes

© 2007, Clarence Byrd Inc. 2


Additions
 1. Amortization,
Depreciation, and
Depletion

 2. Recapture Of CCA

 3. Reserves Deducted In
Prior Years

 4. Losses On Dispositions Of
Capital © 2007, Clarence Byrd Inc. 3
Additions - Continued
 5. R&D (Accounting
Amounts)

 6. Warranty Costs
(Accounting
Amounts)

 7. Debt Discount
Amortization

 8. Foreign Taxes Paid


(Accounting Amounts)
© 2007, Clarence Byrd Inc. 4
Additions - Continued
 9. Excess Of Taxable
Capital Gains Over
Allowable Capital
Losses

 10. Income Tax Expense

 11. Interest And Penalties


On Income Tax
Assessments

 12. Automobile Costs


(Non- Deductible)
© 2007, Clarence Byrd Inc. 5
Additions - Continued
 13. 50% Of Business Meals

 14. Club Dues And Cost Of


Recreational Facilities

 15. Non-Deductible
Accounting Reserves

 16. Political Contributions

© 2007, Clarence Byrd Inc. 6


Additions - Continued
 17. Charitable Donations

 18. Asset Impairment


Write- Downs

© 2007, Clarence Byrd Inc. 7


Deductions
 1. CCA

 2. CEC

 3. Terminal Losses

 4. Deductible Reserves

© 2007, Clarence Byrd Inc. 8


Deductions
 5. Gains On Dispositions Of
Capital Assets (Accounting
Amounts)

 6. Deductible R & D Costs

 7. Deductible Warranty Costs

 8. Debt Premium Amortization

© 2007, Clarence Byrd Inc. 9


Deductions - Continued
 9. Foreign Non-Business Tax
Deduction – ITA 20(12)

 10. Allowable Business


Investment Losses

© 2007, Clarence Byrd Inc. 10


Corporate Taxable
Income
 Deductions Not Available
To Corporations
 Lifetime Capital Gains
Deduction
 Employee Stock Option
Deduction
 Home Relocation Loan
Deduction
 Northern Residents
Deductions
 Social Assistance And
© 2007, Clarence Byrd Inc. 11
Corporate Taxable
Income
 Deductions Available To
Corporations
 Losses (Same as for
individuals)
 Charitable Donations (A
deduction rather than a
credit)
 Dividends (Unique to
corporations)

© 2007, Clarence Byrd Inc. 12


Dividends - The Problem

Corporate Tax Rate = 40%

AALtd.
Ltd. B Ltd. C Ltd.

$1,000 $600 $360

© 2007, Clarence Byrd Inc. 13


Dividends From Untaxed
Income
 Corporation Taxed At 20% On
$100
 Individual Pays $24 [(30%)($100
- $20)]
 Total = $44 = ($20 + $24)

 Corporation Not Taxed


 Individual Pays $30
[(30%)($100)]
 Total = $30 < $44 When
Corporation Taxed
© 2007, Clarence Byrd Inc. 14
Dividends On Preferred
Shares
 Debt At 10%
 Cost Of Capital If Corporation Taxed =
6%
 Cost Of Capital If Corporation Not Taxed
= 10%
 Preferred Shares At 8%
 Redeemable/Retractable Preferred
 Accounting may treat as debt

© 2007, Clarence Byrd Inc. 15


Stop Loss Rules
 The Scenario  Anti-Avoidance:
 Acquire At $10 On Loss Disallowed
June 30 Unless:
 Receive $1  Own 365 Days; And
Dividend On July 1  Corporation Owns
 Sell At $9 On July 2 No More Than 5%
for loss of $1 Of Payor

© 2007, Clarence Byrd Inc. 16


Acquisition Of Control
- The Problem

Profit Loss
Company Company
Acquisition

Loss Transferred To Profit Company

© 2007, Clarence Byrd Inc. 17


Meaning Of
Acquisition Of Control
 Control: Ownership of
shares that carry the
right to elect a majority
of the board of
directors.
 Common Scenario: One
person acquires shares
from a different arm’s
length person.

© 2007, Clarence Byrd Inc. 18


Meaning Of
Acquisition Of Control

 Can also occur through redemption of


shares
 A owns 60 percent – B owns 40 percent –
If all of A’s shares were redeemed, B
would have acquired control.

© 2007, Clarence Byrd Inc. 19


Deemed Year End - ITA
249(4)
 Example: Dec. 31 year
end,
acquisition on June 30,
2007

 Deemed New Year


End June 30, 2007

 Keep Old Year End

 Allowed To Establish
New Year End
© 2007, Clarence Byrd Inc. 20
Deemed Year End - ITA
249(4)
 Usual Year End
Procedures
 File Return
 Value Inventories
 Short Fiscal Period
 CCA Calculations
 Annual Business Limit
 Counts Towards Loss
Expiry
© 2007, Clarence Byrd Inc. 21
Acquisition Of Control
 Net Capital Losses
And Allowable
Business
Investment Losses
– ITA 111(4)(a) &
(b)

 Unused Carry
Forwards Die

 New Losses Cannot


Be Carried Back© 2007, Clarence Byrd Inc. 22
Acquisition Of Control
 Non-Capital Losses -
111(5)
 Can Be Carried Forward
 Subject To Restrictions
 Must Carry On Business In
Which Losses Occurred
 Reasonable Expectation Of
Profit
 Can Only Be Applied
Against Income Generated
By The Same Or A Similar
Line Of Business

© 2007, Clarence Byrd Inc. 23


Accrued Losses
 Inventories
 Normal Year End
Procedures

 Accounts
Receivable -
111(5.3)
 Maximum Write-Off
Required

© 2007, Clarence Byrd Inc. 24


Accrued Losses
 Depreciable Property
 Asset Cost =
$100,000
 UCC = $ 60,000
 FMV = $ 50,000
 ITA 111(5.1)
 Write Down To $50,000
 The $10,000 Is
Deemed CCA
© 2007, Clarence Byrd Inc. 25
Accrued Losses
 Eligible Capital Property
- 111(5.2)
 CEC > 3/4 FMV

 Write Down

 ITA 20(1)(b) Deduction

© 2007, Clarence Byrd Inc. 26


Accrued Losses
 Non-Depreciable Property
- 111(4)(c) & (d)
 ACB > FMV

 Write Down

 Capital Loss (Will disappear


if not used at deemed year
end.)

© 2007, Clarence Byrd Inc. 27


ITA 111(4)(e) Election

 General Rule

 Can elect between ACB and FMV

 FMV > ACB: Creates Capital Gain


 May also create recapture (Can’t avoid if
you want the capital gain.)

© 2007, Clarence Byrd Inc. 28


ITA 111(4)(e) Election
 Case 1
 Capital Cost = $ 50,000
 FMV = 100,000
 UCC = 20,000

 Elect $100,000
 Capital Gain

$ 50,000
 Recapture

30,000
 New Cap. Cost © 2007, Clarence Byrd Inc. 29
ITA 111(4)(e) Election
 Case 2
 ACB = $ 50,000
 FMV = 30,000
 UCC = 20,000
 Elect $30,000
 Capital Gain

$ Nil
 Recapture

10,000
 New ACB © 2007, Clarence Byrd Inc. 30
ITA 111(4)(e) Election
 Case 3
 ACB = $ 50,000
 FMV = 5,000
 UCC = 20,000

 Write down to $5,000 is


required by 111(5.1)
 The $15,000 is deemed
CCA

© 2007, Clarence Byrd Inc. 31


Profits In The Loss
Business

During 2007, Loss Leader experiences an overall Net Loss


of $150,000, with all of the loss arising in their shoe
division. Their hat division broke even for the year. In
2008, the shoe division broke even, while the hat division
showed a profit of $200,000.
• No Acquisition in 2007: 2008 Income = $50,000
• Acquisition in 2007: 2008 Income = $200,000

© 2007, Clarence Byrd Inc. 32


Non-Capital Loss Carry
Overs
 Example
 Business Losses ($60,000)
 Dividends Received 10,000
 Bond Interest 5,000
 ABIL ( 3,000)
 Taxable Capital Gains 15,000
 Allowable Capital Losses( 7,000)
 Total ($40,000)

© 2007, Clarence Byrd Inc. 33


ITA 3 Rules
3(a) Non-Capital $15,000
3(b) Net Capital 8,000
3(c) Sum $23,000
3(d) Non-Capital ( 63,000)
Net Income Nil

Net Capital Loss Carry Over Of $8,000


Available
© 2007, Clarence Byrd Inc. 34
Alternatives

 No Net Capital Loss


Deduction
 Net Capital Loss
Deduction Of $8,000

© 2007, Clarence Byrd Inc. 35


Alternative 1 - Non-Capital
Loss With No Net Capital
Deduction
Part E:
 Business Loss $60,000
 ABIL 3,000
 Dividends 10,000 $73,000
Part F:
 ITA 3(c) ( 23,000)
Non-Capital Loss $50,000

© 2007, Clarence Byrd Inc. 36


Alternative 2 - Non-Capital
Loss With Net Capital
Deduction Of $8,000
Part E:
 Business Loss $60,000
 ABIL 3,000
 Dividends 10,000
 Net Capital Loss 8,000 $81,000
Part F:
 ITA 3(c) ( 23,000)
Non-Capital Loss $58,000

© 2007, Clarence Byrd Inc. 37


Ordering Of Taxable Income
Deductions
 Timing
 Oldest must be used
before others of same
type
 No other restrictions on
order

 Type
 Restricted By Income
Type
 Restricted By Time
© 2007, Clarence Byrd Inc. 38
Geographical Allocation
 Permanent Establishments – ITR
400(2)
 Fixed Place Of Business
 Stock Of Inventories, Land,
Equipment

 Activity: Permanent
Establishments
 Gross Revenues
 Salaries And Wages

 Procedures
 A Simple Average
 No Weighting © 2007, Clarence Byrd Inc. 39
Gross Revenues
Province Amount Percent
Alberta $250,000 25.0
Manitoba 400,000 40.0
Ontario 350,000 35.0
Totals $1,000,000 100.0

© 2007, Clarence Byrd Inc. 40


Salaries And Wages
Province Amount Percent
Alberta $100,000 20.0
Manitoba 200,000 40.0
Ontario 200,000 40.0
Totals $500,000 100.0

© 2007, Clarence Byrd Inc. 41


Allocation To Provinces
Province Average Taxable Amount
Percent Income Allocated
Alberta 22.5 $100,000 $ 22,500

Manitoba 40.0 100,000 40,000

Ontario 37.5 100,000 37,500

Total $100,000

© 2007, Clarence Byrd Inc. 42


Federal Tax Payable
 Basic Rate - ITA 123(1)
 38% Of Taxable Income

 Federal Tax Abatement -


ITA 124(1)
 10% Of Taxable Income Earned
In A Province

 Surtax - ITA 123.2


 Use 4% Of 28% Of Taxable
Income
 Repealed as of 2008
 General Rate Reduction
 7% Of Full Rate Taxable Income
© 2007, Clarence Byrd Inc. 43
Provincial Corporate
Rates
 General (%)  Small Business (%)
 Alberta 10.0  Alberta 3.00
 British Col. 12.00  British Col. 4.50
 Nova Scotia 16.00  Nova Scotia 5.00
 Ontario 14.00  Ontario 5.50
 Quebec 9.90  Quebec 8.50

© 2007, Clarence Byrd Inc. 44


Tax Payable With
$100,000 Taxable Income
Basic At 38% Of $100,000 $38,000
Abatement At 10% Of $100,000
( 10,000)
Surtax At 4% Of $28,000 1,120
GRR At 7% Of $100,000 ( 7,000)
Total Federal Tax $22,120
Provincial At 15% Of $100,00015,000
Total (Rate = 37.12%) $37,120
© 2007, Clarence Byrd Inc. 45
Objectives Of Corporate
Taxation
 1. Avoid Double Taxation
 Corporation Gets Dividend
Deduction
 Individual Gets Gross Up And
Credit
 2. Prevent Avoidance Through
Corporation
 Corporation: Prevent Capital
Gains From Becoming Dividends
 Individual: Prevent Dividends
From Becoming Capital Gains
 3. Providing Incentives
 Small Business Deduction
 M&P, ITCs, SR&ED
© 2007, Clarence Byrd Inc. 46
Small Business
Deduction (SBD)
 Objectives
 Relief To Small
Business
 Encourage Active
Business Income
 Provide For The
Accumulation Of
Capital In A New
Business

© 2007, Clarence Byrd Inc. 47


Basic Concepts
 Canadian Controlled
Private Corporation (CCPC)
 Active Business Income
 Annual Business Limit
 2007 and subsequent -
$400,000
 Associated Companies
 Must share the $400,000
limit
© 2007, Clarence Byrd Inc. 48
SBD Example With
$100,000 Of Taxable
Income
Federal Tax At 38% $38,000
Federal Tax Abatement ( 10,000)
Tax Before Surtax $28,000
Federal Surtax 1,120
Tax Before SBD $29,120
SBD At 16% ( 16,000)
Federal Tax $13,120
Provincial Tax At 5% 5,000
Total Tax Payable $18,120

© 2007, Clarence Byrd Inc. 49


Property Income
 The Problem
 Interest and rent may
involved an active
business
 The Solution
 Specified Investment
Business does not get SBD
 Excludes businesses with
5 or more full time
employees
 Incidental Property
Income
 Treated As Active
© 2007, Clarence Byrd Inc. 50
© 2007, Clarence Byrd Inc. 51
Related Individuals -
251(2)(a)

Individual

© 2007, Clarence Byrd Inc. 52


Other Definitions
 Related Corporations
 One Corporation - ITA 251(2)(b)
 Two Corporations - ITA 251(2)(c)

 Control - 256(1.2)(c)
 More Than 50% FMV - All Shares
 More Than 50% FMV - Voting Shares

 Group – 256(1.2)(a)
 Specified Class - 256(1.1)
© 2007, Clarence Byrd Inc. 53
Other Definitions
 Deeming Rules
 ITA 256(1.2)(d) – Holding Companies
 Shareholder of holding company is deemed to own
held shares.
 ITA 256(1.3)
 Children under 18
 ITA 256(1.4)
 Options to own
 Right to force redemption or cancellation
 ITA 256(2)
 A associated with B
 C associated with B
 A and C have deemed association
© 2007, Clarence Byrd Inc. 54
Association Rules

ITA 256(1)(a) one of the corporations controlled, directly or


indirectly in any manner whatever, the other;

More than 50%


Company A Company B

© 2007, Clarence Byrd Inc. 55


Association Rules

ITA 256(1)(b) both of the corporations were controlled directly or


indirectly in any manner whatever, by the same person or group of
persons;

Ms. Smith

More than 50% More than 50%

Company A Company B

© 2007, Clarence Byrd Inc. 56


Association Rules

ITA 256(1)(c) each of the corporations was controlled, directly or indirectly in any
manner whatever, by a person and the person who so controlled one of the
corporations was related to the person who so controlled the other, and either of
those persons owned, in respect of each corporation, not less than 25% of the issued
shares of any class, other than a specified class, of the capital stock thereof;

Mrs. Smith Mr. Smith

More than 50% More than 50%

Not less than 25%


Company A Company B

© 2007, Clarence Byrd Inc. 57


Association Rules

ITA 256(1)(d) one of the corporations was controlled, directly or indirectly in any
manner whatever, by a person and that person was related to each member of a
group of persons that so controlled the other corporation, and that person owned, in
respect of the other corporation, not less than 25% of the issued shares of any class,
other than a specified class, of the capital stock thereof;

Mrs. Goh
Mr. Goh Mr. Goh’s Brother

More than 50% More than 50%

Not less than 25%


Company A Company B

© 2007, Clarence Byrd Inc. 58


Association Rules

ITA 256(1)(e) each of the corporations was controlled, directly or indirectly in any
manner whatever, by a related group and each of the members of one of the related
groups was related to all of the members of the other related group, and one or more
person who were members of both related groups, either alone or together, owned in
respect of each corporation, not less than 25% of the issued shares of any class,
other than a specified class of the capital stock thereof;
Mr. Brown Mr. Fortin
Mrs. Brown Mrs. Fortin

More than 50% More than 50%

40%

Company A Company B

© 2007, Clarence Byrd Inc. 59


Calculating The SBD
 ITA 125(1) Specifies The
Deduction As
16% Of The Least Of:
 Net Canadian Active Business
Income
 Taxable Income, Less:
 10/3 Times The Foreign Non-
Business Income Tax Credit
Without Consideration Of The ART
Or The GRR; And
 3 Times The Foreign Business
Income Tax Credit Without
Consideration Of The GRR
 The Annual Business Limit
($400,000), Less Any Portion
© 2007, Clarence Byrd Inc. 60
Allocated To Associated
Elimination Of SBD For
Large Corporations

 Reduction = (A)(B/$11,250), where


 A Is The Corporation’s Annual Business
Limit
 B is .225% Of The Excess Of Taxable
Capital Employed In Canada (TCEC) over
$10,000,000
 When TCEC = $10,000,000: no
reduction
 When TCEC = $15,000,000: reduction =
© 2007, Clarence Byrd Inc. 61
100%
Elimination Of SBD For
Large Corporations
 Taxable Capital Employed In Canada

GAAP determined debt and equity capital of the


corporation, less debt and equity investments in
other corporations. When not all of the
corporation’s Taxable Income is allocated to a
province, the resulting amount is multiplied by
the same percentage that is applied to the
abatement in order to determine the portion of
the total capital that is employed in Canada.

© 2007, Clarence Byrd Inc. 62


Personal Services
Corporations
 The Problem
 Individual establishes a
corporation to provide
employee type services
 The Solution
 Personal services
corporations are not
eligible for the SBD
 Can only deduct salaries
and other expenses that
would be available to an
employee
© 2007, Clarence Byrd Inc. 63
Management Companies
 Objective
 Organized to provide
services to an
unincorporated business
(usually a professional
practice)
 Eligible for small business
deduction provided markup
is reasonable (15%)

© 2007, Clarence Byrd Inc. 64


Professional
Corporations
 Several provinces now
permit professionals
(e.g., accountants) to
incorporate
 This has reduced the
need for management
companies
 In general, eligible for
the SBD

© 2007, Clarence Byrd Inc. 65


Manufacturing And
Processing Profits
Deduction
 General Rules
 Tax Credit
 Only On M&P Income
 A 7% Reduction In Tax
Payable
 Does not get 7 percent
general rate reduction.
 Only beneficial at
provincial level and for
CCA classes
© 2007, Clarence Byrd Inc. 66
M&P Deduction –
Example
Tax At 38% ($100,000) $38,000
Abatement At 10% ( 10,000)
GRR Nil
Net After Abatement $28,000
Surtax At 4% 1,120
M & P At 7% ( 7,000)
Net Federal Tax $22,120
Provincial At 15% 15,000
Effective Total Tax 37,120

© 2007, Clarence Byrd Inc. 67


Calculation - ITA 125.1(1)
 Tax Credit = 7% of the
lesser of:
 M & P Profits (ITR), Less
Amounts Eligible For The
SBD
 Taxable Income, Less
 SBD Amount
 3 Times The Foreign Business
Income Tax Credit
 Aggregate Investment Income
Under 129(4) – Interest +
Taxable Capital Gains +Rents –
Net Capital Losses Deducted
(No Dividends) © 2007, Clarence Byrd Inc. 68
M&P Deduction
 Eligibility
 10 Percent Of Gross
Revenues From
M&P Activities
 Meaning Of M & P
 ITA 125.1(3) -
Definition
 ITA 125.1(3) -
Excluded Activities
 See Also IT-145R

© 2007, Clarence Byrd Inc. 69


M&P Formula

[ Adjusted Active
Business Income
] ( 100 / 75 M & P Labour Costs) + ( 100/85 M & P Capital Costs)
( Total Labour Costs) + ( Total ABI Capital Costs)

All Items Defined In ITR5200

© 2007, Clarence Byrd Inc. 70


General Rate Reduction
 2007: 7% of full rate
taxable income
 7.5% for 2008
 8.0% for 2009
 9.0% for 2010
 9.5% for 2011 and
subsequent

© 2007, Clarence Byrd Inc. 71


Application TO CCPCs
 Taxable Income Reduced By:
 Income Eligible For The SBD
 100/16 Of The Small Business Deduction
 Income Eligible For The M&P Deduction
 100/7 Of The M&P Deduction
 Aggregate Investment Income Under ITA
129(4)

© 2007, Clarence Byrd Inc. 72


Application TO Non-
CCPCs
 Taxable Income Reduced By:
 Income Eligible For The M&P
Deduction
 100/7 Of The M&P Deduction

© 2007, Clarence Byrd Inc. 73


Foreign Tax Credits
 Basic Concepts
 Gross pre-withholding
amounts included in
income

 Tax credit for


withholding

 Withholding rate
established by treaty

© 2007, Clarence Byrd Inc. 74


Non-Business (Property)
FTC
 Lesser Of:
 Actual Foreign Non-Business Income Tax
Paid
 And An Amount Determined By:
 Foreign
NonBusiness Income
 ( TaxOtherwise )
Payable
 Adjusted
DivisionB Income

© 2007, Clarence Byrd Inc. 75


Non-Business (Property)
FTC
 Adjusted Division B  Tax Otherwise
Income Payable
 Net Income, Less  Basic + Surtax,
 Net Capital Loss Less
Carry Overs  Abatement
Deducted  ITA 123.3 (ART)
111(1)(b)  ITA 123.4 (GRR)
 Dividends
Deducted

© 2007, Clarence Byrd Inc. 76


Non-Business (Property)
FTC
 If actual withholding exceeds
limit:
 No Carry Forward
 Excess Can Be Deducted
Under ITA 20(12)

© 2007, Clarence Byrd Inc. 77


Business FTC
 Least Of
 Actual Foreign Business Income Tax Paid
 An Amount Determined By:

 Foreign BusinessIncome 
 ( TaxOtherwise )
Payable
 Adjusted
DivisionB Income

 Tax Otherwise Payable, Less Non-


Business FTC

© 2007, Clarence Byrd Inc. 78


Business FTC
 Adjusted Division B  Tax Otherwise
Income Payable
 Net Income, Less  Basic + Surtax,
 Net Capital Loss Less
Carry Overs  No Abatement
Deducted  ITA 123.3 (ART)
111(1)(b)  ITA 123.4 (GRR)
 Dividends

© 2007, Clarence Byrd Inc. 79


Business FTC
 Additional Rules
For Unused
Amounts
 Carry Back 3 Years
 Carry Forward 10
Years
 Only Applies To
Incorporated
Foreign Income

© 2007, Clarence Byrd Inc. 80


Investment Tax Credits
 Credit Vs. Deduction
 Value Of Credit = 100%
 Value Of Deduction = [(100%)(t)]

© 2007, Clarence Byrd Inc. 81


Investment Tax Credits
 Current Expenditures
 Credit Deducted From Expenditures
 Lose Deduction

 Used In Current Period (Generally)

 One Year Delay For SR&ED

© 2007, Clarence Byrd Inc. 82


Investment Tax Credits
 Capital Expenditures
 Credit Deducted From Capital Cost In
The Following Period
 Lose CCA

© 2007, Clarence Byrd Inc. 83


Eligible Property
 Eligible Assets
 Qualified Property
 Qualified SR&ED
 Salaries of an
eligible apprentice
 Costs of creating
child care spaces

© 2007, Clarence Byrd Inc. 84


Rates
 Qualified Property - 10%
 SR&ED (CCPC)
 $2 Million At 35%
 Excess At 20%
 SR&ED (Non-CCPC)
 20%
 Apprentice Salaries
 10% On Maximum of $2,000
 Child Care Spaces
 Lesser of $10,000 and 25 percent of the
costs for each space

© 2007, Clarence Byrd Inc. 85


Refundability
 General Rules
 No Tax Payable
 Can’t Use Credits
 Government Writes Cheque To The
Business

© 2007, Clarence Byrd Inc. 86


Refundability
 Current SR&ED
 100 Percent On Current
Amounts That Qualify For
The Extra 15%
 40 Percent On Other
Current SR&ED
 Other (Including SR&ED
Capital Expenditures
 40 Percent For CCPCs and
Individuals
 No Upper Limit
© 2007, Clarence Byrd Inc. 87
Carry Overs
 Back Three Years

 Forward Twenty
Years

 Must Take All Other


Credits For The
Year And Reduce
Tax Payable To Nil

© 2007, Clarence Byrd Inc. 88


© 2007, Clarence Byrd Inc. 89