Transcript Commerce 619 - Pearson Education Canada

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.
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Additions

1. Amortization, Depreciation, and
Depletion

2. Recapture Of CCA

3. Reserves Deducted In Prior Years

4. Losses On Dispositions Of Capital
Assets (Accounting Amounts)
© 2007, Clarence Byrd Inc.
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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.
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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 (NonDeductible)
© 2007, Clarence Byrd Inc.
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Additions - Continued

13. 50% Of Business Meals

14. Club Dues And Cost Of
Recreational Facilities

15. Non-Deductible Accounting
Reserves

16. Political Contributions
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Additions - Continued

17. Charitable Donations

18. Asset Impairment WriteDowns
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Deductions

1.
CCA

2. CEC

3. Terminal Losses

4. Deductible Reserves
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Deductions

5. Gains On Dispositions Of Capital
Assets (Accounting Amounts)

6. Deductible R & D Costs

7. Deductible Warranty Costs

8. Debt Premium Amortization
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Deductions - Continued

9. Foreign Non-Business Tax
Deduction – ITA 20(12)

10. Allowable Business Investment
Losses
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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 Workers’
Compensation
© 2007, Clarence Byrd Inc.
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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.
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Dividends - The Problem
Corporate Tax Rate = 40%
AALtd.
Ltd.
$1,000
B Ltd.
C Ltd.
$600
$360
© 2007, Clarence Byrd Inc.
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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
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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.
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Stop Loss Rules

The Scenario




Acquire At $10 On June
30
Receive $1 Dividend On
July 1
Sell At $9 On July 2 for
loss of $1
Anti-Avoidance: Loss
Disallowed Unless:


© 2007, Clarence Byrd Inc.
Own 365 Days; And
Corporation Owns No
More Than 5% Of Payor
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Acquisition Of Control
- The Problem
Profit
Loss
Company
Company
Acquisition
Loss Transferred To Profit Company
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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.
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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.
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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
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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
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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
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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
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Accrued Losses

Inventories


Normal Year End
Procedures
Accounts Receivable 111(5.3)

Maximum Write-Off
Required
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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
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Accrued Losses

Eligible Capital Property 111(5.2)

CEC > 3/4 FMV

Write Down

ITA 20(1)(b) Deduction
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Accrued Losses

Non-Depreciable Property 111(4)(c) & (d)

ACB > FMV

Write Down

Capital Loss (Will disappear if not
used at deemed year end.)
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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.)
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ITA 111(4)(e) Election

Case 1




Capital Cost = $ 50,000
FMV = 100,000
UCC = 20,000
Elect $100,000




Capital Gain
Recapture
New Cap. Cost
New UCC
$ 50,000
30,000
100,000
75,000
[$50,000 + (1/2)($100,000 - $50,000)]
© 2007, Clarence Byrd Inc.
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ITA 111(4)(e) Election

Case 2




ACB = $ 50,000
FMV = 30,000
UCC = 20,000
Elect $30,000




Capital Gain
Recapture
New ACB
New UCC
$ Nil
10,000
30,000
30,000
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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
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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.
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Non-Capital Loss Carry Overs

Example
Business Losses
 Dividends Received
 Bond Interest
 ABIL
 Taxable Capital Gains
 Allowable Capital Losses
 Total

© 2007, Clarence Byrd Inc.
($60,000)
10,000
5,000
( 3,000)
15,000
( 7,000)
($40,000)
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ITA 3 Rules
3(a) Non-Capital
3(b) Net Capital
3(c) Sum
3(d) Non-Capital
Net Income
$15,000
8,000
$23,000
( 63,000)
Nil
Net Capital Loss Carry Over Of $8,000 Available
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Alternatives

No Net Capital Loss Deduction

Net Capital Loss Deduction Of
$8,000
© 2007, Clarence Byrd Inc.
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Alternative 1 - Non-Capital Loss
With No Net Capital Deduction
Part E:
Business Loss
 ABIL
 Dividends

$60,000
3,000
10,000
$73,000
Part F:

ITA 3(c)
( 23,000)
Non-Capital Loss
$50,000
© 2007, Clarence Byrd Inc.
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Alternative 2 - Non-Capital Loss With
Net Capital Deduction Of $8,000
Part E:
Business Loss
 ABIL
 Dividends
 Net Capital Loss

$60,000
3,000
10,000
8,000
$81,000
Part F:

ITA 3(c)
( 23,000)
Non-Capital Loss
$58,000
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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
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Geographical Allocation

Permanent Establishments – ITR 400(2)



Activity: Permanent Establishments



Fixed Place Of Business
Stock Of Inventories, Land, Equipment
Gross Revenues
Salaries And Wages
Procedures


A Simple Average
No Weighting
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Gross Revenues
P ro v in c e
A m ount
P e rc e n t
$ 2 5 0 ,0 0 0
2 5 .0
M a n ito b a
4 0 0 ,0 0 0
4 0 .0
O n ta rio
3 5 0 ,0 0 0
3 5 .0
$ 1 ,0 0 0 ,0 0 0
1 0 0 .0
A lb e rta
T o ta ls
© 2007, Clarence Byrd Inc.
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Salaries And Wages
Province
Amount
Percent
$100,000
20.0
Manitoba
200,000
40.0
Ontario
200,000
40.0
$500,000
100.0
Alberta
Totals
© 2007, Clarence Byrd Inc.
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Allocation To Provinces
P ro v in c e
A v e ra g e T a x a b le
P e rc e n t
In c o m e
A m ount
A llo c a te d
A lb e rta
2 2 .5 $ 1 0 0 ,0 0 0
M a n ito b a
4 0 .0
1 0 0 ,0 0 0
4 0 ,0 0 0
O n ta rio
3 7 .5
1 0 0 ,0 0 0
3 7 ,5 0 0
T o ta l
$ 2 2 ,5 0 0
$ 1 0 0 ,0 0 0
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Federal Tax Payable

Basic Rate - ITA 123(1)


Federal Tax Abatement - ITA
124(1)


10% Of Taxable Income Earned In A
Province
Surtax - ITA 123.2



38% Of Taxable Income
Use 4% Of 28% Of Taxable Income
Repealed as of 2008
General Rate Reduction

7% Of Full Rate Taxable Income
© 2007, Clarence Byrd Inc.
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Provincial Corporate Rates

General (%)





Alberta
British Col.
Nova Scotia
Ontario
Quebec

10.0
12.00
16.00
14.00
9.90
Small Business (%)





© 2007, Clarence Byrd Inc.
Alberta
British Col.
Nova Scotia
Ontario
Quebec
3.00
4.50
5.00
5.50
8.50
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Tax Payable With
$100,000 Taxable Income
Basic At 38% Of $100,000
Abatement At 10% Of $100,000
Surtax At 4% Of $28,000
GRR At 7% Of $100,000
Total Federal Tax
Provincial At 15% Of $100,000
Total (Rate = 37.12%)
© 2007, Clarence Byrd Inc.
$38,000
( 10,000)
1,120
( 7,000)
$22,120
15,000
$37,120
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Objectives Of Corporate
Taxation

1. Avoid Double Taxation



2. Prevent Avoidance Through
Corporation



Corporation Gets Dividend Deduction
Individual Gets Gross Up And Credit
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.
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Small Business Deduction (SBD)

Objectives



© 2007, Clarence Byrd Inc.
Relief To Small Business
Encourage Active
Business Income
Provide For The
Accumulation Of Capital
In A New Business
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.
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SBD Example With $100,000 Of
Taxable Income
Federal Tax At 38%
Federal Tax Abatement
Tax Before Surtax
Federal Surtax
Tax Before SBD
SBD At 16%
Federal Tax
Provincial Tax At 5%
Total Tax Payable
© 2007, Clarence Byrd Inc.
$38,000
( 10,000)
$28,000
1,120
$29,120
( 16,000)
$13,120
5,000
$18,120
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Property Income

The Problem


The Solution



Interest and rent may involved an
active business
Specified Investment Business
does not get SBD
Excludes businesses with 5 or
more full time employees
Incidental Property Income

Treated As Active Business
Income
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© 2007, Clarence Byrd Inc.
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Related Individuals - 251(2)(a)
Individual
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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.
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Other Definitions

Deeming Rules

ITA 256(1.2)(d) – Holding Companies


ITA 256(1.3)


Children under 18
ITA 256(1.4)



Shareholder of holding company is deemed to own held shares.
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.
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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.
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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.
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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.
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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’s Brother
Mr. Goh
More than 50%
More than 50%
Not less than 25%
Company A
Company B
© 2007, Clarence Byrd Inc.
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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. Fortin
Mrs. Fortin
Mr. Brown
Mrs. Brown
More than 50%
More than 50%
40%
Company A
Company B
© 2007, Clarence Byrd Inc.
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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 Allocated To Associated
Corporations.
© 2007, Clarence Byrd Inc.
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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 = 100%

© 2007, Clarence Byrd Inc.
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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.
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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.
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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.
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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.
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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)
Abatement At 10%
GRR
Net After Abatement
Surtax At 4%
M & P At 7%
Net Federal Tax
Provincial At 15%
Effective Total Tax
© 2007, Clarence Byrd Inc.
$38,000
( 10,000)
Nil
$28,000
1,120
( 7,000)
$22,120
15,000
37,120
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.
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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.
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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.
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Application TO CCPCs

Taxable Income Reduced By:

Income Eligible For The SBD


Income Eligible For The M&P Deduction


100/16 Of The Small Business 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 Non Business Income

 Adjusted Division B Income

  Tax Otherwise Payable

© 2007, Clarence Byrd Inc.

75
Non-Business (Property) FTC

Adjusted Division B
Income


Tax Otherwise Payable

Net Income, Less
 Net Capital Loss
Carry Overs Deducted
111(1)(b)
 Dividends Deducted
© 2007, Clarence Byrd Inc.
Basic + Surtax, Less
 Abatement
 ITA 123.3 (ART)
 ITA 123.4 (GRR)
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Non-Business (Property) FTC

If actual withholding exceeds limit:


No Carry Forward
Excess Can Be Deducted
Under ITA 20(12)
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Business FTC

Least Of
Actual Foreign Business Income Tax Paid
 An Amount Determined By:

 Foreign Business Income

 Adjusted Division B Income


  Tax Otherwise Payable


Tax Otherwise Payable, Less Non-Business FTC
© 2007, Clarence Byrd Inc.
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Business FTC

Adjusted Division B
Income


Tax Otherwise Payable

Net Income, Less
 Net Capital Loss
Carry Overs Deducted
111(1)(b)
 Dividends
© 2007, Clarence Byrd Inc.
Basic + Surtax, Less
 No Abatement
 ITA 123.3 (ART)
 ITA 123.4 (GRR)
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Business FTC

Additional Rules For
Unused Amounts



© 2007, Clarence Byrd Inc.
Carry Back 3 Years
Carry Forward 10 Years
Only Applies To
Incorporated Foreign
Income
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Investment Tax Credits

Credit Vs. Deduction


Value Of Credit = 100%
Value Of Deduction = [(100%)(t)]
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Investment Tax Credits

Current Expenditures
Credit Deducted From Expenditures
 Lose Deduction
 Used In Current Period (Generally)
 One Year Delay For SR&ED

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Investment Tax Credits

Capital Expenditures
Credit Deducted From Capital Cost In The
Following Period
 Lose CCA

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Eligible Property

Eligible Assets




Qualified Property
Qualified SR&ED
Salaries of an eligible
apprentice
Costs of creating child
care spaces
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Rates


Qualified Property - 10%
SR&ED (CCPC)



SR&ED (Non-CCPC)


20%
Apprentice Salaries


$2 Million At 35%
Excess At 20%
10% On Maximum of $2,000
Child Care Spaces

Lesser of $10,000 and 25 percent of the costs for each
space
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Refundability

General Rules



No Tax Payable
Can’t Use Credits
Government Writes Cheque To The Business
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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.
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Carry Overs

Back Three Years

Forward Twenty Years

Must Take All Other
Credits For The Year
And Reduce Tax Payable
To Nil
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© 2007, Clarence Byrd Inc.
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