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4562 Lecture 3 - Corporate Tax for CCPCs
Last updated May 1, 2015
This lecture discusses
- Taxation of Business Income and Integration
- Associated Corporations
- Scientific Research and Experimental Development (SR&ED) and
- CPA Canada’s Mock Simulation Mamma Jill’s Pizza (problem set)
Readings
ADMS 3520 Lecture 9 Notes
Read sections ITA 89, 125(1) to (7), 125.1(1), 129(6), 256
FIT Ch. 12 (exclude 12300 to 12390)
Recommend
Ch. 12, Review Questions 1 to 4, 6&7, 10; Multiple Choice 1 to 3, 5, 6; Exercises 3 to 5
Lecture 3 Problem Set
Remember to print the lecture notes, read the lecture notes and do the Problem Set and
Exercises. You should also review the recommended Review Questions and Multiple
Choice Questions and you may wish to bring your textbook and the Act to class.
In ADMS 3520 lecture 9 you learned about the three main types of corporations and
about the tax preferences given to Canadian controlled private corporations (CCPCs).
Recall that a public company is a company resident in Canada with a class of shares
listed on a designated stock exchange in Canada; and a private company is a company
resident in Canada that is not a public company and that is not controlled by one or more
public companies [s. 89(1)]. A CCPC is a private corporation that is a Canadian
corporation and that is: (a) not controlled by non-residents and/or public companies; and
(b) that does not have any class of shares listed on a designated stock exchange [s.
125(7)].
The most significant of these tax preferences is the small business deduction [s. 125(1)]
which results in a low rate of tax for the first $500,000 of Canadian active business
income.
You also learned about
- associated corporations and how they must share this $500,000 annual business limit
- some of the basic rules that make corporations associated
- the three basic rules in s. 256(1)(a) to (c)
- the rules that determine whether
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- individuals are related [s.251(2)(a)] by blood [s. 251(6)(a)], marriage [s.
251(6)(b)] and adoption [You also learned that a person is deemed to be
related to himself: s. 256(1.5) ]
- corporations and individuals are related: s. 251(2)(b) and
- two corporations are related 251(2)(c)
- the deemed ownership rule for shares owned by minors: s. a.256(1.3)
- the anti-avoidance rule: s. 256(2.1)
Now we will learn the more complex rules.
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Types of Income Earned by Canadian controlled private corporations
(CCPCs)*
* Note: if a corporation becomes a CCPC or ceases to be a CCPC then:
(a) its taxation year will be deemed to end immediately prior to becoming/ceasing to be a
CCPC; and
(b) a new taxation year will begin [subsection 249(3.1) of the Act]
Deemed year-ends and their tax consequences will be discussed in lecture 8
There are three basic types of income earned by CCPCs:
2.1
Canadian Active Business Income (Can ABI): s. 125(7)
See definition of “active business…”
= Division B Net income - foreign ABI - specified investment business income (SIB) personal services business income (PSB)
- ABI includes an adventure in the nature of trade
See definition of “income…from an active business”
- active business income includes income incidental to the business (s. 125(7)) such as
- interest on accounts receivable
- interest on the short-term investment of working capital
- recapture of CCA previously deducted in computing ABI
- short-term rental of premises usually used in an active business
2.2
Specified investment business (SIB): s. 125(7)
Investment income will be active business income only if
1. The investment business has > 5 full-time employees throughout the year (see
definition of SIB: s. 125(7) or
2. The investment income earned relates to: (a) an amount paid or payable by an
associated company; and (b) the expense is deductible by the associated company, in any
taxation year, from an active business carried on in Canada: see s. 129(6).
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SIB income
= investment income which is not active (most investment income is not active)
= Canadian and foreign rents, royalties, interest, dividends and taxable capital gains
There are two types of SIB income
1. tax-free Canadian dividends (s. 112) are subject to a 33 and 1/3% Part IV tax which is
potentially refundable as a dividend refund
2. other investment income which is taxed in Ontario at 46.17% (28% plus 6 and 2/3%
additional refundable tax (ART) plus 11.5% Ontario tax rate
- 26 2/3% is potentially refundable as a dividend refund- net tax is about 19.5% [i.e.,
46.17% - 26.67%]
We will talk more about SIB income next week.
2.3
Personal services business (PSB): s. 125(7)
If it is not deemed to be active (due to one of the three exceptions listed below), the
incorporated employment income is a personal services business (PSB)
A PSB exists when:
1) a corporation provides services;
2) the person who provides the services on behalf of the corporation is a specified
shareholder; and
3) the person, described in (2), would reasonably be considered to be providing
the services of an employee (as opposed to the services of a self-employed
independent contractor)
A specified shareholder is someone who, at any time in the year, owns 10% or more of
any class of shares of the corporation [s. 248(1)]. For purposes of this definition, shares
owned by persons related to the taxpayer are deemed to be owned by the taxpayer.
PSB income is not eligible for:
 the small business deduction;
 dividend refund treatment (i.e., PSB income is not AII, discussed next lecture);
and
 for year-ends ending after October 31, 2011, PSB income is not eligible for the
general rate reduction. Hence for PSB income tax is paid at the top corporate rate
 Also when computing PSB income the corporation cannot deduct any expense
other than:
1. salary paid to the incorporated employee; and
2. section 8 expenses that the incorporated employee could deduct if
he/she was not incorporated
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SIB and PSB Income Deemed to be Active (Exceptions)
- SIB and PSB income is deemed to be active if there are > 5 full-time employees
employed in the business throughout the year: s. 125(7) definitions of SIB and PSB
- SIB income (e.g. rent, interest etc.) is deemed to be active if the investment income
earned relates to: (a) an amount paid or payable by an associated company; and (b) the
expense is deductible by the associated company, in any taxation year, from an active
business carried on in Canada. S. 129(6) and Exhibit 12-12 of FIT
- PSB income is deemed to be active if it’s earned from services provided to an
associated corporation: s. 125(7) definition of PSB
2.5
Test Yourself on ABI vs. SIB vs. PSB:
1. Peter owns 100% of P Ltd. and P Ltd. owns 100% of the common shares of S Ltd. P
Ltd. has one full-time employee (Peter). Prior to the incorporation of P Ltd., Peter was an
employee of S Ltd. S Ltd. earned $200,000 active business income in Canada in 2014
(after deducting all expenses) and is using $200,000 of its business limit to claim the
small business deduction on this entire amount. P Ltd. earned $130,000 in 2014: $50,000
by renting a building to S Ltd. for use in its active business and $80,000 in respect of
management fees charged for services that Peter performs for S Ltd.
Which of the following statements is true?
(a) P Ltd. earned $50,000 of specified investment business income and $80,000 of
personal services business income.
(b) P Ltd. earned $50,000 of active business income and $80,000 of personal services
business income.
(c) P Ltd. earned $130,000 of specified investment business income.
(d) P Ltd. earned $130,000 of active business income.
The correct answer is (d).
[Note: rental income is usually property income (but it meets the exception). Can you
explain why it meets the exception? Management fee income initially appears to be
personal services business (PSB) income (but it meets the exception). Can you determine
why it appears to be PSB income? Can you explain why it meets the exception?]
2. A Ltd. manufactures machine parts in Canada and also owns 60% of B Ltd. Mr. A
owns all of the A Ltd. shares and is a resident of Canada. B Ltd. earns interest and rental
income and has no employees. A Ltd. pays rent to B Ltd. for the warehouse it uses in its
manufacturing business. How should B Ltd. report the rental income it received from A
Ltd.?
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(a) income from property
(b) active business income
(c) specified investment business income
(d) personal services business income
The correct answer is (b)
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3.1
Associated Corporations
Why is it important to determine whether corporations are associated?
- it is relevant only for CCPCs
1. Associated CCPCs must share the $500,000 annual business limit for the SBD
- the associated corporation rules prevent you from incorporating several corporations
and multiplying your access to the small business deduction (SBD)
2. the 35% Scientific Research and Experimental Development (SRED) Investment Tax
Credit (ITC) is available only for the first $3 million of expenditures of an associated
group of CCPCs
3. The $500,000 SBD limit is reduced if the corporation is “large”. The formula takes
into consideration the size of an entire associated group of CCPCs.
4. SIB income is deemed to be active if the income relates to: (a) an amount paid or
payable by an associated company; and (b) the expense is deductible by the associated
company, in any taxation year, from an active business carried on in Canada (as
discussed above)
5. PSB income is deemed to be active if it is earned from services provided to an
associated corporation (as discussed above)
3.2
Why is it important to determine whether individuals and/or corporations are
related?
1. It is relevant for several of the association rules
2. It is relevant for rules you have taken in ADMS 3520 and ADMS 4561 for non-arm’s
length transfers (because related persons are deemed not to deal at arm’s length)
3. It is relevant for rules we will take later in this course (e.g., affiliated person rules in
the lectures on s. 85(1) and s. 84.1)
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Basic Association Rules
Besides the association rules you learned in ADMS 3520, that is two corporations are
associated if any one of (1), (2), or (3) applies:
1. One corporation controls the other s. 256(1)(a);
2. Two companies are each controlled by the same person or group of persons s.
256(1)(b);
3. One person controls one corporation and another person controls a second
corporation; the two persons are related; and one person owns 25% or more of
each corporation (i.e., cross ownership) s. 256(1)(c)
4. Shares owned by a minor child are deemed to be owned by the parents: s.
256(1.3). Note: that each parent is deemed to own all of the shares of the minor
child for purposes of the association rules (hence there can be double-counting)
5. Anti-avoidance rule: Two companies are deemed to be associated if one of the
main reasons for their separate existence was to reduce tax (e.g., by accessing
another small business deduction): s. 256(2.1)
There are several more complex rules. Corporations are also associated if any one of the
following applies:
256(1)(d) One corporation is controlled by a person and the other corporation is
controlled by a group of persons; the one person is related to each person in the group
that controls the other corporation; and that one person owns 25% or more of the other
corporation
256(1)(e) Both corporations are controlled by related groups of people; each person in
one group is related to each person in other group; and one or more persons who are
members of both groups (i.e., people who own shares in both corporations) either alone
or together own 25% or more of both corporations
3.4
Other association rules
Note: these other association rules only apply for purposes of determining if two (or
more) corporations are associated. As you will see there are lots of rules that make it
easier for corporations to be associated. If associated, corporations must share various
things like the $500,000 annual business limit.
256(1.1) Shares of a specified class. These shares don't count for purposes of the “25%
cross-ownership” tests/conditions found in 256(1)(c) to (e). Defined as non-convertible,
non-voting, fixed dividend ($ or %) with a dividend rate not greater than the prescribed
rate at the time of issue, and redemption amount not > issue price (plus any unpaid
dividends)
256(1.2)(b) A corporation can be considered to be controlled at the same time by several
persons or groups of persons (a group = 2 or more persons, each of whom owns shares of
the same corp.)
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256(1.2)(c) You are deemed to have control if you own > 50% of the FMV of all shares
(or all common shares) of the corporation
256(1.2)(d)-(f) Look-through rules for shares owned through holding corporations,
partnerships or trusts:
- For corporate owned shares you multiply through the ownership percentages…e.g., If
Mr. X owns 50% of P Ltd. which owns 50% of S Ltd., he is deemed to own 25% (i.e.,
50% x 50%) of the shares of S. Ltd. for purposes of the association rules (e.g., the cross
ownership test).
For shares owned by trusts, the beneficiary is deemed to own shares owned by the trust.
If the trust is discretionary (i.e., the trustee determines the amount, if any, of the trust’s
income or capital that a beneficiary is entitled to) then each beneficiary is deemed to own
all of the shares owned by the trust (for purposes of the association rules). If the trust is
not discretionary (i.e., the beneficiaries are entitled to a certain amount of the trust’s
income and/or capital based on the trust deed) then each beneficiary is deemed to own the
shares owned by the trust based on the FMV of their respective beneficial interest of the
trust (for purposes of the association rules).
For partnerships, each partner is deemed to own the shares owned by the partnership
based on their respective share of the income/loss of the partnership (for purposes of the
association rules)
Recall: in the case of a minor, s. 256(1.3) would deem the parent(s) to own the shares.
256(1.4)(a) If you have options that if exercised would give you control then you have
(de facto) control
256(1.5) A person is related to himself or herself
256(2) Triangular association: if Co A and Co B are both associated with Co. C (a
CCPC), then Co A is deemed to be associated with Co. B (triangle forms) unless Co. C
elects to have a business limit of nil. Annual election by Co C is necessary to avoid
having the triangular association rule apply
256(5.1) De facto control counts as control ("controlled directly, indirectly or in any
manner whatever")
3.5
Test Yourself:
1) David owns 100% of the shares of David Inc. David's wife, Dottie, owns 100% of
Dottie Inc. Dottie owns 55% of DD Inc. David owns 10% of the shares of DD Inc. Their
daughter, Janice (2 years old) is the sole beneficiary of a discretionary trust which owns
the other 35% of the shares of DD Inc. Which of the following statements is true?
(a) Dottie Inc. and DD Inc. are associated.
(b) David Inc. is associated with DD Inc.
(c) David Inc. won't be associated with Dottie Inc. if DD Inc. files an election deeming it
to have a business limit of nil.
(d) All of the above
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The correct answer is (d).
[Can you explain why all of the above is correct?
For (a) note: how Dottie Inc. and DD Inc. are controlled by the same person, since Dottie owns
more than 50% of the shares of each; i.e., 55% of DD Inc. and 100% of Dottie Inc., s. 256(1)(b).
For (b) note: one person controls each company since David controls David Inc. and Dottie
controls DD Inc.; David and Dottie are related by marriage, s. 251(2)(a); and David owns 25% or
more of both, s. 256(1)(c). David is deemed to own the 35% of shares owned by his minor
daughter and the daughter is deemed to own all of the shares owned by the trust.
For (c) the triangular association rule will apply since both David Inc. and Dottie Inc. are
associated with the same third company (i.e., DD Inc.) unless DD Inc. elects to have a business
limit of zero.]
2)
Jack and Ken are married to women who are sisters. Jack owns 100% of the common
shares of J Ltd. and Ken owns 100% of the common shares of K Ltd. J Ltd. and K Ltd.
each own 20% of the common shares of F Inc. Sixty per cent of the common shares of F
Inc. are owned by the father-in-law. Which of the following statements are true?
(a) J Ltd. and K Ltd. are associated.
(b) F Ltd. is associated with J Ltd. and K Ltd.
(c) J Ltd., K Ltd. and F Ltd. are related.
(d) All of the above.
The correct answer is (c).
[Note that “related” is not the same as “associated”; related persons do not share things
like the annual business limit]
3)
Larry is married to Teresa's sister. Teresa and Larry each own 50% of the common shares
of L Ltd. Teresa and Larry each also own 25% of S Ltd. The other 50% of S Ltd. is
owned equally by Teresa's two daughters, ages 19 and 16. Which of the following
statements is correct?
(a) S Ltd. and L Ltd. are not associated.
(b) S Ltd. and L Ltd. are associated under s. 256(1)(b).
(c) S Ltd. and L Ltd are associated under s. 256(1)(d).
(d) S Ltd. and L Ltd. are associated under s. 256(1)(e).
(e) None of the above.
The correct answer is (b).
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[Note that (d) is also correct since all the conditions of 256(1)(e) are also met. However,
once you’ve correctly determined that 2 companies are associated under 256(1)(b) you
would typically stop there since when 2 companies are associated under a paragraph of
the Act, they are associated and must share various things (like the annual business limit).
Also note: if both of Teresa's daughters were 18 years of age or older, the answer would
be (a).]
4
Small Business Deduction (S.125) and Integration for Business Income
- Exhibit 12-1 of FIT shows the theory behind integration with a 15.3% and a 27.5%
combined federal and provincial corporate income tax rate. In lecture 4 we will discuss
eligible dividends which have a 38% gross-up for “eligible” dividends paid out of income
taxed at the general rate (theoretically 27.5%) and how this will complicate matters for
CCPCs because they will have to calculate a GRIP account. This lecture will show the
mechanics behind the theoretical 15.3% rate.
A tax system is integrated if the tax paid when income is earned through a corporation
and distributed as a dividend to the shareholder is the same as the tax paid when the same
income is earned directly by the individual. The examples in the Appendix attached to
these notes review this concept.
As Appendix Example 1 shows, integration works when
1. the combined federal-provincial corporate tax rate is 15.3% and
2. the combined federal-provincial dividend tax credit (DTC) is equal to the 18% grossup.
When the combined corporate rate is higher than 15.3% or the combined DTC is less than
the 18% gross-up, the incorporation of a business is generally not advantageous from an
income tax perspective unless the income will be retained in the corporation for several
years to benefit from the initial tax deferral.
In most provinces, integration for income eligible for the small business deduction (SBD) does
not work perfectly because the combined federal provincial corporate income tax rate is not
15.3% and the combined dividend tax credit is less than the 18% gross-up. In Ontario, for
example, the combined corporate tax rate (for CCPCs earning ABI eligible for the SBD) is
15.5% (in 2014) and the combined federal and provincial DTC is slightly less than the 18%
gross-up. The Ontario gross-up and provincial dividend tax credit will be discussed in lecture 11.
Appendix Example 2 shows the tax savings that results from a 15% combined federal provincial
corporate income tax rate when the combined DTC equals the 18% gross-up. Appendix Example
3 shows the tax cost of incorporating when the DTC is 94.444% (i.e., 13/18 federally + 4/18
provincially) of the 18% gross-up when the combined federal provincial corporate income tax
rate is 15%.
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Note: The April 21, 2015 federal budget has decreased the non-eligible dividend gross up and
adjusted the DTC starting in 2016. The non-eligible dividend gross up and the DTC will be:
Current:
Non-elig. div.
Gross up
18%
Federal DTC
(x grossed-up div.)
13/18
Starting in
17%
21/29
2016
17%
20/29
2017
16%
20/29
2018
15%
9/13
2019
- Exhibit 12-2 of FIT shows the effect of the SBD with an assumed 4% provincial rate
- s. 125(1) = Small Business Deduction (SBD) = 17% of the least of 3 amounts
Least of:
Objective
1. Canadian active
business income
1. Only Canadian ABI is eligible
2. Taxable income
minus
100/28 x foreign nonbusiness tax credit
minus 4 x foreign
business tax credit
2. Limited to Canadian taxable income only
Foreign income is removed by grossing-up the foreign tax credits
(a) FNBTC gross-up reflects an assumed federal rate of 28% on foreign nonbusiness income
(b) FBTC gross-up reflects tax rate of 25% on foreign business income
3. Business limit
3. $500,000 business limit shared by associated corporations, reduced by the
s. 125(5.1) $10 M size test)
Note: The April 21, 2015 federal budget has increased the small business deduction starting in
2016. The small business deduction credit will be increased from 17% to:
17.5%
18%
18.5%
19%
in 2016
in 2017
in 2018, and
in 2019
Size (taxable capital)
The purpose of the 125(5.1) $10 M size test rule is to reduce/eliminate the SBD for “large”
CCPCs (or a member of an associated group of CCPCs that altogether are “large”). If a
corporation’s (or associated group’s) taxable capital in Canada in the immediate prior year is
1.$10M or less, there is no reduction.
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2. between $10 million and $15 million, the annual business limit (i.e., $500,000) is
reduced to zero on a straight-line basis.
3. $15 million or greater, the business limit is nil.
Examples of straight-line reduction if taxable in Canada is between $10M and $15M
Prior Year’s Taxable capital
$10M
$11M
$12M
$13M
$14M
$15M
Business limit
100%
4/5
3/5
2/5
1/5
0
Example: A CCPC in 2014 has the following facts:
ABI = $400,000; M&P profits = $100,000
Taxable income = $380,000
Taxable capital in Canada = $12.5 million
Aggregate investment income (AII) $80,000
The CCPC is not associated with any other companies
Question: Calculate the CCPC’s 2013 small business deduction (SBD).
Answer:
Calculation of SBD =
17% x $250,000 = $42,500
Where $250,000 is the least of:
a) ABI = $400,000
b) Taxable Income = $380,000 (note: there is no foreign income)
c) Business Limit
= 50% x $500K = $250,000 (since $12.5 is halfway between $10M and $15M)
In most of our questions, the CCPCs have taxable capital in Canada < $10 million & the
restriction will not apply. Sometimes it will.
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M&P Credit (S. 125.1)
In this course, you will always be given M&P profits
M&P deduction = 13%* of the lesser of:
(i) M& P profits minus amount eligible for SBD
(ii) Taxable income
minus 1. amount eligible for SBD (backs out SBD)
2. Aggregate Investment Income (backs out net investment income
3. 4 x Foreign business tax credit (proxy for foreign business income)
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Aggregate Investment Income will be discussed next week as it relates to the taxation of
investment income.
6
R&D and Investment Tax Credit Rules
(SRED rules are very complicated. Ignore material in Ch. 12, 12260 on the
prescribed proxy amount)
The 2013 federal budget requires additional information about tax advisors who assist a taxpayer
with a SR&ED claim (starting in 2014 and thereafter). Information about any contingency fees
(i.e., fees based on a percentage of the tax savings) and the amount of fees payable will need to
be provided to the CRA. Penalties will result if the required information is not provided.
6.1
Investment tax credits (ITCs). 127(5)
= a tax credit for investing in new property and R&D expenditures in Canada
Two types s. 127(9):
1. 10% ITC for qualified property (e.g., manufacturing equipment) used in Atlantic
provinces & Gaspe only
2. A 15% or 35% ITC for scientific research and experimental development expenditures
(SRED). (Prior to 2014 the ITCs were 20% or 35%)
Carryover period for unused ITCs:
= similar to period for non-capital losses (-3 years, + 20 years)
However, ITCs earned in the period from 1998 to 2005 will also be eligible for a 20 year
carryforward period [s. 127(9.01)]
Any ITC claimed reduces the tax cost of the asset or reduces the s. 37(1) SRED pool in
the year that the ITC is received
All ITCs must be claimed by taxpayers within 12 months of the taxpayer's filing due
date for the taxation year. All R&D claims are audited.
6.2
Basics on ITCs for R&D1
1. Section 37(1) expenditures are Canadian current expenditures on SRED
(Prior to 2014 Canadian capital expenditures on depreciable property used for SRED was
also considered an eligible expenditure for purposes of SR&ED)
1
Most Canadian provinces and one territory also have R&D tax credits. The CRA has provided a summary of such
provincial credits (that exist as of June 30, 2014) at
http://www.cra-arc.gc.ca/txcrdt/sred-rsde/prv-crdts-eng.html
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The basics are that in order to qualify as SRED, the project
(1) advance scientific knowledge
(2) involve technological uncertainty and
(3) be carried out by qualified staff in a scientific manner
2. Section 37(1) expenditures are fully deductible but don't have to be claimed in the
year (they can be saved in a section 37 pool and deducted in a future year; there’s
an indefinite carryforward period). Rent expense and the cost of land and building is
not allowed as a SR&ED deduction since these expenditures are specifically excluded
from SR&ED, s. 37(8)(d)
3. All Section 37(1) expenditures in the year are eligible for an investment tax credit
except: used equipment, rent expense and land and buildings (excluding prescribed
special purpose buildings such as wind tunnels)
(Starting January 1, 2014 and thereafter capital expenditures will no longer be
considered an eligible expenditure for purposes of SR&ED. Hence they will no longer be
eligible for an ITC, as per the March 29, 2012 federal budget.)
4. The ITC rates are generally 15%.
(Prior to 2014 the ITC rate was 20% (not 15%). There is no change to the 35% ITC
discussed below)
5. A special 35% ITC is available for CCPCs only, but it is limited by 3 tests:
(a) $3M Expenditure Limit
Only the first $3M of annual SR&ED expenditures are eligible. Associated CCPCs must
share this $3M annual expenditure limit
(b) Taxable Income Limit
Only a CCPC with taxable income, together with the taxable income of any associated
corporations, in the immediately prior year of $500,000 or less can get the full $3M
annual expenditure limit. Taxable income, of the associated group, above $500,000
reduces the expenditure limit as follows:
- with taxable income between $500,000 and $800,000, the $3M SRED expenditure limit
is reduced to zero on a straight-line basis
(c) Taxable Capital Limit
Only a CCPC with taxable capital, together with the taxable capital of any associated
corporations, in the immediately prior year of $10M or less can get the full $3M annual
expenditure limit. Taxable capital, of the associated group, above $10M reduces the
expenditure limit as follows:
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- with taxable capital between $10 million and $50 million, the $3M SRED expenditure
limit is reduced to zero on a straight-line basis.
6. Part of the 35% ITCs are "refundable" for certain taxpayers under s. 127.1 there is a 100% refund on ITCs for current expenditures (for qualifying CCPCs)
(prior to 2014, 40% of the ITC for eligible capital SR&ED expenditures was refundable)
(note: there is also a 40% refund for ITCs for current expenditures eligible for the 15%
ITC; i.e., current expenditures in excess of the $3M annual limit)
- these "refundable" amounts can be claimed even if taxes are not owing
- CCPC’s, who together with associated companies, have taxable income in the prior year
of $500,000 or less can claim refundable ITCs. Other companies cannot (i.e., they can
only claim non-refundable ITCs)
Test Yourself:
X Ltd. (a CCPC) was incorporated in 2013 and has a December 31 year-end. In 2014, X
Ltd. incurred SRED expenditures: $200,000 of a current nature (excluding rent) and
$100,000 of a capital nature (excluding used equipment). X Ltd. has taxable capital of
$5,000,000 and no associated corporations. X Ltd. had no taxable income in 2013 or
2014. What is X Ltd.'s maximum refundable investment tax credit (ITC) for 2014?
(a)
(b)
(c)
(d)
$30,000
$70,000
$105,000
$200,000
The correct answer is (b).
[Note: The question does not ask you to compute the amount of SR&ED expenditures
that can be deducted (i.e., $200,000). The maximum refundable ITC for 2014 is $70,000
(i.e., 100% x $200,000 x 35%). Starting in 2014 and thereafter capital expenditures no
longer qualify as SR&ED.]
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APPENDIX
REVIEW OF INTEGRATION- ACTIVE BUSINESS INCOME EARNED
THROUGH A CORPORATION VS. EARNED DIRECTLY
Example #1: $100,000 of Canadian active business income earned in 2014 by a corporation vs.
earned directly by an individual. The taxpayer lives in a province with a 15.3% combined federal
and provincial corporate income tax rate on the first $500k of active business income and with a
5/18 (times the 18% gross-up) provincial dividend tax credit. The taxpayer has a 45% marginal
personal tax rate since he/she has other income and is in the top federal tax bracket (29%) plus
provincial tax. You can assume that the individual has other income and has used up all personal
tax credits. Recall that the federal DTC on non-eligible dividends in 2014 is 13/18 of the 18%
gross-up.
Income earned directly
Business income
Personal tax: $100,000 x 45%
After-tax income
Income earned through corporation and retained
Business income before salary
Combined corporate income tax @ 15.3%
After-tax retained earnings (RE)
Comparison of tax assuming income retained in corporation
Tax paid if unincorporated
Tax paid if incorporated
Initial tax saved by incorporating (i.e., tax deferral)
Personal tax if entire retained earnings paid as a dividend
Taxable div. = after-tax RE ($84,700) x 1.18
Tax ($99,946 x 45%)
Federal & Provincial DTC:
(13/18 + 5/18) x $15,246 (gross-up, i.e., $99,946 - $84,700)
Pers. tax (deferred until payment of dividend)
Net tax savings (cost) of incorporation ($29,700 - $29,730) =
$100,000
(45,000)
$ 55,000
$100,000
(15,300)
$84,700
$45,000
$15,300
$29,700
$99,946
$44,976
(15,246)
$29,730
($30) i.e., approx. nil
There is a $29,700 deferral while income is left in the corporation but additional tax is paid when
the dividend is paid out to the shareholder. Integration essentially exists because the total tax
paid is approximately the same regardless of whether the income is earned in a corporation or
earned personally.
Integration exists because the combined federal-provincial corporate tax rate is 15.3% and the
provincial dividend tax credit is 5/18 of the gross-up. Recommendation: Incorporate if you
intend to keep the income retained in the corporation for at least a year before paying dividends.
Copyright © Joanne Magee/Jason Fleming
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16
Example #2: Same facts as above except that the combined federal provincial corporate income
tax rate is 15%.
Income earned directly
Business income
Personal tax: $100,000 x 45%
After-tax income
Income earned through corporation and retained
Business income before salary
Combined corporate income tax @ 15 %
After-tax retained earnings (RE)
Comparison of tax assuming income retained in corporation
Tax paid if unincorporated
Tax paid if incorporated
Initial tax saved by incorporating (i.e., tax deferral)
Personal tax if entire retained earnings paid as a dividend
Taxable div. = after-tax RE ($85,000) x 1.18
Tax ($100,300 x 45%)
Federal & Provincial DTC:
(13/18 + 5/18) x $15,300 (gross-up, i.e., $100,300 - $85,000)
Pers. tax (deferred until payment of dividend)
Net tax savings of incorporation ($30,000 - $29,835) =
$100,000
(45,000)
$ 55,000
$100,000
(15,000)
$85,000
$45,000
$15,000
$30,000
$100,300
$45,135
(15,300)
$29,835
$165
There is a deferral of personal tax while income is left in the corporation but additional tax is
paid when the dividend is paid out. Integration does not quite exist because the taxpayer saves
$165 by earning the income through a CCPC and paying it out as a dividend to the shareholder.
The total personal and corporate tax is $44,835 ($15,000 and $29,835) using a corporation rather
than the $45,000 (45%) paid when the income is not incorporated.
Integration does not exist because the 15% combined federal-provincial corporate rate is less
than 15.3%. (The 5/18 of the gross-up provincial dividend tax credit works.)
Recommendation: Incorporate to save tax. Must consider whether the tax savings exceed the
costs of setting up and maintaining the corporation.
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17
Example #3: Same facts as example #2 except that the provincial dividend tax credit is 4/18 of
the 18% gross-up (not 5/18).
Income earned directly
Business income
Personal tax: $100,000 x 45%
After-tax income
Income earned through corporation and retained
Business income before salary
Combined corporate income tax @ 15 %
After-tax retained earnings (RE)
Comparison of tax assuming income retained in corporation
Tax paid if unincorporated
Tax paid if incorporated
Initial tax saved by incorporating (i.e., tax deferral)
Personal tax if entire retained earnings paid as a dividend
Taxable div. = after-tax RE ($85,000) x 1.18
Tax ($100,300 x 45%)
Federal & Provincial DTC:
(13/18 + 4/18) x $15,300 (gross-up, i.e., $100,300 - $85,000)
Pers. tax (deferred until payment of dividend)
Net tax cost of incorporation ($30,685 - $30,000) =
$100,000
(45,000)
$ 55,000
$100,000
(15,000)
$85,000
$45,000
$15,000
$30,000
$100,300
$45,135
(14,450)
$30,685
$685
There is a deferral of personal tax while income is left in the corporation but $30,685 of
additional tax is paid when the retained earnings are paid out as a dividend. Integration does not
exist because it costs $685 more when it is earned through a CCPC and paid out as a dividend.
The total personal and corporate tax is $45,685 ($15,000 and $30,685) using a corporation rather
than the $45,000 (45%) paid when the income is not incorporated.
Integration doesn’t exist because the 4/18 (of the 18% gross-up) provincial dividend tax credit is
too low (i.e., less than 5/18) even though the 15% combined federal provincial corporate income
tax rate is less than 15.3%.
Recommendation: Don’t incorporate unless you expect to keep the income in the corporation a
long time before paying dividends.
Think about how the tax savings from incorporation in the examples above would have
changed if the tax on the dividend had been lower (or almost zero) because it was received
by a family member with little or no other income (and who was not subject to kiddie tax).
(Note: the tax-free amount of dividend income in Exhibit 13-5 of FIT)
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