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Corporate Taxation Outline
Fall, 2002 – Prof Cy Fien
1) RESIDENCY
For companies registered on or after 1965:
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S. 250(4)(a) corp a deemed resident of Canada if registered after 1965.
ITA S. 2(1): If resident in Canada for part of the year, then subject to tax.
ITA S. 3: report all income in that year from all sources, inside and outside of Canada.
For companies registered before 1965:
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C/L test (applies only to companies registered before 1965): the place of central management
of corporate business. (HL: DeBeers Consolidated, 1906)
1) Crossley Carpets: place of management can be split by location. Directors can be in 2
different countries, with equal sharing  dual residence. (rare) However, such cases
Canada’s Tax Treaty with the US stipulates that the country of incorporation will
establish residency.
2) Thompson: Where is centre of vital residency?
S.97 MB Companies Act, S.192 CBCA: directors are in charge of management. But, under
USA, S/H can take management into their own hands.
Look at the location from which they manage the business (i.e. look for de facto control). (Unit
Construction Co. Ltd) (1959)
ITA S. 2(1): If resident in Canada for part of the year, then subject to tax.
ITA S. 3: report all income in that year from all sources, inside and outside of Canada.
2) CONTROL OF COMPANIES
(NB: be sure not to confuse test for residency with test for control)
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Most sections of the ITA have no def’n of control. S. 186(2) and S.256(1.2) do have a
definition, but it is for that section only.
C/L definition of control: shareholder (or group of S/H) who own sufficient shares to elect the
board of directors. (Buckerfields, Duha Printers)
Most co. by-laws say 50%+1 of S/H votes elect the board. (USA can call for more –S.140 Mb
Corp Act, S.146(2) CBCA – but other s/h agreements mean squat).
“Control” means de jure control, not de facto. (Buckerfields)
De jure control means “effective” control (50%+1 of voting shares). (Duha) (closely held corp)
“Effective control” means manifest ability to elect board of directors. (Silicon Graphics)
(widely held corp.) (see case brief below)
A group is not sufficient. There must be a common connection. (Silicon Graphics)
o Agreement to vote together, or
o Agreement to act in concert, or
o History of business relationship, or
o Family relationship.
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Silicon Graphics (2002) (FCA) What makes a group?
Most of the company’s S\H were outside Canada (74-89%), but there was no evidence of a common
connection or agreement among them. The board and management were based in Toronto. (De jure
control appeared to be outside of Canada, but de facto control inside of Canada.) Was the company
controlled by non-residents (thus preventing designation as CCPC, as defined in 125(7))? De jure
control is interpreted to be “effective control”.
 Simple ownership of a mathematical majority of shares in a widely-held corp. with some
common identifying feature (e.g. place of residence) but without a common connection does not
constitute de jure control.
 In a relatively wide-held corporation there must be an agreement or common connection to
establish “effective control.”
Silicon Graphics commentary:
Might want to challenge the case’s definition of effective control, since Buckerfields explicitly
rejected de facto control as the test, and found that effective control is analogous to jure (50+1) control.
Thus, you could argue that Silicon Graphics was wrongly decided, in that it blurred the line between de
jure control and de facto control, and relied overly on Technical interpretations and public statements of
officials, rather than caselaw such as Buckerfields. Also, in stating that the ratio was consistent with
public policy, in that it encouraged the growth of small businesses in Canada and Silicon (in its former
incarnation as “Alias) was operating mostly in Canada, it exceeded its jurisdiction. It is up to Parliament
to develop tax law to encourage small business, not the courts.
In addition, in deciding that there was no de facto control in the US, in that a US company co. did
not attempt to exercise control (even though it had loaned Alias $5 million and its founder sat on the
board, which should have been seen as sufficient evidence in itself given that the power to elect board
members is the very substance of de jure control), this case wrongly places importance on the fact that
the US company did not appear to want control. If it had wanted it, the size of its interest indicates it
probably could have exercised it. A failure to exercise control, or lack of desire for control, does not
nullify the power to exercise control.
This decision was rendered in June. Since the deadline for appeal to the SCC has not yet run out, it
is perhaps premature to consider this case the last word on de jure control.
Southside Car Market (1982) FTC
s. 256(1) means that if person controls one company, and is part of a group that controls another
company, the 2 companies are not necessarily assoc’d. (Southside Datsun is not associated with
Coast Finance, because Warmington does not
control Southside.)
Warm.
Affetu.
SD
50/50
SCM
56/24
CF 100%
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A group of people cannot be said to control a co. when it is controlled by a single person.
Vineland Quarries Ltd (1966) (Exchequer Court)
Control can flow through interposed corporations, to create relationship of associated companies.
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Parthenon (1977) (FCA)
Only the party at the top of the chain of command, in situations of companies and persons owning
subsidiaries, is deemed to have control (not every link in the chain). (overturned by statute amendment)
ITA S.256(6.1) overturned Parthenon
 C/L def’n restored, such that links also have control, where each has 50%+1.
 25% is necessary or sufficient control for companies to be considered associated.
ITA s. 256(5.1)
 Control can lie with group or person that has direct or indirect influence with results in “control
in fact”.
CCRA I.T. 64 R3, para 19. Examples of de facto control where ownership of voting shares is less
than 50%. (Applies only to sections that refer to “control, directly or indirectly in any manner
whatever”.)
i.
the percentage of ownership of voting shares (when such ownership is not more than 50 per
cent) in relation to the holdings of other shareholders;
ii.
ownership of a large debt of a corporation which may become payable on demand (unless
exempted by subsection 256(3) or (6)) or a substantial investment in retractable preferred
shares;
iii.
shareholder agreements including the holding of a casting vote;
iv.
commercial or contractual relationships of the corporation, for example, economic dependence
on a single supplier or customer;
v.
possession of a unique expertise that is required to operate the business; and
vi.
the influence that a family member, who is a shareholder, creditor, supplier, etc., of a
corporation, may have over another family member who is a shareholder of the corporation.
“Although the degree of influence is always a question of fact, close family ties (between parents and
children or between spouses) especially lend themselves to the development of significant influences.
Generally, these persons must demonstrate their economic independence and autonomy before escaping
presumptions of fact which apply naturally to related persons.”
Potential influence is sufficient. Actual influence not required.
Excluded: franchise contract controlling hours, products, etc, or any contract dictating such terms.
When does control matter?
 For status as a CCPC.
 To qualify for full small business deduction. If it can be shown that co. controlled another
company, then it will have to share the deduction with that company.
ITA S.256(6.1) (Simultaneous Control) (Cy says read and know)
(a) Where a subsidiary corp is controlled by parent corp, the subsidiary is controlled by the parent,
AND any person or group of persons that controls the parent.
(b) Where a corp is controlled by a group (persons and/or corps) and any group that controls a member
of the group.
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3) RELATED PERSONS/ASSOCIATED CORPORATIONS
(A) Persons (related to each other):
What does it mean to be related?
ITA s. 251(1) (an irrebuttable presumption)
(a) Related persons (i.e., those connected by blood relationship, marriage or adoption) are deemed not
to deal with each other at arm’s length; and
(b) It is a question of fact whether unrelated individuals are dealing with each other at arm’s length at a
given moment. (For the purposes of the course, assume that unrelated persons are
dealing at arm’s length.)
ITA S.251(2)(a) (Related persons are individuals connected by blood, marriage or common-law
partnership, or adoption.)
Who are family members?
ITA S.251(6) (Family members defined) See p. 2(b) of the materials for Related Persons
Includes blood (or adoptive) relationships:
(a) descendants, siblings parents,
(b) spouse, spouse’s sibling, spouses parents, sibling’s spouse, son or daughter-in-law,
(b.1) common-law spouse creates the same relationships
(c) adoption creates the same relationships.
Note On Related Persons: This does not include uncles/aunts and nieces/nephews. Note also the
expanded definition of spouse in s. 252(4) common-law means co-habitees for one year or more, or less
if there is a child of the union.
(B) For Corporations (related to persons, or other corporations):
Is a person related to a corp?
ITA S.251(2)(b):
i.
A corp is related to the person who controls it
ii.
A corp is related to any person who is related to the person who controls the corp
iii.
A corp is related to any person who is related to a person in (I) or (II)
Are two corps related?
ITA S.251(2)(c) Two corps are related if:
i.
They are controlled by the same person or group of persons
ii.
Each corp is controlled by one person, and those persons are related to each other
iii.
One corp is controlled by one person, and that person is related to anyone in a related group
that controls the other corp.
iv.
One corp is controlled by one person, who is related to each member of an unrelated group that
controls the other corp.
v.
One corp is controlled by an unrelated group, and the other corp is controlled by a related
group, and any member of the related group is related to all of the people in the unrelated
group.
vi.
Two corps are both controlled by separate unrelated groups, but each member of one of the
unrelated groups is related to at least one member of the other unrelated group.
Are two corps related to a third corp?
ITA s.251(3) Two corps that are related to a third corp as described in S.251(2)(c) are considered to be
related to each other.
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Is a group related or unrelated?
ITA S.251(4) defines:
Related group means a group of persons each member of which is related to every other member of the
group;
Unrelated group means a group of persons that is not a related group (look for a common connection to
establish the group, as in Silicon Graphics).
NOTE: If two people are not related, they both cannot be related to the corp by virtue of their
ownership. However, for two corps to be related, it doesn’t make a difference if they are considered to
be part of a related group or not.
Does a person or group have de facto control?
ITA S.251(5)
(a) where a related group is in a position to control a corporation, it shall be deemed to be a related
group that controls the corporation, regardless of whether it is part of a larger group by which the
corporation is in fact controlled.
(b) where a person has a right to control, either immediately or in the future and either absolutely or
contingently:
(i) to, or to acquire, shares of the corporation to control the voting of the corporation, unless
contingent on death, bankruptcy or permanent disability of an individual, he will be deemed to be in the
same position of control as the current owner.
(ii) to cause a corporation to redeem, acquire or cancel any shares of it capital stock owned by
other shareholders of the corporation, the person shall, except when the right is a contingent one
dependent on the death, permanent disability, or bankruptcy of an individual, be deemed to have the
same position in relation to the control of the corporation as the current owner.
(c) where a person owns shares in two or more corporations, the person shall as shareholder of one of
the corporations be deemed to be related to himself, herself, or itself as shareholder of each of the other
corporations.
Does a person or corp have indirect control?
ITA s.256(5.1)
Defines indirect control as when an individual holds influence which results in control in fact. This
influence is held in a manner other than through 51%.
- This is de facto control, not direct control.
EXAMPLE: Jim holds 49% of the shares a of a public corporation, which the other 51% is held by
10,000 shareholders. The court will find that he holds such influence that it is equivalent to control in
fact.
Mimetex Pharmaceuticals Inc (2001) FTC [an application of 256(5.1)]
M was deemed to be controlled by (or associated with) a parent co. in US, even though the US co. only
owned 50% of the voting shares., b/c the US co had been the only investor in M, had loaned it $$
interest free, gave it a license for no consideration, and overruled the Cdn directors. Therefore, M was
not a CCPC, b/c it was controlled by a non-resident S/H.
Rosario Poirier Inc. (2002) FTC [an application of 256(1.2)(a) and (b)]
Issue: Did RPI (owned 100% by dad) control Trab (owned 100% by son)? Dad had signing authority
on account of co. owned by son, signed documents on behalf of son, son and co. were economically
dependent on dad’s company as its sole client, personnel were integrated, etc. Therefore, RPI
controlled Trab. Ratio: One entity may be found to be in control of another co., despite lack of
ownership of voting shares, if it exercises de facto control (and notwithstanding that another person or
group of persons may also control the company).
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ITA S. 256(1)(a) means that once one corp controls another directly or indirectly in any matter
whatever, those to corporations are associated with one another. The fact that another TP has
de jure control is irrelevant, given that 256(1.2)(b)(ii) allows more than one entity to control a
corp.
4) TAXATION YEAR
Corporations
S.249(1)(a) For a corporation, the taxation year is a fiscal period.
S.249.1 Corp’s can choose their year-end, but not more than 53 weeks after start-up.
S.249(1)(7) If a corp fails to choose a year-end for its first tax return, the MNR must approve its choice.
If it wants to change its year-end, it must get approval for that as well.
S.150(1)(a) Must file tax return w-in 6 mo’s of year end.
s. 157(1) Monthly instalments of tax payments are based on the lesser of 1/12 of its estimated tax
liability for the year, or 1/12 of its tax liability for the previous year. Then, within 2 months of the
fiscal year end, the co. must pay the difference between the actual tax liability and what was paid in the
monthly instalments. (However, a corp eligible for the Sm Bus deduction, whose taxable income for
the preceding year was $200,000 or less, has three months.)
Query: What if the taxes owed by the company last year are less than the amount owed this
year? Answer: The balance of the taxes owing must be paid within 2 months of the corporations fiscal
year end. (Note that filing isn’t required for 6 months, so get an accountant to guess!)
Query: What if the taxes owed last year are greater than those owed this year?
Answer: RC will pay back the difference, along with interest at the prescribed rate + 2%. But the
interest only starts to accumulate 6 months after fiscal year end (presuming you wait to pay until two
months after your year end)
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5) HOW TO CALCULATE INCOME AND TAX
Worldwide income (S.3 – business I, I from property, capital gains), then taxable income, then tax.
Same as for an individual, except a person can have income from employment, and gets a capital gains
exemption [s.110.1(6)].
A review ...
Section 3
s.3(a) Aggregate all sources of income: business, property, employment, office, and general source
and any deemed income under s.56 (Basically all of your positive income goes into this section)
s.3(b) Determine the amount, if any, by which
(I) taxable capital gains (this will include taxable capital gains on personal use property except on
listed personal property)
(Note: s.3(b) cannot be negative. If losses exceed gains, the entry in this section will be zero. You are
restricted to apply your allowable capital losses against your allowable capital gains.
Note: In relation to listed personal property, these gains are netted out in taxable net gains from
disposition of listed personal property and thus are not included in taxable capital gain.)
- except from disp of listed personal property
+
taxable net gain from disposition of listed personal property
Exceeds
(II) allowable capital losses
except from disposition of listed person property
and
except allowable business investment losses (ABIL’s can be offset against
ordinary income, not just against taxable CGs)
S.38: Add s.3(a) + 3(b)
Then subtract
Subdivision (e) deductions: ss. 60-66
3(d) Amount arrived at in s.38
less
losses from all sources of business property, employment, office
less
allowable business investment losses
and s.3(d) amount is income
- s.3 will apply the same way to corporations as it does to individuals EXCEPT ...
A) a company will never have employment income;
B) dividends are taxed differently when they’re received by a corporation.
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6) DIVIDENDS AND THE THEORY OF INTEGRATION
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Integration gives back to the TP the tax already paid by the company on the profit that
generated the dividend. (It works perfectly when the combined tax rate on corporations is 20%,
and the combined tax credit amounts to 25% of the gross-up, but achieves largely the same
ends when the province, as it does in Mb., allows somewhat less than its share.)
S.248: A dividend is any stock dividend paid by a company.
Individuals claim:
100% of taxable dividend
+25% of “
“
125% of taxable dividend
[S.82(1)(a)(ii)(A)]
[S.82(1)(b) – the “gross-up” amount]
then,
16.67% of the dividend is returned to TP as a dividend tax credit under ITA S.82.
(equivalent of 2/3 of 25% -- the gross-up amount)
6.25% of the dividend is returned as a dividend tax credit under S.4.7(1)(c) of the Mb ITA.
(equivalent of 1/4 of 25%)
Corporations claim
100% of taxable dividend
-100% of “
“
0% of taxable dividend
[S.82(1)(a)(ii)(A)]
[S.112(1)(a)]
Note: If corps are
associated, then must
pay Part IV Tax.
SAMPLE PROBLEM #1:
Assumed facts:
 The ABC Corp. makes a profit of 1000, and decides to pay a dividend to its sole shareholder, a
holding company called Marvellous Money.
 There is a combined federal/provincial tax rate on corporations of 20%, leaving 800 to be paid
as a dividend.
 Marvellous Money receives the $800 dividend from ABC.
 Frank owns Marvellous Money. MM pays the entire dividend to Frank.
 Frank’s federal marginal tax rate is 26% (note: not the maximum).
 His provincial marginal tax rate is 17.4% ( a combined total I tax rate of 43.4%)
 Federal tax credit rate on dividends is 16.67%
 Provincial tax credit rate on dividends is 6.25%
I.
If Frank had received the income of $1000 from employment, or in his capacity as a sole
proprietor:
He would pay federal tax at the rate of 26% ……………….. $260
He would pay provincial tax at the rate of 17.4% …………. $174
Combined tax……………..………………………………… $434
II.
If the money flows from ABC, through Marvellous Money, to Fred:
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a) ABC’s taxes: Corporate income tax was (combined fed/prov) 20% in the year the $1000 profit was
made. (statutory authority??) Therefore, before paying the dividend to Marvellous Money, ABC is
assumed to have paid a 20% tax, or $200, on this income, which may or may not be the case, depending
on the other devices (such as fast depreciation) that may have been used to avoid taxes.
b) Marvellous Money’s taxes: Weirdly, instead of the ITA simply stating in one section that dividends
received by one Canadian company from another Canadian company are not taxable, ITA S.
82(1)(a)(ii)(A) stipulates that companies must declare 100% of the dividend (assuming it is a taxable
dividend). Then, as per ITA S. 112(1)(a), they can then subtract 100% of the dividend, with the net
result that there is no tax owing on the dividends received. Marvellous Money would pay 0% tax on the
dividend from ABC.
c) Fred’s taxes:
Fred must declare the entire dividend received [as per S. 82(1)(a)(ii)(A)]. He must then “gross up” the
amount by 25%, [as per S. 82(1)(b)], to arrive at the total reportable dividend income.
Dividend received (S. 82(1)(a)(ii)(A)):
+ Gross-up of 25% (S. 82(1)(b))
Total dividend income
800
200
1000
1000
Fred is then assessed tax on the “grossed up” amount, at his marginal tax rate (statutory authority for
marginal tax rates?):
Federal tax on 1000
+ Provincial tax on 1000
Total tax before credits
260
174
434
- 434
However, in recognition of the fact that ABC has already paid tax on this “grossed up” amount (i.e. the
total profit originally made by ABC), the federal and provincial governments then give him a tax credit.
The federal rate of 16.67% (or 2/3 of the gross- up amount) (ITA S.121) and the provincial rate of
6.25% (or ¼ of the gross-up amount) (MB ITA S. 4.7(1)(c)) are calculated as follows:
Federal tax credit 800 x 16.67 = 133.36
100
Provincial tax credit 800 x 6.25 = 50.00
100
Total tax credits
183.36
+ 183.36
________
 749.36 Net income
The total tax payable by Fred (434 income tax due minus 183.36 in tax credits) is 250.64.
Since ABC already paid $200 tax on the same income, the total tax paid (200 +250.64 = 450.64)
reflects an effective tax rate of 45.06%. Since the TP’s combined income tax rate was 43.4%, the effect
of this system of integrating taxes is that the effective rate of tax on corporate income is 1.67 per cent
higher than it would be if a shareholder was simply able to receive the profits directly, rather than
through the corporation.
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One could note that the government can take advantage of the time value of money by taking the $200
up front, when the profit is made. With this in mind, you could say that the government effectively
collects more than the resulting 45.06% in taxes, to the extent that the profit is held in the company
without being paid to an individual taxpayer. (E.g., assume a 5% per year benefit to receiving the $200
tax in 2000 in the above scenario, while a dividend is not paid until 2005. The government effectively
has received an added benefit of the compound interest of 5% on 2000, which is $55.26.)
One could also argue the opposite: Corporations get all of the legal advantages of being considered a
separate legal entity, so perhaps they ought to pay full income tax on all profits in the year in which
they are received, just as an individual taxpayer does. Viewed through this particular lens, the existing
system gives shareholders the benefit of deferring tax in excess of 20% on income that in a de facto
sense is “theirs”, with the result that they benefit from being able to reinvest and produce further
income with that unpaid tax.
However, since there are benefits to both government and the individual regarding the time value of
money, it would appear that the integration theory probably strikes a fair balance.
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SAMPLE PROBLEM #2:
Butch Nepon owns Nepon Inc., a corporation which owns Butch’s Generic Soft Drink Shop.
If Butch owned the shop personally, he would pay tax (T) on income earned from that source.
Since the corporation owns it, the corporation must pay tax (T1) on that income, while Butch must pay
tax (T2) on the dividends he receives from the corporation.
Theoretically, under a perfect system of integration T should equal (T1 + T2), because we don’t want to
penalize Butch for owning a corporation. Here’s how it works:
(1) Nepon Inc. has a taxable income of $1,000. Corporations pay 20% tax, including provincial tax, so
Nepon Inc.’s total tax payable would be $200 leaving it with retained earnings and potential
dividends of $800.
(2) Butch gets $800 in dividends and declares 125% of this = $1,000. [s.82(1)(a)(ii)(A) (100%) and
s.82(1)(b) (25%)] He is in the 29% tax bracket, so:
STEP ONE: Calculate Federal Tax owing:
(a) Federal tax = 29% x $1,000 = $ 290.00
(b) F. Tax credit = 16.67% x $800 = $ 133.33 (c) Net federal tax = $290 - $133.33 = $ 156.67
STEP TWO: Calculate Provincial Tax owing:
(d) Provincial tax = 17.4% x $1000 = $174.00
(e) Pr. Tax credit = 6.25% x $800 = $50
(f) Net provincial tax = 174 – 50 = $124.00
(g) Butch’s total tax = $156.67 + $124.00 = $ 280.67
(h) Butch’s net income = $800 – 280.67 = $519.33
(3) Add Butch’s total tax payable to the corporate tax paid ($200.00) and the total tax paid on the shop’s
income is $480.67.
(4) If Butch had been a sole proprietor, his tax would have been:
(a) Federal tax = 29% x $1,000 =
$ 290.00
(b) Provincial tax = 17.4% x $1000 = $ 174.00
$ 464.00
True, the two figures aren’t exactly the same, but they’re close.
How does this work? In essence, the tax credit has the effect of negativing the tax paid by the
corporation, or vice-versa, so that there are no additional ramifications of owning a business through a
corporation rather than directly:
NOTE: When the business tax rate or the individuals tax rate significantly changes (eg corporation
taxed at 45%) then the Theory of Integration is thrown way off kilter, and the existence of the
corporation completely changes the amount of tax being paid.
NOTE: The result of this is that an individual who is in the 50% tax bracket, will end up only paying
approximately 30% tax on dividends, so as not to duplicate payments made by the corp.
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7) THE EFFECT OF INTEGRATION ON LARGER CORPORATE
ENTITIES (WHOSE TAX RATE IS HIGHER THAN 20%)
Example #1:
A CCPC is taxed at the rate of 24%:
Assume: 1000 in corporate income
Corp tax is 24%, or $240.00
Net income available for a dividend is $760.00
TP pays top marginal tax rate of 29% (federal) and 17.4% (provincial)


760 in income to the S/H as a dividend
760 x 1.25 = 950.00 total reportable income [s.82(1)(a)(ii)(A) (100%) s.82(1)(b) (25%)]
Federal tax:
29% of 950 = 275.50
minus 16.67% of 760 = 126.70

275.50 – 125.50 = 148.80 federal tax payable
Provincial tax:
17.4% of 950 = 164.30
minus 6.25% of 760 = 47.50

164.30 – 47.50 = 116.80 provincial tax payable
 TOTAL TAX PAID BY INDIVIDUAL: 148.80 + 116.80 = $265.60
But, $240 was already paid by the Corp on its profit,
 TOTAL TAX PAID ON ORIGINAL INCOME: $505.60, which is an effective tax rate of 50.56 %,
compared to the individual tax rate of 46.4%.
This means the interposition of a corporation between the individual and profits results in more taxes
paid on income, than if they had been received directly by the individual. However, it’s hard to feel
sorry for TP’s in this situation since by deferring dividends and taking advantage of such things as fastdepreciation, the TP still has huge tax advantages available to her, and with a smart tax planner can
probably end up paying considerably less than if the profits were simply paid out annually, as they
would be with a sole proprietorship.
Example #2
In a widely-held corp, which is taxed at 39% of profits, the effect is as follows:
Assume: 1000 in corporate income
Corp tax is 39%, or $390.00
Net income available for a dividend is $610.00
TP pays top marginal tax rate of 29% (federal) and 17.4% (provincial)


$610 in income to the S/H as a dividend
$610 x 1.25 = 762.50 total reportable income [s.82(1)(a)(ii)(A) (100%) s.82(1)(b) (25%)]
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Federal tax:
29% of 762.50 = 221.13
minus 16.67% of 610 = 101.69

221.13 – 101.69 = 119.44 federal tax payable
Provincial tax:
17.4% of 762.50 = 132.68
minus 6.25% of 610 = 38.13

132.68 – 38.13 = 94.56 provincial tax payable
 TOTAL TAX PAID BY INDIVIDUAL: 119.44 + 94.56 = $ 214
But, $390 was already paid by the Corp on its profit,
 TOTAL TAX PAID ON ORIGINAL INCOME: $604.00 which is an effective tax rate of 60.4%,
compared to the individual tax rate of 46.4%.
Marginal tax brackets for individuals for 2003:
Federal
Provincial
16%
22%
26%
29%
10.9%
14.9%
17.4%
17.4%
The matching of federal to provincial brackets is approximate. The first few thousand dollars in the
26% federal bracket is actually taxed at the 14.9% provincial bracket.
8) CORPORATE TAX RATES
Tax rates of companies are a function of two different things:
a) category of company;
b) type of income the company is earning.
ITA S.123(1)(a) sets the initial federal tax rate on corporate income at 38%
ITA S.124(1) reduces the rate to 28% if the income is earned in a province (as contrasted with a foreign
country)
This section is known as the provincial tax credit and anticipates that provinces will be levying
their own provincial corporate rate of tax on top of the federal tax.
This rate applies "taxable income earned in a province" which shifts our attention to
s.124(4)(a) (which defines province, and how to tell if income is earned in a province) See Regs. 400413.
ITA R. 402(3): Permanent Establishment in two provinces? Use a formula based on the gross R
earned by the company and attributed to the permanent establishment, and on the salaries paid in the
province. (Once you figure out the income in each province, apply the provincial tax rate.)
14
Which province taxes a company that carries on extra-provincial business? Regulations 400-413 of
the Act sets out rules which determine which province has the right to apply its provincial tax rate to the
company’s income. All provinces have agreed to use and abide by these rules.
IN MANITOBA s.7(1) of the provincial act (Chapter I10, 1980 RSM) states that a corporate rate of 17%
will be paid on income which is earned in the year in Manitoba. S.7(5) cross references to s.124(4)(a)
of the Act and therefore applies the above mentioned regulations to determine if Manitoba can tax the
corporate income.
TOTAL CORP TAX = FEDERAL TAX RATE (28%) + PROVINCIAL RATE (?)
Categories of company, and their tax rates:
1. Public Corp, defined in ITA S.89(1) (Resident in Canada, listed on a Cdn stock exchange.)
2. Private Corp, Defined in 89(1) (resident in Canada, not traded publicly, or controlled by
public co.)
Tax Rates for each of these two groups:
+

38% -- ITA S.123(1)(a)
10% -- ITA S.124(1)
5% -- ITA S.123.4(2)
16% -- Mb ITA S.7(1)
39% (23% federal, 16% provincial)
3. Canadian Controlled Private Corp (CCPC) (defined in ITA S.125(7), private, resident and
incorporated in Canada, not controlled directly or indirectly in any manner whatever by nonresident persons or by a combination of non-resident persons and public corporations. BUT
a. If 50% owned by non-resident and/or public corp, then no control, so eligible to be a
CCPC (IT 458 R2 para 2).
b. Under S.251(5)(b), if a non-resident has an option or any other contingent right to
acquire shares in a CCPC, that person is deemed to already hold the shares, and this
could tip the balance over 50% to deny CCPC status.)
Categories of tax rates for CCPC’s:
(ABI rates refer to net income from ANT, other than specified investment business, or PSB)
1. ABI up to $200,000/year, and less than $15M taxable capital in the
preceding year under S.125(5.1)
+
38% ITA S. 123(1)(a)
10% ITA S. 124(1)
16% ITA S. 125(1) (“Small Bus Deduction”)
+
16% Mb ITA S. 7(1)
11% Mb ITA S. 7(3)
 17% (12% federal, 5% provincial)
…..More
15
2.
ABI from $200,000 to $300,000/year
+
38% ITA S. 123(1)(a)
10% ITA S. 124(1)
7%
ITA S. 123.4(3)
+
16% Mb ITA S. 7(1)
11% Mb ITA S. 7(3)
 26% (21% fed, 5% provincial)
3. ABI more than $300,000/year:
+
38% ITA S. 123(1)(a)
10% ITA S. 124(1)
5% ITA s. 123.4(2)
+
16% Mb ITA S. 7(1)

39% (23% fed, 16% provincial)
4. Investment income (inc. specified inv’t bus. income, income from prop.,
taxable capital gains)
 50.67% (34.67 fed, 16% prov)
BUT, when the Investment income is paid out in dividends,  26.67%
fed. tax is refunded, so the final rate is 24% (8% fed., 16% prov.)
+
38%
ITA S.123(1)(a)
+
6.67%
ITA S. 123.3(a)
10%
ITA S.124(1)
+
16%
Mb ITA S.7(1)

50.67% (45.67% federal, 16% provincial)
But
26.67%
ITA s. 129(1) and 129(3) when retained
______
earnings are paid out as dividends.
24% (6% federal, 16% provincial)
5. Personal Services Business Income
38%
ITA S.123(1)(a)
10%
ITA S.124(1)
5%
ITA S.123.4(2)
+
16%
Mb ITA S.7(1)

39% (23% federal, 16% provincial)
BUT, if a PSB receives dividend income (which is not part of taxable income
ITA S. _____),  33%. This tax is refunded when the dividend income is in
turn later dividended out. (question – what section??)
4. “No Label” Corp: Neither public nor private under above definitions. E.g. non-resident corp,
or controlled subsidiary of a public corp.
+
38% ITA S. 123(1)(a)
10% ITA S. 124(1)
5% ITA s. 123.4(2)
+
16% Mb ITA S. 7(1)

39% (23% fed, 16% provincial)
(reduced federal rate for manufacturing and processing)
16
CCPC – breakdown of type of income for tax purposes
Section 3 Income
Bus.
Source
Income
s. 125(7)
(CCPC)
Tax Free Receipts
Aggregate
Investment
Income-AII
(s. 129(4))
ABI
PSB
17%,
26%,
39%
39%
Spec’d Inv.
Business
50.67%,
24% after
refund
Property Income
(inc. royalties,
non-business
surpluses)
½
Capital
Gains
50.67%
 24%
Dividends
½
Capital
Gains
(See also chart at page 25 of CB)
9) IS A COMPANY A PERSONAL SERVICES BUSINESS?
The issue for a company in which a specified shareholder provides services to another company is: Do
the services constitute a PSB within the meaning of 125(7)? To decide this, one must consider whether
the incorporated employee could reasonably be regarded as being an officer and employee of the
recipient of the services, but for the existence of the company that is contracted to provide the services.
Test of PSB or Contract of Services (Employment) (Wiebe Door)
 Control test
 Integration test
 Economic reality test
 Delegation test
 Specific results test
However, the article “Whose business Is It?” by Joanne Magee makes the point that the case stands for
the principle that “there are no magic tests of employment status that replace an examination of the
whole relationship”. She says the whole relationship is to be assessed in a kind of “four in one” test:
control, integration, economic reality, and specific results. She also denies that the case stands for the
correctness of using the perspective of the employee. Rather, she recommends use of a series of 14
questions to assess the overall relationship. (Red flag in notes.)
Personal Services Business [defined in S.125(7)]
(from article by I. Michael Robison, p.29)
1. Incorporated employee.
2. Incorporated employee must be a specified S/H, or related to a specified S/H (owns 10% or
more of shares, directly or indirectly, or connected to someone who owns 10% or more). (ITA
248(1) defines specified shareholder,) (S. 251(2) defines related person. See Section 3 above)
3. But for the corp, the incorporated employee would normally be considered an employee of the
entity receiving the services. (“Employee” defined by C/L def’n, since ITA includes only an
17
extended definition: S.248(1) which says “officer,” and “director” are akin to employees.)
Thus, if a person wants to provide services through a PSB to a company of which he is a
director, he should resign from his position as director, otherwise he will be considered an
employee and likely taxed at the top rate of 46.7%). (Also, consider whether the person is an
employee under the C/L test.)
Note: It is usually better to be an employee, because if the PSB pays 39% tax on its net income, and
then the S/H has to pay tax on the dividend from the remaining 61%. The dividend tax for the top tax
bracket is about 30%, which means there is an effective tax rate on the profits of about 58%.
Note: You can avoid a PSB designation (and its higher tax rate) if you have more than five FT
employees. (ITA S. 125(7))
Why is it so bad to be a PSB?
S. 125(1) The small business deduction (SBD) (16% reduction in fed tax). A PSB is not entitled to this.
S.18(1)(p) a PSB is denied most deductions available to a CCPC. Can only claim salary, benefits for
employees and fees for collecting overdue accounts.
Pre-PSB cases:
Ralph Sazio v. MNR (1966) Exchequer Court
Coach for Hamilton Ti-Cats incorporated as Sazio Ltd, and contracted with team to sell his
coaching services.
 A corporation can be formed to provide the services of an individual, provided valid
contractual arrangements are in place.
 Test of whether company is valid is: Who would sue for breach of contract?
 This case can be used against a person who is a 10%+ S/H, but who wants to be
classified as an employee of a corp.
Potvin
If it is illegal to incorporate the type of business engaged in, co. cannot be taxed as a business.
MNR v. Leon (FCA)
Sons of the founder of Leon’s each incorporated to provide executive services. Disallowed.
 If no bona fide reason to incorporate, company can be treated as a sham at tax law and
ignored.
Stubart Investments
Leon overturned.
 It is okay to create a company to reduce taxes paid, even without a valid business
purpose.
The response of Parliament:
ITA s. 245(2) (The GAAR provision)
ITA S. 125(7) Definition of PSB (unless there are more than 5 FT employees)
NOTE: Cy says there is a bias in the court system against finding PSB’s, perhaps because of the large
penalties which the T may face.
Sagaz Industries Canada (SCC) (2001) (employee or independent contractor.?)
The central question is whether the person who has been engaged to perform the services is performing
them as a person in business on his own account. Consider:
 the level of control the employer has over the worker's activities
 whether the worker provides his or her own equipment,
 whether the worker hires his or her own helpers,
 the degree of financial risk taken by the worker,
 the degree of responsibility for investment and management held by the worker,
18


the worker's opportunity for profit in the performance of his or her tasks.
The designation of "independent contractor" is not always determinative for the purposes of
vicarious liability
David T. McDonald Company Limited v MNR (TaxCt, 1992)
David McDonald’s wife and kids held all common shares, which means he was a specified shareholder
[S. 251(2)]. DM was to be S. Corp.’s sales manager for footwear products. DM kept his own schedule
including spending winters away, he was not integrated into any administrative organization of S.
Corp., he did not report to its president or any senior officers, and he did not participate in its pension or
medical plan. Therefore, he was an independent contractor and not an employee pursuant to the Wiebe
Door test.
NOTE: Cy states that the fact that DM had not been employed by S Corp prior to DM Corp being hired
was very important to the courts determination that he was in fact an independent contractor
NOTE: DM was a director of the company. This allowed him to sign certain documents on behalf of S.
Corp. The court and counsel for MNR agreed that this fact is of little significance.
Societe de Projets ETPA Inc. v. MNR (FTC, 1992)
Fact situation similar to Sazio. TP, a specified shareholder, had a long term business relationship with a
client, providing design and packaging ideas as an independent contractor. Then he incorporated, and
provided the same services, although he opted out of the pension plan, and while he stayed in the health
plan, he reimbursed the company for this. Devoted half of his time to this client and half to managing
income properties. Worked independently, paid rent, assumed costs for travel, etc, and risk. Could TP
be reasonably be regarded as an officer or employee of the client corp, and therefore his company be a
PSB?
Held: No PSB here, after applying Weibe Door criteria. (But for the corporation, the individual would
not be an employee of the client.)
Criterion Capital (2001) TCC
TP owned Criterion, and Clearly Canadian. He was an executive and director at Clearly. At Criterion
he was an employee. Criterion had a contract with Clearly to do special projects, using TP.  split in
income between himself and company. Court accepted there was no employment relationship for the
special projects.
 Nothing precludes being an employee and providing service to employer as a contractor.
Healy Financial Corp (1994) TCC
The corporate taxpayer (which was wholly owned by H) and WH Ltd. (which was wholly owned by W)
each owned 50 per cent of the shares of N Inc. N Inc. agreed to pay the taxpayer $6,000 per month for
the services of H. H was an officer and director of N Inc. He set up a computer program, but had no
office on the premises, and was not involved in day-to-day business of the company. His partner ran
the business, while H worked on other projects for N Inc.
Held: Looks like a PSB, but the nature of the services provided by H (principally in developing a
computer program) were not of an 'employee' nature.
 If nature of the work performed on contract is not of the type normally done by an
employee, then not a PSB.
 Lack of office space, and day-to-day involvement, can help negate PSB status.
Bruce E. Morley Law Corp (2002) TCC
Bruce M. was an employee of BEM Law Corp. He was also an officer and director of Clearly
Canadian (therefore an employee). [Remember that “Employee” according to S.248(1) (extended
definition) also includes “officer,” inc. director.] BEM contracted with Clearly to provide the legal
services of Bruce M. Court found BEM to be a PSB because of the employment relationship that Bruce
19
M had with Clearly. In other words, but for the corp, Bruce M would have provided the services to
Clearly himself. The court said even without the pre-existing employment relationship with Clearly, it
would have found a PSB, because there was not a sufficient detachment from the day-to-day operations
of Clearly (Bruce M was essentially there full time).
 If the company receiving the services is connected to the person providing the services
(specified S/H, director, or officer) through a corp. a PSB is more likely to be found.
 If there is not sufficient independence between the person providing the service, and the client
company, then a PSB will be found.
THE 5 FULL TIME EMPLOYEE EXCEPTION....
S.125(7)(c) defines an exception to a P.S.B. where "the corporation employs in the business throughout
the year more than 5 full time employees".
Hughes and Co. (1989) TCC
H's company had 4 full time individuals, and several part-time employees in Brandon. H spent a lot of
time on the phone re: company business, but he practiced law full time in Wpg, and only received a
$8250/yr honorarium. He wanted to count as the 5th FT employee, and sd he was available 24
hours/day. In the alternative, he said the part-timers should be included in calculating the >5 employee
exception. Court of Appeal didn’t buy either argument.
 More than 5 full time employees mean at least 6 full time employees.
Lerric Investments (2001) (FCA) (overturned Hughes)
Joint venture of 9 companies, one of whom is Lerric. Owned and derived income from apt blocks.
 JV’s don’t have employees (more passive than a partnership); the employees are affiliated with
the participating companies.
 In obiter, court sd it was not convinced of the correctness of Hughes. Sd more than 5 FT could
be 5 FT and 1 PT.
Ben Raedarc Holdings Ltd
The appellant, Town Properties, owned an office building, and operated a retail property business. It
claimed that it had at least six full-time employees performing janitorial work. The janitors worked, on
average, 20 hours per week and received annual leave, stat holidays, and coffee breaks. Employment
Standards Act, insurance policies, indicate 20 hours the minimum. Court found the employees could not
be classified as full-time employees b/c co’s personnel records were inaccurate and unreliable.
 Normally 4 hours a day is enough for FT employment.
Woessner v. Canada
The Woessners operated a construction company and owned several properties in Calgary. All three
Woessners claimed that they were employed by the corporation. The company also employed two
superintendents to run the buildings. The Woessners claimed that these employees were full-time, as
were their own positions. Appeals dismissed. The superintendents were not full-time employees. They
were employed to work less than the regular working hours of each working day and the manager's
spouse frequently did the manager's work. The company, therefore, did not have more than five fulltime employees.
 Live-in employees, whose work is intermittent, will not be considered FT.
(To argue against this, show that the combination of a rent-free apartment and wages = FT wage.)
CCRA’s position on >5 FT employees
 It likes Hughes. More than 5 FT employees means at least 6 FT employees.
20

If two employees share a full time position where the individuals alternate days (eg. Mon.,
Wed., Fri.,) then for the purposes of the Act, they will constitute one full time employee.
However, this doesn't apply where the employees alternate mornings and afternoons etc.
 Also notice that the exception in s.125(7)(c) requires that the employees be employed
"throughout the year". Interpretation Bulletin 73R5 (para 15) stated that vacancies caused by
termination will not disqualify a corporation from the exception as long as there aren't any
undue delays in filling the position.
NOTE: It has to be more than 5 full time employees in the business. If the employees are working for
the corp in other capacities, but not in the business, the exception will not be met. This is a question of
fact.
For exam answer on PSB
Is “X” a PSB? To decide this, one must consider whether the incorporated employee could reasonably
be regarded as being an officer and employee of the recipient of the services, but for the existence of the
company that is contracted to provide the services. In other words, is the corporation providing the
services of an employee or an independent contractor. [ITA 125(7)]
(Note: The designation as a PSB results in a loss of the small business deduction (125(1), and other
deductions allowed a CCPC (18(1)(p), so this designation has harsh consequences.).
1. Is employee a specified shareholder? [ITA s. 248(1)]
OR related to or dealing non-arms length with a specified shareholder? [ITA S. 251(2)]
2. Is it a contract of service vs. contract for service? .(Wiebe Door)
o Control test
o Integration test
o Economic reality test
o Delegation test
o Specific results test
3. Consider also:
o Company benefit plans (inclusion normally indicates employment)(Societe de Projet)
o How many clients does the corporation have. One hints at a P.S.B. (Bruce Morley) but
not decisive. (Bruce E. Morley-PSB, David T MacDonald – No PSB, Societ-No PSB)
o Nature of services—are they normally provided by an employee? (Healy)
o Is office space provided? (Healy-no office-no PSB) (Societe-paid rent-no PSB)
o Is employee an officer or director of the client company (Robison article) (Bruce E.
Morley)
o Is there a pre-existing business relationship? (Societe-depends on benefits
arrangements)
o Day-to-day involvement? (Healy-not involved--noPSB) (Bruce E Morley-involvedPSB)
o Is the contract for services extraneous or in addition to, an employment contract?
(Criterion) (NOTE: this case can be argued for non-employment arrangements,
possibly, if contract is for the kinds of things that are “extras”)
4. Does the >5 FT employees exception apply?[ITA s. 125(7)] (Hughes, Lerric, etc)
5. If TP wants to be to opt for being an employee, instead of a PSB, he can be prevented from claiming
this by Sazio, which upheld the principle that if a validly-incorporated business contracts with another
business, it’s contract will be recognized by the court, and not set aside as a sham.
21
10)
WHEN ARE COMPANIES ASSOCIATED W- EACH OTHER?
(Note: being associated is different from being related, which is covered in s. 251.)
The notion of being associated was established to avoid a situation of several CCPC’s, owned
by the same individual or individuals, each reaping the advantage of the lower tax rate for the
1st $200,000 in income, so, e.g. that $600,000 in income could be spread among three
companies.
RULES FOR ASSOCIATED CORPORATIONS S.256(1)(a-e)
(Cross-ownership is present in each case.)
S. 256 (1) One corporation is associated with another if at any time during the tax year;
(a) one of the corporations controlled, directly or indirectly, in any matter whatever, the other;
(50%+1 = control)
(b) both of the corporations were controlled, directly or indirectly, in any matter whatever, by
the same person or group;
("Group" for this purpose is defined at s.256(1.2) as two or more persons who own shares of the
capital stock of the corporation. This is a really wide open definition.)
(c) each of the corporations were controlled, directly or indirectly in any matter whatever, by a
person and the person who controlled one of the corporations was related to the person whoso
controlled the other, and either of those persons owned, in each corporation, not less than 25%
of the issued shares of any class of shares (other than a specified class);
(Each company owned by related persons, and one of them has 25%+ in the other company.)
(NOTE: This is stricter then related persons provision , as cross-ownership is required.)
(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 corp., and that person owned, in the other corporation, not less than 25% of any class
(other than a specified class);
(Owner of “A” related to everyone in the group that owns B, and owns 25%+ of B.)
or
(e) each of the corporations was controlled, directly or indirectly, 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 persons who were members of both related groups, either alone
or together, owned, in respect of each corp., not less than 25% of a class of shares (other than a
specified class).
[Everyone in both groups is related, and at least one of them (or a sub-group) holds 25%+ in both
companies.]
S. 256(2) Two companies are associated if they are both associated with a third company. BUT,
If the middle company elects not to claim the small business deduction, this will break the
association of the two other corps.
What is control?
De facto control
S. 256 (5.1) If one firm has influence that results in control in fact, then it controls. E.g. if A
has 49% of B’s shares, and 35 strangers own the balance, A has control in fact. IT64R4 gives
an example in which A had 35% of the shares, and was the sole customer. A had control in
fact. Demand loan can create the same kind of control.
22
Majority ownership
S. 256 (1.2)(c)(i) A has control if A owns shares worth more than 50% of FMV of the
corporation, even if the shares are non-voting.
(ii) A has control if A has 50% +1 of the common shares of the corp. …. BUT:
S. 256 (1.1) for cross-ownership, ownership of specified class shares do not count as ownership
for the purpose of control.
Watch for references to specified shares in rules c, d, and e.
What is a group?
S. 256(1.2)(a): does not say members of group have to be related. No common interest
required. Just have to control, i.e. have more than 50%. (You can have one w- 10% and one w80%. Still a group.)
S. 256(1.2)(b)(ii): There can be multiple control groups. i.e. A owns 60% and B & C each
own 20% of the company. There are four possible control groups in this scenario, A; A&B;
A&C; A&B&C. (NOTE: There does not need to be a common interest between the parties, to
be a group you can be enemies.)
S. 256 (1.5) Person deemed to be related to himself for purpose of ownership in another corp. (i.e.
if the owner of A is in the related group that owns B, he is related to himself, thus fulfilling the
need to be related to each person in the group).
23
11)
SMALL BUSINESS DEDUCTION (rate reduction)
S.125(1) provides for a 16% reduction in federal tax on the first $200,000 of ABI. It may be claimed by
any business with less then 15 million taxable capital. To determine the amount that will be eligible for
this deduction:
Calculate:
a) All income from ABI in Canada, other than from a partnership
PLUS
The “specified partnership income” of the corporation
(S. 125(7) (A) – the anti-avoidance measure -- It captures all of the co’s share
of the ABI of the partnership.
The co. is entitled to its share of the amount of ABI up to $200,000, according to its
proportion of ownership.
e.g., the company is one of three equal partners in a partnership that makes 600,000.
The partnership is allocated, in effect, a rate reduction on the first 200,000 – one-third
of which (66,666) is credited back to each of the partners
And
b) all losses from ABI in Canada, other than from a partnership
And
c) the specified partnership loss of the corporation.
Then
d) determine whether the corporation is associated with another CCPC, in which case the
$200,000 SBD will have to be allocated among all of the associated corporations.
NOTE: If the corporation has less than a 365 day fiscal year (first or last year of business), then
s.125(5)(b) states that the eligible deduction is to be pro rated.
S. 123.4(3): Similar rules apply to the next $100,000 of income (which instead of a 16% rate reduction
gets a 7% rate reduction).
NOTE: joint ventures are not referred to in the Act, so there is an open question about whether the
partnership rules apply to them, although the argument for a different treatment is considered weak.
NOTE: rate reduction thresholds are not indexed.
NOTE: Specified Investment Business Income is treated as if it were property income. S. 129(4)
24
12)
(a) INVESTMENT (PROPERTY) INCOME VS . BUSINESS
INCOME
Definition of property income not in the Act. Have to look at the C/L. Always a question of fact
(Marconi)
Ask: does the income flow from property or from business?
Walsh and Micay v. M.N.R. (1965) (leading case on property income)
Two lawyers purchased a couple of apartment buildings and a shopping centre late in 1960 and
attempted to claim the maximum full annual CCA on these properties. CCA can be taken for the full
year; but if its a business, s.11(3) says that the CCA must be pro-rated and therefore, only 1/6 of CCA
could be claimed. They argued that Reg. 1100(3), which requires the pro-rating of CCA, only applies to
business sources and not to property sources, as only a business can have a short tax year. In property
source income, the full calendar year is used. SO...were the rents collected by the taxpayers business or
property source income? (Don’t worry about the section numbers)
Held, this was a property source, as only minimal janitorial and snow removal services were provided,
not more involved and elaborate amenities such as breakfast, maid or laundry service (court’s examples
of what might indicate a business source). Rent can be classed as either a property or business source.
The court focuses on the degree of labour in determining that the labour provided here was more
passive than active and thus making this a property source as opposed to a business source where the
pro-rating CCA would apply. The types of services provided are what a landlord of a property source
would normally provide.
NOTE: It is a question of fact as to what point mere ownership of real property and the letting thereof
has passed into commercial enterprise and administration.
 Property is presumed to be a passive generator of income, so taxed as investment income,
unless considerable effort is expended to generate the income.
 There is no magic line to establish at what point property income becomes ABI.
 Rent can be classified as either a property or business source.
 To distinguish real estate business from real estate investment, consider the level of services
provided as a supplement to the rental of the real property. The greater the level of services,
the greater the likelihood that the income is from RE business.
 Minimal services such as janitorial, snow removal, heating, etc, are adjuncts to the ownership
of property, and do not alter the status of income from property.
 Extensive ancillary services such as maid service, linen, laundry and food services suggest
business.
Elm Ridge Country Club Inc v The Queen (FCA)
The issue is whether the interest income constitutes income from property. The term is generally
regarded as signifying the return on invested capital where little or no time, labour, or attention is
devoted to producing the return. Dividends, interest, rents, and royalties might constitute income from
business if sufficient time and effort is expended in earning them or if the property is employed and
risked in a business.
 As a general rule, interest is income from property within the meaning of S. 149 (5)(e)(i).
 Dividends, interest, rents, and royalties might constitute income from business if sufficient time
and effort is expended in earning them or if the property is employed and risked in a business.
 A non-profit corp’s investment activities are considered passive or accessory to its principal
activities, and are therefore taxable.
CY: For a for-profit corporation, there is a rebuttable presumption that the activity of a corporate
taxpayer is a business source rather than property source.
25
Point Grey Golf and Country Club (1996 – affirmed 2000). Similar facts to above, except the money
was put into a fund to build a new clubhouse.
 Investment income of a non-profit group is taxable, even if the fund generating the income is a
separate fund for a distinct purpose related to the activities of the group
 Court affirms the Krishna two-step test to characterize short-term investment income.
1.
Determine whether the taxpayer's investments are an integral part of his other
business activities. If they are, then the income is business income; if they are not,
then:
2.
Determine whether the taxpayer's investment activities constitute a separate
business. If they do, the income is business income. If the investment activity
does not constitute a separate business, the income is from property.
NOTE: Most of the next cases are pre-1990. Since then the wording and the numbering of the ITA
has changed. Therefore, only read these cases for there general ideas.
Burri v. Q. (FCTD, 1985)
Facts: Corporation owns an apartment building. The apartments were rented unfurnished except for
stoves and refrigerators. A coin-operated laundry was operated by a concessionaire with rentals being
paid to B. The tenants were provided with parking, television cable service and the right to use a
swimming pool which was shared with other adjacent apartment buildings. The property was managed
by a property manager. Revenue assessed saying this was not investment income from a property
source but rather ABI.
Held: Services provided by the T to the tenants were of a very limited nature and typical of what any
owner of a modern apartment building would expect to have to provide. These services were incidental
to the making of revenue from property through the earning of rent.
 Possibly there is a rebuttable presumption that corporate income is from a business source
(this is questionable). It is a question of fact, so don't put too much weight on the presumption.
 Income earned from property is taxed as investment income, where the services provided in
relation the property are incidental to the primary purpose of deriving investment income.
Etoile Immobiliere v. MNR (1992, TaxCt Can.)
Corporation owned 158 townhouses which they operated much like a private village and from which
they received rental income. The corp. provided such services as a swimming pool, lots of staff, an
elaborate security system, amusement parks, and large underground parking area. There was security
personnel, maintenance personnel, contract security with dogs, lifeguard, accountant.
Held: ABI
NOTE: The court notes the presumption (albeit rebuttable) that income derived from a corporation is
business income.
MRT Investments (1976)
The fact that you hire a property manager to manage the property, as opposed to your own employee is
probably not relevant to the determination of business v. property.
Canadian Marconi v. R. (SCC, 1986) (ABI or property income?)
CM owned a broadcasting division and sold it for 18 million dollars. The money was invested in short
term interest bearing securities and earned interest while the company was looking for a business to
invest the funds. About 20% of the working hours of the senior company officer placed in charge of
investments was taken up with this. Furthermore, at any one time there were as many as twelve
employees involved in the management of the investments. The extent of the activity of this staff in
managing the investments and their vigilance in earning a maximum return from the funds is evidenced
26
from their numerous purchases completed each year, the variation in the lengths of terms of deposits
made and securities purchased according to the trend of market interest rates and the fact that seldom
would the staff invest interest made in the same investment. Finally, the funds available for investment
represented 1/2 of total assets of the corporation during period in question.
Held: business source. The court mentions the existence of a presumption, and indicates that courts
should examine the activity involved in the income source. The commercial reality was that the TP,
perhaps unwillingly and contrary to its business strategy, had been compelled to enter into an
investment business
NOTE: The court states the presumption is an eminently logical one to draw when a company derives
income from a business activity in which it is expressly empowered to engage. However, it must be
recognized that the presumption is rebuttable.
For Exam: (review article at CB p. 149)
Marconi affirms the presumption that a corporation’s income is ABI, but Ensite (below), released on
the same day, stated no such presumption existed. Since Ensite dealt with the issue of whether income
from investment is “incident to business”, it could be that there is no presumption when the issue is
whether income is “incident to business. However, in cases that address “property vs. business”, as
Marconi did, it may be easier to argue for a presumption. Nonetheless, these are both pre-1990
decisions, based on legislation that has since been amended (removing the requirement for objects in
the articles of incorporation which the court in Marconi stated as relevant), so a fact-based analysis is
now called for, and is the safer route to take. This is especially so, since a presumption is rebuttable
anyway, and only truly has an effect in cases in which the arguments on each side are equally strong.
12 (b) INTEREST INCOME: INCIDENTAL/PERTAINING
TO BUSINESS (ABI) or INVESTMENT INCOME (SIB)?
(The most difficult cases for characterizing income.)
Rules:
Typically, a TP will want earnings under $300,000 to be ABI, b/c property income taxed at roughly
50%. But with more than $300,000, TP will usually want it to be investment income (SIB), b/c while
taxed at 51%, 26% is returned to the TP. (ITA S. 129)
Only ABI may access the small business deduction. Only investment (property) income by a CCPC is
eligible for the refundable tax on income from property (RDTOH).
Marsh and McLennan (FCA, 1983) (leading case on I income incidental to business)
M acted as a go-between for other insurance providers. The purchasers of insurance would first pay
their premiums to M, who would then remit the amount to the individual insurance companies within
60 days. During that dead time M would hold between 15-22 million dollars and invest it in short-term
debt instruments. 20% of the income of the business was generated this way. Was the income to be
characterized as ABI or SIB?
Held: ABI.
The funds which earned the interest are incidental to the business of M, therefore the interest earned is
ABI and taxed at the appropriate rate. The court used the terminology "temporary surplus required for
ongoing business". The investment transactions were incidental to the main business; there was no
separate investment business. The money was necessary to pay the insurance companies.
27



The LeDain test for income incidental to business vs income from property is: was the invested
money employed and risked in the business.
If you are investing capital that is clearly needed for the operation of the business it is going to
be found to be incidental and ABI.
Look for “inter-connection”, “inter-dependence”, “interlacing.”.
Brown Boveri Howden Inc. (FCA) (Marsh McLennan applied)
B built turbo generating equipment. When B made a turbo generation agreement, it generally
was a four or five year agreement as this was how long it would take to build generally.
Throughout the contract, the customer is charged progress payments on a schedule. The money
was necessary to be paid before B would proceed to the next step in the process. Sometimes
that money would be paid, but wouldn't be needed by B right away and, you guessed it, they
earned interest.
Held: ABI. Followed Marsh and said that the money was used in carrying on business and the
interest came from a business source therefore ABI tax rate.
TEST: The funds were required by B to meet its business obligations, and were at risk in the
business.
Ensite Ltd. v. Q (1986) (SCC) (no corporate business presumption)
E decided to finance the establishment of a manufacturing plant in the Philippines. The TP decided that
it would commit up to five million dollars of its own money, while up to forty million dollars would be
covered by loans. The loans were made available through swap arrangements between the Central
Bank of the Phillippines and the commercial banks which made the loans to the taxpayer’s Philippine
branch. The commercial banks obtained Philippine pesos from the Central Bank upon depositing U.S.
dollars with the Central Bank. The TP made U.S. dollar deposits with the commercial banks, which
then made the peso loans in an equivalent amount to the T’s Philippine branch. The U.S. dollar deposits
were made by the TP out of surplus cash retained from its operations. The T took the position that the
interest earned on the deposits was investment income.
Held: ABI, because without the cash by law the plant could not be built. (note how this is at odds with
Point Grey Golf and Country Club)
 Affirmed LeDain’s test: whether the property was employed and risked in the business.
(Risk must be more than a remote risk).
 Ask: was the use of the property linked to a definite obligation or liability of the business?
 Ask: would the withdrawal of the fund generating the income have a profoundly
destabilizing affect on corporate operations?
 (Narrows LeDain's test in Marsh, pointing out that the Marsh test could serve to put most
corporate assets beyond the reach of creditors.) (note, in this case, the law required the
creation of the fund.)
 Business income from investments is income derived from a fund that is employed and
risked in the TP’s business. The temporary investment of working capital constitutes an
intrinsic part of the business.

1. If corporate funds are put aside for immediate obligations to be met = ABI
2. If corporate funds are put aside to meet capital needs in the future = SIB income
(Cy doesn't think this distinction makes a lot of sense.)
NOTE: As to the SCC comments relating to the Ledain test, Cy says they are just probably trying to
explain Ledain’s test and that Ledain’s test is always applied. However, discuss both on exam.
Canadian Marconi v. R. (SCC, 1986) (ABI)
28



A source of interest income that is essentially operated as a separate business will be
considered a business source.
Consider: number and value of transactions, time devoted to investment activities (here it was
20%), relationship between investment income and total income (interdependence).
The greater the amount of time devoted to, and the greater the value of the investment activities
as compared to the business activities, the more likely it is that the investment segment
constitutes a separate business  ABI.
Point Grey Golf and Country Club (1996 – affirmed by FCA in 2000). Money was put into a fund to
build a new clubhouse, and generated interest.
 Court adopts the Krishna two-step test to characterize short-term investment income, thus
refining the LeDain test:
1. Determine whether the taxpayer's investments are an integral part of his other
business activities. If they are, then the income is business income; if they are not, then:
2. Determine whether the taxpayer's investment activities constitute a separate
business. If they do, the income is business income. If the investment activity does not
constitute a separate business, the income is from property.
Ben Barbary Company Limited (1989) FCC
Corporation owned a restaurant, bar, convenience store etc. They sold everything except the restaurant
and took a note back from the purchaser for a 9% mortgage. Wanted interest to be income from a
business source. Articles of incorporation included such transactions as part of the business.
Held: property source.
 The articles of incorporation cannot override the facts about whether interest is income from a
business.
 Income can not be incidental to business, when the business has been sold.
Alexander Co. Ltd. v. MNR (90 DTC 1984)
This is a case very similar to Ben Barbary. Here three commercial shopping centers were sold. There
was a mortgage back and interest was paid by the purchaser. The interest was found to be passive
income from a property source.
From CCRA bulletin IT-73R76:
 Active business income as defined in 125(7) includes income “incident to” or “pertaining to”
the active business, but to include this collateral income as ABI there should be a relationship
of dependence of some substance between the property in question and the active business. The
business should be in a position of having to rely on the property income.
 A mortgage will not be considered ABI, b/c the underlying asset is tied up and cannot be
accessed for the ongoing obligations of the business.
 If an associated company may include investment income as ABI, then the TP may also claim
the income as ABI.
 If rental income is deemed to be ABI, and the CCA on the rented building was deducted in
calculating active business income, any recapture of the CCA on the dispositionof the building
is also considered ABI.
 If a corporation is established to earn ABI, the presumption of ABI operates. But if a
corporation is formed as a holding company, it is considered to receive property income.
29
13)
SPECIFIED INVESTMENT BUSINESS INCOME
Three types of investment income: 1) income from property, 2) capital gains, 3) Specified Investment
Business income.
Capital Gains vs. ANT: Was property acquired to re-sell, or produce income (Regal Hastings). Look
at evidence of intention at time of purchase (e.g. expertise, K to maintain, quick sale).
Aggregate Investment Income (AII): S. 129(4) – definition
Net taxable capital gains
+
Net income from property sources (except s. 112 dividends)
(including specified investment business income)
Specified Investment Business (SIB): s. 125(7) – definition
A business whose primary purpose is to derive income from property (inc. interest dividends,
rents or royalties) (excluded: income from personal property), UNLESS,
(i) the corporation employs more than five FT employees, or
(ii) any associated corp provides managerial, administrative, financial maintenance or other
similar services, without which the corp would likely have to employ more than 5 FT
employees.
Note: Hughes is the test for 5+ employees: More than 5FT employees means six or more FT.
But remember Lerric: 5FT and 1PT sufficient. (Cy says the jury is out on this one. CCRA
Views 2002-0120775: Hughes test will be used, so TP should be prepared for a fight if they
want to use the Lerric standard.)
Every business is a combination of capital and effort. SIB is a kind of middle category. Hard to say
where to draw the line, if there are not more than 5 FT employees. SIB designation is to your
disadvantage, because it results in a loss of the CCPC deduction.
Mayon Investments (1990) TCC (e.g. of SIB)
Mortgage interest income generated from mortgage broker business. 2 FT and 1 PT employees.
TP argued that the business was akin to a bank as the risk involved with the mortgages required
investigations and appraisals – i.e. a provision of services. Therefore, argued specific goal is to derive
income from business. Court agreed it was a business.
 Where the principle purpose of the business is to derive income from property, there will be an
SIB, because that is exactly the SIB definition.
 Substantial services will be required to take a company out of the SIB definition.
 To avoid an SIB definition, the majority of income must be derived from services, rather than
property.
Luigi Tiengo (1990) TCC (e.g. of ABI)
LT was an engineering firm which did design sketches for furniture manufacturers; advised at the
various phases of production, and assisted in marketing. The sketches that were done were at times
discarded, others evolved towards prototypes that were the property of T’s clients. The TP would
continue to assist in developing and producing the final products, as to the choice of colors, upholstery,
shapes, etc. Rather than being paid for each service rendered, the T was paid a percentage of revenue
from the sales of products which T helped its client develop to market. ABI designation found, based
30
on a) payment wasn’t a royalty; and b) the primary purpose of company was to generate income by
providing services.
 A royalty designation can be defeated when (A) the tangible asset of the TP is not the primary
reason for payment of commission, and/or (B) consulting services enhance the value of the
product sold for commission.
 Look for provision of added service to defeat SIB designation.
 Assessment of purpose of income for purpose of SIB designation is a question of fact.
Note: this does not prevent intellectual property from being seen to generate royalties.
Note: other cases can be distinguished on the basis that the property at issue in LT was owned by the
TP’s customer (the prototype), whereas in other cases the property might be owned by the TP.
Alamar Farms (1992) TCC (surprising e.g. of ABI) (Cy says wrongly decided)
AF received royalties from oil wells and mineral rights located on it's property. It also received income
from farming. RC calls the income as S.I.B. income. Held: Sorry, it's ABI!?!?! Court sd icome it was
incidental to the TP’s principal activity of farming (an ABI). It was also incidental to as well as it
pertained to) the T’s active farming business due to the fact that it was necessary thereto and it was
risked therein.
 The case appears to misapply the test for income “incidental to” or “pertaining to” business,
as defined in Marsh McLennan, and Ensite, by failing to address the business need for the
underlying capital, rather than the income. But, perhaps it is an exception that pertains to
farmland.
 Rental payments from surface leases and royalty income may be incidental to taxpayer’s
principal activity of farming, and therefore ABI.
 To generalize the principal: If the same property is used to generate ABI and investment
income, all income may be characterized as ABI.
31
14)
(a) TAX RATES ON INVESTMENT INCOME
Investment income (inc. specified inv’t bus. income, income from prop., taxable
capital gains)  50.67% (34.67 fed, 16% prov)
BUT, when the Investment income is paid out in dividends,  26.67% fed. tax is
refunded, so the final rate is 24% (8% fed., 16% prov.) HOW 
+
+
+

But
-
38%
ITA S.123(1)(a)
6.67%
ITA S. 123.3(a)
10%
ITA S.124(1)
16%
Mb ITA S.7(1)
50.67% (45.67% federal, 16% provincial)
26.67%
Refund from ITA s. 129(1) and 129(3)
when retained earnings are paid out
_____
as dividends to CCPC’s.
NET: 24% (6% federal, 16% provincial)
Refundable Dividend Tax on Hand (RDTOH): This concept used to erase the benefit of a TP
investing in dividend-paying investments through a company, instead of personally. The company is
charged 50.67% up front on dividend income, and it does not get the benefit of the lower tax rate until it
pays out the dividend. At that point, the government refunds the company the 26.67% it is holding in
the company’s (notional) RDTOH account.
The refund is equal to 1/3 of taxable dividends paid by the corporation – S. 129(1). Therefore, to get
back a refund, a company must pay out a dividend. The refund will be 1/3 of the amount of the
dividend paid. Therefore, to get 26.67 back, a company must pay 3X that amount, or $80.
The refund is limited to the maximum in the account, so the TP will want to pay out in dividends 3X
whatever is in the RDTOH account, if he wants to get the maximum refund. If the corp. has RDTOH of
$100 and pays out $400 in taxable dividends, then the corporation only gets a dividend refund of $100
instead of ($400/3 =) $133.
The refund can be applied against other corporate taxes.
Only people with a lot of money will want to use this mechanism in their companies. For income up to
300,000, it is of more benefit to characterize it as ABI, rather than investment income. But for
substantial amounts of income over $300,000, it may be better to characterize the entire income as
investment income, because instead of the tax rate of 39% on income over $300,000, it is subject to net
tax of 24%. You have to use one or the other, can’t split investment income into two categories.
See example on next page
32
EXAMPLE: $1000 in income.
Gross
Investment
Income of Corp:
$1000
Total taxes: 50.67% or
$506.70
Fed:
34.67%
$346.70
(4.1% of
earnings) (other
corp sources)
Retained
earnings of
$493.30
(or 49.3%)
RDTOH 26.67%
 $266.70
Prov*:
16% 
$160
Fed tax of
8%  $80
$41
Dividend
payout of
$800 needed
for full
recapture of
RDTOH
(3x $266.70)
The $800 dividend is comprised of
Retained Earnings:
$493.30
RDTOH
266.70
other source income
41.00
800.00
*NOTE: A 12% provincial tax, rather than 16%, would result in perfect integration. As it stands,
running income through a corporation means payment of a dividend requires a drain on other corporate
income, amounting to 4% of total investment income.
Interest S.129(2.1) : Where there is a dividend refund, the Minister shall pay or apply interest at the
prescribed rate for the period beginning on the day that is the later of
(a) 120 days after the end of the year;
(b) The filing of the corporation’s return.
Loophole closed: Some corporations ended up with huge RDTOH accounts, but no profits to pay out
dividends and get the refund. No bank would lend $31.67 to get $26.00 back. So, other corporations
would come along and buy the corporation by paying the shareholders 10 - 20% of the RDTOH
amount. The new corporation would amalgamate with the other corporation, and use its money to pay
out dividends and get the RDTOH! To stop this action, RC put in s.129(1.2) which prevents an
acquiring corporation from getting the benefits of RDTOH from a corporation that it takes over. If “one
of the main purposes” of the transaction was to get the RDTOH, the RDTOH account is forfeited.
33
14(b) Part IV Tax (applies to dividend income)
An anti-deferral mechanism. It equalizes taxes between a person who has investments in a holding
company, and someone who holds investments directly.
S. 186 (1)(a) and (b) sets out the scheme.
Part IV tax is paid only by private corporations on taxable dividends received from:
 Non-connected Canadian corps (CCPC’s, or other private co. held by an individual or related
group). (S. 186 (1)(a))
 Foreign affiliates.
 Connected corporations (in which case the Part IV tax is in proportion to the dividend refund
paid to the payer corp.) (S. 186(1)(b))
Connected Corporations
S. 186 (4) A payer and recipient are connected with each other if:
 The recipient controls the payer, (see definition of control below) or
 The recipient owns more than 10 per cent of the voting shares of the payer, and the FMV of all
of the shares owned by the recipient exceeds 10 per cent of the FMV of all issued shares.
 If Corp A owns more than 10 per cent of Corp B, and receives a dividend from Corp B, Corp A is
only subject to Part IV tax if Corp B obtained a dividend refund in respect of the dividend paid to Corp
A. (NOTE: the underlying assumption is that if a recipient owns more than 10% of the payor, then the
recipient company was interposed for tax avoidance.)
S. 186 (2) (definition of control) For this part, one corporation is controlled by another corporation if
more than 50% of its issued share capital (having full voting rights) belongs to the other corporation, to
persons with whom the other corporation does not deal at arm’s length, or to the other corporation and
persons with whom the other corporation does not deal at arm’s length.
eg. Ms. R. owns 45% of the payor corporation and also owns the recipient corporation which
owns 6% of the payor corporation. By virtue of s.186(2), the recipient corporation would be
considered to be in control and thus connected to the payor corporation.
So, under s.186(4)(a) where the receipt. corp. owns 51% of the payer corp. they are connected. Under
s.186(4)(b) if the receipt. corp. owns 11% of voting shares and 11% of shares by value of the payer
corp. they are connected. As well, under s.186(2) if Jim were to own 100% of the receipt. corp., the
receipt. corp. owns 5% of the payer corp., and Jim’s brother owns 50% of the payer corporation, then
the corp. would be connected since Jim is non-arms length to the recipient corp.
IT 269R3: CCRA says with 10 per cent of the shares representing FMV, you have enough to be
connected, but there may be an issue, because there may not be 10 per cent control. Another
shareholder may have 80%, and have full control. Therefore, your 10 per cent is actually worth less
than 10 per cent, because of the lack of control. Therefore, CCRA will discount it. However, Cy says
above 15%, control is assumed. Similarly, if you have 50%, that is not enough for majority control, but
if there are multiple owners of the other 50%, and you have effective control, your 50% is actually
worth more than 50%, so it represents a majority share.
34
Example (from page 649 of the Krishna text)
“A” is a private corporation, which owns 60 per cent of the issued and outstanding shares of “B”.
“B” pays a dividend to all shareholders of $150,000.
“B” gets back an RDTOH refund of $30,000.
What are the tax consequences for “A”?
“A”
B pays a dividend of $90,000 to “A”
Owns 60%
“B”
“B” pays a total dividend of 150,000, 60% of which goes to “A” ($90,000).
“B” is a connected corporation to “A”, because “A” owns more than 50% of “B” [(S. 186(4) ]
“A” must account for its share of the RDTOH benefit to “B”. It does so by paying a Part IV tax
proportionate to its ownership. Therefore it pays 60% of $30,000, or $18,000. [S. 186(1)(b)]
NOTE: Forcing “A” to pay its proportion of the refundable tax avoids a situation in which the
interposition of a corporation allows a TP to defer taxes, and means that the gov’t keeps the refundable
tax until it is paid out at the end of the chain by an individual shareholder.
Non-Connected Corporations
S. 186 (1)(a) Part IV tax is paid by private corporations on taxable dividends received from:
non-connected Canadian corps (CCPC’s, or other private co. held by an individual or related group).
Unlike connected companies, non-connected companies pay an automatic 1/3 tax into a Part IV
RDTOH account, regardless of whether the company paying the dividend gets back that amount.
Companies do not pay Part IV tax if the payer does not get a dividend refund. E.g. a dividend from
personal services business would not result in Part IV, because a PSB does not have an RDTOH
account.
Problem on page 51
Company A, with 55 per cent of the common shares, is connected to Payor Co, because it has majority
ownership [186(2)]
Company B, with 5 per cent of the common shares, is connected to Payor Co, since it is controlled by
an TP who controls the Payor Co. 186(2)
Company C, with 25% of the common shares, is connected to Payor, because it has 15% of FMV
ownership (25% of 60%), and >10% voting shares. [186(2)]
35
Company D, with 15 per cent of the common shares, owns less than 10% of FMV, so it is not
connected.
The Payor company will get all of its $10,000 in RDTOH back, because it is less than the maximum
refund of 1/3 of dividends paid out. (CITE ___)
The three connected companies will divide the RDTOH of $10,000 proportionately. (186(1)(b)
 Company A pays 55% of 10,000 = $5,500
 Company B pays 5% of $10,000 = $500
 Company C pays 25% of $10,000 = $2,500
The unconnected company will pay a Part IV tax of 33% of its dividend: (186(1)(a)
 Company D pays 1/3 of $7,500 = $2,500.
All of these Part IV payments go into the companies RDTOH accounts, and are available for refunds
when they are paid to shareholders.
When a private corporation receives an assessable dividend from a portfolio investment in
shares, a 33.33% refundable tax must be paid on the dividend under s.186(1)(a). This Part IV
tax also goes into the recipient corporation’s RDTOH under s.129(3)(b) and its fully refundable
to the corporation when the dividend income is passed on to its shareholders under s.129(1).
NOTE: a connected company will not always end up paying dividend tax. IF the payor company did
not have any RDTOH to give it a refund, then the recipient companies have no tax to pay.
Addendum re: Part IV tax
S. 186 (1)(c) and (d) give a company receiving a dividend an option. Non-capital losses can be applied
to Part IV tax, on a 1/3 basis.
From the Levene outline: where a receipt. corp. has Part IV tax to pay, and also has a non-capital loss
which is available for use that year (carried from -7 or +3 years), the corporation can apply that loss
against any dividends which were received. This effectively reduces the amount of Part IV tax which
ultimately must be paid.
CY: This option is rarely taken by knowledgeable tax lawyers. Such non-capital losses are better used
to offset gains from other sources. However, they may be useful if your non-capital losses against
refundable Part IV tax are gone by virtue of s.111(3). Remember that the Part IV tax is refundable while
the tax levied on other sources is not. It makes more sense to use the non-capital loss in a situation
where non-refundable tax will be offset. Cy says that don’t do this unless you have a situation where
non-capital losses are expiring. You never want to use refundable tax to wipe out losses; you want to
use permanent tax against these losses.
36
15)
CORPORATE DISTRIBUTIONS
There are four ways that a corporation’s assets reach the hands of its shareholders:
1. Declared Dividends (two types: taxable and capital)
2. Winding up the Corporation
3. Redemption and Purchase Back of Shares (R and PB)
4. Shareholder Appropriations and Loans.
No matter how the money comes out of the corporation (1-4), there is usually the same tax affect. The
one exception is with Capital dividends. The other is Paid Up Capital (PUC) – the money put into the
treasury for the original acquisition of shares.
S.89(1) defines “taxable dividends”: Any dividend that does not result from a s.83(2) election (for a
capital dividend) is a taxable dividend.
Taxable: (dealt with previously, except for)
Stock Dividends
s.248 a dividend can be in the form of a stock dividend (the dividend is paid in stock as
opposed to in cash). When this happens, assets remain the same, retained earnings are reduced
by the amount of the dividend that was issued, and paid up capital is increased by the amount of
the dividend. (In effect, retained earnings are converted to PUC. This is mostly done with
public companies by issuing a preferred share in the company.)
Dividend in specie
s.52(2) Even more rare: a company pays out a dividend with assets in specie. The shareholder
is given a cost base equal to the value of the dividend at FMV.
1. CAPITAL DIVIDENDS (tax free)
Capital Dividends
S.83(2)(a) states that before payment of a dividend, a company can elect to make the full amount of the
dividend a Capital Dividend. The maximum value of the elected dividend is the total amount held in
the company’s capital dividend account.
s.83(2)(b) allows the shareholder to take the dividend tax free.
(Note: the election can only be made on the full amount of the dividend. If a S/H wants the companies
to pay out part of the dividend as a Capital Dividend, then two separate dividends have to be paid,
preferably on two separate dates for clarity.)
Purpose
The capital dividend account dividend is set up to give all capital dividends the same treatment, whether
they flow through a company or not.
Capital Dividend Account
S.89(1) defines the account as the net of the following calculation:
(a) 1/2 net capital gains,
+ (b) all dividends received from another corporation’s CDA,
+ (c) 1/2 of the proceeds from the sale of intangible capital property, minus 1/2 of the eligible
capital expenditures of the corporation (the acquisition of intangible capital property
such as goodwill, franchise and license rights),
+ (d) life insurance proceeds minus the adjusted cost base of the policy.
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– (e) all of the capital dividends previously paid out of the corporation’s CDA.
POLICY: Notice that the amounts are basically those which would be tax free if claimed by an
individual. For example, if an individual were to make a $100 capital gain, she would only be taxed on
1/2 or $50 of that.
NOTE: Work through the example on page 16(a), assuming that the $100 in income was a capital gain.
CAUTIONS
(1) s.184(2)(a) imposes a penalty where a corporation makes an election which is greater than the
amount held in the capital account. The penalty works out to 75% of the excess election.
(2) Remember that money only goes into the capital account where the income came through a capital
gain. It is possible that RC will view the capital gain as an adventure in the nature of trade! We have to
go back to first year and analyze the intention etc. of the corporation. If it is an A.N.T., then the full
amount is taxable and nothing goes into the capital account. So if you realize this too late, your capital
account will be less than you actually think it is since you included the capital gain which was actually
income from an A.N.T. So when a dividend is declared, RC will find that you didn't have enough
money in your capital account and the penalty from s.184(2)(a) will apply.
(3) Relief is offered under s.184(3), under which TP’s can elect to take the dividend as a taxable
dividend. However, all shareholders have to agree on this. This may be difficult to achieve. Also,
some of them may have already sold their shares by the time they are notified of the problem.
(4) The Capital Dividend Account (CDA) is calculated at a particular point in time. IE: If the company
has a capital gain in October and expects that they will have a capital loss of the same amount in
November it is necessary for them to declare the CDA dividend prior to the capital loss in November as
once the capital loss occurs, the CDA account will be wiped out. If a dividend is paid out before
November, the tax free dividend works and the CDA account after the capital loss will just be negative.
(Cy says that if this scenario occurs and you don’t have the money to pay the dividend in October,
borrow the money from the bank and arrange with the shareholders to put the money back into the
company, or pay the dividend out by promissory note.)
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16)
WINDING UP A CORPORATION
Two possibilities: (1) company can sell everything, and pay out PUC and dividends, or (2) can sell
enough to pay debts, and then distribute assets in kind or in specie to shareholders.
S. 203 and 204 are the applicable sections for both the ITA and the Mb ITA
 A special resolution of the shareholders of each class of shares starts the process. Then the co.
files articles of dissolution.
 The shareholder relinquishes his shares, which are cancelled. s. 84(9)
 In return, the S/H receives a distribution of the assets of the corporation to him. These assets
can be returned by a cash dividend or a deemed dividend (s. 84(2)).
 S/H declares capital gain or loss.
Distribution of Assets in Kind
Same tax effect as if Co had sold all assets and paid out cash dividend.
S. 69(5)(a) Co. is deemed to have sold assets at FMV to S/H
(b) S/H given a cost base of FMV
S. 84(2) each class of S/H is deemed to have received a dividend equal to the value of property
distributed to that class, less the PUC for that class. The difference is deemed to be a dividend.
Capital dividend?
S. 83(2) if the S/H wants the company to elect a capital dividend, then it has the same problem
described above. The company will have to declare more than one dividend (preferably on separate
days for clarity), if this election is to be made on the amount in the company’s capital account.
S. 88(2)(b)(i) and (iii): This section allows a split of the dividend, making the election under 83(2)
easier.
Paid-up Capital of a class
s. 89(1)(b)(iii) definition: What is paid into treasury is the PUC.
Disposition of Shares
S. 248(1)(b)(i) Whenever a share is cancelled, there is a disposition of the share for capital gains
purposes.
What happens if shareholders are issued shares at different prices?
The calculation of the tax consequences would be simple if the same S/H who bought the original
shares still owned them at wind-up. A portion of the dividend would be the PUC, and there would be
no capital gain or loss, just a deemed dividend. (CB p. 61) However, it is more likely that in the
meantime, someone else has also bought shares in the class. What then?
Assume:
S/H #1 paid $1000 for 1 share. Then, S/H #2 paid $600 for 1 share. At wind-up, the company paid out
$2500 to the class.
 The PUC is 1600.
 The deemed dividend is 900.
 Each S/H gets $450 in deemed dividend

 Both shareholders are considered to receive net proceeds, after the dividend, of $800 ($1600/2).

 S/H #1 paid $1000, received net proceeds of $800, so he is left with a capital loss of $200.
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
S/H #2 paid $600, received net proceeds of $800, so she is left with a capital gain of $200.
What happens if a shareholder sells his shares to another shareholder, before wind-up?
Example #1
S/H #1 acquires shares from treasury for $1000. S/H #2 buys those shares for $1500. At wind-up,
property with a value of $2500 is distributed to S/H #2.
 S/H #1 has a capital gain of $500.
 PUC is $1000
 2500 – 1000 (puc) = $1500 deemed dividend [s. 84(2)]
 S/H #2 gets a deemed dividend of $1500.

 The adjusted proceeds to S/H #2 are $1000.

 Since S/H #2 paid $1500 for the shares, he’s left with a capital loss of $500.
Example #2
S/H #1 buys 150 shares at $1500 from treasury. Later, S/H #2 buys 50 shares at $500 out of treasury.
Then, business does incredibly well and #2 sells his shares to #3 for $2000. At wind-up, the company
distributes $3000 to the class.
 #2 realized a $1500 capital gain
 PUC is $2000
 Deemed dividend is $1000 ($3000 distribution – PUC of $2000)
My analysis is:
 #1 receives 3/4 of $3000 = 2250. Included in this is adjusted proceeds of $1500 (being 3/4 of
puc). This means #1 had a deemed dividend of $750. There is no capital gain or loss, since he
paid $1500, and got back proceeds of $1500.
 #3 receives 1/4 of $3000 = $750. Included in this is adjusted proceeds of $500 (being 1/4 of
puc). This means #3 has a deemed dividend of $250. However, #3 paid $2000. Since his ACB
is $500, his capital loss is $1500.
Levene’s analysis is:
1) Figure out #1’s capital gain/loss situation. He first must figure how much
he got for his shares. The class got $3000, and since he owned 3/4 of the
shares in the class he got $2250. So, the s.54(j) proceeds from disposition
are $2250 - $750 (deemed dividend) = $1500. Since his cost base was
$1500 he ends up without any capital gain or loss.
2) Figure out #2’s capital gain/loss situation. He got $3000 x 1/4 for his shares
since he only owns 25% of the shares in the class = $750. So his proceeds
from disposition are $750 - $250 (deemed dividend) = $500. Since he paid
Dick $2000 for the shares, he ends up with a net $1500 capital loss.
Remember that the deemed dividend will be the amount over and above the PUC which is already in
the corporation regardless of how many times the shares trade hands and for how much.
EXAM.......Guaranteed that there will be a situation where a deemed dividend is paid out to another
corporation. Just don't forget that this goes back to the RDTOH and Part IV tax stuff.
Example #3
S/H A buys shares at $1000, and sells them to B for $1500. At windup, there is $100 to pay out. There
is no deemed dividend, b/c $100 is less than PUC of $1000. B’s ACB of $1500  capital loss of
$1400.
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Example #4
S Ltd issues 100 common shares for $1000 each, or a total of $100,000.
X owns 50 of them, after purchasing them from an arms length person for $100,000.
Y owns the other 50 (Y is at arms length to X).
S. Ltd has $400,000 to distribute at windup. $100,000 is in the capital dividend account.
What are the tax implications for X?
My Answer:
1. X is entitled to half of the distribution, or $200,000.
2. It would be to X’s advantage if the company elected to distribute the money in two dividends – one a
capital dividend account dividend under S. 84(2), which would be non-taxable (X’s share would be half
of the $100,000, or $50,000), the other a taxable cash dividend of $150,000.
3. The taxable portion of the other cash dividend would be subject to a PUC reduction, i.e. X would not
be taxed on the 1st $50,000 of the dividend, as that would be considered the adjusted proceeds of the
payout. That would leave $100,000 that would be a taxable dividend.
4. Since X is getting $100,000 as a dividend, and $50,000 as a non-taxable dividend, his adjusted
proceeds are $50,000. (S. 54) He paid $100,000, therefore he has a capital loss of $50,000.
Cy’s Answer
Ist step: What is the deemed dividend? It is the total paid, minus the PUC.
 X, holding half the shares, gets 200,000, minus half of the PUC ($50,000). His deemed
dividend is therefore $150,000.
2nd step: Election? (Note, it has to be a separate dividend, as election affects the entire dividend)
 If the company elects to pay a non-taxable capital dividend account dividend, half of
the capital account of $100,000 can be paid to X in this form of a dividend. Therefore
X gets a non-taxable capital account dividend of $50,000
 That leaves a taxable dividend to X of $100,000.
3rd step: (a) To assess capital gains or losses, subtract the deemed dividend (not the taxable dividend)
from the total distribution. (b) Then compare that figure to the TP’s ACB.
 $200,000 - $150,000 = $50,000
 ACB = $100,000. Therefore, X’s has adjusted proceeds of minus $50,000. That
amounts to a capital loss of $50,000.
NOTE: On the wind up of a company, there are two circumstances where you may have to take Part IV
taxes, RDTOH, into account:
(1) If there is a deemed dividend under s.84(2), you are actually receiving an actual dividend. If the
payer company has an RDTOH account, it will be entitled to a refund of $1 for every $3
dividended out to the extent of the account. This RDTOH refund must be added to the payer’s
net worth in order that it can be dividended out as the payer company is winding up.
(2) If you are a corporation who is receiving a deemed dividend on the wind up of a company, and
part of the dividend paid by the winding up company gives the winding up company an
RDTOH refund, then the company receiving the dividend will have the implications discussed
under Part IV (IE: necessary to determine if connected and what taxes are payable).
*THEREFORE, a deemed dividend needs to be scrutinized in the same manner as any other dividend
when the dividend is being received by a corporate shareholder.
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17)
REDEMPTION AND PURCHASE BACK OF SHARES
Redemption rights: can be vested in either the company or the shareholder, according to the constating
documents of the corp. A unilateral right. (Usually for preferred shares)
Purchase back rights: no entitlement to redemption, but each agrees to the buy-back. A bilateral
contract. (Usually for common shares.)
The rights can attach to a particular shareholder, and do not have to apply to the entire class of shares.
A solvency test is applied (Mb Corp Act: s. 34 for redemption, s. 32 for buy back). Redemption or buy
back may not happen if it has the potential to deprive creditors of their payment.
Relevant Authority
S. 84(3) The calculation of tax consequences starts on a class basis, then an individual basis.
Step 1 – Calculate deemed dividend. (Payment minus PUC)
Step 2 – Calculate capital gain or loss. (ACB of TP, minus adjusted proceeds)
S. 89(1) defines PUC to be a share’s pro rata apportionment of the PUC of the entire class.
S. 84(2) for purposes of capital gains and losses, the proceeds of the disposition of shares is reduced by
the amount of any 84(3) deemed dividend.
S. 84(9) whenever a share is cancelled, there is a disposition of the share for capital gains purposes.
S. 129(1) a deemed dividend is treated in the same way as an actual dividend, for RDTOH purposes.
Process
Step 1: Calculate the deemed dividend as per 84(3), treating PUC on a class-based pro rata basis
(89(1)).
 Take the proceeds of the sale, and subtract the PUC
 deemed dividend.
Step 2: There must be a disposition of the share for capital gains purposes (s. 84(9)).
 Take the proceeds of the sale, and subtract the deemed dividend. (s. 84(2))
 adjusted proceeds.
 Take the adjusted proceeds, and subtract the TP’s ACB
 resulting capital loss/gain.
Step 3: Consider whether the companies are connected, and the impact this will have on PART IV tax.
Deal with deemed dividend and capital gains/loss separately.
Deemed dividend
 A deemed dividend in Step 1 will be considered tax free to any company under s. 112. BUT
 Connected companies will have to pay the pro-rated RDTOH.
 Non-connected companies will have to pay a 1/3 tax on the deemed dividend under Part IV.
(this amount is refundable.) (Don’t have to calculate for exam.)
Capital gain
 50% of a capital gain is taxable.
 It gets included in AII – aggregate investment income, and is therefore subject to a 50.67% tax
rate, 26.67% going into RDTOH for later a subsequent refund on the payment of a dividend.
(Don’t have to do the calculation.)
Example #1 S/H #1 buys 10 shares from treasury for 100,000. S/H #2 buys 20 shares from treasury
for $20,000. Co redeems 10 of #2’s shares for $90,000.
Step 1 – the deemed dividend under s. 84(3) is the proceeds of the sale ($90,000) minus PUC (1/3 of
$120,000 = $40,000 – s. 89(1)). Therefore, the deemed dividend is $50,000.
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Step 2 -- #2 paid $10,000 for the shares (ACB). Under s. 84(2) she received the proceeds of $90,000
minus the deemed dividend of $50,000, or $40,000. Thus she has a capital gain of $30,000.
Slight change to Example #1
SH1 buys 10 shares for $100,000. SH2 buys 20 shares for $20,000’ Company redeems 10 of SH2's
shares for $10,000
SH2 pro rata share of PUC is $40,000 (ie: 10/30 x $120,000)
SH2 distribution is 10,000; dividend calculation 10,000 - 40,000 = nil (When dividend calculation
ends up in the negative, there will be no deemed dividend)
Capital Gains? [proceeds of $10,000 – deemed dividend of 0] – ACB = ?
$10,000 - $10,000 = no CG
Example #2
S/H #1 buys 20 shares from treasury for $20,000. She then sells 10 shares to S/H #2 for $15,000. The
company redeems 10 shares of S/H #2 for $35,000. It then winds up and pays S/H #1 $58,000 for her
remaining 10 shares. What are the tax implications for #1 and #2?
S/H #1
She has a $5000 capital gain on the ten shares sold to #2.
Her remaining ten shares are redeemed on windup for $58,000.
Step 1 – the deemed dividend under s. 84(3) is the POS minus PUC, PUC being pro rated on a
per share basis according to 89(1): 58,000 - $10,000  deemed dividend of $48,000.
Step 2 – there must be a disposition of shares for capital gains purposes – s. 84(9). According
to s. 84(2), we take the POS minus the deemed dividend. $58,000 - $48,000 = $10,000. Subtracting
the TP’s ACB of $10,000 – No capital gain or loss.
Example #3
S/H #1 buys ten shares from treasury for $1000. S/H #2 buys 10 shares from treasury for $3000. The
company redeems all ten shares from #2 for $5000. Then it winds up and pays out $10,000 to S/H #1.
What are the tax implications for both?
Problem on page 67
1. Calculate deemed dividend as per s. 84(3):
$12,000 (POS) - $10,000 (PUC) = $2,000 (deemed dividend)
2. Calculate capital gain/loss as per s. 84(9) and 84(2):
$12,000 (POS) - $2,000 (DD) = $10,000 (adjusted proceeds)
TP’s ACB was $6000, so there was a capital gain of $4000.
3. The companies are not connected.
Therefore, while S gets its $2000 dividend tax free under s. 112, the same dividend results in a
payment of Part IV tax of 33.33% (s. 186(1)(a)), or $666.67. This is RDTOH, and will be
refundable when the company pays out a dividend.
50% of the capital gain is taxable, so ½ of $4000, or $2000 is included as Aggregate
Investment income, and is subject to a 50.67 tax rate, of which 26.67 goes to RDTOH.
Process
Step 1: Calculate the deemed dividend as per 84(3), treating PUC on a class-based pro rata basis
(84(9).
 Take the proceeds of the sale, and subtract the PUC
 deemed dividend.
Step 2: There must be a disposition of the share for capital gains purposes (s. 84(9)).
 Take the proceeds of the sale, and subtract the deemed dividend. (s. 84(2))
 adjusted proceeds.
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
Take the adjusted proceeds, and subtract the TP’s ACB
 resulting capital loss/gain.
Step 3: Consider whether the companies are connected, and the impact this will have on PART IV tax.
Deal with deemed dividend and capital gains/loss separately.
Deemed dividend
 A deemed dividend in Step 1 will be considered tax free to any company under s. 112. BUT
 Connected companies will have to pay the pro-rated RDTOH.
 Non-connected companies will have to pay a 1/3 tax on the deemed dividend under Part IV.
(this amount is refundable.
Capital gain
 50% of a capital gain is taxable.
 It gets included in AII – aggregate investment income, and is therefore subject to a 50.67% tax
rate, 26/67% going into RDTOH for later a subsequent refund on the payment of a dividend.
There’s another problem on page four of class notes for Nov 4.
CAUTIONS
1) When buying shares on the market, this notion of PUC is very important. If you invest in a class in
which the PUC is less than the price you pay for the stock, you will end up with a deemed dividend, on
which you pay tax, even if you haven’t made any money on your investment.
To avoid this, you can set up a company to buy the shares. Since you purchase shares in your
company, your PUC in those shares will be equivalent to the price you pay for them. Or, you can have
the company set up a separate class of shares for you to buy into. E.g. if the company has already
issued 1000 common shares, now selling for $100 each, and a PUC for each share of $20, you would
have a potential liability for a large taxable dividend. You should get the company to set up a separate
class of share, rather than issue more shares in the same class.
2) If you agree to a purchase back of your shares, but the company wants to pay you over time, you
will still have to declare all of the income in the year of the purchase back, and pay taxes on it.
(Gabezuelo 83 DTC 679) S.248 says the definition of “amount” is “value”. Therefore, while you may
not actually have the cash, the fact that you have a promissory note or an agreement which indicates
that you are owed the money is a thing of a value and thus you fall under this definition.
3) if a private company owns the shares, consider whether there is Part IV tax. If companies are
connected, when the shares are redeemed the recipient company pays no tax b/c of Part IV. (IT 269R3)
ADDING P.U.C. TO THE BALANCE SHEET
(A) There are only three legitimate ways to add PUC to the balance sheet:
1) pay a stock dividend, i.e. give stock to shareholders in lieu of a cash dividend. This is a way to
capitalize retained earnings.***
2) issue shares out of treasury for consideration.
3) restructure capital, i.e. increase PUC in one class of shares, while simultaneously decreasing
PUC in another class.
*** 1) Stock dividends
This is usually done by giving shareholders of one class stocks in a different (usually preferred) class.
Under s.52(3), the shareholder is assigned a cost for the stock dividend equal to pro rata drawdown on
retained earnings. The value of a stock dividend to a S/H is exactly the same as if a cash dividend had
been paid.
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Authority
S. 248(1) a dividend includes a stock dividend. The “amount” of the stock dividend is defined to be the
amount of the increase in the PUC of the corp by virtue of the payment of the stock dividend.
S. 52(3) the stock is assigned a cost equal to its “amount.”
THEORY: This actually allows the corporation to ensure that the shareholders will hold more stock in
the company. The process behind a stock dividend is as though the money was paid out to the
shareholder, and the shareholder used the money to purchase the preferred shares. Except with a stock
dividend the shareholder has no option but to get the preferred shares. Pretty sneaky eh?
(B) Illegitimate ways to add PUC to the balance sheet.
S. 84(1) If you otherwise add PUC to the balance sheet, there will be an automatic deemed dividend.
 E.g. if you transfer $$ from retained earnings to PUC, then the class of shares that is given an
increase in PUC will be deemed to have received a dividend under 84(1).
 E.g. Company issues shares worth $500, but buyer only pays $300. If company adds $500 to
PUC, then $200 is treated as deemed dividend for the entire class of shares (not just the S/H’s
particular shares).
S53(1)(b) The deemed dividend (from increased PUC) increases the cost base of the shares in that
class. So someone who paid $10/share, would have a new ACB of $11, if the addition to PUC
amounted to $1 per share.
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18)
SHAREHOLDER BENEFITS AND LOANS
Another way to distribute assets to shareholders.
S. 15(1) Two subcategories:
1) appropriations: The S/H takes property of the company, with the intention of keeping it,
without proper authorization of the company. E.g., sole S/H w- signing authority writes herself
a cheque, or, buys an asset worth $80,000 for $15,000. The value is taxed as income to the S/H
– ordinary income, not dividend income.
2) advantages: using a capital asset, e.g. company car. Or, causes company to buy a house, and
then lives in it rent free. Taxed as a benefit.
Examples:
1) S/H uses residence owned by corp, w-out paying FMV rent. (Paul’s Hauling Ltd) (Cy’s case,
saved in file) (An apt rented in another city for purely business purposes is not a personal
benefit, even if it is used for companies not paying the cost.)
2) Holiday paid for by corporation (Donald Hart) (A holiday oriented toward one's business or
professional interests remains a holiday; it is not, per se, a business trip.)
3) S/H uses corporate car for personal use (SS. 15(5), 6(1)(e), 6(2)
4) S/H loan is forgiven without repayment. S. 15(2.1)
How to value the advantage?
1) Statute formulas may apply (as with cars or S/H loans, shown above).
2) When a shareholder gets a reduced rate of rent on a corporate-owned residence, the rate of
return to corporation is the appropriate basis for calculation, rather than free-market rental.
(Youngman v. the Queen)
3) Use of a corp to pay for personal expenses will result in imputed interest and other shareholder
benefits being assessed against a S/H. (Fingold v. the Queen)
CAR FORMULA:
S.15(5) Cars owned by the corporation but used by a shareholder will
fall under the same formula used in the employee situation s.6(1)(e) and s.6(2).
 The benefit is = 2% per month of the original cost of the car. It doesn’t matter if the car is new
or used.
 If the corporation leases the car, the benefit which is tacked onto the shareholders income is
equal to 2/3 of the monthly lease payment.
 If the shareholder is paying the company any rent for the car, the amount that the shareholder is
paying will be deducted from the above inclusion. s.6(1)(b).
The shareholder will be exempt from s.15(1) application where she can demonstrate that 90% of the
use of the car is for business purposes and less than 12000 km of annual personal use is being put on the
car. Then the benefit will only be the normal benefit as calculated above times the amount of the 1000
km allowed which is being put on. If the shareholder falls within this exception the benefit is calculated
as:
Benefit = Personal Use Kilometers x 2% of original cost (or 2/3 of lease cost)
12,000
NOTE: The result of this formula is that few company cars are used for personal use.
LOANS AND INDEBTEDNESS
S. 15(9) the benefit of an interest-free or low-interest loan must be claimed as income.
46
S.80.4(2) Where a shareholder or connected person (not dealing at arms length) receives a loan from
the corporation (or a related corp, or partnership), the person shall be deemed to have received a benefit
equal to the amount by which
(a) all interest on such loans (at the prescribed rate under S. 80.4(7)(b), and Reg. 4301)
exceeds
(b) the amount of interest paid on all such loans (within 30 days of year-end)
(NOTE: This only applies to S/H who are persons. Companies can make interest-free loans between
them without tax consequences.)
Persons Connected with a Shareholder
s.80.4(8) For the purposes of subsection (2), a person is connected with a shareholder of a corporation if
that person does not deal at arm’s length.
Exception to calculation of benefit
S. 80(4)(b) no interest will be imputed, if the principal of the loan has been included in the income of
the S/H under s. 15(2)
Loan used to earn income?
S.80.5 provides an offsetting deduction, washing out the benefit of the imputed interest. (This means
that only money borrowed for personal use is subject to income tax.)
NON-REPAYMENT OF SHAREHOLDER INDEBTEDNESS
If a shareholder were permitted to owe the corporation monies on account of a loan or other
indebtedness forever, the shareholder could gain access to the corporation’s property without incurring
dividend tax.
S.15(2) The S/H must include as income the principal amount of the loan, unless the loan or
indebtedness arose:
1) in the ordinary course of the corp's business and in the case of a loan, lending money was part
of its ordinary business (s.15(2.3));
2) the debtor is an employee of the corp. but not a specified employee as defined at s.248(1)
(s.15(2.4));
3) to acquire a dwelling where the debtor is also an employee of the corp. who received the loan
or became indebted because of the employee's employment (s.15(2.4));
4) to acquire treasury shares of the corp. or a related corp. where the debtor is also an employee of
the corp. who received the loan or became indebted because of the employee's employment
(s.15(2.4));
5) to acquire a car to be used in employment where the debtor is also an employee of the corp.
who received the loan or became indebted because of the employee's employment (s.15(2.4));
AND
Bona fide arrangements are made at the start of the loan for repayment in a reas. time (Q. of Fact);
OR
The loan is repaid within one year from the end of the corp's fiscal year in which the loan arose, other
than a repayment which is part of a series of loans and repayments (see s.15(2.6)).
S.15(2) The full amount of the loan is attributed to the TP as ordinary income and not a dividend.
Offsetting provision
s.20(1)(j) on repayment the loan will be a deduction for the taxpayer.
However, while you do get the money back, depending on how high your other income is, when you
include the loan income, it will probably be taxed at the highest level but when you deduct it your credit
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will be at a lower level due to the deduction. Furthermore, even though you do get the refund, you are
allowing .revenue to hold the money while you are paying down the loan.
BUT, the refund can be gradual if portions of the principal are paid down each year.
Connected persons
s.15(2.1) a connected individual is a person with whom the shareholder does not deal with at armslength.
THEREFORE, it doesn’t pay to borrow from the corp unless you fall within one of the exceptions. If
you do fall within one of the exceptions it may be an advantage because the interest rate may be lower.
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19)
S. 85 ROLLOVERS
S. 85 provides a special rule to accommodate business reorganizations, and the transfer of capital
between businesses, including between a sole proprietorship and a corporation. Normally, s. 69(1)(b)
would tax the transfer as a deemed disposition at FMV, and capital gains tax would apply (where the
parties were non-arms length). S. 85 defers the tax, if the TP elects to do so, by allowing the TP to
transfer assets at less than FMV. However, there are severe limits.
(See diagrams in notes.)
Rules:
General rules
1) Transferor can be an individual, corp, or partnership.
2) Transferee has to be a taxable Canadian corporation.
3) Property being transferred can be any kind of eligible property
4) Transferor must take back at least one share of the corporation for each asset transferred. In
addition, the corp can pay with cash, or a promissory note, or by assuming a debt. Non-share
consideration is referred to as “boot”.
5) Both parties must elect an amount that is the deemed value of the asset being transferred.
Under 85(1)(a) both have to agree on the price chosen (the “elected amount”), which becomes
the transferor’s deemed proceeds of disposition, and the transferee’s cost.
6) The deadline for filing the form for the election is the earliest date by which either party has to
file their tax return. (Co’s generally have 6 mo’s from year-end.) If you miss the deadline, you
pay a penalty (note: huge).
Specific rules re amounts
7) The upper limit of the elected amount is FMV.
8) The lower limit of the elected amount is: the greater of
a. the value of the “boot” (e.g. promissory note), OR
b. for non-depreciable property (land and inventory) the ACB of the property;
for depreciable property, the UCC.
9) Boot cannot be greater than the elected amount.
10) The total of boot and shares must reflect the FMV of the asset.
11) If you take back too much consideration then s. 15(1) deemed income will result.
12) If you take back too little, and the company is a related company, then a potential penalty under
85(1)(e.2) arises.
What is eligible property?
s. 85(1.1) Non-depreciable capital property (shares and land), depreciable capital property, eligible
capital property (good will, intangibles), inventory.
Exception: real property inventory (land bought for a flip) (probably not on exam)
Process
1) The parties choose the elected price for the transfer. It will usually be the ACB of the transferor.
This becomes the deemed disposition.
2) The deemed disposition becomes the ACB of the corporation.
3) The corp holds the property until sale
4) The corp then sells the property, and declares the portion between the ACB and the POS as a capital
gain.
Depreciable property
5) If the property is depreciable, and the corp depreciates some of the value (this depreciation is a
deduction from income), when it re-sells the property, it must recover the depreciated amount as
income.
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6) If the transferor already declared depreciation before the transfer, then the corporation is deemed to
take on the transferor’s ACB and UCC amounts.
What the Transferor takes back
7) The package taken back must have the same FMV as what was put into the corp.
8) Part of this package must be shares.
9) If the transferor takes the entire amount as shares, then she might have a problem if she wants to
sell those shares. That’s because the ACB of each share reflects the elected amount. E.g. if the
asset’s FMV was $100, the elected amount was $20, and the SH took back 10 shares, each share
would reflect an ACB of $2. The balance of the sale price of the shares would be subject to capital
gains tax. Therefore, if she sold 2 shares for 20$, she would have to pay tax on the capital gain of
$16.
10) If the SH wants to get her ACB money out right away, tax free, she should take a combination of
cash equal to her ACB (or “boot”) and shares. The shares would then have an ACB of -0-. The
boot could be cashed out with no tax consequences (being equal to ACB). The shares would be
subject to capital gains in their entirety (except on wind-up. See PUC considerations below).
A perfect rollover: election at ACB or UCC, boot at the level of election, and shares for the balance.
Transferor takes back too little consideration
S.85(1)(e.2) Where parties are related, CCRA assumes that if the corp pays less in shares and boot than
the FMV, the intent is to benefit the related shareholder. Thus, the deficiency in FMV will be added to
the elected amount.
In this situation, if the Dad gave the
Son-30%
Company an asset $100,000 and
Dad-40%
Son-30%
claimed a $60,00 EA, he would be
transferring 60% of $40,000 of this
to his sons, whose share value would
increase by that amount. ($24,000).
To avoid this, CCRA will add
Family Business
$24,000 to his elected amount 
an EA (for him only) of $84,000.
The result is double tax. This is really a harsh provision. The transferor ends up with a higher elected
amount and has to pay a capital gains tax. The gain will also be taxed when the corporation is
dissolved, since the asset will be sold, and capital gains will again be paid on the amount over the
elected amount.
(However, if the related person is a corporation you own, this provision does not apply.)
Transferor takes back too much consideration
S.15(1) states that if a benefit is conferred on a shareholder by a corporation then the amount of the
benefit shall be included in the shareholders income for the year. So the amount which the
consideration exceeds the FMV of the transferred asset will be deemed income and not a deemed
dividend.
Timing for Filing of Election
s.85(6) Any election shall be made on or before the day that is the earliest of the days on or before
which any T making the election is required to file a return of income pursuant to s.150 for the taxation
year in which the transaction to which the election relates occurred.
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WHAT CAN BE PAID TO THE TRANSFEROR
a) Cash: FMV is the face value of the cash;
b) Debt: e.g. Promissory note. The FMV of the debt will depend on the interest paid, and when it
is due. If it is due several years later, the present value is less than face value. To make a
promissory note = FMV, make it due on demand. If it is not due on demand, it should carry
FMV interest.
c) Preferred Shares: these are shares under s.248 which do not have a right to share in assets
upon dissolution. To value these shares consider:
i. Retractable preferred shares are the most usual type. Fixed price. These can be cashed
in at any time by the shareholder. They maintain their original value, usually paying
dividends along the way.
ii. Redeemable preferred shares are cashed in when the company wants to buy out the
shareholder. Less common.
d) Common Shares: Their value lies in the fact that shareholders are allowed to share in assets
upon dissolution. The value of these shares is determined by the value of the assets at the time
of the rollover. This can be difficult to estimate.
i. At the start-up of a business, you might want to use common shares. The
shares will be worth whatever you put in.
ii. If you are the sole shareholder, they can also be useful, because the difficulty in
making a correct assessment is moot. All of the shares belong to you anyway,
so they automatically represent the value of the entire company.
e) Assumed Liabilities - Consideration can take place through assuming liabilities of the
transferor. NOTE: assumption of liabilities is BOOT and will have to be counted as such
(however, not counted in boot calculation under s.85(1)(f)
f) Land - payment of FMV land. This is BOOT and the transferee corp will have to calculate
capital gain/loss.
NOTE: All of these values are determined at the time of the rollover. If things change immediately
after, this has no effect on value.
Valuing shares wrong
If you won’t have an evaluation completed for several months, but you want to rollover now, you want
to avoid 85(1)(e.2) – which adds to the elected amount if you value your shares too low. Therefore, you
need a price adjustment clause in your shareholder agreement. It allows you to assign a reasonable
value to the shares, and then if you find the value is incorrect, the redemption amount will later be
adjusted to reflect re-valuation. The right amount is ultimately taken.
E.g. if you thought your tractor was worth $50,000, and you took 50 common shares worth
$1000 each, but you later find it was only worth $25,000, the common shares will be re-adjusted to be
worth $500 each. If you took preferred shares, however, the redemption amount cannot change.
Therefore you would have to give back half of your pref-shares (or get more from the company, if the
original valuation was too low).
[NOTE: if you don’t make a reasonable attempt to value the asset, the price adjustment clause
will be meaningless, and there will be tax consequences.]
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THE COST BASE (OR ACB) OF THE CONSIDERATION
S.85(1)(f)(g)(h) are the sections that assign cost base to the consideration received by the transferor:
The sections must be applied in the order listed:
(1) The Boot -- S.85(1)(f)
In almost every case (for us in every case) the ACB of boot is its FMV
(2) Preferred Shares -- S.85(1)(g) If there is only one class of shares, the formula is:
..Elected Amount – boot = ACB of pref shares...
E.g. FMV of asset is $1000, ACB is 100. The transferor takes a demand note for $60, and 94
$10 pref. shares (or $940).
Answer: 100 – 60 = 40. Therefore, 40 is the ACB of the $940 of pref. shares.
(3) Common Shares -- S.85(1)(h) The formula for the cost of common shares is:
..Elected amount – boot – amount assigned pref. shares = ACB of common shares..
E.g. FMV of asset is $100, UCC is 40 (also the EA). Transferor takes back $20 in pref shares,
$70 in common shares, a $5 demand note, and $5 in assumed liabilities.
What is the ACB of the common shares? Answer: 40 – 10 – 20 = $10.
NOTE: If there is more than one class of common shares then just allocate the amount determined in
s.85(1)(h) pro rata amongst the shares.
NOTE: Review Election Form; Section 85 Agreement, and Articles of Incorporation on page 105.
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EXAMPLES:
ACB = $10 EA = $10, FMV = $100
a) The consideration paid is $10 in cash and $90 in preferred shares
- step 1: s.85(1)(f) - cost base of boot is $10
- step 2: s.85(1)(g) - cost base of preferreds is $10 - $10 = 0
- Therefore, the $10 is transferred cash free, and when the preferred shares are sold, if at current value,
there will be a capital gain of $90.00 ($90.00 - 0)
b) The consideration paid is $100 in preferred shares.
- step 1: s.85(1)(f) no cost base to assign to boot as there is no boot
- step 2: s.85(1)(g) - cost base of preferreds is $10 - 0 = $10.00
- Here, no money comes tax free as the tax consequences are spread over the entire $100 of preferred
shares. To get the $10 out as in A, there will be a $1 capital gain due to the fact that the cost base of the
preferreds is $10. Therefore, the type of payment in A, is much preferable.
(c) The consideration paid is $10 preferreds, $90 commons
- step 1: s.85(1)(f) - no cost base to assign to boot as there is no boot
- step 2: s.85(1)(g) - $10 - 0 = $10 cost base for preferreds;
- step 3: s.85(1)(h) - $10 - 0 - $10 = 0 cost base for commons.
Because two classes of shares were created, the preferred shares can be sold, and X can access the EA
without any tax consequences.
d) The consideration paid is $20 preferreds, $80 commons
- step 1: s.85(1)(f) - no cost base to assign to boot as there is no boot
- step 2: s.85(1)(g) - $10 - 0 = $10
- step 3: s.85(1)(h) - $10 - 0 - $10 = 0.
This leaves an ACB for the commons of 0, and a $10 gain for the preferred when you sell them.
Therefore, not as good as situation (a) or (c).
Therefore, for the transferor to get back EA tax free:
a) Always pay cash for the EA amount;
b) Issue two classes of shares, with the preferred amount being the EA.
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(4) Paid Up Capital in shares taken back
.85(2.1)(a) The PUC Grind Section
This comes into play to avoid a misuse of the lifetime capital gains exemption, when a corporation
redeems shares, or winds up. Normally, whatever a corp paid for the asset would be PUC. But for
purposes of rollover assets PUC is calculated according to this formula.
The rule can be stated this way: “when the taxpayer transfers property under 85, and the PUC of the
share consideration is greater than the cost to the corporation of the property (less the fair market value
of any boot), subsection 85(2.1) will reduce the PUC of the shares by the excess amount.
”
The Formula:
Stated capital for corporate purposes (FMV of shares)
Minus PUC grind.
Equals PUC for tax purposes
PUC grind = A - B
FMV of shares
– PUC grind
= PUC for tax purposes
Where A = corporate PUC (FMV of the shares) and
B = (EA – Boot)
Example #1
Property is transferred to MyCo. Under s.85(1): FMV is $300, ACB is $100. The transferor takes back
$150 as a promissory note (boot) and $150 as common shares. The EA is $150. What is the PUC of
the common shares?
FMV of shares 
$150
PUC grind 
$150
150 – (150-150) = 150 – 0 = 150
PUC for tax purp.
0
End result
Without s.85(2.1) the taxpayer could redeem the common shares at their FMV ($150) for a tax-exempt
capital gain of $150 under the lifetime capital gains exemption. There would be no deemed dividend.
The amount paid would be equal to the PUC of the shares. But, when s.85(2.1) is in play, and
corporation redeems the common shares, the transferor ends up with a deemed dividend instead of a
capital gain s.84(3).
Redemption Price $150
PUC of shares NIL
Deemed dividend under s.84(3) $150
Actual cash received on disposition $150
Deemed POD s.54(1) para.j NIL
 Deemed Dividend $150
See pages 113(c) and (d) for further exercises.
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Levene’s Example:
Dee transferred capital property to Dee Ltd. The capital property had an ACB of $5000 and FMV of
$10,000. Dee could receive any of the following packages of consideration:
Notes at FMV
$5000 $2500 $2500
Preferred Shares
$4500 $7500 Common Shares (PUC) $500 - $2500
(a) Given an elected amount of $5000, which would be the cost of each item of consideration under
each possible package of consideration?
(b) What will be the P.U.C. for tax purposes under each possible package of consideration?
ACB = $5000 Assumed EA = $5000
FMV = $10,000 Ideal Purchase Price = $10,000
Scenario A:
s.85(1)(f) = $5000
s.85(1)(g) = $5000 - $5000 = 0
s.85(1)(h) = $5000 - $5000 - 0 = 0
Preferred Shares
s.85(2.1) =
$5000 - (0) x 4500/5000 = $4500
PUC will be reduced by $4500 leaving it at 0. Notice that s.85(1)(g) assigns a cost base to Prefs of 0 as
well.
Common Shares
s.85(2.1)
$5000 - (0) x $500/$5000 = $500
PUC will be reduced by $500 leaving it at 0. Notice that s.85(1)(h) assigns a cost base to commons of 0
as well.
Scenario B:
s.85(1)(f) = $2500
s.85(1)(g) = $5000 - $2500 = $2500
Preferred Shares
s.85(2.1) =
$7500 - 2500 = $5000
Therefore, PUC is reduced by $5000 to $2500 which is the cost base under s.85(1)(g)
Scenario C:
s.85(1)(f) = $2500
s.85(1)(g) = 0
s.85(1)(h) = $5000 - $2500 = $2500
s.85(1.2)(e) places EA at $10,000 as shareholder benefit
- Therefore, Transferor will have a $5000 capital gain
- since the transferor has already had a $5000 CG, by virtue of s.85(1)(e.2), the cost base for the assets
will result in no gain when they are sold in less they increase in value.
Common Shares
s.85(2.1)
$2500 - (5000 - 2500) = 0
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Therefore PUC is not reduced at all, leaving PUC at $2500 so that no further gain will be suffered by
the transferor on the sale of the shares.
Remember that EA is also the cost base for the recipient corp as well. Therefore, the corp gets the
bumped up cost base.
Consider:
Transferor wants to transfer assets to a corporation in which her daughter owns all of the common
shares. The property being transferred is securities:
ACB = $100,000
FMV = $125,000
Consideration received by mother for transferring the shares:
Note = $100,000
Pref Share = $1000
- Remember the ideal consideration would have been $125,000, so we have a deficiency of $24,000.00.
This deficiency will be included under s.85(1)(e.2). This makes the EA $124,000.
- Since mother’s ACB is $100,000 and her deemed proceeds are $124,000, she will have a capital gain
of $24,000.00.
Cost of assets:
s.85(1)(f) = $100,000
s.85(1)(g) = $100,000 - $100,000 = 0
Preferred Shares
s.85(2.1)
$1000 - ($124,000 - 100,000) = (23,000)
- When this calculation is negative, there will be no dividend reduction.
- Therefore, the cost base of the shares is $1000.00
- Under s.85(1)(e.2), the common shareholder receives the benefit that her mother has already been
taxed on. Common shareholders receive the benefit as they have the right to share in equity upon
dissolution. Since the daughter is the only common shareholder, she will receive the entire benefit.
Since the daughter gets the shares for nothing, her cost base isn’t increased, but her shares have just
gone up in value $24,000. Double tax will occur when the daughter gets out as the daughter will have a
capital gain of this amount on sale of shares or on wind up. While the corp gets the benefit of the
increased EA, the common shareholder will get dinged with the benefit when she gets out.
Consider:
FMV = $900,000 (therefore ideal consideration paid should be $900,000)
EA = $577,500 (this is ideal EA)
Consideration paid:
$247,500 (assumed mtg)
$330,000 (note)
$322,500 (common shares)
$900,000 (therefore proper consideration is paid)
s.85(1)(f) = $330,000
s.85(1)(g) = 0
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s.85(1)(h) = $577,500 - 577,500 - 0 = 0
s.85(2.1) =
$322,500 - (577,500 - 577,500) = $322,500 PUC reduction, leaving PUC at 0.
What are the tax consequences to the t’or if the corp redeemed the debt issued by the corp for
$330,000 and he sells his shares in the corp for $425,000?
- The debt has a cost base of $330,000 so there is no tax consequence for redeeming the debt. The cost
base for the shares is 0, so there will be a $425,000 CG.
What are the tax consequences to t’or if the corporation redeems the shares for $425,000?
- s.84(3) would be a deemed dividend of proceeds - PUC = $425,000 - 0 = $425,000 deemed dividend
NOTE: The effective tax rate for capital gains and dividends are very similar after the dividend tax
credit.