Navigating the tax traps
1
Chapter 12 problems
2
Typical client question
3
Approach
• Look at each scenario and calculate the
tax flow under each, first as a receipt
assuming an individual, then as a
corporation
• You can then compare the two and make
a recommendation to your client
4
Received as individual
Interest income (8% of $200,000)
Grossed-up dividend (5% of $550,000 
$16,000
5/
4)
Taxable capital gain (10.5% of $550,000 
1/
34,375
2
28,875
Incremental income and taxable income
$79,250
Federal tax on taxable income of $109,250 (i.e., $79,250 incremental income +
$30,000 other income); $15,372 on the first $83,088 + 26% on the next
$26,162)
Less:dividend tax credit (131/3% of $34,375)
$4,583
other personal tax credits
Basic federal tax
2,100
$22,174
(6,683)
$15,491
Provincial tax
$9,139 on first $83,088 + 15% on next $26,162
less:
personal tax credits
dividend tax credit (6⅔% of $34,375)
Total tax payable
13,063
(1,400)
(2,292)
$24,862
5
Received through a corporation
Investment income received through a corporation:
(i) Corporation
Interest income
Dividend income (5% of $550,000)
Taxable capital gain
Corporation income
Tax @ 41%
$16,000
27,500
28,875
$72,375
Tax @ 40%
$16,000
27,500
28,875
$72,375
72,375
72,375
Less: inter-corporate dividends [sec. 112]
Taxable income
Corporation tax under Part I @ 41% / @ 40%
27,500
$44,875
27,500
$44,875
$18,399
9,167
$17,950
9,167
Part IV tax @ 33⅓% of $27,500
Additional refundable tax (6⅔%  ($16,000 +
$28,875)
2,992
Total tax
Corporation retention* (excluding non-taxable portion of capital
gain which can be distributed tax-free)
Potentially refundable tax:
Part I tax (26⅔% of ($16,000 + $28,875))
$11,967
Part IV tax
9,167
Potentially available for taxable dividend
2,992
(30,558)
(30,109)
$41,817
$42,266
$21,134
$62,951
$11,967
9,167
21,134
$63,4006
The dividend at 41%
• Note that a dividend of $62,951 will result in a
dividend refund of only $20,984 (i.e., $62,951  1/3),
not the $21,134 that was added to the RDTOH for
the year. This deficiency results from imperfections
in the tax rates. A larger dividend of $63,402 (i.e., 3 
$21,134) would have to be paid, using other sources
of funds, to clear the RDTOH. Alternatively, the
maximum dividend that can be paid in this case is
$62,726, determined algebraically, as follows:
R = 1/3D
D= N – T + R
= N – T + 1/3D
= (N – T)  3/2
= ($72,375 – $30,558)  3/2
= $62,726
R = $20,909
where:
R = dividend refund
D = dividend
N = Division B net income
T = total tax
7
To shareholder
Grossed-up dividend from corporation ($62,951  5/4) /
($63,400  5/4)
$78,689
$79,250
$22,028
$22,174
Federal tax on income from grossed-up dividend + $30,000;
$15,372 on the first $83,088 + 26% on the remainder)
Less: dividend tax credit (13⅓% of
$78,689) / (13⅓% of $79,250)
$10,492
other personal tax credits
2,100
Basic federal tax
$10,567
(12,592)
2,100
(12,667)
$9,436
$9,507
$12,979
13,063
(1,400)
(1,400)
(5,246)
(5,283)
$15,769
$15,887
Provincial tax
$9,139 on first $83,088 + 15% on remainder
less:
personal tax credits
dividend tax credit (6⅔% of grossed-up dividend)
Total tax payable
8
Tax comparison
Investment income received directly
$24,862
$24,862
Investment income received through corporation:
Corporate tax
$30,558
Less: refund to corporation
21,134
$30,109
$9,424
21,134
$8,975
Individual tax
15,769
15,887
Total tax
$25,193
$24,862
Tax cost of using corporation
$ 331
Note how integration is perfect when the
combined net corporate rate of tax is 20%
(i.e., 40% + 62/3 – 262/3%).
Nil(2)
9
Other points to look at:
Other considerations:
Advantages of incorporating —

Estate planning considerations:

Possible income splitting by having his wife and children subscribe for the
shares of the investment company if they have their own source of capital
to buy the shares.
Disadvantages of incorporating —

Initial prepayment of tax:
Tax on corporate income
$30,558
$30,109
4,000
4,000
$34,558
$34,109
Less: tax on total income received directly
24,862
24,994
Prepayment through corporation
$9,696
$9,115
Tax on individual’s $30,000 of existing income
[$7,500 – ($2,100 + $1,400)]

Administrative costs of a corporation;

Corporate losses not available to shareholder to offset personal income.
7,500 on $30,000 @ 25% (combined
federal and provincial).
10
Problem 15 – what are the
issues?
•
•
•
•
High Income Limited
Investment income
Scarf retail business
Should she incorporate?
– Show numbers
11
High Income Limited
• The ultimate effect of incorporating the
investment portfolio is a small tax cost
(relative to earning the income directly) on
both the interest income and the capital
gain, and no cost or benefit relating to
either receipt of dividends.
• (Calculations follow)
12
High Income Limited
• Additionally, income earned by High Income
Limited from GIC interest, portfolio dividends, and
capital gains would need to be paid out to the
shareholder in the year to avoid a prepayment on
taxes on this income. The tax liability on the
dividends received from the connected corporation
Stage can be deferred by leaving the dividends in
High Income Limited. This indicates that if they
intend to keep the money for reinvestment in the
company, there is a prepayment of taxes on all of
the sources of income excepting the Stage
dividends. Further, from a tax perspective, there is
no benefit to earn income from those sources
13
High Income Limited
• If incorporated, High Income Limited (HIL)
would be considered to be carrying on a
“specified investment business” (SIB) under
the definition of that term in subsection
125(7) of the Act. This means that the
investment income earned by the company
would not be considered active business
income (ABI) and would, therefore, be
ineligible for the small business deduction
normally allowed to Canadian-controlled
private corporations (CCPC) on their first
$500,000 of ABI
14
Incorporation issues
• GIC Interest & Capital Gains
• When received by a corporation, ½ of the capital gain would
be put into a capital dividend account and would not be
subject to tax. Capital dividends could then be issued tax-free
after filing the proper election.
• The taxable portion of the capital gain and the GIC interest
would then be pooled together as “aggregate investment
income” (AII). They would both be initially taxed at 48⅔%
(38% basic federal rate less the 10% federal abatement plus
the 6⅔ additional refundable tax plus the assumed 14%
provincial rate). Of this, 26⅔% is a refundable portion that
goes into the Refundable Dividend Tax on Hand account to
be refunded when dividends are paid out.
• Upon paying this income in the form of dividends, the
corporation is refunded a portion of the taxes at a rate of
26⅔% of the income, resulting in an ultimate corporate tax
rate of 22% (48⅔% - 26⅔%) on this income.
15
Incorporation issues
• There is a small tax prepayment (no deferral benefit) because
earning this type of income directly is taxed at 46%, while it
would be taxed at 48⅔% if earned by a corporation.
• The refundable tax mechanism ensures that the total tax paid
by the corporation on the income and shareholder on the
dividends will be similar in amount as the tax that they would
pay earning the investment income personally.
• Since the investment income is ultimately taxed at 22%
(higher than 20% needed for perfect integration), there will be
a small tax cost in using the corporation to earn investment
income.
• Dividends paid out of the investment income of CCPCs are
not considered “eligible dividends” and are subject to the 25%
gross up to arrive at the total amount taxable at the marginal
tax rate. A federal and provincial dividend tax credit
(approximately the amount of tax paid at the corporate level)
will apply to reduce the personal taxes payable.
16
Incorporation issues
• Portfolio investment in public corporation shares
• The $10,000 dividend received from the publicly traded company is
subject to Part IV tax at 33⅓%. This tax takes away the advantage
of tax deferral. Earning this income through the holding company
results in a tax prepayment of $1,109.33.
• The Part IV will be added to the Refundable Dividend Tax on Hand
(RDTOH) and refunded at $1 for each $3 of taxable dividends paid
to Susan.
• This dividend received from the publicly traded company is
considered to be an “eligible dividend” for tax purposes and will be
added to the General Rate Income Pool (GRIP) of the corporation.
When they receive dividends from this account, they must include in
your income a 44% gross up to arrive at the taxable amount and you
are eligible to deduct a dividend tax credit. The effective tax rate on
dividends from GRIP is about 22.24% in the top combined federal
and provincial personal tax bracket.
17
Incorporation issues
•
•
•
•
Investment in 40% common shares of Stage
The holding company does not pay tax on the dividends received from
Stage because dividends are exempt from Part I tax and there is no Part IV
tax since the two corporations are connected.
Since this dividend comes out of the after-tax earnings of Stage, which has
been taxed at 16% (all income earned by Stage is subject to the small
business deduction), this dividend will come out of the Low Rate Income
Pool (LRIP). It is not an “eligible dividend” and is therefore subject to the
25% gross-up when received personally and a dividend tax credit can be
claimed. 32.5% effective tax rate on dividends from LRIP.
Since the holding company does not pay tax on dividends received from a
connected corporation for which the connected corporation did not receive a
dividend refund, the tax liability can be deferred indefinitely while the
dividends are left in the holding company. For this reason, it is advisable to
receive this source of income through High Income Limited. High Income
Limited will not be able to claim the capital gains deduction when it sells the
Stage shares in the future. If Stage is expected to increase in value
significantly then shares should not be held in High Income Limited.
18
The scarf business
•
•
•
•
If the scarf business were to be incorporated, the corporation would be a
Canadian-controlled private corporation earning active business income.
The effective total federal and provincial tax rate after claiming the small
business deduction would be 16%. Compared to the 46% total personal tax
rate (your current personal tax rate), there is a tax saving of $5,400 as well
as a deferral of $60,000 in tax payable.
If incorporated, the scarf retail business would be considered to be a CCPC
eligible for a small business rate of 16% on the first $500,000 of active
business income (38% basic federal rate less the 10% federal abatement
less the 17% federal small business deduction plus the assumed 5% net
provincial rate after provincial small business deduction). Since the
business would not meet the definition of a specified investment business or
a personal services business [ssec. 125(7)] all $200,000 of taxable income
would be considered to be from an “active business”.
When paid out, the $168,000 in non-eligible dividends would be grossed up
by 25% to arrive at the taxable amount. The federal and provincial dividend
tax credits which combined are equal to the amount of the gross-up are
then deducted to arrive at the taxes payable.
19
Tax to be paid
GIC
Interest
High Income Limited
Income
Tax @ 48⅔% on investment
income [Part I]
Tax @ 33⅓% on portfolio
dividends [Part IV]
Refund on payment of dividend:
@ 26⅔% of investment income
@ 33⅓% of portfolio dividends
Available for payment of dividend
Susan (assumes 46% combined rate)
Dividend received
Gross-up (41% on eligible dividends
25% on other-than-eligible dividends)
Income for taxes
Tax @ 46%
Less: eligible dividend tax credit
(assume 13/23 Fed & 10/23 Prov)
non-eligible dividend tax credit (⅔)
(assume ⅔ Fed & ⅓ Prov)
Net tax paid
Dividends
Public
company
Stage
Capital Gains
NonTaxable
taxable
5,000
10,000
20,000
10,000
(2,433)
-
-
(4,866)
2,567
(3,333)
6,667
20,000
5,134
1,333
3,900
3,333
10,000
20,000
2,666
7,800
3,900
10,000
20,000
7,800
975
4,875
4,100
14,100
5,000
25,000
1,950
9,750
2,243
6,486
11,500
4,485
-
(4,100)
-
-
(975)
1,268
2,386
(5,000)
6,500
(1,950)
2,535
10,0001
20
Tax summary
High Income Limited (net after
refund)
1,100
-
-
2,200
Susan
1,268
2,386
6,500
2,535
Total
2,368
2,386
6,500
4,735
2,300
2,3862
6,500
4,600
68
-
-
135
2,433
3,333
-
4,867
(133)
(947)
6,500
(267)
Tax paid on equivalent amount of
income if received directly by
Susan (a)
Cost /(Benefit) of incorporation
Tax paid by High Income Limited
before paying dividend
(b)
Deferral / (prepayment) of tax
through High Income Limited (a)(b)
21
Tax consequences of incorporating the
scarf retail business
Corporation
Income from active business
Corporate tax (@ 16%)
Available for dividend
$200,000
(32,000)
$168,000
Susan
Dividend
$168,000
Add: gross up (25%)
42,000
Income subject to tax
210,000
Personal tax before credit (@ 46%)
Dividend tax credit (assume equal to gross up)
96,600
(42,000)
Net tax
54,600
Add: tax paid by corporation
32,000 (A)
Total tax
86,600
Tax on income if unincorporated
$ 92,000 (B)
Tax cost/(savings) of incorporation
$(5,400)
Tax deferral/(prepayment) available through incorporation ((B) – (A))
$ 60,000
22
Chapter 13
Planning use of corporation and
shareholder-manager remuneration
23
Dog vs cat
24
Objectives for today
• Understand the more common elements in
the remuneration of a shareholder-manager
and the considerations needed to make a
choice
• Salary vs dividend tradeoff including taxfree
amounts
• Reasons for a holding company
• Why we have GAAR
• How to maintain eligibility of shares for capital
gains exemption
25
Employment remuneration
• Consideration of cash needs
– Immediate and future needs
• Need to optimize mix
– What is optimum level in order to meet
various deductions available?
26
Comparison
Dividend later
Bonus Now
A
B
Corporate
income
1,000
1,000
1,000
Bonus
1,000
0
0
Taxable income
Nil
1,000
1,000
Tax @ 16/32.5%
0
-160
-325
Nil
840
675
1,000
840
675
DGU 25%/45%
0
210
304
Taxable income
1,000
1,050
979
460
483
450
0
-210
-304
Net tax
460
273
146
Cash available
540
567
529
Funds for
dividend
Income
Combined tax
46%
DTC 25/45
Tax deferral
Tax cost
460-160
300
135
27
-11
460-325
27
Other considerations
• Individuals tax bracket
• Deductions and CF available to
shareholder
• Province of residence of corporation
28
Salaries and bonuses
• General guideline – should fully utilize
deductions and credits
• Reduce ABI to SBD threshold
• Salaries and bonuses need to be reasonable
– Reasonableness of bonus in relation to profit and
services rendered
– Payment for real and identifiable service
– Some justification for expecting a bonus over
regular salary
– A legal obligation to pay the bonus
29
Shareholder benefits and
loans
• Shareholder benefits
– Home purchase loan
– Vehicle purchase loan
– Share purchase loan
30
Exceptions
• A loan made to a shareholder who is also
an employee but not a specified employee
• A loan made to a shareholder who is also
an employee to:
– Buy a house
– Buy shares
– Buy a car to use in performance of duties
• A loan fully repaid within one year is
excluded from income inclusion and/or
interest benefit calculations
31
Example
• Smartmoney Mfg Ltd built a 21-room
house for its principal shareholder-officer
on a country property owned by him. The
company expensed the costs as
promotion expenses on the basis that he
would use the property to entertain
distributors of the company’s products to
ensure continuing outlets for the
company’s products.
• What are the tax consequences?
32
Considerations
• Is there a benefit to the shareholder?
• What is the value?
33
Solution
• Value of house plus GST included in
income of shareholder
– Company does not own the property
– Company expensed the cost on its books
– Shareholder has received a benefit
• Normally deductible but company must
own the property
34
Another problem
• Mr Edwards owns all of the outstanding
shares of Edwards Inc which manages
over 20 large apartment buildings.
• One spring the company paid for repairs to
his cottage ($8,500 plus GST)
• Because of his busy schedule, he forgot to
tell the controller to send him a bill
35
Considerations
• Is forgetfulness an excuse?
• He owns the company – does this matter?
• What would CRA do in this case?
36
Solution
• Shareholder benefit in the amount of
$8,500 plus GST because the company
paid for it.
• Company would probably be denied the
deduction and be forced to pay tax on it –
the expense was not incurred to earn
income
• Double taxation issue – Mr Edwards pays
tax on money he never received, and the
company pays tax on money they spent
37
Shareholder loan flowchart
Is the loan to a
corporation resident
in Canada?
Does the loan meet
one of the
exceptions?
Was the loan repaid
within one year from
the end of the fiscal
period
Loan principal taken
into income in the
year loan made
Is the loan to a
shareholder or
connected person?
No implications
Loan principal not
included in income
Deemed interest
benefit
Employment or
shareholding
Income deduction in
year of repayment
38
example
• Mr I.M Portly owns all the O/S shares or Run
for Your Life Limited and he is the president.
On July 1, 2008 the company made a loan to
him of $19,500 to buy a car at FMV. All other
employees are eligible to receive this loan.
Car is required for his duties. Loan is
repayable in two equal instalments starting
July 2009 with no interest.
• Is there a taxable benefit?
• Can the company’s position be affected by
this loan?
39
considerations
•
•
•
•
Just him or all employees?
Interest rate?
Set terms of repayment?
Why is it needed?
40
solution
• Normally yes, but there is an exception
because:
– For use in performance of duties
– Loan was received because of employment not
because he was a shareholder
– Repayment arrangements
– Reasonable time to repay
• Interest benefit calculated at prescribed rate
• Foregone interest is not a deduction for the
company
• Interest deductible if company took loan out
41
Fringe benefits
•
•
•
•
•
Private health insurance
Group accident insurance
Retirement benefits
Retiring allowance
Income splitting
42
Tax-free dividends for 2011
25%
41%
Taxable dividend
36,223
72,308
Gross-up (25/41)
9,056
29,646
Taxable income
45,279
101,954
Tax
11,656
32,246
Less deductions
-2,600
-2,600
Less DTC
-9,056
-29,646
0
0
36,223
72,308
Total tax
Net cash retained
43
Data
• Company earns $120,000 of ABI
• Shareholder has no other income and has
federal personal tax credits of $2,000 and
provincial personal tax credits of $1,290
44
Salary vs dividends
Salary
Pretax corp income
Dividend
120,000
120,000
-120,000
0
Taxable income
0
120,000
Corp tax @16%
0
-19,200
Available for dividend
0
100,800
36,145
13,405
0
19,200
Total paid
36,145
32,605
Difference
3,540
Savings as % of salary
3.0%
Savings as % of tax on
salary
9.8%
Salary
Personal tax paid
Corporate tax
45
Salary vs dividend?
46
Approach
• Need to use excel to do some modelling
using rates
47
How much to pay?
• If a salary of
$47,200 is paid to
maximize her CPP
contribution then,
based on the
assumption given,
her RRSP
contribution will be
$8,496. In order for
her to retain
$40,000 after tax
she will need to pay
a dividend of
$10,778.
Tax on Income
$47,200
Cash
$47,200
RRSP contribution
(8,496)
(8,496)
Dividend
10,778
10,778
Gross-up
2,695
$52,177
Federal tax
DTC
Credits
CPP credit
Provincial tax
DTC
Credits
CPP credit
Total tax paid
$(8,612)
1,797
2,100
324
(5,442)
898
1,400
216
$(7,319)
Salary
CPP paid
(7,319)
(2,163)
$40,000
48
Holding companies
•
•
•
•
Extension of integration
Compensation issues
Deferral of tax
Implementing an estate freeze
49
Small business corporation
• A Small Business Corporation is a
corporation which was at any particular
time:
– A CCPC, and
– All or substantially all (90%+) of FMV of
assets were
• Used principally in an active business carried on
by
– The particular corporation or
– A related corporation
• Share or debt that was connected
• A combination of the above
50
QSBC?
51
Purification needed?
52
Qualified small business
share
• At any time:
– A share that meets the following:
• SBC test
– Owned by individual
– Spouse
– Partnership related to individual
• Holding period test
– 24 month owned by individual or related person
• Basic asset test
– 50% of assets used in active business operations
53
What is active?
The FMV of the assets of K Ltd. is as follows:
FMV
Active business assets
%
Nil
Nil
Shares of Cyber Corp
$1,450,000
Term deposits
100,000
94.0 %
6.0 %
$1,550,000
100.0
%
The FMV of the assets of Cyber Corp. is as follows:
Active business assets:
Cash
Accounts receivable
Inventory
Prepaid expenses
Fixed assets
Goodwill
Other: marketable securities
Total
FMV
$ 4,500
780,000
920,000
1,000
150,000
200,000
$2,055,500
700,000
$2,755,500
%
74.6 %
25.4 %
100.0
%
54
Tests to be met for K
•
•
•
•
•
•
•
•
•
•
•
•
•
•
(1)
SBC Test
At the time of sale, K Ltd. must be a small business corporation (SBC). A SBC is defined as a CCPC
having all or substantially all (i.e., at least 90%) of the FMV of its assets either used principally in an
active business carried on primarily in Canada, or shares or debt of a connected SBC, or a combination
of the two [ssec. 248(1)].
K Ltd. is a CCPC since all the shares are owned by Karen who is a resident of Canada.
Cyber Corp. is connected to K Ltd., because K Ltd. controls Cyber Corp. But Cyber Corp. is not a SBC
as it does not meet the 90% test, i.e., 74.6%.
Thus, K Ltd. does not meet the SBC test.
(2)
Holding Period Test
Throughout the 24 months preceding the sale, the shares cannot be owned by anyone other than Karen
or a person related to Karen. Karen has owned the shares of K Ltd. since 1994. Thus, this test is met.
(3)
Basic Asset Test
In order to meet this test, K Ltd. needs to have more than 50% of the FMV of its assets used in an active
business carried on primarily in Canada for the 24 months preceding the sale. K Ltd. does not have any
of its assets used in an active business, but it does have shares of a connected corporation. Therefore,
the modified asset test must be used.
(4)
Modified Asset Test
This test requires that K Ltd. and Cyber Corp. both meet the 50% test throughout the 24 months
preceding the sale and that either K Ltd. or Cyber Corp. meet the 90% test throughout the 24 months
preceding the sale.
On reviewing Cyber Corp., it can be seen that more than 50% of its assets are used principally in an
active business carried on primarily in Canada, i.e., 74.6% of its assets are used in this way.
On reviewing K Ltd., it can be seen that at least 90% of the FMV of its assets are shares of a connected
corporation, Cyber Corp., meeting the 50% test, i.e., 94%.
Thus, this test is met.
55
Failed the test
• K Ltd. meets both the holding period test and the modified
asset test, but fails the SBC test. Therefore, the shares of
K Ltd. are not QSBC shares and thus Karen will not qualify
for the capital gains deduction.
56
What could be done?
• In order for K Ltd. to become a SBC, Cyber Corp. must be a
SBC. The following alternative could be considered as a way
to have Cyber Corp. become a SBC immediately before the
sale of the shares.
• Approximately $471,600* of the marketable securities could
be sold on the open market and the cash used to reduce the
liabilities. However, the sale of the marketable securities
would result in a capital gain which would be subject to full
corporate tax net of refundable tax if dividends are paid prior
to the sale of shares.
• Be careful not to become too precise when doing this
calculation. Remember, the fair market value of the assets,
especially goodwill, is subject to challenge. If your fair market
values are too high, then you will not have sold enough
securities to meet the 90% test.
57
What to do…
* Total assets including $2,055,500 of active business assets ($2,055,500 ÷
.90)
$2,283,889
Less: active business assets
2,055,500
Maximum value of marketable securities
$ 228,389
Current marketable securities
$ 700,000
Maximum marketable securities
Sell marketable securities
(228,389)
$ 471,611
58
Kiddie tax
• A special income tax computed at the top
rate is levied on specified income of a
minor
– Dividends derived from unlisted shares of any
corporation
– Income from trust or partnership which
derives income from the business of providing
property or services to a business carried on
by a relative of the minor or a corporation in
which the relative is a specified shareholder
59
Exceptions
• Minor has no parent resident in Canada
• Inheritance from parent
• Full time attendance at post-secondary
institution
• Eligible for disability tax credit
60
GAAR
• New section 245 of the Act is a general
anti-avoidance rule which is intended to
prevent abusive tax avoidance
transactions or arrangements but at the
same time is not intended to interfere with
legitimate commercial and family
transactions.
61
GAAR framework
• (a) Does any other provision of the Act or other rule of law
apply to stop the taxpayer from achieving the intended
advantage?
• (b) Does the transaction result, directly or indirectly, in a tax
benefit, as defined in ssec. 245(1), i.e., a reduction, avoidance
or deferral of tax or an increase in a refund?
• (c) Is the transaction part of a series of transactions which
would result, directly or indirectly, in a tax benefit?
• (d) Can the transaction reasonably be considered to have
been undertaken or arranged primarily for bona fide purposes
other than to obtain the benefit?
• (e) Can it reasonably be considered that the transaction
would result, directly or indirectly, in a misuse of the
provisions of the Act or an abuse having regard to the
provisions of the Act read as a whole?
62
GAAR
63
Using the framework
(1)
(a)Does any other provision of the Act or other
rule of law apply to stop the taxpayer from
achieving the intended advantage?
(b)Does the transaction result, directly or
indirectly, in a tax benefit, as defined in ssec.
245(1), i.e., a reduction, avoidance or deferral
of tax or an increase in a refund?
(c) Is the transaction part of a series of
transactions which would result, directly or
indirectly, in a tax benefit?
(d)Can the transaction reasonably be considered
to have been undertaken or arranged primarily
for bona fide purposes other than to obtain the
benefit?
(e)Can it reasonably be considered that the
transaction would result, directly or indirectly,
in a misuse of the provisions of the Act or an
abuse having regard to the provisions of the
Act read as a whole?
•
•
No(1)
•
Yes(2)
•
Yes(3)
No(4)
•
(1)
The contribution and the
withdrawal are specifically permitted
under the Act.
(2)
A deferral of tax will be
achieved with the contribution and,
depending upon the marginal tax rate
in the year of withdrawal, there may
be a tax saving.
(3)
Since each transaction hinges
on the other, these transactions could
be considered a series. However,
since the answer to (b) was yes, then
(d) can be addressed directly after (b).
(4)
It may be possible to argue
that the contribution was made for
bona fide reasons, but an
unanticipated need for cash
necessitated the withdrawal. This
argument is not likely to be successful
when the withdrawal follows the
contribution within a short period of
time or when the same transactions
are repeated over a period of years.
(5)
Each transaction is specifically
permitted under the Act.
Yes(5)
64
Using the framework
(2)
(a)Does any other provision of the Act or other
rule of law apply to stop the taxpayer from
achieving the intended advantage?
(b)Does the transaction result, directly or
indirectly, in a tax benefit, as defined in ssec.
245(1), i.e., a reduction, avoidance or deferral
of tax or an increase in a refund?
(c) Is the transaction part of a series of
transactions which would result, directly or
indirectly, in a tax benefit?
(d)Can the transaction reasonably be considered
to have been undertaken or arranged primarily
for bona fide purposes other than to obtain the
benefit?
(e)Can it reasonably be considered that the
transaction would result, directly or indirectly,
in a misuse of the provisions of the Act or an
abuse having regard to the provisions of the
Act read as a whole?
•
•
No(6)
•
Yes(7)
•
Yes(8)
(6)
A gift to a spouse that does not
result in the funds producing income
from property is not subject to the
attribution rules
(7)
The fact that second generation
income generated by the loan is not
taxed to the husband reduces his tax.
(8)
The cash gift to pay the taxes
resulted in the wife having more cash to
reinvest which would create more
second-generation income. However,
since the answer to (b) was yes, then
(d) can be addressed directly after (b).
(9)
It may be possible to argue that
the loan was primarily for a bona fide
business, investment or family purpose,
as indicated in paragraph 4 of
Information Circular 88-2.
•
No(9)
No(10)
(10)
IT-511R suggests, in paragraph
6, that compound interest, i.e., income
on attributed income or “secondgeneration” income is not subject to
income attribution. The CRA, thereby,
suggests that this transaction is not a
misuse or abuse of provisions of the
Act. As a result, the GAAR should not
apply.
65
Using the framework
(3)
(a)Does any other provision of the Act or other
rule of law apply to stop the taxpayer from
achieving the intended advantage?
No(11)
(b)Does the transaction result, directly or
indirectly, in a tax benefit, as defined in ssec.
245(1), i.e., a reduction, avoidance or deferral
of tax or an increase in a refund?
Maybe(12)
(c) Is the transaction part of a series of
transactions which would result, directly or
indirectly, in a tax benefit?
Maybe
(d)Can the transaction reasonably be considered
to have been undertaken or arranged primarily
for bona fide purposes other than to obtain the
benefit?
Maybe
(e)Can it reasonably be considered that the
transaction would result, directly or indirectly,
in a misuse of the provisions of the Act or an
abuse having regard to the provisions of the
Act read as a whole?
Maybe
•
•
(11) Section 74.4 only
applies to transfers to a
corporation by an individual.
(12) There may be no tax
benefit from this transaction.
The loan capital was paid from
earnings of Wells Ltd. that had
been taxed. That capital will
earn income in Stieb Ltd. that
will be taxed at the corporate
rate applicable to the type of
income generated. On the
other hand, it might be possible
to argue that the surplus in
Wells Ltd. would otherwise
have been distributed to Mrs.
Hogart in the form of dividends
which would have been taxed.
Then, if she loaned the funds to
Stieb Ltd., the corporate
attribution rules would have
applied.
66
Using the framework
(4)
(a)Does any other provision of the Act or other
rule of law apply to stop the taxpayer from
achieving the intended advantage?
(b)Does the transaction result, directly or
indirectly, in a tax benefit, as defined in ssec.
245(1), i.e., a reduction, avoidance or deferral
of tax or an increase in a refund?
(c) Is the transaction part of a series of
transactions which would result, directly or
indirectly, in a tax benefit?
(d)Can the transaction reasonably be considered
to have been undertaken or arranged primarily
for bona fide purposes other than to obtain the
benefit?
(e)Can it reasonably be considered that the
transaction would result, directly or indirectly,
in a misuse of the provisions of the Act or an
abuse having regard to the provisions of the
Act read as a whole?
•
No(13)
•
Yes(14)
Yes(15)
•
•
No(16)
•
(13) As long as the sale of the
investments was at fair market
value, then the Act has no
prohibition on this transaction.
The borrowing to purchase
investments is specifically
contemplated in paragraph
20(1)(c).
(14) What was non-deductible
interest is now technically taxdeductible.
(15) See (13), above.
(16) Having borrowed to
purchase the house rather than to
finance the investments initially,
the re-structuring of the debt
could be regarded as a
transaction to obtain the tax
benefit of interest deductibility.
(17) There may be a misuse of
provisions or an abuse of the Act
read as a whole.
No(17)
67
Using the framework
(5)
(a)Does any other provision of the Act or other
rule of law apply to stop the taxpayer from
achieving the intended advantage?
(b)Does the transaction result, directly or
indirectly, in a tax benefit, as defined in ssec.
245(1), i.e., a reduction, avoidance or deferral
of tax or an increase in a refund?
(c) Is the transaction part of a series of
transactions which would result, directly or
indirectly, in a tax benefit?
(d)Can the transaction reasonably be considered
to have been undertaken or arranged primarily
for bona fide purposes other than to obtain the
benefit?
(e)Can it reasonably be considered that the
transaction would result, directly or indirectly,
in a misuse of the provisions of the Act or an
abuse having regard to the provisions of the
Act read as a whole?
No(18)
Maybe(19)
Maybe
Maybe
Maybe
• (18)Subsection
56(4.1) only deals
with individuals.
• (19)Case similar to
situation (3). See
Note (12). In this
case, if the
statement that the
loan was made to
avoid subsection
56(4.1) is taken
literally, then there
may be a misuse
or an abuse in
answer to (e).
68
Bonus vs dividends
• Reconsider use of bonus, EPSP
• In Ontario, 46.4% on bonus or ESPS
• Ontario corporate tax rate is 40.79% reducing to
33.67% in 2012 on nonM&P ABI over $400,000
• Dividend after tax income of Opco to a holding
company and pay eligible dividends when Ontario
eligible dividend rate is 22.38% (2010)
• Approximately 10.3% more funds to invest if retain
nonM&P income in company and you avoid the
employer health tax on the bonus
• Ensure sufficient salary for maximum RRSP
69
Bonus vs dividends
• Consider impact on SRED – qualify for full
refundable ITC if income of corp is less than
$400,000
• ITC is reduced dollar for dollar over SB limit
• AMT – alternative minimum tax – a minimum
tax if your expected tax is not paid
• If owner/manager has AMT, pay salary or
bonus to use up credit
• Impact on corporate instalments
70
Bonus vs dividends
• No EI or CPP if pay a dividend
• No EHT in Ontario if pay a dividend
• Paying salary reduces retained earnings
and possibly capital taxes
71
Advantages of holdco
• Assume CCPC
• Pay dividends from opco to holdco will
move GRIP balance (this is the eligible
dividends balance)
• Opco has losses in subsequent year –
GRIP in holdco is not affected if
transferred
72
Disadvantage of holdco
• Assume CDN traded securities which pay
taxable dividends
• If personal ownership, tax rate is 24.64%
on dividends
• If in holdco, tax rate is 33 /3% (Part IV tax)
73
EPSP
• Deferral of tax on bonus is 180 days
• Deferral of tax on EPSP is up to 13
months
• Can be for owner and manager only
• No limit on contributions
• No withholding other than EHT
• Doesn’t reduce RRSP or RPP
• No investment restrictions
74
Example
• September 2008 year end
• Pay $1 million bonus – tax is pad in March
2009
• EPSP tax is paid in April 2010
75
Should she incorporate?
76
Proprietorship
— Income earned directly
(A)
Personal tax
Business income
$150,000
Tax 1st
$127,021
$26,880
Balance
22,979 @
29%
6,664
Less: federal personal tax credits
$33,544
(2,100)
31,444
Provincial tax (17% of ($150,000 – 127,021) + $15,776)
19,682
Less: Provincial personal tax credits
(1,400)
Total personal tax
$49,726
77
Through a corporation
Income earned through corporation
Corporate tax
Business income before salary
Salary
Taxable income
Federal tax @ 11% (38% – 10% – 17%)  $100,000
Provincial tax (5%  $100,000)
After-tax retained earnings
Personal tax
Salary received
Tax 1st
$40,970
Balance
9,030 @ 22%
Less: Federal personal tax credits
Provincial tax (12% of ($50,000 – $40,940) + $4,097)
Less: Provincial personal tax credit
Total personal tax
$150,000
(50,000)
100,000
(11,000)
(5,000)
$84,000
$50,000
$6,146
1,987
$8,133
(2,100)
6,033
5,181
(1,400)
$9,814
78
Deferral benefit
(B)Tax deferral on $84,000 in after-tax retained earnings
$50,000 salary + $84,000 dividend  1.25
$155,000
Tax 1st
$127,021
$26,880
Balance
27,979 @ 29% 8,114
$34,994
Less: Personal tax credits
(2,100)
DTC (131/3% of $84,000  1.25)
(14,000)
18,894
Provincial tax (17% of ($155,000 – $127,021) + $15,776)
20,532
Less:
(1,400)
Provincial personal credit
Provincial dividend tax credit (6 2/3% of $84,000  1.25)
(7,000)
Total tax
31,026
Less tax paid on $50,000 salary (above)
(9,814)
Amount of personal tax deferred until payment of dividend
$21,212
79
Tax savings
Personal tax paid now on $150,000
$49,726
Tax paid now if incorporated
Corporate tax
$16,000
Personal tax on $50,000 salary
9,814
25,814
Tax paid later on dividend
21,212
$47,026
Tax saving from incorporation ($49,726 – $47,026)
$2,700
80
Notes
• Note that if Nancy received the dividend
today, she would pay $2,700 less than if she
earned the income directly (or received a
$150,000 salary from her company).
• This is because the combined federal and
provincial corporate tax rate is 16%.
• There is perfect integration of personal and
corporate taxes, i.e., no tax savings or cost,
when the combined federal provincial
corporate tax rate is 20%.
81
Scholarship program
• Scholarship program for children of key
employees
– Cannot be related to shareholders
• No taxable benefit to employee
• No tax to child (56(3))
• Deductible by company
82
Wrapup
• Lots of options available
• Consider all factors before making
decision
83
Next week
• Problem 9 for discussion
• Read chapter 15
• Assignment 1: problem 6 & problem 11
84