3520-9: Last updated on March 11, 2014
1
Lecture 9: Taxable Income and Tax for Corporations – last updated March 11, 2014 –
changes in red.
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1.1
There are three main types of corporations [ITA 89(1)]
 Public corporations
 resident in Canada, listed on a designated Canadian stock exchange (all Canadian
exchanges are designated)
 Private corporations = not public
 Canadian controlled private corporations (CCPCs) = a special type of private corporation
= a private corporation that is not controlled by public companies or non-residents
 Income earned by a CCPC is eligible for special tax treatment
 Canadian active business income is eligible for the Small Business Deduction
 Investment income is eligible for other special treatment that results in lower tax
rates
 Research & development tax incentives are more generous
Computation of Net Income [12-1 to 12-4]
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4
Exercise 12-1 [Review of Net Income]
Exercise 12-2 [Taxable Income]
Exercise 14-4 [Associated Companies]
Exercise 13-1 [Integration (Non-Eligible Dividends)]
Exercise 13-2 [Integration (Eligible Dividends)]
Exercise 12-7, 15-2 [Active Business Income]
Three Main Types of Corporations
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3
Corporations are taxed as separate entities & are taxpayers [see definitions of taxpayer &
person in ITA 248 (1)]
Corporations file T2 returns (individuals file T1 returns) & include their financial statements
with their tax returns
Recommended Exercises
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2
1-8
Corporations use financial statement income to calculate Division B income (also called net
income for tax purposes)
 See Fig. 12-1
 Exercise 12-1 reviews some important items
Computation of Taxable Income [12-5 to 12-9]
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Division B income minus Division C deductions = Taxable income
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
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4.1
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ITA 112
This deduction means that dividends between Canadian corporations are essentially tax-free
and this prevents double taxation
Loss Carryovers [12-24 to 12-30]
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5
ITA 110.1(1): limited to 75% of net income
The rules are the same as for individuals except that donations by a corporation are eligible
for a taxable income (division C) deduction rather than a tax credit
 This is because corporations are subject to a flat tax rate rather than progressive tax rates
All unclaimed donations can be carried forward 5 years
Dividends from Taxable Canadian Corporations[12-10 to 12-12]
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4.3
The 3 major Division C deductions for corporations earning income in Canada are:
 Charitable donations [ITA 110.1(1)]
 Dividends from taxable Canadian corporations [ITA 112]
 Loss carryovers [ITA 111]
See Fig. 12-2
Charitable Donations
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4.2
2-8
ITA 111: the rules are the same as for individuals
the two most important carryovers are
 Non capital losses
 carry back 3 years, carry forward 20 years
 Net capital losses
 carry back 3 years, carry forward indefinitely. Can only be used to offset taxable
capital gains
Federal Tax Payable [12-45 to 12-74]
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The following table sets out the general corporate tax rate for business income in 2013 and
the lower rate for the first $500,000 of active business income earned by Canadian controlled
private corporations (CCPCs). The actual provincial rates vary depending on the province
see tables and example especially at 12-50, Figure 12-3, 12-67
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
3-8
For $100 of income
General
Eligible
for
rate for
Small Business
business
Deduction
income
Basic or general corporate rate [ITA 123]
38
Federal abatement (for income subject to provincial taxes)
(10)
[ITA 124, Reg. 400-402]
28
Small Business Deduction
5.1
38
(10)
28
(17)
General rate reduction
(13)
Non-business or business foreign tax credit
(FTC)
(FTC)
Political contributions credit [ITA 127(3)]
(PTC)
(PTC)
Investment tax credit [ITA 127(5)]
(ITC)
(ITC)
15
11
Provincial tax (assumed to be Ontario in 2013)
11.5
4.5
Total tax
26.5
15.5
Basic Corporate Rate under ITA 123 and General Rate Reduction under ITA 123.4(2)
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Basic rate = 38% x taxable income
Tax rates have been reduced federally to make Canadian taxes more competitive. This
reduction has been accomplished by subtracting from the basic tax rate the general rate
reduction
 The general rate reduction is 13% in 2013.
CCPCs earn 2 types of income that do not qualify for the 13% general rate reduction because
they already benefit from other preferential corporate tax treatment
 Active business income eligible for the 17% small business deduction (discussed later)
 Investment income (e.g. interest income, rental income and taxable capital gains) earned
by a CCPC and subject to refundable tax provisions (introduced in lecture 10)
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
5.2
Federal Abatement
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5.3
= a reduction = 10% of taxable income “earned in a province” [ITA 124]
Reason
 the 10% makes room for provincial income taxes which apply to this income
 the formula for calculating “taxable income earned in a province” is in Part IV of the
Regulations (Reg. 400-402)
 For the purposes of this course all of the company’s taxable income is assumed to
be earned in a province
Small Business Deduction (SBD)
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6
4-8
ITA 125
 the small business deduction = 17% of the first $500,000 of Canadian active business
income earned by a CCPC.
The logic is that incorporated small businesses have a hard time getting bank loans to finance
their businesses
Therefore, the income tax rate is lower to allow more retained earnings to be reinvested in the
business
The Small Business Deduction is 17% of the least of the following 3 amounts:
 (1) Canadian active business income (ABI)
 Objective = Only Canadian ABI is eligible, not foreign ABI, not incorporated
employment income (“personal services business”), not investment income
 (2) Taxable income (with an adjustment for foreign income, not covered in this course)
 Objective = Limited to taxable income (which will only be < Canadian active
business income if there are non-capital losses claimed)
 (3) Business limit, which is $500,000 (and which must be shared by associated
corporations)
The small business deduction is also restricted to small CCPCs (small based on their balance
sheet, discussed in ADMS 4562)
Association Rules [14-35 to 14-46]
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It is important to determine whether CCPCs are “associated” because associated CCPCs must
share the $500,000 annual business limit [ITA 125(3)]
This means that taxpayers cannot set up > 1 corporation to multiply your access to the small
business deduction
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
6.1
Related Persons under ITA 251
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6.2
5-8
ITA 251(2)(a)
 Related = individuals connected by blood, marriage, adoption
 Related by blood = horizontal (i.e., parents, grandparents, children, grandchildren etc.) or
vertical relationship (i.e., brothers and sisters) (not aunts, uncles, nieces, nephews,
cousins) [ITA 251(6)(a)]
 Related by marriage = spouse (or common law partner), parents-in-law, siblings-in-law,
children in law, etc. [ITA 251(6)(b)]
ITA 251(2)(b)
 A corporation & a person are related if the person controls the corporation
ITA 251(2)(c)(i)
 Two corporations are related if they are controlled by the same person or group of
persons
Associated Corporations: Corporations are Associated If
6.2.1 One corporation controls the other
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see Figure 14-1 [ITA 256(1)(a)]
Example in text: If a taxpayer owns A Ltd. and A Ltd. owns 75% of B Ltd. then A Ltd. and B
Ltd. are associated
Control typically means ownership of more than 50% of the voting shares of the corporation
6.2.2 Two companies are controlled by the same person or group of persons
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see Figure 14-2 [ITA 256(1)(b)]
Example in text (control by same person): If Mr. A owns 75% of A Ltd. and 75% of B Ltd,
the two corporations are associated
Another example (control by a group of persons): The group of Mike and Ken controls 2
companies. M Ltd. is owned 10% by Mike and 45% by Ken. K Ltd. is owned 20% by Mike
and 35% by Ken. Note how the group of Mike and Ken together own more than 50% of the
shares of M Ltd and K Ltd. You may wish to draw a diagram to assist you (corporations are
typically drawn as rectangles)
for group definition (= 2 or more people who own shares in the corporation) see ITA
256(1.2)(a)
6.2.3 Two related persons control two different corporations. One person owns 25% or more of
each corporation
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see Figure 14-3 [ITA 256(1)(c)]
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
6-8
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Example in text: Mr. A and Mrs. A each control their own company. The husband also owns
30% of the shares of the wife's company
 The “25% or more” cross-ownership rule is just an arbitrary rule that can make corporations
controlled by related persons associated
If there had been < 25% cross ownership, Mr. and Mrs. A’s corporations would have still been related,
but they would not have been associated and therefore would each have a $500,000 annual business limit
available (for the small business deduction)
6.2.4 Shares owned by a minor child are deemed to be owned by the parent(s)
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ITA 256(1.3)
Example: Mr. A owns a company. His 14 year old daughter owns another company. Mr. A
is deemed by ITA 256(1.3) to own all of his daughter’s shares (for purposes of the associated
corporation rules)
This rule was introduced to close a loophole (taxpayers using their children to own shares to
get around the association rules)
6.2.5 Anti-avoidance rule
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7
Integration and Business Income [13-1 to 13-24]
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8
Two companies are deemed to be associated if one of the main reasons for their separate
existence was to reduce tax (e.g., by accessing another small business deduction) [ITA
256(2.1)]
Example: Mr. A owns a company that owns retail stores. The operations of the newest store
are put in a separate company owned by Mrs. A. The main reason for doing this is to be able
to access another small business deduction. The companies can be deemed to be associated if
they are not already associated
The term “integration” means that you pay the same amount of income tax whether you
incorporate or not
It also means that you pay the same amount of income tax if you pay yourself with salary or
dividends
Corporate tax rates that will make integration effective depend on whether the dividends are
eligible or non-eligible
 For eligible dividend with a 38 percent gross up, the required rate is approximately 28
percent
 For non-eligible dividend with a 25-percent gross up, the required rate is 20 percent
 Discussed in ADMS 4562
Incorporating a Small Business [15-1 to 15-11]
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
8.1
Advantages (Tax and Non-Tax)
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8.2
Limited liability for shareholders of a corporation
If the income is eligible for the 17% small business deduction, there is a big deferral of tax. If
not, the deferral is small
Availability of $750,000 QSBC lifetime capital gains exemption for shares of a qualified
small business corporation
Remuneration options if shareholder = employee (tax-free benefits, accrued bonus, pension,
company cars, etc.)
Possible income splitting with family members as shareholders and employees
 payment of reasonable salaries to employees
 payment of dividends to shareholders who may pay tax at lower rates (dividends are
subject to kiddie tax if shareholders are minors)
 Anonymity of investors
 on kiddie tax see CTP 11-114 to 11-124
Disadvantages (Tax and Non-Tax)
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9
7-8
Losses are trapped in the corporations and cannot be used by the shareholders. Can only be
carried forward or back against the corporation’s taxable income
Cost to set up and maintain (incorporation costs, ongoing annual legal, accounting and other
costs)
Options for Compensation for Shareholder-Managers (Active Business Income) [15-41 to
15-45]
 Before the eligible dividend regime was introduced in 2006, it was important to pay a bonus
to reduce corporate taxable income to amount eligible for SBD (i.e., $500,000) – this is no
longer important because the purpose of the eligible dividend regime is to achieve integration
for high rate business and other factors are more relevant.
 When advising clients as to compensation, the first question that a tax professional will ask is
obviously “How much cash flow do you need (after tax)? Tax professionals then use software
to consider the following qualitative issues:
Salary
 Payment of salary makes individual eligible for CPP and RRSP contributions, the
working income tax benefit (WITB), deductions for child care expenses and the
employment credit
 And RRSPs are important: tax-free compounding, $2,000 pension credit on RRSP
annuity income/RRIF (if 65 or older), pension income splitting if no RPP
 Salaries and bonuses paid to family members must be reasonable [ITA 67] given the
responsibilities assumed and duties performed - therefore income-splitting with
family members is limited by the reasonability test
 CPP is a cost/benefit proposition
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).
3520-9: Last updated on March 11, 2014
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8-8
A bonus can be accrued to save corporate tax but accrued bonuses must be legal
obligations to be deductible and must be paid within 180 days of the company’s yearend [ITA 78(4)]
Dividends
Dividends increase the amount of taxable income (by the gross-up) and will therefore have a
negative effect on social benefits delivered through the tax system (e.g. GST credit, Ontario
Trillium Benefit) and clawbacks (e.g., EI and OAS)
At lower marginal rates, there may be unused dividend tax credit
The kiddie tax was introduced in 1999 to stop people from saving tax by using minor children
as shareholders in their incorporated small businesses
Each family member can still use the CG exemption to shelter any CG when they sell the
shares (if the shares are QSBC shares). As the kiddie tax will only apply to capital gains on
non-arm’s length sales, it can be avoided by either 1. postponing the sale to the year of the
child’s 18th birthday or 2. ensuring that the sale is to an arm’s length person.
see example at 15-42
This edition of the notes was updated by Priya Shah [p_shah@yorku.ca] and Joanne Magee
(jmagee@yorku.ca).