Chapter 15
Corporate Taxation And
Management Decisions
The Decision To Incorporate

Tax Reduction

Tax Deferral

Income Splitting

Other Considerations
2
© 2008, Clarence Byrd Inc.
Incorporation:
Other Factors To Consider

Limited Liability

Shareholders’ Liability To Creditors
Limited To Amounts Invested

For Smaller Corporations, Personal
Guarantees Almost Always Required To
Obtain Significant Financing

Protection from other types of liabilities
(e.g., product liability)
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© 2008, Clarence Byrd Inc.
Incorporation:
Other Factors To Consider

Lifetime capital gains deduction

Foreign taxes

Estate planning

Loss deductions

Tax credits

Charitable donations

Cost of maintaining corporation

Winding-up procedures
4
© 2008, Clarence Byrd Inc.
Tax Reduction

See Paragraph 15-66 (Based on
$100,000 of income)

Save $1,280 for CCPC with SBD

Neutral with respect to dividends

All other cases involve tax cost

$4,460 for public company

$4,460 for CCPC on non-eligible

$3,410 for CCPC investment income
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© 2008, Clarence Byrd Inc.
Tax Deferral

See Paragraph 15-66

Neutral on non-eligible dividends

Prepay


CCPC investment income

Eligible dividends subject to Part IV
Deferral in other cases

$11,500 for public company or CCPC without
SBD

$29,000 for CCPC earning ABI
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© 2008, Clarence Byrd Inc.
CCPC Income > Small Business Limit

The Problem





If over $400,000 ABI
Combined rate can be 50%
A tax cost of nearly $5,000 on
$100,000 of income
This has been reduced by
eligible dividends
The Solution

Bonusing down (paying salary).
7
© 2008, Clarence Byrd Inc.
Imperfections In
Integration System

Provincial dividend tax credits – non-eligible dividends

DTC  1/3 Gross Up – Favours use of corporation

DTC < 1/3 Gross Up – Favours not incorporating

Actual range: 18.5% to 38.5%
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© 2008, Clarence Byrd Inc.
Imperfections In
Integration System

Provincial dividend tax credits – eligible dividends

DTC  7/18 (39%) Gross Up – Favours use of corporation

DTC < 7/18 (39%) Gross Up – Favours not incorporating

Actual range: 21.5% to 38.5%
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© 2008, Clarence Byrd Inc.
Imperfections In
Integration System

Different Federal/Provincial
combined tax rates

Combined rates for CCPC on ABI
range from 14% to 19%

>20% - Favours not
incorporating

<20% - Favours use of
corporation
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© 2008, Clarence Byrd Inc.
Tax Free Dividends
 Basic Concepts
 $1 Non-Eligible Dividend Received
 $1.25 Increase In Taxable Income
[($1)(125%)]
 Individuals In Lowest Federal Tax Bracket
 Taxes
Are $0.1875 [($1.25)(15%)]
 Federal
Dividend Tax Credit = $0.1667
[($0.25)(2/3)]
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© 2008, Clarence Byrd Inc.
Tax Free Dividends

Tax on first $1 of noneligible dividends is
$0.0208
($.1875 - $.1667)

First $1 of noneligible dividends uses
up available credits of
$0.1387
($.0208 ÷ $.15)
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© 2008, Clarence Byrd Inc.
Use Of Tax Credits

$1 of salary uses $1 of credits

$1 non-eligible dividends uses
$0.1387 of credits

Dividends are a better until
credits are used
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© 2008, Clarence Byrd Inc.
Amounts Available Tax Free

Single Individual



$37,773 Non-Eligible
$69,833 Eligible
With Dependent
Spouse


$51,066 Non-Eligible
$83,950 Eligible
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© 2008, Clarence Byrd Inc.
Amounts Available Tax Free
Don’t
forget the AMT
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© 2008, Clarence Byrd Inc.
Income Splitting
Splitting income a very
powerful tool
 Corporations very effective
here
 Few limits for spouses and
adult children
 Problems with minor children
(tax on split income)

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© 2008, Clarence Byrd Inc.
Shareholder Benefits

The owner-manager
environment
 Not
arm’s length
 Few constraints on use of
corporate resources
 Sometimes difficult to separate
business and personal use
 Travel
 Automobiles
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© 2008, Clarence Byrd Inc.
Shareholder Benefits

Automobiles
 Standby
charge
 Operating cost benefit

See Chapter 2
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© 2008, Clarence Byrd Inc.
Shareholder Benefits

Benefits other than loans
 Included
in shareholders’
income
 Not deductible for
corporation
 Should be avoided!
19
© 2008, Clarence Byrd Inc.
Shareholder Benefits

Loans - ITA 15(2)

General Requirements



Principal Amount Must Be Added
To Shareholder’s Income
No Imputed Interest Under ITA
80.4(2)
Can Be Deducted Under ITA
20(1)(j) When It Is Repaid
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© 2008, Clarence Byrd Inc.
Shareholder Loans

Exceptions




Corporation In Lending
Business: ITA 15(2.3)
Loan Repaid Prior To
Second Balance Sheet Date
Not Specified Shareholder
If not in income – imputed
interest under ITA 80.4(2)
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© 2008, Clarence Byrd Inc.
Shareholder Loans

Exceptions

Loans To
Shareholder/Employee:
ITA 15(2.4)



To Acquire Personal Residence
To Acquire Shares Of The
Company
To Acquire An Automobile To Be
Used In Employment Duties
22
© 2008, Clarence Byrd Inc.
Management Compensation

General Principle: Salary is Benchmark
 Fully
taxable to shareholder
 Fully deductible to corporation
23
© 2008, Clarence Byrd Inc.
Management Compensation

Tax effective solutions
 RPPs
 DPSPs
 Private
health care
 Stock options
24
© 2008, Clarence Byrd Inc.
Salary Vs. Dividends
Example: Ms. Olney has $100,000 of corporate income and is
subject to a tax rate of 45 percent
SALARY: No corporates taxes – personal taxes of $45,000 – retention
of $55,000. Like direct receipt of income.
Dividends: Retention will depend on type of corporation and type of
income (see Paragraph 15-66). Better retention only in the case of a
CCPC earning active business income.
25
© 2008, Clarence Byrd Inc.
Salary vs. Dividends
– Other Considerations

Provincial rates and credits
 Tax
rates on individuals are not an issue
 High
dividend tax credit rates encourage the
use of dividends
 High
corporate tax rates encourage the use of
salary
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© 2008, Clarence Byrd Inc.
Salary vs. Dividends
– Other Considerations

Income splitting
 Some
family members
with no income
 Can receive substantial
amounts of tax free
earnings
27
© 2008, Clarence Byrd Inc.
Salary vs. Dividends
– Other Considerations

RRSP Contributions (2008)

$21,000  18% = $116,667 =
required 2008 earned income

Dividends  Earned Income

RRSP

CPP
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© 2008, Clarence Byrd Inc.
Salary vs. Dividends
– Other Considerations

Cumulative net investment
loss (CNIL)



CNIL reduces available lifetime
capital gains deduction
Receipt of dividends reduces CNIL
Added costs of salary


CPP and EI premiums
Payroll taxes (in some provinces)
29
© 2008, Clarence Byrd Inc.
Salary vs. Dividends
– Other Considerations

Added benefits of salary


CPP and EI tax credits
Corporate tax payable

If distributions exceed income

No tax savings with salary
30
© 2008, Clarence Byrd Inc.
Dividends - Problem

Problem - All Dividend
Approach



Use Up Tax Credits At A Slow Rate
May Leave Unused Tax Credits
Solution


Pay A Lesser Amount Of
Dividends
Sufficient Additional Salary To
Absorb Tax Credits
31
© 2008, Clarence Byrd Inc.
Basic Data

Corporate Taxable Income = $29,500

Combined Corporate Tax On ABI = 16%

Provincial Tax On First $37,885 Of Personal
Taxable Income = 10%

Individual Has Combined Tax Credits Of $3,920

Provincial Dividend Tax Credit = 1/3 Of Gross Up
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© 2008, Clarence Byrd Inc.
All Salary
No Corporate Tax Payable
 Salary Received = $29,500

Taxes At 25% (15% + 10%)
Personal Tax Credits
Tax Payable
($7,375)
3,920
( 3,455)
After Tax Cash Retained
$26,045
33
© 2008, Clarence Byrd Inc.
All Dividends
 Maximum
Dividend
Corporate Income
Corporate Tax At 16%
Available For Dividends
 Taxable
$29,500
( 4,720)
$24,780
Dividends
Dividends Received
Gross Up (25%)
Taxable
$24,780
6,195
$30,975
34
© 2008, Clarence Byrd Inc.
All Dividends
 Personal
Taxes On Dividends
Tax At 25 Percent [(25%)($30,975)]
$7,744
Personal Tax Credits
( 3,920)
Dividend Tax Credit (Equal Gross Up)
( 6,195)
Tax Payable (Negative $2,371)
Nil
 After
Tax Cash Retained
Dividends Received
Tax Payable
Cash Retained
$24,780
Nil
$24,780
35
© 2008, Clarence Byrd Inc.
All Dividends

The All Dividend Approach Leaves $2,371
In Unused Personal Tax Credits

A Combination Of Salary And Dividends
May Provide A Better After Tax Retention
36
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
 Consider:


For Each $1,000 Of Additional Salary Paid
Dividends Are Reduced $840.00 [($1,000)(1.00 - .16)]
Increase In Salary
Decrease In Dividends
Decrease In Gross Up
Change In Taxable Income
$1,000.00
( 840.00)
( 210.00)
($ 50.00)
37
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
Decrease In Dividend Tax Credit
$210.00
Each $1,000 Increase In Salary Results In An Increase
Of Tax Payable Of $197.50 [$210.00 – (25%)($50)]
Each $1.00 Increase In Salary Increases Tax Payable By
$0.1975.
To Use Up $2,371 In Credits, Need Additional Salary Of
$12,005 ($2,371/$0.1975)
38
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
Pre-Salary Taxable Income
Salary
Corporate Taxable Income
Corporate Tax At 16 Percent
Available For Dividends
$29,500
( 12,005)
$17,495
( 2,799)
$14,696
39
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
Dividends Received
Gross Up (25%)
Taxable Dividends
Salary
Taxable Income
$14,696
3,674
$18,370
12,005
$30,375
40
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
Personal Tax At [(25%)($30,375)]
$7,594
Personal Tax Credits
( 3,920)
Dividend Tax Credit (Gross Up)
( 3,674)
Personal Tax Payable
Nil
41
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
Dividends Received
Salary Received
Personal Tax Payable
After Tax Retention
$14,696
12,005
Nil
$26,701
42
© 2008, Clarence Byrd Inc.
Dividend/Salary Combination
 All
Salary Approach
$26,045
 All
Dividend
$24,780
 Dividend/Salary
$26,701
43
© 2008, Clarence Byrd Inc.
Conclusions

All Dividends



Ineffective
Doesn’t Use All Credits
Need Minimum Salary of
$12,005 To Use Credits
44
© 2008, Clarence Byrd Inc.
Conclusions

Combination salary/dividend
improves on all dividend and all
salary

Reflects the fact that the 16
percent corporate rate is below
the 20 rate built into the
dividend gross up and tax credit
procedures.
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© 2008, Clarence Byrd Inc.
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© 2008, Clarence Byrd Inc.