The New Eligible Dividend Rules –
A Closer Look
Presented for The Canadian Institute of Financial Planners –
National Conference
Kim G C Moody, CA, TEP
RSM Richter LLP
June 11, 2007, Calgary, Alberta
RSM Richter is an independent member firm of RSM International,
an affiliation of independent accounting and consulting firms.
A Closer Look at the New Eligible Dividend Rules
Agenda
• Brief history
• What is GRIP and why is it so important?
• Traditional remuneration strategies – revisited.
• Asset vs. share example
• Use of a triangle structure
• Shareholder agreements
• How should advisors and their clients deal with the changes?
1
Brief History
•
•
•
•
November 23, 2005 – Department of Finance News Release.
Announces that, effective January 1, 2006, taxation will be reduced
for “eligible dividends” in order to level the playing field for
corporations and income trusts.
Many questions/issues.
Draft legislation released June 29, 2006 – 66 pages of draft
amendments and explanatory notes.
2
Department of Finance Release
Brief History (cont’d)
•
•
•
September 29, 2006: CICA-CBA Joint Committee on Taxation
releases comments to Department of Finance.
2nd round of draft legislation released October 16, 2006 – mostly
minor changes but some changes noteworthy.
Bill C-28, which contains eligible dividend draft legislation, received
First Reading October 18, 2006 and passed by the House of
Commons on December 11, 2006.
3
Department of Finance Release
Brief History (cont’d)
•
•
•
Received 3rd reading on February 14, 2007 and Royal Assent on
February 21, 2007.
October 31, 2006 – Department of Finance News Release – new
“Distribution Tax” for publicly traded income trust and partnerships.
October 31, 2006 Release appears to be a response to recent
announcements of BCE and Telus and Jack Mintz’s paper “Income
Trust Conversions: Estimated Federal and Provincial Revenue
Effects”
4
The New Tax Pools
•
•
By definition, dividends are paid out of after-tax corporate retained
earnings.
New rules introduce two new tax pools:
a) General-rate income pool (“GRIP”); and
b) Low-rate income pool (“LRIP”)
•
At most, a given corporation will have one GRIP or one LRIP at any
time.
5
What is GRIP and Why is it Important?
•
•
•
•
•
Company can pay eligible dividends to the extent that it has a GRIP
balance.
Preferential tax treatment to Canadian residents for receipt of an
eligible dividend.
Gross up of 45% and dividend tax credit of 11/18 of the grossed up
amount.
Results in an effective tax rate of 17.4493% for 2007.
Effective tax rate to decrease to 14.549% in 2009.
6
General Rate Income Pool (“GRIP”)
•
•
•
New definition of GRIP will appear in subsection 89(1) of the Act.
Applicable only for a taxable Canadian corporation that is a
Canadian-controlled private corporation (“CCPC”) or a deposit
insurance corporation (“DIC”).
DIC’s are ignored for the purposes of this presentation.
7
GRIP - Timing
•
GRIP is calculated at the end of a particular taxation year.
8
GRIP – Calculation – Overview
•
•
•
•
•
Calculated by formula A – B
Can be a positive or negative amount.
In broad terms, A is the corporation’s GRIP at the end of the taxation
year determined without reference to any specified future tax
consequences.
Specified future tax consequences includes the carryback of noncapital losses under paragraph 111(1)(a).
B adjusts that amount calculated under A to the extent that specified
future tax consequences for preceding taxation years reduce the
corporation’s taxable income subject to the general corporate rate.
9
GRIP – Calculation of “A”
•
•
•
•
A = the positive or negative amount that would, before taking into
consideration the specified future tax consequences, be
determined by the following:
A = C + .68 (D-E-F) + G + H – I
C = corporation’s GRIP at the end of its preceding taxation year.
D = the corporation’s taxable income for the particular taxation year
10
GRIP – Calculation of “A”
(con’td)
•
E = the amount determined by multiplying the amount, if any,
deducted by the corporation under subsection 125(1) (the small
business deduction) for the particular taxation year by the
quotient obtained by dividing 100 by the rate of deduction
provided under that subsection for the particular taxation year.
•
F = if the corporation is a CCPC, the lesser of the
corporation’s aggregate investment income or the taxable
income for the particular taxation year of a CCPC and if the
corporation is not a CCPC nil.
11
GRIP – Calculation of “A”
(cont’d)
•
•
G = the total of:
a) An eligible dividend received by the corporation in the
particular taxation year; or
b) An amount deductible under section 113 in computing
the taxable income of the corporation in the particular
taxation year
H = the total of all amounts determined under new
subsections 89(4) to (6) in respect of the corporation for the
particular taxation year – this is to be discussed in later
slides.
12
GRIP - Calculation of “A”
(cont’d)
•
•
I
= a) unless paragraph (b) applies, the amount, if any, by which
i) the total of all amounts of each of which is the amount of
an eligible dividend paid by the corporation in its
preceding taxation year
exceeds
ii) the total of all amounts each of which is an excessive
eligible dividend designation made by the corporation in
its preceding taxation year, or
b) if subsection (4) applies to the corporation in the particular
taxation year, nil
Note that, as stated earlier, the calculation of ‘A’ is calculated before
taking into consideration the specified future tax consequences.
13
GRIP – Calculation of “B”
•
B = 68% of the amount, if any, by which
a) the total of the corporation’s full rate taxable incomes (as would be
defined in the definition “full rate taxable income” in subsection
123.4(1), if that definition were read without reference to its
subparagraphs (a)(i) to (iii)) for the corporation’s preceding three
taxation years, determined without taking into consideration the
specified future tax consequences, for those preceding taxation
years, that arise in respect of the particular taxation year,
exceeds
14
GRIP – Calculation of “B”
(cont’d)
b) the total of the corporation’s full rate taxable incomes (as would be
defined in the definition “full rate taxable income” in subsection
123.4(1), if that definition were read without reference to its
subparagraphs (a)(i) to (iii)) for those preceding taxation years
15
GRIP – Calculation of “B”
(cont’d)
•
See subsection 248(1) for the definition of “specified future tax
consequences”.
16
GRIP Summary
•
•
•
•
•
•
GRIP is generally the amount of after-tax income that was subject to
the general corporate tax rate, i.e. no small business deduction.
“GRIP bump” allowed for the 2000-2005 taxation years.
Includes receipt of “eligible dividends” and foreign dividends
deduction under subsection 112.
Does not include “aggregate investment income”.
Deduct “eligible dividends” paid.
Adjusted for specified future tax consequences for preceding
taxation years.
17
Alberta
Dividend Tax Rates
Federal - dividend gross up
Alberta - dividend gross up
Federal dividend tax credit
Alberta dividend tax credit*
Dividend tax rate
2006
2007
2008
2009
2010
2011
< $300,000 > $400,000 < $400,000 > $430,000 < $400,000 > $460,000 < $400,000 > $500,000 < $400,000 > $500,000 < $400,000 > $500,000
25.000%
45.000%
25.000% 45.000% 25.000%
45.000%
25.000% 45.000%
25.000%
45.000% 25.000%
45.000%
25.000%
45.000%
25.000% 45.000% 25.000%
45.000%
25.000% 45.000%
25.000%
45.000% 25.000%
45.000%
13.333%
18.966%
13.333% 18.966% 13.333%
18.966%
13.333% 18.966%
13.333%
18.966% 13.333%
18.966%
6.000%
7.500%
5.500%
8.000%
4.500%
9.000%
3.500% 10.000%
3.500%
10.000%
3.500%
10.000%
24.5838%
18.1743%
25.2088% 17.4493% 26.4588%
15.9993% 27.7088% 14.5493%
27.7088%
14.5493% 27.7088%
14.5493%
* The Alberta dividend tax credit on non-eligible dividends (i.e. income subject to the small business rate) may require minor adjustments due to technical issues related to different Federal
and Alberta small business thresholds.
18
2007 Top Marginal Rates, Dividend Tax Credit Rates and Amount of
Dividends that May be Received Without Incurring Tax in 2007*
Combined Top
Eligible Dividend
Amount of Eligible
Marginal Rates
Tax Credit Rate
Dividends Received Tax Free
Eligible
Dividends
Applied to
Applied to
Actual Dividend Taxable Dividend
Actual
Taxable
Dividend
Dividend
Federal
14.55%
27.50%
18.97%
$66,420
$96,310
British Columbia
18.47
17.40
12.00
150,840
218,720
Albertab
17.45
11.60
8.00
53,225
77,175
Saskatchewan
20.35
15.95
11.00
59,780
86,680
Manitoba
23.83
15.95
11.00
46,930
68,050
Ontarioc
24.64
9.72
6.70
45,535
66,025
Québec
29.69
17.26
11.90
26,580
38,540
New Brunswick
23.02
17.40
12.00
56,715
82,235
Nova Scotia
28.35
12.83
8.85
28,045
40,665
Prince Edward
Island
24.44
15.23
10.50
40,890
59,290
Newfoundland
32.52
9.64
6.65
13,780
19,980
*Source: taxnetpro.com; Carswell.
19
Proposed Corporate Tax Rates
Table 3: Proposed Corporate Income Tax Rates, 2007 - 2011
2006
2007
2008
2009
2010
2011
(percent)
Federal Rates
Alberta
Total
22.12
21.0
20.5
20.0
19.0
18.5
10.0
10.0
10.0
10.0
10.0
10.0
32.12
31.0
30.5
30.0
29.0
28.5
• Source – Department of Finance Backgrounder – October 31, 2006
20
Traditional Remuneration Strategies - Revisited
•
The following slide illustrates the cash flow difference between
paying a bonus from a Corporation versus incurring full corporate
taxes and paying taxable (non-eligible and eligible) dividends.
21
Traditional Remuneration Strategies - Revisited (cont’d)
Alberta - Bonus v. No Bonus
Bonus
2006
No Bonus
Bonus
2007
No Bonus
Bonus
2008
No Bonus
Bonus
2009
No Bonus
Bonus
2010
No Bonus
Bonus
2011
No Bonus
Taxable income
Bonus
Taxable income after bonus
$ 1,000,000
$ 700,000
$ 300,000
$ 1,000,000
$
$ 1,000,000
$ 1,000,000
$ 600,000
$ 400,000
$ 1,000,000
$
$ 1,000,000
$ 1,000,000
$ 600,000
$ 400,000
$ 1,000,000
$
$ 1,000,000
$ 1,000,000
$ 600,000
$ 400,000
$ 1,000,000
$
$ 1,000,000
$ 1,000,000
$ 600,000
$ 400,000
$ 1,000,000
$
$ 1,000,000
$ 1,000,000
$ 600,000
$ 400,000
$ 1,000,000
$
$ 1,000,000
Corporate income tax
Federal - small business rate
Federal - general rate
Alberta - small business rate
Alberta - general rate
Total corporate income tax
$
$
$
$
$
39,360
9,000
48,360
$
$
$
$
$
39,360
154,840
12,000
62,220
268,420
$
$
$
$
$
52,480
12,000
64,480
$
$
$
$
$
52,480
132,720
12,900
57,000
255,100
$
$
$
$
$
46,000
12,000
58,000
$
$
$
$
$
46,000
123,000
13,800
54,000
236,800
$
$
$
$
$
44,000
12,000
56,000
$
$
$
$
$
44,000
120,000
15,000
50,000
229,000
$
$
$
$
$
44,000
12,000
56,000
$
$
$
$
$
44,000
114,000
15,000
50,000
223,000
$
$
$
$
$
44,000
12,000
56,000
$
$
$
$
$
44,000
111,000
15,000
50,000
220,000
Dividend Pool
Non-eligible - Federal
Non-eligible - Alberta
Eligible - Federal
Eligible - Alberta
$
$
$
$
251,640
251,640
-
$
$
$
$
248,640
348,640
482,940
382,940
$
$
$
$
335,520
335,520
-
$
$
$
$
334,620
364,620
410,280
380,280
$
$
$
$
342,000
342,000
-
$
$
$
$
340,200
400,200
423,000
363,000
$
$
$
$
344,000
344,000
-
$
$
$
$
341,000
441,000
430,000
330,000
$
$
$
$
344,000
344,000
-
$
$
$
$
341,000
441,000
436,000
336,000
$
$
$
$
344,000
344,000
-
$
$
$
$
341,000
441,000
439,000
339,000
$
$
203,000
70,000
$
$
-
$
$
174,000
60,000
$
$
-
$
$
174,000
60,000
$
$
-
$
$
174,000
60,000
$
$
-
$
$
174,000
60,000
$
$
-
$
$
174,000
60,000
$
$
-
$
273,000
$
-
$
234,000
$
-
$
234,000
$
-
$
234,000
$
-
$
234,000
$
-
$
234,000
$
-
Personal income tax
Salary - Federal
Salary - Alberta
Total personal income tax on
Salary
Personal income tax
Eligible Dividend - Federal
Eligible Dividend - Alberta
Total personal income tax on
eligible dividend
$
$
-
$
$
70,264
13,882
$
$
-
$
$
59,693
11,028
$
$
-
$
$
61,544
5,263
$
$
-
$
$
62,562
-
$
$
-
$
$
63,435
-
$
$
-
$
$
63,871
-
$
-
$
84,146
$
-
$
70,721
$
-
$
66,807
$
-
$
62,562
$
-
$
63,435
$
-
$
63,871
$
$
49,281
12,582
$
$
48,693
17,432
$
$
65,707
18,873
$
$
65,531
20,510
$
$
66,976
23,513
$
$
66,624
27,514
$
$
67,368
27,950
$
$
66,781
35,831
$
$
67,368
27,950
$
$
66,781
35,831
$
$
67,368
27,950
$
$
66,781
35,831
$
61,863
$
66,125
$
84,580
$
86,041
$
90,489
$
94,138
$
95,318
$
102,612
$
95,318
$
102,612
$
95,318
$
102,612
Total taxes
$
383,223
$
418,691
$
383,060
$
411,862
$
382,489
$
397,745
$
385,318
$
394,174
$
385,318
$
389,047
$
385,318
$
386,483
Net cash flow (income
minus total taxes)
$
616,777
$
581,309
$
616,940
$
588,138
$
617,511
$
602,255
$
614,682
$
605,826
$
614,682
$
610,953
$
614,682
$
613,517
Net cash flow after tax per
$ of income
$
0.61678
$
0.58131
$
0.61694
$
0.58814
$
0.61751
$
0.60226
$
0.61468
$
0.60583
$
0.61468
$
0.61095
$
0.61468
$
0.61352
Personal income tax
Non-eligible dividend - Federal
Non-eligible dividend - Alberta
Total personal income tax on
non-eligible dividend
22
Traditional Remuneration Strategies - Revisited
Summary of cash flows:
2006
2007
2008
Bonus
616,777
616,940
617,511
No Bonus
581,309
588,138
602,255
2009
2010
2011
614,682
614,682
614,682
605,826
610,953
613,517
23
Traditional Remuneration Strategies - Revisited
Summary
•
•
•
•
•
By 2009 there is a nominal difference between a bonus down to
small business deduction (“SBD”) limit and no bonus (i.e. full
dividend).
Allows for a deferral of personal taxes if funds kept inside the
corporation, i.e. tax deferral of approximately 8% for 2007
(increasing to 10.5% for 2011).
Need to determine what the cash needs are of shareholder and
corporation; automatic bonus down to SBD limit is not necessary.
Reduction of bonus will reduce section 67 risks.
Watch SR + ED issues.
24
Asset Sale vs. Share Sale
•
The following example illustrates the cash flow difference between:
1. Selling the shares of a corporation personally, and
2. Selling the assets of a corporation and paying a dividend to the shareholder.
25
Asset Sale vs. Share Sale - Example
Facts – Share sale
•
•
•
•
•
Mr. Apples sells shares.
FMV = $1,000,000
ACB = $0
Mr. Apple is a resident of Alberta.
No ECGD
26
Asset Sale vs. Share Sale – Example
(cont’d)
Proceeds
ACB
Capital Gain
½ Taxable
Tax Rate
Personal Tax
1,000,000
0
1,000,000
500,000
39%
195,000
Total Cash Flow
Proceeds
1,000,000
Personal Taxes
(195,000)
Total Cash Flow
805,000
27
Asset Sale vs. Share Sale – Example
(cont’d)
Facts – Asset Sale
•
•
•
•
•
Mr. Apples owns 100% of Opco.
Opco’s only asset is goodwill.
FMV = $1,000,000
Corporation and Shareholder are resident of Alberta.
Assume SBD for Opco is not available.
28
Asset Sale vs. Share Sale – Example
(cont’d)
Corporation
Proceeds
Taxable portion – 50%
Tax Rate
1,000,000
500,000
31%
155,000
Proceeds
1,000,000
Corporate Taxes
(155,000)
Cash to Distribute
845,000
CDA Dividend
(500,000)
Eligible Dividend
(340,000)
Non-eligible Dividend
(5,000)
$ 845,000
29
Asset Sale vs. Share Sale – Example
Consequences
Dividend
Tax Rate
Tax Payable
CDA Dividend
500,000
0%
0
Eligible Dividend
340,000
17.45%
59,330
5,000
25.2%
1,260
Non-Eligible Dividend
$845,000
$60,590
30
Asset Sale vs. Share Sale – Example
Consequences (cont’d)
Total Cash Flow
Proceeds
1,000,000
Corporate Taxes
(155,000)
Personal Taxes
(60,590)
Total Cash Flow
$ 784,410
31
Asset Sale vs. Share Sale – Example
Summary
Total Cash flow:
Share Sale
Asset Sale
•
•
•
$805,000
$784,410
Difference between proceeds share sale and asset sale is
narrowing.
Not as big a bias for seller to sell shares.
May defer taxes personal taxes if funds are invested in corporation.
32
Triangle Structure
Trust
100%
99%
HoldCo
1%
OpCo
33
Advantages of Triangle Structure
•
•
•
Can push GRIP to Holdco.
QSBC preservation.
Reinvest after-tax corporate proceeds in Holdco (by paying tax-free
inter-corporate dividends from Opco to Holdco).
34
Shareholder Agreements
•
•
Should be flexible to allow manipulation and distribution of GRIP.
Necessity if have non-resident shareholders.
35
How Should Advisors and Their Clients Deal With the
Changes?
•
•
•
•
New rules are complicated.
Rules of thumbs no longer applicable.
Each situation must be evaluated to ensure proper tax planning is
undertaken.
General practitioner need to exercise extreme caution.
36