Module 8: Taxable income and tax payable Corporations Part 1

Transcription

1 Module 8: Taxable income and tax payable Corporations Part 1 Overview As with an individual, a corporation's income is determined under section 3. For corporations, section 3 income is reclassified prior to doing the corporate tax calculations. This is because the various deductions and additions to tax payable for a corporation are based on the reclassification of income items. A large number of the ITA sections you studied in previous modules are generally applicable to both individuals and corporations, except when specifically identified as applicable only to one or the other. For example, you learned that dividends are taxable in the taxation year they are received, regardless of whether they are received by an individual or by a corporation. Similarly, when you studied how to determine business income or loss for tax purposes, you learned that all these rules are applicable for both individuals and corporations. The calculation of a capital gain or loss, or the determination of an allowable business investment loss, is the same whether calculated for an individual or a corporation. There are some exceptions, but they are always mentioned in the ITA. For example, the dividend gross-up and credit regime is applicable for individuals and not corporations. In this module, you will learn what type of corporation is entitled to the small business deduction and that this deduction must be shared among associated corporations where applicable. Furthermore, if certain conditions are met, a corporation may be entitled to a deduction for manufacturing and processing profits. Test your knowledge Begin your work on this module with a set of test-your-knowledge questions designed to help you gauge the depth of study required Module Types of corporations 8.2 Calculating net income and taxable income 8.3 Federal basic tax, general rate reduction, and tax abatement 8.4 Associated corporations and the small business deduction 8.5 Other deductions in calculating tax payable Learning objectives 8.1 Explain the principles underlying the taxation of corporations, identify the different types of corporations, and explain why the differences are important. (Level 1) 8.2 Reconcile accounting income and net income for tax purposes, classify the different types of income of a corporation, and determine the taxable income. (Level 1) 8.3 Compute the basic tax payable, the general rate reduction, and the tax abatement under Part I, identifying common deductions in this process, and briefly explain the process of allocating taxable income among provinces. (Levels 1 and 2) 8.4 Calculate the small business deduction including the situation of an associated corporation. (Level 1) 8.5 Determine whether a corporation is eligible for the manufacturing and processing profits deduction, the investment tax credit, and the foreign tax deduction. (Level 2) file:///f /Courses/ /CGA/TX1/06course/m08intro.htm[11/10/2010 4:44:03 PM]

2 Assignment reminder: Assignment #3 (see Module 9) is due at the end of week 9 (see Course Schedule). You may wish to take a look at it now in order to familiarize yourself with the requirements and to prepare for any necessary work in advance. Module summary Print this module file:///f /Courses/ /CGA/TX1/06course/m08intro.htm[11/10/2010 4:44:03 PM]

3 8.1 Types of corporations Learning objective Explain the principles underlying the taxation of corporations and identify the different types of corporations and explain why the differences are important. (Level 1) Required reading Optional reading LEVEL 1 Text: 11,210 to 11,216 (Level 1) ITA: Definitions, 89(1): private corporation, public corporation, 125(7) Canadian-controlled private corporation (Level 1) IT: 391R REG: 3200, 7100 The different rules that apply in computing a corporation's tax payable depend on its corporate status. There are five types of corporations: Canadian-controlled private corporation (CCPC) other private corporation public corporation corporation controlled by a public corporation other For the purpose of this course, you confine your analysis of corporate status to public corporations and private corporations. Public corporation The definition of a "public corporation" is given in subsection 89(1) and refers to REG 3200, which lists the stock exchanges in Canada. REG 3200 is optional reading and not examinable. In practice, public corporations are generally companies listed on a Canadian stock exchange and companies that elect to be public corporations in specific circumstances. Private corporation The definition of a "private corporation" is found in subsection 89(1). A private corporation is a corporation that is resident in Canada and is: not a public corporation not controlled by one or more public corporations or by a prescribed federal Crown corporation (listed in REG 7100) not controlled by a combination of public and prescribed federal Crown corporations For more details on the definition of private and public corporations, review IT-391R, which is optional reading and not examinable. file:///f /Courses/ /CGA/TX1/06course/m08t01.htm[11/10/2010 4:44:04 PM]

4 8.2 Calculating net income and taxable income Learning objective Reconcile accounting income and net income for tax purposes, classify the different types of income of a corporation, and determine the taxable income. (Level 1) Required reading Optional reading LEVEL 1 Text: 11,010 to 11,020; 11,050 to 11,085 (include Example Problem in 11,085); 11,160 (Level 1) Text: 11,090 to 11,125; 11,135 to 11,155 (omit Example Problem 11-7 in 11,155) (Level 2) ITA: 2(2), 12(1)(j) and (k), 18(1)(p), 82(1), 90(1), 110.1, 111, 112(1) (Level 1) ITA: Definitions, 89(1): Canadian corporation, taxable Canadian corporation (Level 1) ITA: Definitions, 125(7): active business carried on by a corporation, income of the corporation for the year from an active business, personal services business, specified investment business (Level 1) ITA: Definitions, 248(1): specified shareholder (Level 1) REG: 1100(3) (Level 2) Forms: T2 Corporation Income Tax Return; T2 Schedule 1; T2 Schedule 4; T2 Schedule 7 (found on the CRA website in the Forms and Publications section) IT: 73R6, 232R3 Reconciliation of accounting income to net income for tax purposes Remember that "income for tax purposes" is a legal concept and is not income for accounting purposes. (Income for tax purposes is calculated under section 3 of the ITA). T2 Schedule 1 is the form used to reconcile net income (loss) as reported in the financial statements to net income (loss) for tax purposes when filing a T2 Corporation Income Tax Return. Types of income As with an individual, a corporation's income is classified according to different sources, for example, business or property. For corporations, section 3 income is reclassified before doing the corporate tax calculations. This is because the various deductions and additions to tax payable for a corporation are based on specific categories of income. Each corporation that is carrying on a business may realize the following types of income [defined in subsection 125(7)] for ITA purposes: active business income (ABI) specified investment business income personal services business income The following example illustrates the calculation of net income and the classification of different types of business income. file:///f /Courses/ /CGA/TX1/06course/m08t02.htm[11/10/2010 4:44:04 PM]

5 Example Client Inc. generated the following data for its taxation year ending December 31: Business A income $185,000 Business B loss (58,000) Interest on bonds 5,000 Canadian public corporation taxable dividends 25,000 Interest on loan to acquire shares of the Canadian public corporation 3,000 Taxable capital gain on disposition of shares 37,500 Allowable capital loss on disposition of land (9,000) Compute Client Inc.'s income for the year under section 3. Solution Taxable income Certain elements must be deducted from or added to the corporation's income to determine its taxable income, as defined in subsection 2(2). For corporations, charitable donations are deductible under Division C in computing taxable income. Also, income inclusions for the dividend received by a corporation from a taxable Canadian corporation and certain dividends received from a foreign affiliate are not subject to Part I tax and are deductible in computing taxable income. Loss carryover The rules on loss carryovers set out in paragraphs 111(1)(a) to (e) are the same for a corporation as for an individual. T2 Schedule 4 is the prescribed form for keeping track of a corporation's losses. LEVEL 2 Acquisition of control The intent of the so-called "stop-loss" rules is to prevent taxpayers from obtaining tax benefits from losses, especially when there is no real disposition of the acquired property. Further, there are limitations for the transferability of losses to new corporations when there is a change in control. The text sections 11,095 to 11,125 outline the rules pertaining to the acquisition of control and its effect on losses and the tax values of its assets. The following summarizes the rules that apply to limit the use of losses where control of a corporation changes. 1. Deemed year end A corporation is deemed to have a year end immediately before an acquisition of control. This year end will add one year to the age of any existing losses, causing them to expire more quickly than would otherwise have been the case. Any current-period losses are therefore determined before the change and consequently the normal restrictions apply to loss carryovers, the carryover period, charitable donations, and replacement property rules. As well, REG 1100(3) requires that CCA be prorated for the short year. 2. Net capital losses expire Net capital losses incurred prior to the acquisition of control expire and cannot be deducted in the year of change in control or in subsequent years, and net capital losses incurred in a taxation file:///f /Courses/ /CGA/TX1/06course/m08t02.htm[11/10/2010 4:44:04 PM]

6 year after change in control may not be carried back to a year prior to acquisition. This rule also applies to property losses and allowable business investment losses that are normally considered non-capital rather than net capital losses. 3. Accrued losses realized The corporation is deemed to have realized any losses accrued on its depreciable and eligible capital properties immediately prior to the acquisition of control. These losses are known as "pregnant losses" and are equal to the difference, if any, between UCC and the fair market value of all the property in the class. Any accrued inventory losses, using the "lower of cost or market" rule, or accounts receivable losses are also realized just prior to the deemed year end. Accrued losses on non-depreciable property are deemed to be realized at the deemed year end. If the fair market value of a property is less than the ACB, the realized loss will increase the capital loss prior to the acquisition of control. If nothing is done, these allowable capital losses (now part of the net capital loss balance) will expire upon change in control. To ease the tax burden, corporations may elect to create a taxable capital gain using an election under paragraph 111(4)(e) to offset the deemed allowable capital loss that would otherwise expire. A similar election is available permitting a corporation to elect to have a deemed disposition for any depreciable property on which recapture has accrued. In both these elections, the objective is to permit the corporation to trigger capital gains or recapture to reduce the amount of net capital losses or non-capital losses that would otherwise expire due to the acquisition of control. This is illustrated in Example Problem 11-6 in text section 11, Non-capital losses limited use after change in control Non-capital losses from carrying on a business and farm losses incurred prior to change in control may be used only if: the business in which the loss was sustained is carried on throughout the year in which the losses are applied; there is reasonable expectation of profit from that business; and the losses may only be applied against income from the business and/or the income of a business selling similar properties or providing similar services. The deemed year end forms a barrier through which non-capital losses may pass only if the above conditions are met. Note that non-capital losses stemming from a property income source are not deductible after an acquisition of control. file:///f /Courses/ /CGA/TX1/06course/m08t02.htm[11/10/2010 4:44:04 PM]

7 Solution 3(a) Business A income $185,000 Interest on bonds 5,000 Taxable dividends ($25,000 $3,000) 22,000 $212,000 3(b) Taxable capital gain $ 37,500 Allowable capital loss (9,000) 28,500 3(d) Business B loss (58,000) Income for the year per section 3 $182,500 Note: If you classify the net income according to the definitions in section 125, the sources of income are split as follows: Active business ($185,000 - $58,000) [125(7)] $127,000 Property income Interest on bonds Net taxable dividends $ 5,000 22,000 27,000 Net taxable capital gain ($37,500 $9,000) 28,500 $182,500 file:///f /Courses/ /CGA/TX1/06course/m08t02sol.htm[11/10/2010 4:44:05 PM]

8 8.3 Federal basic tax, general rate reduction, and tax abatement Learning objective Compute the basic tax payable, the general rate reduction, and the tax abatement under Part I, identifying common deductions in this process, and briefly explain the process of allocating taxable income among provinces. (Levels 1 and 2) Required reading LEVEL 1 Text: 11,225 to 11,255 (Level 1) Text: 11,260 to 11,270 (Level 2) ITA: 123(1), 123.4(1) and (2), 124(1) (Level 1) REG: 400(2)(a) to (g), 402(1) to (5) (Level 2) Federal basic tax payable Subsection 123(1) establishes the basic tax rate applicable to taxable income of a corporation. The federal corporate tax rate is 38%. General rate reduction Subsection 123.4(2) provides for a general rate reduction from tax otherwise payable by a corporation. You will find the general rate reduction percentage for 2010 (10%) and later calendar years in the text section 11,245. This rate reduction does not apply to income eligible for preferential treatment, such as the small business deduction, the manufacturing and processing deduction, or the refundable tax on investment income provisions. These items continue to attract the 38% tax rate. Federal tax abatement Under subsection 124(1), any corporation (private or public) with income earned in a province is entitled to a deduction from its tax otherwise payable, equal to 10% of its taxable income earned in a province. This is in recognition that all provinces and territories impose tax on corporate income. The federal tax abatement does not provide complete relief if the province's tax rate is higher than 10%. LEVEL 2 Permanent establishment Taxable income is allocated based on whether the corporation has a permanent establishment in a specific province or territory. Read Text section 11,260 to understand the concept of a "permanent establishment." Allocation of taxable income As a basic rule, under REG 402(1) and (2), where a corporation has a permanent establishment in a province and has none elsewhere, its taxable income is entirely allocated to that province for the taxation year. However, if a corporation has a permanent establishment in more than one province, its taxable income for the year is allocated among the different permanent establishments in accordance with the rules set out in file:///f /Courses/ /CGA/TX1/06course/m08t03.htm[11/10/2010 4:44:05 PM]

9 REG 402(3). The calculation is found on Form T2 S5-1. Example Louis Ltd. manufactures bicycles. For the fiscal period ending December 31, 2010, the company s taxable income earned in Alberta is $160,000. Assume the income is not eligible for any preferential treatment. Louis Ltd. s computation of Part I tax is as follows: Basic tax [subsection 123(1)] $160,000 38% $ 60,800 General deduction from tax [subsection 123.4(2)] $160,000 10% (16,000) Abatement [subsection 124(1)] $160,000 10% (16,000) Part I tax $ 28,800 Redo the above calculation assuming the income is eligible for preferential treatment. Solution file:///f /Courses/ /CGA/TX1/06course/m08t03.htm[11/10/2010 4:44:05 PM]

10 Solution Basic tax [subsection 123(1)] $160,000 38% $ 60,800 Abatement [subsection 124(1)] $160,000 10% (16,000) Part I tax $ 44,800 Note how the abatement did not change between the two situations. file:///f /Courses/ /CGA/TX1/06course/m08t03sol.htm[11/10/2010 4:44:06 PM]

11 8.4 Associated corporations and the small business deduction Learning objective Calculate the small business deduction including the situation of an associated corporation. (Level 1) Required reading Optional reading LEVEL 1 Text: 12,110 to 12,125.30; 12,140 to 12,200.30; 12,205 to 12,210 (Level 1) ITA: 125(1) to 125(4), 256(1), 256(1.2), 256(1.5) (Level 1) ITA: Definitions, 125(7): Canadian-controlled private corporation (Level 1) Form T2 Schedule 23 (found on the CRA website) Text: 12,130 (elimination of small business deduction for large CCPCs) ITA: 125(5.1) IT: 64R4 Consolidated, 458R2, and 73R6 Associated corporations You will find that certain rules draw on the concept of "associated corporations," whether for calculating the small business deduction or for determining if some of the property income should be treated as active business income (ABI). Thus, this concept is very important for the purposes of establishing tax payable for many corporations. Subsection 256(1) provides the basic rules for determining whether two corporations are associated at any time in the year. Read text sections 12,170 to 12,210 (omit 12,200.40), and review the following additional three examples, which illustrate the basic rules. Example 1 Consider the following two situations. Assume that no specified class of shares is issued, meaning that only common shares are issued. In the first situation, Mrs. Adam controls both Arco Ltd. and Biaz Ltd. Because Mrs. Adam directly controls both companies, Arco Ltd. and Biaz Ltd. are associated per paragraph 256(1)(b). That is, the same person or group of persons controls both corporations, directly or indirectly. Consider the second situation. Citing the relevant section(s) of the ITA to support your answer, determine whether Dingo Ltd. and Callas Ltd. are associated. file:///f /Courses/ /CGA/TX1/06course/m08t04.htm[11/10/2010 4:44:07 PM]

12 Solution Example 2 In the following corporate structure, under paragraph 256(1.2)(d), what percentage of shares are Ms. Blake and Mr. Ali deemed to own of Albaz Ltd., Cello Ltd., and Dak Ltd.? Solution file:///f /Courses/ /CGA/TX1/06course/m08t04.htm[11/10/2010 4:44:07 PM]

13 Example 3 In the following situation, Anne, Lisa, and Brenda are sisters. Assume that no specified class of shares is issued, meaning that only common shares are issued. Citing the relevant section(s) of the ITA to support your answer, determine whether Ding Ltd. and Dong Ltd. are associated. Solution The rules for establishing that two corporations are associated are quite extensive. For supplementary reading on this subject, consult IT-64R4, which is optional reading and not examinable. Small business deduction A corporation must be a Canadian-controlled private corporation [as defined under subsection 125(7)] throughout its taxation year to qualify for the small business deduction (SBD) allowed under subsection 125(1). The SBD was introduced to help small businesses finance operations with retained earnings. Exhibit 12-2 in text section 12,110 illustrates how the SBD affects the calculation of the effective total corporate tax. Note that the SBD rate is 17% for 2009 and Paragraph 125(1)(c), which sets out one of the limits applicable to the calculation of the SBD, mentions "the corporation's business limit for the year." This limit is set at $500,000 for 2009 and 2010 in subsection 125(2) if the corporation is not associated in the year with any other CCPC. Note the wording "in the year" rather than "throughout the year"; this wording means that, if the corporations are associated for at least one day during the year, the business limit must be allocated among them for that taxation year, as provided for in subsection 125(3). Large CCPCs (with taxable capital employed in Canada between $10 and $15 million) are not fully eligible for the small business deduction. The SBD business limit of $500,000 (for 2009 and 2010) is reduced by $1 for every $10 of taxable capital in excess of $10 million until it is eliminated at $15 million. Review IT-73R6 and IT-458R2 for further information. These bulletins are optional readings and not examinable. Activity Small business deduction In this activity, you calculate the small business deduction in a scenario involving two associated companies. file:///f /Courses/ /CGA/TX1/06course/m08t04.htm[11/10/2010 4:44:07 PM]

14 Solution 1 The same group of persons (Mrs. Roy and Mr. Nelson) directly controls Dingo Ltd. and Callas Ltd. Therefore, Dingo Ltd. and Callas Ltd. are associated per paragraph 256(1)(b). A group of persons means two or more persons, each of whom owns capital shares of the capital stock of the corporation. There is no requirement for the group to be related. file:///f /Courses/ /CGA/TX1/06course/m08t04sol1.htm[11/10/2010 4:44:07 PM]

15 Solution 2 Under paragraph 256(1.2)(d), each shareholder is deemed to own shares of each of the corporations, calculated as follows, even though, in fact, they directly hold none of these shares: Mr. Ali Ms. Blake Albaz Ltd. 30% 60% 30% = 5.4% 70% 60% 30% = 12.6% Dak Ltd. 30% 60% = 18% 70% 60% = 42% Cello Ltd. 30% 42% = 12.6% 70% 42% = 29.4% In addition, subsection 256(1.5) states that a person who owns shares in two corporations is deemed to be related to himself. file:///f /Courses/ /CGA/TX1/06course/m08t04sol2.htm[11/10/2010 4:44:08 PM]

16 Solution 3 Ding Ltd. and Dong Ltd. are associated. Per paragraph 256(1)(e), two corporations are associated if each of the corporations is controlled by a related group and each of the members of one of the related groups is related to all of the members of the other related group, and one or more persons who are members of both related groups own not less than 25% of the shares of any class, other than a specified class, of each corporation. file:///f /Courses/ /CGA/TX1/06course/m08t04sol3.htm[11/10/2010 4:44:09 PM]

17 8.5 Other deductions in calculating tax payable Learning objective Determine whether a corporation is eligible for the manufacturing and processing profits deduction, the investment tax credit, and the foreign tax deduction. (Level 2) Required reading Optional reading LEVEL 2 Text: 11,310 to 11,325; 11,337 to 11,345.10; 12,230 (Level 2) ITA: 125.1(1) and (3) (Level 2) REG: 5201 (Level 2) Text: 11,330 to 11,335 (computation of foreign tax credit) Text: 11, (computation of investment tax credit) ITA: 126(1), (2) and (7), 127(5), (11) and (11.1), IC: 78-4R3, 78-4R3SR Manufacturing and processing profits deductions The federal government introduced the manufacturing and processing profits (M&P) deduction to provide encouragement to the manufacturing industry by allowing a reduced tax rate on manufacturing profits. The M&P deduction under subsection 125.1(1) is available to any private or public corporation. The percentage deduction is the same as the general rate reduction (9% for 2009 and 10% for 2010). The M&P deduction is the lesser of the following amounts: a. Manufacturing and processing profits earned in Canada during the year Less: Amount of income qualifying for the SBD b. Taxable income Less: The aggregate of: amount of income qualifying for the SBD 3 times the foreign tax credit deducted from business income under subsection 126(2) (this calculation determines the foreign business income component of the taxable income) its aggregate investment income, if the corporation is a CCPC A corporation entitled to the SBD whose taxable income does not exceed the business limit is not eligible for the M&P deduction. This is illustrated in the Example Problem 12-8 in text section 12,230. Part LII of the Regulations contains the provisions for calculating the portion of ABI that applies to manufacturing or processing. Part LII consists of REG 5200 to For the purposes of this course, only REG 5201 is examinable. REG 5201 is the Small Manufacturer's Rule. A small manufacturing corporation that is eligible for the file:///f /Courses/ /CGA/TX1/06course/m08t05.htm[11/10/2010 4:44:09 PM]

18 M&P deduction is not required to use the complex formula provided in REG 5200 if it satisfies the following conditions: a. Its activities during the year are primarily manufacturing or processing in Canada of goods for sale or lease. b. Active business income (ABI), including ABI of all associated corporations, does not exceed the business limit for the year. c. The corporation is not engaged in any of the activities not considered manufacturing or processing as defined under subsection 125.1(3) at any time during the year. A few examples of such activities include farming, logging, and construction. d. The corporation does not carry on any active business outside Canada during the year. If all the above conditions are met (being the "small manufacturer s rule"), the M&P deduction is allowed on total business income, even if the latter does not consist solely of ABI from manufacturing or processing (that is, passive sources of income are included in the calculation). file:///f /Courses/ /CGA/TX1/06course/m08t05.htm[11/10/2010 4:44:09 PM]

19 Module 8 Self-test Question 1 Discuss the legislative intent underlying the following tax rule: A Canadian-controlled private corporation may claim a small business deduction on its active business income up to the annual business limit allocated to it. This deduction must be shared among corporations that are associated for tax purposes with the taxpayer. Solution Question 2 For each of the following situations, determine if the taxpayer is a Canadian-controlled private corporation that qualifies for the small business deduction. If not, explain why. Solution Question 3 a. A group of six full-time psychologists operate a counselling business through a limited partnership. Each psychologist is a limited partner. b. A private manufacturing firm incorporated in Canada. The company is controlled by a pharmaceutical corporation listed on the New York Stock Exchange. c. A student paint business incorporated in Manitoba with branches in five other Canadian provinces. The company is privately held by an individual resident in Hong Kong. d. A geologist, Prisella Preston, works at Enerco Resources on a full-time basis as an independent consultant. Prisella bills Enerco on a monthly basis, through Preston Corporation, owned 50% by Elvis and 50% by herself. Elvis and Prisella are the only employees of Preston Corporation. e. A holding corporation is owned by a trust and Mr. Johannson. The holding corporation owns a rental property in Toronto and five minority interests in various public corporations. All investments are passively held for Mr. Johannson's grandchildren. Rita is the owner-manager of Kid's Plus, a Canadian-controlled private corporation that manufactures and distributes clothing for children and teens. In the current year, the corporation estimates it will have net income from active business (and taxable income) of $525,000. Advise Rita as to how she can minimize her taxes payable, and what other considerations are important for the current year ended December 31. Solution Question 4 Discuss the tax implications of being "associated." Solution Question 5 For each of the following unrelated cases, determine whether the corporations are "associated" for the purpose file:///f /Courses/ /CGA/TX1/06course/m08selftest.htm[11/10/2010 4:44:10 PM]

20 of obtaining the small business deduction: a. Regan owns 100% of AGM Canada Inc., a CCPC, and 25% of American Coffee, a foreign company. Regan's brother owns 75% of American Coffee. b. Archie and Veronica together own 60% of two CCPCs: Company A and Company B. Jughead owns the other 40% of Companies A and B and 100% of Company C. c. Bart owns 100% of the shares of Barton Enterprises. His two sons, Kevin and Neil, each own 30% of Iron Gates Inc. Barton Enterprises holds the balance of the Iron Gates shares. Solution file:///f /Courses/ /CGA/TX1/06course/m08selftest.htm[11/10/2010 4:44:10 PM]

21 Self-test 8 solution 1 Equity among taxpayers. The government does not want a group of successful small businesses that are controlled by the same group of persons to all receive preferential tax treatment. file:///f /Courses/ /CGA/TX1/06course/m08selftestsol1.htm[11/10/2010 4:44:10 PM]

22 Self-test 8 solution 2 ITA section 125(7) a. Because they are a limited partnership, the psychologists are not classified as a Canadiancontrolled private corporation (CCPC). They must incorporate as a CCPC. b. Because the company is controlled by a public corporation, it is not classified as a CCPC. c. Assuming that the resident in Hong Kong is considered a non-resident of Canada for tax purposes under the residency rules, the business is not classified as a CCPC as it is not controlled by a Canadian resident. d. In all likelihood, this is a personal services business or an incorporated employee. Consequently, the small business deduction is disallowed. e. The holding corporation is a CCPC because it is privately held and controlled by Canadian residents. However, to obtain the small business deduction, the company must be carrying on an active business, which it is not. Since the company is only passively holding investments, and realizes only income from property, the company is ineligible for the small business deduction. file:///f /Courses/ /CGA/TX1/06course/m08selftestsol2.htm[11/10/2010 4:44:11 PM]

23 Self-test 8 solution 3 Since Kid's Plus is a Canadian-controlled private corporation (CCPC), it can achieve significantly lower tax rates as a result of the small business deduction (SBD) on the first $500,000 of active business income (ABI). Based on the estimated net income from ABI, Kid s Plus will benefit from a tax deferral in the form of the 17% SBD on the first $500,000. The remaining $25,000 may qualify for the manufacturing and processing profits (M&P) deduction of 10% of manufacturing and processing profits that are not subject to the SBD or the general rate reduction of 10% if Kid s Plus is not eligible for the M&P deduction. As the owner-manager of a CCPC, Rita has the flexibility to either pay out dividends or pay herself a reasonable salary/bonus for services rendered to her company. Salary/bonus is deductible from taxable income of the corporation whereas dividends are paid from after-tax income. Salary/bonus received will be taxed in the hands of Rita at her applicable personal income tax rate. The dividends will need to be grossed-up (offset by the dividend tax credit) and subject to personal taxes as well. In general, if the corporation s taxable and ABI is within the SBD threshold (first $500,000 of ABI), the decision to pay salary or dividend is not critical. If Rita does not need additional funds, the corporate income should be retained within Kids Plus to be taxed at its lower rate and then used for reinvestment. Depending on Rita s income tax bracket, her requirement for personal funds and the projected level of the corporation s taxable income in future years, she will need to determine which is the most advantageous from a tax planning perspective for both the corporation and herself combined. file:///f /Courses/ /CGA/TX1/06course/m08selftestsol3.htm[11/10/2010 4:44:12 PM]

24 Self-test 8 solution 4 When two or more CCPCs are associated for tax purposes, the small business deduction must be shared among the associated companies. Also, all associated corporations are related corporations and as such must transact between themselves at fair market value. Most additional tax preferences and incentives must also be shared. The intention of the associated status is to prevent multiple access to various tax preferences/incentives by the same principal owners. file:///f /Courses/ /CGA/TX1/06course/m08selftestsol4.htm[11/10/2010 4:44:12 PM]

25 Self-test 8 solution 5 a. AGM Canada Inc. and American Coffee are associated because the person who controls AGM is related to the person who controls American Coffee, and that same person owns not less than 25% of the share of American Coffee [subsection 256(1)(c)]. This should not have any affect since American Coffee is a foreign company, not resident in Canada for tax purposes, or subject to the small business deduction. b. Company A and Company B are associated because they are both controlled by the same group of persons [subsection 256(1)(b)]. Since Jughead is not in a position to control Company A or Company B, Company C is not associated with Company A or Company B assuming these people are not related. c. Barton Enterprises and Iron Gates are associated because Barton Enterprises is controlled directly by Bart who is related to each member of the group that controls Iron Gates [subsection 256(1)(d)]. file:///f /Courses/ /CGA/TX1/06course/m08selftestsol5.htm[11/10/2010 4:44:12 PM]

26 Module 8 summary Taxable income and tax payable Corporations Part I This module deals with the computation of taxable income and tax payable for a corporation. Depending on the type of income earned, certain deductions are allowed in computing tax payable. The types of corporations are: Public Private Canadian-controlled private corporation (CCPC), which is a form of private corporation Different rules apply in computing a corporation's tax payable depending on whether or not it is a private or a public corporation. Income for income tax purposes is a legal concept. Accounting income of a corporation must be reconciled to income for tax purposes in accordance with section 3. From taxable income, the following may be deductible: taxable dividends received from taxable Canadian corporations or a corporation that is controlled by it and is resident in Canada taxable dividends received from foreign corporations may be deductible in certain circumstances charitable donations loss carryforwards (non-capital, net capital, farm losses, and restricted farm losses). The non-capital loss carryforward period is extended to 20 years (from 10 years) for losses incurred in taxation years that end after For the purposes of computing corporate tax payable, section 3 income must be reclassified into separate categories: three forms of business income active business income (ABI) specified investment business income (income from a business whose principal purpose is to derive income from property) personal services business income aggregate investment income (AII), which includes passive forms of income, such as property income and taxable capital gains The basic federal tax rate applicable to a corporation's taxable income is 38%. There is a general rate reduction from tax of 9% (for 2009) and 10% (for 2010) if the corporation is not eligible for any other tax incentives, such as the small business deduction (SBD), manufacturing and processing profits (M&P) deduction, and the refundable tax on aggregate investment income. In recognition of the taxes imposed by provinces, a federal tax abatement of 10% is allowed on taxable income allocated to the provinces. If the corporation has a permanent establishment in more than one province, a calculation of taxable income earned for each province is usually necessary. The calculation uses gross wages and gross sales on a permanent establishment basis. file:///f /Courses/ /CGA/TX1/06course/m08summary.htm[11/10/2010 4:44:13 PM]

27 This module looks at the relationship between corporate taxpayers who are associated corporations for the purposes of the SBD. Where a corporation is a CCPC throughout its taxation year, it may qualify for the small business deduction (SBD). For 2009 and 2010, the SBD is 17% of the lesser of the following amounts: ABI taxable income corporation's business limit for the year Associated CCPCs must share the business limit for the SBD. The business limit is prorated where the taxation year of the corporation does not coincide with the calendar year. The business limit is $500,000 for 2009 and A corporation can claim a 9% (for 2009) and a 10% (for 2010) manufacturing and processing profits (M&P) deduction on eligible manufacturing and processing income that is not eligible for the SBD. file:///f /Courses/ /CGA/TX1/06course/m08summary.htm[11/10/2010 4:44:13 PM]