Chapter 15 Corporate Taxation And Management Decisions.

Chapter 15Chapter 15

Corporate Taxation AndCorporate Taxation And

Management DecisionsManagement Decisions

The Decision To IncorporateThe Decision To Incorporate

Tax ReductionTax Reduction

Tax DeferralTax Deferral

Income SplittingIncome Splitting

Other Other ConsiderationsConsiderations

© 2010, Clarence Byrd Inc.© 2010, Clarence Byrd Inc.22

Incorporation: Incorporation: Other AdvantagesOther Advantages

Limited LiabilityLimited Liability

Shareholders’ liability to creditors Shareholders’ liability to creditors limited to amounts investedlimited to amounts invested

For smaller corporations, personal For smaller corporations, personal guarantees almost always guarantees almost always required to obtain significant required to obtain significant financingfinancing

Protection from other types of Protection from other types of liabilities (e.g., product liability)liabilities (e.g., product liability)


Incorporation: Incorporation: Other AdvantagesOther Advantages

Lifetime capital gains Lifetime capital gains deductiondeduction

Flexibility on timing and Flexibility on timing and character of incomecharacter of income

Foreign taxesForeign taxes

Estate planningEstate planning


Incorporation: Incorporation: DisadvantagesDisadvantages

Loss deductionsLoss deductions

Tax creditsTax credits

Charitable donations Charitable donations

(deduction, not credit)(deduction, not credit)

Cost of maintaining Cost of maintaining

corporationcorporation

Winding-up proceduresWinding-up procedures


Tax ReductionTax Reduction

See Paragraph 15-66 (Based See Paragraph 15-66 (Based on $100,000 of income)on $100,000 of income) Save $1,100 for CCPC with SBDSave $1,100 for CCPC with SBD

Neutral with respect to dividendsNeutral with respect to dividends

All other cases involve tax costAll other cases involve tax cost$1,040 for public company$1,040 for public company

$1,040 for CCPC on non-eligible $1,040 for CCPC on non-eligible incomeincome

$1,360 for CCPC investment income$1,360 for CCPC investment income


Tax DeferralTax Deferral

See Paragraph 15-66See Paragraph 15-66

Neutral on non-eligible dividendsNeutral on non-eligible dividends

Prepay Prepay CCPC investment incomeCCPC investment income

Eligible dividends subject to Part IVEligible dividends subject to Part IV

Deferral in other casesDeferral in other cases $16,000 for public company or CCPC $16,000 for public company or CCPC

without SBDwithout SBD

$30,000 for CCPC earning ABI$30,000 for CCPC earning ABI


CCPC Income > Small Business CCPC Income > Small Business LimitLimit

The ProblemThe Problem If over $500,000 ABIIf over $500,000 ABI

Flow through rate can be Flow through rate can be near 50%near 50%

The SolutionThe Solution Bonusing DownBonusing Down


Imperfections InImperfections InIntegration SystemIntegration System

Provincial dividend tax credits – non-eligible dividendsProvincial dividend tax credits – non-eligible dividends

DTCDTC 1/3 (33-1/3%) Gross Up – Favours use of corporation 1/3 (33-1/3%) Gross Up – Favours use of corporation

DTC < 1/3 (33-1/3%) Gross Up – Favours not incorporatingDTC < 1/3 (33-1/3%) Gross Up – Favours not incorporating

Actual range (2010): 10.5% to 40.0%Actual range (2010): 10.5% to 40.0%



Provincial dividend tax credits – eligible dividendsProvincial dividend tax credits – eligible dividends

DTCDTC 7/17 (41.2%) Gross Up – Favours use of corporation 7/17 (41.2%) Gross Up – Favours use of corporation

DTC < 7/17 (41.2%) Gross Up – Favours not incorporatingDTC < 7/17 (41.2%) Gross Up – Favours not incorporating

Actual range: 20.9 to 38.9%Actual range: 20.9 to 38.9%



Different federal/provincial Different federal/provincial combined tax rates combined tax rates

Combined rates for CCPC on Combined rates for CCPC on ABI range from 12% to 19%ABI range from 12% to 19%

As all rates are less than As all rates are less than 20%, they favour 20%, they favour incorporationincorporation


Tax Free DividendsTax Free Dividends

Basic ConceptsBasic Concepts$1 Non-Eligible Dividend Received$1 Non-Eligible Dividend Received$1.25 Increase In Taxable Income$1.25 Increase In Taxable Income

[($1)(125%)][($1)(125%)]Individuals In Lowest Federal Tax Individuals In Lowest Federal Tax

BracketBracketTaxes Are $0.1875 [($1.25)(15%)]Taxes Are $0.1875 [($1.25)(15%)]

Federal Dividend Tax Credit = $0.1667 Federal Dividend Tax Credit = $0.1667 [($0.25)(2/3)][($0.25)(2/3)]


Tax Free DividendsTax Free Dividends

Tax on first $1 of Tax on first $1 of non-eligible non-eligible dividends is dividends is $0.0208 $0.0208 ($.1875 - $.1667)($.1875 - $.1667)

First $1 of non-First $1 of non-eligible dividends eligible dividends uses up available uses up available credits of $0.1387 credits of $0.1387 ($.0208 ÷ $.15)($.0208 ÷ $.15)


Use Of Tax CreditsUse Of Tax Credits

$1 of salary uses $1 of $1 of salary uses $1 of

creditscredits

$1 of non-eligible $1 of non-eligible dividends uses $0.1387 of dividends uses $0.1387 of creditscredits

Dividends are a better Dividends are a better until credits are useduntil credits are used


Amounts Available Tax FreeAmounts Available Tax Free

Single IndividualSingle Individual $40,844 Non-$40,844 Non-

EligibleEligible $ 66,625 Eligible$ 66,625 Eligible

With Dependent With Dependent SpouseSpouse $28,051 Non-$28,051 Non-

EligibleEligible $80,096 Eligible$80,096 Eligible


Amounts Available Tax FreeAmounts Available Tax Free

Don’t forget the Don’t forget the alternative minimum alternative minimum tax (AMT)tax (AMT)


Income SplittingIncome Splitting

Splitting income a very Splitting income a very powerful toolpowerful tool

Corporations very effective Corporations very effective herehere

Few limits for spouses and Few limits for spouses and adult childrenadult children

Problems with minor Problems with minor children (tax on split children (tax on split income)income)


Shareholder BenefitsShareholder Benefits

The owner-manager The owner-manager environmentenvironmentNot arm’s lengthNot arm’s lengthFew constraints on use of Few constraints on use of

corporate resourcescorporate resourcesSometimes difficult to Sometimes difficult to

separate business and separate business and personal usepersonal useTravelTravelAutomobilesAutomobiles



AutomobilesAutomobilesStandby chargeStandby chargeOperating cost benefitOperating cost benefit

See Chapter 3, Employment IncomeSee Chapter 3, Employment Income



Benefits other than Benefits other than loansloansIncluded in Included in

shareholders’ incomeshareholders’ incomeNot deductible for Not deductible for

corporationcorporationShould be avoided!Should be avoided!



Loans - ITA 15(2)Loans - ITA 15(2) General RequirementsGeneral Requirements

Principal amount must be Principal amount must be added to shareholder’s added to shareholder’s incomeincome

No imputed interest under No imputed interest under ITA 80.4(2)ITA 80.4(2)

Can be deducted under Can be deducted under ITA 20(1)(j) when it is repaidITA 20(1)(j) when it is repaid


Shareholder LoansShareholder Loans

ExceptionsExceptions Corporation In Lending Corporation In Lending

Business: ITA 15(2.3)Business: ITA 15(2.3) Loan repaid prior to Loan repaid prior to

second balance sheet second balance sheet datedate

Not Specified Not Specified ShareholderShareholder

If not in income – If not in income – imputed interest under imputed interest under ITA 80.4(2)ITA 80.4(2)


Shareholder LoansShareholder Loans

ExceptionsExceptions Loans To Loans To

Shareholder/Employee:Shareholder/Employee:ITA 15(2.4)ITA 15(2.4)

To acquire personal To acquire personal residenceresidence

To acquire shares of the To acquire shares of the companycompany

To acquire an automobile to To acquire an automobile to be used in employment be used in employment dutiesduties


Management CompensationManagement Compensation

General Principle: Salary is General Principle: Salary is BenchmarkBenchmarkFully taxable to shareholderFully taxable to shareholderFully deductible to corporationFully deductible to corporation


Management CompensationManagement Compensation

Tax effective solutionsTax effective solutionsRPPsRPPsDPSPsDPSPsPrivate health carePrivate health careStock optionsStock options


Salary Vs. DividendsSalary 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.

Salary vs. Dividends Salary vs. Dividends – Other Considerations– Other Considerations

Provincial rates and creditsProvincial rates and credits

Tax rates on individuals are not an issueTax rates on individuals are not an issue

High dividend tax credit rates encourage High dividend tax credit rates encourage the use of dividendsthe use of dividends

High corporate tax rates encourage the High corporate tax rates encourage the use of salaryuse of salary



Income splittingIncome splittingSome family Some family

members with no members with no incomeincome

Can receive Can receive substantial amounts substantial amounts of tax free earningsof tax free earnings


Salary vs. DividendsSalary vs. Dividends – Other Considerations – Other Considerations

RRSP Contributions (2009*)RRSP Contributions (2009*)

$22,000 $22,000 18% = $122,222 = 18% = $122,222 = required 2009 earned incomerequired 2009 earned income

Dividends Dividends Earned Income Earned Income

RRSPRRSP

CPPCPP

*2010 Not Available Yet*2010 Not Available Yet



Cumulative net Cumulative net investment loss (CNIL)investment loss (CNIL) CNIL reduces available lifetime CNIL reduces available lifetime

capital gains deductioncapital gains deduction Receipt of dividends reduces Receipt of dividends reduces

CNILCNIL

Added costs of salaryAdded costs of salary CPP and EI premiumsCPP and EI premiums Payroll taxes (in some Payroll taxes (in some

provinces)provinces)



Added benefits of salaryAdded benefits of salary CPP and EI tax creditsCPP and EI tax credits

Canada employment Canada employment creditcredit

Corporate tax payableCorporate tax payable If distributions exceed If distributions exceed

incomeincome

No tax savings with salaryNo tax savings with salary


Dividends - ProblemDividends - Problem Problem Problem

- All Dividend Approach- All Dividend Approach Use up tax credits at a slow Use up tax credits at a slow

raterate May leave unused tax creditsMay leave unused tax credits

SolutionSolution Pay a lesser amount of Pay a lesser amount of

dividends dividends Sufficient additional salary to Sufficient additional salary to

absorb tax creditsabsorb tax credits


Basic DataBasic Data Corporate Taxable Income = $29,500Corporate Taxable Income = $29,500

Combined Corporate Tax On ABI = 16%Combined Corporate Tax On ABI = 16%

Provincial Tax On First $40,970 Of Personal Provincial Tax On First $40,970 Of Personal Taxable Income = 10%Taxable Income = 10%

Individual Has Combined Tax Credits Of $3,920Individual Has Combined Tax Credits Of $3,920

Provincial Dividend Tax Credit = 1/3 Of Gross Provincial Dividend Tax Credit = 1/3 Of Gross UpUp


All SalaryAll Salary

No Corporate Tax PayableNo Corporate Tax Payable Salary Received = $29,500Salary Received = $29,500

Taxes At 25% (15% + 10%)Taxes At 25% (15% + 10%) ($7,375)($7,375)Personal Tax CreditsPersonal Tax Credits 3,920 3,920Tax PayableTax Payable ( 3,455)( 3,455)

After Tax Cash RetainedAfter Tax Cash Retained $26,045 $26,045


All DividendsAll Dividends

Maximum DividendMaximum DividendCorporate IncomeCorporate Income $29,500$29,500

Corporate Tax At 16%Corporate Tax At 16% ( 4,720) ( 4,720)

Available For DividendsAvailable For Dividends $24,780$24,780Taxable DividendsTaxable Dividends

Dividends ReceivedDividends Received $24,780$24,780

Gross Up (25%)Gross Up (25%) 6,195 6,195

TaxableTaxable $30,975 $30,975


All DividendsAll DividendsPersonal Taxes On DividendsPersonal Taxes On Dividends

Tax At 25 Percent [(25%)($30,975)]Tax At 25 Percent [(25%)($30,975)] $7,744 $7,744Personal Tax CreditsPersonal Tax Credits ( 3,920)( 3,920)Dividend Tax CreditDividend Tax Credit (Equal Gross Up)(Equal Gross Up)

( 6,195)( 6,195)Tax Payable (Negative $2,371)Tax Payable (Negative $2,371) Nil Nil

After Tax Cash RetainedAfter Tax Cash RetainedDividends ReceivedDividends Received $24,780$24,780Tax PayableTax Payable Nil NilCash RetainedCash Retained $24,780$24,780


All DividendsAll Dividends

The All Dividend Approach Leaves The All Dividend Approach Leaves $2,371 In Unused Personal Tax $2,371 In Unused Personal Tax CreditsCredits

A Combination Of Salary And A Combination Of Salary And Dividends May Provide A Better After Dividends May Provide A Better After Tax RetentionTax Retention


Dividend/Salary CombinationDividend/Salary Combination

Consider:Consider:For Each $1,000 Of Additional Salary PaidFor Each $1,000 Of Additional Salary PaidDividends Are Reduced $840.00 [($1,000)(1.00 - .16)]Dividends Are Reduced $840.00 [($1,000)(1.00 - .16)]

Increase In SalaryIncrease In Salary$1,000.00$1,000.00

Decrease In DividendsDecrease In Dividends( 840.00)( 840.00)

Decrease In Gross UpDecrease In Gross Up ( 210.00) ( 210.00)

Change In Taxable IncomeChange In Taxable Income ($ 50.00) ($ 50.00)



Decrease In Dividend Tax CreditDecrease In Dividend Tax Credit $210.00$210.00

Each $1,000 Increase In Salary Results In An Each $1,000 Increase In Salary Results In An Increase Of Tax Payable Of $197.50 [$210.00 – Increase Of Tax Payable Of $197.50 [$210.00 – (25%)($50)](25%)($50)]

Each $1 Increase In Salary Increases Tax Payable Each $1 Increase In Salary Increases Tax Payable By $0.1975.By $0.1975.

To Use Up $2,371 In Credits, Need Additional To Use Up $2,371 In Credits, Need Additional Salary Of $12,005 ($2,371/$0.1975)Salary Of $12,005 ($2,371/$0.1975)



Pre-Salary Taxable IncomePre-Salary Taxable Income $29,500$29,500

SalarySalary ( 12,005) ( 12,005)

Corporate Taxable IncomeCorporate Taxable Income $17,495$17,495

Corporate Tax At 16 PercentCorporate Tax At 16 Percent ( 2,799)( 2,799)

Available For DividendsAvailable For Dividends$14,696$14,696



Dividends ReceivedDividends Received$14,696$14,696

Gross Up (25%)Gross Up (25%) 3,674 3,674

Taxable DividendsTaxable Dividends$18,370$18,370

SalarySalary 12,005 12,005

Taxable IncomeTaxable Income $30,375$30,375



Personal Tax At [(25%)($30,375)]Personal Tax At [(25%)($30,375)]$7,594$7,594

Personal Tax CreditsPersonal Tax Credits ( 3,920) ( 3,920)

Dividend Tax Credit (Gross Up)Dividend Tax Credit (Gross Up) ( 3,674)( 3,674)

Personal Tax PayablePersonal Tax Payable Nil Nil



Dividends ReceivedDividends Received$14,696$14,696

Salary ReceivedSalary Received 12,005 12,005

Personal Tax PayablePersonal Tax Payable Nil Nil

After Tax RetentionAfter Tax Retention$26,701$26,701



All Salary ApproachAll Salary Approach $26,045$26,045

All DividendAll Dividend$24,780$24,780

Dividend/SalaryDividend/Salary$26,701 $26,701


ConclusionsConclusions

All Dividends All Dividends IneffectiveIneffective Doesn’t use all creditsDoesn’t use all credits

Need minimum salary of Need minimum salary of $12,005 to use credits $12,005 to use credits (in this example)(in this example)


ConclusionsConclusions

Combination Combination salary/dividend improves salary/dividend improves on all dividend and all on all dividend and all salarysalary

Reflects the fact that the 16 Reflects the fact that the 16 percent corporate rate is percent corporate rate is below the 20 rate built into below the 20 rate built into the dividend gross up and the dividend gross up and tax credit procedures.tax credit procedures.



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Chapter 15 Corporate Taxation And Management Decisions.

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