Chapter 17 Corporate Taxation And Management Decisions.

Chapter 17Chapter 17

Corporate Taxation AndCorporate Taxation And

Management DecisionsManagement Decisions

© 2006, C. Byrd Inc.© 2006, C. Byrd Inc.22

The Decision To IncorporateThe Decision To Incorporate

Tax ReductionTax Reduction

Tax DeferralTax Deferral

Income SplittingIncome Splitting

Other Other ConsiderationsConsiderations


Tax ReductionTax Reduction

Only one situation Only one situation provides provides reductionreduction

CCPC on amounts CCPC on amounts eligible for SBDeligible for SBD

Small – Less than Small – Less than 1 percent in text 1 percent in text exampleexample


Tax DeferralTax Deferral

Moderate amount for Moderate amount for Public CorporationsPublic Corporations

Large amount for CCPC Large amount for CCPC on amounts eligible for on amounts eligible for SBDSBD

Prepayment for CCPC on Prepayment for CCPC on investment incomeinvestment income

Neutral for dividendsNeutral for dividends


CCPC Income > Small Business CCPC Income > Small Business LimitLimit

The ProblemThe Problem Taxed at 38 percent at Taxed at 38 percent at

corporate levelcorporate level Taxed at over 50 percent Taxed at over 50 percent

on flow through to on flow through to individualindividual

The SolutionThe Solution Bonusing down.Bonusing down.


Imperfections InImperfections InIntegration SystemIntegration System

Provincial dividend tax creditsProvincial dividend tax credits

DTCDTC 1/3 Gross Up – Favours use of 1/3 Gross Up – Favours use of corporationcorporation

DTC < 1/3 Gross Up – Favours not DTC < 1/3 Gross Up – Favours not incorporatingincorporating


Imperfections InImperfections InIntegration SystemIntegration System

Different Different Federal/Provincial Federal/Provincial RatesRates

>20% - Favours not >20% - Favours not incorporatingincorporating

<20% - Favours use of <20% - Favours use of corporationcorporation


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)


Incorporation: Incorporation: Other Factors To ConsiderOther Factors To Consider

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 Factors To ConsiderOther Factors To Consider

Lifetime Capital Gains Lifetime Capital Gains DeductionDeduction

Foreign TaxesForeign Taxes

Estate PlanningEstate Planning

Loss DeductionsLoss Deductions

Charitable DonationsCharitable Donations

Maintenance CostsMaintenance Costs

Winding-Up ProceduresWinding-Up Procedures


Payments To Owner/ManagerPayments To Owner/Manager

Need For FundsNeed For Funds Other IncomeOther Income CPP/RRSPCPP/RRSP CNILCNIL Corporate IncomeCorporate Income Need To Bonus Need To Bonus

DownDown Target BracketTarget Bracket


Corporation’s Need For FundsCorporation’s Need For Funds

Corporation’s Tax Corporation’s Tax RateRate

Alternative Alternative Investment Investment OpportunitiesOpportunities

Alternative Sources Alternative Sources Of FundsOf Funds


Salary Vs. DividendsSalary Vs. Dividends

Basic PrinciplesBasic Principles Salary Deductible To CorporationSalary Deductible To Corporation Dividends Taxed Favourably At Dividends Taxed Favourably At

Individual LevelIndividual Level

Income Not Eligible For SBDIncome Not Eligible For SBD Bonusing Down Requires SalaryBonusing Down Requires Salary

Income Eligible For SBDIncome Eligible For SBD Corporate Rate > 20%Corporate Rate > 20% Provincial Dividend Tax Credit > Provincial Dividend Tax Credit >

1/3 Gross Up1/3 Gross Up


Tax Free DividendsTax Free Dividends

Owner/Managers Deal Largely With Owner/Managers Deal Largely With Non-Eligible DividendsNon-Eligible Dividends

Basic ConceptsBasic Concepts $1 Dividend Received$1 Dividend Received $1.25 Increase In Taxable Income [($1)(1.25)]$1.25 Increase In Taxable Income [($1)(1.25)] Individuals In Lowest Federal Tax BracketIndividuals In Lowest Federal Tax Bracket

Taxes Are $0.1906 [($1.25)(15.25%)]Taxes Are $0.1906 [($1.25)(15.25%)] Federal Dividend Tax Credit = $0.1667 [($0.25)Federal Dividend Tax Credit = $0.1667 [($0.25)

(2/3)](2/3)]


Tax Free DividendsTax Free Dividends

Tax on first $1 of Tax on first $1 of dividends is dividends is $0.0239 ($.1906 - $0.0239 ($.1906 - $.1667)$.1667)

First $1 of First $1 of dividends uses up dividends uses up available credits of available credits of $0.1567 ($.0239 $0.1567 ($.0239 ÷÷ $.1525)$.1525)


Use Of Tax CreditsUse Of Tax Credits

$1 Of Salary Uses $1 Of Credits$1 Of Salary Uses $1 Of Credits

$1 Dividends Uses $0.1567 Of $1 Dividends Uses $0.1567 Of

CreditsCredits

Dividends Better Until Credits Are Dividends Better Until Credits Are

UsedUsed


Amounts Available Tax FreeAmounts Available Tax Free

Single IndividualSingle Individual $35,110 Non-$35,110 Non-

EligibleEligible 65,819 Eligible65,819 Eligible

With Dependent With Dependent SpouseSpouse $45,680 Non-$45,680 Non-

EligibleEligible $77,045 Eligible$77,045 Eligible


Salary To Owner/ManagerSalary To Owner/Manager

The Owner/Manager The Owner/Manager EnvironmentEnvironment

No Outside No Outside

ShareholdersShareholders

Complete Discretion Complete Discretion

With Respect To With Respect To

Amount And Types Of Amount And Types Of

CompensationCompensation



Salary Payments - Role In IntegrationSalary Payments - Role In Integration

Like Direct Receipt Of IncomeLike Direct Receipt Of Income

Deduction Eliminates Tax Payable At Deduction Eliminates Tax Payable At Corporate LevelCorporate Level



Salary PaymentsSalary Payments RRSP Contributions (2006)RRSP Contributions (2006)

$18,000 $18,000 18% = $100,000 18% = $100,000Dividends Dividends Earned Income Earned Income

Use of Personal Tax Use of Personal Tax CreditsCredits

Lost If Not UsedLost If Not UsedSalary Uses Up FasterSalary Uses Up Faster


Other ConsiderationsOther Considerations

Earned Income For CPP Earned Income For CPP PurposesPurposes Dividends Do Not Count As EarnedDividends Do Not Count As Earned

IncomeIncome

Cumulative Net Investment Cumulative Net Investment Loss (CNIL)Loss (CNIL) CNIL Reduces Available Lifetime CNIL Reduces Available Lifetime

Capital Gains DeductionCapital Gains Deduction Receipt Of Dividends Reduces CNILReceipt Of Dividends Reduces CNIL

Added Costs Of SalaryAdded Costs Of Salary CPP And EI PremiumsCPP And EI Premiums Payroll Taxes (In Some Provinces)Payroll Taxes (In Some Provinces)


Dividends - ProblemDividends - Problem Problem - All Dividend Problem - All Dividend

ApproachApproach Use Up Tax Credits At A Slow Use Up Tax Credits At A Slow

RateRate May Leave Unused Tax May Leave Unused Tax

CreditsCredits

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 = 20%Combined Corporate Tax On ABI = 20%

Provincial Tax On First $36,378 Of Personal Provincial Tax On First $36,378 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 PayableSalary Received = $29,500Salary Received = $29,500

Taxes At 26% (16% + 10%) ( 7,670)Taxes At 26% (16% + 10%) ( 7,670)

Personal Tax CreditsPersonal Tax Credits 3,920 3,920

After Tax Cash RetainedAfter Tax Cash Retained $25,750 $25,750


All DividendsAll Dividends

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

Corporate Tax At 20%Corporate Tax At 20% ( 5,900) ( 5,900)

Available For DividendsAvailable For Dividends $23,600$23,600Taxable DividendsTaxable Dividends

Dividends ReceivedDividends Received$23,600$23,600

Gross Up (25%)Gross Up (25%) 5,900 5,900

TaxableTaxable $29,500 $29,500


All DividendsAll DividendsPersonal Taxes On DividendsPersonal Taxes On Dividends

Tax At 26 Percent [(26%)($29,500)]Tax At 26 Percent [(26%)($29,500)] $7,670 $7,670Personal Tax CreditsPersonal Tax Credits ( 3,920)( 3,920)Dividend Tax CreditDividend Tax Credit (Equal Gross Up)(Equal Gross Up)

( 5,900)( 5,900)Tax Payable (Negative $2,150)Tax Payable (Negative $2,150) Nil Nil

After Tax Cash RetainedAfter Tax Cash RetainedDividends ReceivedDividends Received $23,600$23,600Tax PayableTax Payable Nil NilCash RetainedCash Retained $23,600$23,600


All DividendsAll Dividends

The All Dividend Approach Leaves The All Dividend Approach Leaves $2,150 In Unused Personal Tax $2,150 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 $800.00 [($1,000)(1.00 - .20)]Dividends Are Reduced $800.00 [($1,000)(1.00 - .20)]

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

Decrease In DividendsDecrease In Dividends( 800.00)( 800.00)

Decrease In Gross UpDecrease In Gross Up ( 200.00) ( 200.00)

Change In Taxable IncomeChange In Taxable Income $ Nil $ Nil



Decrease In Dividend Tax CreditDecrease In Dividend Tax Credit $200.00$200.00

Each $1,000 Increase In Salary Results In An Each $1,000 Increase In Salary Results In An Increase Tax Payable Of $200.00Increase Tax Payable Of $200.00

Each $1.00 Increase In Salary Increases Tax Each $1.00 Increase In Salary Increases Tax Payable By $0.20.Payable By $0.20.

To Use Up $2,150 In Credits, Need Additional To Use Up $2,150 In Credits, Need Additional Salary Of $10,750 ($2,150/$0.20)Salary Of $10,750 ($2,150/$0.20)



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

SalarySalary ( 10,750) ( 10,750)

Corporate Taxable IncomeCorporate Taxable Income $18,750$18,750

Corporate Tax At 20 PercentCorporate Tax At 20 Percent ( 3,750)( 3,750)

Available For DividendsAvailable For Dividends$15,000$15,000




Gross Up (25%)Gross Up (25%) 3,750 3,750

Taxable DividendsTaxable Dividends$18,750$18,750

SalarySalary 10,750 10,750

Taxable IncomeTaxable Income $29,500$29,500



Personal Tax At [(26%)($29,500)]Personal Tax At [(26%)($29,500)]$7,670$7,670

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

Dividend Tax Credit (Gross Up)Dividend Tax Credit (Gross Up) ( 3,750)( 3,750)

Personal Tax PayablePersonal Tax Payable Nil Nil




Salary ReceivedSalary Received 10,750 10,750

Personal Tax PayablePersonal Tax Payable Nil Nil

After Tax RetentionAfter Tax Retention$25,750$25,750



All Salary ApproachAll Salary Approach $25,750$25,750

All DividendAll Dividend$23,600$23,600

Dividend/SalaryDividend/Salary$25,750 $25,750


ConclusionsConclusions

All Dividends All Dividends IneffectiveIneffective Doesn’t Use All CreditsDoesn’t Use All Credits

Need Minimum Salary of Need Minimum Salary of $10,750 To Use Credits$10,750 To Use Credits


ConclusionsConclusions

Results Identical For:Results Identical For: All SalaryAll Salary Any Dividend/Salary Combination Any Dividend/Salary Combination

With At Least $10,750 Of SalaryWith At Least $10,750 Of Salary Reflects Perfect IntegrationReflects Perfect Integration

20% Corporation Rate20% Corporation Rate Dividend Tax Credit = Gross UpDividend Tax Credit = Gross Up


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Chapter 17 Corporate Taxation And Management Decisions.

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