Corporate Tax Flashcards
Business income included in what form for Corporations
T2
Items to deduct from business income (Not inclusive)
Accounting gain on sale of depreciable capital asset
CCA on depreciable capital asset
Terminal losses
Financing expenses (Issuing shares, borrowing money are deducted on a straight-line basis over 5 years)
Bond premium amort (Interest deductible to the extent it is legally payable)
Allowable capital loss and business investment less
SR&ED expenditures deductible for tax purposes
Pension contributions to trustee
Cash paid for warranties
Landscaping costs paid that were not deducted in accounting income
Equity income on investments using the equity method
Items to Add to business income (Not inclusive)
Recapture on the sale of a depreciable asset
Accounting amortization on depreciable capital assets
Income tax - current and deferred /future taxes
interest and penalties on late pmt of income tax
Accounting losses on disposal of capital assets
Taxable capital gains
Charitable or political donations
SR&ED deducted for accounting purposes
Reserves and contingent liabilities
Warranties
Pensions
50% Meals & Ent (Exclude- food and bev that are ordinary course of business, expenses billed to client, anything that is an employee taxable benefit, all employees benefit to a max of 6 events per year)
Club due and recreation fees
Bond Amortization
Automobile mileage allowances unless taxable benefit (.59 for first 5,000km, .53 for additional)
Lease costs on passenger vehicle in excess of permitted amount
Equity loss or dividends received on investment using the equity method
Asset write-downs and impairments
Foreign advertising directed at CDN market
Life insurance where corp is the beneficiary
Foreign taxes paid to the extent they are claimed as a tax credit
Division C Deductions
Donations
CDN Dividends
Net capital loss carryovers
Non-capital loss carryovers
What is included in Aggregate investment income (AII)
Interest that is not incidental
Passive net rental income (net of expenses)
Passive foreign income
Royalties
ALL Dividends
Net taxable capital gains (net of current year allowable capital losses used)
= Net AII (Used for ABI calculation)
Less dividends deducted under Div C (foreign dividends)
Less Net cap loss carryforwards used in Div C
=AII
What is included in Adjusted Aggregate investment income (AAII)
AII
Less Net capital loss carryforwards deducted under Division C
Less Div C dividends from connected corps
Net Canadian active business income (ABI)
Net Income for tax purposes
Less:
Net AII
Foreign business income
Taxes payable CCPC detailed approach
\+ basic federal tax 38% -federal abatement 10% -SBD ** 19% if AAII > than 50K reduce limit by $5 for every dollar over 50K if TCE > than 10Mil prior year reduce limit -Manu deduct 13% -Gen rate 13% \+Additional refundable tax ** 10 2/3 % -foreign tax credits -investment tax credits = Federal Part 1 tax \+provincial tax \+ part IV tax ** -Dividend refund out of RDTOH ** = Tax payable before instalments
** for CCPC only
Taxes payable NON-CCPC detailed approach
\+ basic federal tax -federal abatement -Manu deduct -Gen rate -foreign tax credits -investment tax credits = Federal Part 1 tax \+provincial tax = Tax payable before instalments
Calculate the small business deduction
The small business deduction (SBD) lowers the tax rate on ABI earned by a CCPC
19% of the lower of:
1. ABI earned in Canada
2. Taxable income less:
100/28 x foreign tax credit on foreign non-business income and
4 x FTC on foreign business income
3. Annual business limit 500K allocated to the company taking into account any reductions due to AII or TCE
if AAII > than 50K reduce limit by $5 for every dollar over 50K
if TCE > than 10Mil prior year reduce limit
Marginal Tax rates
Federal Part 1 tax for CCPC (ABI < SBD Limit): 9%
CCPC AII: 38 2/3%
Non-CCPC income and all other income (ABI > SBD Limit): 15%
Tax rates and reductions for types on income
Basic federal Part 1 tax: 38% Federal abatement: 10% SBD: 19% Manufacturing & Processing Credit: 13% General rate reduction: 13% ART: 10 2/3% (Charged on AII on top of basic - abate but not including GRR)
FTC for non-business income
FTC for non-business income is the lesser of:
1. Foreign tax paid
2. Net foreign non-business income x tax otherwise payable (+basic fed tax - abate + refundable tax on CCPC investment income - GRR for non-CCPC) divided by adjusted net income (Net income less net cap losses of other years and dividends deducted in div C)
3.
FTC for non-business income
FTC for non-business income is the lesser of:
- Foreign tax paid
- Net foreign non-business income x tax otherwise payable (+basic fed tax - abate + refundable tax on CCPC investment income - GRR for non-CCPC) divided by adjusted net income (Net income less net cap losses of other years and dividends deducted in div C)
FTC for business income
FTC for business income is the lesser of:
- Foreign tax paid
- Net foreign business income x tax otherwise payable (+basic fed tax - abate + refundable tax on CCPC investment income - GRR for non-CCPC) divided by adjusted net income (Net income less net cap losses of other years and dividends deducted in div C)
The passive income business limit reduction calculation for CCPC
When AAII is greater than 50K reduce the 500K business limit:
(Allocated business limit / 500,000) x 5 x (AAII - 50,000)
Manufacturing credit (M&P)
13% of the lesser of:
- M&P profits. less amounts eligible for SBD
- Taxable income, less the sum of:
a. amount eligible for the SBD
b. 4 x FTC on foreign business income
c. AII (CPCC only)
GRR calculation
13% of full rate taxable income Full rate taxable income: Taxable income - income eligible for SBD - income eligible for M&P - AII included in taxable income (CCPC Only) = Full rate taxable income X 13% = GRR
Personal Service business tax implications
33% tax rate applies
Not eligible for SBD or GRR
No expenses are eligible for deduction for PSB income except:
Salary paid in the year
Benefits/allowances provided to employee
Expenses that would have been deducted by an individuals employment income
Legal expenses incurred in collecting fees for services
Personal Service business definition
A PSB is a business of providing services where:
- An individual who performs services on behalf of the corp. or any person related to the incorp employee is a specified shareholder of the corp - not less than 10% interest
AND
- The incorp employee would reasonably be regarded as an employee of the person to whom the services where provided
UNLESS
- the corp employs more than 5 FT employees or
- the services are provided to an associated corporation
SR&ED Expenditure limit
$3,000,000 per calendar year and shared between associated corps
Expenditure limit phases out when TCE of all allocated corps exceeds 10,000,000 and eliminated at 50,000,000
SR&ED Pool is calculated as
Balance at beginning year
+ qualified expenditures, current year
- expenditures deducted from income , current year
- investment tax credits claimed in previous year
= Balance, End of year
SR&ED qualified expenditures
Includes: Engineering and design work Operations research Mathematical analysis Computer programming data collection Overhead relating to the above
Excludes:
Market research or sales promotion
Quality control or routing testing
Research in social sciences or humanities
prospecting for, exploring for, drilling for, or producing minerals, petroleum or natural gas.
The commercial production of a new or improved material device or product.
Style changes
routine data collection
Capital expenditures
SR&ED Investment tax credits (ITC) rates
ITC’s can be used to reduce income taxes payable and in some cases provide a refund
CCPC:
Increased to 35% is it is below the expenditure limit of 3Mil (100% refundable)
15% for amounts above expenditure limit (40% refundable)
Public:
15% on all expenditures (non-refundable)
SR&ED carryforward rules
Qualifying SR&ED can be deducted in the current year to determine NIFTP (can create a non-cap loss) or can be added to SR&ED pool and carried forward.
If non-cap loss is created by SR&ED then loss can only be carried forward for 20 years (normal)
If the SR&ED is kept in the cost pool it can be held indefinitely.
SR&ED Expenditure limit calculation
Max 3,000,000
3,000,000 x [(40,000,000 - A) / 40,000,000]
where A is the lesser of:
- 40,000,000
- The amount that the TCE for the preceding year exceeds 10,000,000
If the corporation’s taxable capital employed in Canada is $10,000,000 or less, the corporation’s expenditure limit is $3,000,000
SR&ED Refund rates
Qualifying CCPC - CCPC throughout the year and had a taxable income in the preceding year no greater than 500K
Expenditures up to 3Mil - ITC’s earned at 35% = 100% refund rate
Expenditures over 3Mil - ITC’s earned at 15% rate = 40% refund rate
Non-qualifying CCPC - preceding year taxable income over 500K
Expenditures up to 3Mil - ITC’s earned at 35% = 100% refund rate
Expenditures over 3Mil - ITC’s earned at 15% rate = NIL
Public Company = 15%, non-refundable
What does ERDTOH track
Refundable taxes paid on eligible dividends received by the corporation. Payment of any type of dividend (either eligible or non-eligible) can trigger a refund out of this account
What does NERDTOH track
Includes refundable taxes on investment income and Part IV tax on non-eligible portfolio dividends. Only payment of non-eligible dividends can trigger a refund out of this account.
Ordering rule between ERDTOH and NERDTOH
When non-eligible dividends are paid, the refund must come out of NERDTOH first. Balance can come out of ERDTOH.
NERDTOH calculation
Balance at the end of preceding year before deducting the dividend refund for the preceding year.
Less: dividend refund on non-eligible dividends paid in the preceding year
Plus: Refundable portion of Part I tax on investment income
Refundable Part I tax is equal to:
The least of:
a) 30 2/3% of AII, less:
[non-business FTC less (8% of foreign investment income)]
b) 30 2/3% of the net of the following:
Taxable income
Less: The amount eligible for the SBD
Less: 100/(38 2/3) × non-business FTC
Less: 4 × business FTC
c) Part I tax
Plus: Part IV tax paid on non-eligible dividends received in the year
Part IV refundable tax is determined as follows:
• 38 1/3 % × dividend received from non-connected taxable Canadian corporations (referred to as portfolio dividends),
PLUS
• Investor’s share of dividend refund received by a connected corporation
Refundable Part I tax calculation
The least of:
a) 30 2/3% of AII, less:
[non-business FTC less (8% of foreign investment income)]
b) 30 2/3% of the net of the following:
Taxable income
Less: The amount eligible for the SBD
Less: 100/(38 2/3) × non-business FTC
Less: 4 × business FTC
c) Part I tax
ERDTOH calculation
Balance at the end of the preceding taxation year before deducting the dividend refund for the preceding year
Less: Dividend refund on eligible or non-eligible dividends paid in the preceding year from the ERTOH account
Plus: Part IV tax paid on eligible dividends received in the year
A private corporation’s dividend refund for year is determined as follows:
(used to calculate both NERDTOH and ERDTOH)
First amount is the lesser of:
• 38 1/3% of the total of eligible dividends paid in the year, and
• Its ERDTOH balance at the end of the year
Second amount is the lesser of:
• 38 1/3% of the total of non-eligible dividends paid in the year, and
• Its NERDTOH balance at the end of the year after NERDTOH paid
Third amount is either:
• If 38 1/3% of the total of all non-eligible dividends paid in the year is greater than the balance in its NERDTOH account at the end of the year, the lesser of:
o The amount of the excess, and
o The amount by which is ERDTOH at the end of the year is greater than the first amount above, if any
• In any other case, nil
Taxable capital small business limit reduction calculation
TCE
Reduction = A × (B / 11,250) A = amount of the corporation's small business limit for the year B = 0.225% (0.00225) of the corporation's taxable capital employed in Canada, in the previous year, in excess of $10,000,000
Eliminates at $15,000,000
Calculate TCE from Balance sheet Long-term debt \+Total equity Less investments =TCE
Purpose of the Part IV tax for CCPC
To tax CCPC’s on Canadian dividends received to prevent tax deferral on these dividends.
The tax paid is refunded when the corp pays out the dividend and the individual pays tax on dividends received.
This encourages the CCPC to pay out the dividends, instead of holding them.
Calculate Part IV refundable tax for CCPC
38 1/3% x dividends received from non-connected taxable Canadian corps
PLUS Investor’s share of dividend refund received by a connected corp
ART Calculation
ART on AII income - charged to prevent tax deferral. Tax is refunded when the CCPC pays after-tax investment income by way of dividends.
10 2/3% of the lesser of:
AII included in taxable income
Taxable income less the amount eligible for SBD
What is refundable portion of Part I tax
It is the tax charged on AII and is refunded when the CCPC pays out the dividend relating to investment income
Taxes payable CCPC Simple approach (Only use when NIFTP = Taxable Income)
- Determine the rates for specific types of income and sum them by income type (ABI >business limit, ABI < business limit, AII)
- Apply rates to specific types of income
- Add Part IV tax and deduct dividend refund
- Deduct instalment payments
= Tax payable
General rate income pool (GRIP)
C + [72% × (D – E – F)] + G + H – I
C: GRIP at the end of the preceding tax year
D: Taxable Income for the current year
E: Amount eligible for the SBD for the year
F: AII included in taxable income
G: Eligible dividends received in the year from another corporation
H: An amount associated with amalgamations and wind-ups before 2006
I: Eligible dividends paid during the preceding year
72% x (taxable income, less SBD less AII)
Plus Eligible dividends received in the year from another corporation
Less Eligible dividends paid during the preceding year
How do the courts assess whether an asset is considered capital property or inventory?
- Primary intention - Did the taxpayer intend to use the asset as inventory or capital ?
- Secondary intention - If the primary intention was frustrated, did the taxpayer at the time of purchase have a motivating intention to sell the property at a profit?
Behaviour factors they look at are:
- The relationship between the transaction and the normal course of business
- Nature of the asset - If can be used over time then capital
- Length of ownership - long period implies capital
- # and frequency of transactions - a large # of similar transactions implies inventory
- Supplemental work done on the property - If no work was done to increase value then implies capital
How to treat accounting and legal fees incurred to borrow money
Accounting, legal and other fees incurred to borrow money are deductible on a straight-line basis of 20% per year for five years
Involuntary Dispositions - Replacement ppty rules
Generally applies where property is lost, stolen, expropriated, destroyed by fire or natural disaster.
Type of ppty: All capital ppty except for vacant land. Replacement ppty must be acquired for same or similar reason.
Timing of replacement: within 24 months following the end of taxation year.
Tax implications: If ppty is purchased after fiscal year end, TCG and recapture must be paid, but can file an amended tax return for refund once ppty is purchased.
TCG = Lesser of:
Normal gain: Proceeds - original cost
Deemed gain: replacement cost - original cost
Recapture= Lesser of:
(Lesser of proceeds and replacement cost) less UCC
Replacement cost
ACB of new ppty = Replacement - (normal gain - deemed gain)
Voluntary Dispositions - Replacement ppty rules
Does not apply where property is lost, stolen, expropriated, destroyed by fire or natural disaster.
Type of ppty: Only real ppty used in business other than rental. Replacement ppty must be acquired for same or similar reason.
Timing of replacement: 12 months following the end of taxation year.
Tax implications: If ppty is purchased after fiscal year end, TCG and recapture must be paid, but can file an amended tax return for refund once ppty is purchased.
TCG = Lesser of:
Normal gain: Proceeds - Original cost
Deemed gain: replacement - Original cost
Deferred Recapture = Lesser of
(Lesser of proceeds and replacement cost) less UCC
Replacement cost
ACB of new ppty = Replacement - (normal gain - deemed gain)
ACB/Capital Cost and UCC of replacement ppty
ACB of land
Cost of replacement
-deferred gain
= ACB
Capital cost and UCC of building Cost of replacement - deferred gain = Capital Cost - Deferred recapture = UCC of replacement
Sale of redundant assets - treatment
Marketable securities: Any losses cannot be transferred to an affiliated company. Seller can hold losses to be used against future securities gains. (Suspended loss or stop-loss)
Computers: Recapture (UCC - lower of cost and proceeds)
Vehicle: No recapture or terminal loss calculated on the sale of a class 10.1 vehicle. I additional CCA may be taken with half year rule applied. (Suspended loss or stop-loss)
Equipment: Any terminal losses denied with sale to an affiliate. Denied loss will remain in CCA class of seller and they are able to continue with CCA each year. (Suspended loss or stop-loss). If vehicle is no longer affiliated with seller then can claim full loss.
Financially troubled business - order of debt forgiveness
ITA requires companies to apply forgiven debt to use up unexpired loss carryovers in the following order
Mandatory: Non-capital losses excluding farm and ABIL Farm losses Restricted farm losses ABIL grossed up to 100% Net capital losses grossed up to 100%
Election: Capital cost of depreciable ppty UCC of depreciable ppty Resource pools ACB of non-depreciable capital ppty Current year cap loss realized = balance 50% inclusion rate in business or property income
Classes at a 100% rate for accelerated investment income
classes 43.1, 43.2, and 53
Advantages and disadvantages to incorporation
Advantages:
o Limited liability for shareholders
o Tax deferral on earnings, since cash is retained in a corp and dividend payments are delayed.
o Potential tax reduction of SBD eligible
o Greater potential for income splitting through capital gains or dividends for adults that are active in the business. The family member must be a shareholder
o Flexibility for yearend dates
o Capital gains exemption on future disposition of shares of qualified SBD
Disadvantages:
o Cost of initial incorporating and ongoing compliance inclusion financial statements, tax returns, annual fees
o Any dividends paid to minors would be subject to TOSI
o Any dividends paid to adults not active in the business would be subject to TOSI
o Inability to claim losses against personal income
Section 85 rollover requirements
Transfer property to a corporation
o Must jointly elect with corporation with T2057.
o Assets must be transferred to a taxable Canadian corp
o The assets transferred must be eligible (AR - section 22 is more beneficial, assets with accrued losses are not eligible, not eligible: cash, equivalents, prepaid expenses)
o The transferor must take back a share of the corporation as consideration
o The transferor may also take back non-share consideration (boot).
o Elected amount may be anywhere in between the cost of the asset and the FMV. Tax will be deferred when select ACB or UCC as tax basis
o Consideration for the transfer must equal FMV of the property transferred
o Must be filed in the tax return that comes due first between the individual or corporation in the year the assets are transferred.
o Can late-file up to three years from the filing deadline of the election, The sale will have to be amended to include at least 1 share. A late-filing penalty will apply
Section 85 rollover eligible and non-eligible assets
Included:
o Inventory (not land)
o Non-depreciable capital property: marketable securities, land
o Depreciable capital property: equipment, buildings, intangibles
Not included
o Typical assets not included: Cash, prepaids -sold as FMV
o Assets with accrued losses are not included – sold at FMV
Section 22 election for accounts receivable
o Allows for AR to not be considered capital property.
o Results in any transferor losses to be business losses
o Results in any transferee gains to be business income
Section 85 floor and ceiling
Ceiling or maximum amount that can be elected is the FMV
Floor or minimum amount that may be elected is greater of
-FMV of any boot (NSC)
-Tax value of the asset being transferred:
• Non-depreciable ppty = lesser of FMV, ACB
• Depreciable ppty = lesser of FMV, UCC, capital cost
Section 85 must knows
- Maximum amount of the NSC or boot is the tax value of the asset being transferred.
- FMV of consideration (NSC + shares) must equal FMV of the ppty transferred, otherwise there will be negative tax consequences
- Consideration elected may exceed the tax cost if the transferor wants to trigger a capital gain or recapture
- If Elected cost = UCC of depreciable property then no tax consequence
- If boot > sum of elected amount then must raise the elected amount to = boot
- Elected amount becomes the POD for the transferor and the cost of capital for the transferee
Section 85 – Elected amount – no tax consequences:
o Cannot exceed the FMV at the time of transfer
o Cannot be less that the FMV of NSC
o Cannot be less than the lesser of the FMV of the ppty and the transferor cost at time of disposition.
o Where 1 & 3 differ the greater of the two represents the lower limit
Section 85 share ACB and PUC
- ACB of shares = Elected amount – NSC
* PUC Reduction = Shares consideration – (Share consideration – (elected amount – NSC)
Deferred Tax Liability and Assets rule
For Assets:
If NBV (accounting basis) > Tax basis (UCC) = Deferred Tax liability If NBV (accounting basis) < Tax basis (UCC) = Deferred Tax Asset
For Liabilities:
If NBV (accounting basis) > Tax basis (UCC) = Deferred Tax Asset If NBV (accounting basis) < Tax basis(UCC) = Deferred Tax liability
TOSI Exclusions
- The excluded business exception can be applied to any family member who is 18 years or older in the particular year. If the family member is engaged on a regular, continuous, and substantial (20 hours per week) basis in the business in the current year or 5 previous years.
- Excluded shares: can apply to income received by a family member who is 25 years or older in the year if all of the following apply:
- The income is received on excluded shares. Excluded shares are shares that represent at least 10% of the votes and value of the company.
- Less than 90% of the income of the corporation is from the provision of services.
- The shares are not shares in a professional corporation. - An amount received by a family member 25 years or older would not be subject to TOSI if the amount is considered a reasonable return for the family member’s contribution to the business. Factors considered:
• work performed by the family member for the business
• property contributed by the family member to the business
• risks assumed by the family member with respect to the business
• payments made in the past to the family member for their contribution
Acceptable transfer pricing methods
CUP: comparable uncontrolled price method. - preferable
RPM: resale price method- common for distribution activities
Cost plus method: common for manufacturing or services
Employee remuneration deductibility rule
Is deductible as long as it is paid within 180 days following the end of the taxation year
Order of dividends to be paid - CCPC
o First pay our the CDA account (capital dividends) since they are tax free
o Then designate sufficient dividends as non-eligible to obtain a full refund of the balance in the NERDTOH account
o designate remaining deemed dividends subject to tax as eligible to the extent of the balance in the GRIP account
o Lastly, any remaining dividends will be deemed non-eligible dividends
Required adjustment to working capital to maintain argument for 90% of assets used for active business in QSBC requirements for LCGD
Total BV current assets Less: Current BV Liabilities = Total working capital Less: WC required to run the business (should be given) = Excess working capital
(FV of assets - excess WC) / FV of assets = % of assets being used for active business
WC required to run the business - excess WC = Required reduction to assets
Acquisition of control
There will be a deemed year end the day before the acquisition; therefore 2 tax years in 12 months.
Capital losses expire immediately upon acquisition; therefore cannot be used the tax year after the acquisition.
Can carry forward the non-capital losses if the following is met:
- same of similar business continues to be carried on by the corporation for reasonable expectation of profit.
- The losses can only be used to offset income from that same business or a similar business.
If the acquired company can charge management fees for actual services provided it can use that revenue to apply the losses.
These requirements do not change if the corporations are amalgamated or windup.
Acquisition of control election
ITA rules allow a corporation to elect to have a deemed disposition of any depreciable or non-depreciable capital property on which capital gains or recapture have been accrued.
TOSI impact
If loaned or income given to an adult child that is not actively involved in the business then:
- Taxed at the full rate of 33% if loan is not repaid within 1 year.
- Would not be eligible for the deduction for any repayment of loans.
- Unable to use the basic personal amount and education credits.
- Tax credits that can be used are generally limited to dividend and FTC.
If parent takes the loan from the corp and then loans to the adult child, the same rules above would apply to the adult child income.
CRA assertions and accounts examples on procedures
- Accuracy of accounting income
- Classification of expenses in accounting income
- Occurrence and accuracy of capital gains
- Occurrence and accuracy of dividends
- Classification and completeness of capital assets (CCA)
- Accuracy of liabilities
Factors in determining whether a sale is capital income or business income
Primary intention: Taxpayer intention Secondary intention: If primary was frustrated, did the taxpayer have a motivation to sell the property at a profit. Other factors: normal business activities how long the property has been held for How many transactions have been made.
A SBC is
A CCPC that has all or substantially all (that is, greater than 90%) of the FMV of
assets:
i. used principally to earn active business income;
ii. as shares in a connected SBC; or
iii. some combination of (i) or (ii).
Steps to qualify for QSBC shares for LCGE
- At the time of disposition the corp must be a SBC
- The shares must have not been owned by anyone other than the taxpayer during the prior 24 months before disposition
- Over the past 24 months more than 50% of the FV of assets must have been used primarily for active business in Canada
