Proprietors, Partners, and Corporations (41) Flashcards

Question

stock dividends

Answer 1

Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayer’s income for that year in the same manner as if the dividend had been received in cash. If they are paid by a taxable Canadian corporation, stock dividends are subject to the dividend gross up and tax credit scheme. The amount of the stock dividend for tax purposes is deemed to be equal to the increase in the corporation’s paid up capital that results from the issue of the new shares, and this amount is determined by the corporations directors.

Answer 2

Dividends issued by a Corporation A corporation can issue four distinct types of dividends: regular dividends, capital dividends, capital gains dividends or stock dividends. A capital dividend is a special dividend payment the flows from a special account called the capital dividend account. This account can include the tax free portion of capital gains, gain from the death benefit of a company owned life insurance policy, and the tax free portion of sales of good will. As a result, this type of dividend is not typically paid on a regular basis. Because capital dividends arise from tax-free sources of income, they are not taxable to shareholders. After the dividend, the corporation’s cash will be reduced to an amount calculated as: (cash – capital dividend) The corporations FMV value will drop to an amount calculated as: (FMV – capital dividend) According to the stop-loss rule, if an individual who has control over a private corporation that paid him capital dividends subsequently disposes of those shares and that disposition results in a loss, that loss will be reduced. The amount of the reduction according to the stop loss rule is the amount calculated as: The lesser of (A and B) • A = the sum of all capital dividends that the taxpayer received on those shares; and • B = the greater of ($0 and (the capital loss – all taxable dividends received by the taxpayer on those shares)) This effectively disallows a capital loss that arises from the payment of a tax free capital dividend, but allows a capital loss arising from the payment of a taxable dividend. The gain from the death benefit of a life policy is the excess of the death benefit over the ACB of the life policy. The ACB of a term policy is $0. A capital gains dividend is a distribution of the capital gains of a mutual fund to unit holders. ``` A stock dividend is a dividend payment by the way of corporation’s stock. Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayers income for that year in the same manner as if the dividends had been received as cash. ``` Stock dividends are dividends issued by a corporation that are paid by the issuance of shares of any class of the capital stock of that corporation. Stock dividends received by a taxpayer in a year must be included in the taxpayer’s income for that year in the same manner as if the dividend had been received in cash. If they are paid by a taxable Canadian corporation, stock dividends are subject to the dividend gross up and tax credit scheme. The amount of the stock dividend for tax purposes is deemed to be equal to the increase in the corporation’s paid up capital that results from the issue of the new shares, and this amount is determined by the corporations directors. The ACB of the new shares is the amount of the dividend prior to the gross up. The ACB of all his shares is the weighted average cost. Sometimes corporations will pay a dividend of retained earnings from a gain arising from the special circumstances or a unique event and that the directors do not expect to pay such amounts on a regular or periodic basis. They will sometimes label this as a special circumstance dividend to ensure the shareholders do no expect to receive these amounts on a regular basis.

Answer 3

The shareholders of a small business may draft a shareholder’s agreement when first incorporating the company or at any time. The agreement sets out the rights and obligations of the shareholders. The agreement must be in compliance with the provisions of the Business Corporations Act in the jurisdiction in which the corporation has been incorporated. The agreement may: • Include the rules that will govern the running of the corporation • Outline the rights and responsibilities of the shareholders in running the business • Stipulate whether loans to shareholders will be permitted For calculating and taxable benefit from interest-free loans, the interest rate is prescribed as provided for in the ITA.

Answer 4

Canadian Controlled Private Corporation (CCPC) is a Canadian private corporation that is not controlled directly or indirectly by one or more non-residents or public corporations. Canadian control requires that at least 50% plus 1 of the common shares must be owned by Canadian residents. As a CCPC, business income earned by a corporation up to the business limit for purposes of the small business deduction is taxed at a combined federal and provincial corporate tax rate of about 20%. The small business deduction is an income tax deduction that currently reduces the federal corporate income tax rate applied to qualifying active business income up to the small business limit of a CCPC to 12%. The small business limit is the annual amount of active business income eligible for the reduced tax rate. For 2009 and later years, the small business limit for the small business limit is $500,000. Under Canadian law, the directors of a corporation do not need to be shareholders in the corporation. A corporation is a separate legal entity from the shareholders. Accordingly, the corporation can contract with any individual shareholder to be an employee of the corporation. Only active business income earned by a CCPC is eligible for the small business deduction. Active business income refers to income from the business, but excludes income from property. For a CCPC, active business income eligible for the small business deduction is taxed at roughly half the basic federal rate. For 2015, the small business limit form the small business deduction is $500,000. The small business deduction is only available in respect to active business income earned by a CCPC. Other types of income, such as investment income or income from a personal services business, do not qualify. The corporation would pay one rate of tax on income up to $500,000 and a higher rate on income greater than $500,000. Associated corporations must share the annual business limit. If two corporations are owned by the same person, they would be associated corporations. For 2015, the federal tax rate for income eligible for the small business deduction is 11%. The provincial corporate income tax rate for income eligible for the small business deduction varies significantly from province to province, but we have assumed that the rate might typically be around 9% The combined federal and provincial corporate income tax rate for income eligible for the small business deduction is about 20%.

Answer 5

A bonus is an employment benefit to the employee and an employment expense to the employer. A bonus can be accrued on the books of the company and deducted from income tax purposes even its not paid to the employee until the 179 days after the corporation’s year end. A corporate paid RRSP contribution is a taxable benefit to the employee and an employment expense to the employer. Dividends paid to shareholders are paid with after-tax profits and are not an expense to the corporation. Dividends paid to the shareholders are paid with after tax profits and are not an expense to the corporation. A deferred profit sharing plan (DPSP) is not a taxable employment benefit to the employee, but it is an employment expense to the employer. The funds withdrawan from a DPSP are a taxable benefit to the employee.

Answer 6

A bonus is an employment benefit to the employee and an employment expense to the employer. A bonus can be accrued on the books of the company and deducted from income tax purposes even its not paid to the employee until the 179 days after the corporation’s year end. A corporate paid RRSP contribution is a taxable benefit to the employee and an employment expense to the employer. Dividends paid to shareholders are paid with after-tax profits and are not an expense to the corporation. Dividends paid to the shareholders are paid with after tax profits and are not an expense to the corporation. A deferred profit sharing plan (DPSP) is not a taxable employment benefit to the employee, but it is an employment expense to the employer. The funds withdrawn from a DPSP are a taxable benefit to the employee.

Answer 7

The owner/manager of a CCPC can take her compensation in the form of salary or dividends. Accordingly, most of the retained earnings would not be eligible for payment as an eligible dividend. So, a CCPC keeps track of any retained earnings that were subject to tax at the general corporate income tax rate in an account called the general rate income pool (GRIP). A corporations general rate income pool (GRIP) is the amount of retained earnings of the corporation that is taxable income of the corporation that has not benefited from the small business deduction or certain other special tax rates. A CCPC can pay eligible dividends only to the extent of its general rate income pool. An ineligible dividend is a dividend that is paid from a corporation’s retained earnings that have benefited from the small business deduction or certain other special tax rates and that is not eligible for the enhanced dividend tax rate. And individual taxpayer reports taxable dividend that is a grossed up amount of the dividend received and deducts from payable a federal dividend credit. The individual taxpayer can also claim a provincial dividend tax credit, the conversion rate for which varies from province to province. The effective tax rate on ineligible dividends is the rate calculated as: • (dividend gross up rate x (Effective tax rate on ordinary income – (federal+ provincial conversion rates) The after tax dividend income is the amount calculated as: • (amount of ineligible dividend x (1 – effective tax rate (ETR) on ineligible dividends)); or • (amount of ineligible dividends x (1 – dividend gross up rate x (ETR on ordinary income – (federal and provincial conversion rates) For 2015 and subsequent years, the dividend gross up rate for ineligible dividends is 118% and the federal conversion rate for the dividend tax credit on ineligible dividends is 11.0168% Because the minimum tax removes the benefit of the dividends tax credit, it is fair that the taxable amount is the amount received, not the amount grossed up. For minimum tax purposes, the dividend grossup of taxable amount of the dividend is deducted.

Answer 8

There are a variety of differences between a corporation and a partnership. Once a partnership begins to produce taxable income, incorporation can provide significant tax advantages for deferral and avoidance. General partners are jointly and severally liable for the debts and other obligations of the business. Shareholders are not, unless they were to give personal guarantees. The opportunity for flow-through of losses is available to the partnership. A corporation can carry forward business losses, but not to transfer them to the shareholders. The corporation would only be subject to an income tax rate of about 20% on eligible net income up to the small business limit. The tax advantages of incorporation are primarily the deferral of personal tax on eligible net income up to the small business limit left in the corporation and the capital gains exemption for the sale of the shares of a small business corporation. Both require taxable income. General partners are jointly and severally liable for the debts and obligations of the business. Shareholder are not, unless they were to give personal guarantees. A bank providing financing would likely require the shareholders to personally guarantee any loans.

Answer 9

Lifetime Capital Gains Exemption (LCGE) is an income tax exemption, available to an individual, from taxation of capital gains realized on the disposition of qualified property: qualified small business corporation shares, qualified farm and qualified fishing property. The LCGE Limit is the maximum amount of taxable capital gains eligible for the Lifetime Capital Gains Exemption. For 2015, the maximum amount of the capital gains for the Lifetime Capital Gains Exemption (LCGE) is $813,600 and the LCGE Limit is $406,800 and it is indexed annually to the CPI.

Answer 10

The owner of a depreciable asset can deduct capital cost allowance (CCA). Recapture of CCA is a taxable event that occurs when a taxpayer disposes of a depreciable property on which CCA has been deducted and disposes of it for an amount greater than its undepreciated capital cost (UCC). Recapture of Capital Cost Allowance is calculated as: (The greater of ($0 and (the lesser of (FMV and original cost)) – the UCC) For capital assets and depreciable assets, and excess of (FMV over the original cost) must be reported as taxable capital gains.

Answer 11

Holding Companies A holding company can be established to hold an investment portfolio purchased with the earnings from an operating company. Dividends received by the holding company from the operating company are not subject to Part I tax, but dividends received by the holding company on its portfolio investments many be subject to a refundable part IV tax. So, dividends paid to the holding company from the operating company are neither subject to Part I or Part IV taxes. The holding company has the authority to distribute its income in a form that provides the best tax advantage for the investor. If the income is paid in the form of dividends, the funds will qualify for the dividend gross up and tax credit. So, establishing the holding company provides a tax deferral for the owner on the personal income tax that would have to be paid on the dividends received by the holding company from the operating company. If the funds are paid in the form of salary or wages, the holding company, not the operating company, can claim an employment expense deduction. The shareholder will then pay personal tax on this amount based on their effective tax rate.

Answer 12

Dividend payments from non-Canadian Corporations In general, when a corporation receives a cash dividend, it must include this amount in its income. There is no dividend gross up or tax credit available to the corporation. However, dividends received from other taxable Canadian corporations and from certain non-resident corporations can be deducted when computing taxable income for the recipient corporation, such that they are not subject to Part I tax. If the dividends are received from corporations that not subject to tax in Canada, the deduction does not apply. The dividend gross up and tax credit are only available to individuals.

Answer 13

Loans to Shareholders Shareholders who are also employees of a corporation can receive loans from that company without having to pay tax on the principal, as long as bona fide arrangements were made at the time of the loan for repayment within a reasonable time, and the loan was made: • To facilitate a home purchase • To facilitate the purchase of previously unissued shares of the corporation; or • To facilitate the purchase of a car to be used in employment duties A shareholder may also be able to receive a tax free loan from the corporation, regardless of the purpose of the loan, as long as it is repaid within one year of the end of the corporation’s taxation year in which the loan was made. This applies whether or not the shareholder is an employee of the corporation.

Answer 14

Incorporating Professional practices In those provinces that do permit incorporated professional practices, the limited liability only applies to the financial debts and obligations of the business. Shareholders remain liable for their own professional negligence and are not protected by the corporate shell.