ACC 522 Chapter 10 Notes: Determination of Taxable Income and Taxes Payable

Determination of Taxable Income

For individuals, the process of converting NI for tax purposes to TI focuses largely on two areas:
the utilization of losses and the lifetime capital gain deduction.
The basic format and the comparative marginal rates of tax that are relevant to decision maker.
Taxable Income (TI) = Net Income (NI) Special Reductions
o NI consists of the aggregate of the five sources of income.
o Special reductions are grouped together in Division C of the ITA. Several of these
reductions apply to individuals; the most important of these are the loss carry-over
provisions and the lifetime capital gain deduction.
Third reduction relates to employment income derived from stock options.
Study Exhibit 10-1 to see the taxable income formula for an individual
o The items in the formula must be included in the order in which they appear.
In part 1 of the formula, (b) includes the item net taxable gains from listed personal property. It
requires that only net gains be included in the formula.
o Losses from listed personal property can be offset only against gains from LPP.
o A loss that cannot be used in a given year can be carried back 3 years or forward 7 years
for use against a listed personal property gain in those years.
o Net taxable gain for the year is the amount by which the current years taxable gain
exceed the allowable losses from the current years plus those from a carry-over year.
The special reductions portion of the formula deals with transactions of other years or modifies
the treatment of certain items in the net income portion.
Loss Carry-Overs
Capital losses can be deducted only to the extent that capital gains were realized in the year.
Losses from business, employment, and property, and ABIL, can be offset against all other
sources of income; they too may be restricted if the losses are greater than the combined total of
other income sources.
Losses incurred in the particular year must be deducted first, as part of NI, before losses of other
years can be applied.
Net Capital Losses
Allowable capital losses incurred in a current year, if they cannot be utilized in arriving at NI, are
reclassified as net capital losses. These can be carried back 3 years and forward indefinitely.
During this carry-over period, the net capital losses can be deducted only to the extent that the
taxpayer has realized net capital gains for that year. Can only be used to offset capital gains.
However, upon the death of an individual, the unused losses may be utilized as a deduction
against any other type of income earned in the year of death or in the preceding year.
Non-Capital Losses
Most other losses incurred in a year, if they cannot be used, are reclassified as non-capital losses.
Employment losses, business losses, and property losses, as well as ABIL, if they cannot be used
because there is insufficient income in the year, discard their identity and become lumped
together as non-capital losses.
Non-capital losses can be carried back 3 years and forward for 20 years and regardless of the type
of income earned.
o One exception to the 20-year carry-forward limit. A non-capital loss that was created by
an ABIL can be carried forward for only 10 years. If the loss is unused after the 10-year

carry-forward period, that unused loss is reclassified as a net capital loss and can be
carried forward indefinitely to be used against future capital gains.
Farm Losses and Restricted Farm Losses
Farm losses concern taxpayers whose chief source of income is farming or fishing. Losses are
actually business losses and are created in the same way as the non-capital losses.
o Can be carried back 3 years and forward 20 years.
Restricted farm losses are losses from farming where farming is not the primary source of the
taxpayer. The annual deductible loss in this situation can be no more than $2,500 plus of the
next $12,500 ($8,750 annually).
o These unused losses can bee carried back 3 years and forward 20 years but can only be
deducted to the extent that farming income was earned in those years.
Sample Calculation of Loss Carry-Overs
Taxpayers who anticipate that their following year income will be much higher and therefore
subject to a higher rate of tax, may prefer to delay utilizing the non-capital loss until 20X2.
It should be noted that the losses incurred in a given year must be used to the extent possible in
that year when determining NIFTP. Only unused loss carry-over can be utilized in other years.
Loss Utilization Impact on Decision Making
The sooner losses are utilized; the sooner cash flow will be increased as a result of reduced taxes.
The taxpayer must utilize them against source of income within a specified time period.
Forms of Business Organization
Organizational structure chosen to carry on an active business has an influence on loss utilization.
In a proprietorship, losses can be offset against the owners other income sources in the year of
loss or carried over to other years, also against all other sources of income.
In a corporation, a business suffers losses, the share value will decline, but such a loss can be
recognized only by the shareholder when the shares are sold or if the corporation becomes legally
bankrupt or is insolvent.
If a corporation ceases operations, the shareholder would recognize the business losses when the
shares were disposed off. However, this loss would be a capital loss, of which only would be
available for use against other capital gains.
If the share loss qualified as an ABIL, of the loss would be available for carry-over against
other sources of income.
In summary, when an individual chooses a corporate structure over a proprietorship or
partnership, the risk of not being able to use a loss for tax purposes is increased.
Preserving Tax Losses
Actual expenses should be deferred for tax purposes, when possible, and that accrued gains
should be realized sooner than later.
Reducing Expenses
If the expenses are not claimed in a particular year, they can be deduced in a subsequent year.
By not claiming CCA, the UCC of the assets class would remain at a higher amount; the CCA
deduction would thus be preserved for future years.
It is not necessary to claim a reserve for A/R that may be uncollectible. If the receivables still
remain doubtful in future years, they can be deducted at that tie, after the loss carry-overs have
been utilized.
Creating Income
Gains can be realized for tax purposes by triggering a disposition.

Sale of capital property can create capital gains and/or recapture of CCA, which can be used to
offset the losses carried over.
o Because the property has been sold and reacquired, its cost base for tax purposes is
increased by the gain.
Business suffering in losses can create taxable income by leasing out assets with lease-andbuyback agreements.
The Capital Gain Deduction
The deduction applies only to gains realized on three specific types of property qualified small
business corporation share, qualified farm property, and qualified property used in a family
fishing business.
All individuals who are resident in Canada are permitted to reduce their TI by the net capital
gains realized on these properties over their lifetime to a maximum of $750,000. As only of
capital gains are included for tax purposes, the maximum deduction is $375,000 of net taxable
capital gains.
A qualified small business corporation must be a small business corporation at the time the
shares are sold. Two further requirements are to be met: shares must not have been owned by
another non-related person in the past 24-months, and during that same period, more than 50% of
the FMV of the assets of the corporation must have been used in an active business.
Ability to claim the capital gain deduction is limited by two items capital losses incurred
(ABIL), and accumulated investment losses, which are referred to as the cumulative net
investment loss.
The capital gain deduction is to provide a deduction only to the extent that lifetime capital gains
exceed capital losses.
The cumulative net investment loss (CNIL) is more difficult to understand. It is based on the
premise that an investment in capital property normally results in two types of returns the
annual net income (loss) from rents, dividends, or interest (property income), and the change in
the value of the investment itself (capital gain or loss).
Under the CNIL provisions, a capital gain deduction cannot be claimed to the extent that the
accumulated annual investment returns (from all types of property) from 1988 to the year in
question are in a negative portion.
o If property expenses exceed property incomes on a cumulative basis, the capital gain
deduction is reduced by that amount.
o The CNIL does not eliminate or reduce an individuals total available capital gain
exemption; it simply delays it use until a later year.
Read Situation & Analysis on Pg. 376
Calculation of Tax for Individuals
Federal tax is expressed in terms of a tax rate applied to the individuals taxable income.
Taxes for individuals are expressed as a percentage of the taxpayers taxable income.
Non-residents do not pay provincial taxes but instead pay an additional tax (48%) that is a
percentage of the federal basic tax.
Federal tax rates are seasonable. Provincial tax rate vary considerably from province to province
and are subject to regular changes based on provincial budget demands.
Overall Tax Calculation
Read Exhibit 10-3 for how to determine federal and provincial tax for an individual

Federal tax is reduced by tax credits, which have been divided into two categories. The first
category of tax credits recues the primary federal tax to an amount referred to as the basic federal
tax.

Federal Tax
Federal tax is determined by applying progressively higher tax rates to higher levels of annual
income.
Each rate of tax is applied separately to the portion of the individuals income that falls within the
applicable range.
Personal Federal Tax Credits
A tax credit is a specific reduction of the tax otherwise payable and has a value equal to its stated
amount. Tax credits benefit all individuals equally, whereas tax deductions provide a greater
benefit to those in higher tax brackets.
A tax deduction reduces taxable income; the related amount of tax saving is based on the
marginal tax bracket of the individual for that particular year.
The credits below are normally established as 15% (lowest federal tax bracket) multiplied by a
designated amount.
Basic
All individuals receive a basic credit of $1,623, which is equivalent to $10,822 of taxable income.
Income below $10,822 is not subject to federal tax.
Spouse or Equivalent to Spouse
Individuals supporting a spouse receive an additional credit of $1,623, which is equivalent to
taxable income of $10,822. The credit is reduced by 15% of the spouses net income.
The spouse support is not available when support payments are being made to a spouse who is
separated and living apart.
Child
A credit of $329 (15% of $2,191) for each child under age 18 at the end of the year can be
claimed by either parent when the child resides with the parents throughout the year.
Any unused credit can be transferred to the other parent.
Infirm Dependents
A credit of $960 (15% of $6,402) is available for supporting a related person who is at least 18
years of age and is dependent by reason of physical or mental infirmity.
The credit is reduced by 15% of the dependents net income in excess of $6,420.
Caregiver
In-home care for a parent or grandparent who is 65 years of age and above or for a dependent
relative who is inform are entitled to a $660 tax credit against federal tax (15% of $4,402).
Credit is reduced by 15% of the dependents net income in excess of $15,033. The credit is
completely eliminated when the dependents income exceeds $19,345.
Family Caregiver
Amounts on which credits for family members are increased $2,000 where dependent are infirm.
The $2,000 is added to each of the following amounts: (1) spouse or equivalent, (2) child under
18, and (3) caregiver amount. Tax credit is 15% of the increased amounts.
Age Amounts
Individuals who are 65 years of age or older can claim an additional credit of $1,008, which is
equivalent to taxable income of $6,720 (15% of $6,720).
The limit of $6,720 is reduced by 15% of the taxpayers net income in excess of $33,884.
Credit is completely eliminated when net income reaches $78,684. If the age credit is unused it
can be transferred to a spouse.

Pension
Individuals can claim a credit of 15% of the firs $2,000 of qualified pension income received in a
year.
Employee Credit
Individuals who are employed can claim a credit of 15% of $1,095 ($165) in 2012.
Adoption Expenses
A credit of 15% for eligible adoption expenses on completed adoption of an eligible child, up to a
maximum of $11,440.
Public Transit Pass
Credit of 15% of the cost of monthly public transit passes for unlimited travel on local buses,
streetcars, subways, commuter trains or buses, and local ferries.
Credit is available for transit passes for the taxpayer, a spouse and child under age 19 at the end
of the year.
Childrens Fitness Credit
Credit is a maximum of $75 (15% of the fees paid in 2012 (max. $500) that relate to the cost of
registering a child, under age 16 at the beginning of the year, in a program of physical activity.
Childrens Arts Tax Credit
The art is a maximum of $75 (15% of the fees paid in 2012 max of $500) that relate to the cost
of registering a child, under the age of 16 at the beginning of the year in an eligible program of
artistic, cultural, recreational or development activities.
First-Time Home Buyers Credit
Individuals who acquire a qualifying home for the first time can claim a credit of 15% on up to
$5,000 for a maximum credit of $750.
Individuals cannot have owned a home in the past 4 years.
Volunteering Firefighters
Perform a minimum of 200 hours of volunteer hours of firefighting services to a fire department
can claim a tax credit of $450 (15% of $3,000).
Charitable Donations
Gifts to charities receive a credit of 15% on the first $200 of contributions and 29% on the
remainder. Annual donations cannot exceed 75% of the individuals net income for the year.
Donation in excess of the limit can be carried forward for five for subsequent taxation year.
Medical Expenses
Tax credit for medical expenses is 15% of the qualified medical expenses that exceed either 3%
of the taxpayers income for the year, or $2,109, whichever is less.
Taxpayers with net income above $70,300 can deduct all medical expenses above $2,109.
The tax credit for medical expenses paid for other dependents (over 18) is 15% of the qualified
expenses that exceed either 3% of the dependents NI for they year, or $2,109, whichever is less.
Disability
Severe and prolonged mental/physical impairment can claim an additional credit of $1,132, which
is equivalent to TI of $7,546. An additional credit of $660 is available for a person under 18.
Education Amount, Tuition Fees, and Textbook Amount
Claim a credit of 15% of tuition fees paid. Full-time students have an additional credit equal to
15% of $465 for each month of full-time attendance.
o Amounts to $70/month.
Part-time education credit of 15% of $140 or $21 or available for each month of attendance.
The unused portion is transferable (within limits) to spouse, parent, or grandparent.
Alternatively, a student may keep the unused credit and carry it forward indefinitely until such
time as he/she has sufficient income to use the credit.

Maximum credit that may be transferred to a spouse or parent is $750 annually less any credit
used to reduce the students tax to zero.
Interest on Student Loans
Deduct 15% of the interest portion of student loan payments. Can be claimed in the year it is
earned or in any of the following five years.
CPP and EI
Taxpayers can claim a tax credit of 15% of their maximum allowable CPP and EI contributions in
any year.
Dividend Tax Credit
Two dividend tax credit calculations. Determining which one to use depends on the type of
dividend received by an individual.
Dividends designated as eligible receive a dividend tax credit of 6/11 of the 38% gross-up, which
is 15% (15.019%) of the taxable amount. Eligible dividends refer to: (1) taxable dividends from
Canadian public corporations, (2) taxable dividends from Canadian private corporation that are
not Canadian controlled, (3) taxable dividends from CCPC at the high corporate tax rate.

Non-eligible dividends receive a dividend tax credit of 2/3 of the 25% gross-up which is 13

1
3

% of the taxable amount.

Other Federal Tax Credits
Canadian taxpayers can reduce their Canadian taxes through the foreign tax credit.
The credit for foreign investment income is further limited to 15% of the foreign income earned;
however, any unused amount can be used as a deduction from income, rather than a credit.
Unused foreign tax credits can be carried back 3 years and forward 10 years.
Tax credit for federal political contributions is based on a graduated scale. The annual credit is
75% of the first $400, 50% of the next $350, and 33
o

1
% of contributions over $750.
3

However, total annual political contributions credit cannot exceed $650.

Provincial Taxes
Individuals subject to tax in a particular provincial jurisdiction if they resided in that province on
the last day of the calendar year. An exception to this rule requires that an individual who resides
in a particular province but carries on business from permanent establishments in other provinces
must allocate business income to those provinces.
If all sales had been made to a province from another province, then there would be no allocation
to the first province, and all the business activity would be allocated to the host area.
Special Adjustments to the Tax Calculation
There are two basic areas where the normal tax calculations may be adjusted to a higher amount:
(1) alternative minimum tax; and (2) the special tax on old-age security benefits.
The Alternative Minimum Tax (AMT)
AMT rules are designed to impose a minimum level of tax on individuals when the normal
amount of tax has been reduced as a result of certain tax preference items being included in
income.
Any additional minimum tax paid in one year can be carried forward for up to seven years to
reduce the normal tax of a future year to the extent that the minimum tax rules do not apply.
AMT only applies to individuals.

Special Tax on Old Age Security Benefits

Special tax is equal to 15% of NI in excess of $69,562, up to a maximum of the Old Age Security
Payments.
Final Returns on Deceased Taxpayers
Taxable Income and Net Capital Losses
In the year of death, capital losses that are unused can be deducted from any source of income in
the year of death or the previous year.
The amount available for this application is the unused net capital losses at the date of death
minus any capital gain deductions claimed in prior years.
Tax Returns and the Use of Tax Credits
In the year of death, representatives must file a final tax return and include all income accrued.
All non-refundable tax credits can be claimed in full regardless of the date of death.
Income that qualifies as a right or thing may be included in the final tax return of a deceased
taxpayer or optionally included in a separate rights and things return.