ACCO 655/2194

SECTION CC

TAXATION AND DECISION-MAKING

COURSE NOTES

WEEK 9

 OTHER ISSUES IN CORPORATE

TAXATION
 CORPORATE TAXATION AND
MANAGEMENT DECISIONS

John Molson School of Business

Graduate Diploma in Chartered Professional Accountancy Program
Concordia University
Larry Jacobson, MBA, CPA, CA
February, 2020
 Copyrighted Materials

All book excerpts included in these notes come from the required text for this course:
Byrd & Chens Canadian Tax Principles, 2019-2020 Edition. We gratefully
acknowledge permission from the publisher to use these excerpts.

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 OTHER ISSUES IN CORPORATE TAXATION
Byrd & Chen: Chapter 14

1. ACQUISITION OF CONTROL

2. ASSOCIATED COMPANIES - ITA 256

3. INVESTMENT TAX CREDITS (ITCs) - ITA 127(5), PLUS SR&ED

4. TAX BASIS SHAREHOLDERS’ EQUITY

5. DISTRIBUTIONS OF CORPORATE SURPLUS

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 ACQUISITION OF CONTROL

Issue:
Some corporations have accumulated large amounts of net capital and non-capital
losses. Sometimes these corporations are in poor economic health, have little chance
of using the losses, and consider closing down. The question arises if the
government should permit these corporations to be taken over by others and allow
the new owners to use the unutilized losses. A disadvantage for the government is
that the purchaser would pay less tax, which could prove to be quite costly to the
government.

Solution:
Allow the purchaser to use the business losses of the acquired corporation, but only
as long as it continues to carry on the business. In this way jobs could be saved and
these businesses might again become viable, helping the economy.

DEFINITION OF ACQUISITION OF CONTROL

 Person or group acquires control (>50% voting shares) from an unrelated party

 Control includes indirect control

 Can also occur through redemption of shares:

A owns 60 percent of a corporation
B owns 40 percent
If all of A’s shares are redeemed, B will have acquired control.

 Person acquires >75% of the FMV of all shares of the corporation from an
unrelated party (even if they are non-voting shares)
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SPECIAL RULES FOR THE ACQUIRED CORPORATION WHEN THERE
IS AN ACQUISITION OF CONTROL:

1) Year End

 Deemed year end immediately before control changes.

 May create a short fiscal period.

o CCA must be prorated
o Annual business limit must be prorated
o Short year counts as a taxation year for carry over purposes

 A new taxation year end must be selected although the old year end can be
retained.

2) Net Capital Losses

 111(4)(a) & (b) Unused net capital losses carry over expire.

 New net capital losses realized after the acquisition cannot be carried back.

3) Non-Capital Losses (business losses only)

 111(5) Unused non capital losses carry over can be c/f or c/b only if:

a) the business (and not just the corporation) that generated the losses is
carried on for profit or with a reasonable expectation of profit

b) the business that generated the losses continues to be carried on throughout

the year the loss is to be deducted, and

c) the losses can be deducted from income earned from carrying on the same
or similar business. A “Similar Business” is a business where substantially all
income is derived from the sale, leasing, rental or development of similar
properties, or the rendering of similar services.

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4) Miscellaneous items:

 Inventory
Inventory which has an accrued loss must be written down to FMV.
The resulting loss is added to the non-capital losses.

 Accounts receivable
No reserve for doubtful a/c permitted.
Instead, all potential reserves must be written off as bad debts.

 Depreciable property
If UCC at deemed year end > FMV of assets in class, then class must
be written down to FMV and the amount written down is treated as
CCA

Example: Building

CC: $200,000
FMV: $140,000
UCC: $160,000

 Property written down now has a $140,000 UCC.

 $20,000 is deemed to be CCA claimed in final period prior to the

acquisition of control.

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 Non-depreciable capital property

If ACB > FMV, then must write down to FMV, resulting in a capital loss.

Example: Land

ACB: $100,000
FMV: $ 5,000

 Property written down, now has a $5,000 ACB

 $95,000 is deemed to be a capital loss claimed in final

period prior to the acquisition of control.

 Charitable donations

Undeducted balance cannot be c/f (carried forward) after the acquisition of

control.

 ABIL

Will expire on deemed year end and must be removed from the non-capital
loss balance carry over, and cannot be c/f.

 Property losses

Property losses which form part of the non-capital loss balance cannot be c/f
after the acquisition of control.

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111(4)(e) ELECTION FOR PROPERTY WITH ACCRUED GAINS

 Can elect to have deemed disposition/reacquisition of any depreciable or non-

depreciable capital property for which there is an accrued gain or potential
recapture of CCA

 The corporation can choose deemed proceeds of disposition at any point

between the lesser of the FMV and the ACB/CC, which also results in an
increase in the ACB, CC and UCC.

EXAMPLE 1: BUILDING
 Capital Cost $ 50,000
 FMV $100,000
 UCC $20,000

 Elect $100,000
 Capital Gain $ 50,000
 Recapture $ 30,000
 New Cap. Cost $100,000
 New CC (for UCC)$ 75,000*

* [$50,000 + (1/2)($100,000 - $50,000)]

EXAMPLE 2: LAND
 ACB $ 40,000
 FMV $100,000

 Elect $100,000
 Capital Gain $ 60,000
 New ACB $100,000

 Why would a corporation elect to have a FMV disposition?

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*You only need to study the following for the CFE if tax is your elective roll.*

ACQUISITION OF CONTROL OF A CCPC BY NON-RESIDENTS

Tax Implications

1. The corporation is no longer entitled to the small business deduction.

2. If there are some remaining Canadian minority shareholders, they will not be
eligible for the CGD when they sell their shares in the future (because the
corporation will no longer qualify as a QSBC. Planning: Consider crystalizing
the CGD prior to the sale. Refer to Week 10 for crystallization procedure.

3. The RDTOH is lost, as the company is no longer a CCPC. Planning: Pay out
taxable dividends prior to the sale of the company to fully utilize the balance.

4. The CDA, which permits the payment of tax free dividends to Canadian
shareholders, is of no value to the non-resident shareholders. If there will be no
more Canadian shareholders after the sale, then pay CDA dividends to the
Canadian shareholders prior to the sale.

5. Employee stock option taxation is less favourable, because holders will now be
taxed when the options are exercised, and not when the shares are sold as it is
for a CCPC.

6. The balance owing for a corporation’s year will be due two months after the
year end instead of three for a CCPC.

7. As the company is no longer entitled to the SBD, income earned will now go
into the GRIP account and eligible dividends will be paid which entitles the
remaining Canadian shareholders to an enhanced dividend tax credit.

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11
12
13
ASSOCIATED COMPANIES - ITA 256

Are these associated????

Issue:
A CCPC can claim the SBD on a maximum amount of $500,000 per year,
resulting in a net tax saving of $30,000 if there was no SBD
(i.e., $500,000 x (19% SBD - 13% GRR = $30,000). Assume we have a
corporation that makes windows and doors and has $1,000,000 of active
business income (ABI) per year. If the owner decides that he would rather
own two companies, one which manufactures doors and the other windows,
both of which would make $500,000 per year, would each company be
entitled to the $500,000 SBD? If yes, then would be an additional tax savings
of $30,000.

Solution:
The companies are considered to be associated, and associated companies
must share the Annual Business Limit of $500,000.

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DEFINITIONS:

Control vs Ownership:

Corp A

80%

Corp B

30%

Corp C

 Control: Corp. A is deemed to control 30% of Corp. C

 Ownership: Corp. A is deemed to own 24% of Corp. C

Shares owned by a minor child

 Shares owned by a child ≤ 18, they shall be deemed to be owned by each of

his parents (i.e., there is double counting).

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 EXAMPLES - ASSOCIATED CORPORATION RULES:

256(1)(a): Direct control and indirect control

One of the corporations controlled, directly or indirectly in any manner

whatever, the other.

256(1)(b): Common Control

Both of the corporations were controlled, directly or indirectly in any manner

whatever, by the same person or group of persons (the group does not have to
be related);

Other Examples:

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256(1)(c): Control by Related Persons + Cross Ownership

Each of the corporations was controlled, directly or indirectly in any manner

whatever, by a person and the person who so controlled one of the
corporations was related to the person who so controlled the other and either of
those persons owned, in respect of each corporation, not less than 25% of the
issued shares of any class, other than a specified class, of the capital stock
thereof.

Related Persons:

 Individuals are related if connected by blood, marriage, common law

partnership or adoption.

 Includes parents, grandparents, including those of the spouse, spouse’s

siblings and their spouses, plus a person’s children and their spouses.

 Corporations are related to a person, or a related group of persons, that

controls the corporation.

 The following are not related: A person’s niece, nephew, cousin, aunt
or uncle.

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256(1)(d): Control by a Person and Related Group + Cross Ownership

One of the corporations was controlled, directly or indirectly in any manner

whatever, by a person and that person was related to each member of a group
of persons that so controlled the other corporation, and that person owned, in
respect of the other corporation, not less than 25% of the issued shares of any
class, other than a specified class, of the capital stock thereof;

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256(1)(e): Control By Related Groups + Cross Ownership

Each of the corporations was controlled, directly or indirectly in any manner

whatever, by a related group and each of the members of one of the related
groups was related to all of the members of the other related group, and one or
more persons who were members of both related groups, either alone or
together, owned in respect of each corporation, not less than 25% of the issued
shares of any class, other than a specified class of the capital stock thereof.

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256(2) - Association Through A Third Corporation

This provision indicates that two corporations, both of which are associated
with a third corporation, are deemed to be associated with each other.
However, the third corporation can elect not to be associated with the other
two corporations. A consequence of this is that the third corporation’s annual
business limit will be set at nil. However, the election will allow the other two
corporations to be exempt from the association rules under ITA 256(2).

Husband Wife

100% 100%
50% 50%

Husband Mgt. Ltd. Wife Ltd.

Ltd.

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 INVESTMENT TAX CREDITS (ITCs) - ITA 127(5)

PURPOSE:

Provide an incentive to both individuals and corporations to carry out selected

activities or invest in selected regions of the country.

GENERAL RULES

- Can deduct specified % of the cost of eligible expenditures from taxes payable.

- However, ITC claimed in the year for:

 Current expenditures: Must be included in income in the following tax

year.

 Capital expenditures: Must be deducted from cost of qualified capital

property in the following tax year.

ELIGIBLE EXPENDITURES AND RATES

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DETAILED RULES:

ELIGIBLE APPRENTICES:

 These are non-refundable credits

 Unused ITCs can be carried back 3 years and carried forward 20 years.

QUALIFIED PROPERTY - ITA 127(9)

 Must be depreciable property that is a new building or new machinery and

equipment used primarily in qualified activities in the locations noted in the
table on the previous page.

 Qualified activities include manufacturing and processing, farming, fishing,

logging, and storage of grain.

 As the ITC is deducted from the cost of the property, future CCA on
qualified property purchases ends up being reduced.

 If the ITC cannot be used in the year because there is not sufficient taxable
income, then 40% of the ITC’s earned in the year are refundable. See also
refundable ITC’s for SR&ED expenditures, following.

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SCIENTIFIC RESEARCH & EXPERIMENTAL DEVELOPMENT (SR&ED)

WHAT YOU NEED TO KNOW FOR THE CFE IF TAX IS NOT YOUR
ELECTIVE ROLE:

Who can claim SR&ED investment tax credits?

 Individuals, corporations, and trusts are entitled to make a claim for SR&ED
expenditures.

 SR&ED includes basic research, applied research, and experimental

development of new products and processes, including the field of
information technology.

 Expenses that are excluded from SR&ED: Market research, sales promotion,
and routine product testing.

If you note on the CFE that a person appears to have made SR&ED expenditures,
then you should consider filing form T661 with the CRA. Approved SR&ED
expenditures will entitle the person to investment tax credits which will reduce the
net taxes payable by the person.

Due to the complexity of the rules, a specialist in this area should be consulted.
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WHAT YOU NEED TO KNOW FOR THE CFE IF TAX IS YOUR
ELECTIVE ROLE:

In addition to the previous page you should understand the following 10 pages.

 SR&ED references: ITA: 37(1) and Regulation 2900

INCENTIVES FOR SR&ED ACTIVITIES

There are two incentives for which both individuals and corporations are entitled:

1. Deduction of SR&ED expenditures from income (see below)

2. Deduction of ITCs from taxes payable (see below)

1. DEDUCTION OF SR&ED EXPENDITURES

 SR&ED expenditures use a pooling method. That is, all expenditures are
combined into one account.

 Added to the pool are all current expenditures made in or out of Canada, which
are used  90 % for SR&ED.

 For 2014 and later years, capital expenditures are not added to the pool.
However, the taxpayer can claim CCA on these purchases.

 Amounts from this pool can be deducted when computing net income for the
current year or any future year (not limited to a 20 year carry forward).

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2. DEDUCTION OF ITCs FOR SR&ED EXPENDITURES

 ITC Rate for CCPCs

o 35% ITC Rate: On a maximum of $3 million of SR&ED expenditures

per year (referred to as the Annual Expenditure Limit).

 The $3 million annual expenditure limit is reduced for large

CCPCs which have taxable capital in excess of $10 million.

 The $3 million annual expenditure limit must be allocated among

associated companies

 Refer to the SR&ED question which follows, for a numerical

example

o 15% ITC Rate: If the SR&ED expenditures are in excess of the annual
expenditure limit, the excess qualifies for the 15% ITC rate.

 ITC Rate for Non-CCPCs (including Individuals and Public

Corporations)

o 15% on all eligible expenditures

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REFUNDABLE INVESTMENT TAX CREDIT - ITA 127.1

 When a corporation has no taxes payable, the ITC is of no immediate

advantage unless there is a refund mechanism

 ITA 127.1 allows ITC refunds in select circumstances

 Refunds only apply to individuals and CCPCs. Public companies are not
eligible for ITC refunds.

 Refunds are only allowed for ITCs earned on SR&ED expenditures and for
Qualified Property purchases.

 Eligible apprentices and child care spaces ITCs are not refundable.

REFUND RATES FOR QUALIFYING CCPCs (taxable income in the preceding

year ≤ $500,000):

1. 100% refund for SR&ED expenditures that qualify for the 35% ITC rate.

2. 40% refund for SR&ED expenditures that qualify for the 15% ITC rate.

3. 40% refund for Qualified Property which qualifies for the 10% ITC rate.

REFUND RATES FOR INDIVIDUALS:

 40% refund on all ITCs earned in the year.

 Example:

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ITC CARRYOVER

 Unused ITCs can be carried back 3 years and carried forward 20 years.

 Must claim all other tax credits before claiming ITC in a year.

 Also must reduce federal taxes payable to fullest extent possible by ITC in
current year before carrying back unused ITC.

 When there is an acquisition of control, carry forward of ITCs is permitted if

the same conditions to carry forward non-capital losses are met (i.e., business
continued, with a reasonable expectation of profit, etc.).

Remember: Individuals and corporations can get both a deduction in computing net
income for SR&ED expenditures plus the deduction of the ITC from taxes payable.

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 QUESTION

SR&ED and QUALIFIED PROPERTY

Natalia owns 100% of the shares of New Age Limited (NAL), a Canadian controlled private
corporation. NAL carries on scientific research and experimental development (SR&ED)
activities with respect to finding the ingredients for a cream which will reduce fat and tone
muscles when massaged into the skin.

During its fiscal year ended December 31, 2019, NAL incurred the following costs related to its
SR&ED activities:

 Current expenditures: $3,625,000

 Capital expenditures: $180,000

NAL purchased $500,000 of new machinery to be used in the processing of the cream. The
processing is to take place in Newfoundland.

NAL has Part I taxes of $10,000 in 2019. Its taxable capital employed in Canada equaled $15
million in 2018. It is not associated with any other corporation.

REQUIRED

Determine for 2019:

1. The maximum deductible SR&ED expenditures

2. Total amount of the ITCs earned
3. The refundable ITCs
4. The unused ITCs for the year

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 SR&ED SOLUTION

ITCs and Refundable ITCs

Nature Deductible ITC ITC Refundable ITC
SR&ED rate
Current SR&ED ................................ $2,625,000 35% $918,750 100% $918,750
Current SR&ED $1,000,000 15% $150,000 40% $ 60,000

Capital SR&ED ................................. 0 0% 0 0% 0

Deductible SR&ED $3,625,000 1,068750 $978,750

PLUS
Qualified Property $ 500,000 10% $ 50,000 40% $ 20,000

Total ITCs 1,118750 $998,750

2019 Expenditure limit for NAL:

$3,000,000 x {($40,000,000 – ($15,000,000 – 10,000,000)) ÷ $40,000,000} = $2,625,000

Unused ITCs:

Total ITCs earned, per previous page $1,118,750

ITCs used:
Credit against Part I tax (10,000)
Refundable:
(limited to $998,750 - $10,000 used) (988,750)

Unused ITCs $120,000

The unused ITCs can be carried back 3 years and carried forward 20 years.

29
ITCs that are deducted or refunded in the year in respect of:

 SR&ED expenditures must be included in income for the following year

[par. 12(1)(t)].

 Qualified property will reduce the UCC of the class in the following year.

*The following was taken from the September 2016 CFE. You only need to
study this if Tax is your elective role.*
Note that in the response that you were expected to provide the tax criteria.

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31
32
 TAX BASIS SHAREHOLDERS’ EQUITY

Tax Basis Retained Earnings Tax Consequences

-Capital Stock or PUC Returned to shareholders tax free

-Pre-1972 CSOH Returned to shareholders tax free,

but on wind-up only

-Capital Dividend Account (CDA) Tax free 83(2) dividend

-RDTOH Taxable dividend to shareholder

and dividend refund to company

-Post 1971 Undistributed

Surplus Taxable dividend

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PUC - ITA 89(1)

 LSC (Legal Stated Capital) is the accounting and legal term for the capital of a
corporation

 PUC (Paid-Up Capital) is the tax term for LSC. It is the capital stock issued
and paid for in the legal sense, as above, as adjusted by the ITA

 It is calculated on an average basis per share issued of a class

 PUC represents the amount of capital that can be returned (paid) to the
shareholders without being taxed as a dividend.

 The return is based on the amount originally invested and may be different
from the ACB

 Example:

o J & J Ltd. issues 1,000 shares of stock on January 1, 2018 for $10,000
($10 per share) to Mr. A.

o On December 31, 2019 Ms. B purchases 3,000 shares from the

company for $60,000 ($20 per share).

 Mr. A (January 1, 2018): - PUC = $10,000 ÷ 1,000 = $10.00

- ACB = $10,000 ÷ 1,000 = $10.00

 Ms. B (December 31, 2019): - PUC = $70,000 ÷ 4,000 = $17.50

- ACB = $60,000 ÷ 3,000 = $20.00

 The PUC of Mr. A’s shares increases to $17.50 per share. His ACB remains at
$10 per share.
 PUC is only used when shares are redeemed by a corporation, when a
corporation is wound-up, or there is a reduction to a corporation’s PUC.
 When shares are sold, you use the ACB, and not PUC, to compute the CG
34
PRE-1972 CAPITAL SURPLUS ON HAND (CSOH)

*Note: Unless tax is your elective role, you do not have to learn CSOH*

 Consists of capital gains and losses which accrued prior to 1972.

 The amount can only be used when the corporation is wound up.

 Example: Refer to the CDA example, following.

35
CAPITAL DIVIDEND ACCOUNT (CDA) - ITA 83(2)

 Basically contains the non-taxable portion of net capital gains that have been
realized by a private corp. after 1971

 CDA calculation:

Includes the non-negative balances of each of the following:

+ The non-taxable portion of capital gain less allowable capital losses and
less allowable business investment losses.

+ The non-taxable portion of net gain on disposition of eligible capital

property in past years

+ Untaxed insurance proceeds on death of policyholder where

company was beneficiary, less ACB of policy

+ CDA dividends received

- CDA dividends paid

 Basic concept is that as the above amounts are not taxable to the corporation
they should flow through tax free to the shareholders.

 Appropriate elections must be filed and no later than the date the dividend
becomes payable

36
  Example: A corporation bought land in 1960 and sold it in 2018. The
attributes are as follows:

1960: Purchase cost (ACB) $100,000

$200,000 CSOH
Dec. 31, 1971: FMV $300,000
$500,000 = CG
2019: Proceeds from sale $800,000

 In the above example, $200,000 is added to the CSOH balance, and $250,000
(1/2 of $500,000) is added to the CDA balance

 The $200,000 CSOH can be paid out tax free to the shareholders, but
only at the time the company is wound up

 The $250,000 CDA can be paid out at any time as a tax free dividend to
its shareholders

Planning for dividends paid out of the CDA account

1. Capital losses: Assume a CCPC intends to pay a dividend and also foresees
that it will soon realize a capital loss. If the ½ of the capital loss will reduce the
CDA account below the proposed dividend, the dividend should be declared
and the election made to pay it out of the CDA account prior to the capital loss
being realized.

2. CRA Reassessments: Assume a dividend is paid out of the CDA account and
the CRA subsequently reassesses the CDA balance (e.g., it changes a capital
gain into business income). If the capital dividend paid is in excess of the
revised CDA balance, the excess amount is subject to a 60% penalty. To fix
this problem the company can elect within 90 days after the date of the penalty
assessment to separate the dividend paid into two dividends; one dividend that
does not exceed the CDA and the remainder as a taxable dividend.

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 DISTRIBUTIONS OF CORPORATE SURPLUS

REGULAR CASH DIVIDENDS

 Taxable to individual shareholder, with gross up and dividend tax

credit (DTC)

 When a corporation receives a dividend it is added to net income, and then

deducted in computing taxable income.

 When dividends are received by a private corporation the Part IV tax applies,
which is subsequently refunded when the recipient corporation pays out
dividends

STOCK DIVIDENDS

 Pro-rata distribution of new shares to existing shareholders

 Taxable to individuals

 Will increase the PUC of the company

 Example:

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DIVIDENDS IN KIND

 Dividends that are payable in assets other than cash or shares.

 There is a deemed disposition of the asset at FMV resulting in a possible

capital gain for the company

 The shareholder will declare a taxable dividend = FMV of the asset distributed

 The shareholder will have asset with ACB = FMV of the asset distributed

 Example:

A corporation distributes an investment as a dividend in kind to an individual

shareholder. The investment has a cost of $1 million and a FMV of $1.5
million.

Shareholder: Taxable dividend of $1.5 million, which must be grossed up.

The ACB of the investment is $1.5 million.

Corporation: Disposition at $1.5 million, capital gain of $500,000.

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84(1) DEEMED DIVIDENDS – INCREASE IN PUC

 Where a corporation issues shares with a PUC in excess of the consideration

received for the shares, ALL the shareholders are deemed to have received a
dividend in proportion to their shareholdings.

 Consideration for the issue of shares could be cash or non-cash, or a reduction

in a liability

 This deemed dividend is also added to the ACB of the shares

 For tax purposes, a deemed dividend is treated exactly like any other dividend
declared by a corporation.

 Example: A corporation purchases an asset from its major individual

shareholder. The asset is worth $100,000, and the company issues Class A
shares with a PUC of $110,000 in payment. There would be an 84(1) dividend
of $10,000 deemed to have been received by all shareholders of Class A shares
only, pro-rata to their shareholdings. The dividend must be grossed up and the
shareholders would be entitled to a dividend tax credit. The $10,000 deemed
dividend is also added to the ACB of the shares.

 Summary: 84(1) Deemed Dividend:

 in PUC is more than  in Net assets

 in PUC is more than  in Net liabilities

 in PUC of Class A shares is more than  in PUC of Class B shares

 Exceptions to 84(1) Deemed Dividends. There is no deemed dividend:

 If  in PUC is less than  in Net assets

 Where PUC  of Class A shares = PUC  of Class B shares

 Where a corporation converts contributed surplus into PUC.

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84(2) DEEMED DIVIDENDS – ON WINDING-UP

 A resident corporation that distributes its property to its shareholders on its

winding-up is deemed to have paid a dividend = funds available for
distribution less both the PUC and the pre-1972 CSOH

 Of this deemed dividend, if there is a CDA, an election is made to treat part of

the dividend as not taxable

 The deemed dividend reduces the proceeds of disposition

 This topic would be examined after the midterm, when we review ITA 88(2)
wind-ups

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84(3) DEEMED DIVIDENDS ON REDEMPTION OR CANCELLATION OF
SHARES

CFE: This is probably one of the more important areas when dealing with corporate
surplus and dividends. Therefore, be sure to understand the tax implications from a
redemption of shares as outlined below.

 Where a corporation redeems, acquires or cancels its own shares, there is a

deemed dividend = Redemption price – PUC

 As the shares have been disposed of, you must also compute a CG/CL

 The deemed dividend reduces the proceeds of disposition

 Example:
Mr. Jones owns all 5,000 shares of L&L Ltd. The shares have a PUC of
$80,000 and his ACB is $10,000. One-half of the shares are redeemed for
$55,000.

Redemption proceeds $55,000

Deduct PUC [(1/2)($80,000)] (40,000)
ITA 84(3) Deemed Dividend $15,000

Redemption proceeds $55,000

84(3) Dividend, per above (15,000)
POD $40,000
ACB (5,000)
Capital Gain $35,000

Taxable Capital Gain $17,500

NOTE: If there is a capital loss on the redemption, it will be disallowed only

if the shareholder is affiliated with the corporation after the redemption.

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84(4) DEEMED DIVIDENDS ON REDUCTION OF PUC

 A corporation might decide to reduce its PUC by way of a distribution to its

shareholders.

 If the distribution exceeds the PUC reduction, a deemed dividend is created.

 Example:
ABC Ltd. distributes $1,000,000 cash to its shareholders. The company does
not declare a dividend, but instead reduces its Legal Stated Capital, which has
a balance of $1,500,000. The PUC of the corporation was $700,000 prior to
the distribution.

Amount distributed $1,000,000

Reduction to PUC 700,000

Deemed dividend $ 300,000

84(4.1) DEEMED DIVIDENDS ON REDUCTION OF PUC

 When a public company reduces its PUC, the entire reduction is considered to
be a deemed dividend.

 There is an exception to this rule where the payment is derived from a

transaction outside the corporation’s normal business.

43
 CORPORATE TAXATION, INTEGRATION, AND
MANAGEMENT DECISIONS
Byrd & Chen: Chapter 15

THE DECISION TO INCORPORATE

1. Tax considerations and the Integration Concept

2. Other advantages and disadvantages

BASIC TAX CONSIDERATIONS WHEN DECIDING TO INCORPORATE

Note: By incorporating there will be a dual system of taxation, i.e., at the company
level and then at the individual level when salaries or dividends are received.

1. Tax Reduction
Sometimes the total taxes that would be paid at the combined corporate and
personal level will be less than if the individual had earned the business
directly as an individual proprietor.

2. Tax Deferral
When Net Income at the individual level is > $210,371 the individual will be
paying federal and provincial taxes ≈ 51% vs. a CCPC which pays ≈ 11.5%
if eligible for the SBD

Note:
Deferral can only be achieved on money left in the corporation and not paid
out to the shareholder

44
3. Using Imperfections in the integration system
Imperfections are caused by variations in the provincial tax rates and
provincial dividend tax credits.

Examples:

a. Provincial tax holidays (e.g., a 5 year holiday from paying provincial

corporate taxes).

b. Non-eligible dividends in 2019 are grossed up by 15%. For federal

purposes, the individual receives 9/13 of the gross up as a dividend
tax credit. If the province of residence provides > 4/13 provincial
dividend tax credit, it is more beneficial to pay dividends to recipients
in that province.

4. Income Splitting
Occurs if the corporation is able to pay salaries and dividends to family
members in low tax brackets.

45
ADVANTAGES AND DISADVANTAGES OF INCORPORATING:

Advantages:

1. Limited liability, as the corporation is a separate legal entity. (Note: As a

result, banks often require personal guarantees from the major shareholders
for corporate loans.)

2. Lifetime CGD of $866,912 (for 2019) if company is a QSBC. The CGD

will increase annually by the rate of inflation.

3. Flexibility on Timing, Type and Distribution of Income: Stabilization of

income of individual through salary/dividends at owner’s discretion.

4. Foreign Taxes: Foreign estate taxes can often be avoided by placing

foreign property in a corporation.

5. Estate planning advantages by freezing the share values of the corporation.

6. Capital Gain Deferral: For sales of eligible SBC where proceeds reinvested
in another eligible SBC.

7. Tax Deferral: If income is retained by the corporation.

8. Tax Reduction through Income Splitting: If can pay salaries and

dividends to family members who are in low tax brackets

9. Stock Option: Low tax rate due to the stock option deduction.

46
Disadvantages:

1. Use of Losses: Can’t use corporate losses against other personal sources of
income.

2. Tax Credits: If a person’s income is earned entirely by the corporation, the

personal tax credits will be wasted.

3. Charitable donations in a corporation are deductible and may result in less

tax savings compared to a maximum 33% federal (+ provincial) personal tax
credit.

4. Additional Maintenance Costs: Legal, accounting, annual returns, tons of

government forms, and tax on capital.

5. Winding-up procedures more complicated than for a proprietorship

6. Higher Taxes: Possible increase in overall taxes

47
 TAX REDUCTION AND TAX DEFERRAL

It is largely affected by:

1. Type of corporation: CCPC or public

2. Type of income of corporation: ABI or property income (including SIB)

3. Type of income paid to the shareholder: Salary or dividend

4. CCPC with ABI: > $500k or ≤ $500 re SBD

5. Tax Bracket of Individual: If Net Income is ≤ $210,371, individual tax will

be at lower rate than the maximum tax bracket

6. Ability to split income amongst low tax bracket family members

So, there is no simple answer. It depends.

48
TAX RATES

Corporate tax rates (2019):

Tax on Dividends:

How much tax do individuals pay on dividends?

49
BASIC EXAMPLES

Assume:
An individual earns sufficient income to be in the top tax bracket (Estimated to be
51% federal and provincial combined). This individual has the choice of earning
an additional $100,000 directly, or can have a corporation earn the $100,000 and
pay corporate taxes, and then pay out the after tax income as a dividend to the
individual.

Amount of after tax income:

If earned directly by the individual:

Income $100,000
Taxes (51,000)
After tax income $49,000

If earned through a CCPC, it will depend on the type of income earned:

- Active income with SBD

- Active income with no SBD
- Investment income
- Dividend income

Example of perfect integration:

Do we have perfect integration in Canada?

If we don’t, should we incorporate for tax purposes?

50
CCPC – ACTIVE BUSINESS INCOME AND INTEGRATION

Conclusion:

Tax Reduction: With SBD: Small tax disadvantage to flow income through the
corporation.
No SBD: More costly to flow income through the corporation.

Tax Deferral: With SBD: Yes, large deferral

No SBD: Yes, smaller deferral, but still important

Tax planning: Bonusing Down:

If a CCPC earns active business income in excess of its annual business limit
($500,000, or less if shared with an associated company), consider accruing a
bonus to bring the earnings down to the $500,000 level. This results in a lower
corporate tax rate as the SBD is received on all of the income.
51
CCPC – INVESTMENT INCOME (OTHER THAN DIVIDENDS)

Conclusion:

Tax Reduction: No, worse

Tax Deferral: Worse

52
CCPC – CANADIAN DIVIDEND INCOME AND INTEGRATION

Conclusion:

Tax Reduction: None

Tax Deferral: - Eligible dividend: No deferral (worse).

- Non-eligible dividends: Some deferral.

- Connected, no Part IV Tax: Large deferral (See the example on the

next page)

53
USE OF HOLDING COMPANY

Example to avoid immediate tax on dividends

Sam Mary

Holdco

Opco

54
INTEGRATION CONCEPT SUMMARY

(based on an individual incorporating who has a personal tax rate of 51%)

Tax Reduction (Total individual and corporate taxes)

1. If entitled to the SBD, almost perfect integration. Total taxes will be

slightly higher if you incorporate.

2. Other cases (no SBD, or investment income other than Canadian

dividends): Integration does not work as well. There will be higher
combined taxes if you incorporate this type of income.

3. Canadian Dividends: Perfect integration. There are no additional taxes

when Canadian dividends are flowed through a corporation.

Tax Deferral (where income is not immediately paid to shareholder)

1. CCPC with SBD: Large deferral

2. CCPC with no SBD: Smaller deferral

3. CCPC with investment income: No deferral (worse)*

4. CCPC receiving eligible dividends: No deferral (worse)*

5. CCPC receiving non-eligible dividends: Some deferral*

6. CCPC receiving dividends not subject

to Part IV tax: Large deferral

* Not only does investment income offer little or no tax deferral advantages, if
the investment income is high enough (over the $50,000 annual threshold), it
will reduce the Annual Business Limit (i.e., the amount available for the small
business deduction).

55
NEW ASSUMPTION

What happens to our conclusions if a recipient shareholder’s tax rate is less than
the 51% rate?

 If the individual rate is lower, the greater the tax savings by incorporating.

 This encourages the payment of salary and dividends to lower tax bracket
individuals, if possible (referred to as income splitting).

56
 INCOME SPLITTING

Incorporation provides the opportunity of income splitting by redistributing the

income from family members in a high tax bracket to those in a lower tax bracket.

This can be done by:

1. Having the corporation pay family members reasonable salaries. (Note:

You don’t have to incorporate to pay salaries to family members)

2. Having the corporation pay to the lower tax bracket family members
dividends (they must be shareholders).

 Example: For 2019, if an individual has no income other than

non-eligible dividends, what is the amount of dividends that they
could receive without owing any federal tax?

57
Conclusion for income splitting:

If dividends can be paid to those in the lowest tax bracket, it will then be
possible, for all the previous scenarios examined, to show an overall tax
reduction by earning income through a corporation.

How easy is it to split dividends from a family controlled corporation?

Potential problems:

1. Control: Could lose control of corporation when family members own

shares.

2. Tax On Split Income (TOSI): Generally, dividends received from a

family owned company by children or a spouse who are not actively
engaged in the business, will pay tax at the highest tax bracket rate
(33% federal + highest provincial rate), and no credits will be allowed
other than dividend and foreign tax credits.

3. Attribution rules will apply if the parent loaned a minor the money to
buy the shares. If the split income rule applies, then the attribution
rules will not.

4. Ownership: The dividends and shares legally belong to the recipient.

58
Takeaway: Should I incorporate for tax reasons?

1. Usually not recommended to incorporate if all of the annual corporate

earnings are to be distributed to the owner/manager by way of salary or
dividends.

2. If not all of the earnings need to be distributed, then advantageous to

incorporate as there is a substantial deferment of tax (11.5% corporate tax vs
51% individual tax).

3. If corporation can sprinkle dividends/salary to family members in a low tax

bracket, then advantageous to incorporate. Note: The new TOSI rules will
make it more difficult to sprinkle dividends, unless the exceptions apply.
Refer to the course notes for Week 6.

4. Usually not recommended for an individual to transfer personal investments

to a corporation, as corporate investment income in a CCPC is taxed at a
high level.

59
 CFE CASE

SOLAR PANELS SOLUTIONS INC.

INTEGRATION CONCEPT

September 2018 CFE – Day 2 Simulations Page 60

Solar Panel Solutions Inc. (SPS) is a Canadian public company founded in 2001
that manufactures solar panels. . . . You, CPA, work in the tax group at CPA LLP.
Sheila LaRoche, a tax partner with the firm, recently met with Roger to discuss a
number of issues relating to the 2017 year-end. Sheila asks you to assist with
Roger’s requests.

A board member suggested that SPS pay dividends in 2018. Roger already
receives annual dividends from Vitality Corp. (VC), a Canadian-controlled private
corporation. VC typically earns active business income below the small business
limit and is not associated with SPS. Roger wants to understand from a
qualitative and quantitative perspective how the tax treatment of dividends paid
by SPS will differ from the VC dividends he receives. He receives around
$100,000 in dividends from VC in addition to his $200,000 annual salary (which
will not be reduced) and expects that SPS would pay him a $100,000 dividend in
2018.

60
 MARKING GUIDE
SOLAR PANELS SOLUTIONS INC.

INTEGRATION CONCEPT

Note: This is the suggested answer for those who have chosen tax as their
elective role. However, all candidates would benefit from reading the following,
as it provides the type of answer required on the CFE when discussing the
integration concept.

61
62
63
64
SHAREHOLDER BENEFITS - ITA 15(1)

 The owner-manager environment:

o Non arm’s length
o Few constraints on use of corporate resources
o Sometimes difficult to separate business and personal use
 Travel
 Automobiles
 Other

 Benefits conferred on a shareholder, ITA 15(1) – tax implications:

1. Value of benefit included in income

2. Not considered to be a dividend

3. No deduction to the company for cost of the benefit (contrast with

employment benefit)

4. Possible penalties to company and shareholder if benefits not

reported on the filed tax returns.

65
SHAREHOLDER LOANS - ITA 15(2)

 Loans to a shareholder (including shareholder debt) must be added to the

shareholder’s income in the year of the loan, unless it is repaid before the
end of the company’s taxation year following the year the loan was made.

 If a person connected to the shareholder received the loan (spouse, children,

parent, etc.), the amount is added to their income (and not to the
shareholder). These amounts will be subject to the Tax On Split Income
(TOSI).

 If the loan is received from a related corporation, the same rule applies

 If a loan that has been included in income is repaid, the shareholder will
receive a deduction from income in the year of repayment - ITA 20(1)(j)

80.4 IMPUTED INTEREST

 Loans to shareholders are subject to the interest benefit rules, similar to

employee loans (i.e., for interest free or loans below the prescribed rate of
interest).

 If a shareholder loan is included in income under 15(2), there is no imputed

interest.

 If the shareholder used the loan proceeds for investment purposes, the
deemed interest can be deducted as an expense on the shareholder’s tax
return.

66
Exceptions to Shareholder Loan Inclusion:

For all shareholders:

1. If the loan is repaid before the end of the company’s taxation year
following the year the loan was made.

2. The loan was made in the ordinary course of the lender’s business.

For shareholders who are also employees:

1. If the loan is used to:

a) acquire a personal residence

b) acquire newly issued stock of the corporation

c) acquire a car to use for employment

and the loan:

i) was made to the person in his/her capacity as an employee

ii) has bona fide repayment terms

or

2. The shareholder/employee owns < 10% of the shares

67
EXAMPLE:

Solution:

If repaid January 1, 2020:

- $162,000 is not included in Ms. Fisk’s income, because it was repaid

before the end of the following tax year.

- Deemed interest for Ms. Fisk for 2019: $162,000 x 2% x 7/12 = $1,890

If repaid December 31, 2020:

- $162,000 will have to be included in Ms. Fisk’s income for her 2019 tax
year, the year the amount was received, because it was not repaid before
the end of the corporation’s following tax year.

- No deemed interest under 80.4

- Ms. Fisk can deduct the $162,000 from her income in the year it is
repaid. In the example above, this would mean Ms. Fisk could deduct the
$162,000 from income in her 2020 tax return.

68
 CFE CASE

PERFECTO PAINTERS INC.

SHAREHOLDER LOANS

Appendix I: May 2016 CFE – Day 3 Simulations Page 220

Case #2 (Suggested time 90 minutes)

You, CPA, started as the part-time controller for Perfecto Painters Inc. (PPI) in
January 2016, one month ago. . . . Peter (your boss) noted a few issues and
asks for your help. He wonders if there are taxation considerations related to
these issues, details of which are presented in the notes to the financial
statements (Appendix I). He hopes you can provide him with advice. . . .

APPENDIX I
To meet his personal needs, (Peter) took out an interest free shareholder loan of
$10,000 from PPI. It was his first time taking a company loan. He does not know
when he will repay the loan.

Comments from the Board of Examiners’ Report

Note 2 of Appendix I provided information regarding an interest-free shareholder

loan that Peter took out during 2015 in order to meet his personal needs. . . In
order to demonstrate competence on this breadth assessment opportunity,
candidates had to explain the tax consequences for Peter’s . . . loan from PPI.
Candidates performed relatively well on this assessment opportunity since most
of them were able to provide sufficient tax knowledge of the treatment of
shareholder loans, with few errors . . . Strong candidates concisely explained the
tax treatment of shareholder loans. . . Weak candidates did not know what the
tax implications of the shareholder loans were or provided confused
explanations.

69
QUESTION:

Once a business is incorporated, how should management be compensated?

MANAGEMENT COMPENSATION

1) Salary/bonus: Easiest. Deductible by company (accrual method). Taxable to

employee (cash basis)

The following are several tax effective alternatives. The goal: Full
deduction for the company and less than full or no inclusion in the
individual’s income:

2) Registered Pension Plan (RPP): Deductible by company in year of

contribution, deferred and taxable to employee on retirement

3) Deferred Profit Sharing Plan (DPSP): Similar advantages to RPP

4) Private Health Care Plan Premiums: Premiums are deductible by the

company, not taxable as an employee benefit (at least federally)

5) Stock options: Deferred taxable benefit until exercised or sold, and usually
only ½ is taxed

6) Leased automobile: When the employer leases an automobile and gives it to

an employee, the lease benefit is only 2/3 of the lease value.

7) Dividends: Executive must be a shareholder. See next page for analysis.

70
 SALARY vs. DIVIDENDS

It is a trade-off: Salaries are deductible by the corporation, dividends are not.

Factors influencing the decision:

1) Tax savings: For most cases (other than where income splitting is possible),
there would be a tax savings by paying salaries.

2) Dividend tax credit (DTC) rates: The higher the provincial DTC, the greater
the tax savings by paying dividends.

3) Corporate tax rates:

 High corporate rates, more desirable to pay salaries
 Lower corporate rates (or a tax holiday), dividends become more
attractive

4) Income splitting: If the individual recipient has no other source of income,

dividends are desirable as can receive non-eligible dividends up to $26,364 and
not have individual tax to pay.

5) Earned income:
 Need “earned income” to contribute to RRSP, CPP/QPP, and to deduct
child care costs.
 Salary is “earned income,” dividends are not.
 The maximum RRSP contribution in 2019 is $26,500. To obtain the
maximum RRSP deduction, previous year’s earned income must be
$147,222 x 18% = $26,500.
 Many CCPCs pay the owner managers sufficient salaries to enable the
maximum RRSP contribution

71
6) Cumulative net investment loss (CNIL): If an individual has a negative
CNIL, the CGD is restricted. CNIL can be reduced or eliminated by the receipt
of dividends.

7) Added costs of salary – CPP (QPP) and EI: Employer’s share of these taxes
discourages the payment of salaries by the corporation. But these plans are
advantageous for the employee shareholder.

8) Provincial payroll taxes: Several provinces levy payroll and health taxes
based on salaries paid.

9) Use of tax credits: If an individual has unused tax credits, consider paying
more salaries and less dividends to use up the credits and enable the corporation
to receive a deduction for the salaries.

10) Small business deduction: If active business income (ABI) > $500,000,
consider paying salary/bonus to reduce income to $500,000.

11) Canada employment tax credit: Only available on employment income.

Maximum credit in 2019 is $1,222.

12) Dividend refund: If there is an Eligible RDTOH balance, the payment of an

eligible dividend can trigger a dividend refund to the corporation, which could
exceed the tax paid by the shareholder.

13) Capital Dividend Account: If the corporation has a CDA balance, dividends
can be paid out on a tax free basis.

CONCLUSION:
No one right answer. It depends on all the above factors and sometimes on
subjective factors, such as the desire to increase one’s retirement income.
72
 CFE CASE

PERFECTO PAINTERS INC.

SALARY VS DIVIDENDS

Appendix I: May 2016 CFE – Day 3 Simulations Page 220

Case #2 (Suggested time 90 minutes)

You, CPA, started as the part-time controller for Perfecto Painters Inc. (PPI) in
January 2016, one month ago. . . . Peter (your boss) noted a few issues and
asks for your help. He wonders if there are taxation considerations related to
these issues, details of which are presented in the notes to the financial
statements (Appendix I). He hopes you can provide him with advice. . . .

APPENDIX I

Peter recently heard at a networking event that there may be a tax advantage to
declaring dividends instead of taking salary. He wonders what the tax
implications would be of doing so.

Comments from the Board of Examiners’ Report

. . . In order to demonstrate competence on this breadth assessment opportunity,

candidates had to explain the tax consequences for Peter’s compensation . . .
from PPI. Candidates performed relatively well on this assessment opportunity .
. . and demonstrated some understanding of the tax treatment of dividends
versus salary. Strong candidates . . . explained both dividend and salary
considerations to Peter, from both an employee and an employer perspective.
Strong candidates also demonstrated a general understanding of the theory of
integration. . . Some weak candidates identified that the tax treatment for the two
types of remuneration for Peter (dividends and salary) differed but did not explain
the difference in the tax treatments between them. Other weak candidates only
listed the treatment of either dividend or salary but did not compare the two
options.

73
Planning: Owner/Manager needs funds
Assume an owner/manager of a CCPC requires funds. The corporation either has
the necessary funds, or has the ability to borrow the funds and on lend them to the
shareholder.

Question: What are the alternatives for the corporation to get the funds to the
shareholder, other than paying a salary/bonus?

Method Tax Implications

1. Shareholder loan Must be repaid before the end of the

following tax year if not unless otherwise
exempted.
If repaid, add interest benefit to shareholder
based on the prescribed rate
From the 2017 CFE: Many weak candidates
also recommended a shareholder loan as a way for
Gloria to take money out tax free, failing to
recognize that she would not be able to pay it back
within the required time.
Therefore, should usually only recommend
if the funds are needed for a short period.

2. Capital dividend (CDA account) Dividends are tax free. Must elect.

3. Reduce PUC Generally no tax consequences.

4. Redemption of shares Deemed dividend/CG possible.

continued . . .

74
(Planning: Owner/Manager needs funds – continued)

5. Eligible dividends Need sufficient amounts in the GRIP a/c.

The net tax on eligible dividends is lower
than that for non-eligible dividends.
Payment of eligible dividends will entitle the
corporation to a dividend refund of 38 1/3%
of the dividends paid to the extent there is an
Eligible RDTOH balance. Individual tax
rates on eligible dividends received from the
corporation are roughly 36% at the top
bracket, so there is a benefit having the
corporation paying out eligible dividends.

6. Non-eligible dividends Taxed at a higher rate compared to eligible

dividends. Individuals taxed at roughly
45%, which is approximately 9% higher
than eligible dividends. Dividends paid
also entitles the corporation to a dividend
refund based on 38 1/3% times dividends
paid if there is a sufficient balance in the
RDTOH accounts.
Note: There is no dividend refund to the
corporation if dividends are paid out of the
CDA account.

7. Bonus Shareholder must be an employee as well.

Advantage: Company deducts on an accrual
basis, shareholder declares when received if
within 180 days of the year-end.
Particularly useful when the CCPC has
active income in excess of its annual
business limit ($500,000).

75