Tax Lesson 20 YOURLOGO Start Lecture Note: This screen has no script. Static page. YOURLOGO Start Lecture

Corporate Taxation Many of the above topics apply equally to corporations (e.g., most rules related to the taxation of business income, capital gains, CCA and CECA apply to all taxpayers) Corporations face a flat tax rate (i.e., there are no graduated tax rates) and the federal corporate tax rate is 38%. All corporations that are subject to provincial tax are eligible for a federal abatement of 10% (on income subject to provincial tax) Corporations who: (i) owe more than $3,000 in tax in the year; and (ii) who owed more than $3,000 in the prior year must pay instalments (due at the end of each month) Instalments are the least of: (a) 1/12 of an estimate of the current year’s taxes owing (if you underestimate, you will pay interest on the underpaid instalments); (b) 1/12 of the prior year’s taxes owing; and (c) 1/12 of the taxes owing from 2 years ago for the first 2 instalment payments and 1/10 of (the prior year’s taxes owing – the 2 instalment payments already made) for the next 10 instalment payments

Corporate Taxation (cont) Corporations must pay any balance of tax owing 2 months after year-end even though their tax return is due later (i.e., 6 months after year-end) CCPCs that claim the small business deduction (discussed below) with taxable income (together with any associated companies) of less than $500,000 have 3 months after year-end to pay their balance of tax owing CCPCs that meet various criteria (e.g., that claim the small business deduction, that have taxable income (together with any associated companies) of less than $500,000, and that have made all required tax filings and paid all required taxes and instalments owing for the past year) can pay quarterly instalments (due at the end of each quarter)

Small Business Deduction (SBD) CCPCs are eligible for the small business deduction, which is a 17.5% tax credit on the lesser of: Canadian active business income earned in the year. This excludes most property income and personal services business income. Property income is deemed to be active business income if the company has more than 5 full-time employees; or if an associated corporation can deduct the amount when it computes its active business income. Personal services business income, which is essentially incorporated employment income, is deemed active if there are more than 5 full-time employees or if the services are provided to an associated company; and Annual business limit of $500,000. The business limit must be shared among associated corporations If the company, together with associated corporations, has taxable capital in the prior year of $15M or more then the company is not “small” and the annual business limit is $0. If taxable capital is between $10M and $15M the annual business limit is reduced from $500,000 to $0 on a straight line basis (as taxable capital increases from $10M to $15M) Note: how the federal corporate tax rate on income eligible for the SBD is 10.5% (i.e., 38% - 10% federal abatement – 17.5% SBD)

Small Business Deduction (SBD) (cont) The SBD was lower prior to 2016. The SBD was scheduled to increase from 2017 to 2019; however, the March 22, 2016 federal budget has frozen the SBD at 17.5% Two companies are associated if: one company controls the other; or if both companies are controlled by the same person (or the same group of persons). Also if two companies are controlled by different people (or groups), the people are related, and there is cross-ownership of 25% or more, then the 2 companies will be associated The March 22, 2016 federal budget has also made the following changes: Personal services business (PSB) income (that is not deemed to be active business income) will be subject to tax at a higher federal corporate tax rate (i.e., 33%, the same as the top personal federal tax rate). Prior to 2016, PSB income was subject to a 28% federal corporate tax rate (i.e., 38% - 10% federal abatement) A CCPC’s active business income from providing services or property to a private corporation will not be eligible for the small business deduction if the CCPC (or someone related to the CCPC) has a direct or indirect interest in the private corporation. This ineligibility for the SBD will not apply if 90% or more of the CCPC’s income is active business income earned from arm’s length persons other than the private corporation. Note: a “direct or indirect interest” presumably means ownership of a certain number of shares; however, as of now, the government does not appear to have defined this term

Manufacturing and Processing (M&P) and General Rate Reduction (GRR) Manufacturing and processing companies can get an M&P tax credit equal to 13% of their Canadian M&P income. However, they can only get this credit on M&P income that does not qualify for the SBD All companies that earn income that does not already benefit from special tax treatment; such as: the SBD, investment income subject to refundable tax treatment (discussed below) and the M&P tax credit, can get a GRR tax credit equal to 13% of their (full-rate) taxable income For example, if a CCPC earned $1M of taxable income in 2016 and all of the company’s income was Canadian active business income and $400,000 of its income was Canadian M&P income then the company could get: the SBD (a 17.5% tax credit) on $500,000 of income; the M&P tax credit (a 13% tax credit) on $400,000 of income; and the GRR (a 13% tax credit) on $100,000 of income Note: how the federal corporate tax rate on income not eligible for the SBD is 15% (i.e., 38% - 10% federal abatement – 13% M&P or GRR credit)

Refundable Taxes (Investment Income) Canadian dividend income earned by corporations is subject to special tax treatment. These dividends are allowed as a Division C deduction and hence are not included in taxable income (and hence are free from Part I tax). (Part I tax refers to a large number of sections in the Act, and you can think of it as normal federal tax) These dividends, when earned by a private corporation, are subject to Part IV tax. Public companies do not pay Part IV tax Any Part IV tax paid by a private corporation is added to the corporation’s refundable dividend tax on hand (RDTOH) account. The corporation can get a refund of this tax when it pays a taxable dividend The RDTOH account is a notional account that keeps track of refundable taxes that a private corporation can get back from the federal government The Part IV tax on Canadian dividends received from non-connected corporations is 1/3 of the dividend received For example, if a private company receives a $90,000 dividend from a non-connected company, it will pay $30,000 in Part IV tax (and $30,000 will add to the company’s RDTOH account) Recall that two companies are connected if: (a) one company controls the other; or (b) if one company owns more than 10% of the shares of the other company (representing both voting rights and fair market value)

Refundable Taxes (Investment Income) (cont) The Part IV tax on Canadian dividends received from connected corporations is less (it is equal to the parent’s ownership percentage x the payer company’s dividend refund) All private companies can get a dividend refund, a reduction of federal tax payable, if they pay a taxable dividend to their shareholders. The dividend refund equals the lesser of: (a) 1/3 of the taxable dividends paid; and (b) the company’s RDTOH balance. Public companies do not pay Part IV tax and do not get a dividend refund CCPCs (not all private corporations) that earn investment income (other than dividends from Canadian corporations) must: Calculate Aggregate Investment Income (AII). AII is all investment income included in taxable income. Canadian dividend income is not included in taxable income and any net capital loss carryovers claimed in the year (to offset taxable capital gains) effectively reduce the taxable capital gains included in taxable income for that year (and reduces AII) Pay normal (Part I) corporate tax plus an additional refundable tax equal to: 6 and 2/3% x AII; and CCPCs with AII have 26 and 2/3% of their AII added to their RDTOH account

Example Problem Corporate Taxes Payable ZH Inc. (ZHI) is a CCPC with a December 31st year-end. ZHI operates a retail business and earns investment income. Calculate ZHI’s minimum taxable income, federal income taxes payable and the balance of its refundable dividend tax on hand (RDTOH) account and any dividend refund for its December 31, 2016 year-end. You note the following information: The net income for tax purposes for the year is $417,000 The Canadian retailing business income for the year is $300,000 Property income of $117,000 was earned in the year consisting of: Canadian dividends received from connected companies of $20,000. The connected companies did not receive a dividend refund; Canadian dividends received from non-connected companies of $30,000; Taxable capital gains of $15,000; Interest income (earned on long-term investments) of $25,000; and Foreign investment income of $27,000. Note: no foreign income tax was paid on this income

Example Problem Corporate Taxes Payable (cont) The company claimed a net-capital loss carry forward of $10,000 from 2014 as a Division C deduction in the year The company is not associated with any other companies and has taxable capital of less than $10M in the prior year The opening balance in the RDTOH account as of January 1, 2016 is $11,000 The company paid taxable dividends in the year of $60,000