Tax Lesson 1 YOURLOGO Start Lecture Note: This screen has no script. Static page. YOURLOGO Start Lecture

Separate Entities Generally speaking separate legal entities can enter contracts, buy assets, borrow money and go to court to sue or be sued. Examples of separate legal entities include individuals, corporations and partnerships (aside from the legal liability of the partners) General partners are fully liable for the liabilities of the partnership so a partnership is only a separate legal entity for all purposes except for legal liability A trust is not technically a separate legal entity. The trustee is a separate legal entity and the trustee legally owns and manages the assets of the trust (for the benefit of the beneficiaries) Drawing an organizational (org.) chart can help you keep track of the information in the question- for example, who are the separate entities in the question?- and this helps you to answer the question Taxpayers are entities that have to file income tax returns and pay income taxes. Examples of taxpayers include individuals, corporations and trusts Individuals have a calendar year-end and their income tax return due date is typically April 30th of the following year. (If the taxpayer or his/her spouse is self-employed then they have a June 15th tax return deadline, but any taxes owing are still due April 30th)

Separate Entities (cont.) Corporations can have any year-end they want and their income tax return due date is 6 months after year-end. A corporation is drawn as a rectangle on an org. chart Partnerships must have a calendar year-end if any of the partners are individuals (if all partners are corporations then they can have any year-end they want). Partnerships do not file income tax returns (but typically do file an information return). A partnership is drawn as an oval on an org. chart Trusts (aside from graduated rate estates, discussed below) have a calendar year-end. A trust’s income tax return is due 90 days after year-end. A trust is drawn as a triangle on an org. chart If a taxpayer files an income tax return late the taxpayer will be subject to a penalty equal to: (a) 5% of the unpaid tax; plus (b) 1% of the unpaid tax for each full month that the return is late (to a maximum of 12 months). There are also other penalties for not reporting income etc. (not discussed in these notes)

Separate Entities (cont.) After a taxpayer files a tax return, the Canada Revenue Agency (CRA) will assess (or re-assess) the return. The CRA usually assesses shortly after the return is filed (but they can reassess up to 7 years later). If fraud is involved the CRA can reassess even after 7 years If the taxpayer disagrees with the CRA and cannot informally resolve the dispute they can file a Notice of Objection within 90 days of the date of mailing of the assessment. Individuals have a longer deadline (i.e., the later of 1 year after the tax return due date and 90 days after the mailing of the assessment). If this still does not resolve the dispute taxpayers can appeal to the Tax Court of Canada

Partnerships A partnership is not a taxpayer for income tax purposes. Instead it calculates its net income for income tax purposes (as if it were a taxpayer) and then all income/loss flows out to the partners. The partners then pay tax on the income allocated to them. Any income or loss allocated keeps its form, for example dividends earned by a partnership remain as dividends when allocated to a partner (same for capital gains, active business income, etc.) The partner’s share of any income (or loss) is reported on his/her/its income tax return and the partner pays any required income tax each year. A partner’s share of any losses can be used to offset the taxpayer’s other income (and reduce his/her/its taxes payable) Each partner has a partnership interest in the partnership which is a capital property with an adjusted cost base (ACB). The partner’s ACB of his/her/its partnership interest equals his/her/its: capital contributed to the partnership plus share of any income less share of any loss less any drawings taken out of the partnership

Partnerships (cont.) Certain corporate partners cannot defer income earned through a partnership. If the partnership’s year-end differs from the corporation’s year-end and the corporation is entitled to more than 10% of the partnership’s income then: Corporate partners will need to accrue stub period income in addition to reporting their share of the actual partnership income for the year. Stub period income is the estimated income that would have been earned in the period between the partnership’s year-end and the corporation’s year-end. (To avoid this stub period income inclusion the corporation and partnership should have the same year-end)

Trusts and Graduated Rate Estates A trust can allocate income and capital gains to a beneficiary and receive a tax deduction for this allocation. Allocated capital gains, dividends and foreign income keep their form and are included in the beneficiary’s taxable income (as capital gains, dividends and/or foreign income). Any other income allocated is taxed as property income. Losses cannot be allocated out of a trust Trusts are taxed as individuals, but do not get most personal tax credits. Trusts created upon death are testamentary trusts. All other trusts are inter vivos trusts A deceased individual’s representative (i.e., the executor) can only designate (i.e., choose) 1 testamentary trust to be a graduated rate estate. A graduated rate estate can only exist for the first 36 months after death, and a graduated rate estate can have an off-calendar year-end. (Prior to 2016, a deceased individual could have more than 1 testamentary trust, and testamentary trusts could have an off-calendar year-end for more than 36 months) A graduated rate estate will be allowed graduated tax rates. (Prior to 2016, testamentary trusts were taxed at graduated tax rates for more than 36 months) All trusts, except for graduated rate estates, have a December 31st year-end and are taxed at the individual’s top graduated tax rate (i.e., 33% federally)

Integration Integration exists when the tax paid on a specific amount of a certain type of income is the same regardless of whether the income is earned by an individual or earned by a corporation (and then paid out to a shareholder of the corporation)

Example Problem Integration [Solutions for all example problems are at the end of these notes. Make sure you attempt each example problem before you look at the solution] Calculate the amount of any federal tax advantage or disadvantage from earning $100,000 of business income in 2016 in a Canadian controlled private corporation (CCPC) versus as a sole proprietor. Assume any after-tax corporate income will be paid as a dividend to the corporation’s shareholder and assume that the individual has other income in excess of $200,000. The CCPC is not associated with any other companies and has taxable capital of less than $10M in the prior year.