Chapter 14 Other Issues In Corporate Taxation

© 2011, Clarence Byrd Inc.2 Acquisition Of Control - The Problem Profit Company Loss Company Acquisition Loss Transferred To Profit Company

© 2011, Clarence Byrd Inc.3 Meaning Of Acquisition Of Control ► Control: Ownership of shares that carry the right to elect a majority of the board of directors. ► Common Scenario: One person acquires shares from a different arm’s length person.

© 2011, Clarence Byrd Inc.4 Meaning Of Acquisition Of Control ► Can also occur through redemption of shares  A owns 60 percent – B owns 40 percent – If all of A’s shares were redeemed, B would have acquired control.

© 2011, Clarence Byrd Inc.5 Deemed Year End - ITA 249(4) ► Example: Dec. 31 year end, acquisition on June 30, 2010  Deemed New Year End - June 30, 2010  Can Keep Old Fiscal Year End  Allowed To Establish New Year End

© 2011, Clarence Byrd Inc.6 Acquisition Of Control ► Net Capital Losses And Allowable Business Investment Losses – ITA 111(4)(a) & (b)  Unused Carry Forwards Die  New Losses Cannot Be Carried Back

© 2011, Clarence Byrd Inc.7 Acquisition Of Control ► Non-Capital Losses – ITA 111(5)  Can Be Carried Forward  Subject To Restrictions ► Must Carry On Business In Which Losses Occurred ► Reasonable Expectation Of Profit ► Can Only Be Applied Against Income Generated By The Same Or A Similar Line Of Business

© 2011, Clarence Byrd Inc.8 Accrued Losses ►I►I►I►Inventories NNNNormal Year End Procedures ►A►A►A►Accounts Receivable – ITA 111(5.3) MMMMaximum Write-Off Required

© 2011, Clarence Byrd Inc.9 Accrued Losses ►D►D►D►Depreciable Property AAAAsset Cost = $100,000 UUUUCC = $ 60,000 FFFFMV = $ 50,000 ►I►I►I►ITA 111(5.1) WWWWrite Down To $50,000 TTTThe $10,000 Is Deemed CCA

© 2011, Clarence Byrd Inc.10 Accrued Losses ► Eligible Capital Property – ITA 111(5.2)  CEC > 3/4 FMV  Write Down  ITA 20(1)(b) Deduction

© 2011, Clarence Byrd Inc.11 Accrued Losses ► Non-Depreciable Property – ITA 111(4)(c) & (d)  ACB > FMV  Write Down  Capital Loss (Will disappear if not used at deemed year end.)

© 2011, Clarence Byrd Inc.12 ITA 111(4)(e) Election ► General Rule  Can elect between ACB and FMV  FMV > ACB: Creates Capital Gain  May also create recapture on depreciable assets (can’t avoid if you want the capital gain.)

© 2011, Clarence Byrd Inc.13 ITA 111(4)(e) Election ► Case 1  Capital Cost = $ 50,000  FMV = 100,000  UCC = 20,000 ► Elect $100,000  Capital Gain $ 50,000  Recapture 30,000  New Capital Cost100,000  New UCC75,000 [$50,000 + (1/2)($100,000 - $50,000)]

© 2011, Clarence Byrd Inc.14 ITA 111(4)(e) Election ►C►C►C►Case 2 AAAACB = $ 50,000 FFFFMV = 30,000 UUUUCC = 20,000 ►E►E►E►Elect $30,000 CCCCapital Gain$ Nil RRRRecapture10,000 NNNNew ACB30,000 NNNNew UCC30,000

© 2011, Clarence Byrd Inc.15 ITA 111(4)(e) Election ► Case 3  ACB = $ 50,000  FMV = 5,000  UCC = 20,000 ► Write down to $5,000 is required by ITA 111(5.1)  The $15,000 is deemed CCA

© 2011, Clarence Byrd Inc.16 Profits In The Loss Business During 2011, Loss Leader experiences an overall Net Loss of $150,000, with all of the loss arising in their shoe division. Their hat division broke even for the year. In 2012, the shoe division broke even, while the hat division showed a profit of $200,000. No Acquisition in 2011: 2012 Income = $50,000 Acquisition in 2011: 2012 Income = $200,000

© 2011, Clarence Byrd Inc.17

© 2011, Clarence Byrd Inc.18 Related Individuals - 251(2)(a) Individual

© 2011, Clarence Byrd Inc.19 ►R►R►R►Related Corporations OOOOne Corporation - ITA 251(2)(b) TTTTwo Corporations - ITA 251(2)(c) ►C►C►C►Control - ITA 256(1.2)(c) MMMMore Than 50% FMV - All Shares - Or MMMMore Than 50% FMV - Voting Shares ►G►G►G►Group – ITA 256(1.2)(a) ►S►S►S►Specified Class – ITA 256(1.1) Other Definitions

© 2011, Clarence Byrd Inc.20 ►D►D►D►Deeming Rules IIIITA 256(1.2)(d) – Holding Companies ►S►S►S►Shareholder of holding company is deemed to own held shares. IIIITA 256(1.3) ►C►C►C►Children under 18 ►S►S►S►Shares deemed to be owned by parent IIIITA 256(1.3) - Rights and options ►O►O►O►Options to own ►R►R►R►Right to force redemption or cancellation IIIITA 256(1.5) ►P►P►P►Persons are related to himself, herself, or itself Other Definitions

© 2011, Clarence Byrd Inc.21 ►I►I►I►ITA 256(2) ►A►A►A►A associated with B ►C►C►C►C associated with B ►A►A►A►A and C have deemed association Other Definitions

© 2011, Clarence Byrd Inc.22 Association Rules ITA 256(1)(a) One of the corporations controlled, directly or indirectly in any manner whatever, the other; Company ACompany B More than 50%

© 2011, Clarence Byrd Inc.23 Association Rules ITA 256(1)(b) Both of the corporations were controlled directly or indirectly in any manner whatever, by the same person or group of persons; Company ACompany B More than 50% Ms. Smith More than 50%

© 2011, Clarence Byrd Inc.24 Association Rules ITA 256(1)(c) 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; Company ACompany B More than 50% Mrs. SmithMr. Smith Not less than 25%

© 2011, Clarence Byrd Inc.25 Association Rules ITA 256(1)(d) 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; Company ACompany B More than 50% Mr. Goh Mrs. Goh Mr. Goh’s Brother Not less than 25%

© 2011, Clarence Byrd Inc.26 Association Rules ITA 256(1)(e) 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 person 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; Company ACompany B More than 50% Mr. Brown Mrs. Brown Mr. Fortin Mrs. Fortin 40%

© 2011, Clarence Byrd Inc.27 Investment Tax Credits ► Credit Vs. Deduction  Value Of Credit = 100%  Value Of Deduction = [(100%)(tax rate)]

© 2011, Clarence Byrd Inc.28 Investment Tax Credits ► Current Expenditures  A credit against Tax Payable during the current year  Added back to income in the following year.

© 2011, Clarence Byrd Inc.29 Investment Tax Credits ► Capital Expenditures  A credit against Tax Payable in the current year  Credit deducted from capital cost in the following period  Lose CCA on amount of investment tax credit

© 2011, Clarence Byrd Inc.30 Eligible Property ► Eligible Expenditures  Salaries of an eligible apprentice  Costs of creating eligible child care spaces  Qualified Property  Qualified SR&ED

© 2011, Clarence Byrd Inc.31 Rates ► Apprentice salaries  10% on maximum of $20,000 per apprentice ► Child care spaces  25% on a maximum of $10,000 per space ► Qualified property - 10% ► SR&ED (CCPC)  $3 million at 35%  Excess at 20% ► SR&ED (non-CCPC)  20%

© 2011, Clarence Byrd Inc.32 Refundability ►G►General Rules NNo Tax Payable CCan’t Use Credits GGovernment Writes Cheque To The Business

© 2011, Clarence Byrd Inc.33 Refundability ► Current SR&ED  100 percent on current amounts that qualify for the extra 15%  40 percent on other current SR&ED ► Other (including SR&ED capital expenditures)  40 percent for CCPCs and individuals  No upper limit

© 2011, Clarence Byrd Inc.34 Carry Overs ► Back Three Years ► Forward Twenty Years ► Must Take All Other Credits For The Year And Reduce Tax Payable To Nil Before Using

© 2011, Clarence Byrd Inc.35 Acquisition Of Control ► Unused investment tax credits may create attractive takeover targets ► Given this, there are rules similar to those that apply to loss carry forwards.

© 2011, Clarence Byrd Inc.36 Tax Basis Shareholders’ Equity ► Paid Up Capital (PUC)  Based On Legal Stated Capital  ITA 89(1)  Similar To Contributed Capital in Accounting

© 2011, Clarence Byrd Inc.37 Tax Basis Shareholders’ Equity ► Retained Earnings  Pre-1972 Capital Surplus On Hand ► Capital Gains Accrued Before 1972 ► Realized After 1971  Pre-1972 Undistributed Surplus  Post-1971 Undistributed Surplus  Capital Dividend Account ► Treatment Of RDTOH (an asset from a tax point of view)

© 2011, Clarence Byrd Inc.38 Paid Up Capital ►I►I►I►Importance AAAAn investment of after tax funds CCCCan be distributed tax free NNNNote: PUC is not equal to ACB ►D►D►D►Defined LLLLegal Capital (as per corporate law) LLLLimited number of adjustments

© 2011, Clarence Byrd Inc.39 Paid Up Capital Example: J & J issues 1,000 shares of stock on January 1, 2011 for $10,000 ($10 Per Share) and an additional 3,000 shares on December 31, 2012 for $60,000 ($20 Per Share). 1/1/11: PUC = ACB = $10 Per Share 31/12/12: PUC = $70,000 ÷ 4,000 = $17.50 Per Share Individual buying on December 31, 2012 PUC = $17.50/Share ACB = $20.00/Per Share

© 2011, Clarence Byrd Inc.40 Capital Dividend Account ► General Idea  Like RDTOH - A Tracking Mechanism  Private Companies Only (including non-Canadian controlled)  With election, balance can be distributed tax free

© 2011, Clarence Byrd Inc.41 Capital Dividend Account ►C►C►C►Components UUUUntaxed Portion Of Net Capital Gains CCCCapital Dividends Received UUUUntaxed Portion Of CEC Gains UUUUntaxed Life Insurance Proceeds RRRReduced By Capital Dividends Paid

© 2011, Clarence Byrd Inc.42 Use Of Corporate Surplus ► Cash dividends  Subject to gross up and tax credit procedures (Individuals)  Not deductible in determining corporate income of payor

© 2011, Clarence Byrd Inc.43 Use Of Corporate Surplus Stock Dividends Common Stock (100,000 Shares)$1,000,000 Retained Earnings 4,000,000 Total Shareholders’ Equity$5,000,000 A 10 percent stock dividend is declared (FMV = $70 per share) Transfer To PUC - [(100,000)(10%)($70)] = $700,000

© 2011, Clarence Byrd Inc.44 Use Of Corporate Surplus Stock Dividends Common Stock (110,000 Shares)$1,700,000 Retained Earnings 3,300,000 Total Shareholders’ Equity$5,000,000 Holder of 100 shares at $60 gets 10 new shares at $70 Taxable Dividend = $700 ACB = ($6,000 + $700)/110 = $60.91

© 2011, Clarence Byrd Inc.45 Dividends In Kind Example: Distribute An Investment With A Cost Of $1 Million And A FMV Of $1.5 Million. Recipient: Taxable Dividend Of $1.5 Million Payor: Disposition At $1.5 Million, Capital Gain Of $500,000

© 2011, Clarence Byrd Inc.46 ITA 83(2) Capital Dividend ► All Dividends Are Taxed If No Election ► Election (Form T2054) Allows Any Dividend To Be Treated As A Capital Dividend (If Balance Available In Capital Dividend Account)  Penalty For Excess Election  Does Not Reduce ACB Of Shares  Does Not Reduce PUC Of Shares

© 2011, Clarence Byrd Inc.47 ITA 84(1) Deemed Dividend ► General Idea ► PUC Increase In Excess Of Net Asset Increase ► Creates Added Tax Free Distribution ► ITA 53(1)(b) - Addition To ACB Of Shares ► Exceptions ► Stock Dividends ► Shifts Between Classes ► Conversion Of Contributed Surplus

© 2011, Clarence Byrd Inc.48 ITA 84(2) Deemed Dividends ► With winding-up under ITA 88(2):  ITA 84(2) Deemed Dividend Equals The Excess Of The Amount Distributed Over PUC

© 2011, Clarence Byrd Inc.49 Components Of 84(2) Dividend ► ITA 88(2)(b)  Indicates That ITA 84(2) Deemed Dividend Is Made Up Of: ► Capital Dividend (If Elected) ► Distribution Of Any Pre-1972 CSOH [Deemed Not To Be A Dividend By 88(2)(b)(ii)] ► Residual Is A Taxable Dividend

© 2011, Clarence Byrd Inc.50 ITA 84(3) Deemed Dividend  On Redemption, Acquisition By Corporation, Or Cancellation Of Shares  General Idea: If Payment To Shareholder Exceeds PUC, The Excess Is A Deemed Dividend  If Payment Exceeds ACB, The Excess Is A Capital Gain  Remove ITA 84(3) Deemed Dividend From POD under ITA 54

© 2011, Clarence Byrd Inc.51 ITA 84(3) Example Mr. Jones owns all 5,000 shares of L&L Ltd. The shares have a PUC of $75,000 and his ACB is $40,000. One-half of the shares are redeemed for $55,000. Redemption Price$55,000 PUC [(1/2)($75,000)]( 37,500) ITA 84(3) Deemed Dividend $17,500

© 2011, Clarence Byrd Inc.52 ITA 84(3) Example (Continued) Redemption Price $55,000 ITA 84(3) Dividend( 17,500) POD $37,500 ACB( 20,000) Capital Gain $17,500

© 2011, Clarence Byrd Inc.53 ITA 84(4) Deemed Dividends ► A Liquidating Dividend Involving a PUC Reduction ► If Amount Distributed Exceeds PUC, The Excess Is A Deemed Dividend

© 2011, Clarence Byrd Inc.54 ITA 84(4) Example Company distributes $80 per share. The shares have a PUC Of $60 Per Share. ITA 84(4) Deemed Dividend Of $20 Per Share PUC Down By $60 To Nil ACB Down By $60

© 2011, Clarence Byrd Inc.55 ITA 84(4.1) Example If Public Company Entire distribution is treated as deemed dividend Exception if transaction considered to be outside the normal course of business (e.g., company sold business segment and distributed the proceeds)

© 2011, Clarence Byrd Inc.56