1. Chapter 17 Corporate Taxation And Management Decisions

2. © 2007, Clarence Byrd Inc. 2 The Decision To Incorporate Tax Reduction Tax Reduction Tax Deferral Tax Deferral Income Splitting Income Splitting Other Considerations Other Considerations

3. © 2007, Clarence Byrd Inc. 3 Tax Reduction See Paragraph 17-59 See Paragraph 17-59 No case involves a tax savings through the use of a corporation No case involves a tax savings through the use of a corporation Neutral with respect to dividends Neutral with respect to dividends $160 cost for CCPC earning ABI $160 cost for CCPC earning ABI $6,451 cost for CCPC on other income $6,451 cost for CCPC on other income

4. © 2007, Clarence Byrd Inc. 4 Tax Deferral See Paragraph 17-59 See Paragraph 17-59 Neutral on non-eligible dividends subject to Part IV Neutral on non-eligible dividends subject to Part IV Prepay on eligible dividends subject to Part IV Prepay on eligible dividends subject to Part IV Deferral in other cases Deferral in other cases $26,880 for CCPC earning ABI $26,880 for CCPC earning ABI $8,880 for CCPC on other income $8,880 for CCPC on other income

5. © 2007, Clarence Byrd Inc. 5 CCPC Income > Small Business Limit The The Problem Taxed Taxed at 38 percent at corporate level at over 50 percent on flow through to individual The The Solution Bonusing Bonusing down.

6. © 2007, Clarence Byrd Inc. 6 Imperfections In Integration System Provincial dividend tax credits – non-eligible dividends Provincial dividend tax credits – non-eligible dividends DTC  1/3 Gross Up – Favours use of corporation DTC  1/3 Gross Up – Favours use of corporation DTC < 1/3 Gross Up – Favours not incorporating DTC < 1/3 Gross Up – Favours not incorporating Actual range: 18.5% to 38.5% Actual range: 18.5% to 38.5%

7. © 2007, Clarence Byrd Inc. 7 Imperfections In Integration System Provincial dividend tax credits – eligible dividends Provincial dividend tax credits – eligible dividends DTC  7/18 (39%) Gross Up – Favours use of corporation DTC  7/18 (39%) Gross Up – Favours use of corporation DTC < 7/18 (39%) Gross Up – Favours not incorporating DTC < 7/18 (39%) Gross Up – Favours not incorporating Actual range: 21.5% to 38.5% Actual range: 21.5% to 38.5%

8. © 2007, Clarence Byrd Inc. 8 Imperfections In Integration System Different Federal/Provincial rates Different Federal/Provincial rates Combined rates for CCPC on ABI range from 15.1% to 21.6% >20% - Favours not incorporating <20% - Favours use of corporation

9. © 2007, Clarence Byrd Inc. 9 Income Splitting Splitting income a very powerful tool Splitting income a very powerful tool Corporations very effective here Corporations very effective here Few limits for spouses and adult children Few limits for spouses and adult children Problems with minor children (tax on split income) Problems with minor children (tax on split income)

10. © 2007, Clarence Byrd Inc. 10 Incorporation: Other Factors To Consider Limited Liability Limited Liability Shareholders’ Liability To Creditors Limited To Amounts Invested Shareholders’ Liability To Creditors Limited To Amounts Invested For Smaller Corporations, Personal Guarantees Almost Always Required To Obtain Significant Financing For Smaller Corporations, Personal Guarantees Almost Always Required To Obtain Significant Financing Protection from other types of liabilities (e.g., product liability) Protection from other types of liabilities (e.g., product liability)

11. © 2007, Clarence Byrd Inc. 11 Incorporation: Other Factors To Consider Lifetime capital gains deduction Lifetime capital gains deduction Foreign taxes Foreign taxes Estate planning Estate planning Loss deductions Loss deductions Charitable donations Charitable donations Cost of maintaining corporation Cost of maintaining corporation Winding-up procedures Winding-up procedures

12. © 2007, Clarence Byrd Inc. 12 Payments To Owner/Manager Need For Funds Other Income CPP/RRSP CNIL Corporate Income Need To Bonus Down Target Bracket

13. © 2007, Clarence Byrd Inc. 13 Corporation’s Need For Funds Corporation’s Tax Rate Corporation’s Tax Rate Alternative Investment Opportunities Alternative Investment Opportunities Alternative Sources Of Funds Alternative Sources Of Funds

14. © 2007, Clarence Byrd Inc. 14 Salary Vs. Dividends Basic Principles Basic Principles Salary Deductible To Corporation Salary Deductible To Corporation Dividends Taxed Favourably At Individual Level Dividends Taxed Favourably At Individual Level Income Not Eligible For SBD Income Not Eligible For SBD Bonusing Down Requires Salary Bonusing Down Requires Salary Income Eligible For SBD Income Eligible For SBD Corporate Rate > 20% Corporate Rate > 20% Provincial Dividend Tax Credit > 1/3 Gross Up Provincial Dividend Tax Credit > 1/3 Gross Up

15. © 2007, Clarence Byrd Inc. 15 Tax Free Dividends Owner/Managers Deal Largely With Non- Eligible Dividends Owner/Managers Deal Largely With Non- Eligible Dividends Basic Concepts Basic Concepts $1 Dividend Received $1 Dividend Received $1.25 Increase In Taxable Income [($1)(1.25)] $1.25 Increase In Taxable Income [($1)(1.25)] Individuals In Lowest Federal Tax Bracket Individuals In Lowest Federal Tax Bracket Taxes Are $0.1938 [($1.25)(15.5%)] Taxes Are $0.1938 [($1.25)(15.5%)] Federal Dividend Tax Credit = $0.1667 [($0.25)(2/3)] Federal Dividend Tax Credit = $0.1667 [($0.25)(2/3)]

16. © 2007, Clarence Byrd Inc. 16 Tax Free Dividends Tax on first $1 of dividends is $0.0271 ($.1938 - $.1667) Tax on first $1 of dividends is $0.0271 ($.1938 - $.1667) First $1 of dividends uses up available credits of $0.1748 ($.0271 ÷ $.155) First $1 of dividends uses up available credits of $0.1748 ($.0271 ÷ $.155)

17. © 2007, Clarence Byrd Inc. 17 Use Of Tax Credits $1 Of Salary Uses $1 Of Credits $1 Of Salary Uses $1 Of Credits $1 Dividends Uses $0.1748 Of Credits $1 Dividends Uses $0.1748 Of Credits Dividends Better Until Credits Are Used Dividends Better Until Credits Are Used

18. © 2007, Clarence Byrd Inc. 18 Amounts Available Tax Free Single Individual $35,083 Non-Eligible $66,420 Eligible With Dependent Spouse $47,859 Non-Eligible $79,988 Eligible

19. © 2007, Clarence Byrd Inc. 19 Salary To Owner/Manager The Owner/Manager Environment The Owner/Manager Environment No Outside Shareholders No Outside Shareholders Complete Discretion With Respect To Amount And Types Of Compensation Complete Discretion With Respect To Amount And Types Of Compensation

20. © 2007, Clarence Byrd Inc. 20 Salary To Owner/Manager Salary Payments - Role In Integration Salary Payments - Role In Integration Like Direct Receipt Of Income Like Direct Receipt Of Income Deduction Eliminates Tax Payable At Corporate Level Deduction Eliminates Tax Payable At Corporate Level

21. © 2007, Clarence Byrd Inc. 21 Salary To Owner/Manager Salary Payments Salary Payments RRSP Contributions (2008) RRSP Contributions (2008) $20,000  18% = $111,111 = required 2007 earned income $20,000  18% = $111,111 = required 2007 earned income Dividends  Earned Income Dividends  Earned Income Use of Personal Tax Credits Use of Personal Tax Credits Lost If Not Used Lost If Not Used Salary Uses Up Faster Salary Uses Up Faster

22. © 2007, Clarence Byrd Inc. 22 Other Considerations Earned Income For CPP Purposes Earned Income For CPP Purposes Dividends Do Not Count As Earned Income Dividends Do Not Count As Earned Income Cumulative Net Investment Loss (CNIL) Cumulative Net Investment Loss (CNIL) CNIL Reduces Available Lifetime Capital Gains Deduction CNIL Reduces Available Lifetime Capital Gains Deduction Receipt Of Dividends Reduces CNIL Receipt Of Dividends Reduces CNIL Added Costs Of Salary Added Costs Of Salary CPP And EI Premiums CPP And EI Premiums Payroll Taxes (In Some Provinces) Payroll Taxes (In Some Provinces)

23. © 2007, Clarence Byrd Inc. 23 Dividends - Problem Problem - All Dividend Approach Problem - All Dividend Approach Use Up Tax Credits At A Slow Rate Use Up Tax Credits At A Slow Rate May Leave Unused Tax Credits May Leave Unused Tax Credits Solution Solution Pay A Lesser Amount Of Dividends Pay A Lesser Amount Of Dividends Sufficient Additional Salary To Absorb Tax Credits Sufficient Additional Salary To Absorb Tax Credits

24. © 2007, Clarence Byrd Inc. 24 Basic Data Corporate Taxable Income = $29,500 Corporate Taxable Income = $29,500 Combined Corporate Tax On ABI = 20% Combined Corporate Tax On ABI = 20% Provincial Tax On First $37,178 Of Personal Taxable Income = 10% Provincial Tax On First $37,178 Of Personal Taxable Income = 10% Individual Has Combined Tax Credits Of $3,920 Individual Has Combined Tax Credits Of $3,920 Provincial Dividend Tax Credit = 1/3 Of Gross Up Provincial Dividend Tax Credit = 1/3 Of Gross Up

25. © 2007, Clarence Byrd Inc. 25 All Salary No Corporate Tax Payable No Corporate Tax Payable Salary Received = $29,500 Salary Received = $29,500 Taxes At 26% (16% + 10%)($7,670) Personal Tax Credits 3,920 Tax Payable( 3,750) After Tax Cash Retained $25,750

26. © 2007, Clarence Byrd Inc. 26 All Dividends Maximum Dividend Maximum Dividend Corporate Income$29,500 Corporate Tax At 20% ( 5,900) Available For Dividends$23,600 Taxable Dividends Taxable Dividends Dividends Received$23,600 Gross Up (25%) 5,900 Taxable$29,500

27. © 2007, Clarence Byrd Inc. 27 All Dividends Personal Taxes On Dividends Personal Taxes On Dividends Tax At 26 Percent [(26%)($29,500)] $7,670 Personal Tax Credits( 3,920) Dividend Tax Credit(Equal Gross Up)( 5,900) Tax Payable (Negative $2,150) Nil After Tax Cash Retained After Tax Cash Retained Dividends Received$23,600 Tax Payable Nil Cash Retained$23,600

28. © 2007, Clarence Byrd Inc. 28 All Dividends The All Dividend Approach Leaves $2,150 In Unused Personal Tax Credits The All Dividend Approach Leaves $2,150 In Unused Personal Tax Credits A Combination Of Salary And Dividends May Provide A Better After Tax Retention A Combination Of Salary And Dividends May Provide A Better After Tax Retention

29. © 2007, Clarence Byrd Inc. 29 Dividend/Salary Combination Consider: Consider: For For Each $1,000 Of Additional Salary Paid Dividends Dividends Are Reduced $800.00 [($1,000)(1.00 -.20)] Increase In Salary$1,000.00 Decrease In Dividends( 800.00) Decrease In Gross Up ( 200.00) Change In Taxable Income $ Nil

30. © 2007, Clarence Byrd Inc. 30 Dividend/Salary Combination Decrease In Dividend Tax Credit$200.00 Each $1,000 Increase In Salary Results In An Increase Of Tax Payable Of $200.00 Each $1.00 Increase In Salary Increases Tax Payable By $0.20. To Use Up $2,150 In Credits, Need Additional Salary Of $10,750 ($2,150/$0.20)

31. © 2007, Clarence Byrd Inc. 31 Dividend/Salary Combination Pre-Salary Taxable Income$29,500 Salary ( 10,750) Corporate Taxable Income$18,750 Corporate Tax At 20 Percent ( 3,750) Available For Dividends$15,000

32. © 2007, Clarence Byrd Inc. 32 Dividend/Salary Combination Dividends Received$15,000 Gross Up (25%) 3,750 Taxable Dividends$18,750 Salary 10,750 Taxable Income$29,500

33. © 2007, Clarence Byrd Inc. 33 Dividend/Salary Combination Personal Tax At [(26%)($29,500)]$7,670 Personal Tax Credits ( 3,920) Dividend Tax Credit (Gross Up) ( 3,750) Personal Tax Payable Nil

34. © 2007, Clarence Byrd Inc. 34 Dividend/Salary Combination Dividends Received$15,000 Salary Received 10,750 Personal Tax Payable Nil After Tax Retention$25,750

35. © 2007, Clarence Byrd Inc. 35 Dividend/Salary Combination All Salary Approach$25,750 All Salary Approach$25,750 All Dividend$23,600 All Dividend$23,600 Dividend/Salary$25,750 Dividend/Salary$25,750

36. © 2007, Clarence Byrd Inc. 36 Conclusions All Dividends Ineffective Doesn’t Use All Credits Need Minimum Salary of $10,750 To Use Credits

37. © 2007, Clarence Byrd Inc. 37 Conclusions Results Identical For: Results Identical For: All Salary All Salary Any Dividend/Salary Combination With At Least $10,750 Of Salary Any Dividend/Salary Combination With At Least $10,750 Of Salary Reflects Perfect Integration Reflects Perfect Integration 20% Corporation Rate 20% Corporation Rate Dividend Tax Credit = Gross Up Dividend Tax Credit = Gross Up

38. © 2007, Clarence Byrd Inc. 38