Chapter 11 PDF

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Professor: Christine Cook
Fall 2018
Chapter 11 Lecture Notes...

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Chapter 11 – Computation of Taxable Income and Tax After General Reductions for Corporations Business Income Incorporation vs. Proprietorship  Both begin with GAAP income and require adjustments  No difference in deductions related to business activities  There are potential differences in tax rates Overview: Taxable Income

Selected Division C Deductions  Individuals o Employee Stock Option o Home Relocation Loan o Capital Gains Deduction o Loss Carryovers  Corporations o Dividends o Charitable gifts o Loss carryovers Deduction of Taxable Dividends (Sec, 112/113)  Purpose: o Integration – to prevent the double taxation of corporate income  Qualifying Dividends Include: o Taxable Canadian corporations; o Taxable subsidiary corporations resident in Canada; and o Foreign affiliates which have been appropriately taxed in a foreign jurisdiction which has treaty with Canada Charitable Donations (Sec. 110.1(1))  Deductible under Division C for corporations  Limit: 75% of corporation’s net income for tax purposes under Division B  Carry forward unused donations: 5 years

Loss Carryovers (Sec. 111) Type of Loss Apply Against type of income Net Capital loss Taxable capital gains Non-capital loss Any type of income Restricted farm losses Farm income Farm losses Any type *for taxation year ending after 2005 

Carryover Back 3 3 3 3

Forward Indefinitely 20* 20* 20*

Non-capital losses for the year for corporations: + Losses from business and property + ABIL + Net capital losses deducted under Division C - Income from business and property - Taxable capital gains less allowable capital losses = Non-capital loss for the year

Net capital loss for the year = Allowable capital loss for the year – Taxable capital gains for the year Note: Net capital losses are stated using the inclusion rate in the year they were incurred: - Prior to 1998 = ½ - 1988 and 1989 = 2/3 - 1990 to Feb. 27, 2000 = ¾ - Feb. 28 to Oct. 17, 2000 = 2/3 - After October 17, 2000 = ½ Adjust to today’s inclusion rate Application of Division C Deductions  Consider: 1. Type of income the deduction can be applied against 2. Number of years available in the carryover period 3. The likelihood that the type of income needed will arise in the carryover period  Generally, apply most restrictive first Application of Control (AOC)  Purpose: To curb “tax-loss trading” transactions  When: Control has been acquired by a person or group of persons based on voting rights (>50%)  Implications: o Deemed year end o Accrued losses triggered o Certain losses expire o Restrictions on the carryover of business losses  Options: Elect under 111(4)( e) to trigger recapture and capital gains AOC – Deemed Year End  Immediately before the time of the acquisition of control  Impact: o Tax returns must be filed o Unpaid amounts under 78(1) o Prorated CCA and SBD

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Due to potential short year:  May lose year on loss carryovers  May lose year on donation carryover

AOC – Accrued but Unrealized Losses  These losses are still “in the bag” and have not been realized and so have value as they will not be subject to carryover limits  Unrealized losses realized – Sec. 111 o A/R losses 111(5.3) o Terminal losses 111(5.1) o ECP losses 111(5.2) o Capital losses 111(4)(c)  Possible relief with election under 111(4)( e) AOC – Effect on Losses  Expire at deemed year end if not used o Net capital losses o Property losses o ABILs (e.g. All losses expire except business losses)  Business losses survive but may be restricted AOC – 111(4)(e) Option  Applies to capital property (depreciable & non-depreciable)  Deemed disposal at lesser of: 1. FMV of property 2. Greater of: i) ACB of property, and ii) Designated (elected) amount  Result: 1. Triggers recapture and/or capital gains, thus increases income at the deemed year end 2. Uses up losses that might expire immediately, or losses that may expire in the future 3. May protect non-capital losses 4. Increases cost for tax purposes  For CCA: UCC + Recapture + ½ capital gain  For CG: Designated (elected) amount AOC – Conditions for Loss Utilization (Sec. 111(5))  Non-capital losses carried forward after AOC are deductible if: 1. Loss business carried on throughout the year 2. Loss business carried on with reasonable expectation of profit  Loss deductible only against income from the same business or sale of similar products or services  “Business” is not the same as “corporation” AOC – Steps to Take: 1. Deemed year-end on the day before AOC 2. Determine any accrued losses and unrealized gains 3. Determine the tax position of the company with the automatic realization of the accrued losses 4. Consider election to create income 5. Recalculate Division B and taxable income after the election

6. Recalculate cost base of properties 7. Determine whether the business losses can be used after the AOC 8. Determine the steps needed to use up the business losses that survived Objectives of Tax Law Affecting Corporations  Primary o Raise revenue for the gov’t  Secondary o Prevent double taxation o Prevent tax avoidance o Provide tax incentives Types of Corporations

General Rates for Corporations  General federal rate of tax is 38%  Adjustments available: o 13% General rate reduction on certain business income o 10% abatement from federal tax payable o 18% small business deduction o 13% M&P deduction for certain corporations o Foreign tax credits o Other tax credits

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Reduction of 13% on all “full rate taxable income” Full rate tax. Income – a corporation’s tax. Income that has not benefited from special rate reductions such as: o Small business deduction o Aggregate investment income o Manufacturing and processing profits deduction

o Income from a personal services business Abatement from Federal Tax  Purpose: allows for the imposition of provincial tax  Rate: 10%  Reduced abatement only if there is a permanent establishment in another country (e.g. branch)  Tax. Income is allocated to provinces in which there is a permanent establishment (Reg.400(2))  Allocation of income among provinces based on average of (Reg. 400 (2)) o Salaries and wages attributed to each province, and o Gross revenue attributed to each province Tax Deductions/Credits  M&P Profits Deduction o Purpose: A tax incentive to all incorporated Canadian M&P businesses taxable in Canada o Note: No difference in the net federal tax rate applied to M&P profits or the rate applied to profits from other types of businesses. Differences exist in provincial rates  Foreign Tax Deduction (Credit FTC) o Purpose: prevent double tax on foreign source income o Theory: Canadian residents taxed on world income but country where income earned has first tax right o Result: pay higher of two tax rates o Types: Non-business tax deduction – 126(1)  Business income tax deduction (126(2)) o Note: Separate calculation for each country  Investment Tax Credit (ITC) o Purpose: Extra incentive to stimulate new investment in Canada in certain specific business sectors and regional locations

Non-Business tax deduction is the lesser of: i) Foreign non-business income tax paid

ii) Note: “tax otherwise payable” for non-business income is federal tax less the 10% abatement and the general tax rate reduction. This definition is different from business income Business tax deduction is the least of: i) Total foreign business income tax paid PLUS unused foreign tax credits

ii) iii)

Tax otherwise payable before abatement minus general rate reduction less any non-business income tax deduction

Note: “tax otherwise payable” for business income is federal taxes before any deduction of the abatement and other tax credits Scientific Research & Experimental Development (SR&ED)  “systematic investigation or search carried out in a field of science or tech by means of experiment of analysis…”  General deduction of expenditures: o R&D expenditures of a current nature made in a year are 100% deductible o Expenditures not deducted in a year are placed in a pool and may be deducted in a future year SRED ITC  ITC is a direct reduction of taxpayer’s liability  ITC available as a specified percentage of SRED expenditures made o General rate = 15% o Enhanced rate = 35%  ITC claimed in current year, reduces SRED pool in following year Qualified Scientific Research Expenditures  Given rise to two pools:...