Week 10 - Zoom Lecture - Net income & Taxable income PDF

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Net income & Taxable income...

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7/4/2021

Taxation 1 – Zoom Lecture Week 10 Beverly Poon CPA, CGA [email protected]

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Agenda 

Chapter 12 - Taxable Income And Tax Payable For Corporations 

Computation of Taxable Income

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Federal Tax Payable 

Federal Tax Abatement Small Business Deduction

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Manufacturing and Processing Deduction

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General Rate Reduction Foreign Tax Credit

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Chapter 12 – Computation Of Net Income 

Start by converting accounting income to Net Income For Tax Purposes then calculate Taxable Income 

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Need to make adjustments 

Temporary differences – Amortization and CCA, Pension cost deductions

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Permanent differences – Meals and Entertainments, Capital Gains

Reconciliation between accounting Net Income and Net Income For Tax Purposes is required on the corporate return

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Chapter 12 – Computation Of Taxable Income 

Once Net Income For Tax Purposes is established, there are certain specific items deducted to arrive at Taxable Income – specified in Division C of the ITA

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3 items deducted from Net Income For Tax Purposes to arrive at Taxable income

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Two items that are treated differently for individuals and corporations

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Charitable donations, Dividends and Loss carry overs

Charitable Donations 

Individuals – tax credit against tax payable

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Corporations – deduct donations from Net Income For Tax Purposes to derive Taxable Income

Dividends 

Individuals – gross up and tax credit

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Corporations – included in Net Income For Tax Purposes but deducted for Taxable Income

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Chapter 12 – Computation Of Taxable Income 

Pledge Ltd. had Net Income For Tax Purposes for the year ending December 31, 2020 of $383,000. This amount included $16,780 in taxable capital gains as well as $18,300 in dividends received from taxable Canadian corporations. In 2020, Pledge also made donations to United Way and BC Children’s hospital totaling $12,300. At the beginning of the year, the Company had available non-capital loss carry forward of $73,000, as well as a net capital loss carry forward of $21,000 [(1/2)($42,000)]. Determine Pledge’s minimum Taxable Income for the year ending December 31, 2020 and the amount and type of any carry forwards available at the end of the year.

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Chapter 12 – Computation Of Taxable Income 

Dividends On Shares Sold For Loss (Stop Loss Rules) 

Declaration and payment of dividends by a Corporation reduces the Corporation’s net assets – share value will decrease by the same amount

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A company can acquire shares of a corporation at a time when it’s expected that dividends will be paid by those shares. The company can receive the dividends tax free, and if the shares fell by the amount of the dividend they can be sold to create a capital loss

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ITA 112(3) and (3.01) contains “stop loss” rules for shares held at capital property and ITA 112(4) and (4.01) for shares held as inventory

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Stop loss rules apply 

Shares held for less than one year or

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Corporation holding the shares, along with other non-arm’s length persons owns more than 5% of the class of shares on which the dividend was received

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If conditions are met then the loss is eliminated by the amount of dividends received

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Chapter 12 – Computation Of Taxable Income 

On April 10, 2019, Asset Management Corp. acquires 2,000 of the 10,000 shares of Lumina Ltd. at a cost of $15.80 per share. On March 31, 2020 these shares pay a dividend of $1.89 per share. These are the only dividends that were received on these shares. Asset Management Corp sells the Lumina Ltd shares on June 15, 2020 for $12.30 per share. Asset Management Corp. has taxable capital gains of $40,000 in the year. What is the amount of the allowable capital loss that Asset Management Corp. would include in its tax return for the taxation year ending December 31, 2020?

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Chapter 12 – Computation Of Taxable Income 

Non-Capital Loss Carry Over For A Corporation 111(8)

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The non-capital loss of a taxpayer for a taxation year means the amount determined by the formula A – D where

A is the amount determined by the formula E–F E is the total of all amounts each of which the taxpayer’s loss for the year from an office, employment, business or property (including farm losses), the taxpayer’s allowable business investment loss for the year, and net capital loss carry overs deducted in the calculation of Taxable Income for the year and dividends received from taxable Canadian corporations and deducted in computing Taxable Income. F is the amount of income determined under ITA 3(c) D is the taxpayer’s farm loss for the year (amount included in E)

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Chapter 12 – Computation Of Taxable Income 

For the taxation year ending December 31, 2020, Loren Ltd. has business and property income of $74,400. Also during the 2020 taxation year they had capital asset dispositions which resulted in capital gains of $28,700 and capital losses of $42,300. The Company experiences a further loss on the arm’s length sale of shares of a small business corporation in the amount of $167,800. Determine Loren Ltd.’s Net Income For Tax Purposes for 2020. Indicate the amount and type of any loss carry overs available at the end of the year

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Chapter 12 – Computation Of Taxable Income 

Loser Ltd., a Canadian public company for taxation year Dec 31, 2020 

Capital Gains On Capital Asset Sales

$111,000

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Capital Losses On Public Company Stock Sales

84,000

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Allowable Business Investment Loss

5,250

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Dividends Received From Taxable Canadian Corps

48,000

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Canadian Source Interest Income

27,200

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Net Business Loss

273,000

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Company has available net capital loss carry forward of $19,000 – deduct in 2020

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Determine the non-capital loss balance (ITA 111(8) and net capital loss carry forward for Loser Ltd. at the end of the 2020 taxation year.

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Chapter 12 – Federal Tax Payable 

Basic Rate – ITA 123 – 38%

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Federal Tax Abatement – ITA 124(1) – reduction of 10% 

Only applicable to income earned in a Canadian province or territory - need to reduce if there are foreign operations

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General Rate Reduction – 13% - Only applied to “full rate taxable income”

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General Federal Corporate Rate = 15% (38% - 10% - 13%)

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Other Rates 

Small Business Deduction

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M&P

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Investment Income

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Chapter 12 – Federal Tax Payable 

Tanning Ltd., a Canadian public company, has Taxable Income for the taxation year ending Dec 31, 2020 in the amount of $263,000. It has Canadian permanent establishment in British Columbia and Alberta. Tanning’s gross revenues for the 2020 taxation year is $3,739,000, with $1,765,000 of this accruing at the PE in BC, and $1,264,000 accruing at the PE in Alberta. Wages and salaries total $372,000 for the year. Of this total, $163,000 is at the PE in BC and $98,000 is at the PE in Alberta. Tanning has sales to the U.S. through a permanent establishment in Alaska. Calculate Federal Tax Payable for the taxation year ending Dec 31, 2020. Ignore any foreign tax implications.

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Chapter 12 – Small Business Deduction 

Small Business Deduction - 19%

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Federal deduction – first $500,000 of active business income, same limit for provinces with the exception of Saskatchewan of $600,000

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CCPC in BC with active business income under $500,000 – Total Tax Payable is 11%

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Criteria for the small business deduction: 

Canadian Controlled Private Corporation (CCPC)

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Deduction only available on “active business income” earned in Canada

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Annual business limit - first $500,000 of active business income earned in a year

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The $500,000 annual business limit must be shared among associated corporations

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Chapter 12 – Small Business Deduction 

Small Business Deduction - 19% of the least of 3 figures

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(A) Net Canadian Active Business Income

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(B) Taxable income less:

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(i) 100/28 times the ITA 126(1) credit for taxes paid on foreign non-business income, calculated without consideration of the additional refundable tax credit under ITA 123.3 or the general rate reduction under ITA 123.4 and

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(ii) 4 times the ITA 126(2) credit for taxes paid on foreign business income, calculate without consideration of the general rate reduction under ITA 123.4

(C) The annual business limit of $500,000, less any portion allocated to associated corporation, less any Taxable Capital Employed In Canada or Adjusted Aggregate Investment Income Grind.

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Chapter 12 – Small Business Deduction 

Taxable Capital Employed in Canada reduction A x B/$11,250 where

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A – amount of the corporation’s annual business limit for the year ($500,000 or less if shared with associated corporations)

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B – 0.225% of the excess over $10 million of the previous year end’s total Taxable Capital Employed in Canada of the corporation and any associated companies

Adjusted Aggregate Investment Income Reduction [D/$500,000][(5)(E - $50,000)] where 

D – amount of the corporation’s annual business limit for the year ($500,000 or less if shared with associated corporations)

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E – the total of all amounts each of which is the Adjusted Aggregate Investment income of the corporation or of any corporation with which it is associated for the preceding year

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Chapter 12 – Small Business Deduction 

Caraton Inc. is a CCPC that began operations on Jan 1, 2020 and has selected at Dec 31, year end. It does not have any associated companies. For the 2020 taxation year, Caraton Inc. has Net income For Tax Purposes of $620,000. The amount is made up of dividends from taxable Canadian corporations of $122,000, active business income of $456,000 and foreign non-business income of $60,000. The foreign income was subject to withholding in the foreign jurisdiction at a rate of 15%. Caraton Inc. receives a foreign tax credit against federal Tax Payable that is equal to the amount withheld. Caraton Inc. has a non-capital loss carry forward of $125,000 which it intends to deduct during 2020

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Determine the amount eligible for the small business deduction for the year ending Dec 31, 2020.

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Chapter 12 – Small Business Deduction Taxable Capital Employed in Canada (TCEC) Grind – ITA 125(5.1) 

Largely Small Inc. is a CCPC. For the year ending December 31, 2020, its Net Income For Tax Purposes is $1,233,000, all of which is active business income, except for $36,000 in foreign source non-business income. 15% of this amount was withheld in the foreign jurisdiction and the corporation receives a foreign tax credit against federal Tax Payable that is equal to the amount withheld. The corporation's only deduction in the calculation of Taxable Income is for a non-capital loss carry forward of $914,000. The corporation had Taxable Capital Employed in Canada of $11,300,000 for the year ending December 31, 2019, and $11,600,000 for the year ending December 31, 2020. It is not associated with any other corporation.

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Determine the amount of Largely Small Inc.’s small business deduction for the year ending December 31, 2020.

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Chapter 12 – Adjusted Aggregate Investment income Grind – ITA 125(5.1) 

Investco Ltd. Is a Canadian controlled private corporation. For the fiscal year ending December 31 2020, its Net income For Tax Purposes and Taxable Income is made up of active business income of $350,000, plus ADJUSTED Aggregate Investment Income of $125,000. For 2019, it’s ADJUSTED Aggregate Investment income was $105,000. It’s TCEC was $9 million for 2020 and $8 million for 2019. Because of its association with Subco Ltd., it’s 2020 allocation of the annual business limit is $300,000. Subco’s Taxable Capital Employed in Canada was $200,000 for 2020 and for 2019. Subco has no ADJUSTED Aggregate Investment Income in either year

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Determine the amount of Investco’s small business deduction for the year ending December 31, 2020.

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Chapter 12 – Manufacturing And Processing Profits Deduction 

M&P deduction will be equal to the corporation’s general rate reduction % multiplied by the lesser of 

A - M&P profits, less amounts eligible for the small business deduction and

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B – Taxable Income less the sum of 

The amount eligible for the small business deduction

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Relevant factor (4) multiplied by the foreign tax credit for business income calculated without consideration of the general rate reduction under ITA 123.4 and

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Where the corporation is a CCPC throughout the year the Aggregate Investment Income defined in ITA 129(4)

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Chapter 12 – Federal Tax Payable 

Teeling Ltd. Is a CCPC. For the year ending Dec 31, 2020, the Company has Taxable income of $320,000, all of which is active business income. Of this amount $188,000 results from M&P activity. As it is associated with two other corporations, its share of the annual business limit is $150,000. Determine the Company’s federal Tax Payable for the year ending December 31, 2020. Include in the solution any M&P deduction available.

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Chapter 12 – Federal Tax Payable Example

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Chapter 12 – Foreign Tax Credits For Corporations 

Foreign Non-Business Income Tax Credit – lesser of  

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Tax Paid to the foreign government Amount determined by the following formula:

Foreign Business Income Tax Credit is the least of  

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Tax paid to the foreign government Amount determined by the following formula

Tax Otherwise Payable for the year less any foreign tax credit taken on nonbusiness income

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Chapter 12 – Foreign Tax Credits For Corporations 

Internat Inc. is a CCPC. For the year ending Dec 31, 2020, it has Net Income For Tax Purposes of $146,000, including foreign business income of $20,000. The foreign government withheld $3,000 in taxes on this income, resulting in a net remittance of $17,000. None of the Company’s income involves manufacturing and processing and, based on ITR 402(3) formula, 88% of the Company’s income was allocated to a province. In calculating Taxable income, the Company deducts $30,000 in dividends received from taxable Canadian companies, a non-capital loss carry forward of $75,000, and a net capital loss carry forward of $25,000. Determine the Company’s Part I Tax Payable for the year ending Dec 31, 2020. Include any carry overs available at the end of the year.

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