Chapter Objectives

1. Chapter Objectives Be able to: • Explain the distinguishing characteristics of a CCPC. • Explain how different types of income earned by a CCPC are taxed. • Explain the tax benefits of incorporating a business. • Explain and apply the dividend versus salary guidelines. • Explain and apply the shareholder loan alternatives. • Identify and apply the two limitations on the Small Business Deduction.

2. Definition and Basic Principles of CCPCs • A CCPC is a private corporation that is not controlled (50% or less) by a public corporation or a non-resident of Canada. • CCPCs are distinguished from other corporations in three basic ways: rates of tax, double taxation, and secondary relationships. • For rates of tax, there are different rates of tax for different levels of income. Whereas, public corporations only have one rate of tax for any level of income. • For double taxation, only income over $200,000 is subject to double taxation. Whereas, all income of a public corporation is subject to double taxation. • For secondary relationships, CCPCs are closely associated with their shareholders and, thus, secondary relationships (such employee, creditor, etc.) are common. These relationships do not exist with public corporations.

3. Taxation of Income Earned by a CCPC • A CCPC’s net income for tax purposes must be allocated into five areas before taxes can be computed: active business income, specified investment business income, personal services business income, capital gains, and dividends. Active business income • Active business income is business income from any business carried on by the corporation other than a specified investment business and a personal services business. • A CCPC is entitled to reduce its federal taxes by 16% for the first $200,000 of active business income earned in each taxation year. This reduction is commonly referred to as the small business deduction. • The unused portion of the small business deduction can not be carried over to other years.

4. Taxation of Income Earned by a CCPC (continued) Specified Investment Business Income • A specified investment business is a business with a primary purpose to derive income from property. • Property income includes interest, rents, royalties and dividends from non-affiliated foreign corporations. Dividends from other Canadian corporations and foreign affiliates are excluded since these dividends are not taxable. Rental income from the leasing of movable property is also excluded from property income. • Also, if a corporation employs more than five full-time employees to generate the property income, it is no longer regarded as achieved with little labour and, thus, it will be treated as active business income. • A special refundable tax of 6 2/3 must be paid but is refundable upon payment of dividends.

5. Taxation of Income Earned by a CCPC (continued) Personal Services Business Income • A personal services business is a business that provides services to a CCPC by a specified shareholder of the CCPC. This business exists in spite of the fact that the apparent relationship is employment. • Not only is the small business deduction not available to this business but there is also limitation on the permitted expenses. • If an appearance of employment does not exist, then this business would be treated as active business income. Capital Gains • The treatment of taxable capital gains is identical to the treatment given to specified investment business income (property income). • However, the non-taxable portion of capital gains can be distributed as a tax-free capital dividend (election required).

6. Taxation of Income Earned by a CCPC (continued) Dividends • Dividends received from non-connected corporations (such as a portfolio of public companies) are taxed at 33 1/3% (Part IV tax) of actual dividends received but this tax is fully refundable upon the payment of dividends. • Dividends received from connected corporations (such as related CCPCs) are only taxed if the paying corporation receives a refund of its Part IV tax. In that instance, the receiving corporation must pay Part IV tax equal to its proportionate share of the other corporation’s refund.

7. Tax Benefits of Incorporating a Business • Tax deferral - As a result of the small business deduction and no dividend distributions to shareholders, a tax deferral of 20% is possible. • Employment benefits - Certain employment benefits are deductible by an employer but are not taxable to an employee/shareholder. • Flexibility in Family Ownership • Stabilization of Annual Income - Dividends are discretionary and, thus, the timing and taxation of dividends can be managed. Tax Benefits of Incorporating Investments • There are no significant benefits to incorporating investments.

8. Dividends versus Salary • On Income over $300,000 and the shareholder needs the funds, a salary should be paid in order to avoid double taxation. • On Income over $300,000 and the shareholder does not need the funds, a salary should still be paid in order to avoid double taxation and then the funds could be lent back to the corporation with no future tax implications. • On Income between $200,000 and $300,000 and the shareholder needs the funds, a salary should be paid in order to avoid double taxation. • On Income between $200,000 and $300,000 and the shareholder does not need the funds, a choice needs to be made between a 6% tax deferral and the future impact of double taxation. • On Income Eligible for the Manufacturing and Processing Reduction, the same guidelines can be applied as Income between $200,000 and $300,000.

9. Loans to Shareholders • A corporation is permitted to advance or loan funds to a shareholder, provided that the shareholder is also an employee and that the loan is advanced due to employment, for the following purposes: 1) To assist the shareholder in acquiring a personal residence; 2) To permit the shareholder to acquire shares from the treasury; and 3) To assist the shareholder in acquiring an automobile to be used in performing employment duties. • Loans for the above purposes have no tax consequences to the shareholder if the repayment terms are reasonable. • A corporation can make a loan for other purposes but in such cases the loan must be repaid within one taxation year of the year in which the advance was made. If it isn’t, the full amount of the loan will be taxable to the shareholder as business income.

10. Limitations of the Small Business Deduction • Associated corporations must share a single $200,000 annual limit in computing the small business deduction for each associated corporation. The owners of the associated corporations can allocate the single $200,000 annual limit amongst the associated corporations in any manner they wish. • Large corporations with taxable capital over $10 million will have a reduced or eliminated small business deduction. In general terms, taxable capital consists of shareholder equity plus debt less an allowance for the cost of investments in other corporations. • In addition to loosing their small business deduction, large corporations must pay a large corporation tax of 0.225% on taxable capital over $10 million.