How are the net capital losses and non-capital losses of a corporation affected when W)ting control of the corporation shifts from one shareholder to another? 9. Fifth shares off corporation that has non-capital losses are about to be sold and if those losses arise from business operations, why is it important for the vendor to consider the nature of the purchaser? 10, An existing corporation that operates a profitable retail business is considering expanding its activities to include maturating. The expansion business can be organized in either of two basic ways.Describe them, Also, what factors must be considered when a choice is being made between the two structures? 11. How does the tax treatment of interpenetrate dividends affect the legislation between dividends and capital gains when one corporation invests in shares Of another corporation? (Assume that both entities are taxable Canadian corporations. ) 12. Explain why the federal tax reduction of 9% or a provincial tax reduction on manufacturing and processing activities may apply to an amount that is greater than or less than the corporation’s actual income from manufacturing.
Is it possible for a corporation that earns $500,000 from retail activities and suffers a loss of $50,000 from manufacturing activities to be eligible for the 9% manufacturing reduction? 13. What is the marginal tax rate for a public corporation in Ontario on income derived from a chain of restaurants? Show calculations. 14, Because income earned by a corporation is first subject to corporate tax and then taxed a second time when after-tax profits are distributed to individual shareholders, shareholders are entitled to claim a dividend tax credit. Does the dividend tax credit eliminate the double taxation of corporate profits?Explain. 15.
The following statement appeared in the media: “There are 60,000 Canadian corporations that earned a profit for the year but incurred no income tax ability. ” Is it possible that this statement is true? If it is, explain the principal reasons why, and State your opinion as to Whether changes to the tax System are warranted. Solutions to Review Questions RI 1-1 .
By law. A corporation is recognized as an entity which has the power to act on its own behalf and enter into enforceable legal agreements. It can own property, sell and lease property, and borrow funds in the same way that an individual can.Although the corporation is owned by its shareholders, the affairs of the corporation are separate from the affairs of its owners. Therefore, property owned by the corporation is not property owned by the shareholder, and debts of the corporation are not debts of the shareholders, As a separate entity, the corporation is subject to income tax on its profits. However, when those after profits are distributed to the shareholders they are again included in the shareholders income tort tax purposes [TIT 12(1 Hajj)]. RI 1 -2.
A shareholder can have both a primary and a secondary relationship with the corporation.Under a primary relationship, the shareholder provides equity capital to the corporation in exchange for shares. The shareholder can receive a return from the shares in the form of dividend distributions and/or share value enhancement. Under a secondary relationship, the shareholders may also act as a creditor, supplier, customer, employee, or lesser to the corporation. They can, therefore, loan money to the company in exchange for interest, lease property to the company in exchange for rent, provide services in exchange for salary and so RI 1-3.The following factors may influence the value of a corporation’s common share capital. Profits earned or losses incurred by the corporation. Profits retained belong to he common shareholders and the share value increases accordingly.
Dividends paid by the corporation. Dividend distributions reduce the equity of the corporation and the share value declines accordingly. Increases or decreases in the value of assets owned by the corporation, including tangible assets such as land and buildings, and intangible assets such as goodwill.
RI 1-4. A shareholder who provides share capital to a corporation can realize a return on investment from dividends or from capital gains when shares that have increased in value are sold. The n,vow are related because dividend payments alter he value of the shares, thereby affecting the potential capital gain (loss) on sale. It after corporate profits are retained by the corporation, the value of the shares increases, which may create a capital gain if the shareholder sells the shares.On the other hand, if corporate earnings are distributed as a dividend, the value of the shares decline and reduce the amount of capital gain that would otherwise occur when the shares are sold. RI I -5. 11 is not always true that a shareholder prefers a dividend over a capital gain.
First of all, the shareholder may be entitled to the capital gains deduction n shares Off qualified small business corporation (CBS), in Which case a capital gain is preferable to a dividend. Both dividends and capital gains have preferential treatment (dividends the dividend tax credit, capital gains – 1/2 taxable).In the lowest tax bracket for individuals the tax rate on Non-eligible dividends is normally lower than the rate on capital gains.
However, the opposite occurs in the top two brackets. The tax rate on Eligible dividends is normally lower than the rate on capital gains in all tax brackets. Using the marginal rates developed in Chapter 10 (Exhibit 10-6) for a particular province, the rates can be marred as follows: Eligible el Nan-eligible Capital Gains Dividends Low bracket 2nd bracket 3rd bracket High bracket Keep in mind that the timing of the tax may be different for each option.Capital gains are taxed only when the property is sold whereas dividends are taxed when received.
RI I -6. Mm the primary relationship, dividends paid by the corporation are not deductible by the corporation when determining its income for tax purposes, but the receipt Of the dividends is taxable to the shareholder. Therefore, corporate income distributed to shareholders as dividends are subject to bono levels of tax.In secondary relationships, payments to the shareholder for salary, interest, and rents are all deductible for tax purposes by the corporation and fully taxable to the recipient. Because such payments reduce corporate income before tax it effectively shifts corporate income from the corporation to the shareholder with the result being that there is only one level of tax. RI 1-7. The conversion to net income for tax purposes to taxable income for corporations is different because it includes several special reductions that are not permitted tort individuals.
In arriving at taxable income a corporation, in edition to deducting net capital losses and noncommittal losses, can also deduct: dividends from taxable Canadian corporations included in net income [TIT 112(1)], dividends from foreign affiliate corporations included in net income [TIT 113], and charitable donations [TIT A further difference is that a corporation is not entitled to the capital gains deduction which exempts $750,000 of gain on certain qualified properties.RI 1 -8. If voting control of a corporation shifts from one shareholder or group of shareholders to another, any net capital and noncommittal losses are affected as follows: Net capital losses are deemed to expire [TIT 111(4)(a)l. Noncommittal losses that were incurred from a business operation continue to be carried forward, but can only be offset against profits earned by the business that incurred the loss or a similar business.In addition, the loss business must be carried on at a profit or with a reasonable expectation of profit throughout the taxation year in which the losses carried forward are deducted. Fifth loss business is terminated before the losses are used, the loss carryovers will not be available [TIT 111 Non-capital losses that were incurred trot Bails and property losses, i.
. , rent, are deemed to expire [TIT I II(S)], A deemed year end occurs at the date to the control change [TIT 249(4)]. This causes operating losses (if any) up to that date to be included as restricted noncommittal losses.
Depreciable property, eligible capital property and capital property are deemed to be sold at FM on the date of the control change if the specific property is valued below its tax cost [TIT II 1(4), (5. 1) & (5. 2)].
This has the effect of triggering unrealized losses and including them in the above restrictions. (Note: control must be acquired by an arm’s length party for the above to apply TIT RI I -9. A change in control from a sale Of the shares Will restrict the use Of the loss carryovers so that they can be used only by the business that incurred the loss or a similar business [TIT 11 1(5)].If the purchaser is in a similar line of business they can, after the share acquisition, take steps to combine their profitable operations with the acquired loss corporation. The loss carryovers can then be used against the future profits of the purchaser’s operations. This would not be the case if the purchaser was in a different line of business. Therefore, a loss corporation has greater value to a researchers in the same line of business who can easily use the prior losses to create tax savings. The vendor should seek out such buyers.
RI 1-10.The existing profitable retail corporation can expand its new manufacturing activity by using a separate corporation to house the new activity, or it could operate the manufacturing operation as a division of the existing corporation In addition to any legal and administrative considerations, the following tax items should be considered when making the choice: Fifth new manufacturing operation should incur losses, they could not be immediately used if a separate corporation structure was used, as those losses would belong to the new corporation as a separate taxpayer However, under a division structure, any losses from the manufacturing operation could be immediately Offset against the retail profits creating additional cash flow from tax savings. This cash flow could be used to help fund the cost of the expansion.If the new venture fails, the divisional Structure leaves the existing corporation fully liable for the obligations, whereas the separate corporation structure may limit the liability. The alternate structures will have an impact on the amount of income that is subject to the Manufacturing and processing profits (M&P) deduction – 2009) [TIT 125.
1 The general rate reduction ; 2009) [TIT 124. 4] is applicable to other types of income, Therefore, most corporate income is subject to a net federal tax rate of 19%. Certain provinces have special rates for manufacturing and processing income, It is the possibility of provincial tax savings that makes the allocation of M&P income important.Under the separate corporation structure, the maximum profit eligible for he reduction is the actual manufacturing profits earned, However, when the operations are combined in the same corporation with the profitable retail activity, the manufacturing profits available for the deduction is determined by an arbitrary formula based on the ratio of manufacturing capital and labor to total capital and labor of the combined operating profit [Rob 5200].
This formula may produce an arbitrary manufacturing income for tax purposes that is greater than Or less than actual. The magnitude of this difference can be estimated and once determined should be considered as part of the decision recess. RI I-II.The owner Of shares Of a corporation can realize a return on that investment from dividends and/or capital gains when the shares are sold. The payment of dividends reduces the value of the share and therefore reduces the potential capital gain on the shares. With respect to corporate shares, dividends and capital gains are closely related. However, when one corporation invests in shares of another corporation, the consequence of the capital gain/dividend relationship is altered.
Dividends received by a corporation from another Canadian corporation can be deducted room the recipient’s net income when arriving at taxable income thereby providing a tax tree return on investment [TIT 112(1)].