CHAPTER 11:

Corporations - An
Introduction

Prepared by

Kristie Dewald
University of Alberta
Electronic Presentations in Microsoft PowerPoint

Copyright 2016 McGraw-Hill Education Limited

Corporations An Introduction
I.
II.
III.
IV.

Relationship between the Corporation and Its

Shareholders
Determination of Taxable Income
Calculation of Corporate Tax
The Integration of Corporate and Individual
Taxation

I.

Relationship Between the Corporation

and its Shareholders

Incorporated Company = artificial person

separate from owner (s).
Recognized by law as an entity:
has the power to act in its own right and
to enter into enforceable legal agreements.

A. Corporation Defined
A corporation, as a separate entity:
can buy, own, sell, and lease property
Not considered owned by the shareholders
can borrow funds for its own use as well as loan funds to
others.
Shareholders are liable for the corporations debts only to
the extend of capital contributions

B. Tax Impact of Shareholder / Corporate

Relationships
Legal separation of the corporation from its shareholders
creates a two tiered system of taxation:
Corporation is subject to tax
Shareholder is subject to a second level of tax on income
from the corporation (ultimately income flows to individuals)

Corporations relationship with shareholders:

1.
2.

The Primary Relationship - provides equity capital to the

corporation
The Secondary Relationships shareholder as a creditor,
supplier, customer, employee or lessor to the corporation
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The Primary Relationship

Shareholder contributes cash or other property in exchange
for shares.
Contribute Cash

Shareholder

Corporation
Shares

Shareholders realize a return on investment through

dividends or through a capital gain when they sell their
shares at a profit.
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The Primary Relationship

The Secondary Relationships

Secondary relationships:
creditor, supplier, employee, customer, or lessor

Tax consequences and cash flows between the parties

are different from those in the primary relationship.

Primary and Secondary Relationships

Difference between the two relationships centres on
the tax treatment of income flows:
Primary relationship:
dividends paid by the corporation are not deductible, but are taxable to
the recipient.

Secondary relationships:
payments such as salaries, interest, and rents are deductible and
taxable to the recipient.

II. Determination of Taxable Income

A corporations taxable income is:
Net income for tax purposes less special deductions
Donations to charitable organizations
Net capital losses
Non-capital losses
Dividends from taxable Canadian corporations
Dividends from foreign affiliates

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A. Loss Carry-Overs
Loss carry-over provisions are the same as with
individuals
Net capital losses:
can be carried back three years and forward indefinitely
Used only against taxable capital gains.

Non-capital losses:
can be carried back three years and forward 20 years
Used against any other source of income.

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Acquisition of Control
Ownership can change when shares are transferred or
sold.
The carry-forward of unabsorbed losses may be
attractive to acquiring shareholders
if they can use those losses .

Change in beneficial ownerships:

Net-capital losses are deemed expired, and
Non-capital losses from business operations may be used,
subject to restrictions.

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Acquisition of Control
Non-capital losses resulting from business operations
are restricted as follows:
Must carry on business in which losses occurred
Reasonable expectation of profit
Losses can only be deducted against business
income earned by same or similar business.

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Acquisition of Control
Purpose of restrictions is to prevent the transfer of
unabsorbed corporate losses to other parties.
Deemed year end immediately before the change in
control.
Adds any operating losses making them subject to the
restrictions.
Depreciable property, eligible capital property, and other capital
property are deemed to be sold at FMV if:

FMV < tax cost

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Loss in Corporate Groups

Shareholders

Corporation A
Profits $100,000

Corp A profits
Corp B loss
Corp C profit
Net loss for group

$100,000
(400,000)
50,000
$(250,000)

Corporation B
Loss ($400,000)
Corporation C
Profits $50,000

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B. Dividends from Other Canadian

Corporations
Dividends received included as property income for net
income for tax purposes.
Dividends are deducted from taxable income if:
received from a taxable Canadian corporations, or
foreign affiliate corporations
Foreign affiliate, Canadian corp. must have at least a 10% equity
interest in the foreign corporation.

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Dividends from Other Canadian

Corporations
Result is dividends flow tax-free to other corporations.
Private corporations may be subject to a temporary
Part IV tax (Chapter 13).
Removes the second level of tax until dividends are
received by individuals.

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III. Calculation of Corporate Tax

Three basic categories for tax purposes:
1.

Public corporations
Resident in Canada
Shares are traded on a stock exchange.

2.

Private corporations
Resident in Canada
Not a public corporation or controlled by public corporations

3.

Canadian-controlled private corporations (CCPCs)

Resident in Canada
Not a public corporation, and
Not controlled by non-residents of Canada.

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Determination of Tax for Corporations

19

A. Federal Tax
The basic federal tax is 38% of the corporations taxable
income.
Then, reduced by the provincial abatement of 10%
Provides room for the provinces to impose tax.

Federal tax may be increased or reduced further based

on specific types of income earned by certain
corporations.

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General Tax Reduction

General tax reduction - applies to particular types of
income:
Public corporations:
Federal tax is reduced by 13% of the corporations taxable income not
subject to manufacturing and processing activities.

CCPC:
Federal tax is reduced by 13% on active business income:
Above the annual small business limit and
Not eligible for the M&P reduction

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Refundable Tax on Investment Income

Applies only to the investment income of a CCPC.
Additional tax is 10 2/3% of investment income and
Fully refundable to the corporation when dividends are paid to
shareholders.

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Additional Tax on Personal Services

Business Income
Additional tax of 5% is applied to personal services
business income
Increases the federal rate on this income to 33%
(Basic 38% - Abatement 10% + 5%)

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Small Business Deduction

Available only to CCPCs.
Deduction permits the normal federal tax rate to be
reduced by 17.5% to the lesser of:
The first $500,000 of annual active business income of the
corporation, or
Taxable income

Net federal tax is 10.5%

(38% - 10% - 17.5%)

Two or more corporations owned by similar shareholders

may have to share the $500,000 limit
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Manufacturing and Processing Deduction

Profits from manufacturing and processing activities are
subject to a rate reduction:
Public Corporations - rate reduction of 13%.
CCPCs same rate reduction
only on annual manufacturing profits in excess of the small business
deduction limit described previously.

Federal rate on manufacturing activities is 15%

same as income eligible for the general rate reduction

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Manufacturing and Processing Deduction

Arbitrary formula is used:
MC + ML
X
TC + TL

Total
Business =

Mfg. Profits

Profits

Where:
MC = manufacturing capital TC = total capital
ML = manufacturing labour TL = total labour
The result of this formula may be higher or lower than the
actual manufacturing profits.
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Full-rate Taxable Income and GRIP

Full-rate taxable income = taxable income that:
Does not benefit from the small business deduction, and
Is not investment income earned by a CCPC

Full-rate taxable income less applicable taxes, when paid

out as a dividend, qualifies as an eligible dividend
Subject to a higher gross up
Subject to a higher dividend tax credit

CCPCs keep track by maintaining a GRIP (general rate

income pool)
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GRIP
A corporations GRIP is:
Increased annually by 72% of its full-rate taxable income
Meant to approximate the after tax income
Reduced by the amount of eligible dividends distributed

Public company income is normally classified as full-rate

taxable income
Not necessary to maintain a GRIP

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Low Rate Income Pool (LRIP)

Public corporations may receive non-eligible dividends
from a CCPC
Cannot be classified as full-rate taxable income

Tracked in an account call LRIP

Amounts in LRIP, when paid as dividends retain noneligible status
Public corporations must pay non-eligible dividends
before eligible dividends if they have a balance in LRIP
Subject to penalties if they do not

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B. Provincial Tax
Expressed as a % of corporate taxable income.
Each province and territory imposes a primary flat rate of
tax on all corporate income.
Certain provinces apply:
a reduced rate of tax on first $500,000 (or more) of active
business profits of CCPCs, and
some reduce the rate for manufacturing profits.

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Provincial Tax
Regular
Income

Income
Regular eligible
Income for SBD

Income
eligible
for SBD

Alberta 12% (3)

BC
11%
(2.5)
Manitoba 12%
(0)
New Brunswick 13.5%
(4)
Newfoundland 15%
(3)
Labrador 14%
(3)
NW Territories 11.5%
(4)

Nova Scotia 16%

(3)
Nunavut 12%
(4)
Ontario 11.5% (4.5)
P.E.I. 16% (4.5)
Quebec 11.9% (8)
Saskatchewan 12%
(2)
Yukon
15%
(3)

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Multi-Provincial Tax
A corporation incorporated or based in a particular
province will be taxed entirely in that province unless
it carries on business in another province through a permanent
establishment such as an office, branch, warehouse, or
factory.

If such a permanent establishment exists, the profits

attributable to that location are based on the ratio of:
sales in the province to total sales, and
wages paid in the province to total wages
multiplied by the total business profits of the whole corporation.

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Multi-Provincial Tax
an example
Wages paid in Alberta
Total wages paid by corp.

33%

Sales in Alberta
Total sales of corp.

45%

39%

Average of
a and b

=
2

33 + 45

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IV. The Integration of Corporate and

Individual Taxation
Corporations are taxed on their profits separate from their
shareholders.
After-tax corporate profits are distributed in the form of a
dividend,
tax is again payable on the dividends received.

Two-tier system creates the possibility of double taxation.

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IV. The Integration of Corporate and

Individual Taxation
Effect of double taxation is modified by the dividend tax
credit
Individual applies to reduce personal tax on dividends
received from Canadian corporations
Represents a credit for all or a portion of corporate tax paid
on the income
Assumes the corporate tax rate is either 27.5% or 15%

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Dividend Tax Credit

Public Corporation - example
Corporate taxable Income
$ 1,000
Corporate Taxes - 27%
(270)
Net cash (paid out in dividends)
730
Dividends received by shareholder - eligible
Tax, net of dividend tax credit (35%) (256)
Net cash, after tax, to shareholder

$ 730
$ 474

Total tax paid on $1,000:

Corporate $ 270
Individual 256
Total
$ 56
Effective tax rate is 53% ; Maximum personal rate on business income = 50%
Double tax = 3%
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Dividend Tax Credit

CCPC example
Corporate taxable income
Corporate taxes - 15%
Net cash (paid out in dividends)

$ 1,000
(150)
$850

Dividends received by shareholder -non-eligible

Tax, net of dividend tax credit (41%)
Net cash, after tax, to shareholder

$850
(349)
$501

Total tax paid on $1,000

Corporate
$150
Individual
349
Total
$499
Effective rate (rounded) = 50%
Amount of double taxation is nil.
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IV. The Integration of Corporate and Individual

Taxation
In a public corporation, double taxation on returns to the
owner is automatic.
In a CCPC, double taxation may or may not occur
depending on the nature of the income.
Corporate tax and tax on distributions has a significant
impact on:
Dividend policy
Equity structures
Form of business organization

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