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Chapter 17 Corporate Taxation And Management Decisions.

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Presentation on theme: "Chapter 17 Corporate Taxation And Management Decisions."— Presentation transcript:

1 Chapter 17 Corporate Taxation And Management Decisions

2 © 2006, C. Byrd Inc. 2 The Decision To Incorporate Tax Reduction Tax Reduction Tax Deferral Tax Deferral Income Splitting Income Splitting Other Considerations Other Considerations

3 © 2006, C. Byrd Inc. 3 Tax Reduction Only one situation provides reduction Only one situation provides reduction CCPC on amounts eligible for SBD CCPC on amounts eligible for SBD Small – Less than 1 percent in text example Small – Less than 1 percent in text example

4 © 2006, C. Byrd Inc. 4 Tax Deferral Moderate amount for Public Corporations Moderate amount for Public Corporations Large amount for CCPC on amounts eligible for SBD Large amount for CCPC on amounts eligible for SBD Prepayment for CCPC on investment income Prepayment for CCPC on investment income Neutral for dividends Neutral for dividends

5 © 2006, C. Byrd Inc. 5 CCPC Income > Small Business Limit The The Problem Taxed Taxed at 38 percent at corporate level at over 50 percent on flow through to individual The The Solution Bonusing Bonusing down.

6 © 2006, C. Byrd Inc. 6 Imperfections In Integration System Provincial dividend tax credits Provincial dividend tax credits DTC  1/3 Gross Up – Favours use of corporation DTC  1/3 Gross Up – Favours use of corporation DTC < 1/3 Gross Up – Favours not incorporating DTC < 1/3 Gross Up – Favours not incorporating

7 © 2006, C. Byrd Inc. 7 Imperfections In Integration System Different Federal/Provincial Rates Different Federal/Provincial Rates >20% - Favours not incorporating <20% - Favours use of corporation

8 © 2006, C. Byrd Inc. 8 Income Splitting Splitting income a very powerful tool Splitting income a very powerful tool Corporations very effective here Corporations very effective here Few limits for spouses and adult children Few limits for spouses and adult children Problems with minor children (tax on split income) Problems with minor children (tax on split income)

9 © 2006, C. Byrd Inc. 9 Incorporation: Other Factors To Consider Limited Liability Limited Liability Shareholders’ Liability To Creditors Limited To Amounts Invested Shareholders’ Liability To Creditors Limited To Amounts Invested For Smaller Corporations, Personal Guarantees Almost Always Required To Obtain Significant Financing For Smaller Corporations, Personal Guarantees Almost Always Required To Obtain Significant Financing Protection from other types of liabilities (e.g., product liability) Protection from other types of liabilities (e.g., product liability)

10 © 2006, C. Byrd Inc. 10 Incorporation: Other Factors To Consider Lifetime Capital Gains Deduction Lifetime Capital Gains Deduction Foreign Taxes Foreign Taxes Estate Planning Estate Planning Loss Deductions Loss Deductions Charitable Donations Charitable Donations Maintenance Costs Maintenance Costs Winding-Up Procedures Winding-Up Procedures

11 © 2006, C. Byrd Inc. 11 Payments To Owner/Manager Need For Funds Other Income CPP/RRSP CNIL Corporate Income Need To Bonus Down Target Bracket

12 © 2006, C. Byrd Inc. 12 Corporation’s Need For Funds Corporation’s Tax Rate Corporation’s Tax Rate Alternative Investment Opportunities Alternative Investment Opportunities Alternative Sources Of Funds Alternative Sources Of Funds

13 © 2006, C. Byrd Inc. 13 Salary Vs. Dividends Basic Principles Basic Principles Salary Deductible To Corporation Salary Deductible To Corporation Dividends Taxed Favourably At Individual Level Dividends Taxed Favourably At Individual Level Income Not Eligible For SBD Income Not Eligible For SBD Bonusing Down Requires Salary Bonusing Down Requires Salary Income Eligible For SBD Income Eligible For SBD Corporate Rate > 20% Corporate Rate > 20% Provincial Dividend Tax Credit > 1/3 Gross Up Provincial Dividend Tax Credit > 1/3 Gross Up

14 © 2006, C. Byrd Inc. 14 Tax Free Dividends Owner/Managers Deal Largely With Non- Eligible Dividends Owner/Managers Deal Largely With Non- Eligible Dividends Basic Concepts Basic Concepts $1 Dividend Received $1 Dividend Received $1.25 Increase In Taxable Income [($1)(1.25)] $1.25 Increase In Taxable Income [($1)(1.25)] Individuals In Lowest Federal Tax Bracket Individuals In Lowest Federal Tax Bracket Taxes Are $ [($1.25)(15.25%)] Taxes Are $ [($1.25)(15.25%)] Federal Dividend Tax Credit = $ [($0.25)(2/3)] Federal Dividend Tax Credit = $ [($0.25)(2/3)]

15 © 2006, C. Byrd Inc. 15 Tax Free Dividends Tax on first $1 of dividends is $ ($ $.1667) Tax on first $1 of dividends is $ ($ $.1667) First $1 of dividends uses up available credits of $ ($.0239 ÷ $.1525) First $1 of dividends uses up available credits of $ ($.0239 ÷ $.1525)

16 © 2006, C. Byrd Inc. 16 Use Of Tax Credits $1 Of Salary Uses $1 Of Credits $1 Of Salary Uses $1 Of Credits $1 Dividends Uses $ Of Credits $1 Dividends Uses $ Of Credits Dividends Better Until Credits Are Used Dividends Better Until Credits Are Used

17 © 2006, C. Byrd Inc. 17 Amounts Available Tax Free Single Individual $35,110 Non-Eligible 65,819 Eligible With Dependent Spouse $45,680 Non-Eligible $77,045 Eligible

18 © 2006, C. Byrd Inc. 18 Salary To Owner/Manager The Owner/Manager Environment The Owner/Manager Environment No Outside Shareholders No Outside Shareholders Complete Discretion With Respect To Amount And Types Of Compensation Complete Discretion With Respect To Amount And Types Of Compensation

19 © 2006, C. Byrd Inc. 19 Salary To Owner/Manager Salary Payments - Role In Integration Salary Payments - Role In Integration Like Direct Receipt Of Income Like Direct Receipt Of Income Deduction Eliminates Tax Payable At Corporate Level Deduction Eliminates Tax Payable At Corporate Level

20 © 2006, C. Byrd Inc. 20 Salary To Owner/Manager Salary Payments Salary Payments RRSP Contributions (2006) RRSP Contributions (2006) $18,000  18% = $100,000 $18,000  18% = $100,000 Dividends  Earned Income Dividends  Earned Income Use of Personal Tax Credits Use of Personal Tax Credits Lost If Not Used Lost If Not Used Salary Uses Up Faster Salary Uses Up Faster

21 © 2006, C. Byrd Inc. 21 Other Considerations Earned Income For CPP Purposes Earned Income For CPP Purposes Dividends Do Not Count As Earned Income Dividends Do Not Count As Earned Income Cumulative Net Investment Loss (CNIL) Cumulative Net Investment Loss (CNIL) CNIL Reduces Available Lifetime Capital Gains Deduction CNIL Reduces Available Lifetime Capital Gains Deduction Receipt Of Dividends Reduces CNIL Receipt Of Dividends Reduces CNIL Added Costs Of Salary Added Costs Of Salary CPP And EI Premiums CPP And EI Premiums Payroll Taxes (In Some Provinces) Payroll Taxes (In Some Provinces)

22 © 2006, C. Byrd Inc. 22 Dividends - Problem Problem - All Dividend Approach Problem - All Dividend Approach Use Up Tax Credits At A Slow Rate Use Up Tax Credits At A Slow Rate May Leave Unused Tax Credits May Leave Unused Tax Credits Solution Solution Pay A Lesser Amount Of Dividends Pay A Lesser Amount Of Dividends Sufficient Additional Salary To Absorb Tax Credits Sufficient Additional Salary To Absorb Tax Credits

23 © 2006, C. Byrd Inc. 23 Basic Data Corporate Taxable Income = $29,500 Corporate Taxable Income = $29,500 Combined Corporate Tax On ABI = 20% Combined Corporate Tax On ABI = 20% Provincial Tax On First $36,378 Of Personal Taxable Income = 10% Provincial Tax On First $36,378 Of Personal Taxable Income = 10% Individual Has Combined Tax Credits Of $3,920 Individual Has Combined Tax Credits Of $3,920 Provincial Dividend Tax Credit = 1/3 Of Gross Up Provincial Dividend Tax Credit = 1/3 Of Gross Up

24 © 2006, C. Byrd Inc. 24 All Salary No Corporate Tax Payable No Corporate Tax Payable Salary Received = $29,500 Salary Received = $29,500 Taxes At 26% (16% + 10%) ( 7,670) Personal Tax Credits 3,920 After Tax Cash Retained $25,750

25 © 2006, C. Byrd Inc. 25 All Dividends Maximum Dividend Maximum Dividend Corporate Income$29,500 Corporate Tax At 20% ( 5,900) Available For Dividends$23,600 Taxable Dividends Taxable Dividends Dividends Received$23,600 Gross Up (25%) 5,900 Taxable$29,500

26 © 2006, C. Byrd Inc. 26 All Dividends Personal Taxes On Dividends Personal Taxes On Dividends Tax At 26 Percent [(26%)($29,500)] $7,670 Personal Tax Credits( 3,920) Dividend Tax Credit(Equal Gross Up)( 5,900) Tax Payable (Negative $2,150) Nil After Tax Cash Retained After Tax Cash Retained Dividends Received$23,600 Tax Payable Nil Cash Retained$23,600

27 © 2006, C. Byrd Inc. 27 All Dividends The All Dividend Approach Leaves $2,150 In Unused Personal Tax Credits The All Dividend Approach Leaves $2,150 In Unused Personal Tax Credits A Combination Of Salary And Dividends May Provide A Better After Tax Retention A Combination Of Salary And Dividends May Provide A Better After Tax Retention

28 © 2006, C. Byrd Inc. 28 Dividend/Salary Combination Consider: Consider: For For Each $1,000 Of Additional Salary Paid Dividends Dividends Are Reduced $ [($1,000)( )] Increase In Salary$1, Decrease In Dividends( ) Decrease In Gross Up ( ) Change In Taxable Income $ Nil

29 © 2006, C. Byrd Inc. 29 Dividend/Salary Combination Decrease In Dividend Tax Credit$ Each $1,000 Increase In Salary Results In An Increase Tax Payable Of $ Each $1.00 Increase In Salary Increases Tax Payable By $0.20. To Use Up $2,150 In Credits, Need Additional Salary Of $10,750 ($2,150/$0.20)

30 © 2006, C. Byrd Inc. 30 Dividend/Salary Combination Pre-Salary Taxable Income$29,500 Salary ( 10,750) Corporate Taxable Income$18,750 Corporate Tax At 20 Percent ( 3,750) Available For Dividends$15,000

31 © 2006, C. Byrd Inc. 31 Dividend/Salary Combination Dividends Received$15,000 Gross Up (25%) 3,750 Taxable Dividends$18,750 Salary 10,750 Taxable Income$29,500

32 © 2006, C. Byrd Inc. 32 Dividend/Salary Combination Personal Tax At [(26%)($29,500)]$7,670 Personal Tax Credits ( 3,920) Dividend Tax Credit (Gross Up) ( 3,750) Personal Tax Payable Nil

33 © 2006, C. Byrd Inc. 33 Dividend/Salary Combination Dividends Received$15,000 Salary Received 10,750 Personal Tax Payable Nil After Tax Retention$25,750

34 © 2006, C. Byrd Inc. 34 Dividend/Salary Combination All Salary Approach$25,750 All Salary Approach$25,750 All Dividend$23,600 All Dividend$23,600 Dividend/Salary$25,750 Dividend/Salary$25,750

35 © 2006, C. Byrd Inc. 35 Conclusions All Dividends Ineffective Doesn’t Use All Credits Need Minimum Salary of $10,750 To Use Credits

36 © 2006, C. Byrd Inc. 36 Conclusions Results Identical For: Results Identical For: All Salary All Salary Any Dividend/Salary Combination With At Least $10,750 Of Salary Any Dividend/Salary Combination With At Least $10,750 Of Salary Reflects Perfect Integration Reflects Perfect Integration 20% Corporation Rate 20% Corporation Rate Dividend Tax Credit = Gross Up Dividend Tax Credit = Gross Up

37 © 2006, C. Byrd Inc. 37


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