Chapter Objectives Be able to: n Calculate taxable income. n Explain and apply the loss carryover rules. n Explain and calculate the lifetime capital gain deduction. n Calculate federal and provincial tax and tax credits.

Determination of Taxable Income n In general terms, to arrive at taxable income, net income for tax purposes is reduced by loss carryovers, lifetime capital gain deduction, and stock option deductions.

Loss Carryovers n Loss carryovers are losses from other years that were restricted by the aggregating formula. n Since they are a reduction of net income for tax purposes, losses incurred in the current year must be deducted first as part of the net income calculation. n Unused allowable capital losses are classified as net capital losses and can be carried back three years and forward indefinitely but they continue to be only deductible against capital gains. n Unused business, property and employment losses and ABILs are classified as non-capital losses and can be carried back three years and forward seven against any source of income. n Farm losses are treated the same as business losses except the carry forward period is ten years. Losses of hobby farmers are classified as restricted farm losses and have special rules.

Loss Utilization’s Impact on Decision Making n The sooner that losses are utilized, the sooner that cash flow will be increased as a result of reduced taxes. n The loss utilization rules and the time period for their use make it an important consideration in decision making. n The corporate structure can diminish a taxpayer’s opportunity to use losses as quickly as possible given that it is a separate taxable entity and this corporate loss can not be offset against a shareholder’s other income. n Given that non-capital losses do expire, managers should consider reducing or deferring expenses or creating income.

Lifetime Capital Gain Deduction n Qualified small business corporation shares and qualified farm property are the only properties that qualify for this deduction. n The lifetime capital gain deduction is $500,000 and one-half or $250,000 is deductible from taxable income. n A small business corporation qualifies when it is CCPC and it uses all or substantially all of its assets to conduct an active business in Canada. n Qualified farm property includes real property, eligible capital property used in the farming business, a share of a family farm corporation, and an interest in a farm partnership. n The capital gain deduction is limited by capital losses incurred (including ABILs) and accumulated investment losses (which is referred to as the cumulative net investment loss or CNIL).

Calculation of Tax n Federal tax is always a percentage of taxable income.Provincial taxes are also a percentage of taxable income. However, the territories and non-residents apply a tax that is a percentage of basic federal tax (which is net of first category tax credits). n Federal tax is computed as taxable income times graduated rates of tax less first and second category tax credits. Provincial tax is computed in a similar fashion. n First category federal tax credits include: dividend, basic, spouse, equivalent to spouse,infirm dependents, care giver, age, disability, pension, C.P.P., E.I., charitable donations, medical expenses, education amount, and tuition fees. n Second category federal tax credits include: foreign taxes paid, political contributions, labour-sponsored fund credit, logging tax credit, and investment tax credits in certain cases.

Special Upward Adjustments to Tax Calculation n The Alternative Minimum Tax and the Special Tax on OAS Benefits will, if applicable, result in upward adjustment of income taxes. n The alternative minimum tax rules are designed to impose a minimum level of tax on individuals when the normal amount of tax has been reduced as a result of certain tax preference items being included in taxable income. This tax is only temporary since it can be carried forward up to seven years and used to reduce tax payable in a future year. n The special tax on OAS benefits (clawback) is computed as 15% of a stipulated threshold to a maximum of the benefits received.