1. Tax Lesson 4 YOURLOGO Start Lecture
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2. Business Income
Business income is revenue less expenses from selling goods or providing services. These rules apply to all taxpayers (i.e., corporations, individuals and trusts) earning business income
Any reasonable current expense incurred to earn business income is deductible (unless specified in the Act as not deductible). Many deductible current expenses are treated the same for tax and financial accounting purposes; e.g., cost of goods sold expense, salaries expense, interest expense, rent expense and utilities expense, among others, are typically treated the same
Some expenses are specifically not deductible for tax purposes. Examples of non-deductible expenses include:
Reserves (i.e., estimates of future expenses) are generally not deductible. Instead a deduction may be claimed when the actual amount of the expenditure is known (for example, warranty reserve or contingent liabilities)
Exceptions- allowance for bad debts; unearned revenue; sales that can be returned after year-end for refund- these reserves are allowed for tax purposes (i.e., the tax and accounting treatment is the same). Note: any reserve taken for tax purposes must be added to the next year’s income. Then another reserve may be available in that year

3. Business Income (cont.)
Amortization
Expenses related to recreational facilities and club dues
Meals and entertainment expenses are only 50% deductible
Interest expense (and fines) imposed under the Act
Any fine or penalty levied by a government (i.e., federal, provincial or municipal)
Accrued salaries and bonuses are only deductible if paid within 180 days from a corporation’s year-end (otherwise they are deductible in the year paid). Drawing a timeline can be helpful for determining important dates and deadlines
Foreign advertising aimed at the Canadian market. When attempting to market to Canadians, Canadian media (i.e., T.V., newspapers and magazines) should be used. When marketing to foreigners, foreign media can be used
Safety deposit box rental fees are no longer deductible for tax purposes

4. Business Income (cont.)
Capital expenditures (i.e., expenditures which provide a lasting value) are only deductible if the Act specifically allows the deduction. Goodwill write-downs, the impairment of long-term assets and stock option compensation expense are not deductible for tax purposes (since they are capital expenditures). Examples of capital expenditures incurred to earn income that are deductible:
Capital Cost Allowance (CCA) - up to a maximum based on the asset classes’ CCA rate. Assets are grouped together in a CCA class. All costs incurred to acquire the asset including: certain taxes, transportation, legal fees etc. are included in the cost of the asset. Any GST/HST paid by a GST/HST registrant will be recovered as an input tax credit (ITC) and will not add to the cost of an asset
Note: provincial taxation, e.g. HST, is not testable on CPA exams, but the GST (which is a federal tax) is testable
Most asset classes are subject to the half-net rule which means that only ½ of the normal CCA can be claimed in the year of purchase (exceptions: class 12 tools costing less than $500 and class 14 limited life intangible assets)
If an asset is disposed of, it is removed from the undepreciated capital cost (UCC) of the CCA asset class. The lesser of: (a) original cost; and (b) proceeds of disposition is subtracted from the UCC

5. Business Income (cont.)
If the UCC balance is negative, the negative amount is brought into income as recapture. Recapture is typically business income
If the UCC balance is positive, but no assets remain in the CCA asset class, then the positive balance can be claimed as a terminal loss. A terminal loss is (typically) a business loss. If there is a positive UCC balance and at least 1 asset remaining in the CCA asset class then you claim CCA (as discussed above)
Manufacturing equipment purchased in 2016 (and until the end of 2025) will go in new CCA class 53. Class 53 has a 50% declining balance CCA rate (and the ½ net rule applies)
Manufacturing equipment purchased before 2016 goes in class 29 (as long as the taxpayer elects). Class 29 has a 50% straight line CCA rate (and the ½ net rule applies)
Note: how 50% straight line CCA is different from 50% declining balance. For example for an asset costing $1,000 the CCA using 50% straight line versus 50% declining balance (with the ½ net rule) is:
50% Straight line 50% declining balance
Year 1 CCA $250 $250
Year 2 CCA $500 (i.e., $1,000/2) $375 (i.e. $750 x 50%)

6. Business Income (cont.)
Cumulative Eligible Capital Amount (CECA) - ¾ of the amount paid for eligible capital property, i.e., intangible assets with an indefinite life (such as goodwill and initial incorporation costs), adds to the CEC account. Only taxpayers operating a business have a CEC account and there is only one CEC account per taxpayer
CECA can be claimed at a maximum rate of 7% per year (if there is a positive CEC balance). There is no half- net rule for CECA. Dispositions are removed from the CEC balance based on ¾ of the proceeds of disposition received
If the CEC account becomes negative there will be recapture (i.e., business income). If the CEC account is positive and the business has ceased to exist then the taxpayer can claim a terminal loss (i.e., a business
Note: the March 22, 2016 federal budget has made major changes to CEC starting January 1, (These changes were first proposed in the 2014 federal budget). Starting in 2017, the existing tax treatment of CEC will be eliminated and replaced with a new CCA asset class, with a 5% CCA rate. The existing CCA rules, for example, the half-net rule, recapture and capital gains, will apply to this new CCA class. Note: starting in 2017, the full amount spent on CEC (not just ¾) would add to this new CCA class

7. Business Income (cont.)
For 2016 the current CEC rules remain as is. For taxpayers with an existing CEC balance as of December 31, 2016, this balance will move over to the new CCA asset class on January 1, CCA can be claimed on this balance at a 7% CCA rate (for up to 10 years). (CEC purchases made in 2017, and thereafter, will have a 5% CCA rate)
Also starting January 1, 2017, initial incorporation costs of up to $3,000 can be deducted in the year as a current expense. Prior to 2017, these costs are treated as CEC. Initial incorporation costs in 2017, and thereafter, in excess of $3,000, add to the new CCA asset class (as discussed above)
Expenses Related to Financing- These expenses include legal, accounting, investment banking and other expenses related to borrowing money (excluding interest expense) or issuing shares. These expenses are considered capital expenditures. However, they are deductible, but only 1/5 of the expenditure is deductible in the year incurred, and 1/5 is deductible in each of the next 4 taxation years. (Interest expense is fully deductible in the year as long as it was incurred to earn income)

8. Example Problem Business Income
Sue is the sole shareholder of S Inc. a Canadian controlled private corporation (CCPC) with a December 31st year-end. Sue and S Inc. are new clients of your accounting firm and she has come to you for tax advice. She wants you to: (a) calculate S Inc.’s minimum net income for tax purposes; and (b) calculate S Inc.’s GST owing and remind her of the due date for the GST return (ignore HST).
Sue has provided you with the following information:
S Inc. operates a bakery in Toronto and has been in business for several years
S Inc.’s net income for accounting purposes for its December 31, 2016 year-end has been calculated as follows:
Bakery sales (assume all sales are taxable for GST purposes) $140,000
Cost of goods sold (assume no labour costs/salary are included) ,000
Gross margin ,000
Rent expense (note 1) ,000
Depreciation expense (note 2) ,000
Interest expense (note 3) ,000
Salaries and bonuses expense (note 4) ,000
Legal and accounting fees (note 5) ,000
Reserve for contingent loss (note 6) ,000
Net income (loss) for accounting purposes ($8,000)

9. Example Problem Business Income (cont.)
Notes: 1) Rent expense consists of $20,500 for commercial rent for the bakery and $9,500 for Sue’s personal rent expense. Sue thinks that because she is the sole shareholder it is okay for S Inc. to pay for her personal rent expense (all of the bakery’s business is conducted at the bakery where Sue has an office). 2) Depreciation expense is for furniture and equipment acquired on January 5, 2016 at a cost of $50,000 (excluding GST). For accounting purposes, this furniture and equipment is being amortized over a five year period. 3) Interest expense consists of $6,500 for interest related to a bank loan used to finance the purchase of furniture and equipment and to fund working capital, $400 for interest related to a late income tax payment from a prior tax year and $100 in safety deposit box fees. 4) Salaries and bonuses expense includes an accrued bonus of $8,000 payable to Sue from the December 31, 2016 year-end. Sue has informed you that this amount will be paid on July 31, 2017.

10. Example Problem Business Income (cont.)
5) Legal and accounting fees consists of $7,500 incurred for regular and on-going business advice and $1,500 which was incurred as part of (and related to) the January 5th purchase of furniture and equipment. 6) A reserve for a contingent loss has been recorded for accounting purposes in the year because a large corporate customer has complained to Sue and Sue thinks this customer may demand a refund for an order of baked goods purchased in December. The bakery’s policy is that all sales are final and no returns are allowed. Sue has estimated that the maximum possible refund that this customer may demand is $2,000; however, to date no refund has been demanded or paid to this customer.

11. Example Problem CCA/CECA
Given the following information, calculate the maximum CCA, CECA and other applicable tax consequences in Also discuss the 2017 tax consequences for the CEC. You can ignore the capital dividend account and ignore the replacement property rules. Your client, Purple Co., is a CCPC with a December 31st year-end. Purple Co. operates an active business and had the following undepreciated capital cost (UCC) balances at the start of 2016: Class 1 (4%): $700,000 Class 12: $2,000 Class 8: $50,000 Class 10: $60,000

12. Example Problem CCA/CECA (cont.)
On February 15, 2016 Purple Co. made the following dispositions and purchases:
It sold the class 1 (4%) building for proceeds of disposition of $900,000. There were no other assets in this class. The original cost of this class 1 (4%) building was $820,000
It sold the class 12 asset (computer software) for proceeds of disposition of $1,200. There were no other assets in this class. The original cost of this class 12 asset (computer software) was $4,000
It purchased a new (previously unused) building for $1,000,000. The building is used in the business (note: Purple Co. is not a manufacturer)
It purchased several new computers for $100,000
It purchased a used private airplane for $1,400,000. This airplane is expected to make it easier to travel for business purposes and help increase revenue
It purchased goodwill (as part of a business acquisition) for $100,000