midterm exam notes for AFM 461.docx

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Department
Accounting & Financial Management
Course
AFM 461
Professor
Dan Rogozynski
Semester
Fall

Description
Chapter 12 Active business • Only an active business qualifies for the small business deduction • Active business is defined as any business carried on b the corporation other than a specified investment business or a personal service business and includes an adventure or concern in the nature of trade (ITA 125(7)) o A specified investment business (SIB) is defined to mean: 1. A business (other than the business of a credit union or of leasing property other than real property) 2. The principle purpose of which is to derive income from property (including interest, dividends, rents and royalties) 3. Unless the corporation employs in the business throughout the year more than five full-time employees • Also exception if the corporation does not employ more than 5 full- time employees but another corporation associated with it that provides the service does o Personal service business, can be thought of as an incorporated employee, defined to mean: 1. A business of providing services where: • An individual who performs services on behalf of the corporation or any personal related to the incorporated employee (a specified shareholder owning more than 10% of ownership) • Exception: o The corporation employs throughout the year more than 5 full- time employees or o Services are provided to an associated corporation Small business deduction calculation • A credit against the tax otherwise payable on income • To qualify, must be a Canadian-controlled private corporation throughout the year • Formula is: o 17% of the least of: 1. Net Canadian active business income 2. Taxable income fully taxed in Canada achieved by removing from the total taxable income, foreign-source income estimated as the sum of: • Foreign-source investment income, estimated as 100/28 times the foreign tax credit on foreign non-business income • Foreign-source business income, estimated as the relevant factor, 4 times the foreign tax credit on foreign business income • Taxable income exempt from Part I tax b reason of an enactment of Parliament 3. the business limit, $500,000 less any portion allocated to associated corporation • this business limit is reduced if the taxable capital in the preceding year exceeds $10 million by the following formula: o A x B/11,250 o A is the corporation’s business limit for the year o B is 0.225% x (D – 10 million) o D is the corporation’s or the associated group’s, total taxable capital employed in Canada for its preceding taxation year Federal Part I tax payable schedule Taxable income ---------------------------------------------------------------------------- xxxx Basic federal tax (38%) ------------------------------------------------------------------- xxxx Federal abatement (10% of Canadian sourced income) ------------------------ (xxxx) Additional refundable tax -------------------------------------------------------------- (xxxx) Foreign business tax credit ------------------------------------------------------------ (xxxx) Foreign non-business tax credit ------------------------------------------------------ (xxxx) Small business deduction -------------------------------------------------------------- (xxxx) Investment tax credit ------------------------------------------------------------------- (xxxx) General deduction ----------------------------------------------------------------------- (xxxx) 13% of taxable income less: The amount of income eligible for the manufacturing and processing profits deduction Income from a personal service business The amount of income eligible for the small business deduction Aggregate investment income Dividend refund (on dividends received from non-connected corp, 33%) ----- (xxxx) Federal tax payable ------------------------------------------------------ xxxx Associated companies • When two or more CCPC are associated for tax purposes, the business limit of $500,000 must be reduced • An individual is related to everyone except aunts, uncles, niece, nephew and cousins • An individual relates to a corporation through control (control you either have it or you don’t, ownership is multiplication) • A related group is a group of persons each of whom is related to each member of the group. • Two corporations are related where: o Both corporations are controlled by the same person o One corporation is controlled by one person, who is related to a person or any member of a related group that controls the other corporation o One corporation is controlled by one person or a related group and that person or one member of the related group is related to each member of the unrelated group which controls the other corporation o Two corporations are controlled by unrelated groups and at least one member of one of the group is related to each member of the other group • For association rules, there are five general rules 256(1)(a)(b)(c)(d)(e) o 256(1)(a) -> one company controls the other o 256(1)(b) -> both companies controlled by the same person or group of persons o 256(1)(c) -> all the following conditions must be satisfied: 1. Each of the corporations must be controlled, directly or indirectly in any manner whatever, by a person (control test) 2. The person who controls one of the corporations must be related to the person who controls the other corporation (related test) 3. Either of the two persons own not less than 25% of the issued shares of any class, other than specified class o 256(1)(d) -> applies where one corporation is controlled by a single person and the other corporation is controlled by a group of persons 1. One of the corporations must be controlled, directly or indirectly in any manner whatever, by one person (control test) 2. That person must be related to each member of a group of persons that controls the other corporation (related test) 3. That person must own not less than 25% of the issued shares of any class, other than specified shares, of the capital stock of the other corporation o 256(1)(e) -> applies to two group-controlled corporations 1. Each of the corporations must be controlled, directly or indirectly in any manner whatever, by a related group (control test) 2. Each member of one of the related groups must be related to all of the members of the other related group (related test) 3. One or more members of both related groups must own, either alone or together, not less than 25% of the issued shares of any class, other than a specified class of shares of the capital stock of the other corporation Investment tax credit • Everyone qualifies for 20% investment tax credit for all qualifying scientific research and development • For CCPC, there is an additional 15% (20% after 2013), restricted in total to $3 million of qualifying expenditures, provided taxable income of preceding year does not exceed 500,000 o if exceeded 500,000, limit of $3 million is reduced by $10 for every dollar of excess, at 800,000, limit is reduced to 0 (formula is 8,000,000 – 10 times (greater of 500,000 or the taxable income of the associated group) o limit is also reduced if the taxable capital exceeds 10 million. The limit is reduced by $3 for every $40 in taxable capital in excess of 10 million. At 50 million of taxable capital, the expenditure limit is nil • there is also refundable investment tax credit (only available if preceding year taxable income not exceeding $500,000) as follow: o 100% cash refund of the available 35% ITC based on qualifying SR&ED current expenditures not in excess of the expenditure limit for the year o 40% cash refund of the available 35% ITC based on qualifying SR&ED capital expenditure o 40% cash refund of the available 20% ITC on qualifying SR&ED current expenditures in excess of the expenditure limit • Prescribed proxy amount -> elected to allocate overhead related directly to SR&ED in Canada o 60% of the salary base of employees directly engaged in SR&ED o Exception is with specified employee (an individual, together with the shares of the related individual, owns more than 10%) • Lesser of: a. ¾ of their full salary b. 2.5 times the year’s maximum pensionable earnings for CPP purposes (51,100 for 2013) Additional refundable tax (ART) • A refundable tax on “aggregate investment income” • Calculated as: o 6 2/3% x the lesser of: 1. Aggregate investment income and 2. Taxable income minus the amount on which the small business deduction is based • Aggregate investment income: o Net taxable capital gains for the year o Less: net capital losses deducted under division C o Plus: income from property (Canadian and foreign) o Less: dividends deducted under division C o Less: losses from property (Canadian and foreign) Calculate refundable portion of Part I tax Step 1: calculate refundable dividend tax on hand Step 2: calculate Part IV tax on taxable dividends received (at 1/3%) Step 3: calculate dividend refund Refundable dividend tax at end of the year: RDTOH, end of last year -------------------------------------- xxxx Dividend refund for last year ------------------------------- (xxx) Add: refundable dividend tax on hand (step 1) -------- xxxx Part IV tax (step 2) ----------------------------------------------xxxx RDTOH at end of the year ----------------------------------- xxxxx Less: Dividend Refund (step 3) ------------------------------ (xxxx) RDTOH carryforward ------------------------------------------- xxxxx Step 1: Refundable dividend tax on hand (RDTOH) - Accumulates all of the tax paid and refunds to the company at a rate of $1 of refund for every $3 of taxable dividends paid - Refundable portion of Part I tax - Total of: 1. Where the corporation was a CCPC throughout the year, the least of;  26 2/3% x aggregate investment income  Less the net of: non-business foreign tax credit minus 9 1/3 x foreign investment income  26 2/3% x taxable income less the total of: • The amount eligible for the small business deduction • 100/35 x non-business foreign tax credit • 4 x business foreign tax credit  Part I tax Step 2: Part IV tax on taxable dividends received (33 1/3%) Step 3: Dividend refund - The private corporation will obtain a dividend refund each year equal to the lesser of: 1. 1/3 of all taxable dividends paid in the year and 2. The corporation’s RDTOH at the end of the year Chapter 13 Deductibility of expenses - Salaries: salaries paid must be reasonable (sec 67) and must be paid within 179 days after the corporation’s year-end (ssec. 78(4)) - Royalties (for arm’s length): to be deductable in current year (2013), must be paid out by the second taxation year (2015) 1. If it is not paid out by the second taxation year, must be added back to the corporation’s third taxation year income, 2016 (par.78(1)(a) 2. Could jointly elect by June 30, 2017 (this is when the 2016 tax return is due) (par.78(1)(b), the effect is:  The royalty is deemed to have been paid by the corporation and received by Mr. Scott at the beginning of 2016  The royalty is deemed to have been lent back to the corporation such that when the corporation repays the amount there will be no further tax consequences  If election is filed late, then 25% of the royalty will be added back to the corporation’s 2016 income (ssec.78(3)) Shareholder loans - Application of subsection 15(2) must be considered, basically any loans made to shareholders is required to be included in income of the borrower for the year in which the loan was made - Two general exceptions, as long as bona fide arrangement exists: 1. Indebtedness between non-resident persons 2. Arises in the ordinary course of the lender’s business - Four specific exceptions 15(2.4) 1. 15(2.4)(a) -> a loan made by the corporation to a shareholder who is, also, an employee, but not a specified employee (owns at least 10% shares) 2. A loan made by the corporation to a shareholder who is, also an employee to assist him/her to acquire:  15(2.4)(b) -> a home for his/her own occupation  15(2.4)(c) -> previously unissued, fully paid shares of the corporation purchased directly from the corporation  15(2.4)(d) -> a motor vehicle to be used in the performance of his/her
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