tx2: advanced personal and corporate taxation · 2014-03-10 1 tx2: advanced personal and corporate...

2014-03-10

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TX2: Advanced Personal and

Corporate Taxation Instructors:

Dawn Highfield (Modules 1, 5 &6)

[email protected]

Michael Luzny (Modules 2-4 & 7-10)

[email protected]

Module 1: Benefits to Shareholders

1. Benefits conferred on a shareholder

2. Loans to shareholders

3. Non-resident shareholders

4. Paid-up capital (PUC)

5. Deemed dividends

6. Ethics and tax planning

7. Writing a tax opinion

1. Benefits Conferred on a Shareholder

General Rule under subsection 15(1)

◦ Applies each time a corporation confers a

benefit on a shareholder

◦ The value of the benefit received is added into

“ordinary” income of the shareholder, not

dividend income.

mailto:[email protected]

mailto:[email protected]

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Rules are broad and cover many

situations, including where: 1. a payment has been made to a shareholder other

than pursuant to a bona fide business transaction

2. funds or property of the corporation have been

appropriated in any manner whatever to, or for

the benefit of a shareholder.

3. a benefit or advantage has been conferred on a

shareholder by a corporation.


Often results in double taxation

Exception is when the benefit was

conferred on the shareholder in their

capacity as an employee

15(1) does not apply to amounts already

included in income under section 84


Other subsections to be aware of:

◦ 56(2) Indirect payments

◦ 246(1) Benefit conferred on a person

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Value of the Benefit

◦ generally based on FMV of the property appropriated

◦ If the property used principally for business purposes, the rental value or the costs of maintaining the property for the period of personal use will be used to determine the value of the benefit.

◦ If the property is used mainly by the shareholder, CRA values the benefit on the basis of costs assumed by the corporation with respect to the property, plus the foregone yield on the capital invested for the acquisition of the property where the amount thus calculated exceeds the rental value or where no rental value can be established.


The rules in ss 15(1.2) apply to include

the value of forgiven debt in income of

the shareholder

SS 15(5) Automobile Benefit


Review example 1-1:

◦ Reading 1-1

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Exceptions:

◦ reducing the corporations paid-up capital

◦ redeeming, cancelling, or acquiring shares by the corporation

◦ winding-up, discontinuing, or reorganizing the corporation’s business

◦ winding-up a Canadian Corporation

◦ paying a dividend or a stock dividend

◦ conferring on all holders of common shares a right, identical for each common share, to buy additional shares of the corporation

◦ converting contributed surplus into paid-up capital by an insurance corporation or a bank

◦ converting any contributed surplus created on the issue of a class after march 31, 1077, to paid-up capital of such class of shares, pursuant to paragraph 84(1)(c.3)


Transfer of property between

corporations and shareholders

Beware of

◦ ss 69(1) results in a 15(1) benefit if the

corporation overpays for the asset

◦ ss 69(4) results in a 15(1) benefit when a

corporation sells an asset to a shareholder for

an amount less than FMV.


Subsection 163(2) penalty for false

statements or omissions

◦ This penalty is often imposed by CRA on

15(1) benefit assessments

◦ It is calculated as the greater of $100 or 50%

of the tax evaded

◦ It is imposed when a person, knowingly or in

circumstances amounting to gross negligence,

has made, participated in, assented to, or

acquiesced in a false statement or omission.

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Planning:

◦ Consider the use of a price adjustment clause

for the sale of assets between a shareholder

and corporation when FMV is difficult to

determine.

◦ Consider the use of internal controls when

dealing with shareholder expenses


General rule under subsection 15(2)

◦ Where a corporation has made a loan to a person or partnership that was a shareholder of that particular corporation, the amount of the loan must be included in the income of the person or partnership to whom the loan was made in the taxation year during which it was made

◦ Exception: The rule does not apply if the loan is made to another corporation resident in Canada or a partnership all of whose members are corporations resident in Canada.


Subsection 15(2) applies in the following

situations:

◦ When a loan is made to a person who is:

a shareholder of a particular corporation

connected with a shareholder of a particular

corporation

a member of a partnership, or a beneficiary of a

trust, that is a shareholder of a particular

corporation

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Exceptions - Subsection 15(2) does not

apply if: 1. Repayment is made in the following taxation year

– 15(2.6)

2. Loans are made in the ordinary course of the

lender’s business – 15(2.3)

3. Loans are received as employees – 15(2.4)


1. Repayment:

◦ Depending on the Corporation yearend, you may have up to two years to pay back the loan.

◦ In order for the exception to apply, the repayment must not be part of a series of loans and repayments.

◦ Repayment in the form of declared dividends or wages credited to the loan account are not considered part of a series of loans and repayments by CRA.


2. Ordinary Course of business

◦ In order for this rule to apply, bona fide

arrangements must be made, and adhered

to, for the loan to be repaid within a

reasonable time.

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3. Loans received as employees

◦ When the loan is made to a shareholder who

is also an employee or executive, the loan

must be used to:

purchase a dwelling for personal use

purchase treasury shares

purchase an automobile to be used in employment

◦ In all cases

The loan must be obtained because of employment

Bona fide arrangements for repayment are required


3. Loans received as employees ◦ If the shareholder owns less than 10% of the

shares of the corporation, the restriction on the previous slide do not apply.

◦ Criteria for consideration: Are similar benefits granted to other employees of the

corporation?

Is the loan in proportion to the importance of the services rendered to the corp, considering the salary and other remuneration paid?

Would an employee of a similar-sized business who was not a shareholder have received a similar loan?

What is the extent of the ee-sh’s control over the corporation?


Deduction on repayment

◦ Paragraph 20(1)(j) allows a taxpayer to deduct

from income any repayment previously

included in income under 15(2) in the year

the repayment is made.

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Deemed interest – subsection 80.4(2)

◦ When a shareholder or connected person

receives a low-interest or interest free loan,

they may be required to include a benefit

equal to the interest evaded in income.

◦ This rule does not apply if the amount of the

loan was included in income under subsection

15(2).


Employee-shareholder

◦ If loan was received in capacity as an employee, the amount of the benefit is included in employment income under subsections 80.4(1) & 6(9)

◦ If loan is used to purchase a dwelling, the benefit is calculated using the lesser of:

the prescribed rate in effect when the loan was made,

the prescribed rate in effect each quarter during which the loan remains unpaid.


Deduction under section 80.5

◦ This deduction is available if the loan is used

to acquire an income-producing property.

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3. Non-resident shareholders

Non-residents are required to pay tax on

benefits received from Canadian

Corporations under paragraph 214(3)(a)

◦ The taxable amount is considered a dividend

◦ Part XIII tax applies at a rate of 25%.

◦ The amount is payable by the corporation and

can be recouped from the non-resident.

4. Paid-up Capital (PUC)

Defined in subsection 89(1)

It is essential in determining the tax

consequences of transactions affecting the

capital stock of a corporation.

PUC ≠ ACB


Definition:

◦ Paid-up capital is generally equal to the

amount recorded as issued and outstanding

share capital as determined under the

legislation under which the corporation was

formed.

◦ It represents the contribution of capital to the

corporation on issue of shares, as recorded in

the corporation’s legal records.

◦ Accounting PUC ≠ Legal PUC

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There are many sections in the income

tax act that affect PUC and result in

adjustments to PUC values.

These adjustments are intended to

prevent the conversion of other income

into a capital gain in transactions involving

the issue of shares.


PUC is calculated separately for each

class of shares.

PUC per share is equal to PUC for the

entire class divided by the number of

issued in that class.

PUC is not equal to ACB.


Example:

Jim acquires 100 class A shares for

$20,000. This amount is entered into legal

PUC in the corporation’s books.

Class A shares previously issued: 500

shares with a PUC of $4,000.

Calculate the PUC and ACB of Jim’s

shares.

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PUC represents the return on capital that

may be received by a shareholder without

the amount being subject to tax as a

dividend.

PUC of a share is not affected by a

subsequent purchase or sale of that share.


PUC serves to determine whether there

is a deemed dividend in the case of

certain transactions provided for in

section 84.

ACB is one of the elements used to

calculate the capital gain or loss on the

sale of shares.

See comparative table (Exhibit 1-1 in

reading 1-4)


The corporation’s ACT of incorporation

determines the amount that can be

recorded as the amount paid for the

shares in the legal books of the

corporation:

◦ If the shares have nominal value, the amount

paid is the nominal value and any excess is

included in contributed surplus.

◦ If the shares have no nominal value, typically

FMV of consideration received is recorded.

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Practical aspect

◦ ACB of shares is usually easy to determine

based on information contained in the

purchase documents.

◦ PUC is sometimes difficult to calculate. You

cannot rely on the financial statements to

determine PUC. You should start by looking at

the legal books of the corporation.

5. Deemed Dividends

Section 84 was designed to prevent the

withdrawal of funds of a corporation

resident in Canada as a return on capital.

These transactions are therefore deemed

dividends and taxed as such in the hands

of the shareholder.

5. Deemed Dividends

Taxation of Dividends to individuals

◦ After 2005, must determine if the dividend is

designated as an eligible dividend

◦ The gross-up and tax credit rates vary

depending on the type of dividend.

◦ CCPC’s can designate dividends as eligible up

to the balance in the General Rate Income

Pool and the end of the year.

◦ Non-CCPC’s can designate all dividends as

eligible as long as they have a nil balance in the

Low Rate Income Pool at the end of the year.

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5. Deemed Dividends

When transactions involving a

corporation resident in Canada results in

a deemed dividend under section 84, this

dividend can be designated as an eligible

dividend, taking into account the

limitations mentioned on the previous

slide.

5. Deemed Dividends

Artificial Increase in PUC – subsection

84(1) Arises where the PUC of the issued

shares of a class of shares is increased

without:

◦ A corresponding increase in the value of the

corporation’s assets

◦ A corresponding reduction in the value of its

net liabilities

◦ A corresponding reduction in the PUC of

another class of shares

5. Deemed Dividends

Conversion of Contributed surplus to

PUC of a class of shares may give rise to a

deemed dividend under ss 84(1) unless

the following conditions are met:

◦ The contributed surplus arises from the issue

of shares of such class after March 31, 1977

◦ Neither the rollover provisions of sections

84.1 or 212.1 are applied on the issuance

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5. Deemed Dividends

Paragraph 53(1)(b) will add the value of a

deemed dividend calculated under

subsection 84(1) to the ACB of the shares

held.

This adjustment is required to ensure that

double taxation does not occur.

5. Deemed Dividends

Example:

Mr. & Mrs. Smith each own 100 Class A shares

of the corporation Smith Ltd., for which they

paid $10,000 each. Smith Ltd. is a CCPC that

has nil GRIP.

Mrs. Smith transfers land valued at $30,000 for

100 Class A shares having a PUC and FMV of

$50,000. The ACB of the land is 20,000.

Calculate the tax consequences for Mr. & Mrs.

Smith and Smith Ltd.

5. Deemed Dividends

Consequences for Mrs. Smith Deemed Dividend – 84(1)

Increase in PUC of Class A shares $50,000

Increase in net assets (FMV of land) 30,000

Deemed Dividend $20,000

Mrs. Smith’s share (200 / 300) $ 13,333

Taxable Benefit – 15(1)

FMV of Class A shares received $50,000

FMV of Land 30,000

20,000

Deemed Dividend (84(1)) (20,000)

Benefit conferred on Mrs. Smith 0

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5. Deemed Dividends

Consequences for Mrs. Smith ACB of the Class A shares

Acquisition cost of the 100 new shares $30,000

Deemed dividend – 84(1), 53(1)(b) 13,333

$43,333

ACB of the 100 shares held before transfer 10,000

ACB of the 200 shares held by Mrs. Smith $52,333

Capital Gain on Land

POD – FMV of shares received $50,000

ACB 20,000

Gain 30,000

Less: Amount already included in income 13,333

Capital Gain $16,666

Taxable Capital Gain (50%) $ 8,334

5. Deemed Dividends

Consequences for Mr. Smith Deemed Dividend – 84(1)

Increase in the PUC of the Class A shares $50,000

Increase in net assets: FMV of land 30,000


Mr. Smith’s share (100/300) $ 6,667

ACB of Class A Shares

ACB of 100 shares held before deemed dividend $10,000

Deemed Dividend – 84(1) 6,667

ACB of 100 shares held by Mr. Smith $16,667

For Smith Ltd

Cost of land (69(1)) $30,000

5. Deemed Dividends

Distribution on the reorganization or

winding-up of a business

◦ A deemed dividend is calculated as the value

distributed to or appropriated by the

shareholders less the PUC of the shares held

at the time.

◦ The dividend is calculated per share class and

each shareholder receives a benefit equal in

proportion to the number of shares held.

◦ If property other than cash is distributed, the

deemed disposition takes place at FMV.

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5. Deemed Dividend

Purchase or redemption of shares by the

issuing corporation – subsection 84(3)

◦ Results in a deemed dividend

◦ To avoid double taxation, the subsection 84(3)

deemed dividend is removed from the POD

of the share by virtue of the definition of

POD under paragraph (j) in section 54.

5. Deemed Dividends

Two step process:

1. Determine whether there is a deemed

dividend under subsection 84(3).

2. Determine whether the disposition of the

share results in a capital gain or loss.

5. Deemed Dividends

Example:

- Mr. T owns 2,000 Class B share of Alpha

Ltd. These shares have a PUC of $20,000

and a redemption value of $30,000. The

ACB of the shares for Mr. T is 18,000.

- On December 31, 2013, Alpha Ltd.

redeems the 2,000 shares held by Mr. T.

- Alpha is a CCPC with a large GRIP.

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5. Deemed Dividends

Tax Consequences

Deemed Dividend

Amount paid on redemption $30,000

PUC 20,000

Deemed dividend $10,000

Capital Gain

POD (54) (30,000 – 10,000) $20,000

ACB 18,000

Capital Gain $ 2,000

Taxable Capital Gain $ 1,000

5. Deemed Dividends

Subsection 40(3.6)

When a shareholder suffers a loss on the

redemption, acquisition or cancellation of a

share and immediately after the transaction the

shareholder or his spouse control the

corporation, the resulting loss is deemed to be

nil.

The capital loss denied to the shareholder is

added to the ACB of the remaining shares held

by the shareholder under paragraph 40(3.6)(b)

5. Deemed Dividends

Reduction in PUC – 84(4)

When there is a PUC reduction of a class of

shares without a reduction of the number of

shares through a redemption, acquisition or

cancellation of share, a deemed dividend may

result. The value will be equal to the amount

paid to the shareholders that exceeds the PUC

reduction of the class of shares.

This may result in a reduction to ACB under

subparagraph 53(2)(a)(ii)

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5. Deemed Dividends

Example

Mary holds 250 Class B common share of

Jane Ltd. The PUC of the shares is 50,000

and the FMV is 250,000. Jane Ltd. no

longer requires as much capital as it did

on incorporation. It decides to reduce the

PUC of the 250 shares to $5,000 and

pays Mary $45,000. The ACB of the 250

Class B common shares is equal to PUC

of $50,000.

5. Deemed Dividends

Tax Consequences for Mary Deemed Dividend – 84(4)

Amount Paid $45,000

Reduction in PUC (50,000 – 5,000) 45,000

Deemed Dividend 0

ACB of Class B Shares

ACB before PUC reduction $50,000

Amount paid less dividend (45,000)

ACB after the reduction in PUC $ 5,000

5. Deemed Dividends

Tax Consequences for Mary if 84(3) applied

Deemed Dividend – 84(3)

Amount Paid $45,000

PUC of shares (45/250 x 50,000) 9,000


Capital Gain

POD – s54 (45,000 – 36,000) $9,000

ACB (9,000)

Capital Gain $ 0

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5. Deemed Dividends

Deemed Dividend payable from the capital

dividend account Deemed dividends under subsections 84(1) to (4) may

be deemed to have been paid from the CDA if the

subsection 83(2) election is filed.

Dividends paid out of CDA are not taxable.

Under subsection 112(3) to (3.2), if the shares on which

the dividend is deemed to be paid are disposed of and

the result is a loss, this loss may be reduced by the

dividend paid out of the CDA.

5. Deemed Dividends

Shares distributed in transactions covered

by 84(2) to 84(4)

Where property distributed to shareholders

includes shares of the capital stock of the

corporation, the shares should be valued at

their PUC and not FMV

5. Deemed Dividends

Example

Anne Benson owns 200 Class D shares of

XYZ Ltd., having a PUC and ACB of

$4,000 and an FMV of $20,000.

In 2013, XYZ Ltd. redeems 100 Class D

shares owned by Anne in exchange for 10

Class E shares and $6,000 cash. The Class

E shares have a PUC of $1,600 and an

FMV of $4,000.

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5. Deemed Dividends

Tax Consequences for Anne


Cash $6,000

PUC of Class E shares 1,600 $7,600

PUC of Class D shares (2,000)


5. Deemed Dividends

Tax Consequences for Anne

Capital Gain

POD – s54

FMV of Class E shares + cash 10,000

Deemed Dividend (84(3)) (5,600) $4,400

ABC (2,000)

Capital Gain $2,400

Taxable capital gain (50%) $1,200

ACB of the 10 Class E shares $4,000

5. Deemed Dividends

Planning

You should always assess the impact on

PUC of a class before issuing new shares

of the class.

◦ You must consider the future impact for

shareholders in the case of a purchase or

redemption of shares by the corporation.

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5. Deemed Dividends

Example

In 2005 Henry incorporated H Inc. On

incorporation, Henry acquired 100 common

shares of the capital stock of Communication

Inc. for $10,000

The company has grown and is currently worth

$200,000. They need more capital and Shelly is

willing to invest $200,000 into the corporation

for a 50% interest. She will get 100 common

shares of the corporation.

5. Deemed Dividends

Tax Consequences

PUC of each of the 200 common shares issued

PUC of original 100 shares $10,000

PUC of 100 new shares 200,000

Total PUC 210,000

PUC per share ($210,000 / 200) $1,050

5. Deemed Dividends

Tax consequences for Shelly:


Amount Paid $200,000

PUC of the 100 cs (100 x $1,050) (105,000)

Deemed Dividend $ 95,000

Capital Gain

POD – s54

Amount paid $200,000

Deemed Dividend (95,000) $105,000

ACB of 100 common shares (200,000)

Capital loss (95,000)

Allowable capital loss (50%) $(47,500)

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5. Deemed Dividends

Tax consequences for Hank:


Amount Paid $200,000

PUC of the 100 cs (100 x $1,050) (105,000)

Deemed Dividend $ 95,000

Capital Gain

POD – s54

Amount paid $200,000

Deemed Dividend (95,000) $105,000

ACB of 100 common shares (10,000)

Capital gain 95,000

Taxable capital gain (50%) $ 47,500

6. Ethics and Tax Planning

Know your responsibilities as a CGA. You

may be faced with the following

challenges:

◦ Informing the client about the ITA provisions

that the client is violating

◦ Deal with situations in which the client wants

to structure financial affairs in ways that are

contrary to the ITA.

6. Ethics and Tax Planning

As a tax advisor, you have the following

obligations:

◦ Possess the knowledge required in taxation

matters in order to convey appropriate

information to clients

◦ Act professionally when advising clients.

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7. Writing a tax opinion

Tax opinions should be set out in writing

and should contain the followng elements:

◦ Terms of reference

◦ Facts and assumptions

◦ Laws and documents consulted

◦ Analysis and conclusion

◦ Limitations

◦ Restrictions on use

tx2: advanced personal and corporate taxation · 2014-03-10 1 tx2: advanced personal and corporate...

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