CHAPTER 11:

Corporations -
An Introduction

Prepared by
Matthew Roman, CPA, MTax
KPMG, LLP

Electronic Presentations in Microsoft® PowerPoint®

Copyright © 2022 McGraw-Hill Education Limited

1
 Corporations – An Introduction

I. Relationship between the Corporation and Its

Shareholders
II. Determination of Taxable Income
III. Calculation of Corporate Tax
IV. The Integration of Corporate and Individual
Taxation

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 I. Relationship Between the Corporation and
its Shareholders

• Incorporated Company = artificial person

– separate from owner(s).

• Recognized by law as an entity:

– has the power to act in its own right and
– to enter into enforceable legal agreements.

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 A. Corporation Defined
• A corporation, as a separate entity:
• can buy, own, sell, and lease property
– Not considered owned by the shareholders

• can borrow funds for its own use as well as loan funds to
others.
– Shareholders are liable for the corporation’s debts only to the
extend of capital contributions

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 B. Tax Impact of Shareholder / Corporate
Relationships
• Legal separation of the corporation from its shareholders
creates a two tiered system of taxation:
– Corporation is subject to tax
– Shareholder is subject to a second level of tax on income
from the corporation (ultimately income flows to individuals)

• Corporation’s relationship with shareholders:

1. The Primary Relationship - provides equity capital to the
corporation
2. The Secondary Relationships – shareholder as a creditor,
supplier, customer, employee or lessor to the corporation
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 The Primary Relationship

Shareholder contributes cash or other property in exchange

for shares.
Contribute Cash

Shareholder Corporation
Shares

• Shareholders realize a return on investment through

dividends or through a capital gain when they sell their
shares at a profit.
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 The Primary Relationship 2

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 The Secondary Relationships

• Secondary relationships:
– creditor, supplier, employee, customer, or lessor

• Tax consequences and cash flows between the parties

are different from those in the primary relationship.

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 Primary and Secondary Relationships

• Difference between the two relationships centres on

the tax treatment of income flows:
– Primary relationship:
• dividends paid by the corporation are not deductible, but are taxable to
the recipient.
– Secondary relationships:
• payments such as salaries, interest, and rents are deductible and
taxable to the recipient.

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 II. Determination of Taxable Income

A corporation’s taxable income is:

Net income for tax purposes less special deductions

• Donations to charitable organizations [110.1]

• Net capital losses [111(1)(b)]
• Non-capital losses [111(1)(a)]
• Dividends from taxable Canadian corporations [112(1)]
• Dividends from foreign affiliates [113(1)]

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 A. Loss Carry-Overs

• Loss carry-over provisions are the same as with

individuals
– Net capital losses:
• can be carried back three years and forward indefinitely
• Used only against taxable capital gains.
– Non-capital losses:
• can be carried back three years and forward 20 years
• Used against any other source of income.

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 Acquisition of Control

• Ownership can change when shares are transferred or

sold.
• The carry-forward of unabsorbed losses may be
attractive to acquiring shareholders
– if they can use those losses .
• Change in beneficial ownerships:
– Net-capital losses are deemed expired [111(4)(a)]
– Non-capital losses from business operations may be used,
subject to restrictions [111(5)]

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 Acquisition of Control 2

Non-capital losses resulting from business operations

are restricted as follows: [111(5)]
– The business which incurred the losses must be
carried on throughout the year,
– with a reasonable expectation of profit.
– The losses can be deducted against income from
the business which incurred the losses and from a
business selling similar products or providing
similar services.

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 Acquisition of Control 3
• Purpose of restrictions is to prevent the transfer of
unabsorbed corporate losses to other parties.

•Deemed year end – immediately before the change in

control. [249(4)]
– Adds any operating losses making them subject to the
restrictions.
– Accrued losses on depreciable property and other capital
property are recognized where: [111(5.1), 111(4)(c), (d)]

FMV < tax cost

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 Loss in Corporate Groups

Shareholders

Corporation A Corporation B
Profits $100,000 Loss ($400,000)

Corp A – profits $100,000 Corporation C

Corp B – loss (400,000) Profits $50,000
Corp C – profit 50,000
Net loss for group $(250,000)

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 B. Dividends from Other Canadian
Corporations
• Dividends received included as property income for net
income for tax purposes. [12(1)(j)]

• Dividends are deducted from taxable income if:

– received from a taxable Canadian corporations [112(1)]
– foreign affiliate corporations [113(1)]
• Foreign affiliate, Canadian corp. must have at least a 10% equity
interest in the foreign corporation. [95(1)(d)]

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 Dividends from Other Canadian Corporations

• Result is dividends flow tax-free to other corporations.

• Private corporations may be subject to a temporary –
Part IV tax (Chapter 13).
• Removes the second level of tax until dividends are
received by individuals.

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 III. Calculation of Corporate Tax
Three basic categories for tax purposes:
1. Public corporations [89(1)]
• Resident in Canada
• Shares are traded on a stock exchange.
2. Private corporations [89(1)]
• Resident in Canada
• Not a public corporation or controlled by public corporations
3. Canadian-controlled private corporations (CCPCs) [125(7)]
• Resident in Canada
• Not a public corporation, and
• Not controlled by non-residents of Canada.

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 Determination of Tax for Corporations
Federal tax:
Basic federal tax (rate x taxable income) XX
Abatement for provincial tax (XX)
XX
Refundable tax on investment income XX
Add'l tax on personal services business income XX
XX
Less:
General rate reduction XX
Small business deduction XX
Manufacturing and processing deduction XX
Federal tax credits XX (XX)
XX
Provincial tax:
Primary provincial tax (rate x taxable income) XX
Specific provincial tax credits (XX) XX
Combined federal and provincial tax XX

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 A. Federal Tax

• The basic federal tax is 38% of the corporation’s taxable

income. [123(1)]
• Then, reduced by the federal abatement of 10% [124(1)]
– Provides room for the provinces to impose tax.
• Federal tax may be increased or reduced further based
on specific types of income earned by certain
corporations.

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 General Tax Reduction
• Applies to particular types of income: [123.4]

– Public corporations:
• Federal tax is reduced by 13% of the corporation’s taxable
income not subject to manufacturing and processing
deduction.

– CCPC:
• Federal tax is reduced by 13% of business income not
eligible for the small business deduction and/or the
manufacturing and processing deduction.

• Decreases the federal rate to (38% - 10% - 13%) = 15%

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 Refundable Tax on Investment Income

• Applies only to the investment income of a CCPC.

– Additional tax is 10 2/3% of investment income [123.3]
– Fully refundable to the corporation when dividends are paid to
shareholders.
• Increases the federal tax rate on CCPC investment income
to (38% - 10% + 10 2/3%) = 38 2/3%

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 Additional Tax on Personal Services Business
Income
• Additional tax of 5% is applied to personal services
business income (PSB) [123.5]
• Increases the federal tax rate on PSB income to
(38% - 10% + 5%) = 33%

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 Small Business Deduction
• Available only to CCPCs.
• Reduces the federal tax rate by 19% on the lesser of:
[125(1), (1.1)]
– The first $500,000 of annual active business income of the
corporation, or
– Taxable income
• Net federal tax rate is (38% - 10% - 19%) = 9%
• Two or more corporations owned by similar shareholders
may have to share the $500,000 limit [125(2)]

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 Manufacturing and Processing Deduction

• Profits from manufacturing and processing activities are

subject to a rate reduction: [125.1]
– Public Corporations - rate reduction of 13%.
– CCPCs – same rate reduction
• only on manufacturing profits in excess of the small business
deduction limit described previously.
• Federal rate on manufacturing activities is (38% - 10% -
13%) = 15%
– same as income eligible for the general rate reduction

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 Manufacturing and Processing Deduction

Arbitrary formula is used: [Reg.5200]

MC + ML Total
X Business = Mfg. Profits
TC + TL Profits

Where:
MC = manufacturing capital TC = total capital
ML = manufacturing labour TL = total labour

• The result of this formula may be higher or lower than the

actual manufacturing profits.

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 Exhibit 11-8
Combined Federal & Provincial Taxes - 2022
An assumed provincial rate of 4% is used for income subject to the small business deduction. A
provincial rate of 12% is used for all other income.
Public
Corporations Canadian-controlled private corporations

1st $500,000 Other

of business business Investment
Income income income income
Basic federal tax 38% 38% 38% 38%
Federal abatement (10) (10) (10) (10)
General tax reduction (13) (13)
Refundable tax on investment income 10⅔

Small business deduction . (19) . .

Federal tax 15 9 15 38
Assumed Provincial tax 12 4 12 12
Combined rate 27% 13% 27% 50⅔%

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 Full-rate Taxable Income and GRIP
• Full-rate taxable income = taxable income that:
– Does not benefit from the small business deduction, and
– Is not investment income earned by a CCPC

• Full-rate taxable income less applicable taxes, when paid

out as a dividend, qualifies as an eligible dividend
– Subject to a higher gross up
– Subject to a higher dividend tax credit

• CCPCs keep track by maintaining a GRIP (general rate

income pool)

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 GRIP
• A corporation’s GRIP is: [89(1)]
– Increased annually by 72% of its full-rate taxable
income
• Meant to approximate the after tax income
– Reduced by the amount of eligible dividends distributed

• Public company income is normally classified as full-rate

taxable income
– Not necessary to maintain a GRIP

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 Low Rate Income Pool (LRIP)
• Public corporations may receive non-eligible dividends
from a CCPC
– Cannot be classified as full-rate taxable income
• Tracked in an account call LRIP [89(1)]
• Amounts in LRIP, when paid as dividends retain non-
eligible status
• Public corporations must pay non-eligible dividends
before eligible dividends if they have a balance in LRIP
– Subject to penalties if they do not

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 B. Provincial Tax

• Expressed as a % of corporate taxable income.

• Each province and territory imposes a primary flat rate of
tax on all corporate income.
• Certain provinces apply:
– a reduced rate of tax on first $500,000 (or more) of active
business profits of CCPCs, and
– some reduce the rate for manufacturing profits.

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 Exhibit 11-9 - Actual Combined Rates by
Province (2022)
Income Income
Regular eligible Regular eligible
Income for SBD Income for SBD

Alberta 23% 11% Nova Scotia 29% 11.5%

BC 27% 11% Nunavut 27% 12%
Manitoba 27% 9% Ontario 26.5% 12.2%
New Brunswick 29% 11.5% P.E.I. 31% 10%
Newfoundland & Quebec 26.5% 12.2%
Labrador 30% 12% Saskatchewan 27% 10%
NW Territories 26.5% 11% Yukon 27% 9%

Rates are current to Feb 28, 2022 and do not reflect any possible changes for provincial budgets released at a later date

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 Multi-Provincial Tax
• A corporation incorporated or based in a particular
province will be taxed entirely in that province unless
– it carries on business in another province through a permanent
establishment such as an office, branch, warehouse, or
factory. [Reg.400(2)]
• If such a permanent establishment exists, the profits
attributable to that location are based on the ratio of:
[Reg.402(1)]
– sales in the province to total sales, and
– wages paid in the province to total wages
– multiplied by the total business profits of the whole corporation.

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 Multi-Provincial Tax
an example
Wages paid in Alberta = 33%
Total wages paid by corp.

Sales in Alberta = 45%

Total sales of corp.

Average 33 + 45
= 39%
2 =
39% of taxable is earned in Alberta for tax purposes

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 IV. The Integration of Corporate and Individual
Taxation
• Corporations are taxed on their profits separate from their
shareholders.
• After-tax corporate profits are distributed in the form of a
dividend,
– tax is again payable on the dividends received.
• Two-tier system creates the possibility of double taxation.

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 IV. The Integration of Corporate and Individual
Taxation2
• Effect of double taxation is modified by the dividend tax
credit
– applies to reduce personal tax on dividends received from
Canadian corporations
– represents a credit for all or a portion of corporate tax
paid on the income
– assumes the corporate tax rate is either 27.5% or 13%

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 Dividend Tax Credit
Public Corporation - example
Corporate taxable Income $1,000
Corporate Taxes - 27% (270)
Net cash (paid out in dividends) $ 730

Dividends received by shareholder - eligible $ 730

Tax, net of dividend tax credit (35%) (256)
Net cash, after tax, to shareholder $ 474

Total tax paid on $1,000:

Corporate $270
Individual 256
Total $526
Effective tax rate is 53% ;
Maximum personal rate on business income (Exhibit 10-7) = 50%
Double tax = 3%

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 Dividend Tax Credit
CCPC example
Corporate taxable income $1,000
Corporate taxes - 13% (130)
Net cash (paid out in dividends) $ 870

Dividends received by shareholder -non-eligible $870

Tax, net of dividend tax credit (43%) (374)
Net cash, after tax, to shareholder $496

Total tax paid on $1,000

Corporate $130
Individual 374
Total $504

Effective rate (rounded) = 50%

Double taxation or Tax savings is nil.

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 IV. The Integration of Corporate and Individual
Taxation
• In a public corporation, double taxation on returns to the
owner is automatic.
• In a CCPC, double taxation may or may not occur
depending on the nature of the income.
• Corporate tax and tax on distributions has a significant
impact on:
– Dividend policy
– Equity structures
– Form of business organization

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