Continue the Lecture 2 Problem Set Question 1 and Assume the Following

Lecture 4 Problem Set: As well as the problem below (which is a continuation of the Lecture 1 and 2 Problem Set Question 1), also review the comprehensive summary problem in Chapter 12, 12500. The recommended exercises are also very good, especially exercise 10, which shows how integration works

Last updated January 7, 2015

Problem Continue the Lecture 2 Problem Set Question 1 and assume the following: - that instead of being a public corporation, NPI is a Canadian controlled private corporation and - that $110,000 of NPI’s business limit has been allocated to associated corporations - also assume that NPI’s taxable capital (including the taxable capital of associated corporations) in the prior year is below $10M

Required:

Part (a) Compute NPI’s taxable income and federal and provincial income tax. Assume that the provincial income tax rates are the same as in the lecture 2 problem set (i.e., ignore the provincial small business deduction). [If this were a midterm question you would be given approximately 66 minutes to complete this question.]

Part (b) Compute NPI’s refundable dividend tax on hand account (RDTOH), capital dividend account (CDA) and general rate income pool account (GRIP). Assume that: - the dividends received are from a corporation that is not connected with NPI and $10,000 are eligible dividends ($30,000 are non-eligible); - the opening RDTOH is $2,000 and the opening GRIP is zero. Also assume that the only capital transaction that occurred prior to 2014 was the $20,000 net capital loss from 1989; and - taxable dividends paid by NPI in the year are $7,000 and they are designated as eligible dividends. [If this were a midterm question you would be given approximately 29 minutes to complete this question.]

Part (c) Explain why NPI will likely not qualify for the extra month to pay its balance due and why it likely won’t qualify for quarterly instalment payments in 2015. For part (c) only give Income Tax Act references to support your answer. Hypothetically if NPI (together with any associated companies) had taxable income below $500,000 when would its balance of taxes owing be due? what would it have to pay in instalments? and when would its instalment payments be due? Assume NPI has a perfect compliance history. Assume the 2013 taxes payable was $340,000 and that 2015 taxes payable are estimated to be $400,000. Also assume that instalments are payable on total federal and provincial tax owing. Note: taxes payable would be lower if taxable income was below $500,000, but this is a hypothetical scenario. [If this were a midterm question you would be given approximately 22 minutes to complete this question.] Solution

The portion of the solution that appears in blue is as per Lectures 1 and 2. The Lecture 4 problem set does not ask for Income Tax Act references for parts (a) and (b), hence they are not needed in your answer Net income from financial statements: s. 9(1) $669,688 ADD:

Depreciation: s. 18(1)(b) 137,250 Charitable donations: s. 18(1)(a) 50,000 Bonus expense: s. 78(4) 250,000 Meals & Entertainment: s. 67.1(1) 50% of (13,250 + 5,750) 9,500 Sports club membership dues: s. 18(1)(l) 5,500 Warranty reserve: s. 18(1)(e) 17,200 Legal & accounting for share issue: s. 20(1)(e) 60,000 Interest on deficient tax instalments: s. 18(1)(t) 4,000 UK tax on business income 9,000 UK tax on investment income 3,400 Income tax provision: s. 18(1)(e) $411,562 Net loss on sale of A Co. shares: s. 18(1)(b) 2,500 Net taxable capital gain: s. 38(a) ((50% x $25,700 CG) – (50% x $2,500 CL)) 11,600 $971,512

DEDUCT:

Capital Cost Allowance: s. 20(1)(a) 135,700 Actual warranty expenditures: s. 9(1) 8,000 Net gain on sale of B Co. shares: s. 18(1)(b) 25,700 1/5 x legal & accounting fees for share issuance: s. 20(1)(e) 12,000

(181,400)

Net Income for Tax Purposes under Div B 1,459,800

DIV C DEDUCTIONS:

Charitable donations ($50,000 + $8,000) 58,000 (limited to 75% x $1,459,800)

Dividends from taxable Cdn. corporations 40,000

Net capital loss carryforward ($20,000 x ½ x 3/2 = 15,000 limited to net taxable capital gain 11,600 (144,600) Taxable Income 1,315,200 CALCULATION OF FEDERAL & PROVINCIAL TAX

Federal tax (38% x $1,315,200) $499,776

Federal abatement (Note 1) (10% x (55% + 37%) x $1,315,200) (120,998)

Subtotal 378,778

Additional refundable tax (Note 2) 1,263

Subtotal 380,041

DIV E DEDUCTIONS:

Small business deduction (Note 3) 66,300

Non-business foreign tax credit 3,400

Business foreign tax credit 9,000

General rate reduction (Note 4) 117,813

(196,513)

Part I tax 183,528 Part IV tax (1/3 x $40,000) 13,333 Less: Dividend Refund (from below) (2,333) Total Federal Tax 194,528

Provincial tax:

Ontario (11.5% x 37% x $1,315,200) 55,962

N. S. (16% x 55% x $1,315,200) 115,738 171,700

Total Federal and provincial tax $366,228

Note 1:

Provincial allocation

Revenue Salary/wages Average

$ % $ %

Ontario 1,080,000 39.5% 146,800 34.4% 37%

Nova Scotia 1,620,000 59.3% 216,200 50.6% 55%

United Kingdom 34,000 1.2% 64,000 15% 8% 2,734,000 100% 427,000 100% 100%

Note 2:

Investment Income

Canadian Foreign Dividends Total

Net taxable CG 11,600 11,600

Bond Interest 8,000 8,000

UK investments 10,950 10,950

Dividends 40,000 40,000 ______

19,600 10,950 40,000 70,550

(Bank interest on short term investment of working capital, interest on outstanding accounts receivable and rental income from the short-term rental of excess warehouse space are all considered ABI)

Aggregate Investment Income*:

Investment income 70,550

Net capital loss claimed (11,600)

* A simpler and acceptable alternate way to calculate Aggregate Investment Income (AII) is as follows: AII = bond interest income of $8,000 plus U.K. investment income of $10,950 = $18,950. Additional Refundable Tax

6 2/3% x lesser of:

(i) Aggregate investment income 18,950

(ii) Taxable income minus amount eligible for SBD ($1,315,200 – 390,000) 925,200

6 2/3% x $18,950 $1,263

Note 3: Small business deduction

17% x the least of:

(i) Net Canadian active business income (Net income – UK business income – investment income) (1,459,800 – 34,000 – 70,550) $1,355,250

(ii) Taxable income less: $1,315,200

(a) 100/28 x $3,400 NBFTC 12,143

(b) 4 x $9,000 BFTC 36,000 (48,143) 1,267,057

(iii) Business limit ($500,000 – 110,000) 390,000

17% x $390,000 $66,300

Note 4:

General rate reduction

Taxable income minus: $1,315,200

(i) 100/13 x M & P deduction nil

(iii) Aggregate investment income 18,950 (408,950)

Subtotal 906,250 13% x $906,250 $117,813

Part (b) Refundable dividend tax on hand and Dividend refund

RDTOH: Balance at Jan. 1, 2014 (given) 2,000 Refundable portion of Part I tax (see *) 2,675 Part IV tax (1/3 x 40,000) 13,333 RDTOH balance $18,008

* Refundable portion of Part I tax Least of: (a) 26 and 2/3% x AII from above ($18,950) 5,053 Less: NBFTC 3,400 Minus 9 1/3% x $10,950 (Foreign non-bus inc) 1,022 2,378 $2,675 (b) Taxable income 1,315,200 Less: Amt. eligible for SBD 390,000 100/35 x $3,400 NBFTC 9,714 4 x $9,000 BFTC 36,000 435,714 26 and 2/3% of 879,486 $234,530

(c) Part I tax $183,528

Least amount $2,675

The Dividend Refund is the lesser of:

(a) Taxable dividends paid $7,000 x 1/3 = $2,333, and (b) RDTOH account of $18,008

The dividend refund is $2,333.

Non-taxable portion of capital gains [i.e., ½ of 2014 net capital gains of $23,200 (i.e., $25,700 - $2,500)] $11,600 minus Non-allowable portion of capital losses (i.e., 1/3 of 1989 capital loss of $30,000*) $10,000

Dec. 31, 2014 CDA balance $1,600

* Recall that in 1989 the capital gains inclusion rate was 2/3 and net capital losses carried over are stated at their inclusion rate for the year the loss was incurred. Hence a $20,000 net capital loss carried forward from 1989 means that in 1989 the actual capital loss was $30,000 [i.e., $20,000 / (2/3)]

General rate income pool (GRIP)

Opening balance $0

Add: eligible dividends received $10,000

72% of: Taxable income earned in 2014 $1,315,200 Less: active business income eligible for the SBD ($390,000) Less: aggregate investment income (AII) ($18,950) $906,250 x 72% = $652,500

GRIP (before payment of eligible div.) $662,500

Less: eligible dividends paid ($7,000)

GRIP (after payment of eligible div.) $655,500

Note: how there is a sufficient balance in the GRIP account to pay a $7,000 eligible dividend in the year.

Part (c)

NPI is a CCPC throughout the year and it does claim the small business deduction; however because its taxable income is greater than $500,000 in 2014 it must pay its 2014 balance owing 2 months after year- end and not 3 months after year-end, s. 248(1) “balance-due day”.

Copyright © Joanne Magee/Jason Fleming NPI meets most of the requirements for quarterly instalments (i.e., it’s a CCPC that claims the small business deduction, has taxable capital together with associated corporations of less than $10M and has a perfect compliance history in the last 12 months) however its taxable income is above $500,000 and hence it does not qualify for quarterly instalment payments, s. 157(1.1).

If NPI, together with associated corporations had taxable income of less than $500,000 then its 2014 taxes owing would be due 3 months after year-end, due March 31, 2015 and it would qualify for quarterly instalment payments due at the end of each quarter, i.e., due March 31, 2015, June 30, 2015, September 30, 2015 and December 31, 2015.

The (hypothetical) 2015 quarterly instalment payments (using the total federal and provincial tax payable) would be the least of:

1) 1/4 of estimated 2015 taxes payable (i.e., $400,000) = $100,000

2) 1/4 of 2014 taxes payable (i.e., $366,228) = $91,557; and

3) 1/4 of 2013 taxes payable (i.e., $340,000) = $85,000 for the first instalment payment and 1/3 of [2014 taxes payable (i.e., $366,228) – 1st payment made (i.e., $85,000)] = $93,743 for the last 3 payments.

NPI should choose either option 2 or 3 since they result in the same overall amount of instalment payments for the year. Note: this is hypothetical since NPI does not actually qualify for quarterly instalment payments (and hence it must make monthly instalment payments). Also, the actual provincial taxes would be lower since we ignored the provincial small business deduction.

Also note that instalments are not required on Part IV tax payable (i.e., $13,333 in 2014); and the dividend refund for 2014 (i.e., $2,333) technically should not be included in the instalment calculation. Private corporations can reduce their instalment payments by the estimated dividend refund for the “current” year (i.e., 2015), s. 157(3). Since the question said to “assume instalments are payable based on total federal and provincial tax owing” we’ve ignored these complications (which are beyond the scope of this course).

The Canada Revenue Agency (CRA) collects taxes and instalments for all provinces (except Quebec and Alberta) and remits the appropriate share to the province.