The Basics of Corporate Income Tax and Shareholders’ Dividend Tax
A corporation is a legal entity separate from its owners, the share holders, and is subject to federal and provincial income taxes (like individuals). There are two ways in which the taxation of a corporation differs from that of an individual. Firstly, a corporation is subject to both federal and provincial taxes on capital. Secondly, unlike individuals, who are charged progressive income tax rates, corporations are charged flat rates of tax. Depending on the type of corporation and the types of income earned, the tax rates are fixed. The income of a corporation is subject to two levels of taxation, at the corporate and at the shareholder levels. After the payment of corporate tax, the after-tax profit is distributed among shareholders in the form of dividends. This dividend is subject to income tax at the shareholders marginal tax rate. By integrating these two tax regimes, the Income Tax Act is able to minimize the double tax by offering a dividend tax credit at the shareholder level. For perfect integration, it is necessary that the combined federal and provincial corporate tax rate is 20 per cent (without any surtax). That way the dividend tax credit is equal to the taxes the corporation already paid on the before-tax-income distributed to the shareholder as a dividend. This together with the dividend “gross-up” rule ensures that the corporate income distributed as dividend is only taxed at the shareholder’s own marginal tax rate. As the corporation’s own tax rate increases there begins to be a progressively increasing double taxation on the same income. Anyway, like perfection, the Income Tax Act‘s ability to eliminate double taxation when paying out dividends to individual shareholders remains unachieved because of federal and provincial surtaxes, different provincial tax rates and changing corporate tax rates based on the type of corporation and its type of income, and the amount of income earned. There are ways to integrate corporate and individual tax systems both for active business income (ABI) and passive or investment type income. Then there is under-integration, over-integration and deferral, due to which the shareholder loses or gains as ordained. Dividends from Canadian controlled corporations to other Canadian controlled corporate shareholders is tax free. Ergo, the multitude of available tax planning strategies and structures is tremendous and with consequence should it not be arranged professionally. Its best to contact the lawyers at Levy Zavet PC when arranging your affairs in order to minimize your tax.
Dividend Tax Credit
This is a mechanism for grossing up income first earned by a corporation that was distributed as after tax profits to shareholders in the form of a dividend and is known as the Dividend Tax Credit. The dividend received by a shareholder is grossed-up to near the amount of income earned before tax by the corporation. Then the shareholder is given a tax credit to approximate the amount earlier paid by the corporation as tax on its income. It (the gross up) was 25 per cent under the old rules and the tax credit was 13 and 1/3 per cent of the dividend. In July 2006, a draft legislation proposed to reduce the tax rates on dividends, followed by Bill C -28 providing clarification on the same. The law was enacted in early 2007 imposing income tax on flow-through entities (generally income trusts) in respect of certain distributions made to investors. Investors in these entities are taxed as if the distributions were dividends. These changes reduced the effective personal tax rate on eligible dividends, the maximum of which ranges now from 24% to 37%, depending on the taxpayer’s province of residence.
The purpose is to eliminate (or reduce) the double taxation that otherwise happens when dividends are paid to individuals resident in Canada (Canadian shareholders) from a corporation also resident in Canada (Canadian corporation) and paying full corporate tax. Incidentally, under the Income Tax Act, dividends are classified as eligible or non-eligible. A taxpayer getting non-eligible dividends does not qualify for the reduced tax rate applied on the dividend income. The rules (new Dividend Tax Credit) stipulate that Canadian-controlled private corporations (CCPCs) and non-CCPCs are to classify their income as from the 1) general rate income pool (GRIP), and/or from the 2) low rate income pool (LRIP). A CCPC can pay eligible dividends if it has GRIP (or a sufficient GRIP) at the end of a tax year. Likewise, a non-CCPC can pay eligible dividends as long as it does not have a LRIP at the time the dividend is paid. Corporations issuing excessive eligible dividends are to pay a 20 per cent penalty tax. This is one of many an anti-avoidance rules to make sure savvy investors don’t use corporations as special vehicles to launder monies into the company only to pay it back out to themselves as eligible dividends followed with a larger dividend tax credit than they really deserve. The provinces of Alberta, British Columbia, Saskatchewan, Manitoba, Newfoundland, Ontario, and Quebec, and the Northwest Territories followed the federal proposals by enacting similar legislations. The tax credit for non-eligible dividends in Ontario has been kept unchanged at 5.13 per cent. But again, its best to contact the lawyers at Levy Zavet PC to obtain a professional opinion on how to arrange your affairs and corporations so as to make strong sense of how to receive and declare dividends.
Corporate tax
The income tax regime for corporations has two broad policy objectives. The first is to bring down the rate of corporate income tax so that the income tax bias against incorporation is reduced or eliminated. The second is to avoid any undue tax deferral advantage which may result if the corporate income tax rate is less than the maximum tax rate for individuals. There are two components in the federal income tax paid by a corporation, the basic federal corporate income tax and the federal corporate surtax.
A “small-business” CCPC with annual income less than $400,000, is eligible for the small-business deduction on its applicable tax rate. Hence, the basic federal corporate income tax rate is 17% after the small-business deduction. Therefore, it turns out that for Ontario small-business CCPCs the combine federal and provincial tax rate is about 20%. Otherwise, thirty eight (38) per cent is the basic federal corporate income tax rate, to which is added the applicable provincial corporate tax. To make the imposition of provincial corporate income tax easy, there is a 10 per cent reduction known as the provincial abatement. It applies only to corporations earning money from any province in Canada. If a corporation carries on business in the United States as well, no provincial abatement is applicable, no provincial corporate income tax is payable, and the corporation has to pay income tax at a federal tax rate of 39.12 per cent.
These are some of the issues taken into account while planning and structuring a corporation’s tax obligations, along with one’s personal income tax, part IV tax, capital gains tax, dividend credits/refunds, federal and provincial rate deductions and abatements, and so on. Contact the lawyers at Levy Zavet PC as soon as you are ready to discuss your tax structuring and planning schemes for arranging the affairs of your estate.
