Taxation

• All business decisions should be based upon cash flows after tax. It is cash flow after tax that is relevant to a decision at the end of the day. The overall goal of a business is to ethically maximize the wealth of its owners. Wealth and the changes in wealth of a business can only be measured after tax costs have been deducted.  
• Taxation is a controllable cost as managers can make decisions that change the amount and/or timing of taxes paid. 
• Failing to take the after-tax approach can result in the adoption of a tax structure that is permanently inefficient and can lead to poor decisions that appear to be successful from a before-tax perspective.
• Failing to take the after-tax approach can result in the adoption of a tax structure that is permanently inefficient and can lead to poor decisions that appear to be successful from a before-tax perspective.
• The three sources of Canadian tax law are statute law, common law, and international tax conventions. 
• Tax planning is the use of legitimate methods to arrange financial activities in a way that will reduce or defer the related tax costs. The CRA allows legitimate tax planning. 
• Tax evasion is making false claims or omissions with the intent to deceive in an attempt to reduce or defer taxes. It is illegal in Canada under the Income Tax and Excise Tax Acts and is a criminal offense if deemed to qualify as tax fraud. The CRA will deny claims that are found to be evasive. 
• Tax avoidance is a gray area between planning and evasion. This situation arises when technically legal methods are used for the primary purpose of avoiding/reducing/deferring taxes, rather than these benefits arising from a natural business decision. If the CRA interprets the action as being abusive then they may deny the associated benefit. The line between abusive tax avoidance and legitimate planning can often be hard to distinguish. 
• Activities that could be used to reduce or defer income taxes are restricted by the Income Tax Act through the inclusion of specific anti-avoidance rules (which prohibit certain activities and often focus on non-arm’s-length transactions) and the General Anti-Avoidance Rule (aka the GAAR, which is more subjective and is often used to deter actions deemed to be abusive of the system). 
• Canadian income tax must be paid on the taxable income of:

  A)Persons who are resident in Canada at any time during the year; and

  b) Persons who were not resident in Canada during the year who were employed in Canada, carried on business in Canada or who disposed of taxable Canadian property during the year.
• The term "persons "in the Income tax Act, includes individuals, corporations, and trusts. 
• Taxpayers have 90 days from receiving the Notice of Assessment to file a notice of objection. If they are unhappy with the result, then they may appeal to the Tax Court of Canada within 90 days of the objection decision. Further appeals may be made to the Federal Court and (highly unlikely but possible) to the Supreme Court.  
• Individuals must pay their tax balance by April 30th of the following year, unless they own a business, in which case they have until June 15th. 
• Taxes are often withheld at the source, meaning that the entity making the payment deducts the taxes before issuing the pay and sends it to the government. This is most common for employment income, but also often applies to pension and employment income benefits. 
• Individuals are required to pay taxes in installments on a quarterly basis if their taxes exceed $3,000 in both the current year and one of the two preceding years. 
• Corporations must pay tax installments on a monthly basis. Installments are not required if the corporation’s federal tax for either the current or previous year is less than $3,000. 
• On the Income Tax and Benefit Return T-(1), net income for tax purposes is located on line 23600 and taxable income is calculated on line 26000. 
• An individual is deemed to be a resident of Canada if they maintain a level of connectivity to the country through factors like family, financial accounts, owned homes, social ties, licenses, passports, and insurance. If a person is found meet the status of resident at any point during the year, then they will be required to pay income taxes on their income earned across the world. 
• A corporation is considered to be a resident if they were incorporated in Canada. 
• The sojourner rule states that anyone who spends more than 182 days in the country is deemed to be a resident.
• Non-residents are subject to income tax if they were employed in Canada, carried on business in Canada, or disposed of a taxable property in Canada at any point during the year. Non-residents are taxed on income earned in Canada only. 
• Canadian residents can be subject to taxes in both Canada and a foreign country. However, Canada has many treaties with foreign countries (though not all) that are designed to prevent residents from being taxed twice on the same income (aka double taxation). There are also provisions in the Income Tax Act to prevent double taxation. 
• Statutory Scheme


  Layout used to visualize net income for tax purposes, from Section 3 of the Income Tax Act
• The calculation of taxable income for both individuals and corporations starts with the net income for tax purposes and subtracts additional allowable deductions (known as Division C deductions), the categories of which differ between the types of entities. Individuals may make deductions for unused losses from other years, employee stock options, and capital gains on certain property. Corporations can make deductions for charitable donations, unused losses from other years, dividends from Canadian corporations, and dividends from foreign affiliates.
• Calculating net income for tax purposes

  1. Section 3(a): Include all income from the current year except capital gains (employment, business, property, and other), only include profits, deduct associated expenses

  2. Section 3(b): Cover capital gains and losses from the current year, start with taxable capital gains (1/2 of actual gains), subtract allowable capital losses (1/2 of actual losses), result must be positive or zero

  3. Section 3(c): Deductions from other types of income in the current year, subtract this subtotal from the end result of 3(b)

  4. Section 3(d): Subtract any losses this year from all types of income except capital gains and other, including allowable business investment losses (ABIL), subtract the sum of these losses from the result of 3(c) to get net income for tax purposes
• The subtotal of the amounts in Section 3(a) will be positive, as all the values in this section must be positive
• If the result in Section 3(b) is negative, we can carry the amount to another year
• The new subtotal in Section 3(c) must be zero or positive
• After Section 3(d), we can calculate taxable income
• For tax purposes, a taxpayer would generally prefer that a loss be treated as a business loss for tax purposes verses a capital loss. There are two reasons. Firstly, only one half of a capital loss is an allowable capital loss. Secondly, an allowable capital loss may only be applied to reduce taxable capital gains. In the case of business losses, the full amount of the loss may be applied against all income from other sources. 
• Both the amount of the deduction and flexibility to apply business losses against any other type of income means that if a financial loss occurs, there is a greater tax benefit treating it as a business loss versus a capital loss. Unfortunately, a taxpayer cannot decide between the two treatments when the loss occurs. 
• How the asset was employed determines whether the transaction is a business loss or a capital loss. If the asset was inventory or property was bought to resell, the loss is a business loss. If the asset was a capital asset, such as a building used in the business or shares purchased as an investment, the loss is a capital loss. 
• Property income is income that is generally considered passive, in that little time, labour or attention has been expended in producing the return. It includes:  

  • Dividend income (subject to gross-up and dividend tax credit) 
  • Interest income 
  • Rental Income (calculated on a net basis) 
  • Royalty income on the ownership of patents, copyrights, and mineral rights 
• Dividends paid by one corporation to another is included in net income for tax purposes. 
• Where dividends are received by a Canadian corporation from another Canadian corporation or from the foreign affiliate of the Canadian corporation, those dividends may be deducted under Division C of the income tax act. 
• A corporation qualifies as a foreign affiliate if the Canadian corporation own 10% or more of the foreign corporation. 

  Dividends received by individuals on investments in taxable Canadian corporations are included in the individual’s net income for tax purposes when received. The amount that must be included in income is not the actual amount. Taxable dividends from Canadian Public Corporations are grossed up. 
• Taxable dividends from Canadian Private Corporations are grossed up by 15% or 38% depending upon the tax rate paid by the corporation on the income that is the source of the dividend. Dividends requiring the 38% gross up are referred to as eligible dividends, whereas dividends requiring 15% are referred to as non-eligible dividends. Corresponding tax credits of 27.5% or 13% of the grossed-up dividend are available to the individual. 
• This system of gross-up and tax credits is intended to eliminate double taxation of corporate profits. Therefore, dividends received from another Canadian Corporation, or a foreign affiliate are part of net income for tax purposes, but not included in taxable income. 
• The calculation of depreciation used in accounting involves the use of judgement to determine the useful live, depreciation method and rates.  
• The income tax act replaces depreciation with Capital Cost Allowance (CCA). There is no judgement in determining rates, methods and useful lives of assets allowed in the calculation of CCA. This removes the opportunity for taxpayers to abuse this area and makes the administration of this part of taxation more manageable.