taxation II Notes

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Solution to Assignment Problem 15-9

Facts:
Ms. Morgan is the sole shareholder in her own CCPC
The company qualifies for the SBD and its total tax rate is 15% Ms. Morgan’s tax rates are 29% Federal plus 12% provincial (= 41% total tax) Any dividends paid out by Ms. Morgan’s company are non-eligible dividends The provincial dividend tax credit is 25% of the gross-up

NIFTP of the business is $170,000, after deducting her salary of $84,000

Objective:

Ms. Morgan wishes to receive $20,000 after-tax from her corporation for a vacation

If Ms. Morgan is to receive salary exclusively:

After tax retention = $20,000 desired after-tax funds
(1 - .41)

= $33,898 salary required from the company

If Ms. Morgan is to receive dividends exclusively:

Her personal tax rate is:

(1.25)(41%) – (2/3 + 25%)(25%) = 28.33% total taxes payable

After tax retention rate = $20,000 desired after-tax funds (1 - .2833)

= $27,906 dividend required from the company
(after corporate taxes have been paid)

The corporation must earn pre-tax income of $32,831
($27,906  [1- .15]) in order to pay Ms. Morgan a dividend of $27,906.

In Conclusion:

The dividend option requires that the corporation forfeit less of its earnings to meet Ms. Morgan’s request for vacation money:

$33,898 salary vs $32,831 dividend

This situation can also be examined by looking at which option has the highest tax cost:

Under the Salary Option:

The Corporation saves tax on the salary expense:
[(15%)($33,898)]( 5,085)
Ms. Morgan pays taxes on the salary:
[(41%)($33,898)] $ 13,898
The net Tax Cost of the salary alternative $ 8,813
 

Under the Dividend Option:

The corporation is already paying tax
on all income, therefore there is no change Nil
Ms. Morgan pays tax on the dividend$ 7,906
The net Tax Cost Of the Dividend alternative $ 7,906

Therefore, from a tax cost perspective, the salary option is $907 more expensive Solution to Assignment Problem 15-10

Facts:

Robert Lucas is the sole shareholder of Speelburg Films Ltd., a CCPC with a December 31 year-end. For 2013, Speelburg’s Taxable Income before salaries or dividends is $123,000 – all active business income.

Due to large capital expenditures, the total cash available for payment of income taxes, dividends or salaries is only $49,000.

Mr. Lucas spends all his effort on Speelburg and, therefore, has no other source of income. He has tax credits of $3,900 available.

Other Information:

His province levies 6% income taxes on personal income up to $43,561.

His province provides a tax credit equal to 35% of the gross-up on eligible dividends and 30% on ineligible dividends.

All of the company’s activities are in a province that levies 3% tax on income eligible for the small business deduction.

Part A:

Determine the after-tax amount of cash that Mr. Lucas will retain if all of the company’s cash is used to pay taxes and salary.

The combined federal/provincial tax rate applicable to Speelburg Films Ltd. would be 14% = (38% - 10% - 17% + 3%).

The amount of cash available ($49,000) must pay the taxes on $123,000 corporate taxable income and the rest will be Mr. Lucas’s salary. Therefore, let χ be the maximum amount of salary that can be paid. Solving for χ:

χ = $49,000 - [(14%)($123,000 - χ)]

χ = $36,953.

This can be verified by the following calculation:

Corporate Taxable Income Before Salary $123,000
Maximum Salary ( 36,953)
Corporate Taxable Income After Salary $ 86,047

Corporate Tax @14% = $12,047

This leaves $36,953 ($49,000 - $12,047) available for payment of salary.

Mr. Lucas would have the following amount of after tax cash:

Salary Payment $36,953
Tax Before Credits [(15% + 6%)($36,953)]( 7,760)
Personal Tax Credits (Given) 3,900
After Tax Cash Retained (All Salary) $33,093...
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