Tax Planning and the Salary Dividend Mix - Part II
Get a grip (and a GRIP) on complex new legislation.
By Ed Kroft, LLB, LLM, CGA (Hon.)
In the last issue, I discussed certain issues relating to a corporation deducting salary or wages. What about a Canadian-controlled private corporation (CCPC) paying taxable dividends instead? Dividends, unlike salary, are not deductible in computing income of the CCPC under Part I. However, individuals resident in Canada may pay less Part I tax on taxable dividends because of the application of the gross up and dividend tax credit provisions in sections 82 and 121 of the Income Tax Act.
The October 16, 2006 Proposed Legislation
On October 16, 2006, the federal government released a notice of ways and means motion detailing measures relating to the taxation of dividends previously released in draft on June 29, 2006. The legislation is intended to reduce the effective tax rate on taxable dividends paid by corporations out of “active business income” not subject to the 16 per cent small business deduction (i.e. the active business income not subject to a 17.62 per cent combined federal B.C. corporate tax rate in 2006).
The “eligible dividends” will be eligible for a gross up of 45 per cent rather than 25 per cent for non eligible dividends. The dividend tax credit would increase in a corresponding fashion from 2/3 of the gross up to 11/18 (or 18.97 per cent ).
B.C. just announced that the B.C. dividend tax credit would be 12 per cent. Therefore taxable dividends paid in 2006, would, if the legislation passes, be subject to combined federal and B.C. individual marginal tax rates as shown in figure 1.
These proposals were suggested originally in November 2005 to encourage investors to purchase shares of corporation rather units of income trusts. The proposals are intended to integrate corporate and personal taxes so that the investor gets a full credit for the underlying Federal and B.C. taxes paid by a corporation, including a CCPC, on its high rate active business income (in excess of $400,000 in 2006).
How do the Proposals Work?
For the payor corporation:
You will likely be pleased to see computers do tax calculations to assist you with the complex new legislation. CCPCs and non CCPCs will be obsessed with different formulae. The CCPC will only be able to pay “eligible dividends” out of its “general rate income pool” or GRIP. If a CCPC wants to pay “eligible dividends,” it needs to get a GRIP before the end of its taxation year. Generally, it can do so by earning the active business income over the federal “small business” active income threshold of $300,000 ($400,000 in 2007) or it can receive “eligible dividends” on shares it holds (maybe from CCPC’s or non CCPC’s such as public corporations).
The non CCPC will be obsessed with not having an “LRIP” or a “low rate income pool” as all dividends it pays will be eligibleunless it has an LRIP. It can acquire an LRIP in a number of ways, including receipt of non eligible dividends on shares it holds in a CCPC. The legislation also contains transitional rules regarding the opening GRIP and LRIP accounts. Dividends out of investment income are not affected by all these complex rules because dividends from this source are not “eligible dividends” but subject to the rules dealing with dividend refunds from the refundable dividend tax on hand account.
Ed Kroft, LLB, LLM, CGA (Hon.), is a partner in the Vancouver offices of McCarthy Tetrault, Barristers and Solicitors, which has more than 40 tax lawyers across Canada. His practice is limited to taxation.
For the recipient:
How will an individual know if he or shereceives an eligible dividend? Subsection 89(14) of the Act states that the “eligible dividend” must be designated as such by the payor. The payor must notify the recipient in writing at the time of the payment of the “eligible dividends.” No late designations can be made and a late designation/ notification will not be eligible for “fairness relief.”
A client will want to know:
Does the corporation paysalary, dividends or both in 2006? What if dividends were paid early in 2006 but no designations as “eligible dividends” were made at the time of payment? Should a corporation “bonus down” to $300,000 or $400,000 in 2006? Stay tuned for Part 3.