An Introduction to Corporate Tax Law

If tax law can be compared to solving a Rubic's Cube, then corporate tax law is like solving it in the dark. The law relating to the taxation of corporations is as complex and cumbersome as Canadian law gets. Without the assistance of a tax lawyer or chartered accountant, even a rocket scientist would be at a loss to understand sections 123 to 219 of the Income Tax Act, which it calls "the rules applicable to corporations."

To further complicate matters, each province has its own corporate tax laws, which are interrelated to the federal Act. Ontario's Corporation Tax Act, for example, contains 114 sections; yet it states in s. 11(1): "Except as hereinafter provided, the income or loss of a corporation for a taxation year from a business or property shall for the purposes of this Act be determined in accordance with subdivisions a and b of Division B of Part I of the Income Tax Act (Canada) and the said subdivisions a and b are applicable to this Act in so far as the said subdivisions apply to corporations."

Not only are the laws for the taxation of corporations more complex than for personal tax, but there are other disadvantages as well. The owner(s) of a corporation must file both personal and corporate tax returns each year. In many cases this involves increased accounting fees. Unlike a sole proprietorship or partnership, corporate losses cannot be deducted from the owner's personal income. Nor are corporations eligible for personal tax credits. Every dollar earned is taxed.

However, the advantages of incorporating often outweigh the negative tax consequences. For example, Canada offers extremely attractive research and development tax credits, such as the Scientific Research and Experimental Development program. For every dollar spent on qualifying expenditures, to a maximum of $2 million, the government will pay 35 cents. You do not even need income to qualify for the SR&ED program.

Another example of tax relief applied to Canadian-controlled private corporations, which are entitled to claim a small-business deduction on all active business income earned in Canada. This deduction provides for a 12% federal tax rate. However, there is a limit on the amount of income that qualifies for this largesse. The 2003 federal budget increased this limit from $200,000 to $300,000 over a four-year period. The first $25,000 increment applies to the 2003 tax year and each of the next three years add another $25,000. (The net result, when fully phased in, is an annual tax saving of $9,000.)

Third, corporations are entitled to a $500,000 lifetime capital gains exemption for small business shares.

And finally, corporations can work with the payment of funds to owners and shareholders—through the use of dividends instead of salary, deferring tax on bonuses, and the use of stock options and shareholder loans—to reduce personal income taxes. If you incorporate a small business, you can determine when you personally receive income; thus, instead of getting your income when it's received, being incorporated permits you to take your income at a time when you'll pay less in tax.