Taxation in Canada: An Overview Corporate Taxable Income (Continued) - PricewaterhouseCoopers LLP
For Canadian income tax purposes, financial statement income is modified by specific rules of the Income Tax Act. This article continues a brief discussion of the more frequently encountered adjustments that must be made to financial statement income to obtain taxable income.
Dividends Received from Canadian Companies: Canada generally does not tax dividends that a Canadian corporation receives from another Canadian corporation. Thus, dividends received by a Canadian holding company from Canadian subsidiaries are tax free. However, to discourage the deferral of tax by Canadian investment holding companies on portfolio dividends (defined to be stock holdings of less than 10% of unrelated corporations), a refundable tax of 33-1/3% is assessed on such Canadian dividends. This tax is refunded when dividends are paid by the holding company to its shareholders. Where the dividend is paid to non-resident shareholders, it is subject to withholding tax.
Dividends Received from Foreign Affiliates: Complex tax provisions exist that deal with the taxation of non-Canadian income earned by foreign corporations in which a Canadian resident corporation has at least a 10% interest, held either directly or in combination with related companies. These foreign affiliate rules create a tax environment favourable to Canadian companies that expand abroad because dividends received from their foreign affiliates can be received free of Canadian tax where the affiliate carries on active business in a country that has a tax treaty with Canada. However, depending on the type of income earned by the foreign corporation, the jurisdiction in which the foreign corporation is incorporated and/or operating and the type of Canadian resident shareholder, certain income may be taxed in Canada on either a remittance or an accrual basis.
Dividends Received from Non-Canadian Unrelated Companies: Such dividends are fully taxable. However, Canada allows a tax credit, thereby reducing the Canadian tax liability, for foreign withholding tax paid in respect of the dividend.
Club Dues, Yacht, Lodge or Golfing Facilities: The Income Tax Act specifically prohibits the deduction of membership fees or dues which entitle anyone to use the facilities of any club, the main purpose of which is to provide dining, recreational or sporting facilities. In addition, no deduction is allowed for the use or maintenance of a yacht, lodge or golf course, unless the taxpayer is in the business of providing such assets for hire.
Business Meals and Entertainment Expenses: Generally, only 50% of expenditures for meals, drinks and entertainment may be deducted for tax purposes. Specific exemptions apply in a number of situations.
Imputation of Interest: When a corporation resident in Canada has loaned money to a non-resident and the loan has remained outstanding for at least one year without interest at a reasonable rate having been included in computing the lender's income, interest on the loan at a prescribed rate is deemed received and must be included in computing the Canadian corporation's income for the year. This rule does not apply if the loan was made to a subsidiary corporation and the money used in the subsidiary's business to gain or produce income. These provisions also do not apply if the loan itself had been considered a deemed dividend and subject to non-resident withholding tax.
Unpaid Amounts: When amounts owing to non-arm's length parties for a deductible expense (other than salaries, wages, or other remuneration owing to employees) are allowed to remain unpaid for more than two complete tax years, a significant penalty will apply. These unpaid amounts are added to the taxpayer's income for the third tax year following the year in which the expense was incurred. Any amounts included in a taxpayer's income under these provisions are not deductible if subsequently paid.
However, if the taxpayer and the non-arm's length party to whom the amounts are owing file an agreement in prescribed form by the date on which the taxpayer's tax return for that third succeeding tax year is due, the unpaid amount is not included in the taxpayer's income, but is deemed paid by the taxpayer and received by the non-arm's length person and loaned back to the taxpayer. If the expense incurred is for an item to which the non-resident withholding tax provisions apply, withholding tax will be due on the deemed payment.
When unpaid salaries, wages, or other remuneration owing to an employee are not paid before 180 days after the end of the tax year in which the liability was incurred, the unpaid amount is deemed not to have been incurred as an expense in the year. However, a deduction will be allowed for such unpaid amounts when actual payment is made.
Inter-Company Asset Transfers: The Canadian tax system provides sophisticated rules facilitating the tax-free transfer of assets between Canadian corporations as well as the reorganisation of Canadian companies and their foreign affiliates. Examples include:
- Transfers of capital assets to a Canadian corporation in exchange for shares;
- Winding-up of certain subsidiaries and partnerships;
- Corporate mergers accomplished by amalgamations;
- Demergers in certain circumstances;
- Share-for-share exchanges; and
- Conversion of shares, bonds, debentures or notes with conversion terms into corporate shares.
Unreasonable Expenses: In order to qualify as a deduction in the computation of taxable income, expenditures must be incurred for the purpose of earning income subject to tax, must not be specifically disallowed by provisions of the Income Tax Act, and must be "reasonable in the circumstances". What is "reasonable in the circumstances" is often a matter of considered opinion, for negotiation with a tax assessor or ultimately, in some situations, for the courts to decide. Expenses considered unreasonable in the circumstances may be disallowed in whole or in part in arriving at taxable income, even when the amounts in question have been spent.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a PricewaterhouseCoopers LLP professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your PricewaterhouseCoopers LLP advisor, or:
David W. Steele PricewaterhouseCoopers LLP 145 King Street West Toronto, Ontario M5H 1V8 Canada
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