Taxation and the Annual Report

Transcription

1 Taxation and the Annual Report Lakehead University September 2003 Overview of the Lecture 2.3 Taxation of Business Income 2.4 The Annual Report 2

2 2.3 Taxation Businesses, like individuals, must pay taxes on their income. Businesses can deduct all direct, operating and financing expenses from sales before arriving at earnings before taxes (EBT). While EBT is taxed at the owner s personal tax rate in the case of sole proprietorship and partnership, corporations are subject to corporate tax rates Taxation Corporations can earn four types of income: Active business income: Income from operations. Passive income: Royalties, rent, interest and the like. Intercorporate dividends: Dividends from another corporation. If the dividend is from a taxable Canadian corporation, then the full amount of the dividend received is not taxable. Capital gains: Selling price of a capital asset minus its purchase price. Transaction costs can be deducted. 50% of net capital gains are taxable. 4

3 Corporate Tax Rates Two distinct types of corporation for tax purposes: 1. Non-manufacturing (general) companies. 2. Companies engaged in manufacturing and processing. On top of that, a firm can be a Canadian-controlled private corporation (CCPC), in which case the first $300,000 earned may be taxed at lower rates. 5 Remarks on Corporate Tax Rates Manufacturing and processing firms are subject to lower tax rates than non-manufacturing companies. CPCCs income is taxed progessively: Lower rate for the first $200,000 and greater rate for 200,000th to 300,000th dollar earned. Combined (federal and provincial) corporate tax rate in Ontario in 2001 was 41.74% for non M&P firms and 33.87% for M&P firms. This rates will be 30.12% for both non M&P and M&P firms in

4 Remarks on Corporate Tax Rates Corporate tax rates result from the competition among countries and provinces to attract companies. Since the establishment of a company is a long-term investment, it is important to know the trend in corporate taxes. Capital losses may be carried back (3 years) and forward (indefinitely) to reduce capital gains in other years. 7 Tax-Deductible Expenses For corporations, operating expenses and interest expense are tax-deductible. Amortization is tax deductible. Dividends paid, however, are not tax-deductible. Capital cost allowance (CCA): Depreciation for tax purposes. 8

5 Capital Cost Allowance Capital cost allowance (CCA) is depreciation for tax purposes in Canada. It provides a tax shield for firms. To calculate the CCA for an asset, we must first determine the CCA class of this asset. CCA rate varies according asset class. The half-year rule: Only one half of an asset value can be depreciated for tax purposes in the first year. This measure exists to discourage firms from acquiring assets towards the end of the year to reduce their tax bill. 9 CCA Classes and Rates Class Rate Assets 1 4% Buildings acquired after % Furniture, photocopiers 10 30% Vans, trucks, tractors, and equipment 13 Straight-line Leasehold improvements 22 50% Pollution control equipment 43 30% Manufacturing equipment 10

6 Capital Cost Allowance Let V denote the asset cost at the time of its purchase, and let c denote the CCA rate for the asset class (not straight-line). CCA depreciation in the first year, denoted D 1, is D 1 = c V 2, and the undepreciated capital cost (UCC) after one year is UCC 1 = V D 1 = V cv 2 = (1 c)v 2 + V Capital Cost Allowance CCA depreciation in the second year is D 2 = c UCC 1 and the undepreciated capital cost after two years is UCC 2 = UCC 1 D 2 = (1 c)ucc 1 = (1 c) 2V 2 + (1 c)v 2. 12

7 Capital Cost Allowance Similarly, in the third year is D 3 = c UCC 2 and thus UCC 3 = UCC 2 D 3 = (1 c)ucc 2 = (1 c) 3V 2 + (1 c)2v Capital Cost Allowance We can generalize this expression for all t 2, i.e. D t = c UCC t 1 and UCC t = (1 c) t V 2 + (1 c)t 1V 2. 14

8 Capital Cost Allowance: An Example Mississauga Manufacturing Ltd. just invested in some new processing machinery to take advantage of more favourable CCA rates in a new federal budget. The machinery qualifies for 25 percent CCA rate and has an installed cost of $1,800,000. Calculate the CCA and UCC for the first five years. 15 Capital Cost Allowance: An Example Answer: In the first year, the CCA rate can only be applied on half the instalment cost, which is $900,000. This means a CCA depreciation of in the first year, and thus 25% 900,000 = $225,000 UCC 1 = 1,800, ,000 = $1,575,000 16

9 The CCA depreciation in the second year is 25% 1,575,000 = $393,750, and thus UCC 2 = 1,575, ,750 = $1,181, For the first five years, we have Year Beginning UCC CCA Ending UCC 1 $1,800, $225, $1,575, ,575, , ,181, ,181, , , , , , , , ,

10 Asset Purchases and Sales Suppose an asset is sold at time T for $S. There are two possibilities: (i) S > UCC T : If S > UCC 0, the difference S UCC 0 is taxed as capital gain, and the difference UCC 0 UCC T is substracted from the asset pool (assuming the asset pool is continued). (ii) S UCC T : In this case, the difference UCC T S is added to the asset pool and depreciates until the asset pool is terminated (possibly forever). 19 Asset Purchases and Sales In reality, this procedure will be applied on net acquisitions of assets. That is, what is added to or subtracted from the asset pool depends on the net proceeds from asset sales and purchases. When an asset pool is terminated (the last asset in it has just been sold), then the difference between UCC and the sale proceeds are either added to or subtracted from the firm s income. If the sales price is below UCC, the terminal loss (UCC S) is subtracted from income. If, on the other hand, S > UCC, then the difference (S UCC) is added to income and CCA is recaptured. 20

11 Individual Income Tax Rates Federal tax rates in 2002: Taxable income Tax Rate From 0 to 31,677 16% From 31,677 to 63,354 22% From 63,354 to 103,000 26% Above 103,000 29% 21 Individual Income Tax Rates Ontario tax rates in 2002: Taxable income Tax Rate From 0 to 31, % From 31,893 to 63, % Above 63, % 22

12 Taxes on Investment Income Interest Income: Taxed as personal income. Dividends: Dividend tax credits (Federal: 13.33% of 125% of dividend; Ontario: 5.13% of 125% of dividend). Capital Gains: Capital gains from Canadian companies are taxed at 50% of individual s marginal tax rate. 23 Taxes on Investment Income Let t f denote the individual s federal marginal tax rate, let t p denote the individual s provincial tax rate (Ontario), and let m denote the individual s investment income. If m is an interest payment, taxes paid are If m is a dividend, taxes paid are (t f +t p ) m [ (t f ) + (t p ) ] m. If m is a capital gain, taxes paid are (t f +t p ) m 2. 24

13 Taxes on Investment Income: An Example Investment Income of $100, Net of Taxes Tax Bracket (t f,t p ) If Interest If Capital Gain If Dividend (16%, 6.05%) $77.95 $88.98 $95.51 (22%, 9.15%) $68.85 $84.43 $84.14 (26%, 11.16%) $62.84 $81.42 $76.63 (29%, 11.16%) $59.84 $79.92 $