Tax, Management, Audit, and Finance/Strategy Notes

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Determination of Taxable Income

Part A

+ employment income

+ business income

+ property income

+ other income

subtotal: must be 0 or +

Part B

Taxable Capital Gains

- allowable capital losses

Net capital gains (must be 0 or +)

running total: must be 0 or +

Part C

- other deductions

running total: (must be 0 or +)

Part D

- employment losses

- business losses

- property losses

- allowable business investment losses (ABILs)

running total: must be 0 or +)

^ Net Income for Tax Purposes

Aquisition of Control (AOC) rules

When?

• more than 50% of the voting shares acquired by non related person

What happens?

• deemed taxation year end right before AOC

  • file tax return for short tax year (prorate)

  • choose new tax year

• loss carry-overs

  • net capital losses, property losses, and ABILs expire

    • capital losses can be recognized to offset capital gains

  • non capital losses can be carried forward if

    • businesss in the same genre (industry)

    • probablity of income

• Inventory

  • LCNRV

  • resulting loss recognized for tax purposes

• AR

  • no bad debt reserve

  • uncollectibe amounts must be claimed as BDE

• property

  • FMV < UCC — UCC reduced to FMV — difference is CCA

    • ACB remains

  • FMV < ACB — ACB reduced to FMV — difference is capital loss

Stop-Loss Rules - For individual

capital loss on transfer to affiliated corporation

• loss denied

• denied loss added to corporation ACB

terminal loss on transfer to affiliated corporation

• terminal loss denied

• remains in UCC of individual

• individual claims CCA each year until asset sold to non-affiliated party

Stop-Loss Rules - For corporation

capital loss on transfer to affiliated corporation

• loss denied to transferor

• no addition to ACB

• transferor can claim a loss only when sold to non affiliated person

terminal loss on transfer to affiliated corporation

• terminal loss denied

• remains in transferor’s UCC and continues to claim CCA until transferee sells to non affiliated party

ITA 85 “rollover”

• allowable transfer of assets at the tax cost

• defers the tax at transfer time

requirements

• consideration must include shares

• may include boot too

• must file a joint election

• eligble property: capital, inventory, resource

how to go at it

• election amt = ACB = boot = non-share consideration

• FMV - ACB = share consideration

• boot > ACB = difference = gain

CCPC taxation

General rate reduction

• Income - AII - SBD = GRR (-13%)

SBD

• 1st $500,000 of ABI (limit applies to all associated corps) (-19%)

Refundable tax on AII

• 10 2/3% of lesser of

  • AII

  • TI - SBD

ERDTOH and NERDTOH

1. non taxable Capital gains — CDA

2. GRR — ERDTOH — (9%) — Gross Up 15% — 6/11

3. Other Inc — NERDTOH — (28%) — Gross Up 38% — 9/13

should have an equaling effect on the income received by the corporation and the income receieved by the individual

Benefits and disadvantages of Incorporating

Benefits

• tax deferral - SBD

• employment benefuts

• flexibility in family ownership

• choice between salary vs divs

Disadvantages

• losses cannot offset income earned by SH

Loans to Shareholders

Loans to SHs (or SH affliates) included in SH income in the taxation year unless

• SH is also employee

• and advance is due to employment (not specofied employee 10% ownership) relationship

  • for personal residence

  • for treasury shares

  • for car for work duties

• then shares not included in income if repayment is reasonable and documented

• if interest < prescribed rate, difference is taxable income

When loans that are taxable repaid they can be deducted from income in that year

Limitations of SBD

AAII = AII less:

• net capital gains and losses

• carry overs

• portfolio divs

SBD reduced by the AAII

• for each $1 of AAII greater than $50,000 — SBD reduced by $5

SBD reduced by the assets

• in excess of $10 million SBD reduced until $15 million when SBD = 0

SBD shared amongst associated groups (allocation is upto the owners)

ITA 84.1 - non arm’s length transfer of shares

• individual and purchases are related

• purchaser and subject corporations are connected after

• any increase to PUC not allowed

• any non share consideration —> deemed dividend

ITA 85.1 - share for share exchange

• purchaser corp buys subject corp

• individual and purchaser are related

• no boot, no increase to ACB or PUC

86(1) - reoroganization of share capital (estate freeze)

• taxpayer to dispose of all shares of that class

  • must amend articles of incorporation

  • consideration must include shares and could include non share consideration

• Cost of non share = FMV of non share

• ACB of new shares = ACB of old shares - FMV of NSC

• deemed proceeds = ACB of old shares + NSC

87(1) - Amalgamations

• merger of two of more corporations (vertical or horizontal)

• new corporation is created- old ones cease to exist

• conditions

  • all assets and liabilities become the assets and liabilities of the new company

  • all shareholders become shareholders of the new company

• Taxation year

  • new taxation year at date of amalgamation

  • can choose any new tax year

  • the tax years of the old corporations end on day of amalgamation

• losses of old companies

88(1)

• parent corporation must own at least 90% of shares of sub

• shares of sub are deemed disposition at MAX(ACB,PUC)

• sub deemed disposed all assets and liabilities at tax cost —> parent aquired at tax values

• losses of sub can not be used until the end of the first year after wind up

• bump is available if the tax values of the assets are lower than the ACB of the shares

  • ACB of net assets can not exceed FMV of the net assets at the time that the parent gained control

  • Bump = ACB shares - net assets - dividends to parent

Holding corporations

• tax deferral purpose, maximum felxibility, when cash isn’t needed

• assuming that corporations can get dividends tax free

  • Dividends that flow through to the Holding corporation can be reinvested at the full amount (individuals receieve them net of tax and can only reinvest that amout)

• leveraged buy out

  • holding corporation borrows funds, holding corporation buys the active business corporation

  • corporation pays dividends to holding and those dividends are used to pay off the debt borrowed

• minimizing tax on sale of shares

  • retained earnings can be distributed as a dividend —> value of shares decreases —> lower capital gain

  • anti avoidance rules: if the dividend payment exceeds the safe income (income paid taxes on) —> excess is capital gain and taxed as it

selling/buying assets vs shares of a company in a buyout

implications for vendor

• shares

  • capital gains; if it is a QSBC can use the CGLE

• assets

  • two levels of tax; one for corporation (capital gains)

  • one for the taxes at the dividends

  • recapture/terminal loss (business income)

Implications for purchaser

• shares

  • all the assets are at tax costs which means there will be future larger capital gains

• assets

  • bought at FMV which means lower capital gains

QSBC qualifications

• SBC test

  • owned by individual/person related to individual

  • at time of the sale: 90% of FMV of assets were in active use

  • CCPC

• holding period test

  • for the past 24 months was owned by the individual

• basic asset test

  • for the past 24 months more then 50% of FMV of assets was in active use

Liability for tax

Residency

• individuals

  • continuing state of relationship

    • time

    • motives

    • maintenance of place

    • routine

    • financial and social connections

  • or 182+ days in Canada

• corporation

  • incorporated in Canada

  • if not incorporated in canada, has central management and control in Canada

• non residents are still taxed on net income

  • (business in canada, disposal of Canadian property, employed in Canada)

Canadian Source Income

• withholding tax on amount from canada to non Canadians

• 25% (may be reduced under treaty)

• income: dividends, rents, royalties, pension

Gain onsettlement of debt

• settle debt for less than owing

  • —> gain but not included in taxable income

  • gain applied to reduce losses carried over from other years

    1. non cap loss

    2. farm loss

    3. restricted farm loss

    4. allowable business investment losses

    5. net capital losses

  • gain not used applied to lower UCC or ACB

    6. depreciable property

    7. capital property

    8. other properties

  • if still balance

    9. ½ of remainder included in income

Superficial Losses

• if a taxpayer reaquires the same property within the same 30 days —> the loss is superficial and deemed to be nil for tax purposes

• when seller is individual

  • loss added to ACB

  • recognized when property is sold

  • same treatment when sale to spouse, affiliated corporation

• when seller is corporation

  • denied the capital loss

  • retained by corporation

  • may be recognized when property is deemed sold or sold

TOSI

Tax On Split Income

• dividends received by minor child from private corporation

  • subject to 33% marginal tax rate

• also applied to capital gains arising on sale of private property to non arms length —> deemed dividend

• interest and dividends received by adult family members from private corps

• exclusions on income to

  • spouse when business owner is 65+

  • amts received by adults working more than 20+ hours/week

  • amts received by adults 25+ who own at least 10% (if not professional corporation)

• those who do not meet exclusions

  • reasonableness test: if not reasonable salaries —> 33% marginal tax

Attribution Rules

Income from property transferred to spouse

• as long as married —> income remains with individual

• process is called attribution

• interest free loans- any income earned —> attributed to lender

• capital gains are attributed

• if equivalent to arm’s length —> no attribution

Property transferred to a minor child

• income on property transferred —> attributed to parent

• capital gains/losses not attributed

• may apply to nieces or nephews

Transfers and loans to corporation

• corporation of spouses and children

• corporation uses the funds to invest and pass income to family members

• prescribed rate of interest added to income of individual

loans to adults family members

• income earned on property that was bought with loaned funds attributed to person making the loan

RRSP

• tax deduction

• taxed when taken out (contributions and income)

• can contribute to spouse and deduct from income

Life learning plan

• can take upto $20,000 over 4 years tax free

• must return over 10 years in equal instalments

Homebuyers’ plan

• can take upto $35,000 tax free

• must return over 15 years in equal instalments

RRSP contribution limit

• lesser of

  • prescribed rate: $31,560

  • 18% x earned income

• deduct: pension adjustment

• add: unused RRSP deduction room

TFSA

• limited to $7,000 a year (accumulates indefinetly) 1% on over contribution

• can contirbute to spouse plan (combined annual $12,000)

• not tax deductible

• withdrawals added to accumulated room next year

RESP

• $50,000 contribution limit

• income and grant is taxed and contributions not deductible

Canada Education Savings Grant

• contribute upto 20% annual upto $500 max grant

• lifetime- $7,200 max

• if child does not pursue post secondary education CESG must be returned

withdrawal not to child

• additonal tax of 20%

• rollover to RRSP avoids both levels of taxes

Death of Taxpayer

Tax implications

1. income from ll sources accrued upto the date of death

2. capital property deemed disposed at FMV

   • if spouse beneficiary: transferred at cost

3. executors are given control of the assets

4. Must file a terminal return and maybe “Right or Things” return

   • due 6 months from the date of death or April 30th, whichever is later

5. expiring capital losses of the tax payer

   • can elect to use them in the year of or year prior to dying on ANY income

Personal Trusts

• trustee deals with the settlors property in the trust for the benefit of the beneficiaries

• due 90 days (T3) after year end of trust

• trust is considered to be a resident where the trustees are residents

• income paid to beneficiaries gets deducted

• all income retains its source

• losses do not flow through to the beneficiary

Testamentary Trusts

• consequence of death

• calendar year end

• top marginal tax rate

Inter Vivos Trusts

• created during life time

• calendar year end

• top marginal tax rate

Graduated Rate Estate

• arises on death not longer than 36 months

• non-calendar tax year

• can apply the graduated tax rate

Spousal Trust

• trust at ACB/UCC

• spouse must be entitled

• no other person may receive the trust unless the spouse dies

HST basics

• business and end consumers have to pay it

• ITCs can be recoverable

  • must be claimed within 4 years

  • can not claim expenses incurred prior to registration unless inventory or capital property or rent related to periods after registration

HST reporting periods

Annual taxable supplies < $1,500,000 (annual filing)

$1,500,000 < ATS < $6,000,000 (quarterly filing)

ATS < $6,000,000 (monthly filing)

Types of Supplies

• taxable supplies

  • any goods, property, or services made in the course of commercial activity

  • HST charged, ITCs can be claimed

• zero-rate supplies

  • HST not taxed, ITCs can be claimed

  • examples: basic groceries, prescription drugs, medical devices

• exempt supplies

  • no HST, no ITCs

  • examples: most healthcare and dental, educational services, insurance, child care, music lessons

Small supplier status

• not required to register for HST

• total taxable supplies do not exceed $30,000 a year

Place of Supply rules

• goods: where goods are delivered

• services: billing adress of the customer

• real property: where property situated

• intangibles: where can be used or billing adress

Tax collected/not collected or paid/not paid in error

• can apply for rebate from CRA

• supplier can go back to charge the customer but the customer is ultimately liable for this

Input Tax Credit Rules

1. HST must be paid

2. HST registrant

3. purchase must be used in the course of commercial activity

4. ITC claimed within time limits

5. documentary evidence

Input Tax Credit allowances

1. meals, entretainment, and club dues (50%)

2. reasonableness (in excess of reasonable amount)

3. bad debts (uncollectible amounts —> BDE)

4. maximum purchase price of $30,000 on car

5. maximum $800/month on lease of car

6. HST on company benefits must be collected and remitted

Dealines for filing returns

• monthly & quarterly filers: one month

• annual individual filers: April 30th filing and June 15th remittance

• annual corporation filers: 3 months

• deadline for filing appeals

  • 90 days

• installments applicable for annual filers for net owing greater then $3,000

Interest and penalties

• installment interest compunds daily

• penatly 1% plus 0.25% for each month late

• directors of corporations are still personally liable for remmitance of taxes even after company ceases to exist

Types of Budgets

1. set at zero at the beginning of periods

2. historical data

3. cashflow per unit

4. goals and workbackwards

5. direct value addition

Benefits of Budgets

• requires all levels of management to plan ahead

• provide definite objectives for evaluating performance

• early warning system

• facilitates coordination of activities

• greater awareness of operations in the entire business

• motivates personnel throughout the organization

• forces to plan and think about the future of the company

negatives of budgeting

• can be seen as pressure devices

• departmental conflicts

• difficult to reconcile personal and corporate goals

• waste may arise if management doesn’t wanna lose cost room

• managers may overestimate the costs

Top down vs participative approach to budgets

top down: upper managements sets the budget

participative: employees contribute to the budgets

operating vs capital budget

operating

• covers day to day activities

• focuses on short term control

capital

• covers long term capital expenditure

• focuses on long term control

static budget vs flexible budget

static

• prepared for the budgeted level of activity

• no controls for if the actual level changes significantly

flexible

• provides estimates for any level of activity

• adaptable

• to flex budget:

  • variable costs change in direct proportion to changes in activity

  • total fixed costs remain unchanged ith the relevant range

Responsibility Centre

any individual who has control and is accountable for activities

especially valuable in a decentralized company

responsibility centres

• cost center: objective is to keep costs low

• revenue center: maximize revenue

• profit center: maximize profits

• investment center

Quantity standards vs Cost standards

Quantity Standard

• specify how much input should be used to make product or provide a service

• examples:

  • standard rate per hour

Price Standard

• how much should be paid for each unit of the input

• examples:

  • standard hours per unit

Price Variance

AQ * (AP - SP)

Actual Quantity * (Actual Price - Standard Price)

Quantity Variance

SP * (AQ - SQ)

Standard Price * (Actual Quantity - Standard Quantity)

Principal Agent Problem

conflict between the interest of the agent and principal (separation between the decision maker and the risk bearer)

SMART goals

Specific, Measurable, Achievable, Relevant, Timely

Balanced Scorecard

Financial

Customer

Internal process

Learning and Growth perspective (People/Employees)

Category — Objective — Measure — Initiative

Examples of why Direct Material Price Variance Occurs

• change in quality/price of material

• volume discount

• new supplier

Examples of why Direct Material Quantity Variance Occurs

• fluctuations in usage

• change in production process

• change in equipment (more efficient)

Examples of why Direct Labour Price Variance Occurs

• new union contract

• change in mwthod of training of workers

• unanticipated overtime

Examples of why Direct Labour Quantity Variance Occurs

• better/worse training of workers

• unreasonable labour hours standard

• change in equipment ortechnology

Board of Directors

Should

• look out for the best interest of the company

• majority of independent directors

• knowledgable of the industry and FS

• meet regularly (min 4Q)

Responsibilities

• assist with strategic decisions

• Monitor risks

• review FS

• develop key policies

• audit committee

• compensation committee

Independence

member with no direct or indirect material (interefere with independent judgement) relationship with the issuer

directors must disclose self interest/non independence if/when it arises

Responsibility of a Director

Fiduciary Duty

• confidentiality

• honesty

• interest of organization first

Duty of Care

• diligiently

• prudently

• seek and analyze all information before making decisions

Nomination Committee

made of of independent direcors should nominate directors

directors can be personally liable for

• unpaid employee wages

• unpaid vacation pay

• unpaid source deductions (taxes, EI, CPP)

• allowing a corpoation to act illegally

compensation committe

• independent direcotrs

• review and approve goals relevant to CEO compensation

• receommend compensation

Audit committee

• fully independent directors

• min 3 members

• auditors discuss information with the audit committe

• oversee work of External auditors

• review FS and MD&A

Financial Distress meaning

the entity is no longer able to meet its current cash obligations

path for companies experiencing financial distress

1. Financial distress identified

2. can you improve operations? if no,

3. can you get financing help (loans from anybody)? if no,

4. can you informally negotiate with the creditors? if no,

5. file for bankruptcy (CCAA (big) or BIA (small))

   1. prove insolvent

   2. government grants bankruptcy protection (creditors can’t take action)

   3. continue operations

   4. prepare plan for restructuring debt and send to creditors

      • 50% of creditors must agree

      • 60% debt of those creditors

   5. approved/not approved

      • approved —> emerge from bankruptcy protection

      • not approved —> liquidation

Creditors of a company and order of paying them in liquidation

1. employee wages and government remmittance

2. secured loans

3. preffered creditors

4. unsecured loans

Murders and Executions

Quant analysis

• is consideration enough?

• how can i finance this acquisiton?

Qual analysis

• is there a fit with strategy, culture, and products?

• are therey synergies?

• risks and opportuntiies?

Due Dilligence

• to investigate the target company

  • not overpaying

  • awareness of risks and controls

  • validating assumptions and numbers

• CSRS

Ethical models

• Utilitarianism: looks at outcome of actions if the total good gets maximized for stakeholders

• Rights and Duties: is the process fair? emphasize duty and morality

• Virtues: focus on speocific values that are core to the company- nased on moral character

Audit Procedures for Accounting Estimates

• develop a point estimate (analytical procedure, recalculation

• test how management made the estaimate and related disclosures (inquiry, discussion, recalculation)

• testing of controls over the estimate process

Audit Procedures for Contingent Liabilities

• inquire of management/employees if there are any unreported contingent liabilities

• confirm with legal team

• review legal expense accounts

• review meeting minutes of BOD and correspondence between clients and legal counsel

Audit Procedures for Subsequent Events

• gain understanding of managment process of dealing with subsequent events

• read board meeting minutes

• analyze interim results such as budgets, cash flow forcasts, and other reports like accounting decsions, loan repayments, and compliance