You recently met Susan Taylor at a cocktail party. As a result of your conversation with her, Susan has come to you for tax advice. She wants to know how her income will be taxed. She also wants to know whether she should incorporate and earn the same types of income through a corporation called High Income Limited. She would be the sole shareholder and only employee of that corporation. Susan has received various types of income in 2012. These incomes are as follows:
• Interest income from GIC - $5,000
• Dividend income from a publicly traded corporation - $10,000
• Capital gains from selling public company shares - $20,000
• Susan owns 40% of all the issued and outstanding common shares of Stage Lighting Limited (Stage). Her best friend, Mary, who lives in Ontario, owns the rest of the common shares. The company is in the business of manufacturing customized lighting products. She received $20,000 in dividends (for which Stage did not receive any dividend refund) from Stage this year. All income earned by Stage is eligible for the small business deduction.
Susan would like to understand whether she should incorporate a holding company to earn the four different types of income mentioned above.
Susan runs a small fashion store selling high-end handmade scarves. The business is operated as a sole proprietorship. Active operations started four years ago and the business started to make sizable profit last year. The estimated taxable retail income in 2012 is $200,000. Susan would like to know whether she should incorporate this business.
Additional Information and Assumptions
Assume that the effective combined federal and provincial corporate tax rates for 2012 on the following types of income are:
• Active business income (ABI) (eligible for the small business deduction)
38% - 10% - 17% + 5% (net provincial) .............................................. 16%
• Specified investment business income
38% - 10% + 6%% + 14% (provincial) - initially ................................. 48%%
48%% - 26%% - ultimately when dividends paid ................................... 22%
• Capital gains
Taxed portion is taxed as income from a SIB above Non-taxed portion .......... 0%
The non-taxed portion of the capital gain is added to the capital dividend account. Dividends can be paid out of the balance of this account with no tax cost to the recipient shareholder.
Assume that, if the ABI increases to the point where it exceeds $500,000 (small business deduction), then the effective federal rate on the ABI in excess of the small business limit will be
• Combined federal and provincial rate:
38% - 10% - 13% (general rate reduction) + 14 (provincial) ....................... 29%
Assume that the effective combined federal and provincial personal tax rates for 2012 are:
• The effective combined federal and provincial personal tax rate:
Top marginal rates 29% (federal) + 17% (provincial) ............................... 46%
• Effective combined federal and provincial tax rate for dividends from:
Low Rate Income Pool ................................................................. 32.5%
General Rate Income Pool ............................................................. 25.5%
REQUIRED
Please draft a memo analyzing the tax implications of the above situation. Your memo should address and conclude on the following issues:
(A) Based on the theory and a conceptual understanding of incorporation, determine whether Susan can save and/or defer income tax by incorporating a holding company to earn interest income, dividend income from a public company, capital gains from selling public company shares, and dividend income from Stage Lighting Limited.
(B) Based on the theory and a conceptual understanding of incorporation, determine whether Susan can save and/or defer income tax through incorporation of her fashion business.
(C) Discuss some of the general (i.e., not specific to Susan) quantitative and qualitative pros and cons of incorporation.