The New Eligible Dividend Rules

1
The New Eligible Dividend Rules A Closer Look
Presented for The Canadian Institute of Financial
Planners National Conference Kim G C Moody, CA,
TEP RSM Richter LLP June 11, 2007, Calgary,
Alberta
2
A Closer Look at the New Eligible Dividend Rules

• Agenda
• Brief history
• What is GRIP and why is it so important?
• Traditional remuneration strategies revisited.
• Asset vs. share example
• Use of a triangle structure
• Shareholder agreements
• How should advisors and their clients deal with
  the changes?

3
Brief History

• November 23, 2005 Department of Finance News
  Release.
• Announces that, effective January 1, 2006,
  taxation will be reduced for eligible dividends
  in order to level the playing field for
  corporations and income trusts.
• Many questions/issues.
• Draft legislation released June 29, 2006 66
  pages of draft amendments and explanatory notes.

4
Department of Finance ReleaseBrief History
(contd)

• September 29, 2006 CICA-CBA Joint Committee on
  Taxation releases comments to Department of
  Finance.
• 2nd round of draft legislation released October
  16, 2006 mostly minor changes but some changes
  noteworthy.
• Bill C-28, which contains eligible dividend draft
  legislation, received First Reading October 18,
  2006 and passed by the House of Commons on
  December 11, 2006.

5
Department of Finance ReleaseBrief History
(contd)

• Received 3rd reading on February 14, 2007 and
  Royal Assent on February 21, 2007.
• October 31, 2006 Department of Finance News
  Release new Distribution Tax for publicly
  traded income trust and partnerships.
• October 31, 2006 Release appears to be a response
  to recent announcements of BCE and Telus and Jack
  Mintzs paper Income Trust Conversions
  Estimated Federal and Provincial Revenue Effects

6
The New Tax Pools

• By definition, dividends are paid out of
  after-tax corporate retained earnings.
• New rules introduce two new tax pools
• General-rate income pool (GRIP) and
• Low-rate income pool (LRIP)
• At most, a given corporation will have one GRIP
  or one LRIP at any time.

7
What is GRIP and Why is it Important?

• Company can pay eligible dividends to the extent
  that it has a GRIP balance.
• Preferential tax treatment to Canadian residents
  for receipt of an eligible dividend.
• Gross up of 45 and dividend tax credit of 11/18
  of the grossed up amount.
• Results in an effective tax rate of 17.4493 for
  2007.
• Effective tax rate to decrease to 14.549 in 2009.

8
General Rate Income Pool (GRIP)

• New definition of GRIP will appear in subsection
  89(1) of the Act.
• Applicable only for a taxable Canadian
  corporation that is a Canadian-controlled private
  corporation (CCPC) or a deposit insurance
  corporation (DIC).
• DICs are ignored for the purposes of this
  presentation.

9
GRIP - Timing

• GRIP is calculated at the end of a particular
  taxation year.

10
GRIP Calculation Overview

• Calculated by formula A B
• Can be a positive or negative amount.
• In broad terms, A is the corporations GRIP at
  the end of the taxation year determined without
  reference to any specified future tax
  consequences.
• Specified future tax consequences includes the
  carryback of non-capital losses under paragraph
  111(1)(a).
• B adjusts that amount calculated under A to the
  extent that specified future tax consequences for
  preceding taxation years reduce the corporations
  taxable income subject to the general corporate
  rate.

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GRIP Calculation of A

• A the positive or negative amount that would,
  before taking into consideration the specified
  future tax consequences, be determined by the
  following
• A C .68 (D-E-F) G H I
• C corporations GRIP at the end of its
  preceding taxation year.
• D the corporations taxable income for the
  particular taxation year

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GRIP Calculation of A(contd)

• E the amount determined by multiplying the
  amount, if any, deducted by the corporation
  under subsection 125(1) (the small business
  deduction) for the particular taxation year by
  the quotient obtained by dividing 100 by the
  rate of deduction provided under that subsection
  for the particular taxation year.
• F if the corporation is a CCPC, the lesser of
  the corporations aggregate investment income or
  the taxable income for the particular taxation
  year of a CCPC and if the corporation is not a
  CCPC nil.

13
GRIP Calculation of A(contd)

• G the total of
• An eligible dividend received by the corporation
  in the particular taxation year or
• An amount deductible under section 113 in
  computing the taxable income of the corporation
  in the particular taxation year
• H the total of all amounts determined under new
  subsections 89(4) to (6) in respect of the
  corporation for the particular taxation year
  this is to be discussed in later slides.

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GRIP - Calculation of A(contd)

• I a) unless paragraph (b) applies, the amount,
  if any, by which
• i) the total of all amounts of each of which is
  the amount of an eligible dividend paid by the
  corporation in its preceding taxation year
• exceeds
• ii) the total of all amounts each of which is an
  excessive eligible dividend designation made by
  the corporation in its preceding taxation year,
  or
• if subsection (4) applies to the corporation in
  the particular taxation year, nil
• Note that, as stated earlier, the calculation of
  A is calculated before taking into
  consideration the specified future tax
  consequences.

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GRIP Calculation of B

• B 68 of the amount, if any, by which
• the total of the corporations full rate taxable
  incomes (as would be defined in the definition
  full rate taxable income in subsection
  123.4(1), if that definition were read without
  reference to its subparagraphs (a)(i) to (iii))
  for the corporations preceding three taxation
  years, determined without taking into
  consideration the specified future tax
  consequences, for those preceding taxation years,
  that arise in respect of the particular taxation
  year,
• exceeds

16
GRIP Calculation of B(contd)

• the total of the corporations full rate taxable
  incomes (as would be defined in the definition
  full rate taxable income in subsection
  123.4(1), if that definition were read without
  reference to its subparagraphs (a)(i) to (iii))
  for those preceding taxation years

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GRIP Calculation of B(contd)

• See subsection 248(1) for the definition of
  specified future tax consequences.

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GRIP Summary

• GRIP is generally the amount of after-tax income
  that was subject to the general corporate tax
  rate, i.e. no small business deduction.
• GRIP bump allowed for the 2000-2005 taxation
  years.
• Includes receipt of eligible dividends and
  foreign dividends deduction under subsection 112.
• Does not include aggregate investment income.
• Deduct eligible dividends paid.
• Adjusted for specified future tax consequences
  for preceding taxation years.

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AlbertaDividend Tax Rates
20
2007 Top Marginal Rates, Dividend Tax Credit
Rates and Amount of Dividends that May be
Received Without Incurring Tax in 2007
Source taxnetpro.com Carswell.
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Proposed Corporate Tax Rates
Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011 Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011 Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011 Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011 Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011 Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011 Table 3 Proposed Corporate Income Tax Rates, 2007 - 2011
2006 2007 2008 2009 2010 2011
(percent) (percent) (percent) (percent) (percent) (percent)

Federal Rates 22.12 21.0 20.5 20.0 19.0 18.5
Alberta 10.0 10.0 10.0 10.0 10.0 10.0
Total 32.12 31.0 30.5 30.0 29.0 28.5

• Source Department of Finance Backgrounder
  October 31, 2006

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Traditional Remuneration Strategies - Revisited

• The following slide illustrates the cash flow
  difference between paying a bonus from a
  Corporation versus incurring full corporate taxes
  and paying taxable (non-eligible and eligible)
  dividends.

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Traditional Remuneration Strategies - Revisited
(contd)Alberta - Bonus v. No Bonus
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Traditional Remuneration Strategies - Revisited

• Summary of cash flows

2006 2007 2008 2009 2010 2011
Bonus 616,777 616,940 617,511 614,682 614,682 614,682
No Bonus 581,309 588,138 602,255 605,826 610,953 613,517
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Traditional Remuneration Strategies - Revisited
Summary

• By 2009 there is a nominal difference between a
  bonus down to small business deduction (SBD)
  limit and no bonus (i.e. full dividend).
• Allows for a deferral of personal taxes if funds
  kept inside the corporation, i.e. tax deferral of
  approximately 8 for 2007 (increasing to 10.5
  for 2011).
• Need to determine what the cash needs are of
  shareholder and corporation automatic bonus down
  to SBD limit is not necessary.
• Reduction of bonus will reduce section 67 risks.
• Watch SR ED issues.

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Asset Sale vs. Share Sale

• The following example illustrates the cash flow
  difference between
• Selling the shares of a corporation personally,
  and
• Selling the assets of a corporation and paying a
  dividend to the shareholder.

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Asset Sale vs. Share Sale - Example

• Facts Share sale
• Mr. Apples sells shares.
• FMV 1,000,000
• ACB 0
• Mr. Apple is a resident of Alberta.
• No ECGD

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Asset Sale vs. Share Sale Example(contd)
Proceeds 1,000,000
ACB 0
Capital Gain 1,000,000
½ Taxable 500,000
Tax Rate 39
Personal Tax 195,000
Total Cash Flow
Proceeds 1,000,000
Personal Taxes (195,000)
Total Cash Flow 805,000
29
Asset Sale vs. Share Sale Example(contd)

• Facts Asset Sale
• Mr. Apples owns 100 of Opco.
• Opcos only asset is goodwill.
• FMV 1,000,000
• Corporation and Shareholder are resident of
  Alberta.
• Assume SBD for Opco is not available.

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Asset Sale vs. Share Sale Example(contd)
Corporation
Proceeds 1,000,000
Taxable portion 50 500,000
Tax Rate 31
155,000
Proceeds 1,000,000
Corporate Taxes (155,000)
Cash to Distribute 845,000
CDA Dividend (500,000)
Eligible Dividend (340,000)
Non-eligible Dividend (5,000)
845,000
31
Asset Sale vs. Share Sale ExampleConsequences
Dividend Tax Rate Tax Payable
CDA Dividend 500,000 0 0
Eligible Dividend 340,000 17.45 59,330
Non-Eligible Dividend 5,000 25.2 1,260
845,000 60,590

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Asset Sale vs. Share Sale ExampleConsequences
(contd)
Total Cash Flow

Proceeds 1,000,000
Corporate Taxes (155,000)
Personal Taxes (60,590)
Total Cash Flow 784,410
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Asset Sale vs. Share Sale ExampleSummary

• Total Cash flow
• Share Sale 805,000
• Asset Sale 784,410
• Difference between proceeds share sale and asset
  sale is narrowing.
• Not as big a bias for seller to sell shares.
• May defer taxes personal taxes if funds are
  invested in corporation.

34
Triangle Structure
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Advantages of Triangle Structure

• Can push GRIP to Holdco.
• QSBC preservation.
• Reinvest after-tax corporate proceeds in Holdco
  (by paying tax-free inter-corporate dividends
  from Opco to Holdco).

36
Shareholder Agreements

• Should be flexible to allow manipulation and
  distribution of GRIP.
• Necessity if have non-resident shareholders.

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How Should Advisors and Their Clients Deal With
the Changes?

• New rules are complicated.
• Rules of thumbs no longer applicable.
• Each situation must be evaluated to ensure proper
  tax planning is undertaken.
• General practitioner need to exercise extreme
  caution.