Canadian Tax System & Doing Business in Ontario - February 25, 2013 Seminar (in English)

1
Catholic Crosscultural Services
Canadian Tax System &
Doing Business in Ontario
Sonja Chong, FCA
Partner – Income Taxation
Harris & Chong LLP
Chartered Accountants
2225 Sheppard Avenue East
Suite 1202, Atria III
Toronto, Ontario M2J 5C2
Telephone: (416) 499-3112, Ext. 309
Fax: (416) 499-7372
Email: schong@harrisandchong.ca
February 25, 2013

INDEX
Pages
1. Canadian tax system 3 - 9
2. Record Keeping, Financial Statements and Tax Returns 10 - 14
3. Selection of Business Structure 15 - 19
4. Tax Rates and Tax Case Studies for carrying
on businesses in Ontario 20 - 26
5. Tax Planning for New Tax Residents 27 – 31
NOTE: This presentation was prepared in early 2012, and have not been
updated. The information contained herein is for general informational purposes
only. We recommend professional advice always be sought before taking
specific planning steps.
Provided by Sonja Chong, FCA 2

Who Is Liable to Pay Tax
• Canadian tax residents for Canadian income tax purposes – worldwide
income earned directly, or earned indirectly in certain circumstances
• Non-resident (foreign) corporations deemed resident in Canada if mind and
management in Canada
• Non-residents who earn specific types of income from Canada, e.g. rental
income from Canadian real estate
• International tax treaties may provide relief from double taxation, as with the
brand new Tax Information Exchange Agreements (TIEA)

Worldwide Income
• Income earned directly by tax residents
– ordinarily resident
– sojourner (183 day rule)
• Income earned indirectly via foreign entities (*) may be taxed
– Foreign Accrual Property Income (FAPI) of controlled foreign affiliates
(CFA); very wide scope
– Look through rules as if CFA does not exist
– For investments in Offshore Investment Funds - include in income an
amount equal to a percentage (2% plus interest rate prescribed under
Regulations) of the designated cost
– Certain income of non-resident trusts (limited look-through rules and
great tax planning opportunities for new residents)
* Many recent changes.

Foreign Affiliate (FA)
• To be a controlled foreign affiliate (CFA), it must first be a FA.
• To be a FA of a person, the person must have at least a 1% direct or indirect
interest, and at least an aggregate 10% direct or indirect interest in the non-
resident corporation held by the person and all related persons
• Is ForCo a FA of Mr. A?
ForCo
Canada
Foreign
Father of AThird Party
39% 60%
1%
A

Controlled Foreign Affiliate (CFA)
• a CFA at anytime of a resident taxpayer:
1. is a FA which at that time is controlled by the particular taxpayer, or
2. is a FA of the taxpayer and would be controlled by the taxpayer. In
determining control, the taxpayer would include all shares of the FA
that he/she owns, and:
(a) persons (include residents and non-residents) who deal at
non-arm’s length (“NAL”) with the taxpayer,
(b) all shares of the FA owned by any set of resident
persons not exceeding four persons, and
(c) any person who does not deal at arm’s length with any other
Canadian resident shareholder .

CFA
An Illustration
• A, B and C are not related to and deals at arm’s length with each other
• Is ForCo a FA and/or CFA of each of A and B?
• ForCo is A’s FA since A has more than 10%.
• ForCo is B’s FA as B has 10%.
• Is ForCo A’s CFA?
• Is ForCo B’s CFA?
ForCo
Canada
Foreign
A B
C
10%
49%
41%

Foreign Affiliates
Tax Free Repatriation of Active Business Income
Canada Canada
Treaty Country Treaty Country
Tax rate = 45%
Profit = $100,000
Canadian tax = $45,000
Carries on active
business directly
(branch)
Profit = $100,000
Tax rate = 20%
Withholding tax = 10%
Carries on active business
($)
Profit 100,000
ForCo’s foreign tax (20,000)
Dividend to CanCo (exempt surplus) 80,000
Foreign withholding tax (8,000)
CanCo’s cash retention 72,000
 $80,000 dividend income received by CanCo free of Canadian tax. A tax savings of $27,000, being $80,000 less $8,000 less
$45,000
CanCo
A
100%
CanCo
ForCo
A
100%
100%

Controlled Foreign Affiliates
Foreign Accrual Property Income (FAPI)*
Canada
($)
Dividend Income 80
Deduct: FAPI (20)
Deduct: Foreign Tax ($20 x 3) (60)
Net Dividend Income 0
Net cash retained in CanCo 75
* Now includes active business income earned in non-treaty and non-TIEA countries.
Any Foreign
Country
FAPI 100
Deduct: Foreign Tax ($20) x 4 (80)
Subject to Canadian Tax 20
Canadian Tax @ 25% (38% - 13%) 5
Summary
Foreign Tax 20
Canadian Tax 5
Total 25
CanCo
ForCo
100%
FAPI (generally means
property income, sometimes
business income deemed to
be property income)

Importance of Record Keeping
• required in order to prepare financial statements
• facilitate analysis for tax planning
• facilitate budgeting for business
• typical types of taxes, withholding and remittances
- income tax (includes tax on capital gains)
- harmonized goods and services tax
- withholding of employee tax, EI and CPP
- property tax
- land transfer tax
- business licence tax
- workplace safety insurance
• crucial in the removal of conditions for immigrants under the business entrepreneur
category

Tax and Information Returns
• income tax returns - calendar year for individuals and inter-vivos trusts, any
year end for corporations
• information returns - foreign assets
• tax evasion versus tax planning to avoid or minimize tax
• tax evasion is a criminal offence
• failure to file income tax or information returns could attract significant
interest and penalties
• timely and effective tax planning can save taxes and eliminate unnecessary
stress
• tax returns are one of the documents that are reviewed for purposes of
establishing residency for immigration purposes

Accountants’ Reports on Financial Statements
• Notice to Reader
• Review Engagement
• Auditor’s Report

Information Returns for Foreign Assets
1. T1134A - Foreign affiliates which are not CFAs
2. T1134B - Controlled foreign affiliates
3. T1141 - Resident transferor of property to non-resident trusts
4. T1142 - Resident beneficiary who received a loan, or a
distribution of trust income or capital from a non-
resident trust in any given year
5. T1135 - All other foreign assets
- Only needs to file if aggregate cost of specified foreign
property exceeds $100,000
Exception for first-year residents (other than a trust)

T1135
Information Return for Specified Foreign Property (“SFP”)
Three Levels of Penalties
1. Failure to file return
S.162(7) Greater of $100, and $25 per day not exceeding 100 days ($2,500)
2. Fails to file knowingly or
amounting to gross negligence 1st 24 months Maximum
S.162(10)(a) & S.162(10.1)(a) $500/month per S.162(10)(a) 5% of the greatest of all
amounts each of which is the
total of the cost amount to the
taxpayer at any time during
the year of a SFP less any
penalty under S.162(7) &
S.162(10)(a)
3. Knowingly or under
circumstances amounting to
gross negligence, fails to
comply with a CRA demand to
file
1st 24 month Maximum
S.162(10)(b) & S.162(10.1)(b) $1,000/month per S.162(10)(b) 5% of the greatest of all
amounts each of which is the
total of the cost amount to the
taxpayer at any time during
the year of a SFP less any
penalty under S.162(7) &
S.162(10)(b)

Selection of Business Form/Structure
Depends on:
• business risks, and the need to limit business liabilities to business assets
• minimization of income tax
• effective and multiple use of the lifetime $750,000 capital gains exemption
(CGE)
• personal cash needs
• other considerations

Business Form/Structure
1. Sole proprietorship
2. Partnerships - registration required
- general versus limited
3. Joint Ventures
4. Corporations
5. Trusts
6. A creative combination of one or more of the above

Business Form/Structure
Personal Trusts
• legal ownership versus beneficial ownership
• four elements - settlor/transferor, trustee, trust property, beneficiaries
• inter-vivos (taxed at highest marginal individual tax rate) versus testamentary trusts
(taxed at graduated rates)
• can be a flow-through entity (much like partnerships)
Resident
Trust
Settlor/Transferor Beneficiaries
Trust Property
Trustee

Business Structure
1. Sole proprietorship/Joint Venture/Partnership
- family members can be joint venturers or partners
- take advantage of the graduated tax rate system to reduce aggregate
tax liability for family
- business losses can be deducted against other types of income
- highest marginal individual tax rate for 2011 and 2012 is 46.41%
(Federal – 29%; Ontario – 17.4096%)

Business Structure
2. Corporations
- limited liability
- family members can be shareholders (watch under 18 children and
grandchildren)
- 2011 combined Federal (11%) and Ontario (4.50%) tax rate on first
$500,000 of active business income (“ABI”) of Canadian controlled
private corporations (CCPC) is 15.5%
- compare this 15.5% rate to highest personal tax rate of 46.41%
- personal cash requirements can be extracted from the corporation via
salary, dividends, loans or a combination thereof
- consider using Structure 1 (on page 18) for start-ups (with expected losses),
then change business structure (can be done on a tax-free basis) to
corporate structure (generally lower tax rates on the first $500,000 of
ABI) on the upswing

Top Marginal Combined Tax Rates (%) - Ontario Resident Individuals
2012 2011
Employment & Other Income 46.41 46.41
Capital Gains 23.20 23.20
Canadian dividends – Non-eligible 32.57 32.57
Canadian dividends – Eligible 29.54 28.19

2012 2011
1. CCPC Small Business Rate (a) 15.50 15.50
2. M & P Rate (and not 1) 25.00* 26.50
3. General Corporate Rate (and not 1 or 2) 26.75* 28.25
4. CCPC Investment Income Rate 46.41 46.41
5. Capital Gains Rate 23.20 23.20
Combined Federal and Ontario Corporate Tax Rates (%)
(a) On the first $500,000 of the annual active business income of Canadian
Controlled Private Corporations (CCPC).
* Expected reduction in these rates from 2011 is based on “scheduled” increase
of “general rate reduction” from 11.5% in 2011 to 13% in 2012.

Concept of Tax Deferral - Example One
CCPC Sole-Proprietorship
Active business income 300,000 300,000
Tax rate (2011) 15.5% Graduated Rates
Corporate tax (A) 46,500 N/A
After-tax earnings, i.e. dividends 253,500 N/A
Individual tax (graduated rates) on
- dividend (B) 63,594 N/A
- business income N/A 123,156
Total corporate and individual
taxes (C) = (A) + (B) 110,094 (D) 123,156
Tax Savings (D) - (C) 13,062
Tax deferral (25.55% !) (D) - (A) 76,656

Concept of Tax Deferral - Example Two
CCPC Sole-Proprietorship
Active business income 300,000 300,000
Tax rate (2010) 15.5% Highest Rate
Corporate tax (A) 46,500 N/A
After-tax earnings, i.e. dividends 253,500 N/A
Individual highest marginal rates on
- dividend (32.57%) (B) 82,565 N/A
- business income (46.41%) N/A 139,230
Total corporate and individual
taxes (C) = (A) + (B) 129,065 (D) 139,230
Tax Savings (D) - (C) 10,165
Tax deferral (30.91% !) (D) - (A) 92,730

Advantages of Corporate Structure
• huge 30.91% (46.41% versus 15.5%) tax deferral for those at top marginal
rate
• individual residents can each receive about $38,500 of dividend paid out
of small business rate retained earnings, and about $51,500 of dividend paid
out of general business rate earnings completely tax-free (except for $450
and $750 of Ontario Health Premium - OHP)
• up to $750,000 of capital gains on sale of shares of small business
corporations can be exempt from tax (CGE)
• use of trusts with corporations
- to create multiple use of CGE
- to take advantage of tax-free dividends
- for credit proofing purposes
- for estate planning purposes
- to reduce probate fees
• tax-effective Wills

Life Cycle of a Business
1. Start-up
Mr. A Mr. A and Mrs. A
carries on business carry on business
2. Profitable (reorganize Structure 1 to 2 on a tax-free basis
Mr. A
common shares
CanCo
carries on active business

Life Cycle of a Business
3. Mature - reorganize Structure 2 to 3 on a tax-free basis
Mr. A Trustee
A
B
A - voting shares B - non-voting shares
- preferred shares - growth shares; captures
- value frozen appreciation in value of CanCo
CanCo/CCPC
carries on active business
Resident
Trust
Mr. A, Mrs. A, children,
grandchildren can be
beneficiaries, if structured
properly

Tax Planning for New Tax Residents
• deemed acquisition at fair market value (“FMV”) before becoming resident
• collect all income prior to becoming resident, if home country tax liability is
lower
• reorganize foreign company structure so up to FMV can be extracted tax-free
(!!!) - watch home country taxation rules
• select appropriate business structure - see Life Cycle of Business
• about $38,000 non-eligible dividend tax-free every year if individual has no
other sources of income (except for $450 Ontario Health Premium or OHP)
• about $51,500 eligible dividend tax-free every year if individual has no other
sources of income (except for $750 OHP)
• effective use of offshore trusts
• watch FAPI of controlled foreign affiliates
• watch active business income of controlled foreign affiliates sourced from non-
treaty or non-TIEA countries - proposed to be deemed FAPI

Case Study
Tax-free Extraction of Value Accrued
1. Original 2. On Becoming Resident
HKCo
Mr. Omar
Cost = $100
FMV = $1 million
PUC = $100
100%
HKCo
Mr. Omar
Cost = FMV = $1 million
PUC = $100
100%
Foreign
HoldCo
Mr. Omar
Cost = FMV = $1 million
- takes back shares worth $1 and loan (promissory note of $999,999)
3. To reorganize structure
HKCo
100%
100%

Offshore Trusts
• legal ownership versus beneficial ownership
• four elements – settlor/transferor, trustee, trust property, beneficiaries
• typically additional element for offshore trusts - protector as a watchdog over the
trustee
• taxation rules of non-resident trusts first proposed to be changed in the 1990
Federal Budget; latest changes (significant) released in 8/27/2010 Draft
Legislation (DL)
• Complex taxation rules proposed in 8/27/2010 Draft Legislation and 9/28/2010
Notice of Ways and Means Motion for contributions by long-term tax residents
• benefits remain particularly for new residents/immigrants, and those who stand to
receive or inherit significant assets from foreign resident relatives/friends
• key is the cumulative period of residency of the settlor/transferor

Offshore Trusts
Immigrant Trust
Bahamian Trust
Company
Bahamian
Trust
Mr. A gifted $3 million to trust
say prior to moving to Canada
Beneficiaries could be Mr. A’s spouse
and children who also move to Canada
$3 million of portfolio
investments
• provided income earned in a year by the trust is not distributed to resident beneficiaries in the same year,
income on $3 million capital accumulates free of tax for maximum 60 months
• assumes home country does not levy tax based on say citizenship
• cash requirements can be met by distribution out of trust capital - tax-free
• trust to be restructured/wound up before 60-month deadline
• Form T1141 - to be filed every year by Mr. A
• Form T1142 - upon distribution of trust income and/or trust capital, and/or loans made to beneficiaries;
resident beneficiaries to file

Offshore Trusts
Inheritance/Testamentary Trust/Inter-Vivos
Bahamian Trust
Company
Bahamian
Trust
Grandmother’s will provides that $5
million be settled in a trust for the benefit
of her children and grandchildren in
Canada (or grandmother makes a gift
while alive)
Beneficiaries can be children and
grandchildren resident in Canada
and/or other non-resident relatives
$5 million of portfolio
investments
• tax exempt status of trust is perpetual as grandmother never resided in Canada
• no information reporting necessary until trust income or trust capital distributed to or loans made to
resident beneficiaries (T1142)
• watch foreign income and estate tax rules

Canadian Tax System & Doing Business in Ontario - February 25, 2013 Seminar (in English)

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