Business and Operations
Business Advisor: Jan/Feb 2011
By Gordon Jessup
By Gordon Jessup
We are in interesting times. While reports indicate that the Canadian
economy is moving in the right direction, some uncertainty lingers due
to sluggish growth in the United States and sovereign debt concerns for a
number of European countries.
In light of declining corporate income tax, use these tax deferral strategies to reap permanent income tax savings.
We are in interesting times. While reports indicate that the Canadian economy is moving in the right direction, some uncertainty lingers due to sluggish growth in the United States and sovereign debt concerns for a number of European countries. But, there is a silver lining. Corporate income tax rates are declining and it means an opportunity for Canadian businesses to realize permanent tax savings through the use of tax deferral strategies.
Yes, you heard right: corporate income tax rates are declining. The federal government has announced that the general corporate tax rate will be reduced from 18 per cent to 16.5 per cent Jan. 1, and to 15 per cent on Jan. 1, 2012. Provincial corporate tax rates in British Columbia, New Brunswick and Ontario are also scheduled to decline.
|Corporate tax rates are declining. It’s a great time to use deferral strategies for permanent tax savings.
What does this mean for businesses in Canada? It means an opportunity for permanent income tax savings through the use of tax deferral strategies. Here’s how it works. When tax rates decline, the taxable income deferred is subject to a lower rate of tax. The result is a permanent tax savings.
Corporations can defer tax in two ways: reducing taxable income by accelerating tax deductions and/or by deferring income inclusions.
Accelerating tax deductions
I see several opportunities to claim tax deductions that companies either overlook or ignore. They are unrealized losses on the balance sheet.
For example, doubtful accounts (potential bad debts) and obsolete inventory are unrealized losses. If you have a general reserve for these items in your accounting records (for example, two per cent of sales), they are not tax deductible. However, if you can identify specific obsolete inventory items or accounts that may be bad debts, you can claim tax deductible reserves for them. Take the time to review individual receivable accounts and inventory items to see if you have these opportunities. These deductions can be claimed even if the general reserves are not adjusted for financial statement purposes.
The sale or disposition of an asset, resulting in either a capital or income loss, is another example of an unrealized loss that could translate to an immediate tax deduction. For example, if it has been your policy to recognize foreign exchange gains and losses when realized (sold or disposed of), then check to see if there are any losses that can be realized before year end. You may be able to claim the foreign currency loss by selling the foreign currency.
Another opportunity to accelerate deductions is to ensure that all newly acquired assets are put into use before year-end. Capital cost allowance (depreciation for tax purposes) cannot be claimed on assets that are not available for use. This rule was introduced many years ago to counter taxpayers who would purchase assets immediately before the end of their year-end for the tax deduction.
Claiming allowable reserves, selling assets at a loss and putting assets in use can be done at the end of the year. Other techniques like making life insurance premiums tax deductible or accelerating the deduction for leasehold improvements require prior planning.
Life insurance premiums are not tax deductible unless the policy is required as collateral by a lender. So when renewing the terms of your loan, it may be possible to have the lender add the requirement for insurance, thus making the cost of the life insurance deductible.
Leasehold improvements are deductible over the lesser of the term of the lease plus its first renewal term or five years. So when entering into a new lease, structure the terms in order to accelerate the tax deductions for leasehold improvements. For example, rather than enter into a five year lease with an option to renew for another five years, enter into a four-year lease with an option to renew for another year and then another five years. This will allow you to deduct the leasehold improvements over a five-year period rather than a 10-year period, thereby realizing the deductions faster.
Reducing income inclusions
Income inclusions can be reduced by delaying the shipment of goods or the provision of services into the next tax year. Of course, you will want to ensure that your customer is not negatively impacted by this strategy. You want to defer your revenue, not lose it.
This is not an exhaustive list of ways in which a company can defer its income tax. There are many other ways to achieve this result. Some are more aggressive than others and you should always seek professional tax advice so that you understand your options. / BJ
Gordon Jessup is a partner in the Tax Practice in the Toronto office of Fuller Landau LLP. Fuller Landau provides tax, accounting and business advisory services to owners of growth-oriented, mid-sized businesses. www.fullerlandau.com .