Varying provincial tax rates on corporations and varying provincial dividends tax credits for individuals can result in imperfections in the integration system. Briefly explain how these imperfections can influence the decision to use a corporation to earn business income.

Question

Quizplus · Accepted Answer

The Answer is The goal of integration is to ensure that, when a corporation is used, the combined corporate and individual taxes paid will be same as those paid by an individual receiving the same income directly. For eligible dividends, the enhanced gross up and tax credit procedures are based on the assumption of a combined federal/provincial corporate tax rate of 27.54 percent. For non-eligible dividends, the gross up and tax credit procedures are based on the assumption of a combined federal/provincial corporate tax rate of 13.04 percent. If the actual combined rate exceeds these rates, it will discourage the use of a corporation. If the actual combined rate is less than these rates, use of a corporation becomes more attractive.
The other assumption that is inherent in the integration system is that the combined federal/provincial dividend tax credit will be equal to the gross up. For eligible dividends, the federal credit is equal to 6/11 of the gross up. For the combined credit to equal the gross up, the provincial credit must be equal to 5/11 of the gross up. For non-eligible dividends, the federal credit is equal to 9/13 of the gross up. For the combined credit here to equal the gross up, the provincial credit must be equal to 4/13 of the gross up. If the provincial credit exceeds these values, the combined credit exceeds the notional corporate taxes and makes the use of a corporation more attractive. Alternatively, if the provincial credit is less than these values, the credit does not compensate for corporate taxes paid and this discourages the use of a corporation.

Varying Provincial Tax Rates on Corporations and Varying Provincial Dividends