To begin with, corporate business income is the company’s profit for the year.
The basic formula that will be discussed in details as follows:
Accounting Net Income
Items that increase accounting net income, but are not subject to tax;
Capital gain (accounting) on the sale of a depreciable capital property such as building
Items not included in calculation of accounting net income, but are subject to tax
Recapture on the sale of depreciable capital asset
Items deductible from net income, but not deductible for tax
Amortization on the financial statements
Items that are not deducted from accounting income, but deductible for tax
Capital Cost Allowance (CCA) on depreciable capital assets
Net income for tax purposes
Generally, financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP) or based on ASPE for small businesses in Canada. Therefore, the accounting income presented in the financial statements is income defined by GAAP.
Many of the rules to calculate business income for corporations under GAAP are very similar to computing the income under Income Tax Act (ITA). However, there are a number of differences that need to be addressed. As a result, the first step in calculating taxable income for a corporation is to convert accounting net income from the financial statements under GAAP into net income for tax purposes. And only then, computation continues further from total to net income (Division B income for tax purposes) to Taxable income (Division C Income).
And to successfully make this conversion in calculating taxable income, there are a number of adjustments that need to be made for each particular circumstance. Number of adjustments might be necessarily because of different allocation patterns that the company used and that result in timing differences between net income on the financial statements and net income for tax purposes. We will be discussing these adjustments in more detail further. However, most common examples include differences between depreciation and amortization of tangible and intangible assets and Capital Cost Allowance (CCA), or for example, alternative methods to determine pension expense deductions. Other adjustments might also involve permanent differences between accounting and tax amounts. Such an example would be a difference that results in non-taxation of one-half of capital gains and including another half as taxable capital gain.
Important to note, that reconciliation between accounting net income and net income for tax purposes is an absolute requirement under Canadian Income Tax Act. The major form the CRA requires to provide for this reconciliation is designated Schedule 1. MOreover, conversion of the accounting net income into net income for tax purposes is equally applicable to both incorporated and unincorporated businesses. Business income earned by an individual is typically included into his/her personal income tax return (T1) that individuals need to file by June 15 each year (self-employed), while business income earned by corporation in Canada is included in the T2-corporate tax return that must be filed within six months after the year end.
The most common adjustments to conversion of accounting Net Income to Net Income For tax Purposes:
Additions to Accounting Income:
Income tax expense (corporate)
Amortization, depreciation and depletion of tangible and intangible assets recorded on the financial statements (accounting amounts)
Any recapture of CCA
Tax reserves deducted in the prior year
Losses on the disposition of capital assets (accounting amounts)
Pension expenses (accounting amounts)
Scientific research and experimental development expenditures (accounting amounts)
Warranty expense (accounting amounts, at the end of the year)
Amortization of discount on long-term debt issued
Foreign tax paid (accounting amounts, at the end of the year)
Excess of taxable capital gains over allowable capital losses
Interest and penalties on income tax assessments
Unpaid remuneration (>180 days after year end)
Non-deductible automobile costs
Finty present of business meals and entertainment expenses
Club dues and cost of recreational facilities
Non-deductible reserves and contingent liabilities (accounting amounts at year end)
Asset write-down including impairment losses on intangibles
Fines, penalties and illegal payments
Financing fees – deductible over 5 years period
Deductions from Accounting Income
Capital Cost Allowance (CCA)
Amortization of cumulative eligible capital (CEC)
Tax reserves claimed for the current year
Gains on disposition of capital assets (accounting amounts)
Pension funding contributions
Deductible scientific research expenditures
Deductible warranty expenditures
Amortization of premium on long-term debt issued
Foreign non-business tax deduction
Allowable business investment losses
Once the conversion adjustments from net income to taxable income from above is complete on Schedule 1, we will arrive at Division B income. Then, additional specified items can be deducted from the resulting net income for tax purposes in order to arrive at taxable income and which are commonly referred to as Division C deductions. These deductions are specified in Division C of the Income Tax Act and are as follows:
The following are selected Division C Deductions:
Charitable gifts, gifts of medicine or gifts of a cultural property to institutions
Carry-over of non-capital losses
Carryover of net capital losses
Carryover of restricted farm losses
Carryover of limited partnership losses
Dividends from Canadian corporations
Dividends from foreign affiliates
Unlike the situation for individuals (that are typically provided with non-refundable tax credits) corporations are also able to deduct charitable donations (but under Division C deductions) from net income for tax purposes in the determination of their taxable income. The types of donation that provide a corporation with this deduction are exactly the same as the types of donations that will provide an individual with a tax credit. Also, corporations are subject to the same limitation of 75% of net income for tax purposes (Division B) that is also applicable to individual taxpayers.
But nonetheless, the deduction is limited to 100% of the amount of a taxable capital gain in respect of gifts of appreciated capital property. Moreover, the deduction is to 100% of any CCA recapture that can arise on the gift of depreciable capital property.
Also, any unused donations can be carried forward five years to be deducted in future periods. However, the total claim for donations carried forward to a year and current donations made in that year can not exceed division B income limit. In addition, corporations do not need to deduct the maximum allowable donations amount in a given year, and any undeducted amounts can be available for deduction in future periods. It is particularly important for deduction, that any donation needs to be supported by actual receipt for tax purposes and necessarily to include all prescribed information required.