Basic Principles

AuthorVern Krishna
ProfessionProfessor of Common Law, University of Ottawa Barrister at Law
Up to this point, we have looked at the rules in re spect of the computa-
tion of net income, taxable income and tax payable. Most of the rules
apply to all taxpayers, including individuals, corporations and t rusts.
We turn our attention now to the rules that apply specif‌ically to cor-
porations and their shareholders.
The complexity of corporate taxation derives from the division of
economic and legal ownership. In terms of economic relationships, the
shareholders of a corporation own its assets, whilst corporate prof-
its and losses accrue to their benef‌it or detriment. Thus, in economic
terms, the income and losses of the corporation ref‌lect upon the share-
holder’s f‌inancial stake in the cor poration.
In corporate law, however, a corporation and its shareholders are
separate legal entities. Thus, shareholders do not have a direct legal
interest in the asset s of the corporation, but have a legal interest in the
corporat ion’s equity.
This distinction between the economic and the legal relationships
between the shareholders of a corporation and the corporate entity
works well in corporate law. The corporation, which is a statutory en-
tity, allows shareholders to limit their personal liability for corporate
debts. Thus, for most corporate purposes, a creditor of a corporation
cannot attach personal liability to its shareholders.
Tax law generally follows the corporate model that a corporation
is a separate tax payer in its own right.1 However, the legal distinction
between a corporation and its shareholders gives rise to diff‌icult prob-
lems. Tax law cannot focus solely on the legal relationship and com-
pletely ignore the economic relationship between a corporation and its
shareholders. Thus, although the corporation and its shareholders are
separate taxpayers, we shall see many tax r ules that reach through the
corporat ion to its sha reholders.
For most purposes, we calculate the income of a corporation in a
manner simil ar to that of an individual. Of course, a corporation ca nnot
claim personal t ax credits and dependency deductions. But apart from
these disti nct circumsta nces, we determine the net income and ta xable
income of a corporation according to the general rules described in the
preceding ch apters.
There are, however, two important differences in the ta xation of in-
dividuals and corporations. First, most individuals (at least those who
are employees) f‌ile their income taxes on a cash basis. Corporations
may not use cash basi s accounting and must use the accr ual basis. This
requirement is implicit in section 9.
Second, individuals who are employees must report t heir income
on a calendar-year basis.2 In contrast, cor porations may select their f‌is-
cal year on any twelve-month basis.3
1) Separate Legal Entity
A corporation is a “person” and, therefore, a “taxpayer.”4 The def‌ining
attribute of a corporation is that it is a legal ent ity distinct from its
Thus, unlike a partnership, which is a relationship between per-
sons carr ying on business in common with a view to prof‌it,5 a corpora-
tion has a legal existence separate and apart from its shareholders.
Since a corporation is a separate entity, its property, assets and li a-
bilities belong to, or f‌low from, the corporation. This is so even if it ha s
only one shareholder who owns all of its issued and outst anding shares.
1 Income Tax Act, RSC 1985, c 1 (5th Supp) [ITA], subs 248(1) “person,” “taxpayer.”
2 Ibid, para 249(1)(b).
3 Ibid, para 249(1)(a) and subs 249.1(1).
4 Ibid, subs 248(1) “person,” “taxpayer.”
5 See, for example, Partnerships A ct, RSO 1990, c P.5, s 2.
Basic Pri nciples 399
The “one person company” is no less a separate legal identity than a
publicly-held cor poration.
2) The Salomon Doctrine
Salomon v Salomon & Co6 is the locus classicus upholding the principle
that a corporation has a legal identit y that is distinct from its sharehold-
ers. Salomon incorporated a company to which he sold his unincorpor-
ated shoe manufacturing busi ness in return for all but six of its issued
shares and £10,000 of secured debentures. When the company fell upon
hard times and wa s wound up a year later, the unsecured creditors, al-
leging that the company was a mere al ias or agent of its principal share-
holder, claimed that Salomon was personally li able to indemnify their
claims. The House of Lords held that t he parties had complied with all
of the requirements of the corporate statute authorizing the creation of
the company, that the corporation was not a sham, and that Salomon had
not acted fraudulently. As a secured creditor of the corporation, Salomon
ranked ahead of its unsecured creditors. As Lord Macnaghten said,
The company attains m aturity on its birth. There is no per iod of min-
ority — no interval of incapacit y . . . . The company is, at law, a differ-
ent person altogether from the s ubscribers to the memorandum; and,
though it may be that af ter incorporation the busines s is precisely the
same as it was before, t he same persons are man agers, and the same
hands receive the prof‌it s, the company is not in law the agent of the
subscriber s or truste e for them. Nor are the subsc ribers, as members
liable, in any shape or form, e xcept to the extent and in the man ner
provided by the Act .7
3) Parent and Subsidiary
The principle that a corporation is a legal entity separate from its share-
holders also applies to the relationship between a parent company and
its subsidiar y. Thus, in the absence of a specif‌ic statutory provision to
the contrary, a parent corporation and its subsidi ary are separate and
distinct legal entities. This is so even where the parent owns all t he
6 Salomon v Salomon & Co, [1897] AC 22 (HL).
7 Ibid at 51. Although Mr. Salomon had not comm itted any fraud on his creditors ,
it was found that he ha d sold his business to hi s company at an extravagant
price. As Lord Ma cnaghten stated, the price “re presented the sangui ne expecta-
tions of a fond owner rat her than anythin g that can be called a bus inesslike or
reasonable e stimate of value” (at 49).

To continue reading

Request your trial

VLEX uses login cookies to provide you with a better browsing experience. If you click on 'Accept' or continue browsing this site we consider that you accept our cookie policy. ACCEPT