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Taxation and the financial policy of Canadian closely-held corporations

University of British Columbia

Closely-held corporations differ from widely-held corporations in that there are only a few shareholders, most or all of whom participate actively in management. This implies that the objective function is the owners' utility rather than profits, and corporate behaviour is influenced by both the corporate and personal income taxes. This dissertation builds a theoretical model of a closely-held corporation based on these features and uses this model to study empirically farmers' decisions to incorporate. The theoretical model determines the financial policy of a closely-held corporation from the static utility maximization problem of its owner. The model differs from previous work in that the set of financial instruments is extended beyond taxable dividends to include owner's salary, in-kind benefits, and the change in loans from the owner. Also, the modelling of the tax system is unusually detailed and includes the special tax provisions applying to incorporated Canadian small businesses . The Kuhn-Tucker conditions for the model show that the quantities of in-kind benefits consumed by the owner will depend on prices which are adjusted for the tax consequences of the goods' purchase. For dividends, salary, and changes in the amount of shareholder's loans, a financial optimum requires that it is not possible to decrease total personal and corporate taxes paid by increasing one financial variable and decreasing another. More specific conclusions are derived from the model in two ways. First, tax rates applying in Ontario in 1980 are substituted in the Kuhn-Tucker conditions to produce graphs showing the optimal financial policy in the more common situations'. Second, linear programming is used to provide numerical examples of optimal financial policies. This information is used to illuminate a number of tax policy issues relating to closely-held corporations. Other chapters discuss the extension of the model to multiple owners, many time periods, and the decision to incorporate. The last issue is studied empirically using a sample of 3,000 Saskatchewan farmers. Probit analysis shows that the probability that a farm will be incorporated is positively related to the farmer's education and the tax savings from incorporation.

Text

2010-05-02

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http://hdl.handle.net/2429/24321

Economics

University of British Columbia

Graduate