tax planning using private corporations. 25 2017... · using private corporations. september 25,...
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• Policy context
• Historical context: current rules
• Consultations: approaches put forward for discussion
• Key questions for discussion
2Department of Finance – September 2017
Increasing Incentives for Tax Planning Using
a Private Corporation
The growing gap between corporate and personal income
tax rates since 2000 has increased rewards associated with
tax planning in a private corporation…
… Over this period, a growing share of
high-income self-employed individuals have
chosen to incorporate
Department of Finance - July 2017 3
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
2000 2002 2004 2006 2008 2010 2012 2014 2016
Federal-Provincial Tax Rates
Combined Federal-Provincial
Small Business Rate: 14.4% (2017)
Combined Federal-Provincial
General Corporate Income Tax Rate: 26.7% (2017)
Top Combined Federal-Provincial Personal Income Tax
Rate: 51.6% (2017)
37.2
percentage
point gap
(2017)
0%
1%
2%
3%
4%
5%
6%
7%
8%
2001 2003 2005 2007 2009 2011 2013
Ta
xa
ble
Active
In
co
me
/ G
DP
Trend in Taxable-Active-Income-to-GDP Ratio, by Type of Business
Canadian Controlled Private Corporations (CCPCs)
Public Corporations and Private Corporations other than CCPCs
Individuals with Self-employment Income
Integration
• Low corporate tax rates on business income are intended to provide
a tax advantage as long as income is retained for active business
reinvestments.
• Income that is paid out of a corporation as a dividend is generally
meant to be subject to the same amount of tax as income received
directly by the individual.
Corporate taxes on earnings + Personal taxes on dividends = Personal
taxes on income earned directly
• Integration issue: incentive to hold savings financed by retained
earnings within corporations to save taxes
• This issue was recognized in 1972
4Department of Finance - July 2017
Historical context: Current rules
• Current system introduced in 1972
• Refundable taxes on investment income ensure integration when
business owner uses after-tax income to finance a passive portfolio
within a corporation
• In 1972, the introduction of Part V tax ensured integration when
using retained earnings to finance a passive portfolio
• Part V tax repealed on the basis that:
• It was seen as complex
• This added complexity was believed not necessary
I believe that these small corporations which enjoy the benefit of the lower rate of tax will, in fact, use these savings to expand their businesses, to improve their technology and to create more jobs for Canadians
5Department of Finance - July 2017
Consultations
• Government is seeking input on best manner to eliminate deferral
advantages going forward
• Paper lays out two broad approaches:
• Reintroduction of Part V tax, with adjustments
• Introduction of a deferred taxation model
- A deferred taxation model could take various forms, two of which are described in the paper:
• Apportionment approach
• Elective approach
6Department of Finance - July 2017
Reintroduction of Part V Tax
• Imposition of an upfront tax when retained earnings are used to
acquire passive investments
• This additional tax would bridge the gap with top PIT rate
- For example, a business eligible for the small business deduction would pay a 35% additional tax at the time of acquisition of portfolio assets
• Tax refundable if later on assets are used to reinvest in the business
• Need to keep track of income streams in order to apply the appropriate amount of tax when investment assets are purchased
• Passive investment income would continue to be taxed as per
current rules
7Department of Finance - July 2017
Deferred Taxation Model: Apportionment Approach
• Need to track source of financing for passive investments in order to
estimate deferral
• Affects businesses at the moment of dividend payout:
• Affects tax outcomes at the moment a dividend is paid out, rather than when an investment asset is acquired
- But in effect, same overall outcome as Part V tax
• Those saving to reinvest in their business not materially affected
• Precision in tax outcomes, tailored to various business situations
8Department of Finance - July 2017
Deferred taxation model: elective approach
• Minimizes needs for tracking, in favour of proxy methods
• Default tax treatment tailored to the case of a business using
retained earnings to finance portfolio investments
• Elections available for businesses with general rate income
• Under both approaches, options to keep current tax regime available
when investments finance with savings taxed at the personal level
9Department of Finance - July 2017
Key questions for discussion
• Government is seeking feedback, in particular:
• What is the best approach to tackle the issue?
• How to minimize complexity, while achieving policy objectives?
• Capital dividend account: what is the appropriate scope of the new tax regime with respect to capital gains?
• Transition issues
10Department of Finance - July 2017
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Ted Cook, Director – Tax Legislation Division Department of Finance (Canada)
Income Sprinkling and Conversion of Dividends into Capital Gains
3 2017 Taxation of Private Corporation Policy Conference
Overview
● Tax-planning arrangements under which income that would otherwise have been taxed as income of a high-income individual in the absence of the “income sprinkling” arrangement is instead taxed as income of a lower-income individual, typically a family member of the high-income individual
● The intended effect of the arrangement is to have the income subject to a lower or nil effective rate of income tax by accessing otherwise unused tax attributes of the lower-income individual
● Tax benefits from income sprinkling increase with: The difference in tax rates between the transferor and the transferee
The amount of income that can be sprinkled
The number of individuals who can receive the sprinkled income
Income Sprinkling
4 2017 Taxation of Private Corporation Policy Conference
Example
● In base scenario, net earnings are taxable at full PIT rates in the hands of the self-employed individual
● In the scenario where the individual incorporates, the after-CIT profits are paid out as dividends to the owners of the CCPC, including the individual’s spouse and adult child
● Taxes are reduced because the spouse and adult child do not pay federal tax on the dividend income
Income Sprinkling
CCPC
Owner Owner Spouse Child
Federal CIT (10.5%) n/a $23,000 n/a n/a n/a
Provincial CIT (4.5%) n/a $10,000 n/a n/a n/a
Federal PIT $49,000 n/a $11,000 $200 $200
Provincial PIT (ON) $30,000 n/a $9,000 $500 $500
Total tax $79,000
Average tax rate 36%
$54,000
25%
Net self-employment earnings of $220,000
Net profits of $220,000
Post-CIT $187K dividend allocated60%/20%/20% among Owner, Spouse and Child
Base Scenario:Self-employed Incorporated
$112,000 $37,000 $37,000
5 2017 Taxation of Private Corporation Policy Conference
Dividends by Age
Income Sprinkling
0
100
200
300
400
500
600
700
800
900
1,000
0 2 4 6 810
12
14
16
18
20
22
24
26
28
30
32
34
36
38
40
42
44
46
48
50
52
54
56
58
60
62
64
66
68
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98
10
0
No
n-e
lig
ible
div
ide
nd
s ($
mil
lio
n)
Age
2006
2010
2014
6 2017 Taxation of Private Corporation Policy Conference
Issue
● The use of a private corporation in particular facilitates income sprinkling
arrangements
● Income sprinkling raises a number of tax policy concerns
High income individuals able to control income and to whom it is paid can obtain
tax benefits not available to those who do not control income
Erodes tax base
Income Sprinkling
7 2017 Taxation of Private Corporation Policy Conference
Existing Rules
● Existing rules that constrain income sprinkling Longstanding rule restricts the deduction of expenses (including salary) if amount not reasonable
Attribution rules apply to gift arrangements to redirect income back to the high-income individual
Tax on split income (TOSI) introduced in 1999
● Existing rules not fully effective in constraining sprinkling with adults Attribution rules apply to spouses, but tax planning can circumvent the rules
Limited rules to address arrangements involving other adults (such as children)
Jurisprudence has limited the effective scope of some of the rules: 1998 Neumann decision (Supreme Court of Canada)
● Some structures have been identified that seek to circumvent the TOSI rules applicable to minors
Income Sprinkling
8 2017 Taxation of Private Corporation Policy Conference
LCGE Multiplication
● The Lifetime Capital Gains Exemption (LCGE) provides an exemption in computing
taxable income in respect of capital gains realized by individuals on the disposition
of qualified farm or fishing property (QFFP) and qualified small business
corporation shares (QSBCS)
● By having family members (or a family trust) as shareholders of the QSBC, the
LCGE limit of each family member can be accessed on a disposition of the QSBCS
● This raises a concern the individuals may be able to claim the LCGE even though
they may not have invested in, or otherwise contributed to, the business value
reflected in the capital gains from the disposition of the QSBCS
Income Sprinkling
9 2017 Taxation of Private Corporation Policy Conference
Policy Response
Proposals to address income sprinkling
● Expand TOSI rules to Canadian resident individuals, whether minor or adult, who receive ‘split income’
● Refine ‘split income’ definition Include new categories of amounts, such as corporate debt
Income received by an individual over 17 from a corporation will only be split income if a related individual (a ‘connected individual’) has a certain measure of influence over the corporation
● Introduce a reasonableness test to determine whether split income received by an individual over 17 will be subject to the TOSI The test is more stringent for individuals between 18 and 24
Income Sprinkling
10 2017 Taxation of Private Corporation Policy Conference
Policy Response – LCGE Multiplication
Proposals to address LCGE multiplication
● Individuals will no longer qualify for the LCGE in respect of capital gains that are realized, or that accrue, before the taxation year in which the individual attains the age of 18 years
● The LCGE will generally not apply to the extent that a taxable capital gain from the disposition of property is included in an individual’s split income
● Subject to certain exceptions, gains that accrued during the time that property was held by a trust will no longer be eligible for the LCGE
Transitional rules would allow affected individuals to elect to realize, on a day in 2018, a capital gain in respect of eligible property by way of a deemed disposition for proceeds up to the fair market value of the property
Income Sprinkling
11 2017 Taxation of Private Corporation Policy Conference
CONVERSION OF DIVIDENDS INTO CAPITAL GAINS
12 2017 Taxation of Private Corporation Policy Conference
Overview
● Dividends are taxed at a higher rate than capital gains, which are only one-half taxable
● Individual shareholders can reduce their income taxes by converting corporate income (e.g., amounts that would otherwise be paid out as dividends) into capital gains
● The federal and provincial tax savings in 2016 associated with converting dividends into lower-taxed capital gains is approximately $17,500 per $100,000 of conversions of ineligible dividends (at the average/highest
provincial tax rate for ineligible dividends paid from corporate earnings taxed at the small business rate)
$11,100 per $100,000 of eligible dividends (at the average/highest provincial tax rate for eligible dividends paid from corporate earnings taxed at the 15% general rate)
Conversion of Dividends
13 2017 Taxation of Private Corporation Policy Conference
Section 84.1 – Dividend Treatment (applicable)
● Section 84.1 addresses individual tax avoidance that can arise when an individual sells shares of a Canadian corporation to another corporation related to the individual (e.g., owned by individual, spouse, siblings, children/grandchildren)
● Such share sales could, absent section 84.1, be used to convert dividends in the hands of the individual into lower-taxed capital gains, including gains eligible for the Lifetime Capital Gains Exemption (LCGE) This is because the related corporation could pay the individual with the proceeds of a
dividend from the Canadian corporation, which the related corporation can receive tax-free because the inter-corporate dividend deduction is available
● To prevent this result, the proceeds from the share sale are treated as a taxable dividend and not as a capital gain if section 84.1 applies
Conversion of Dividends
14 2017 Taxation of Private Corporation Policy Conference
Section 84.1 – Capital Gains (inapplicable)
● Section 84.1 does not apply on a sale of shares by individuals to their
children, to any other related individual, or any arm’s length person
Individuals can claim capital gains treatment – including the LCGE, where
available – on a direct sale of shares to their children
It is not necessary for section 84.1 to apply in this case because the individual
purchaser would face dividend taxation if they attempt to withdraw earnings of
the corporation
Conversion of Dividends
15 2017 Taxation of Private Corporation Policy Conference
Avoidance of Section 84.1 (cont’d)
● The conversion of dividends into lower-taxed capital gains ineligible for the
LCGE benefits owners of both large and small private corporations
● Section 84.1 applies only to sales by individuals to corporations and can be
avoided
Conversion of Dividends
16 2017 Taxation of Private Corporation Policy Conference
Intergenerational Business Transfers
● It is argued by some that existing section 84.1 should be loosened with
respect to the LCGE to facilitate intergenerational business transfers
● The tax policy concern regarding intergenerational business transfers is
distinguishing a genuine sale, where the children carry on the business, from
a sale that facilitates the conversion of dividends into capital gains
Conversion of Dividends
17 2017 Taxation of Private Corporation Policy Conference
Policy Response
● Proposed amendment to section 84.1 to address “multi-step” planning
● Proposed introduction of a supporting anti-avoidance rule to address other
transactions that could be used to convert dividends into capital gains
● Comments sought regarding whether, and how, it would be possible to
better accommodate genuine intergenerational business transfers while still
protecting against potential abuses
Conversion of Dividends
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in respect
of anything done or omitted to be done wholly or partly in reliance upon the
contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Speaker name: David G. Duff Affiliation: Allard School of Law, University of British Columbia
Passive Income: Historical and Legislative Context and Comments
2 2017 Taxation of Private Corporation Policy Conference
Background to Proposals
● long-term reductions in corporate rates (general and small business) and
recent increases in personal rates – incentive to earn and retain income in a
corporation (both for business and non-business purposes)
● lower tax on capital gains than dividends with LCGE and 50% inclusion rate
– incentive for surplus stripping
● individual unit and progressive rates – incentive for income-splitting and
multiplication of LCGE, facilitated by SCC decision in Neuman (1998),
limited scope of TOSI in section 120.4, and provincial regulatory changes
Passive Income: Historical and Legislative Context and Comments
3 2017 Taxation of Private Corporation Policy Conference
Is there a problem?
● 50% growth in CCPCs from 2001 to 2014
● substantial increase in ABI of CCPCs as a share of GDP and decrease in
self-employment income as a share of GDP
● revenue losses, efficiency/neutrality concerns, and implications for tax
fairness (horizontal and vertical equity)
● are all these tax benefits necessary to encourage small businesses?
Passive Income: Historical and Legislative Context and Comments
4 2017 Taxation of Private Corporation Policy Conference
Possible Structural Reforms
● reduce personal rates, increase corporate rates, adopt a single corporate rate,
and/or adopt a dual rate income tax with higher and progressive rates on labour
income and a lower flat rate on capital income
● repeal LCGE and increase capital gains inclusion rate to restore symmetry between
effective tax rate on capital gains and dividends
● flatten rates and/or adopt a spousal or familial unit either generally or for specific
tax benefits like the LCGE
Passive Income: Historical and Legislative Context and Comments
5 2017 Taxation of Private Corporation Policy Conference
Alternatives to Structural Reforms
● rules denying low corporate rates (and LCGE) to specific categories of taxpayers,
to income other than active business income (passive income), and/or to income
used to acquire assets not used in an active business (passive investments)
● anti-avoidance rules to prevent surplus stripping
● attribution and other rules (like the TOSI) to regulate income-splitting and
multiplication of LCGE
Passive Income: Historical and Legislative Context and Comments
6 2017 Taxation of Private Corporation Policy Conference
Rules Excluding Specific Kinds of Taxpayers
● personal services businesses (incorporated employees) excluded from SBD after
November 12, 1981
● > 5 FTE exception (arm’s length until 1984)
● additional 5% federal tax applicable after 2015 (so 33%)
● non-qualifying businesses (professional practices of accountants, dentists, lawyers,
doctors, veterinarians, chiropractors and certain services businesses) excluded
from SBD from 1979 to 1984
● Quebec approach limits SBD to primary and manufacturing businesses or
businesses with a minimum number of employees (at least 5,500 hours)
Passive Income: Historical and Legislative Context and Comments
7 2017 Taxation of Private Corporation Policy Conference
Higher Rates on Passive Income
● portfolio dividends received by private or subject corporations – refundable Part IV
tax (similar to effective tax rate on non-eligible dividends)
● investment income of a CCPC – not eligible for SBD, additional tax under section
123.3, partly refunded (but not fully integrated)
● includes income from property, income from a specified investment business [> 5 FTE
exception], and net taxable capital gains
● excludes income from property incident or pertaining to an active business or used or
held principally for the purpose of gaining or producing income from an active business
● cases generally recognize reasonable reserves for business purposes but not passive
investments for later investment in active business
Passive Income: Historical and Legislative Context and Comments
8 2017 Taxation of Private Corporation Policy Conference
Higher Rates on Income Used to Acquire Passive Investments
● refundable tax on ineligible investments – enacted in 1972 and retroactively
repealed in 1973
not “actively” considered by the Government “at the present time” due to liquidity
issues
● alternative approach: deferred taxation with no dividend refund for tax on
investment income, and tax on dividends (including dividends from the non-
taxable portion of capital gains) based on the source of the capital used to
acquire passive investments (apportionment or elective methods)
consultation on “any aspect” of possible rule to tax corporate passive income
Passive Income: Historical and Legislative Context and Comments
9 2017 Taxation of Private Corporation Policy Conference
Comments on Passive Income Proposals (1)
● deferral advantage from passive investment of retained corporate income is a
legitimate concern, particularly for high-income earners who have already maxed
out on tax-favoured savings vehicles
● deferred taxation is conceptually ingenious but not intuitively obvious and extremely
complex (particularly for CCPCs)
● refundable tax on ineligible investments is more easily understood, much less
complex, and more clearly consistent with the core purpose of the SBD to help
CCPCs grow through internal finance
Passive Income: Historical and Legislative Context and Comments
10 2017 Taxation of Private Corporation Policy Conference
Comments on Passive Income Proposals (2)
● tax on ineligible investments puts pressure on distinction between passive
investments for business purposes and passive investments for personal
wealth accumulation
passive investment to finance later expansion?
passive investment to finance parental leave?
passive investment with mixed purposes (retirement and business
emergencies)?
● consider combining a tax on ineligible investments with safe harbours or a
threshold, which might also help address liquidity issues
Passive Income: Historical and Legislative Context and Comments
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Speaker name: Kevin Milligan Affiliation: Vancouver School of EconomicsUniversity of British Columbia
kevin.milligan@ubc.ca
Integration and the Taxation of Passive Income: An Economic Perspective
2 2017 Taxation of Private Corporation Policy Conference
Carter Commission V.4, p. 84
“The system would neither encourage nor
discourage the retention of earnings by
corporations.”
Integration and Passive Income: An Economic Perspective
3 2017 Taxation of Private Corporation Policy Conference
Roadmap
• Why integration?
• Do proposals improve integration?
• How much will the changes affect businesses?
• Caveats on Implementation.
Integration and Passive Income: An Economic Perspective
4 2017 Taxation of Private Corporation Policy Conference
What is Integration?
● Tax at individual level should reflect tax paid at corporate level.
● Or, all paths for a $ from “profit to pocket” should bear same tax.
● Also, no financial gain from readjusting location of savings.
“The system would neither encourage nor discourage the retention of earnings
by corporations.”
Integration and Passive Income: An Economic Perspective
5 2017 Taxation of Private Corporation Policy Conference
Why Integration?
● Neutrality: Target is for people to make same decisions under taxation as
they would without taxation.
This is a free-market goal: business decisions based on the business merits.
This is the literal definition of economic efficiency for taxation.
Integration and Passive Income: An Economic Perspective
6 2017 Taxation of Private Corporation Policy Conference
Why Integration?
● Neutrality: Target is for people to make same decisions under taxation as
they would without taxation.
This is a free-market goal: business decisions based on the business merits.
● Retirement savings? Maternity leaves? ‘Buffer’ savings? Saving for
investment?
These are all fine, but inside/outside firm should be a business decision.
Integration and Passive Income: An Economic Perspective
7 2017 Taxation of Private Corporation Policy Conference
Why Integration?
● Neutrality: Target is for people to make same decisions under taxation as
they would without taxation.
This is a free-market goal: business decisions based on the business merits.
● Retirement savings? Maternity leaves? ‘Buffer’ savings? Saving for
investment?
These are all fine, but inside/outside firm should be a business decision.
● Reminder: the reason we have SBD is to facilitate investment.
Not as a place to tax-advantage savings for those with large portfolios.
Integration and Passive Income: An Economic Perspective
8 2017 Taxation of Private Corporation Policy Conference
Ways Current Integration Falls Short
● It’s notional: still get DTC when firm pays no tax.
Can do direct passthrough of tax bills, e.g. Taiwan; ‘franking’ in Australia
● Fed-Prov: one national gross-up rate for whole country.
● Tax-exempts like pension funds / RRSPs can’t claim DTC.
● Capital gains rate is currently too low compared to dividends/wages.
● Firms claiming SBD have ‘head-start’ deferral advantage for saving.
Integration and Passive Income: An Economic Perspective
9 2017 Taxation of Private Corporation Policy Conference
Does Proposal Improve Integration?
● Focus on high bracket: why?
Flat rate on passive income calibrated for high-bracket investors.
High-bracket investors more likely to have substantial passive portfolios.
● Low-mid bracket investors
Currently disadvantaged for passive saving in CCPC. This shortcoming not
addressed.
More likely to have open RRSP/TFSA room for long-term savings.
Integration and Passive Income: An Economic Perspective
10 2017 Taxation of Private Corporation Policy Conference
Does Proposal Improve Integration?
● Current system is over-integrated: favours retained earnings inside firm.
Current tax of passive income inside/outside firm is comparable…but…
But savings inside the firm get a ‘head start’ from light taxation of SBD.
● Proposed correction: remove RDTOH.
Increases tax on passive income to compensate for ‘head start’.
For a high-bracket Ontario investor, effective rate on passive income is 73%.
Excessive? Need higher rate to balance big ‘head start’ to achieve integration.
Integration and Passive Income: An Economic Perspective
11 2017 Taxation of Private Corporation Policy Conference
Does Proposal Improve Integration?
Evidence #1: Try to replicate Finance Table 7
Integration and Passive Income: An Economic Perspective
STATUS QUO
STATUS
QUO PROPOSAL
INDIVIDUAL INSIDE CCPC
INSIDE
CCPC
ITEM RATE SAVINGS SAVINGS SAVINGS
Start with $100 of pre-corp tax active businss income 100.00 100.00 100.00
Federal SBD tax rate 10.50% 10.50 10.50 10.50
Ontario SBD tax rate 4.50% 4.50 4.50 4.50
Starting Principal 46.50 85.00 85.00
Interest at 3% 3.00% 27.29 27.29
Special tax on passive income 50.17% 13.69 13.69
RDTOH account 30.67% 8.37
Federal personal tax 33.00%
ONT personal Tax 20.53% 7.00
Portfolio value at end of 10 years 53.41 98.60 98.60
Refund of pre-paid tax RDTOH 8.37
Amount available for distribution as dividend 106.97 98.60
Taxable personal income after grossup 17.00% 125.15 115.36
Federal personal tax 33.00% 41.30 38.07
ONT personal tax 20.53% 25.69 23.68
Dividend tax credit, federal 10.52% 13.17 12.14
Dividend tax credit, ONT 4.30% 5.38 4.96
After-Tax Net Worth after 10 years 53.41 58.52 53.94
12 2017 Taxation of Private Corporation Policy Conference
Does Proposal Improve Integration?
Evidence #2: Observation
● If system is currently properly integrated, there should be no advantage to
retaining earnings.
● We observe financial planners advising clients to save in CCPC for tax
savings.
http://lmgtfy.com/?q=doctors+canada+incorporation+deferral+advantage
● If system were today properly integrated, all that advice would be wrong…
Integration and Passive Income: An Economic Perspective
13 2017 Taxation of Private Corporation Policy Conference
How much will proposals matter?
● We need to keep the scale of the change in mind.
● Imagine $100,000 in passive portfolio; 5% interest.
RDTOH is 30.67%, or $1,534.
But this is taxed as non-eligible dividend at 45.30% (Ont, high bracket)
So, RDTOH is worth $838 if paid immediately.
This is <1% of principal, but knocks down rate of return.
After 10 years, could affect terminal value of portfolio by 8-15%.
Integration and Passive Income: An Economic Perspective
14 2017 Taxation of Private Corporation Policy Conference
How much will proposals matter?
● Target savings: $33,333/yr of retained earnings over 3 years @ 5% interest.
Maternity leave? Savings for new equipment?
Integration and Passive Income: An Economic Perspective
STATUS QUO STATUS QUO PROPOSAL
PERSONAL INSIDE CCPC INSIDE CCPC
ITEM TAXABLE
Balance in RDTOH notional account at
end of Year 3 $3,118 $0
Balance in CCPC retained earnings at end
of Year 3 $0 $105,067 $105,067
No change to cash flow.
$3,118 in RDTOH notional account
15 2017 Taxation of Private Corporation Policy Conference
How much will proposals matter?
● Terminal value of these savings once personal tax is paid.
Integration and Passive Income: An Economic Perspective
PERSONAL INSIDE CCPC INSIDE CCPC
ITEM TAXABLE
Balance in RDTOH notional account at
end of Year 3 $3,118 $0
Balance in CCPC retained earnings at end
of Year 3 $0 $105,067 $105,067
Balance on personal account at end of
Year 3 $58,370 $59,189 $57,483
Status quo: CCPC beats personal by $819.
Proposal: Personal beats CCPC by $887.
16 2017 Taxation of Private Corporation Policy Conference
Carter Commission V.4, p. 84
“The system would neither encourage nor
discourage the retention of earnings by
corporations.”
Integration and Passive Income: An Economic Perspective
17 2017 Taxation of Private Corporation Policy Conference
Caveats on Implementation
● Lots of important challenges await…
Transition: how the grandfathering will work.
Intercompany shareholdings; investments.
We will hear more today!
● This is serious: Need to weigh the costs and benefits of proposals.
Finance’s response: are there non-messy fixes?
Integration and Passive Income: An Economic Perspective
18 2017 Taxation of Private Corporation Policy Conference
Final thought
● This package is clearly a ‘patch’ on a messy system.
● Should we wait for Carter 2.0 before acting?
If we can’t have it all, should we do anything?
● I argue: no
We can all play “fantasy tax reform”….
We must also ask: does this improve on status quo?
Integration and Passive Income: An Economic Perspective
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in respect
of anything done or omitted to be done wholly or partly in reliance upon the
contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Jack MintzThe School of Pubiic PolicyUniversity of Calgary
Tax Planning Using Private Corporations: Passive Income
2 2017 Taxation of Private Corporation Policy Conference
● Economic role of passive assets:
Retained earnings held in passive assets provides liquidity.
Provides equity finance for investment – investment has been shown to be
higher if firms have cash flow.
Internal resources enable better firms to separate themselves from poor quality
firms to raise equity and debt finance.
Passive assets improve credit risk.
Passive asset provides savings within the corporation for investors when
withdrawn (this is the focus of the July 18th proposals).
Passive Income Rules
3 2017 Taxation of Private Corporation Policy Conference
Benefits of July 18th Passive Income Rules
● Intent is to improve integration of corporate and personal taxes by clawing
back deferral if active business income is invested in passive assets.
● Reduces (but does not achieve fully) neutrality between savings held inside
and outside the CCPCs by investors.
● Reduces the incentive to create CCPCs rather than sole proprietorships or
partnerships (no particular evidence provided on the size of the distortion –
U.S. studies (e.g. Austin Goolsbie suggest not large).
● Raises more revenue for government to lock-in high personal income tax
rates levied in 2015. About $23 billion of passive income is roughly 16% of
active business income (total industry passive income is 10% of operating
income).
Passive Income Rules
4 2017 Taxation of Private Corporation Policy Conference
Distortions/Complexity created by Passive Income Rules
1. Given limitations on full refundability of losses – self-employed losses can
be generally used against other personal income while losses trapped in a
company – rules lead to higher taxes on corporate risky investment.
2. Limits deferral with passive assets – creates a bias towards deferral
achieved through real assets, which could lead to sub-marginal
investments.
3. Indifference works for investors at the top rate – tax neutrality does not
approximate for CCPC owners with marginal tax rates below the top rate.
4. Passive assets for business purposes, as opposed to savings, would need
some sort of brightline test but difficult to properly do (eg. private equity
investments by venture capitalists).
Passive Income Rules
5 2017 Taxation of Private Corporation Policy Conference
Distortions/Complexity created by Passive Income Rules
5. Tax on passive income already results in a significant loss in real principal
with non-tax sheltered assets. (Bond paying 3 percent with 2 percent
inflation and 50% tax rate as real return of -0.5%).
6. Private companies becoming public or non-CCPC could avoid passive
income rules – leads to a new distortion with respect to ownership.
7. Rules are exceedingly complex especially with allocation method.
8. Few countries follow Canadian rules – potential loss in tax competitiveness
especially relative to the United States.
Passive Income Rules
6 2017 Taxation of Private Corporation Policy Conference
Canada’s Tax on Small Business not Competitive
Passive Income Rules
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
$1M $2M $3M $4M $5M $6M $7M $8M $9M $10M $11M $12M $13M $14M $15M $16M $38M $39M $40M
Marg
inal E
ffecti
ve T
ax R
ate
Size of Capital (CAD$ Million)
Canada Small Business Entrepreneur USA Entrepreneur (S Corporation) USA Entrepreneur (Small Business)
7 2017 Taxation of Private Corporation Policy Conference
A Better Approach
● To reduce distortions and complexity as well as encourage growth:
Consider an election to pass income of corporation to owner (egU.S. sub-chapter S
corporations)
Removes the distinction between passive and active business income.
Reduces distinction between self-employed income and private corporate income.
Treats losses similarly to self-employed income and therefore risk.
Would eliminate benefit (if any left) of small business deduction. IIntroduce
investment and employment tax credits instead to encourage investment.
Given small business deduction is of little value with integration, move to single
corporate income tax rate and dividend tax credit. Equalize capital gains and dividend
tax rates.
Passive Income Rules
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in respect
of anything done or omitted to be done wholly or partly in reliance upon the
contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Bruce BallCPA Canada,Alex LaurinC.D. Howe Institute,Jeffrey Trossman Blake, Cassels & Graydon LLP
Taxation of Investment Income
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in respect
of anything done or omitted to be done wholly or partly in reliance upon the
contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Assessing the Policy Objectives of the Finance Proposals
3 2017 Taxation of Private Corporation Policy Conference
What is the policy objective for passive income proposal?
● To eliminate tax incentives for CCPC owners to retain “active” earnings, if
the goal is to hold “passive” investments for future personal consumption
● To eliminate a perceived “unfair” tax advantage to CCPC owners compared
to other investors
● Incentive to retain earnings fostered by low small-business income tax rate
leaving greater investment potential
● Tax “inequity” derived from partial relief of CCPC taxes on passive
investment income
Assessing the Policy Objectives
4 2017 Taxation of Private Corporation Policy Conference
Three Key Observations
1. Measured against a consumption-based tax system with progressive
rates, the current CCPC tax regime has many unobjectionable features
2. General-rate earnings (retained for future personal consumption) enjoy no
significant tax advantages, and produce a suboptimal outcome when
measured against a consumption tax baseline; small-business-rate
earnings enjoy a tax outcome pretty much on par with personal retirement
savings.
3. The proposed regime would not level the playing field: it would leave small
business owners with significantly less tax-assisted retirement saving
opportunities than available to some others.
Assessing the Policy Objectives
5 2017 Taxation of Private Corporation Policy Conference
Features of PIT Regime
● Personal Investment Income
Under comprehensive income base, both the initial capital and the investment
income are taxed. Cascading of taxes on saving encourages consumption in the
present, and distorts investment choices (housing)
Under consumption tax base, tax cascading is avoided: retirement plans, TFSA,
other registered accounts
Real-world tax systems are hybrids
Canada’s PIT operates largely on a consumption tax basis (less than 20% of
investment income accumulations are subject to tax)
Assessing the Policy Objectives
6 2017 Taxation of Private Corporation Policy Conference
Features of CCPC Regime
● CCPC Income Regime
Income spent on “active” business consumption attracts no immediate tax
Retained income used for passive investments gets partial relief
Income distributed for personal consumption attracts personal taxes
PIT/CIT integration mechanism = no double taxation
Under perfect integration, business income used for personal consumption
would be taxed on a near consumption basis
Passive investment income sourced from earnings subject to the general CIT
rate is under-integrated = higher effective tax burden on income distributed for
personal consumption
Assessing the Policy Objectives
7 2017 Taxation of Private Corporation Policy Conference
Tax Illustrations: Is the Current CPCC Regime Equitable?
Net Wealth Available for Personal Consumption after Ten Years, 2017
$100,000 Initial Gross Investment, Provincial Average, 3% Rate of Return
Assessing the Policy Objectives
Regime
Interest Dividends Capital Gains
Wealth ($) Gap Wealth ($) Gap Wealth ($) Gap
Salary IncomeTaxable Account 56,632 - 59,177 - 61,476 -
RRSP/TFSA 65,763 +16% 65,763 +11% 65,763 +7%
Current Regime:
CCPC Income
Small Bus. Rate 60,838 +7% 66,522 +12% 69,988 +14%
General Rate 56,204 -1% 60,933 +3% 63,825 +4%
Proposed Regime:
CCPC Income
Small Bus. Rate 56,068 -1% 58,324 -1% 60,937 -1%
General Rate 52,227 -8% 55,193 -7% 56,284 -8%
8 2017 Taxation of Private Corporation Policy Conference
Unequal Tax-Assisted Retirement Wealth Opportunities
Maximum Tax-Assisted Career Accumulations of Retirement Wealth
$150,000 Salary at Retirement
Assessing the Policy Objectives
Source: Pierlot and Siddiqi (2011). Actuarial valuations under standard assumptions assuming 35-year career.
9 2017 Taxation of Private Corporation Policy Conference
Leveling the Playing Field
● The proposed CCPC regime – in effect restricting business owners to
personal RRSP room to tax-effectively save for retirement – would not level
the field
● The proposed regime – if enacted – should be accompanied by a reform of
the tax-assisted retirement savings system that would equalize possibilities
● SB owners are at greater risk of insufficient RRSP room because of:
potential bankruptcy, fluctuating income, early withdrawals to fund business
● Annual income-based limits on retirement savings should be abandoned
and replaced with a uniform lifetime accumulation limit set to replicate
maximum DB accumulations
Assessing the Policy Objectives
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in respect
of anything done or omitted to be done wholly or partly in reliance upon the
contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Implementation and Technical Issues with the Finance Proposals
11 2017 Taxation of Private Corporation Policy Conference
Outline of Proposal
Proposal would be to make refundable taxes non-refundable in certain
circumstances, as a way of promoting perceived horizontal equity between
business owners and employees
• Premise that business owners and employees are similarly situated is open to
serious debate – but that is not the purpose of this part of the discussion
• Refundable tax rates assume business owner is in top rate bracket
• not true for many small business owners, who would face significant tax increase
• this design flaw would need to be fixed
• Overall approach would result in dramatically different tax treatment of “active
income” (“AI”) and “passive income” (“PI”)
Policy Conference
12 2017 Taxation of Private Corporation Policy Conference
Outline of Proposal
• Existing distinctions in domestic rules (between AI and PI) for CCPCs serve a
much narrower purpose – stakes are much higher in proposed regime
• New system would introduce a new policy – effectively taxing the rate “gap” as if
it had been immediately distributed
• This is achieved indirectly by making currently refundable taxes non-refundable;
overall effect is to (theoretically) put owner in same position as if “gap” had been
distributed and taxed immediately; therefore, effect is to tax corporation’s capital
• New concepts needed
Policy Conference
13 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Core Definition
Distinguishing AI from PI – Basic definition of PI
• Should income from property presumptively be classified as PI?
− If so, why?
− Income from property can include economically productive activities
• Leasing/licensing of property – real/personal/intangible property –
different rules?
− Early stage software development – is that income from property?
Policy Conference
14 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Core Definition
• Is a >5 employees test appropriate?
− If so, why?
− Current “specified investment business” definition serves a narrower purpose; stakes
now much higher
− Core service providers may not be employees
− Consider equivalence rules as in old Part XI ($250K rule)
− Rules should address provision of services by employees of affiliates and
partnership structures, as in definition of “investment business” in 95(1); paragraph
(b) of “specified investment business” is unduly narrow
• This is complicated!
Policy Conference
15 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – “Excess” Passive Assets
Distinguishing AI from PI – Rules to delineate “excess” passive assets
• Rules should recognize business realities which may require seemingly
excess passive assets to be retained in corporation for good business
reasons having nothing to do with tax deferral
− Prudent cash management to plan for contingencies generally
− Retention of cash for possible identified extraordinary expenses
− Maintaining credit standing opposite bank or other creditors
Policy Conference
16 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – “Excess” Passive Assets
− Retention of cash for future acquisitions that can reasonably be
anticipated
− Retention of cash for possible future capital investment that can
reasonably be anticipated in machinery & equipment, real estate,
intangible property, R&D, etc.
− Concept needed to define what is meant by “excess” passive assets
Policy Conference
17 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – “Excess” Passive Assets
• Policy alternatives include a qualitative test or a bright-line test
− Qualitative test - what is “reasonable in the circumstances” – disputes likely
− Bright-line test could look to specific dollar thresholds and/or specific time
horizons (e.g., 36-month rule in FIE proposals – paragraph (d) of “qualifying
entity” definition in proposed subsection 94.1(1), Bill C-10, passed by House
of Commons Oct. 29/07)
− Trade-off among objectives of fairness, workability, likelihood of disputes
− This is complicated!
Policy Conference
18 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Inter-affiliate Payments
Active business income should not become “passive” just
because it is paid from one corporation to another
• For example, one company in the group may lease real or personal
property or lend money to the main operating company
• 129(6) adopts the principle that character does not change in limited
circumstances, and for the limited purpose for which it now applies
Policy Conference
19 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Inter-affiliate Payments
−129(6) requires payor and payee to be “associated” corporations
for active business income to retain its character when paid
within the group
“associated” concept pertains to the SBD, so not appropriate for
this much larger purpose
Alternatives
“affiliated”
“non-arm’s length”
Minimum 10% votes/value test, as in 95(2)(a)(ii)
Policy Conference
20 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Inter-affiliate Payments
consider other factors in designing inter-affiliate payments rule
apportionment of expenses and losses
payments involving partnerships
Policy Conference
21 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Inter-corporate Dividends
• For dividends, the “connected” test in Part IV determines whether
dividend is a “portfolio” dividend subject to 38-1/3% refundable tax
− In determining whether Part IV tax is non-refundable, is this the right
test?
− Anomalies in the “connected” test
186(2) has been interpreted as a “count-the-shares” rather than “count-
the-votes” test; corporations can be related without being connected
Unusual to require “more than 10%” rather than “10% or more”
Policy Conference
22 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Inter-corporate Dividends
− From a policy perspective, is the “connected” test really the correct test to
distinguish AI from PI?
Consider whether dividend received from non-arm’s length (but not
“connected”) corporation should be subject to permanent Part IV tax
What about dividend from arm’s length, active corporation in which investor
has (say) a 9% interest? – Part IV tax applies, but is it appropriate for that tax
to be permanent?
Discussion raises more fundamental question of what is meant by
“reinvestment in the business”
Should rules create a tax incentive for investing in affiliated, rather than
unaffiliated active businesses? Why?
There should be a coherent basis for making the distinction
Policy Conference
23 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
• Capital gain could arise from disposition of asset used to earn AI (“active asset”)
or PI (“passive asset”)
• Proposals would change the integration rules by denying CDA as a way to tax
the rate “gap”
− Should distinguish capital gains from dispositions of passive vs. active asset
− Capital gain from disposing of active asset is, in effect, a way of realizing the value
built up in the active business
Policy Conference
24 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
● Appreciation may be the result of any number of factors:
- creation or enhancement of goodwill,
- development of trade names or brands,
- discovery of a technological breakthrough,
- valuable supply or distribution agreements,
- appreciating land values,
- luck, and
- an innumerable list of other factors.
Policy Conference
25 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
● If and when the corporation disposes of a tangible or intangible asset used
in the business, the resulting gain does not conceptually resemble a passive
return
● Gain represents current realization of expected future cash flows
● It follows that there is a fundamental distinction between capital gains
realized from disposition of an asset used in an active business and other
capital gains (for example, from disposing of a publicly traded portfolio
investment)
Policy Conference
26 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
● This distinction is recognized in the foreign affiliate rules
● These rules are a good starting point for designing a new system
● These rules draw a distinction between property used in carrying on an
active business (“excluded property”) and other property
● Taxable capital gains from dispositions of excluded property are excluded
from the definition of “foreign accrual property income” (“FAPI)
Policy Conference
27 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
● Excluded property definition takes account of the possibility that the
disposing affiliate may dispose of an active business by selling shares of a
lower tier subsidiary
● Shares of a foreign affiliate that derive “all or substantially all” of their value
from property used in an active business are thus defined as excluded
property
● Determination of “excluded property” status of shares can be complicated in
practice
Policy Conference
28 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
● While foreign affiliate system was designed to achieve different legislative
objectives, it provides a good starting point
● Taxable capital gain derived from a disposition of an asset used in an active
business should be regarded as AI, and the accompanying non-taxable
portion should be added to CDA
● Treatment of such gains as passive income seems conceptually flawed
Policy Conference
29 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
● Rules needed to treat shares of certain corporations as excluded property
under the new regime
● 10% test similar to foreign affiliate definition makes some sense
● If private corporation realizes gain from disposing of shares of a foreign
affiliate that meet the current “excluded property” definition, taxable portion
of that gain ought to be classified as AI under the new regime and not
treated as PI
Policy Conference
30 2017 Taxation of Private Corporation Policy Conference
“Active” vs. “Passive” Income – Capital Gains
• Gains from dispositions of goodwill, trademarks and other intangibles used in a
business:
− Gain on sale would have been regarded as business income prior to recent changes
to replace ECE regime with Class 14.1
− Should those changes affect AI/PI distinction?
Policy Conference
31 2017 Taxation of Private Corporation Policy Conference
Classification of Losses
• If loss is realized, need to determine whether “active” or “passive”
− Similar to distinction between “active” losses and FAPLs in foreign affiliate rules
− Rules will be needed to track “surplus” accounts
Policy Conference
32 2017 Taxation of Private Corporation Policy Conference
Source of Capital
Income derived from capital not sourced from “lightly taxed” income is
not intended to be subject to new regime
• Premise of consultation paper is that a system is needed to distinguish:
− Capital derived from “lightly” taxed business income (income on which “should” be
subject to non-refundable corporate taxes),
from
− Capital derived from other sources (income on which should still be eligible for
refundable treatment)
Policy Conference
33 2017 Taxation of Private Corporation Policy Conference
Source of Capital
• Non-refundable corporate tax should not apply to:
− Investment income derived from capital contributed by shareholder in non-rollover
transaction
No rate “gap” – asset came in from after-tax dollars of shareholder
− Investment income derived from capital acquired by corporation through issuance of
debt/equity/other securities in non-rollover transaction (e.g., borrowing, share
offering)
No rate “gap” – asset came in from after-tax dollars of investor
− Investment income derived from capital acquired by corporation from a foreign
source dividend, interest or other payment
No rate “gap” – asset came in from foreign source
Policy Conference
34 2017 Taxation of Private Corporation Policy Conference
Source of Capital
• Need to create and track several “surplus” or similar accounts to give effect to
these principles
• Need special rules for rollovers, amalgamations, wind-ups, divisive
reorganizations
• Revisit active/passive distinction in FIE proposals and FAPI rules
• Developing coherent rules is complicated!
Policy Conference
35 2017 Taxation of Private Corporation Policy Conference
Transition
Government states that new rules will apply only “going forward”
●How to achieve this without byzantine transitional rules?
●Non-refundable taxes amount to a tax on the “capital” represented by the
rate “gap”
− Apparent ~73% “all-in” tax on investment income is designed to tax the rate “gap” as
if it had been immediately distributed
− Unless and until it is distributed, this is capital of the corporation
− elimination of refundability will erase a potential future corporate asset (the refund)
as the new system comes into effect
Policy Conference
36 2017 Taxation of Private Corporation Policy Conference
Transition
• To make changes truly prospective:
− Income derived from capital accumulated before new regime takes effect (and
income derived from that income) should not be subject to non-refundable taxes
− That capital was accumulated in a regime in which “high” taxes on private
corporations’ investment income were temporary/refundable
− Will require a determination of aggregate passive assets on “coming-into-force” date,
and tracking of “surplus” account, ordering rules, etc.
Policy Conference
37 2017 Taxation of Private Corporation Policy Conference
Scope of Application
CCPCs vs. foreign-controlled corporations
• premise of proposed regime is a Canadian resident individual owner- not true
for foreign controlled corporation
• special 10-2/3% tax already applies only to CCPCs in recognition of this basic
difference
• competitiveness issue
• would have to deal with branch tax if proposed to extend new regime to foreign-
controlled corporations
Policy Conference
38 2017 Taxation of Private Corporation Policy Conference
Reality of Under-integrated System
• If all benefits of deferral are to be eliminated, the under-integrated system
leaves those considering a new business with a heavy cost to get limited
liability, unless they plan to reinvest substantially all profits “in the business” in
perpetuity, rather than earmarking a portion of profit for future consumption at
some point
• Elective check-the-box system could help
• Fine-tune rules to mitigate under-integration, don’t just assume under-
integration away
Policy Conference
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in respect
of anything done or omitted to be done wholly or partly in reliance upon the
contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Possible Alternatives to Finance Proposals
40 2017 Taxation of Private Corporation Policy Conference
Other Possible Alternatives
● “Check the Box” Flow Through
● Impose a Refundable Tax on Ineligible Investments?
● Repeal or Replace the Small Business Deduction?
● Increase the corporate refundable tax rate?
● Comprehensive Tax Review?
Policy Conference
41 2017 Taxation of Private Corporation Policy Conference
Check the Box Flow Through
● Integration and debate around use of tax deferral is less relevant if
shareholders can be taxed on income as a flow through
● Can set corporate and personal rates without same concern around
integration if there is a “safe harbour” for private corporation owners to pay
single level of tax at personal rate if they so choose
● A lower tax rate could be applied on business income to provide an incentive
similar to SBD (similar rule under consideration in US?)
● Seems like an approach worth study if starting a brand new tax system
● Significant transitional issues?
Policy Conference
42 2017 Taxation of Private Corporation Policy Conference
Impose a Refundable Tax on Ineligible Investments?
● Was referred in the consultation paper but dismissed
● Makes the most theoretical sense for what Finance is trying to do?
• The best way to prevent the accumulation of investment income on the tax
deferral is to prevent you from investing it in the first place?
• Works best if:
− One single source of income where after-tax use is a concern
− One good use of assets and one bad
• Would create need for complicated rules in concept and application, and would
have adverse business implications such as waiting for tax refunds when
passive assets are repurposed for business use
Policy Conference
43 2017 Taxation of Private Corporation Policy Conference
Repeal or Replace The Small Business Deduction?
● Is the Small Business Deduction the Issue?
• Using 10-Year accumulation rationale, is retaining general rate income (GRI) for
investments a significant issue if no income sprinkling/gain planning?
− Practically, any benefit provided from investing the deferral is eaten away by the
under integration on GRI and/or investment income
• Investing cash in a private corporation and earning investment income is also
not an issue (pure investment corporation, conceded in paper)
• Is after-tax SBI the only materially contentious source of investments?
• If so, would it make more sense to focus on the small business deduction?
• Following charts use Finance Table 7 assumptions with actual rates for 2017
Policy Conference
44 2017 Taxation of Private Corporation Policy Conference
10-Year Net Worth Analysis – General Rate Business Income
Policy Conference
Personally Corporation Adv./Disadv.
BC $61,110 $62,015 $905
Alberta 60,706 60,755 49
Saskatchewan 61,043 62,536 1,493
Manitoba 57,495 55,506 -1,989
Ontario 53,370 54,885 1,515
Quebec 53,658 54,575 917
New Brunswick 53,671 56,858 3,187
Nova Scotia 52,757 49,344 -3,413
PEI 56,209 55,069 -1,140
Newfoundland & Labrador 56,302 49,902 -6,400
Assumed Rates Used by Finance 57,535 60,457 2,922
45 2017 Taxation of Private Corporation Policy Conference
10-Year Net Worth Analysis – Income Eligible for the SBD
Policy Conference
Personally Corporation Advantage
BC $61,110 $65,113 $4,003
Alberta 60,706 64,555 3,849
Saskatchewan 61,043 66,485 5,442
Manitoba 57,495 61,025 3,530
Ontario 53,370 58,510 5,140
Quebec 53,658 57,549 3,891
New Brunswick 53,671 58,095 4,424
Nova Scotia 52,757 56,993 4,236
PEI 56,209 59,279 3,070
Newfoundland & Labrador 56,302 60,766 4,464
Assumed Rates Used by Finance 57,535 63,207 5,672
46 2017 Taxation of Private Corporation Policy Conference
10-Year Net Worth Analysis – Observations
● Small business income:
• Provincial numbers fairly consistent – integration on SBI generally works
• “Province of Finance” NW > All provinces other than Saskatchewan
• Average NW advantage is $4,200 – Is this significant on $100,000 of SBI?
● General Rate Income (GRI)
• Keeping GRI in a corporation and paying it out later as a dividend represents a
cost in many provinces, investing the deferral helps reduce the cost
• The integration on investment income is imperfect as well
• Unclear any changes are needed on GRI without more study?
● Results do vary based on the rate of return & type of income
Policy Conference
47 2017 Taxation of Private Corporation Policy Conference
Is the Small Business Deduction an Issue?
● Considerations and questions that could be considered:
• In terms of the growth in the number of private corporations, do we know how
much growth is directly related to reinvesting the value of the SBD in passive
assets?
• If the government deals with income sprinkling and capital gain planning, how
many taxpayers would set up private companies in the future for passive
investment tax planning purposes? Motivation often based on multiple factors?
Policy Conference
48 2017 Taxation of Private Corporation Policy Conference
Is the Small Business Deduction an Issue?
● Considerations and questions that should be considered:
• If the possibility of reinvesting the SBD saving is a concern, would amending,
replacing or just repealing the small business deduction reduce the growth of
private corporations used for passive investment tax planning purposes?
• Redesign the SBD as a more targeted tax expenditure designed to reward
economic growth, positive impact on economy and risk taking (rather than
tracking and dealing with corporations investing it)?
Policy Conference
49 2017 Taxation of Private Corporation Policy Conference
Increase the corporate refundable tax rate?
● This was action government took previously – would more of the same help?
● Issues:
• At the end of the day, the tax is returned when dividends are paid - tax deferral
was effectively invested?
• Not refunded if passive assets invested in business – punitive?
• For the same reasons discussed before, take a good look at the SBD?
Policy Conference
50 2017 Taxation of Private Corporation Policy Conference
Comprehensive Tax Review?
● Passive income proposals suggested in paper would make for a complicated
tax system and seem to assume other aspects of the tax system are
effective and should remain in place (e.g. small business deduction)
● Paper assumes aspects that are theoretically part of the system but are not
working in reality (e.g. integration)
● Ensure key drivers of the tax system make sense before adding more
complication around them?
● A review of other countries indicates what Canada is examining would be
fairly unique – blazing a trail brings risk?
● Are there better ways to deal with the key issues of concern?
Policy Conference
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Sandra MahDLA Piper (Canada) LLP
H. Michael DolsonFelesky Flynn LLP
Taxation of Investment Income: Practitioner Perspectives on Proposals and Potential Issues
2 2017 Taxation of Private Corporations Policy Conference
Syllabus
● Policy issues
● Anticipated legislative issues
● Anticipated behavioural response and real-world results
Practitioner Perspectives
3 2017 Taxation of Private Corporations Policy Conference
Policy Issues
● Intergenerational equity issue:
Proposed changes level playing field within some cohorts, not between them
Even intra-cohort levelling may be superficial
Cascading gender equity and racial equity implications
Cascading vertical equity implications
Practitioner Perspectives
4 2017 Taxation of Private Corporations Policy Conference
Policy Issues
● If tax policy objective is to prevent tax-motivated incorporation, entire
package may be a poorly targeted solution
Similar to issues with continued approach to PSB corporations
For many incorporated services businesses, incorporation is payer’s choice
Significant non-neutrality due to payroll taxes and provincial laws
Benefits disproportionately enjoyed by payers:
Consider employees vs. contractors in Calgary 2015-16
Payers advertise purported tax benefits to workers so workers don’t revolt
● Admittedly less of an issue for professionals
● Is this policy negatively affecting how CCPCs will finance their businesses
Practitioner Perspectives
5 2017 Taxation of Private Corporations Policy Conference
Policy Issues
● Foreign solutions to this problem do not seem to have been considered
Some may be better or worse than what is proposed, but should be canvassed
● Example: Netherlands minimum salary regime
Corporation must pay controlling shareholder wages equal to the lesser of:
Greater of (i) €45,000; and (ii) 75% of corporation’s pre-wage taxable income; and
Proven wages of a similarly-skilled worker
75% requirement inapplicable if shareholder generated <90% of profit
If shareholder is underpaid, imputed employment income plus penalty
● Might satisfactorily address passive income and income splitting issues,
while potentially being simpler
Practitioner Perspectives
6 2017 Taxation of Private Corporations Policy Conference
Policy Issues
● Is the small business deduction still viable?
Are the significant recent efforts to preserve integrity worth the effort?
● Is integration still good tax policy?
Proposed regime represents significant departure from integration principle
Apportionment method might achieve integration over long horizon using Milligan’s
assumptions, but that is not what integration has historically been about
Practitioner Perspectives
7 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Finance is probably downplaying the complexity of the apportionment
method for passive income
Likely end result will be something similar to a domestic equivalent of the FA
surplus rules, in order to prevent chicanery
Not clear how loans (for shareholder or inter-corporate) would factor in
Not clear how losses will be allocated or tracked
Not clear if assets can change status from passive to active
Not clear how dividends will be paid
Practitioner Perspectives
8 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Elective method requires assumptions too simplistic to work in practice
Why is it reasonable to assume that shareholder contributions are not used to
make passive investments?
What if SBD-electing corporation earns $600,000 of income?
What if corporation is unsure whether or not its income qualifies for the SBD?
Real problem for potential PSB corporations or potential SIB corporations
Extreme unfairness if workers are not causing PSB proliferation
● Here, the benefits of simplicity are illusory given the complexity of transition
Practitioner Perspectives
9 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Proposed regime will place considerable pressure on both bright-line tests
and common-law tests relating to active vs. passive income
Considerable additional tax wedge between ≤5 full-time employees and >5 full-
time employees for, say, property rental businesses
Likely to encounter Ensite-type litigation surrounding use or risking of income-
producing properties in active business
Incentive for characterizing two potentially separate businesses (e.g. real estate
development and real estate leasing) as a single business
Practitioner Perspectives
10 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Will capital gains realized on disposition of business assets/goodwill
continue to generate CDA?
White Paper suggests not, if source of gain is reinvested corporate income
This seems to be an improper result
Practitioner Perspectives
11 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● “Control” is too high a threshold for an investment in another corporation to
generate a CDA-increasing capital gain
Creates punitive result if two or more arm’s length corporations go into business
More realistic threshold required, along the lines of FA status
● “Exclusively” is an unattainable threshold for subsidiary’s investment in
business assets
More realistic threshold would resemble the QSBC share test
● Other circumstances may exist where capital gains should generate CDA
Practitioner Perspectives
12 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Important aspects of proposed regimes lack sufficient detail to provide
meaningful comment:
Is the election one time or for each fiscal year for the Elective Method?
Potential limited use of election - only those corporations that have significant
passive investment or immaterial passive investments
Investment corporation election
Effects of election if made by existing corporation, and timing and types of transfer
that will result in transfer tax
How will grandfathering be accomplished?
Will it phase out over time?
Care will have to be taken to avoid capital lock-in effect
Practitioner Perspectives
13 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Extension of regime to non-CCPCs may have unintended negative effects
Private corporations used by non-residents to make investments in Canada
No tax policy reason to be concerned about deferred personal income, Canada
can’t tax that income anyway
Extension of regime without caution would materially increase effective tax rate,
decrease foreign investment in Canada
But increased tax cost would largely be payable to foreign governments
Canadian tax revenues could be less than under current regime
● Better idea would be to limit extended regime to private corporations
controlled by Canadian residents
Practitioner Perspectives
14 2017 Taxation of Private Corporations Policy Conference
Legislative Issues
● Non-refundable tax rate is likely too high
Assumes CCPC shareholders in top income bracket
Others have provided calculations demonstrating effect on lower bracket
taxpayers
Consider tax consequences for minority shareholders
● Assumption that all persons with CCPC investment income are top rate
taxpayers is not sound
There are reasons to hold investments in a CCPC rather than RRSP/TFSA, so
not simply people who have maxed out contributions
For example, may wish to invest in real estate or a non-eligible small business
Increases the number of taxpayers subject to tax beyond the top income bracket
Practitioner Perspectives
15 2017 Taxation of Private Corporations Policy Conference
Taxpayer Responses
Practitioner Perspectives
16 2017 Taxation of Private Corporations Policy Conference
Taxpayer Responses
● Considerable uncertainty going forward
Clients anticipate CPC will promise to repeal anything that is enacted
Preservation of existing regime for grandfathering, etc., and limited short-term
revenue impact means promise is credible
● Rate and rule change fatigue
Changes to subsection 55(2) and SBD rules still being processed
Federal rate increases plus Alberta rate increases
Considerable anger and willingness to be very aggressive
Practitioner Perspectives
17 2017 Taxation of Private Corporations Policy Conference
Taxpayer Responses
● If taxpayers believe rules will eventually be repealed, easy options to defer
income or mitigate impact until expected repeal:
Invest in non-income producing investment properties (i.e. Amazon.com shares)
that will generate capital gains at an undetermined future time
FA-based options
Use business profits to pay down debts instead of saving
Practitioner Perspectives
18 2017 Taxation of Private Corporations Policy Conference
Taxpayer Responses
● Clients can avoid proposed rules by making riskier investments:
Without CDA, no disincentive to engage in adventure or concern in the nature of
trade, especially since no passive income generated
House “flipping” or development versus proven commercial rental properties
Working interests in oil & gas properties
Financing leases for tangible personal property
Reinvest in business or invest in other business to non-advisable extent
Significant tax distortion between business and passive investment opportunities
with same pre-tax rate of return
Practitioner Perspectives
19 2017 Taxation of Private Corporations Policy Conference
Taxpayer Responses
● Numerous other techniques to defeat rules, for example:
Buy-bump or buy-bump-sell transactions for shareholders of corporations with
significant accrued gains on capital assets
Invest in widely-held, non-SIFT partnerships to earn business income
● More aggressive options obviously exist
Practitioner Perspectives
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Speakers: Albert Baker (moderator), David Christian, Michael Wolfson, Rachel Gervais
September 25, 2017
INCOME SPRINKLING PANEL
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Speaker name: David ChristianCompany: Thorsteinssons, LLP
INCOME SPLITTING –BACKGROUND AND HISTORY
3 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● There is no general policy in the Income Tax Act (Canada) that prevents
income splitting – Neuman v. The Queen, 98 DTC 6297 (SCC)
● However, the Income Tax Act (Canada) has always contained anti-
avoidance rules relating to income splitting
4 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● Income War Tax Act
No specifically defined attribution rules. Subsection 4(4) read:
A person who, after the first day of August, 1917, has reduced his income by the transfer or assignment
of any real or personal, movable or immovable property, to such person's wife or husband, as the case
may be, or to any member of the family of such person, shall, nevertheless, be liable to be taxed as if
such transfer or assignment had not been made, unless the Minister is satisfied that such transfer or
assignment was not made for the purpose of evading the taxes imposed under this Act or any part
thereof.
5 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● By the time of tax reform in 1970, the rules had evolved into a more familiar
form:
Attribution of income from property transferred to a spouse or to a person under
19
Both attribution rules applied while transferor alive and resident in Canada
No attribution of business income, income from loaned property, or second-
generation income
6 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
Denial of deduction of salary paid by a spouse to a spouse (no inclusion to
recipient, so no double taxation)
Similar rule for remuneration by a partnership in which a spouse is a partner
Rule that gave discretion to Minister to allocate income of a spousal partnership
to one spouse alone
Attribution rule for transfer of rights to income
7 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● Post-tax reform: the modern attribution rules take shape:
Attribution of income and gains from property transferred to spouse
Retention of rules on remuneration of spouses, including partnerships (later
replaced by subsection 103(1.1))
Attribution of income from property transferred to spouse
8 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
Attribution of income, but not gains, from property transferred to a person under
18
No attribution of business income, income from loaned property, or second-
generation income
No corporate attribution – passive income can be split by transfer to a
corporation in which spouse or minor holds a share interest
Transfers of rights to income taxable: see subsections 56(2) and (4)
9 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● Expansion of the attribution rules – 1985 Budget
“[Income splitting] was easy, efficient, and anomalous....What was a tolerated
tax-planning device soon became an industry, and like all other tax-planning
industries, it became a perceived menace to the Department of Finance that
had to be erased….As seems to be the case recently with so many legislative
amendments that try to erase a simple planning technique, the amendments
introduced complexities and difficulties that far outweighed the menace they
were intended to cure.”
Samuel Minzberg, 1986 CTF National Tax Conference
10 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● After the 1985 Federal Budget the “modern” form of the attribution rules is
introduced:
Attribution of income and gains from property transferred to spouses, and of
income from property transferred to minor children and nieces and nephews
Specific trust attribution rules
The introduction of the corporate attribution rule
Attribution of income from loaned property unless a commercial rate of interest
paid
No attribution of business income or second-generation income
11 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● The effect of subsection 56(2)
The Minister of National Revenue attempted to apply subsection 56(2) of the
Income Tax Act (Canada) to discretionary dividends paid on shares
Result was the McClurg and Neuman cases at the Supreme Court of Canada,
which found subsection 56(2) did not apply to dividends, regardless of
contribution - or lack of it – by the shareholder receiving the dividend
12 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● Reaction to Neuman: the kiddie tax
Commencing in 2000, section 120.4 imposed an effective prohibition on splitting
income with minors by imposing the top marginal tax rate on “split income”
received by the minor.
The kiddie tax broke with prior models by taxing split income at the top marginal
rate to the recipient, and making a parent jointly and severally liable with the
minor for the tax, rather than attributing the income to where it was “supposed”
to go
Effect of kiddie tax: eliminate incentive to split income with minors
13 2017 Taxation of Private Corporation Policy Conference
INCOME SPLITTING - BACKGROUND
● Later developments:
Pension income splitting permitted for 2013 and subsequent years
The “family tax cut”, which permitted splitting of income by all taxpayers,
implemented for 2014, was repealed after 2015 by the new government
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
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Speaker name: Michael WolfsonCompany: University of Ottawa
CCPCs and Income Sprinkling: (Some of) the Numbers
15 2017 Taxation of Private Corporation Policy Conference
Acknowledgements
● Social Sciences and Humanities Research Council -- funding
● Statistics Canada – data assembly and front-line analysis
● Neil Brooks, Mike Veall, Scott Legree, Brian Murphy – co-authors
● Canadian Tax Journal – editorial and peer review
● Disclaimer – my own views; full responsibility rests with Michael Wolfson
16 2017 Taxation of Private Corporation Policy Conference
How the Empirical Analysis Was Done
T2S50
Share
Owners T2s &
GIFIs for
CCPCs
T1s
Individuals
& Families
T4s
T5s
Increment in
Retained Earnings
“Full
Income”
etc.
• all data linked and analyzed
within Statistics Canada’s
secure environment
• challenging record linkages
• GIFI data “calendarized”
• unable to link trusts
• no data on share
ownerships < 10%, nor on
voting control
• only family members living
at same address
• ⇒ under-estimates re
sprinkling?
17 2017 Taxation of Private Corporation Policy Conference
Percentage of filers with over 10% ownership shares in at least one
CCPC, 2001 to 2011, by total T1 income deciles and top groups
Decile 1 < 5,800
Decile 2 < 11,900
Decile 3 < 16,900
Decile 4 < 21,700
Decile 5 < 27,500
Decile 6 < 34,100
Decile 7 < 41,500
Decile 8 < 51,600
Decile 9 < 68,800
P90-95 < 86,700
P95-99 < 163,300
Next 0.9 < 577,000
Next 0.09 < 2,305,700
Top 0.01 ≥ 2,305,700
18 2017 Taxation of Private Corporation Policy Conference
Number of CCPCs directly owned by owners, by total T1
income group, 2011Decile 1 < 5,800
Decile 2 < 11,900
Decile 3 < 16,900
Decile 4 < 21,700
Decile 5 < 27,500
Decile 6 < 34,100
Decile 7 < 41,500
Decile 8 < 51,600
Decile 9 < 68,800
P90-95 < 86,700
P95-99 < 163,300
Next 0.9 < 577,000
Next 0.09 < 2,305,700
Top 0.01 ≥ 2,305,700
19 2017 Taxation of Private Corporation Policy Conference
Complexity of CCPC ownership: Maximum number of
levels of ownership, by total T1 income group, 2011
Decile 1 < 5,800
Decile 2 < 11,900
Decile 3 < 16,900
Decile 4 < 21,700
Decile 5 < 27,500
Decile 6 < 34,100
Decile 7 < 41,500
Decile 8 < 51,600
Decile 9 < 68,800
P90-95 < 86,700
P95-99 < 163,300
Next 0.9 < 577,000
Next 0.09 < 2,305,700
Top 0.01 ≥ 2,305,700
20 2017 Taxation of Private Corporation Policy Conference
Trend Effects of Including CCPC Undistributed Income in
the Measurement of Income Inequality
21 2017 Taxation of Private Corporation Policy Conference
Average Amounts of Directly Owned CCPC Income by (After-
Tax + Capital Gains + Direct CCPC) Income Quantile, 2011
22 2017 Taxation of Private Corporation Policy Conference
Income Sprinkling: Widely Disseminated Advice“Small business owners who employ family members for income-sharing purposes
need to pay a reasonable salary, and be able to show the paperwork behind the
pay. But what’s reasonable? . . .Unfortunately, the CRA doesn’t have a hard and fast
rule for what’s deemed an acceptable salary. But if you pay the family member what
you would pay a typical employee, the CRA would have little reason to discount the
deduction. To determine a realistic wage isn’t difficult, though. Career websites list
average wages for jobs in numerous industries. According to the federal
government’s Job Bank site, the median hourly wage for an office clerk is $18 an
hour, for instance, although the site indicates you could go as high as $28 and still
be in the right ballpark.” Kira Vermond, “One Way To Reduce Small-Business
Taxes: Income-Splitting,” Globe and Mail, Monday, May 4, 2015
(www.theglobeandmail.com/report-on-business/small-business/sb-tools/one-way-to-
reduce-small-business-taxes-income-splitting/article24207847/).
25 2017 Taxation of Private Corporation Policy Conference
Numbers of CCPCs by Industrial Classification
Restaurants Lawyers Doctors
26 2017 Taxation of Private Corporation Policy Conference
3.47 Evaluation requirements for direct program spending. Direct program
spending is subject to …. (evaluation) over a five-year cycle. The policy defines
evaluation as the systematic collection and analysis of evidence on the
outcomes of programs to make judgments about their relevance, performance,
and alternative ways to deliver them or to achieve the same results.
3.48 Evaluation requirements for tax-based expenditures. …the policy
requirement to evaluate programs does not apply to tax-based expenditures.
3.77 Conclusion … overall we concluded that the Department fell short on
managing tax-based expenditures. We reached this conclusion because these
expenditures were not systematically evaluated and the information reported
did not adequately support parliamentary oversight.
Spring 2015 Report 3 on “Tax-Based Expenditures”
http://www.oag-bvg.gc.ca/internet/English/parl_oag_201504_03_e_40349.html
27 2017 Taxation of Private Corporation Policy Conference
Incomes of Individuals Working in the “Offices of Doctors”
● n.b. these incomes are
after subtracting salaries
and office expenses paid
by the “Offices”, both
CCPCs and self-employed
● there were over 7,500
doctors in 2011 receiving
more that $350,000 on their
T1s
● doctors owning CCPCs had
much more total family
income
● not yet known how much
was from “sprinkling”
Numbers of Doctors by Individual Income and Ownership of a Private Company
Income ($000s) Reported on Individual Income Tax Returns
$100-$200 $200-$350 $350-$500 > $500 > $100
Does not Own a CCPC 10,050 8,120 2,750 960 21,880
Owns a CCPC 18,300 8,110 2,480 1,390 30,280
Totals 28,350 16,230 5,230 2,350 52,160
Average Family Incomes ($000s) of Doctors and
Their Immediate Families Plus Income Retained in a CCPC
Income ($000s) Reported on Individual Income Tax Returns Income ($000s) Reported on Individual Income Tax Returns
$100-$200 $200-$350 $350-$500 > $500
Does not Own a CCPC 240 337 483 730
Owns a CCPC 378 498 673 1,402
28 2017 Taxation of Private Corporation Policy Conference
Between $1,996 and $4,600 of private income, GIS benefits reduce at its regular rate of 50% (GAINS is gone and the new top up hasn’t begun to reduce)
Between $4,600 and $8,400 in private income, GIS benefits reduce at a rate of roughly 92% (50% for the regular GIS benefit + 42% for the increased GIS top-up which reduces within this zone)
For the first $1,996 of private income, benefits reduce at 100%(50% for regular GIS + 50% for GAINS). This is the same as before.
After $8,400 of private income, GIS benefits again reduce at a rate of 50% (The top-up is completely gone)
Compare
Effective
Income Tax
Rates for Low
Income
Seniors, the
“Poverty Trap”
from 50 to
100% (and
higher)
29 2017 Taxation of Private Corporation Policy Conference
Concluding Comments
● first time: shining a statistical light into a dark corner of Canada’s income tax
this kind of analysis is not easy, but as concluded by the AG, it needs to be done,
done well, and made available to Parliament and the public on a regular basis
● CCPCs are widely used especially among those with the highest incomes
● income sprinkling appears to involve a significant (individual + corporate) income tax
revenue cost, possibly on the order of at least $500 million per year
it is horizontally inequitable = unfair
it induces an important non-neutrality in the tax system, thereby encouraging non-
productive tax planning costs in addition to its revenue costs
● while powerful vested interests complain loudly about having to pay tax at top rates as
high as 50%, hundreds of thousands of Canada’s seniors face much higher effective
income tax rates, and no one seems to care
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
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Speaker name: Rachel Gervais Company: BDO Canada LLP
Income Splitting –Technical Summary of Proposed Legislation
31 2017 Taxation of Private Corporation Policy Conference
Tax on Split Income (TOSI)
Applies by virtue of S.120.4(2) “Specified Individual”* will be subject to the top personal tax rate for the year on the individual’s “Split
Income”* for the year
Proposals extend rules to apply to all Canadian resident individuals who
included in income certain amounts that are derived from a business that is, or
was, sufficiently linked to a related individual who is resident in Canada
Proposals apply to minors and adult family members
To apply the new rules, must consider new or modified definitions, new
reasonableness tests for certain types of income of individuals 18 years of age
and older, and anti-avoidance rules * Revised definitions under S. 120.4(1) of the Act
32 2017 Taxation of Private Corporation Policy Conference
Revised Definition of “Specified Individual” – S. 120.4(1)
Age Current TOSI Proposed TOSI
Under age 18
(minor)
• Canadian resident
throughout the year
• Parent resident in
Canada at any time
during the year
• At no time in the year
was a non-resident
Canadian resident at end of the year*
At any time during the year either:
• Parent resides in Canada, or
• A related individual resides in Canada, and the minor receives certain income
derived from a business of that related individual
Age 18 or older
(adult)
Not applicable Canadian resident at end of the year*
At any time during the year a related individual resides in Canada, and the adult
receives certain income derived from a business of that related individual.
* Where individual dies in the year, Canadian resident immediately before death
Note: for purposes of the proposed rules, related person is extended to include aunts, uncles, nieces or nephews
33 2017 Taxation of Private Corporation Policy Conference
New definition of “Connected Individual” – S.120.4(1)
Sets out factors applicable when considering the degree of connectivity between an
individual and a corporation relevant for:
Definition of specified individual in determining whether a business is sufficiently linked to a related
individual, when looking at whether income is derived from that business
Definitions of split income (income from indebtedness under para. (d) of the definition of split income),
related source, and split portion (i.e. for the purposes of applying the reasonableness test under
Subparagraph (b)(ii) of the definition of split portion)
A connected individual in respect of a corporation includes an individual resident in
Canada who can be shown to meet any of the following conditions set out in paragraphs
(a) through (d) of the definition:a) Strategic influence
b) Equity influence
c) Earnings influence
d) Investment influence
34 2017 Taxation of Private Corporation Policy Conference
“Specified Individual” - Example
● Facts:
Mr. and Mrs. X
X Corp. incorporated in 1990. Upon incorporation, Mr. and Mrs. X each subscribed for 50% of the common
shares of X Corp for a nominal amount.
Mr. X was never active in the business and worked part-time for another employer while spending a significant
amount of time caring for their child X Jr.
Mrs. X ran the business and its value grew considerably
X Jr. became involved in the business and by 2016, was running the business by himself.
In early 2016, the X family undertook a standard “freeze” for X. Corp – Mr. and Mrs. X each exchanged their
common shares for fixed value, redeemable and retractable preferred shares with an aggregate redemption
value of $4M. X Jr. subscribed for all the newly issued common shares of X Corp. for a nominal amount
Plan was for each of Mr. and Mrs. X to receive approximately $100K of dividends annually by way of share
redemptions of their preferred shares throughout retirement – Standard “Wasting Freeze”
This $200K would represent the majority of Mr. and Mrs. X’s annual retirement income. They will also receive
Canada Pension Plan payments.
35 2017 Taxation of Private Corporation Policy Conference
“Specified Individual” - Example
● Analysis under proposed TOSI rules:
Both Mr. and Mrs. X will be “Specified Individuals”
Related individual (X Jr.) resides in Canada and Mr. and Mrs. X receive income (dividends)
derived from a business carried on by corporation of which X Jr. is a specified shareholder.*
All dividends received by way of share redemption by Mr. and Mrs. X may be subject to TOSI
Mr. X – Clearly subject to TOSI on dividends as he was never active in the business at all
Mrs. X – Possibly subject to TOSI on dividends – Will depend on reasonableness test
discussed later – i.e. What is reasonable given Mrs. X’s past contributions to X Corp and past
compensation prior to retirement?
* X Jr. would also meet the criteria outlined in the proposed new definition of “connected individual” contained in S.120.4(1) which
may be relevant if the fact pattern was different and X. Jr was not a specified shareholder as defined in S. 248(1)
36 2017 Taxation of Private Corporation Policy Conference
“Specified Individual” – Discussion of Example
● Becoming specified individuals will reduce Mr. and Mrs. X’s retirement income significantly –
Planning was implemented assuming marginal rates on share redemption dividends. Now
potentially subject to highest marginal rate on every dollar received
● Retroactive Taxation? - $4M of preferred share value accumulated prior to 2017.
Appropriate to now tax all that value at highest marginal rates?
● How will X Corp’s cash flow be impacted? – Will now require significantly more cash to give
Mr. and Mrs. X equivalent amounts of retirement income as planned.
● How much time and money will X Corp./X family need to spend to justify reasonableness of
Mrs. X’s dividends? – How much money did she draw in the past?
● What happens on death if Mr. and Mrs. X pass away with unredeemed preferred shares
outstanding? – Could entire remaining value be taxed at dividend rates? – See proposed
S.120.4(4) – More facts would be required to answer this question
37 2017 Taxation of Private Corporation Policy Conference
Revised Definition of “Split Income” – S. 120.4(1)
Category Current TOSI Proposed TOSI
Private company taxable dividends, S.15 shareholder
benefits
Paragraph (a) Paragraph (a) – no change
Business income from a partnership Paragraph (b) Paragraph (b) – change for “related source” definition
Business income from a trust Paragraph (c) Paragraph (c) – change for “related source” definition
Income from indebtedness Not applicable Paragraph (d) – new
Taxable capital gains and income from the
disposition of certain property
Not applicable Paragraph (e) – new
Section 246 amounts (conferred benefits) Not applicable Paragraph (f) – new
Reinvested – split income, income subject to the
attribution rules and capital dividends where certain
conditions met (for individuals under the age of 25)
Not applicable Paragraph (g) - new
38 2017 Taxation of Private Corporation Policy Conference
New Definition – “Split Portion” – S. 120.4(1)
For a specified individual who is 18 years of age or older, it will generally be necessary to determine if there is a “split
portion” of the amount of their split income. Only the “split portion” will be subject to TOSI (subject to the anti-
avoidance rule under S. 120.4(1.1)(d))
Category of split income Paragraph of the definition Reasonableness Test
Amounts under paragraph (g) of split
income – of individuals under the age of 25
Paragraph (a) No
All amounts of split income, except those
covered in paragraphs (e) and (g) of that
definition
Paragraph (b) Yes*
Amounts under paragraph (e) of split
income – taxable capital gains and income
from the disposition of certain property
Paragraph (c) Yes**
* Based on contribution factors (arm’s length view) and what has been paid/payable. Must also consider anti-avoidance rules, restriction rules for 18 – 24,
deeming rule for inherited property (S.120.4(1.1)(e)(ii) and (iii))
** Test requires consideration of whether certain income from the property would be considered split income
39 2017 Taxation of Private Corporation Policy Conference
Example – “Split Income” – Paragraph (e)
● Facts
Mr. A owns 60% of the common shares of A. Corp. He runs the business independently
The other 40% of the common shares are owned by Mr. A’s uncle (age 50) who
contributed $40,000 to subscribe for share capital when A. Corp was incorporated.
There was no intention to income split with Mr. A’s uncle, he was simply a source of
start-up capital. Mr. A’s uncle is not (and never was) involved in the management of the
business
The shares of A. Corp are being sold by the current shareholders after 2017 to arm’s
length purchasers. A capital gain will be realized upon sale by each of the current
shareholders.
None of the shareholders have ever received any dividends on the common shares
40 2017 Taxation of Private Corporation Policy Conference
Example – “Split Income” – Paragraph (e)
● Is Uncle’s gain on the disposition of shares subject to TOSI?
Uncle is a “specified individual” in respect of A. Corp’s business
Resident in Canada
Related to Mr. A (Proposed S. 120.4(1.1) – uncles and nephews are related)
Business of A. Corp is carried on by Mr. A. and Mr. A is a specified shareholder* of A. Corp.
Uncle’s gain on the disposition is included in Paragraph (e) of the definition of “split income” Uncle is a “specified individual”
Uncle has a taxable capital gain from the disposition of property
The property is a share of the capital stock of a corporation which is not a public company or mutual fund corporation
Would paragraph (c) of the “split portion” definition exclude this gain from TOSI?
Appears as though we would need to determine if the capital gain would have been included in split income had it been
received as an amount included in Paragraphs (a) – (d) of the definition of “split income” (i.e. as a dividend, business
income or income from indebtedness)
How can we answer this? Does the reasonableness test apply? If so, what would be reasonable given Uncle’s original $40,000
contribution?
* Also a connected individual however not relevant given particular fact pattern
41 2017 Taxation of Private Corporation Policy Conference
“Split Income” – Paragraph (e) – Discussion of Example
● If the gain is subject to TOSI:
Why should Uncle’s gain be treated differently than that of an arm’s length investor? He
was simply a source of start-up financing who happened to be Mr. A’s Uncle – No
income splitting intention
What if Uncle wanted to claim LCGE on his gain realized? No longer available under
proposed rules to constrain LCGE multiplication*
What if Mr. A. wanted to increase his interest in the company and purchase his Uncle’s
shares? – If gain subject to TOSI, would gain be taxed at dividend rates? – If proposed
Section 120.4(4) applies, gain would be taxed as a non-eligible dividend
* Assumes no election made to crystallize LCGE under proposed S. 110.6(18)
42 2017 Taxation of Private Corporation Policy Conference
Constraining the Capital Gains Exemption
Background
The government is particularly concerned that the current LCGE rules can be
used to “multiply” the LCGE so that it is available to family members who are not
involved in the business
The government:
views that these individuals may not have effectively contributed to the business;
is also concerned about the use of family trusts, primarily those that are
discretionary, to allocate capital gains and income among family members
43 2017 Taxation of Private Corporation Policy Conference
Constraining the Capital Gains Exemption
New Restrictions on Minors
Proposed age limit so that minors will no longer qualify for the LCGE in respect
of capital gains that are realized, or that accrue
LCGE will no longer be available to minors regardless of whether the child is
involved in the business
If minor acquires qualifying property and disposes of it when they are an adult,
the increase in the value of the property during the time the individual was a
minor will not be eligible for the LCGE
It may be necessary to have a valuation of the shares completed at the beginning of the
taxation year in which the minor turns 18 years old
44 2017 Taxation of Private Corporation Policy Conference
Constraining the Capital Gains Exemption
Tying the use of the LCGE to the new TOSI Rules
• Proposals provide that the LCGE will generally not apply if the taxable capital
gain arising from a disposition is included in an individual’s split income
• If an amount is not included in TOSI only because the recipient of the income
is already taxed at the top marginal tax rate, restriction on LCGE can apply
• If a taxable capital gain (TCG) from the disposition of a property is included
in individual’s split income, then the amount that the individual can deduct
under the LCGE in computing the TCG is reduced by 2 times the amount of
the TCG included in computing the individual’s split income
45 2017 Taxation of Private Corporation Policy Conference
Constraining the Capital Gains Exemption
How Property in Trusts is Affected
• New limits for beneficiaries of a trust from claiming any LCGE on dispositions
• In order for an associated gain from property held by a trust to be eligible for
the LCGE, it must be designated by an “Eligible LCGE Trust”
• An “Eligible LCGE Trust” includes:
• A spousal or common-law partner trust or alter ego trust where the individual
claiming the LCGE is the trust’s principal beneficiary;
• Certain employee share ownership trusts, where the individual beneficiary is an
arm’s length employee of the employer sponsor of the arrangement
46 2017 Taxation of Private Corporation Policy Conference
Constraining the Capital Gains Exemption
How Property in Trusts is Affected
• Trust measures would apply in situations where the trust realizes a capital
gain and allocates it to a beneficiary, and also where the trust elects to
transfer the property with an accrued gain to a beneficiary who realizes the
gain at a later date on a disposition
• These measures would not prevent trusts that are currently eligible to
undertake rollovers to beneficiaries from continuing to do so; however,
unless an exception applies, no deduction would be allowed under the LCGE
in respect of the capital gain that is ‘transferred’ from a trust on a rollover of
property to a beneficiary
47 2017 Taxation of Private Corporation Policy Conference
Constraining the Capital Gains Exemption
Election for Deemed Disposition in 2018
• Transitional rules provide for grandfathering of certain dispositions that occur
in 2018, allowing an individual to elect to realize in 2018, a capital gain in
respect of eligible property by way of a deemed disposition for proceeds up
to the FMV of the property
• Transitional rules provide an opportunity for property that currently does not
qualify for the capital gains exemption in 2017 to be purified as proposed
legislation will reduce the holding period from 24 months to 12 months
• This means that the purification process must happen before December 31,
2017 in order for the crystallization to occur in 2018
Disclaimer:
This material is for educational purposes only and is not intended to be
advice on any particular matter. No one should act on the basis of any
matter contained in these materials without considering appropriate
professional advice. The presenters expressly disclaim all liability in
respect of anything done or omitted to be done wholly or partly in
reliance upon the contents of these materials.
Tax Planning Using Private Corporations -
July 18, 2017:
Analysis and Discussion with FinanceOttawa, ON
Allan Lanthier (Moderator)Retired Partner, EY LLP
Greg BellKPMG LLP
Mark BrenderOsler, Hoskin & Harcourt LLP
Bruce HarrisPwC LLP
Robert RaizenneOsler, Hoskin & Harcourt LLP
Surplus Stripping
2 2017 Taxation of Private Corporation Policy Conference
Topics
Surplus stripping - history and policy framework
Section 84.1 and section 246.1
Share transfers – inter vivos and on death
Issues – transition; double taxation; uncertain results
Intergenerational transfers
Allan Lanthier - September 25, 2017
3 2017 Taxation of Private Corporation Policy Conference
Two streams of surplus stripping rules
● First Stream: Shareholder/corporation rules (mostly complete by 1926)
Initial versions of 84(1), 84(2), 84(3), 15(2)
● Second Stream: Other ways to surplus strip: 84.1, 246.1
History of second phase is more complicated
There was an antecedent to 84.1, which returned in 1977
246.1 antecedents (32A(2) – 138A – 247(1))
Repealed in 1948, restored in 1963, repealed again in 1988
Allan Lanthier - September 25, 2017
4 2017 Taxation of Private Corporation Policy Conference
1917 Act – Perfect Integration
Corporate rate = 4%
Top personal rate = 25%
Tax deferral potential on
corporate earnings, both
business and investment = 21%
Corporate tax fully integrated
with personal tax
Robert Raizenne - September 25, 2017
5 2017 Taxation of Private Corporation Policy Conference
1917 Act – Perfect Integration
BUT – Shareholder immediately taxable on undistributed income UNLESS Minister determines
(i) no avoidance motive, and (ii) undistributed income not in excess of needs of business
BUT – Attribution of undistributed income reversed in 1918, retroactive to 1917; rule became
no attribution unless Minister concluded avoidance, and undistributed income was in excess of
needs of business
Other features of 1917 Act:
1. Shareholder / corporation transactions reviewable
2. Capital gains not taxed: the original sin?
Robert Raizenne - September 25, 2017
6 2017 Taxation of Private Corporation Policy Conference
The Amendments Begin
● Stock dividends made fully taxable as dividends from 1918
● IRC v. Burrell, [1924] 2 K.B.: UK CA holds “winding-up dividend” constitutes proceeds on capital account
● 84(2) prototype enacted in response to Burrell
Broad meaning subsequently given to “winding-up” notion in subsection 84(2):
● MNR v. Merritt, [1942] S.C.R. 269: winding-up is not a term of art
● Amendment in 1948 adds “directly or indirectly” language; Testimony of W.R. Jackett, HoC Standing Committee on
Banking and Commerce:
“ ‘Or what would have been’ refers to the case where there was no actual distribution, proper distribution, or property of the
corporation to the shareholders … one case would be where a corporation ceased carrying on business and the
shareholders just took the property according to some arrangement without going through the proper winding up and
distribution of assets” … to catch a “subterfuge”
● Conn Smythe, [1970] S.C.R. 64
● MacDonald, 2013 FCA 110
Robert Raizenne - September 25, 2017
7 2017 Taxation of Private Corporation Policy Conference
1926 Budget – a “big budget”
Continuing manifestations of “tax avoidance”
House of Commons Debates, 1926, Georges Henri Boivin, Minister of
Customs and Excise:
“We want to obviate the practice, followed by certain corporations, of escaping the
payment of taxation by allowing their profits to remain as reserve for a year or two
and then distributing those profits in other ways than in the form of dividends to
shareholders, as for instance, by the purchase of stock at a premium, or by
reducing capital stock for more than its value at the time it was sold”
Robert Raizenne - September 25, 2017
8 2017 Taxation of Private Corporation Policy Conference
1926 Budget – Details
1. At a time of declining tax rates, there was a conscious choice to terminate integration:
not politically palatable
2. Additional avoidance rules enacted, including:
84(1) – capitalization of earnings
84(3) – share redemptions
84.1 – NAL share transfers
15(2) / Shareholder loans
Deemed dividends limited to available undistributed income on hand (UIOH)
3. Intercorporate dividend deduction legislated
4. “Personal corporation” rule causes “holding companies” to be taxed on an attribution basis
Prototypes
Robert Raizenne - September 25, 2017
9 2017 Taxation of Private Corporation Policy Conference
1938-1950
1938 Enactment of section 32A: Treasury Board direction
C. Fraser Elliott, Commissioner of Taxation:
“By reason of the amendments referred to and other amendments, it can be stated generally that, neither
directly nor indirectly, can the earned surplus of a company be put out of the channel of taxation under
any name or scheme, on distribution. It will be taxed, whether done by way of ordinary dividend, winding
up, stock dividend, premium, loan, or through controlled or personal corporations”
1943 32A amended: Treasury Board direction expressly extended to “surplus stripping” transactions
1945 Ives Report
Robert Raizenne - September 25, 2017
10 2017 Taxation of Private Corporation Policy Conference
1938-1950 (continued)
1948 Income Tax Act Previous rules carried over, with some exceptions; Treasury Board direction references to “surplus stripping”
deleted
Shareholder benefit rule – subsection 15(1) – added
1949 Dividend tax credit prototype added to alleviate double taxation
1950 Carter Commission: where one Canadian corporation acquires control of another, at a time when the other
corporation has undistributed income on hand, such undistributed income will become “designated surplus”
and a dividend will not pass tax-free between the corporations to the extent that it is paid out of the designated
surplus
Designated surplus rules proved complex and ineffective and interfered with business transactions
Robert Raizenne - September 25, 2017
11 2017 Taxation of Private Corporation Policy Conference
The Oracle Speaks: W.R. Jackett, 1960 CTF Conference
“…, the law has always been constructed on the basis that the tax on the distributions to
individuals was only deferred and must ultimately be paid.”
The 1926 amendments were designed to treat all non-dividend distributions from the
corporation to the shareholder as “deemed” dividends.
“However, there are other means of escaping the second tax: … by using provisions in the Act
designed for some other object to put the individual shareholders in possession of all or a
substantial part of the undistributed corporate earnings without paying the second tax on them.
… Examples of these means are: (a) transactions making use of the exemption for inter-
company dividends; (b) transactions making use of exempt entities; and (c) transactions
making use of [non-residents].”
Robert Raizenne - September 25, 2017
12 2017 Taxation of Private Corporation Policy Conference
1963 – Enactment of section 138A
● Carter Report: A Major Weakness of the Present System of Taxing Corporations – “Surplus Stripping”
● General anti-surplus stripping rule added to Act
● Carried over intact to 1972 Reform Act as subsection 247(1)
● Amended in 1986 to remove ministerial discretion
● Repealed in 1988 as part of GAAR reshuffle:
Technical Notes: “Because the scope of that general anti-avoidance rule is broad enough to cover
the transaction to which subsection 247(1) was intended to apply, that subsection is no longer
necessary”
Methodologies of two rules are not the same
● No substantial judicial guidance
● C.W. Primeau, “Surplus Stripping: The Departmental View” (1974) 22:5 Canadian Tax Journal 421-429.
Robert Raizenne - September 25, 2017
13 2017 Taxation of Private Corporation Policy Conference
1977 Budget
● Designated surplus rules repealed
● Modern 84.1 enacted
Robert Raizenne - September 25, 2017
14 2017 Taxation of Private Corporation Policy Conference
1980 – Finance comments on 247(1)
“When it became clear that the designated surplus approach was not effective, a
"ministerial discretion" provision was introduced in 1963 to contain a groundswell of
surplus-stripping developments. In the absence of a reasonable and workable system,
this created taxpayer uncertainty, further administrative difficulties and otherwise
unnecessary expenditure of time and effort in the planning of business transactions
and in the enforcement of the law.”
“Its continued presence is indicative of the genuine difficulty in designing workable
rules to determine the tax on surplus distributions where there is a differential
treatment of dividends and capital gains.”
Robert Raizenne - September 25, 2017
15 2017 Taxation of Private Corporation Policy Conference
Post-GAAR case law comments on “scheme” in the Act
Pre-Canada Trustco
● McNichol, 97 DTC 111, per Justice Bonner:
“the scheme of the Act calls for the treatment of distributions to shareholders of corporate property as income”
and other provisions of the Act demonstrated “the existence of a legislative scheme to tax as income all
distributions by a corporation to a shareholder, even those of a less orthodox nature than an ordinary dividend”
● RMM, 97 DTC 302, per Justice Bowman:
“The Income Tax Act, read as a whole, envisages that a distribution of corporate surplus to shareholders is to
be taxed as a payment of dividends. A form of transaction that is otherwise devoid of any commercial
objective, and that has as its real purpose the extraction of corporate surplus and the avoidance of the
ordinary consequences of such a distribution, is an abuse of the Act as a whole.”
Robert Raizenne - September 25, 2017
16 2017 Taxation of Private Corporation Policy Conference
Post-GAAR case law comments on “scheme” in the Act
Post-Canada Trustco
● Evans, 2005 TCC 684, per Justice Bowman: “The only basis upon which I could uphold the Minister's application of section 245 would be to find that there is some
overarching principle of Canadian tax law that requires that corporate distributions to shareholders must be taxed as dividends,
and where they are not the Minister is permitted to ignore half a dozen specific sections of the Act. This is precisely what the
Supreme Court of Canada has said we cannot do”
“[McNichol and RMM] were early general anti-avoidance rule cases and we did not have the benefit of the Supreme Court of
Canada's guidance that we have today. If we had had the benefit of the Supreme Court of Canada's views, our analysis might
have been quite different.”
Robert Raizenne - September 25, 2017
17 2017 Taxation of Private Corporation Policy Conference
Post-GAAR case law comments on “scheme” in the Act
Post-Canada Trustco (continued)
● McMullen, 2007 TCC 16, per Justice Lamarre: “In conclusion, the respondent has not persuaded me, or has not presented any evidence establishing, that there was any abuse of the
Act read as a whole, or that the policy of the Act read as a whole is designed so as to necessarily tax corporate distributions as
dividends in the hands of shareholders.”
● Collins & Aikman, 2009 TCC 299, per Justice Boyle: No scheme against surplus stripping – applies comments from Evans and McMullen.
2010 FCA 251: “We see no reason to conclude that the limited scope of [84.1 and 212.1] was anything other than a deliberate policy
choice by Parliament.”
Robert Raizenne - September 25, 2017
18 2017 Taxation of Private Corporation Policy Conference
Post-GAAR case law comments on “scheme” in the Act
Post-Canada Trustco (continued)
● Copthorne, 2011 SCC 63, per Justice Rothstein: “What is not permissible is basing a finding of abuse on some broad statement of policy, such as anti-surplus stripping, which is not
attached to the provisions at issue”
Tax Court: “While the Act contains many provisions which seek to prevent surplus stripping, the analysis under subsection
245(4) must be firmly rooted in a unified textual, contextual and purposive interpretation of the relevant provisions. As such,
reliance on a general policy against surplus stripping is inappropriate to establish abusive tax avoidance”
● Gwartz, 2013 TCC 86, per Justice Hogan: Crown abandoned position that there is a scheme against surplus stripping in the Act
Justice Hogan finds no scheme – cites Copthorne, McMullen, Collins & Aikman
● Descarries, 2014 TCC 75, per Justice Hogan: “the Act does not contain any general prohibition stating that any distribution by a company must be done in the form of a
dividend”
Robert Raizenne - September 25, 2017
19 2017 Taxation of Private Corporation Policy Conference
CRA Recent Administrative Practice
From 2014 APFF Roundtable: « En toute déférence, il nous apparaît qu'on doit plutôt, selon nous, tenir compte dans cette analyse, de
l'alinéa 82(1)b), de l'article 121 ainsi que des paragraphes 84(1), 84(2), 84(3), 84(4) et 15(1) L.I.R. supportant une politique fiscale qui a pour but d'imposer exclusivement sous forme de dividendes les surplus d'une société versés directement à leurs actionnaires qui sont des particuliers. »
« Ces dispositions reflètent, selon nous, une politique fiscale claire et non ambiguë de la part du ministère des Finances, qu'on appelle communément les Règles d'intégration, laquelle est également appuyée par toute une série d'autres dispositions (entre autres, l'article 84.1 L.I.R. ainsi que les paragraphes 84(2), 246(1) et 245(2) L.I.R., en tenant compte de l'ancien paragraphe 247(1) L.I.R. et particulièrement des notes explicatives du ministère des Finances se rapportant à ce paragraphe) ayant pour but d'éviter que les particuliers actionnaires obtiennent indirectement les surplus d'une société sous une forme autre qu'un dividende. En somme, dans une situation comme dans l'affaire Descarries, les Trois opérations d'évitement constituent, selon nous, un abus des Règles d'intégration. »
Robert Raizenne - September 25, 2017
20 2017 Taxation of Private Corporation Policy Conference
CRA Recent Administrative Practice
From 2014 APFF Roundtable (continued): « Compte tenu de ce qui précède et des décisions défavorables rendues par la CCI à l'égard de l'analyse des
paragraphes 84(2) et 245(2) L.I.R. dans le cadre de dossiers impliquant des dépouillements de surplus, l'ARC croit nécessaire, avec déférence pour la position prônée par la CCI, de s'adresser à la Cour d'appel fédérale ou à la Cour suprême du Canada pour qu'un tribunal supérieur, d'une part, confirme la portée très large du paragraphe 84(2) L.I.R. établie récemment par la Cour d'appel fédérale dans l'affaire MacDonald, et d'autre part, statue sur la présence ou non d'un plan spécifique de la L.I.R. visant à imposer toute distribution directe des surplus d'une société canadienne à titre de dividendes imposables entre les mains de ses actionnaires qui sont des particuliers; ainsi que d'un plan spécifique de la L.I.R. pour contrer également les dépouillements indirects des surplus d'une telle société. »
Robert Raizenne - September 25, 2017
21 2017 Taxation of Private Corporation Policy Conference
CRA Recent Administrative Practice
From 2015 CTF Roundtable: The CRA is nevertheless concerned with surplus stripping arrangements and has expressed those concerns to
the Department of Finance
The CRA will still maintain its position of applying the GAAR and/or subsection 84(2) to cases like The Queen v. Macdonald where a taxpayer uses losses or other tax shelter to reduce a capital gain realized as part of a surplus stripping scheme
Also, the CRA will rely on the reasoning in Descarries where a taxpayer seeks to extract corporate surplus in a manner contrary to the object, spirit or purpose of specific anti-avoidance provisions, such as sections 84.1 and 212.1
Robert Raizenne - September 25, 2017
23 2017 Taxation of Private Corporation Policy Conference
Surplus Stripping
● CRA has previously asserted there is a general scheme in the Act against surplus stripping
Removing retained earnings of a corporation by way of capital gains rather than dividends
See, for example, Technical interpretation 2012-0433261E5, published June 18, 2013
“Notwithstanding the recent decision in Gwartz et al. v. The Queen, 2013 TCC 86, the CRA
intends, at the next opportunity, to demonstrate to the Court that there is a specific scheme of
the Act for taxing the distribution of surplus of a Canadian corporation as a taxable dividend in
the hands of individual shareholders and that there is also an overall scheme of the Act
against surplus stripping.”
● The courts have found that the Act does not contain a general scheme to prevent surplus stripping
See Evans v. The Queen, 2005 TCC 684, The Queen v. Collins & Aikman Products Co., 2010
FCA 251 and Copthorne Holdings Ltd. v. The Queen, 2011 SCC 63
Gregory Bell - September 25, 2017
24 2017 Taxation of Private Corporation Policy Conference
Surplus Stripping “Scheme”
● Evans (2005 TCC) - GAAR rejected“The only basis upon which I could uphold the Minister's application of section 245 would be
to find that there is some overarching principle of Canadian tax law that requires that
corporate distributions to shareholders must be taxed as dividends, and where they are not
the Minister is permitted to ignore half a dozen specific sections of the Act. This is precisely
what the Supreme Court of Canada has said we cannot do.”
“Counsel argues that this case is similar to Justice Bonner's decision in McNichol … and
mine in RMM … . These cases were early general anti-avoidance rule cases and we did not
have the benefit of the Supreme Court of Canada's guidance that we have today. If we had
had the benefit of the Supreme Court of Canada's views, our analysis might have been
quite different.”
Contradicted his own judgment in RMM v. Canada (1997 D.T.C. 302 (TCC))
Gregory Bell - September 25, 2017
26 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
● Individual sells shares of Privateco to non-arm’s length corporation
(Newco) to realize a capital gain
● Consideration is a promissory note
● Cash of Privateco to be used to repay promissory note
Might amalgamate or redeem high adjusted cost base (“ACB”)
shares
No 55(2)
● However, under existing rules (and no change under proposed rules)
84.1(1)(b) - Individual deemed to receive a dividend of $99
instead of a capital gain of $99
Dividend equal to amount of note in excess of greater of
“hard” ACB and PUC of Privateco shares
Same result if Individual uses CGE
Gregory Bell - September 25, 2017
27 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
● Individual sells shares to non-arm’s length corporation to realize a
capital gain
● Consideration is high-basis / high paid-up capital shares
● Cash of Privateco to reduce PUC of Newco shares
Might amalgamate or redeem high ACB shares
No 55(2)
● However, under existing rules (and no change under proposed
rules)
84.1(1)(a) – PUC of Newco shares reduced to $1
PUC reduced to greater of “hard” ACB and PUC of
Privateco shares
Same result if Individual uses CGE
Gregory Bell - September 25, 2017
28 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
● Parent sells Privateco shares to Child
(i.e. a non-arm’s length individual) for
cash to realize capital gain
● Child sells Privateco shares to Newco for
Promissory Note
● Cash of Privateco to be used to repay
promissory note
Gregory Bell - September 25, 2017
29 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
Under Existing Rules
● 84.1 does not apply
● Parent has capital gain
Parent has sold shares to child
84.1 can only apply if Parent sells shares
to a non-arm’s length corporation
Child not deemed to receive a dividend
Child has “hard” ACB in shares of
Privateco
Provided Parent does not claim
capital gain exemption (“CGE”)
84.1(2)(a.1)(ii)
Gregory Bell - September 25, 2017
30 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
Under Existing Rules
● 84(2) could possibly apply
84(2) deems amounts distributed
“in any manner whatever” to a
shareholder to be a dividend
Can apply if cash of Privateco is
considered to be distributed on
discontinuance, winding-up or a
reorganization of Privateco’s
business
Gregory Bell - September 25, 2017
31 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
Under Proposed Rules
● 84.1 applies to Child
Child deemed to receive dividend of $99
Capital gain realized by Parent does not
create “hard” tax ACB
See proposed amendment to
84.1(2)(a.1)(ii)
Previous dispositions by non-arm’s
length persons does not create “hard”
ACB
Gregory Bell - September 25, 2017
32 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares
Under Proposed Rules
● 84.1 applies to Child
Child deemed to receive dividend of $99
Capital gain realized by Parent does not create
“hard” tax ACB
See proposed amendment to 84.1(2)(a.1)(ii)
Previous dispositions by non-arm’s length
persons does not create “hard” ACB
Even if intermediate sale to third-party
Gregory Bell - September 25, 2017
33 2017 Taxation of Private Corporation Policy Conference
Non-Arm’s Length Sale of Shares – 84.1
● Department of Finance Explanatory Notes
“The objective of [the amendment] is to ensure that an individual cannot use more than
the greater of their so-called “hard” arm’s length share cost and the PUC of their share
to extract corporate surplus on a tax-free basis or as capital gains from a corporation.”
● The amendments to section 84.1 apply in respect of dispositions that occur
on or after July 18, 2017.
Gregory Bell - September 25, 2017
35 2017 Taxation of Private Corporation Policy Conference
Transitional/Technical Issues
Pipeline Planning
● Estates holding high ACB shares where it was planned that pipeline planning be implemented
● Impacted by 84.1
● May no longer be possible or practical to carry out 164(6) planning, (for example, July 18, 2017 is
more than one year after death)
For existing pipeline notes or high-PUC shares, could new 246.1 apply on payment of the note or
return of PUC?
Gregory Bell - September 25, 2017
36 2017 Taxation of Private Corporation Policy Conference
Transitional/Technical Issues
Interaction with Tax on Split Income
● Is 120.4(4) necessary?
Based on the changes to 84.1 and the LCGE rules, 120.4(4) should not be
necessary
● If 120.4(4) is not repealed should 84.1 be amended?
Where 120.4(4) applies, an individual is deemed to have an ineligible dividend
equal to twice the taxable capital gain
There should be an exception in 84.1(2)(a.1)(ii) to create hard ACB in
recognition that the gain has already been taxed as a dividend
Gregory Bell - September 25, 2017
38 2017 Taxation of Private Corporation Policy Conference
Non-arm’s Length/Intergenerational Transfers
● 84.1 generally applies on the transfer of shares of a corporation between siblings and between parents and their children
Privateco is owned 50/50 by two siblings
FMV of a 50% interest is $3 million
ACB is nominal
Gain qualifies for the LCGE
Tax rate on capital gains is 25%
Tax rate on non-eligible dividends is 45%
● The income tax arising on a sale by one sibling is as follows:
Gregory Bell - September 25, 2017
39 2017 Taxation of Private Corporation Policy Conference
Non-arm’s length/Intergenerational Transfers
● Recommendations
An exception to 84.1 should be provided to facilitate “true” dispositions of shares
of corporations between family members (inter vivos and testamentary)
The exception could include a number of conditions to ensure that the proposed
disposition is not a disguised surplus strip, for example:
Limit to sales of “active businesses”
Limit to sales of a significant portion of a shareholder’s interest
Limit the rate of return on any share consideration
Gregory Bell - September 25, 2017
41 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Considerations
Is it the policy intent to tax an individual at the ineligible dividend rate on death?
Is there a change in policy regarding double tax and the ability to increase the
ACB of capital properties held by a corporation to mitigate double tax?
Gregory Bell - September 25, 2017
42 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning - Summary
“Pipeline” Planning
Impacted by 84.1 amendments
Existing pipeline notes or shares might be impacted by proposed 246.1
164(6) Planning
Enhanced 164(6) planning impacted by proposed 246.1
Gregory Bell - September 25, 2017
43 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
● Pipeline – Existing Rules
Objective
Limit tax as a result of death to tax on capital gain realized by deceased
Can be implemented any time after death of shareholder
Subject to certain constraints
● Pipeline – Proposed Rules
Based on draft legislation, pipeline transactions will result in deemed dividend to estate
Gregory Bell - September 25, 2017
44 2017 Taxation of Private Corporation Policy Conference
84.1 Amendment – Impact on Post-Mortem “Pipeline” Planning
● Individual A passes away
● Individual A owned shares of Privateco
with low ACB and paid-up capital (“PUC”)
● Individual A deemed to have capital gain
of $99 on death
Subsection 70(5)
● Estate of A has high ACB in shares of
Privateco
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45 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
● Estate transfers shares of Privateco to Newco for a
promissory note or shares with high PUC (“Pipeline”)
● Pipeline is to prevent double taxation on value of shares
held at death
Deemed gain on death
Dividend on eventual distribution of Privateco’s
assets
● Planning steps may involve amalgamating Newco and
Privateco to “bump” ACB of Privateco’s capital property
88(1)(d) bump is potentially available
Eliminates gains on Privateco’s assets that were
reflected in gain on the shares of Privateco
Gregory Bell - September 25, 2017
46 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
Under Existing Rules
● Individual has capital gain on death
70(5)
● Estate is not deemed to have a dividend
84.1 does not apply
Estate has “hard” ACB in Privateco
shares
84(2) does not apply
If certain conditions are met under
CRA guideline
47 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
Under Proposed Rules
● Estate is deemed to receive dividend of $99
See proposed amendment to 84.1(2)(a.1)(ii)
Previous dispositions by non-arm’s length
persons does not create “hard” ACB
Estate and Individual A would be considered
non-arm’s length
● Significant impact to many estate plans
Is this result intended?
Gregory Bell - September 25, 2017
48 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
Bump Issues
● There must be an acquisition of control as a consequence of death
(88(1)(d.3)) – this is often unrealistic
● Bump denial rules
● There may not be bump room as a consequence of a previous
estate freeze
88(1)(d) limits the available bump of the ACB of Privateco’s assets
to:
The amount by which the amount determined under
88(1)(b)(ii) (ACB) exceeds:
Cost amount of property and cash held by the
subsidiary immediately before the winding up less debts
of the subsidiary and certain other adjustments
Gregory Bell - September 25, 2017
49 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
164(6) – Existing Rules
Eliminates capital gain from deemed disposition on death
Wind-up company or redeem shares and receive distribution as a dividend
Rules require that the steps be implemented within one year of death
The estate must be a graduated rate estate
Gregory Bell - September 25, 2017
50 2017 Taxation of Private Corporation Policy Conference
Post-Mortem Planning
164(6) Enhanced Planning– 246.1 could apply
Involves redemption of Privateco shares to
create a capital loss carry back and a
dividend
Planning enhanced by internal transfer of
capital property to create CDA and RDTOH
This planning increased the ACB of the
property
Gregory Bell - September 25, 2017
52 2017 Taxation of Private Corporation Policy Conference
Recommendations
● Tax deemed gain on death as a dividend to the extent of safe income
Safe income is a measurement of the after-tax income which has not been
distributed to a shareholder
If the intent is to put a person who has incorporated in the same position as a
person who has not incorporated then only undistributed income should be
taxed at dividend rates
● Tax remaining gain at capital gains rate
The balance of the inherent gain in the shares should be taxed at capital gains
rates as it represents inherent gains in the underlying assets of the corporation
Gregory Bell - September 25, 2017
53 2017 Taxation of Private Corporation Policy Conference
Recommendations
● Simplify 164(6)
Introduce a new election to treat all or a portion of the capital gain on death as a
dividend on the final return
An exception would be provided in 84.1 equal to the elected amount
Corresponding increase in the ACB of the share
● Simplify legislation to eliminate double tax on death
Bump rules in 88(1)(d) are too complicated and often not a solution
Introduce a new election to increase the ACB of capital property held by a
corporation to the extent of gain recognized on death
Gregory Bell - September 25, 2017
54 2017 Taxation of Private Corporation Policy Conference
Summary
● Transitional/Technical Issues
Relief should be provided from the application of 84.1 where an individual has
passed away prior to July 18, 2017
Clarification should be provided that 246.1 will not apply to existing notes/PUC
created on pipeline planning
120.4(4) should be repealed or alternatively “hard ACB” should be created
under 84.1 where 120.4(4) applies
● Non-arm’s length/intergenerational transfers
An exception to 84.1 should be provided to facilitate “true” dispositions of shares
of corporations between family members (inter vivos and testamentary)
Gregory Bell - September 25, 2017
55 2017 Taxation of Private Corporation Policy Conference
Summary
● Tax on Death/Post Mortem Issues
The inherent gain on shares of a private company should be taxed at dividend
rates to the extent of safe income, the balance of the gain should be taxed at
capital gains rates
164(6) should provide a new election to treat the gain on death as a dividend on
the final return (an exception would be provided in 84.1 equal to the elected
amount)
An election should be provided to increase the underlying ACB of assets of a
private corporation by the amount of the capital gain recognized on death
Gregory Bell - September 25, 2017
57 2017 Taxation of Private Corporation Policy Conference
Policy Concerns Underlying New 246.1
● “…a separate anti-stripping rule to counter tax planning that circumvents the specific provisions of the
tax law meant to prevent the conversion of a private corporation's surplus into tax-exempt, or lower-
taxed, capital gains. In general, the anti-stripping rule would apply to non-arm's length transactions
where it is reasonable to consider that "one of the purposes" of a transaction or series is to pay an
individual shareholder/vendor non-share consideration (e.g., cash) that is otherwise treated as a
capital gain out of a private corporation's surplus in a manner that involves a significant disappearance
of the corporation's assets. In such a case, the non-share consideration would be treated as a taxable
dividend.“
● Put differently, converting corporate surplus/taxable earnings that should be taxable as dividends into
capital gains at individual shareholder level
i.e. the opposite of what subsection 55(2) produces at corporate level
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58 2017 Taxation of Private Corporation Policy Conference
246.1 - Overview
● Interaction with other surplus stripping rules
Section 84.1
subsection 84(2)
● Broadly speaking, targets two categories of transactions
“classic” surplus stripping transactions - McNichol, Evans, MacDonald, among
others
Is new 246.1 intended to be 84(2) on steroids?
CDA, PUC and boot generating transactions
Internal vs external CDA generation?
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59 2017 Taxation of Private Corporation Policy Conference
246.1 - Architecture
● amount receivable directly or indirectly by an individual resident in Canada
● amount receivable directly or indirectly in any manner whatever from a NAL person
● series of transactions
disposition of property
Increase or reduction of PUC
● It can reasonably be considered that
one of the purposes
reduction or disappearance of assets
tax otherwise payable and in consequence of any distribution of property of a corporation
is avoided
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60 2017 Taxation of Private Corporation Policy Conference
246.1 – Non-Arm’s Length Context
● Internal step-up transactions
ECP crystallizations
Internal CDA generation transactions
Post-mortem estate planning
CDA streaming
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61 2017 Taxation of Private Corporation Policy Conference
Example 1 – ECP Step-up transactions
● Announced repeal of the eligible capital property regime effective as of
January 1st, 2017
● Many taxpayers internally disposed (e.g. section 85) of ECP in 2016 to
trigger ECA taxable at low corporate business income rate
Prepayment of tax at low corporate rate ≈ 27%
Creates CDA which can be paid to shareholder tax free
Cheaper than taxable dividend (≈ 40% for eligible and ≈ 44% for ineligible)
No tax cost to the corporation if gain sheltered by non-capital losses or other tax
attributes
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62 2017 Taxation of Private Corporation Policy Conference
Example 1 – ECP Step-up transactions
• Opco transfers intangibles/goodwill to NewCo
triggering a $5M gain: $2.5M taxable as
business income
• Opco’s CDA is increased by 50% of the
triggered gain
Business
Assets
NewCo
Opco
Taxpayer
ECP
Shares
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63 2017 Taxation of Private Corporation Policy Conference
Example 1 – ECP Step-up transactions
• Opco pays cash dividend to Taxpayer or
increases PUC, thereby triggering a
deemed dividend and increasing ACB
• Opco elects for capital dividend treatment
under 83(2)Business
Assets
NewCo
Opco
Taxpayer
ECP
Increase in the
shares’ ACB
Deemed
dividend
→ Capital
dividend
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64 2017 Taxation of Private Corporation Policy Conference
Example 1 – ECP Step-up transactions
● If 246.1 applies: Taxable dividend of $2.5M
CDA decreased by $2.5M Permanent loss of CDA
● Consider the following scenarios: Cash CDA dividend paid before July 18
246.1 does not apply
Cash CDA dividend paid on or after July 18 246.1 apply?
PUC increase out of CDA before July 18, ROC on or after July 18 246.1 apply?
● Assume ECP step-up was done in contemplation of an arm’s length sale of Newco in 2017 Opco disposes of Newco shares to AL purchaser for cash in 2017 (before or after July 17)
Opco pays a 2.5M CDA dividend to Taxpayer on or after July 18, 2017 246.1 apply?
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65 2017 Taxation of Private Corporation Policy Conference
Example 2 – repayment of shareholder loans
• Shareholder Loan rule in 15(2)
• Loan of $100K included in income if not repaid in the year following the end of the taxation
year in which Opco made the Loan
• Assume Opco is a CCPC that carries on an active business
• Several different ways Taxpayer could repay the Loan
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66 2017 Taxation of Private Corporation Policy Conference
Example 2 – Salary alternative
● Assume Opco earns $227,043
● Highest personal tax bracket = 53.53% (Fed. + Ontario)
● Salary needed to repay the Loan = $215,192.60
● Personal tax on salary = $115,192.60
● Net corporate tax = $3,140 ($227,043-215,192) x 26.5%
● Total corp/personal tax = $118,332
Salary of $215,192.60
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67 2017 Taxation of Private Corporation Policy Conference
Example 2 – Dividend alternative
● Assume Opco earns $227,043
● Effective tax rate for eligible dividend = 39.34% (Fed. + Ontario)
● Eligible dividend needed to repay the Loan = $164,853.28
● Corporate tax on $227,043 = $60,166
● Personal tax = $64,853
● Total corp/personal tax $125,020
Note lack of integration compared to salaryDividend of $164,853.28
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68 2017 Taxation of Private Corporation Policy Conference
Example 3 – Capital gain alternative
● Assume Opco earns $227,043
● Opco also realizes $137,893 capital gain on the transfer to NewCo resulting in $68,946 addition to CDA
● Opco pays $68,946 CDA and $51,193 eligible dividend for TP to net $100K
● Total tax = $95,272 [$60,166 + $20,139 + $13,445 +$1,522 refundable tax]
Opco
Newco
Trigger capgain
of
Assets
Taxpayer
Repayment
of Loan
capital
dividend
& eligible
dividend
1
2 3
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69 2017 Taxation of Private Corporation Policy Conference
Example 3 – Comparison
● Scenario 1 – Salary
Tax cost = $118,332
● Scenario 2 – Taxable dividend
Tax cost = $125,020
● Scenario 3 – Capital gain
Tax cost = $95,272
● Would 246.1 apply to scenario 3?
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70 2017 Taxation of Private Corporation Policy Conference
Example 4 – Internal capital gain
To be updated
Safe Income = $1M
FMV = $10M
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71 2017 Taxation of Private Corporation Policy Conference
Example 4 – Internal capital gain
• Holdco transfers Opco to Newco triggering
capital gain of $1M
• Holdco pays $500K capital dividend
• Section 246.1 apply to dividend, portion of
dividend?
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72 2017 Taxation of Private Corporation Policy Conference
Example 5 – Planning to avoid double tax
Holdco
• Estate’s ACB equals FMV at time of death
• Holdco transfers certain property to Sub to
trigger capital gains to allow payment CDA and
RDTOH on redemption of Estate’s preferred
shares. Purpose is to avoid double tax.
• Other property of Opco sold for cash
• Capital loss in estate carried back under
subsection 164(6).
• Does 246.1 apply with respect to CDA created
on property transferred to Sub?
• What about CDA created on third party sales?
Estate
SubProperty
Preferred
shares
Children
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Example 6 – Planning to access LCGE
● X owns 1000 common shares of Opco - nominal ACB/PUC
● FMV of Opco is $1M
Active business assets = $800M
Excess cash = $200K
● In light of new rules affecting LCGE, X wants to elect to crystallize gain
● Purification required:
X exchanges 200 commons for 200,000 fixed value preferred shares
X rolls preferred shares to Holdco
Opco redeems preferred shares
● Consequences:
Does 55(2) apply to redemption? Redemption results in reduced gain/FMV
Bona fide reorganization? If 55(2) applies, capital gain and CDA addition
Does 246.1 apply to CDA distribution by Holdco?
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74 2017 Taxation of Private Corporation Policy Conference
Other Possible Areas of Concern
● CDA streaming
Resident and non resident shareholders
Holdco realizes gains on sale of assets
Distribute CDA to resident shareholders
● Donation of listed securities
Holdco donates securities to registered charity/private foundation
Taxable capital gain is nil
Full CDA addition
● Stepping up ACB/PUC where 84.1 does not apply
Individual sells shares of non-connected corporations to Holdco at FMV
Holdco issues boot or high PUC shares
Holdco distributes cash to repay note or return capital
● Corporate Owned Life Insurance
Policy, disposition of property, CDA addition – series of transactions?
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75 2017 Taxation of Private Corporation Policy Conference
246.1 – Arm’s Length Context
● Text of new 246.1 is extremely broad
● Explanatory notes ambiguous
● Is 246.1 intended to apply to bona fide commercial transactions?
Sale of assets
Leveraged buy-outs
Sale subject to earn out
Converting arm’s length basis into PUC
Interaction with 55(2)
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76 2017 Taxation of Private Corporation Policy Conference
Example 7 - Arm’s Length Sale of Assets
• Opco sells assets to an arm’s length third party, Buyco
• Opco realizes capital gains & pays CDA dividend to Individual
• Series includes a disposition of property, amount received from NAL person
and CDA dividend
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77 2017 Taxation of Private Corporation Policy Conference
Example 8 - Arm’s Length Sale: Balance of Sale
• Buyco acquires Opco shares from Individual for cash payable at closing and
balance of sale
• Buyco amalgamates with Opco and uses cash from Opco’s operations to
pay off balance of sale
• Is 246.1 intended to apply to the balance of sale?
• Distinguish “future” versus “current” cash of Opco to fund balance of sale?
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78 2017 Taxation of Private Corporation Policy Conference
Example 9 - Arm’s Length Sale: Leveraged Buyout
• Buyco purchases Opco shares from Individual
• Buyco uses its own cash and funds borrowed from a third-party to satisfy
purchase price in full at closing
• Buyco amalgamates with Opco and uses cash from Opco’s operations to
pay off the third-party debt
• Is 246.1 intended to apply to the portion of the purchase price that was debt
financed?
Brender & Harris - September 25, 2017
79 2017 Taxation of Private Corporation Policy Conference
Example 10 - Arm’s length Sale Subject to Earn-Out
• Buyco acquires Opco shares from Individual for cash payable at closing and
balance of sale subject to an earnout maximum
• Buyco amalgamates with Opco and uses cash from Opco’s operations to
satisfy the earnout
• Is 246.1 intended to apply to the earnout payments?
• Distinguish “future” versus “current” cash of Opco to fund balance of sale?
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80 2017 Taxation of Private Corporation Policy Conference
Example 11 – PUC step up to hard ACB
• Individual acquires Opco shares in arm’s
length transaction
• Arm’s length ACB of Opco shares = $1M
• PUC = $1
• ACB for 84.1 = $1M
Individual
Is 246.1 intended to be a domestic 212.1?
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81 2017 Taxation of Private Corporation Policy Conference
Example 11 – PUC step up to hard ACB
Is 246.1 intended to be a domestic 212.1?
Individual
• High ACB/low PUC shares transferred to Holdco
• Individual's ACB/PUC of Holdco shares = $1M
• 84.1 does not apply – “Hard ACB”
• Opco pays $100K taxable dividend to Holdco
• Holdco distributes $100K to individual as a
reduction of PUC
• Does 246.1 apply?
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82 2017 Taxation of Private Corporation Policy Conference
Example 12 – Interaction with 55(2)
Sister Brother
SIOH = 2 M
FMV = 10 M
• OPCO redeems shares from BCo for $5M
• Subsection 55(2) applies – Bco realizes
capital gain of $4M
• Does 246.1 apply if Bco pays a capital
dividend paid of $2M?
• What if Bco sells Opco shares to Sco for
$5 million resulting in $2.5M gain and
$2.5M of CDA?
Brender & Harris - September 25, 2017
84 2017 Taxation of Private Corporation Policy Conference
"Classic" Surplus Stripping: MacDonald v The Queen
3. Declared dividends
JS
PC
PC
601
5. Endorsement
of cheques
4. Endorsement
of cheques
6. PC wound up
1. Purchase
of shares for a
note from JS
2. Transfer of shares
of PC to 601 for a
note from 601
Taxpayer
1. Taxpayer sold shares of PC to his brother-in-law JS in exchange for a promissorynote from JS equal to the value of the netassets of PC less a $10,000 spread
• Sale to individual was necessary to avoidthe application of s. 84.1
• Total consideration $525,000
2. JS transferred the shares of PC to hisholding company (“601”) in exchange for apromissory note from 601 of $525,000
3. PC declared dividends to 601 immediatelyafter the steps above in the amount of (i)$500,000 and (ii) $10,000. A third dividendof $25,000 was declared several monthslater. Dividends were payable by cheques
4. 601 endorsed the cheques to JS
5. JS endorsed the cheques to the taxpayer
6. PC was wound up
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85 2017 Taxation of Private Corporation Policy Conference
MacDonald - Decision
● Tax Court : 84(2) not applicable given that Note 1 was not property of OpCo. When MacDonald received payment pursuant to Note 1, he received such payment qua
creditor – no longer shareholder of Opco.
GAAR does not apply as there is no misuse or abuse of 84(2) (“not an anti-surplus stripping provision”), 3 (the Act permits the triggering of capital gains to be offset by capital losses), and 128.1(4) (capital gain on departure could have been offset by capital losses).
● Federal Court of Appeal: the winding-up of a corporation is “a process” and the phrase “in any matter whatever” in 84(2) requires a more global perspective. Opco’s property “ended up through circuitous means in the hands” of Macdonald and
therefore the only reasonable conclusion is that 84(2) applies.
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86 2017 Taxation of Private Corporation Policy Conference
MacDonald - Decision
● FCA decision not appealed, but is questionable
● Court influenced by fact that corporate property found its way into the hands
of the shareholder
At the beginning of the date PC had cash and MacDonald was a shareholder,
and at the end of the day MacDonald had PC's cash
● What if purchase was instead financed with Bank debt?
MacDonald restricted to its facts?
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87 2017 Taxation of Private Corporation Policy Conference
Limits of 84(2) on "classic" surplus strip
● Assume a fact pattern slightly different from that of MacDonald:
Vendor sells shares of Opco, which has undistributed surplus, to a non-arm’s
length individual
NAL buyer borrows from Bank and pays cash to Vendor with proceeds of Bank
loan
NAL buyer transfers shares of Opco to Newco
Opco winds up and distributes cash to Newco
Newco distributes cash to NAL buyer, who repays the Bank loan
Brender & Harris - September 25, 2017
88 2017 Taxation of Private Corporation Policy Conference
On or After July 18, 2017
Opco
Intercorporate
dividend upon
OpCo’s wind up
Cash for OpCo’s shares
NAL Buyer
Dropdown of
OpCo into
NewCo for
shares with
high PUC or a
Note
Return of Capital or
Note Repayment
1
2
3
Newco
VendorBank
4
5
Loan from arm’s
length 3rd party
Loan Repayment6
• 84(2) does not apply because Vendor
does not receive Opco's property
• 84.1 does not apply to Vendor because
Vendor does not transfer to a
corporation
• 84.1 now applies to NAL Buyer - NAL
Buyer has soft ACB in Opco shares
• 246.1 should not apply to NAL Buyer
because 84.1 already applies
• 246.1 applies to Vendor ?
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89 2017 Taxation of Private Corporation Policy Conference
Classic surplus strip – 246.1
● Now assume no third party lender, but Buyer deals at arm’s length with
Vendor
Pre-July 18, 2017
84.1 does not apply to Vendor or Buyer
84(2) applies to Vendor based on MacDonald reasoning since Opco cash ends up in
Vendor's hands
84(2) does not distinguish between arm's length and non-arm's length transactions
Under new rules
84.1 does not apply to Vendor or Buyer
84(2) applies to Vendor
246.1?
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90 2017 Taxation of Private Corporation Policy Conference
Classic Surplus Strip and 246.1
● Now assume the same facts as previous example, but AL Buyer borrows
from Bank to finance acquisition of Opco
Pre-July 18, 2017
84.1 does not apply to Vendor or Buyer
84(2) arguably does not apply since Opco cash does not end up in Vendor's hands
GAAR?
Under new rules
84.1 does not apply to Vendor or Buyer
246.1?
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91 2017 Taxation of Private Corporation Policy Conference
Concluding Remarks
● 246.1 – a “specific general anti-avoidance rule”
Catch-all provision where 84.1 and 84(2) do not apply
should it reconcile with subsection 88(2)
Is there now clearly a scheme in the Act against surplus stripping?
Overreaching - could apply to transactions that are not surplus strips
● As drafted, results in reliance on CRA for guidance
Guidance through explanatory notes insufficient
● A more targeted rule is recommended - rules should be clear for such common place transactions as paying dividends and
disposing of property
● Principle of Integration - punitive effect of section 246.1
Asymmetrical vs symmetrical approach
How does 246.1(3) work?
Part III tax – effect of excess CDA election
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Concluding Remarks
● Consider surplus stripping rule akin to subsection 55(2) at the individual shareholder level – pro rata distribution of
taxed/SIOH and untaxed surplus
● Is CDA denial appropriate? Possible alternatives to CDA denial
Hybrid surplus
Ordering rule
CDA suspension
● Non-arm’s length persons and “accommodating” parties
When is a third party an accommodating party?
● Better transitional rule - Section 246.1 should not apply to CDA arising from before July 18, 2017 (i.e. no
retroactivity)
● If taxation rates change, what then? Will 246.1 be repealed?
Brender & Harris - September 25, 2017
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