On August 9, 2022, legislative proposals relating to the Income Tax Act (the “Act”) and other tax legislation were released by the Department of Finance for public feedback (the “August Proposals”). The August Proposals seek to implement certain measures previously announced in the 2022 Federal Budget tabled in the House of Commons on April 7, 2022 (the “Budget”), including the proposed substantive CCPC rules.
In recent years, a number of Canadian taxpayers implemented planning that involved causing a Canadian-controlled private corporation (“CCPC”) to cease to qualify as such. The general objective was to realize capital gains or earn certain investment income in the “non-CCPC” at the general corporate tax rate, rather than at the higher investment income tax rate applicable to CCPCs, which generally includes refundable taxes. A number of these non-CCPC structures remain in existence today.
The Budget proposed to introduce a new “substantive CCPC” regime that generally would cause the higher investment income tax rate to apply to all investment income of a non-CCPC that is controlled in law or fact by one or more Canadian resident individuals. Thus, if these rules are passed into law, the advantage of a non-CCPC structure in most cases will be eliminated.
We previously reported on the substantive CCPC rules in our Budget Review, our article on share transactions involving a non-resident or public company, and our article on post-Budget planning considerations. The August Proposals contain more comprehensive draft legislation to implement the substantive CCPC regime proposed by the Budget. If enacted as proposed, the rules generally would come into effect for tax years ending on or after April 7, 2022, with some exceptions.
The key components of the draft legislation are the integration of substantive CCPCs into the Act and an anti-avoidance provision to address planning around substantive CCPC status. The August Proposals also include measures to address certain tax deferrals that were available to CCPCs with foreign subsidiaries.
Substantive CCPCs
Key components
The proposed definition of “substantive CCPC” was first introduced in draft form along with the Budget in April and was not amended by the August Proposals. A “private corporation” generally will constitute a “substantive CCPC” if:
- it is controlled, directly or indirectly in any manner whatever, by one or more Canadian resident individuals; or
- it would, if each share of the capital stock of a corporation that is owned by a Canadian resident individual were owned by a particular individual, be controlled by the particular individual.
The August Proposals also include a number of consequential amendments to incorporate the concept of substantive CCPCs into the Act. Such amendments include changes to the definitions for amounts such as the “low rate income pool” (LRIP), “general rate income pool” (GRIP), “capital dividend account” (CDA), and “non-eligible refundable dividend tax on hand” (NERDTOH), along with extending to substantive CCPCs the application of section 123.3 refundable tax on “aggregate investment income”, which generally includes taxable capital gains, rent and royalties.
In addition to the tax integration components, there is also a new anti-avoidance rule proposed to address planning around substantive CCPC status. The new anti-avoidance rule is targeted at Canadian-resident corporations that would otherwise not be considered substantive CCPCs where it is reasonable to consider that one of the purposes of the transaction, or series of transactions, is the avoidance of substantive CCPC status. The new anti-avoidance rule includes a transitional provision where genuine commercial transactions entered into prior to April 7, 2022 (that meet certain other criteria) will get an extension to the application of the substantive CCPC regime.
Observations
1. New corporate classes
As a consequence of the introduction of the substantive CCPC regime, “private corporations” for purposes of the Act can effectively be divided into at least four general categories, which each category having its own benefits and disadvantages (although the benefits of a substantive CCPC are not apparent). The categories are summarized below:
- CCPC
- Benefits:
- Small business deduction
- Lifetime capital gains exemption for “qualified small business corporation” shares
- Enhanced benefit for research and experimental development
- Disadvantages:
- Subject to refundable tax on investment income
- Benefits:
- CCPC with filed and unrevoked subsection 89(11) election
- Benefits:
- Lifetime capital gains exemption for “qualified small business corporation shares”
- Enhanced benefit for research and experimental development
- Disadvantages:
- No small business deduction
- Subject to refundable tax on investment income
- Benefits:
- Non-CCPC
- Benefits:
- No refundable tax on certain types of investment income
- Disadvantages:
- No small business deduction
- No lifetime capital gains exemption for “qualified small business corporation shares”
- No enhanced benefit for research and experimental development
- Benefits:
- Substantive CCPC
- Disadvantages:
- No small business deduction
- No lifetime capital gains exemption for “qualified small business corporation shares”
- Subject to refundable tax on investment income
- No enhanced benefit for research and experimental development
- Disadvantages:
2. Potential for unusual situations
The new legislation proposed in the Budget and the August Proposals may have increased the likelihood of unusual situations of legislative interpretation. For example, if a CCPC is determined to have a non-resident shareholder who exercises de facto control, the corporation should cease to qualify as a CCPC under the definition of that expression in subsection 125(7) of the Act. However, that corporation then could also satisfy the definition of substantive CCPC. For example, if all of the voting shares are owned by Canadian resident individuals, the “second prong” of the substantive CCPC definition should apply. This may have been intended by the drafters, to avoid planning techniques that continue to allow for non-CCPC status. However, this would appear to extend the somewhat punitive category of substantive CCPC to a broader range of corporations than may be thought necessary.
3. Anti-avoidance rule application
In the example included in the August Proposals, Canadian resident individual shareholders of a corporation issue their non-resident children voting, non-participating shares of the corporation in order to cause the corporation to lose its CCPC status prior to the corporation realizing a material capital gain and thus avoid refundable tax on the taxable portion of that gain.
If one of the individual Canadian resident shareholders is found to exercise de facto control over the corporation, then the corporation would be a substantive CCPC. This aligns with our understanding of the regime so far.
If, however, none of the individual Canadian resident shareholders is found to exercise de facto control over the corporation, according to the example, the anti-avoidance rule would then apply since the corporation’s taxable capital gain would, absent the issuance of the skinny voting shares, have been subject to refundable tax. The example suggests that the application of the proposed anti-avoidance rule is based more on results than purpose.
It should be noted that this example is also cited as an example in the context of the notifiable transaction rules (discussed in our Budget Review), which suggests that both sets of rules may ultimately apply in non-CCPC situations.
International planning
The final components of the August Proposals are focused on an international subject. This includes a reduction to the “relevant tax factor” (“RTF”) in respect of “foreign accrual property income” (“FAPI”) of a “controlled foreign affiliate” of a CCPC (or a substantive CCPC) from 4 to 1.9. This reduction serves to limit the amount of the tax deferral that could previously have been recognized by CCPCs earning investment income through a controlled foreign affiliate.
Prior to this reduction, the RTF for all Canadian corporations was the same (i.e., 4), regardless of whether they were CCPCs, and was calculated as the inverse of 25%, being the federal corporate tax rate of 38% less the general rate reduction of 13%. Consequently, it did not account for the full rate of refundable taxes that a CCPC would otherwise be subject to in Canada. Very generally, this reduction to the RTF for CCPCs (and substantive CCPCs) will take into account these refundable taxes and reduce the deduction that a CCPC (and a substantive CCPC) may claim as a proxy for foreign tax paid on FAPI.
Conclusion
If you are involved with a non-CCPC structure, please contact a member of the Miller Thomson LLP tax team to discuss your options.
