Moore
November 2022 Newsletter

The top rate of tax on personal income is around 50% or higher, depending on your province of residence. Meanwhile, the top federal+provincial rate of tax on a corporation’s income is somewhat lower.

As a result, there would be an incentive to have one’s investments held in a corporation. As long as the income remained in the corporation, the tax paid on interest income would be lower. To counter this, since 1995 there has been a refundable tax on investment income earned by a Canadian‑controlled private corporation (CCPC). The tax is currently 10.67% of the investment income. As a result, a CCPC pays about 50% combined federal+provincial tax on investment income. The tax is refunded once the CCPC pays out enough dividends — at which point the shareholder will be paying personal tax on the income.

The refundable tax applies to income such as interest, rent and royalties. It does not apply to dividends, which are taxed differently (but may also be subject to a refundable “Part IV” tax). Interest that pertains to or is incident to an active business (e.g., interest on a cash “float” needed to run the business) is not subject to the refundable tax. Similarly, rent from an active business (e.g., running a hotel) will not be subject to the tax.

In recent years, a number of tax planners devised structures to cause a corporation not to be a CCPC. Usually being a CCPC is an advantage, as it gives access to the small business deduction (low rate of tax on the first $500,000 of active business income each year), enhanced credits for scientific research and experimental development, and other benefits. But for investment income it was a disadvantage. So, some CCPCs arranged to be “continued” in a foreign country (e.g., Cayman Islands or British Virgin Islands), to no longer be a “Canadian” corporation and thus not a CCPC subject to the refundable tax. There were other schemes as well, such as introducing a foreign holding company so that the company was no longer “Canadian‑controlled”.

The CRA is attacking these plans using the General Anti-Avoidance Rule, but whether it will win these cases in the Courts is uncertain. To solve the problem, the Department of Finance announced changes in the April 2022 federal Budget, and released detailed legislation on August 9, 2022.

Under the new rules, a company that would be a CCPC except for the kinds of planning above will be considered a “substantive CCPC”. It will not get the benefits of a CCPC (such as the small business deduction), but it will be subject to the refundable tax on investment income. So, it will pay tax of about 50% up-front on investment income, with the refundable tax refunded once it pays out enough dividends.

Evidently this planning had become widespread: the April 2022 Budget estimates that these changes will save the federal government over $4 billion over five years.

Last modified on November 1, 2022 12:00 am