A deeper dive into the new world of private corporation taxation
Download as PPTX, PDF1 like1,133 views
The document summarizes proposed new rules regarding the taxation of private companies in Canada. Some key points: - The small business deduction limit will be reduced for associated groups based on their aggregate investment income exceeding $50,000, at a rate of $5 reduction for every $1 over that threshold. - Refunds of refundable dividend tax on hand will be regulated through new "eligible" and "non-eligible" RDTOH accounts, with eligibility determined by whether dividends are paid from passive or active income. - The proposals aim to limit the perceived "deferral advantage" of retaining earnings in a corporation rather than paying them out as personal income, but also maintain incentives for venture capital
A deeper dive into the new world of private corporation taxation
- 1. A DEEPER DIVE INTO THE NEW WORLD OF PRIVATE COMPANY TAXATION
- 2. • Summary of Proposed Rules • Policy Rationale • Background • Mechanics • Practical Issues • Policy Issues • Planning Ideas AGENDA
- 3. • Two main components to PI rules • Small business limit reduced based on associated group’s “adjusted aggregate investment income,” at the rate of a $5 reduction for every $1 of AAII in excess of $50,000 • RDTOH refunds regulated through use of 2 RDTOH accounts • “Eligible RDTOH” (new) - Eligible dividends give rise to refund of Part IV taxes that were paid in respect of dividends that were received from non-connected corporations and from connected corporations if payer received refund from Eligible RDTOH • “Non-eligible RDTOH" (old) - refund of RDTOH available on payment of non-eligible dividend only SUMMARY OF PROPOSED RULES
- 4. • Small business deduction • The grind to the SBD starts when the AAII of all associated corporations equals $50,000 • This figure is derived from the hypothetical investment return of 5% on $1 million; the $1 million hypothetical investment conforms to the Govt’s October 2017 announcement • Govt’s implicit position is that $1 million is a sufficient savings buffer • The SBD goes to $0 when AAII of associated group reaches $150,000 SUMMARY OF PROPOSED RULES
- 5. • RDTOH • The federal dividend tax credit rate for an eligible dividend is 15%; this DTC rate assumes a combined corporate tax rate – the general corporate rate – of approximately 25% • The federal DTC rate for a non-eligible dividend is 9% in 2019; this DTC rate assumes a combined corporate tax rate - the SBD rate and the post-refund aggregate investment income rate of approximately 14% (but it should be 20% for AII) • The federal refundable tax rate on AII is 30 2/3%; this rate is based on an individual tax rate of approximately 50% • The Part IV tax rate is 38%; this rate is based on an individual tax rate on dividends of roughly 38% SUMMARY OF PROPOSED RULES
- 6. • RDTOH • If an eligible dividend is paid, generating an RDTOH refund, the corporation receives 38% of the dividend back and the individual receives federal DTC of 15% • This result is theoretically incorrect: the individual’s DTC rate should be 9% (2019) SUMMARY OF PROPOSED RULES
- 7. • RDTOH • If an ineligible dividend is paid generating an RDTOH refund, the corporation receives 38% of the dividend back, and the individual receives a DTC of 9% - theoretically correct (under integration aside) • If an eligible dividend is paid, generating an RDTOH refund consisting solely of Part IV tax paid on portfolio dividends (out of payer's GRIP) or from a connected corporation that received a refund to its Eligible RDTOH, the individual receives a DTC of 15% - theoretically correct SUMMARY OF PROPOSED RULES
- 8. • Theoretical upshot • Eligible dividends should not generate a refund of RDTOH, except for the portion of RDTOH generated by Part IV tax on portfolio dividends or in respect of dividends received from a connected corporation that received a refund to its Eligible RDTOH • Regime of eligible and ineligible dividends likely should have been tied to RDTOH mechanism from the outset • Two universes: LRIP, ineligible dividend, 9% DTC, refund OR, GRIP, eligible dividend, 15% DTC, no refund SUMMARY OF PROPOSED RULES
- 9. • Deferral Advantage • General idea of the PI proposals in their July 18 and Budget 2018 forms is to restrict access to the ‘deferral advantage’ gained by retaining after-tax income in the corporation to invest • Policy is based on theoretical comparison between incorporated business versus sole proprietorship of employee – horizontal equity POLICY RATIONALE
- 10. • SBD rule targets this issue by reducing the availability of small business rate after tax income for investing by increasing the corporate rate of tax when the investment income is ‘too high’ POLICY RATIONALE
- 11. • The Small Business Deduction • SBR is approximately 10 points lower than the general corporate rate (GCR) • SBD available in respect of active business income (ABI) earned by a CCPC • Subject to business limit of $500,000 (Ontario) shared among associated corporations • Gradual elimination where taxable capital of associated group equals $10 M; eliminated at $15 M POLICY RATIONALE
- 12. • Tax policy rationale for the SBD • makes capital available to companies – small enterprises – that have difficulty sourcing capital elsewhere • Small enterprises are a source of job creation • So, using the excess cash to save or invest is also contrary to the initial rationale and expectation • SBD Rule targets this policy issue too POLICY RATIONALE
- 13. • Integration, sort of … • RDTOH rule ensures that the RDTOH refund is available only when dividend is sourced from income taxed at the SBR (should be the post refund AII rate) and is subject to DTC of 9% (should be higher) • More of a technical fix, than in the spirit of July 18, 2018 • Forces under integration on AII to avoid over integration POLICY RATIONALE
- 14. • July 18 Proposals • Squarely targeted deferral advantage • October Retreat • Commitment re $1 million • Further reductions in the SBR BACKGROUND
- 15. • July 18 Proposals • Passive income (PI) earned on capital derived from active business income (ABI) taxed at the SBR subject to the high rate of taxation applicable to PI earned in a CCPC • But, no refund of the refundable tax when a dividend is paid. • And, dividends sourced from PI earned on capital derived from ABI taxed at the SBR (“SBR/ABI”) treated as ineligible dividends. • And, capital gains realized on the disposition of capital property derived from SBR/ABI does not give rise to additions to the corporation’s capital dividend account. • PI earned on and capital gains in respect of capital derived from ABI taxed at the general corporate rate (“GCR/ABI”) treated in the same manner, except that the dividends from such PI would be treated as eligible dividends. BACKGROUND
- 16. • July 18 Proposals • No change in the treatment from PI earned on capital derived from shareholder contributions and, presumably, other similar sources of capital, such as debt. • PI earned on capital derived from PI taxed at the GCR - not subject to these new rules • Transitional rules promised – rules intended to apply on a go-forward basis with limited impact on existing stock – “grandfathering” • Might be extended to all private corporations, not just CCPCs • Anti-avoidance rules will be required, including rules to address cross-border structures BACKGROUND
- 17. • July 18 Proposals • For the purposes of these rules, PI includes aggregate investment income (as defined in the Act) and dividends subject to Part IV tax • PI is thus income from property, capital gains and dividends that give rise to refundable tax • But, Gov’t is considering variations in definition of PI for the purposes of these rules, for e.g., c.g. arising on the sale of Opco shares might still give rise to addition to CDA BACKGROUND
- 18. • Proposed mechanics of July 18 Proposals • Elective method …. • Default: all dividends would be non-eligible • Election: CCPC elects out of SBR and all dividends from PI are eligible dividends • Further election under both: if CCPC earns only PI, current system would apply by election • intercorporate dividends (and other transfers) paid to such a corporation (the electing Investco receiving dividend from opco or porfolioco) would be subject to appropriate refundable tax – some sort of tracking of ultimate source of the passive assets in the electing corporation • presumably, CCPC with mixed PI and ABI would transfer PI assets to a sisterco to keep things simple BACKGROUND
- 19. • The PI Proposals addressed an apparent flaw in this regime : an individual who incorporates their business will have more capital to invest after the payment of corporate level compared to a taxpayer earning employment income. • Taxpayers are using their corporations to accumulate wealth or “save”. • The quantum of the apparent advantage – the “deferral advantage” - is equal to all the PI income earned on this “incremental capital”. • Therefore, in the theory of the PI Proposals, if all of that income is subject to a 100% tax, half paid by the corporation in the year the PI is earned and the other half paid on distribution, the deferral advantage is eliminated. BACKGROUND
- 20. • The initial 50% rate is achieved by eliminating the refund. • The additional dividend tax imposed on distribution (with no amount capable of being paid from the capital dividend account) effectively taxes the remainder of the income earned on the capital. BACKGROUND
- 21. • In summary: The deferral advantage available to the CCPC owner is unfair when compared to the employee, and is therefore contrary to good tax policy • Other potential policy responses: • Increase the corporate rate on a targeted basis – as under the PSB rules? • Increase SBR? • Identify and target problem sectors? BACKGROUND
- 22. • October Retreat • Press conference, October 18, Hampton NB • “Minister Morneau outlined today the Government’s intention to move forward with measures to limit the tax deferral opportunities related to passive investments, while providing business owners with more flexibility to build a cushion of savings for business purposes – for example to deal with a possible downturn or finance a future expansion – as well as to deal with personal circumstances, such as for parental leave, sick days or retirement. The intent of the new rules will be to target high-income individuals who can benefit under current rules from an unlimited, personal, tax-preferred savings account via their corporation, far beyond the pension, RRSP and TFSA limits available to other Canadians. This is inherently unfair, and the Government is committed to fixing it, while it reflects on the feedback received from Canadians during the consultation period. BACKGROUND
- 23. • October Retreat • Press conference, October 18, Hampton NB • “In further developing these measures, the Government will ensure that: • - All past investments and the income earned from those investments will be protected; • - Businesses can continue to save for contingencies or future investments in growth; • - A $50,000 threshold on passive income in a year (equivalent to $1 million in savings, based on a nominal 5-per-cent rate of return) – an amount that is exceeded by only about 3 per cent of corporations – is available to provide more flexibility for business owners to hold savings for multiple purposes, including savings that can later be used for personal benefits such as sick-leave, maternity or parental leave, or retirement; and • - Incentives are in place so that Canada’s venture capital and angel investors can continue to invest in the next generation of Canadian innovation. BACKGROUND
- 24. • October Retreat • Fall Economic Statement October 25, 2017 • Gov’t will move forward with measures to limit deferral opportunities, but: • Measures will apply on go-forward basis • Businesses will be able to save for contingencies • Threshold of $50,000 to provide flexibility to hold savings for multiple purposes • Venture capital and angel investors …. • Gov’t will consider scope of rules re their applicability to capital gains on sale of shares of Opco … • Rules would not affect income from property that is incidental to an active business BACKGROUND
- 25. • Press conference, October 20, 2017, Waterloo Ontario • “Finance Minister Bill Morneau and Minister of Small Business and Tourism Bardish Chagger today announced the next steps in the Government's plan to move forward on changes to the tax system that will ensure that Canadian-controlled private corporation (CCPC) status is not used to reduce personal income tax obligations for high-income earners rather than supporting small businesses. • “Minister Morneau announced that as the Government moves forward with corporate tax changes, including targeted measures on passive investments, it will ensure incentives are maintained so venture capital and angel investors can continue to invest in the next generation of Canadian innovation. • “The Government will work with the venture capital and angel investment sectors to identify how this can be best achieved. With this proposal, and the Innovation and Skills Plan announced in Budget 2017, the Government's objective is to support and enhance Canada's growing innovation and technology sector. BACKGROUND
- 26. • SBD Rule • SBL to be reduced as a function of AAII • Ratio of $5 reduction for every $1 of investment income in excess of $50,000 • Rule applies to reduce the SBL of the associated group • Key terms are “AAII”, “active assets”, an anti-avoidance rule expanding the definition of “associated” MECHANICS
- 27. • SBD Rule • AAII is defined as “aggregate investment income” modified as follows • Calculate AII as though subparagraph (a)(i) described the eligible portion of capital gains other than gains from the disposition of an “active asset” • Make a similar adjustment for capital losses • Add back net capital losses carried over from a previous year and add back taxes paid on foreign accrual property MECHANICS
- 28. • AAII • Include dividends from non-connected corporations • Include income from a specified investment business and income from savings in a non-exempt life insurance MECHANICS
- 29. • SBD Rule • “active asset” defined as • An asset used in the active business carried on by a CCPC primarily in Canada • A share of a corporation that is connected to the CCPC and that would be a QSBC share if it were held by an individual (“active shares”) MECHANICS
- 30. • An interest in a partnership if • The fmv of the interest is equal to more than 10% of the value of all of the interests in the partnership • For the previous 24 months the partnership property comprised 50% active business assets or active shares, • And at the time of disposition, all or substantially all of the partnership property was active MECHANICS
- 31. • “associated corporations” redefined in 125(5.2) to include a corporation • To which the particular corporation has made a loan or transfer of property • With which the particular corporation was related, • Where the purpose of the loan or transfer was to reduce the particular corporations AAII MECHANICS
- 32. • RDTOH Refund Rules • Availability of RDTOH refund to be restricted to dividends paid from passive income • Eligible dividends to be restricted to dividends paid from active income MECHANICS
- 33. • RDTOH Refund Rules • New Rules • Two new accounts: Eligible RDTOH and Non-eligible RDTOH • Refund of Non-eligible RDTOH available on payment of a non-eligible dividend • Refund of Eligible RDTOH available on payment of eligible dividend, and, if the non-eligible RDTOH is not sufficient, on the payment of non-eligible dividend (but why/when would you?) MECHANICS
- 34. • Non-eligible RDTOH includes: • (a) 30 2/3% of a CCPC’s AII • (b) Part IV tax paid in respect of eligible dividend received from connected corporation unless the dividend caused a refund in the connected payer corporation from its Eligible RDTOH MECHANICS
- 35. • Eligible RDTOH includes: • (a) Part IV tax from • Non-connected corporations • Connected corporations where payment of dividend caused refund of Eligible RDTOH MECHANICS
- 36. • Transitional Rules • The new regime commences January 1, 2019 • For CCPCs • The Eligible RDTOH will open with the lesser of (A) the corporation’s RDTOH balance and (B) 38 1/3% of its GRIP balance • The Non-eligible RDTOH will open with A minus B – i.e., its RDTOH account minus 38 2/3% of its GRIP balance • For other private corporations, their RDTOH becomes the Eligible RDTOH MECHANICS
- 37. • Associated corporations • The rule applies to reduce the SBL of an associated group of corporations • Be wary of the deeming rule in 256(1.2) dealing with discretionary trusts and parents, etc • Be wary of deeming rule in 256(1) • Be wary of anti-avoidance rule in 125(5.2) PRACTICAL ISSUES
- 38. • Under integration • Be wary of paying non-eligible dividends in when Non-eligible RDTOH is not sufficient • Pay eligible dividends before non-eligible dividends to reduce Eligible RDTOH to zero first PRACTICAL ISSUES
- 39. • Reductions in the SBR • Reduction of SBR from 11.5% to 9% is accompanied by a corresponding increase in the rate of personal taxation of 1.5% because of changes to the DTC • The tax on ineligible dividends will go from 45.3% to 47% • The new higher personal tax will apply to dividends paid out of income that was taxed at the higher rate. POLICY ISSUES
- 40. • Integration • Significant under-integration of investment income has developed with DTC based on SBR and with consequent decrease in DTC • Further practical issue where income taxed at GCR must be used to generate refund due to, for example, a decline in the value of the investments POLICY ISSUES
- 41. • Management of investment returns in the corporation • The loss of the SBD due to too-high investment income will result in a punitive increase in the tax rate to the corporation from the SBR to the GCR • The loss happens quickly – on a ratio $5 of SBL for every dollar of AAII • Consider investing in more conservative assets, growth for capital gain assets, or consider timing realizations to certain years to minimize impact;. PLANNING
- 42. QUESTIONS?
- 43. gowlingwlg.com Gowling WLG (Canada) LLP is a member of Gowling WLG, an international law firm which consists of independent and autonomous entities providing services around the world. Our structure is explained in more detail at gowlingwlg.com/legal David P. Stevens Partner Business Law David.stevens@gowlingwlg.com +1 416 862 3556