Michael Goldberg is a partner and tax lawyer at Minden Gross LLP in Toronto.
Here’s a fact for you: Every public and foreign-controlled Canadian corporation (PAF) pays tax at 26.5 per cent on all income, including investment income, and just 13.25 per cent on realized capital gains. (These are Ontario tax rates; similar rates apply in other provinces.)
There are good policy reasons for these tax rates, as Canada tries to remain competitive with other countries around the world.
Interestingly, these tax rates are about one half of the rates paid on the investment income and capital gains of owner-managed companies in Canada – specifically, Canadian-controlled private corporations (CCPCs). Your typical corner store, manufacturing or service business, or holding company in Canada is most likely a CCPC.
In recent years, some owner-managers have implemented perfectly legal tax planning to take advantage of the same rates available to PAFs. This is done by converting a CCPC to a different type of private corporation – called a non-CCPC. But now, the CRA has embarked on an audit project to shut down this planning and deny Canadian owners access to the rates available to PAFs.
If this project is successful, PAFs will enjoy significant tax advantages relative to Canadian owners in this country. While this advantage is actually a tax deferral, not an absolute tax savings, it is meaningful because it leaves more cash in the hands of the company to reinvest today.
It is unclear why disadvantaging Canadian owner-managers and investors relative to PAFs would be a desirable policy option. But, apparently, the CRA believes exactly this, as do certain other writers who have recently criticized this type of planning without acknowledging that PAFs have always enjoyed a tax advantage.
The details
Investment income earned by CCPCs is subject to tax rates that are meant to be about the same as what a top-rate Canadian individual taxpayer would pay. For example, a CCPC in Ontario will pay 50.17 per cent tax on its investment income, and 25.09 per cent on its realized capital gains – about double the rate paid by PAFs.
There are some good reasons why owners may want their corporations to have CCPC status. CCPCs can, for example, access low tax rates on the first $500,000 of active business income and some advantageous tax credits. Also, shareholders of CCPCs may be able to enjoy other tax benefits, including the ability to shelter $913,630 (in 2022) in capital gains on their private-company shares using the lifetime capital-gains exemption.
But there are good arguments that Canadian owner-managers who have no use for CCPC advantages should be able to opt into the same tax treatment as PAFs so that they can also benefit from the lower rates. However, there’s no prescribed system currently in the Income Tax Act for CCPCs to give up their CCPC advantages and opt into being taxed at PAF rates.
The planning
There are several ways for a Canadian corporation that isn’t a PAF (a CCPC, for example) to benefit from the PAF tax advantage. To do so, the corporation will need to be, or become, a non-CCPC, which can be accomplished in many ways – including with planning that is fully in accordance with our Canadian tax laws.
Regardless of how a corporation becomes a non-CCPC, it should be kept in mind that, in an unrelated context, the Supreme Court of Canada recently reaffirmed the fundamental principle that taxpayers are entitled to arrange their affairs to minimize their taxes payable.
Nevertheless, the CRA – which has been aware of non-CCPC planning for more than a decade – has recently decided that the planning is abusive. So, at significant cost to the federal government and taxpayers, the CRA has begun an audit project and is reassessing non-CCPCs using the General Anti-Avoidance Rule (GAAR) – a provision in our tax law that can deny tax-planning benefits if the planning violates the spirit of the law, even if it’s within the wording of the law.
Many tax professionals disagree that non-CCPC planning meets the criteria for reassessment under GAAR. Court cases are expected to follow soon, but the uncertainty created by this project will go on for years.
The fairness
The reality is that the PAF tax advantage is not a loophole and should not be limited solely to PAFs. The CRA should stop this costly non-CCPC audit project and the pending litigation. Further, the Department of Finance should ensure that Canadian business owners and investors have the ability to opt-in to the PAF tax rates if they are willing to forego the other benefits that come with being a CCPC.
Alternatively, if they truly believe that it’s good government policy to leave Canadian owner-managers and investors at a disadvantage relative to public and foreign-controlled Canadian corporations, they should enact legislation that applies on a go-forward basis so that their policy is made very clear.
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