Canadian pension funds and their subsidiaries are subject to a
rule that prohibits them from investing in shares of a corporation
having more than 30% of the votes for the election of directors,
except in the case of qualifying real estate, resource and
investment subsidiaries (the so-called 30% Rule). The 2015 federal
budget announced that the 30% Rule would be reviewed. For this
purpose, the Department of Finance issued a consultation paper on
June 3 stating that it will be accepting comments from interested
parties on whether the 30% Rule should be retained, relaxed or
eliminated for federally regulated pension plans. The consultation
paper also poses a number of questions related to governance,
investment and tax issues related to the 30% Rule (see Pension Plan Investment in Canada: The 30 Per Cent
The original purpose of the 30% Rule was to limit pension plans
to making passive investments, rather than active investments for
which they would be involved in managing the day-to-day operations
of businesses in which they invest. However, partly in response to
lower interest rates and volatility in the public equity markets,
pension plans have made an increasing number of private equity or
similar type of investments for which they are taking on a larger
equity stake in business enterprises. Pension plans have
implemented a variety of approaches and structures to reduce the
impact of the 30% Rule on these investments.
The 30% Rule limits only the percentage of voting shares that
may be owned by a pension plan. It does not restrict a pension plan
from acquiring more than a 30% equity interest by, for example,
investing in non-voting shares in addition to voting shares
carrying a 30% voting interest. The consultation paper asks the
following questions: whether the original purpose of the 30% Rule
remains valid; whether there are additional risks in pension plans
taking an active role in the operation of a business; and whether
other pension investment rules should be implemented in connection
with a relaxation of the 30% rule to address any such risks.
The consultation paper notes that the 30% Rule may affect
investment performance and financial market efficiencies by
restricting the category of investments that pension plans may
make. The paper asks for input on whether the 30% Rule impedes
pension plans' investment returns or imposes additional costs
on pension plans. It also asks whether the 30% Rule creates an
inequity between larger and smaller pension plans or whether its
removal would create such an inequity.
Most countries do not have a restriction – like the 30%
Rule – that places an ownership limit on pension plans'
investments in business assets. However, unlike the tax regimes in
many of these other countries, the Income Tax Act (Canada)
does not contain provisions that limit the tax efficiency of
investments in business assets by pension funds. Consequently,
Canadian pension plans can structure investments in business
entities to reduce or eliminate entity-level taxation by, for
example, capitalizing the investment with significant related party
debt or structuring the investment through a
"flow-through" entity, such as a partnership. In
contrast, as an example of a system that does impose tax rules
related to such investments, the U.S. Internal Revenue Code
contains earnings stripping rules that limit the deductibility of
interest payments made to pension plans and certain other investors
in specific circumstances. It also imposes an unrelated business
income tax on pension plans and other tax-exempt entities that
derive certain types of income directly or indirectly through a
flow-through entity. The consultation paper asks whether Canada
should adopt any new tax rules to preserve the Canadian corporate
tax base in connection with the elimination or relaxation of the
30% Rule, similar to tax rules in the United States or other
The consultation paper requires that submissions on the 30% Rule
be made by September 16, 2016.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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