On June 3, the Department of Finance, Canada (Finance Canada)
released a consultation paper entitled "Pension Plan
Investment in Canada: The 30 Per Cent Rule." Among other
investment rules, federally regulated pension plans and certain
other persons are restricted under federal law from holding more
than 30 per cent of the voting shares to elect directors of a
corporation. A similar rule exists in a number of provinces
including Ontario and Québec. However, Québec has
enacted legislation exempting the Caisse de dépôt et
placement du Québec from this rule, and in its 2015 Budget,
Ontario announced that it intends to eliminate the rule. In that
context, the federal government is considering whether to eliminate
the rule, is seeking stakeholder input on the usefulness of the
rule, and has set out in the consultation paper considerations
relating to prudential questions, investment performance effects
and tax policy.
While the elimination of the rule without further action would
affect a limited number of pension plans and other persons, the
consultation paper raises possible income tax measures that could
affect many pension plans. Finance Canada's premise is that
elimination of the 30% rule will lead to higher levels of
"active" investing by pension plans. In this regard, it
raises concerns stemming from the potential ability of a tax-exempt
pension plan to shift business income from taxable persons to the
plan and thereby to realize investment returns on Canadian equity
investments (or what in all the circumstances should be treated as
an equity investment) on a pre-tax basis (i.e., before the
imposition of a corporate-level or equivalent tax). A basic
Canadian tax principle is that dividend income is received after
the imposition of corporate tax on the issuer of the shares.
Finance Canada is concerned about tax revenue consequences and
also, in the interests of fairness and efficiency, considers it
desirable to create a "level playing field" for investors
and the businesses controlled by them.
With respect to tax measures, the consultation paper describes
two tax planning techniques: earnings stripping via related party
debt and the use of private flow-through entities (i.e.,
partnerships and trusts that earn Canadian-source business income).
With respect to related party debt, it raises the possibility of
extending Canada's thin capitalization rules. These rules deny
an interest deduction on debt of a Canadian corporation that is
owed to certain non-resident shareholders where the debt-equity
ratio exceeds a prescribed limit. The suggestion is to apply
similar rules in respect of debt of a Canadian corporation that is
owed to a pension plan that controls the corporation. With respect
to flow-through entities, it raises the possibility of extending
Canada's "SIFT" rules which essentially subject
publicly-traded trusts and partnerships to tax on certain defined
sources of income as if the entity was a corporation. The
suggestion is to extend those rules to trusts and partnerships that
are controlled by a pension plan.
As mentioned, the tax measures, if implemented, would likely
have a broad impact on the investment activities of all Canadian
pension plans. The tax policy considerations for which Finance
Canada has sought input as listed in the consultation paper are as
Are any of the tax policy concerns
relating to the ability of tax-exempt pension plans to acquire
controlling positions in taxable corporations (e.g., potential
strategies to eliminate corporate-level taxation, which could
provide an advantage to the plans or the businesses they control)
material in nature?
How does the potential relaxation or
elimination of the 30 per cent rule impact any concerns described
in respect of the previous question?
Should the Government consider
implementing tax measures (e.g., thin capitalization restrictions,
application of the SIFT tax to pension-controlled trusts and
partnerships) to limit the ability of pension plans to undertake
tax planning strategies to reduce or eliminate entity-level income
tax on business earnings? Are there other potential tax measures
that the Government should consider in this regard? What
considerations should be taken into account in the assessment of
such potential measures?
The closing date for submissions is Friday September 16,
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guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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