Canada: Tax Proposals Target Tax Planning Using Private Corporations

Last Updated: July 25 2017
Article by Antoine Desroches

Most Read Contributor in Canada, December 2017

On July 18, 2017, Canada's Minister of Finance released a consultation paper and draft legislative proposals that target the use of private corporations to sprinkle income among family members, hold passive investments and strip surplus by converting corporate surplus into capital gains. In the government's view, such tax planning strategies provide tax advantages that unfairly help the wealthiest Canadians. The proposals, if enacted, will affect both small and large private corporations and their shareholders.


Income sprinkling, also known as income splitting or shifting, generally occurs when income that would otherwise be realized by a high-tax-rate individual is realized by family members who are in a lower tax bracket. Income sprinkling is often achieved through a private corporation and, until now, has been viewed as perfectly legal and acceptable tax planning. For instance, the high-income individual, in his or her capacity as controlling shareholder of the private corporation, may cause the corporation to distribute a portion of the corporation's after-tax income to family members, most frequently through a family trust or discretionary-dividend shares. This strategy makes it possible to achieve a lower aggregate effective tax rate for the family, including by accessing unused tax credits or multiplying the use of the lifetime capital gains exemption.

The Income Tax Act (Canada) already contains rules preventing income sprinkling in certain circumstances, including the so-called attribution rules and the kiddie tax rules (tax on split income). The government is proposing to tighten some of these rules, particularly those regarding the tax on split income and the lifetime capital gains exemption.

Generally, under the proposals, the tax on split income would be modified so that it applies after 2017 to any Canadian resident individual, whether a minor or an adult, who earns split income from a private corporation (or partnership or trust) in which a connected individual has an interest. Specifically, the tax on split income would be modified by:

  • subjecting adult individuals' split income to a reasonableness test that takes into account the individual's labour and capital contributions to the corporation as well as previous dividends and remuneration received from the corporation (the test would be stricter for individuals aged 18 to 24);
  • introducing the concept of "connected individuals"—i.e. Canadian residents who are connected to a private corporation, either because they exercise control over it or participate in 10% or more of its equity value, because the property they transferred to the corporation represents 10% or more of the corporation's property value, or because they participate in the performance of the services constituting the corporation's business; and
  • expanding the definition of "split income" to include—in addition to certain dividend, partnership and trust income—compound split income (i.e. income on previously-taxed split income).

Also, measures are proposed to address the multiplication of claims to the lifetime capital gains exemption of an individual on the disposition of eligible shares of a private corporation, which is approximately $835,000 for 2017. Specifically, the following capital gains would no longer qualify: (i) capital gains realized or that accrue while the individual is a minor, (ii) capital gains included in the individual's split income, and (iii) capital gains accrued while the shares are held by a trust.

However, the transitional rules would allow individuals to elect to realize a capital gain on qualified shares in 2018 by way of a deemed disposition at fair market value and to claim the lifetime capital gains exemption in respect of that capital gain.


According to the government, a tax-deferral advantage is achieved when surplus funds are retained in a corporation for passive investment purposes instead of being distributed to the shareholders, through taxable dividends, salary or otherwise, for the shareholders to invest personally. Because the corporate tax rates on active income are lower than the marginal personal tax rate, when surplus funds are left in a private corporation, the tax that would have been payable upon distribution of the surplus to the shareholders can be deferred, resulting in the corporation having more capital to invest.

The government does not propose any specific measures and is instead seeking consultation on the appropriate means of eliminating this tax-deferral advantage. The alternatives considered by the government include the elimination of the current refund of some of the corporate tax on passive investment income, the implementation of an additional refundable tax on corporate surplus that is not reinvested in the corporation's business or in other eligible investments, and the elimination of the increase in the capital dividend account for the non-taxable portion of capital gains derived from passive investments. According to the government, a transition period will be provided before any such proposal becomes effective.


The surplus of a private corporation is generally distributed through salary or dividends, which are then included in the personal taxable income of the recipient. However, as only one-half of a capital gain is taxable, capital gains are effectively taxed at a lower rate. Therefore, to access corporate surplus, some individuals have engaged in transactions that trigger capital gains for themselves or in the corporation and make it possible to pay tax-free capital dividends. These techniques are called "surplus stripping."

Various provisions of the Income Tax Act (Canada) restrict surplus stripping. The government proposes measures to further restrict surplus stripping and, specifically, transactions used to sidestep current anti-surplus stripping provisions.

In general, the new anti-surplus stripping measures would apply to non-arm's length transactions entered into on or after July 18, 2017 where one of the purposes of the transaction is for the corporation to distribute non-share consideration (e.g. cash) to a shareholder in a manner that would result in a capital gain and cause a significant reduction of the corporation's assets. In such cases, the non-share consideration would be treated as a taxable dividend.


Certain aspects of the proposals represent a significant shift in tax policy and are likely to have a broad financial impact on private corporations and their shareholders. The proposed elimination of the so-called tax-deferral advantage for passive corporate investments is particularly far-reaching and will have unexpected consequences for profitable private corporations.

For instance, corporate surplus may be accumulated in order to start a new active division or business or to provide funding in low seasons of a cyclical business. In addition, entrepreneurs and family members involved in their businesses generally do not benefit from pension plans, employment insurance, parental benefits and other social benefits available to employees, and they have risked their capital, not to mention invested considerable time, in setting up the business. They also may not have accrued significant Canada or provincial pension plan entitlements, as a portion of their income may be earned through dividends, rather than salary. Such a dramatic change would place private businesses on a different footing from public corporations and foreign-owned corporations, which can retain after-tax corporate surplus and thus defer shareholder-level income tax—including withholding tax, in the case of foreign-owned corporations. The retained surplus may be used to fund current or future expansion, debt repayment, share buy-backs or dividends, pension plans, future retirement bonuses, or other post-retirement income, as well as any number of things that may not, strictly speaking, represent an immediate, or even future, reinvestment in the current business.

The government is inviting comments and ideas regarding the announced measures by October 2, 2017.

About Norton Rose Fulbright Canada LLP

Norton Rose Fulbright is a global law firm. We provide the world's preeminent corporations and financial institutions with a full business law service. We have 3800 lawyers and other legal staff based in more than 50 cities across Europe, the United States, Canada, Latin America, Asia, Australia, Africa, the Middle East and Central Asia.

Recognized for our industry focus, we are strong across all the key industry sectors: financial institutions; energy; infrastructure, mining and commodities; transport; technology and innovation; and life sciences and healthcare.

Wherever we are, we operate in accordance with our global business principles of quality, unity and integrity. We aim to provide the highest possible standard of legal service in each of our offices and to maintain that level of quality at every point of contact.

For more information about Norton Rose Fulbright, see

Law around the world

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.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions