Canada: Budget 2018: Tempered Private Company Passive Investment Income Changes Unveiled

Last Updated: March 6 2018
Article by Todd Miller

In July 2017, the Department of Finance tabled proposals to significantly amend the rules respecting the taxation of passive income earned by private corporations to address what it perceived to be an inappropriate deferral advantage enjoyed by the shareholders of such corporations.  During the public consultation period that followed the release of the proposals, the Government received stakeholder feedback that was almost universally negative, with criticisms that highlighted the far-reaching impact of the proposed measures, their damaging effect on Canada's global tax competitiveness, and their administrative complexity.

While Budget 2018 introduced measures to limit the tax deferral advantages perceived to be afforded to private company investment income, they are simpler and narrower in scope than those originally envisioned and, thus, are (at least to some extent) responsive to the extensive public feedback provided over the course of last summer. 

If enacted, the new measures will impose (i) an additional limit on the favourable small business tax rate enjoyed by a Canadian-controlled private corporation (a "CCPC")1 to the extent the passive investment income of the CCPC (or what the new rules refer to as the "adjusted aggregate investment income" of the CCPC) exceeds $50,000, and (ii) more stringent requirements on the types of dividends that must be paid by a private corporation to trigger a refund of refundable dividend tax on hand.

Reduced "Business Limit" Where Passive Income Threshold Exceeded

At present, the preferential small business tax rate (currently 10.5%) applies in respect of up to $500,000 of "qualifying active business income" of a CCPC (the "business limit")2.  Active business income of a CCPC exceeding the business limit is taxed at the higher, general corporate tax rate.

The business limit is reduced on a straight-line basis for CCPCs having between $10 million and $15 million of "total taxable capital employed in Canada" (and is completely eliminated when such capital exceeds $15 million). 

As part of its stated objective of encouraging CCPCs benefiting from the favourable small business tax rate to reinvest a greater portion of their after-tax profits in active business assets and operations, Budget 2018 introduces a second business limit reduction test, which will be based on a CCPC's passive investment income.  Specifically, where a CCPC (and corporations with which it is associated) earns more than $50,000 of passive investment income in a particular taxation year, the amount of income eligible for the favourable small business rate will be reduced on a straight-line basis on passive income earnings up to $150,000, at which point the business limit will be completely eliminated.

For purposes of the new business limit reduction measures, passive income will be determined with reference to the CCPC's "adjusted aggregate investment income" ("AAII"), which will be based on the CCPC's existing "aggregate investment income" (i.e., income otherwise subject to refundable tax under section 129 of the Income Tax Act (Canada) (the "Tax Act")) with the following notable adjustments:

Exclusions

  • Capital gains and losses realized from the disposition of (i) property used principally in an active business carried on primarily in Canada by the CCPC or a related CCPC,  (ii) a share of another CCPC that is connected3 with the CCPC, where all or substantially all of the fair market value of its assets are attributable (directly or indirectly) to assets used principally in an active business carried on primarily in Canada, and (iii) certain partnership assets;
  • Net capital losses carried over from other taxation years; and
  • Investment income that may be considered incidental to the CCPC's active business.

Inclusions

  • Dividends from non-connected corporations; and
  • Income from savings in a life insurance policy that is not an exempt policy.

The new business limit reduction measures with respect to passive investment income are set to apply to taxation years beginning after 2018 and will, as indicated, operate alongside the existing taxable capital-related reduction rule discussed above (thus, a particular CCPC's business limit will be determined by applying the greater of the two reductions). It should also be noted that the new business limit proposals contain certain anti-avoidance measures designed to prevent taxpayers from inappropriately delaying or circumventing the application of the new rules through, for example, the use of short taxation years or transfers of assets to a related, but unassociated, corporation.

Limiting Access to Refundable Taxes

The Tax Act contains a series of rules concerning the computation and taxation of income earned by private corporations.  A cornerstone of the rules is the principle of "integration", which essentially strives to equate the overall tax burden associated with income earned by a corporation and distributed to its shareholders  with the tax that would have been paid by the shareholders had they earned the income directly. 

In furtherance of this objective, investment income earned by a private corporation is taxed at rates that are substantially similar to the highest personal income tax rates, with a portion of such tax being refundable upon the payment of dividends to shareholders (known as "refundable dividend tax on hand" or "RDTOH"), in recognition of the shareholder tax liability in respect of such dividends.  

Under current rules, business income of a private corporation not benefitting from the favourable small business rate is generally added to a notional tax account known as the "general rate income pool" or "GRIP", and is available for distribution out of such account (with full RDTOH recovery to the corporation upon the payment of sufficient dividends) as an "eligible dividend" (dividends designated as "eligible dividends" are taxed in the hands of shareholders at a lower net rate than those that are not so designated4). 

To address concerns associated with allowing business income taxed at the comparatively low general corporate tax rate to trigger RDTOH recovery on distributions to shareholders, and yet benefit from "eligible dividend" treatment, Budget 2018 proposes to divide a private corporation's RDTOH account into two accounts – an "eligible RDTOH account", that will be accessible upon the payment of eligible dividends and in certain instances, non-eligible dividends, and an "non-eligible RDTOH account" that will only be accessible on the payment of non-eligible dividends.

For the purposes of the new rules, the "eligible RDTOH account" of a private corporation will include refundable taxes paid by the corporation under Part IV of the Tax Act in respect of eligible dividends received from non-connected Canadian corporations (i.e., portfolio dividends), whereas the "non-eligible RDTOH account" will generally include investment income-related taxes paid by the corporation under Part I and under Part IV (in relation to non-eligible portfolio dividends or dividends from a "connected" corporation.5

The rules provide that the payment of an eligible dividend will give rise to a refund only to the extent that there is a positive balance in the corporation's eligible RDTOH account.  Payments of non-eligible dividends will trigger refunds from the corporation's non-eligible RDTOH account until exhausted (at which point non-eligible dividends will trigger refunds from the corporation's eligible RDTOH account (to the extent of the balance thereof)).  

The proposed rules contain transitional provisions with respect to the allocation of current RDTOH balances between the two new accounts.6

The new measures concerning RDTOH access are applicable to taxation years beginning after 2018, with the same anti-avoidance rules noted above potentially applying in respect of taxpayer attempts to defer the effective time of the measures through the use of short taxation years.

Co-authored by Alexis Lemajic (Articling Student)

Footnotes

1 The favourable small business rate available to CCPCs must be shared amongst any group of CCPCs that are "associated" for the purposes of the Income Tax Act (Canada).

2 Budget 2018 confirmed that the Government is moving ahead with its previously announced proposal to reduce the small business tax rate for qualifying active business income of CCPCs from 10.5% to 10% in 2018, and to 9% in 2019.

3 Within the meaning contained in subsection 186(4) of the Tax Act.

4 The difference in the net tax burden imposed on eligible and non-eligible dividends varies fairly significantly between provinces.  Generally, a non-eligible dividend is one paid from a private corporation's active business income that is subject to the small business tax rate, or its investment income earnings.

5 Excluding certain eligible dividends from a connected corporation in circumstances where the dividend triggers a refund out of the paying corporation's eligible RDTOH account.  

6 For CCPCs, the eligible RDTOH account will be set at the lesser of (i) the CCPC's existing RDTOH balance, and (ii) 38 1/3% of its GRIP  balance, with the remaining balance being allocated to the non-eligible RDTOH account (in the case of any other corporation, the existing RDTOH balance will be allocated to the eligible RDTOH account).

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2018

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

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

Authors
Similar Articles
Relevancy Powered by MondaqAI
Minden Gross LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Minden Gross LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
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
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

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