The Canadian government recently closed a tax loophole that allowed certain corporations to side-step the refundable tax regime which is commonplace for Canadians earning investment income through their “Canadian-controlled private corporations” (“CCPCs“).
In simple terms, a CCPC is a privately held corporation incorporated in Canada that is not controlled by non-residents and/or public corporations. A CCPC that earns investment income (such as dividends, interest, capital gains and other income from property) must pay an additional “refundable” tax. This tax is refunded to the CCPC only when it pays out sufficient dividends to its individual (non-corporate) shareholders. The purpose of the refundable tax regime is to ensure tax neutrality between personally held investments and investments earned through a corporation which are generally taxed at a lower rate in Canada. Here are some numbers to consider:
- Combined federal and provincial tax rate on investment income other than capital gains earned by a CCPC resident in Ontario: 50.2% (25.1% in the case of capital gains)*
- Combined federal and provincial tax rate on investment income other than capital gains earned by a general corporation resident in Ontario: 26.5% (13.25% in the case of capital gains)
*The effective tax rate for a CCPC after receiving a refund of its refundable tax is roughly 20% (10% in the case of capital gains) in Ontario.
Before April 7, 2022, a typical tax planning strategy involved continuing CCPCs under the laws of foreign low-tax jurisdictions such as the Cayman Islands or the British Virgin Islands. Exporting the CCPC meant that it no longer qualified as a CCPC under Canadian tax laws, however it would remain a Canadian tax resident as long as the “mind and management” of the corporation remained in Canada. Consequently, the CCPC would lose its CCPC status and be subject only to the 26.5% corporate tax rate on investment income (13.25% in the case of capital gains).
Starting from taxation years ending on or after April 7, 2022, the Canadian government introduced a new type of corporation for tax purposes: the “Substantive CCPC.” This new definition in the Income Tax Act directly targets non-CCPC planning. Essentially, CCPCs that would qualify as CCPCs if they hadn’t been continued abroad, are now classified as Substantive CCPCs and subject to the same anti-deferral refundable tax regime as CCPCs, but without enjoying the benefits of being a true CCPC.
Let’s briefly discuss some of the differences:
General Rate Income Pool “GRIP” Account: A CCPC has a GRIP account that allows it to pay “eligible dividends” to shareholders to the extent that it has a positive GRIP balance. Eligible dividends are taxed less than “non-eligible dividends” making them advantageous for shareholders. On the other hand, a Substantive CCPC does not have a GRIP account, instead it has a Low Rate Income Pool (“LRIP“) account. The LRIP includes investment income earned by the Substantive CCPC, excluding eligible dividends it receives. A Substantive CCPC can pay eligible dividends only if it has no LRIP at the time of the dividend payment. Therefore, a CCPC has more flexibility in paying out eligible dividends compared to a Substantive CCPC.
Reassessment Period: A CCPC benefits from a shorter, three-year reassessment period whereas a non-CCPC, including a Substantive CCPC, has the regular four-year reassessment period. This means that a CCPC is less likely to be reassessed by the CRA compared to a non-CCPC.
Small Business Deduction “SBD”: The SBD is a lower tax rate available to CCPCs earning active income. A non-CCPC does not have access to the SBD. However, this may not be consequential for most non-CCPCs since the SBD does not apply to passive investment income anyway.
A CCPC that migrated out of Canada should consider continuing back to Canada to restore its CCPC status. The following considerations should be taken into account:
- A deemed year-end occurs immediately before the change of status from a Substantive CCPC to a CCPC. Therefore, consider filing articles of continuance on the first day of the corporation’s taxation year to avoid having to file a stub period return;
- The change of status will likely be subject to the new “Notifiable Transactions” reporting rules, which are expected to come into effect in late June 2023;
- The newly continued CCPC is allowed to add certain amounts to its GRIP account, including the cost amount of property held immediately before the end of the preceding taxation year;
Given the above, it may no longer make financial sense to maintain a corporation in a foreign jurisdiction. Our lawyers can assist bringing your corporations back to Canada.
This publication is intended for general information purposes only and should not be relied upon as legal advice.