Canada | Publication | April 14, 2022
On April 7, the minister of finance tabled the 2022 federal budget (Budget 2022).
Some key tax measures proposed in Budget 2022 concern Canadian private corporations. These new measures, if enacted, would (i) allow more medium-sized Canadian-controlled private corporations (CCPC) to benefit from the small business deduction (SBD), (ii) amend the recently enacted provisions to facilitate intergenerational business transfers while protecting the integrity of the tax system, and (iii) provide new rules designed to prevent manipulating CCPC status or using a controlled foreign affiliate in a manner that circumvents the anti-deferral and integration regimes applicable to the passive income of CCPCs.
Below is a brief summary of these new measures.
The SBD allows CCPCs to reduce their federal corporate income tax rate from 15% to 9% on their first $500,000 of active business income (the Business Limit). The Business Limit is, however, subject to a phase-out on a straight-line basis if (i) the taxable capital employed in Canada of a CCPC and any associated corporations is between $10 million and $15 million (the Taxable Capital Reduction) and if (ii) the aggregate investment income of a CCPC and any associated corporations is between $50,000 and $150,000 (the Investment Income Reduction). The reduction of the Business Limit is generally equal to the greater of the Taxable Capital Reduction and the Investment Income Reduction.
Budget 2022 proposes to increase from $15 million to $50 million the upper limit of the Taxable Capital Reduction, therefore allowing more medium-sized CCPCs to benefit from the SBD. This new measure does not, however, increase the range over which the Investment Income Reduction applies. As a result, CCPCs and associated corporations with aggregate investment income over $150,000 still cannot claim the SBD.
This measure, if enacted, would apply to taxation years that begin on or after April 7, 2022.
Bill C-208 received royal assent on June 29, 2021, and amended the Income Tax Act (Canada) (ITA) in order to facilitate intergenerational share transfers (the Intergenerational Transfer Rules). The day after royal assent, the Department of Finance Canada clarified in a public statement that the Intergenerational Transfer Rules would only apply as of January 1, 2022.
In a subsequent statement, the Department of Finance Canada reversed its position and confirmed the Intergenerational Transfer Rules apply in law, but indicated they contain significant loopholes that may inadvertently permit the opportunity for surplus stripping. This statement also confirmed the government’s intention to propose legislative amendments to address issues such as:
Budget 2022 announces a consultation process on how the existing rules could be strengthened to protect the integrity of the tax system while continuing to facilitate genuine intergenerational business transfers. While no draft legislation was released with Budget 2022, the government announced its intention to table a bill in the fall 2022, after conclusion of the consultation process.
To prevent certain tax planning strategies resulting in the avoidance or loss of CCPC status, Budget 2022 introduces a new concept of “substantive CCPC.”
A substantive CCPC would be defined as a private corporation (other than a CCPC) that at any time in a taxation year (i) is controlled, directly or indirectly in any manner whatever, by one or more Canadian resident individuals, or (ii) would, if each share of the capital stock of a corporation that is owned by a Canadian resident individual were owned by a particular individual, be controlled by the particular individual.
Thus, a private corporation would be a substantive CCPC even if a non-resident person has a right to acquire all of its shares. An anti-avoidance provision would also be introduced to deem a corporation to be a substantive CCPC if it is reasonable to consider that one of the purposes of any “transaction” (as defined in subsection 245(1) of the ITA), or series of transactions, was to cause the corporation not to qualify as a substantive CCPC.
This new measure would ensure the aggregate investment income earned by a substantive CCPC is taxed in the same manner as a CCPC (i.e., at a federal tax rate of 38⅔%, of which 30⅔% would be refundable upon payment of dividends, in accordance with the ITA). In addition, investment income earned by a substantive CCPC would be added to the “low rate income pool” (LRIP) such that dividend receipts would not entitle an individual shareholder to an enhanced dividend tax credit.
This measure, if enacted, would apply to taxation years ending on or after April 7, 2022, except for certain taxation years ending as a result of an acquisition of control resulting from a sale of all or substantially all of the shares of a corporation to an arm’s-length purchaser pursuant to a written purchase and sale agreement entered into before April 7, 2022, provided that the sale occurs before the end of 2022.
The foreign accrual property income (FAPI) rules prevent taxpayers from gaining a tax deferral advantage when earning certain types of investment income through controlled foreign affiliates by including in a Canadian shareholder’s income its participating share of a controlled foreign affiliate’s FAPI (even though no distribution has been made by the controlled foreign affiliate). If the Canadian shareholder is a CCPC, the income is subject to a federal tax rate of 38⅔%, of which 30⅔% is refundable upon distribution.
Such FAPI income inclusion is subject to a deduction based on the “foreign accrual tax” (generally referred to as the foreign tax paid) multiplied by a “relevant tax factor.” Under the current legislation, two different relevant tax factors exist: one for corporations and certain partnerships (i.e., 4) and another one for individuals (i.e., 1.9).
The relevant tax factor applicable to a corporation generally allows for a deduction equal to the full FAPI income where the foreign accrual tax equals or exceeds 25% (in contrast with a controlled foreign affiliate of an individual, which requires foreign accrual tax of at least 52.63% to obtain the same deduction). In addition, the inclusion of certain amounts in respect of FAPI generally increases the “general rate income pool” of a CCPC and thus allows the CCPC to pay eligible dividends, which results in a further tax advantage compared to investment income earned by a CCPC in Canada.
To eliminate any tax incentive for CCPCs and substantive CCPCs to earn investment income through a controlled foreign affiliate, Budget 2022 proposes to (i) apply the “relevant tax factor” of individuals to CCPCs and substantive CCPCs, (ii) remove certain amounts from the “general rate income pool” (GRIP) of CCPCs, and (iii) add certain amounts to the capital dividend account of CCPCs and substantive CCPCs, in an attempt to allow income that was subject to a tax rate of 52.63% or higher to flow tax-free to an individual shareholder while ensuring income subject to a lower tax rate is subject to an appropriate level of taxation on an integrated basis.
These measures, if enacted, would apply to taxation years that begin on or after April 7, 2022.
The authors wish to thank articling student Michel Gosselin-Trépanier for his help in preparing this legal update.
Publication
On September 18, 2024, the "Decree amending the list that sets forth goods whose import and export are subject to regulation by the Ministry of Energy" (the "Decree") was published in the Federal Official Gazette.
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