The Best Laid Plans of Tax Advisors: Substantive CCPC Concept Eliminates Effective Planning StrategiesTuesday, April 12, 2022
Read online or download the full update here.
On April 7, 2022, the Department of Finance Canada released Canada’s federal budget for 2022 (“Budget 2022”). To follow up on our previous tax law update on Budget 2022, the below takes a deeper look at the concept of a “substantive CCPC”. The introduction of this concept eliminates a number of commonly used planning strategies for deferring tax.
What Is a Substantive CCPC?
Under the proposed legislation accompanying Budget 2022, a substantive CCPC is a private corporation that: (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 corporation that is owned by a Canadian resident individual were owned by one individual, be controlled by that individual.
Why Was this Concept Introduced?
Budget 2022 introduced the concept of a substantive CCPC to combat tax planning strategies designed to avoid the additional refundable tax imposed on Canadian controlled private corporations (“CCPCs”) on certain investment income, including capital gains. The purpose of this additional refundable tax is to prevent individuals from deferring tax on investment income by holding investments through a corporation (as opposed to in their individual capacity).
For example, pursuant to the additional refundable tax, an Ontario corporation that is a CCPC pays tax on certain investment income at a combined (federal and provincial) rate of approximately 50%. However, a Canadian resident Ontario corporation that is not a CCPC (a “non-CCPC”) pays tax on this investment income at a rate of approximately 25%. When also accounting for provincial tax, this investment income is taxed at approximately 50% for CCPCs and 25% for non-CCPCs.
If a taxpayer (or taxpayers) caused their CCPC to be a non-CCPC prior to receiving certain investment income, they were effectively able to avoid the additional refundable tax. Taxpayers have used various planning strategies to achieve this, including continuing their corporation to a foreign jurisdiction while keeping the corporation’s mind and management in Canada, issuing special voting shares to a non-resident person or giving a non-resident person an option to acquire a majority of the voting shares of their corporation.
Most notably, common planning had emerged in the past few years (known as “111(4)(e) planning”) which achieved a tax deferral for sellers and a step-up in the basis of depreciable assets for a non-resident purchaser in an acquisition of a Canadian target company. On the signing of the purchase agreement, the corporation would lose its CCPC status because the non-resident corporation has a right to acquire control of the corporation. This planning was beneficial from a tax perspective because it allowed the corporation to trigger capital gains on certain depreciable capital assets at a lower tax rate before the sale of the business. This resulted in lower taxes for a seller and the ability of the purchaser to depreciate such assets in the future, thereby reducing both parties’ tax liabilities.
Budget 2022 also discusses the implementation of provisions intended to prevent tax-deferral CCPCs and their shareholders may realize from investment income earned through controlled foreign affiliates of the CCPC.
What Are The Implications for My Business?
Budget 2022’s introduction of the substantive CCPC will override these planning strategies by taxing non-CCPCs on investment income as if they were CCPCs. To quote the budget, this measure is intended to “address tax planning that manipulates CCPC status without affecting genuine non-CCPCs (e.g., private corporations that are ultimately controlled by non-resident persons and subsidiaries of public corporations).”
Although an exemption is available for transactions where a written agreement has been entered into before April 7, 2022 (provided certain other conditions are met), the substantive CCPC rules will generally apply to taxation years ending on or after April 7, 2022. This means that these rules could potentially have retroactive effect on certain transactions. In any case, they will certainly prevent the use of the planning strategies described above on a go-forward basis.
As they say, the best laid plans often go awry.
This update is intended as a summary only and should not be regarded or relied upon as advice to any specific client or regarding any specific situation.
If you would like further information regarding the issues discussed in this update or if you wish to discuss any aspect of this commentary, please feel free to contact us.