For quite a few years now, many Canadians with substantial amounts of investment income and capital gains have been using private corporations that are not “Canadian-controlled private corporations” (“CCPCs) as a means of achieving substantial tax deferral.
A CCPC will pay federal and provincial tax at a rate of about 50% on investment income (including the taxable portion of capital gains). This includes a high “refundable dividend tax on hand” (“RDTOH”) component. This is refunded when taxable dividends are paid, and removes any significant corporate-level tax deferral.
In contrast, a corporation that is resident in Canada, but not a CCPC, will pay the “general corporate tax rate”. This is 15% federally, and, assuming income is earned in a province, the applicable provincial tax rate. In Ontario, this totals 26.5%. If the income is not earned in a province, there is an additional 10% federal tax, bringing the total to 25%.
There are two ways that a private corporation may be resident in Canada, but not be a CCPC:
- Where voting control is in the hands of non-residents of Canada, or
- Where it is incorporated outside of Canada, even if controlled by Canadians
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In fact, I first wrote about using the first way to switch to non-CCPC status in a paper I presented at the 2010 Ontario Conference of the Canadian Tax Foundation.
Of course, the simplest way to use that approach might be to issue shares that just have votes, but no equity value, to Uncle Joe who lives in Dallas, Texas, such that he has voting control.
However, for a number of reasons, that approach might not be available or acceptable in any given situation.
Hence, the approach that I developed, in the paper I presented in 2010, entailed putting direct voting in the hands of a US C corporation that would be controlled by the Canadian shareholders.
Since that time, most of the planning in this area has focused around the second way-a corporation formed outside of Canada, but resident in Canada based on “mind and management”.
It would be possible to convert a CCPC to a non-CCPC by “continuing” it an appropriate foreign jurisdiction. Because the Directors would all be Canadians, it would remain resident in Canada, but it would no longer be a CCPC, as defined, because it would be deemed to have been newly formed outside of Canada.
The British Virgin Islands (“BVI”) has been the most popular jurisdiction to continue, at least from what I have seen.
This type of conversion has been implemented in many situations in recent years where a CCPC is about to realize a large capital gain. If it is converted prior to the realization of the gain, the taxable portion would be subject to the lower general corporate tax rate, rather than the much higher CCPC investment income tax rate.
So far, there has been no suggestion of the Canada Revenue Agency attempting to apply the “General Ant-Avoidance Rule” (“GAAR”) to such planning. However, it is certainly possible that the Ministry of Finance would introduce legislation in the future to remove the substantial corporate-level tax deferral that is possible.
