The government estimates it can collect an extra $4.2-billion over the next five years by cracking down on Canadians’ use of foreign corporations to minimize income taxes.
The budget released on Thursday says “some people are manipulating” the status of corporations – creating foreign corporations that are, in substance, Canadian companies – to pay low income tax rates. It proposes a number of amendments to tax laws that would treat them equally.
While the language speaks of corporations, it’s really about people – wealthy people who can create structures that allow them to park income in a foreign corporation, pay a lower corporate rate and save money by deferring those taxes for years.
“The rate of tax that private corporations pay on their investment income is intended to be the same as what the individual would pay,” says Rob Jeffery, a tax partner at Deloitte LLP. “The whole concept is that individuals should not be able to pay less tax by simply putting all of their investments into a wholly owned corporation. And there’s a number of mechanisms within the Canadian income tax acts that achieve that, or attempt to achieve that.”
Here’s why Canadians choose foreign corporate structures for tax purposes, according to conversations with chartered public accountants and tax professionals on Friday:
A Canadian-controlled private corporation (CCPC) will pay income taxes on the order of 50 per cent or more in most provinces. But once it pays out a dividend to its shareholders, it gets a refund on its taxes roughly equivalent to the dividend. That can push the corporate rate, effectively, down into the 20 to 30 per cent range or better. (The Canada Revenue Agency then taxes the individual on the dividend income.)
A foreign-controlled corporation has much lower income tax rates because it doesn’t get the benefit of paying these dividend-based “refundable taxes.” If an individual can place investment income in a foreign corporation, the rate is much lower. If the individual can keep it parked there for a number of years without paying out a dividend, there’s big savings to be had by deferring taxes indefinitely.
“Let’s say you earn investment income of $100 and it’s inside a Canadian-controlled private corporation,” explains Tara Benham, national tax leader at Grant Thornton LLP. “With $100 of investment income and a 50 per cent tax rate, you have $50 worth of cash left to go off and buy more investments. Whereas if you have $100 worth of investment income in a non-CCPC, and you pay 27 per cent tax, you have $73 left to invest. So if you’re going to leave the investment income inside the corporation, you’ve got more money to invest.”
Ms. Benham said she believes the amendments will create new definitions of what’s considered a Canadian corporation.
“So essentially it’s called the substantive CCPC,” she says. “My understanding of it is if, in effect, you are controlled somewhere up and down the string by Canadians, then you really are a Canadian-controlled private corporation. Therefore you should fall into the refundable regime. That’s how they’re trying to claw those entities in.”
The idea is that if the amendments to tax law are successful at redefining foreign corporations as Canadian corporations because they’re controlled by Canadian individuals, the CRA will be able to collect the higher tax rate from them.
The refundable treatment of corporate taxes inside a Canadian private company “is something that’s been part of the tax system for a long time,” says Bruce Ball, vice-president of taxation at the Chartered Professional Accountants of Canada. “So I think their perspective is they’re trying to equalize it. And I do think it’s probably more affluent people that are using it.”
The government says the amendments will apply to taxation years that end on or after April 7 of this year, meaning corporations that are well into a fiscal year right now will find new taxation rules applying to past activities.
“Typically, when a budget applies, they only apply to transactions that happen from budget day forward,” Deloitte’s Mr. Jeffery says. “So it is unusual that there is actually an element of retroactivity in here because of the way that they’ve chosen to introduce the changes.”
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