Finance provided useful comments on its "Tax Planning Using Private Corporations" Consultation Paper
On September 25, 2017, at a conference held by the Canadian Tax Foundation in Ottawa, Finance discussed the grandfathering of existing passive investments, noted the possibility of providing relieving measures to ensure there is no double tax on death by extending the time to make a subsection 164(6) election, and commented on payments from capital dividend accounts (among other things).
Grandfathering of existing passive investments
In its Consultation Paper, Finance acknowledges that existing stocks of passive assets held in Canadian private corporations are significant, and stated that its intention was that the new rules would apply on a "go-forward basis", but did not explain what this actually meant.
At the conference, Finance reiterated that the intent of the proposals was not to impact the existing stock of savings and investment on those savings, and that Finance was looking at different options for grandfathering investments. For example, one option could be to allow a taxpayer to set up a company to hold the investments so as to receive current tax treatment on those investments. However, this option would necessitate having "walls" around the corporation Finance said it welcomes comments on how to grandfather existing investments.
In the Consultation Paper, Finance proposes to change the underlying taxation system related to holding passive investments, essentially doing away with the policy of income integration, as it relates to passive income. The proposals significantly increase the flow-through tax rate on investment income earned in a private corporation. On the inevitable distribution from the corporation, it is intended that both the individual earning the income directly and the individual earning the income through the corporation will have the exact same after-tax funds.
Finance was asked whether it would consider carving out pipeline planning from the new proposed anti-surplus stripping rules and if not, whether it would relax the requirements for making a subsection 164(6) election to alleviate the double tax problem that arises on death. Finance was also asked if it would provide transitional rules for pipeline planning.
Finance stated that it could not make any pronouncements on these matters until the consultation period ended. However, Finance noted that Finance is not considering a carve-out for pipeline transactions.
Finance advised that double tax is not a result that it was trying to achieve with its proposals. Thus, it may consider relaxing the requirements to be eligible for the subsection 164(6) election, including allowing more time to make the election to alleviate the double tax problem on death, since pipeline planning would no longer be available under the proposed rules.
Finance acknowledged the need for transitional rules for individuals who didn't complete a pipeline transaction in time and who were relying on pipeline planning to alleviate a deceased's double tax problem. In particular, where a person died before July 18, 2017 and the time period for making a subsection 164(6) election has expired. Finance said that, while double tax is not its intention, the specifics of how the double tax issue may be addressed are not known at this time.
Subsection 164(6) can be used to carry back an estate's capital loss to the deceased's terminal return to offset the capital gain realized, as long as the loss is realized during the estate's first taxation year. The result is that the income is only taxed once as a deemed dividend.
"Pipeline" planning was one possible option that was used to avoid double taxation when a taxpayer who owned shares in a private company died and the corporation was wound up after his/her death.
Capital dividend payments caught by new proposed 246.1
Finance was asked in what situations a capital dividend could be paid without triggering the new anti-avoidance rule in proposed section 246.1. Finance discussed two examples where Finance does not intend to challenge the capital dividend payment.
Specifically, Finance noted that if a corporation held marketable securities for a long period of time and realized a capital gain on the disposition of the securities which appreciated in value, then a capital dividend could be paid without triggering the anti-avoidance rule. Finance also said that, where a corporation transfers capital property to a subsidiary and realizes a capital gain as part of a restructuring in an arm's-length sale, it does not intend to challenge the capital dividend payment.
Finance also addressed a concern that the rule may inappropriately apply to bona fide arm's-length transactions and said that, as a general statement, the rule is not intended to target arm's-length transactions. However, the existence of an arm's-length sale in a series of transactions does not overrule any non-arm's-length elements in the transaction.
Finance stated that proposed new section 246.1 is not just a backstop to section 84.1. Rather, it was introduced to introduce a scheme into the Act regarding surplus stripping in non-arm's length situations.
Finance discussed how section 246.1 came to light. After Finance noticed a legislative gap in section 84.1 and was under the impression that "the courts were not observing the scheme in the Act to prevent surplus stripping" related to the conversion of dividends to capital gains, Finance decided to introduce section 246.1 to address situations it found where section 84.1 would not apply.
Tax on Split Income (TOSI)
The TOSI rules introduce a "reasonableness" test to determine if an amount that an adult specified individual receives should be subject to the top marginal tax rate. The reasonableness test takes into account labour and asset contributions (including risks assumed in supporting a business) and previous returns or remuneration received by the individual.
Finance stated that, a comparison of the contributions of each individual to the business would look not only at their capital contributions, but also "sweat equity". The analysis will depend on the facts of each case.
Finance said that, where a related person provides a family member with funds to start up a business, they will be considered to have made a significant contribution to the business and would be entitled to a "super return" given the inherent risk associated with a start-up family business.
Under the TOSI proposals, a new reasonableness test would seek to ensure that amounts received by an adult specified individual from a business where a family member is a principal (e.g., a "connected individual" in the case of income derived from a corporation) are included in the adult specified individual's split income "to the extent that the amounts are not commensurate with what would be expected in arrangements involving parties dealing at arm's length". Further, "an amount would not be considered reasonable in the context of the business to the extent that it exceeds what an arm's-length party would have agreed to pay to the adult specified individual", considering the following factors: labour contributions, capital contributions - including risks assumed in support of the business, and previous payments or remuneration.
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Information is current to October 10, 2017. The information contained in this publication is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's National Tax Centre at 416.777.8500