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20.07.2017 02.00 Age: 2 days

Canada takes aim at anti-avoidance through private corporations

The Canadian federal government has begun consulting on proposals to restrict high-income individuals' use of private corporations for tax planning.

The proposals were sketched out in the 2017 budget announcement earlier this year, and have now been published in detail, with draft legislation and explanatory notes.

They focus on:

  • using private corporations for 'income sprinkling' - that is, the splitting of income between several members of a family;
  • deferring tax on investment income by holding a passive investment portfolio inside a private corporation; and
  • converting a private corporation's regular income into less heavily taxed capital gains.

'Many of the richest Canadians are unfairly exploiting the tax rules designed to help businesses thrive', said finance minister Bill Morneau. However, tax advisors Moodys Gartner described the proposals as 'clearly an attack on entrepreneurs ... not good'.

The 'sprinkling' provision will extend the so-called 'kiddie tax' provisions in s120.4 of the Income Tax Act to adults in certain circumstances, most notably where individuals do not actively contribute to the business in terms of either labour or capital, said Moodys. These shareholders will pay taxes on income from the business at the highest marginal tax rates, though the final tax liability would be subject to a reasonableness test.

A further proposal is to disallow multiple members of a family from using their lifetime capital gains deductions to each shelter a capital gain on the disposition of qualified small business shares and farm property.

Another provision will stop small business owners deferring tax when they hold passive investments inside their company, instead of distributing the income from these investments as it is earned. The consultation document outlines a number of potential approaches centered on changes to the refundable tax regime in order to end the deferral, and asks for feedback in respect of these approaches.

'We do not agree with the need to change the status quo', commented Moodys. 'This is clearly a tax grab.'

The third strand of the programme aims to shut off a tax planning strategy by which corporate surpluses can, in some cases, be converted to capital gains instead of being distributed as dividends and taxed as such. The new measure would eliminate 'pipeline planning', often used by family businesses to eliminate the double taxation that often results when the primary shareholder of a private company dies and their estate is distributed, said Moodys.

'These changes have the potential to add another layer of complexity to an already mind-numbingly complex area', the firm said. 'They risk increasing compliance costs and distracting from the core businesses carried on [by small companies].'

However, according to law firm Davies Ward Phillips & Vineberg, the new rules will at least only be applied to future tax planning, not retrospectively.


Canada takes aim at anti-avoidance through private corporations