On July 18, 2018, the much-anticipated discussion paper, Tax Planning Using Private Corporations, was released by the Department of Finance. The paper, which covers income sprinkling, the taxation of passive corporate income, and surplus stripping, was accompanied by draft legislation and explanatory notes. Submissions on these proposals are being accepted by the government until October 2, 2017.

Given the sweeping nature and complexity of the proposals and the relatively brief consultation period, we invite members to share submissions here in the interest of encouraging constructive dialogue in the tax community.

Please note that the views reflected in any posted submission are those of the author(s) and not of the Canadian Tax Foundation.

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CTF Policy Conference on Tax Planning Using Private Corporations (September 25, 2017): Questions from Participants

Submitted by Bernard Spiegal

Submitted by Aaron Grinhause

Submitted by Brian Fingold

Submitted by Brody Thomson

Submitted by Neil Bronsch

Submitted by Ram Romanovsky

Submitted by Jeremy Bergen  (Updated August 14)

Submitted by Thomas E. McDonnell

Submitted by Raj Juneja

Submitted by Cory G. Litzenberger

Submitted by Kevyn Nightingale

Submitted by Allan Lanthier

Submitted by Jason Stephan

Submitted by Marc-André Godard

Submitted Joe Milla

Submitted by Brassard Goulet Yargeau Services financiers intégrés to the Honourable Minister William F. Morneau

Submitted by Mtre Erin Lesser & Mtre Austin del Rio

Submitted by Ward & Uptigrove CPA's

Submitted by J. K. Whittaker & Associates

Submitted by Glenn Lott

Submission to the Minister on holding passive income by Brassard Goulet Yargeau Services financiers intégrés 

Submitted by Barrie Broughton

Submitted by Felesky Flynn LLP

Submitted by Waterloo Centre for Taxation in a Global Economy, University of Waterloo

Comments

  • Robert Shortly 8/1/2017 4:16:35 PM +15

    What is fair about the increased cost to the small business corporation of trying to comply with the draconian and vague reporting requirements of all the proposed
    changes?

    Robert Shortly

  • Barry Hall 8/3/2017 10:12:58 AM +4

    First off I have a hard time understanding how changes to 84.1 to eliminate "pipeline" arrangements thus double taxation is "fair". Secondly, many corporation hold rental properties which are inherently more risky and time consuming than investments that generate income, dividends and or capital gains; how is it "fair" that a corporation that holds rental properties should pay a combined corporate and personal tax north of 70%?

  • Craig Gutwald 8/12/2017 4:55:23 PM -1

    The private corporation proposals all hinge on one major assumption - "Rich people are using the system to reduce or defer tax". The reality, in my experience, is that corporations are used mainly by average everyday low to middle class Canadians to carry on their businesses such as plumbers, carpenters, welders, contractors, accountants, etc. Messing around with system that has been in place for decades will only hurt THESE people, not the rich.

  • Canadian Tax Foundation 8/15/2017 6:50:55 PM +4

    Grandfathering provisions are required for pipelines, where shares were acquired prior to July 18, 2017, pursuant to the terms of a will.

    We have several cases of a taxpayer inherited shares of a private corporation. The one year term of the Estate permitted per 164(6) of the ITA, to carry back a loss has passed.

    The taxpayer has not yet completed the structuring of the pipeline. If grandfathering provisions are not created to address this, it is a grossly unfair result.

    Posted on behalf of Rhonda Pomerantz

  • Michael Calder 8/18/2017 11:42:22 AM +6

    One of the stated objectives of the Fed was to assist Family Transition Planning. Take 3 sisters. One sister is being bought out by the other two. The vendor has to be concerned with 120.4(4). The purchasers must fund the acquisition debt personally and pay additional tax. If you try to redeem to a holdco 55 applies and possibly 246.1. It's also likely that not all the interest on the borrowing to redeem the shares is deductible. Thanks for all the help Mr Fed.

  • Robert Kepes 9/20/2017 11:18:24 AM +3

    I’m looking at the TOSI and how it affects estate freezes. TOSI applies after 2017.

    Scenario 1

    Father is the founder of Opco, a CCPC that earns active business income. Father is married to Mother. They have one daughter who is active in the business and will take over when Father retires.

    Father owns 100% of the voting common shares of Opco. Let’s say Father freezes his common shares of Opco. Takes back frozen preferred shares. Daughter subscribes for new voting common. Father retires and she runs the business. She is a connected individual because she controls Opco. Father is a specified individual because

    • He is resident in Canada,

    • He is related to daughter who is not a trust, is resident in Canada, and she is related to father whose income includes an amount of income (i.e. dividends) from a property (i.e., the preferred shares),

    • It’s reasonable to conclude the dividends on the preferred shares are derived from a business, and

    • The business is carried on by a corporation of which the daughter is a specified shareholder.

    Question: Is Father subject to TOSI on dividends paid on the preferred shares after 2017? I think the only way for TOSI not to apply is if Father meets the reasonable test. When a person is over 17 years old, split income applies to amounts other than “excluded amounts” which are amounts that are not a “split portion”. That is, the TOSI applies to the “split portion”. The split portion is the amount in excess of what an arm’s length person would have paid the father “having regard to” 4 factors. No one knows how much weight to give to each factor.

    • The functions test: It says functions performed “before the amounts were paid or became payable”. The rule likely looks at Father’s labour contribution in the year the dividend is paid because a “split portion” is defined as a particular amount in respect of a taxation year (say 2018). If he’s retired the function test will amount to zero.

    • The contributed assets test: this refers to how much money was lent or invested in the company. This clearly looks at assets contributed at any time to the source business. Father would have to look back over the history of the company to see what assets or loans (if any) he contributed to the business. Could be only the original share subscription of $10.00 and nothing more.

    Subsection 84(9) deems father to have disposed of the share to the corporation. However, the reasonableness test requires the assets to have been contributed directly or indirectly in support of the source business carried on by the company. Arguably that’s different than disposing of shares to the corporation under either sections 85 or 86.

    • The assumed risks test: the draft legislation says you look at the risks assumed by the individual (i.e. father) in respect of the source business. The words “risk” and “assumed” are not defined in the proposals, but one can imagine it refers to whether a specified individual (e.g., spouse or adult child) has given a personal guarantee for the liabilities of the business. Another example is where a spouse has agreed to allow the matrimonial home to be pledged as security for a loan from say a bank to the business. Presumably this looks at risks currently assumed by father, which is likely zero given that he is retired.

    • The previous income test: this looks at all amounts (e.g. salary, dividends) that, before the end of the year, were paid or became payable to by any person to or for the benefit of the individual (i.e., father) in respect of the source business. I emphasize before the end of the year because the explanatory notes leave that out. That is, the notes imply that you can look at the person’s previous salary or dividend history and take that into account as a factor in determining whether the dividends paid to father in, say, 2018, are reasonable. This seems to make sense – if father was receiving salary and bonuses of $100,000/yr then why shouldn’t he be entitled to get a post-retirement dividend of $100,000/yr? Except I think the draft legislation doesn’t work that way because a “split portion” is defined as a particular amount in respect of a taxation year (say 2018) and the previous income test looks at income before the end of the year (before December 31, 2018). It doesn’t look at income before the end of 2017 or 2016 etc.

    It’s highly likely that TOSI applies to father. If it does then it doesn’t matter if the estate freeze was done before 2018 or after 2017 – the TOSI applies in 2018 forward. So much for no retroactivity in the rules! Big surprise and harsh result!

    Scenario 2

    Let’s continue the example and say father dies and transfers his shares into a testamentary spousal trust for Mother. She is the income and capital beneficiary during her lifetime. Daughter is the contingent capital beneficiary. Opco pays dividends to the testamentary spousal trust, which pays it out to Mother. She has become a specified individual in relation to the daughter for the same reason that father, while alive, was a specified individual.

    There’s a rule in new clause 120.4(1.1)(e)(C) that is meant to be a relieving rule for inherited property. The explanatory notes say:
    • Where property in respect of a source business is acquired by or for the benefit of an individual as a consequence of the death or a person, that individual may not have made any contributions to the business prior to the inheritance. In order to provide continuity and ensure that the reasonableness test applies appropriately to the individual inheriting the property, that individual will be deemed to have made the same contribution to the source business as the deceased individual.

    Sounds good, but let’s look at the draft legislation. Clause 120.4(1.1)(e)(C) says “if the particular amount (i.e., the dividend) is in respect of property (i.e. the preferred shares) owned by the individual (i.e. Mother) and the individual (i.e. Mother) acquired the property as a consequence of the death of another person (i.e. Father)…”

    Can she rely on this clause to pick up her husband’s contributions to the source business?

    I believe the answer is no. The phrase “as a consequence of death” is defined in subsection 248(8). It says (among other things) that an acquisition of property under or as a consequence of the terms of the will of a taxpayer’s spouse (i.e. father) is considered to be an acquisition of the property as a consequence of the death of the spouse. Since the testamentary spousal trust was contained in the father’s will, the spouse will be considered to have acquired the preferred shares as a consequence of father’s death.

    Unfortunately, ss. 248(8) may not help because clause 120.4(1.1)(e)(C) clearly says the shares have to be owned by the Mother and no one else. Problem is that the Mother doesn’t own the preferred shares directly. The testamentary spousal trust owns them.
    If subsection 248(8) is insufficient to make clause 120.4(1.1)(e)(C) apply, then there should be an amendment so that the clause applies if a spousal trust owns the shares.
    Of course, even if clause 120.4(1.1)(e)(C) applies, Mother is in the same position as was Father while he was alive post-retirement. She would have to prove he met the reasonableness tests as set out above.
    Lastly, If TOSI applies to the dividends paid through the testamentary spousal trust, then it doesn’t matter if the father dies before 2018 or after 2017 – the TOSI applies in 2018 forward. Once again, so much for no retroactivity!

    Any thoughts or comments?

  • Robert Kepes 10/29/2017 12:57:41 PM

    I am revisiting my comment of 9/20/2017.

    One problem in Scenario 1 of the TOSI applying after Father retires from the source business seems to have been fixed. On October 16, 2017 Ministers Chagger and Morneau announced the government’s intention to proceed with the income sprinkling proposal. Specifically, the Backgrounder says the government will introduce reasonableness tests for adult family members aged 18-24, as well as those 25 and older. These adults will be asked to demonstrate their contribution to the business based on four basic principles – whether they have made a contribution through any combination of the following:
    • Labour contributions;
    • Capital or equity contributions to the business;
    • Taken on financial risks of the business, such as co-signing a loan or other debt; and/or
    • Past contributions in respect to previous labour, capital or risks.
    This 4th factor is new as of the October 16, 2017 press release and is not in the July 18 Proposals. This is a welcome addition because current contributions of labour, capital or risks will justify current dividends, but that is no help to the shareholder who is retired. The ability to recognize past contributions provides relief for the retired shareholder who continues to receive dividends.

    Of course, this brings its own host of problems, which are that shareholders will have to keep track of and maintain records of their current and past contributions from the time they became shareholders. That will be well beyond the 7-year limitation period for record-keeping.

    A new problem:

    New to me, maybe not to others. Clause (b)(II)(B) of the definition of “split income” makes a distinction between the operating entity and the source business.

    On a closer reading subparagraph (b)(iii) of the definition of “split income” provides that the contributions of labour, capital and risk must be provided to the source business and not to the operating entity. That should mean that a specified individual’s contributions to the corporation that owns the source business or to a holding company won’t count as contributions.

    I assume the distinction between contributions to the corporation and to the source business is deliberate. I say this because we’re all familiar with the decision in McGillivray Restaurant where the FCA held that factual control of a corporation is not the same as factual control of the underlying business. The 2017 federal budget proposed subsection 256(5.11) to overrule McGillivray and therefore it’s reasonable to conclude that the Department of Finance is well aware of the distinction between the corporation and the underlying source business.

    With respect to TOSI, I can’t think of a contribution to a source business that is not also a contribution to the operating entity, except perhaps being a corporate director. And maybe even a lender. Arguably a director or a lender is contributing labour, capital or risk to the corporation, and not the underlying source business. This distinction should be eliminated such that contributions to holding companies and operating entities should be taken into account.

11/18/2017 6:45:14 AM