Updated: June 21, 2024
The substantive Canadian Controlled Private Corporation (CCPC) rules target tax planning strategies that manipulate a corporation’s status in order to defer tax on investment income.
The substantive CCPC rules apply to taxation years ending on or after April 7, 2022. Certain commercial transactions entered into before April 7, 2022, may be exempt. These measures were enacted as part of Bill C-59 on June 20, 2024.
What is a substantive CCPC?
A substantive CCPC is a non-CCPC private corporation at any time in the taxation year when:
- It's controlled (in law or in fact) directly or indirectly, by one or more Canadian resident individuals, or
- It would be controlled by a particular individual if that individual owned all the shares owned by Canadian resident individuals (even if they're dealing at arm's length).
In other words, under the new rules, a corporation would be considered a substantive CCPC if the only reason it isn’t a CCPC is because a non-resident or public corporation has the right to acquire its shares. The substantive CCPC legislation includes an accompanying anti-avoidance provision. This means a non-CCPC may be deemed to be a substantive CCPC where it’s reasonable to conclude that one of the purposes of a transaction or series of transactions is to avoid the substantive CCPC status. In a non-exhaustive list, Finance provides two examples of when the anti-avoidance rule may apply (assuming the ordinary rules do not):
- Canco is a CCPC owned by three Canadian resident individuals. Prior to realizing significant capital gains, Canco issues non-participating voting preferred shares (skinny voting shares) to the non-resident children of the individuals, causing Canco to lose its CCPC status. The Canadian shareholders claim that the skinny voting shares were issued for estate planning purposes.
- Canco is a CCPC owned by a limited partnership (GPCo) that is a Canadian partnership. The general partner of GPCo, is wholly-owned by a Canadian resident individual. Prior to Canco realizing significant capital gains, the partner sells all of their GPCo shares to a non-resident individual, resulting in GPCo losing its CCPC status.
In these examples, Finance indicates that the anti-avoidance rules would apply. Specifically, the rules would apply as it would be reasonable to conclude that one purpose of the transaction was to avoid the substantive CCPC status to ultimately receive a more favourable tax result on the capital gains (unless there are clear facts indicating otherwise).
How is a substantive CCPC taxed?
Substantive CCPCs are subject to the same refundable tax regime on its investment income as a CCPC. The Income Tax Act (the Act) imposes an additional tax on investment income earned by CCPCs for integration purposes. This means a substantive CCPC is subject to a significantly higher corporate tax rate on investment income (currently ranging from 46.67% to 54.67% depending on the province) compared to the tax rate on investment income if it were a private corporation that is neither a CCPC nor substantive CCPC (currently ranging from 23% to 31%). However, a portion of this additional tax is refundable when the company pays a taxable dividend. Investment income generally includes net property income and net taxable capital gains, but excludes dividend income already subject to a refundable tax under Part IV of the Act.
Furthermore, the amended capital dividend account and general rate income pool rules align the treatment of a substantive CCPC and CCPC for integration purposes. Otherwise, substantive CCPCs are treated as non-CCPCs for all other purposes under the Act and therefore aren’t eligible for the small business deduction, the enhanced credit for Scientific Research and Experimental Development (SR&ED), or other tax benefits available to CCPCs. In addition, to facilitate administration of the changes, there is a one-year extension of the normal reassessment period in certain circumstances.
Proposed FAPI rule changes for CCPCs and substantive CCPCs
Budget 2022 also proposed changes to tighten the Foreign Accrual Property Income (FAPI) rules and if enacted, would impact both CCPCs and substantive CCPCs. Draft legislation hasn’t been introduced yet for these FAPI changes. The FAPI rules are complex and are intended to prevent taxpayers from deferring tax on investment income earned through a controlled foreign affiliate. Read our 2022 Federal budget summary for more information.
Takeaway
The substantive CCPC rules could have a significant impact on existing structures and share transactions involving non-resident or public corporations—we can help you navigate them. Contact your local advisor or reach out to us here.
Disclaimer
The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Doane Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.
