This summer the Department of Finance (“Finance”) released a consultation paper on tax planning using private corporations. A private corporation is a company that does not trade its stock on a public stock market. In other words, the shares of private corporations are privately-owned, in many cases by related individuals and groups of investors. According to Finance, the tax proposals are aimed at addressing “specific tax planning strategies involving the use of private corporations – strategies that can result in high-income individuals gaining tax advantages that are not available to most Canadians.” However, the consultation paper has received significant backlash due to the consequences the tax proposals will have, if implemented in the form proposed, on small business owners in Canada. Finance is in the process of hearing and reviewing submissions from the public in response to the consultation paper. Changes to the rules proposed are anticipated, but there is uncertainty around the extent of such changes.
Embedded in the details of the proposals is a change that will affect how gifts of capital property, most commonly publicly listed securities, by private corporations will be treated for tax purposes. Under the current rules, which are well-known to planned givers, when a private corporation makes a gift of shares (either flow-through shares of mining corporations or public company shares listed on a stock exchange) with an accrued gain to charity, the non-taxable portion of the capital gain can be credited to the private corporation’s “capital dividend account” (“CDA”). The corporation’s CDA is a notional account designed to track certain tax-free surpluses accumulated by the corporation. These surpluses can be distributed to the shareholders of the private corporation in the form of tax-free capital dividends. A simple example illustrates how the current rules work:
- In 2000, a private corporation, Xco, used $100 of its retained earnings derived from income taxed at the lower corporate rate of tax to purchase 100 shares of Yco, a public corporation listed on the Toronto Stock Exchange.
- In 2017, the shares of Xco are worth $1,000 on the public market. Thus, Xco’s accrued gain on the shares is $900 ($1,000 – $100).
- In 2017, Xco gifts all of its shares of Yco to a Canadian registered charity. Xco does not receive an advantage from the charity in exchange for the gift.
- On the day the gift is made, Xco’s CDA balance is $150.
- Xco receives an official charitable donation tax receipt from the charity for the fair market value of the shares, that being $1,000.
- The taxable portion of Xco’s gain on the shares is zero since, under the Income Tax Act (Canada), the capital gains inclusion rate for gifts of public company shares is zero.
- The non-taxable portion of the capital gain, that being the full $900 gain in this case, is credited to Xco’s CDA. Thus, after the gift is made, Xco’s CDA balance is $1050. This amount can be distributed to the shareholders of Xco as tax-free capital dividends.
- The net result of these rules is that the cost of making the gift to the charity after the rules are applied is very low.
In its consultation paper, Finance is proposing to eliminate the rule that contemplates that the non-taxable portion of the capital gain can be credited to the CDA (and subsequently paid-out as a tax-free capital dividend) if the property gifted was acquired with income that had been subject to a beneficial rate of tax. In other words, Finance is proposing that this new rule will apply where “the source capital of the investment is income taxed at corporate income tax rates.”
Finance did indicate that it will be considering whether additions to the CDA should be preserved in certain limited situations; however, the consultation paper does not mention situations involving gifts to charity.
According to Finance, the proposed new rule is meant to ensure that tax consequences between individuals and corporations are the same. Given that changes are expected, Miller Thomson’s Social Impact Group will watch and keep you informed about whether this change remains for implementation.