On July 18, 2017, the Department of Finance released a consultation paper regarding Tax Planning Using Private Corporations (the Consultation Paper). While our expertise is in corporate and securities law, and we do not purport to be experts in tax law, these changes, if enacted as proposed, could have a significant impact on many of our clients (e.g., investment fund managers). Accordingly, there are three main areas discussed in the Consultation Paper with respect to taxation of private corporations that we would like to highlight. 

First, the proposed changes would attack “dividend sprinkling” by applying a “split income” tax starting in 2018 on a dividend (effectively raising the tax rate on such income to the highest marginal rate) received by an individual derived from a business of a related individual (including through a corporation of which the related individual can exert influence) where the dividend is unreasonable having regard to such circumstances as the dividend recipient’s labour and capital contributions to the business. “Dividend sprinkling" refers to the practice of lowering a family's aggregate income tax liability through a corporation paying dividends on a class or classes of shares held by family members who are in a lower tax bracket (as compared to the owner-manager).

Second, generally starting in 2018, the proposed changes would eliminate the ability to claim the Lifetime Capital Gain Exemption (i) on gains that accrued before the taxation year in which the individual turned 18 years old, (ii) on gains that accrued during the time that the subject property was held by a trust (subject to very limited exceptions), and (iii) to the extent that a taxable capital gain from the disposition of the subject property is subject to the “split income” tax discussed above. Under the proposals, a transitional rule would allow certain affected individuals to elect to realize, on a day in 2018, a capital gain in respect of eligible property by way of a deemed disposition for proceeds up to the fair market value of the property (resulting in an increase in cost basis of the property, thereby reducing taxable capital gains on a later sale) and to use their lifetime exemption with respect to the gain. However, in certain circumstances, minors cannot benefit from this transitional rule.

Third, the Consultation Paper discusses the taxation of passive investments inside a private corporation. While the federal government has not yet proposed legislation on this point, it appears that the federal government is exploring ways to remove the deferral advantage associated with a corporation using active business income to make passive investments. The Consultation Paper indicates that any such rules are intended to apply on a going forward basis (i.e., they are not intended to impact, as much as possible, existing passive investments held by a corporation).