Proposed changes to private incorporation tax rules could have costly consequences for corporate clients, say lawyers who have reviewed potential shifts to the Income Tax Act.
The federal Liberal government has been at the centre of ongoing controversy over the proposed changes, which were announced this summer and could go into effect later this fall.
The changes could cause double taxation for clients with private corporations or family trusts in some circumstances, lawyers say. The changes could also end up taxing a holding company’s assets at a rate of 70 to 90 per cent, they say.
Marion Howard, a tax lawyer in solo practice in Campbellville, Ont., says new anti-avoidance rules being added to s. 246.1 of the Income Tax Act will have an impact on the capital dividend accounts of private corporations by subjecting them to new taxation.
Howard says some corporate lawyers may not be aware of the intricacies of how the change will impact a shareholder’s income tax.
“They don’t realize that they have to potentially contact all of their clients and tell them that they need to rework their shareholder agreements and the ownership of their life insurance,” says Howard.
Section 246.1 is headlined in the proposal as intending to address “non-arm’s length dividend stripping — individual” and is intended to be an anti-avoidance measure to prevent the distribution of a corporate surplus to an individual shareholder on a tax-free basis, a practice known as “surplus stripping.”
“Myself and other tax lawyers are afraid that the way that 246.1 is drafted, whether it was intended or not, we can’t pay a capital dividend out of the capital dividend account,” she says.
Howard says this is urgent because the new rules are effective as of July 18 of this year, when the proposed changes were announced.
In particular, Howard is concerned about how these changes will mean a corporation can no longer pay out a tax-free dividend related to life insurance paid into a capital dividend account when a shareholder dies, at least not until the company is wound-up.
“All those shareholder agreements out there are all set up to accommodate this corporate-owned life insurance,” says Howard. Therefore, it may be more advantageous to change the policies to individual holders instead, which wouldn’t be subject to additional taxation.
When asked about tax lawyers’ concerns about these potential consequences, Finance Minister Bill Morneau told Law Times that, currently, a period of consultation about the changes is ongoing.
“To the extent that people have concerns around language, around how the plans will work, we’re going to listen because we want to get it right,” says Morneau.
“But, again, our objective is to make sure our system is fair.”
Brandon Siegal, principal of Siegal Tax Law in Toronto, says that the government’s attempts to stop tax deferral will mean that there is less incentive to invest in the economy and that the resulting taxation on private corporation dividends would be double taxation, with rates up to 73 per cent.
“It creates an environment where you are explicitly worse off making money through the corporation than you were beforehand,” says Siegal.
Robert Kepes, partner with Morris Kepes Winters LLP in Toronto, says the new language with s. 246.1 mirrors a section, 247.1, that was taken out of the act in the mid-1980s with the introduction of the General Anti-Avoidance Rule.
GAAR states that where transactions are only being attempted to reduce, avoid or defer taxes owing, they may be invalidated by the Canada Revenue Agency.
“I think one of the reasons they’re bringing this in is because there have been some court cases that have said there isn’t a general policy in the Income Tax Act against dividend stripping,” says Kepes. “I think they’re introducing 246.1 so that the government can point to it and say that there is a policy.”
The Canadian Bar Association says proposed tax changes deserve a longer and more thoughtful consultation period than the 75 days the government allotted. The association had come under fire from some members after it opposed the changes as part of the Coalition for Small Business Tax Fairness.
“We have facilitated a process through which our members can express their views,” says spokeswoman Katya Hodge.
Editor's note: Change made Sept. 28, 2018 at 4:47 p.m. to clarify point made by Marion Howard in 10th paragraph.