This tax ‘loophole’ has helped rich Canadians avoid millions in taxes for their private corporations. Now the government wants to shut it down

The federal government plans to stamp out a tax planning strategy that wealthy Canadians are using to minimize substantial taxes on their corporations' investment income.

The proposed measure, outlined in the 2022 federal budget, would tackle an increasingly popular tax planning approach in which Canadians are manipulating the ... status of their corporations to avoid paying" a higher rate on their investment income earned in the corporations.

The government said this amendment to the Income Tax Act would increase federal revenues by an estimated $4.2 billion over five years, according to the budget tabled on April 7.

This move came a month after a Star investigation exposed a loophole" in Canada's tax code that experts say allowed rich Canadians to slash immediate tax on the passive investment income such as interest, dividends and capital gains.

It was a blatant tax avoidance scheme, and the government has acted on it," said Allan Lanthier, former adviser to both the Canada Revenue Agency and the Department of Finance, who previously estimated the loophole" could have resulted in hundreds of millions in avoided tax.

While the government identified a number of ways for corporations to change their Canadian-controlled private corporation (CCPC) status for tax benefits, Lanthier said a majority of the companies that have used the technique have opted for continuing their corporations in foreign jurisdictions.

This is how it worked:

While passive income for a CCPC is subject to a tax rate of about 50 per cent, a non-CCPC is taxed at about half of that rate.

So, a company does what's known as a continuance - allowing it to reincorporate in a new jurisdiction, where it will be governed by foreign corporate laws, becoming a non-CCPC.

The company operates out of Canada and is subject to taxes on its worldwide income. But its passive income will be taxed in Canada at the lower, non-CCPC rate.

The Star reported that at least three separate corporations - including one owned by Canadian businessman Jim Balsillie - are in court fighting reassessments of the sizable tax savings they achieved by implementing this technique.

All three companies were previously registered in Canada and continued into the British Virgin Islands becoming non-CCPCs, shortly before pocketing hefty gains from passive income, according to the tax appeal documents.

The Canada Revenue Agency (CRA) is seeking to recover the allegedly avoided tax from these companies in its reassessments by applying Canada's general anti-avoidance rule (GAAR), a tool allowing the CRA to stop certain arrangements that it deems inappropriate.

For Balsillie's numbered company, the switch to a non-CCPC status allegedly resulted in a million-dollar tax benefit. His lawyer had said the company followed the rules of the Income Tax Act and that the CRA is asserting the company should pay the highest possible amount in taxes.

Colin Smith, a tax lawyer and a partner of Thorsteinssons LLP who acts for Balsillie, said, non-CCPCs have been used transparently for over a decade by thousands of Canadians and are blatantly legal."

While the existing rules allow the federal government to challenge the tax avoidance technique, it can be both time-consuming and costly," according to the government's supplementary information released alongside the budget.

The government is now introducing the concept of substantive CCPCs" in an effort to prevent companies from taking advantage of different tax treatments between the two statuses of private corporations.

Under the proposed measure, companies that have continued into a foreign jurisdiction or have otherwise switched out of their status as a Canadian-controlled private corporation will be considered substantive CCPCs" if they are private corporations that are managed in Canada and ultimately controlled by Canadian-resident individuals.

The substantive CCPCs will be subject to the same higher rate as other Canadian-controlled private corporations on their investment income, starting from taxation years that end on or after April 7, 2022.

Lanthier said the proposed measure is a ham-handed" way to tackle the issue.

I don't think they went about it in the right way ... there are still going to be judgment calls and uncertainty. And the rules add another layer of extraordinary complexity to the tax code," he said.

D.T. Cochrane, a policy researcher at Canadians For Tax Fairness, said, Overall, we're glad to see the government identifying and closing tax avoidance schemes.

It's good that the finance minister seems to be paying attention. Are they paying attention as promptly as they should be? That's debatable."

It appears the CRA only began in recent years cracking down on this technique of shifting a private company's status for tax purposes, although the strategy emerged as early as 2010, according to a paper presented to the Ontario conference of the Canadian Tax Foundation.

Cochrane also noted that he was disappointed with the lack of ambition and urgency in the budget as the government did not address several broader tax loopholes that it was expected to.

Sheila Wang is a municipal politics and general assignment reporter for YorkRegion.com and its sister papers. Reach her via email: swang@metroland.com