Court OKs non-CCPC tax planning

When could a client’s foreign corporation actually be considered a Canadian-controlled private corporation?

This sort of non-CCPC tax planning, which the feds targeted in the 2022 federal budget, could exit on a high note. The Tax Court of Canada has sided with a company that challenged the Canada Revenue Agency’s (CRA) use of the general anti-avoidance rule (GAAR) to reassess its taxes owing following a series of transactions that changed the company’s CCPC status.

A foreign corporation doesn’t pay the additional refundable corporate income tax that a CCPC pays on investment income.

In the 2024 case of DAC Investment Holdings Inc. v. The King, Justice Steven D’Arcy wrote that the purpose of DAC’s continuance to the British Virgin Islands was clearly to shed its CCPC status ahead of a share sale, but concluded the threshold to apply GAAR had not been met.

“By carrying out the avoidance transactions in order to be taxed as a private corporation that is not a CCPC, the appellant did not abuse any of the provisions at issue,” Justice D’Arcy’s decision reads.

Gergely Hegedus, partner and tax lawyer with Dentons Canada in Edmonton, said taxpayers shouldn’t get too excited about the result, since the ruling came down as Parliament continues considering a bill that would legislate non-CCPC planning out of existence.

“I think the scope of the decision is pretty limited as a result,” Hegedus said.

Under Bill C-59, which is at third reading in the House of Commons, “substantive” CPCCs — private corporations that fail to meet the technical definition of a CCPC, but are ultimately controlled by individuals resident in Canada — would be taxed on investment income in the same manner as CCPCs.

“The proposed amendments are likely to pass and make this kind of planning inaccessible,” Hegedus said.

According to the Tax Court ruling, DAC was originally incorporated in Ontario in 2001. The corporation was then reincorporated in the British Virgin Islands in April 2015, weeks before selling its shares in a company. That transaction resulted in a capital gain of $2.36 million.

The CRA reassessed DAC’s tax return the following year, levying $91,000 in refundable tax that would have been due had it remained a CCPC. The agency also denied a general reduction of $148,000 claimed as a result of DAC’s non-CCPC status.

Justice D’Arcy characterized the taxpayer’s transactions as a choice to move between two tax regimes, noting that the decision had its “pluses and minuses.”

“On the minus side, it lost access to the low eligible small business tax rate for its business income, the refundable dividend tax credit for a portion of its tax paid at the general tax rate on its aggregate investment income, and the dividend gross-up and credit system,” D’Arcy wrote in his May 9 decision. “It also lost access to a number of benefits that are only available to CCPCs. Since [DAC] chose not to be a Canadian corporation, it lost the benefit of the rollover provisions in section 85 and the tax deferral rules for amalgamations and wind‑ups.”

Ultimately, the avoidance transactions “did not defeat the underlying rationale of the provisions at issue or circumvent the provisions in a manner that frustrated their object, spirit or purpose,” the judge concluded.

The 30-day deadline for an appeal has yet to expire, but Michael Goldberg, partner with Aird and Berlis LLP in Toronto, expects one will be forthcoming, leaving outstanding reassessments and reviews of non-CCPCs in a holding pattern until the Federal Court of Appeal weighs in.   

“Even if no appeal is filed, whether the minister will treat all non-CCPCs that have been assessed the same or whether it will continue to challenge some fact patterns remains to be seen,” Goldberg said. “As a result, in my view, the taxation of non-CCPCs is still far from having been resolved.”

While uncertainty reigns for taxpayers who have previously executed non-CCPC tax planning strategies, the future fate of the practice seems to have been sealed thanks to the provisions in C­-59. The changes were originally unveiled more than two years ago as part of Budget 2022.

The same bill also contains updates to GAAR, including a new 25% penalty that kicks in when the rule is applied, as well as a new test providing that a transaction’s significant lack of “economic substance” will be an “important consideration” tending to indicate that it is abusive.

Pooja Mihailovich, partner with Osler Hoskin & Harcourt LLP in Toronto, said it’s difficult to know whether the same result would have been reached in the DAC case under the updated GAAR.  

“But even under the amended GAAR, the same analytical framework applies, as does the requisite level of rigour in stress testing whether the transactions in issue are abusive,” she said. “To this extent, the outcome would likely not have been any different even if it was determined, for example, that the transactions were significantly lacking in economic substance as ultimately the issue is whether there was a misuse or abuse of the relevant provisions.”