Investment income in a CCPC

Income tax policy, rules, problems, strategy and software. Property and consumption taxes too.
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DavidR
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Post by DavidR »

Icarus wrote:DavidR, since you seem knowledgeable in these things, I hope you can answer a question for me. I spoke to an accountant who cautioned me against holding U.S. domiciled stocks in a corporation because of poor treatment of the distributions:
The calculation is actually kind of complicated, but it is cheaper from a Canadian income tax perspective to hold these [U.S. domiciled] investments personally. When you flow it through a corporation, claiming a foreign tax credit on the income you receive from the US throws off the integration part.

If a corporation earns $1,000 of US portfolio income, the calculation would be

Foreign income = $1,000
US withholding tax = (150)
Canadian corporate tax = (231) (includes foreign tax credit)

Net as dividend 619
Tax on dividend (194)

Net 425

Effective tax rate = 57.5%

Personally - combined US and Canadian tax is 46.41%

Also, the corporate tax above (effective corporate tax of 38.1%) assumes that you pay a dividend of $351. If no dividends are paid, the corporate tax includes another $117 of refundable tax, bringing the corporate rate up to 49.8%. So, earning this income in a corporation is not advisable - you don't get a deferral and it doesn't integrate well.
I'm not all knowledgeable on these issues. I know that investment income is less favourably taxed within corps than personally. Does the foreign withholding tax exacerbate the problem, as this message implies?
Yes, your accountant's explanation is consistent with my general understanding.
Icarus wrote:Also, the consensus here seems to be that a corporation will protect your estate from U.S. estate taxes, but I've heard a few people rumble that it's not necessarily true. Can you comment?
Sorry, I have no expertise in US estate issues. I have learned a little from the postings of Norbert and others, but don't feel qualified to comment myself.
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Post by adrian2 »

David,

How do you jive the figures in Icarus' quote (effective corporate tax of 38.1%) with your figure of 23% tax rate for interest, after the refundable tax?

Icarus,

I'll repeat what I've answered to your same question on November 2006:

The above does not mention:

(1) in many instances the tax on dividends paid from a CCPC is much lower than 19.4% - as low as zero for a substantial amount if dividends are the sole source of individual income and various exemptions and credits are utilized. In this case, total tax involved is 38%, which is within a reasonable range for a middle level of income.

(2) how the comments above are related to a corporation not being able to "fully utilize the foreign tax credit". I can agree to the fact that some investment income (interest and foreign dividends) is more harshly taxed if earned in a corporation, but this would apply equally to foreign stocks, Canadian-domiciled mutual funds investing in foreign stocks and US-domiciled funds.
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Post by DavidR »

adrian2 wrote:David,

How do you jive the figures in Icarus' quote (effective corporate tax of 38.1%) with your figure of 23% tax rate for interest, after the refundable tax?
Well I was hoping no-one would ask me to go through the other guy's numbers, because I don't know the province, or the fiscal year end, etc... but I guess I am being thoroughly tested!

Looks like he has arrived at 38% by adding the 15% witholding tax to the 23% (combined Federal and Provincial) Canadian corporate taxes. I think he has simplifed things a little.... But I agree with his overall conclusion that foreign withholding taxes 'exacerbate the problem with investment income being taxed within a corp'
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Post by adrian2 »

DavidR wrote:But I agree with his overall conclusion that foreign withholding taxes 'exacerbate the problem with investment income being taxed within a corp'
Why is that? AFAIK, the corporation gets a full credit for the foreign withholding tax in most cases, and in all instances for myself in the past years. Not too different compared to foreign withholding tax on a personal tax return.
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Post by DavidR »

adrian2 wrote:
DavidR wrote:But I agree with his overall conclusion that foreign withholding taxes 'exacerbate the problem with investment income being taxed within a corp'
Why is that? AFAIK, the corporation gets a full credit for the foreign withholding tax in most cases, and in all instances for myself in the past years. Not too different compared to foreign withholding tax on a personal tax return.
Try it on a T2 - you'll see that the refundable portion of part I tax (and ultimately the dividend refund) is significantly reduced when part of the tax has gone to a foreign goverment rather than to Ottawa. So although the full foreign tax credit is taken, the dividend refund is a lot smaller than when the investment income is not subject to WH tax. (Kind of a hidden tax, I guess, that you may not have noticed...)
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Post by adrian2 »

DavidR wrote:If you are carrying on an Active business, and you are eligible for small business rates, you deduct a 16% SBD and pay Federal tax of 13.12%. Add Ontario tax (using Ontario as a typical province) of 5.5% for 18.62% total.

If you are carrying on an active business but not eligible for small business rates, you deduct 7% and pay 22.12%. Add Ontario tax of 14.0% for 36.12%

If you are a CCPC earning investment income you add 6.67% and pay 35.79% - of which 26.67% is refundable. After the dividend refund the Federal tax is only 9.12%. Add Ontario of 14.0% for 23.12%.
As promised, I've run the numbers through QT T2 (2005/2006 rates).

Here are the results:

1. for an extra $1,000 in small business income:
FED goes up $131
ONT goes up $55
Total goes up $186 (exactly as you indicated)

2. for an extra $1,000 in interest income:
FED (after Part I refund) goes up $92
ONT goes up $140
Total goes up $232 (exactly as you indicated)

3. for an extra $1,000 in foreign income AND an extra $100 in foreign withholding tax:
- in comparison to scenario 2:
FED (after Part I refund) goes down $26
ONT stays the same
Total goes down $26
Conclusion: you only get a 26% credit of the face value of the withholding tax, instead of 100%. It is still better (and more correct) to report the gross foreign income plus the withholding tax, instead of net foreign income and no withholding.

Hats off and an A+ for you. Shame on me for not being aware of it.
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Post by esviagra »

CCPC investments are subject to 6 2/3% tax -> line 604 on T2. Isn't this tax suppose to be refundable and added to the RDTOH value?
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Post by izzy »

"Integration" can be a bit of a lottery if dividends are paid out to a shareholder in a different province since the provincial dividend tax credit is calculated on the assumption that shareholder is resident in the same province as the corporation.
To an extent the same can occur if the dividends are paid out of retained earnings in a later year than earned.
For example; coupled with the gradual decrease in the small business rate in Manitoba is a proportionate decrease in the small business dividend tax credit, thus if the earnings were earned in 2004 and will be paid out as a dividend in 2010 the dividend tax credit allowed will not match the small business tax paid on those earnings at the corporate level and that will result in a greater amount of TOTAL tax on those earnings.Deferring income in this way can carry a cost.Theoretically the opposite could occur if rates were rising although I am sure such a LOSS of revenue would be compensated for by some innovative tax provision or other .
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Post by adrian2 »

esviagra wrote:CCPC investments are subject to 6 2/3% tax -> line 604 on T2. Isn't this tax suppose to be refundable and added to the RDTOH value?
Yes - David's calculations and my numbers above include the effect of the refund (and assume enough dividends are paid from the CCPC).
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adrian2 wrote:Conclusion: you only get a 26% credit of the face value of the withholding tax, instead of 100%. It is still better (and more correct) to report the gross foreign income plus the withholding tax, instead of net foreign income and no withholding.
One more thing re: undesirability of holding foreign stocks in a CCPC.

Getting a 26% credit for foreign taxes is of course a long way from getting a full credit, but it's still better than a 0% credit.

You'll still get 0% credit for foreign taxes paid for:
- an RESP holding any foreign stocks / foreign domiciled mutual funds / Canadian domiciled mutual funds investing outside Canada
- an RRSP holding foreign stocks from most countries (except USA which recognizes RRSP's) / foreign domiciled mutual funds investing outside their residence (e.g. US-based ETF's investing in EAFE) / Canadian domiciled mutual funds investing outside Canada
- a non-registered account holding foreign domiciled mutual funds investing outside their residence (e.g. US-based ETF's investing in EAFE) - this scenario I believe nobody has mentioned it before, correct me if I'm wrong

As almost no financial gurus recommend against situations listed above, I don't see a blanket no-no applicable to holding foreign stocks in a CCPC - they are still better tax-wise than all the scenarios above.
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Post by Bylo Selhi »

adrian2 wrote:- a non-registered account holding foreign domiciled mutual funds investing outside their residence (e.g. US-based ETF's investing in EAFE) - this scenario I believe nobody has mentioned it before, correct me if I'm wrong
I believe I mentioned that in a recent thread on topic, but regardless, it bears repeating.
As almost no financial gurus recommend against situations listed above, I don't see a blanket no-no applicable to holding foreign stocks in a CCPC - they are still better tax-wise than all the scenarios above.
I doubt tax pros would recommend holding foreign securities in a CCPC per se, however, when there are other considerations, e.g. to protect from US estate tax, to invest money that has been transferred out of an operating company, to split income, etc. then those benefits may well outweigh the added frictional costs.
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Post by Stan »

DavidR wrote:
adrian2 wrote:
DavidR wrote:If you are a CCPC earning investment income you add 6.67% and pay 35.79% - of which 26.67% is refundable. After the dividend refund the Federal tax is only 9.12%. Add Ontario of 14.0% for 23.12%.

Investment income is not part of GRIP because it has not been taxed at the general rate.
Do the numbers above assume the interest is reported on Schedule 7 or not? Doesn't it make a difference?
The above numbers are for investment income reported on Schedule 7. If you have reported your interest income on schedule 7, then it is included in the above calculation.

If it is interest from an active business's checking account, on the cash that it maintains as a prudent part of managing its working capital, then I think you will find that most professionals will treat it as active income. Thus it will be taxed at either the SB rate or the general rate, depending upon whether the corp is a CCPC and whether its income exceeds the SBDL on not. So it may end up as part of GRIP or it may not....
I just read this thread and thought I would comment on this. I have a CCPC with active business and do include the interest income as active income. Excess funds are moved to an investment company where I get a variety of income including interest which is not taxed as active income.

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Post by adrian2 »

Bylo Selhi wrote:
adrian2 wrote:As almost no financial gurus recommend against situations listed above, I don't see a blanket no-no applicable to holding foreign stocks in a CCPC - they are still better tax-wise than all the scenarios above.
I doubt tax pros would recommend holding foreign securities in a CCPC per se, however, when there are other considerations, e.g. to protect from US estate tax, to invest money that has been transferred out of an operating company, to split income, etc. then those benefits may well outweigh the added frictional costs.
We're kind of splitting hairs (at least we're not debating in the new section), but have you seen any recommendations to the tune of "do not hold any foreign securities (stocks/funds/anything) in an RESP because the foreign tax is irrevocably lost"? Then what's the big deal with losing 3/4 of the credit for foreign stocks in a CCPC?

Some people do not bother to switch their RRSP's US indexed allocation from the CIBC index fund (with rebate) to VTI, even though it would mean going from a 0% FTC to a 100% FTC.

Some people recommend using Vanguard's VPL/VGK just by looking at the MER's alone - in a non-registered account may be cheaper to pay a slightly higher MER at TD e-Funds and be able to claim a FTC.
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Post by Bylo Selhi »

adrian2 wrote:Then what's the big deal with losing 3/4 of the credit for foreign stocks in a CCPC?
You're right, we are splitting hairs. You're right that if you look only at MER differences you may miss other costs that are as great or greater.

All I'm trying to say is if you have a choice between holding foreign stuff individually and in a CCPC you should opt for personally unless there are other reasons for using a holdco that outweigh the FTC considerations.
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Post by couponstrip »

As promised, I've run the numbers through QT T2 (2005/2006 rates).

Here are the results:

1. for an extra $1,000 in small business income:
FED goes up $131
ONT goes up $55
Total goes up $186 (exactly as you indicated)

2. for an extra $1,000 in interest income:
FED (after Part I refund) goes up $92
ONT goes up $140
Total goes up $232 (exactly as you indicated)

3. for an extra $1,000 in foreign income AND an extra $100 in foreign withholding tax:
- in comparison to scenario 2:
FED (after Part I refund) goes down $26
ONT stays the same
Total goes down $26
Conclusion: you only get a 26% credit of the face value of the withholding tax, instead of 100%. It is still better (and more correct) to report the gross foreign income plus the withholding tax, instead of net foreign income and no withholding.
So if I am to understand this correctly, 7.4% of foreign income is lost in a CCPC that would otherwise have been received had the foreign income been received personally (after accounting for FTC). Does this apply to both US ETF dividends and the US withholding tax portion of ADR dividends (such as VEA)?

Is the foreign withholding tax paid to EAFE countries completely lost regardless of whether it is received by a CCPC or personally in a non-registered account?
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Post by adrian2 »

couponstrip wrote:So if I am to understand this correctly, 7.4% of foreign income is lost in a CCPC that would otherwise have been received had the foreign income been received personally (after accounting for FTC). Does this apply to both US ETF dividends and the US withholding tax portion of ADR dividends (such as VEA)?
I would rather call it losing 74% of the foreign tax in a CCPC instead of getting it all back in a personal non-registered account. 74% of 15% (the US withholding tax rate) is 11.1%. I don't know of any countries where the withholding tax is 10%; some are higher than the US.
couponstrip wrote:Is the foreign withholding tax paid to EAFE countries completely lost regardless of whether it is received by a CCPC or personally in a non-registered account?
My understanding is that if the ETF is domiciled in a separate jurisdiction between Canada and the stocks (e.g. US listed ETF's investing in non-US stocks), the withholding tax applied between the stocks' countries and the ETF is completely lost.
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Post by Icarus »

adrian2 wrote:
couponstrip wrote:So if I am to understand this correctly, 7.4% of foreign income is lost in a CCPC that would otherwise have been received had the foreign income been received personally (after accounting for FTC). Does this apply to both US ETF dividends and the US withholding tax portion of ADR dividends (such as VEA)?
I would rather call it losing 74% of the foreign tax in a CCPC instead of getting it all back in a personal non-registered account. 74% of 15% (the US withholding tax rate) is 11.1%. I don't know of any countries where the withholding tax is 10%; some are higher than the US.
My understanding as well; however, for active business income the CCPC is taxed at 18% whereas you are taxed at 46% personally (less in AB, I guess). By using the CCPC, you retain (82/54) = 1.5X more income to invest and therefore receive 1.5X more dividends. So even though the tax hit is higher due to the loss of the FTC, the increased total dividends will more than compensate. The net effect is more after-tax dollars in your pocket throught the CCPC. This applies only to CCPCs with active business income, obviously. Also, you need to make sure you're drawing enough dividends (in contrast to salary) from your CCPC to recover refundable tax from the RDTOH account, or your effective tax rate is higher.

The bottom line is that, provided your CCPC has active business income, you are still better to own foreign stocks and ETFs in the CCPC. If, however, you have a non-registered account for other reasons, then it is best to keep the Canadian dividend payers in the CCPC and the non-Canadian dividend-payers outside the CCPC.
adrian2 wrote:
couponstrip wrote:Is the foreign withholding tax paid to EAFE countries completely lost regardless of whether it is received by a CCPC or personally in a non-registered account?
My understanding is that if the ETF is domiciled in a separate jurisdiction between Canada and the stocks (e.g. US listed ETF's investing in non-US stocks), the withholding tax applied between the stocks' countries and the ETF is completely lost.
You can get around this problem by owning Canadian-domiciled index funds (eg. TD, CIBC), provided they do not simply own foreign-domiciled ETFs (i.e. they hold the equities directly). Note, however, that the tracking error tends to be much higher than with the Vanguard products, which can more than wipe-out the advantage of the FTC. Also note that the advantage is much smaller if you own the foreign funds in a CCPC, since you don't get most of the FTC anyway.
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Post by Doug »

I thought that I would summarize investing in a CCPC as opposed to a nonregistered account. In a CCPC, you'll get the tax deferral on the money that you initially invest. You'll be able to avoid US estate tax. Taxes on investment returns will be slightly higher: this is even if you yearly take out all investment returns (except unrealized capital gains) to get back the refundable tax back. You'll lose the ability to tax loss harvest. You'll lose some of the foreign tax credit. Your investment costs will be higher due to the cost of having a CCPC. Comments are appreciated.
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Post by adrian2 »

Doug wrote:Taxes on investment returns will be slightly higher: this is even if you yearly take out all investment returns (except unrealized capital gains) to get back the refundable tax back.
Not necessarily - interest and its like is taxed at 23% combined rate at the corporate level - that is usually quite acceptable.
Doug wrote:You'll lose the ability to tax loss harvest.
Not sure what you mean - tax loss harvesting works exactly the same in a corporate or personal account.
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Post by Doug »

http://www.financialwisdomforum.org/for ... highlight=

The above thread is about tax loss harvesting in a CCPC.
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Reason: replace old domain name with www.financialwisdomforum.org to reflect new domain name effective 19-Jan-2014
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Post by Doug »

The 2009 Ontario tax rate on interest in a corporation is 48.7%.

http://www.kpmg.ca/en/services/tax/docu ... 0Final.pdf
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Post by adrian2 »

Doug wrote:The 2009 Ontario tax rate on interest in a corporation is 48.7%.

http://www.kpmg.ca/en/services/tax/docu ... 0Final.pdf
See upthread on this page.
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Post by adrian2 »

Doug wrote:http://www.financialwisdomforum.org/for ... p?t=106999

The above thread is about tax loss harvesting in a CCPC.
Easy to sidestep - if concerned about the capital dividend account, just bring the CDA balance to zero before tax loss harvesting.
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Post by Doug »

Thank you for correcting me. In an Ontario corporation in 2009, the tax on interest is 23.12% and capital gains is 11.56% (a simplification when it comes to capital gains). This assumes that you take out all investment income from the corporation yearly. Otherwise, the rate on interest will be 48.7%, slightly higher than the top marginal tax rate of 46.41%. The extra tax you paid would be approximately refundable when you take the retained investment income out of the corporation. The ineligible dividends from a CCPC, that are a consequence of investment income, will also be subject to personal taxation.

If a CCPC receives eligible dividends as investment income, there is a refundable 33.3% tax on that. If those eligible dividends are taken out of the corporation that year, that tax will be refunded so the net tax will be 0. One will pay tax on those eligible dividends at a personal level.

Based on integration, the tax you pay at the corporate and personal level should roughly equal the tax you would pay if you didn't have a corporation. However, as pointed out upthread, if you're paying dividends from retained earnings in the CCPC, tax rates may have changed with time. If a shareholder is in a different province than the corporation, integration may be less than perfect.
Last edited by Doug on 13 Jun 2009 21:13, edited 1 time in total.
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Post by Doug »

Icarus, in the post that I've linked to previously, presents one situation where tax loss harvesting might not make sense in a CCPC. In fact, he makes a cogent argument for realizing capital gains that one doesn't have to realize. A person gives themself a salary of $117,000 per year to obtain maximal RRSP contribution room. Dividends are issued from the corporation to get all refundable tax back. But say that person needs more money for personal needs, and is drawing additional salary or dividends from active business income. This limits the amount of money that can be left inside the CCPC for reinvestment. However, the tax paid on harvesting capital gains will be lower than the tax paid on active business income. By harvesting capital gains, one might be able to keep more money inside the CCPC for reinvestment.
Last edited by Doug on 13 Jun 2009 22:12, edited 1 time in total.
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