Investment income in a CCPC

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Investment income in a CCPC

Postby Norbert Schlenker » 13 Jan 2007 15:28

Something tells me I'm going to have to call KPMG next week to get a definitive answer but there's no harm in asking here.

Suppose one has an investment portfolio inside a Canadian controlled private corporation (CCPC). Reasons are legion: money from an active business that hasn't been paid out in some way, avoiding US estate tax liability, hiding behind the limited liability, whatever. The investment portfolio produces income, say interest, Canadian dividends, foreign dividends, and capital gains. That income gets taxed at the corporate level (Part I and Part IV) but can then be dividended out to the shareholder(s).

Suppose the corporation pays a dividend. Is it subject to the old gross-up/DTC rules (25%/13.33%) or the new (45%/19%) rules?
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Postby Bylo Selhi » 13 Jan 2007 15:44

Evelyn Jacks on p.17 Jan07 Advisor.ca wrote:Starting in 2006, shareholders qualify for a new dividend gross-up of 45%, offset by a 19% federal DTC, on dividends distributed by public corporations and CCPCs in cases where income (other than investment income) is subject to tax at the general corporate rate....
[my bold, the article isn't yet online and Jacks isn't a CA.]

Added: Update on reduced taxation of dividends
Under the draft legislation, only eligible dividends qualify for the reduced tax rate. The draft legislation sets out rules for determining whether a corporation’s dividends are eligible. The rules differ depending upon the status of the corporation. For example, a Canadian-controlled private corporation (CCPC) may pay eligible dividends to the extent that its taxable income is not subject to the small business tax rate (excluding investment income). Such income would accumulate in the general rate income pool (GRIP), representing the balance that may be designated as eligible dividends. Dividends not paid from the GRIP would be considered ineligible and taxed at the existing higher rate.
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Postby Norbert Schlenker » 13 Jan 2007 18:06

The Deloitte verbiage is interesting except that I can't find any mention of terms like GRIP in the Ways and Means motion. There's no doubt that investment income is subject to the general rate - that's what makes it so unpleasant inside a CCPC. What I want to know is whether being so subject makes it income from which an "eligible dividend" can be paid or whether it's specifically excluded under some other provision. I can't figure it out from anything I've read.
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Postby martingale » 13 Jan 2007 19:24

My understanding is that it IS eligible because it ISN'T subject to the small business tax credit. However, I don't know how to find an authoritative source for that and I am definately not an accountant, so take that with a grain of salt.

In general if it's an individually controlled CPCC and you're trying to get the income out of it without paying the steep tax rate on investment income then there's usually Some Way to do that. Depends on the tax situation of the owner of the corporation who is receiving the dividend. Can they charge the firm a management fee and take some of it out as personal income? That may or may not get a better rate.

Investing is simple. Taxes are complicated. Get a professional accountants advice with the taxation aspects, it's well worth the money spent.
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Re: Investment income in a CCPC

Postby adrian2 » 13 Jan 2007 20:30

Norbert Schlenker wrote:Suppose the corporation pays a dividend. Is it subject to the old gross-up/DTC rules (25%/13.33%) or the new (45%/19%) rules?

Funny you should ask. I've just received an envelope from CRA with the T5 summary and a brochure outlining the changes. The short answer to your question is yes. As you flow the dividends through a corporation, they retain their character as "eligible" or not.

CRA, with my underlining wrote:“general rate income pool”
[...] is generally relevant for determining the extent to which such corporations can pay eligible dividends in any given taxation year without making an excessive eligible dividend designation.

The general rate income pool (GRIP) of a corporation at the end of a particular taxation year is the positive or negative amount calculated by reference to a formula:
A – B
In broad terms, A is the corporation’s GRIP at the end of the taxation year determined without reference to any specified future tax consequences, such as the carry-back of non-capital losses under paragraph 111(1)(a), and B adjusts that amount at the end of the taxation year to the extent that specified future tax consequences for preceding taxation
years reduce the corporation’s taxable income subject to tax at the general corporate rate in section 123 of the Act. As a result, a CCPC or DIC can have a negative GRIP.

The bulk of the GRIP is contained in the description of A, which itself is the positive or negative amount determined by another formula:
C + 0.68(D – E – F) + G + H – I
[...]
Eligible dividends received by the corporation in the particular taxation year and amounts deductible by the corporation under section 113 in respect of dividends received from a foreign affiliate are included under the G amount.
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Postby Norbert Schlenker » 13 Jan 2007 20:41

You've got to be kidding me. What does that mean? :lol:

I'm going to take your word that an eligible dividend will flow right through. What about interest, foreign dividends and taxable capital gains, which are part of aggregate investment income? It looks to me like the formula excludes them from GRIP.

What lunatic dreams up language like

B is 68% of the amount, if any, by which

(a) the total of the corporation’s full rate taxable incomes (as would be defined in the definition "full rate taxable income" in subsection 123.4(1), if that definition were read without reference to its subparagraphs (a)(i) to (iii)) for the corporation’s preceding three taxation years, determined without reference to any specified future tax consequences, for those preceding taxation years, that arise in respect of the particular taxation year,

exceeds

(b) the total of the corporation’s full rate taxable incomes (as would be defined in the definition "full rate taxable income" in subsection 123.4(1), if that definition were read without reference to its subparagraphs (a)(i) to (iii)) for those preceding taxation years.


:roll:
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Postby adrian2 » 13 Jan 2007 20:52

Norbert Schlenker wrote:You've got to be kidding me. What does that mean? :lol:

This was my fun research project this morning. Ask my wife what she thinks of my idea of fun! :wink:

Norbert Schlenker wrote:I'm going to take your word that an eligible dividend will flow right through. What about interest, foreign dividends and taxable capital gains, which are part of aggregate investment income? It looks to me like the formula excludes them from GRIP.

My interpretation is that it's only eligible dividends received, although the funny part with 68% may be indirectly including it.

I plan to do my corporate taxes in the next few weeks and I'll keep you posted if you're interested.
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Postby DavidR » 13 Jan 2007 23:31

Norbert Schlenker wrote:You've got to be kidding me. What does that mean? :lol:

I'm going to take your word that an eligible dividend will flow right through. What about interest, foreign dividends and taxable capital gains, which are part of aggregate investment income? It looks to me like the formula excludes them from GRIP.

:roll:


Regarding interest income and capital gains, I believe they would indeed be excluded from GRIP, because of the RDTOH workings. Integration works just fine for interest and capital gains with the lower gross up.
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Postby adrian2 » 14 Jan 2007 11:59

DavidR wrote:Regarding interest income and capital gains, I believe they would indeed be excluded from GRIP, because of the RDTOH workings. Integration works just fine for interest and capital gains with the lower gross up.

:?: Interest income inside a CCPC is taxed at the large corporation rate (no small business deduction).
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Postby DavidR » 14 Jan 2007 12:26

adrian2 wrote:
DavidR wrote:Regarding interest income and capital gains, I believe they would indeed be excluded from GRIP, because of the RDTOH workings. Integration works just fine for interest and capital gains with the lower gross up.

:?: Interest income inside a CCPC is taxed at the large corporation rate (no small business deduction).


Not necessarily. A small amount of incidental interest income may well qualify as active income and be eligible for the small business rate.

But the point I was making is that interest income will usually be considered as Investment income, and thus subject to an extra 6 2/3% Federal tax and to the RDTOH regime.

26 2/3% of the Federal tax on investment income is refundable at a rate of $1 for every $3 of taxable dividends paid. RDTOH is not just related to Part IV tax on portfolio dividends, it applies to interest and capital gains too.
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Postby adrian2 » 14 Jan 2007 13:15

DavidR wrote:A small amount of incidental interest income may well qualify as active income and be eligible for the small business rate.

I very much doubt the above. You have to declare the interest income inside a CCPC as part of "investment income" and that section does not qualify for the small business deduction.

DavidR wrote:But the point I was making is that interest income will usually be considered as Investment income, and thus subject to an extra 6 2/3% Federal tax and to the RDTOH regime.

26 2/3% of the Federal tax on investment income is refundable at a rate of $1 for every $3 of taxable dividends paid. RDTOH is not just related to Part IV tax on portfolio dividends, it applies to interest and capital gains too.

The extra tax on investment income inside a CCPC is refundable when the CCPC pays dividends. That extra tax was introduced just to bring the tax on interest in a CCPC up from the corporate rate (40% or so) to the maximum personal rate (47% or so). By having the extra tax refunded, you get back at the corporate rate level, not at the small business level.
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Postby DavidR » 14 Jan 2007 14:42

adrian2 wrote:
DavidR wrote:A small amount of incidental interest income may well qualify as active income and be eligible for the small business rate.

I very much doubt the above. You have to declare the interest income inside a CCPC as part of "investment income" and that section does not qualify for the small business deduction.

DavidR wrote:But the point I was making is that interest income will usually be considered as Investment income, and thus subject to an extra 6 2/3% Federal tax and to the RDTOH regime.

26 2/3% of the Federal tax on investment income is refundable at a rate of $1 for every $3 of taxable dividends paid. RDTOH is not just related to Part IV tax on portfolio dividends, it applies to interest and capital gains too.

The extra tax on investment income inside a CCPC is refundable when the CCPC pays dividends. That extra tax was introduced just to bring the tax on interest in a CCPC up from the corporate rate (40% or so) to the maximum personal rate (47% or so). By having the extra tax refunded, you get back at the corporate rate level, not at the small business level.


1. OK I should have clarified. If a CCPC has no active business of any kind, then none of its interest income will ever qualify for the SBD. But if the company carries on an active business AND invests its retained earnings, then you have to look at where the interest income comes from: is it from retaining some cash for 'active' business purposes, or for investments?

2. My point is that investment income does not become part of GRIP. The refund is to integrate the tax system, and it does a reasonable (but not perfect) job. From my earlier post "Regarding interest income and capital gains, I believe they would indeed be excluded from GRIP, because of the RDTOH workings. Integration works just fine for interest and capital gains with the lower gross up."
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Postby Norbert Schlenker » 14 Jan 2007 15:14

DavidR wrote:The refund is to integrate the tax system, and it does a reasonable (but not perfect) job. From my earlier post "Regarding interest income and capital gains, I believe they would indeed be excluded from GRIP, because of the RDTOH workings. Integration works just fine for interest and capital gains with the lower gross up."

You seem to know what you're talking about so let me ask you a related question. This refund for the purpose of corporate-personal integration only applies to CCPCs.

There is nothing equivalent for mutual fund corporations. They are subject to taxes at the general rate on investment income that is not a Canadian dividend. Is such income part of GRIP?
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Postby DavidR » 14 Jan 2007 15:59

Norbert Schlenker wrote:You seem to know what you're talking about so let me ask you a related question. This refund for the purpose of corporate-personal integration only applies to CCPCs.

There is nothing equivalent for mutual fund corporations. They are subject to taxes at the general rate on investment income that is not a Canadian dividend. Is such income part of GRIP?


Sorry Norbert, I have no experience with preparing T2s for mutual fund corporations. I do several dozen T2s each year for small investment holding companies, and several dozen T2s for active businesses (some of whom have income > SBDL) , so I have been following the GRIP / eligible dividend / RDTOH stuff closely... but I have no insights into mutual fund corporations.
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Postby adrian2 » 14 Jan 2007 17:40

DavidR wrote:1. OK I should have clarified. If a CCPC has no active business of any kind, then none of its interest income will ever qualify for the SBD. But if the company carries on an active business AND invests its retained earnings, then you have to look at where the interest income comes from: is it from retaining some cash for 'active' business purposes, or for investments?

You lost me here. On a T2 you have to identify interest income. Once you identify it, it no longer qualifies for the SBD. How do you enter the two different figures "the active part" and "the investment part"?

DavidR wrote:2. My point is that investment income does not become part of GRIP. The refund is to integrate the tax system, and it does a reasonable (but not perfect) job. From my earlier post "Regarding interest income and capital gains, I believe they would indeed be excluded from GRIP, because of the RDTOH workings. Integration works just fine for interest and capital gains with the lower gross up."

How does the integration work fine if interest and CG inside a CCPC is taxed at the large corporation rate (assuming I'm right on #1)? In any case, for CG you haven't even argued that it may qualify for the SBD.
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Postby ColdCanuck » 14 Jan 2007 19:20

You might find the following helpful

http://www.fin.gc.ca/drleg/ITAdtc06_e.html

but I doubt it, who writes this stuff ? ':?'
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Postby DavidR » 14 Jan 2007 19:34

adrian2 wrote:You lost me here. On a T2 you have to identify interest income. Once you identify it, it no longer qualifies for the SBD. How do you enter the two different figures "the active part" and "the investment part"? .


Schedule 7 is used to report investment income, including any interest that is investment income. If interest is active income, it does not go onto schedule 7.

For example, let's say my CCPC is carrying on an active business. Because of the seasonality of the business, it carries some cash at certain times of the year, and earns some interest. If I consider all or some of that interest to be incidental to my active business, then I will leave it off of schedule 7.


adrian2 wrote:How does the integration work fine if interest and CG inside a CCPC is taxed at the large corporation rate (assuming I'm right on #1)? In any case, for CG you haven't even argued that it may qualify for the SBD.


The refundable portion of Part I tax is what makes integration work. I have never tried to argue that capital gains qualify for the SBD. I have said that they do not form part of GRIP. A 25% gross up with a dividend refund to the Corporation puts the individual shareholder into the same place he would have been if he had earned the interest or taxable capital gain personally rather than in a corporation. (See also the CDA account for getting the 'tax free half' of the gain out of the Company and into the shareholder's hands.)

Nothing has changed with respect to earning capital gains or investment interest in a CCPC. What has changed is that if the CCPC earns dividends from public companies that pay "Eligible Dividends", the CCPC can flow the eligible dividend back out (with the enhanced gross up, rather than the 25% gross up). And if the CCPC earns Active Business income in excess of the SBDL, it will now (to the extent of its GRIP pool) be able to pay Eligible dividends. This corrects the under-integration that has existed for so many years on active business income in excess of the SBDL.
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Postby adrian2 » 14 Jan 2007 21:45

DavidR wrote:
adrian2 wrote:You lost me here. On a T2 you have to identify interest income. Once you identify it, it no longer qualifies for the SBD. How do you enter the two different figures "the active part" and "the investment part"? .

Schedule 7 is used to report investment income, including any interest that is investment income. If interest is active income, it does not go onto schedule 7.

For example, let's say my CCPC is carrying on an active business. Because of the seasonality of the business, it carries some cash at certain times of the year, and earns some interest. If I consider all or some of that interest to be incidental to my active business, then I will leave it off of schedule 7.

I guess you (or your accountant) is more aggressive than I would be. To me, Schedule 7 is to report interest and other investment income. If the box says interest, then I'll put all the interest there, not part of it. At the bottom of the same schedule, it calculates the "Income from active business in Canada" as (the net income for tax purposes) - (foreign income) - (taxable CG) - (property income, which includes interest income). This value then is used for the SBD. Bottom line is that for interest reported on Schedule 7 the CCPC does not get the SBD.

Using your rationale, one can argue that all interest income is incidental; I would not do that.

A 25% gross up with a dividend refund to the Corporation puts the individual shareholder into the same place he would have been if he had earned the interest or taxable capital gain personally rather than in a corporation.

For the interest part, again, only if you do not report it on Schedule 7.
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Postby DavidR » 14 Jan 2007 23:51

adrian2 wrote:For the interest part, again, only if you do not report it on Schedule 7.


Sorry, but you are misunderstanding this. Part of the tax on Investment income is Refundable. If you are a CCPC and have included Interest income in your Investment income on schedule 7 then you are paying refundable taxes (even if you don't realize it). These refundable taxes go into your RDTOH account. It is the Combination of a Dividend Refund/RDTOH account to the corporation and a 25% dividend gross up that makes integration work for Investment income.

My point throughout this thread has been that the gross up remains at 25% for Investment income (except when the CCPC receives eligible dividends from its investment portfolio). There was no need to enhance the dividend tax credit for capital gains or investment interest. A CCPC's investment income does not enter into the calculations of its GRIP balance.
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Postby Icarus » 15 Jan 2007 02:12

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?

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?

Thanks.
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Postby adrian2 » 15 Jan 2007 09:33

DavidR wrote:
adrian2 wrote:For the interest part, again, only if you do not report it on Schedule 7.


Sorry, but you are misunderstanding this. Part of the tax on Investment income is Refundable. If you are a CCPC and have included Interest income in your Investment income on schedule 7 then you are paying refundable taxes (even if you don't realize it). These refundable taxes go into your RDTOH account. It is the Combination of a Dividend Refund/RDTOH account to the corporation and a 25% dividend gross up that makes integration work for Investment income.

Sorry, I'm not misunderstanding this. I'm fully aware of the refundable tax and I'm getting it back every year by paying dividends out of my corporation.

I've stated upthread, and you have not refuted me, that by getting back the refundable tax on investment income, you get at the general corporate tax level, not at the small business tax level. It's only when you don't report the interest on Schedule 7 (which I believe it's wrong) that integration would work (by making interest appear as small business income, eligible for SBD, and btw not even subject to the refundable tax on investment income).

DavidR wrote:My point throughout this thread has been that the gross up remains at 25% for Investment income (except when the CCPC receives eligible dividends from its investment portfolio). There was no need to enhance the dividend tax credit for capital gains or investment interest.

And I continue to believe you're mistaken.
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Postby DavidR » 15 Jan 2007 10:31

adrian2 wrote: And I continue to believe you're mistaken.


OK, I'm not sure what the source of the confusion between us is, so let me try a different approach. The Federal corp tax rates start as follows: 38% less 10% abatement + surtax 1.12% = 29.12%.

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%.

Investment income is not part of GRIP because it has not been taxed at the general rate.

GRIP includes after-tax income, other than investment income, which has not benefited from the SBD.

In the Formula GRIP = C+0.68(D-E-F)+G+H-I you will see that F is Investment income.
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Postby adrian2 » 15 Jan 2007 10:43

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?
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Postby DavidR » 15 Jan 2007 10:59

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....
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Postby adrian2 » 15 Jan 2007 11:42

DavidR wrote: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.

Thanks. I'll try to wrap my head around your numbers when I get a chance to open Quicktax T2.
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