Canadian provincial corporate tax rates on investment income range from 10 per cent in Alberta and British Columbia to 16 per cent in Nova Scotia and Prince Edward Island, with Quebec and Ontario in the mid-range at 11.9 per cent and 11.5 per cent respectively. The difference in rates encourages interprovincial tax plans, which involve the shifting of income to lower-rate provinces.
The current provincial tax system applicable to corporations is premised on the assumption that all business corporations (as opposed to non- profit corporations) carry on a business from a permanent establishment. Where a corporation has a permanent establishment in a province and a permanent establishment outside that province, taxable income is allocated to the permanent establishment in the province by means of a formula based on relative sales and payrolls. While details differ slightly from province to province, the taxable income allocable to a permanent establishment of a corporation in a particular province is the product obtained by multiplying the corporation’s taxable income by one-half the aggregate of:
- the proportion of its taxable income for the year that the gross revenue for the year reasonably attributable to the permanent establishment in the province is of its total gross revenue for the year; and
- the proportion of its taxable income for the year that the aggregate of the salaries and wages paid in the year by the corporation to employees of the permanent establishment in the province is of the aggregate of all salaries and wages paid in the year by the corporation.
Several characteristics of the allocation system are important in the context of interprovincial tax planning:
- Where a corporation has no permanent establishment, it is deemed to have a permanent establishment in the place designated in its articles or by-laws as its head office or registered office.
- Because the allocation formula applies to ‘taxable income’, investment income is allocated in the same manner as business income.
- While the provincial system is based on the assumption that all corporations carry on a business, Canadian tax law recognises that a corporation may not carry on any business at all. Paragraph 13 of Canada Revenue
Agency Interpretation Bulletin IT-420 R 3 contains the following statement:
- ‘Where a corporation was incorporated to earn income by carrying on business there is a general presumption that profits arising from its activities are derived from a business or businesses. However, in some circumstances, a corporation’s entire profits can be characterised as income from property, as in the case of a corporation formed for the sole purpose of holding the shares of a second corporation or holding a property to be rented under a long-term lease to a single tenant with limited landlord responsibilities.’
- The statutory provision that a corporation that has no permanent establishment is deemed to have one at the place designated in its articles as its head office confirms the position that a corporation may not carry on any business.
- Provincial tax legislation reflects the provisions in the Canadian constitution that limit the taxation power of the provinces to direct taxation ‘within the province’.
Because Canadian-resident corporations are not taxable on dividends received from Canadian resident corporations that they control, redundant cash of an operating subsidiary can be distributed to its parent and then lent by the parent to the subsidiary at interest to fund portfolio investments by the subsidiary. If the parent’s only activities consist of holding shares of and lending dividend proceeds to its subsidiary, the interest income will be allocable to the province in which its head office is situated. Recent decisions by the Alberta Court of Appeal in Husky Energy Inc v Alberta (2012 ABCA 231) and Canada Safeway Ltd v Alberta(2012 ABCA 232) confirm that such plans cannot be characterised as abusive under provincial general anti-avoidance rules.
Another example of interprovincial income shifting is transferring the head office of a holding corporation to a low-rate province in anticipation of a sale of shares of a subsidiary.
The fact that the top combined rates on individuals in Ontario and Quebec will exceed 49 per cent in 2013 while the combined rate in Alberta is 39 per cent does not encourage income shifting because individuals are subject to provincial tax on worldwide income by the province in which they are resident. The use of trusts to shift income has ceased to be as attractive as it was because of the recent Supreme Court of Canada decision in Garron Family Trust (Trustee of) v R (2012 SCC 14). The Court held that the test for determining trust residence is central management and control over trust property rather than the residence of the trustees.
Canada has an integrated approach to the taxation of investment income, so there is no material difference between tax paid by an individual who earns the income directly and the combined corporate and individual tax when the income is taxed at the corporate level and the after-tax portion distributed to the individual as a dividend. The integration is effected by refunding a portion of federal tax when dividends are paid, by permitting 50 per cent of capital gains to be distributed as a tax-free dividend and by crediting an individual dividend recipient for a portion of the corporate tax paid. The integration regime facilitates the shifting of investment income by an individual to a corporation. Combined federal and provincial corporate tax rates on investment income range from 44.67 per cent in Alberta to 50.67 per cent in Nova Scotia and Prince Edward Island, with Quebec and Ontario in the mid-range at 46.57 per cent and 46.17 per cent respectively.
The facility with which investment income can be shifted between provinces effectively deters provinces from increasing rates to the point where income shifting can produce material tax savings.