Ontario Announcement Throws a Wrench into Integration
In November 2018, Ontario announced that it would not adopt the federal government clawback (subsection 125(5.1) of the small business deduction [SBD]) when a CCPC's adjusted aggregate investment income (AAII) is more than $50,000. The federal SBD clawback is effective for a CCPC for a taxation year beginning after 2018, at a rate of $5 for every $1 of AAII when the AAII was more than $50,000 in the previous taxation year. The full $500,000 SBD is therefore eliminated once AAII exceeds $150,000 (that is, $500,000 − $5 × [$150,000 − $50,000]) in the prior year. The Ontario rules (Bill 57), which received royal assent on December 6, 2018, cause some unexpected integration results when corporate income is subject to the Ontario (not the federal) SBD and the after-tax amount is ultimately paid out as dividends. In 2019, a CCPC in Ontario earning ABI with access to the SBD is taxable at 12.5 percent (9 percent federal plus 3.5 percent Ontario). At general rates (not the SBD), a CCPC is taxable at 26.5 percent (15 percent federal plus 11.5 percent Ontario), and a CCPC that claws back the federal (but not Ontario) SBD is taxable at 18.5 percent (15 percent federal plus 3.5 percent Ontario). As a result, an Ontario CCPC subject to the federal SBD clawback (because its AAII is more than $50,000) regains access to the 8 percent Ontario tax deferral, valued at up to $40,000 in 2019 ($500,000 × [11.5% − 3.5%]).
When after-tax corporate income is paid out to the shareholder, a CCPC with access to the SBD has total (integrated) corporate and personal taxes of 53.97 percent. A CCPC taxed at the general tax rates is subject to integrated taxes of 55.54 percent, and the CCPC (with AAII in excess of $50,000) that claws back the federal (but not Ontario) SBD is taxable at the combined integrated tax rate of only 51.33 percent. The result is a breakdown of integration, as seen on the accompanying table.
When the federal SBD is clawed back because of AAII, dividends paid by the CCPC to an individual will be eligible dividends as a result of the increase to the general-rate income pool (GRIP) account. Since each province does not have its own independent GRIP balance, there is no adjustment for the fact that Ontario tax is being paid at the lower SBD rate. (Ontario could, theoretically, create its own Ontario GRIP at the cost of additional complexity in an already overbearing tax system.) The result of paying eligible dividends from GRIP (defined federally in subsection 89(1)) is that a CCPC whose AAII exceeds $50,000 has a lower integrated tax rate and the federal government enjoys increased revenue at Ontario's expense.
A similar situation occurs in Saskatchewan: since January 1, 2018, a CCPC has had access to the provincial SBD on ABI up to $600,000, although the federal SBD limit is only $500,000. A Saskatchewan CCPC that earns ABI between $500,000 and $600,000 has a GRIP account addition, even though the Saskatchewan corporate tax rate paid on this income is only 2 percent. As a result, that Saskatchewan CCPC has an integrated tax rate of 42.78 percent in 2019 (in this $100,000 range); a CCPC taxable at general rates both federally and provincially (on income above $600,000) has an integrated rate of 48.75 percent.
In Quebec, a CCPC's ABI may qualify for the federal SBD but not the Quebec SBD (unless its employees worked at least 5,500 hours during the taxation year). Consequently, there is no addition to the GRIP account, and dividends from the CCPC are taxed as other-than-eligible dividends to the individual. This results in a 2019 integrated tax rate of 57.32 percent. Alternatively, if the CCPC chose to forgo the federal SBD, the 2019 integrated tax rate would drop to 56.05 percent. If the 5,500 hours test is met and the SBD is thus available both federally and in Quebec, the 2019 integrated tax rate is 54.31 percent. (See Hiren Shah and Manu Kakkar, "Coming to Grips with Quebec's Lack of GRIP" (2017) 17:2 Tax for the Owner-Manager.)
The policy for an Ontario corporation and its shareholders means that it will take about nine years to break even on the upfront tax cost, using a 4 percent compounded after-tax return on the 6 percent deferral inside the CCPC. (From the accompanying table, a CCPC that earns AAII under $50,000 provides a tax deferral of 6 percent [$8,750 − $8,150] that comes with a 2.64 percent tax cost [53.97% − 51.33%].)
A taxpayer and its advisers may want to reconsider investment and remuneration strategies and determine whether the tax deferral of 6 percent or the lower overall integrated rate of 51.33 percent better supports the shareholders' objectives and the corporation's business.
Tax Templates Inc., Toronto