07 March 2018

Welcome changes to the refundable dividend tax rules

I promised in my last post that I would visit the changes proposed in the 2018 federal budget with respect to the account for refundable dividend tax on hand (RDTOH), and here is the result. There are some very provisions coming into effect that will really bring some needed integration and antiabuse provisions in this field for Canadian-controlled private corporations (CCPCs).

The changes will affect certain key forms that need to be filed:


This is important, as eligible dividends paid from GRIP, because of the "gross-up and credit" system of reporting taxable dividends, are more or less accounted for on the individual T1 returns with minimal impact on the overall tax collected when you add the effects of personal and corporate taxes together. Non-eligible dividends paid from LRIP will result in being effectively marginally taxed at the personal level. Until now, if there were balances in both pools there was no rule governing which pool had to be drawn upon first for paying dividends to shareholders.

The changes



Beginning with the first taxation year after 2018, the RDTOH will be divided into two accounts:

  1. The current account will be designated as "non-eligible RDTOH".
  2. A new account, to be known as "eligible RDTOH", will be created.
  3. Where a corporation is a CCPC throughout that first year, an opening balance will be created for eligible RDTOH equal to the lesser of a) its RDTOH at the end of the previous year, and b) 38⅓% of its GRIP at the same date. An anti-avoidance provision will be in effect to prevent any manipulation concerning the opening balance.
  4. Otherwise, additions to eligible RDTOH will arise from Part IV tax on "eligible portfolio dividends", which are dividends received from a) corporations with which the corporation is not connected under ITA s. 186(4), and b) connected corporations paying dividends from their own eligible RDTOH accounts.

Why is that necessary? It is because of the rules that will also come into force with respect to obtaining dividend refunds relating to Part IV tax and the refundable portion of Part I tax paid in previous years that had already flowed into the RDTOH:

  1. If a corporation pays an eligible dividend, it will not be able to obtain a dividend refund unless it has a positive balance for eligible RDTOH.
  2. If it pays a non-eligible dividend, it will obtain a dividend refund as long as there is a positive balance in either RDTOH account.
  3. The non-eligible RDTOH account must be depleted before a dividend refund can be obtained with respect to its eligible RDTOH account.

 Why does this matter?

This is related to Ottawa's efforts to ensure that passive income within corporations is properly taxed when it flows back to individual shareholders. The current régime which provided for a single RDTOH pool was inconsistent with that goal, so it had to be dividend to ensure that taxation was occurring properly with respect to each source of investment income occurring for the corporation. This change was both necessary and desirable.

Penalties will still exist for eligible dividends paid that are in excess of available GRIP for the year, reported as Part III.1 tax on T2 Schedule 55. Therefore, several different sets of forecast and other calculation scenarios will be necessary before directors decide to declare any relevant dividends. Another reason to have a very good CFO at your side.

None of these changes affect the existing rules concerning the capital dividend account, out of which tax-free capital dividends can be paid, but it is still necessary to maintain up-to-date calculations as to what the eligible balance is. The relevant forms for this exercise are T2 Schedule 89 and T2054, mailed together to the office stated in the instructions, on or before the date the dividend is first paid or payable.. The corporation's auditors should have already compiled the necessary information, if it is not already available internally.

02 March 2018

The passive income controversy (cont'd)

Bill Morneau finally brought down his budget last Tuesday. While the flavour du jour is gender-based analysis, you had to dig (as per usual) to find out what Finance is doing to really improve the Income Tax Act, among other laws. They have come up with an interesting resolution to the taxation of passive income in CCPCs that I discussed earlier here and here, as well as doing a needed correction to the handling of refundable dividend taxes on hand. I'll deal with the latter matter in a subsequent post.

The Budget (and the real document)


The public version, which most commentators appear to have focused on, is an interesting PR exercise as usual:




However, to see what is really going on, you always have to read this:




 What they're doing with the Small Business Deduction


Where they start discussing their proposal for limiting the availability of the small business deduction (SBD) to CCPCs (at pp. 17-20 and pp. 53-55), you discover that this is really a multiple-factor calculation. The basic formula is:

 $  ABL = BL - max(A,B)  $

where:

  • ABL = adjusted business limit to what can be claimed for the small business deduction
  • BL = the business limit otherwise available
  • A = limitation with respect to taxable capital employed in Canada (a concept borrowed from the Part I.3 tax on large corporations), which is already in effect as ITA 125(5.1)
  • B = limitation with respect to adjusted aggregate investment income (ie, passive income) for the year (being the figure from the T2 Schedule 7 with some adjustments)
The very brief summary of the impact is that:

  • if a CCPC's taxable capital is less than CAD 10 million, and its passive income is less than CAD 50,000, it will continue to have full access to its business limit
  • if either its taxable capital is greater than CAD 15 million, or its passive income is greater than CAD 150,000, it will have no access to the small business deduction
  • there is a transitional phase where the above calculation comes into play; it is effectively a percentage reduction of what the dollar amount would otherwise be

The charts that illustrate the impact (as shown in p. 74 of the Budget and pp. 18-19 of the Tax Measures) are very poorly done, as they fragment the extent of its impact. Some commentators have said that these limitations are straight-line calculations, but they are wrong. Both limitations are curvilinear in nature as shown in the following.

The taxable capital limitation


The limitation with respect to a CCPC's taxable capital employed in Canada is:

$ \left[ \frac{0.00225(C-10,000,000)}{11,250} \right],  10,000,000 \leq C \leq 15,000,000 $

where C is such taxable capital, and the business limit after reduction for this limitation is:


The passive income limitation


The limitation with respect to a CCPC''s passive income for the year is

$ \left[ \frac{BL}{500,000} - 5(E-50,000) \right],  50,000 \leq E \leq 150,000$

where E is the adjusted aggregate investment income for the year.



Further testing proved that these calculations are effectively percentage reductions to what otherwise would be the business limit to which a CCPC would be entitled.

This also begs the question as to what to expect when the two curves intersect - as that could happen - and this is something that the wizards at Finance decided not to try to visualize. I tried to summarize this in a single formula, but that was not a practical solution. Through the tried-and-true "brute force" technique, I compiled a dataset of calculated datapoints and have constructed a chart of my own, which proves to be revealing:


You can see that the curve has a definite peak, either side of which tapers down to eventual ineligibility for the small business deduction. That may be worth investigating further, in order to help out with any necessary tax planning such corporations may need to undertake.

I like this solution, but do object to the way it's being advertised. CPA Canada has described it as being "much simpler than what was originally proposed," but no-one has mentioned its integration with the taxable capital limitation in any detail yet, but it represents a very significant expansion. If this goes through in its proposed form, it will essentially expand this anti-abuse provision, because much of the work that CCPCs and their tax advisers have done over the years in making sure that their taxable income is low enough to fully qualify for the small business deduction will become useless, as it's much more difficult to fudge passive income and capital employed. This is to be welcomed, together with last year's exclusion of personal services business income (as now shown on line 520 of Schedule 7) from the SBD and the new SBD denial rules.

This area is becoming rather exciting now. Let's see what happens next.

08 December 2017

The screws are being turned...

Ontario is reforming its labour laws once more, and this time there are some real changes to take note of. Here are what I think are the most significant ones that are happening to the Employment Standards Act, 2000. I've organized them according to when they come in force.

On Royal Assent (27 November 2017)


The following provision came into effect immediately:

5.1 (1) An employer shall not treat, for the purposes of this Act, a person who is an employee of the employer as if the person were not an employee under this Act.

(2) Subject to subsection 122 (4), if, during the course of an employment standards officer’s investigation or inspection or in any proceeding under this Act, other than a prosecution, an employer or alleged employer claims that a person is not an employee, the burden of proof that the person is not an employee lies upon the employer or alleged employer.

This is huge, for two immediate reasons:
  • this will force an employer to document, before engaging a worker, the reasons why the work is being done by an independent contractor instead of an employee
  • as the Canada Revenue Agency, in its payroll audits, follows provincial law in determining who an employee is, their work has gotten much easier as they can now demand to see such documentation to satisfy themselves as to such status

This gets better over the coming months.

1 January 2018


The following definition in s. 1(1) is amended to read:

“employee” includes, 

(a) a person, including an officer of a corporation, who performs work for an employer for wages,
(b) a person who supplies services to an employer for wages,
(c) a person who receives training from a person who is an employer, if the skill in which the person is being trained is a skill used by the employer’s employees, or
(d) a person who is a homeworker,

and includes a person who was an employee;

The portion in bold replaces the current provision relating to interns and other trainees, and it looks like it removes any remaining excuses employers might have to say that training doesn't count for being paid.

1 April 2018


The following definition is added to s. 1(1):


“difference in employment status”, in respect of one or more employees, means,

(a) a difference in the number of hours regularly worked by the employees; or
(b) a difference in the term of their employment, including a difference in permanent, temporary, seasonal or casual status;

Why is this important? It's because of the new provisions that have been inserted into Part XII concerning equal pay for equal work:


41.2 In this Part, “substantially the same” means substantially the same but not necessarily identical.

 ...

42.1 (1) No employer shall pay an employee at a rate of pay less than the rate paid to another employee of the employer because of a difference in employment status when,
(a) they perform substantially the same kind of work in the same establishment;
(b) their performance requires substantially the same skill, effort and responsibility; and
(c) their work is performed under similar working conditions.

(2) Subsection (1) does not apply when the difference in the rate of pay is made on the basis of,
(a) a seniority system;
(b) a merit system;
(c) a system that measures earnings by quantity or quality of production; or
(d) any other factor other than sex or employment status.

(3) No employer shall reduce the rate of pay of an employee in order to comply with subsection (1).

(4) No trade union or other organization shall cause or attempt to cause an employer to contravene subsection (1).

(5) If an employment standards officer finds that an employer has contravened subsection (1), the officer may determine the amount owing to an employee as a result of the contravention and that amount shall be deemed to be unpaid wages for that employee.

(6) An employee who believes that their rate of pay does not comply with subsection (1) may request a review of their rate of pay from the employee’s employer, and the employer shall,
(a) adjust the employee’s pay accordingly; or
(b) if the employer disagrees with the employee’s belief, provide a written response to the employee setting out the reasons for the disagreement.

(7) If a collective agreement that is in effect on April 1, 2018 contains a provision that permits differences in pay based on employment status and there is a conflict between the provision of the collective agreement and subsection (1), the provision of the collective agreement prevails.

(8) Subsection (7) ceases to apply on the earlier of the date the collective agreement expires and January 1, 2020.
Similar provisions have also been inserted to prevent the use of employment agencies to try to make an end run around these prohibitions.

What does this mean? Quite simply, too many employers were claiming that anyone who was not a permanent full-time employee could therefore be hired at a discount. This was, frankly, abusive behaviour on their part which the law has sought to punish in recent times in both the legislature and the courts. I can also see the need to express all compensation in terms of specified hours per pay period for each employee, in order to determine an hourly rate in order to show that compliance is being achieved across all such classifications of employees, whether full-time, part-time, seasonal or casual. While I disagree with the present régime at Queen's Park on many things, this time I think they got it right.

Stay tuned. I'm sure there's going to be a lot of fun seeing this come into force.

27 November 2017

Better ideas they could have used earlier

My earlier post on how governments should not consult may have been somewhat wordy, but it's time to revisit the subject now that some more sober thought is starting to be published.

The Fall Economic Statement expanded on the subject, specifically at pp. 46-56:



And last week the Parliamentary Budget Officer weighed in with its analysis of the issue:



The concern I have is that both of these documents carry useful data that should have been included in the original consultation paper. Analysis of how many Canadian-controlled private corporations (CCPCs) would not have to worry about the changes would have forestalled many emotional outbursts that were sure to have been included in the 21,000 submissions that were received. Consultations only truly work when the big picture is given a chance to be presented—theoretical examples such as the ones originally given don't properly give the target audience a chance to discuss the issues in a thoughtful and logical way.

I suspect I'll be coming back to this matter from time to time, in order to keep everyone up to date.

02 November 2017

This will have lenders worried

One of the consequences of having experience is that you can remember when things had been brutal when a company was going through financial problems. Back in the 1980s, the secured lenders were rather cavalier about how they went in to scoop assets from a debtor in collecting on their collateral, and they didn't care if anyone got stuck with remaining debts afterwards. There were too many stories I knew of back then, and I actually had to go in and work at one company that had been on the brink of shutting down before it was saved by an acquirer.

One of the more abrupt scenarios was if you were in business in Québec, where the Code of Civil Procedure allowed seizures to be undertaken by secured lenders without notice. This only changed when the federal Bankruptcy and Insolvency Act was amended in 1992 to provide a ten-day notice period before such action, which brought that province into line with the rule already in place in the common-law provinces.

Other examples of bad behaviour exist to the present day. The most egregious I've seen is when a secured lender seizes collateral before a debtor collapses, and realizes, at any price, quick proceeds by power of sale. It was standard practice that the creditor would just scoop the proceeds, and that was that.

According to the courts, that is not acceptable behaviour in the following circumstances:
  • The creditor is now required to take reasonable precautions to obtain a fair market value on the property, and, should the proceeds exceed the amount due, return the difference to the debtor.
  • It the debtor has unremitted balances of Tax/CPP/EI source deductions and/or GST/HST, and the debtor does not have sufficient funds to pay them, the CRA will now go after the lender for any amounts owing
 The first principle arose from the English case of Cuckmere Brick Co Ltd v Mutual Finance Ltd, where Salmon LJ stated:

I accordingly conclude, both on principle and authority, that a mortgagee in exercising his power of sale does owe a duty to take reasonable precaution to obtain the true market value of the mortgaged property at the date on which he decides to sell it. No doubt in deciding whether he has fallen short of that duty, the facts must be looked at broadly and he will not be adjudged to be in default unless he is plainly on the wrong side of the line.

Canadian courts have adopted a similar approach.

The latter is a consequence of jurisprudence that has only arisen in recent years, and is neatly summarized in a case decided by the Federal Court of Appeal this past summer. While such debts may (with the exception of source deductions) rank only with other unsecured creditors at the time of bankruptcy, any move to realize upon security before that point will have massive consequences, as noted here:
  • A creditor is obliged to pay proceeds from a tax debtor’s assets to the Crown whether or not that creditor is aware the debtor hasn’t remitted its taxes.
  • The creditor can be personally liable for the debtor’s GST/HST arrears
  • The Crown will now be more aggressively inclined to pursue creditors post-bankruptcy to recover amounts obtained from the debtor’s assets in pre-bankruptcy actions.
  • This will not be available with respect to certain "prescribed security interests" (generally involving real estate), but the amount of the interest must be reduced by any collateral being held as well as any payments that have been made, and the exemption will not apply where a deemed trust amount has arisen before an interest has been registered.
This will force lenders to get more documentation and assurance that debtors do not have issues that may complicated efforts to protect their security. It appears accountants will have a bit more on their plate to work on.

24 October 2017

How not to consult

I have to admit that I was one of the 21,000 who made a submission to the Department of Finance for their consultation this summer on Tax Planning Using Private Corporations. Here is a copy of what I sent:





At this particular time, unless the Department has good PDF scraping software, I doubt that anyone has even read this yet, and one columnist in The Globe and Mail has calculated that the resources needed to do it manually are too huge to be realistic. I essentially argued that the principal proposal relating to taxation of passive investments harkens back to the original concept of tax reform that was introduced in 1972, which I still believe should have been retained instead of being abandoned in 1973.

Historical background


Interestingly, the original proposal that was promoted in the 1970 White Paper called for private corporations to be treated the same as partnerships. Ottawa has scanned the original white paper to the Web, and a copy is here:




The feds backed away from that when they introduced the actual bill in 1971, and a handy summary of it is here:





 This eventually translated into the Act that implemented it all:




The intended tax on passive investments was abandoned in 1972, with retroactive effect:



What just happened now


Enough about the history. In any case, I did my civic duty, but subsequent events showed the the feds had no real intention of fully assessing the content of these submissions, and their response reeks more of panic than anything else:


All of this suggests that the initial consultation was essentially a sham. Perhaps someone may analyze the submissions some day through Access to Information requests, but I'm not holding my breath. All in all, this was a bush-league exercise, and a huge embarrassment.

Could this have been done better?

There are more sophisticated procedures that are in place elsewhere in the world, but I prefer what has been put in place in the UK, which has been summarized in a very good set of principles, available here. They can be expressed as follows:

  1. Consultations should be clear and concise 
  2. Consultations should have a purpose 
  3. Consultations should be informative 
  4. Consultations are only part of a process of engagement 
  5. Consultations should last for a proportionate amount of time 
  6. Consultations should be targeted 
  7. Consultations should take account of the groups being consulted 
  8. Consultations should be agreed before publication 
  9. Consultation should facilitate scrutiny 
  10. Government responses to consultations should be published in a timely fashion 
  11. Consultation exercises should not generally be launched during local or national election periods
I doubt that the one just held by Finance complies satisfactorily on any of these counts. It doesn't appear that anyone has even done an online search to get help on how to do so, while I was able to quickly find a great start here.

The English jurisprudence on the subject is very enlightening as well, as seen in this article. Notably, it must "take place when policies can be influenced and views genuinely taken into account," and the decision-maker must give "'conscientious consideration' to the outcome of the consultation process." Quite a contrast to what we have just witnessed.

Follow-up


There were extensive submissions from CPA Canada and the Joint Committee on Taxation of the Canadian Bar Association and CPA Canada that I won't reproduce here, but for which I've provided links. The latter group's package of submissions add up to more than 150 pages in total.

I've only been able to find one submission online from any of the Big Four accounting firms, in this case from Deloitte, and it's quite comprehensive. It contrasts quite sharply with my polemic, but I'm not ashamed of that.





The initial analysis coming out on Finance's panic is rather interesting. Here is the Tax Alert put out by EY this week:



The repercussions will be coming out fast and furious now.

29 June 2017

Helping people to get lit since 1975

It was purely by happenstance that I discovered that a company I had once worked for from 1985 to 1990 has just been in the news this spring, through becoming the vehicle by which a medical marijuana producer has become the first publicly listed company in Canada in that industry. The company is Maricann Group Inc.

That's rather interesting, since it was an electrical lighting fixture manufacturer and distributor when I knew it, operating as Danbel Industries Inc, a subsidiary of Noma Industries Limited ("Noma"). It was founded by two brothers-in-law, Les Bresge and Ben Shtang, back in 1975, and was taken over by Noma in 1985. The circumstances behind that acquisition are irrelevant to this discussion, as I want to explain what happened to it after I left.

That is not easy, but it was still feasible as all transactions were carried out by publicly listed companies, and SEDAR provides access to all documents of such entities back to 1997, and CIPO's trademark database was useful for disclosing another material change prior to that.

1994


1 July: Amalgamation of Danbel with Noma Inc, a subsidiary of Noma Industries Limited and manufacturer/distributor of Christmas lights and accessories at that time. It continues operations as an operating division of that company.

1997


9 January: Noma announces that it has reached an agreement to sell the assets of Danbel to Applied Inventions Management, an unlisted junior company then trading on the Canadian Dealer Network.

1998


10 June: After delays relating to a dispute concerning the purchase price, Noma and AIM close the deal. Immediately prior to that, AIM assigns its rights to the acquisition to 1158478 Ontario Inc, a company controlled by Les Bresge. After the acquisition closes, 1158478 immediately changes its name to Danbel Inc.

21 December: Danbel Inc undergoes a reverse takeover with Augusta Technologies Limited, a junior company listed on the Alberta Stock Exchange. Augusta's previous shareholders are cashed out, and it is renamed as Danbel Industries Corporation.

1999


9 December: The TSE grants approval for Danbel to transfer its listing to that exchange.

2001


23 August: Danbel's secured lender appoints a receiver with respect to its operating subsidiaries.

6 September: The receiver assigns most of the operating subsidiaries into bankruptcy.

2002


15 January: The receiver assigns Danbel Inc into bankruptcy.

21 January: Trade is suspended on the TSE. Cease-trade orders issued by the OSC, BCSC and ASC would continue in effect until 4 March 2011.

2011


16 December: Name changed to Danbel Ventures Inc.

2012


21 December: Exit of Les Bresge from the company.

2017


21 April: Reverse takeover, described as a "reverse three-cornered amalgamation", is undertaken with Maricann Inc, a company licensed as a medical marijuana producer since 2013. Danbel changes its name to Maricann Group Inc.

24 April: Trading of Maricann shares begins on the Canadian Stock Exchange.

This constitutes the essential details, which I doubt will be covered in detail anywhere else, and may be of use if anyone pursuing a business degree wants to investigate it further. It does disclose several fascinating aspects of how public listings can be obtained rather easily on the Canadian markets.

Throughout the documentation, there are other interesting details tying together many underlying developments over the years that would be fascinating to insiders, but I will not dwell upon them here. However, they are all publicly available for people to look at.

The corporate history of Noma is also quite fascinating in itself, and deserves a separate article. That I will come back to at another time.