Article content continued

A CCPC pays tax of about 15 per cent on up to $500,000 of annual business income, and 27 per cent on business income above that limit. The difference between these rates and the higher rates that apply to individuals is paid in the future, when the CCPC eventually pays dividends to its shareholders.

Investment income of a CCPC is taxed at a higher rate than business income — at about 50 per cent, roughly the same as the top personal tax rate. As a result of the “tax integration” rules, there is generally no further net tax when the after-tax investment income is paid as dividends to the CCPC’s shareholders. So where is the loophole?

The government is concerned that, if the CCPC does not require the after-tax business income for business expansion, and instead uses the funds to acquire portfolio investments, the CCPC has more starting capital to invest than an individual does. This allows the CCPC to compound its investment returns on a larger amount. Even though the CCPC pays a 50-per-cent current tax on its investment income, its investment portfolio will therefore be greater in the future than the individual’s.

The preferred solution set out in Mr. Morneau’s package is as follows. If a CCPC uses after-tax business income to acquire portfolio investments, the investment income will suffer a significant extra tax burden. The CCPC will still pay 50-per-cent immediate tax on the investment income but, in addition, “tax integration” will no longer apply, and so the shareholders will pay additional tax when the after-tax investment income is distributed as dividends in the future. For example, if a CCPC pays tax on business income at the small-business rate, an individual in Ontario who is taxed at the top personal tax bracket will face a combined tax rate on investment income, including the tax paid by the CCPC, of close to 73 per cent in 2017. This combined rate leaves the CCPC and its shareholders with the same amount of investment capital in the future as an individual who is taxed at 50 per cent and who uses the after-tax funds for portfolio investment.