Tax on Split Income Rules that tax capital gains as Dividends
The Income Tax Act (Canada) (the “Act”)2 deems a person to dispose of his or her capital property, such as shares of a Canadian private or public corporation, as a result of death or emigration from Canada (collectively, “Deemed Dispositions”). These Deemed Dispositions create taxable events where the value of the shares at the time of the Deemed Dispositions is in a gain or loss position even though the shareholder will still own the shares and will not have received any proceeds from the sale that he or she can use to pay the Deemed Disposition taxes.
Under the Proposals, Deemed Dispositions of corporate securities (for this discussion we’ll focus on shares only) of Canadian private corporations will be taxed as top tax rate dividends rather than as capital gains taxed at the shareholders marginal tax rates, regardless of the age3 of the shareholder unless the owner can establish that his or her personal contribution of human and/or financial capital met certain uncertain and difficult-to-meet hurdles in the discretion of the Canada Revenue Agency (CRA).4
The effect of this aspect of the Proposals will be to eliminate marginal tax rate taxation for adults who are subject to this element of the Proposals and to increase the tax rates on Deemed Dispositions for many shareholders of Canadian private corporations from the top marginal tax rate of 26.76% to the top marginal tax rate applicable to dividends of 45.30%.5 This tax increase will apply if the affected shareholder acquired their interest in the Canadian private corporation with no or nominal consideration and, in many cases, the tax increase will also apply even where the acquisition has been made with their own assets and/or borrowed funds. In their current form, the Proposals will apply to all existing or accumulated value in Canadian private corporations – not just on value that appreciates after July 18, 2017.
The Proposals do not impact the capital gains rate realized by investors in public corporation shares in any way or form.6 As a result, Deemed Dispositions of such shares will continue to attract tax at ordinary marginal capital gains rates subject to a maximum tax rate of 26.76%. This will be true whether the person acquiring the shares received the shares as a gift,7 with his own wealth or whether he acquires the shares with borrowed funds, including borrowed funds from non-arm’s length persons at favourable interest rates.8