Advanced Corporate Tax: A "Cheat Sheet" for Business Owners
Canadian corporate tax law is a landscape filled with both powerful planning opportunities and dangerous pitfalls. Whether you are structuring a deal, planning for succession, or simply trying to optimize your annual return, understanding the mechanics of the Income Tax Act is essential.
This guide breaks down the complex rules into four understandable pillars: The "No-Go" Zones, Common Traps, The "Moves" (Planning), and Corporate Reorganizations.
1. The "No-Go" Zones: Anti-Avoidance Rules
The Canada Revenue Agency (CRA) has specific weapons designed to stop taxpayers from artificially reducing their tax bills. Knowing these triggers keeps you on the right side of the law.
TOSI (Tax on Split Income): This rule stops high-income earners from sprinkling dividends to family members to use their lower tax brackets. If you pay dividends to a family member who doesn't meet a specific exception (like working 20+ hours a week in the business), that income is taxed immediately at the top marginal rate, and their personal tax credits are denied.
Subsection 55(2) (Capital Gains Stripping): This is one of the most critical rules in corporate tax. Generally, dividends between corporations are tax-free. However, if you pay a large tax-free dividend to reduce the value of a company before selling it (to lower your capital gain), the CRA can re-characterize that dividend as a Capital Gain.
The "Good Money" Exception: You are allowed to strip out "Safe Income on Hand"—the hard-earned, tax-paid profits earned from operations since 1971. It is the "unsafe" income (like unrealized gains on land) that gets you in trouble.
FAPI (Passive Offshore Income): Thinking of hiding cash in a shell company in the Bahamas? If a Controlled Foreign Affiliate (CFA) earns passive income (like interest or rent), the Canadian parent company is taxed immediately on that money, even if it stays offshore.
2. Common Traps: Where People Trip Up
These are technical landmines that often result in unexpected tax bills.
The "Association" Trap (The Siamese Twins): If you own one corporation and your spouse owns another, the CRA often views them as "Associated" if there is significant cross-ownership (usually 25%). Associated corporations are like Siamese Twins—they may have two heads, but they share one stomach. They must share the single $500,000 Small Business Deduction limit, which effectively doubles the tax rate on any income over that shared limit.
The "Boot" Trap: When you transfer an asset to your corporation (Section 85 rollover), the goal is to defer tax. However, if you take back cash (called "Boot") that is greater than the tax cost of the asset, you trigger an immediate capital gain. The rule is simple: You cannot defer tax on cash you put in your pocket.
The Debt Forgiveness "Grind": If a bank or creditor forgives your debt, it isn't a free lunch. The CRA forces you to "grind" (reduce) your tax attributes in a specific order: first your losses, then your depreciable assets, and finally the cost base of your investments. This reduces your ability to claim tax breaks in the future.
3. The "Moves": Proactive Tax Planning
Once you know the rules, you can use legal structures to save tax or defer it to the future.
The Estate Freeze: This strategy is used to pass a family business to the next generation. The parent exchanges their growing "Common Shares" for fixed-value "Preferred Shares". This caps the parent's tax bill at the current value. The children then subscribe for new Common Shares. The result? All future growth (and the future tax liability) accrues to the children.
Purifying for the LCGE: Every business owner wants to use their $1.25 Million Lifetime Capital Gains Exemption (LCGE) when they sell. To qualify, 90% of your company's assets must be used in active business at the time of sale. If your company is hoarding too much passive cash, you must "purify" it (pay off debt or pay a dividend) to meet that 90% test before you sell.
The Safe Income Strip: Before selling shares to a third party, you can pay a tax-free dividend to a holding company equal to your Safe Income on Hand. This lowers the value of the company you are selling, which reduces the capital gain tax you pay personally on the sale.
4. Corporate Reorganizations: The Toolkit
When restructuring a business, different sections of the Tax Act serve different purposes.