Using Your Corporation to Save: does it still make sense?

I know this article will be controversial, and I know the usual detractors will say that I am biased (and thus must be ignored), but Federal Budget 2024 does force the entire financial planning community to ask a vital question: is using a Canadian Controlled Private Corporation ("CCPC") still a viable way to set money aside for retirement purposes?

The question must be asked because those who track the history of tax changes cannot fail to notice the following historical pattern:

• 2014 - the federal government increases the taxation on 'non-eligible dividends' that are paid to shareholders of CCPCs that benefit from the small business tax rate (currently 12.2% in Ontario for active CCPC income below $500,000).
• 2018 - the federal government introduces the concept of a tax on passive income for CCPCs that earn more than $50,000 in passive income either within the CCPC or within any associated companies (e.g. Holdco).
• 2024 - the federal government introduces the concept of increasing the 'inclusion rate' on capital gains earned by a CCPC in its non-registered corporate investment account from 50% to 66.6%, plus reduces the tax-free capital dividend account credits from 50% to 33%, and thus accelerates the application of the tax on split income described in point no. 2 above.
• 2024 - Budget papers makes concessions for allowing capital gains on $2M resulting from the sale of shares of the CCPC to be taxed on 33% instead of 50% of the capital gain, but specifically denies this concession to certain professionals like doctors, consultants and many others.

It is as if the strategy of using the corporation as if it were a pension plan is not favoured by our tax authorities and that the legislator is 'nudging' the industry to seek other ways to help business owners save for retirement.

Cautionary Tale for those who see the CCPC as if it were a pension plan.

Under existing laws, when a business owner saves within the corporation he or she is now at the mercy of a number of taxes. We view these as 'tax leakage' that saps away the vitality of the wealth that the business owner is trying to accumulate for retirement.

(i) Immediately, there is the Active Business Tax which could be at the low rate (eg 12.2% in Ontario) on the first $500,000 of taxable corporate income or regular rate (26.5% in Ontario) thereafter. Worst-case, once this first tax is paid, over a quarter of the income earned is lost right away.

(ii) If too much (i.e. $50,001 +) passive investment income builds up within the CCPC's non-registered investment account, the CCPC faces a second problem in that the $500,000 small business allowance is now eliminated at the rate of $5 for every additional 1$ of passive income that exceeds $50,000. Thus, for example, if a CCPC earns $150,000 in passive income, the Active Business Tax in point no. (i) on first dollar earned, will now be 18% (in Ontario) and not 12.2%..

(iii) If the retained earnings invested by the CCPC generate any passive income while it is owned by the company (eg. interest income, foreign dividends etc.) the tax on that passive income is about 50.17% (in Ontario). Thus, over half of the wealth that the CCPC is trying to generate for retirement purposes is lost in the hands of the corporation before anything can be paid out to the shareholder via dividends. Certainly, since Canadian dividends and capital gains are taxed more favourably, the pain isn't as severe for those forms of income, but still, what is left for the shareholder is reduced. Let's not forget that a portion was "taken off the top" when earned by the CCPC under the first level of tax in point no.(i) - and maybe point no. (ii) as well.

(iv) At some point the shareholder will want to spend some of the cash that the CCPC invested, for retirement purposes, and to get that money into his or her hands, the CCPC will declare a dividend. The 4th level of taxation now comes in the form of personal tax when the shareholder declares the dividend amount on the T1 General tax declaration.

(v) The shareholder may wish to retire outside of Canada as well. The Income Tax Act (Canada) will also impose a "Departure Tax" on those business owners who opt to become non-residents of Canada for tax purposes. While certain assets are 'exempt assets' many will be caught by this taxable event. More wealth that the business owner was counting on is lost due to this rule.

(vi) Finally, if personal wealth is trapped in the value of the shares of the CCPC, due to the property stored inside of the Non-Registered Investment account, unless a spousal rollover is possible, the death of the shareholder creates yet another tax issue, in the form of the 'deemed disposition' on death. The deceased taxpayer is deemed for tax purposes to have disposed of his or her capital property at fair market value the day prior to the death, and the value must be recognized as taxable income in the terminal tax return of the individual. A similar punitive rule also applies to RRSP and RRIF assets held in registered accounts at the point of death (when a spousal rollover isn't possible).

When seen from this vantage point of view, one can understand the exasperated comments from so many in our financial community who have always recommended that business owners use their CCPC as the primary way to build up a retirement nest egg. It might have worked well prior to 2018, but the trend is not encouraging.

Is "Corporate Investing" the Only Way to Save for Retirement?

Fortunately, the tax laws do allow business owners who operate through a CCPC to set up registered pension plans ("RPP") and retirement compensation arrangements ("RCA") if the goal is to sequester money for retirement purposes. These laws have been codified since 1986 (RCA) and 1991 (RPP) and while not always well understood by most, have shown their worth over decades of experience.

How then, do these RPP/RCA solutions compare with the traditional "corporate investing" strategy that most Canadians follow?

The best way to illustrate their unique value proposition is to contrast it with the corporate savings approach by going over the 5 'tax leakages' reviewed previously.

1) Active Business Tax. $0.00 on contributions made by the CCPC to the pension account.

Since the Income Tax Act provides the CCPC with a full expense for any dollar contributed either to the RPP or RCA, the first layer of taxation (12.2% to 26.5%) does not occur. We are deferring the tax because the income is being sheltered for retirement purposes. Our pension client starts the race to retirement with 100 cents on the dollar instead of a fraction.

2) Passive Income Tax. $0.00 on growth within the pension account.

Because the RPP is usually a "pension trust" section 149(1)(o) of the Income Tax Act specifically exempts the income generated (regardless of its form as interest, dividends or capital gains) for any ongoing taxation. I would rather face a 0% tax on income than a 50.17% tax rate...

3) Tax On Passive Income. $0.00 reductions to the $500,000 small business limit.

Since the pension plan is not an asset of the CCPC, and is not generating any taxable passive income in any event, the 1:5 elimination of the $500,000 small business allowance does not occur when growth occurs inside the RPP/RCA. This helps the CCPC continue to benefit from the lowest Active Business Income tax rate as long as possible, leaving more for operations and other corporate uses.

4) Departure Tax $0.00 on becoming a non-resident for any pension assets

The capital inside of the pension plans sponsored by the CCPC are considered "exempt assets" under the Departure Tax rules, much like personal RRSP assets are. Thus, if a shareholder has been able to accumulate say $1,000,000 in the RPP by the time they opt to leave Canada, there would be no taxable deemed disposition on that asset.

5) Deemed disposition on Death. Could be $0.00. Income splitting also possible.

Since RPPs and RCAs do allow family members employed by the family enterprise to be paid a salary, nothing stops them from joining the pension arrangements set up by the CCPC. In that case, should the shareholder die while in receipt of a pension, the 'pension surplus' created by this death is retained within the pension fund and isn't subjected to either provincial probate fees or the federal deemed disposition rules. Significant family wealth can remain intact in the event of death.

In cases where it was not possible for family members to join the plan, since taxation occurs in the hands of the beneficiary and not within the Estate, having many beneficiaries does allow for some limited forms of income splitting and thus a lower tax burden on the survivors.

One Tax Instead of (up to) 5 Taxes: the pension path.

So far, the shareholder using the pension strategy has never paid any income taxes on the top-line revenues initially earned by the CCPC that were directed to the RPP. All of that capital has been allowed to compound without any tax leakage and is ready to pay a pension benefit in retirement. Mathematically, one can see that the Pension approach (if everything else is held constant) must mean that the shareholder has more money for the last stage of life than the one who followed the traditional corporate investing strategy.

Those who think little of the pension solution will be quick to point out that pension benefits are personally taxable at personal graduated tax brackets and often make the observation that: "You now have to pay over 50% on your pension benefits!"

Aside from the obvious point that I'd rather pay 50% on a pool of $2,000,000 than 25% tax on a pool of $1,000,000, even the assertion of being taxed at the top personal bracket is often not even true.

For example, Canada has signed tax conventions with over 100 countries around the world where the non-resident withholding tax on pension income is fixed at a flat 15% (not 53.5%). Even those who retire to a tax heaven face a flat 25% withholding tax in Canada on their pension income.

And even those who stay put and retire in Canada as 'residents' might be able to do "pension income splitting" with a spouse who has little or no income, and save the couple thousands of dollars in personal tax every year.

A Final Note

I can understand why so many in the industry have no appetite to learn about pension plans and as such act as if they did not exist (or are too expensive, complex etc.), and thus fear any move by the tax authorities to 'tighten the screws' with the traditional corporate passive investing strategy. Often, to develop proficiency with these more complex solutions, individuals have to take extra courses and may not see an immediate financial benefit to themselves over other simpler (or better remunerated) solutions.

While I sympathize with their plight, ultimately, our first loyalty should always be to the business owner and their family. If the 'Corporate Investing' approach isn't yet dead, it is certainly under attack as demonstrated by the recent Budget Papers. Fortunately, those who take advantage of the tax and pension laws that govern RPPs and RCAs can provide much-needed tax relief to the beleaguered entrepreneurs they serve.

One last parting thought: I do not claim that a pension solves all of the Earth's problems. Other solutions (permanent life insurance, estate freezes, family trusts, etc. etc.) continue to be critically important and co-exist with a pension strategy. However, I sincerely believe that a 100% corporate passive income retirement approach cannot be more tax-effective than a pension-based approach for the reasons set out above.

Jean Pierre Laporte, BA, MA, LLB, RWM

CEO INTEGRIS Pension Management Corp.

[email protected]