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Federal Tax - Investment Income. Canada v. DAC Investment Holdings Inc.
In Canada v. DAC Investment Holdings Inc. (Fed CA, 2026) the Federal Court of Appeal allowed a Crown appeal, this brought against the Tax Court's allowing an appeal of an MNR income tax reassessment regarding "tax measures applicable to Canadian-controlled private corporations (CCPCs) that minimize any tax deferral advantage arising from holding investments through a corporation".
The court considers ITA s.123.3 ['Refundable tax on CCPC’s investment income'] (re private corporations) and s.123.4 ['Corporation Tax Reductions'], which here address investment income by private corporations:(a) Section 123.3
[33] In Canada’s major tax reform in 1971, the Minister of Finance stated that the reform had the objective that "“the taxation of investment income will be the same whether it is received directly or through a private corporation”" (Canada, Department of Finance, Budget Speech by the Honourable E.J. Benson, Minister of Finance (18 June, 1971) [1971 Budget Speech]).
[34] This fundamental principle has stood firm ever since. In 1995, section 123.3 was enacted to increase the corporate tax rate on investment income in light of this principle. The section was designed to account for current tax rates and therefore increased the corporate tax rate to prevent tax deferral when investment income is earned through a corporation. The tax is refunded as dividends are paid. The rate prescribed in section 123.3 was increased in 2016 for the same reason.
[35] Section 123.3 provides:Refundable tax on CCPC’s investment income
Impôt remboursable sur revenu de placement — SPCC
123.3 There shall be added to the tax otherwise payable under this Part for each taxation year by a corporation that is throughout the year a Canadian-controlled private corporation an amount equal to 10 2/3% of the lesser of
123.3 Est à ajouter à l’impôt payable par ailleurs en vertu de la présente partie pour chaque année d’imposition par une société qui est une société privée sous contrôle canadien tout au long de l’année le montant représentant 10 2/3 % du moins élevé des montants suivants :
(a) the corporation’s aggregate investment income for the year (within the meaning assigned by subsection 129(4)), and
a) son revenu de placement total pour l’année, au sens du paragraphe 129(4);
(b) the amount, if any, by which its taxable income for the year exceeds the least of the amounts determined in respect of it for the year under paragraphs 125(1)(a) to (c).
b) l’excédent éventuel de son revenu imposable pour l’année sur le moindre des montants déterminés à son égard pour l’année selon les alinéas 125(1)a) à c). [36] The Tax Court described the object, spirit and purpose of this provision at paragraph 139:[139] A consideration of the text, context and purpose of section 123.3 leads to the conclusion that the object, spirit and purpose of the section, its rationale, is to, together with the refundable tax regime and the dividend gross-up and tax credit scheme, prevent the use of a CCPC to defer taxes that may be payable at a higher rate by the shareholders of the CCPC, while maintaining the integration of taxes paid by CCPCs and their shareholders. [37] This is a description of the overall taxation scheme for investment income in the ITA, but section 123.3 only addresses the part of the scheme aimed at deferral.
[38] In my view, the object, spirit and purpose of section 123.3 is to reduce income tax deferral opportunities that individuals earning investment income directly might otherwise obtain by earning such income through a CCPC (Canada, Department of Finance, Explanatory Notes Relating to the Income Tax Act (Ottawa: December 2015) at 6).
(b) Section 123.4
[39] In 2001, section 123.4 of the ITA introduced a reduction in the corporate tax rate for all corporations except those that already enjoy an incentivized tax rate. The reduction was designed to increase the international competitiveness of business in Canada.
[40] Investment income of a CCPC already benefits from an incentivized corporate tax rate because a portion of the tax is refunded as dividends are paid. These refunds were introduced as part of the 1971 tax reform mentioned above. (Canada, Department of Finance, The Budget Plan 2000: Better Finances, Better Lives (Ottawa: 28 February 2000) at 222 [Budget Plan 2000]).
[41] Accordingly, investment income earned by a CCPC is not included in the section 123.4 rate reduction (subparagraph (b)(iii) of the definition of "“full rate taxable income”"). The relevant provisions are set out below (emphasis added):"Corporation Tax Reductions"
Réductions de l’impôt des sociétés
Definitions
Définitions
"123.4 (1)"" …"
123.4 (1) […]
"full rate taxable income"" of a corporation for a taxation year is"
revenu imposable au taux complet En ce qui concerne une société pour une année d’imposition :
"…"
[…]
"(b)"" if the corporation is a Canadian-controlled private corporation throughout the year, the amount by which that portion of the corporation’s taxable income for the year that is subject to tax under subsection 123(1) exceeds the total of"
b) si la société est une société privée sous contrôle canadien tout au long de l’année, l’excédent de la partie de son revenu imposable pour l’année qui est assujettie à l’impôt prévu au paragraphe 123(1) sur le total des montants suivants :
"…"
"(iii)"" except for a corporation that is, throughout the year, a cooperative corporation (within the meaning assigned by subsection 136(2)) or a credit union, the corporation’s aggregate investment income for the year, within the meaning assigned by subsection 129(4);"" and"
[…]
(iii) son revenu de placement total, au sens du paragraphe 129(4), pour l’année, sauf si elle est, tout au long de l’année, une société coopérative, au sens du paragraphe 136(2), ou une caisse de crédit;
"…"
[…]
"General deduction from tax"
Déduction d’impôt générale
"(2)"" There may be deducted from a corporation’s tax otherwise payable under this Part for a taxation year the product obtained by multiplying the corporation’s general rate reduction percentage for the year by the corporation’s full rate taxable income for the year."
(2) Est déductible de l’impôt payable par ailleurs en vertu de la présente partie pour une année d’imposition par une société le produit de la multiplication du pourcentage de réduction du taux général qui lui est applicable pour l’année par son revenu imposable à taux complet pour l’année. [42] The Tax Court described the object, spirit and purpose of section 123.4 at paragraph 158 of the reasons:[158] It is clear from the text of section 123.4 and the various statements made by the government when introducing and subsequently increasing the General Rate Reduction that the object, spirit and purpose of section 123.4 is to lower the general corporate tax rate, such that the highest non-refundable corporate tax rate levied under the Act is 15%. The 15% is composed of the 28% General Tax Rate minus the 13% General Rate Reduction provided for in section 123.4. [43] The Tax Court used the term "“general corporate tax rate”" above to refer to a rate that is not incentivized (reasons at para. 154). The Tax Court’s description of the object, spirit and purpose describes the legislation but not its rationale.
[44] In my view, part of the object, spirit and purpose, or rationale, of section 123.4 is to foster international competitiveness for Canadian business. As mentioned above, section 123.4 does not apply to already incentivized rates such as investment income of a CCPC.
[45] As far as I am aware, fostering competitiveness was the only reason stated by the Department of Finance for providing a tax rate reduction for corporations except where the rate was already incentivized. However, it is inconceivable that the Department of Finance was not aware, and took into account, that excluding investment income of a CCPC would have the effect of preserving the fundamental principle stated in the 1971 Budget Speech that investment income should be taxed the same whether it is received directly or through a private corporation.
[46] In my view, the object, spirit and purpose for excluding investment income of a CCPC from the section 123.4 tax rate reduction is two-fold: (1) the investment income already has a preferential tax rate; and (2) the exclusion preserves the fundamental principle that investment income should be taxed the same whether it is received directly or through a private corporation.
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