What we don’t know are the details – the ground rules on which tax strategies are based.  While a number of provinces have indicated that they will harmonize with federal changes, the Ontario budget states that a decision will be made when details become available, with similar remarks in the Alberta budget.  If, for example, the Ontario government were to enact legislation with comparable changes, the tax rate on eligible dividends would drop from 31.34% to just over 23% - about the same rate as capital gains.  However, if it doesn’t, the tax rate in Ontario on eligible dividends would exceed 26%[v] (remaining at 31.34% for ineligible dividends). 

Based on discussions with Department of Finance officials, where a Canadian-controlled private corporation earns both eligible and non-eligible income, current thinking is that it would not have to first “clear out” the ineligible income.  While the proposals themselves hint at this result[vi], specific confirmation has yet to be announced, nor have any details been released on how Part IV tax would work under the new system[vii].

This uncertainty makes tax planning tough.  Assuming, for the moment, that the federal tax breaks are matched provincially (e.g., in Ontario), tax strategies for CCPCs would change substantially.  Consider the following:

• The practice of bonusing-down to the small business limit – which had already been the subject of more and more second guessing due to drops in corporate tax rates in recent years - could become the exception rather than the rule.  If the profits are left in the corporation to take advantage of the deferral due to relatively low corporate tax rates, subsequent dividends will attract only a small degree of double-taxation compared to bonuses.[viii] 
  
   
• The sale of goodwill and other eligible capital property, as opposed to capital gains, will become even more attractive.  Under pre-existing rules, these sales would attract only one-half of the general corporate tax rate (without the 6 2/3% surtax and with the benefit of the current 7% rate reduction), but there is a material degree of double-taxation if the proceeds are dividended out of the corporation[ix].  If the proposals are in full effect both federally and provincially, this disincentive will be greatly reduced. 
  
   
• Similarly, safe income strips allow tax-free intercorporate dividends to be paid prior to a share sale, but at the cost of higher taxation if the safe income were distributed to shareholders as dividends, i.e., relative to a straight capital gain.  This disincentive will also be greatly reduced.
  
   
• Since the taxation of dividends would match capital gains, the advantages of purposely triggering corporate-level capital gains prior to a distribution (to gain access to refundable tax and the capital dividend account balances) would decrease[x]. 

However, tax advisors who counsel specific strategies such as these prior to the release of details may act at their peril.[xi] 

Another example of such retroactive legislation is the infamous section 3.1, which has been the subject of continued professional criticism.  This is the proposal that would legislate a “reasonable expectation of profit” test. 

Department of Finance officials have made conciliatory statements[xii].  While various informal remarks have been made to the effect that revised legislation could be restricted to negating the effects of the Singleton and Ludco cases (notably that income, per paragraph 20(1)(c) refers to net rather than gross income), there is very little “on the record”, and tax practitioners can only guess how the still-secret revisions would affect a specific fact situation.

International Tax

Another type of retroactive legislation is where we do know the particulars, but the particulars could change.  A good example pertains to so-called “FIEs” and non-resident trusts.  It is a safe bet that it will be most of a decade from inception to finalization of these complex proposals.  Originating in 1999, draft legislation was first released in 2000, and we are now in our fifth version[xiii].  A discussion of the changes along the way would require a treatise, yet the proposals would generally take effect for taxation years beginning after 2002.  

In this case, there has been a bona fide attempt to ensure that changes that adversely affect taxpayers would be effective only after the date of announcement.  Nevertheless, the complexity of these proposals raises the possibility that seemingly-benign changes could have unanticipated and unforeseen effects.[xiv]  (Similar remarks could be made in respect of major foreign affiliate amendments have been kicking around since the end of 2002.) 

I think it is also fair to say that these provisions can present obstacles to various types of international transactions (for example, it is dangerous for Canadians to transact with structures involving non-resident trusts).  Is it possible that the new government could have a different attitude toward whether these traps and complexities are really necessary? 

Of course, the most blatant form of retroactive legislation is where there is no prospective announcement of any details.  In recent years, there have been a few examples of this sort of thing, for example, Manitoba’s retroactive reaction to a previous incarnation of a “Quebec shuffle”.  However, the more recent changes to the general anti-avoidance rule and its retrospective effect in respect of application to tax treaties and regulations have definitely ramped things up, setting the stage for more of the same. 

In fact, just days ago, the Quebec government followed suit and clamped down on a Quebec trust mechanism involving non-Quebec-resident beneficiaries.[xv]  The clamp down was retroactive to all non-statute barred years.  So we now have two rather blatant examples of retroactive legislation.  Personally, I expect other examples to follow.

In summary, courtesy of GAAR and other broadly worded anti-avoidance rules, a cloud of uncertainty hangs over tax planning; the best hope of taxpayers is that that they won’t “get caught”.  Legislative uncertainty also hangs over major areas.  And more lately, the threat of out-and-out retroactive legislation has become more of a reality.     

When you put it all together, it is a bad situation - that cries out for our professional organizations to be more assertive than ever.