Category: Tax

If you are currently operating your small business as a sole proprietor, you may have come face-to-face with the age-old question: Should I incorporate? For most small businesses, incorporation brings a shiny new title as a Canadian-Controlled Private Corporation (“CCPC”). The decision to incorporate carries both legal and financial implications, and from a tax perspective, the advantages can be extremely worthwhile, especially for CCPCs. For many business owners, a CCPC can mean reducing tax exposure, keeping more money in the business, and gaining greater flexibility in determining how and when income is taxed. Sounds like a pretty good deal, if you ask us. So, what exactly are the main tax advantages of a CCPC?

1. Lower Tax Rates Through the Small Business Deduction

Arguably, the biggest tax advantage of a CCPC is access to the Small Business Deduction (“SBD”), a tax credit given to CCPCs to reduce the tax rate on the first $500,000 of active business income earned in Canada.

Most non-CCPC corporations in Ontario face a combined federal and provincial corporate tax rate of 26.5%.  However, CCPCs enjoy a combined federal and provincial tax rate of just 12.2% by way of the SBD rate reduction. This allows CCPCs to be taxed at about half the rate of a non-CCPC or public corporation. The 12.2% tax rate applies to a CCPC’s active business income, up to $500,000 for any given taxation year, effectively reducing both federal and provincial taxes to a rate that is lower than even the lowest personal income tax bracket available to sole proprietors. It is important to note that any active business income beyond the $500,000 limit will then be taxed at the general corporate combined rate of 26.5%, much like how marginal tax rates apply to individuals.

In practice, this means that if you are operating as a CCPC, you will experience a significant tax advantage for the first $500,000 in active business income that you make, allowing you to retain more earnings than if you were operating as a sole proprietor. This gives you greater flexibility to reinvest in your business or plan for future withdrawals.

There are several important considerations to keep in mind with the SBD. First, the SBD will only apply to income from an active business carried on in Canada, so investment income is excluded. Relatedly, the SBD is decreased by $5 for every $1 of investment income over $50,000 and is completely phased out at $150,000 of investment income. Second, the SBD begins to phase out once a corporation’s annual taxable capital exceeds $10 million and will be completely eliminated at $50 million.  Lastly, if you control multiple associated corporations, the $500,000 limit is shared among all of them, preventing taxpayers from multiplying the deduction across related entities.

2. Tax Deferral: The Ability to Control When You Pay Personal Tax

When a business is incorporated, profits can remain inside the corporation as retained earnings. Through retained earnings, owners can delay paying personal tax until they actually withdraw funds, typically through dividends or salary. This flexibility allows business owners to re-invest in growth, build reserves, or plan withdrawals strategically. By comparison, a sole proprietor must report and pay personal tax on all business income in the year it is earned.

CCPCs may also benefit from special rules when earning investment income, such as interest, rental income, or capital gains. Although this type of income is initially taxed at a higher corporate rate, Canada’s Refundable Dividend Tax on Hand (“RDTOH”) system allows a portion of that tax to be refunded to the corporation when dividends are later paid to shareholders. This affords CCPC owners greater control over their finances.

3. Capital Dividends: Accessing Tax-Free Corporate Distributions

In addition to dividend planning and tax deferral opportunities, unlike sole proprietorships and public corporations, private corporations and CCPCs benefit from the ability to pay capital dividends. Unlike eligible or non-eligible dividends, both of which are taxable in the hands of shareholders, capital dividends may be received entirely tax-free when properly declared.

Capital dividends are funded through a corporation’s Capital Dividend Account (“CDA”), a tax account that tracks amounts that can be treated as tax-free. Non-exhaustively, these amounts include the non-taxable portion of capital gains, capital dividends received from other corporations, and certain tax-free amounts arising from eligible capital property dispositions. To learn more, read our previous blog post on corporate dividends.

3. Lifetime Capital Gains Exemption: Planning for a Tax-Efficient Exit

One of the most significant long-term tax advantages available to shareholders of a CCPC is access to the Lifetime Capital Gains Exemption (“LCGE”).

Under section 110.6 of the Income Tax Act (“ITA”), individuals who sell shares of a qualifying CCPC may be eligible to shelter up to $1,250,000 (as of 2026) in capital gains from taxation. In practical terms, this means that when a business owner sells CCPC shares, or perhaps the CCPC in its entirety, much of the gain on the sale of their shares may be received tax-free.

This exemption can create significant financial advantages in situations of retirement, succession planning, or a third-party sale. By contrast, sole proprietors generally do not have access to the LCGE when selling their business assets unless they fall under the category of specific farm and fishing assets. Instead, asset sales typically trigger taxable capital gains (and potentially recaptured depreciation), resulting in a higher overall tax burden. Incorporation can therefore play an important role in maximizing after-tax proceeds upon exit.

4. Allowable Business Investment Losses and the Bigger Picture of Incorporation

While CCPCs offer substantial tax advantages when a business succeeds, they may also provide meaningful tax relief if the business does not thrive as planned. If shares of a CCPC are disposed of at a capital loss or become worthless, those losses may qualify as Allowable Business Investment Losses (“ABILs”).

Pursuant to section 3(d) of the ITA, 50% of capital losses from a CCPC may be deducted not only against personal capital gains, but also against all sources of income, such as employment income, business income, property income, or income from an office. By contrast, capital losses incurred by sole proprietors are generally restricted to offsetting capital gains only.

Taken together, these rules demonstrate how incorporating, especially if you fit into the CCPC designation, can unlock significant tax planning opportunities. From accessing the SBD and deferring personal taxation on retained earnings to distributing certain corporate surpluses tax-free through the CDA and leveraging specialized tools such as the LCGE and ABILs, incorporation offers advantages that are simply not available to sole proprietors. For business owners focused on growth, succession planning, or long-term financial efficiency, operating as a CCPC can provide greater flexibility, meaningful tax savings, and enhanced control over future financial outcomes.

Have further questions? Contact our tax planning lawyer

Alex Shchukin is a Toronto lawyer in the commercial litigation team at Devry Smith Frank and has expertise in a broad range of commercial litigation and related matters. Alex can be reached at alex.shchukin@dsf.theleadshub.biz and/or 416-446-5099.

This blog was co-authored by articling student Mariem Naem.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs.”

As the new year begins, many employees enjoy their year-end bonuses earned on top of their salary for a job well done. For these employees, bonuses come in the form of a straightforward cash payout. For other employees, especially those in the startup space, compensation may come with a strategic choice: receiving cash bonuses or employee stock options (“ESOs”). ESOs are rights conferred upon an employee to purchase a certain number of shares of a corporation at a fixed price during a certain period of time.

Tax treatment for cash bonuses is vastly different when compared to ESOs, and as such, merits careful consideration for whether taking ESOs is the financially correct decision for any given employee. Not only is tax treatment inherently different between the two, but the complexity of the tax regime for ESOs is arguably much higher and therefore can put off some employees from even considering them.

However, it would be prudent to know the pros and cons of either compensation structure before making a concrete decision as an employee. Choose wisely, and your wallet will thank you.

Division C Deductions on Taxable Income

Per section 2(2) of the Income Tax Act (the “ITA”), taxable income is calculated as your total income for the year plus additions (such as taxable capital gains) less deductions permitted under Division C of the ITA. One of those deductions, found in section 110(1)(d) or (d.1) , applies a deduction when qualifying ESOs are exercised. As a result, unlike bonuses, which are fully taxable, only 50% of the benefit gained from exercising the ESOs will be subject to taxation at the employee’s progressive tax rate, effectively halving the tax payable.

Qualifying for a Deduction

In order to qualify for a deduction when exercising ESOs, several conditions must be met: the employee must deal at arm’s length with the employer, meaning the parties are unrelated and act independently; the shares are “prescribed shares” as described in Regulation 6204 of the Income Tax Regulations (effectively a “normal” common share); and the stock option price is greater or equal to the fair market value of shares when ESOs were first given.

Amount and Timing of Benefit of ESOs

Section 7(1) of the ITA governs how ESOs are taxed when they are exercised. It is to be noted that section 7(5) stops claimants who did not receive the ESOs by virtue of employment, and instead, for example, received the benefit as shareholders, from utilizing section 7.

Initially, an employee will be presented with an ESOs contract, specifying their contractual right to purchase company shares at a fixed price. No taxation occurs at this point.

Strategically, an employee should exercise their stock options when the exercise price is lower than the fair market value of the shares. Any benefit received at this point must be reported on the employee’s annual tax return, unless the employer is a Canadian-controlled private corporation (“CCPC”). At this point, a deduction may be applied to the benefit derived from qualifying ESOs. In other words, unless the employer is a CCPC, taxation of ESOs occurs when you exercise the option to buy the shares.

If the employee paid to receive the ESOs, the cost is deductible.

To illustrate with a simple example, assume an employee was granted ESOs to acquire 10 shares at a price per share of $10 when the fair market value of each share was also $10. The employee then exercises the ESOs when the fair market value of each share jumps to $20. The benefit is the difference between the fair market value of the shares at acquisition time, the amount paid by the employee to exercise the ESOs, and any price paid to acquire the ESOs by the employee, all multiplied by the amount of shares acquired. Thus, in this example, the benefit is $100 ($10 difference x 10 shares).

After holding the shares, an employee may later sell them for a capital gain or loss pursuant to the ESOs contract. A gain occurs if the shares are sold for more than what the employee paid to obtain them. To prevent the same shares from being taxed twice (because it was already taxed when the employee exercised their stock options), section 53(1)(j) provides a tax mechanism to avoid double taxation under the capital gain mechanisms.

Where an employee exercises stock options granted by a CCPC, they enjoy a tax deferral. The employee only reports the aforementioned benefit when the shares are sold, at which point the Division C tax deduction can be claimed. However, this can only be done if the employee holds the shares for a minimum of 2 years.

Cash Bonuses

Unlike ESOs, cash bonuses offer little flexibility in tax treatment and therefore do not provide any deduction. They are treated the same as all other income, subject to the same progressive tax income rates, as well as pension and employment insurance deductions.

Despite offering no deductions, cash bonuses do come with a special advantage: they can be directly deposited by the employer into an employee’s registered retirement savings plan (“RRSP”), effectively bypassing the withholding taxes that would otherwise apply to RRSP contributions equal to the employee’s progressive tax bracket, thereby allowing an employee to receive and invest the full untaxed amount of the bonus into their RRSP.

The real benefit to cash bonuses as compared to ESOs is simple: cash bonuses are money now. As such, cash bonuses can be seen as short-term gain, while ESOs are more long-term investments, and their viability for any given employee depends on risk tolerance and most importantly, patience.

If you are presented with a choice of stock options or a cash bonus and need assistance understanding what makes more sense for you, our tax planning lawyers can help you decide. Have further questions? Contact our tax planning lawyer.

Alex Shchukin is a Toronto lawyer who joined the commercial litigation team at Devry Smith Frank in 2025 and has expertise in a broad range of commercial litigation and tax planning matters. Alex can be reached at alex.shchukin@dsf.theleadshub.biz and/or 416-446-5099.

This blog was co-authored by articling student Mariem Naem.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs.”

Directors of a corporation shoulder significant responsibilities in managing a corporation. The corporate veil will generally shield a director from personal liability by recognizing the corporation as a separate legal entity. However, under both the Income Tax Act and the Excise Tax Act, directors can still be held personally liable for unremitted source deductions or GST/HST owed by their companies.

If directors can prove they acted with due diligence, they can be protected from being held jointly and severally, or solidarily liable for the corporation’s outstanding tax liabilities.

The Legal Framework of the Due Diligence Defence

Section 227.1(3) of the Income Tax Act and section 323(3) of the Excise Tax Act both set out the due diligence defence: directors will not be personally liable if they exercised the degree of care, diligence, and skill to prevent the failure that a reasonably prudent person would have exercised in comparable circumstances. Courts have interpreted this standard through a consistent line of cases.

The burden of proof lies squarely on the director to demonstrate due diligence on a balance of probabilities. The defence is assessed on an objective standard, based on factual, detailed, and credible evidence of the steps taken to prevent the default.

The defence must be based on preventative, not reactive measures. Directors who have taken active steps to avoid non-compliance will be excused from personal liability. Efforts made after the default has already happened will not excuse the non-compliance. Directors must act when they first become aware that the corporation is facing financial difficulties.

Courts have held that reliance on experts, such as accountants or lawyers, may form part of a due diligence process, but directors cannot ultimately abandon their responsibilities to the corporation and play a passive role by relying on others’ assurances without independently confirming that statutory remittances are being made.

A director’s sophistication or business experience can increase the objective standard expected of them. Where the director is a new business owner or Director, the Courts will grant a measure of flexibility, evaluating what a reasonably prudent person with similar experience could have done in the same situation.

Although the Income Tax Act and Excise Tax Act refer specifically to “directors,” personal liability can also extend to “de facto directors”. These are individuals who, while not formally appointed, effectively act in a director capacity.

Hamad v the Queen, 2019 TCC 137: A Blueprint for the Successful Use of the Due Diligence Defence

In this case, Hamad was the CEO and director of RER Hydro Ltd, a company developing water-powered turbine technology in Quebec. This company received major funding from the Government of Quebec. In 2014, after a change of government, Quebec terminated its funding commitments. As a result, the company was insolvent, eventually declaring bankruptcy in 2015.

The CRA assessed Hamad personally for over $15,000.00 in unremitted employment insurance contributions, insurance contributions, penalties, and interest for the period of June-August 2014. In response, Hamad raised the due diligence defence.

Mr. Hamad’s actions showed what genuine due diligence looks like in practice. When the company’s funding collapsed, he called an emergency shareholders’ meeting to be transparent about the financial crisis and propose solutions. He pushed for an additional $3.1 million in shareholder investment, sought restructuring advice, and hired a consultant to help stabilize cash flow and manage financial planning. Further, he personally invested more than $4 million into the company to keep it afloat. Eventually, he made the difficult but responsible decision to lay off employees and seek protection under the Companies’ Creditors Arrangement Act to manage the company’s debts. In the end, management sold the firm’s assets to pay secured creditors, including the CRA.

The court found that this was sufficient to demonstrate that Hamad took every reasonable step to prevent losses and act in good faith. Because the default stemmed from unforeseeable external factors, Hamad actively sought solutions and documented his actions, and because he was able to show continuous, good-faith oversight and preventative engagement, even if the company ultimately collapsed, the Court agreed he had met the requirements for the due diligence defence.

Hirjee v. the King, 2023 TCC 4: Where the Due Diligence Defence Falls Short

In this case, Hirjee was the sole director of 1621844 Alberta Inc., a company that operated 4 Bell Mobility Retail Stores in Alberta. The company ran into financial difficulties after Bell Mobility changed its commission structure, which reduced revenues and caused operating costs to exceed profits. Despite hiring a bookkeeper and external accountant to handle filings, the CRA still held Hirjee personally liable for approximately $375,000 in unremitted GST/HST.

Hirjee argued he should be relieved of personal liability because he exercised due diligence by retaining a qualified professional to manage tax filings, and because his ability to act had been severely impaired by mental health challenges during the relevant assessment period. He argued that these factors satisfied his due diligence when measured against what a reasonably prudent person would have done in comparable circumstances.

The Tax Court of Canada found that while hiring a bookkeeper and accountant were relevant to the analysis, it was not sufficient to establish due diligence. The Court recognized that serious mental illness could excuse liability when a director is incapable of understanding and discharging their duties. However, Hirjee’s condition did not meet that threshold. He was still capable of overseeing the business, signing filings, and taking active steps to prevent non-remittance.

The Court emphasized that directors must take positive, preventative action to ensure statutory remittances are made, not merely rely on others’ expertise. Hirjee had exclusive signing authority over the company’s bank account, yet failed to delegate authority, appoint a replacement director, or establish a separate remittance account to ensure GST/HST funds were protected once he knew the business was struggling and that his mental health was declining. In the Court’s view, he failed to exercise the care, diligence, and skill of a reasonably prudent person in comparable circumstances. The due diligence defence, therefore, failed.

The decision reaffirms that the due diligence standard is objective. Personal attributes such as inexperience, ignorance, or diminished capacity do not excuse a director’s obligations unless they render the individual truly incapable of fulfilling them.

Conclusion

The due diligence defence is a narrow safeguard against personal tax liability. It protects only directors who take concrete, preventative steps, not those who rely passively on others. Hamad shows how proactive leadership can succeed, while Hirjee shows that delegation without oversight is not enough. Diligence means action: stay engaged, anticipate risks, and document efforts to stay compliant.

If you are in need of a tax law lawyer, please contact Graeme Oddy at Graeme.Oddy@dsf.theleadshub.biz or by phone at 416-446-5810.

This blog was co-authored by articling student Mariem Naem.

This article is provided for general informational purposes only and does not constitute legal advice. Laws and interpretations can change, and specific circumstances may vary. Readers should consult with qualified legal counsel for advice tailored to their situation.

One of the benefits of incorporation is that it allows for the use of dividends, which can be taxed at lower rates through the dividend tax credit regime.

The plot twist? Not all dividends are made equal. Dividends are taxed at differing rates depending on their type, and misclassifying the kind of dividend you declare can quickly land you in hot water with the Canada Revenue Agency (“CRA”).

As such, it is crucial that business owners know the differences in types of dividends and plan dividend issuance strategies accordingly.

The Benefit of Dividends – Dividend Tax Credits

Individuals must report the full amount of dividends received from a taxable Canadian corporation as per sections 82(1)(a) and (a.1) of the Income Tax Act (the “ITA”). Then, the ITA applies a “gross up” amount, which artificially inflates the dividend to approximate the corporation’s pre-tax income before it was distributed. Section 121 of the ITA then applies a credit equal to the “gross up” in order to avoid double taxation on the individual. A deep dive into the dividend tax credit mechanism was previously discussed here.

There are two broad categories of taxable dividends: eligible and non-eligible dividends. The difference has a significant impact on the gross up rate. Per section 82(1)(b) of the ITA, eligible dividends receive a 38% gross up, while non-eligible dividends receive a 15% gross up.

Designating a Dividend

Whether dividends are eligible or non-eligible depends on the type of corporation paying them and whether the income was taxed at the small business deduction rate or the general corporate rate.

It is the responsibility of the corporation’s directors to declare the type of dividend being paid. This declaration will inform shareholders how to report the dividend, and which gross up rate applies on their tax returns.

Non-Eligible Dividends

Any investment income earned within the corporation and any active business income earned within the small business deduction limit (which is $500,000.00 in Ontario, as of 2025) gives rise to non-eligible dividends. The latter depends on whether the corporation is a Canadian Controlled Private Corporation (“CCPC”), which is a designation given to small, privately held businesses controlled by Canadian residents.

Eligible Dividends

Any income earned over the small business deduction limit allows corporations to declare eligible dividends. For instance, CCPCs may declare eligible dividends on any business income earned over $500,000.00, since income that exceeds that small business deduction limit is taxed at the general corporate rate.

All shareholders receiving an eligible dividend must be notified in writing at the time of payment. Public corporations are required to release a general statement that their dividends are eligible; either through their corporate website, in financial reports, or in other shareholder publications. Non-public corporations, such as CCPCs, have an additional obligation in that they must notify each shareholder specifically, by letter, cheque stub, or in its minutes if all shareholders are directors.

Punitive Tax

Under section 185.1 of the ITA, if a corporation incorrectly designates a dividend as eligible, it can face a 20% tax penalty on the amount of the error. This creates a strong incentive for corporations to be precise when deciding how to classify their dividends.

LRIP and GRIP

To keep track of which income gives rise to non-eligible versus eligible dividends, corporations maintain two balances of income: the Lower Rate Income Pool (“LRIP”) and the General Rate Income Pool (“GRIP”). LRIP must first be depleted by issuing non-eligible dividends before GRIP can be used for eligible dividends, otherwise there will be a penalty tax.

LRIP is a balance that is continuously adjusted throughout the year.

GRIP is determined at the end of a tax year and includes last year’s dividends. As such, there is a bit more nuance because at one point in the year, a dividend may exceed the GRIP and therefore be excessive, but may no longer be excessive at the end of the year. To avoid punitive tax, it is important for CCPCs to calculate their GRIP balance, and for non-CCPCs to calculate their LRIP balance. Otherwise, there may be excessive elections.

Capital Dividends

Eligible and non-eligible dividends are taxable. Capital dividends on the other hand, are 100% tax-free when properly declared and the shareholder can receive these amount with no personal tax liability.

CCPCs are the only corporations that have the advantage of claiming capital dividends.

Capital dividends are paid out from the capital dividend account (“CDA”) which tracks certain tax-free amounts such as the non-taxable portion of net capital gains, capital dividends received from other corporations, the non-taxable portion of gains on eligible capital property, and net life insurance proceeds.

The corporation must elect to treat the dividend as a capital dividend. The election must be made on time and in the prescribed form. If elections are made improperly or in excess of the amount in the CDA, a 60% penalty tax will be imposed.

Business Planning

Understanding the different types of dividends allows a corporation to strategically maximize shareholder confidence through smart tax planning. By taking advantage of capital dividends and non-eligible dividends first, then using the GRIP to pay eligible dividends, businesses can avoid penalty taxes, and individual shareholders can take advantage of dividend tax credits or tax-free income in the case of capital dividends. It is important to consult with a tax planning lawyer to learn about your options.

Have further questions? Contact our tax planning lawyer

Alex Shchukin is a Toronto lawyer in our commercial litigation team and has expertise in a broad range of commercial litigation and related matters. Alex can be reached at alex.shchukin@dsf.theleadshub.biz and/or 416-446-5099.

This blog was co-authored by articling student Mariem Naem.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs.”

As we move from warm cottage weather to the colder gusts of wind and eventual snowfalls that are non-negotiable staples of the Canadian climate, many retirees gear up to migrate temporarily across the border to escape the cold.

These retirees, informally known as “snowbirds”, are individuals who reside in Canada for the majority of the year, and then reside temporarily in places like the southern United States for the rest of the year.

As such, it is crucial that snowbirds (and other temporary relocators) consider the impact of the Income Tax Act (the “ITA”) on questions of residency and taxation of income.

Different Types of Residents and Non-Residents

Under Canadian tax law, you can be a factual resident, a deemed resident, or a common law resident.

A factual resident is someone who has significant residential ties with Canada, which, among other things, includes having a residence in Canada, a spouse in Canada, and/or dependants in Canada.

A deemed resident, per section 250(1)(a) of the ITA, is someone who lived in Canada during the tax year for 183 days or more in a calendar year.

When an individual has connections both inside and outside Canada, and the deemed residency rules fail to provide a clear answer, the common law can be used to determine whether an individual can be considered a resident of Canada for tax purposes. This is referred to as being a “common law resident.”

The leading common law guidance on questions of residency is Thomson v. Ministry of National Revenue, which stands for the proposition that residency is determined by examining whether an individual maintains a “settled connection” or “continuing state of relationship” with Canada.

Common law residency is also supported by the Canada Revenue Agency’s (“CRA”) Income Tax Folio S5-F1-C1, which outlines key factual indicators that can be used to establish common law residency.

For snowbirds, the categorization is mostly clear: snowbirds are, by and larg,e residents of Canada and therefore will have Canadian tax rules apply to their worldwide income. However, it is not out of the realm of possibility that snowbirds may sometimes be non-residents.

Non-residents are normally, customarily or routinely living in another country and not considered residents of Canada. They lack significant residential ties to Canada because they lived outside the country throughout the tax year or stayed in Canada for less than 183 days. Non-residents of Canada are only taxed on Canadian-source income.

Taxation of income becomes more intricate for both residents and non-residents once passive income is involved.

Taxation of Passive Income

Passive income refers to any income that a person earns without actively participating in the business or activity that generates it. This can include investment income, rental income, capital gains, dividends, and pensions.

For residents, taxation of passive income earned in Canada is straightforward: all of it is reported on the Canadian tax return. This includes income earned abroad, for example, when snowbirds rent out a property they own in Florida, when they are not occupying the premises.

For non-residents, taxation of passive income becomes more nuanced in that it then follows the procedures set out under Part XIII of the ITA. All passive income earned by non-residents is subject to a 25% withholding tax, per section 212(1). This means that as a non-resident, 25% of your Canadian passive income is withheld and sent to the CRA before you receive it. Other countries use the same mechanism; for example, the United States has a withholding tax rate of 30%.

Treaty with the United States to Reduce Withholding Tax

Recognizing that withholding tax rates can be excessive when applied on top of regular individual progressive tax rates, the Canadian government entered into bilateral tax treaties with other countries, including the United States, to reduce overall tax liability owed for cross-border residents.

For example, if you are a Canadian resident who owns property in Florida that earns rental income, not only will you owe taxes to the Canadian government based on your individual progressive rate, but also to the United States at its 30% withholding tax rate. This exposes you to unreasonable double taxation.

The bilateral treaty steps in to address and eliminate this problem.

Article XXIV of the United States bilateral treaty applies to ensure that Canada provides you with a foreign tax credit for the 30% tax paid to the United States. As a result, you will only be liable for Athe merican tax rate.

Following our previous example, this would mean that your rental income earned will be taxed by the United States at 30%, but the individual progressive rate taxes you owe Canada will be offset by the foreign tax credit, effectively cancelling out your Canadian tax liability.

You can also make certain elections to the CRA or Internal Revenue Service in the United States to reduce your tax liability even further, depending on your circumstances.

Understanding your Canadian tax residency status and the protections afforded by bi-lateral tax treaties is essential for snowbirds and other individuals with cross-border ties. With strategic tax planning, you can minimize the risk of double taxation, ensure compliance on both sides of the border, and make the most of your retirement or investment income abroad.

Have further questions? Contact our tax planning lawyer

Alex Shchukin is a Toronto lawyer who joined the commercial litigation team at Devry Smith Frank in 2025 and has expertise in a broad range of commercial litigation and related matters. Alex can be reached at alex.shchukin@dsf.theleadshub.biz and/or 416-446-5099.

This blog was co-authored by articling student Mariem Naem.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs.”

As a small Canadian business owner, you may be paying unnecessary additional tax on business income.

Your corporation earns income and may distribute dividends, if it is profitable, to its shareholders (including you), which you then have to pay individual tax on, creating a double taxation problem. You pay tax twice on the same income; once at the corporate flat rate, and again at the progressive individual rate.

Recognizing the problem, the government created specific mechanisms and schemes that you can take advantage of through strategic tax planning to effectively help you avoid double taxation, save money, and reduce unnecessary tax burdens.

Taking advantage of these mechanisms, such as paying yourself in dividends rather than by salary or retained earnings, can help you save money long term, especially if you are a small Canadian business owner.

What is Double Taxation?

Shareholders are taxed at an individual level based on progressive tax rates set out by the federal and provincial governments.

Progressive tax rates rely on a “bracket system” which divides income into portions, and each portion is taxed at a specific rate, similar to climbing stairs. As your income increases, each new portion is taxed at a higher rate, but the lower rate still applies to the earlier portions. For example, federally, the first $57,375 of your income will be taxed at 14.5%. The next portion, income between $57,375 and $114,750, is taxed at 20.5%. The brackets keep rising on any income earned above that threshold, up to $253,414.

Conversely, as a small Canadian business owner, when your corporation earns income, it is taxed on that income at a corporate flat rate. Subsequently, when you distribute the net profits as dividends to yourself as the sole shareholder, those dividends will be subject to your individual progressive tax rate. The same income is being taxed twice. This is referred to as “Double Taxation”.

To demonstrate how double taxation operates, assume you own a corporation that earns $1,000, you are the sole shareholder of the corporation, the corporation is taxed at a flat rate of 20%, you are personally taxed 19.55% for any amounts $52,886 or less, and this is your sole source of income.

The full amount of $1,000 will be declared as income by the corporation, meaning 20% will be paid in corporate tax, leaving the corporation with $800. This $800 is referred to as retained earnings or “after-tax dollars”. If the $800 is distributed as salary, you, as the shareholder, now have to pay 19.55% tax on the $800 you receive, leaving you with a net profit of $643.60 and a $156.40 tax liability.

The same income of $1,000 is getting taxed twice; once at the corporate level for 20%, and then again at the individual level at 19.55%. You, as both an individual and shareholder, have paid a total of $356.40 in taxes on income of $1,000.

If, however, you were operating the business as a sole proprietorship and not through a corporation, that same $1,000 would be taxed at 19.55%, leaving you with $804.50 profit.

Double taxation, therefore, disincentivizes individuals from creating and operating Canadian small businesses because it results in a higher tax burden, making it more financially attractive to earn income personally than to earn it through a corporation.

The government has various policy interests in encouraging individuals to start corporations, including economic growth. Thus, in response, the government created a compensation scheme between individuals and corporations to integrate their taxes at the corporate and individual level so that the taxes paid would equal what an individual alone would pay (“Integration”).

Small Canadian-owned businesses, formally called Canadian Controlled Private Corporations (“CCPC”), particularly benefit from the Integration scheme because they are offered significantly lower corporate flat rates and small business deductions, tax-free dividends, and other mechanisms that result in maximum after-tax income.

Integration – The Government’s Scheme to Prevent Double Taxation

Integration involves a 3-step process to ensure that double taxation is prevented.

First, when a corporation distributes its after-tax dollars as dividends, the shareholder will declare a “gross-up” on those dividends. A gross-up is an artificial increase in the amount of a dividend to approximate what the corporation earned before taxation. For a CCPC, the gross up, according to the Income Tax Act, is 15%. Any dividend you receive will be increased by 15% to determine how much your dividend needs to be “grossed up” or boosted. This is purely for calculation purposes and does not reflect the amount actually earned from a dividend.

Second, the shareholder pays taxes on the grossed-up amount at their progressive federal and provincial rate.

Third, the shareholder will be entitled to a dividend tax credit, equal to the gross-up amount, which reverses the artificial increase and ensures that the personal tax owed reflects the corporate tax that was paid.

Following our previous example, if the corporation had $800 to distribute as dividends, following the 20% corporate tax taken off from the $1,000 income, you, as the shareholder, would report $920 on your personal tax return, not $800. The dividend has been “grossed up” by $120 to mimic the corporation’s pre-tax earnings. At a personal tax rate of 19.55% for any amounts $52,886 or less, $179.86 in taxes is owed.

However, the dividend tax credit (equal to the gross-up of $120) reduces personal tax liability and reverses the artificial increase the gross-up caused. Ultimately, $59.86 will be taxed.

Altogether, the Integration scheme results in the shareholder paying $59.86 in tax, as opposed to $156.40 without the Integration scheme. The tax payable will be lower than what an individual is likely to pay personally, thereby addressing the problem of double taxation and making incorporation a more enticing option for small Canadian business owners.

The Benefits of Paying Yourself through Dividends

Depending on the state of your business, paying yourself in dividends rather than by salary can help reduce your overall tax burden and leave more after-tax dollars in your pocket.

In addition to tax savings and reduced administrative burdens on your corporation, dividends can also be the most flexible option when withdrawing income from your business, if you have any profits.

Have further questions? Contact Us.

Alex Shchukin is a Toronto lawyer who joined the commercial litigation team at Devry Smith Frank in 2025 and has expertise in a broad range of commercial litigation and related matters. Alex can be reached at alex.shchukin@dsf.theleadshub.biz and/or 416-446-5099.

This blog was co-authored by articling student Mariem Naem.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs.”

When selling a business, there are assets like property tied to the business, and as such, it may seem logical to just sell the property. After all, many businesses own the property where their physical storefront operates, be it owned outright or under mortgage(s). However, with careful tax planning based on share sales of qualifying small business shares and the consequent application of the lifetime capital gains exemption, business owners can nullify the tax consequences related to the sale of a business. This planning depends on a few key considerations.

The Tax Outcome of a Sale – Capital Gains and Losses

Upon any sale, the proceeds of what is being sold may be more than what was originally paid, in addition to how much it cost to make that investment; this is what is referred to as a “capital gain”.

In the inverse, the proceeds may be less than what was originally paid, in addition to how much it cost to make that investment; this is what is referred to as a “capital loss”.

These concepts are important because they have significant tax consequences: capital gains over $250,000 are currently taxed at 50% (with the rate to jump to 66.6% on January 1, 2026^[i]), while capital losses are a bit more nuanced. Capital losses, in the year that they are applied to reduce taxable capital gains, will then become net capital losses if there are more capital losses than can be applied to taxable capital gains for that year. These net capital losses then become essentially permanent reserves that can be accessed to offset future (or even past) taxable capital gains. Net capital losses can offset any previous 3 years’ taxable capital gains, or indefinitely into the future^[ii].

Essentially, you either pay taxes, reduce your taxes, and/or create a bank of losses to apply against future taxes.

Offsetting Capital Gains – Share Sale and Lifetime Capital Gains Exemption

Rather than selling assets, a potentially more effective way of selling a business, depending on prior business organization planning, would be to sell the shares of the business, rather than the assets. As opposed to selling the assets, selling the shares would transfer not only the assets, but also the liabilities of the transferor to the transferee, which may make winding up a business much less of a hassle in the long run^[iii].

Not all businesses operate under share structures, and typical “mom and pop” shops may operate as sole proprietorships. Businesses that operate under share structures who decide to go through a share sale might find themselves reaping the benefits of the lifetime capital gains exemption. A lifetime capital gains exemption is an exemption on capital gains for a specified amount throughout the lifetime of the individual claiming it^[iv]. As of July 31, 2025, the lifetime limit is $1,250,000 for qualifying sales, which, for many small businesses winding up, is essentially a complete shield against taxable capital gains^[v]. This is even more pertinent in times where the capital gains tax rises, as it is planned to in 2026.

The Test to Apply the Lifetime Capital Gains Exemption

The test to qualify for the lifetime capital gains exemption applying following a share sale, while fairly strict, is, at its core, not particularly difficult for small Canadian businesses to meet. Per section 125(7) of the Income Tax Act (the “ITA”), the corporation must be what is known as a “Canadian-controlled private corporation” or “CCPC”^[vi]. This is effectively a private Canadian corporation other than a corporation controlled by right or, in effect, by non-residents or public corporations. More specifically, the key trait of a CCPC is that it is not foreign-controlled, meaning 50% or more of the shares must be held by Canadian residents, and it cannot be controlled in effect by non-residents^[vii].

The other part of the test is to determine whether the shares disposed of qualify as qualifying small business corporation, or “QSBC”, shares. Per section 110.6(1) and section 248(1) of the ITA, QSBC shares exist, at determination time, when a CCPC has at least 90% of its fair market value of assets attributed to being used mainly in an active business carried on primarily in Canada by the corporation or a related corporation, among two other situations; however, this is the most prevalent amongst CCPCs and thus deserves particular attention^[viii]. Otherwise, there is a requirement of continuous ownership by the individual or a related person throughout the prior 2 years, and a requirement of more than 50% fair market value of assets attributed to assets used principally in an active business carried on primarily in Canada by the corporation or related corporation throughout the prior 2 years. The latter requirement may seem redundant, but it exists to prevent businesses from aggressively disposing of passive assets right before a share sale to qualify as disposing of QSBC shares.

As such, one of the more common ways to disqualify a business for QSBC share status and consequently the lifetime capital gains exemption is based on what assets are being used by the business; there needs to be a concerted effort to extract passive assets from the business.

A tax planning lawyer can help with that and explain in more detail all the nuances of these tax designations and the potential benefits and risks. If there is one key message to be imparted, it is that it is never too early to start tax planning.

Have further questions? Contact our tax planning lawyer.

Alex Shchukin is a Toronto lawyer who joined the commercial litigation team at Devry Smith Frank in 2025 and has expertise in a broad range of commercial litigation matters. Alex can be reached at alex.shchukin@dsf.theleadshub.biz and/or 416-446-5099.

This blog was co-authored by summer law student Muskan Agrawal.

 “This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs.”  

[i] Scotiabank. Everything you need to know about capital gains tax in Canada. https://www.scotiabank.com/ca/en/personal/advice-plus/features/posts.everything-you-need-to-know-about-capital-gains-tax-in-canada.html

[ii] Canada Revenue Agency. Line 25300- Net capital losses of other years. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-25300-net-capital-losses-other-years.html;Canada Revenue Agency. Definitions for capital gains. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/personal-income/line-12700-capital-gains/definitions-capital-gains.html

[iii] CanadiansMe. Key Considerations Before Selling Your Business: Navigating Asset Sale vs. Share Sale. https://canadiansme.ca/key-considerations-before-selling-your-business-navigating-asset-sale-vs-share-sale/

[iv] CPA. Claiming the lifetime capital gains exemption on holding company shares. https://www.bccpa.ca/news-events/cpabc-newsroom/2022/november/claiming-the-lifetime-capital-gains-exemption-on-holding-company-shares/

[v] BMO. Lifetime Capital Gains Exemption demystified: Strategies for maximizing your gains. https://privatewealth-insights.bmo.com/en/insights/wealth-planning-and-strategy/lifetime-capital-gains-exemption-demystified-strategies-for-maximizing-your-gains/ ; Government of Canada. Line 25400- Capital gains deduction. https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-25400-capital-gains-deduction.html

[vi] Income Tax Act, RSC 1985, c 1 (5^th Supp), s 125(7).

[vii] Government of Canada. Type of corporation. https://www.canada.ca/en/revenue-agency/services/tax/businesses/topics/corporations/type-corporation.html

[viii] Income Tax Act, RSC 1985, c 1 (5^th Supp), s 110.6(1), 248(1);    Small Business Corporation (SBC), Practical Law Canada Glossary 2-569-6220.

Cryptocurrency (or crypto) has become increasingly popular in recent years, with more Canadians investing in digital currencies like Bitcoin, Ethereum, and others. Nevertheless, with this popularity comes a range of complex legal and tax-related questions. One of the most common questions that crypto investors and traders in Canada face is whether the profits from their crypto transactions should be reported as capital gains or business income. 

How Does the Canada Revenue Agency Define Cryptocurrency? 

First and foremost, in any legal or tax-related question, it is advisable to search and understand the definition of the term as defined by the appropriate authority. This way, when reading an income tax folio or an interpretation bulletin from the Canada Revenue Agency (“CRA”), all specific terms are defined and locating the appropriate rules and explanations is more accurately achieved.  

Notably, however, for the term “cryptocurrency”, the CRA merely provided reference information for the public to simply understand the term, rather than assigning a specific definition to be strictly followed. Also importantly, crypto-assets such as cryptocurrencies are not necessarily securities for income tax purposes. What this means is that there is much open to interpretation, and an accounting or legal expert may be best suited to interpret a client’s tax filing needs and concerns. 

The CRA understands cryptocurrencies to be “crypto-assets that are designed to function as a medium of exchange. They can be used to buy products or services, traded for other currencies, or acquired for speculative purposes. Unlike traditional currencies, cryptocurrencies are not controlled by centralized entities such as central banks.” 

Crypto-asset “can generally be described as a digital representation of value that relies on a cryptographically secured distributed ledger, or a similar technology, to validate and secure transactions. Common examples of crypto-assets include, but are not limited to: 

• cryptocurrencies (payment/exchange tokens); 

• utility tokens; 

• security tokens; and 

• non-fungible tokens (NFTs).” 

Understanding Capital Gains vs. Business Income 

Before diving into the specifics of cryptocurrency transactions, it is important to understand the basic difference between capital gains and business income. 

• Capital Gains: These are profits you earn when you sell an asset, such as property or stocks, for more than what you paid for it. In Canada, you only pay tax on 50% of your capital gains. This is typically applicable to investments you buy and hold with the intention of selling them for profit later. 

• Business Income: This refers to profits earned from an active business activity. In the context of crypto, if you are regularly buying and selling cryptocurrency as part of a business operation, then the profits from these activities are considered business income, and you may be taxed differently than on capital gains. 

So, What Is the Difference in the Context of Crypto in Canada? 

For crypto in Canada, the difference between capital gains and business income often comes down to your intention and your course of conduct, such as how frequently you are buying and selling cryptocurrencies. 

• Capital Gains: If you buy cryptocurrency as an investment and hold onto it for a long time before selling, you are likely dealing with capital gains. This situation is similar to someone buying stocks or real estate with the goal of holding onto it for future appreciation. The CRA tends to view this as an investment activity, and any profits from these sales would likely be considered capital gains. 

• Business Income: If you are frequently buying and selling cryptocurrencies, or if you are using crypto for more active purposes (like mining or trading as part of your business), then the CRA might consider this to be business activity. In this case, any profits would be considered business income, and you would be subject to regular income tax rates, which could be higher than capital gains tax rates (i.e. 100% of business income is taxable). 

How Does the CRA Decide? 

The CRA does not have a one-size-fits-all answer, and determining whether your crypto activity falls under capital gains or business income depends on the facts and circumstances of your case. The CRA looks at factors such as: 

1. Frequency of Transactions: If you are buying and selling crypto often, it is more likely to be considered business income. For example, if you are trading crypto daily or weekly, the CRA may view this as a business activity. 
2. Intention and Period of Ownership: Did you buy the cryptocurrency with the intent to hold it as an investment, or were you planning to sell it quickly for a profit? If your primary goal is long-term investment, it may lean toward capital gains. But if you are buying and selling for quick profits, it may be considered business income. 
3. Expertise and time spent: If you have specialized knowledge or skills related to cryptocurrency, such as being a professional crypto trader and/or much of your time is spent studying the market and investigating potential purchases, it could be more likely considered business income.  
4. Regularity and Organization: If you are carrying out your crypto transactions in a structured and organized way, similar to how a business operates, this could also indicate that your activity is more business-oriented. 
5. Advertising: If you advertised or otherwise made it known that you are willing to purchase cryptocurrencies, then your course of conduct could be considered business income as well. 

The above list is not exhaustive, and the CRA could factor in other things as well, such as financing for the crypto transaction(s) and more. 

What Should You Do? 

As a crypto investor in Canada, it is crucial to properly report your crypto activities on your taxes. The CRA expects you to keep records of all transactions, including dates, amounts, and the value of crypto in Canadian dollars at the time of the transaction. 

If You Are a Casual Investor: If you are buying and holding crypto as a long-term investment, it is likely you will report your profits as capital gains. Remember, you only pay tax on 50% of the capital gains, which can be a more tax-friendly approach than reporting business income. 

If You Are an Active Trader or Miner: If you are actively trading or mining crypto, then it is more likely that you will need to report your earnings as business income. This means you will be subject to regular income tax rates. 

Consult a Tax Professional: Since the CRA looks at each situation individually, it is always a good idea to consult a tax professional who can help you determine whether your crypto transactions should be classified as capital gains or business income. 

Conclusion 

The key takeaway here is that whether your crypto profits are considered capital gains or business income depends largely on how you engage with crypto. If you are holding your cryptocurrency as an investment for the long term, capital gains likely apply. If you are buying and selling frequently or treating your crypto activity as a business, then business income may be the appropriate classification. 

Remember, the CRA has specific guidelines for different types of transactions, so make sure you report your earnings correctly to avoid any issues down the line. Again, with cryptocurrencies, the CRA guidelines are not as clear-cut, and every person’s dealing with cryptocurrencies may vary. 

If you are unsure about how to handle your taxes, it is always best to consult with a tax expert familiar with cryptocurrency laws. Call our tax lawyer, Graeme Odd,y at 416-446-5810 or email at graeme.oddy@dsf.theleadshub.biz. 

This article was co-authored by Articling Student, Sanaz Sakhapour. 

This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique, and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situations and needs. 

On June 28, 2024, the Supreme Court of Canada released its decisions in Dow Chemical Canada ULC v. Canada[1] and Iris Technologies v. Canada,[2] which addressed the question of jurisdiction in tax matters.

Tax Jurisdiction in Canada

Two courts in Canada have jurisdiction to hear tax matters: the Tax Court of Canada (“Tax Court”) under the Tax Court of Canada Act, R.S.C. 1985 c. T-2 and the Federal Court under the Federal Courts Act, R.S.C. 1985, c. F-7 (“FCA”).

The Tax Court has jurisdiction over various tax matters, including under the Income Tax Act, R.S.C., 1985, c. 1 (5^th Supp.) (“ITA”) and Excise Tax Act, R.S.C., 1985, c. E-15 (“ETA”), dealing with the Goods and Services Tax (“GST”). The Tax Court has exclusive jurisdiction over the correctness of tax assessments under the ITA and ETA  and has jurisdiction to hear appeals and references regarding tax matters. However, the Tax Court has limited remedial powers; it cannot provide administrative law remedies and can only remit a decision back to the Minister of National Revenue (the “Minister”) for reconsideration.

The Federal Court has jurisdiction to judicially review decisions from federal boards and tribunals, including discretionary decisions made by the Minister regarding tax matters. However, the Federal Court does not have jurisdiction to hear appeals of tax assessments or other non-discretionary decisions relating to tax matters. Unlike the Tax Court, the Federal Court has broad remedial powers, may grant administrative law remedies, and can compel the Minister to take, or refrain from taking, certain actions.

Dow Chemical Canada ULC v. Canada

Facts

In Dow Chemical, Dow Chemical Canada ULC (“Dow”) entered into a non-arm’s length loan agreement with a related Swiss company. As a result, Dow incurred expenses for its 2006 and 2007 taxation years and reported income for the 2006 taxation year in respect of the toll manufacturing services it provided to the Swiss company.

Following a review of the transactions between Dow and the Swiss company, the Minister reassessed Dow for its 2006 taxation year, applying the transfer pricing rule set out in s. 247(2) of the ITA and significantly increasing Dow’s income for that year. Section 247(2) states that where a taxpayer is dealing with a non-arm’s length and non-resident person, the amounts in a given transaction will be adjusted to reflect what would have been agreed to if the person was at arm’s length.

Dow requested that the Minister use her discretion under s. 247(10) of the ITA to make a downward transfer pricing adjustment. Section 247(10) provides that where an amount is identified that would decrease the taxpayer’s income, a downward adjustment cannot be made unless the Minister decides that the circumstances are appropriate. Here, the Minister refused. Dow sought judicial review of the Minister’s discretionary decision in the Federal Court and appealed the 2006 reassessment to the Tax Court.

In the appeal for reassessment, the parties referred a question of law to the Tax Court:

“Where the Minister of National Revenue has exercised her discretion pursuant to subsection 247(10) of the Income Tax Act (“ITA”) to deny a taxpayer’s request for a downward transfer pricing adjustment, is that a decision falling outside the exclusive original jurisdiction granted to the Tax Court of Canada under section 12 of the Tax Court of Canada Act and section 171 of the ITA?”[3]

The Tax Court determined that the Minister’s discretionary decision under s. 247(10) was a necessary component of the tax assessment, and thus could be reviewed by the Tax Court under their jurisdiction to review the correctness of assessments. The Federal Court of Appeal allowed the appeal, stating that the Federal Court had exclusive jurisdiction to judicially review discretionary decisions by the Minister under s. 247(10).

Decision

In a 4-3 majority, the Supreme Court of Canada dismissed the appeal.

Justice Kasirer, writing for the majority, noted that a decision under s. 247(10) is distinct from a tax assessment; a “tax assessment” is “a purely non-discretionary determination by the Minister of the taxpayer’s tax liability for a particular taxation year.”[4] In contrast, a decision under s. 247(10) allows for discretion and is “based on policy considerations rather than the strict application of the law to the facts.”[5] If the Court accepted Dow’s proposed expanded definition of “assessment,” which would include discretionary decisions that it claims are directly linked to assessments, this would create significant legal uncertainty.[6] Accordingly, challenges to the Minister’s discretionary decisions must be heard by the Federal Court.

Justice Kasirer then turned to the issue of remedies. Dow sought an order for reconsideration and reassessment; however, such an order cannot compel the Minister to reconsider her discretionary decision under s. 247(10) because the decision was not an assessment nor part of one. In contrast, the Federal Court has access to administrative law remedies; the Federal Court may grant a declaration to quash the Minister’s discretionary decision under s. 247(10) upon a judicial review of the decision. The Minister then will have to reconsider and possibly issue a new decision, which may affect the amount of tax owing and thus impact the correctness of the assessment, which is reviewable by the Tax Court.[7] As such, there may be an occasion where a matter will proceed under the jurisdiction of both courts.

Iris Technologies v. Canada

Facts

Iris Technologies Inc. (“Iris Technologies”) filed GST returns claiming tax refunds under the ETA. The Minister audited the reporting periods and issued assessments disallowing some of the tax credits claimed and imposing penalties.

Iris Technologies applied for judicial review of the Minister’s assessment in the Federal Court. Iris Technologies sought three declarations:

1. The Minister failed to afford procedural fairness in the audit and failed to provide Iris Technologies with an opportunity to respond to the proposed adjustments;
2. The assessments were made without evidentiary foundation and were contrary to findings of fact made by the Minister; and
3. The assessments were made for the improper purpose of seeking to deprive the Federal Court of the jurisdiction in a related application.[8]

The Attorney General moved to strike the application for judicial review. The prothonotary dismissed the motion, stating that the application was not bereft of any chance of success. The Federal dismissed the Attorney General’s appeal. The Federal Court of Appeal allowed the appeal and struck out the application on the grounds that it was, essentially, a collateral challenge to the correctness of an assessment, which is a matter within the exclusive jurisdiction of the Tax Court.

Decision

The Supreme Court of Canada unanimously dismissed the appeal and granted the Attorney General’s motion to strike the application. The Court agreed that the Federal Court lacked jurisdiction to hear the first two of Iris Technologies’ claims. For the third claim, all agreed that it should be struck, but were split 4-3 on the reason for doing so.

Justice Kasirer, writing for the majority, confirmed that, notwithstanding the issuance of a tax assessment, the Federal Court has exclusive jurisdiction to conduct judicial review of the Minister’s discretionary decisions, including those that directly impact tax liability.[9] The Federal Court has jurisdiction to hear applications for judicial review under section 18.1 of the FCA. Section 18.5 of the FCA provides an exception to this jurisdiction if Parliament expressly provides an appeal to another court; s. 302 of the ETA provides taxpayers an opportunity to appeal the correctness of tax assessments to the Tax Court.[10] Here, a tax assessment under the ETA is not a discretionary power; it is a non-discretionary determination where the outcome is dictated by statute.[11]

The first two claims alleged by Iris Technologies regarding procedural unfairness and lack of an evidentiary foundation for the assessment were within the jurisdiction of the Tax Court. Justice Kasirer determined that “they are best characterized as attacks on the correctness of the assessment which is the proper subject matter of an appeal to the Tax Court.”[12] As the Tax Court has exclusive jurisdiction over challenges to the correctness of assessments per s. 302 of the ETA, s. 18.5 of the FCA applies and ousts the Federal Court’s jurisdiction.[13]

While the third claim alleging that the Minister acted with an improper purpose could fall within the jurisdiction of the Federal Court, Justice Kasirer determined that it should be struck. Iris Technologies did not allege facts that, if assumed to be true, would give any support to the claim. Iris Technologies did not demonstrate any motive or conduct of the Minister besides to allege that the assessment was issued to deprive the Federal Court of jurisdiction in a related proceeding. Justice Kasirer rejected this argument; the mere fact that an assessment was issued does not oust the Federal Court’s jurisdiction. If the true purpose of the application is to seek practical relief against the exercise of ministerial discretion, the bar in s. 18.5 of the FCA does not apply and the Federal Court retains jurisdiction.[14]

In obiter, Justice Kasirer also stated that the declaratory relief sought by Iris Technologies would have no practical effect.[15] A declaration will only be granted if it will have practical utility and settle a ‘live controversy’ between the parties.[16] Here, the declaration would not quash or vacate the assessments; as such, it would serve little to no purpose.

The State of Tax Jurisdiction Post Dow Chemical and Iris Technologies

These decisions demonstrate several important principles for determining jurisdiction for tax matters:

• Appeals of tax assessments, which are objective and non-discretionary, are properly the jurisdiction of the Tax Court.
• In contrast, appeals involving discretionary decisions made by the Minister, including whether to make a downward adjustment under s. 247(10) of the ITA, must proceed via a judicial review application in the Federal Court.
• However, if a discretionary decision involves a tax assessment, the decision in Dow Chemical indicates that it may be necessary to seek relief in both the Federal Court and Tax Court.
• The Tax Court does not have jurisdiction in an application for judicial review where the true purpose of the application is to seek practical relief against the exercise of ministerial discretion. In such circumstances, s. 18.5 of the FCA ousting Federal Court jurisdiction does not apply and the Federal Court retains jurisdiction over the matter.

While it remains important for taxpayers to commence proceedings in the proper jurisdiction, the question of jurisdiction remains murky and unclear. This is particularly true for cases such as Dow Chemical which may require a taxpayer to seek a remedy in both the Federal Court and Tax Court. In Dow Chemical, Justice Kasirer noted that “Parliament has turned its mind to the difficulties that arise from the fractured jurisdiction of the Tax Court and the Federal Court over tax matters…In my view, it falls to Parliament to respond, if appropriate, to the[se] concerns.”[17] While we await further clarification from Parliament, the jurisdictional debate will continue to plague taxpayers and tax lawyers alike.

The line of cases underscores the importance of commencing tax litigation in the correct jurisdiction. If you have a tax matter, please reach out to our Toronto tax lawyer by calling 416-449-1400 or emailing info@dsf.theleadshub.biz to schedule a consult.

This article was co-authored by Articling Student, Leslie Haddock.

This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.

[1] Dow Chemical Canada ULC v Canada, 2024 SCC 23 [Dow Chemical].

[2] Iris Technologies Inc. v Canada, 2024 SCC 24 [Iris Technologies].

[3] Dow, supra at para 17.

[4] Ibid at paras 41-43.

[5] Ibid at para 50.

[6] Ibid at paras 57 and 78.

[7] Ibid at paras 104-107.

[8] Iris Technologies, supra at para 16.

[9] Ibid at para 7.

[10] Ibid at paras 33-34.

[11] Ibid at para 7.

[12] Ibid at para 10.

[13] Ibid at paras 37-38.

[14] Ibid at paras 41-44.

[15] Ibid at para 57.

[16] Ibid at para 58, citing Daniels v Canada (Indian Affairs and Northern Development), 2016 SCC 12 at para 11.

[17] Dow, supra at paras 114-115.

The saying remains true. There are two things you cannot avoid in life: death and taxes. The Supreme Court of Canada (“SCC”) recently released a huge judgment on the case of Deans Knight Income Corp. v. Canada, reiterating one of the most important principles of Canadian tax law: the general anti-avoidance rule (“GAAR”).

Background

The following sections of the Income Tax Act were at issue in this case:

• 111(1)(a), which “allows non-capital losses to be carried back 3 years or carried forward 20 years in order to offset income in those years”; and
• 111(5), which has the following limiting effect on the above à “if control of the corporation has been acquired, non-capital losses from before the acquisition cannot be carried over, unless the corporation continues the same or similar business that incurred the losses”.[i]

In 2008, a venture capital company called Matco entered into an investment agreement with a struggling corporation, Deans Knight Income Corporation (“DKIC”) (F.K.A. Forbes Medi-Tech) whereby the former seized control of the latter, restructured it, renamed it, and changed its business operations. Deans Knight Capital Management (“DKCM”) was then brought in by Matco to use DKIC as a corporate vehicle for a stock launch by using its Tax Attributes. The effect of these transactions was the creation of a loophole, offsetting non-capital losses as in s.111(1)(a) of the Income Tax Act, thereby gaining a substantial tax break without triggering the limitation under s.111(5).

Though the transactions were highly complex, their essence and goal was tax avoidance. Corporate transactions motivated in this way are subject to certain specific rules against avoidance. S.111(5) is a prime example of a specific anti-avoidance rule. But since it was not triggered by way of a highly convoluted loophole created by DKIC, the SCC held that the GAAR kicks in to nip the avoidance in the bud.

What is the GAAR?

Section 245 of the Income Tax Act establishes the GAAR, which serves as a “provision of last resort” against tax avoidance, penalizing offenders who abused the system without violating any specific provision of the Act.[ii] Think of the GAAR like a superhero’s sidekick. If a taxpayer can avoid a specific anti-avoidance rule through a loophole, but nevertheless engages in abusive corporate transactions, the sidekick GAAR will swoop in to save the day.

This rule is intended for situations that undermine the rationale and objective of those Income Tax Act provisions relied on by the taxpayer.[iii] The SCC reiterated the three questions courts and government officials must ask when determining whether the GAAR applies:

1. Was there a tax benefit?
2. Was the transaction giving rise to the benefit based on avoidance?
3. Was this avoidance-based transaction an abuse of the taxation system?

The SCC noted that in situations where there was a series of corporate transactions, the second question can be answered with a ‘yes’ if at least one of the transactions was for tax avoidance.[iv] The question of abuse at inquiry number three is where those evaluating corporate transactions look to the rationale behind the provision of the Income Tax Act avoided by the taxpayer.[v] If the taxpayer undermined the rationale of the provision, then the transaction was abusive and the GAAR was broken.

How did DKMI break the GAAR?

It was clear on the facts of the case that DKIC received a major tax benefit through an avoidance transaction. So, the SCC honed in on the third step of the GAAR analysis. It was through careful consideration of the “object, spirit and purpose” of s.111(5) that DKIC undermined its rationale.

Justice Rowe, writing for an eight-judge majority, explained how s.111(5) vitiates a corporate taxpayer’s ability to carry over past losses only where it has undergone a shift in control and “there is a break from the corporation’s past business”.[vi] Prior to its investment agreement with Matco, DKIC was actually a scientific research company. After Matco gained control over DKIC did DKIC switch its business dealings to the financial sector. This directly opposes s.111(5), which is meant to protect the controlling party’s interest “in strengthening the corporation’s business, rather than using the corporation as a vessel for unrelated activities that would have distorted its identity”.[vii]

There was no continuity between the identity of DKIC before and after the series of transactions with Matco and DKCM. DKIC became a corporate vessel for DKCM to use for “an unrelated venture planned by DKCM and selected by Matco”.[viii] Justice Rowe concluded that there was certainly abuse, because the impugned transactions “achieved the very result s.111(5) seeks to prevent” through a series of highly complex dealings which managed to avoid the relevant sections of the Income Tax Act.[ix]

Summary

The GAAR exists to protect the taxation system from abuse by covering up loopholes discovered by taxpayers when abiding by the terms of specific provisions found in the Income Tax Act. It is meant to be a last resort, applying only where a taxpayer successfully avoided a specific anti-avoidance rule. In DKIC v Canada, the appellant corporation engaged in a number of transactions with two other corporations, resulting in a loophole that allowed DKIC to avoid the rule under s.111(5) of the Income Tax Act. The SCC thus held that the GAAR had to apply, as this abuse undermined the rationale and objective of s.111(5). Corporations cannot stave off taxes, and by applying the GAAR, the SCC was able to hold DKIC accountable for its nefarious operations.

If you are considering a scheme that purports to provide you with a huge tax benefit, it is always worth seeking the advice of legal counsel. If you are later on found to have violated the GAAR, severe penalties and interest may apply. Contact a Toronto tax lawyer at DSF today to discuss your tax planning needs.

This article was co-authored by law student Rachel Weitz.

“This article is intended to inform. Its content does not constitute legal advice and should not be relied upon by readers as such. If you require legal assistance, please see a lawyer. Each case is unique and a lawyer with good training and sound judgment can provide you with advice tailored to your specific situation and needs.”

[i] Deans Knight Income Corp. v Canada, 2023 SCC 16 at para 2 [DKIC v Canada]

[ii] Ibid at para 62.

[iii] Ibid at para 45.

[iv] Ibid at para 55.

[v] Ibid at para 57.

[vi] Ibid at para 82.

[vii] Ibid at para 111.

[viii] Ibid at para 127.

[ix] Ibid at para 140.