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INTRODUCTION
Capital
Tax is a tax levied on corporations at the federal level and in many of the
provinces of Canada. Although the tax rates appear to be relatively small
(between 0.200% and 0.60%), the amount of corporate tax revenue generated by
this tax is substantial.
Another
factor that makes capital taxes unique from most other taxes levied in
Canada is the fact that these taxes are not based upon the profitability of
a company. Instead the tax is
based on the "taxable capital" of a company at the end of each
fiscal year, which in most cases is a much larger amount than corporate
profits on which income taxes are paid.
Further, as capital tax is not based on corporate profits, it is
possible for a company to have a capital tax liability even if the company
has losses in the current year. As
well, capital intensive industries with little or no revenue can also be
subject to these taxes. Examples of these industries include real estate
construction, pharmaceutical research and many larger startup ventures.
As noted below, various provinces and the federal government have or will be
eliminating the capital tax regime.
LIABILITY FOR CAPITAL TAX
The
discussion here is restricted to the capital tax issues of corporations that
are not financial institutions. Corporations that qualify as financial
institutions are subject to their own version of capital tax.
Capital
tax is levied by the federal and many of the provincial governments.
Corporations that have "taxable capital" of over $50 million ($10
million prior to 2004) in Canada are subject to the federal version of
capital tax, called Large Corporations Tax (LCT). The provinces of
Saskatchewan, Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia each
charge their own provincial capital tax. The provinces of Alberta, British
Columbia, Prince Edward Island and Newfoundland do not currently levy a
provincial capital tax on companies that are not financial institutions. As
well, the Yukon Territory, Northwest Territories and Nunavut do not
currently levy a capital tax.
The
February 18, 2003 federal budget proposed to eliminate the federal capital
tax (Large Corporation Tax) over five years. The phase-out began for
taxation years ending after 2003, and the tax will be fully eliminated in
2008.
The
previous Ontario government was committed to eliminate the Ontario capital
tax by 2008 (to coincide with the federal elimination). Under the new
government this elimination will no longer be going ahead.
The
thresholds at which each province starts to charge their capital tax varies,
with some provinces exempting small corporations (such as Ontario) to
provinces that charge the tax on every dollar of "taxable capital"
(such as Quebec). The thresholds are explained in greater detail in the next
section. Larger companies often have to pay capital taxes at both the
federal and provincial levels.
CAPITAL
TAX CALCULATION
Capital
tax calculations differ from province to province and differ as well from
the federal calculations.
In
general terms, the starting point for determining the capital tax liability
is the calculation of the corporation’s capital. This value generally
includes the sum of the corporation’s balance sheet values for share
capital, retained earnings, contributed surplus, most liabilities and
certain reserves.
The
second step is to subtract any general exemption or minimum threshold amount
allowed by
the taxing jurisdiction. For example, in calculating the federal LCT a
deduction of $50,000,000 is taken from the taxable capital amount at this
step. (Note: The $50,000,000 LCT deduction is shared among related
companies.) The general
exemption amounts for the provinces that levy capital taxes are contained in
the attached Capital
Tax Grid.
The
third step, and the focus of the attached Capital Tax Grid, is the deduction
of an amount for the "Investment Allowance". The investment
allowance is determined by using the cost amount of eligible investments of
the corporation. In the provinces of Saskatchewan, Manitoba, Ontario and
Quebec the investment allowance results from a proration factor that is
based on a proportion of eligible investments over total assets. Therefore,
each dollar invested in an eligible investment does not necessarily reduce
taxable capital by an equivalent amount. The attached Capital Tax Grid
attempts to categorize various types of investments that could potentially
be eligible for the investment allowance.
If the
word "eligible" appears in the attached grid, then this type of
investment may be eligible for the investment allowance in the relevant
jurisdiction. Therefore,
purchasing an "Eligible" investment could potentially save the
corporation some capital tax. If the word "Not Eligible" appears
in the attached grid, then this type of investment would likely not qualify
for the investment allowance and hence not reduce the capital tax liability
of the corporation purchasing the ineligible investment.
After
both the general exemption amount and the investment allowance have been
deducted from the original capital amount, the resulting value is called
"taxable capital".
The
last step to calculate the capital tax liability is to multiply the taxable
capital amount by the capital tax rate of the jurisdiction and by the
percentage allocable to the particular province. The reason for the
allocation is for situations where a company has operations (a permanent
establishment) in more than one province in which it is subject to capital
tax.
The
current capital tax rates are:
Federal
0.200%
Saskatchewan
0.600%
Manitoba
0.300%
Ontario
0.300%
Quebec
0.600%
New
Brunswick
0.300%
Nova
Scotia
0.300%
Note
that when capital tax rates change during a corporation’s taxation year,
the applicable capital tax rate must be determined on a prorated basis.
FEDERAL
LCT OFFSET
An
interesting note about the federal LCT is that there is some relief
available from the tax in the form of a tax credit. The amount of LCT
payable can be used as a credit to reduce the amount of federal corporate
surtax payable. As well, to the extent that LCT cannot be used to reduce the
federal corporate surtaxes, the excess LCT paid can be used as a credit
against
corporate surtaxes in any of the previous three corporate tax years or in
the following seven corporate tax years in the future. For this reason, the
effective federal LCT tax rate ultimately paid may not necessarily equal the
full 0.200% rate indicated above.
Provincial
capital tax rules generally do not provide for similar types of offsets
against other types of taxes.
RBC
INVESTMENT’S ROLE IN THIS PROCESS
The
attached Capital Tax Grid has been compiled in order to provide advisors
with a reasonable level of understanding when dealing with clients on
capital tax related issues. It is important, however, that there is a clear
understanding of the role played by the advisor, Financial Planning
Advisory, the Tax Advisory Group (TAG) and the Retail Bond department in
supporting this business. Simply put, RBC Investments is a provider of
products and trade execution, but is not the originator of the Capital Tax
strategy. Advice regarding applicable strategies and recommendations
regarding specific securities and issuers should come from the client’s
tax advisor, not from any employee of RBC Investments. For this reason,
Financial Planning Advisory, TAG and the Retail Bond departments will not
provide any advice or opinions as to the applicability of any particular
security for a Capital Tax strategy.
NOTE:
As
the information contained in the attached Capital
Tax Grid is of a general nature and does not constitute tax advice on
Capital Tax issues, the Capital Tax Grid must be used for Internal Purposes
Only. This means that the Capital Tax Grid should not be distributed to
clients or to other centres of influence (COIs). A statement to this effect
is also contained at the bottom of the Capital Tax Grid.
The
above information is based on the current and proposed tax law in effect as
of the date of this writing and is for information purposes only. It should
not be construed as offering tax advice. Individuals should consult with
their own tax advisors before taking any action based upon the information
contained here.
Contact the Group today to find out more information
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