A Canadian-Controlled Private Corporation (CCPC) is a private business incorporated in Canada that is not controlled by one or more non-residents of Canada. Control in this context includes legal control, in which more than 50 percent of the voting rights to elect a majority of the Board of Directors is controlled by Canadian residents, and factual control, in which the majority control is maintained by Canadian residents irrespective of any direct or indirect influence that, if exercised, would result in control. Factual or de facto control includes, for example, exercising a shareholder’s agreement, an option to purchase shares, a convertible debt or other means. In other words, a CCPC must always be controlled directly or indirectly by at least 50 percent Canadian residents.
There are many advantages for a Canadian corporation to maintain its CCPC status:
The Canadian federal government promotes jobs and investments in Canada by allowing CCPCs to earn refundable investment tax credits (ITCs) under the Scientific Research and Experimental Development (SR&ED) Program. CCPCs can qualify for a 35 percent refundable ITC on SR&ED expenditures for up to $3 million, and for a 15 percent non-refundable ITC on any amount thereafter.
CCPCs under the SR&ED can also qualify for a 15 percent refundable ITC on an amount over $3 million and 40 percent of the ITC can be refunded.
Lastly, once a CCPC becomes profitable and earns income from active business, it is subject to a small business income tax rate. In turn, the first CA500,000 of income is subject to a lower federal tax rate (9 percent as of January 1st, 2019).
CCPCs benefit from a one-time CA$866,000 lifetime capital gain exemption. In turn, when a Canadian shareholder disposes of certain qualifying shares and realizes a capital gain in which the sale of the shares exceeds the purchase price and reasonable share disposition price, the first CA866,000 of capital gain realized by the individual shareholder will not be subject to income tax. This income tax exemption only applies if the shares are held by the individual Canadian shareholder for at least 24 months.
Since this income tax exemption applies per individual Canadian shareholder, splitting founder shares with a spouse or family trust can amount to even greater profits, provided that the shares qualify under a CCPC.
Individual taxpayers can also defer their capital gains realized from the sale of shares by reinvesting the proceeds of the shares into another qualifying small business. To qualify, the individual must reinvest the proceeds made in the year of disposition or within 120 days after the end of that fiscal year. Moreover, this capital gains deferral only applies to individuals and does not apply to professional investment corporations, trusts or partnerships. The deferral is also limited to shares from both CCPCs and must therefore be issued by the corporation to the individual rather than by, for example, shares acquired by purchase.
III. Employee Stock Option Benefits
Some early-stage CCPCs might give their employees a stock option to buy into the company. In this regard, CCPCs offers two clear advantages to Canadian employees:
First, stock options are subject to capital gain tax. However, this tax only applies if the option-holder disposes of their shares for a higher amount. Therefore, employees can generally defer paying capital gains until the option-holder decides to dispose of their shares.
Second, an employee can benefit from a 50 percent capital gain tax exemption for exercising stock options, provided that at least 24 months have passed from the time the employee exercised the share option. Although this 50 percent deduction is also available to non-CCPCs, these non-CCPCs are subject to additional conditions, including a requirement that stock-option shares are not sold for below market value. In turn, non-CCPCs might be more conservative in valuing their stocks.
Successful Canadian businesses are occasionally acquired by US competitors or complementary businesses. Many of these acquisitions utilize share-for-share or cash-for-share deals that allow sellers to buy into the purchasing US company. While the Canadian Income Tax Act (ITA) provides that capital gains are not taxed when shares of a US-incorporated businesses are sold to a US purchaser until the shares are disposed of, the same does not necessarily apply when Canadian-incorporated businesses are sold for shares of a US purchaser. In turn, Canadian shareholders may end up with significant tax liability, particularly if the purchased US shares cannot be sold, are undervalued by the public market, or when disposing of US shares is premature or financially unappealing.
To circumvent these issues, Canadian companies have typically structured acquisitions as exchangeable share deals in which the purchased US-stocks are paid for by issuing shares of a newly incorporated Canadian subsidiary of the purchasing US company. This allows Canadian shareholders to defer capital gain taxes until the shares of the Canadian subsidiary are sold for shares of the purchasing US company. However, structuring these convertible share options can be costly, complex and time-consuming, which can deter less experienced purchasers or discourage nominal transactions.
Another important consideration for non-residents of Canada is that under the ITA, dividend payments payable by Canadian companies to non-resident shareholders are subject to a 15 to 25 percent holdback tax. In 2008, the Canada-US Tax Treaty was enacted, which reduced this hold-back amount to 5 to 15 percent for US shareholders.
Founders should be mindful of these potential challenges before incorporating in Canada, particularly if they intend to eventually sell or merge their businesses with US competitors or complementary businesses.
The status of your corporation will directly influence the success of your business. It is important to maintain status as a Canadian Controlled Private Corporation if you wish to reap the benefits. If you wish to discuss whether your corporation has status or any other issue discussed in this post feel free to contact one of our legal professionals.
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