Taxation of Passive Income in a Private Corporation

by kevinmil

I will be speaking at two academic conference in the next few weeks on the topic of the proposed changes to the taxation of Canadian-controlled private corporations (CCPCs). In preparation for these conference, I have prepared some spreadsheets to explore how the mechanics of the proposals should work. I have shared these with the public here, and I welcome feedback at My disclosure documents can be found here.

The proposals can be found on the Finance website here:

In this blog post, I explore three scenarios for the taxation of passive portfolios. The reform also changes rules about ‘sprinkling’ income to family members, and converting income into capital gains. I don’t discuss those issues here in this blog post.

The aim of the reform to passive portfolios is to ensure people with portfolios of taxable assets face the same tax rates whether they choose to save inside or outside the firm. We economists call this ‘neutrality’. Neutrality is desirable because it allows people to make decisions based on the business merits, rather than having their decisions distorted by taxation. That’s both efficient and fair. Moreover, the reason societies have corporations is to facilitate productive investment, not to offer tax savings to those with large passive portfolios.

So, I defend as economically sound the aim of the reform to strive for neutrality. But will the reform actually achieve neutrality? One important question is whether the officials at the Department of Finance got the math right. It is this question I address with my spreadsheets and scenarios below. Another important question is whether the legislative/legal/accounting approach taken by Finance is the most effective. I leave that question to others.

Before getting to the scenarios, let me start with the bottom line:

In my view, Finance got the math right with their proposals on the taxation of passive portfolios.

Scenario 1: The (Incorrect) Immaculately-Conceived Principal

The spreadsheet is here.

This scenario compares the taxation of $100 of passive interest income in various tax locations:

  • Personal (taxable)
  • Personal (TFSA)
  • Inside a private corporation in the status quo
  • Inside a private corporation under the proposal

My view is this is the wrong way to approach the question. Why? Because it doesn’t account for how the principal that generated the investment income was taxed. For savings inside a CCPC, the initial principal is taxed very lightly, so those savings get a large ‘head start’ compared to savings outside the CCPC where the principal faces initial heavy taxation. This is apples-vs-oranges.

For this scenario, it’s as though the principal were ‘immaculately conceived’ and its taxation can be ignored. I think this is wrong. Why do I present an incorrect scenario here? Because I’ve seen many analyses from reputable financial planners that use this approach and I wanted to see that I can replicate it and understand it.

In the spreadsheet, I can replicate the claim being made that the effective tax rate on investment income is 73%. But, I contend that the basis for this calculation is wrong–they are assuming the principal is immaculately conceived.

Scenario 2: Start with the taxation of principal

The spreadsheet is here.

This is the correct way to approach the question. It starts with apples-vs-apples. $100 of pre-tax corporate active business income for all cases. I compare the same four cases as Scenario 1, using a high-bracket Ontario investor and a one-year time horizon. The main result is in Row 25. Savings on personal account yield $47.15, and in a TFSA yield $47.90. In the status quo, inside a CCPC the yield after one year is $47.63. Under the proposed reform, RDTOH is removed, so the one-year yield falls to $47.20.

There are several important points here:

  1. The aim of the reform is neutrality for savings inside and outside the firm. The success in meeting this goal can be learned by comparing D25 with J25. They are very close. They are not exactly the same because the dividend tax credits and gross-up rates lead to small discrepancies.
  2. The proposed change under the reform is to no longer allow the RDTOH refund. This leads to the differences between columns H and J. The one-year difference is 43 cents, or 0.43% of the initial $100 in earnings. this strikes me as quite small.
  3. Of note, the TFSA in this example does better than any other savings location. If you had dividends or capital gains income the advantage of the TFSA would shrink. This is important for the following reason: in most cases, it makes much more sense to invest through a TFSA or RRSP than inside a CCPC. Using a private corporation to house a passive portfolio really makes sense if you have exhausted TFSA/RRSP room. It is less clear why it would make sense to anyone with only a smaller amount of savings that could be housed in TFSA or RRSP. (But these scenarios do exist–for example Americans living in Canada face big tax issues with TFSA/RRSPs…..)

Scenario 3: Replication of Finance Table 7 

The spreadsheet is here.

In the Finance discussion document, the key table for the taxation of passive portfolios is Table 7. They go about the calculations in a different way than I did in Scenario 2. It is a very useful check on my calculations to see if I can replicate their Table 7 result, and to see if it matches my Scenario 2 result.

Of note, the Notes to Table 7 state they are based on:

“simplified tax rate assumptions, chosen to remove small discrepancies that can arise due to imperfect integration of federal-provincial tax rates and differences between the top personal income tax rate that applies in each province and current tax rates on corporate passive investment income.”

In English, this just says that the gross up rate (117%) and the tax rate on passive investments (38.67%) are one-size fits all. They adjusted their Table 7 tax rates so that the numbers work ‘perfectly’.

I take a slightly different approach. I just use Ontario. So, I expect that my numbers will differ a bit, but the patterns of where taxes on savings are heaviest should remain the same.

In Scenario 3, I start with a one-year horizon. Of note, I get the exact same results as I did in Scenario 2. This gives me strong confidence I’m getting it right–I got the same answer using two different approaches. The answer is that saving through a CCPC yields a 0.43% per year advantage over savings in an individual taxable account.

Underneath, I do a ten-year investment horizon like in Finance Table 7. I find that saving inside a CCPC currently gives you a 5.11% advantage over a ten-year horizon. Finance Table 7 finds a 4.89% advantage. Under the reform, this advantage drops to 0.53% over ten years. Finance finds a 0.00% difference over ten years. The differences between my numbers and Finance are driven by the fact I use ‘Ontario’ and they use ‘simplified’ tax rates. So, I am very confident I can replicate Finance Table 7.

The lessons here:

  1. I have independently replicated Finance Table 7.
  2. The status quo gives CCPC savers about a 0.43% per year advantage over people saving outside a CCPC.
  3. Over a ten-year horizon, the gain is 5.11% of the initial corporate earnings. Five buck on a hun.
  4. According to p. 12 of the Finance document, there was $26.2B of passive income in 2015, so it doesn’t take much of a rate change to create a sizeable change in tax revenue. BUT, remember that the Finance document says they intend to ‘grandfather’ in existing CCPC savings, so any new tax revenue would only start phasing in through time.


The point of my spreadsheets and this blog post is to present an exploration of the taxation of passive investment income inside CCPCs. I hope this can contribute to public debate. I am interested to hear feedback at

I have confidence in my ability to check on Finance’s math. In my view, Finance got the math right here. I do not have the professional capacity to judge whether Finance has the draft legislation correct. I leave that question to others.