PPP a golden opportunity to realize capital gains at 50% inclusion rate if you act before June 25

Many business owners and professionals have used their corporations as a vehicle for saving for retirement. The tax measures introduced in the 2018 federal budget, however, targeted income sprinkling, holding a passive corporate investment portfolio and converting a private corporation’s regular income into capital gains. This has meant higher taxes for business owners and incorporated professionals and their families and less money for retirement savings.

An additional challenge for business owners and incorporated professionals is that the 2024 federal budget has proposed the inclusion rate for capital gains to increase from 50 per cent to 66.7 per cent effective June 25, 2024. This means that investment portfolios owned by a corporation would be subject to the higher taxes from the first dollar of capital gains that is realized. Only capital gains that are realized on personally owned assets would be eligible for the 50-per-cent inclusion rate on the first $250,000 of capital gains, and this does not apply to corporations.

This provides a golden opportunity for business owners and incorporated professionals to realize capital gains taxes on their corporately owned investment portfolios and get a deduction by contributing the funds to a Personal Pension Plan (PPP) or Individual Pension Plan (IPP).

The golden opportunity

The tax year for individuals is Jan. 1 to Dec. 31 of each year. However, corporations have fiscal years that do not necessary end in Dec. 31. This means that if a corporation realizes capital gains on appreciated securities before June 25, 2024, in a fiscal year that ends in March 31, for example, then those capital gains taxes would only be payable when the corporation files an income tax return after March 31, 2025.

Contributions to a PPP or IPP can be made up to 120 days after the fiscal year end of a corporation and be deducted from the income of the corporation in that fiscal year. This means that in the above example, contributions to a PPP or IPP could be made by July 30, 2025, and would be a deduction against the income of the company for the March 31, 2024, to March 31, 2025, fiscal year.

Therefore, 50 per cent of the capital gains that would be included in income on appreciated securities sold before June 15, 2024, could be completely offset by contributing an equivalent amount to a PPP or IPP in the form of current service or past service contributions.

This is a great opportunity for taking advantage of the 50-per-cent inclusion rate for capital gains, without the need to pay any taxes on the gains due to the offsetting deductions for contributing to a PPP or IPP. Depending on when the fiscal year end of the corporation is, and the particular circumstances of that business owner or incorporated professional, this is a scenario that should be discussed with their tax and financial advisors.

Personal Pension Plans are very underutilized by business owners, and the following sheds some light on how these plans work.

The best kept secret in tax and retirement planning

One extremely tax-effective solution that is still available to business owners and incorporated professionals is the Personal Pension Plan, or PPP. The PPP is a “three accounts in one” combination registered pension plan governed by the same rules as other tax-assisted retirement plans and has been available since 2012 but is extremely underutilized. It was developed by pension lawyer Jean-Pierre Laporte of Integris Pension Management Corp. “The PPP is the most tax effective retirement savings program in Canada and is superior to IPPs and RRSPs,” Laporte says.

By combining elements of defined contribution (DC) and defined benefit (DB) rules, the PPP gives business owners and incorporated professionals more flexibility, allowing them to take a break from contributing to the plan when cash is tight, and it has higher limits than RRSPs that are capped at 18 per cent of income to a maximum of $31,560 for 2024. Depending on the age of the pension plan member, annual contributions to a PPP can be as high as $51,800 per year.

According to Integris, “The key advantage of the PPP design is that it provides flexibility with respect to the amount of contributions made each year. In good years, a business owner might utilize the DB component of the PPP to tax-deduct as much as possible. In lean years, the same business owner may elect to save under the DC component and reduce contributions to a mere 1% of salary. When business subsequently picks up again, the member could look back to the years where contributions were small and retroactively effect a ‘buy back of past service,’ thus creating additional contribution room.”

A third account, the “additional voluntary contribution” (AVC) subaccount, forms the third component of the PPP plan design. It allows for the tax-deferred transfer of RRSP assets and is not permanently “locked in” by pension legislation, making the funds in it accessible at any time to the business owner. If and when the member chooses to use the DC account in a particular year instead of the DB account, contributions can be made on a voluntary basis to the AVC account as well during the year, triggering a personal tax deduction for the plan member of up to 17 per cent of their T-4 income in that year.

Additional benefits

The PPP includes the following additional tax deductions and advantages that are not available to business owners and incorporated professionals who save through their corporation or via RRSPs:

Past service purchases – The ability to buy back past service allows you to earn a pension for the years where you had T4 income from the corporation before the plan was set up. A typical amount of deduction can vary between $30,000 and over $500,000.

Special payments – These can be made if the return on the assets in the DB component of the PPP are less than the prescribed 7.5 per cent per year rate of return expectation, or if there is a deficit/liability in the plan due to poor performance of the portfolio.

Terminal funding – If early retirement is elected, terminal funding can enable the purchase of an enhanced pension that is indexed to inflation. The typical amount of this tax deduction can range between $55,000 to over $1,000,000.

RRSP double dips – In the year the plan is set up, the member can claim a personal tax deduction by contributing to his or her RRSP, in addition to the annual pension plan deduction claimed by the corporation for its contribution.

Investment management fee deductions – Under the Income Tax Act, the investment fees for managing the pension money are tax deductible, whereas the management fees for managing RRSPs and other registered assets are not.

Interest deductions – If the corporation borrows money to contribute to the PPP, the interest on the borrowed funds will be tax deductible, whereas interest on money borrowed to contribute to an RRSP is not tax deductible.

Higher annual contribution limits compared to RRSPs – The contribution limit to a PPP can be $2,250 (at age 40) to $21,061 (age 64) more than the allowable maximum RRSP contribution.

GST/HST Pension Entity Rebate – This rebate applies to PPPs that use the trust platform and gives the corporation a rebate of 33 per cent of all HST paid in connection with the PPP. On the insurance platform the PPP is HST-free to the company.

Lifetime Capital Gains Exemption – Terminal Funding and Buy Back of Past Service can be used to “purify” the corporation of non-active business income assets, so it can qualify for the Lifetime Capital Gains Exemption. The amount of the Lifetime Capital Gains Exemption (LCGE) is $1,016,836 in 2024 and is indexed to inflation. The budget 2024 proposes to increase the LCGE to apply to up to $1.25 million of eligible capital gains. This measure would apply to dispositions that occur on or after June 25, 2024. This type of purification needs to be done when a corporation is sold through a share transaction.

Inter-generational tax-deferred wealth transfer – In a family business where several family members participate in a single-family PPP, upon the death of retired family members, PPP assets earmarked to fund the stream of pension benefits become surplus. The plan provisions can stipulate that any surplus in the pension plan belongs to the surviving plan members to fund their own pension benefits. This will eliminate the problem of “deemed disposition” of RRSPs on death and will allow for the transfer of wealth from one generation to another without triggering any immediate tax. Taxes of course will eventually be payable when pension income is taxed in the hands of retiring plan members.

Superior creditor protection features – Whereas RRSPs at banks and financial institutions are creditor-protected only in the event of bankruptcy, the PPP is provided with the highest level of creditor protection in Canada that applies to all formal registered pension plans. The assets of the pension plan cannot be seized by creditors of the plan member (except spousal creditors under Family Law legislation), nor of the corporation that sponsors the pension plan. Moreover, pursuant to recent changes that were made in 2008 to the federal Bankruptcy and Insolvency Act, the annual contributions required of the company to the pension plan receive “super priority” in the event of the insolvency of the corporate sponsor and rank above the claims of the secured creditors such as major commercial lenders.

Considering all the above advantages, a business owner, or incorporated doctor, dentist, lawyer or accountant, can tax-shelter hundreds of thousands of extra dollars in a PPP due to the more generous tax treatment of registered pension plans by the Income Tax Act (Canada).

The only legal stipulation for a business owner or incorporated professional to be able to benefit from a PPP is that he/she and any family members who receive a salary from the corporation for work done is receiving T4 income from the corporation, since dividend income does not qualify as “pensionable.”

Membership in the PPP can be restricted to the business owner and one or more key employees (who can be family members). For example, a 45-year-old business owner who incorporated in 2010 and had a T4 eligible income of $150,000 per year (opting to take the rest of his income in dividends), would be able to claim the following corporate deductions, assuming a 5-per-cent-a-year growth rate for invested assets:

• Past service of $129,121
• Special payments of $126,493 (assuming assets grow at 5 per cent annually vs. 7.5 per cent)
• Terminal funding (age 56) of $1,091,997 (discussed further below).
• Deduction for payment of fees (assuming 1 per cent fee per year on assets) of approximately $23,339 assuming he/she retires at age 65.
• Extra contributions in excess of RRSP limits over 20 years: $625,108

Therefore, this business owner can significantly exceed the tax savings that RRSPs offer. For example, at age 57, the company will have accumulated an extra $1,027,327 in registered dollars over and above what the RRSP can provide (including Terminal Funding).

If the business owner decides to retire early, a tax-deductible terminal funding amount can be paid by the corporation to pay for an unreduced early retirement pension. Assuming the business owner in the above example elects to retire at age 57 (which he could do by simply shifting his compensation from salary to dividends and continuing to work as before), he could receive a $160,409-a-year pension that would reduce to $156,801 at age 65 and trigger a supplemental corporate tax deduction of $1,089,640 in the form of terminal funding. Higher pensions would be payable in proportion to the salary received by the business owner from the corporation.

It is important to note that the $160,409 pension in this example is also eligible for pension income splitting with a spouse as early as age 55, whereas RRIF income can be income-split only starting at age 65. The business owner and spouse can each claim a $2,000-per-person pension income credit. Therefore, the taxable pension income of the business owner in this case would be only $80,204. This means that his marginal tax bracket would drop from 45 per cent to 30 per cent if he lives in Ontario.

While the intention of the Department of Finance is to restrict the ability of business owners and incorporated professionals to treat their corporations as a retirement savings vehicle, the PPP can help them absorb the effects of higher taxes and create a substantially larger retirement nest egg at the same time.

Tina Tehranchian, MA, CFP®, CLU®, CHFC®, CIM®, MFA-PTM (Philanthropy) is a FP CanadaTM Fellow and a Senior Wealth Advisor at Assante Capital Management Ltd. in Etobicoke, Ont. She can be reached at (905) 707-5220 or through her website at https://tinatehranchian.com, Assante Capital Management Ltd. is a member of the Canadian Investor Protection Fund and the Canadian Investment Regulatory Organization. Before acting on any of the above, please make sure to see a professional advisor for individual financial advice based on your personal circumstances.

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