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 The integration regime is an important component of the Canadian tax system to ensure fairness and equity in the amount of taxes paid whether the income is earned through a corporation and distributed to the shareholder and if the income was earned directly by an individual. The regime attempts to limit the advantages of earning income through another vehicle using integration. The Income Tax Act contains measures to ensure that integration is achieved through. One of the mechanisms is the capital dividend account, allowing the tax-free flow through of capital dividends from a corporation to an individual. Integration is achieved by only taxing half the capital gains in the corporation with the other half distributable to the individual tax free, reflecting the same tax rate as an individual which would have been taxed at half of the capital gains at the highest marginal tax rate. Another mechanism is the eligible refundable dividend tax on hand (ERDTOH) and non-eligible dividend tax on hand (NERDTOH). 

       The ERDTOH pool consists of total refundable taxes paid under part IV on eligible dividends from non-connected corporations, such as portfolio dividends and part IV tax on taxable dividends received from connected corporations that were paid from those corporations ERDTOH balances. The NERDTOH pool consists of the 30.67 percent of a corporation’s aggregate investment income and total taxable income that exceed the small business deduction (SBD) limit, and total taxes payable under part IV by the corporation for the year less the amount determined for the ERDTOH balance. As a result of the ERDTOH and NERDTOH regimes, this penalizes the taxpayer for keeping passive income in the corporation in aims of deferral of taxation, and incentivizes distribution of the income in the form of a dividend to the shareholder to recover the refundable taxes. This eliminates the advantage of tax deferral of passive income in the corporation and further integrates the corporate and personal tax systems. The end result of the combined corporate and personal tax on the investment income would be more or less the same as if the investment income were earned personally.

       For the distribution of dividends from a corporation to an individual, Canada uses the imputation system, where the income is taxed on the corporate and shareholder level, with a gross up on the dividend and tax credit applicable to the shareholder to offset all or part of the corporate tax paid on the dividend. In Canada, there is a tax-deferral advantage available from earning active business income through a CCPC as there is a lower, preferential corporate tax rate for small businesses – small business deduction (SBD), but the overall combined corporate and personal tax rate is higher than the rate if the income were taxed as personal income. Passive investment income earned through a CCPC would have no tax savings than if the individual shareholder were to personally earn investment income directly. Tax savings are available to individuals who earn investment income personally rather than through a corporation. See Table 2 below for an illustration of the effective tax rate.

 Table 2 – Calculation of After-Tax income for a CCPC (Ontario)

      From Table 2, we can see that the Canadian integrative tax system works to ensure the overall tax paid if earned personally or through a corporation is more or less equal, but is punitive for passive investment income earned through a CCPC. This however, is not perfect, as there still lies a tax deferral advantage for income earned in a corporation. The largest tax deferral lies with CCPCs earnings income subject to the Small Business Deduction (SBD). We can see that Parliament encourages CCPCs to reinvest their surplus to earn active business income with preferential tax rates and the deferral advantage. In Ontario, a tax deferral of approximately 3.36 percent on investment income is available, where the highest combined marginal personal tax rate is higher than the corporate rate applicable to investment income. This may incentivize taxpayers to consider the tax deferral on passive income. 

Similarly, the introduction of the additional SBD rules was intended to promote the investment of after-tax income and aimed to limit a CCPC’s access to the SBD where the corporation used its after-tax income to earn investment income, rather than reinvesting directly in its active business. The legislation enacted in 2016 and 2018 resulted in the reduction of the SBD limit where a CCPC earns passive investment income in excess of a specified amount and new restrictions on the sharing of the SBD limit amount associated corporations. The SBD limit available to a CCPC is reduced on a straight-line basis where a corporation’s adjusted aggregate investment income (AAII) exceeds $50,000, reduced by $5 for every $1 of AAII above the $50,000 threshold. 

There are many mechanisms used in the Canadian tax system to make integration as equitable and perfect, but still has its imperfections. The updated SBD rules limits the capacity for CCPCs to invest their surplus income in passive investments and encourages CCPCs to reinvest in earning active income. Deferral benefits still exists in investing through a CCPC in Ontario, and where a CCPC reinvests certain types of after-tax income in active business of the corporation.