Finance Canada Considers Eliminating the "30 Per Cent Rule"

On June 3, the Department of Finance, Canada (Finance Canada) released a consultation paper entitled "Pension Plan Investment in Canada: The 30 Per Cent Rule." Among other investment rules, federally regulated pension plans and certain other persons are restricted under federal law from holding more than 30 per cent of the voting shares to elect directors of a corporation. A similar rule exists in a number of provinces including Ontario and Québec. However, Québec has enacted legislation exempting the Caisse de dépôt et placement du Québec from this rule, and in its 2015 Budget, Ontario announced that it intends to eliminate the rule. In that context, the federal government is considering whether to eliminate the rule, is seeking stakeholder input on the usefulness of the rule, and has set out in the consultation paper considerations relating to prudential questions, investment performance effects and tax policy.

While the elimination of the rule without further action would affect a limited number of pension plans and other persons, the consultation paper raises possible income tax measures that could affect many pension plans. Finance Canada’s premise is that elimination of the 30% rule will lead to higher levels of "active" investing by pension plans. In this regard, it raises concerns stemming from the potential ability of a tax-exempt pension plan to shift business income from taxable persons to the plan and thereby to realize investment returns on Canadian equity investments (or what in all the circumstances should be treated as an equity investment) on a pre-tax basis (i.e., before the imposition of a corporate-level or equivalent tax). A basic Canadian tax principle is that dividend income is received after the imposition of corporate tax on the issuer of the shares. Finance Canada is concerned about tax revenue consequences and also, in the interests of fairness and efficiency, considers it desirable to create a "level playing field" for investors and the businesses controlled by them.

With respect to tax measures, the consultation paper describes two tax planning techniques: earnings stripping via related party debt and the use of private flow-through entities (i.e., partnerships and trusts that earn Canadian-source business income). With respect to related party debt, it raises the possibility of extending Canada’s thin capitalization rules. These rules deny an interest deduction on debt of a Canadian corporation that is owed to certain non-resident shareholders where the debt-equity ratio exceeds a prescribed limit. The suggestion is to apply similar rules in respect of debt of a Canadian corporation that is owed to a pension plan that controls the corporation. With respect to flow-through entities, it raises the possibility of extending Canada's "SIFT" rules which essentially subject publicly-traded trusts and partnerships to tax on certain defined sources of income as if the entity was a corporation. The suggestion is to extend those rules to trusts and partnerships that are controlled by a pension plan.

As mentioned, the tax measures, if implemented, would likely have a broad impact on the investment activities of all Canadian pension plans. The tax policy considerations for which Finance Canada has sought input as listed in the consultation paper are as follows:

1. Are any of the tax policy concerns relating to the ability of tax-exempt pension plans to acquire controlling positions in taxable corporations (e.g., potential strategies to eliminate corporate-level taxation, which could provide an advantage to the plans or the businesses they control) material in nature?
2. How does the potential relaxation or elimination of the 30 per cent rule impact any concerns described in respect of the previous question?
3. Should the Government consider implementing tax measures (e.g., thin capitalization restrictions, application of the SIFT tax to pension-controlled trusts and partnerships) to limit the ability of pension plans to undertake tax planning strategies to reduce or eliminate entity-level income tax on business earnings? Are there other potential tax measures that the Government should consider in this regard? What considerations should be taken into account in the assessment of such potential measures?

The closing date for submissions is Friday September 16, 2016.

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