A return to a world of dual taxation of Canadian-source dividends paid to individuals:

This dual approach differentiates between CCPCs and non-CCPCs. The former continues to receive tax treatment as before – dividends are grossed up by one quarter, and federal and provincial dividend tax credits follow. The latter receives the “new” treatment brought forward by Finance Minister Goodale in the Fall of 2005, and later ratified by the Conservative government. This includes a gross-up of 45% (not 25%) and higher federal and provincial dividend tax credits (federal at 11/18ths of the gross-up).

The two methods result from the different rates of corporate tax paid before the dividend distribution. As such, then, our Canadian law effectively now recognizes a tracking of “creditable tax”, a concept found in European tax systems.

This would be fine and simple if it stopped here. However, the complexity of real life requires further refinements to cover special situations, with the result that this change involves 19 pages of explanation.

We now see two new concepts added to our tax landscape: “GRIP” and “LRIP”. These are special accounts – the former involves CCPCs only and the latter involves non-CCPCs only. In both situations, it is possible that a subject corporation in fact may never have a balance in these new accounts.

The GRIP account for a CCPC tracks taxable income that has not benefited from the small business rate (ie active income above the small business deduction level – currently $300,000 and heading for $400,000 through 2007) or other tax preference rates (including RDTOH).

The LRIP account for a non-CCPC likely has a narrower application. First, it includes income received from a shareholding in a CCPC which enjoyed the small business rate. Second, it includes any retained earnings earned at the small business rate that is brought from a CCPC which “goes public”.

The norm is that a non-CCPC pays an “eligible” dividend, unless it has an LRIP balance, which requires it to either pay a new 20% Part lll.1 tax or reclassify the amount of the dividend as an “ordinary” dividend (which gets the lower gross-up treatment). This requires shareholder consent!

There is no ordering for CCPCs between ordinary and eligible dividends and both can trigger a dividend refund from the RDTOH account.

There is a new ordering for non-CCPCs to pay ordinary dividends first if they have an LRIP balance, as measured at the time of the dividend payment. This is contrary to the GRIP account which measures only at the fiscal year-end.

GRIP is a continuity account, which can be positive or negative, calculated as follows:

(i) Opening balance PLUS (ii) 68% of taxable income for the year NOT eligible for SBD or dividend refund MINUS (iii) 68% of amounts for the year NOT eligible for the SBD or dividend refund which have been carried back within the allowable carryback period (3 years!) PLUS (iv) eligible dividends received during the year from a sub PLUS (v) dividends received during the year from a foreign affiliate which are deductible under Sec 113 MINUS (vi) eligible dividends paid in the PRECEDING year (excluding any excessive eligible dividends).

The system at point (iii) reduces the GRIP account prospectively, not retrospectively. Thus, dividends that were “eligible” in that earlier fiscal period do not become excessive thanks to a carryback. This also explains why GRIP can be negative.

The GRIP can have a starting balance on January 1, 2006 which looks back as far as 2001, as follows: 63% of the afore-mentioned full-rate taxable income for all fiscal years that ended after 2000 and before 2006 LESS all taxable dividends paid in that same period.

There are other adjustments for amalgamations and wind-ups.

THE LRIP also is a continuity account which only can have a positive balance and is calculated as follows:

(i) Opening balance PLUS (ii) ineligible dividends received during the year which are deductible from Part l tax MINUS (iii) ineligible dividends paid in the year MINUS (iv) excessive eligible dividends paid in the year.

There are other additions to LRIP for “investment corporations” and CCPCs who elect NOT to be CCPCs.

There are also other adjustments for amalgamations and wind-ups.

There appears not to be any historical starting balance on January 1, 2006 for LRIP.

There is an anti-avoidance section where either a GRIP or LRIP has been artificially maintained or increased/decreased. This causes the entire eligible dividend to be reclassified as “excessive” and the Part lll.1 tax then is increased from 20% to 30%, with no provision to reclassify as “ordinary”.

Non arms-length shareholders are enjoined with their corporation in any Part lll.1 tax liability assessed. The tax is due along with the regular tax obligation.

An election to reclassify an excessive dividend can be made within 90 days of the related Notice of Assessment, with no provision for extension.

This election requires the written concurrence of all shareholders whose addresses are known to the corporation. If this election is made after 30 months after the dividend was paid, then the corporation must seek the concurrence of all shareholders.

A Part lll.1 tax form must be included now along with the regular return, for every Canadian corporation that pays a taxable dividend.