Eligible Dividends – Split-Dividend Designation and Late Designation
Under the rules of the Act, the dividend tax credit (DTC) is available to shareholders to help relieve the double taxation of corporate income, which is subject to tax at both the corporate level and at the personal shareholder level. An “eligible dividend,” i.e., a dividend paid out of income that was taxed at the general corporate income tax rate, qualifies for an enhanced DTC. A taxable dividend that is not an eligible dividend, i.e., a dividend paid out of income that was taxed at a lower rate (most often the small business income tax rate), qualifies for the regular DTC.
The 2012 Budget proposes to simplify the manner in which a corporation resident in Canada designates eligible dividends, by allowing the corporation to designate any portion of a dividend to be an eligible dividend at the time it pays out a taxable dividend. In addition, the 2012 Budget proposes that a corporation would have the ability to make a late designation of eligible dividends up to three years after the day the designation was first required to be made, provided the Minister is of the opinion that accepting the late designation is just and equitable in the circumstances. These measures will apply to taxable dividends paid on or after March 29, 2012.
Employee Profit Sharing Plans
Employee Profit Sharing Plans (EPSPs) are trust arrangements that are intended to enable employers to share profits with their employees. The 2012 Budget introduces a special tax payable by specified employees on excess EPSP amounts. A specified employee is an employee who has a significant equity interest in the employer or who does not deal at arm’s length with the employer. An excess EPSP amount of a specified employee is the portion of the employer’s EPSP contribution that is allocated by the plan trustee to the specified employee that exceeds 20% of the employee’s annual salary. The rate of the special tax will be equal to the top combined federal and provincial marginal tax rate. In the case of a specified employee resident in the province of Quebec, the tax rate will be equal to the top federal marginal rate. Any excess EPSP amount will not also be subject to regular income tax.
This special tax will apply in respect of EPSP contributions made on or before March 29, 2012, other than contributions made before 2013 pursuant to a legally binding obligation arising under a written agreement or arrangement entered into before March 29, 2012.
Retirement Compensation Arrangements
A retirement compensation arrangement (RCA) is a form of retirement savings arrangement generally funded by employer contributions. The 2012 Budget proposes new prohibited investment and advantage rules to prevent RCAs from engaging in certain non-arm’s length transactions. The new rules will impose a special tax on RCAs, and will be closely based on existing rules for Tax-Free Savings Accounts and Registered Retirement Savings Plans. The 2012 Budget also proposes new restrictions on the ability to obtain RCA tax refunds where the property of the RCA has decreased in value as a result of a prohibited investment or advantage.
The prohibited investment rules will generally apply to investments that were acquired or became prohibited investments on or after March 29, 2012. The advantage rules will generally apply to advantages extended, received or receivable on or after March 29, 2012, including RCA advantages that related to property of the RCA acquired, or transactions occurring before March 29, 2012. The rules restricting the RCA tax refunds will apply in respect of RCA tax on RCA contributions made on or after March 29, 2012.
Registered Disability Savings Plans
The 2012 Budget proposes several changes to the rules governing Registered Disability Savings Plans (RDSPs). These changes include: (i) permitting certain family members to become plan holders of an RDSP on a temporary basis, for adults who might not be able to enter into a contract; (ii) introducing a proportional repayment rule to replace the 10-year government repayment rule for certain withdrawals made after 2013; (iii) amending the maximum and minimum withdrawal limitations and requirements; (iv) allowing investment income earned in a registered education savings plan to be transferred to an RDSP on a tax-free rollover basis provided the plans share a common beneficiary and certain other conditions are met; and (v) extending the period for which an RDSP may remain open when a beneficiary becomes ineligible for the disability tax credit.
Group Sickness or Accident Insurance Plans
Employer contributions made to a group sickness or accident insurance plan are generally not included in an employee’s income. The 2012 Budget proposes to include the amount of an employer’s contributions to a group sickness or accident insurance plan in an employee’s income for the year in which the contributions are made, to the extent the contributions are not in respect of a wage loss replacement benefit payable on a periodic basis. This measure will apply in respect of employer contributions made on or after March 29, 2012 to the extent that the contributions relate to coverage under the plan after 2012. Contributions made on or after March 29, 2012, but before 2013, will be included in the employee’s income for 2013.
Mineral Exploration Tax Credit
The 15% mineral exploration tax credit available to individuals in respect of specified mineral exploration expenses incurred in Canada, and renounced to them in respect of flow-through share investments, was scheduled to expire at the end of March 2012. The 2012 Budget proposes to extend the credit for another year, by extending: (1) the date for incurring qualifying exploration expenditures to the end of 2014; and (2) the deadline for the corporation and the investor to enter into a flow-through share subscription agreement governing renunciation to March 31, 2013.
Overseas Employment Tax Credit
The overseas employment tax credit (OETC) entitles qualifying employees who are residents of Canada to a tax credit equal to the federal income tax otherwise payable on 80% of their qualifying foreign employment income, up to a maximum foreign employment income of $100,000. The 2012 Budget proposes to phase out the OETC over four years, during which the factor will be reduced from 80% to 60% for the 2013 taxation year, 40% for the 2014 taxation year, 20% for the 2015 taxation year, and nil for 2016 and subsequent taxation years. The phase out rules will not apply with respect to qualifying foreign employment income earned by an employee in connection with a project or activity to which the employee’s employer had committed in writing prior to March 29, 2012. In this circumstance, the employee’s OETC will remain at 80% until it is eliminated in 2016.
Medical Expense Tax Credit
The Medical Expense Tax Credit provides income tax relief for taxpayers with above-average medical and disability-related expenses. The 2012 Budget proposes to add blood coagulation monitors, when prescribed for use by a medical practitioner, to the list of qualifying medical expenses eligible for the credit. This measure will apply to expenses incurred after 2011.
Life Insurance Policy Exemption Test
A holder of a life insurance policy is exempt from the income accrual rules in respect of the policy if the policy is an exempt policy. A life insurance policy is an exempt policy if the fund accumulating within the policy (that is, the savings component) does not exceed the fund that would have accumulated in a benchmark policy. This test is commonly referred to as the exemption test.
The benchmark policy is a hypothetical policy prescribed by the Income Tax Regulations. It is intended to establish a benchmark that differentiates between an insurance or protection oriented life insurance policy and an investment oriented life insurance policy.
The regulations defining the exemption test date back to the early 1980s. Since then, there has been a significant evolution in the form of life insurance policies being sold in the Canadian market. Consequently, it is generally accepted that the exemption test needs to be updated.
The 2012 Budget proposes to make several technical improvements to the exemption test to reflect improvements in life expectancy, current interest rates, and industry practices in Canada and other countries. Consequential changes will also be made to the investment income tax under Part XII.3 of the Act (a proxy tax imposed on the life insurer on the savings component of an exempt policy).
The Canadian life insurance industry has been engaged in consultations for many years with the Government with respect to the exemption test, and further consultations are contemplated. Any amendments to the tax rules arising from these consultations will apply to life insurance policies issued after 2013.