“Our Government is meeting the challenge of global economic uncertainty with a plan that is real. A plan that is responsible. A plan that is working.”
The Honourable Jim Flaherty
Minister of Finance
The Honourable Jim Flaherty, Minister of Finance, tabled the third federal budget of the Conservative minority government today. In his Budget Speech, Minister Flaherty emphasized the government’s fiscal management and continuing debt reductions. Planned debt reduction in 2007-2008 is $10.2 billion, which will bring the federal debt to $457.1 billion – a cumulative debt reduction of more than $37 billion since the Conservative government came into office.
The Budget contains tax proposals to:
- extend for three years the accelerated capital cost allowance treatment for investment in machinery and equipment used in the manufacturing and processing sector;
- streamline the rules that apply to dispositions of “taxable Canadian property” by non-residents;
- implement a new Tax-Free Savings Account for Canadian resident individuals 18 years of age and older. Although contributions would not be deductible, income and gains on investments within the account, and amounts withdrawn from the account, would not be included in income; and
- adjust the “dividend gross-up” and “dividend tax credit” rates for eligible dividends effective January 1, 2010 to reflect proposed corporate income tax rate reductions.
- The Budget confirms the government’s intention to proceed with certain previously announced tax measures “as modified to take into account consultations and deliberations since their release.” These include: draft amendments relating to the taxation of foreign affiliates;
- modifications to the tax rules that apply to “SIFT” trusts and partnerships – and measures to facilitate their conversion to corporations; and
- draft amendments relating to the taxation of financial institutions to align more closely with accounting standards.
Interestingly, the previously announced income tax measure to limit the deductibility of interest and certain other expenses where a taxpayer does not have a reasonable expectation of profit was not referred to in the Budget.
The Budget does not contain any new corporate income tax rate reductions. Minister Flaherty did state, however, that the federal government is calling on the provinces to reduce their corporate income tax rates – the goal being to achieve a combined federal-provincial tax rate of 25 per cent by 2012.
In this Budget Briefing 2008, we summarize the tax proposals highlighted above and other important proposed tax changes.
BUSINESS INCOME TAX MEASURES
Capital Cost Allowance
M&P Machinery and Equipment
In general, machinery and equipment used in manufacturing and processing (M&P machinery and equipment) is included in Class 43 of Schedule II to the Income Tax Regulations (the Regulations) and is eligible for a capital cost allowance (CCA) rate of 30%, computed on a declining balance basis. The 2007 Budget proposed a temporary incentive for M&P machinery and equipment acquired on or after March 19, 2007 and before 2009. Under regulations proposed to implement this incentive, eligible M&P machinery and equipment will be included in Class 29 and be eligible for a 50 per cent straight-line CCA rate.
The Budget extends eligibility for this accelerated CCA rate to eligible M&P machinery and equipment acquired in 2009. The Budget also proposes the following incentives for eligible M&P machinery and equipment acquired in 2010 and 2011:
- assets acquired in 2010 will be eligible for a 50% declining balance rate in the year of acquisition, a 40% rate the following year, and a 30% rate thereafter; and
- assets acquired in 2011 will be eligible for a 40% declining balance rate in the year of acquisition, and a 30% rate thereafter.
The accelerated rates for M&P machinery and equipment are subject to the normal half-year rule.
Accelerated Capital Cost Allowance for Clean Energy Conservation Class 43.2 of Schedule II of the Regulations provides accelerated CCA (50% per year on a declining balance basis) for specified clean energy generation equipment. For assets acquired on or after February 26, 2008, the Budget proposes a number of changes to expand the list of assets eligible for accelerated CCA rates under Class 43.2, including the following:
- the eligible uses for ground source heat pump systems will be broadened;
- the list of feedstocks for eligible biogas production systems will be expanded; and
- certain restrictions on the use of equipment used in thermal energy systems, bio-oil production systems and biogas production systems will be eliminated.
Aligning Rates with Useful Life
The CCA rate will be increased for the following types of property acquired on or after February 26, 2008 to reflect an updated assessment of their useful lives as follows:
- for railway locomotives and capital expenses for the refurbishment or reconditioning of a railway locomotive: from 15% to 30%;
- for carbon dioxide pipelines, including certain ancillary equipment: from 4% to 8%; and
- for pumping and compression equipment and ancillary equipment on a carbon dioxide pipeline: to 15%.
Scientific Research and Experimental Development
Following consultations conducted by the Department of Finance and the CRA in late 2007 and early 2008, the Budget proposes to extend income tax incentives for Scientific Research and Experimental Development (SR&ED) by allowing certain salaries and wages expended in respect of SR&ED carried on outside of Canada to qualify for the investment tax credit (ITC) and by making the enhanced ITC rate available to a larger number of Canadian-controlled private corporations (CCPCs) in respect of a greater expenditure limit.
Salary or Wages for SR&ED carried on outside Canada
Under the current SR&ED regime, expenditures incurred on SR&ED carried on outside Canada do not qualify for the ITC. The Budget proposes to extend the ITC to certain of such expenditures by deeming permissible salary or wages paid to a Canadian resident employee in respect of SR&ED carried on by the taxpayer outside Canada in support of SR&ED it carried on in Canada to be expenditures made in respect of SR&ED carried on in Canada. Annual salary or wages qualifying for this treatment will be limited to 10% of the total salary and wages paid to employees for the year in respect of SR&ED actually carried on in Canada.
Salary or wages qualifying for the ITC will not include remuneration based on profits or a bonus where the remuneration or bonus, as the case may be, is paid to a “specified employee” of the taxpayer, and will not include salary or wages paid to any employee in respect of SR&ED carried on outside Canada unless the taxpayer reasonably believes that the salary or wages are not subject to an income or profits tax imposed by the government of another country because of the employee’s presence or activity there.
The Budget proposes that these measures be effective in respect of SR&ED carried on outside Canada on or after February 26, 2008, with the 10% limit being pro-rated for the taxation year that includes February 26, 2008.
The Enhanced ITC for CCPCs
Under the current rules, CCPCs are eligible for an enhanced ITC on qualified SR&ED expenditures of up to $2 million. The enhanced ITC is phased out for CCPCs whose taxable income for the previous taxation year is at least $400,000 or whose taxable capital employed in Canada for the previous year is at least $10 million. It is eliminated altogether for CCPCs with previous year’s taxable income of $600,000 or taxable capital employed in Canada of $15 million.
The Budget proposes to increase the expenditure limit for the enhanced ITC to $3 million. The expenditure limit would continue to be eroded by $10 for each $1 by which the CCPC’s taxable income for the previous year exceeded $400,000, with the result that the enhanced ITC would be eliminated altogether for a CCPC whose previous year’s taxable income was at least $700,000. The phase out for prior-year taxable capital employed in Canada would continue to apply beginning at taxable capital of $10 million, but the threshold for complete denial of the credit would be increased from $15 million to $50 million.
The Budget proposes that these measures be effective for taxation years ending on or after February 26, 2008, pro-rated based on the number of days in the taxation year that are after February 25, 2008.
SIFT Tax: Provincial Component
“Specified Investment Flow-Through” (SIFT) trusts and partnerships are subject to a tax – the SIFT tax – that was recently enacted to ensure that SIFT trusts and partnerships and their investors are taxed on non-portfolio earnings in a manner similar to the taxation of corporations and their investors. For more information on the SIFT tax, see Osler Update, “Canadian Government Announces New Tax on Publicly-Traded Income Trusts and Partnerships,” dated November 2, 2006. The SIFT tax is effective currently for SIFT trusts or SIFT partnerships that were not SIFT trusts or SIFT partnerships on October 31, 2006; but, it will not be effective until 2011 for a pre-existing SIFT trust or SIFT partnership provided such pre-existing SIFT trust or partnership does not undergo undue growth before that time.
To achieve its objective, the SIFT tax is intended to reflect corporate tax rates and therefore includes a component intended to approximate the federal corporate tax rate and an additional component intended to approximate a provincial corporate tax rate. The revenues from this latter component are distributed to the provincial governments. The provincial component is currently 13% which rate reflects an average provincial corporate tax rate. The Budget proposes that for a SIFT vehicle’s 2009 and subsequent taxation years, the provincial component of the SIFT tax will instead be based on the general provincial corporate income tax rate in each province in which the SIFT vehicle has a permanent establishment. The distributions or allocations of the SIFT vehicle that are subject to SIFT tax will be allocated to such provinces using the provincial allocation formula that generally applies in the corporate income tax context and that takes into account wages and salaries paid, and gross revenues earned, in each province in which a permanent establishment is located. A SIFT vehicle’s taxable distributions or allocations that are not allocated to any province will bear a provincial tax component of 10%. The provincial SIFT tax component for distributions or allocations attributable to Québec will be deemed to be nil to take into account the fact that Québec will impose its own SIFT tax.
Cross-Border Business and Investment: Compliance Relief
The Budget proposes relieving measures intended to reduce and simplify the reporting requirements that currently apply when a non-resident disposes of “taxable Canadian property” (TCP). It is hoped that these changes will remove what has been increasingly perceived as a deterrent to non-residents investing in Canada. All of the proposals will apply for dispositions of TCP that occur after 2008.
Changes to Section 116 Requirements
Very generally, TCP is property of a non-resident any gain or income from the disposition of which can be subject to tax under the rules of the Income Tax Act (the Act). TCP includes, among other things, shares of a private Canadian corporation. Under the current rules of section 116 of the Act, a purchaser who acquires certain types of TCP from a non-resident person must withhold and remit to the Minister of Finance (the Minister) a portion of the amount payable for the TCP, on account of any tax payable by the non-resident on the disposition. No withholding is required if the non-resident complies with its obligation to file a notice with, and obtains from, the CRA, a clearance certificate issued in respect of the disposition and provides such certificate to the purchaser on a timely basis. Obtaining a clearance certificate has increasingly become a cumbersome process.
The Budget proposes to exempt TCP that is “treaty-exempt property” at the time of disposition from the requirements of section 116 of the Act. A TCP will be “treaty-exempt property” at the time of disposition if any income or gain realized on the disposition thereof by the non-resident would be exempt from tax in Canada under the terms of a tax treaty. If the TCP is acquired by a related person, the purchaser must, in addition, provide a notice to the Minister within 30 days after the date of the acquisition. The notice must set out basic information about the transaction and the non-resident vendor.
A “safe-harbour” from the withholding and remittance requirements of section 116 of the Act currently exists where a purchaser has, after reasonable enquiry, no reason to believe that the vendor is a non-resident. A new safe-harbour is introduced for certain acquisitions of TCP from a person who the taxpayer believes is a treaty-resident vendor. A purchaser of TCP will now be relieved from any obligation to withhold and remit under section 116 of the Act if:
- the purchaser concludes, after reasonable enquiry, that the vendor is, under a tax treaty entered into by Canada and another country, a resident of that country;
- any income or gain realized on the property by the vendor would be exempt from tax in Canada under the terms of that treaty if the vendor were resident in that country for purposes of that treaty; and
- the purchaser sends to the Minister a notice setting out basic information about the transaction and the vendor within 30 days after the date of acquisition.
It should be noted that although a determination of the vendor’s residency for treaty purposes is based on the purchaser’s reasonable due diligence, no similar relieving standard applies to the requirement to determine that the TCP is of a kind eligible for relief from Canadian income or gains tax under the treaty.
Return Filing Requirements
Consistent with the proposed changes to section 116 of the Act, the Budget proposes to exempt a non-resident person from having to file a Canadian income tax return for a taxation year solely as a result of having disposed of TCP in the year in the following qualifying circumstances:
- no tax is payable by the non-resident under Part I of the Act for the year;
- the non-resident is not liable to pay any amount under the Act in respect of any previous taxation year (other than certain amounts for which the Minister holds adequate security); and
- each TCP disposed of by the non-resident in the year is “excluded property” for purposes of section 116 of the Act (which now includes “treaty-exempt property”) or a property in respect of which the Minister has issued a clearance certificate to the non-resident under section 116.
PERSONAL INCOME TAX MEASURES
No new personal tax rate changes or new personal tax credits were announced. However, the Budget announced several measures that will be welcomed by individuals.
Registered Tax-Free Savings Account
The Budget proposes the introduction of a new registered savings plan, the Tax-Free Savings Account (TFSA), that will complement saving by individuals through a registered retirement savings plan (RRSP). The TFSA is intended to be a flexible vehicle that will permit Canadian residents aged 18 and over to contribute up to $5000 annually (indexed annually), starting in 2009, to the TFSA for any purpose.
Unused contribution room for a year may be carried forward indefinitely, but excess contributions will attract a penalty tax of one per cent per month. Withdrawals can be made at any time without restriction, and the individual will be permitted to re-contribute amounts withdrawn to the TFSA in a subsequent year.
Wile the contributions will not be tax deductible, all income and gains earned in the plan will be tax-exempt and all withdrawals will be tax-free. Moreover, amounts withdrawn from the TFSA will not be taken into account in determining eligibility for federal income-tested benefits, such as Old Age Security benefits, the Guaranteed Income Supplement or Employment Insurance benefits.
Other important features of the TFSA include the following:
- a TFSA may generally hold the same investments as a RRSP, but investments in any entities with which the account holder does not deal at arm’s length will not be permitted;
- interest on funds borrowed to invest in a TFSA will not be tax deductible, but TFSA assets may be used as collateral for a loan;
- the attribution rules will not apply to funds transferred by an individual to his or her spouse or common law partner who contributes such funds to a TFSA;
- an individual’s TFSA may be transferred on a tax-free basis to a spouse or common law partner or that person’s TFSA on the death of the individual; otherwise, the TFSA will lose its tax-exempt status on the individual’s death, such that investment income and gains accruing after the date of death will be taxable;
- on the breakdown of a marriage or common law relationship, an amount may be transferred tax-free from the TFSA of one party to the TFSA of the other party; and on ceasing Canadian residence, an individual may retain his or her TFSA and benefit from tax-free accumulation and withdrawals, but will not be permitted to make contributions or accrue contribution room during the period of non-residence.
Registered Education Savings Plans
The Budget proposes to extend by 10 years certain time and age limits applicable to RESPs. The RESP contribution period is prolonged from 21 to 31 years following the opening of the plan (and from 25 to 35 years for disabled RESP beneficiaries). The deadline for terminating a RESP is extended from the end of year 25 following the opening of the plan to the end of year 35 (years 30 and 40, respectively, for disabled RESP beneficiaries). The maximum beneficiary age for contributions to a family RESP is increased from 21 to 31 years.
A grace period is also proposed to allow students to continue to draw educational assistance payments from a RESP for six months after ceasing to be enrolled in a qualifying program.
These changes will apply starting in 2008.
Registered Disability Savings Plan (RDSP)
The 2007 Budget introduced the RDSP Program to help parents and others save to ensure the long-term financial security of a child with a severe disability. The Government is currently working with financial institutions to put the necessary administrative mechanisms in place so that RDSPs can be made available in 2008. The Budget provides that the RDSP program will be reviewed three years after RDSPs become operational. The Budget also proposes that the mandatory collapse of a RDSP will be required only where the beneficiary’s condition has improved to the extent that the beneficiary no longer qualifies for the disability tax credit. This change will not affect a plan holder’s ability to voluntarily collapse the plan.
Dividend Tax Credit
Since 2006, eligible dividends paid to Canadian resident individuals have been subject to a higher gross-up and an enhanced “dividend tax credit” (DTC) in recognition that these dividends are generally paid out of income that has been taxed at the general corporate rate, rather than out of income that has been taxed at a reduced rate, such as that payable by small business corporations.
First proposed in the Budget of May 2, 2006, the enhanced DTC measure was established with reference to the average 2010 federal-provincial corporate tax rate anticipated at that time. The 2007 Economic Statement of October 30, 2007 proposed reductions to the general federal corporate income tax rate from 19.5% in 2008 to 15% by 2012. It also stated that consideration would be given to adjusting the enhanced DTC to ensure the appropriate tax treatment of dividend income.
The Budget proposes to adjust the dividend gross-up factor and DTC rate for eligible dividends to reflect the corporate income tax rate reductions that were announced in the 2007 Economic Statement and became law on December 14, 2007. Specifically, the Budget proposes to reduce the eligible dividend gross-up from its current level of 45% to 44% effective January 1, 2010, to 41% effective January 1, 2011, and to 38% effective January 1, 2012. The enhanced DTC rate will also be reduced on the same schedule, moving from 11/18 of the gross-up amount to 10/17 for the 2010 taxation year, to 13/23 for the 2011 taxation year and to 6/11 for taxation years after 2011. In general terms, the effect of these changes will be to increase the effective rate of personal tax payable on eligible dividends in recognition of the reduction in the rate of corporate tax applicable to the income from which the eligible dividend was paid.
Medical Expense Tax Credit
Starting in 2008, the Budget extends the list of medical expenses that are eligible for the medical expense tax credit, including certain devices prescribed by a medical practitioner and certain expenses incurred for service animals trained to assist an individual who is severely affected by autism or epilepsy. The Budget also clarifies that effective February 26, 2008, drugs and medications that may be purchased without a prescription remain ineligible.
Mineral Exploration Tax Credit
The Budget proposes to extend the 15% mineral exploration tax credit to flow-through share agreements entered into on or before March 31, 2009. The credit, which is available to individuals with respect to specified mineral exploration expenses incurred in Canada and renounced to them in respect of flow-through share investments, was otherwise scheduled to expire at the end of March 2008.
OTHER INCOME TAX MEASURES
Donation of Exchangeable Securities
The Budget includes a proposal to further expand the existing exemption from taxation of capital gains realized in respect of donations of certain publicly listed securities to a registered charity or other qualified donee. Under current law, the capital gains inclusion rate is zero for a capital gain arising from a gift to a qualified donee of certain publicly traded securities (including shares, debt obligations or rights listed on a designated stock exchange, shares of mutual fund corporations and units of mutual fund trusts) and the full value of such donated securities is eligible for a charitable donation tax credit or deduction.
The Budget proposes to extend the existing capital gains tax exemption to capital gains realized on the exchange of unlisted securities that are shares or partnership interests (subject to certain unspecified exceptions) effective for donations made on or after February 26, 2008 where:
- the unlisted securities included, at issuance, a condition allowing the holder to exchange them for publicly traded securities;
- the publicly traded securities are the only consideration received on the exchange; and
- the publicly traded securities are donated within thirty days of the exchange.
Where the exchangeable security is a partnership interest, it is intended that the exemption apply only to the portion of the capital gain realized on the exchange that is attributable to the economic appreciation of the partnership interest and not to any portion of the capital gain resulting from a previous reduction in the adjusted cost base of the partnership interest.
Unlisted Shares Held by Private Foundations
In the 2007 federal Budget, the government introduced a capital gains exemption for publicly-listed securities donated to private foundations. This exemption was enacted in the 2007 Budget legislation that received Royal Assent on December 14, 2007.
To protect against “self-dealing” between a private foundation and persons connected with the foundation, the 2007 Budget legislation also introduced an “excess corporate holdings” regime, limiting the percentage of shares of any class of a corporation that may be held by a private foundation, taking into account shares held by the foundation and by persons not dealing at arm’s length with the foundation (“relevant persons”). The excess corporate holdings rules apply to both listed and non-listed shares. Where the prescribed limit is exceeded, a divestment obligation is triggered. Generally, the divestment obligation is triggered where a foundation holds more than two per cent of outstanding shares of a given class, and the foundation and all relevant persons together hold more than 20% of the class. Certain “entrusted shares” donated before March 19, 2007 and subject to a condition that they be retained by the foundation are exempted from the divestment obligation. At the time the 2007 Budget legislation was introduced, the Department of Finance signalled its intention to further review the excess corporate holdings rules to provide relief in respect of unlisted securities held before the date of the 2007 Budget.
The Budget proposes to provide this relief by exempting unlisted shares held by a private foundation on March 18, 2007 from the divestment obligation. However, the exemption will not be available where the unlisted shareholding provides the foundation (together with non-arm’s length persons) with a controlling interest in a corporation that holds listed shares in another corporation, and those listed shares (if held by the foundation) would cause the excess corporate holdings limit to be exceeded.
The Budget also proposes to introduce a concept of “substituted shares” being shares acquired in the course of certain tax-deferred transactions such as a conversion, a share-for-share exchange, a reorganization of capital or an amalgamation. The substituted shares will be treated the same as the original shares for the purposes of applying the exemptions from the excess corporate holdings regime and the timing of any applicable divestment obligations.
The Budget also proposes to introduce rules attributing shares held by certain trusts to a private foundation, and to extend the anti-avoidance rules to a situation where a trust is used to avoid a divestment obligation.
Remittance of Source Deductions
The Budget proposes two changes relating to the remittance of source deductions. First, the penalty applicable to a late remittance will be changed from a flat 10% of the amount required to be remitted to a graduated penalty: 3% if the remittance is one to three days late, 5% if it is four or five days late, 7% if it is six or seven days late, and 10% if it is more than seven days late. This change is consistent with a CRA pilot project created in 2003 which, according to the Budget, has resulted in fewer late remittances.
The Budget also proposes to relax the mandatory requirement that large remitters make remittances at a financial institution (rather than directly to the CRA), by deeming a remittance received by the CRA at least one full day before the due date to satisfy this requirement.
These changes will be effective for remittances due on or after February 26, 2008. The Budget indicates that similar changes will be made to the Employment Insurance and Canada Pension Plan legislation.
SALES AND EXCISE TAX MEASURES
The Budget does not introduce any significant changes to the federal GST or other excise taxes.
There are, however, several sectors where specific amendments are proposed.
GST/HST Health Measures
The Budget proposes a number of new relieving measures to expand the scope of GST exemption for health care services, such as permitting certain diagnostic services including blood tests or x-rays to be exempted where they are provided on the order of a registered nurse. Similarly, zero-rating will be provided for the provision of prescription drugs not only by medical practitioners but also by other health professionals who are authorized to prescribe such drugs under provincial legislation.
The Budget also proposes that exempt health care services provided by health professionals will be exempt regardless of whether such services are supplied directly by the health professional or through a corporation.
These changes apply to supplies made after February 26, 2008.
GST/HST Treatment of Long-Term Residential Care Facilities The Budget contains measures to clarify the application of certain rules regarding the GST/HST treatment of long-term residential care facilities to ensure that the GST New Residential Rental Property Rebate and GST/HST exempt treatment apply to such facilities. This change will generally apply effective February 26, 2008 but may also apply to certain past transactions where the owner has paid tax on the facility or elects to have the new rules apply.
GST/HST Treatment of Property Leases for Wind and Solar Powered Equipment
Effective February 26, 2008, the Budget proposes to provide that any supply of a right-of-entry or use to generate or evaluate the feasibility of generating electricity from the sun or wind will be deemed not to be a supply and any payments made for such supply will be deemed not to be a consideration for GST/HST purposes, unless that supply is made directly to a consumer or a person who is not a GST registrant.
Provincial Sales Tax Harmonization
The Government reaffirmed its commitment to work with the Provinces to move to a harmonized federal/provincial system, although no indication of progress in this area was offered.
The Budget proposes a number of changes to enhance tobacco tax enforcement and compliance as well as the introduction of new excise duties on “imitation spirits” to treat such spirits as genuine spirits rather than beer.
PREVIOUSLY ANNOUNCED MEASURES
The Budget confirms the Government’s intention to proceed with the following six previously announced tax measures, as modified to take into account consultations and deliberations since their release:
Foreign Affiliate Rules
Draft amendments to the foreign affiliate rules were introduced on February 27, 2004 and have not yet been enacted. Many of these rules are expected to apply retroactively to 2004 or earlier and will have a significant impact on the taxation of outbound investments. These amendments are expected to be re-released in draft form and will likely take into account numerous changes that have been suggested by the Department of Finance and taxpayers over the past four years.
Application of GST/HST to Financial Services
Proposed improvements to the application of GST/HST to the financial services sector were announced on January 26, 2007.
Taxation of Financial Institutions
Draft changes to the taxation of financial institutions that were designed to better align income tax laws with accounting standards were released on November 7, 2007. For background on these proposals, as originally announced on December 28, 2006, see Osler Publication, “New Canadian Accounting Standards Bring Tax Changes,” dated January 22, 2007.
SIFT Trusts and Partnerships
Technical amendments to the income tax rules that apply to SIFT trusts and partnerships, together with measures to facilitate the conversion of SIFTs to corporations, were announced on December 20, 2007.
Changes to the automobile expense deduction limits and the prescribed rates for automobile operating expense benefits were announced on December 24, 2007.
Investment Tax Credit Carryforwards
The extension of the carry-forward period for unused investment tax credits of a Canadian business from 10 years to 20 years was announced on January 29, 2008.