- Consultation on Treaty Shopping
- Updates on the Automatic Exchange of Information, Tax Treaties and Tax Information Exchange Agreements
- Consultations on Tax Planning by MNEs
- Captive Insurance
- Private Offshore Banks
- Back-to-Back Loans
- Non-Resident Trusts – Elimination of “Immigration Trusts” Exemption
- Consultation on Eligible Capital Property
- Tax Incentives for Clean Energy
- Mineral Exploration Tax Credit for Flow-Through Share Investors
- GST/HST and Excise Tax Measures
- Graduated Rate Taxation of Trusts and Estates
- NPO Consultation
Budget 2014: Fiscal Integrity as a Work in Progress
Minister of Finance Flaherty takes pride in the integrity measures he has introduced since 2006. Last year, Budget 2013 touted over 75 measures aimed at improving integrity and closing tax loopholes. This is not a big surprise from the Minister who took the heat for closing down income funds almost a decade ago.
True to form, Minister Flaherty’s Budget 2014 continues the pursuit of fiscal integrity. The scale of the integrity and fairness measures introduced by the Government of Canada since 2010 is significant. The total fiscal savings for all of these proposals from the 2010-2011 fiscal year to the 2018-2019 fiscal year is estimated to exceed $23 billion. The Minister of Finance’s fiscal savings estimates also provide a good indication of the slower pace of integrity measures in Budget 2014. While savings from these measures in Budget 2011 were estimated to be over $8-billion, the estimate for Budget 2014 measures is less than $1.8 billion, with most of that attributed to one proposal aimed at so-called “captive insurers.” While presumably not a change that will affect a lot of taxpayers, it is likely that those affected will be affected a lot.
Clearly, protecting the integrity of the tax system helps create a broader, more comprehensive tax base allowing for lower tax rates and a more neutral tax system. However, adjusting to the annual changes to the system is a challenge, not only for those who have taken advantage of the tax planning opportunities, but for all taxpayers from the uncertainty that the new rules can bring to tax planning and compliance.
It seems, however, that the biggest integrity measures from Budget 2014 are yet to come. The Budget discusses on-going efforts of the Organisation for Economic Development and Cooperation (OECD) and G-20 relating to base erosion and profit shifting (BEPS). These are international tax reform efforts triggered in part by revelations of multinational corporations shifting their profits to offshore jurisdictions and paying dramatically low effective tax rates. In Budget 2014 the Government of Canada invites input on various BEPS related questions, including what considerations should guide the Government in determining how it should respond to BEPS issues. Businesses with international operations should pay attention.
As well, Budget 2014 proposes significant treaty shopping rules with limited time for consultation and input. The Minister of Finance had already invited comments on treaty shopping in last year’s budget. A number of interested parties urged the Government of Canada not to move forward on this topic until the OECD first comes forward with its suggestions, if only to ensure that any Canadian proposals fit with those of the OECD. Nevertheless, Budget 2014 contains some fairly detailed treaty shopping proposals that, if adopted, will impact many investments made by foreigners into Canada, as well as Canadians doing business with, or making payments to, non-residents. Although announced as a further consultation, the consultation period is a mere 60 days. It seems clear that this further integrity shoe is ready to drop soon.
Finally, the Minister of Finance again threw in a few “goodies.” These include the “905 credits” for which he has become famous (a search and rescue volunteers tax credit to follow last year’s volunteer firefighters’ tax credit) and some business “goodies” such as the annual 1-year extension of the mineral exploration tax credit and the annual expansion of the accelerated capital cost allowance for clean energy generation equipment.
Consultation on Treaty Shopping
Budget 2014 highlights the progress made by the Government of Canada since the release of Budget 2013 where it first announced its intention to consult on possible measures to combat “treaty shopping.” The term “treaty shopping” refers to situations where residents of third countries may establish entities in treaty countries for the purpose of accessing the benefits of particular bi-lateral tax treaties. In Budget 2013, the Government of Canada expressed its concern that existing anti-abuse provisions were not sufficient to counter such practices, particularly given the Government of Canada’s lack of success in challenging these practices in the tax courts. In August 2013, the Government of Canada released a consultation paper describing these measures and invited stakeholders to provide their comments by December 13th. Having received the feedback from the consultation process, along with growing support from the international tax community, including the OECD, the Government of Canada is now announcing the second phase of this consultation process.
Budget 2014 proposes that, after considering several approaches to combat treaty shopping, a treaty based approach would not be as effective as a domestic law rule. Consequently, the Government of Canada has set out the framework for a new domestic rule that could be introduced into the Income Tax Conventions Interpretation Act to effectively override all of Canada’s existing treaties. If enacted, the rule would apply to taxation years that commence after the enactment of the rule into Canadian law. The proposed rule would contain four elements to address treaty shopping which were developed based on the comments received on the August 2013 consultation paper. The four elements can be summarized as follows:
- Main purpose provision: a benefit will not be provided under a tax treaty to a person in respect of an amount of income, profit or gain (Income) if it is reasonable to conclude that one of the main purposes for undertaking a transaction was for the person to obtain the benefit
- Conduit presumption: Unless proven otherwise, it will be presumed that one of the main purposes for undertaking a transaction that results in a benefit under a tax treaty was for a person to obtain the benefit if the Income is primarily used to pay, distribute or transfer an amount to another person that would not have been entitled to an equivalent or more favourable benefit had the other person received the Income directly
- Safe harbour presumption: The safe harbour presumption provides that, subject to the conduit presumption, it would be presumed that none of the main purposes for undertaking a transaction was for a person to obtain a benefit under a tax treaty in respect of Income if:
- The person (or a related person) carries on an active business (other than managing investments) in the other state and, where the Income is derived from a related person in Canada, the active business is substantial compared to the activity carried on in Canada giving rise to the Income. This portion of the safe harbour rule is similar to the “active trade or business” test in the limitation on benefits provision (Article XXIX-A(3)) in the Canada-United States Treaty
- The person is not controlled by another person that would not have been entitled to an equivalent or more favourable benefit had the other person received the Income directly or
- The person is a corporation or a trust the shares or units of which are regularly traded on a recognized stock exchange
- Relieving provision: If the main purpose provision applies in respect of a benefit under a tax treaty, the benefit is to be provided, in whole or in part, to the extent that it is reasonable having regard to all the circumstances
The Government of Canada provides five examples to help illustrate the intended application of the four elements of the proposed rule. While the Government of Canada invites interested parties to provide comments on the proposed rule, such comments must be presented within 60 days after February 11, 2014. The short timeframe given to provide comments suggests that the consultation period, while still ongoing, will likely not result in material alterations to the proposed rule in the absence of the unlikely scenario that an egregious oversight is brought to the Government of Canada’s attention.
Given the short window afforded by the Government of Canada for these additional consultations, it is likely that the intention is to complete the legislative process in 2014 so as to have the proposed rule apply to the 2015 taxation year. This would leave many taxpayers in a precarious position and in need of quick restructuring to remain compliant with Canadian law. However, as part of the consultation, the Government of Canada requests comments as to whether transitional relief would be appropriate. Taxpayers who may be caught by the proposed rule, which should be many, should be vigilant in making recommendations to the Government of Canada during the 60 day consultation period in order to ensure reasonable transitional relief time to restructure current operations is afforded.
Updates on the Automatic Exchange of Information, Tax Treaties and Tax Information Exchange Agreements
Budget 2007 signalled the Government of Canada’s commitment to including information exchange provisions in all future tax treaties and updates to existing treaties and negotiating tax information exchange agreements (TIEAs) with non-treaty jurisdictions. Since Budget 2013, Canada’s treaty network has expanded to include: ratified tax treaties with Hong Kong, Poland and Serbia; protocols to the treaties with Austria, Barbados, France and Luxembourg; an information exchange agreement under the existing treaty with Switzerland; the coming into force of TIEAs with Liechtenstein and Panama; and signed TIEAs with Bahrain, the British Virgin Islands and Brunei. Canada has also signed the OECD Convention on Mutual Administrative Assistance in Tax Matters, joining over 60 other countries that have signed to-date. Budget 2014 reiterated the federal government’s commitment to combating international tax evasion and aggressive tax avoidance, including updates on treaty-based information exchange and TIEAs.
The Budget update focussed on Canada’s February 5, 2014 intergovernmental agreement (IGA) with the US regarding the application of the US Foreign Account Tax Compliance Act (FATCA). First enacted in March 2010, FATCA seeks to address tax evasion and requires non-US financial institutions to report accounts held by US persons or face punitive withholding tax consequences on US-sourced income. US persons include US citizens and permanent residents (sometimes referred to as “green card holders”). FATCA was troubling to both Canadian financial institutions and US persons with Canadian accounts, since compliance by Canadian institutions was required as of July 1, 2014, regardless of Canadian government approval. Despite being extra-territorial legislation, FATCA could be enforced under threat that the US authorities would apply 30% withholding tax to a non-compliant institution’s US-sourced income. The punitive withholding tax would have applied to financial institutions based in any country lacking an IGA with the US. Hence, it was critically important for Canada to establish the IGA with the US.
The Canada-US IGA established significant exemptions from FATCA as well as information exchange processes. Canadian institutions will report information on US persons to the CRA rather than directly to the Internal Revenue Service (IRS). The information will be transmitted to the IRS under the Canada-US tax treaty subject to the relevant confidentiality provisions of that treaty. Exemptions from reporting include registered accounts (RRSPs, RRIFs, RESPs, RDSPs and TFSAs) and smaller financial institutions, such as credit unions, with assets of less than $175M. The Canada-US IGA also eliminated the application of the FATCA provision requiring financial institutions to close accounts or refuse services to clients in certain circumstances.
The Canada-US IGA provides for reciprocity. The Canada Revenue Agency (CRA) will receive information from the US regarding Canadian residents with US accounts to help enforce Canadian tax compliance. The CRA will not collect the US tax liability of a Canadian citizen if the individual was a Canadian citizen at the time the tax liability arose.
The new Canada-US reporting regime comes into effect starting in July 2014, with exchanges of information beginning in 2015.
Consultations on Tax Planning by MNEs
Tax planning by certain multi-national enterprises (MNEs) has recently attracted global attention because of the very low effective tax rates achieved. This included the attention of governments and tax policy makers, including the Government of Canada, and certain governmental organizations, notably the OECD and the G-20. As a result, the OECD launched a project aimed at addressing BEPS strategies used by MNEs to reduce or avoid taxes. The BEPS project has included a number of working groups each focusing on different aspects of governmental concern, and has included a “BEPS Action Plan” released by the OECD in July, 2013.
In this context, Budget 2014 announced that the Government of Canada would be launching a consultation process and, more specifically, will be seeking input on the following questions:
- What are the impacts of international tax planning by MNEs on other participants in the Canadian economy?
- Which of the international corporate income tax and sales tax issues identified in the BEPS Action Plan should be considered the highest priorities for examination and potential action by the Government?
- Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the Government?
- What considerations should guide the Government in determining the appropriate approach to take in responding to the issues identified – either in general or with respect to particular issues?
- Would concerns about maintaining Canada’s competitive tax system be alleviated by coordinated multilateral implementation of base protection measures?
The Government will also be seeking views on what actions should be taken to ensure the effective collection of sales tax on e-commerce sales to Canadians by foreign-based vendors, and whether it should adopt the approach taken in some other jurisdictions (such as in South Africa and the European Union) where foreign-based vendors are required to register for and collect the local tax. In the case of Canada, this would require non-Canadian businesses to register with the CRA and charge and collect Goods and Services/Harmonized Sales Tax (GST/HST) on e-commerce sales made to residents of Canada.
The consultation period runs for 120 days from February 11, 2014.
The Canadian “foreign accrual property income” (FAPI) regime contains anti-avoidance rules to prevent Canadian taxpayers (such as financial institutions) from shifting income from the insurance of Canadian risks to offshore no- or low-tax jurisdictions.
Certain Canadian taxpayers circumvented the FAPI rules through “insurance swap” transactions by transferring certain Canadian risks (i.e. risks in respect of persons resident in Canada, property situated in Canada or businesses carried on in Canada) to a wholly owned foreign affiliate of the taxpayer. The foreign affiliate would enter into an agreement to exchange the Canadian risks with a third party for foreign risks that were originally insured outside of Canada. Generally, there would be no resulting change to the foreign affiliate’s overall risk profile and economic returns as a result of the agreement to exchange.
In keeping with the “integrity” theme, Budget 2014 clarifies that, as of February 11, 2014, such arrangements will result in FAPI where:
- Taking into consideration one or more agreements or arrangements entered into by the foreign affiliate, or by a person or partnership that does not deal at arm’s length with the affiliate, the affiliate’s risk of loss or opportunity for gain or profit in respect of one or more foreign risks can – or could if the affiliate had entered into the agreements or arrangements directly – reasonably be considered to be determined by reference to the returns from one or more other risks (the tracked risks) that are insured by other parties and
- At least 10 per cent of the tracked risks are Canadian risks
Private Offshore Banks
Canada has extensive rules to prevent Canadians from avoiding tax on offshore investment income. These rules apply to FAPI earned by a controlled foreign affiliate of a Canadian resident taxpayer. Generally, such income is taxed directly in Canada on an accrual basis as it is earned. As a result, moving investment income to an offshore corporation does not typically result in Canadian income tax savings.
However, certain exceptions from the FAPI rules exist in order to facilitate international business. One of the exceptions is for income earned by a regulated foreign financial institution, such as a bank, trust company, credit union, insurance corporation, or a trader or dealer in securities or commodities that is regulated under the laws of the relevant foreign jurisdiction. Some taxpayers have used this exception to save Canadian tax by incorporating their own private offshore bank. The offshore bank invests or trades in securities on its own account rather than for customers, and the income is earned without being taxed in Canada.
The Government of Canada has decided this exception from the Canadian FAPI rules was not intended to apply in these circumstances. Therefore, Budget 2014 proposes adding a number of new conditions to the exception for offshore financial institutions. In future the exception will be limited to the foreign subsidiaries of Canadian financial institutions that have substantial operations in Canada. Under this proposal a high net worth individual or company will not be able to shelter FAPI in a private offshore bank. In a further attempt to discourage more elaborate tax planning, the Government of Canada has indicated that it will continue to monitor this area to ensure that Canadians do not use the FAPI exemption to obtain unintended tax advantages.
Interest payments made by a Canadian resident to a non-resident may be subject to both the thin capitalization rules and the Part XIII withholding tax rules. To avoid the application of these rules, some taxpayers have used back-to-back loan structures (described below). In response to this type of tax planning, Budget 2014 proposes amending an existing anti-avoidance provision in the thin capitalization rules and the introduction of a new anti-avoidance rule for withholding tax on interest payments to stop the use of back-to-back loans. The proposed changes in respect of the thin capitalization rules apply in taxation years that begin after 2014 and those in respect of Part XIII withholding tax will apply to amounts paid or credited after 2014.
In general, the thin capitalization rules deny the deduction of interest paid by a Canadian-resident corporation to certain non-resident shareholders or other non-resident persons to the extent that a 1.5:1 debt-to-equity ratio is exceeded. In addition, the Income Tax Act (Canada) (ITA) generally levies a withholding tax on interest paid or credited by a Canadian resident to a non-arm’s length non-resident. In both cases, the tax rules are invoked where the lender is a non-arm’s length party.
Back-to-back loan structures generally involve interposing an arm’s length intermediary (typically a third party foreign bank) between two related taxpayers in an attempt to avoid the thin capitalization rules or Part XIII withholding tax, or both. Such arrangements might be challenged under the current rules. For example, a back-to-back loan structure could be challenged under a currently existing anti-avoidance provision in the thin capitalization rules that could apply to a non-resident who, instead of making a loan directly to a non-arm’s length Canadian corporation, lends the funds to a third party on the condition that the third party make a loan to the Canadian corporation. While the Part XIII withholding tax rules do not include a specific anti-avoidance provision, the CRA has issued a number of public statements suggesting that such arrangements, when used to avoid Part XIII withholding tax, could, and perhaps should, be challenged using the general anti-avoidance rule (GAAR).
There is some uncertainty as to whether a challenge under GAAR would be successful. The applicability of GAAR to back-to-back structures was recently considered by the Federal Court of Appeal in Lehigh Cement Limited v The Queen. In that case the court held that GAAR did not apply and the CRA did not release any comments in response to the decision.
Any uncertainty that existed regarding the acceptability of back-to-back loan arrangements has been significantly reduced, if not eliminated, with the Budget 2014 proposals. Under the proposals, when a back-to-back loan arrangement exists, the use of the third-party intermediary will essentially be ignored for purposes of applying the thin capitalization rules and Part XIII withholding tax. Pursuant to the proposals, a back-to-back loan arrangement exists when the following conditions are met:
- a taxpayer has a debt owing to a third-party intermediary, and
- the intermediary or any non-resident person that does not deal at arm’s length with the intermediary
- is pledged a property by a non-resident person as security in respect of the obligation;
- is indebted to a non-resident person under a limited recourse debt; or
- receives a loan from a non-resident person on condition that a loan be made to the taxpayer
If there is a back-to-back loan arrangement, the taxpayer will be deemed to owe a debt directly to the non-resident person based on the value of the property pledged by the non-resident or the amount lent by the non-resident through the intermediary. Under the proposals, interest will also be deemed to be paid or payable by the taxpayer to the non-resident person. As a result, the thin capitalization rules and Part XIII withholding tax will apply despite the use of an intermediary. Both the taxpayer and the non-resident will be jointly and severally liable for any resulting withholding tax under these proposals. Accordingly, taxpayers who have used intermediaries to facilitate the financing of their Canadian operations with a back-to-back loan arrangement will want to carefully evaluate the impact of these proposals and may wish to consider refinancing.
Non-Resident Trusts – Elimination of “immigration trusts” exemption
In a surprising development, Budget 2014 proposes the elimination of a special exemption that has existed for decades for the so-called five-year offshore trusts used by many immigrants to Canada. This exemption survived an extensive overhaul of the tax rules governing offshore trusts, so its sudden elimination was not widely expected.
Generally, Canadian residents cannot avoid Canadian tax by settling investment assets on an offshore trust. A number of complex rules governing non-resident trusts (NRT rules) attempt to ensure that offshore trusts will be taxed in Canada if they have been settled by a Canadian resident. The NRT rules generally deem offshore trusts that have a Canadian resident contributor, or a Canadian resident beneficiary and a “connected contributor”, to be resident in Canada for tax purposes and hence taxable in Canada and subject to Canadian tax filing and compliance obligations.
However, there is a 60-month exemption in the NRT rules which generally applies if the only contributor to a non-resident trust is an individual who has been resident in Canada for a total period of not more than 60 months (i.e., a newly resident Canadian). The 60-month exemption effectively allowed up to a 60-month tax holiday for investment income of an offshore trust settled by a new Canadian or temporary resident of Canada.
The elimination of this exemption will apply to existing trusts by no later than their 2015 taxation year. In some cases the exemption will be eliminated for the 2014 taxation year of a trust, for example, if any contribution is made to the trust between February 11, 2014 and December 31, 2014. Every taxpayer with an existing offshore trust structure, and the trustees of those trusts, should consult their tax advisors immediately about this proposed change and should consider whether it would be appropriate to migrate the trust to Canada, wind it up, or take other action.
Consultation on Eligible Capital Property
The income tax implications of acquiring, holding and disposing of property depends upon the nature of that propert;y. For example, when a capital property is sold it generates a capital gain. A sale of inventory, on the other hand, generates income.
Depreciable property is capital property on which “capital cost allowance” (CCA) may be claimed in accordance with the Regulations. CCA allows the owner of depreciable property to deduct the cost of depreciable property over a period of time in computing business or property income. In general, CCA is a percentage of a declining balance. Examples of depreciable property are buildings, equipment, furniture and vehicles used in a business.
Prior to 1972, certain properties, such as goodwill and intangible property were tax “nothings” as their cost was not deductible to the holder and proceeds from their disposition were not taxable. After 1971, special rules applied to treat these properties as “eligible capital property” (ECP). The ECP rules are confusing and complex.
Budget 2014 has announced a public consultation on a proposal to repeal the ECP regime entirely and replace it with a new class of depreciable property to which the CCA rules would apply. Draft legislative proposals will be released for comment. The implementation of the proposal will be determined following the consultation. The proposed CCA regime will, hopefully, simplify compliance for taxpayers and reduce the current complexities inherent in the ECP regime.
New CCA class
The new class of depreciable property for CCA purposes includes “eligible capital expenditures” that are added to the “cumulative eligible capital” (CEC) pool of a business under the ECP rules. An “eligible capital expenditure” is generally a capital expense incurred to acquire rights or benefits of an intangible nature for the purpose of earning income from a business, other than expenditures that are deductible as a current expense or incurred to acquire depreciable property under the CCA regime. “Eligible capital expenditures” include the cost of goodwill when a business is purchased, intangible property such as customer lists and licences, franchise rights for an indefinite period, various farm quotas and fishing licences. Certain soft costs such as incorporation expenses and web site development costs may also be treated as “eligible capital expenditures”.
Under the current ECP regime, 75% of an “eligible capital expenditure” is added to the CEC pool in respect of the business. There is a 7% deduction per year on a declining balance basis of the CEC pool. Under the proposed new CCA regime, the expenditures would be included at a 100% inclusion but the class would have a 5% annual depreciation rate instead of 7%.
Special Rules – Specific Properties and Goodwill
Under the proposed CCA regime, there will be a set of rules for acquisitions and dispositions of specific property. Acquisitions and dispositions of specific property would result in an adjustment to the balance of the CCA class and would be relevant in the calculation of recapture and gains for the specific property.
Different rules will apply to goodwill and to expenditures and receipts that do not relate to a specific property. Every business would be considered to have goodwill associated with it, even if there had not been an expenditure to acquire goodwill. Although not entirely clear, it appears that the starting capital cost for goodwill would be nil unless it was acquired on the purchase of a business. Eligible capital expenditures that do not relate to a specific property of the business, such as the costs of incorporation, would increase the capital cost of the goodwill of the business and, therefore, the balance of the new CCA class.
A receipt that would be a capital receipt in respect of the business under the ECP regime and does not relate to a specific property, would reduce the capital cost of the goodwill of the business and, therefore, the balance of the new CCA class by the lesser of the capital cost of the goodwill (which may be nil) and the amount of the receipt. If the amount of the receipt exceeds the capital cost of the goodwill, the excess would be a capital gain. Previously deducted CCA would be recaptured to the extent that the amount of the receipt exceeds the balance of the new CCA class.
CEC pool balances would be transferred to the new CCA class as of the implementation date of the new CCA regime. The opening balance of the new CCA class would be equal to the balance in the CEC pool of the business at that time. For the first 10 years, the depreciation rate for the new CCA class would be 7% in respect of expenditures incurred before the implementation of the new rules.
Receipts for dispositions of ECP that was acquired or expenditures made before the implementation date may qualify for a 75% (as opposed to a 100%) rate of deduction from the balance of the CCA class. This transition rule is intended to ensure that receipts do not result in excess recapture when applied to reduce the balance of the new CCA class.
Special rules to simplify the transition for small businesses will be considered as part of the consultation process.
Tax Incentives for Clean Energy
The ITA encourages investment in low or no-emission energy generation equipment and energy conservation equipment by providing an accelerated 50 per cent declining-balance CCA rate for certain assets. Budget 2014 proposes to expand Class 43.2 to include certain water-current energy equipment and equipment used to gasify eligible waste fuel for use in a broader range of applications. These measures will apply to eligible equipment acquired on or after February 11, 2014, if the equipment has not previously been used or acquired for use.
Mineral Exploration Tax Credit for Flow-Through Share Investors
Budget 2014 proposes to extend the flow-through mining tax credit that has been in place for a number of years. Annual extensions of this 15% federal tax credit have been a feature of federal budgets for some time. The measure was first introduced in the Economic Statement of October 18, 2000.
Under this proposal the credit will be available to purchasers of flow-through shares under flow-through share agreements entered into on or before March 31, 2015. As in the past, it is available only in respect of a certain Canadian exploration expenses relating to specified kinds of surface or “grassroots” exploration, as described in subsection 127(9) of the ITA.
Flow-through funds raised by mining exploration companies on or before March 31, 2015 can be expended on eligible expenditures prior to the end of 2016, and under the look-back rule, expenditures incurred in 2016 can be renounced to purchasers for deduction and credit in 2015.
The measure is intended as an additional stimulus to surface exploration in Canada. Similar tax measures are in place in Ontario, British Columbia, Manitoba and Saskatchewan.
GST/HST and Excise Tax Measures
Budget 2014 included a few surprises in respect of the GST/HST and excise taxes, including a welcome proposal to expand the scope of joint venture elections from a narrow range of activities to all GST/HST-taxable activities. However, elections between closely related persons will have to be filed with the CRA on a going-forward basis, and the CRA will have a new ability to compel GST/HST registration on 60 days notice.
Expansion of Joint Venture Relief to All GST/HST Activities
There is an existing election that allows a joint venture to appoint one participant to undertake the GST/HST reporting on behalf of the joint venture, thereby greatly simplifying the GST/HST reporting for the remaining participants. Absent the election, each participant would be required to report the GST/HST in respect of their own portion of the activities of the joint venture.
Budget 2014 includes a proposal to expand the scope of activities for which the joint venture election will be available. To date, the list of available activities is narrow, being used mainly in the development and holding of real property. The proposal is to expand the election to apply where the activities of the joint venture are exclusively “commercial activities”, that is, consist of the making of GST/HST-taxable supplies and the participants are engaged exclusively in such activities.
The announcement indicates that the draft legislation to be released following consultation will include related anti-avoidance measures.
New Filing Requirement for Closely Related Persons Elections
Related corporations and partnerships can enter into an election to permit the supply of most property and services without charging or paying GST/HST. From January 1, 2015, these elections will have to be filed with the CRA, and pre-existing elections will have to be filed with the CRA by January 1, 2016. In addition, Budget 2014 proposes to make parties to the closely related person election subject to a joint and several liability provision, though only with respect to supplies made between them from January 1, 2015. This, together with the filing requirement, should cause businesses to review whether existing related party elections should be maintained.
Finally, the election will now be available to a newly-formed corporation or partnership, provided the corporation or partnership continues as a going concern engaged exclusively in commercial activities. This is a helpful expansion of relief for certain reorganizations involving newly-formed corporations or partnerships.
Compulsory GST/HST Registration
Perhaps most surprising is a move consistent with the Government of Canada’s theme of countering non-compliance. Budget 2014 provides the Minister of National Revenue with the discretionary authority to register a person that fails to comply with a requirement to register following notification. The taxpayer will be provided 60 days from the date of the notice to voluntarily register.
The application of this new discretionary power will be most interesting for non-residents selling to Canadians. Under existing law, non-residents are required to register if the common law test for carrying on business in Canada is met. This test is amorphous and often difficult to apply, particularly in the new economy. This amendment is to apply on Royal Assent.
Other GST/HST Amendments
Budget 2014 proposes to eliminate the need for a low income Canadian to check a box on the personal income tax return to apply for the GST/HST credit, instead allowing the CRA to automatically determine eligibility.
In addition, Budget 2014 extends exemptions from the GST/HST to acupuncture and naturopathic services, eyewear to treat or correct a vision defect by electronic means, and the service of designing a training plan to assist individuals with a disorder or disability in certain circumstances.
Excise Tax Amendments
Budget 2014 increases the rates of excise duty on sales of tobacco products for the domestic and “duty free” markets. For example, excise duties on domestic sales will increase by $4.00 per carton of cigarettes and by $6.00 for “duty free” sales, eliminating the preferential treatment for the “duty free” market. Excise duty rates on sales of tobacco products in both markets will be indexed to the Consumer Price Index from December 1, 2019.
In addition, there will be administrative monetary penalties and criminal provisions for false statements under the non-GST/HST parts of the Excise Tax Act, which deal with taxes on insurance premiums payable to non-resident unlicensed insurers, certain fuels, certain fuel-inefficient vehicles and automobile air-conditioners.
Graduated Rate Taxation of Trusts and Estates
Last year, Budget 2013 announced a consultation on the income tax treatment of estates, testamentary trusts and certain inter vivos trusts created before June 18, 1971 (grandfathered trusts). The Department of Finance issued a Consultation Paper on June 3, 2013 soliciting comments on a number of proposed changes to these rules. The consultation period ended on December 2, 2013.
Subject to a significant exception in the case of trusts for the benefit of disabled individuals (described below), Budget 2014 proposes to go ahead with the proposals in the Consultation Paper. In particular, Budget 2014 proposes as follows:
- A flat high marginal tax rate will apply to all grandfathered trusts, testamentary trusts and estates, subject to two exceptions. First, estates will benefit from graduated rates for a 36-month period following death. This exception recognizes the fact that it can take some time to administer an estate. Second, trusts for the benefit of individuals who qualify for the federal disability tax credit will qualify for graduated rates. This exception recognizes the fact that trusts are currently used in estate planning to benefit these individuals (“Henson Trusts”) in order to preserve their access to income tested social assistance benefits
- The instalment rules will be extended to the testamentary trusts. Testamentary trusts are currently required to pay tax owing within 90 days following their year end
- The current $40,000 basic exemption from alternative minimum tax will no longer apply to testamentary trusts
- Testamentary trusts will be required to use a calendar year end
- Testamentary trusts will be subject to Part XII.2 tax
- Testamentary trusts will be required to meet the same conditions to qualify as personal trusts as inter vivos trusts. Currently, testamentary trusts automatically qualify as personal trusts, even if the beneficial interest is purchased for consideration
- Inter vivos trusts are required to recognize investment tax credits in the trust, as opposed to making them available to their beneficiaries. This regime will be extended to testamentary trusts
- A number of tax administration rules will no longer be extended to testamentary trusts, including the time period for filing objections, obtaining refunds for overpayment of tax, and requested reassessments and determinations
These measures will apply to taxation years after 2015. Testamentary trusts that do not have a calendar year end will have a deemed year-end on December 31, 2015.
A non-profit organization (NPO) is defined in the ITA to include a club, society or association organized and operated for social welfare, civic improvement, pleasure or any other purpose except profit and that does not distribute its income to its members or proprietors. Subject to a few exceptions, NPOs are exempt from tax on their income. Budget 2014 notes that the ITA provisions governing NPOs are little changed from the original provisions enacted in 1917.
CRA recently completed a three-year “risk identification project” in which it audited 1440 NPOs for their compliance with the provisions of the ITA. In recent years, the CRA has also issued technical interpretations and rulings that many observers feel are more restrictive than in prior years.
In this context, Budget 2014 expresses the Government of Canada’s concern that some NPOs may be earning profits that are not incidental to their non-profit purposes, maintaining disproportionately large reserves or distributing income to members. Budget 2014 also expresses concern regarding the limited and inadequate reporting requirements applicable to NPOs.
Budget 2014 announces the Government of Canada’s intention to review whether the NPO exemption remains “properly targeted” and whether sufficient “transparency and accountability” provisions are in place. The Government of Canada will release a consultation paper and consult with stakeholders.