On March 22, 2017 (Budget Day), Finance Minister Bill Morneau tabled in the House of Commons the Liberal Government’s second budget, Building a Strong Middle Class (Budget 2017).
Contrary to pre-budget rumours, Budget 2017 did not include measures increasing the capital gains inclusion rate, further restricting the principal residence deduction, taxing health and dental benefits under private health care plans or curtailing the favourable taxation of employee stock options.
Our commentary on the tax initiatives in Budget 2017 follows. Unless otherwise stated, all statutory references are to the Income Tax Act (Canada) (Tax Act).
BUSINESS TAX MEASURES
Tax Planning Using Private Corporations
Budget 2016 announced significant changes to the taxation of small businesses and a wide-ranging review of the federal tax expenditures contained in the Tax Act. The Government announced in Budget 2017 that it will be further reviewing the use of tax planning strategies involving private corporations that, in the view of the Government, inappropriately reduce personal taxes of high-income earners. Strategies specifically identified by the Government include:
- using private corporations to “sprinkle” income (via both dividends and capital gains) to family members who are subject to lower personal tax rates (or who may not be taxable at all);
- taking advantage of the fact that corporate income tax rates (on business income) are generally lower than personal tax rates to facilitate the accumulation of earnings that can be invested in a passive investment portfolio inside a private corporation; and
- “converting a private corporation’s regular income into capital gains” by, for example, accumulating funds in a private corporation and subsequently realizing a capital gain on the disposition of shares, rather than extracting funds on a current basis by way of salary or dividends.
The Government also announced that it will consider whether there are features of the current income tax system that have an “inappropriate, adverse impact on genuine business transactions” involving family members.
The Government will be releasing a paper in the next few months setting out the nature of the issues in more detail and proposed policy responses. It is unclear whether the paper will also address some of the issues arising from the small business taxation measures introduced as part of Budget 2016; however, the Government has committed to ensuring that “corporations that contribute to job creation and economic growth by actively investing in their business continue to benefit from a highly competitive tax regime.”
Meaning of Factual Control
Two forms of control exist for purposes of the Tax Act: de jure control (i.e., legal control) and de facto control (i.e., factual control). De facto control is broader than de jure control, and is relevant for purposes of various rules, including the Canadian-controlled private corporation definition, the affiliated person rules and the associated corporation provisions. Where the Tax Act intends to refer to de facto control, it does so through the use of the phrase “controlled, directly or indirectly in any manner whatever.” The meaning of this phrase, defined in subsection 256(5.1), has been the subject of considerable judicial consideration. In 2002, the Federal Court of Appeal held in Silicon Graphics (2002 FCA 260) that for a person or group of persons to have de facto control they “must have the clear right and ability to effect a significant change in the board of directors or the powers of the board […] or to influence in a very direct way the shareholders who would otherwise have the ability to elect the board.” Other cases such as Mimetix Pharmaceuticals (2003 FCA 106) considered a broad array of so-called operational control factors in evaluating de facto control. The Silicon Graphics test was recently reaffirmed in McGillivray Restaurant (2016 FCA 99), where the Federal Court of Appeal rejected the assertions that subsequent jurisprudence had broadened the test and that de facto control included operational control.
Budget 2017 proposes to override McGillivray Restaurant by adding new subsection 256(5.11) applicable in respect of taxation years that begin on or after Budget Day. New subsection 256(5.11) will provide that for purposes of the Tax Act “the determination of whether a taxpayer has, in respect of a corporation, any direct or indirect influence that, if exercised, would result in control in fact of the corporation (a) shall take into consideration all factors that are relevant in the circumstances; and (b) shall not be limited to, and the relevant factors to be considered in making the determination need not include, whether the taxpayer has a legally enforceable right or ability to effect a change in the board of directors of the corporation, or the board’s powers, or to exercise influence over the shareholder or shareholders who have that right or ability.”
Scientific Research and Experimental Development
Budget 2017 proposes a review of the scientific research and experimental development tax incentive program to ensure its continued effectiveness and efficiency.
Derivatives: Election to Use the Mark-to-Market Method
In the past, there was uncertainty as to whether taxpayers that held derivatives on income account could, in computing income under section 9, use the mark-to-market method or were required to use the realization method. Financial institutions are required to use the mark-to-market method in relation to “mark-to-market property” but most derivatives are not within that definition.
In Kruger Incorporated (2016 FCA 186), the Federal Court of Appeal held that the taxpayer, which was not a financial institution but carried on a business of dealing in options, was entitled to use the mark-to-market method on the basis that it provided an accurate picture of the taxpayer’s income. However, the Court found, despite the unanimous view of the accounting experts that mark-to-market was now the only acceptable method of computing income from derivatives for accounting purposes, and in the absence of evidence relating to the accuracy of the realization method in computing income from derivatives, that the mark-to-market method was only “as accurate” a method of computing income from derivatives as the realization method. In such circumstances, a taxpayer would be free to choose either method. Presumably to deal with cases where there may be uncertainty as to whether mark-to-market accounting does produce as accurate a picture of income as the realization method, Budget 2017 contains a proposal for an elective mark-to-market regime for derivatives held on income account available for taxation years that begin on or after Budget Day. Once made, the election can be revoked only with the concurrence of the Minister and on such terms and conditions as are specified by the Minister.
The elective regime will apply in relation to “eligible derivatives.” An eligible derivative of a taxpayer for a taxation year means a swap agreement, a forward purchase or sale agreement, a forward rate agreement, a futures agreement, an option agreement or a similar agreement if the following conditions are met:
- the taxpayer has produced audited financial statements prepared in accordance with generally accepted accounting principles in respect of the taxation year, or the agreement has a readily ascertainable fair market value;
- the agreement is not a capital property, a Canadian resource property, a foreign resource property or an obligation on account of capital of the taxpayer; and
- in the case of a “financial institution,”as defined in subsection 142.2(1), the agreement is not a “tracking property” other than an “excluded property.”
Where the electing taxpayer is a financial institution, each eligible derivative held by it at any time in the taxation year will be deemed to be mark-to-market property for the purposes of the Tax Act so that the mark-to-market rules will apply to such eligible derivatives.
If the electing taxpayer is not a financial institution, each eligible derivative held at the end of a taxation year is deemed to have been disposed of by the taxpayer immediately before the end of the year and the taxpayer is deemed to have received proceeds or paid an amount, as the case may be, equal to its fair market value at the time of disposition, and to have reacquired, or reissued or renewed, the eligible derivative at the end of the year at an amount equal to such proceeds or amount.
A special rule applies if the taxpayer holds an eligible derivative at the beginning of the first taxation year in respect of which the election applies if the taxpayer did not compute its profit or loss in respect of that eligible derivative in accordance with a method of profit computation that produces a substantially similar effect to mark-to-market. In that case, the eligible derivative is deemed to have been disposed of by the taxpayer immediately before the end of the year and the taxpayer is deemed to have received proceeds or paid an amount, as the case may be, equal to its fair market value at the time of disposition and to have reacquired, or reissued or renewed, the eligible derivative at the end of the year at an amount equal to such proceeds or amount. However, the profit or loss that would arise on the deemed disposition is deemed not to arise in the taxation year immediately preceding the election year, but in the taxation year in which the taxpayer actually disposes of the eligible derivative.
If an agreement is an eligible derivative of a taxpayer but is not a property of the taxpayer (presumably because it is a liability of the taxpayer), the taxpayer is deemed to hold the eligible derivative at any time while the taxpayer is a party to the agreement and to have disposed of it when it is settled or extinguished in respect of the taxpayer.
If a taxpayer (other than a financial institution) does not make the election, it may not use a method of profit computation that produces a substantially similar effect to mark-to-market in computing income in respect of a swap agreement, a forward purchase or sale agreement, a forward rate agreement, a futures agreement, an option agreement or a similar agreement.
A number of ancillary rules are proposed, including the following:
- The suspended loss rule in subsection 18(15) will not apply to the deemed disposition and reacquisition of an eligible derivative under the mark-to-market rules.
- An eligible derivative is not an eligible property that can be transferred by a taxpayer to a corporation under subsection 85(1), by a partnership to a corporation under subsection 85(2) or by a taxpayer to a Canadian partnership under subsection 97(2).
Canadian federal governments have been vexed by straddle transactions for decades. While the Government states in the Budget Documents that these transactions are being challenged using certain judicial principles and existing provisions of the Tax Act, including the general anti-avoidance rule, it believes that these challenges can be time-consuming and costly. One might also add that they may well be unsuccessful.
The basic premise of a straddle is that the taxpayer enters into two (substantially) offsetting transactions. For example, the taxpayer could purchase an option to purchase 100 shares of X Co for $1,000 and write an option to sell 100 shares of X Co for $1,000. Ignoring counterparty risk, if the expiry dates of the option are the same, the taxpayer has no economic risk. At the end of the year, if the value of 100 shares of X Co is other than $1,000, one of the options will be in the money and one will be out of the money. The out-of-the-money option is settled at a loss. Settlement of the in-the-money option is delayed until the following year. The taxpayer can claim a loss in the first year and defer the gain until the following year. In Friedberg ( 4 SCR 285), the Supreme Court of Canada held that the taxpayer was entitled to recognize the loss in the first year.
Budget 2017 proposes a stop-loss rule to defer the realization of a loss on the disposition of a “position” to the extent of any unrealized gain on an “offsetting position.” A gain in respect of an offsetting position would generally be unrealized if it has not been disposed of and is not subject to mark-to-market taxation.
An exception to the new stop-loss rule is proposed. The stop-loss rule will not apply if it can reasonably be considered that none of the main purposes of the series of transactions or events, or any of the transactions or events in the series, of which the holding of both the particular position and offsetting position are part, is to avoid, reduce or defer tax that would otherwise be payable under the Tax Act. As noted below, certain hedging transactions are also excluded from the application of the rule even if one of the main purposes is to avoid, reduce or defer tax.
The term “position” is defined exhaustively and specifies certain properties, obligations or liabilities of a person including a share; a partnership interest; a trust interest; a commodity; foreign currency; a swap agreement, a forward purchase or sale agreement, a forward rate agreement, a futures agreement, an option agreement or a similar agreement; indebtedness owed to or by the person and that is denominated in foreign currency, described in paragraph 7000(1)(d) of the Income Tax Regulations, or convertible into or exchangeable for any of the foregoing properties; and an obligation to redeliver any such property. Where there is more than one property, obligation or liability, it must be reasonable to conclude that they are held in connection with each other.
An “offsetting position” in respect of a particular position of a person (holder) is one or more positions held by the holder and/or a person that does not deal at arm’s length with, or is affiliated with, the holder (connected holder) that have the effect, or would have the effect if held by the holder, of eliminating all or substantially all of the holder’s risk of loss and opportunity for gain or profit in respect of the particular position. To take into account a position held by a connected person, it must be reasonable to consider that it is held with the purpose of eliminating the holder’s risk of loss and opportunity for gain or profit in respect of the particular position.
A particular position is a “successor position” in respect of an initial position that was disposed of if it is an offsetting position in respect of a second position that was an offsetting position in respect of the initial position. The particular position must be entered into during the period that begins 30 days before, and ends 30 days after, the time at which the initial position is disposed of.
An unrecognized gain (or loss) in respect of a position of a person at a particular time in a taxation year is the profit (or loss) that would be included (or deductible) in computing income if it were disposed of immediately before the particular time at its fair market value at the time of disposition.
The new rule will apply if a taxpayer disposes of a position that is not a capital property, or an obligation or liability on account of capital, of the taxpayer.
The taxpayer’s loss will generally be reduced by unrecognized profit (net of unrecognized losses) in respect of positions that are offsetting positions in respect of the particular position, successor positions in respect of the particular position and positions that are offsetting positions in respect of any such successor positions.
Exceptions are provided:
- in the case of certain deemed dispositions, such as on death and on becoming or ceasing to be resident in Canada;
- for certain positions and offsetting positions relating to commodities that the holder of the position manufactures, produces, grows, extracts or processes that are held for the purpose of reducing risk with respect to price changes or currency fluctuations;
- for certain positions and offsetting positions relating to debts incurred in the course of a business (other than a business comprised primarily of the holding of positions and offsetting positions in respect of those positions) to hedge risk with respect to changes in interest rates or currency fluctuations; and
- if the taxpayer is a financial institution, as defined in subsection 142.2(1), a mutual fund corporation or a mutual fund trust.
Clean Energy Equipment: Geothermal Equipment
Geothermal heating is the extraction and direct use of thermal energy generated in the Earth’s interior. Budget 2017 proposes three changes affecting the tax treatment of expenses and expenditures relating to geothermal energy:
- Geothermal energy equipment eligible for accelerated capital cost allowance (CCA) under Classes 43.1 and 43.2 will be expanded to include geothermal equipment that is used primarily for the purpose of generating heat or a combination of heat and electricity. Eligible costs will include the cost of completing a geothermal well (e.g., installing the wellhead and production string) and, for systems that produce electricity, the cost of related electricity transmission equipment. Equipment used for the purpose of heating a swimming pool will not be eligible.
- Certain equipment that is part of a district energy system is currently included in Class 43.1 or 43.2. Geothermal heating will be made an eligible thermal energy source for use in a district energy system.
- Expenses incurred for the purpose of determining the extent and quality of a geothermal resource and the cost of all geothermal drilling (e.g., including geothermal production wells), for both electricity and heating projects, will qualify as a Canadian renewable and conservation expense (CRCE). CRCE may be deducted in full in the year incurred, carried forward indefinitely for use in future years or transferred to investors using flow-through shares.
Accelerated CCA will be available in respect of eligible property only if, at the time the property first becomes available for use, the requirements of all applicable environmental laws, by-laws and regulations have been met. Similarly, CRCE treatment will be available for expenses in geothermal projects only if such expenses, in the year incurred, meet the requirements of all applicable environmental laws, by-laws and regulations.
The measures will apply in respect of property acquired for use on or after Budget Day that has not been used or acquired for use before Budget Day.
Canadian Exploration Expense: Oil and Gas Discovery Wells
Canadian exploration expense (CEE) includes expenditures associated with drilling an oil or gas well that results in the discovery of a previously unknown petroleum or natural gas reservoir (discovery well). CEE may be deducted in full in the year incurred, carried forward indefinitely for use in future years or transferred to investors using flow-through shares.
Budget 2017 proposes that expenditures related to drilling or completing a discovery well (or building a temporary access road to, or preparing a site in respect of, any such well) be classified as Canadian development expense (CDE) eligible for deduction on a 30% declining balance basis.
No change is proposed in relation to the rules that allow drilling expenditures to be classified as CEE where the well has been abandoned (or has not produced within 24 months) or the Minister of Natural Resources has certified that the relevant costs associated with drilling the well are expected to exceed $5 million and that the well will not produce within 24 months.
The amendments will apply to expenses incurred after 2018 (including expenses incurred by a corporation in 2019 that could have been deemed to have been incurred on December 31, 2018, because of the “look-back” rule applicable to flow-through shares). However, grandfathering is provided in relation to expenses incurred before 2021 (excluding expenses incurred by a corporation in 2021 that could have been deemed to have been incurred on December 31, 2020, because of the look-back rule applicable to flow-through shares) where the taxpayer has, before Budget Day, entered into a written commitment (including a commitment to a government under the terms of a license or permit) to incur those expenses.
Reclassification of Expenses Renounced to Flow-Through Share Investors
Certain small oil and gas corporations currently can treat up to $1 million of CDE as CEE when renounced to shareholders under a flow-through share agreement.
Budget 2017 proposes to repeal this rule. The amendment will apply in respect of expenses incurred after 2018 (including expenses incurred by a corporation in 2019 that could have been deemed to be incurred on December 31, 2018, because of the look-back rule applicable to flow-through shares). However, grandfathering is provided for expenses incurred after 2018 and before April 2019 that are renounced under a flow-through share agreement entered into after 2016 and before Budget Day.
In computing income of a taxpayer from a business that is a professional practice of an accountant, dentist, lawyer, medical doctor, veterinarian or chiropractor, the taxpayer is permitted to make an election under paragraph 34(a) to exclude the value of work in progress at the end of the taxation year. Although “work in progress” is not defined in the Tax Act, it is generally accepted that as a result of making the election, the taxpayer need not include in income any estimate of the value of work that has been partially completed but that has not reached the stage at which the taxpayer can bill the client. The taxpayer would, however, be entitled to deduct all expenditures incurred in the year in performing work on the partially completed assignment.
The Government is concerned that this “billed-basis accounting” methodology enables eligible taxpayers to defer tax by permitting the costs associated with work in progress to be expensed without the matching inclusion of the associated revenues. Budget 2017 therefore proposes to eliminate the ability of the above-mentioned professionals to elect to use billed-basis accounting.
This measure will apply to taxation years that begin on or after Budget Day, subject to transitional relief. In this regard, for the first taxation year of a taxpayer that uses billed-basis accounting that begins on or after Budget Day, 50% of the lesser of the cost and the fair market value of work in progress will be taken into account for the purposes of determining the value of inventory held by the business under the Tax Act. For the second and each successive taxation year that begins on or after Budget Day, the full amount of the lesser of the cost and the fair market value of work in progress will be taken into account for the purposes of valuing inventory.
Mutual Fund Mergers
The Tax Act provides rules that allow a mutual fund trust or a mutual fund corporation to “merge” with a mutual fund trust on a tax-deferred rollover basis in a “qualifying exchange.” Amendments to the Tax Act to implement the proposals of Budget 2016 eliminated the ability of shareholders of a multi-class or switch corporation to exchange their shares representing an ownership interest in one investment fund for shares representing an ownership interest in another investment fund on a tax-deferred rollover basis. Some managers of switch corporations want to terminate or wind up their switch corporations on a tax-deferred basis but cannot do so under the existing merger rules because they require the assets of the terminating fund to be transferred to a single mutual fund trust. Budget 2017 extends the merger rules to permit a mutual fund corporation to merge into more than one mutual fund trust. For example, a switch corporation composed of nine investment funds could merge (or “split”) into nine mutual fund trusts. It could also merge into less than nine mutual fund trusts if, for example, it was desirable to consolidate some of the investment funds or if some of the investment funds had few investors.
The new rules apply to mergers on or after Budget Day.
Segregated funds are investment products offered by life insurers that provide returns based on segregated pools of assets. Although such a segregated pool is not a trust, the Tax Act deems a trust (referred to as a “related segregated fund trust”) to exist in respect of which the insurer is the deemed trustee. The related segregated fund trust is deemed to have made its income for the year payable to its beneficiaries (so that it is not subject to tax), and the beneficiaries (i.e., the policyholders) are required to include their share of such deemed payment in computing their income. Since the amount deemed to be payable is the related segregated fund trust’s “income” and not its “taxable income,” it cannot utilize non-capital losses from prior years as they are a deduction in computing taxable income rather than income.
Budget 2017 proposes that for taxation years beginning after 2017, the related segregated fund trust will be deemed to have made its taxable income for the year payable to its beneficiaries. To ensure that historic non-capital loss carryforwards cannot be used for the purpose of determining the taxable income of a related segregated fund trust for taxation years beginning after 2017, non-capital losses for taxation years beginning before 2018 are deemed to be nil.
Budget 2017 also contains a proposal that would allow a related segregated fund trust to merge with another related segregated fund trust on a tax-deferred basis beginning January 1, 2018. The rules will be similar to the rules that allow one mutual fund trust to merge with another mutual fund trust in a qualifying exchange.
Insurers of Farming and Fishing Property
Paragraph 149(1)(t) provides that an insurer of property used in farming or fishing that meets certain qualifications for a period is exempt from Part I tax on its taxable income for the period. Budget 2017 proposes to repeal paragraph 149(1)(t).
This measure will apply to taxation years that begin after 2018.
Repeal of Investment Tax Credit for Child Care Spaces
The Tax Act currently provides an investment tax credit for child care spaces of 25% of the costs incurred to build or expand child care spaces in licensed child care facilities. These facilities must be for the benefit of children of the taxpayer’s employees and must be ancillary to the taxpayer’s business. The maximum value of the credit is $10,000 per space created. Although the credit is not refundable, unused amounts can be carried back three years and forward 20 years.
Subject to transitional relief for eligible expenditures incurred before 2020 pursuant to a written agreement entered into before Budget Day, Budget 2017 proposes to eliminate this investment tax credit for expenditures incurred on or after Budget Day.
Electronic Distribution of T4 Information Returns
Issuers of information returns, colloquially known as information slips, are currently required to provide relevant taxpayers with two copies of the return either by delivery to the taxpayer’s last known address or by personal delivery. Electronic copies may be sent instead of paper copies only if the taxpayer provides express consent in advance.
Budget 2017 proposes to allow employers to distribute T4 (Statement of Remuneration Paid) information returns electronically to employees without having obtained the employees’ express consent. The proposed change is permissive in that employers are not required to distribute electronic copies. Employers must issue paper copies if the employee (i) requests them, or (ii) cannot reasonably be expected to have access to the T4 in electronic format, including because the employee is on extended leave or is no longer an employee of the employer.
Budget 2017 also states that employers must have sufficient privacy safeguards in place before electronic transmission of T4s is permitted; however, draft legislation to that effect has not yet been proposed.
These measures apply in respect of T4s issued for the 2017 and subsequent taxation years.
Consultation on Cash Purchase Tickets
Subsections 76(4) and (5) provide a special rule applicable to income arising out of deliveries of grain to a “primary elevator” or a “process elevator” (as such terms are defined in the Canada Grain Act). Where the holder of a “cash purchase ticket” (as defined in the Canada Grain Act) or other form of settlement is not entitled to receive payment thereunder until after the end of the taxation year in which the grain is delivered, the amount of the purchase price is included in the income for the year following delivery.
The Government notes that the treatment of cash purchase tickets is a departure from the general rule with respect to taxpayers (including other farmers), who must include the amount of a security or other evidence of indebtedness received as payment of a currently payable debt in income in the year in which it is received.
Budget 2017 announces the launch of a consultation process under which stakeholders are invited to provide comments by May 24, 2017, on the ongoing utility and potential elimination of the cash purchase ticket tax deferral.
INTERNATIONAL TAX MEASURES
Combatting International Tax Avoidance and Evasion
Budget 2017 reiterates Canada’s commitment to the Base Erosion and Profit Shifting (BEPS) initiative led by the G20 and the Organisation for Economic Co-operation and Development (OECD). Without setting out any specific new measures, Budget 2017 highlights existing measures that the Government has implemented (or is in the process of implementing) and states that the Government “will continue to work with its international partners to ensure a coherent and consistent response to fight tax avoidance.” Budget 2017 also notes that the Government is “strengthening its efforts to combat international tax evasion through enhanced sharing of information between tax authorities.”
In respect of the multilateral instrument developed to streamline the implementation of various BEPS recommendations, Budget 2017 notes that the Government is “pursuing signature and […] undertaking the necessary domestic processes to do so,” but no time frame is specified. Budget 2017 also notes that the CRA is applying revised international guidance on transfer pricing by multinational enterprises in response to BEPS recommendations, asserts that Canada has robust “controlled foreign corporation” rules and states that Canada has implemented certain requirements for taxpayers, promoters and advisers to disclose specified tax avoidance transactions to the CRA.
Extending the Base Erosion Rules to Foreign Branches of Life Insurers
Unlike Budget 2016, which included extensive expansions to the “back-to-back rules” and the cross-border “surplus stripping” provisions, Budget 2017 contains relatively little in the way of international tax measures. The international tax measures in Budget 2017 are predominantly targeted to Canadian-resident life insurance companies that carry on business directly in a foreign jurisdiction (i.e., through a foreign branch) and, to a lesser extent, through one or more foreign affiliates.
The Tax Act contains special rules in respect of the taxation of Canadian-resident life insurance corporations. While a corporation resident in Canada is generally taxable in Canada on its worldwide income, section 138 provides that a Canadian-resident life insurance corporation’s income includes income from its Canadian business, but not its income from carrying on business in a foreign jurisdiction. Foreign branches of a Canadian-resident life insurance corporation are generally treated similarly to foreign affiliates of a Canadian corporation, such that their foreign business income is generally not taxable in Canada and, in most cases, is exempt from Canadian tax on repatriation.
To prevent Canadian taxpayers from avoiding Canadian income tax by shifting income from the insurance of Canadian risks (e.g., risks in respect of persons resident in Canada) to a controlled foreign affiliate resident in a low- or no- tax jurisdiction, subsection 95(2) generally provides that income from the insurance of Canadian risks of a controlled foreign affiliate (CFA) is considered foreign affiliate property income (FAPI) and therefore taxable in the hands of the Canadian taxpayer on an accrual basis. Additional anti-avoidance rules that apply to foreign affiliates were introduced in Budget 2014 and Budget 2015 in respect of “insurance swaps” and the ceding of Canadian risks. Budget 2017 notes that while other anti-avoidance rules might apply, there is currently no analogous rule to prevent income from the insurance of Canadian risks from being shifted to a foreign branch of a Canadian life insurer. Budget 2017 therefore proposes to amend the Tax Act to introduce new rules applicable to branches.
Through the use of the new term “designated foreign insurance business,” the new rules (modelled on the existing FAPI rules) will apply to deem the insurance of Canadian risks by a foreign branch of a Canadian life insurer to be part of a business carried on by the life insurer in Canada (and the related insurance policies to be life insurance policies in Canada) unless more than 90% of the gross premium revenue from the business from the year from the insurance of risks (net of reinsurance ceded) is in respect of the insurance of risks (other than specified Canadian risks) of persons with whom the life insurer deals at arm’s length. For this purpose, “specified Canadian risk” is proposed to have the same meaning as in paragraph 95(2)(a.23) (i.e., the definition applicable for purposes of the FAPI rules), and is defined to mean a risk in respect of (i) a person resident in Canada, (ii) a property situated in Canada, or (iii) a business carried on in Canada. Like the existing FAPI rules, anti-avoidance rules are also proposed to ensure that the proposed new rules cannot be avoided through the use of “insurance swaps” or the ceding of Canadian risks.
A further anti-avoidance rule is proposed to provide that a risk will be deemed to be a specified Canadian risk that is insured as part of an insurance business carried on in Canada by a particular life insurer resident in Canada if (i) the particular life insurer insured the risk as part of a transaction or series of transactions, (ii) the risk would not otherwise be a specified Canadian risk, and (iii) it can reasonably be concluded that one of the purposes of the transaction or series of transactions was to avoid (A) having a designated foreign insurance business, or (B) the application of the new rules in respect of the risk.
Significantly, while most of the proposed amendments to subsection 95(2) are merely consequential upon the introduction of the new rules applicable to branches, Budget 2017 also proposes an analogous “transaction or series of transactions” anti-avoidance rule for purposes of the existing FAPI rules.
These measures apply to taxation years that begin on or after Budget Day.
PERSONAL TAX MEASURES
Public Transit Tax Credit
Currently, if specific criteria are met, an individual may claim a 15% non-refundable tax credit in respect of public transit passes or electronic fare payment cards. According to the Budget Documents, the Government has determined that this tax credit has been ineffective in encouraging the use of public transit and reducing greenhouse gas emissions.
Budget 2017 repeals this tax credit effective July 1, 2017.
Tuition Tax Credit
In certain circumstances, an individual may claim a 15% non-refundable tax credit in respect of fees for the individual’s tuition paid to certain educational institutions. However, currently no tax credit may be claimed in respect of tuition fees for a course provided by a university, college or other post-secondary institution that is not at the post-secondary school level.
Budget 2017 proposes to extend eligibility for the tuition tax credit to individuals taking occupational skills courses that are offered by a university, college or other post-secondary institution and that are not at the post-secondary school level. However, the credit will not be available if (i) the individual has not attained age 16 before the end of the year in respect of which the fees were paid, or (ii) the purpose of enrolment at the institution cannot reasonably be regarded as being to provide the individual with skills, or to improve the individual’s skills, in an occupation.
This measure will apply in respect of eligible tuition fees for courses taken after 2016.
Budget 2017 also proposes to extend eligibility for tax exemptions in respect of scholarship and bursary income to individuals in the circumstances described above provided that the other requirements to claim these exemptions are met.
This measure will apply to the 2017 and subsequent taxation years.
Mineral Exploration Tax Credit for Flow-Through Share Investors
Resource companies can renounce or “flow through” tax expenses associated with their Canadian exploration activities to investors who acquire flow-through shares. The mineral exploration tax credit provides a further income tax benefit for individuals who invest in mining flow-through shares. This credit is equal to 15% of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors.
Budget 2017 notes that on March 5, 2017, the Minister of Natural Resources announced the Government’s proposal to extend the credit for an additional year, until March 31, 2018.
Disability Tax Credit – Nurse Practitioners
To be eligible for the disability tax credit, an individual must have one or more severe and prolonged impairments in physical or mental functions that restrict the individual’s ability to perform a basic activity of daily living. In addition, a medical practitioner must certify the individual’s impairment.
Budget 2017 proposes to allow nurse practitioners to certify that an individual has an eligible impairment.
This measure will apply to disability tax credit certifications made on or after Budget Day.
Medical Expense Tax Credit – Eligible Expenditures
Budget 2017 proposes to clarify that qualifying medical expenses include expenses paid for the purpose of conceiving a child even if treatment is not indicated because of medical infertility.
These measures are proposed to apply to the 2017 and subsequent taxation years. However, an individual may make a request to have that the measure apply for up to the 10 immediately preceding years.
Consolidation of Caregiver Tax Credits
The Tax Act contains a number of non-refundable tax credits intended to provide tax relief to caregivers. Under the current regime, the following three categories of credits exist:
- Caregiver credit, available where an individual provides in-home care to family members who are either senior parents or grandparents (65 years of age or over) or certain adult family members who are dependent on the caregiver by reason of mental or physical infirmity.
- Infirm dependant credit, available where an individual supports an adult family member (other than a spouse or common-law partner) who is dependent on the caregiver by reason of mental or physical infirmity. The dependant does not need to live with the caregiver.
- Family caregiver tax credit, available as a top-up to other dependency-related credits where an individual supports an adult family member who is dependent on the caregiver by reason of infirmity.
The amount of the credit available is generally based on the dependant’s income.
Budget 2017 proposes to simplify the existing regime by replacing these three categories of credits with a new Canada Caregiver Credit. The new credit is available for each person who, at any time in the year, is dependent on the taxpayer because of mental or physical infirmity, and either is a spouse or a common-law partner of the taxpayer, or has reached the age of 18 and is a dependant of the taxpayer. The persons who qualify as a dependant will not change from the current regime.
The dependant will not be required to live with the taxpayer in order for the taxpayer to be eligible for the new credit. Unlike under the current regime, the new credit will not be available in respect of non-infirm seniors who reside with their adult children.
Subject to indexing, the maximum amount of the credit is $6,883 (reduced dollar-for-dollar by the amount by which the dependant’s income exceeds $16,163). This amount is stated to be generally consistent with the amounts that could have been claimed under the current regime. In addition, the proposals may extend the credit to some caregivers who may not have been eligible under the current regime because of the income level of the dependant.
The Canada Caregiver Credit will apply for 2017 and subsequent taxation years.
Allowances for Members of Legislative Assemblies and Certain Municipal Officers
Employees who are reimbursed for expenses incurred by them in the course of carrying out their employment duties are generally not required to include such amounts in income as taxable benefits, while those who receive non-accountable allowances are generally required to do so. However, elected members of provincial and territorial legislative assemblies and officers of incorporated municipalities, elected officers of municipal utilities boards, commissions, corporations, or similar bodies, and members of public or separate school boards or of similar bodies governing a school district are currently entitled to exclude non-accountable allowances from income.
Budget 2017 proposes to repeal this exemption.
Home Relocation Loans Deduction
Section 80.4 requires an individual who receives a no- or low-interest loan because of employment to include in income as a taxable benefit the difference between the interest rate on the loan (if any) and a prescribed rate. Currently, a deduction may be available, under paragraph 110(1)(j) to offset all or part of the taxable benefit to the extent that the loan qualifies as a “home relocation loan” (as defined in subsection 248(1)).
Budget 2017 proposes to eliminate the deduction in respect of home relocation loans, applicable to benefits arising in the 2018 and subsequent taxation years.
DEFERRED INCOME PLAN MEASURES
Registered education savings plans (RESPs) and registered disability savings plans (RDSPs) are tax-assisted investment plans that are registered with the Government. RESPs help families accumulate savings for a child’s post-secondary education. RDSPs assist persons with disabilities and their families to save for their future.
Investment income earned in RESPs and RDSPs, as well as government grants and bonds, are taxable only when withdrawn.
While the Tax Act includes complex and onerous anti-avoidance rules for tax-free savings accounts (TFSAs), registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs), currently those rules do not generally apply to RESPs and RDSPs.
Budget 2017 proposes that anti-avoidance rules similar to those applicable to TFSAs, RRSPs and RRIFs apply to RESPs and RDSPs. Such rules will generally apply to transactions occurring and investments acquired after Budget Day (subject to some exceptions referred to below). However, for this purpose, investment income generated after Budget Day on previously acquired investments will be considered to be a transaction occurring after Budget Day.
The anti-avoidance rules that will apply to RESPs and RDSPs are the following:
- the advantage rules, which help prevent the exploitation of the tax attributes of a registered plan (e.g., by shifting returns from a taxable investment to a registered plan); and
- the prohibited investment rules, which generally ensure that investments held by a registered plan are arm’s-length portfolio investments.
The exceptions to the Budget Day effective date are as follows:
- The advantage rules will not apply to so-called swap transactions undertaken before July 2017. However, swap transactions undertaken to ensure that an RESP or RDSP complies with the new rules by removing an investment that would otherwise be considered a prohibited investment, or an investment that gives rise to an advantage under the new proposals, will be permitted until the end of 2021.
- Subject to certain conditions, a plan holder may elect by April 1, 2018, to pay Part I tax (in lieu of the advantage tax) on distributions of investment income from an investment held on Budget Day that becomes a prohibited investment as a result of this measure.
CHARITABLE TAX MEASURES
Gifts of Medicine
Donations made by a corporation to a registered charity are normally deductible in computing the corporation’s taxable income (unlike such gifts by individuals for which a tax credit, rather than a deduction from income, is generally available).
In addition, corporations that donate medicine from their inventory to an eligible charity can claim an additional deduction in computing their taxable income equal to the lesser of the cost of the donated medicine and 50% of the amount by which the fair market value of the donated medicine exceeds its cost. An eligible medical gift is generally a gift of a drug to be used in charitable activities carried on outside Canada.
While corporations will continue to be able to deduct as charitable gifts the fair market value of donated medicine, Budget 2017 proposes to eliminate the additional deduction for such gifts made on or after Budget Day.
Ecological Gifts Program
Budget 2017 proposes several amendments to the “ecological gifts program,” which consists of rules that are designed to promote the policy objective of protecting environmentally sensitive land.
Under the current rules, where certain requirements are met, a gift of land (which, for these purposes, includes a covenant or an easement to which land is subject or, for land in Québec, a real servitude on such land) by an individual may enable the individual to claim a charitable donation tax credit, while a corporate donor may be eligible to claim a charitable donation tax deduction.
Generally, a gift of land will be eligible for a credit or a deduction under the ecological gifts rules if the Minister of Environment and Climate Change Canada (ECCC Minister) has (i) certified the fair market value of the gift and (ii) certified the land to be ecologically sensitive land, the conservation and protection of which is important to the preservation of Canada's environmental heritage. In addition, the gift must be made to (i) Her Majesty in right of Canada or of a province, (ii) a municipality in Canada, (iii) a municipality or public body performing a function of government in Canada, or (iv) if approved by the ECCC Minister, a registered charity one of the main purposes of which is the conservation and protection of Canada's environmental heritage.
In addition, capital gains realized in respect of gifts of land in the circumstances described above are exempt from tax unless the land is given to a private foundation.
Donations to Private Foundations No Longer Eligible
The Budget Documents express concern that, in many cases, the majority of directors of a private foundation do not act at arm’s length with each other and that the main donors to a private foundation typically are part of a group that controls the foundation (or do not act at arm’s length with the group). In the Government’s view, this may give rise to potential conflicts of interest in respect of ecological gifts, which can defeat the purpose of the provisions.
Therefore, Budget 2017 proposes that gifts made on or after Budget Day to registered charities that are private foundations will no longer be eligible for the benefits of the ecological gifts program.
Approval of Recipients
Budget 2017 proposes that ecological gifts made on or after Budget Day to municipalities and public bodies performing a function of Government must be approved by the ECCC Minister to be eligible for the benefits of the ecological gifts program.
Transfers of Ecological Gifts
Currently, a charity, municipality in Canada or municipal or public body performing a function of Government in Canada (an organization) must pay a tax if the organization, without the authorization of the ECCC Minister, disposes of or changes the use of land that qualifies for the ecological gifts program rules and that was received by the organization by way of gift. Generally, the tax is equal to 50% of the fair market value of the land immediately before the disposition or change.
To address a concern that if land is transferred by one organization to another for consideration, the provision as written may not apply to dispositions or changes in use by the transferee organization, Budget 2017 proposes to amend the Tax Act to ensure that the transfer restriction regime will also apply to the transferee.
Budget 2017 also proposes to clarify that the ECCC Minister has the ability to determine whether there has been a change in use.
These amendments apply in respect of dispositions or changes in use that occur on or after Budget Day.
Québec civil law provides for the concepts of real servitudes and personal servitudes in respect of property. Currently, donations of real servitudes may be eligible for the benefits of the ecological gifts program, while donations of personal servitudes are not. In order to enhance the number of gifts of ecologically sensitive lands in Québec, Budget 2017 proposes to extend these provisions to donations of certain personal servitudes that have a term of not less than 100 years and that are made on or after Budget Day.
SALES AND EXCISE TAX MEASURES
Opioid Overdose Treatment Drug – Naloxone
The goods and services tax/harmonized sales tax (GST/HST) does not apply to prescription drugs and listed non-prescription drugs used to treat life-threatening conditions.
Naloxone, which is used to treat opioid (e.g., fentanyl) overdoses, qualified for GST/HST relief as a prescription drug. However, a prescription for naloxone is no longer required for emergency use for opioid overdoses outside of hospital settings. To provide for GST/HST-free treatment of naloxone in these circumstances, Budget 2017 proposes to add the drug to the list of GST/HST-free non-prescription drugs that are used to treat life-threatening conditions.
Taxi and Ride-Sharing Services
Taxi operators are required to register for the GST/HST and charge tax on their fares.
For GST/HST purposes, a “taxi business” is defined to mean a business carried on in Canada of transporting passengers by taxi for fares that are regulated under the laws of Canada or a province. Municipalities may also regulate taxi fares under authority delegated by a province.
Commercial ride-sharing services facilitated by web applications that provide passenger transportation services may not be subject to the same GST/HST rules since their fares may not be regulated by a province or municipality.
Effective as of July 1, 2017, Budget 2017 proposes to amend the definition of a taxi business to include persons engaged in a business of transporting passengers for fares within a municipality and its environs when the transportation is arranged or coordinated through an electronic platform or system such as a mobile application or a website. These changes will only apply to transportation services that are supplied in the course of a commercial activity.
GST/HST Rebate to Non-Residents for Tour Package Accommodations
A rebate of the GST/HST that is payable in respect of the Canadian accommodation portion of eligible tour packages is currently available to non-resident individuals and non-resident tour operators.
Budget 2017 proposes to repeal the GST/HST rebate available to non-residents for the GST/HST that is payable in respect of the accommodation portion of eligible tour packages.
A surtax of 10.5% applies on profits arising from the manufacture of tobacco or tobacco products in Canada (subject to certain exemptions). In addition, a federal excise duty applies to all tobacco products sold in the Canadian market.
Budget 2017 proposes to eliminate the tobacco manufacturers’ surtax and increase the tobacco excise duty rates. These measures will be effective as of the day after Budget Day.
The Excise Act and the Excise Act, 2001 impose excise duties on alcohol products. Budget 2017 proposes that excise duty rates on alcohol products be increased by 2% effective the day after Budget Day, in respect of duty that becomes payable after that date. It is also proposed that the rates be automatically adjusted by the Consumer Price Index on April 1 of every year, starting in 2018.
OTHER TAX MEASURES
Budget 2016 proposed to spend nearly $450 million over five years for the CRA to enhance its efforts to crack down on tax evasion and combat tax avoidance. Budget 2017 proposes an investment of an additional $523.9 million over five years to deal with tax evasion and improve tax compliance.
Corporate and Trust Transparency
To protect the integrity of the tax and financial systems, Budget 2017 states that the Government will collaborate with provinces and territories to put in place a national strategy to strengthen the transparency of legal persons and legal arrangements and improve the availability of beneficial ownership information. It will also examine ways to enhance the tax reporting requirements for trusts in order to improve the collection of beneficial ownership information.
Federal Carbon Pricing Backstop
Budget 2017 reiterates the Government’s commitment to implement a carbon pricing framework across all provinces and territories by 2018. Consistent with statements made in the Pan-Canadian Framework on Clean Growth and Climate Change, which was adopted in December 2016, provinces and territories may price carbon through either (i) a direct price-based system (e.g., a carbon tax), or (ii) a cap-and-trade system. The Government will implement a “backstop” pricing mechanism that will apply in jurisdictions that do not meet the federal carbon pricing benchmark.
The Budget Documents indicate that the Government will release a consultation paper containing additional details of the proposed backstop mechanism in the coming months.
TRADE AND TARIFF MEASURES
Budget 2017 proposes several measures to strengthen the protection of domestic producers under Canada’s trade remedy regime, i.e., through the imposition of anti-dumping and countervailing duties and safeguard measures under the Special Import Measures Act (SIMA). These include amendments for a new complaint mechanism for domestic producers to seek the imposition of duties on goods found to circumvent trade remedy measures, formal scope rulings by the Canada Border Services Agency (CBSA), labour union participation in trade remedy proceedings and more flexibility for CBSA in calculating dumping margins. SIMA will also be amended to bring it into conformity with a recent WTO ruling that found that Canada’s treatment of exporters found to be dumping at de minimis levels violated its international trade obligations.
Budget 2017 also proposes that the General Preferential Tariff and Least Developed Country Tariff Rules of Origin Regulations be amended to allow least developed countries (LDCs) to use manufacturing inputs sourced and processed in an expanded list of countries in the production of T-shirts and pants that qualify for duty-free importation into Canada.
STATUS OF OUTSTANDING TAX MEASURES
Budget 2017 confirms the Government’s intention to proceed with the following previously announced tax and related measures, as modified to take into account consultations and deliberations since their release (which modifications are not described in the Budget Documents):
- measures announced on October 3, 2016 to improve fairness in relation to the capital gains exemption on the sale of a principal residence;
- the measure announced in Budget 2016 on information-reporting requirements for certain dispositions of an interest in a life insurance policy;
- legislative proposals released on September 16, 2016, relating to income tax technical amendments;
- legislative and regulatory proposals released on July 22, 2016, relating to GST/HST; and
- measures confirmed in Budget 2016 relating to the GST/HST joint venture election.
Budget 2017 also reaffirms the Government’s commitment to move forward as required with technical amendments to improve the certainty of the tax system.