Budget 2010 reads very well:
- the government will not raise taxes or cut major transfers for health care, education and pensioners
- by targeted reductions in spending, $17.6 billion will be saved over the next five years
- the current deficit of $54 billion will decline to $27.6 billion in 2011-12, $17.5 billion in 2012-13 and $1.8 billion by 2014-15.
There are, however, some assumptions behind those numbers that may be optimistic. A brief look at just two of the challenges that face the country suggests that the government’s predictions may be difficult to realize.
Growth Rates and Productivity
The Parliamentary Budget Office (PBO) headed by Kevin Page has indicated that the government’s plan to “grow out” of the deficit will not work. The PBO predicts that the potential expansion rate of the economy will slump to 1.3% a year by 2020, compared to 3.7% in 2000. Budget 2010 predicts an average rate or real GDP growth for 2011 through 2014 of 2.9%.
Part of the problem is the productivity rate. Statscan indicates that in 2008 Canadian workers were 75% as productive as their US counterparts. For the last 10 years, the gap between US productivity and Canadian productivity has grown by an average of 2% per year. The Conference Board of Canada recently ranked Canada 14th of 17 countries for innovation.
Budget 2010 appears to allocate approximately $380 million next year to economic growth and innovation initiatives.
Health Care System
No rational person would suggest that universally available free health care would not be fabulous. Universally available free basic lodging, food and post-secondary education would also be great. But none of these services can ever be “free”. The government can pay for them out of tax revenues or by borrowing money. The question is not what we, as a nation, desire to have; it is what we, as a nation, can afford to have. The longer we delay a viable health care strategy, the more difficult it will be to implement. Someone with the courage and determination of Joannie Rochette needs to be asked what she would do if she were in charge of the health care system and were provided with the following statistics.
In some provinces, health care costs already account for 50% of provincial expenditures. Health care costs are predicted to rise by 2.5% per year, after accounting for inflation and population growth. The math is pretty easy: another ten years and health costs could easily be at least 25% higher than they are today.
The budget addresses the health care situation by indicating that the government will not cut transfer payments for health care.
Closing Perceived “Loopholes” and Strengthening Compliance
Budget 2010 follows the international trend of restricting the size of “loopholes” and wrestling “tax cheats” to the ground. The Department of Finance describes the intention of these measures as protecting the integrity of the Canadian tax system and, as we have heard before, ensuring that all taxpayers “pay their fair share of tax on income earned in Canada and abroad”. In addition to technical measures, Budget 2010 proposes to arm the Canada Revenue Agency with increased capacity and strength to address aggressive tax planning and compliance risk.
I. SIFT Conversions and Loss Trading
Several of the SIFT trust and partnership conversions into corporations have been structured with the intention of allowing the surviving entity to use losses that existed in another entity prior to the conversion. Some of these transactions relied, to a greater or lesser extent, on the fact that the acquisition of control rules contained in paragraph 256(7)(c) of the Income Tax Act (Canada) (the “ITA”) apply only to corporations, with the result that the loss streaming rules contained in section 111 of the Income Tax Act (Canada) had no application to the conversion transaction. The Income Tax Act (Canada) will be amended so that an acquisition of control rule similar to the current rule in paragraph 256(7)(c) of the Income Tax Act (Canada) will apply where interests in a SIFT trust, SIFT partnership or REIT are transferred to a corporation for a majority of the shares in that corporation.
Paragraph 256(7)(f) of the Income Tax Act (Canada) contains a saving rule that deems an acquisition of control not to have occurred as a part of a SIFT trust wind-up event where a trust that is the shareholder of a corporation distributes the shares of that corporation to its sole beneficiary that is also a trust. The Act will be amended to provide another saving rule that will deem an acquisition of control not to have occurred as part of a SIFT trust wind-up event where a corporation that is the sole beneficiary of a trust that controls another corporation receives the shares that the trust owns in the other corporation on the winding up of the trust.
Both of the above amendments will be effective as of 4 pm EST on March 4, 2010, except for transactions that had been agreed to in writing prior to the effective time. However, the amendments will apply prior to the effective time if the appropriate parties so elect. It would appear that any such election would trigger the operation of both new rules. So if the savings rule could help you, but you were relying on the fact that paragraph 256(7)(c) only applied to corporations, you may be in a difficult place.
II. Foreign Investment Entities and Non-Resident Trusts
Budget 2010 announces revised proposals in respect of the foreign investment entity and non-resident trust rules, which revised proposals are intended “to replace the outstanding proposals for public consultation with a view to developing revised legislation, which will then also be released for public consultation.”
- FOREIGN INVESTMENT ENTITIES
Budget 2010 proposes to replace all existing proposals in respect of the foreign investment entities rules in proposed sections 91.1 through 94.4 of the Income Tax Act (Canada) with a limited enhancement to the existing rule contained in section 94.1 of the Income Tax Act (Canada). Existing section 94.1 of the Income Tax Act (Canada) applies where a taxpayer has invested in “offshore investment fund property” and one of the main reasons for the investment is to reduce or defer the tax liability that would have applied to the income generated from the underlying assets of the fund if such income had been earned directly by the taxpayer. In these circumstances, existing section 94.1 of the Income Tax Act (Canada) generally requires an amount to be included in computing the taxpayer's income from the investment. This amount is determined, in general terms, by multiplying the cost amount of the taxpayer's investment by a factor based on interest rates prescribed under Part XLIII of the Income Tax Regulations. Budget 2010 proposes that the prescribed rate applicable in computing the income inclusion for an interest in offshore investment fund property be increased to the three-month-average Treasury Bill rate plus two percentage points, which rate is intended to better reflect actual long-term investment returns. And so ends, it seems, the decade-old saga of the “FIE Rules”. The complexity associated with the old set of proposed rules will not be missed.
Budget 2010 also proposes to broaden the existing non-resident trust rules that require certain resident beneficiaries who hold 10% or more of the value of all interests in a non-resident trust that is not otherwise deemed resident in Canada to report income on a modified foreign accrual property income basis, so that the rules apply to any resident beneficiary of a non-resident trust (that is not otherwise deemed resident in Canada under the proposed non-resident trust rules discussed below) who, together with any person with whom the beneficiary does not deal at arm’s length, holds 10 percent or more of any class of interests in a non-resident trust (determined by fair market value).
Finally, it is proposed that the relevant reassessment period in respect of interests in offshore investment fund property and interests in non-resident trusts described above be extended by 3 years. It is also proposed that the existing reporting requirements with respect to “specified foreign property” be expanded so that more detailed information is available to the Canada Revenue Agency for audit use.
- NON-RESIDENT TRUSTS
Budget 2010 proposes four general changes to the scope of the non-resident trust rules along with four relatively fundamental changes relating to the application of those rules to the taxation of the trust, its beneficiaries and resident contributors.
Changes to the Scope of the Non-Resident Trust Rules First, under the current proposed rules, any person who is either a “resident contributor” or a “resident beneficiary” of a non-resident trust is jointly and severally, or solidarily, liable for the trust’s income tax liability. As a result, a Canadian tax-exempt entity, such as a pension plan, would effectively be liable for tax despite its tax-exempt status. Budget 2010 proposes to exempt tax-exempt entities from any liability for tax under the nonresident trust rules, except in cases where the tax-exempt entity is used as a conduit to allow a taxpayer to make an indirect contribution to a non-resident trust (in which case the rules of application would continue to apply to ensure that the resident making the indirect contribution is considered a resident contributor of the trust).
Second, Budget 2010 proposes to eliminate the provision in the current proposals that would have deemed a trust to be resident in Canada by reason only of the trust acquiring or holding restricted property. More fundamentally, recognizing that the non-resident trust rules are anti-avoidance rules and are not intended to result in adverse tax consequences in respect of an investment in a bona fide commercial trust, Budget 2010 proposes to expand the definition of “exempt foreign trust” to ensure that bona fide commercial trusts are excluded from the rules. The type of trust contemplated by the expanded definition is one that meets the following six conditions:
- each beneficiary is entitled to both the income and capital of the trust;
- any transfer of an interest by a beneficiary results in a disposition for the purposes of the ITA and interests in the trust cannot cease to exist (otherwise than as a result of a redemption or cancellation for fair market value);
- the amount of income and capital payable to a beneficiary cannot be discretionary;
- interests in the trust are (i) listed and regularly traded on a designated stock exchange, (ii) were issued by the trust for fair market value, or (iii) are widely held;
- the terms of the trust cannot be varied without the consent of all beneficiaries or, in the case of a widely held trust, a majority of the beneficiaries; and
- the trust is not a personal trust.
It is also proposed that a new anti-avoidance rule accompany this expanded definition to provide that a commercial trust that is varied in a non-permitted way will lose its status as an exempt foreign trust with the result that, at such time, the trust will be taxable on all of its income that has been accumulated (together with interest) since the time it first acquired a resident beneficiary or a resident contributor.
Third, the definition of “restricted property” (which will serve a less prominent role given the changes to the definition of “exempt foreign trust”, as described above, but are still relevant for purposes of determining whether a particular transfer of property results in an “arm’s length transfer”) will be limited to shares or rights (or property that derives its value from such shares or rights) acquired, held, loaned or transferred by a taxpayer as part of a series of transactions or events in which “specified shares” (generally, shares with a fixed entitlement right) of a closely-held corporation were issued at a tax cost less than their fair market value.
Finally, it is proposed that a new rule be added to ensure that loans made by a Canadian financial institution to a non-resident trust will not result in the financial institution being a resident contributor to the trust as long as the loan is made in the ordinary course of the financial institution’s business.
Changes to the Taxation of a Deemed Resident Trust, its Beneficiaries and Resident Contributors First, Budget 2010 proposes that a non-resident trust’s property be divided into a resident portion (consisting of property contributed by residents and certain former residents or property substituted for such property) and a non-resident portion. Any income arising from property that is part of the non-resident portion (other than Canadian source income) will be excluded in computing the trust’s income for Canadian federal income tax purposes. However, to the extent that income of the trust is not distributed to the beneficiaries, the amount of accumulated income for the taxation year will be deemed to be a contribution by the trust’s connected contributors and will form part of the resident portion of the trust’s property for the next taxation year. (Undistributed accumulated income from the non-resident portion will not be subject to this deeming provision provided that the non-resident portion of the property is kept separate and apart from all of the property of the resident portion.)
Second, Budget 2010 proposes that the proposed rules that would render resident contributors of a non-resident trust jointly and severally, or solidarily, liable with resident beneficiaries for the tax of the trust be eliminated in favour of a system whereby resident contributors to a trust would be attributed, and taxed on, their proportionate share of the trust’s income for Canadian tax purposes, subject to reduction in limited circumstances to account for the amount of losses of other years claimed by the trust and foreign tax credits designated in respect of certain contributions. (It appears that resident beneficiaries will continue to be liable with respect to the trust’s income tax payable to the same extent under the outstanding proposals.) The income attributed to resident contributors will generally be based on the proportion of the fair market value of their contributions to the trust (measured at the time the contributions were made) to the fair market value of all contributions received by the trust from connected contributors. Budget 2010 further proposes that the trust will be entitled to a deduction for amounts attributed to resident contributors (in addition to the normal rule with respect to income that is payable to beneficiaries in the year).
Third, Budget 2010 proposes ordering rules be introduced with respect to distributions to beneficiaries of a deemed resident non-resident trust. Distributions to resident beneficiaries will be deemed to be made first out of the resident portion of the trust’s income while distributions to non-resident beneficiaries will be deemed to be made first out of the non-resident portion. Distributions to non-resident beneficiaries out of the non-resident portion of the trust will not be subject to withholding tax. However, distributions to non-resident beneficiaries out of the resident portion of the trust will be subject to withholding tax.
Finally, Budget 2010 proposes to permit a non-resident trust that is deemed to be resident in Canada under the nonresident trust rules to claim a foreign tax credit in respect of income taxes paid to another country that treats the trust as a resident of that country for its own domestic income tax purposes (regardless of the 15% limit normally applicable under subsection 20(11) of the Income Tax Act (Canada), but up to the Canadian income tax rate). As is the case with the proposed foreign investment entity rules, Budget 2010 further proposes that the relevant reassessment period for income in respect of trusts subject to these rules be extended by three years.
- DATE OF APPLICATION
Foreign Investment Entities Rules Budget 2010 proposes that the measures regarding foreign investment entities apply for taxation years that end after March 4, 2010. A taxpayer who voluntarily complied with the outstanding proposals in previous years will have the option of having those years reassessed. A taxpayer who does not wish to be reassessed, but who had more income than would have been the case under the existing rules, will be entitled to a deduction in the current year for the excess income.
Non-Resident Trusts Budget 2010 proposes that the measures regarding non-resident trusts apply for the 2007 and subsequent taxation years. An election allowing a trust to be deemed resident for the 2001 and subsequent taxation years will be made available. The attribution of trust income to resident contributors will apply only to taxation years that end after March 4, 2010.
PUBLIC CONSULTATIONS The revised proposals described above will be subject to a consultation process. Comments should be submitted to the Department of Finance with respect to these proposals by May 4, 2010.
III. Amendments to Stock Option Rules
In general terms, the employee stock option rules require employees to include in their income the difference between the fair market value of the optioned securities at the time the option is exercised and the amount paid by the employee to acquire the security (and, where applicable, the option). While this stock option benefit is fully included in the employee’s income, provided that certain conditions are satisfied, the employee is able to deduct one-half of the amount of the benefit when determining his/her taxable income. Where this deduction is available, the employee’s stock option benefit is effectively taxed as a capital gain.
In many instances, employee option holders and their employers prefer to have the employer pay in cash the “in the money” amount of the option in exchange for the cancellation of the option. If properly structured, the employee is still able to have his or her stock option benefit effectively taxed as a capital gain, while the employer will generally be entitled to a tax deduction equal to the amount of the payment. The employer is not permitted to claim a deduction when it issues shares upon the exercise of an employee stock option.
In Budget 2010, the Government has announced measures to prevent the employee and the employer from both claiming their respective tax deductions on the cash-out of a stock option. Under these measures, employees will generally not be able to claim the stock option deduction in connection with a stock option cash out transaction. The employer’s ability to claim the deduction will be unaffected. As an exception to the general rule, should an employer file an election to forgo its deduction in connection with the cash-out payment, the employee’s ability to claim its stock option deduction will not be denied (provided the other conditions of application are satisfied). These new rules are effective after 4:00pm (EST) on March 4th 2010. it appears from the Notice of Ways and Means Motion that the employer election can only be made in respect of options issued after that time.
In addition, as part of its package of amendments to the employee stock option rules, the Government has announced that it will amend these rules so as to make it clear that the disposition of rights under a stock option agreement by an employee to a non-arm’s length person will give rise to an employee benefit at the time of the disposition. The amendments required to give effect to this clarification will also be effective after 4:00pm (EST) on March 4th 2010.
As part of Budget 2000, the Government announced measures (subsequently enacted as subsections 7(8) to (16)) which, in general terms, permitted employees of public companies to elect to defer the inclusion of the stock option benefit realized on the exercise of their stock options, to the year in which they disposed of the optioned securities (subject to an annual limit of $100,000). In Budget 2010, the Government has announced its intention to repeal subsections 7(8) to (16) with respect to stock options exercised after 4:00pm (EST) on March 4th 2010.
Budget 2010 also proposes to clarify that the employer’s source deduction withholding requirements in respect of an employee’s stock option benefit will be determined in the year that the option is exercised and will be computed as if the value of the stock option benefit had been paid to the employee as a cash bonus. If the employee is at that time entitled to the related stock option deduction, the amount of the remittance can be correspondingly reduced. The stated purpose of these measures is to prevent situations from arising where employees are unable to meet their income tax obligations as a result in the decrease in value of securities acquired on exercise of options. These measures will, subject to certain transitional rules, come into effect for securities acquired by the employee after 2010.
Budget 2010 also provides relief for taxpayers who have experienced financial difficulties as a result of their having made the above-noted election to defer the inclusion of the benefit realized on the exercise of their employee stock option. In general terms, Budget 2010 proposes to introduce rules which will allow such taxpayers to make an election in respect of optioned securities disposed of before 2015 that will result in the taxpayer: (i) claiming a stock option deduction in an amount equal to his/her stock option benefit; (ii) including in its income as a taxable capital gain an amount equal to one-half of the lesser of the employee’s stock option deduction and his/her capital loss on the disposition of the securities, and (iii) paying a special tax equal to his/her proceeds of disposition of the securities in the taxation year in which the deduction described in (i) was claimed. The deadline for taxpayers electing for this treatment in respect of securities disposed of before 2010 will be the tax return filing due date for their 2010 taxation year and, in all other cases, will be the date on which their tax returns are due for the year in which the disposition occurs.
IV. Foreign Tax Credit Generators
The fiscal policy behind this amendment (we will get to the amendment shortly) is intriguing. In Article IV of the Fifth Protocol to the Canada-United States Treaty, we see the expansion of anti-avoidance rules to apply to fact situations that depended on someone else’s tax rules as well as Canada’s. That is, the new anti-hybrid entity antiavoidance rules in the treaty are apparently meant to apply where a taxpayer is taking advantage of an arbitrage between the Canadian and US rules. Canadian withholding tax is arguably meant to apply where the US is not appropriately taxing a payment.
Budget 2010 proposes to deny foreign tax credits for a member of a partnership, where that partner did not pay tax to the foreign jurisdiction in respect of the same partnership income. Complementary rules extend the reach of the new rules to foreign affiliates that hold partnership interests and to situations where the foreign jurisdiction does not treat the Canadian taxpayer as owing the same proportion of the shares of a foreign affiliate as the Canadian rules do. The new rules will apply to taxation years ending after March 4, 2010.
For many years it has arguably been possible for Canadian taxpayers to enter into transactions where they received foreign tax credits in Canada, even though the income in respect of those credits was not taxable to them in the foreign jurisdiction. In economic terms, these transactions could be described as involving the purchase of foreign tax credits.
V. Amendments to the Specified Leasing Property Rules
The ITA and Income Tax Regulations contain rules (the “Specified Leasing Property Rules”) which are designed to prevent taxpayers from structuring asset acquisition transactions as financing leases, thereby effectively transferring the benefit of the related capital cost allowance deduction to the lessor in exchange for lower financing costs. Specifically, if applicable, the existing Specified Leasing Property Rules essentially treat a financing lease as a loan from the perspective of the lessor while the related rental payments are treated as blended payments of interest and principal. Consistent with this approach, the Specified Leasing Property Rules restrict the lessor’s ability to claim capital cost allowance to an amount equal to the rental income received in respect of the property in question, less a notional interest component, in cases where such an amount would be less than the capital cost allowance deduction that would otherwise be available to it.
The Specified Leasing Property Rules contain certain exceptions. In particular, these rules do not apply to “exempt property” as defined in the Income Tax Regulations. The definition of exempt property currently includes certain types of: (i) office furniture and equipment; (ii) motor vehicles and trucks; (iii) railway cars, and (iv) buildings. Accordingly, the use of financing leases has continued to remain a potentially advantageous financing strategy when the related leased property fits within the exempt property definition.
In order to address its perception that certain non-resident and tax-exempt lessees are exploiting the exempt property definition, in Budget 2010 the Department of Finance has proposed to extend the application of the Specified Leasing Property Rules to certain types of depreciable property that would otherwise qualify as exempt property when it is the subject matter of a lease to a non-resident or tax-exempt entity (including a government). However, this new limitation will generally not apply in cases where the total value of the leased property is less than $1 million and the parties to the lease do not enter into multiple leases so as to be able to qualify for the exception.
VI. Reporting Aggressive Tax Positions
Budget 2010 proposes a regime under which certain tax “reportable transactions” must be reported to the CRA. The regime is based on similar regimes found in jurisdiction such as those of the United States, the United Kingdom and, most recently, the Province of Québec. The goal of this new information reporting regime is to help tax authorities identify in a timely manner potentially “aggressive tax plannings” not already covered by the current tax shelter rules, as these could lead to potentially abusive tax avoidance transactions to which the General Anti-Avoidance Rule and other specific anti-avoidance substantive rules of the Income Tax Act may apply.
A transaction would be a “reportable transaction” if it featured at least two of the three following “hallmarks”: 1.Generally, a promoter or tax advisor is entitled to fees that are attributable to the amount of the tax benefit from the transaction or that are attributable to the number of taxpayers who participate in or have received advice regarding the transaction; 2. A promoter or tax advisor in respect of the transaction requires “confidential protection” about the transaction; and 3. The taxpayer (or the person who entered into the transaction for the benefit of the taxpayer) obtains “contractual protection” in respect of the transaction (otherwise than as a result of a fee described in the first hallmark). A transaction that is a tax shelter or a flow-through share arrangement would not be impacted by these proposals.
Upon discovery of a reportable transaction that has not been reported when required, the CRA could deny the tax benefit resulting from the transaction. If the taxpayer still wanted to claim the tax benefit, it would be required to file with the CRA any required information and to pay a penalty.
Budget 2010 announces a public consultation on this information reporting proposal and more details on the proposed regime are expected to be released in the near future. Based on all the attention the new Québec regime received from tax practitioners and business groups, this proposed federal regime, albeit being presented as “less strict” than the Québec regime, is surely something we will be hearing a lot about in the next few months.
Changes to the definition of “taxable Canadian property”
Budget 2010 proposes a simple, but profound change to the definition of “taxable Canadian property” to exclude the shares of a corporation, interests in a partnership and interests in a trust that do not derive and have not derived at any particular time in the 60-month period that ends at the time of measurement (i.e., the time of disposition), directly or indirectly, their value principally from one or more of real or immovable property situated in Canada, Canadian resource property or timber resource property.
In very general terms, subject to relief under an applicable income tax treaty or convention, a non-resident is taxable in Canada to the extent that the non-resident carries on business in Canada or disposes of “taxable Canadian property”. In addition, section 116 of the ITA imposes certain compliance, reporting and remittance requirements in circumstances where a non-resident disposes of “taxable Canadian property” that is not an excluded property.
“Taxable Canadian property” is currently defined in the ITA to include shares of a corporation resident in Canada that are not listed on a designated stock exchange, significant interests in listed shares of a corporation resident in Canada, and other interests the value of which are, or were within the 60-month period ending at the relevant time, derived principally from real or immovable property (including Canadian resource property and timber resource property). Gains from dispositions of “taxable Canadian property”, other than of taxable Canadian property that is real or immovable property or shares that derive their value principally from real or immovable property, are generally exempt from taxation in Canada under many of Canada’s international tax treaties.
The above-noted change to the definition of “taxable Canadian property” effectively imports a common treaty exemption to the Income Tax Act (Canada) itself, with the result that shares of corporations resident in Canada (and other interests) will not constitute “taxable Canadian property” if they do not derive their value principally from real or immovable property situated in Canada, Canadian resource property, or timber resource property (subject to the 60-month rule noted above). As a consequence, this measure will eliminate section 116 compliance obligations for these types of properties, reduce the need for tax reporting and exempt a host of nonresident persons who would otherwise be taxable in Canada on the disposition of shares of Canadian corporations and other interests who do not currently qualify for exemptive relief under an existing income tax treaty or convention.
Budget 2010 also proposes to amend the rules contained in certain deferral provisions that deem property to be “taxable Canadian property” so that their application is limited only to the first 60-months following the time of the relevant transaction. For example, many tax-deferral provisions contained in the Income Tax Act (Canada) (section 51, section 85, section 85.1, section 87, etc.) provide that where a taxpayer disposes of taxable Canadian property on a tax-deferred basis, the property that the taxpayer receives in return for the taxable Canadian property is, itself, deemed to be taxable Canadian property. This can be problematic in circumstances, for example, where a non-resident taxpayer exchanges shares of a private Canadian corporation for shares of either a public corporation or another private Canadian corporation that is subsequently taken public. Budget 2010 proposes to limit the application of these deeming provisions to a 60-month period.
Administrative Changes and Tax Reporting
I. Consolidated Reporting
A welcome proposal in Budget 2010 is the government’s announcement that it intends to explore whether new rules for the taxation of corporate groups – such as the introduction of a formal system of loss transfers or consolidated reporting – could improve the functioning of the tax system. Little detail is otherwise provided. Budget 2010 assures that stakeholder views will be sought prior to the introduction of any changes.
A formal system of loss transfers or consolidated reporting would signal a dramatic shift in Canadian tax policy and could greatly simplify intragroup arrangements. For example, an operating company within a corporate group that generates taxable income and that is otherwise precluded from amalgamating (whether for commercial or other reasons) with another member of the corporate group that generates losses is left with no real alternative but to enter into a complicated loss-consolidation transaction or other arrangement. We are hopeful that a formal loss transfer or consolidated reporting system will simplify such a process.
II. Reducing Interest Rates on Refunds to Corporations
Many would suggest that a self-assessment system operates best when a spirit of co-operation and respect exists between tax collectors and taxpayers. In this regard, there is one particular measure in this budget that we find surprising.
We have long been displeased with the fact that the CRA even records the size of the assessments issued by auditors in case it might be a relevant evaluation criterion. Some auditors have been rumoured to have said that if you don’t like a reassessment you can appeal. But, if you are a large corporation, you only get that “privilege” after you have paid one-half of the assessment. Of course, if you ultimately win you get taxable interest at a rate that is only 2% less than the non-deductible rate of interest you must pay on any unpaid tax if you lose. The government has now decided that they are being treated unfairly, since they can borrow money at a rate that is 2% less than the rate they currently have to pay on refunds. So, for corporate taxpayers, the CRA will now pay taxable interest on refunds at a rate that is 4% less than the non-deductible rate that corporate taxpayers must pay on unpaid tax.
III. Refunds of Overpaid Withholding Taxes to Non-Residents
Budget 2010 proposes an amendment to the Income Tax Act to fix a problem which arose when a taxpayer failed to withhold and remit taxes on certain amounts paid to non-residents and was later assessed by the CRA for such amounts. In certain circumstances, a refund of overpaid withholding taxes was no longer available to the nonresident because this non-resident could not file a tax return within the prescribed time.
Payors of funds to non-resident service providers and purchasers of taxable Canadian property from non-residents are required in certain circumstances, pursuant to section 105 of the Income Tax Regulations and section 116 of the Income Tax Act, to withhold and remit to the CRA a portion of the amount paid to the non-resident on account of the non-resident’s potential Canadian tax liability. These obligations can arise even where the non-resident is not liable for Canadian tax, for example because of protection under an applicable tax treaty. In accordance with section 164 of the Income Tax Act, the taxpayer can then claim a refund of overpaid tax provided the taxpayer has filed its income tax return for the year in question within the prescribed period. Since no deadline is imposed on the CRA to assess a taxpayer for amounts the taxpayer failed to withhold, a situation could arise where the nonresident would be unable to recoup any overpayment of tax as the prescribed period for filing a tax return for the tax year in question would have expired. Budget 2010 proposes to amend section 164 to allow the issuance of a refund of an overpayment of such tax if the taxpayer files a return no more than two years after the date of the CRA assessment.
Accelerated Capital Cost Allowance for Clean Energy Generation Under the current capital cost allowance (CCA) regime, specified clean energy generation and conversation equipment benefit from an accelerate CCA rate of 50% per year on a declining balance basis, providing a financial incentive to their use by deferring taxation. These “Class 43.2” goods include equipment that generates or conserves energy by using a renewable energy source (wind, solar, small hydro…) or fuels from waste (landfill gas, wood waste, manure…), or makes efficient use of fossil fuels (high efficiency cogeneration systems for example).
Budget 2010 proposes to expand Class 43.2 to include heat recovery equipment used in a broader range of application and distribution equipment used in district energy systems that rely primarily on ground source heat pumps, active solar systems or heat recovery equipment.
Capital Cost Allowance Deduction Rate of Television Set-top Boxes
Currently, satellite set-top boxes that are used to decode digital television signals are eligible for a decliningbalance CCA rate of 20%, while cable set-top boxes are eligible for a declining-balance CCA rate of 30%. Budget 2010 proposes that satellite and cable set-top boxes that are acquired after March 4, 2010 and that have neither been used nor acquired for use before March 5, 2010 be eligible for a declining-balance CCA rate of 40%.
Renewal of Mineral Exploration Tax Credit
Budget 2010 proposes to extend eligibility for the “mineral exploration tax credit” for one year, to flow-through share agreements entered into on or before March 21, 2011. Flow-through shares allow companies to renounce of “flow-through” tax expenses associated with their Canadian exploration activities to investors, who can deduct the expenses in calculating their own taxable income. The mineral exploration tax credit” is an additional benefit, available to individuals who invest in flow-through shares, equal to 15% of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors. This extension of eligibility, combined with the existing “look-back” rule (which allow funds raised in one calendar year to be spent on eligible exploration up to the end of the following calendar year), will effectively allow funds raised with the credit during the first three months of 2011 to support eligible exploration until the end of 2012.
Simplification of the GST/HST for the Direct Selling Industry
The direct selling industry distributes goods to final consumers through a large number of contractors and sales representatives, rather than through retail establishments. The direct selling industry generally employs two business models: the buy and sell model, where contractors purchase goods from a direct seller and resell the goods to consumers with a mark-up, and the commission-based model, where a network of sales representatives of a direct-selling organization (referred to as a “network seller”) receives commissions for arranging for the sales of the network seller’s goods (“select products”) to consumers.
To simplify the operation of the GST/HST for network sellers employing the commission-based model, the Budget 2009 proposed allowing network sellers that meet certain qualification criteria to apply for the use of a special GST/HST accounting method. Simplified GST/HST accounting already exists under the Excise Tax Act for direct sellers that utilize the buy and sell model.
Budget 2010 confirms the government’s intention to implement the Budget 2009 proposals for simplification of the GST/HST for the direct selling industry and proposes a certain number of enhancements and clarifications to the previously announced measures. These enhancements would apply in respect of the fiscal years of a network seller that begin after 2009, matching the timing of the Budget 2009 proposals. A network seller, other than a new entrant, will be required to apply for approval to use the special GST/HST accounting method before the first day of the fiscal year of the network seller in respect of which that method is to begin applying. However, for a fiscal year of the network seller beginning in 2010, it is also proposed that a transitional measure allow a network seller to apply in 2010 for approval to start using the special GST/HST accounting method in 2010 in respect of the remaining part of that fiscal year.
Customs Tariff – Tariff Reductions on Manufacturing Inputs and Machinery and Equipment
Budget 2010 proposes to eliminate the remaining tariffs on manufacturing inputs and machinery and equipment. The goal of this measure is to assist Canadian industry by lowering the costs of manufacturing inputs and machinery and equipment that are imported from outside North America. Tariffs on the affected goods vary from 2% to 15.5% and represent a non-recoverable tax on production inputs and on new investments that companies make in order to enhance their competitiveness and productivity. The reductions apply to 1,541 tariff items as currently listed in the Schedule to the Customs Tariff. For these items, the Most-Favoured-Nation (MFN) rates of duty will be reduced to nil as of March 5, 2010 for most of them and gradually reduced to nil between March 5, 2010 and January 1, 2015 for the others. In certain instances, these MFN reductions will lead to consequential reductions to the rates of duty under other tariff treatments, namely the General Preferential Tariff, the Costa Rica Tariff, the Peru Tariff, the Australia Tariff and the New Zealand Tariff. It is claimed that this proposal, when fully implemented, will provide $300 million annual duty savings to Canadian business.
Previously Announced Measures
Budget 2010 also includes previously-announced tax measures such as:
- Paperwork Burden Reduction Initiative for small excise taxpayers announced by the Minister of National Revenue on March 21, 2009;
- Enhanced tobacco stamping regime to deter contraband tobacco released on August 6, 2009;
- Improvements to the application of the GST/HST to the financial services sectors released on September 23, 2009;
- Additional measure proposed in relation to the Canada-U.S. Softwood Lumber Agreement;
- Modifications to the rules governing Tax-Free Savings Accounts announced on October 16, 2009;
- Increased flexibility for employer funding of registered pension plans by increasing the pension surplus threshold for employer contributions to 25% from its previous 10% limit, announced on October 27, 2009;
- Technical legislative proposals addressing recent court decision on the GST/HST and financial services, announced on December 14, 2009;
- Measures released in draft form on December 18, 2009 relating to the income taxation of shareholders of foreign affiliates, as well as the remaining measures released in a previous draft relating to foreign affiliates;
- Increased to the Air Travellers Security Charge rates announced on February 25, 2010;
- Rules to facilitate the implementation of Employee Life and Health Trusts, released in draft form on February 26, 2010; and
- The income tax technical and bijuralism amendments that were previously released but not yet implemented.