On March 22, 2011, the Canadian federal government tabled Budget 2011. This bulletin summarizes the principal income tax measures contained in Budget 2011.
A. TAX RATES
Budget 2011 contains no changes to corporate and personal income tax rates and does not propose to withdraw any previously announced planned reductions in income tax rates. Accordingly, the Canadian federal corporate income tax rate applicable to active business income earned by a Canadian-controlled private corporation in excess of $500,000 and to all income earned by any other corporation is reduced from 18% for 2010 to 16.5% for 2011 and to 15% for 2012.
B. CORPORATE TAX MEASURES
Limiting the Deferral of Partnership Income
A partnership is not a person for purposes of the Income Tax Act. The income or loss of a partnership is allocated to its members, who are required to include their share of such income in computing their taxable income in the taxation year that includes the end of the fiscal period of the partnership.
Since 1995, a partnership with a member who is an individual has been required to adopt a fiscal period that coincides with the end of the calendar year; however, this limitation does not apply to a partnership composed entirely of corporate members (other than professional corporations). Consequently, a deferral of income recognition can result where the fiscal period of a corporate partnership ends after the end of the taxation year of its members.
Budget 2011 proposes to limit the deferral of a corporate member of a partnership that, together with related and affiliated persons, is entitled to 10% or more of either the partnership income or of the partnership assets on a termination of the partnership. Such partners will be required to accrue income earned by the partnership during the "stub period" beginning on the end of the fiscal period of the partnership and ending on the end of the taxation year of the corporation.
There will be two methods available to corporate partners to compute the amount of the stub period accrual:
- by multiplying its share of partnership income (other than dividends) for fiscal periods of the partnership ending in its taxation year by the ratio of the number of days in the stub period to the number of days in that fiscal period; or
- by designating a lower amount.
The latter method may result in an additional income inclusion in the following taxation year if there is a positive difference between (1) the amount so designated and (2) the lesser of: (a) the stub period accrual computed under the formulaic approach described above, and (b) the actual pro-rated partnership income of the corporate partner during the stub period. The amount of the additional income inclusion will generally equal the amount of such difference multiplied by the prescribed interest rate for underpayments of tax in the applicable period. There will be a further income inclusion equal to the amount, if any, by which such difference exceeds 25% of the lesser of the amount determined under the formulaic approach and the actual stub period income.
A corporate partner will be entitled to elect to reduce its stub period accrual by its share of certain resource expenses incurred by the partnership in the stub period.
Corporate partnerships will generally be able to elect a new fiscal period ending no later than the last day of the first taxation year ending after March 22, 2011, of a corporate member that has been a member of the partnership since that time. Where the members of a partnership include one or more other partnerships, all partnerships will be required to adopt a common fiscal period.
Transitional relief will be provided to permit a corporate taxpayer to recognize the amounts that it will be required to include in respect of partnership fiscal periods ending in its first taxation year ending after March 22, 2011, over the following five years.
Rules similar to those outlined above will apply in respect of tiered partnership structures.
Stop-loss Rules on Redemption of Shares
Corporations are generally permitted to deduct dividends (or deemed dividends) received (or deemed to have been received) from taxable Canadian corporations. The Income Tax Act contains stop-loss rules which complement this deduction and effectively prevent corporations from claiming losses on the disposition of shares to the extent of any dividends or deemed dividends received thereon on or prior to the disposition, i.e., essentially preventing the generation of a loss through the stripping of corporate assets through tax-free inter-corporate dividends. Exceptions to these stop-loss rules generally apply where the share on which the loss is realized is held for 365 days or more and the shareholder (together with non-arm's length persons) owns no more than 5% of the class of shares on which the dividend or deemed dividend is received. Budget 2011 refers to certain tax-avoidance arrangements designed to improperly benefit from these exceptions to the stop-loss rules.
Budget 2011 proposes to extend the application of these stop-loss rules to any deemed dividend arising on the redemption of shares held by a corporation other than deemed dividends arising on the redemption of shares of a private corporation held by another private corporation.
This measure will apply to redemptions that occur on or after March 22, 2011.
Tax Incentives Relating to Manufacturing and Processing
Budget 2007 introduced an accelerated rate of capital cost allowance (CCA) of 50% (on a straight line basis) for machinery and equipment acquired primarily for use in Canada for the manufacturing and processing of goods for sale or lease after March 18, 2007, and before 2012.
Under Budget 2011 this temporary measure will be extended to qualifying machinery and equipment acquired before 2014.
Tax Incentives Relating to Clean Energy Generation
Specified clean energy generation and conservation equipment is generally eligible for a 50% declining-balance CCA rate. Budget 2011 proposes to expand the class of assets that qualify for this rate by including equipment that generates electricity using waste heat without using chlorofluorocarbons (CFCs) or hydrochlorofluorocarbons (HCFCs).
This measure will apply to eligible assets acquired on or after March 22, 2011, that have not been used or acquired for use before that date.
Deduction Rates for Intangible Capital Expenses in Oil Sands and Oil Shale Projects
Budget 2011 proposes two measures that will affect the deduction rate for intangible costs in the oil sands and oil shale sectors.
- The cost of oil sands leases and other oil sands resource property, which were previously treated as Canadian development expense (CDE), and therefore deductible at a 30% rate on a declining balance basis, will be treated as Canadian oil and gas property expense (COGPE) and deductible at a 10% rate on a declining balance basis. This change will apply to acquisitions made on or after March 22, 2011.
- The cost of development expenses incurred for the purpose of bringing a new oil sands mine into production in reasonable commercial quantities, which were previously treated as Canadian exploration expenses (CEE) and therefore fully deductible in the year incurred, will be treated as CDE. This change will not apply to expenses incurred before March 22, 2011, or to expenses incurred before 2015 for new mines on which major construction began before March 22, 2011. Transitional measures will permit taxpayers to allocate other expenses incurred before 2016 between CEE and CDE in specified proportions.
The impact of these measures will be significant for the oil sands sector. For the junior participants, the ability to fund early-stage development costs using flow-through shares will be adversely affected by fewer deductions eligible for flow-through treatment. Moreover, given the magnitude of the project expenditures in many cases, the present value of the lost tax benefits associated with these expenditures could be meaningful.
C. PERSONAL TAX MEASURES
Tax on Split Income - Capital Gains
The Income Tax Act contains rules (the "kiddie tax") that penalize income splitting between a higher-income taxpayer and a lower-income minor by taxing the minor at the highest marginal rate. The kiddie tax applies to certain types of income, including taxable dividends paid on private company shares and income from certain partnerships and trusts. The kiddie tax has not previously applied to capital gains earned by a minor through income splitting.
Budget 2011 proposes to extend the kiddie tax to capital gains realized by a minor from the disposition of shares to a non-arm's length person, provided that taxable dividends on the shares would have been subject to the kiddie tax (i.e., the shares are not publicly listed). The amount of such capital gain is deemed to be a taxable dividend received by the minor and, therefore, will not benefit from the 50% capital gains inclusion rate or the capital gains exemption for qualified small business corporation shares. Furthermore, the minor will not be entitled to the enhanced dividend tax credit on the deemed dividend that may otherwise have been available.
This amendment will apply to capital gains realized after March 21, 2011.
Donations of Publicly Listed Flow Through Shares
A person who donates publicly listed securities to a registered charity is generally exempt from tax on any accrued gain capital gain. The rules governing flow-through shares in the Income Tax Act essentially allow certain corporations in the oil and gas, mining and renewable energy sectors to renounce certain qualified expenditures to investors, who are permitted to deduct such renounced expenditures in calculating their own taxable income. A consequence of such renunciation is that the cost of such flow-through share to the investor for the purpose of calculating any eventual gain or loss on their disposition is zero. Thus, upon donation of publicly listed flow-through shares, investors benefit from the deduction of the renounced expenditures and applicable federal and provincial tax credits, a charitable deduction or credit for the value of the flow through shares, and relief from capital gains tax. The investor can thus acquire and donate flow-through shares at little after-tax cost.
Effectively, Budget 2011 proposes to deny an investor the benefit of the exemption from capital gains tax on a donation of publicly listed flow-through shares except to the extent that their aggregate fair market value exceeds their subscription price. In particular, the tax-exempt portion of the capital gain realized on such a donation will be limited to the amount by which the capital gain exceeds the difference between (i) the investor's aggregate cost of the flow-through shares of the particular class (i.e., computed without reference to the rule deeming the cost of such shares to be nil) and (ii) any capital gains previously realized in respect of the disposition of flow-through shares of the same class after the issuance on or after March 22, 2011, of flow-through shares of the particular class to the taxpayer
This measure will apply to shares issued pursuant to a flow-through share agreement entered into on or after March 22, 2011.
Anti-avoidance Rules for RRSPs
Budget 2011 proposes several changes to registered retirement savings plan (RRSP) rules to target a small number of taxpayers who have used various tax planning schemes involving their RRSPs, including so-called RRSP strips. RRSP strips are designed to give taxpayers access to funds in their RRSPs without including an appropriate amount in income.
This budget also proposes to adopt anti-avoidance rules for RRSPs similar to those applicable to tax-free savings accounts - the "advantage rules" and the "prohibited investment" rules - and to replace the existing "non-qualified investment" rules for RRSPs.
The advantage rules address a number of matters including transactions that would not have occurred between arm's length parties that were undertaken to benefit from the tax attributes of RRSPs, payments to an RRSP on account or in lieu of payment for services, payments of investment income where the income is tied to the existence of another investment (i.e., another taxable investment), benefits derived from swap transactions between RRSPs and taxable accounts controlled by the annuitant, benefits from "RRSP strip transactions," certain income from certain non-qualified investments, and income from certain prohibited investments. The tax payable in respect of an RRSP advantage will essentially be the fair market value of the benefit.
There is currently no concept of a "prohibited investment" for RRSPs. Under tax-free savings account (TFSA) rules, a "prohibited investment" generally includes an investment in an entity with which the annuitant does not deal at arm's length or in which the annuitant or a non-arm's length person has an interest of 10% or more. This concept is being extended to apply to RRSPs.
Under the proposed prohibited investment rules, a special tax equal to 50% of the fair market value of the investment will apply on its acquisition (or upon it becoming a prohibited investment), generally subject to a refund if the investment is disposed of by the end of the year following the year in which the tax applied, except where the annuitant knew or ought to have known that the investment was a prohibited investment.
A non-qualified investment for an RRSP includes shares in private investment companies, foreign private companies, real property and any other investments that are not permitted under the Income Tax Act. Under current rules, an RRSP that holds a "non-qualified investment" is taxable on its income from the investment and is subject to a penalty tax of 1% per month while it holds the non-qualified investment. In addition, the fair market value of the investment is included in the annuitant's income when the investment is acquired. Budget 2011 proposes to replace these non-qualified investment rules with a special tax equal to 50% of the fair market value of the investment, similar to that described above for the prohibited investment rules.
These measures will apply to transactions occurring (including investment income generated), and investment acquired, after March 22, 2011, subject to the following exceptions:
- the advantage rules will not apply to swap transactions undertaken before July 2011 or to swap transactions undertaken prior to 2013 to ensure compliance with prohibited investment rules or to remove an investment which would otherwise give rise to an advantage;
- while the portion of capital gains accruing after March 22, 2011, will be considered investment income generated after March 22, 2011, the 50% tax will not apply to dispositions prior to 2013 of prohibited investments held on March 22, 2011. Furthermore, prohibited investments acquired prior to March 22, 2011, still held after 2012 will be deemed to be prohibited investments acquired on January 1, 2013.
Individual Pension Plans (IPP)
Budget 2011 proposes to introduce two new measures affecting certain defined benefit registered pension plans. The measures will affect an "individual pension plan" that has three or fewer members, at least one of whom is related for tax purposes to an employer that participates under the plan. An anti-avoidance rule would also cause a plan primarily constituted for the benefit of persons connected to the employer or for highly paid employees to be an IPP in certain circumstances.
The new measures establish an annual minimum withdrawal amount by a member from an IPP after attaining 72 years of age corresponding to the amount that would be required to be withdrawn if the member's share of the IPP assets were held in a registered retirement income fund (RRIF). This requirement would generally apply beginning in the 2012 taxation year.
In addition, the cost of past service under an IPP must be satisfied first by transfers from RRSP assets belonging to the IPP member or a reduction in the member's RRSP contribution room before permitting new past service contributions. This measure would apply to past service contributions made after March 22, 2011 to an IPP other than amounts credited before such time under the terms of an IPP submitted for registration on or before such time.
Lump-sum Payments in Lieu of Health and Dental Coverage on Insolvency
The Canada Revenue Agency (the CRA) will clarify that lump-sum amounts received from insolvent employers by former employees or retirees in lieu of their right to received health and dental coverage shall not be treated as income for tax purposes.
This measure will apply in relation to insolvencies arising before 2012.
Employee Profit-sharing Plans (EPSP)
Budget 2011 announces that the federal government will review existing rules for EPSPs in order to determine whether technical improvements are required in order to ensure that EPSPs are not used inappropriately to direct profit participation to family members with the intent of reducing or deferring taxes or to avoid making Canada pension plan contributions or employment insurance premiums on employee compensation. Prior to any proposals, the federal government will consult with stakeholders.
Mineral Exploration Tax Credit
The 15% investment tax credit for flow-through mining expenses has been extended for another year. The tax credit will be available to flow-through share agreements entered into on or before March 31, 2012. Under the "look-back rule," funds raised with the benefit of the credit before April 2012 can be spent on mineral exploration until the end of 2013.
Other Personal Tax Measures
Budget 2011 proposes several new tax credits for individuals including the Children's Arts Tax Credit, the Volunteer Firefighters Tax Credit and the Family Caregiver Tax Credit. Enhancements are also proposed to the Child Tax Credit, the Tuition Tax Credit and to the access to education assistance payments under registered education savings plans (RESPs).
D. CHARITIES AND OTHER "QUALIFIED DONEES"
Increasing Taxpayer Confidence in the Appropriate Use of Their Donations
Budget 2011 proposes a number of amendments designed to ensure that organizations having the ability to issue official donation receipts ("qualified donees") operate in compliance with the law and introduces new rules for qualified donees designed to enhance transparency and accountability.
These qualified donees (other than registered charities) are: registered Canadian amateur athletic associations (RCAAAs), municipalities in Canada, municipal and public bodies performing a function of government in Canada, housing corporations in Canada constituted exclusively to provide low-cost housing for the aged, universities outside of Canada, the student body of which ordinarily includes students from Canada, and certain other charitable organizations outside of Canada that have received a gift from Her Majesty in right of Canada.
The many proposed measures applicable to these qualified donees include a requirement to be included on a published list maintained by the CRA in order to be entitled to issue official donation receipts, possible suspension of the qualified donee's ability to issue official donation receipts or revocation of its status as a qualified donee for non-compliance with the Income Tax Act and the requirement to maintain proper books and records.
In addition, the Minister of National Revenue will be able to refuse or revoke registration, or to suspend receipting privileges, where an individual with significant influence with respect to the organization (e.g., a member of the board of directors, a trustee, officer or equivalent official or any individual who otherwise controls or manages the operation of the organization) has been engaged in financial dishonesty such as fraud or misappropriation, including having been found guilty of certain offences. The CRA will consult with stakeholders in developing administrative guidance regarding the application of such proposed measures.
These measures will apply on or after the later of January 1, 2012, and Royal Assent to the enacting legislation.
Return of Property to Donor
When property for which a donation receipt has been issued is returned to the donor, the qualified donee is required to issue an amended receipt. To ensure proper compliance by the donors, Budget 2011 proposes that the qualified donee be required to send a copy of the amended receipt to the CRA where the amount of the adjustment exceeds $50.
This measure will apply in respect of gifts or property returned on or after March 22, 2011.
Gifts of Non-qualifying Securities
The Income Tax Act includes various provisions designed to reflect the Department of Finance policy that tax credits and deductions for charitable donations should not be available until the use and benefits of the property donated have actually been transferred to the qualified donee. One such provision applies in the case of donations of non-qualifying securities which include a share, debt obligation or other security issued by the taxpayer or by a person not at arm's length with the taxpayer. Obligations of financial institutions to repay an amount deposited with the institution, as well as shares, debt obligations and other securities listed on a designated stock exchange are excluded from the definition of non-qualifying security.
Under current rules, a donor will not be entitled to the credit or deduction for the donation until such time, within five years of the donation, as the qualified donee has actually disposed of the non-qualifying security. Budget 2011 proposes that such disposition must be for consideration that is not, to any person, a non-qualifying security (i.e., not limited to consideration that is a non-qualifying security of the donor). An anti-avoidance rule is also proposed to ensure application of this rule where as a result of a series of transactions, a particular person holds a non-qualifying security of the donor and the donee has acquired a non-qualifying security of the particular person or the donor.
These measures will apply in respect of securities disposed of by donees on or after March 22, 2011.
Granting of Options to Qualified Donees
Budget 2011 proposes to clarify that a donor is not entitled to a credit or deduction for the granting of an option to a qualified donee until such time as the donee actually acquires the property which is the subject of the option. The amount of the donation would be considered to be the amount, if any, by which the fair market value of the property at the time of that acquisition exceeds any amount payable by the donee for the option and the property. Any receipt issued would be subject to previously announced measures with respect to split receipting such that no credit or deduction will be available to the grantor if the total amount paid by the donee for the option and the property exceeds 80% of the fair market value of the property at the time of its acquisition pursuant thereto.
This measure will apply in respect of options granted on or after March 22, 2011.
E. OTHER MEASURES OR ANNOUNCEMENTS OF INTEREST
Qualifying Environmental Trusts
Special rules apply to a "qualifying environmental trust" (QET) that is maintained solely to pre-fund the reclamation and restoration costs of a mine, quarry or waste disposal site. In general terms, these rules permit the taxpayer to deduct contributions to the QET in the year the contribution is made, and subject investment income of the QET to tax at the general corporate rate.
Under the current rules, the definition of QET requires that the trust be mandated by a law of Canada or a province or the terms of a contract entered into between the taxpayer and the government of Canada or a province. Budget 2011 proposes to modify this condition to include trusts created after 2011 that are mandated by order of a tribunal constituted by a law of Canada or a province. The definition of QET will also be expanded to include a trust established to pre-fund the costs associated with abandonment of a pipeline.
Budget 2011 also proposes to expand the list of "eligible investments" that a QET is permitted to hold to include debt of public corporations, investment-grade debt and securities listed on a designated stock exchange. A QET would be prohibited from holding an interest in a security issued by, in general terms, a person or partnership that is a contributor to, or beneficiary under the trust (or a person or partnership related to or affiliated with such a person or partnership), or a person or partnership in respect of which a contributor or beneficiary of the trust holds at least a 10% interest.
These measures will apply to the 2012 and subsequent taxation years.
F. PREVIOUSLY ANNOUNCED INCOME TAX MEASURES
Budget 2011 confirms the government's intention to proceed with the following previously announced tax measures, as modified to take into account consultations and deliberations since their release:
- Legislation relating to measures announced in the March 2010 budget (including related legislative proposals that were released on August 27, 2010);
- Legislative proposals released on July 16, 2010, relating to income tax technical and bijuralism amendments;
- Legislative proposals released on November 5, 2010, relating to income tax technical amendments;
- Legislative proposals released on December 7, 2010, to accommodate changes to the Saskatchewan Pension Plan;
- Legislative proposals released on December 16, 2010, relating to the Real Estate Investment Trust rules;
- Proposed changes to certain GST/HST rules relating to financial institutions released on January 28, 2011;
- Legislative proposals released in draft form on March 16, 2011, relating to the deductibility of contingent amounts, withholding tax on interest paid to certain non-residents, and the tax treatment of certain life insurance corporation reserves; and
- Outstanding draft legislative proposals relating to foreign affiliates.
Budget 2011 also reaffirms the government's commitment to move forward as required with technical amendments to improve the operation of the tax system.