“In this Budget we are completing our Economic Action Plan, to create jobs now. We are taking limited and focussed additional measures to protect existing jobs and create new jobs. We are also looking ahead, to secure our long-term economic growth.”
“In this Budget our government is closing unfair tax loopholes.”
The Honourable Jim Flaherty
Minister of Finance
The Honourable Jim Flaherty, Minister of Finance, tabled the fifth federal budget of the Conservative minority government today. In his Budget Speech, the Minister emphasized the government’s plan to build on Canada’s economic recovery, to sustain Canada’s economic advantages and implement a return to balanced budgets over the medium-term. The 2010 Budget confirms $19 billion of spending during Year 2 of Canada’s Economic Action Plan, a plan introduced in the 2009 Budget. However, the 2010 Budget also makes it clear that growth in spending in future years will be restrained. Targeted measures are proposed to save $17.6 billion over five years and the government has committed to undertaking a comprehensive review of government administrative functions and overhead costs to identify additional savings. A deficit of $49.2 billion is projected in 2010-11 and a deficit of $27.6 billion is projected in 2011-2012 and deficits are projected to continue through 2014-2015, when a $1.8 billion deficit is forecasted. Although no new significant tax reductions or increases were announced, the Minister indicated that previously announced corporate and personal tax reductions would continue as scheduled.
The 2010 Budget contains tax proposals to:
- eliminate the deferral for public company stock options and restrict employers’ deductions on the cash out of stock options;
- introduce reporting requirements with respect to tax avoidance transactions;
- narrow the definition of “taxable Canadian property”;
- significantly amend previously introduced rules relating to the taxation of non-resident trusts and foreign investment entities;
- limit the ability of corporations to utilize losses where shares of a corporation are issued in exchange for interests in a SIFT trust, a SIFT partnership or a real estate investment trust; and
- deny direct or indirect credits for foreign taxes on income earned via a partnership or a foreign affiliate.
In addition, the government stated that it will explore whether new rules regarding the utilization of losses within corporate groups could improve the functioning of the tax system.
In this Budget Briefing 2010, we summarize the 2010 Budget’s tax proposals.
BUSINESS INCOME TAX MEASURES
Employee Stock Options
Elimination of the Deferral for Public Company Stock Options
The 2010 Budget significantly changes the way in which both employees and employers are taxed in Canada on stock options.
When an employee exercises a stock option, the employee is generally required to include in income a taxable benefit equal to the difference between the fair market value of the shares on the date of acquisition and the exercise price paid by the employee. Provided certain conditions are met, the employee may be entitled to claim a deduction equal to one-half of the stock option benefit under paragraph 110(1)(d) of the Act (the “paragraph 110(1)(d) deduction”).
The 2000 Budget permitted employees of public corporations to elect to defer the income inclusion associated with a stock option exercise from the year of exercise until the year of disposition of the shares, subject to certain conditions. The 2010 Budget proposes to repeal this tax deferral election for public company stock options exercised after 4:00 p.m. (EST) on March 4, 2010. A similar deferral of the taxable benefit from the year of exercise to the year of sale for options issued by a company that is a Canadian controlled private corporation (CCPC) at the date of the option grant remains available.
Special Relief for Tax Deferral Elections
The election by employees to defer their public company stock option benefits, coupled with significant reductions in the share value, has resulted in the current value of many of these securities being less than the deferred tax liability associated with the stock option benefit.
The 2010 Budget proposes to provide relief for those taxpayers who have filed deferral elections. In the year in which the taxpayer disposes of the shares and must include the deferred stock option benefit in income, the taxpayer will be able to elect to pay a special tax for the year which will be equal to the taxpayer’s proceeds from the sale of the shares. For taxpayers resident in the province of Québec, the special tax will be equal to two thirds of the proceeds of disposition. The taxpayer may then claim an offsetting deduction equal to the amount of the stock option benefit and will be required to include in income as a taxable capital gain, an amount equal to one-half of the lesser of the stock option benefit and the capital loss on the disposition of the shares. For securities disposed of before 2010, the election must be made by the taxpayer’s filing due date for 2010. In any other case, the election must be filed by the taxpayer’s filing due date for the year in which the disposition takes place.
While taxpayers who have exercised CCPC options may also have suffered a loss in value of their shares since the date of exercise, no similar relief is provided.
Restriction on the Deduction for the Cash Out of Stock Options
The Act specifically prohibits corporate employers from deducting any amounts on the issuance of any shares on the exercise by employees of a stock option. Where, however, an employee is able to dispose of their stock option for a cash payment from the employer that is equal to the “in the money” value of the stock option, the employer is generally entitled to deduct the amount of the cash payment. In addition, where the appropriate conditions are met, the employee may also be able to claim the paragraph 110(1)(d) deduction.
The 2010 Budget proposes to prevent both the employee’s paragraph 110(1)(d) deduction and the employer’s deduction of the amount of the cash payment from occurring in respect of the same employment benefit. Under the proposed amendments, where the employee exercises the stock option and acquires shares, the employee’s paragraph 110(1)(d) deduction would still be available (assuming it would otherwise have been available). However, where the employee surrenders their stock option to the employer for a cash payment, the employee will only be entitled to the paragraph 110(1)(d) deduction where the employer elects to forgo the corporate deduction in respect of the cash payment. This measure will apply for all stock option exercises (or surrenders for cash payment) that occur after 4:00 p.m. (EST) on March 4, 2010. This change will result in the tax treatment of stock options in Canada more closely resembling the treatment in the United States for the taxation of Incentive Stock Options.
It is common for employers to rely on the long-standing administrative position of the Canada Revenue Agency (CRA) to not require the employer to withhold and remit amounts in those situations where an employee has exercised a stock option and acquired the underlying shares where withholding would cause undue hardship to the employee.
The 2010 Budget proposes to clarify that amounts must be remitted in respect of a stock option benefit to the same extent as if the amount of the benefit had been paid to the employee as a cash bonus. The proposal also clarifies that if a paragraph 110(1)(d) deduction is available, then for purposes of determining the employee’s remittance obligation, the amount of the benefit may be reduced by half. The 2010 Budget specifically precludes the Minister of National Revenue from taking into account the fact that the taxable benefit arose from the acquisition of shares, thereby effectively precluding the ability to rely on the “undue hardship” argument. These clarifications to the remittance rules will only apply in respect of securities acquired by employees after 2010 and will not apply in respect of stock options granted prior to 2011 pursuant to a written agreement entered into before 4:00 p.m. (EST) on March 4, 2010, where the agreement included restrictions on the employee’s ability to dispose of the underlying shares.
Non-Arm’s Length Transfers
The 2010 Budget also proposes to clarify that the disposition to a non-arm’s length person of rights under a stock option agreement results in an employment benefit at the time of the disposition. The supplementary materials to the 2010 Budget point out that the change is being made for clarification purposes only and the government considers these benefits always to have been taxable in these circumstances under the existing set of rules.
Information Reporting of Tax Avoidance Transactions
Tax and finance authorities around the world have expressed concern about arrangements they believe to constitute “aggressive tax planning.” A common theme underlying governments’ “aggressive tax planning” initiatives is a lack of confidence in existing tax laws to allow tax authorities to adequately identify aggressive tax planning at an early stage. The United States tax law has adopted “reportable transaction” rules to identify transactions of this nature, which are required to be reported to the tax authorities. Recently, as a result of a public consultation initiated in the Québec 2008-2009 budget the Québec Department of Finance introduced measures, effective as of October 15, 2009, that require both mandatory and voluntary reporting rules directed at this kind of tax planning and impose stiff penalties for non-reporting of transactions that are found to be subject to the Québec general anti-avoidance rule. A detailed discussion of Québec's measures to combat aggressive tax planning can be found here.
Evidently, the federal government has decided to follow suit with rules directed at identifying aggressive tax planning in a timely manner. A public consultation will be held with a view to formulating additional information reporting requirements with respect to tax avoidance transactions, intended to be effective after 2010. These new reporting rules will supplement existing information reporting provisions regarding tax shelters and flow-through shares, and are intended to strike a balance between the taxpayer’s right to minimize tax and the government’s responsibility to guard against aggressive tax planning arrangements. It is expected that detailed proposals will be released for comment in the near future. This Budget announcement reflects the government’s awareness of initiatives taken by some other jurisdictions, including for example the United States and Québec, but is conceived as possibly being less strict than those regimes.
The new reporting requirement will apply to transactions which are avoidance transactions under the existing provisions of the General Anti-Avoidance Rule (GAAR), entered into by or for the benefit of a taxpayer, which meet at least two of three tests. The three tests, referred to in the 2010 Budget as "hallmarks" are as follows:
- a promoter or tax advisor’s fees are to some extent measured with reference to the tax benefits of the transaction or the number of persons participating in the transaction,
- the promoter or tax advisor insists on confidentiality about the transaction – "confidential protection”, or
- the participant in the transaction enjoys “contractual protection” apart from a fee payable to the promoter or advisor as described in the first hallmark.
The circumstances in which the reporting mechanism would operate as an obligation of taxpayers is not entirely clear. Seemingly, in order to retain the tax benefit of a reportable transaction, it will ultimately be necessary to report the transaction. A taxpayer who fails to report a reportable transaction may reinstate the reporting and thereby preserve at least the opportunity to defend the transaction and enjoy the benefit by paying a penalty for late reporting. However, merely reporting the transaction is no assurance that the sought after tax benefit will be obtained.
Inevitably, through the public consultation process, important notions in this initiative will be examined and amplified. For example, the government’s proposal regarding "contractual protection" would seem to anticipate some measure of protection measured otherwise than by fees, possibly by reference to unrealized tax benefits, although at this time the precise formulation of this notion is unclear. The laws and practices of other jurisdictions already treading this path will likely have some influence on how the Canadian federal rules are designed. This initiative is also interesting because it accompanies two specific legislative measures to combat what the government believes is unwarranted, but possibly not always readily evident, tax avoidance in the form of “Foreign Tax Credit Generators” and “SIFT Conversions and Loss Trading.” These legislative initiatives reflect in a substantial way the government's concern with “tax loopholes.”
SIFT Conversions and Loss Trading
The Act contains rules that limit the ability of corporations to utilize losses and other tax attributes following an acquisition of control. In certain circumstances, where shares of one corporation (the Acquiring Corporation) are issued in exchange for shares of another corporation there is deemed to be an acquisition of control of the Acquiring Corporation and all corporations controlled by it. The 2010 Budget proposes to introduce a similar rule which would apply where shares of a corporation are issued in exchange for interests in a SIFT trust, a SIFT partnership or a real estate investment trust. This rule will be effective in respect of transactions occurring after 4 p.m. (EST) on March 4, 2010, unless the parties are obligated to complete such transactions pursuant to the terms of an agreement in writing entered into before that time.
Taxation of Corporate Groups
In response to concerns expressed by the business community and the provinces regarding the utilization of losses within corporate groups, the government will 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. The views of stakeholder groups will be sought before any changes are introduced.
Specified Leasing Property Rules
The specified leasing property rules, introduced originally to eliminate the after-tax advantages of leasing as a source of financing, effectively recharacterize a lease as a loan, and limit the lessor’s capital cost allowance claim to deemed repayments of principal on the loan. The specified leasing property rules do not apply to “exempt property”, generally property commonly leased for operational purposes and for which the capital cost allowance rate approximates the economic depreciation.
In reaction to a perceived exploitation of the specified leasing property rules – involving the lease of “exempt property” to lessees not subject to tax - the Budget proposes to extend the application of the specified leasing property rules to otherwise exempt property that is the subject of a lease to a government or other tax-exempt entity or a non-resident. Leases of otherwise exempt property will continue to be exempt even if leased to non-taxable lessees if the total value of the subject property is less than $1 million.
Accelerated Capital Cost Allowance for Clean Energy Generation
Class 43.2 of Schedule II of the Income Tax Regulations provides an accelerated capital cost allowance rate (50% per year on a declining balance basis) for specified clean energy generation and conservation equipment. For assets acquired on or after March 4, 2010, the Budget proposes to expand the list of assets eligible for the accelerated capital cost allowance rate to include (a) heat recovery equipment used in a broader range of applications; and (b) distribution equipment used in district energy systems that rely primarily on ground source heat pumps, active solar systems or heat recovery equipment. To better align the flow-through share rules in respect of the renunciation of Canadian renewable and conservation expenses with recent as well as proposed amendments to Class 43.2, which recognize circumstances where the taxpayer may not be the party generating the energy, the 2010 Budget proposes to amend the definition of “principal-business corporation” to ensure that taxpayers producing fuel or distributing energy may also issue flow-through shares for the renunciation of Canadian renewable and conservation expenses.
Reducing the Interest Rate on Overpaid Taxes
The applicable rate used to calculate the interest the government pays in respect of overpayments of most taxes is equal to the average yield of three-month Government of Canada Treasury Bills sold in the first month in the preceding quarter, rounded up to the nearest percentage point, plus 2 percentage points. The 2010 Budget proposes to eliminate the additional 2 percentage points for corporate taxpayers effective July 1, 2010, so that the interest rate payable to corporations by the Minister of National Revenue will be set to the average yield of three-month Government of Canada Treasury Bills sold in the first month in the preceding quarter, rounded up to the nearest percentage point. The interest rate calculation applicable to overpayments by non-corporate taxpayers will not change. This change is in response to the Auditor General’s concerns that when the Minister of National Revenue holds these amounts on deposit and paying interest on them, the government is effectively borrowing funds at a higher rate of interest than necessary.
Federal Credit Unions
In order to promote the continued growth and competitiveness of the credit union sector and enhance financial stability, the 2010 Budget proposes to introduce a legislative framework to enable credit unions to incorporate and continue their operations as federal entities. The 2010 Budget materials note that certain amendments may be necessary in the Act to provide that federal credit unions that otherwise satisfy the definition of “credit union” in the Act will be subject to the same income tax rules as other credit unions.
Capital Cost Allowance for Television Set-top Boxes
The 2010 Budget 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 capital cost allowance rate of 40 percent. Currently, satellite set-top boxes are eligible for capital cost allowance at a rate of 20 percent (Class 8), and cable set-top boxes are eligible for a CCA rate of 30 percent (Class 10).
INTERNATIONAL INCOME TAX MEASURES
Narrowing the Definition of Taxable Canadian Property
With the goal of bringing Canada’s domestic tax rules more in line with Canada’s tax treaties and the tax laws of Canada’s major trading partners, the 2010 Budget proposes to narrow the definition of “taxable Canadian property.” Generally, non-residents of Canada are liable to tax (subject to relief under an applicable bilateral income tax convention) and may be subject to compliance obligations under the Income Tax Act (Canada) (the Act) in respect of gains derived from dispositions of “taxable Canadian property.” Such obligations have long been considered an administrative burden to non-residents investing in private Canadian corporations since under many of Canada’s tax conventions no tax would be payable in respect of any gain realized on a disposition of shares of a Canadian corporation (except those that derive their value principally from real property situated in Canada). Proposals introduced in the 2008 Budget, which largely focused on the certification requirements in section 116 of the Act did not, as a practical matter, achieve their stated objective of eliminating compliance obligations where no tax was payable in respect of a disposition of taxable Canadian property. Proposals in the 2010 Budget will, in many cases, eliminate compliance obligations (and tax liability) under the Act in respect of dispositions by non-residents of Canada of shares of private Canadian corporations and other interests.
Effective after March 4, 2010, the 2010 Budget proposes to significantly curtail the scope of taxable Canadian property.
- Previously, shares of a corporation resident in Canada (other than a mutual fund corporation) that were not listed on a designated stock exchange constituted taxable Canadian property. Under the 2010 Budget proposals, such shares would only constitute taxable Canadian property at a particular time if at any time during the preceding 60-month period, more than 50% of the fair market value of such shares was derived, directly or indirectly, from one or any combination of (i) real or immovable property situated in Canada, (ii) Canadian resource properties, (iii) timber resource properties and (iv) options or interests in respect of the foregoing (the Value Requirement).
- Previously, shares of a corporation resident in Canada that were listed on a designated stock exchange or shares of a mutual fund corporation constituted taxable Canadian property to a non-resident if at any time during the preceding 60-month period, 25% or more of the issued shares of any class or series of the corporation was owned by the non-resident, persons with whom the non-resident did not deal at arm’s length or the non-resident together with such persons (the Ownership Threshold). Under the 2010 Budget Proposals, such shares would only constitute taxable Canadian property if, in addition to the Ownership Threshold, the Value Requirement is satisfied.
Similar proposals set out the circumstances in which shares of non-resident corporations, interests in partnerships, and interests in resident, non-resident or mutual fund trusts will constitute taxable Canadian property.
By narrowing the definition of taxable Canadian property, the 2010 Budget proposals will eliminate section 116 compliance obligations and requirements to file Canadian tax returns in respect of dispositions by non-residents of shares of Canadian corporations (and other interests) that do not derive (or did not derive within the previous 60 months) their value principally from real or immovable property situated in Canada, Canadian resource property or timber resource property. A corollary is that investors that are not entitled to the benefit of a bilateral income tax convention will not be subject to tax under the Act in respect of many investments in Canadian corporations (and other interests). These changes will undoubtedly be welcomed by non-resident investors (such as private equity or venture capital funds) and could reasonably be expected to assist Canadian corporations in attracting additional foreign equity investment.
The 2010 Budget also provides relieving rules in respect of the status of property received in certain deferral transactions as taxable Canadian property. Previously, for example, when taxable Canadian property was disposed of to a corporation for consideration that included shares of a corporation in a transaction to which section 85 of the Act applied, the shares received by the transferor were deemed to be taxable Canadian property. Arguably, by virtue of this deeming rule, the status of such shares as taxable Canadian property continued indefinitely regardless of any change in circumstances. The 2010 Budget modifies this rule by providing that the shares received by the transferor are deemed to be taxable Canadian property for a period of 60 months following the transfer. Thus, shares received on a deferral transaction to which section 85 applied that do not otherwise constitute taxable Canadian property will cease to constitute taxable Canadian property after 60 months have elapsed. Corresponding changes are proposed in respect of other deferral provisions.
Foreign Investment Entities and Non-resident Trusts
Draft rules relating to the taxation of non-resident trusts and foreign investment entities have attracted considerable criticism for their excessive complexity and overly broad application. Those rules, first introduced in 1999 and modified several times, were to apply retroactively to the 2007 and subsequent taxation years. The 2010 Budget proposes significant further amendments to these rules. Public comments on the proposals will be accepted prior to May 4, 2010. A panel of respected tax practitioners will be formed to assist in designing draft legislation to implement the revised proposals, following which draft legislation will be released for further public comment.
Foreign Investment Entities
The 2010 Budget proposes to replace the draft foreign investment entity (FIE) rules in their entirety, reverting back to the current “offshore investment fund property” (OIFP) rules with a few minor modifications. The OIFP rules generally apply when a taxpayer holds an interest in a non-resident entity that derives its value, directly or indirectly, primarily from portfolio investments in certain types of investment property, where one of the main reasons for the taxpayer acquiring, holding or having the interest in the entity is to avoid Canadian tax. When applicable, these rules include a notional amount in computing the taxpayer’s income equal to the designated cost of the taxpayer’s interest in the entity multiplied by a prescribed interest rate, less any actual income (other than capital gains) received from the entity. The 2010 Budget proposes to increase the prescribed rate to the three-month-average Treasury Bill rate plus 2%, and to extend the reassessment period in respect of OIFP interests by three years.
These changes apply to taxation years ending after March 4, 2010. Taxpayers who voluntarily complied with the prior FIE proposals may elect to be reassessed, with any resulting reduction in income being allowed as a deduction in the current year.
The non-resident trust (NRT) rules currently require certain beneficiaries of a NRT to report income on a modified “foreign accrual property income” basis where the fair market value of the beneficiary’s interest in the trust exceeds 10% of the value of all interests in the trust. The 2010 Budget proposes to broaden those rules to apply where any Canadian resident beneficiary who, together with non-arm’s length persons, holds at least 10% of any class of interests in the NRT determined by fair market value, or to residents who contribute “restricted property” to the NRT. This rule is relevant for NRTs that are not deemed resident in Canada under the NRT rules referred to below.
The outstanding NRT proposals generally deem a NRT (other than an exempt foreign trust) to be resident in Canada, and taxed on its world-wide income, if it has a Canadian contributor or a Canadian beneficiary. The 2010 Budget retains the principal framework of the outstanding NRT proposals, with several important changes intended to better target and simplify the rules. The 2010 Budget proposes to significantly extend the exception for commercial trusts – which should relieve many of the problems faced under the outstanding NRT proposals for ordinary commercial investments – subject to a new anti-avoidance rule for certain trusts that mimic genuine commercial trusts. The 2010 Budget also proposes a new rule to ensure that Canadian tax-exempt entities, such as pension funds, Crown corporations and registered charities, will not become liable to tax in Canada in respect of an interest in a NRT, as could have been the case under the prior proposals. Other changes limit the relevance of the prior “restricted property” rules, and prevent the NRT rules from applying as a result of Canadian financial institutions making loans to trusts in the ordinary course of business.
If the NRT rules apply to deem a trust to be resident in Canada, the 2010 Budget proposes to divide the trust’s property into a “resident portion” and a “non-resident portion.” The trust would be taxed only on income accumulated in the resident portion (if kept separate and apart from the non-resident portion), with a deduction allowed for income payable to beneficiaries or income allocated to resident contributors. New ordering rules are to be introduced with respect to trust distributions, with distributions to resident and non-resident beneficiaries to be made first out of the resident portion and non-resident portion of the trust, respectively. Canadian withholding tax will apply to distributions to non-resident beneficiaries out of the resident portion. New rules will also allow the trust to claim a foreign tax credit in Canada for certain foreign taxes (generally up to 15% of the foreign income). Resident contributors will be taxed only on their proportionate share of the trust’s income, reduced by losses claimed by the trust for other years, rather than being jointly and severally liable for the trust’s own tax obligations.
These NRT proposals apply for the 2007 and subsequent taxation years, with an election allowing a trust to be deemed resident for the 2001 and subsequent taxation years. The new proposals attributing trust income to resident contributors apply to taxation years ending after March 4, 2010.
The 2010 Budget proposes to extend the reassessment period in respect of interests in NRTs by three years, and to amend the Income Tax Conventions Interpretation Act to ensure that the NRT rules are not overridden by Canada’s tax treaties (an amendment that would have the effect of reversing recent court decisions).
Foreign Reporting Rules
The 2010 Budget proposes to extend the “specified foreign property” reporting requirements so that more detailed information will be available for audit use with respect to certain foreign investments.
Foreign Tax Credit Generators
The 2010 Budget proposes to deny, in certain circumstances, direct or indirect credits for foreign taxes on income earned via a partnership or a foreign affiliate.
The proposals are intended to address “schemes . . . designed to shelter tax otherwise payable in respect of interest income on loans made, indirectly, to foreign corporations.” However, the proposals, which are not subject to a purpose or other anti-avoidance test nor to any test as to the nature of the assets or business subject to foreign taxation, would appear to have much broader potential application. Taxpayers earning income subject to foreign taxes via a partnership or foreign affiliate should consider the potential application of these rules.
The proposals would apply to any taxpayer which is a member of a partnership where tax in respect of partnership income is paid to a foreign country if the taxpayer’s share of partnership income under the tax law of the foreign country is less than the taxpayer’s share of partnership income under the Act. The proposals apply whether foreign tax is paid directly by the partners or at the partnership level (for example, in the case of a U.S. partnership which has “checked the box” to be treated as a corporation). Almost inevitably, where partnership income is calculated under the tax laws of different jurisdictions, different measurements of income for local tax purposes will result. Consequently, where the sharing of partnership profits is anything but simply pro rata, consideration must be given as to whether the proposals would deny recognition of taxes paid to the foreign government in respect of partnership income, resulting in double taxation of the Canadian partner.
The proposals also apply where a taxpayer holds (directly or through another affiliate) shares in a foreign affiliate, denying recognition of foreign tax where the taxpayer is considered under the tax law of the foreign country to which taxes are paid to own less than all of the shares the taxpayer is considered to hold for purposes of the Act. Particularly where any shares of a foreign affiliate are subject to a “repo” transaction or to treatment as a hybrid under foreign tax law or the foreign affiliate is treated as fiscally transparent under foreign tax law, taxpayers should give consideration to the potential effect of the proposals to deny recognition for foreign taxes. Shares of a foreign affiliate held via a partnership are subject to a rule similar to that discussed in the preceding paragraph.
While the 2010 Budget suggests that the proposals “should generally put the Canadian corporation in the same tax position as if it had made a simple loan to the foreign corporation,” the proposals would appear to subject the Canadian taxpayer who is a partner or earns FAPI to Canadian tax not only upon the net return to the taxpayer, but also upon foreign income applied to pay the foreign tax.
The government states in the supplementary materials to the 2010 Budget that it believes that the foreign tax credit schemes which are the intended target of the proposals can be successfully challenged under existing rules in the Act. As proposed, it appears that a cost of the greater assurance sought in respect of targeted transactions is the potentially broad application of the proposals to taxpayers earning income subject to foreign tax via partnerships or foreign affiliates in circumstances which have no relationship to the transactions which are the stated target of the proposals.
The proposals are effective for taxation years ending after March 4, 2010, and accordingly would deny foreign tax credit recognition (including in respect of foreign taxes paid prior to the Budget announcement) under existing as well as new transactions for the current as well as future taxation years. The Department of Finance encourages stakeholders to submit comments on the proposals before May 4, 2010.
The 2010 Budget does not include any new measures relating to foreign affiliates, noting that the government continues to consider the report of the Advisory Panel on Canada’s System of International Taxation that was released on December 10, 2008. The Advisory Panel recommended, among other significant changes, that the “taxable surplus” regime for taxing the distribution of active business earnings generated in a country without a tax treaty or tax information exchange agreement (TIEA) with Canada be abandoned in favour of a full exemption system. The Advisory Panel also suggested that it was not appropriate to link the existence of a TIEA with access to the favourable “exempt surplus” system.
The 2010 Budget indicates that the government is continuing to pursue TIEA negotiations with 15 countries, although little information has been released about the status of the negotiations. Canada has signed only one TIEA, with the Netherlands Antilles, which has not yet been ratified. The status of that TIEA is somewhat uncertain, as we understand the Netherlands Antilles is expected to cease to exist as a country in October of 2010.
The 2010 Budget confirms the government’s intention to proceed with the December 18, 2009, draft legislation respecting foreign affiliates, “as well as the remaining measures released in a previous draft relating to foreign affiliates.” It is presumed that this is a reference to the as-yet-unenacted measures in the February 27, 2004, draft legislation relating to, among others, foreign affiliate reorganizations, distributions from foreign affiliates, and proposed surplus suspension rules for certain inter-group asset and share transfers. For a detailed description of the December 18, 2009, measures and a summary of the status of recent foreign affiliate changes, see our Osler Update dated February 2, 2010.
Refunds under Regulation 105 and Section 116
The Act currently contains provisions that allow the Minister of National Revenue to refund overpaid tax, provided relevant tax returns have been filed by the taxpayer seeking the refund within certain prescribed periods. The 2010 Budget proposes an amendment to the Act to permit the Minister of National Revenue to refund these types of overpaid withholding tax to a non-resident if the overpayment relates to an assessment of the person that withheld and remitted the overpaid withholding tax and the non-resident files the tax return it is required to file under Part I of the Act no more than two years after the date of such assessment.
PERSONAL INCOME TAX MEASURES
Mineral Exploration Tax Credit
The 2010 Budget proposes to extend the 15% mineral exploration tax credit to flow-through share agreements entered into on or before March 31, 2011. The credit, which is available to individuals for specified mineral exploration expenses incurred in Canada and renounced to them in respect of flow-through share investments, was otherwise scheduled to expire at the end of March 2010.
Registered Disability Savings Plans
Registered Disability Savings Plans (RDSPs) were introduced in the 2007 Budget to help parents and others save for the long-term financial security of a child with a severe disability. An RDSP is a tax-assisted savings vehicle in which investment income accumulates tax-free, and annual contributions to which attract federal government assistance in the form of Canada Disability Savings Grants (CDSGs) and Canada Disability Savings Bonds (CDSBs).
Further relief is provided to individuals with disabilities by:
- Extending the current Registered Retirement Savings Plan (RRSP) rollover rules to allow a transfer of a deceased individual’s RRSP proceeds to the RDSP of a financially dependent infirm child or grandchild, for deaths occurring after March 3, 2010; and
- Allowing a 10-year carryforward of unused CDSG and CDSB entitlements, starting in 2011.
Scholarship Exemption and Education Tax Credit
Under existing rules, a full tax exemption is available for post-secondary scholarships, fellowships and bursaries received in connection with a student’s enrolment in an educational program that entitled the student to the Education Tax Credit. The 2010 Budget proposes to clarify that a post-secondary program that consists principally of research generally will be eligible for the Education Tax Credit – and thus the scholarship exemption – only if it leads to a college or CEGEP diploma or a bachelor, masters or doctoral degree (or an equivalent degree). Accordingly, post-doctoral fellowships will be taxable.
The 2010 Budget also proposes that an amount will be eligible for the scholarship exemption only to the extent it is received in connection with enrolment in an eligible educational program for the duration of the period of study to which the scholarship relates. In addition, if the scholarship is provided in connection with a part-time program, the scholarship exemption will be limited to the amount of tuition paid plus the costs of program-related materials, unless the part-time student is entitled to the Disability Tax Credit or cannot enrol on a full-time basis due to a mental or physical impairment.
These measures will apply to the 2010 and subsequent taxation years.
U.S. Social Insurance Benefits
Under existing rules, Canadian residents receiving certain U.S. social security benefits (including tier 1 railroad retirement benefits but excluding unemployment benefits) are required to include 85% of such benefits in computing their income. The 2010 Budget proposes to reinstate the 50% inclusion rate (which applied prior to 1996) for Canadian residents who have been receiving such U.S. social security benefits since before January 1, 1996 (and for their spouses and common-law partners who are eligible to receive survivor benefits), applicable to benefits received on or after January 1, 2010.
OTHER INCOME TAX MEASURES
Charities: Disbursement Quota Reform
In order to reduce the administrative burden on registered charities, the 2010 Budget proposes significant changes to the disbursement quota rules in the Act. Very generally, the current rules require that a charity’s expenditures on charitable activities and gifts to qualified donees must equal or exceed the total of (a) 80% of the charity’s receipted donations for the previous taxation year, and (b) 3.5% of the value of the charity’s assets which are not used in its charitable activities or administration, if these assets exceed $25,000.
For fiscal years ending on or after March 4, 2010, the 2010 Budget proposes to eliminate all the components of the disbursement quota except for the requirement that a charity expend 3.5% of its accumulated assets on charitable activities. However, the 3.5% disbursement requirement would only apply to charitable organizations if the value of these accumulated assets exceeds $100,000. Charitable foundations would remain subject to the existing $25,000 threshold.
Related measures proposed in the 2010 Budget will give the CRA discretion to exempt some of a registered charity’s accumulated assets from the disbursement quota calculation where the assets are needed for a particular purpose, such as a building project. As well, a proposed new anti-avoidance rule would apply to property transferred between non-arm’s length charities to require that either (1) the transferee spends the amount transferred on charitable activities or gifts to qualified donees, or (2) the transferor excludes the transferred amount from its own disbursement quota.
The 2010 Budget proposes that the Act and other legislation administered by the CRA be amended to allow certain types of notices that can currently be sent to taxpayers only by ordinary mail to be issued electronically. However, notices that are specifically required to be served personally or by registered or certified mail would not be eligible for electronic transmission. The government proposes that the CRA’s existing secure online platforms would be modified to permit taxpayers to authorize the CRA to provide them with electronic notices of certain assessments and reassessments under the Act, notices of determination and re-determination for GST/HST credits, and certain other notices.
EXCISE TAX MEASURES
The 2010 Budget proposes to amend the Excise Tax Act in respect of GST/HST legislation to implement changes to the GST/HST rules that were announced by the Department of Finance on December 14, 2009. As proposed in the December 14 announcement, the amendments to the GST/HST legislation will make it clear that, generally, GST/HST-exempt “financial services” do not include (i) investment management services, (ii) credit management services and (iii) a service that is facilitatory and preparatory to the provision of a service that is a financial service, with the result that these services will be subject to GST/HST. In addition, a “financial service” will not include property (other than a financial instrument) delivered or made available in conjunction with the provision of a financial service.
Consistent with the Government’s approach in other GST/HST amendments, the above changes will generally have retroactive effect, but will not require the payment of GST/HST where payment for services was due or made on or before December 14, 2009, and the service provider did not collect GST on such services. In respect of these new provisions, the period during which the Government may reassess taxpayers will be extended beyond the normal four-year limitation period to the later of (i) one year after the day on which the changes receive Royal Assent and (ii) the end of the normal limitation period.
The 2010 Budget also contains proposals that were first announced in the 2009 Budget to simplify GST/HST accounting requirements, and that provide certain other limited GST/HST relief, for the direct sales sector including network sellers.
The 2010 Budget also contains proposals that will clarify that cosmetic procedures (that is, procedures that are not medically required or reconstructive in nature), as well as goods and services related to such procedures, are subject to GST/HST.
CUSTOM TARIFF MEASURES
In order to create conditions that encourage investments in Canada, and to improve the international competitiveness of Canadian manufacturers, the 2010 Budget provides for the elimination of $300 million of tariffs collected annually on manufacturing inputs and machinery and equipment. This removal of tariffs for Canadian manufacturers continues the initiatives taken in the 2009 Budget, by providing for an immediate elimination of 1,160 tariff items as of March 5, 2010, and the elimination of an additional 381 tariff by January 1, 2015. The government’s timing of this announcement is in advance of its responsibilities as host and co-host of the G8 and G20 Leaders Summits in 2010, and is consistent with its efforts to resist global trade protectionism.
PREVIOUSLY ANNOUNCED MEASURES
The 2010 Budget confirms the government’s intention to proceed with a number of previously announced tax measures and objectives, including the following:
Tax-Free Savings Accounts
On October 16, 2009, the government proposed the introduction of a number anti-avoidance rules intended to address the use of tax-free savings accounts in certain tax planning schemes.
SR&ED – Administrative Improvements
In the 2008 Budget, the government announced new funding for improvements to the administration of the SR&ED program. In the 2010 Budget, the government describes its achievements to date in this regard (including the introduction of a new self-assessment tool and claim form and guide, an increase in the number of technical reviewers who determine program eligibility and provide claimant services and the provision of such technical reviewers with more training and support) and reiterates its commitment to work with stakeholders to identify ways to improve the administration of the SR&ED program.
Strengthening Taxpayer Fairness
In 2007, the CRA introduced a strengthened Taxpayer Bill of Rights and a Taxpayers’ Ombudsman was appointed in 2008. In the 2010 Budget, the government states that the CRA will continue to consult with key stakeholders to identify ways in which transparency and accessibility may be strengthened.
Maintaining Frozen Employment Insurance Rates
In the 2009 Budget, the government announced that Employment Insurance premium rates would be frozen at $1.73 per $100 for both 2009 and 2010. The 2010 Budget confirms that the frozen rate will continue to apply through the end of 2010.
Employee Life and Health Trusts
The rules relating to the recently introduced Employee Life and Health Trusts will be discussed in detail in an upcoming Osler Update.