Budget 2013, tabled in the House of Commons on March 21, was expected to focus on protecting the tax base and addressing “tax loopholes." However, the tax part of the budget contained a significant number of proposed changes to the Income Tax Act (Canada) (the Act) impacting both individuals and corporations as well as stricter reporting requirements for foreign-source income and tax-motivated transactions.
The following highlights the main tax measures announced in the 2013 Budget1
A. Business Tax Measures
Corporate loss trading
The Act contains numerous provisions that are effectively intended to restrict the transferring of tax attributes, including losses, between arm’s length corporations. Budget 2013 indicates that these provisions continue to be undermined. According to Budget 2013, one example involves a transaction where a profitable corporation (Profitco) transfers assets to corporation with tax attributes (Lossco) in consideration for shares of Lossco in a manner that does not result an acquisition of control of Lossco, while often resulting in Profitco holding shares of Lossco representing the bulk of the fair market value of all of Lossco’s issued and outstanding shares. Lossco’s tax attributes are used to shelter income or gain from the transferred assets and Lossco then pays tax-free inter-corporate dividends to Profitco.
Budget 2013 proposes to provide for a deemed acquisition of control of Lossco when a person or group of persons acquires shares of Lossco representing more than 75% of the fair market value of the shares of Lossco, if one of the main reasons that control was not acquired was to avoid the relevant restrictions. This rule, along with related rules designed to avoid the circumvention of this rule, would apply to acquisitions of shares that occur on or after Budget Day, subject to limited grandfathering for transactions completed pursuant to an agreement in writing entered into before Budget Day.
Trust loss trading
The Act contains a number of provisions that, according to Budget 2013, are intended to constrain the ability of taxpayers to engage in arm’s length loss trading transactions. For example, loss carry forwards and certain other tax attributes of a corporation are subject to various restrictions and other rules that generally become applicable when there is an acquisition of control of the corporation. The Act does not contain any similar restrictions for trusts. Budget 2013 proposes to introduce loss-streaming and related rules for trusts where there is a “loss restriction event.”
A loss restriction event would arise where a person or partnership becomes a majority-interest beneficiary of the trust, or a group of persons becomes a majority interest group of beneficiaries of the trust. These terms are defined in the affiliated persons rules contained in section 251.1 of the Act, and these definitions apply in this context with certain modifications. In addition, other existing rules that apply in determining whether there has (or has not) been an acquisition of control of a corporation will also be applicable with “appropriate modifications” in determining whether there has been an acquisition of control of a trust. In many cases, under these rules an acquisition of control is considered not to have occurred as a result of a transaction if there is sufficient “continuity of ownership” after completion of the transaction.
Budget 2013 states that it is generally expected that personal (family) trusts will not be subject to trust loss trading rules, as transactions should typically benefit from the continuity of ownership rules. The Department of Finance is inviting submissions as to whether other transactions involving personal trusts should be protected from the trust loss trading rules.
A number of arrangements have been developed to permit taxpayers to effectively monetize or economically dispose of assets that have an accrued but unrealized gain without triggering immediate tax consequences. Budget 2013 introduces specific rules that target these “synthetic disposition arrangements” by providing for a deemed disposition of a taxpayer’s property upon entering into the arrangement. A “synthetic disposition arrangement” in respect of a taxpayer’s property will generally be defined to mean one or more agreements or other arrangements that:
- are entered into by the taxpayer, or by a person or partnership that does not deal at arm’s length with the taxpayer,
- have the effect (or would have the effect if entered into by the taxpayer rather than a non-arm’s length person or partnership) of eliminating all or substantially all of the taxpayer’s risk of loss and opportunity for gain in respect of the property for a period of more than one year,
- if entered into by a non-arm’s length person or partnership, can reasonably be considered to have been entered into in whole or in part for the purpose of obtaining the effect described in (b) above, and
- do not otherwise result in a disposition of the property.
This measure would apply to agreements and arrangements entered into on or after Budget Day, as well as to arrangements entered into before Budget Day whose term is extended on or after Budget Day.
Character conversion transactions
Certain transactions involving the use of derivative contracts seek to convert the return on an investment from ordinary income to capital gains, only 50% of which are included in income. In a typical transaction, a taxpayer would enter into a contract to buy or sell a capital property at a future date for a price determined by the performance of a reference portfolio of separate assets. The reference portfolio may also include assets that produce ordinary income. Thus, in effect, the transaction converts what would be ordinary income from the reference portfolio into a capital gain on the capital property.
Budget 2013 introduces the concept of a “derivative forward agreement,” being an agreement to buy or sell a capital property where the term exceeds 180 days and, in general terms, the price is determined in whole or in part by reference to an underlying interest (including a value, price, rate, variable, index, event probability or thing) other than (i) the value of the property, (ii) income or capital gains in respect of the property or (iii) if the property is an interest in a partnership trust or corporation, a return or distribution of capital in respect of the property.
Where a taxpayer enters into a derivative forward agreement, Budget 2013 proposes to treat the derivative portion of the return separately from the underlying capital gain or loss on the capital asset. Any return that is not determined by reference to the performance of the underlying capital asset will be treated as being on income account.
Thus, for example where the derivative forward agreement is an agreement to sell a capital asset and the reference portfolio is independent of the capital asset, the taxpayer would have an income gain (or loss) equal to the amount by which the amount received on settlement of the contract exceeds or is less than the value of the capital property at the time that the transaction was entered into. Such income or loss will then be added or deducted in computing the adjusted cost base of the capital property, so as to avoid double taxation.
This measure would apply to agreements entered into on or after Budget Day, or whose terms are extended on or after Budget Day.
Subsection 75(2) of the Act provides for the attribution to the person who transfers property to a trust (the transferor) of any income or loss and any taxable capital gain or allowable capital loss from the property if the property is held on condition that it may revert to the transferor or pass to persons to be determined by the transferor. Subsection 107(4.1) contains a related rule that prevents a tax-deferred distribution of property from a trust where property of the trust is, or has been, subject to this attribution rule.
A recent Federal Court of Appeal decision held that subsection 75(2) does not apply to property transferred to a trust for fair market value consideration. Budget 2013 states that this decision was not in accordance with intended tax policy and that new rules will be introduced to address transfers where the transferee is a non-resident trust. Rather than extending the existing rule in subsection 75(2), Budget 2013 proposes to amend the proposed deemed trust residence rules to apply if a non-resident trust holds property in circumstances described above in the context of the attribution rule.
Specifically, Budget 2013 proposes that a transfer or loan of property by a Canadian resident taxpayer will be deemed to be a contribution of “restricted property” to the trust by the taxpayer. As a result, the Canadian resident taxpayer will generally be treated as having made a contribution to the non-resident trust and the detailed regime set out in proposed section 94 of the Act will be applicable. In addition, Budget 2013 proposes to extend the rule in subsection 107(4.1) of the Act to apply to the trust.
Consultation on graduated rates for testamentary trusts and estates
Under the Act trusts are generally subject to tax at a flat rate that corresponds to the highest rate of individual tax. An exception is provided for testamentary trusts and estates, which are generally subject to tax on the same graduated tax rate as applies to natural individuals. Budget 2013 comments that this potentially allows the beneficiaries of such trusts to access more than one set of graduated rates and questions the tax fairness of such a result. Accordingly, a consultation process will be initiated to explore possible measures to eliminate these benefits. Budget 2013 contemplates that the government will release a consultative paper and provide the public with an opportunity to comment on this topic.
Leveraged life insurance arrangements
A leveraged insured annuity involves the use of borrowed funds, the purchase of a life annuity and a life insurance policy. The arrangement is structured in such a way that the borrowed funds would be invested in the life annuity and the death benefit from the insurance policy would equal the amount invested in the life annuity. The arrangement is generally structured so that the interest on the borrowed funds is deductible and, during the insured’s lifetime, value would accumulate under the policy. This accumulation occurs on a tax-deferred basis provided that the policy qualifies as an “exempt policy” for income tax purposes. On the death of the individual the value of the insurance policy is received as a tax-free death benefit and the proceeds are used to retire the borrowed funds. These arrangements are typically marketed to closely held private corporations.
Budget 2013 suggests that the resulting tax benefits were not intended and proposes to eliminate them by introducing specific rules for "LIA policies." Where a policy is an LIA policy, among other things, income accruing will be subject to annual accrual-based taxation, no deduction will be allowed for any portion of the premium paid and the capital dividend account of a private corporation will not be increased by the death benefit received in respect of the policy.
In general terms an LIA policy will be defined to be a life insurance policy if:
- a person or partnership becomes obligated on or after Budget Day to repay an amount to another person or partnership (the lender) at a time determined by reference to the death of the individual, and
- an annuity contract, the terms of which provide that payments are to continue for the life of the individual, and the policy are assigned to the lender.
The proposed measures would apply to taxation years that end on or after Budget Day but will not apply to leveraged insurance annuities for which all borrowings were entered into before Budget Day.
Generally, a 10/8 arrangement involves a taxpayer investing in a life insurance policy that earns income, borrowing against the security of the insurance policy and then using the borrowed funds for an income earning purpose. Typically, the interest rate on the loan (say 10%) exceeds the interest earned under the insurance policy (say 8%). However, provided the policy is an exempt policy the after-tax cost of the interest is less than the amount accumulating in the policy. In addition, the value accumulating in the policy is typically received as a tax-free death benefit. The taxpayer may also seek to deduct all or a portion of the insurance premiums paid.
Budget 2013 proposes to introduce specific rules to deal with these arrangements by denying the deductibility of the related interest expense and policy premiums that relate to a period after 2013 and restricting any increase in the capital dividend account of a private corporation for death benefits payable after 2013 under the policy that is associated with the borrowing.
Unlike most other proposals in Budget 2013, there is no general grandfathering for existing 10/8 arrangements. Instead, Budget 2013 proposes to introduce measures to alleviate the income tax consequences of a withdrawal from a policy under a 10/8 arrangement before January 1, 2014, in order to repay an associated borrowing.
Accelerated capital cost allowance (CCA) for manufacturing and processing
Currently, there is a temporary CCA measure to allow a write off over three years (generally 25% / 50% / 25%) for certain manufacturing and processing equipment acquired before 2014. Budget 2013 proposes to extend this regime to similar equipment acquired before 2016. Equipment acquired in 2016 and subsequent years will revert to the previous 30% declining balance CCA regime. The proposal would apply for property acquired on or after Budget Day that has not been previously used or acquired for use.
Clean energy equipment: accelerated capital cost allowance
Currently, Class 43.2 provides accelerated CCA for various types of equipment that generate or conserve energy using renewable sources, waste fuel or particularly efficient use of fossil fuels. Budget 2013 proposes to expand the types of eligible biogas production equipment by expanding the types of organic waste that may be utilized by qualifying equipment. Budget 2013 would also broaden the range of eligible cleaning and upgrading equipment. The proposal would apply for property acquired on or after Budget Day that has not been previously used or acquired for use.
Scientific research and experimental development
Scientific Research and Experimental Development (SR&ED) program claimants will be required to disclose whether a third-party tax preparer participated in a SR&ED claim and to provide details of the billing arrangements. When no such tax preparer was involved, the SR&ED program claimant will have to certify that no third party assisted in any aspect of the preparation of the claim. A new penalty of $1,000 per claim is to be introduced where the required information provided is missing or incomplete. The penalty will apply to claims filed on or after the later of January 1, 2014, and the day of royal assent to the enacting legislation.
A number of changes are proposed in this area.
Pre-production mining expenses
Certain expenses of bringing a new mine in a mineral resource into production, such as expenses relating to cleaning, removing overburden, stripping and sinking a mine shaft (pre-production mining expenses) are currently treated as Canadian exploration expenses (CEE). Budget 2013 proposes a transition under which such expenses will instead be treated as Canadian development expenses (CDE) over a four-year period commencing in 2015. Generally, pre-production mining expenses incurred before 2015 will continue to be treated as CEE, and such expenses incurred in 2015, 2016 and 2017 will be treated as being partially CEE and the remainder CDE, with 80% of such expenses remaining as CEE in 2015, 60% in 2016, and 30% in 2017. Where the expense was incurred under an agreement in writing entered into before Budget Day, or either the construction of or the engineering and design work for a new mine had commenced before Budget Day, such expenses will continue to be treated as CEE until 2018. Pre-production mining expenses incurred after 2017 will be treated as CDE.
Accelerated CCA for mining
Currently, certain equipment acquired for use in a new mine is subject to accelerated CCA, rather than the 25% CCA regime otherwise applicable to mining equipment. The accelerated CCA is provided via an additional allowance that is up to 100% of the remaining cost of the eligible asset, up to the amount of income for the year from the mining project. Budget 2013 will phase out this additional allowance over a five-year period commencing in 2017, with the allowance being fully phased out by 2020. The phase-out will be in accordance with a transition schedule set out in Budget 2013, whereby the amount of the allowance available each year would be gradually reduced. The phase-out would not apply to equipment acquired before Budget Day, to certain equipment acquired before 2018 under a written agreement entered into before Budget Day or where either the construction of or the engineering and design work for a new mine was started before Budget Day.
Reserve for future services
Currently the Act permits a reserve in certain cases where a taxpayer has received an amount for services that are to be rendered after the end of the year. Budget 2013 indicates that this reserve was not intended to apply to a taxpayer that receives an amount from a customer that is intended to compensate the taxpayer for future reclamation costs. Accordingly, paragraph 20(1)(m) of the Act is to be amended to prohibit the claiming of a reserve in such cases.
Restricted farm losses
These rules restrict the deduction of farm losses by persons whose chief source of income is not from farming. In recent years these rules have been judicially interpreted in a way that, according to Budget 2013, does not reflect the intended policy of these rules. Budget 2013 proposes to remove any uncertainty in the rules by clarifying that a taxpayer’s chief source of income will not be considered to be farming unless all other sources of income are subordinate to farming. This is a major change from the Supreme Court decision in Moldowan2, and overrules the more recent Supreme Court of Canada decision in Craig3.
In addition, Budget 2013 will increase the deductible limit for restricted farm losses to $17,500 ($2,500 plus 50% of the next $30,000).
The foregoing changes to the restricted farm loss rules will apply to taxation years that end on or after Budget Day.
Taxation of corporate groups
Previous budgets have indicated that the government would review the possibility of modifying the income tax system to a form of corporate group taxation. Budget 2013 announces that this review is complete and that corporate group taxation is not a priority at this time.
B. International Tax Measures
The existing thin-capitalization rules under the Act restrict the deduction of interest payable on certain “outstanding debts to specified non-residents” by corporations resident in Canada and, indirectly, restrict the deductibility of such corporations’ indirect share of interest payable on such indebtedness by partnerships of which they are members. Budget 2013 proposes extensions of these rules so that they also apply to Canadian-resident trusts and to non-resident corporations and trusts that operate in Canada. The amendments would generally apply to taxation years that commence after 2013 and will apply to new and existing borrowings.
In the case of Canadian-resident trusts the proposed rules are intended to operate in the same manner as for Canadian corporations with the necessary changes to reflect the different legal structure applicable to trusts. In the case of non-resident corporations and trusts, the definition of equity amount uses as a starting point 40% of the cost of property used in Canada by the non-resident corporation or trust minus the amount of debt, other than debt owing to specified non-residents. The 40% amount corresponds to the percentage of initial equity that would have been contributed to a company that is funded on a 1.5:1 debt to equity basis.
International funds transfer reporting
Budget 2013 proposes that commencing in 2015, certain financial intermediaries will be required to report to the Canada Revenue Agency (CRA) international electronic funds transfers of $10,000 or more. Other non-tax reporting requirements already exist in respect of such transfers.
Information reports regarding unnamed persons
The Act provides the CRA with authority to require a person to provide documents or information related to tax administration or enforcement. If the CRA is seeking information from a particular person (a third party) regarding unnamed persons, the CRA must first obtain a court order before issuing the requirement to provide documents or information to the third party. The Act currently permits the court order to be obtained on an “ex parte” basis (that is, without notice to the third party). Budget 2013 provides that ex parte applications will no longer be permitted for applications for judicial approval to require third parties to provide information regarding unnamed persons.
Stop international evasion program
Under a new enforcement program, the CRA will be permitted to pay rewards to individuals who report major international non-tax compliance, with the rewards being up to 15% of the recovered taxes. The reward is available only if the information provided results in total assessments or reassessments exceeding $100,000 in federal tax, where the non-compliance involves foreign property, property located outside Canada or transactions conducted outside Canada.
While the name of the program focuses on stopping international tax evasion, the details of the proposal suggest the possibility that rewards may be paid in relation to any assessments of federal tax that arise from information provided. This will potentially create a mini-industry of whistle-blowers with a financial interest in the outcome. For this reason, the program details, when issued, may be expected to address evidentiary and constitutional implications.
Extended reassessment period: specified foreign property
The Act requires annual reporting of specified foreign property costing more than a total of $100,000 owned by a taxpayer. A form T1135 foreign income verification statement must be filed. The normal reassessment period will be extended for taxpayers in certain circumstances where the form T1135 was not properly filed or completed. In addition, the form T1135 is to be revised to clarify the form and to require more detailed information to be provided. The CRA is also intending to provide the ability for taxpayers to file form T1135 electronically.
International banking centres
Budget 2013 will repeal the current exemption for prescribed financial institutions in respect of international banking activity conducted in the metropolitan areas of Montreal and Vancouver. Budget 2013 indicates that this exemption, which dates back to 1987, is largely unutilized and no longer serves the policy reasons for which it was introduced.
A consultative process is to be launched to explore possible measures to “protect the integrity of Canada’s tax treaties.” A consultative paper is to be released on this regard.
C. Personal Tax Measures
Lifetime capital gains exemption
The Act currently provides a lifetime cumulative capital gains exemption for up to $750,000 of capital gains on qualified small business corporation shares, qualified farm property or qualified fishing property. Budget 2013 would increase the cumulative exemption to $800,000 for the 2014 taxation year and provide annual indexing of this limit thereafter.
Dividend tax credit
The gross-up and dividend tax credit for Canadian source dividends received by individuals provides some relief for the double taxation that otherwise arises when income earned and taxed at the corporate level is distributed to its shareholders and subject to tax in their hands. Currently there are different levels of gross-up and credit depending upon whether the dividend is an eligible dividend (generally paid out of corporate income taxed at the general corporate rate) or a non-eligible dividend (paid out of corporate income that is not taxed at the general corporate rate). Budget 2013 will preserve this distinction but will modify the gross-up and dividend tax credit applicable to non-eligible dividends in order to ensure that shareholders are not “overcompensated” for the underlying corporate tax in such cases. Expressed as a percentage of the grossed-up amount of a non-eligible dividend, the effective rate of the federal dividend tax credit for non-eligible dividends will be reduced from 13.33% to 11%. This change would apply to dividends paid after 2013.
Labour-sponsored venture capital funds
A 15-per-cent federal tax credit (the LSVCC tax credit) is provided to individuals for the acquisition of shares of certain labour-sponsored venture funds. Select provinces provide a similar credit.
Budget 2013 proposes to phase out the federal LSVCC tax credit. The credit will be reduced to 10% in 2015 and 5% in 2016 and eliminated for the 2017 and subsequent taxation years.
In order to assist with an orderly phase-out of the federal LSVCC tax credit, the government is seeking stakeholder input by May 31, 2013, on potential changes to the tax rules governing such funds, including the rules related to investment requirements, wind-ups and redemptions.
Extended reassessment period: tax shelters and reportable transactions
Budget 2013 proposes to extend the normal reassessment period where a taxpayer participates in a tax shelter or a reportable transaction to three years from the date, if any, that the special information return required in respect of such tax shelter or reportable transaction return is filed, if this is later than the normal reassessment period otherwise determined. A reassessment or additional assessment under this extended reassessment period may generally be made only to the extent that it reasonably relates to deductions, claims or tax benefits arising in connection with the tax shelter or reportable transactions in respect of which the information return was required.
Taxes in dispute and charitable donation tax shelters
Generally speaking, the Minister may not enforce collection of an amount in respect of assessed taxes where taxpayers other than large corporations have filed a notice of objection and are engaged in a dispute with the Minister regarding such taxes until such dispute is resolved. Budget 2013 proposes to modify this enforcement restriction in respect of assessments concerning amounts claimed by taxpayers for charitable gifts made in connection with tax shelters. In such cases, the proposals under Budget 2013 will allow the Minister to enforce collection of up to 50% of the assessed tax, interest or penalties in respect of such claimed amounts notwithstanding that the assessment is being disputed by the taxpayer. This proposal would apply in respect of amounts assessed for taxation years that end after 2012.
Extension of mineral exploration tax credit
Budget 2013 proposes to extend the existing 15% mineral exploration tax credit for flow-through shares applicable to certain “grass-roots” mining expenditures for one year, to flow-through share agreements entered into on or before March 31, 2014. Taking into account the existing “look-back” rule, this would permit funds raised with the benefit of this credit to be used to support eligible expenditures incurred up to the end of 2015.
Other personal tax measures include:
- changes to the adoption expense tax credit;
- the introduction of a “super-credit” for first-time charitable donors;
- ending the deduction for the cost of renting safety deposit boxes.
D. Previously announced measures
Budget 2013 also confirmed the government’s intention to proceed with a number of outstanding previously announced initiatives including:
- proposed changes to HST rules for financial institutions (January 28, 2011);
- automobile expense amounts previously announced (December 29, 2011, and December 28, 2012);
- legislative proposals related to life insurance policyholder exemption (March 29, 2012);
- legislative proposals related to caseload management of Tax Court of Canada (June 8 ,2012);
- legislative proposals re specified flow-through entities, real estate investment trusts and publicly traded corporations (July 25, 2012);
- legislative proposals for banks with foreign affiliates (November 27, 2012);
- legislative proposals for technical income tax amendments (December 21, 2012).