The Harper government today tabled its first balanced budget in eight years. Being the last budget of the government's current mandate, Budget 2015 delivers on the government's promise of balancing the books in the 2015 – 2016 fiscal period with very few program surprises.
The main tax measures have either been previously announced (such as income splitting, the increase to the universal child care benefit and extending the mineral exploration tax credit), or mentioned in the press over the last several weeks (such as the doubling of the contribution limit to a tax-free savings account, lower minimum registered retirement income fund withdrawals and extending accelerated capital cost allowance for the manufacturing and processing sector). Budget 2015 also delivered on the government's promise to lower the small business tax rate once a balanced budget was achieved.
One surprise announcement is the expansion of the exemption from capital gains tax for the donation of the proceeds from the sale of private company shares and real estate to public charitable organizations. Budget 2015 indicates that this measure will be applicable to donations made after 2016.
The following is a summary of the highlights of the principal income tax measures contained in Budget 2015.
A. Business tax measures
Tax Avoidance of Corporate Capital Gains
Subsection 55(2) of the Income Tax Act (Canada) (the Act1) contains a series of rules designed to prevent a corporate shareholder from significantly reducing a capital gain on the sale of shares where the shareholder has received a tax-free inter-corporate dividend. If these rules apply, the dividend is deemed to be a capital gain received by the shareholder. Certain exceptions apply to this rule, including if the dividend is paid out of the "safe income" of a corporation (generally, from its tax-paid retained earnings), in certain circumstances where Part IV tax is payable on the dividend, and in the case of certain related-party transactions and divisive reorganizations.
The current rules do not apply to structures where a dividend (including a stock dividend) is paid for the purpose of creating an unrealized capital loss on shares that can be used to, in effect, shelter capital gains on other property that is transferred to the corporation prior to a sale.
Budget 2015 proposes to amend subsection 55(2), effective immediately, so that it applies to such structures by deeming any such dividends to be capital gains. Specifically, these amendments will apply where one of the purposes of the dividend is to effect either a significant reduction in the fair market value of any share or a significant increase in the cost of property of the dividend recipient. Budget 2015 also proposes related provisions detailing the application of these rules to stock dividends and other measures designed to ensure that this new rule is not circumvented.
Dividend Rental Arrangement Rules
A corporation may borrow a share for a period of time in order to receive a dividend and pay the lender a fee to compensate it for the use of the share. If the lender is not subject to Canadian tax it would be neutral as to whether it received the dividend or the fee. The corporation would (but for the dividend rental arrangement [DRA] rules) claim the inter-corporate dividend deduction and also deduct the fee paid to the lender. The existing DRA rules deny the inter-corporate dividend deduction in respect of a dividend received on a share as part of a DRA. Generally, a DRA is "any arrangement the main reason for which is to enable a person to receive a dividend on a share of a taxable corporation [where arrangements are made such that] any increase or decrease in the value of the share accrues to someone other than that person."2
Budget 2015 proposes to expand the definition of "dividend rental arrangement" - and the denial of the inter-corporate dividend deduction - to include dividends received by a taxpayer in a "synthetic equity arrangement" (an SEA). Generally, an SEA will exist where the taxpayer (or non-arm's length person thereto) enters into an agreement that provides a counterparty with all or substantially all of the risk of loss and opportunity for gain or profit in respect of the share. Where a person non-arm's length to the taxpayer enters into such an agreement, an SEA will exist only if it is reasonable to conclude that the non-arm's length person knew, or ought to have known, that such result would arise. An exception will apply where the taxpayer can establish that no "tax-indifferent investor" has all or substantially all of the risk of loss and opportunity for gain or profit in respect of the shares as a result of the SEA or related derivatives.
The onus is on the taxpayer to establish the status of the investor by way of representations, including representations that the investor does not reasonably expect to eliminate all or substantially all of its risk of loss and opportunity for gain or profit in respect of the shares. Notwithstanding reasonable reliance on the representations of the investor, if such representations are subsequently found to be untrue, the arrangement will be an SEA.
The definition of "tax-indifferent investor" includes tax-exempt entities, non-residents of Canada who are not taxable in Canada on amounts received under an SEA and certain Canadian trusts and partnerships. The revised DRA rules will not apply to agreements that are traded on a recognized derivatives exchange, unless it can reasonably be considered that the taxpayer knows or ought to know the identity of the counterparty to the agreement.
This measure will apply to dividends that are paid or become payable after October 2015.
Budget 2015 proposed an alternative SEA regime that would deny the inter-corporate dividend deduction on dividends received by a taxpayer on a Canadian share in respect of which there is an SEA, regardless of the tax status of the counterparty. The alternative regime would be less complex but broader in its application. The government has invited stakeholders to submit comments by August 31, 2015, regarding whether the broader alternative proposal should be adopted.
Consultation on Eligible Capital Property Rules
In the 2014 federal budget, the government announced a consultation process on the proposal to repeal the existing eligible capital property regime in the Act and introduce a new capital cost allowance (CCA) class. Budget 2015 indicates that the government has received and considered, and continues to receive, submissions on the proposal and that the government intends to release detailed draft legislative proposals for comment before introducing a bill to implement the proposal.
Accelerated Capital Cost Allowance
For the purposes of the CCA rules, certain manufacturing and processing machinery and equipment is presently included in Class 29 if the property is acquired after March 18, 2007, and before 2016. This temporary treatment generally provides for an accelerated CCA rate of 50% on a straight-line basis (subject to the "half-year rule" for the taxation year in which the machinery or equipment is first available for use).
Budget 2015 proposes to extend this measure until the end of 2025 by introducing a new Class 53 for depreciable property that would otherwise qualify for Class 29 treatment, but which is acquired after 2015 and before 2026. Property included in Class 53 would also benefit from the accelerated 50% rate (subject to the half-year rule), but the CCA deduction would be calculated on a declining-balance basis.
Small Business Tax Rate and Active Business Income Consultation
Under current rules in the Act, the first $500,000 of active business income earned by a Canadian-controlled private corporation is generally eligible for taxation at a reduced rate. This "small business deduction" reduces the federal income tax rate from 15% to 11%. Access to the small business deduction is gradually phased out for corporations with taxable capital employed in Canada in excess of $10 million, with the deduction being totally eliminated when such capital exceeds $15 million.
Budget 2015 proposes to reduce the 11% small business tax rate to 9% over a four-year period, with the final rate of 9% applying from January 1, 2019. Under the proposals, the rate will decrease by 0.5% each year beginning on January 1, 2016 (pro-rated for non-calendar taxation years).
In conjunction with the proposed reduction in the small business tax rate, Budget 2015 also proposes consequential amendments to the gross-up and dividend tax credit mechanism generally applicable to individuals and trusts who receive non-eligible taxable dividends from Canadian corporations. The amendments will generally increase the overall personal tax rate applicable to non-eligible dividends and are generally meant to ensure that the income earned by a corporation and paid out to an individual as a dividend is taxed at the same rate as if the income were earned directly by the individual.
The small business deduction is available on up to $500,000 of active business income of a Canadian-controlled private corporation. Active business income does not include income from a "specified investment business," which is generally defined to mean a business the principal purpose of which is to derive income from property. Budget 2015 announced that the government will review the circumstances in which income from a business, the principal purpose of which is to earn income from property, should qualify as active business income for the purposes of the small business deduction.
B. International tax measures
Withholding for Non-Resident Employers
Budget 2015 proposes measures to relieve certain non-resident employers from Canadian income tax withholding obligations when paying certain non-resident employees who temporarily perform services in Canada. Effective January 1, 2016, a non-resident employer that pays salary or wages to a non-resident employee that has performed services in Canada will not be required to withhold an amount in respect of Canadian income tax where the employer is a qualifying non-resident employer and the employee is a qualifying non-resident employee.
This proposal is intended to ease the administrative burden imposed on many non-resident employers that are currently required to obtain administrative waivers from the Canada Revenue Agency (CRA) to avoid Canadian income tax withholding obligations when sending employees to Canada for temporary assignments. Absent such an administrative waiver, non-resident employers are currently required to withhold an amount in respect of Canadian income tax on any salary or wages paid to a non-resident employee who performs services in Canada, notwithstanding that such non-resident employee may not be liable to Canadian income tax under the terms of an applicable tax treaty.
Generally, a qualifying non-resident employee will be a person who: (i) is resident in a country with which Canada has a tax treaty; (ii) is not liable to Canadian income tax in respect of salary or wages earned in Canada because of the applicable tax treaty; and (iii) is not present in Canada for 90 days or more in any applicable 12-month period. A qualifying non-resident employer for these purposes will generally be defined as an employer that: (i) is resident in a country with which Canada has a tax treaty; (ii) does not carry on business through a permanent establishment in Canada; and (iii) is "certified" by the Minister of National Revenue.
Budget 2015 also proposes relief from penalties that would otherwise arise where a qualifying non-resident employer has failed to withhold as required in respect of payments made to a non-resident employee where it had no reason, after reasonable enquiry, to believe the employee was not a qualifying non-resident employee.
While these proposals should benefit a number of non-resident employers that routinely send employees to Canada for business, it will be important for such non-resident employers to ensure compliance with the certification process (that has yet to be established by the CRA) and make reasonable enquiry into the residency status of their employees.
Captive Insurance Companies
Canada taxes income earned in a controlled foreign affiliate (CFA) from the insurance of Canadian risks on an accrual basis in the hands of the CFA's Canadian parent. Budget 2014 introduced anti-avoidance rules to ensure that a taxpayer could not avoid this accrual-basis taxation by having the CFA insure foreign risks in lieu of Canadian ones, but use insurance risk-ceding arrangements to convert its exposure to foreign risks into an economic exposure to ceded Canadian risks.
The government is concerned that alternative arrangements have been developed over the last year to circumvent these new anti-avoidance rules. These involve the CFA insuring Canadian risks, but ceding those risks for consideration that includes a profit participation in the ceded Canadian risks, even though there is no ongoing exposure to the Canadian risks themselves.
As these arrangements are contrary to the policy intent of Budget 2014, Budget 2015 proposes that accrual-basis taxation will apply to the income that a CFA earns from ceding Canadian risks in exchange for consideration that includes an embedded profit component based on the expected return from the Canadian risks ceded. When the CFA cedes Canadian risks and receives foreign risks in return, the income inclusion would equal the difference between the fair market value of the Canadian risks ceded and the CFA's cost of having acquired those Canadian risks.
This measure will apply to taxation years beginning after April 20, 2015. Interested taxpayers are asked to submit their comments on the proposals by June 30, 2015.
C. Personal and charitable tax measures
Personal Tax Measures
Budget 2015 contains a number of personal tax proposals for individuals and families, including the following.
- As anticipated, an increase in the tax-free savings account (TFSA) annual contribution limit from $5,500 to $10,000 for the 2015 and subsequent calendar years. Budget 2015 also proposes that the tax-free savings account annual contribution limit will no longer be indexed annually to inflation.
- An adjustment in the registered retirement income fund (RRIF) minimum withdrawal factors in respect of individuals aged 71 to 94, which will reduce the mandatory minimum withdrawal amount for the 2015 and subsequent taxation years. Similar changes are proposed for annual payments from a defined contribution pension plan or a pooled registered pension plan.
- An increase in the lifetime capital gains exemption for farm or fishing property from the current indexed amount of $813,600 to $1 million, applicable to dispositions occurring on or after April 21, 2015. Notably, Budget 2015 did not include a corresponding increase in the lifetime capital gains exemption applicable to the disposition of qualified small business corporation shares, which remains at $813,600 for 2015.
- Extending the temporary measures introduced in 2012, allowing a qualifying family member to be the holder of a registered disability savings plan for an adult individual lacking contractual capacity, from the end of 2016 to the end of 2018.
- Permitting the transfer of education credits for the 2014 and subsequent taxation years without adversely affecting the amount of the recently introduced family tax cut.
- Introducing a new non-refundable home accessibility tax credit in respect of certain expenditures made or incurred after 2015 in relation to the renovation or alteration of a principal residence of senior individuals (65 years or older) and individuals who are eligible for the disability tax credit. The renovation or alteration must allow a greater access to, or reduce the risks or harm within, the residence. The credit will be equal to 15% of certain eligible expenditures per calendar year, per qualifying individual, up to a maximum of $10,000 per calendar year for each eligible residence. The credit may also be claimed by certain eligible family members in respect of a qualifying individual.
Charity Tax Measures
Currently, donations of publicly listed securities to qualified donees, and donations of ecologically sensitive land and certified cultural property to certain qualified donees, are exempt from capital gains taxation.
Budget 2015 proposes to expand the exemption from capital gains tax for certain dispositions of private corporation shares and real estate occurring after 2016. The exemption will apply if: (i) the cash proceeds from the disposition of private corporation shares or real estate are donated to a qualified donee within 30 days after the disposition; and (ii) the private corporation shares or real estate is sold to a purchaser that deals at arm's length with both the donor and the qualified donee. The portion of the capital gain that is exempt will be determined by reference to the proportion of the proceeds donated to the total proceeds from the disposition of the shares or the real estate. Certain anti-avoidance measures are also proposed to be implemented.
Amendments to the Act also propose that a registered charity will not be considered to be carrying on a business solely because it acquires or holds an interest in a limited partnership. This will generally allow charities to invest in limited partnerships without jeopardizing their charitable status. These proposed amendments will only apply if: (i) the charity together with all non-arm's length parties holds no more than 20% of the interests in the limited partnership; and (ii) the charity deals at arm's length with each general partner. Budget 2015 proposes that this measure will apply in respect of limited partnership units acquired on or after April 21, 2015, and that the measure will also apply to registered Canadian amateur athletic associations.
Budget 2015 also proposes to allow foreign charitable foundations to be registered as qualified donees under specific conditions. This measure will apply upon Royal Assent.
D. Tax administration and compliance measures
Budget 2015 includes a number of measures particularly relevant in the context of tax compliance, audits, objections and appeals.
Repeated Failure to Report Income Penalty
Where a taxpayer fails to report an amount of income in a taxation year and had failed to report an amount of income in any of the three preceding taxation years, the taxpayer is liable to a penalty equal to 10% of the unreported income for that taxation year. Another penalty, the "gross negligence" penalty, may apply if the taxpayer knew or, under circumstances amounting to gross negligence, ought to have known that an amount of income should have been reported. The gross negligence penalty is generally equal to 50% of the understatement of tax.
Budget 2015 proposes to amend the repeated failure to report income penalty to apply in a taxation year only if a taxpayer fails to report at least $500 of income in the year and in any of the three preceding taxation years. The amount of the penalty will equal the lesser of 10% of the amount of unreported income and 50% of the difference between the understatement of tax related to the omission and the amount of any tax paid in respect of the unreported amount. This measure will apply to the 2015 and subsequent taxation years.
Alternative Arguments in Support of Assessments
The Act currently provides that the Minister of National Revenue may advance an alternative argument in support of an assessment at any time after the normal reassessment period. Budget 2015 proposes to amend the Act to clarify that the CRA and the courts may increase or adjust an amount included in an assessment that is under objection or appeal at any time, provided the total amount of the assessment does not increase. Similar amendments are proposed to be made to the Excise Tax Act (Canada) (the ETA). These measures will apply in respect of appeals instituted after Royal Assent.
Information Sharing for the Collection of Non-Tax Debts
The CRA collects debts owing to the federal and provincial governments under a number of non-tax programs. Confidential taxpayer information currently cannot be used by CRA staff to collect debts under many of these programs. The tax and non-tax collection activities of the CRA must be segregated. Amendments are proposed to the Act and the ETA to permit the sharing of taxpayer information within the CRA in respect of non-tax debts under certain federal and provincial government programs. The ETA will also be amended to permit information sharing in respect of certain programs where such information sharing is currently permitted under the Act. This measure will apply on Royal Assent.
Reporting Requirements for Foreign Assets
A Canadian-resident individual, corporation or trust that, at any time in a taxation year, owns specified foreign property with a total cost of more than $100,000 must file a Foreign Income Verification Statement (Form T1135) with the CRA.
Budget 2015 proposes to simplify the foreign asset reporting system for taxation years that begin after 2014. If the total cost of a taxpayer's specified foreign property is less than $250,000 throughout the year, the taxpayer will be able to report the property to the CRA under a new simplified foreign asset reporting system. The current reporting requirements will continue to apply to taxpayers with specified foreign property that has a total cost at any time during the year of $250,000 or more.
Automatic Exchange of Information for Tax Purposes
In November 2014, Canada and the other G-20 countries endorsed a new common reporting standard for automatic information exchange developed by the OECD and committed to a first exchange of information by 2017-2018. Under the new standard, foreign tax authorities will provide information to the CRA relating to financial accounts in their jurisdictions held by Canadian residents. The CRA will, on a reciprocal basis, provide corresponding information to the foreign tax authorities on accounts in Canada held by residents of their jurisdictions. In order for the CRA to obtain the information to be exchanged, the common reporting standard will require financial institutions in Canada to implement due diligence procedures to identify accounts held by non-residents and report certain information relating to these accounts to the CRA.
Canada proposes to implement the common reporting standard starting on July 1, 2017, allowing a first exchange of information in 2018. As of the implementation date, financial institutions will be expected to have procedures in place to identify accounts held by residents of any country other than Canada and to report the required information to the CRA.
E. Updates on previously announced measures
Budget 2015 provides an update on the government's intention to proceed with a number of outstanding previously announced tax measures, including:
- the expansion of the criteria for a joint venture to make a joint venture election for GST/HST purposes;
- the establishment of higher rate CCA classes for certain equipment used in natural gas liquefaction and certain buildings at a facility that liquefies natural gas;
- the extension of the 15% mineral exploration tax credit for investors in flow-through shares; and
- measures relating to the costs associated with undertaking environmental studies and community consultations that are required to obtain an exploration permit being eligible for treatment as "Canadian exploration expenses."
Budget 2015 also reaffirms the government's commitment to move forward as required with technical amendments to the Act to improve the certainty of the tax system.