Just as there is nominal GDP and real GDP1, there is political fairness and integrity and real fairness and integrity. In his Eighth Action Plan, formerly known as a “budget”, the Minister from Whitby, Ontario has done an admirable job of dealing with fairness and integrity within a political framework.
However, before getting to the Minister’s Plan, please allow us to muse a little on what a real fairness and integrity budget might look like. Consider a budget that we would expect to see if the Minister had started the day reflecting on the thoughts of Jack Mintz2: The small business deduction would be eliminated, saving $3 billion per year3. The GST rate would be increased to, say, 10% ($28 billion per year)4 and its base would be broadened considerably to tax 80% of consumption instead of the current base which comprises 48% of consumption5, in particular, to include food (add $36 billion at the new rate of 10%). This would be combined with extensive credits to low income earners (minus $8 billion6), and a substantial reduction in the income tax payable by middle bracket taxpayers (minus $20 billion). There might even be some proposed adjustments to federal civil servants’ pension and leave benefits7. The net result, assuming a pre-existing current deficit of $26 billion8, would be a $13 billion surplus. Why should we have a surplus now? Despite the recessionary times, these are nonetheless the good times; the bad times will come when the aging baby boomers start retiring in droves with their health care requirements in their retirement party loot bags. In addition, today’s taxpayers have had more than their fair share of government largess and should leave a bit more on the table for the next generation.
Back to reality. “The government will continue to restrain the growth of direct program spending without cutting transfers to persons, including [lest there be any doubt what persons means] those for seniors, children and the unemployed, or transfers to other levels of government in support of health care and social services. [Of course, not cutting the amount of transfers is not the same as maintaining the level of transfers in real terms or as a percentage of GDP.] As well the government will continue to enhance the integrity and fairness of the tax system and will not raise taxes.”9
The deficit for 2012-2013 is projected to be $25.9 billion, followed by $18.7 billion, $6.6 billion, ($0.8 billion), ($3.9 billion), and ($5.1 billion) in the following five years. It’s all about the growth in GDP. In 2011-12 personal income tax is 6.8% of GDP resulting in $120.5 billion. In 2017-18 personal income tax is projected to produce $157 billion of revenues, albeit at 7.4% of GDP, with the increased percentage in GDP accounting for $15 billion of the $37 billion increase. Corporate tax is projected to increase over the same period from $34 billion to $43 billion while remaining at a constant 1.9% of GDP.
The fairness and integrity measures (“FIMs”) in Budget 2013 are projected to add an aggregate amount, over the next five years, of $4.1 billion to government revenues. Rather paltry compared to the projected increase in total tax revenues over the same five year period of $144.4 billion! Did we say it’s all about the growth in GDP? In fairness, FIMs are not about raising money; integrity seldom is.
The biggest ticket FIM is increasing the tax rate on non-eligible dividends to eliminate over-integration. This alone is projected to raise $2.3 billion over five years, more than half of the total for all FIMs. Elimination of new labour-sponsored venture capital corporations is to raise $355 million, while the bronze medal goes to the prevention of trust loss trading which is a close third at $335 million. Honourable mentions go to the elimination of 10/8 leveraged life insurance arrangements ($260 million), reductions in annual deductions for credit unions ($205 million), the elimination of character conversion transactions (aka receiving what is economically an interest return in the form of a capital gain) ($175 million) and the elimination of the deduction of fees for safety deposits boxes ($155 million). Altering the rules for leveraged insured annuities ($100 million), further restricting corporate loss trading by, generally, deeming an acquisition of control to occur if a person or group of persons acquires 75% of the equity in the particular corporation ($95 million), reducing pre-production mine development costs ($45 million), and reducing accelerated capital cost allowance for mining ($10 million) round out the programme. No revenue increase is projected for the taxation of synthetic dispositions or the removal of the reserve for future services in respect of reclamation obligations.
Restricted farming losses are increased to $17,500, but the Moldowan definition of chief source of income is to be codified. The temporary 50% capital cost allowance class for manufacturing and processing machinery and equipment that was scheduled to expire at the end of 2014, has been extended for two years. Trust losses will be subject to trading rules similar to the rules that apply to corporate losses and new rules will apply to non-resident trusts to effectively reverse the consequences of the Sommerer decision. The thin-capitalization rules are extended to Canadian resident trusts and to non-resident corporations and trusts that operate in Canada.
Reassessment periods are extended for reportable transactions that are not reported in a timely fashion and the CRA will be allowed to collect 50% of amounts assessed in respect of charitable donation tax shelters prior to a final resolution of any resulting dispute.
On the tariff side, $1.1 billion is to be raised over the next five years by modernizing Canada’s general preferential tariff regime for developing countries. The government will withdraw general preferential tariff eligibility from seventy-two higher-income and export-competitive countries, including all G-20 countries. No mention is made of Canada’s efforts to enlarge its free-trade partners, although one might think that extending this group might reduce this budget line item. That is not to suggest that expanding our free-trade partners would not produce even greater tax revenues as a consequence of its effect on GDP. All tariffs are being eliminated on baby clothes and sports and athletic equipment (except bicycles). $307 million is to be added to the government coffers by increasing the excise duty rate on manufactured tobacco. This will more closely align the rate on tobacco with the rate on cigarettes.
International Banking Centres legislation is repealed. Corporate consolidation proposals have been shelved. Public consultation will occur regarding treaty shopping and the taxation of testamentary trusts at graduated rates. The CRA will pay bounty hunters 15% of tax collected from persons involved in major international tax non-compliance.
The Closing of Tax Loopholes
Forward Agreement Transactions
Budget 2013 proposes to ensure that derivative transactions cannot be used to convert fully taxable ordinary income into capital gains taxed at a lower rate. Certain types of financial arrangements, described as character conversion transactions in Budget 2013, seek to reduce tax by converting ordinary income to capital gains through the use of derivate contracts.
A character conversion transaction usually involves an agreement (the “Forward Agreement”) to buy or sell a capital property at a specified future date. The purchase or sale price of the capital property under the Forward Agreement is not based on the performance of such capital property over the time period of the Forward Agreement; rather it is usually determined by reference to the performance of a portfolio of investments. The reference portfolio usually contains investments that if held directly would produce ordinary income.
To ensure the appropriate tax treatment of the derivative-based return on a Forward Agreement, Budget 2013 proposes to treat this return as being distinct from the disposition of a capital property that is purchased or sold under the Forward Agreement that has a duration of more than 180 days. Generally, if a Forward Agreement is used and the value of the capital property to be delivered is based entirely on the performance of a reference portfolio, the taxpayer would have an income inclusion equal to the amount by which the fair market value of the property delivered when the agreement is settled exceeds the amount paid for the capital property. In addition, Budget 2013 proposes that the income described above be added to the adjusted cost base of the capital property to prevent double tax on the sale by the taxpayer of such capital property.
Practically speaking, a mutual fund that has entered into a Forward Agreement with a counterparty and receives capital property on the settlement of the Forward Agreement will have an income inclusion equal to the difference between the fair market value of such property and the amount paid for the property under the Forward Agreement. The mutual fund will then distribute that income, along with any returns of capital, to its unitholders. As a result of the proposals in Budget 2013, distributions to unitholders resulting from partial or full settlements of a Forward Agreement by a mutual fund which previously would have been capital gains distributions will now be income distributions. Return of capital distributions are not affected.
These measures will apply to Forward Agreements entered into on or after Budget Day. They will also apply to a Forward Agreement entered into before Budget Day if the term of the agreement is extended on or after Budget Day. If the offering of new units of an existing mutual fund with a Forward Agreement results in the extension of the Forward Agreement, such Forward Agreement will be subject to the Budget 2013 proposals.
Budget 2013 seeks to ensure that the tax consequences of disposing of a property, such as capital gains tax, cannot be avoided by a taxpayer entering into transactions (described as “synthetic dispositions”) that are economically equivalent to a disposition of the property, but where legal ownership of the property is retained by the taxpayer.
A synthetic disposition transaction usually involves a taxpayer entering into an arrangement under which the taxpayer removes the future risk of loss and opportunity for gain in respect of a property and acquires another property the value of which approximates what the taxpayer would have received as proceeds from disposing of the property. To combat this type of transaction, Budget 2013 proposes to treat these types of transactions as dispositions for income tax purposes. Generally, if a taxpayer enters into an arrangement that has the effect of eliminating all or substantially all of the taxpayer’s risk of loss and opportunity for gain in respect of a property of a taxpayer, the taxpayer will be deemed to have disposed of the property for proceeds equal to its fair market value. Also, the taxpayer will be deemed to have reacquired such property immediately after the deemed disposition at a cost equal to the fair market value. Such disposition and reacquisition will not affect the other parties involved in the synthetic disposition transaction. This results in the taxpayer having an immediate capital gain upon entering into the synthetic disposition transaction which will be subject to tax as if the taxpayer had sold the property outright.
Budget 2013 proposals will address the monetization transactions which seek to avoid paying tax on the sale of shares. Take for example a situation where a company (“Canco”) owns $100 million worth of shares of Xco with a nominal cost base. Canco would like to sell such shares but also would like to avoid paying any tax. In order to effectively sell the shares while deferring tax on the capital gain, Canco would enter into a synthetic disposition transaction where it would obtain a ten-year loan for $100 million from a bank. Under the loan terms, Canco can pay off the loan in 10 years by transferring the Xco shares to the bank. In return, the bank has the right to acquire the shares from Canco in 10 years for the same $100 million. This results in the elimination of the risk of loss for Canco, but it also eliminates the opportunity for gain. At the end of 10 years, if the value of the shares is less than $100 million, Canco could pay off the loan by transferring ownership of the Xco shares to the bank. If the value of the shares is more than $100 million, the bank could still acquire these shares for $100 million. Thus, Canco has $100 million and no risk of loss or opportunity for gain, so it has effectively disposed of the Xco shares without paying tax on the capital gain. By deeming Canco to have disposed of its shares at fair market value when it enters into the agreement with the bank, these measures will result in an immediate capital gain to Canco which will be subject to tax.
These measures will apply regardless of the form of agreement. Budget 2013 proposes that these measures are targeted at such examples as agreements that apply to a forward sale of property, a put-call collar arrangement in respect of an underlying property, the issuance of certain indebtedness that is exchangeable for property, a total return swap in respect of property, or a securities borrowing to facilitate a short sale of property that is identical or economically similar to a property of the taxpayer. Budget 2013 proposes that these measures generally will not apply to ordinary hedging transactions, which typically only involve managing the risk of loss, to ordinary course securities lending arrangements or to ordinary commercial leasing transactions.
In addition, to combat the tax benefits of continually owning a property after entering into a synthetic disposition, Budget 2013 proposes that if the taxpayer is deemed to dispose and reacquire a property, the taxpayer will be considered to not own the property for the purposes of determining whether the taxpayer meets certain holding-period tests in the Tax Act.
These measures will apply to agreements and arrangements entered into on or after Budget Day. It will also apply to agreements and arrangements entered into before Budget Day if their term is extended on or after Budget Day.
Leveraged Insurance Annuities and 10/8 Policies
Another measure introduced to improve the integrity and fairness of the tax system (a phrase repeated several times in the Budget Papers) relates to tax advantaged insurance arrangements commonly referred to as leveraged life annuities and “10/8” policies.
In a typical leveraged life annuity, a taxpayer (typically a private corporation) acquires an insurance policy and an annuity. The annuity pays the taxpayer a guaranteed return over an individual’s life and the death benefit under the policy is the return of its investment together with a fixed return. The taxpayer also borrows an amount equal to the amount invested in the annuity and the funds borrowed are used to acquire income-earning investments. The annuity and life insurance policy are assigned to the lender as collateral for the loan.
Under current rules, the leveraged annuity provides several tax benefits to the taxpayer. A portion of the income earned on the invested capital is received tax-free as the life insurance policy is an exempt policy and the interest on the loan is tax deductible as is a portion of the capital invested as it represents a premium under the life insurance policy. On death, the death benefit is received tax-free and, if the taxpayer is a private corporation, added to the corporation’s capital dividend account. With proper planning, this capital dividend account may allow the shareholder to avoid a portion of the capital gain that would be realized on the deemed disposition of the shares on death and convert it into a tax-free capital dividend in the hands of the shareholder’s estate.
The Budget proposes to eliminate these benefits for “LIA policies”. An LIA policy will be defined as a life insurance policy where a particular person becomes obligated to repay an amount to another person (the lender) at a time determined by reference to an individual whose life is insured under the policy and the lender is assigned an interest the policy and an annuity contract that provides for payments for a period that ends no earlier than the death of the particular individual.
Specifically, the Budget will eliminate the deduction for any premiums paid on such policies and, subject to annual accrual-based taxation, any income accruing under the policy. In addition, the death benefit received under such policies will not be added to the capital dividend account of a private corporation receiving the benefit and, for the purposes of determining the fair market value of property deemed to have been disposed of on the death of an individual, the value of an annuity assigned to a lender in connection with an LIA policy will be deemed to be the amount of all premiums paid under the annuity before the individual’s death.
These measures will apply for taxation years ending on or after Budget Day although they will not apply to an LIA in respect of which no borrowings were entered into after the Budget Day.
In a typical 10/8 arrangement, a taxpayer invests in a life insurance policy and then borrows an amount equal to the amount invested in the policy and assigns the policy as security for the loan. The borrowed funds are used to acquire income-earning investments. The amount earned on the policy is typically equal to the interest payable on the loan less a fixed spread (originally these rates were 8% and 10% hence the name 10/8).
Under current rules, the interest payable on the loan should be deductible and the income earned under the policy is received tax-free as the policy is an exempt policy. The arrangements also provide a deduction for a portion of the premiums paid under the policy and an increase in the capital dividend account of any private corporation that receives a death benefit under the policy.
The Budget proposes to eliminate these benefits for “10/8 policies”. A 10/8 policy will be defined as a life insurance policy (other than an annuity) where an amount is payable under the terms of a borrowing to a person that has been assigned an interest in the policy (or an investment contract in respect of the policy) or under a policy loan made in accordance with the terms of the policy and the rate of interest payable on an investment account in respect of the policy is determined by reference to the amount of the interest payable on the borrowing or the maximum amount of an investment account in respect of the policy is determined by reference to the amount of the borrowing or policy loan.
Specifically, the Budget will eliminate the deduction for premiums paid on such policies and interest paid on any borrowings secured by such policies (or an investment account in respect of such policies). In addition, any death benefit received by a private corporation under such policies will not be added to the corporation’s capital dividend account. In order to allow such arrangements to be unwound tax effectively, the Budget also proposes to allow amounts to be withdrawn from such policies to repay the associated borrowings without tax consequences if such amounts are withdrawn prior to January 1, 2014.
These proposals apply for taxation years ending on or after Budget Day in respect of periods after 2013.
Budget 2013 enhances the rules in the Tax Act designed to limit loss trading among arm’s length persons. Generally, a loss trading transaction involves a taxpayer acquiring an interest in an arm’s length trust or corporation that has unused losses and transferring income-producing assets to that trust or corporation so that any income produced by the income-earning assets will be offset by the unused losses.
For corporations, the Tax Act limits the ability of taxpayers to engage in arm’s length loss trading transactions with corporations by, for example, limiting a corporation’s use of losses after an acquisition of control of the corporation. Budget 2013 proposes to extend the loss-trading rules that are applicable on the acquisition of control of a corporation to trusts, so that similar rules would apply where, generally speaking, a person or partnership acquires a beneficial interest in the trust that exceeds 50% of the fair market value of the trust. Generally, this measure will apply to transactions that occur on or after Budget Day, other than transactions that the parties are obligated to complete pursuant to the terms of an agreement in writing entered into before Budget Day.
Budget 2013 also contains measures to strengthen the loss-trading provisions applicable on an acquisition of control of a corporation. Currently, transactions may be undertaken whereby a company (Profitco) sells income-producing assets to another company (Lossco) in exchange for non-voting shares of Lossco so that no acquisition of control occurs and the income and losses can now be offset in Lossco. Budget 2013 proposes to introduce an anti-avoidance rule which will deem there to be an acquisition of control of a corporation that has loss pools when a person acquires more than 75% of the fair market value of the shares of a corporation without otherwise acquiring control of the corporation (for instance, by not acquiring voting control of the corporation), if it is reasonable to conclude that one of the main reasons that control was not acquired is to avoid the restrictions that would have applied to the use of losses. Generally, this measure will apply to a corporation the shares of which are acquired on or after Budget Day unless the shares are acquired as part of a transaction that the parties are obligated to complete pursuant to the terms of an agreement in writing entered into before Budget Day.
As Graham Nash and David Crosby repeat over and over again in the classic rock song “Déjà Vu’, we have all been here before. In its report that was released in 2008, the Advisory Panel on Canada’s System of International Taxation made several recommendations to bring Canada’s thin capitalization rules more in line with international norms. The 2012 Budget made several changes to these rules and Budget 2013 continues the reform of Canada’s thin capitalization rules.
A common planning technique for non-residents investing in Canadian real estate and other assets is to use a non-resident trust or corporation as the entity for making the investment. The advantages of using such vehicles include the fact that such entities are not subject to the thin capitalization limitations under the current provisions of the Tax Act. Currently, these limitations apply only to interest on debts owing by Canadian resident corporations and partnerships of which such corporations are members. Accordingly, non-resident trusts and corporations (and Canadian resident trusts) may be capitalized with a higher proportion of debt than the current 1.5:1 debt to equity ratio would otherwise allow. The higher debt allows for increased interest expense that shelters Canadian income and in many cases is paid to non-resident lenders free of withholding tax.
The Budget proposes to extend a form of the thin capitalization rules to Canadian resident trusts and non-resident corporations and trusts.
For Canadian resident trusts, the existing thin capitalization rules will be modified to reflect the differences in the legal nature of trusts and corporations. For example, beneficiaries will replace shareholders in determining if a person is a specified non-resident and therefore, whether a debt owing to that person is included in outstanding debts to specified non-residents to which the rules apply. As trusts do not have stated or paid-up capital, the equity of a trust will be equal to the aggregate contributions to the trust made by specified non-resident persons and the tax-paid earnings of the trust less any capital distributions paid to non-resident beneficiaries.
Under current rules, any interest paid by a corporation resident in Canada that is not deductible under the thin capitalization rules is deemed to be a dividend paid by the corporation. In the case of a Canadian resident trust, the trust will be entitled to designate the non-deductible interest as a payment of income to a non-resident beneficiary. In this way, the trust will be entitled to a deduction for this amount but the payment will be subject to non-resident withholding tax.
These rules will also apply to partnerships of which a Canadian trust is a member and will apply to taxation years that begin after 2013. The rules will also be extended to non-resident corporations and trusts that carry on business in Canada or that elect to be taxed on their net income pursuant to section 216 of the Tax Act. For these entities, outstanding debts to specified non-resident persons will include any loans used in the Canadian branch of the non-resident corporation or trust if it is a loan from a non-resident who does not deal at arm’s length with the non-resident corporation or trust.
In addition, for purposes of determining the debt to equity ratio of a non-resident corporation or trust, the concept of equity will be replaced with an amount determined by reference to the assets and liabilities of the trust. More specifically, the equity amount of such corporations or trusts will be equal to the amount that is equal to 40% of the amount by which the cost of the property of the corporation or trust used or held by it in carrying on business in Canada (or in the case of a corporation or trust that elects under section 216 of the Tax Act, the cost of Canadian real property or timber resource property owned by it) exceeds all debts owing by the corporation or trust other than debts owing to specified non-residents of the corporation or trust. In effect, the 1.5:1 debt to equity ratio is replaced with a 3:5 debt to net asset ratio (although the debts included in the net asset calculation seem to include all debts and not just those debts relating to the Canadian based assets of the corporation or trust).
These rules will also apply to partnerships of which a non-resident corporation or trust is a member and will apply to taxation years beginning after 2013.
Clarifying Legislation to Respond to Court Decisions and Restore Intended Tax Policy Results
The restricted farm loss (“RFL”) rules apply to taxpayers who have incurred a loss from farming, unless their chief source of income for a taxation year is farming or a combination of farming and some other source of income. RFL rules limit the deduction of farm losses to a maximum of $8,750. In 1977, the Supreme Court of Canada, in Moldowan v. The Queen, 10 held that farming that results in a loss could satisfy the chief source of income test (and the RFL rules would thus not apply) if farming is the taxpayer’s chief source of income in combination with a non-farming source of income that is a subordinate source or business. In 2012, the Supreme Court of Canada in The Queen v. Craig11 overruled Moldowan. In Craig, the Supreme Court held that the particular taxpayer could meet the chief source of income test even though his primary source of income was practicing law and farming (here horse racing) was a subordinate source of income. The important factor for the Court in the Craig decision was the fact that the taxpayer placed significant emphasis on both farming and non-farming sources of income.
Budget 2013 proposes to restore the intended policy of the RFL rules by amending the rules to reflect the interpretation by the Supreme Court in Moldowan. This amendment will clarify that a taxpayer’s other sources of income must be subordinate to farming in order for farming losses to be fully deductible against income from those other sources.
Budget 2013 does increase the RFL limit to $17,500 of deductible farm losses annually.
These measures will apply to taxation years that end on or after Budget Day.
The Tax Act contains rules designed to prevent the use by taxpayers of non-resident trusts to avoid Canadian tax. In this context, the trust attribution rule may apply to attribute to a Canadian-resident taxpayer the income from property held by a trust, if the property is held by the trust in circumstances that grant effective ownership of the property to the taxpayer. Specifically, the trust attribution rule may apply in respect of property held by a trust on condition that the property can revert to the taxpayer, or the taxpayer has influence over the trust’s dealings in respect of the property.
Recently, the Federal Court of Appeal in The Queen v. Sommerer,12 held that the trust attribution rule did not apply to property received by a non-resident trust in exchange for fair market value consideration. Budget 2013 proposes to respond to Sommerer by amending the deemed residence rules to apply if a trust holds property on conditions that grant effective ownership of the property to such taxpayer. In such circumstances, any transfer or loan of the property made directly or indirectly by the Canadian-resident taxpayer will be treated as a transfer or loan of restricted property by the taxpayer. As a result, the Canadian-resident taxpayer will generally be treated as having made a contribution to the trust and the deemed residence rules will apply to the trust.
Budget 2013 also proposes to restrict the application of the trust attribution rule to apply only in respect of property held by a trust that is resident in Canada (as determined without regard to the deemed resident rules) in order to clarify the application of the tax rules that apply to non-resident trusts.
This measure will apply to taxation years that end on or after Budget Day.
Future Reclamation Costs
Under paragraph 20(1)(m) of the Tax Act, a taxpayer earning income from a business may generally claim for a taxation year a reserve for amounts received in respect of, among other things, services that may reasonably be expected to be rendered after the end of the taxation year. The reserve applies only if the amounts received have been included in computing the taxpayer’s income for the year or a previous year. This reserve is not intended to provide relief for taxpayers who have rendered services to customers, but who have future obligations (other than to a customer) arising from providing such services. For example, some taxpayers charge their customers amounts that are intended to compensate for the cost of future reclamation obligations (such as the costs of reclaiming land previously used for waste disposal purposes).
Budget 2013 proposes to clarify the treatment of amounts set aside to meet future reclamation obligations, by amending the Tax Act to ensure that the reserve for future services cannot be used by taxpayers with respect to amounts received for the purpose of funding future reclamation obligations. Budget 2013 notes that taxpayers with future reclamation obligations are generally eligible to use the Qualifying Environmental Trust rules.
This measure will apply to amounts received on or after Budget Day, other than amounts received that are directly attributable to future reclamation costs that were authorized by a government or regulatory authority before Budget Day (which are generally grandfathered until 2018).
Dividend Tax Credit
The dividend tax credit (the “DTC”) is intended to compensate a taxable individual for corporate income taxes that are presumed to be paid. Generally, the DTC is meant to ensure that income earned by a corporation and paid out to an individual as a dividend will be subject to the same amount of tax as income earned directly by the individual.
Under the DTC approach, an individual is first required to include the grossed-up amount of taxable dividends (i.e. the proxy for pre-tax profits) in income. Using the grossed-up amount, the tax system in effect treats the individual as having directly earned the amount that the corporation is presumed to have earned in order to pay the dividend.
The DTC then compensates the individual for the amount of corporate-level tax presumed to have been paid on the grossed-up amount. The tax system has two DTC rates and gross-up factors to recognize the two different corporate income tax rates: those for eligible dividends and those for non-eligible dividends. The current DTC and gross-up factor applicable to non-eligible dividends overcompensate individuals for income taxes presumed to have been paid at the corporate level on active business income. To ensure the appropriate tax treatment of dividend income, Budget 2013 proposes to adjust the gross-up factor applicable to non-eligible dividends from 25% to 18% and the corresponding DTC from 2/3 of the gross-up amount to 13/18.
This measure will apply to non-eligible dividends paid after 2013.
Natural Resource Incentives
Mineral Exploration Tax Credit
Budget 2013 proposes to extend the Mineral Exploration Tax Credit, currently set to expire on March 31, 2013, for an additional year. The credit, which equals 15% of certain “grass-roots” mining expenditures incurred by a mining company and renounced to individual investors, is an additional incentive for individuals to invest in flow-through shares issued by such mining companies to fund mineral exploration. The credit was first introduced in the early 2000s and has traditionally been set to expire after one year, but thus far has been renewed in each annual Federal Budget.
Accelerated Capital Cost Allowance
The capital cost allowance (CCA) regime in the Tax Act provides for an accelerated CCA rate (50% per year on a declining balance basis) for investment in specified clean energy generation and conservation equipment to provide incentives for energy generation equipment that is environmentally friendly. Currently, the accelerated CCA rate applies to equipment that generates or conserves energy by using a renewable energy source, using a fuel from waste, and making efficient use of fossil fuels. Budget 2013 proposes to expand the types of equipment eligible for the accelerated CCA rate to encourage investment in technologies that can contribute to a reduction in emissions of greenhouse gasses and air pollutants and to an improvement in water quality and quantity.
Conversely, Budget 2013 proposes to phase out (generally, from 2017 to 2020) the accelerated CCA rate available for certain assets acquired for use in new mines or eligible mining expansions.
Budget 2013 proposes to better align the deductions for pre-production mining expenses with pre-production oil and gas expenses. Currently, expenses incurred for the purpose of bringing a new mine for a mineral resource in Canada (other than a bituminous sands deposit or an oil shale deposit) into production in reasonable commercial quantities are treated as “Canadian exploration expenses”, which are fully deductible in the year incurred. Budget 2013 proposes that the pre-production mining expenses referred to above will be treated as Canadian development expenses which are only deductible at a rate of 30% per year on a declining balance basis. This transition is proposed to be phased in through 2017. These changes are intended to ensure that mining investment decisions will be based on market factors rather than income tax treatment.
Manufacturing and Processing
Machinery and equipment acquired by a taxpayer after March 18, 2007 and before 2014, primarily for use in Canada for the manufacturing or processing of goods for sale or lease currently qualifies for a temporary accelerated CCA of 50% on a straight-line basis. Budget 2013 proposes to extend this accelerated CCA rate by an additional two years, so that it will also apply to such equipment that is acquired in 2014 and 2015.
Scientific Research and Experimental Development Program
In an attempt to facilitate the CRA’s identification of ineligible or non-compliant Scientific Research and Experimental Development (“SR&ED”) claims, Budget 2013 proposes the enactment of legislation that would require information regarding third-party tax preparers and corresponding billing arrangements be disclosed on the corresponding SR&ED program claim forms. Specifically, the Business Number of any SR&ED program third-party tax preparer that assisted with a particular claim, as well as details regarding fees payable to such third party will be required. Where no third party provided assistance with respect to any aspect of the program claim, the SR&ED claimant will be required to provide certified confirmation to that effect.
The proposed legislation would also impose a penalty of $1,000 in respect of each SR&ED program claim for which any of the foregoing information is missing, incomplete or inaccurate. In circumstances where a third-party SR&ED program tax preparer has in fact been engaged, both the claimant and the third party will be jointly and severally (solidarily) liable for the penalty.
This proposal will apply to SR&ED program claims filed on or after the later of January 1, 2014 and the day of Royal Assent to the enacting legislation.
Administrative Measures Regarding Tax Shelters and Reportable Transactions
Current rules require information returns to be filed in respect of certain tax shelters in order to facilitate CRA’s identification and audit of questionable claims. Similar reporting requirements generally apply to certain tax avoidance transactions dubbed “reportable transactions”.
Budget 2013 seeks to extend the normal reassessment period of a participant in any such tax shelter or reportable transaction where the requisite information returns have not been filed on time. Specifically, the relevant assessment period will be extended to three years following the date the information return is filed. These measures apply to taxation years ending on or after Budget Day.
Furthermore, in an attempt to both accelerate and safeguard collection of taxes, Budget 2013 proposes to permit the CRA to exercise limited collection recourses in respect of charitable donation tax shelter assessments, notwithstanding the taxpayer’s objection thereto.
Specifically, the proposed amendments allow the CRA to collect up to 50% of any disputed tax, interest or penalties assessed in respect of such tax shelters. This measure applies to amounts assessed for 2013 and subsequent taxation years.
International Tax Evasion and Aggressive Tax Avoidance
Through a series of measures, Budget 2013 purports to help combat international tax evasion and aggressive tax avoidance so as to preserve the Government’s revenue base in a manner consistent with its commitment to “tax fairness”.
One such measure calls for requiring certain financial intermediaries (including banks, credit unions, caisses populaires, trust and loan companies, money services businesses and casinos) to report international electronic fund transfers (“EFTs”) of $10,000 or more to the CRA, beginning in 2015. These international EFT reporting requirements will mirror those imposed pursuant to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act and will require financial intermediaries to provide information on the relevant transactions, transaction participants and the intermediaries themselves, all within five working days after the date of the EFT.
Another measure of note seeks to “streamline” the court order process whereby the CRA obtains judicial authorization to require a third party to provide information regarding unnamed persons. Currently, Canadian tax legislation permits the CRA to obtain such judicial authorization without having to notify the third party of its application (on an ex parte basis). However, the current rules also permit the third party to seek a review and appeal of the authorization, once granted, which often delays the information retrieval process. Budget 2013 proposes eliminating the ex parte aspect of the judicial authorization application, thereby eliminating the need for additional review and appeal thereof. It should be noted that third parties will still have an opportunity to contest the authorization application at the actual hearing in respect of such application. This measure will apply upon Royal Assent to the enacting legislation.
Budget 2013 also announces the CRA’s launching of its “Stop International Tax Evasion Program”, pursuant to which it will reward individuals that provide information to the CRA regarding certain non-compliant activity that comprises a foreign component. Specifically, the non-compliant activity must involve foreign property, property located or transferred outside of Canada, or transactions conducted at least partially outside Canada. Moreover, the information provided must result in additional assessments or reassessments exceeding $100,000 of federal tax. The reward will be limited to 15% of the federal tax collected, excluding any penalties or interest. The CRA should be announcing further details on the program in the coming months. Incidentally, all reward payments will be subject to income tax.
Budget 2013 makes explicit the Government’s concern regarding the risks posed to the tax base by “treaty shopping”. It argues that by granting residents of third countries benefits under bilateral tax treaties, treaty shopping through the use of intermediary entities effectively undermines the “balance of compromises” between treaty countries. Where a resident of a third country accesses a Canadian tax treaty’s benefits through treaty shopping, the Government contends that no “reciprocal benefits accrue to Canadian investors or to Canada”.
Accordingly, the Government intends to consult on possible measures to counter treaty shopping without unduly hindering foreign investment. Eventually, a report will be publicly released and commentary from stakeholders will be solicited.