Minister of Finance Jim Flaherty today tabled the 2013 Federal Budget (the “Budget”) entitled Jobs, Growth and Long-Term Prosperity – Economic Action Plan 2013.
We are pleased to provide our summary of tax measures contained in the Budget.
The Budget proposed no changes to general corporate income tax rates. While there are no changes to the marginal income tax rates applicable to individuals, the dividend tax credit available in respect of non-eligible dividends is decreased, effectively increasing the personal income tax rate applicable to these dividends. There were also certain changes to tax credits applicable to individuals.
New spending contained within the Budget is primarily focused on actions to support jobs and growth with these expenditures totalling approximately $900 million in the 2014 and 2015 fiscal years.
Identified sources of new revenues contained in the Budget are mostly derived from closing tax loopholes, combating tax avoidance and focused Canada Revenue Agency (“CRA”) compliance programs. The closing of tax loopholes and compliance measures are forecast to increase revenues by approximately $400 million in the 2014 fiscal year, $1.4 billion in the 2015 fiscal year and approximately $6.6 billion over the next five years. In comparison, savings from spending restraint are forecast to be about $100 million each year in the next five years. The significant focus on tax loopholes and compliance programs is wide-ranging and diverse, covering many areas including tax loss trading, life insurance products, trusts (both Canadian resident and non-resident), thin capitalization rules, targeted GST provisions, the mining industry, derivative transactions that would otherwise convert fully taxable ordinary income into capital gains, limiting the income reserve for amounts received for the purpose of funding future reclamation costs, extending the reassessment period for certain tax avoidance transactions and introducing new penalties and criminal offences relating to electronic suppression of sales software. These measures are more fully discussed in our summary.
From a fiscal perspective, the Budget forecasts a deficit of $25.9 billion for 2013 (compared to a 2013 deficit of $21.1 billion that was projected in the 2012 Budget), $18.7 billion for 2014 and $6.6 billion for 2015. A $0.8 billion surplus is projected for 2016.
Our summary of tax highlights contained in the Budget follows.
Business Income Tax Measures
Leveraged Life Insurance Arrangements
The Federal Government has grown increasingly concerned that certain leveraged life insurance arrangements were providing unintended tax benefits to their participants. These arrangements included, most notably, “leveraged insured annuities” (“LIAs”) and “10/8 plans” or arrangements.
The Budget includes proposed measures designed to eliminate the tax benefits that may otherwise have been available to LIA and 10/8 plan participants. The Federal Government also intends to continue to monitor planning and strategies involving life insurance products and to determine whether further action may be warranted in the future.
Leveraged Insured Annuities
In general, LIAs are marketed and sold to closely-held private corporations. They are integrated investment products that involve a loan that is used to acquire a lifetime annuity and a policy of life insurance, both of which are on the life of an individual, usually the owner-manager of the corporation (the“Insured”). The life insurance policy and the lifetime annuity are assigned to the lender as collateral for the loan. The life insurance policy’s death benefit, payable on the Insured’s death, is generally equivalent to the amount invested in the lifetime annuity. Investors in LIAs receive fixed and guaranteed income until the Insured’s death. At that time, the capital invested in the annuity is returned as a tax-free death benefit.
Although sold as integrated products in the marketplace, each component of a LIA is treated separately for tax purposes. This separate tax treatment leads to the unintended tax benefits that were of concern to the Federal Government, while making LIAs attractive to investors. In brief, these tax benefits enable a portion of the capital invested in LIAs to be received on a tax-free basis, given that:
- the life insurance policy in question is an “exempt policy” under the Tax Act, such that its holder is generally not exposed to annual income taxation and is not taxed on the final payout of the death benefit;
- the interest payable on the loan used to acquire the life insurance policy is, in general, tax-deductible; and
- a portion of the capital that is invested in the LIA, on account of the premium payable in respect of the life insurance policy, may also be tax-deductible.
In addition to the above:
- LIAs also provide for an elimination of taxes payable on retained earnings within a corporation by avoiding capital gains tax liability on the Insured’s (or the owner/manager’s) death; and
- as the life insurance policy that is part of a LIA is generally corporate-owned, the payout of the death benefit results in a credit to the corporation’s capital dividend account (“CDA”) that, in turn, enables the corporation to declare and pay tax-free capital dividends to its shareholders.
In an effort to eliminate these unintended tax benefits, the Budget introduces rules for “LIA policies.” Under these rules, a policy of life insurance may constitute a “LIA policy” if:
- on or after Budget Day, a person or partnership becomes obligated to repay a borrowed amount to a lender by reference to the Insured’s death; and
- an annuity contract is assigned to the lender, and the annuity contract provides for continuous payments during the Insured’s lifetime.
“LIA policies” will be subject to taxation on an accrual basis in respect of the income that is earned within them during a taxation year, while deductions will be disallowed for policy premiums. Upon the Insured’s death, for “LIA policies,” there will be no credit to a private corporation’s CDA and the annuity contract assigned to a lender will be deemed to have been disposed of on the annuitant’s death for proceeds equal to its fair market value (“FMV”). An annuity contract’s FMV, for the purposes of the “LIA policy” rules, will be deemed to be equal to the total of the premiums paid under the contract.
Application Date for the “LIA Policy” Rules
The “LIA policy” rules will only apply to taxation years that end on or after Budget Day. As such, the new measures will not apply to LIAs in respect of which all funds were borrowed prior to Budget Day.
In general, 10/8 strategies permit high-net-worth individuals and closely-held private corporations to achieve greater tax efficiency by:
- maximum-funding or investing a considerable amount of money into a policy of life insurance to significantly and quickly increase its cash value;
- using the life insurance policy or an investment account as collateral for a loan from a third-party lender (which lender often works in conjunction with the insurer), with the borrowed amount being equal to the amount invested in the life insurance policy; and
- investing the borrowed funds in income-producing assets or a business venture, such that the interest payable on the loan is deductible under the Tax Act.
These arrangements are known as 10/8 strategies or arrangements because participants pay 10% interest on the borrowed amount, while earning an 8% return on the amount that they invest in the life insurance policy, for a spread of 2%. As with LIAs, because the policy of life insurance in question is an “exempt policy” under the Tax Act, the 8% annual interest earned in respect of the policy is not included in a taxpayer’s annual income. On the other hand, the taxpayer may be able to claim a deduction from income for the 10% interest paid on the borrowed amount, provided that the loaned funds are invested in income-producing assets or ventures. For corporate-owned policies of life insurance, on the taxpayer’s death, assuming that he or she is the person insured under the policy, the death benefit generally results in a credit to the corporation’s CDA, which may be paid to shareholders by way of a tax-free capital dividend.
The Federal Government’s concern with 10/8 arrangements was the subject of recent litigation in the Federal Court and on appeal to the Federal Court of Appeal (see MNR v. RBC Life Insurance Company etal., 2013 FCA 50). During the course of the litigation, it was revealed, inter alia, that the CRA’s “GAAR Committee” had determined that 10/8 arrangements were not subject to the application of the general anti-avoidance rule in section 245 of the Tax Act, although the arrangements could have still been the subject of challenge under other provisions. Notwithstanding this fact, the effect of the new measures introduced in the Budget is to ensure that 10/8 arrangements are no longer used.
The New 10/8 Arrangement Rules
For taxation years ending on or after Budget Day, if a policy of life insurance or an investment account under a policy of life insurance is assigned to a lender as collateral for a loan and either:
- the interest rate payable on the investment account is determined by reference to the interest rate payable on the loan; or
- the investment account’s maximum value is determined by reference to the interest rate payable on the loan,
then a taxpayer participating in such an arrangement will be denied:
- a deduction for the interest paid or payable on the loan;
- a deduction for the premium that is paid or payable under the life insurance policy; and
- for corporate-owned life insurance policies, the credit to the corporation’s capital dividend account as a result of the death benefit payable under the life insurance policy.
To help terminate the 10/8 arrangements presently in place, the Budget proposes to alleviate the tax consequences to taxpayers on a withdrawal from a policy of life insurance that is subject to a 10/8 plan or arrangement, and the repayment of the borrowed amount, provided that such steps are taken prior to January 1, 2014.
Corporate Loss Trading
The Federal Government introduced certain provisions in the Tax Act over the years to prevent the trading of corporate tax attributes (referred to as “loss pools”)among arm’s length persons. Notwithstanding these provisions, taxpayers continue to enter into certain loss trading transactions which the Federal Government considers inappropriate.
The Federal Government introduces a new measure in the Budget to prevent a profitable corporation (“Profitco”) from transferring, directly or indirectly, income producing property to an unrelated corporation with loss pools (“Lossco”)in return for shares of Lossco.
Consider a typical transaction targeted by this new measure, wherein Profitco avoids acquiring control of Lossco in order to access loss pools of Lossco by acquiring shares of Lossco that represent more than 75% (and often greater than 90%) of the fair market value of all Lossco’s shares, but that do not give Profitco voting control of Lossco. Lossco then uses its loss pools to shelter from tax all or part of the income derived from the property transferred by Profitco and pays tax-free inter-corporate dividends to Profitco.
The Federal Government considers that these loss-trading transactions constitute aggressive tax avoidance and undermine the integrity of the income tax provisions that are meant to prevent the trading of corporate loss pools among arm’s length persons.
The Budget proposes to introduce an anti-avoidance rule (referred to as an “attribute trading restriction”) to support the existing loss restriction rules that apply to the acquisition of control of a corporation. The proposed amendments will deem there to have been an acquisition of control of a corporation that has loss pools (Lossco in the above example) at a particular time when a person (or group of persons) acquires shares of the corporation that represent more than 75% of the fair market value of all the shares of the corporation without otherwise acquiring control of the corporation, if immediately prior to that particular time the person or group of persons held shares, if any, of the corporation with a fair market value that was 75% or less of all the shares of the corporation, and it is reasonable to conclude that one of the main reasons that control was not acquired is to avoid the restrictions that would have been imposed on the use of loss pools.
This attribute trading restriction will restrict the use of a tax attribute arising on the application of certain provisions of the Tax Act
The Budget also proposed related rules to ensure that this anti-avoidance rule is not circumvented. The Federal Government indicated that it will continue to monitor the effectiveness of the constraints on the trading of loss pools and determine whether further action is warranted.
This measure will apply to a corporation the shares of the capital stock 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 between the parties entered into before Budget Day. Parties will be considered to not be obligated to complete a transaction if one or more of those parties may be excused from completing the transaction as a result of changes to the Tax Act.
Taxation of Corporate Groups
Canada does not have a formal system of corporate group taxation like the United States and other jurisdictions. Although Canadian corporate groups may be able to undertake loss consolidation transactions through financing arrangements, reorganizations, and transfers of property on a tax-deferred basis, such consolidation is generally more cumbersome and often requires obtaining tax rulings.
In its 2010 and 2012 Budgets, the Federal Government expressed interest in exploring the issue of whether new rules for the taxation of Canadian corporate groups, such as the introduction of a formal system of loss transfers or consolidated reporting, could improve the functioning of the corporate tax system in Canada.
The Federal Government conducted extensive public consultations on this issue, including with provincial and territorial officials. Generally, businesses indicated that they were primarily interested in a system of group taxation that would allow them to easily transfer losses, tax credits and other tax attributes between members of a corporate group. Provinces and territories expressed their concerns about the possibility that a new system of corporate group taxation could reduce their revenues, and could result in significant upfront costs for governments associated with introducing a new approach to the taxation of corporate groups.
The Federal Government confirmed that it completed its examination of the taxation of corporate groups and determined that moving to a formal system of corporate group taxation is not a priority at this time. The Federal Government indicated that it will continue to work with provinces and territories regarding their concerns about the uncertainty of the cost associated with the current approach to loss utilization.
The Budget proposes changes to align the deductions available for expenses in the mining sector with those available in the oil and gas sector. The alignment of deductions will affect the mining sector generally, including coal producers. This measure is intended to phase out inefficient fossil fuel subsidies.
Pre-Production Mine Development Expenses
Pre-production mine development expenses (“PMDE”) refer to certain expenses (e.g., expenses for removing overburden, stripping, sinking a mine shaft, or constructing an adit or other underground entry) incurred for the purpose of bringing a new mine for a mineral resource located in Canada into production in reasonable commercial quantities, excluding expenses resulting in revenue before production, except for those expenses that exceed such revenue earned. PMDE qualify as Canadian exploration expenses (“CEE”) which may generally be 100% deducted in the year incurred or carried forward indefinitely for use in future years. PMDE incurred after a mine comes into production qualify as Canadian development expenses (“CDE”) and are generally deductible at a rate of 30% per year on a declining-balance basis.
The Budget proposes that specified PMDE be treated as CDE. The transition from CEE to CDE treatment will be phased-in, with PMDE being allocated proportionally to CEE and CDE based on the calendar year in which the expense is incurred. Starting in 2015, 20% of PMDE will be allocated to CDE. The CDE allocation will increase to 40% in 2016, 70% in 2017, and 100% after 2017.
This measure will generally apply to PDME incurred on or after Budget Day. The existing CEE treatment for PMDE will still apply to expenses incurred before Budget Day and expenses incurred before 2017 either under a written agreement entered into by the taxpayer before Budget Day or as part of the development of a new mine, generally where either the construction was started before Budget Day, or the engineering and design work for the construction (evidenced in writing) was started before Budget Day, by or on behalf of the taxpayer. Obtaining permits or regulatory approvals, conducting environmental assessments, community consultations or impact benefit studies, and similar activities will not be considered construction or engineering and design work.
Accelerated CCA for Mining
Most machinery, equipment and structures used to produce income from a mine or an oil or gas project are currently eligible for CCA at a rate of 25% on a declining-balance basis. The 25% rate is also applicable to assets that are used in the initial processing of oil or gas, or ore from a mineral resource.
Accelerated CCA is also provided for certain assets acquired for use in new mines or eligible mine expansions, by way of an additional allowance. The additional allowance allows the taxpayer to deduct in computing income for a taxation year up to 100% of the remaining cost of eligible assets acquired for use in a new mine or an eligible mine expansion, not exceeding the taxpayer’s income for the year from the mining project (calculated after deducting regular CCA).
The Budget proposes to phase out the additional allowance available for mining (excluding bituminous sands and oil shale, already scheduled for phase-out by 2015). The additional allowance will be phased-out over the 2017 to 2020 calendar years. Starting in 2017, a taxpayer will be allowed to claim 90% of the amount of the additional allowance otherwise permitted. The percentage reduces to 80% in 2018, 60% in 2019, 30% in 2020 and nil for later calendar years. Where a taxpayer’s taxation year includes more than one calendar year the additional allowance will be prorated, based on the number of days in each calendar year.
This proposed measure will generally apply to expenses incurred on or after Budget Day. The existing additional allowance will be maintained for eligible assets acquired before Budget Day, and will also apply for such assets acquired before 2018 for a new mine or a mine expansion either under a written agreement entered into by the taxpayer before Budget Day, as part of the development of a new mine or as part of a mine expansion where the construction was started before Budget Day, or the engineering and design work for the construction (evidenced in writing) was started before Budget Day, by or on behalf of the taxpayer. Obtaining permits or regulatory approvals, conducting environmental assessments, community consultations or impact benefit studies, and similar activities will not be considered construction or engineering and design work.
Restricted Farm Losses
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. The RFL rules limit the deduction of farm losses to a maximum of $8,750 annually ($2,500 plus ½ of the next $12,500). Farm losses incurred in a year in excess of that limit can be carried forward for 20 years to be claimed against farming income.
The Budget proposes to amend the RFL rules to overturn a recent Supreme Court of Canada decision in The Queen v. Craig, 2012 SCC 43. In Craig, it was held that a taxpayer could meet the chief source of income test even though his primary source of income was not farming provided that the taxpayer places significant emphasis on both farming and non-farming sources of income. This decision had the effect of overruling a previous decision of the Supreme Court of Canada in Moldowan v. The Queen,  1 SCR 480. In Moldowan, the Court had held that farming that results in a loss could satisfy the chief source of income test 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 a side-line employment or business. The Budget restores this prior Moldowantest requiring 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.
The Budget also proposes to increase the RFL limit to $17,500 of deductible farm losses annually ($2,500 plus ½ of the next $30,000).
These measures will apply to taxation years that end on or after Budget Day.
Reserve for Future Services
Paragraph 20(1)(m) of the Tax Act is designed to permit a taxpayer earning income from a business to claim for a taxation year a reserve for amounts received from customers in respect of, among other things, services that may reasonably be expected to be rendered after the end of the taxation year. This reserve applies only if the amounts received have been included in computing the taxpayer’s income for the year or a previous year.
However, the reserve under paragraph 20(1)(m) of the Tax Act is not intended to apply to amounts received for the purpose of funding future reclamation projects (e.g. a waste disposal facility that charges fees to its customers to cover the future cost of reclaiming its landfill).
Taxpayers with future reclamation obligations are generally eligible to use the Qualifying Environmental Trust (“QET”) rules. Under these rules, a taxpayer may claim a deduction for amounts contributed to a QET established for the purpose of funding the future reclamation of a qualifying site.
In order to clarify the tax treatment of amounts set aside to meet future reclamation obligations, the Budget proposes to amend subsection 20(7) of the Tax Act to specifically exclude a reserve in respect of a reclamation obligation from paragraph 20(1)(m).
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 and that are received: (i) under a written agreement between the taxpayer and another party (other than a government or regulatory authority) that was entered into before Budget Day and not extended or renewed on or after Budget Day, or (ii) before 2018.
Additional Deduction for Credit Unions
The small business deduction effectively provides a preferential corporate income tax rate, on up to $500,000 of qualifying business income, to Canadian-controlled private corporations (“CCPCs”) with taxable capital employed in Canada of less than $15 million. Credit unions also have access to this preferential income tax rate on the same basis as CCPCs.
Credit unions are currently also entitled to an additional deduction from income tax. The amount of taxable income eligible for the additional deduction is subject to a limit based on the credit union’s cumulative taxable income that was taxed at the preferential rate (including as a result of the additional deduction) and the amount of their deposits and member shares. This deduction permits the credit union to accumulate capital and increase its reserve on a preferential tax basis.
Prior to 1972, credit unions were exempt from income tax under Part I of the Tax Act When credit unions became subject to Part I tax, the additional deduction for credit unions was introduced to level the playing field between credit unions and CCPCs. However, the small business deduction has changed significantly over the years. As a result of those changes, the additional deduction for credit unions now provides access to a preferential corporate income tax rate not available to CCPCs.
The Budget proposes to phase-out the additional deduction for credit unions over five calendar years, beginning in 2013. For 2013, a credit union will be permitted to deduct only 80 per cent of the amount of the additional deduction otherwise calculated. The percentage of the additional deduction, otherwise calculated, that a credit union will be permitted to deduct will be 60 per cent for 2014, 40 per cent for 2015, and 20 per cent for 2016. For 2017 and subsequent years, the additional deduction will be eliminated.
This measure will apply to taxation years that end on or after Budget Day. For a taxation year that includes Budget Day, the measure will be prorated to apply only to the portion of the year that is on or after Budget Day. The measure will also be prorated for all taxation years during the phase-out period that do not coincide with the calendar year.
Manufacturing and Processing Machinery and Equipment: Accelerated Capital Cost Allowance
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 qualifies for a temporary accelerated capital cost allowance (“CCA”) rate of 50% calculated on a straight-line basis under Class 29, subject to the half-year rule applied in the acquisition year. These eligible assets would otherwise be included in Class 43 and qualify for a CCA rate of 30% calculated on a declining-balance basis.
The Budget extends the accelerated CCA to eligible assets acquired in 2014 or 2015. Eligible assets acquired in 2016 and subsequent years will qualify for the regular 30% declining-balance rate, and will be included in Class 43.
Clean Energy Generation Equipment: Accelerated Capital Cost Allowance
Class 43.2 provides an accelerated CCA rate (50% per year on a declining-balance basis) for investment in specified clean energy generation and conservation equipment. The class includes eligible equipment that generates or conserves energy by using a renewable energy source, fuel from waste, or making efficient use of fossil fuels. The accelerated CCA provides an incentive for investment in low-emission or no-emission energy generation equipment.
Class 43.2 currently includes biogas production equipment using organic waste that is sewage from an eligible sewage treatment facility, food and animal waste, manure, plant residue or wood waste. The Budget proposes to expand Class 43.2 by making biogas production equipment that uses more types of organic waste eligible for inclusion in Class 43.2, including pulp and paper waste and wastewater, beverage industry waste and wastewater and separated organics from municipal waste.
Class 43.2 also includes only certain cleaning and upgrading equipment used to treat eligible gases from waste (biogas, digester gas and landfill gas). The Budget proposes to expand the range of cleaning and upgrading equipment used to treat eligible gases from waste that is eligible for inclusion in Class 43.2, to all such cleaning and upgrading equipment.
These measures will apply to property acquired on or after Budget Day that has not been used or acquired for use before Budget Day.
Scientific Research and Experimental Development Program
The Budget proposes measures to provide the CRA with new resources and administrative tools to address Scientific Research and Experimental Development (“SR&ED”) claims.
One of these measures will require additional disclosure obligations on SR&ED program claim forms with respect to SR&ED program tax preparers and billing arrangements. The Business Number of third party preparers and details about billing arrangements (e.g. whether a contingency fee arrangement exists and the amount of the fee payable) will now be required. Where third parties are not involved, the claimant will have to certify that no third party assisted in any aspect of the preparation of the SR&ED claim.
The Budget also proposes a new penalty for non-compliance with the new reporting requirements. A $1,000 penalty will apply to each SR&ED program claim for which the information about SR&ED program tax preparers and billing arrangements is missing, incomplete or inaccurate. If a third-party SR&ED program tax preparer was involved, the claimant and the preparer will be jointly and severally, or solidarily, liable for the penalty.
This measure 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.
International Tax Evasion and Aggressive Tax Avoidance
High on the priority list of the G20 countries is the renewed fight against tax evasion and avoidance, money laundering and the proceeds of crime. The Budget specifically proposes a number of measures that are designed to combat international tax evasion and international aggressive tax avoidance.
International Electronic Funds Transfers
The Budget proposes that the Tax Act, the Excise TaxAct (Canada) and the Excise Act, 2001 (Canada) be amended to require that certain financial intermediaries report to the Canada Revenue Agency (“CRA”) international electronic funds transfers (“EFTs”) of $10,000 or more.
This new proposed measure targets taxpayers that may deliberately engage in foreign financial transactions in order to make it more difficult for the CRA to verify the accuracy of their tax reporting. It is meant to be used by the CRA as a tool to discourage taxpayers who might seek to move funds outside of Canada in an attempt to conceal those funds or the income they produce in order to avoid taxation.
Essentially, the reporting requirements would be the same as the current ETF reporting requirements imposed under the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (Canada) which includes banks, credit unions, caisses populaires, trust and loan companies, money services businesses and casinos. The EFT reports will be required to be made to the CRA no later than five working days after the date of transfer and will require financial intermediaries to provide information on the person conducting the transaction, on the receiver of the funds, on the transaction itself and on the financial intermediaries facilitating the transaction. This proposal is intended to commence in 2015. It begs the obvious question as to why it should take well over 18 months for this proposal to come into force.
Stop International Tax Evasion Program
Finally, Canada has a whistleblower program aimed to catch tax evaders with the help of “ordinary”Canadians. Call it, “it pays to squeal.”The CRA will be launching the Stop International Tax Evasion Program pursuant to which the CRA will pay rewards to individuals with knowledge of major international tax non-compliance when they provide information to the CRA that leads to the collection of outstanding taxes due.
The proposal calls for the CRA to enter into a contract with an individual that will provide for the payment of a reward only if the information results in total additional assessments or reassessments exceeding $100,000 in federal tax.
The contract will provide for a reward payment of up to 15% of the federal tax collected (e.g., not including penalties, interest and provincial taxes). Reward payments will be made only after the taxes have been collected and will only be paid where the non-compliant activity involves foreign property or property located or transferred outside Canada, or transactions conducted partially or entirely outside Canada.
To be eligible, individuals seeking rewards will have to meet certain program criteria. The idea for such a program is not new. The United States has been highly successful with this type of program. An example is the UBS/Birkenfeld matter. With the help of a whistleblower, hundreds of millions of dollars were‘recovered’ by the IRS. We can only imagine what impact this new program will have in Canada.
Extended Reassessment Period: Form T1135
Under the current tax regime, a Canadian-resident individual, corporation or trust (or partnership, in some cases) that owns “specified foreign property” at any time during a year with an aggregate cost in excess of $100,000 must file a Form T1135: Foreign Income Verification Statement. “Specified foreign property” is defined as including a wide range of income-earning foreign property such as funds situated, deposited or held outside Canada and tangible property situated outside Canada. There are specific exceptions for property used in carrying on an active business, personal-use property, and certain other types of property outlined in the Tax Act.
For most taxpayers, the normal reassessment period under the Tax Act is three years, during which time the CRA can audit and reassess liability for tax. The Budget proposes to extend this period by a further three years if:
- the taxpayer has failed to report income from a specified foreign property on the taxpayer’s annual income tax return; and
- the taxpayer did not file the Form T1135 on time, or a specified foreign property was not identified, or was improperly identified, on the Form T1135.
The Budget states that the purpose of this new measure is to provide the CRA with more time to assess the risk that foreign income has not been reported accurately in respect of foreign property. This measure will apply to the 2013 and subsequent taxation years.
Revised Form T1135
Form T1135 requires a taxpayer to provide general information regarding the location of specified foreign property and the income generated from the property. The Budget proposes to revise Form T1135 to require more detailed information, including:
- the name of the specific foreign institution or other entity holding funds outside of Canada;
- the specific country to which the property relates; and
- the foreign income generated from the property.
This measure is intended to improve the use of Form T1135 in allowing the CRA to determine whether taxpayers have correctly reported foreign income. Revised Form T1135 will be required to be used for the 2013 and subsequent taxation years.
Improvements to Foreign Reporting Requirements: Form T1135
In the past, taxpayers indicated that they had difficulties in filling out Form T1135 because they found the instructions to be unclear and because the form could not be filed electronically. The Budget proposes certain improvements to the Form T1135 filing process that are designed to help taxpayers meet their filing obligations. Effective for the 2013 taxation year, the CRA will remind taxpayers on their Notices of Assessment of their obligation to file a Form T1135 if they have answered “yes” on their income tax returns to the question of whether they had specified foreign property at any time during the taxation year with an aggregate cost in excess of $100,000. the CRA will also be clarifying the instructions on the form and is in the process of developing a system to allow Form T1135 to be filed electronically.
Thin Capitalization Rules
The thin capitalization (“thin cap”) rules within the Act protect the Canadian tax base from erosion through excessive interest deductions in respect of debt owing to “specified non-residents” (as defined in the Tax Act).
In its 2008 report, the Advisory Panel on Canada’s System of International Taxation made a number of recommendations relating to the thin cap rules, including extending the rules to partnerships, trusts and Canadian branches of non-resident corporations.
Budget 2012 introduced certain amendments to the thin cap rules including, among other things, extending the scope of the thin cap rules to partnerships with one or more Canadian-resident corporate partners and the reduction of the debt-to-equity ratio from 2-to-1 to 1.5-to-1.
The current thin cap rules generally limit the deductibility of interest expense of a Canadian-resident corporation (or a partnership with one or more Canadian-resident corporate partners) in circumstances where the amount of debt owing to specified non-residents exceeds a 1.5-to-1 debt-to-equity ratio.
The current Budget proposes further amendments to the thin cap rules by extending the scope of their application to Canadian-resident trusts, and non-resident corporations and trusts that carry on business in Canada.
Canadian Resident Trusts
The Budget proposes that the existing thin cap rules will be extended to Canadian resident trusts and will be amended to accommodate the legal nature of trusts. A trust’s“equity” for the purposes of the thin cap rules will generally consist of contributions to the trust from specified non-resident beneficiaries plus the tax-paid earnings of the trust, less any capital distributions from the trust to specified non-residents. Trust beneficiaries will be used in place of shareholders in determining whether a person is a specified non-resident in respect of the trust.
Where interest expense of a trust is not deductible as a result of the application of the thin cap rules, the trust will be entitled to designate the non-deductible interest as a payment of income of the trust to a non-resident beneficiary (i.e., the recipient of the non-deductible interest). In such a case, the trust will be able to deduct the designated payment in computing its income, but the designated payment will be subject to non-resident withholding tax under Part XIII of the Tax Act and potentially tax under Part XII.2, depending on the character of the income earned by the trust.
This proposal will also extend the thin cap rules to partnerships with one or more Canadian resident trusts as partners.
Similar to debt owed directly by the trust, where these rules result in an amount being included in computing the income of a trust, the trust will be entitled to designate the included amount as having been paid to a non-resident beneficiary as income of the trust.
Since some trusts may not have complete historical information, any trust that exists on Budget Day will be able to elect to determine the amount of its equity for thin cap purposes as at Budget Day based on the fair market value of its assets less the amount of its liabilities. Each beneficiary of the trust would then be considered to have made a contribution to the trust equal to the beneficiary’s share (determined by reference to the relative fair market value of their beneficial interest in the trust) of this deemed trust equity. Contributions to the trust, tax-paid earnings of the trust and distributions from the trust on or after Budget Day would then increase or decrease (as appropriate) trust equity for thin capitalization purposes.
The 1.5-to-1 debt-to-equity ratio will not change for Canadian resident trusts and partnerships with one or more Canadian resident trusts as partners.
This measure will apply to taxation years that begin after 2013 and will apply with respect to existing as well as new borrowings.
Non-Resident Corporations and Trusts
The Budget also proposes to extend the thin capitalization rules to non-resident corporations and trusts that carry on business in Canada. The application and effect of the thin capitalization rules for a non-resident carrying on business in Canada will be similar to those in respect of a wholly-owned Canadian subsidiary of a non-resident.
However, since a Canadian branch is not a separate person from the non-resident corporation or trust, the branch does not have shareholders or equity for purposes of the thin capitalization rules. Therefore, the thin capitalization rules for non-resident corporations and trusts will differ from the rules for Canadian-resident corporations in certain respects.
A loan that is used in a Canadian branch of a non-resident corporation or trust will be an outstanding debt to a specified non-resident for thin capitalization purposes 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, a debt-to-asset ratio of 3-to-5 will be used, which parallels the 1.5-to-1 debt-to-equity ratio used for Canadian-resident corporations.
Where the non-resident is a corporation, the application of the thin capitalization rules could increase its liability for branch tax under Part XIV of the Tax Act.
A non-resident corporation or trust that earns rental income from certain Canadian properties may elect to be taxed on its net income under Part I of the Tax Act rather than being subject to non-resident withholding tax under Part XIII on its gross rental income. The election allows the non-resident to compute its taxable income as if it were a resident of Canada, with such modifications to the tax rules as the circumstances require. Where such an election is made, the thin cap rules for non-resident corporations and trusts, rather than those for Canadian residents, will apply in computing the non-resident’s Part I tax liability.
This proposal will also extend the thin cap rules to apply to partnerships with one or more non-resident corporations or trust as partners. Any income inclusion for a non-resident partner that arises as a consequence of the application of the thin cap rules will be deemed to have the same character as the income against which the partnership’s interest deduction is applied.
This measure will apply to taxation years that begin after 2013 and will apply with respect to existing as well as new borrowings.
The Federal Government expressed its concern about treaty shopping generally and, in particular, by third country residents who create intermediary entities in treaty countries in order to access treaty benefits offered by Canada to treaty country residents. So far, the Federal Government has not been successful in challenging treaty shopping cases (e.g., Prevost Car and Velcro cases) and in addressing its concerns regarding the significant risks that treaty shopping represents for the Canadian tax base.
While no specific tax measures are proposed in the Budget, the Federal Government announced its intention to consult on possible measures that would address its concerns with treaty shopping and protect the integrity of Canada’s tax treaties while preserving a business tax environment that is conducive to foreign investment. A consultation paper will be publicly released to provide stakeholders with an opportunity to comment on possible measures.
International Banking Centres
The Budget proposes to repeal the International Banking Centre (“IBC”) rules because the policy rationale no longer applies and there has been virtually no use of the provision in recent years. The IBC rules were introduced in 1987 to attract to Canada banking activity normally conducted abroad and to exempt prescribed financial institutions from tax on certain income earned through a branch or office in the metropolitan areas of Montreal and Vancouver.
This measure will apply to taxation years that begin on or after Budget Day.
Personal Income Tax Measures
The Budget introduces a measure to deal with so-called “synthetic disposition arrangements.” These are described as agreements or arrangements which eliminate all or substantially all of the risk of loss and opportunity for gain or profit in respect of a property that a person continues to own. Examples given in the Budget Papers of the kinds of transactions which could be synthetic dispositions are:
- a forward sale of property (whether or not combined with a secured loan);
- a put-call collar;
- exchangeable indebtedness;
- a total return swap; and
- a securities borrowing to facilitate a short sale of property that is identical or economically similar to a property already owned by the taxpayer (or a non-arm’s length person).
The Federal Government’s concern appears to be that a taxpayer can monetize the value of an asset through hedging transactions, derivatives and similar transactions without actually disposing of the asset for tax purposes, with the result that the value of the asset is realized but tax does not become payable until later – potentially much later.
The primary consequence of entering into a synthetic disposition arrangement is a deemed disposition at fair market value of the asset to which the synthetic disposition arrangement relates. The other consequences are discussed further below.
Synthetic Disposition Arrangements –What Are They?
A synthetic disposition arrangement in respect of a particular asset owned by a taxpayer (the “Owner”) is one or more agreements or arrangements entered into by the Owner or a person or partnership that does not deal at arm’s length with the Owner (the “NAL Person”) that:
- have the effect of eliminating all or substantially all of the risk of loss and opportunity for gain or profit in respect of the asset (or would have that effect if entered into by the Owner instead of the NAL Person);
- where an agreement or arrangement has been entered into by an NAL Person, the agreement or arrangement can reasonably be considered to have been entered into, in whole or in part, for the purpose of eliminating all or substantially all of the risk of loss and opportunity for gain or profit in respect of the asset; and
- do not result in a disposition of the asset within one year after the relevant agreements and arrangements are entered into.
Leases of tangible or corporeal property are expressly excepted from being synthetic disposition arrangements. There is no exception for leases of intangible property.
The Budget says that the synthetic disposition arrangement measure is not intended to apply to ordinary hedging transactions designed to manage risk of loss or to ordinary course securities lending arrangements.
The one year period component of the definition of synthetic disposition arrangement provides a safe harbour rule from the deemed disposition under the new synthetic disposition arrangement measure. If, for example, a taxpayer enters into a forward sale of an asset combined with an immediate secured loan from the forward sale purchaser of an amount equal to the forward sale purchase price and the closing date is 364 days in the future, this will not be a synthetic disposition arrangement.
However, the Budget Papers note that transactions which eliminate risk of loss and chance of gain but do not otherwise result in a current disposition for tax purposes can be challenged based on the existing rules in the Tax Act. One would hope that CRA will generally not pursue transactions that fall outside the new synthetic disposition arrangement rule because there is a disposition within one year. Presumably, this will depend on the circumstances of each particular situation.
Where the relevant agreements or arrangements are entered into by the Owner, there is no purpose test. Whether the agreements or arrangements constitute a synthetic disposition arrangement is determined by the effect or result of the agreements or arrangements. Where the relevant agreements or arrangements are entered into by an NAL Person, they will not constitute a synthetic disposition arrangement unless they were entered into for the purpose of eliminating all or substantially all of the risk of loss and opportunity for gain or profit in respect of the asset.
The definition of synthetic disposition arrangement as proposed in the Budget is very broad. Taxpayers who regularly undertake hedging and derivative transactions for financial, rather than tax, purposes may well find it difficult to know with certainty when they are entering into a synthetic disposition arrangement and when they aren’t.
When a synthetic disposition arrangementin respect of an asset is entered into (by the Owner or an NAL Person), the Owner is deemed to have disposed of the asset for proceeds of disposition equal to the fair market value of the asset at that time. If these proceeds exceed the Owner’s tax cost for the asset, the Owner will have a gain taxable on income or capital account depending on the usual factors. The synthetic disposition arrangement rule does not address whether any resulting gain or loss is on income or capital account.
The Owner is also deemed to have reacquired the property immediately after the deemed disposition at a cost equal to fair market value.
It appears that a deemed disposition as a result of having a synthetic disposition arrangement will only accelerate the taxpayer’s gain and will not accelerate losses. This is because the deemed reacquisition of the subject asset would appear to engage the suspended or superficial loss rules.
The deemed disposition and reacquisition of the asset by the Owner as a result of having a synthetic disposition arrangement will not have any tax consequences for other parties involved in the relevant agreements or arrangements.
The Budget provides for consequences of a synthetic disposition arrangement in two areas where the length of ownership of an asset is important – stop loss rules for shares and foreign tax credits.
The Budget will ensure that a synthetic disposition cannot be used to continue legal ownership of an asset so as to meet holding period tests in the stop loss and foreign tax credit provisions while the taxpayer has eliminated all or substantially all of the risk of loss and opportunity for gain or profit in respect of the particular asset.
In certain circumstances, dividends received by a corporation on a share which are deductible by the recipient under section 112 of the Tax Act will reduce a loss realized on a subsequent disposition of the share. This stop loss rule will not apply in certain circumstances if the share in question has been held for at least 365 days.
A taxpayer is deemed not to own a particular share for the purpose of the stop loss rule described above if the taxpayer has been deemed to have disposed of the share under the synthetic disposition arrangement rule, or would be deemed to have disposed of the share under the synthetic disposition arrangement rule if the one year safe harbour were reduced to 30 days, and the taxpayer did not own the share throughout the 365 days before the synthetic disposition arrangement was entered into. This deemed “non-ownership” continues as long as the agreements or arrangements, which result in there being a synthetic disposition arrangement, remain in effect.
In certain circumstances, the foreign tax credit otherwise available to a Canadian taxpayer for foreign withholding taxes paid on foreign source dividend or interest income can be reduced if the taxpayer has disposed of the share or debt obligation on which the dividend or interest was paid within one year after acquiring it.
If a taxpayer has been deemed to have disposed of a share or debt obligation under the synthetic disposition arrangement rule, or would be deemed to have disposed of a share or debt obligation under the synthetic disposition arrangement rule if the one year safe harbour were reduced to 30 days, and the taxpayer did not own the asset throughout the 365 days before the synthetic disposition arrangement was entered into, then, for the purpose of the foreign tax credit limitation rule described above, the taxpayer is deemed to have last acquired the relevant share or debt obligation on the earlier of the time immediately before the share or debt obligation is disposed of and the time that the agreements or arrangements that resulted in there being a synthetic disposition arrangement are no longer in effect.
The synthetic disposition arrangement measure applies 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.
Character Conversion Transactions
In an effort to close perceived tax loopholes, the Budget is cracking down on financial arrangements commonly known as character conversion transactions. Generally, character conversion transactions are transactions that reduce tax by converting ordinary income into capital gains by way of a derivative contract. Instead of challenging these transactions under the current framework of the Tax Act, the Budget proposes legislative amendments to curtail the perceived abuse.
Typically, a character conversion transaction links a derivative investment with the purchase or sale of an otherwise unrelated capital property to form a derivative forward agreement. The pricing formula for the capital property is not based upon the performance of the actual capital property. Instead, the pricing formula is based on the performance of other portfolio investments that produce fully taxable income. If these investments were not coupled together, income from the derivative investment would be taxed as ordinary income and not as a capital gain.
To ensure the appropriate tax treatment of the derivative-based return on a derivative forward agreement, the Budget proposes to treat this return separately from the disposition of the capital property that is purchased or sold under the forward agreement. This measure will apply to derivative forward agreements that have a duration of more than 180 days.
The Budget proposes to amend various parts of the Tax Act to curtail the perceived abuse. Generally, the proposed changes will treat any return arising under a derivative forward agreement that is not determined by reference to the performance of the capital property as being purchased or sold on account of income.
The income (or loss) will be included (or deducted) in the taxpayer’s income at the time of disposition if the capital property is subject to a derivative forward sale agreement and included in the taxpayer’s income at the time of acquisition if the capital property is subject to a derivative forward purchase agreement.
In order to prevent double tax, the Budget also proposes to have the adjusted cost base of the capital property increased (or decreased) to the extent that any income (or loss) is recognized as described above.
This measure will apply to derivative forward agreements entered into on or after Budget Day. It will also apply to derivative forward agreements entered into before Budget Day if the term of the agreement is extended on or after Budget Day.
Trust Loss Trading
The Tax Act restricts the use of pre- and post-acquisition losses where a corporate taxpayer has undergone an acquisition of control. Non-capital losses may be used to offset income earned in the same business after the acquisition.
The Budget proposes to extend these restrictions to trusts, with appropriate modifications. The proposed measure will trigger the application of loss-streaming and related rules to a trust when a person or partnership, together with affiliates, becomes a majority-interest beneficiary of the trust, or when a group becomes a majority-interest group of beneficiaries of the trust (each referred to as a “loss restriction event”). Majority-interest is determined with reference to the fair market value of income or capital interests in the trust.
Existing rules deem certain transactions or events to involve (or not involve) an acquisition of control of a corporation, e.g. death of a shareholder and transactions within certain groups of shareholders. These rules will be extended to apply, with appropriate modifications, in determining whether a trust is subject to a loss restriction event. As a result, it is expected that many typical transactions or events involving changes in the beneficiaries of a personal (family) trust will not be loss restriction events. Stakeholders are invited to comment as to whether there are additional transactions or events that should be treated similarly in determining whether a personal trust is subject to a loss restriction event.
This measure, including any relieving changes that may be made as a result of the public consultation, will apply to transactions that occur on or after Budget Day, unless the transaction is completed pursuant to the terms of a written agreement entered into before Budget Day, pursuant to which the parties are not excused from completing the transaction as a result of changes to the Tax Act.
The Tax Act contains an attribution rule whereby the income or capital gains from property held by a trust, including a non-resident trust, may be attributed to a Canadian resident taxpayer. Such attribution may occur where a contributor to the trust retains “effective ownership” over the property contributed to the trust in one of the following manners:
- the property may revert to the taxpayer;
- the property may pass to persons to be determined by the taxpayer at a time subsequent to the creation of the trust; or
- the property is held on condition that, during the existence of the taxpayer, the taxpayer retains control over the disposition of the property by the trust.
Historically, the Federal Government’s position has been that a sale of property by a beneficiary to a trust would be caught by the above rule, on the basis that the property sold to the trust may revert to the beneficiary in the future. This was the Federal Government’s position even where the sale occurred for fair market value consideration.
This position was held to be incorrect in the recent case of Sommerer v. The Queen(2011 TCC 212, upheld by the Federal Court of Appeal, 2012 FCA 207), where the Courts held that the attribution rule did not apply on a sale of property to a trust by a beneficiary for fair market value consideration. The trust in that case happened to be a non-resident trust.
The Budget expresses the Federal Government’s view that the result in Sommererwas contrary to intended tax policy with respect to non-resident trusts. Accordingly, the Budget proposes to amend the Tax Act such that when a Canadian resident taxpayer transfers or loans property directly or indirectly to a non-resident trust and retains “effective ownership” over the property in the manner described above, the transfer or loan will be treated as a transfer or loan of“restricted property” by the taxpayer. This will cause the deemed residence rules to apply to the trust.
It appears, however, that the reasoning in Sommerer will continue to apply to Canadian resident trusts, such that sales of property by Canadian resident beneficiaries to Canadian resident trusts for fair market value consideration should not trigger the application of the attribution rule described above, notwithstanding the CRA’s earlier administrative position.
These amendments will apply to taxation years that end on or after Budget Day.
Consultation on Graduated Rate Taxation of Trusts and Estates
Currently, income that arises in most inter vivos trusts is taxed at the highest federal tax rate for individuals (i.e., 29%) when it is taxed in the trust and not allocated out to a beneficiary. The income arising in an estate prior to distribution of the estate, in testamentary trusts that are created by Will, and in certain inter vivos trusts (created before June 18, 1971) pay federal income tax at the graduated tax rates applicable to individuals. Where a Will contains testamentary trusts for several family members, the family can benefit from significant tax savings. One result of this difference in applicable tax rates is that, for inter vivos trusts, annual income is usually made payable to the beneficiaries, whereas with testamentary trusts, the income can remain in the trust and added to capital in the subsequent year.
The Federal Government expressed concern in the Budget that this difference in tax treatment for different types of trusts raises questions of tax fairness and neutrality between the treatment of beneficiaries of outright bequests and beneficiaries of inter vivos trusts. As well, concern about delays in administering and distributing an estate in order to continue the availability of multiple graduated rates was raised. In the Budget, the Federal Government expressed the concern that tax planning strategies that incorporate multiple testamentary trusts negatively impact the tax base.
The Federal Government announced in the Budget that it will consult with stakeholders on possible measures to eliminate the tax benefits that arise from taxing testamentary trusts, estates administered over long periods, and pre-June 18, 1971 grandfathered inter vivos trusts at graduated rates. A consultation paper will be released to the public to provide stakeholders with an opportunity to comment on proposed measures.
While testamentary trusts are often used in estate planning to hold bequests from the testator to his or her spouse, children, or other family members, the achievement of tax savings from the creation of these trusts is only one of a number of motivators. For example, many trusts are established in Wills for minor beneficiaries or beneficiaries who are not ready to manage the income the assets may generate. Testamentary trusts are also used for spouses in second marriage situations, in order to preserve capital property for the testator’s children. Testamentary trusts are often used to protect spend-thrift family members from depleting their assets imprudently, and for disabled beneficiaries in order to preserve their entitlement to government benefits. It would be unfortunate if the Federal Government instituted changes to the tax treatment of income in testamentary trusts that would force trustees to pay out income to beneficiaries who are unable to manage money or who would lose important government assistance as a result.
Registered Pension Plans: Correcting Contribution Errors
The Budget proposes to enable administrators of Registered Pension Plans (“RPPs”) to make refunds of contributions in order to correct reasonable errors without first obtaining approval from the Canada Revenue Agency (“CRA”) if the refund is made no later than December 31 of the year following the year in which the inadvertent contribution was made. If an RPP administrator seeks to correct a contribution error after the deadline, the existing procedure, which requires an administrator to seek authorization from the CRA, will continue to apply. Refunds to an RPP member will generally be reported as income of the member in the year received, and deductions claimed by the member in a prior year will generally not be adjusted. For employers who generally use the accrual method of calculating income, a refund of RPP contributions will normally reduce the RPP contribution expense for the year to which it relates.
This measure will apply in respect of RPP contributions made on or after the later of January 1, 2014 and the date of Royal Assent to the enacting legislation.
Labour-Sponsored Venture Capital Corporations Tax Credit
The Budget proposes to phase out the 15% federal Labour-Sponsored Venture Capital Corporations (“LSVCC”) tax credit provided to individuals for the acquisition of shares of LSVCCs on investments of up to $5,000 each year (providing up to $750 in federal tax relief).
The federal LSVCC tax credit will remain at 15% when it is claimed for a taxation year that ends before 2015 and will be reduced to 10% for the 2015 taxation year and 5% for the 2016 taxation year. The federal LSVCC tax credit will be eliminated for the 2017 and subsequent taxation years.
The Budget also proposes to end new federal LSVCC registrations, as well as the prescription of new provincially registered LSVCCs in the Tax Act. An LSVCC will not be federally registered if the application for registration is received on or after Budget Day. A provincially registered LSVCC will not be prescribed for purposes of the federal LSVCC tax credit unless the application was submitted before Budget Day.
In order to assist with an orderly phase-out of the federal LSVCC tax credit, the Federal Government is seeking stakeholder input on potential changes to the tax rules governing LSVCCs, including the rules related to investment requirements, wind-ups and redemptions. The Federal Government will also work with provincial governments with respect to the phase-out of the federal LSVCC tax credit. Stakeholders are encouraged to submit comments with respect to potential changes by May 31, 2013.
Lifetime Capital Gains Exemption
The Tax Act presently provides a lifetime capital gains exemption (“LCGE”) of $750,000 in respect of the capital gains realized on the disposition of qualified property (e.g., qualified small business corporation shares and qualified farm property). Beginning in the 2014 taxation year, the Budget proposes to increase the LCGE by $50,000, to $800,000. The new LCGE limit will apply to all individuals, even those who have previously used their then available LCGE. The LCGE will also be indexed to inflation for taxation years after 2014.
Dividend Tax Credit
The “gross-up” factor and dividend tax credit (“DTC”) applicable to non-eligible dividends was introduced to achieve tax “integration”between income earned by an individual directly, and income earned by a corporation and distributed to an individual as a dividend. Perfect tax integration would mean that the total amount of tax paid in each situation would be the same. According to the Federal Government, the current integration mechanism over-compensates individuals for income taxes presumed to have been paid at the corporate level on active business income, and the DTC on non-eligible dividends places an individual who receives this dividend income from a corporation in a better tax position than if the individual had earned the income directly.
The Budget proposes to adjust the current DTC and gross-up factor applicable to non-eligible dividends in an effort to achieve integration.
The Budget proposal to address this issue adjusts 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. Expressed as a percentage of the grossed-up amount of a non-eligible dividend, this adjusts the effective rate of the DTC in respect of such a dividend from 13.3% to 11%. As a result, the effective federal tax rate on non-eligible dividends will increase from 19.58% to 21.22%.
This measure will apply to non-eligible dividends paid after 2013.
Extension of the Mineral Exploration Tax Credit for Flow-Through Share Investors
Under flow-through share agreements, corporations that incur certain expenses in connection with mineral exploration work undertaken in Canada may renounce or “flow” such expenses through to their shareholders. The shareholders may claim a deduction from their income for the renounced expenses. A 15% federal tax credit is also available for specified mineral exploration expenses once renounced.
The Budget proposes to extend the mineral exploration tax credit for one additional year to flow-through share agreements entered into on or before March 31, 2014.
The Tax Act contains a one-year look-back rule, which enables funds raised in one calendar year that receive the benefit of the mineral exploration tax credit to be spent on eligible exploration up to the end of the following calendar year. The Budget proposals allow funds raised with the credit during the first three months of 2014 to support eligible exploration until the end of 2015.
Adoption Expense Tax Credit
The Tax Act provides a non-refundable adoption expense tax credit (the “AETC”) of 15% (up to a maximum of $11,669 in 2013) for expenses incurred by adoptive parents in relation to their adoption of a child who is under the age of 18. Presently, the AETC covers adoption expenses incurred from the time that a child is matched with his or her adoptive parents to the time that he or she begins living with them. The AETC is only available for the taxation year in which an adoption is finalized.
The Budget proposes to expand the scope of the AETC by extending the adoption period to which the credit applies by treating the time at which the adoption period begins as:
- the time that an adoptive parent applies to a provincial government ministry or to a licensed adoption agency to register for adoption; or
- if an application regarding the adoption of a child is made to a Canadian court, that earlier time.
The expansion of the AETC’s scope is intended to better recognize that adoptive parents face adoption-related expenses even before being matched with a child. The new measure will apply to all adoptions that were finalized after the 2012 taxation year.
Deduction for Safety Deposit Boxes
The cost of renting a safety deposit box from a financial institution will no longer be tax-deductible. Historically, safety deposit box rental costs were considered to fall within the category of expenses related to earning income from business or investments. The need to keep investment and business papers safe justified the tax-deductibility of safety deposit box rental charges. However, in an increasingly electronic and digital world, safety deposit boxes may no longer be used for business or investment purposes, but rather, to hold valuables and other personal property.
This measure will apply to all taxation years that begin before or after Budget Day.
Sales and Excise Tax Measures
GST/HST and Health Care Services
Home Care and Personal Services
Currently, an exemption from GST/HST exists for publicly subsidized or funded homemaker services, such as cleaning, laundering, meal preparation and child care, rendered to an individual who, due to age, infirmity or disability, requires assistance in the home. The Budget proposes to expand this exemption to publicly subsidized or funded personal care services, such as bathing, feeding, assistance with dressing and taking mediations, rendered to such individuals. The expanded exemption will apply to supplies made after Budget Day.
Reports and Services for Non-Health Care Purposes
The Budget proposes to clarify that GST/HST applies to reports, examinations and other services that are not performed for the purpose of protection, maintenance or restoration of the health of a person or palliative care, even if provided by health care professionals. Such services would include, for example, reports prepared solely for the purpose of determining liability in court proceedings.
GST/HST Pension Plan Rules
The Budget proposes two measures to simplify employer compliance with GST/HST pension plan rules.
Election Not to Account for GST/HST on Taxable Supplies.
An employer participating in a registered pension plan will be permitted to jointly elect with a pension entity of that pension plan to treat an actual taxable supply by the employer to the pension entity as being for no consideration where the employer accounts for and remits tax on the deemed taxable supply. The election remains in effect until it is jointly revoked by the employer and the pension entity effective from the beginning of a fiscal year for the employer. Additionally, the Minister has discretion to cancel the election in certain circumstances. This measure applies to supplies made after Budget Day.
Relief from Accounting for GST/HST on Deemed Taxable Supplies
Under the existing GST/HST rules, an employer that participates in a registered pension plan is required to account for and remit GST/HST under the deemed taxable supply rules in respect of every acquisition, use or consumption of the employer’s resources in pension activities, even where the employer’s involvement in the pension plan is minimal.
The Budget proposes to relieve employers from applying the deemed taxable supplies rules for a fiscal year of the employer where the amount of the GST (and the federal component of the HST) that the employer was otherwise required to account for and remit under the deemed taxable supplies rules in the preceding fiscal year is less than each of the following amounts:
- $5,000; and
- 10% of the total net GST (and the federal component of the HST) paid by all pension entities of the pension plan in that preceding fiscal year.
In certain circumstances, employers that do not meet these thresholds may qualify for limited relief. This measure will apply in respect of any fiscal year of an employer that begins after Budget Day.
GST/HST Business Information Requirement
Businesses are generally required to provide the CRA with certain business identification when they register for GST/HST. Currently, a $100 penalty applies for failure to provide this information. The Budget proposes that the CRA be given authority to withhold GST/HST refunds until such time as all prescribed business identification information is provided to CRA. This measure will apply on Royal Assent to the enacting legislation.
GST/HST on Paid Parking
Supplies of Parking by PSBs
Supplies of a property or service made by a Public Sector Body (“PSB”) are exempt from GST/HST if all or substantially all (i.e., 90% or more) of the supplies of the property or service are made for free. The Budget clarifies that this exempting provision does not apply to supplies of paid parking made by way of lease, licence or similar arrangement in the course of a business carried on by a PSB. Occasional supplies of paid parking by a PSB, such as those made as part of a special fund-raising event, would continue to qualify for the GST/HST exemption. This measure will be effective the date the GST legislation was enacted.
Supplies of Paid Parking by Charities
Supplies of parking made by charities (other than municipalities, universities, public colleges, schools or hospitals) are exempt from GST/HST. The Budget clarifies that this exemption does not apply to supplies of paid parking that are made by way of lease, licence or similar arrangement in the course of a business carried on by a charity set up or used by a municipality, university, public college, school or hospital to operate a parking facility. This measure will apply to paid parking supplies made after Budget Day.
GST/HST Treatment of the Governor General
For supplies made after June 30, 2013, the current GST/HST exemption for the Governor General is proposed to end.
Excise Duty Rate on Manufactured Tobacco
Effective after Budget Day, the rate of excise duty on manufactured tobacco (e.g. chewing tobacco or fine-cut tobacco used in roll-your-own cigarettes) is proposed to increase from $2.8925 to $5.3125 per 50 grams or fraction thereof.
First-Time Donor's Super Credit
For an in depth review of the provisions of the Budget impacting the Charities sector please click here for Miller Thomson's Charities and Not-for-Profit Budget Update.
The Federal Government has introduced a new temporary tax incentive to encourage young Canadians to make charitable donations. First-time donors who make charitable gifts prior to 2018 will receive an additional 25% tax credit, over and above the tax credit that is normally available for charitable gifts.
The Budget proposes to introduce a temporary First-time Donor’s Super Credit (“FDSC”). As noted, the FDSC will supplement the standard tax credit with an additional 25% tax credit for a first-time donor on up to $1,000 of donations. Under the new rules, the combined federal tax credits available in respect of the first $1,000 given by a first-time donor will be as follows:
- 40% for donations of $200 or less; and
- 54% for all donations over $200 but not exceeding $1,000.
Only donations of money will qualify for the FDSC. Gifts of property will not qualify. The FDSC is also available only to individuals. Corporations making charitable donations for the first time will not be eligible for the FDSC, and will be limited to the tax deduction normally available for charitable donations by corporations.
In order to qualify as a “first-time donor”, neither the donor nor the donor’s spouse or common law partner (as of December 31 of the year of the gift) can have claimed a donation tax credit or FDSC in any taxation year after 2007. First-time donor couples may share the FDSC in a taxation year. However, the rules provide that the total tax credit that can be claimed by both spouses or common law partners cannot exceed the amount that would be permitted if only one spouse/common law partner were permitted to claim the FDSC.
The FDSC is a time-limited measure. It will only be available for donations made on or after March 21, 2013, and may be claimed only once in the 2013 year or in subsequent years ending prior to 2018. Donations made after December 31, 2017 will not be eligible for the FDSC.
Expanded Collection and Enforcement Powers related to Charitable Donation Tax Shelters
The Budget introduces two measures that will significantly increase the power of the CRA to reassess and collect taxes from donors who have participated in charitable donation tax shelters. Together with measures introduced in previous Budgets which imposed increased penalties for tax shelter promoters and through administrative policies of the CRA, these measures reflect the Federal Government’s continuing efforts to discourage participation in such tax shelters.
Extended Reassessment Period: Tax Shelters and Reportable Transactions
The Budget extends the period in which CRA is permitted to reassess taxpayers who have claimed donation tax credits in respect of a tax shelter donation arrangement. Normally, upon receiving a taxpayer’s filed tax return and after its initial assessment of tax payable, CRA has three years to reassess the donor’s tax liability. In the context of donation tax shelters, such a reassessment would normally occur following an audit of the tax shelter arrangement. CRA requires that information returns must be filed by tax shelter promoters so as to enable CRA to identify and audit tax shelters.
The Budget notes, however, that CRA’s ability to reassess the donor may be delayed or prevented if the tax shelter promoter fails to file the required information return or does not provide documents necessary for a proper audit of the tax shelter. This may result in CRA being unable to conclude its audit of the tax shelter until after the normal reassessment period for the donor has expired. This would prevent CRA from reassessing the donor in respect of tax credits or deductions claimed in respect of the shelter.
The Budget proposes to extend the normal reassessment period for participants in a tax shelter arrangement (but only with respect to the tax shelter) where the promoter of the tax shelter fails to file the required tax shelter information return on time. The reassessment period of the participant will be extended for three years after the promoter files the required return.
A similar extension of the reassessment period will apply in respect of participants in “reportable transactions”, as set out in proposed amendments to the Tax Act, in respect of which promoters must file information returns. Reportable transactions consist essentially of tax avoidance arrangements (including donation arrangements) in respect of which a promoter or advisor will receive a fee, and in respect of which the promoter or advisor had confidential protection or some form of contractual protection (e.g., insurance) in respect of the arrangement.
This measure is proposed to apply to taxation years that end on or after March 21, 2013. It is likely a sensible measure.
Taxes in Dispute and Charitable Donation Tax Shelters
The Budget proposes new legislation that would significantly increase CRA’s ability to collect taxes immediately from donors to donation tax shelter arrangements, even where such taxes are in dispute.
The Budget notes that CRA is generally prohibited from taking collection action in respect of assessed income taxes as well as related interest and penalties where a taxpayer has objected to the assessment. However, the Budget states that in the charitable donation tax shelter context, notwithstanding CRA’s general success in tax shelter litigation, donors may use such litigation as a means of delaying the payment of taxes. Accordingly, the Budget introduces a new measure that modifies the general prohibition on CRA collection action. Proposed legislation in the Budget would provide that where a taxpayer has objected to an assessment of tax (including interest or penalties) that results from the denial of tax credits or deductions claimed in respect of a charitable donation tax shelter arrangement, CRA will be permitted, pending the ultimate determination of the taxpayer’s liability, to immediately collect 50% of the disputed tax, interest or penalties.
The Budget states that this measure is taken in order to discourage participation in questionable charitable donation tax shelters and to reduce the risk that unpaid amounts will ultimately become uncollectible.
This proposed measure will apply in respect of amounts assessed for the 2013 and subsequent taxation years. While it will no doubt assist CRA in discouraging donations tax shelter participation, it is troubling from a tax system fairness perspective.
Information Regarding Unnamed Persons
The Tax Act allows the CRA to require information from a person (referred to as a“third party”) for the purpose of verifying the tax compliance of unnamed persons, provided the CRA obtains a court order. The Tax Act currently allows the CRA to apply to court on an ex parté basis, i.e., without notifying the third party. If the court order is granted, the third party has the ability to have the order reviewed by the Federal Court, and the court has discretion to cancel, confirm or vary the previous court order.
The Federal Government believes this right of review delays the CRA’s ability to obtain information needed by it to properly administer the Tax Act. The Budget proposes to amend these provisions by requiring the CRA to notify the third party before obtaining a court order compelling disclosure of the information of unnamed persons. The third party will be able to participate in the CRA court application, but will have no further right to a judicial review.
This change was motivated by two recent Federal Court of Appeal cases: Canada (National Revenue) v. RBC Life Insurance Company and Canada (National Revenue) v. Lordco Parts Ltd. (“Lordco”), wherein a court order obtained by the Minister of National Revenue was cancelled on judicial review. In the Lordco case, Miller Thomson litigator Daniel Kiselbach represented Lordco Parts Ltd. and was successful in arguing that the representatives of the Minister of National Revenue did not make full and frank disclosure in the Minister's ex parté application for the requirements to provide information on unnamed persons.
The measure will apply upon Royal Assent of the legislation enacting the amendment.
Electronic Suppression of Sales Software Sanctions
To combat tax evasion, the Budget proposes new monetary penalties and criminal offences under the Excise Tax Act and the Tax Act in respect of the use, possession, acquisition, manufacture, development, sale, possession for sale, offer for sale or otherwise making available, electronic suppression of sales (“ESS”)software (commonly known as “zapper” software). The measures will apply on the later of January 1, 2014 and Royal Assent to the enacting legislation.
Aboriginal Tax Policy
The Federal Government has entered into 34 sales tax arrangements under which Indian Act bands and self-governing Aboriginal groups levy a sales tax within their settlement and reserve lands. The Federal Government has also entered into 14 income tax arrangements under which self-governing Aboriginal groups impose personal income tax on residents of their settlement lands. The Federal Government has expressed a willingness to enter into more direct tax arrangements with Aboriginal governments and supports the provinces and territories entering into similar tax arrangements with Aboriginal governments.
Customs Tariff Measures
Tariff Relief for Canadian Consumers
The Budget proposes to eliminate customs tariffs on baby clothing, and sports and athletic equipment (excluding bicycles) for goods imported into Canada after March 31, 2013.
Modernizing Canada's General Preferential Tariff Regime for Developing Countries
It also proposes to change the General Preferential Tariff (“GPT”) regime under the Customs Tariff to ensure that the development assistance intended to be provided by the GPT to developing countries is appropriately aligned with the global economic landscape and targets benefits to countries most in need. These changes will be effective for goods imported into Canada after December 31, 2014, and will be extended for 10 years, until December 31, 2024.
Previously Announced Measures
The Government intends to proceed with the following previously announced tax and related measures, as modified to take into account consultations and deliberations since their release:
- Proposed changes to certain GST/HST rules relating to financial institutions released on January 28, 2011;
- Automobile expense amounts for 2012 announced on December 29, 2011, and for 2013 announced on December 28, 2012;
- Legislative proposals implementing the proposed changes to the life insurance policyholder exemption test announced in the March 29, 2012 Budget;
- Legislative proposals released on June 8, 2012 relating to improving the caseload management of the Tax Court of Canada;
- Legislative proposals released on July 25, 2012 relating to specified investment flow-through entities, real estate investment trusts and publicly-traded corporations;
- Legislative proposals released on November 27, 2012 relating to income tax rules applicable to Canadian banks with foreign affiliates; and
- Legislative proposals released on December 21, 2012 relating to income tax technical amendments.