The Minister of Finance (Canada), the Honourable James Flaherty, tabled the 2014 Federal Budget ("Budget 2014") on February 11, 2014 ("Budget Day"). Budget 2014 did not propose any changes to the personal or corporate income tax rates, however, it did contain several significant proposed amendments to the Income Tax Act (Canada) (the "ITA") and the Excise Tax Act (Canada) (the "ETA"), while also indicating an intention to study, or continue studying, new and previously announced tax measures and policies. While this budget addressed a wide range of tax issues, one cannot help but feel that, in respect of tax matters, Budget 2014 proposes to take more than it gives.
In summary, significant Budget 2014 proposals in respect of the ITA include:
- new captive insurance and offshore banking anti-avoidance rules in the foreign affiliate regime;
- disallowing back-to-back arrangements that avoid the thin capitalization rules and Part XIII withholding tax on interest;
- generally, subjecting testamentary trusts to flat top-rate taxation and eliminating immigration trusts;
- proposing to study the replacement of the eligible capital property ("ECP") regime with comparable treatment under the capital cost allowance ("CCA") system; and
- providing updates and announcing further consultations on base erosion, a proposed domestic treaty shopping rule, exchanges of information between Canada and other countries and non-profit organizations.
With respect to the ETA, significant proposals include:
- the broadening of the application of two existing goods and services tax/harmonized sales tax ("GST/HST") joint elections;
- the addition to the list of zero–rated and exempt supplies made in the health care sector; and
- a specific change designed to combat the underground economy that may result in unwarranted registrations of non–resident persons for GST/HST purposes.
International Tax Measures
Budget 2014 proposes to broaden the back-to-back loan provisions in the thin capitalization rules and to deny the arm's length interest withholding tax exemption for back-to-back loans.
The thin capitalization rules limit interest deductions on debt to non-arm's length non-resident shareholders and certain other non-residents (a "Specified Non-Resident"). The Department of Finance ("Finance") is concerned about arrangements in which taxpayers interpose a third party such as a foreign bank between two related taxpayers (e.g. a foreign parent and its Canadian subsidiary) in order to avoid the thin capitalization rules and/or avoid withholding tax on interest.
Budget 2014 is therefore expanding the existing thin capitalization back-to-back loan rule to cover secured and limited recourse arrangements. In simplified terms, a back-to-back loan will now exist where:
- a taxpayer has an interest-bearing obligation to a third party intermediary; and
- a Specified Non-Resident pledges property to the intermediary to secure the obligation, has limited recourse debt of the intermediary or makes a loan to the intermediary on condition that the intermediary make a loan to the taxpayer.
In these circumstances, for thin capitalization purposes, the taxpayer will be deemed to be indebted to the Specified Non-Resident (capped at the fair market value of the pledged property, amount of the limited recourse loan, or loan made on condition, as applicable), and will correspondingly be deemed to have paid interest directly to the Specified Non-Resident.
Budget 2014 says that a guarantee, in and of itself, will not be considered a pledge of property.
The taxpayer will be deemed for Part XIII purposes to have paid interest to the Specified Non-Resident if the back-to-back arrangement reduces the Part XIII tax on interest.
The thin capitalization measure will apply to taxation years after 2014 and the Part XIII measure to interest paid or credited after 2014.
Budget 2014 expands an existing anti-avoidance rule in the foreign accrual property income ("FAPI") provisions that prevents Canadian taxpayers from moving income from insuring Canadian risks to foreign affiliates in low tax jurisdictions.
Generally, the existing rule includes income from insuring Canadian risks in FAPI if 10 % or more of the gross premium income (net of reinsurance ceded) relates to Canadian risks (i.e., risks in respect of persons resident in Canada, property situated in Canada or businesses carried on in Canada).
The new rule targets arrangements (sometimes referred to as "insurance swaps") under which a foreign affiliate exchanges Canadian risks with a third party for foreign risks but retains the economics of the Canadian risks.
Budget 2014 does this by deeming a foreign affiliate's income from foreign risks to be FAPI where: (i) the foreign affiliate's risk of loss or opportunity for profit on foreign risks can reasonably be considered to be determined by reference to the returns from other risks insured by other parties ("Tracked Risks"); and (ii) at least 10 % of the Tracked Risks are Canadian risks.
This measure will apply to taxation years beginning on or after Budget Day.
Offshore Regulated Banks
Under an exception in the existing FAPI provisions, a foreign financial institution that is regulated in its home jurisdiction generally earns active business income rather than FAPI.
Budget 2014 says this exception was intended to apply to bona fide financial services businesses, but that non-financial institution Canadian taxpayers are avoiding FAPI by forming regulated foreign financial institutions for proprietary investing and trading rather than providing financial services.
Budget 2014 therefore proposes to limit the regulated foreign financial institution exception to the following circumstances:
- the Canadian taxpayer that owns the foreign affiliate is a regulated Canadian financial institution (Schedule I bank, trust company, credit union, insurance corporation, or trader or dealer in securities or commodities that is resident in Canada and whose activities are supervised by the Superintendent of Financial Institutions or a similar provincial regulator), or a 100% subsidiary or parent of such an institution that is also subject to regulation; and
- more than 50% of the total taxable capital employed in Canada of the Canadian financial institution (and all related Canadian corporations) is attributable to taxable capital employed in Canada of regulated Canadian financial institutions.
Certain regulated Canadian financial institutions that have at least $2 billion in equity will be deemed to satisfy the second requirement (as well as their 100% subsidiaries and parent corporations).
This measure will apply to taxation years that begin after 2014. Stakeholders are invited to submit comments within 60 days after Budget Day.
International Tax Consultations and Updates
Budget 2014 provides an update and requests further consultations on four international tax initiatives.
Tax Planning by Multinational Enterprises
Budget 2014 highlights Canada's participation in the project of the Organisation for Economic Co-operation and Development (the "OECD") to address "base erosion and profit shifting" ("BEPS"). Canada confirms that it remains involved in working with other governments in resolving the issues addressed in the BEPS Action Plan released by the OECD in July 2013. This project is intended to grapple with the perception that multinational enterprises are able to effectively avoid corporate taxes in jurisdictions where they earn income by exploiting differences between domestic and international tax rules.
In order to assist Finance in establishing priorities and to guide Canada's participation in international dialogue on these issues, Finance is inviting input from stakeholders on the following questions:
- What are the impacts of international tax planning by multi-national enterprises on other participants in the Canadian economy?
- Which of the international corporate income tax and sales tax issues identified in the BEPS Action Plan should be considered the highest priorities for examination and potential action by Finance?
- Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to Finance?
- What considerations should guide Finance in determining the appropriate approach to take in responding to the issues identified – either in general or with respect to particular issues?
- Would concerns about maintaining Canada's competitive tax system be alleviated by co-ordinated multilateral implementation of base protection measures?
- What actions should Finance take to ensure the effective collection of sales tax on e-commerce sales to residents of Canada by foreign-based vendors?
Finance has invited stakeholders to submit comments within 120 days of Budget Day.
"Treaty shopping" was identified in last year's Budget as an important issue for Finance. This term generally refers to arrangements where a non-resident person, who would not otherwise be entitled to benefits under a tax treaty, uses an intermediary entity that is resident of a state with which Canada has concluded a tax treaty, in order to obtain treaty benefits. In August, 2013, Finance released a consultation paper on this topic and sought comments from interested stakeholders on alternative approaches that could be adopted by Finance to combat abusive treaty shopping. The concerns raised in the comments from stakeholders are briefly summarized in the Budget papers. In the final analysis, Finance appears to prefer a general domestic rule to prevent treaty shopping rather than negotiating changes to Canada's existing tax treaties.
Finance noted that it is an active participant in the OECD work on BEPS which includes plans to address the abuse of tax treaties. In September, 2014 the OECD is scheduled to release recommendations regarding the design of domestic tax rules to curb treaty shopping and these rules may be a factor in the approach adopted by Canada.
Finance is now seeking comments on a proposed rule to prevent treaty shopping. Ironically, there was little or no support for a domestic treaty shopping rule among the submissions made to Finance in connection with the consultation paper but now submissions are being sought on the best way to implement such a rule. To facilitate the feedback from stakeholders, the main elements of such a rule will include the following provisions.
- Main purpose provision - Subject to the relieving provision, treaty benefits would be denied if it is reasonable to conclude that one of the main purposes for undertaking the transaction was to obtain the treaty benefit.
- Conduit presumption - In the absence of contrary proof, there would be a presumption that one of the main purposes for undertaking a transaction that results in a treaty benefit was to obtain the benefit if the relevant treaty income is primarily used to pay, distribute or otherwise transfer, directly or indirectly, an amount to another person or persons that would not have been entitled to an equivalent or more favourable benefit had the other person or persons received the relevant treaty income directly.
- Safe harbour presumption - Subject to the conduit presumption, there would be a presumption, in the absence of contrary proof, that none of the main purposes for undertaking a transaction was for a person to obtain a benefit under a tax treaty in respect of relevant treaty income if:
- the person (or a related person) carries on an active business in the state with which Canada has concluded the tax treaty, and where the relevant treaty income is derived from a related person in Canada, the active business is substantial in comparison to Canadian activity;
- the person is not controlled, directly or indirectly in any manner whatever, by another person that would not have been entitled to an equivalent or more favourable tax benefit had the other person or persons received the relevant treaty income directly; or
- the person is a corporation or trust the shares or units of which are regularly traded on a recognized stock exchange.
- Relieving provision - Even if the main purpose provision applies, a relieving provision allows the benefit to be provided, in whole or in part, to the extent that it is reasonable having regard to all the circumstances.
In addition to seeking feedback in respect of the components of the proposed treaty shopping rule, Finance is requesting comments on these proposals with reference to the specific five examples provided in the Budget papers.
Interestingly, Budget 2014 confidently states that the proposed rule would not apply in respect of an ordinary transaction solely because obtaining a tax treaty benefit was one of the considerations for making an investment. Finance states that since one of the objectives of tax treaties is to encourage trade and investment, the obtaining of treaty benefits will often be a "general consideration" in ordinary transactions and not be the main purpose behind the decision to undertake a transaction.
If adopted, Finance has indicated that the proposed treaty shopping rules will be included in the Income Tax Conventions Interpretations Act, thus applying to all of Canada's tax treaties on enactment.
Automatic Exchange of Information
Budget 2014 provides an update of recent OECD and bilateral exchange of information arrangements. Finance notes that all future tax treaties and updates to such tax treaties will comply with OECD standards for information exchange.
Finance also referred to its recently concluded intergovernmental agreement (the "IGA") with the United States ("US") which contains significant exemptions and other relief to the US-enacted Foreign Account Tax Compliance Act ("FATCA"). While FATCA would have generally required non-US financial institutions to identify accounts held by US persons, the IGA only requires that Canadian financial institutions report information to the Canada Revenue Agency ("CRA") which will be transmitted to the Internal Revenue Service under existing exchange of information provisions in the Canada-United States Tax Treaty and subject to the confidentiality protections in that treaty.
Most types of Canadian registered accounts would be exempt from reporting as will smaller deposit-taking institutions. Finance stated that the CRA will not collect any taxes imposed by the US if the individual was a Canadian citizen at the time the tax liability arose (whether or not the individual was also a US citizen at the time).
The new reporting regime will start in July, 2014.
Finance points to the IGA as being consistent with Canada's support of international commitments to multilateral automatic exchange of information.
Tax Treaties and Tax Information Exchange Agreements ("TIEAs")
Budget 2014 provides an update regarding Canada's extensive tax treaty network and the high level of Canada's activity in the last year in negotiating new tax treaties, new TIEAs and amending existing tax treaties. Canada has 92 tax treaties in force, 3 tax treaties signed but not yet in force, and 8 tax treaties and protocols under negotiation.
Business Income Tax Measures
Consultation on Eligible Capital Property
Budget 2014 proposes to initiate public consultations on the replacement of the ECP regime with a new class of depreciable property to which the existing CCA rules would apply. The existing ECP regime generally governs the income tax treatment of expenditures that are of a capital nature (eligible capital expenditures) as well as certain receipts (eligible capital receipts) that are not otherwise accounted for as business income or in the rules that govern capital property. More generally, this regime governs such items as incorporation costs, customer lists and goodwill.
Finance concedes that the ECP regime has, over the years, become increasingly complex. As part of Budget 2014 Finance stated that it will be considering public input in respect of whether this complexity could be reduced through the integration of ECP in the existing CCA regime.
If implemented, the new rules would allow for the transfer of taxpayers' existing cumulative eligible capital pools ("CEC") to the newly proposed CCA class. The new CCA class would implement a 100% inclusion (as opposed to the 75% CEC inclusion) and a 5% annual depreciation rate as compared to the current 7% rate (of the 75% inclusion) that is provided under the current ECP regime.
In order to implement the new rules in the most straightforward manner possible, it is proposed that the existing CCA rules, including rules relating to recapture, capital gains and depreciation (i.e., the "half-year rule"), would apply. However, Finance also proposes to introduce special rules in respect of goodwill and expenditures that do not relate to specific property of the business (i.e., eligible capital expenditures or receipts under the ECP regime). Such expenditures and receipts would be accounted for by an adjustment to the capital cost of goodwill.
Expenditures that do not relate to specific property of the business would reduce the capital cost of the goodwill of the business and, consequently, reduce the balance of the new CCA class. If the amount of the receipt exceeded the capital cost of the goodwill, the excess would be a capital gain and any previously deducted CCA would be recaptured to the extent that the amount of the receipt exceeds the CCA balance of the class.
Tax Incentives for Clean Energy
In keeping with the Federal Government's continued, albeit tempered, implementation of clean energy initiatives, Budget 2014 proposes the expansion of the current accelerated clean energy generation CCA class (Class 43.2). This class provides an aggressive CCA rate that is equal to 50% per year on a declining balance basis.
The existing class incorporates (by reference to Class 43.1) a detailed list of eligible equipment including wind, solar and small hydro electricity generation equipment, equipment that generates fuel from waste and equipment that improves the efficiency of fossil fuel use (e.g. cogeneration systems).
In order to further encourage investment in technologies intended to reduce emissions of greenhouse gases and other air pollutants, Budget 2014 proposes the inclusion of water-current energy equipment and equipment used to gasify eligible waste fuel in a broader range of applications in the existing accelerated CCA class.
Extension of the Mineral Exploration Tax Credit for Flow-Through Share Investors
Budget 2014 proposes to extend eligibility for the 15% mineral exploration tax credit for one year to flow-through share agreements entered into on or before April 2015.
Personal Income Tax Measures
Taxation of Immigration Trusts
For several decades, non-residents of Canada have had the opportunity to establish a non-resident trust, informally known as an "immigration trust", which was not subject to Canadian taxation on its foreign source income for a 60-month period. The exemption from tax was intended to encourage high net-worth individuals to move to Canada, and in particular, executives who were temporarily transferred to Canada. The 60-month period initially matched the period of time it took to become a citizen of Canada at the time. A specific exemption was maintained for "immigration trusts" when the "non-resident trust" anti-avoidance rules were recently introduced.
Finance considers that the benefits that Canadian resident persons who are beneficiaries of, or contributors to, such trusts obtain from such trusts, raise tax fairness, integrity and neutrality issues.
Budget 2014 proposes to remove the exemption from the application of certain anti-avoidance rules to "immigration trusts". Consequently, such trusts will now be taxed as Canadian resident trusts under the "non-resident trust" rules. These changes will apply to most "immigration trusts" commencing in 2015.
Tax on Split Income ("Kiddie Tax")
Currently, the ITA imposes a tax on split income. This measure limits the ability of taxpayers to split income with a related minor by imposing the highest marginal individual rate (currently 29%) on split income paid or payable to the minor.
Split income includes, inter alia, income from a partnership or trust that is derived from providing property or services to a business carried on by a person related to the minor or in which the related person participates. Budget 2014 proposes to expand this category of split income by including income paid or allocated, directly or indirectly, to a minor from a partnership or trust if: (a) the income is derived from a source that is a business or is from rental property, and (b) the person related to the minor is actively engaged on a regular basis in the income earning activities of the trust or partnership, or, in the case of a partnership, has an interest in the partnership.
This measure will apply to the 2014 and subsequent taxation years.
Graduated Rates of Taxation of Trusts and Estates
Budget 2014 proposes to eliminate graduated rates for the taxation of testamentary trusts and certain grandfathered inter vivos trusts. The proposals will generally proceed with the measures described in the public consultation paper released on June 3, 2013.
The proposal will apply the top marginal tax rate to grandfathered inter vivos trusts, trusts created by will and certain estates, subject to two proposed exceptions.
The first exception is that the graduated rates will apply for the 36 months of an estate that arises on and as a consequence of an individual's death and that is a testamentary trust. After the 36 month period, the trust will be subject to taxation at the highest marginal tax rate.
Second, graduated rates will continue to be provided in respect of testamentary trusts established for the benefit of disabled individuals who are eligible for the federal Disability Tax Credit.
Charities and Non-profit Organizations
Donations of Ecologically Sensitive Land
Through the Ecological Gifts Program, donations to certain Canadian registered charities of gifts of certified ecologically sensitive land (or easements, servitudes and covenants on such land) qualify for charitable tax credits, if made by an individual, or charitable tax deductions, if made by a corporation. Capital gains associated with such donations are also tax exempt. Currently, credits or deductions from these donations can be carried forward for up to five years. Budget 2014 proposes to extend this carry-forward period to ten years.
This measure applies to donations made on or after Budget Day.
Donations by Estates
The Budget contains changes that are designed to provide individuals with more flexibility in utilizing charitable tax credits arising from a gift to a registered charity or other qualified donee made by will or through a beneficiary designation under a RRSP, RRIF, TFSA or life insurance policy.
Under the current rules, these donations are deemed to have been made by the individual immediately before his or her death and may only be applied against tax arising in the last two taxation years of the individual.
Under the new measures, these donations will be deemed to have been made by the individual's estate at the time the donated property is transferred to the qualified donee. The executors and trustees of the individual's estate will have the ability to allocate the charitable tax credits arising from the donation among: (i) the estate's taxation year in which the donation was made; (ii) an earlier taxation year of the estate; and/or (iii) the last two taxation years of the individual.
To qualify, the gifted property must be transferred to the qualified donee within 36 months of the individual's death. In the case of a donation by way of beneficiary designation, the existing rules for determining whether the donated property qualifies as eligible property apply. In all other cases (e.g., gifts by will), the donated property must have been received by the estate on and as a consequence of the individual's death or have been substituted for such property.
The current carry-forward period of five years will continue to apply to other donations made by an estate.
This measure will apply to the 2016 and subsequent taxation years.
Donations of Cultural Property
Under the current donation rules, the value of a charitable gift of property is deemed to be no greater than its cost to the donor if, generally, the donor acquired the property as part of a tax shelter gifting arrangement or held the property for a short period. Gifts of certified cultural property are exempt from this rule.
Budget 2014 proposes to remove this exemption where the certified cultural property was acquired under a gifting arrangement that qualifies as a tax shelter. Accordingly, the value of a gift of certified cultural property will be deemed to be no greater than the donor's cost if the donor acquired the property through a tax shelter gifting arrangement.
This proposed rule will not affect other donations of certified cultural property. It applies to donations made on or after Budget Day.
Non-Profit Organization ("NPO") Consultation Process
Budget 2014 announced a consultation process to review whether the NPO income tax exemption is properly targeted and whether the current reporting requirements for NPOs are sufficient. Finance is concerned that some NPOs may be earning profits that are not incidental to carrying out their non-profit purposes, making income available for the personal benefit of members and maintaining unduly large reserves. There is also concern that the current reporting requirements for NPOs may not allow the CRA to adequately assess the activities of NPOs in evaluating a NPO's entitlement to tax exemption.
The review will not extend to registered charities or registered Canadian amateur athletic associations. Finance intends to release a consultation paper for comment.
GST/HST, Customs and Excise Tax Measures
Broadening the GST/HST Election for Closely Related Persons
The ETA allows for certain closely related persons to make a joint election such that supplies made between them are deemed to occur for nil consideration, thus removing the GST/HST cost associated with such supplies. This beneficial election has a positive effect on cash flow for such taxpayers and decreases the administrative cost and likelihood of accounting error on such inter–company supplies.
However, there has been an apparent gap in the legislation since its inception that made it difficult or impossible for a newly formed entity to make this election – a shortcoming that was particularly felt in the context of internal corporate reorganizations and other corporate acquisition transactions.
The election is being amended by Budget 2014 to eliminate this shortcoming and thus will allow a newly formed person to take advantage of this joint election. This proposed change will not take effect until January 1, 2015.
However, the news is not all positive. One of the benefits of this election, as it presently exists, is that it need not be filed with the CRA. Budget 2014 proposes to add a filing requirement for this election, for both existing and new elections. Accordingly, all taxpayers that have made this joint election in the past will be required to file with the CRA in respect of the election. For such existing elections, the filing will not be due until January 1, 2016.
Further, Budget 2014 proposes to add joint and several liability treatment in certain circumstances for taxpayers that are party to these joint elections.
Broadening the GST/HST Joint Venture Election
Although Budget 2014 does not propose any specific legislative amendments, it does indicate that taxpayers can expect to see a broadening of the election that is presently only available to co–venturers engaged in certain types of joint ventures.
The election generally allows for co–venturers to account for GST/HST as if it were a partnership, by generally allowing a single elected "operator" to account for all of the GST/HST of the venture, rather than for each co–venturer having to account for its proportionate amount of the GST/HST ("Joint Venture Election"). However, the Joint Venture Election has, to date, only been available to joint ventures that carry on certain prescribed activities, most notably activities in real property development and the natural resource sector. Budget 2014 proposes to expand this election so that it is available to any joint venture that is exclusively engaged in commercial activities provided that the participants are also engaged exclusively in commercial activities, but promises certain anti–avoidance provisions as well.
Finance proposes to release draft legislation later in 2014 and to give the public an opportunity to provide its views on such legislation.
Good news for the Health Care Sector
Budget 2014 proposes three specific changes that will impact the health care sector. The biggest change will come for naturopaths and acupuncturists, whose services will now generally become exempt from GST/HST. Although this is good news for their patients, who will no longer have to pay the tax on such services, the naturopaths and acupuncturists will no longer be engaged entirely in commercial activities, and accordingly, will no longer be entitled to full input tax credits to recover the GST/HST spent on their inputs.
In addition, Budget 2014 proposes changes that will exempt the service of designing a training plan for a person with a disorder or disability from GST/HST. Again, this will allow for such services to be supplied without tax to the patients receiving this service, but will prevent the service provider from claiming input tax credits in respect of this service.
Finally, Budget 2014 proposes to modernize the zero–rating provision that allows for prescription eyewear to be purchased without GST/HST. Budget 2014 proposes to expand this provision to also include certain electronic devices designed to treat or correct defects in vision.
Unilateral GST/HST Registrations
Under the present legislation, a person cannot be compelled to register for GST/HST purposes, even if required to by law. Budget 2014 proposes to amend the ETA such that a person can be unilaterally registered for GST/HST purposes by the CRA.
Although this is designed as a means to combat the underground economy, there is risk that overzealous officers at the CRA may choose to unilaterally register non–resident corporations that have specifically designed their business relationships with Canadian customers to ensure that registration is not required, but that are in no way part of the underground economy.
The law surrounding the requirement for a non–resident person to register for GST/HST purposes, and its application, is complex and subtle. Allowing the CRA to unilaterally analyze and apply this law to non–residents provides some cause for concern.
Standardizing Sanctions Related to False Statements in Excise Tax Returns
To be consistent with other federal tax legislation, the portions of the ETA dealing with fuels, fuel-inefficient vehicles and automobile air-conditioners are to be amended to add administrative monetary penalties for false statements. In addition, the related criminal offence provisions are proposed to be amended to provide for the possibility of prosecution by indictment and potential prison sentences in addition to existing monetary penalties for the criminal offence.
Offshore Oil and Gas Development
A remission order permitting the duty-free temporary importation of mobile offshore drilling units ("MODUs") expires in May 2014. Budget 2014 proposes the elimination of the 20 % Most-Favoured-Nation rate of duty on importations of MODUs, thus permanently effecting a duty–free status for such goods.