The Canadian Government introduced its budget today ("Budget 2012") announcing a number of significant tax measures. The following is a brief summary of these measures, many of which come into effect today (the "Budget Day"). In the coming days, the Fasken Martineau tax group will be preparing and circulating detailed analysis of many of these tax changes and describing how they may affect our clients. Stay tuned.
Business Income Tax Measures
Clean Energy Generation Equipment: Accelerated Capital Cost Allowance (CCA)
Budget 2012 proposes to expand existing incentives relating to the purchase of clean energy generation equipment.
Currently, the Income Tax Regulations provide an accelerated CCA rate for taxpayers investing in clean energy generation and conservation equipment (Class 43.2). Budget 2012 proposes to expand the type of clean energy equipment that is included in Class 43.2 and eligible for accelerated CCA.
It is proposed that Class 43.2 will be expanded to include all waste-fueled thermal energy equipment not just waste-fueled thermal energy equipment that provides heat to industrial processes or greenhouses as is currently included in Class 43.2. Budget 2012 also proposes the inclusion of equipment that uses the thermal energy provided primarily by waste-fuelled district energy systems and equipment that uses residue of plants to generate electricity and heat in Class 43.2.
Budget 2012 proposes that equipment using eligible waste fuels will not be eligible for the accelerated CCA rate if applicable environmental laws are not complied with at the time the equipment becomes available for use.
Corporate Mineral Exploration and Development Tax Credit
Budget 2012 proposes to phase out the corporate tax credit for "pre-production mining expenditures". Generally speaking, "pre-production mining expenditures" include certain exploration expenses and pre-production development expenses which are "Canadian exploration expenses".
The credit will apply at a rate of 10 % for exploration expenses incurred in 2012, and at a rate of 5 % for such expenses incurred in 2013.
The credit won't be available for exploration expenses incurred after 2013. The corporate tax credit for pre-production development expenses will be applied at a rate of 10 % for expenses incurred before 2014, 7 % for expenses incurred in 2014, and 4 % for expenses incurred in 2015. The credit won't be available for pre-production development expenses incurred after 2015.
The 10 % corporate mineral exploration and development tax credit for pre-production development expenses will still be available to taxpayers for expenses incurred before 2016 where a written agreement was entered into before Budget Day or where the expenses were incurred as part of the development of a new mine where the construction of the new mine was started before Budget Day or the engineering and design work for the construction of the new mine was started before Budget Day.
Exploration and pre-production development expenses will continue to qualify as "Canadian exploration expenses" and will still be deductible in the year incurred in accordance with the Income Tax Act (Canada) (the "ITA").
Atlantic Investment Tax Credit (AITC)
Oil and Gas Mining Activities
Budget 2012 proposes to phase out the AITC for certain oil and gas and mining activities over a four-year period and, specifically, assets acquired on or after Budget Day for use in particular oil and gas and mining activities. The AITC will apply at a rate of 10 % for assets acquired before 2014 and 5 % for assets acquired in 2014 and 2015.
However, the AITC is not otherwise affected for assets acquired for use in other activities.
Transitional measures are proposed for assets acquired before 2017, for use in particular oil and gas and mining activities.
Electricity Generation Equipment
Electricity generation equipment and clean energy and conservation equipment acquired after Budget Day and used in the Atlantic region primarily in an eligible activity will be added to the "qualified property" definition, such that it is generally eligible for the AITC.
Scientific Research and Experimental Development Program (SR&ED)
SR&ED Investment Tax Credit Rate
Budget 2012 proposes to reduce the general 20% SR&ED investment tax credit rate applicable to SR&ED qualified expenditure pool balances to 15% in respect of taxation years that end after 2013. The 35% SR&ED investment tax credit rate applicable to Canadian-controlled private corporations remains unchanged in respect of an annual maximum of $3 million of qualified SR&ED expenditures.
SR&ED Capital Expenditures
Budget 2012 proposes to exclude capital expenditures (including payments in respect of the use or the right to use property that would, if it were acquired by the taxpayer, be capital property) from eligibility for SR&ED deductions and investment tax credits if property is acquired on or after January 1, 2014. This change will also affect eligible contract payments to the extent that the payment is in respect of a capital expenditure.
SR&ED Overhead Expenditures
Budget 2012 proposes to reduce, under the proxy method for the calculation of the eligible overhead expenditures that qualify for the SR&ED tax incentives, the rate at which the prescribed proxy amount is calculated to 60% (from 65%) for 2013 and to 55% after 2013.
SR&ED Contract Payments
Budget 2012 proposes to disallow from the expenditure base for investment tax credits the profit element of SR&ED expenditures that arise in respect of SR&ED performed by arm's length parties under contract. It is proposed that this be achieved by way of a proxy, under which only 80% of the cost to a payer under an arm's length SR&ED contract will be eligible for SR&ED investment tax credit. SR&ED capital expenditures will reduce the 80% eligibility ratio.
Tax Avoidance Through the Use of Partnerships
Budget 2012 proposes new anti-avoidance measures which reduce the amount of any increase to the adjusted cost base of a partnership interest where a subsidiary is being wound-up under subsection 88(1) of the ITA to the extent that the accrued gain in respect of the partnership interest is reasonably attributable to the accrued gains in certain types of income assets held directly or indirectly by the partnership.
Budget 2012 also proposes a new rule whereby the sale of a partnership interest to a non-resident person will be subject to section 100 of the ITA, unless the partnership is carrying on business in Canada through a permanent establishment in which all of the assets of the partnership are used. Section 100 is intended to fully tax gains on income assets held by partnerships. Section 100 will also apply to dispositions made directly, or indirectly as part of a series of transactions, to a tax-exempt or non-resident person.
Budget 2012 proposes that a single designated partner of a partnership may be empowered to waive, on behalf of all the partners, the three-year limit for making a determination of any income, loss, deduction, or other amount in respect of a partnership, under subsection 152(1.4) of the ITA. Where such a partner is so designated, it will not be necessary to obtain a waiver from each partner of the partnership to extend the 3 year period in which the Minister of National Revenue (the "Minister") may make a determination in respect of the partnership.
Personal Income Tax Measures
Mineral Exploration Tax Credit for Flow-Through Share Investors
Budget 2012 proposes to extend eligibility for the mineral exploration tax credit for one year, to flow-through share agreements entered into on or before March 31, 2013.
Eligible Dividends – Split-Dividend Designation and Late Designation
Currently, a Canadian corporation that pays a taxable dividend has to notify shareholders in writing at the time the dividend is paid if that dividend has been designated as an eligible dividend. A dividend payment cannot be split into non-eligible and eligible portions.
Budget 2012 proposes to simplify the manner in which a corporation pays and designates eligible dividends by allowing the corporation to designate, at the time it pays a taxable dividend, any portion of the dividend to be an eligible dividend. Budget 2012 also proposes to allow the Minister discretion to accept a corporation's late designation of a taxable dividend as an eligible dividend if the corporation makes the designation within the three-year period following the day on which the designation was required. The Minister must be of the opinion that the late designation would be just and equitable in the circumstances.
Group Sickness or Accident Insurance Plans
Budget 2012 proposes to include the amount of an employer's contributions to a group sickness or accident insurance plan in an employee's income for the year in which the contributions are made to the extent that such contributions are not in respect of a wage-loss replacement benefit payable on a periodic basis.
This measure will apply in respect of employer contributions made on or after Budget Day to the extent that the contributions relate to coverage after 2012, except that such contributions made on or after Budget Day and before 2013 will be included in the employee's income for 2013.
Retirement Compensation Arrangements (RCA)
Budget 2012 proposes to extend, with certain modifications, the prohibited investment and advantage rules that currently exist for Tax-Free Savings Accounts, Registered Retirement Savings Plans, and Registered Retirement Income Funds to directly prevent RCAs from engaging in certain non-arm's length transactions. Budget 2012 also proposes a new restriction on RCA tax refunds in circumstances where RCA property has lost value.
Employees Profit Sharing Plans (EPSP)
Budget 2012 proposes a special tax to discourage excessive employer contributions to an EPSP. The special tax will be payable by a specified employee, i.e. who has a significant equity interest in its employer or who does not deal at arm's length with its employer, on an "excess EPSP amount". An "excess EPSP amount" will be the portion of an employer's EPSP contribution, allocated to a specified employee, that exceeds 20% of the specified employee's salary received in the year.
The special tax will be made up of two components: the first component will be equal to the top federal marginal rate and the second component will be equal to the top marginal rate of the province of residence of the specified employee and will be shared with provinces and territories participating in a Tax Collection Agreement.
Life Insurance Policy Exemption Test
For life insurance policies that provide both a protection (i.e., insurance) and savings component, the income earned on the savings component of an exempt policy, as determined under the Income Tax Regulations, is not subject to accrual taxation in the hands of the policyholder. Budget 2012 proposes to modify the life insurance policy exemption test by changing and updating the benchmarks and other indicators used in the exemption test.
The Investment Income Tax levied on life insurers will be recalibrated to neutralize the impact of these proposed changes. Consultations with key stakeholders on the proposed changes will be undertaken by the government. Amendments to the tax provisions arising from these consultations will apply to life insurance policies issued after 2013.
Transfer Pricing Secondary Adjustments
"Transfer prices" are prices at which goods, services and intangibles are traded cross-border between non-arm's length persons. Canadian tax rules permit the Minister to adjust transfer prices to reflect the prices which would prevail between arm's length persons. This adjustment is referred to a "primary adjustment". Where the Minister determines that the transfer prices used by a Canadian taxpayer exceed the arm's length price, the excess portion paid to a non-arm's length party is treated as deemed dividend paid to the non-resident parent company and is subject to Part XIII withholding tax. These so-called "secondary adjustments" were made pursuant to various provisions in the ITA outside the transfer pricing rules contained in section 247.
Budget 2012 purposes a specific new rule to be added to section 247 that will permit the Minister to assess secondary adjustments for the amount of a primary adjustment that is a benefit to any non-arm's length non-resident participating in the transaction. These amounts would be treated as a deemed dividend subject to non-resident withholding tax. The deemed dividend treatment will not apply to non-residents that are controlled foreign affiliates (as defined in subsection 17(15) of the ITA) or, if the Minister concurs, where the non-resident repays the amount of the primary adjustment that would otherwise be a benefit to it. These measures are proposed to apply to transactions occurring on or after Budget Day.
Canadian tax rules currently deny the deductibility of interest for a resident corporation where, and to the extent that, its debt-to-equity ratio in relation to certain non-residents exceeds 2:1. The rule applies to debts owing (i) to non-residents that are specified shareholders (i.e. persons owning, alone or in groups, 25% or more of the votes or value of the corporation) and (ii) to non-resident persons not dealing at arm's length with specified shareholders.
Budget 2012 proposes to reduce the threshold debt-to-equity ratio from 2-to-1 to 1.5-to-1. Further, the scope of the thin capitalization rules are to be extended to apply to debts owing by partnership having at least one Canadian-resident partner and to treat disallowed interest expense deductions as a dividend subject to non-resident withholding tax. In many cases, the thin capitalization rule is contravened due to inadvertence. These proposals significantly increase the risks and costs of inadvertently exceeding the specified debt-to-equity ratio.
Budget 2012 also proposes to reduce the possibility of double taxation resulting from the application of the thin capitalization rule and the foreign accrued property income ("FAPI") rules where a resident corporation has received a loan from a controlled foreign affiliate.
The change to the thin capitalization debt to equity ratio is to apply to taxation years that begin after 2012 while the other proposals apply to taxation years ending after Budget Day, although only a pro-rata portion of denied interest will be treated as a deemed dividend for taxation years that include Budget Day.
Foreign Affiliate Dumping
Budget 2012 proposes new far reaching rules limiting tax benefits resulting from the acquisition of shares of a foreign affiliate by a Canadian subsidiary that is controlled by a non-resident corporation. The principal concern of the government is that such purchases increase deductible interest expenses of the Canadian subsidiary on borrowed money used to make the acquisition while dividends received by the Canadian subsidiary on the shares of the acquired foreign affiliate generally benefit from a dividend received deduction. There is also concern that where the Canadian subsidiary uses its own funds or issues its shares for the acquisition, such acquisitions allow earnings to be extracted from the subsidiary without liability for dividend non-resident withholding tax.
Generally, the Budget 2012 proposals deem non-share consideration paid by the Canadian subsidiary in the acquisition of the foreign affiliate shares to be a dividend subject to non-resident withholding tax unless relieved under an applicable tax treaty. Further, the paid-up capital of shares of the Canadian subsidiary paid as consideration is to be deemed to be nil.
These proposals are not to apply if the investment by the Canadian subsidiary, as opposed to being made or retained by the foreign parent or other non-resident not dealing at arm's length with the parent, was made primarily for bona fide non-tax purposes (i.e. business purposes). The government has invited stakeholders to comment on the appropriate scope of the business purpose exception.
Generally, these proposals apply to transactions that occur on or after Budget Day, subject to certain transitional rules.
Overseas Employment Tax Credit
The Overseas Employment Tax Credit (OETC) is a tax credit for employees who are residents of Canada but employed, generally, by Canadian resident employers outside Canada in certain fields, equal to federal income tax otherwise payable on 80% of qualifying foreign employment income (up to a maximum foreign employment income of $100,000).
Budget 2012 proposes to phase out the OETC over the 2013 to 2016 taxation years, with the proportion of qualifying foreign employment income eligible for the credit reduced to 60%, 40% and 20% for the 2013, 2014 and 2015 taxation years, respectively. The OETC will be eliminated for 2016 and subsequent taxation years.
Base Erosion Rules – Canadian Banks
Budget 2012 announced that certain unspecified changes are to be made to the FAPI rules to alleviate the tax cost to Canadian banks of using excess liquidity of their foreign affiliates in their Canadian operations and to exempt from the FAPI rules certain securities transactions undertaken in the course of a bank's business of facilitating trades for arm's length customers.
Budget 2012 proposes certain measures to ensure that registered charities comply with ITA rules that limit the ability of registered charities to expend resources on political activities. These new measures include: (i) ITA provisions that will prevent registered charities from sidestepping such limitations by making gifts to other qualified donees that are earmarked for political activities; (ii) an increase in the Canada Revenue Agency's education and compliance activities regarding political activities; and (iii) increased obligations on registered charities to provide information regarding political activities.
Intermediate sanctions, namely the suspension of tax receipting privileges for one year, will also be introduced for registered charities that exceed limitations regarding expenditures on political activities. Similar intermediate sanctions will be introduced for registered charities that provide inaccurate or incomplete information in their annual returns.
Budget 2012 also proposes to amend the rules for when certain foreign charitable organizations that have received gifts from the federal government will qualify as "qualified donees" for the purposes of the ITA.
Tax Shelter Administration
Budget 2012 proposes to change certain administrative rules for tax shelters by increasing penalties and limiting the duration of a tax shelter identification number to one year.
In particular, the proposals will:
- modify the calculation of the penalty that applies to a promoter when a person participates in an unregistered charitable donation tax shelter;
- introduce a new penalty for a promoter who fails to meet their reporting obligations with respect to annual information returns; and
- limit the period for which a tax shelter identification number is valid to one calendar year.
Budget 2012 proposes that a tax shelter identification number be valid only for the calendar year identified in the application for the number filed with the CRA. Tax shelter identification numbers issued pursuant to applications made before the Budget Day will be valid until the end of 2013.
Sales and Excise Tax Measures
GST/HST Health Measures
Budget 2012 proposes the following GST/HST health measures:
- Services rendered by pharmacists within a pharmacist-patient relationship for the promotion of the patient's health or for the prevention or treatment of a disease, disorder or dysfunction of the patient will be exempt from the GST/HST. Pharmacists' services of dispensing prescription drugs will continue to be zero-rated.
- Corrective eyeglasses or contact lenses supplied under the authority of an assessment record produced by a person who is entitled under the laws of the province in which the person practices to produce the record authorizing dispensing of corrective eyewear, such as an optician, will be zero-rated.
- Blood coagulation monitoring or metering devices and associated test strips and reagents will be added to the zero-rated medical device list.
- Devices that currently qualify for zero-rating only when supplied on the written order of a medical practitioner will also be zero-rated when supplied on the written order of a registered nurse, occupational therapist or physiotherapist as part of their professional practice.
These measures will generally apply to supplies made after Budget Day.
Doubling GST/HST Streamlined Accounting Thresholds
To further simplify GST/HST compliance for small businesses and public service bodies (PSBs), Budget 2012 proposes to increase the annual taxable sales threshold at or below which eligible businesses can elect to use the Quick Method to $400,000 (from $200,000) and to increase the annual taxable sales and taxable purchases thresholds at or below which eligible businesses or PSBs can elect to use the Streamlined Input Tax Credit Method and eligible PSBs can elect to use the Prescribed Method for Calculating Rebates to $1,000,000 (from $500,000) of taxable sales, and to $4,000,000 (from $2,000,000) of taxable purchases.
This measure will be effective in respect of a GST/HST reporting period (or a claim period of a person) beginning after 2012.