Minister of Finance Jim Flaherty today tabled the 2014 Federal Budget (the “Budget”) entitled The Road to Balance: Creating Jobs and Opportunities.We are pleased to provide our summary of proposed tax measures contained in the Budget.
There were no changes proposed to corporate income tax rates or to personal income tax rates. There were certain favourable changes to tax credits available to individuals.
The Federal Government continued its focus on integrity and tax fairness measures, sometimes described by the Federal Government as closing tax loopholes, albeit to a lesser extent than in past years. Some of the proposed measures appear to be based on changed policy rationale rather than addressing technical deficiencies in the Income Tax Act(Canada) (the “Tax Act”). The revenues that are projected to be raised through integrity measures contained in the Budget total $1.765 billion over the next five years compared with 5-year revenue projections relating to integrity measures proposed in the 2013 budget and the 2012 budget of $6.066 billion and $3.131 billion respectively.
The Budget contains certain proposed and potential upcoming changes in the areas of international taxation, trusts and the charitable and not-for-profit sectors. Certain of the proposed international tax measures specifically target arrangements perceived by the Federal Government to erode the Canadian tax base.
From a fiscal perspective, the Budget reports a much improved budgetary balance than was projected in the 2013 budget. In particular, the Budget forecasts a deficit of $16.6 billion for 2014 (compared to a 2014 deficit of $18.7 billion that was projected in the 2013 budget), a deficit of $2.9 billion for 2015 (compared to a 2015 deficit of $6.6 billion that was projected in the 2013 budget) and a surplus of $6.4 billion for 2016.
Our summary of tax highlights contained in the Budget follows.
Captive Insurance Companies
Current FAPI Regime
The Tax Act treats foreign accrual property income (“FAPI”) earned by a controlled foreign affiliate of a taxpayer resident in Canada as taxable in the hands of the Canadian taxpayer on an accrual basis, whether or not actually distributed back to Canada.
Under the current provisions of the Tax Act, income of a foreign affiliate (“FA”) from the insurance of risks in respect of persons resident in Canada, property situated in Canada or businesses carried on in Canada (“Canadian Risks”) is FAPI, unless more than 90% of the FA’s gross premium revenue (net of reinsurance ceded) is in respect of non-Canadian Risks of persons with whom the FA deals at arm’s length.
The Federal Government says it is concerned about insurance swap arrangements where Canadian Risks, originally insured in Canada, are transferred to an FA of a Canadian taxpayer and then exchanged with a third party for foreign risks that were originally insured outside of Canada, but without changing the FA’s overall risk profile and economic returns. The Federal Government is challenging these insurance swap arrangements under the existing provisions of the Tax Act, including under the general anti-avoidance rule.
Proposed Anti-Avoidance Rule
The Budget proposes to introduce an anti-avoidance rule to deem non-Canadian Risks (the “Foreign Policy Pool”) to be Canadian Risks for FAPI purposes where:
- the FA, or a person or partnership that does not deal at arm’s length with the FA, enters into one or more agreements or arrangements in respect of the Foreign Policy Pool;
- as a result of those agreements or arrangements, the FA’s risk of loss or opportunity for gain or profit in respect of the Foreign Policy Pool and those agreements or arrangements can reasonably be considered to be determined, in whole or in part, by reference to the fair market value of, the revenue, income, loss or cash flow from risks insured by another person or partnership (the “Tracked Policy Pool”); and
- 10% or more of the Tracked Policy Pool is comprised of Canadian Risks.
If the above deeming rule applies in respect of an FA of a taxpayer (or an FA of another taxpayer with which the taxpayer does not deal at arm’s length) and an FA of the taxpayer (or a partnership of which that FA is a member) has entered into agreements or arrangements as described above (the “Targeted Arrangements”), then the activities performed in connection with the Targeted Arrangements and for the purpose of obtaining the risk profile and economic return results described above are deemed to be a separate business other than an active business. As a result, any income of the FA from this deemed separate business (including income that pertains to or is incident to such business) will be treated as FAPI.
Taxpayers with FAs involved in insurance swaps, insurance pooling arrangements or similar arrangements should review these arrangements to determine if this proposed change will affect them.
This anti-avoidance rule will apply to taxation years of taxpayers that begin on or after Budget Day.
Offshore Regulated Banks
Current FAPI Regime
Under the current FAPI regime, income from an “investment business” (as defined in subsection 95(1) of the Tax Act) carried on by an FA of a taxpayer is included in the FA’s FAPI. An investment business is generally a business the principal purpose of which is to derive income from property (including interest, dividends, rents, royalties or any similar returns or substitutes therefore), income from the insurance or reinsurance of risks, income from the factoring of accounts receivable, or profits from the disposition of investment property, subject to certain exceptions. Most financial services businesses would generally be considered investment businesses but for certain exceptions.
One of the exceptions is for a business (other than any business conducted principally with persons with whom the FA does not deal at arm’s length) carried on by an FA as a foreign bank, a trust company, a credit union, an insurance corporation or a trader or dealer in securities or commodities where the activities of the FA are regulated under the laws of: (a) the countries in which the financial business is carried on through a permanent establishment and the country under whose laws the FA is governed and exists, (b) the country in which the financial business is principally carried on, or (c) in certain circumstances, member states of the European Union. It is also necessary for the FA to employ more than five employees full-time in the active conduct of the financial business or, in certain circumstances, have the benefit of the equivalent through certain inter-company services. The Budget refers to this exception as the “regulated foreign financial institution exception”. The purpose of the regulated foreign financial institution exception is to treat certain bona fide financial services businesses carried on by FAs as active businesses rather than as investment businesses.
Targeted Foreign Financial Institution
The Federal Government is concerned that certain Canadian taxpayers that are not financial institutions are taking advantage of the regulated foreign financial institution exception where their main purpose is to engage in proprietary activities that consist of investing or trading in securities on their own account rather than facilitating financial transactions for customers.
New Proposed Conditions for Regulated Foreign Financial Institution Exception
The Federal Government believes that, depending on the particular facts, it may be possible to challenge existing arrangements on the basis that they do not qualify for the regulated foreign financial institution exception. However, since such challenges can be time consuming and costly, the Budget proposes to address this concern by adding new conditions for qualifying under the regulated foreign financial institution exception.
The Budget proposes that the regulated foreign financial institution exception will be available only where the following conditions are satisfied:
- the Canadian taxpayer is:
- a bank listed in Schedule I to the Bank Act, a trust company, a credit union, an insurance corporation or a trader or dealer in securities or commodities resident in Canada, the business activities of which are subject by law to the supervision of a regulating authority such as the Superintendent of Financial Institutions or a similar authority of a province (the “Canadian FI”)
- a subsidiary wholly-owned subsidiary of a Canadian FI, or
- a corporation of which a Canadian FI is a wholly-owned subsidiary corporation and that is subject by law to the supervision of the same regulating authority; and
- the Canadian FI is a bank, trust company or insurance corporation that has, or is deemed for certain purposes to have, $2 billion or more of equity
- in the case of a bank, under the Bank Act,
- in the case of a trust company, under the Trust and Loan Companies Act, or
- in the case of an insurance corporation, under the Insurance Companies Act, or
- more than 50% of the taxable capital employed in Canada (within the meaning assigned by Part I.3 of the Tax Act) of the taxpayer, or a corporation resident in Canada that is related to the taxpayer, for the year is attributable to a business carried on in Canada, the activities of which are subject to the supervision of a regulating authority such as the Superintendent of Financial Institutions or a similar authority of a province.
The general effect of these new conditions appears to be to restrict the regulated foreign financial institution exception to FAs of Canadian resident/ Canadian regulated financial companies having substantial Canadian assets.
The Federal Government indicates that even satisfying the new conditions will not guarantee that an FA will qualify for the regulated foreign financial institution exception. The FA will still have to demonstrate that it is carrying on a regulated foreign financial business in accordance with applicable laws and that any proprietary activities comprise part of that business.
The Federal Government indicates that it will continue to monitor developments in this area to determine whether any further action is required to ensure that the regulated foreign financial institution exception, as proposed to be amended, is not used by taxpayers to obtain unintended tax advantages.
The proposed new conditions for the regulated foreign financial institution exception will apply to taxation years that begin after 2014. In order to ensure that the proposed measures are appropriately targeted, the Federal Government invites stakeholders to submit comments concerning the scope of these proposals within 60 days after Budget Day.
Current Taxation and Deductibility of Interest on Loans to Non-Residents of Canada
Canadian Thin Cap Regime
Under the current Canadian thin capitalization rules, the deductibility of interest expense in computing the income of a corporation or a trust for a taxation year from a business or property is limited where the amount of debt owing to certain non-residents exceeds a 1.5-to-1 debt-to-equity ratio.
The rules apply, in the case of a corporation, to debts owing to a specified non-resident shareholder of the corporation or a non-resident person that is not dealing at arm’s length with a specified shareholder of the corporation (referred to herein as “specified non-resident”). A specified shareholder of a corporation generally means a person that, either alone or together with persons with which such person is not dealing at arm’s length, owns shares representing 25% or more of the votes or value of the corporation.
In the case of a trust, the rules apply to debts owing to a non-resident specified beneficiary of the trust or a non-resident person that is not dealing at arm’s length with a specified beneficiary of the trust (also referred to herein as “specified non-resident”). A specified beneficiary of a trust generally means a person that, either alone or together with persons with which such person is not dealing at arm’s length, owns an interest as beneficiary under the trust with a fair market value of 25% or more of the fair market value of all interests under the trust.
Canadian Withholding Taxes on Interest on Non-Arm’s Length Loans under Part XIII of the Tax Act
Interest paid or credited by a Canadian resident person (or a non-resident person if the interest is deductible in computing the non-resident person’s taxable income earned in Canada) to a non-arm’s length non-resident person is subject to Canadian withholding taxes at the rate of 25% unless a reduced rate is available under a tax treaty.
The Federal Government is concerned that some taxpayers have sought to avoid either or both the thin capitalization rules (including an existing anti-avoidance provision for back-to-back loans in those rules) and Part XIII withholding tax through the use of so-called “back-to-back loan” arrangements. The targeted arrangements generally involve interposing a third party (e.g., a foreign bank) between two related taxpayers (such as a foreign parent corporation and its Canadian subsidiary) in an attempt to avoid the application of rules that would apply if a loan were made, and interest paid on the loan, directly between the two taxpayers.
Proposed New Anti-Avoidance Rule and Amendment to Existing Anti-Avoidance Rule
Notwithstanding that the Federal Government believes that such arrangements could be subject to challenge under existing anti-avoidance rules, the Budget proposes to address back-to-back loan arrangements by adding a specific anti-avoidance rule in respect of withholding tax on interest payments, and by amending the existing anti-avoidance rule for back-to-back loans in the thin capitalization rules.
Amendment to Existing Anti-Avoidance Rule For Back-to-Back Loans
A back-to-back loan arrangement will be considered to exist under the proposed amendments where the following conditions are met:
- a taxpayer has an outstanding interest-bearing obligation owing to a person or partnership (referred to as the “intermediary”);
- as part of a transaction, or series of transactions or events, which includes the taxpayer becoming obligated to pay the particular amount, the intermediary, or any person that does not deal at arm’s length with the intermediary,
- has an interest in property that secures payment of the particular amount which interest was provided directly or indirectly by a specified non-resident (according to the Federal Government, a guarantee would not, in and of itself, satisfy this condition); or
- has an amount outstanding as or on account of a debt or other obligation to pay an amount to a specified non-resident for which recourse is limited, either immediately or in the future and either absolutely or contingently, to the particular debt or other obligation, or that was entered into on condition that the particular debt or other obligation also be entered into; and
- the intermediary is not a specified non-resident.
Where a back-to-back loan arrangement exists, the taxpayer will, in general terms, be deemed to owe an amount to the specified non-resident (referred to herein as the “deemed amount owing”) and not to the intermediary that is equal to the lesser of:
- the outstanding amount of the obligation owing to the intermediary; and
- the total of all amounts each of which is at that time the fair market value of property that secures the obligation and any outstanding amount of debt for which recourse is limited or that was entered into on condition that the particular loan also be entered into as described above.
The taxpayer will, in general terms, also be deemed to have an amount of interest paid or payable to the specified non-resident that is equal to the proportion of the interest paid or payable by the taxpayer on the obligation owing to the intermediary that the deemed amount owing is of that particular obligation.
New Anti-Avoidance Rule
Part XIII withholding tax will generally apply in respect of interest that is deemed paid or payable by the taxpayer in respect of a back-to-back loan arrangement described above to the extent that it would otherwise be avoided by virtue of the arrangement. The specified non-resident and the taxpayer will be jointly and severally (or solidarily) liable for the additional Part XIII withholding tax.
These measures will apply in respect of the thin capitalization rules to taxation years that begin after 2014, and in respect of Part XIII withholding tax to amounts paid or credited after 2014.
Consultation on Tax Planning by Multinational Enterprises
The Federal Government confirmed its commitment to continue to improve the integrity of Canada’s international tax rules and reiterated its growing concerns that substantial corporate tax revenue is being lost due to international tax planning that seeks to shift profits away from nations where income-producing activities take place through an exploitation of the interaction between domestic and international tax rules. The Federal Government indicated that it is actively involved in the work being done by the Organization for Economic Co-operation and Development ("OECD"), of which Canada is a member, and the G-20, including the OECD’s project regarding “base erosion and profit shifting” ("BEPS") strategies used by multinational enterprises ("MNE"s).
In order to address concerns regarding certain tax planning undertaken by MNEs, the Federal Government is seeking input from stakeholders on the following questions:
- what are the impacts of international tax planning by MNEs 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 the Federal Government?;
- are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the Federal Government?;
- what considerations should guide the Federal Government in determining the appropriate approach to take in responding to the issues identified – either in general or with respect to particular issues?; and
- would concerns about maintaining Canada’s competitive tax system be alleviated by coordinated multilateral implementation of base protection measures?
The Federal Government is also inviting input from stakeholders on the actions that it should take to ensure the effective collection of sales tax on e-commerce sales to Canadian residents by internationally-based vendors. In particular, the Federal Government is requesting input regarding the possibility of adopting similar approaches to those taken in certain countries (such as South Africa and the European Union), requiring foreign-based vendors to register with the Canada Revenue Agency and to charge the Goods and Services Tax/Harmonized Sales Tax, as applicable, if they engage in e-commerce sales to Canadian residents.
Consultation on Treaty Shopping
In the 2013 budget, the Federal Government expressed its concerns regarding “treaty shopping” and indicated its intention to seek input from stakeholders. “Treaty shopping” is a term commonly used to refer to arrangements under which a person not entitled to the benefits of a particular tax treaty with Canada uses an entity that is a resident of a state with which Canada has concluded a tax treaty to obtain certain Canadian tax benefits.
The Federal Government indicated that one of the issues identified in the Action Plan released in July 2013 by the OECD on BEPS by multinational enterprises is the abuse of tax treaties. The OECD is expected to issue its recommendations in this regard in September 2014. The Federal Government confirmed that the OECD’s recommendations will be relevant in developing a Canadian approach to address treaty shopping.
August 2013 Consultation Paper and Stakeholder Input
The Federal Government released a consultation paper on treaty shopping in August 2013 to seek the views of interested parties regarding possible approaches to address treaty shopping. Stakeholders had until December 13, 2013 to provide comments.
The consultation paper noted that most countries that have addressed the issue in their tax treaties have used a general rule, i.e., a rule that denies a tax treaty benefit if one of the main purposes for entering into a transaction is to obtain the benefit. The consultation paper also noted that some countries (e.g., the United States and Japan) address the issue with relatively more specific rules governing limitations on benefits.
According to the Federal Government, as stated in the consultation paper, in the Canadian context, there are several factors that support the use of a general approach based on a main purpose provision. Canada has already included such a rule in several of its tax treaties, as have other countries in hundreds of tax treaties worldwide. Thus, a main purpose rule is an approach that is relatively familiar to Canadian taxpayers, tax professionals and Canada’s tax treaty partners.
The Federal Government received several comments from stakeholders on the consultation paper, addressing the respective merits of a general approach and of a more specific approach, and the advantages and disadvantages of a domestic law approach, a treaty-based approach, or a combination of both.
Stakeholders expressed concerns that a general approach might produce less certain outcomes in some cases (compared to a more specific approach). Several stakeholders indicated a preference for the adoption of a more specific rule that would, they suggest, provide greater certainty for taxpayers. The example cited in this regard is the limitation on benefits provision included in U.S. tax treaties (such as Article XXIX-A of the Canada-U.S. tax treaty).
According to the Federal Government, while the U.S. limitation on benefits provision arguably provides a high level of certainty, it does not capture, at least on its own, all forms of treaty shopping. In particular, it does not prevent treaty shopping arrangements that use certain entities, such as publicly-traded corporations or trusts. A general approach may serve to prevent a wider range of treaty shopping arrangements.
Several stakeholders expressed a preference for a solution to treaty shopping that would require the re-negotiation of Canada’s tax treaties. This is based in large part on the view that a domestic law response to treaty shopping would alter the balance of compromises reached in the negotiation of tax treaties. However, the Federal Government expressed the view that the absence of an anti-treaty shopping rule in a tax treaty does not mean that there is an implicit obligation to provide benefits in respect of abusive arrangements. It reiterated its argument on this point that domestic law provisions to prevent tax treaty abuse are not considered by the OECD or the United Nations to be in conflict with tax treaty obligations and a number of other countries have enacted legislation to that effect.
In addition, the Federal Government indicated that some stakeholders have asserted that only a few of Canada’s tax treaties would need to be re-negotiated in order to significantly curtail treaty shopping. As stated in the consultation paper, even if it were possible to re-negotiate within a reasonable period of time Canada’s treaties with certain countries where conduit entities are common, this would not address the Federal Government’s concern that other conduit countries may emerge. Accordingly, the Federal Government expressed the view that a treaty-based approach would not be as effective as a domestic law rule.
Main Elements of New Proposed Anti-Treaty Shopping Domestic Rule
The Federal Government invites comments from interested parties on a proposed rule to prevent treaty shopping. The rule would address arrangements identified as an improper use of Canada’s tax treaties in the consultation paper and, therefore, protect the integrity of Canada’s tax treaties. This proposed rule would use a general approach focussed on avoidance transactions and, in order to provide more certainty and predictability for taxpayers, building on comments received on the 2013 consultation paper, the rule would contain specific provisions setting out the ambit of its application.
According to the Federal Government, the approach would ensure that treaty benefits are provided with respect to ordinary commercial transactions and that, if the rule applies, the benefit that would be reasonable under the circumstances would be provided.
In order to further advance the discussion, the Federal Government has set out the main elements of a proposed rule to address treaty shopping as follows:
- Main purpose provision: subject to the relieving provision, a benefit would not be provided under a tax treaty to a person in respect of an amount of income, profit or gain (relevant treaty income) if it is reasonable to conclude that one of the main purposes for undertaking a transaction, or a transaction that is part of a series of transactions or events, that results in the benefit was for the person to obtain the benefit.
- Conduit presumption: it would be presumed, in the absence of proof to the contrary, that one of the main purposes for undertaking a transaction that results in a benefit under a tax treaty (or that is part of a series of transactions or events that results in the benefit) was for a person to obtain the benefit if the relevant treaty income is primarily used to pay, distribute or otherwise transfer, directly or indirectly, at any time or in any form, 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, it would be presumed, in the absence of proof to the contrary, 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 (other than managing investments) 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 compared to the activity carried on in Canada giving rise to the relevant treaty income;
- the person is not controlled, directly or indirectly in any manner whatever, by 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; or
- the person is a corporation or a trust the shares or units of which are regularly traded on a recognized stock exchange.
- Relieving provision: If the main purpose provision applies in respect of a benefit under a tax treaty, the benefit is to be provided, in whole or in part, to the extent that it is reasonable having regard to all the circumstances.
Even if a transaction results in a tax treaty benefit for a taxpayer, the Federal Government acknowledges that it does not necessarily follow that one of the main purposes for undertaking the transaction was to obtain the benefit. One of the objectives of tax treaties is to encourage trade and investment and, therefore, it is expected that tax treaty benefits will generally be a relevant consideration in the decision of a resident of a state with which Canada has a tax treaty to invest in Canada. Accordingly, the proposed anti-treaty shopping domestic rule would not apply in respect of an ordinary commercial transaction solely because obtaining a tax treaty benefit was one of the considerations for making an investment.
The Federal Government proposes that the rule, if adopted, could be included in the Income Tax Conventions Interpretation Act so that it would apply in respect of all of Canada’s tax treaties.
The rule would apply to taxation years that commence after the enactment of the rule into Canadian law. The Federal Government also requests comments as to whether transitional relief would be appropriate.
Treaty Shopping Examples
The Federal Government invites comments on the following examples in relation to the intended application of the proposed rule to a number of arrangements. We note that the first three examples appear to be based on the treaty shopping cases that the Federal Crown lost in Velcro Canada Inc. v. R. (TCC-2012), Prévost Car Inc. v. R. (FCA-2009) and MIL (Investments) S.A. v. R. (TCC-2006) respectively.
Example 1 – Assignment of income
Aco, a company that is a resident of State A, owns intellectual property used by its subsidiary, Canco, a corporation that is a resident of Canada. State A does not have a tax treaty with Canada and, therefore, payments of royalties by Canco to Aco would be subject to a withholding tax rate of 25 per cent in Canada.
Aco incorporates Bco, an intermediary corporation in State B, a state with which Canada has a tax treaty that provides for a nil rate of withholding tax in Canada on royalties paid to a resident of State B.
Aco assigns to Bco the right to receive royalty payments from Canco. In exchange for the rights granted under the assignment agreement, Bco agrees to remit 80 per cent of the royalties received to Aco within 30 days.
Bco pays tax in State B on its net amount of royalty income. State B does not impose a withholding tax on the payment of royalties made to non-residents.
The royalties received by Bco from Canco are primarily used to pay an amount to Aco and Aco would not have been entitled to a tax treaty benefit had it received the royalties directly from Canco.
As a result, under the conduit presumption it would be presumed, in the absence of proof to the contrary, that one of the main purposes for the assignment of the royalties is for Bco to obtain the benefit of the withholding tax reduction under the tax treaty between Canada and State B. Consequently, the main purpose provision would apply to deny the benefits under the tax treaty between State B and Canada in respect of the royalty payments.
Depending on all the circumstances, it might be possible that, by virtue of the relieving provision, Bco would be allowed the benefits of the tax treaty in respect of the portion of the royalty payments that is not used by Bco to pay an amount to Aco.
If, instead, only 45 per cent of the royalties received by Bco from Canco were used to pay an amount to Aco, the conduit presumption would not apply to create a presumption as to the main purpose of the transaction, and it would be a question of fact whether the main purpose provision applied.
Example 2 – Payment of dividends
The shares of Canco, a Canadian resident corporation, are owned by Bco, a corporation that is a resident of State B. The sole investment of Bco consists of the shares of Canco. Bco was established in State B by its two corporate shareholders, Aco and Cco, residents of State A and State C respectively.
Canada has a tax treaty with State B. Canada also has tax treaties with States A and C, which provide a higher rate of withholding tax on dividends than the rate under the tax treaty with State B.
Under the terms of a shareholders agreement, Bco is required to distribute the entire dividend received from Canco to Aco and Cco almost immediately. Under the domestic laws of State A and State C, dividends received from foreign corporations are subject to tax.
Canco pays a dividend to Bco and Bco uses the dividend to pay a dividend to Aco and Cco. Aco and Cco would not have been entitled to an equivalent or more favourable tax treaty benefit had they received the dividend directly from Canco.
As a result, under the conduit presumption it would be presumed, in the absence of proof to the contrary, that one of the main purposes for the establishment of Bco is to obtain the benefit of the withholding tax reduction under the tax treaty between Canada and State B and, subject to the relieving provision, the benefit would be denied.
In this example, the benefits that would have applied if Bco had not been established may be provided under the relief provision to the extent it is reasonable having regard to all the circumstances. For instance, if Aco and Cco are taxable in State A and State C respectively on the dividend they received from Bco, it may be reasonable in the circumstances to provide the benefits that Aco and Cco would have been entitled to under the tax treaty between Canada and States A and C respectively had the dividend they received been paid directly from Canco.
Example 3 – Change of residence
Aco, a corporation that is a resident of State A, owns shares of a corporation that is a resident of Canada and is contemplating their sale. Such a sale would trigger a capital gain that would be taxable in Canada. Canada does not have a tax treaty with State A. Shortly before the sale, Aco is continued into, and becomes a resident of, State B, a state that does not impose tax on capital gains.
The tax treaty between Canada and State B provides an exemption from tax for capital gains on shares of a Canadian corporation disposed by residents of State B. Aco sells the shares and retains the proceeds of disposition. Aco claims the capital gains exemption available under the tax treaty.
In this example, since the proceeds of disposition remain with Aco, the conduit presumption would not apply. However, the main purpose provision would apply because, based on these facts and in the absence of other circumstances, it is reasonable to conclude that one of the main purposes of the continuation of Aco into State B was to obtain the benefit of the capital gains exemption provided under the tax treaty.
If, instead of becoming a resident of State B shortly before the sale, Aco was already a resident of State B at the time of the initial acquisition of the shares of the Canadian corporation, it would need to be determined whether is it reasonable to conclude that one of the main purposes for the establishment of Aco as a resident of State B was to obtain the capital gains exemption under the tax treaty between Canada and State B.
This is a question of fact and all the relevant circumstances would need to be considered, including, for example, the lapse of time between the establishment of Aco in State B and the realization of the capital gains, and any other intervening events.
Example 4 – Bona fide investments
B-trust is a widely held trust that is a resident of State B, a state with which Canada has a tax treaty. B-trust pursues a strategy of managing a diversified portfolio of investments in the international market. Through recent investments in Canada, B-trust currently holds 10 per cent of its portfolio in shares of Canadian corporations, in respect of which it receives annual dividends. Under the tax treaty between Canada and State B, the withholding tax rate on dividends is reduced to 15 per cent.
Investors in B-trust seek to maximize the return on their investments and rely on the solid reputation of B-trust’s management to make optimal investment decisions. These investment decisions take into account the existence of tax benefits provided under State B’s extensive tax treaty network.
Several investors in B-trust are residents of State B, but a majority of investors are residents of states with which Canada does not have a tax treaty. B-trust annually distributes all of its income to its investors.
In this example, because dividends received by B-trust from Canadian corporations are primarily used to distribute income to persons that are not entitled to tax treaty benefits, it would be presumed under the conduit presumption that one of the main purposes for B-trust to undertake its investments in Canadian corporations and for third state investors to undertake their investments in B-trust, either alone or as part of a series of transactions, was to obtain the benefit under the tax treaty between Canada and State B.
To rebut this presumption, it would have to be clearly established that none of the main purposes for undertaking these investments, either alone or as part of a series of transactions, was to obtain the benefit of the tax treaty between Canada and State B. Investors’ decisions to invest in B-trust are not driven by any particular investments made by B-trust, and B-trust’s investment strategy is not driven by the tax position of its investors.
In this example, and in the absence of other circumstances, there would be sufficient facts to rebut the above presumptions. It follows that the main purpose provision would not apply to deny the tax treaty benefit.
Example 5 – Safe harbour (active business)
Aco is a corporation that is a resident of State A, a state with which Canada does not have a tax treaty. Aco owns all the shares of Finco, a corporation that is a resident of State B. Canada has a tax treaty with State B. Finco acts as a financing corporation for Aco’s wholly owned subsidiaries, including Canco (a resident of Canada) and Bco (a resident of State B).
Bco carries on an active business in State B and that business is substantial in comparison to the activities carried on by Canco. Aco’s other subsidiaries are residents of other states with which Canada has tax treaties which provide tax treaty benefits on payments of interest that are equivalent to those provided under the tax treaty between Canada and State B. Finco receives payments of interest from Aco subsidiaries and reinvests its profits.
In this example, since the interest payments received by Finco from Canco are primarily used to pay an amount to persons that would have been entitled to an equivalent benefit had they received the interest payment directly from Canco, the conduit presumption would not apply.
The safe harbour presumption describes categories of persons that, unless they are used in conduit arrangements, are generally considered not to be engaged in treaty shopping in the course of their normal operations. Since Bco carries on a substantial active business in State B and is related to Finco, it would be presumed under the safe harbour presumption, in the absence of proof to the contrary, that none of the main purposes for Finco to undertake the investment in Canada was for Finco to obtain the benefits of the tax treaty between Canada and State B.
To rebut this presumption, it would have to be clearly established that one of the main purposes for undertaking the investment in Canada was to obtain the benefits of the tax treaty. In this example and in the absence of other circumstances, the above presumption would not be rebutted and the main purpose provision would not apply to deny the tax treaty benefit.
Update on the Automatic Exchange of Information for Tax Purposes
Exchange of Information Provisions Under Tax Treaties
The Federal Government confirmed that the exchange of tax information between countries is an important tool for implementing its commitment to combat tax evasion in order to protect the revenue base and ensure public confidence in the fairness and equity of the tax system. Provisions to facilitate the exchange of tax information are a long-standing feature of many of Canada’s tax treaties.
Canada reinforced its commitment to the exchange of information under tax treaties in the 2007 budget when it announced that all future tax treaties and updates to existing treaties would include the current OECD standard for information exchange and that the Federal Government would be pursuing tax information exchange agreements that include comprehensive exchange of information provisions.
In order to ensure that jurisdictions that have made commitments to exchange information in accordance with the current OECD standard actually do so, the Global Forum on Transparency and Exchange of Information for Tax Purposes has been conducting comprehensive peer reviews of the information exchange practices of its 121 member jurisdictions since 2009. The Federal Government confirmed that Canada, which was subject to a peer review in 2010-2011, has been determined to be fully compliant with the OECD standard, and that Canada supports the work of the Global Forum and recognizes the importance of its peer review process to promote best practices and monitor the effectiveness of agreements to exchange information for tax purposes.
Foreign Account Tax Compliance Act (“FATCA”), Intergovernmental Agreement for the Enhanced Exchange of Tax Information under Canada-U.S. Tax Convention (“IGA”)
In 2010, the United States enacted FATCA. Pursuant to the provisions of FATCA, non-U.S. financial institutions would generally be required to identify accounts held by U.S. persons, which include U.S. citizens living abroad (including U.S. citizens who are resident in Canada for tax purposes), and report to the U.S. Internal Revenue Service (“IRS”) information in respect of these accounts. FATCA was developed to combat offshore U.S. tax evasion through increased transparency, enhanced reporting and strong sanctions.
FATCA has raised a number of concerns in Canada among both U.S. citizens living in Canada and Canadian financial institutions. Without an IGA between Canada and the U.S., Canadian financial institutions and U.S. persons holding financial accounts in Canada would be required to comply with FATCA starting July 1, 2014 as per the FATCA legislation enacted by the U.S. unilaterally. The Federal Government has raised the concern that compliance with FATCA potentially violates Canadian privacy laws.
In response to these concerns, the Federal Government negotiated the IGA with the U.S. which contains significant exemptions and other relief. Under the approach adopted in the IGA announced on February 5, 2014, Canadian financial institutions will report to the CRA information in respect of U.S. persons that will be transmitted by the CRA to the IRS in accordance with the IGA and the current exchange of information provisions of the Canada-U.S. Tax Convention.
In exchange, the CRA will receive information from the U.S. in respect of Canadian resident taxpayers that hold accounts at U.S. financial institutions, which will assist Canadian tax authorities in administering and enforcing compliance with Canadian tax laws.
A variety of registered accounts (including Registered Retirement Savings Plans, Registered Retirement Income Funds, Registered Education Savings Plans, Registered Disability Savings Plans, and Tax-Free Savings Accounts) and smaller deposit-taking institutions, such as credit unions, with assets of less than $175 million will be exempt from reporting.
These new reporting requirements will come into effect starting in July 2014, with an information return filed and information between countries exchanged starting in 2015.
The IGA will not impose any new U.S. taxes or penalties for non-compliance with U.S. tax laws on U.S. persons holding accounts at Canadian financial institutions and is strictly an information sharing agreement.
Each reporting Canadian financial institution would be treated as complying with the applicable reporting under FATCA and not subject to the FATCA withholding tax.
While the Canada-U.S. tax treaty contains a provision that allows a country to collect the taxes imposed by the other country, the CRA will not collect the U.S. tax liability of a Canadian citizen if the individual was a Canadian citizen at the time the liability arose (whether or not the individual was also a U.S. citizen at that time).
This new reporting regime will come into effect starting in July 2014, with Canada and the U.S. beginning to receive enhanced tax information from each other in 2015.
Update on Tax Treaties and Tax Information Exchange Agreements (“TIEA”)
The Federal government confirmed that it will continue to actively negotiate and conclude tax treaties to reduce tax barriers to international trade and investment, combat international tax evasion and aggressive tax avoidance, strengthen Canada’s bilateral economic relationships, and create enhanced opportunities for Canadian businesses abroad.
The Federal Government provided the following update on negotiation of Tax Treaties and TIEA since the 2013 budget and as of February 1, 2014:
- new tax treaties with Hong Kong, Poland and Serbia have come into force;
- protocols to update tax treaties with Austria, Barbados, France and Luxembourg have come into force;
- an agreement concerning the exchange of information provisions of the Canada-Switzerland tax treaty has come into force;
- the Convention on Mutual Administrative Assistance in Tax Matters has been ratified by Canada;
- TIEAs with Liechtenstein and Panama have come into force;
- TIEAs with Bahrain, the British Virgin Islands and Brunei have been signed;
- canada now has 92 tax treaties in force, 3 tax treaties signed but not yet in force, and 8 tax treaties and protocols under negotiation; and
- since 2007, the Government has brought into force 18 TIEAs, signed 4 TIEAs that are not yet in force and is negotiating TIEAs with 8 other jurisdictions.
Remittance Thresholds for Employer Source Deductions
Employers have an obligation to withhold amounts from remuneration paid to employees in respect of income tax, Canada Pension Plan (“CPP”) contributions and Employment Insurance (“EI”) premiums. Employers are then required to remit such amounts to the CRA. With respect to CPP and EI, the remittance includes both the employer and employee contributions. The frequency of an employer’s remittance is dependant upon the particular category of remitter the employer falls in. The basis for determining which category an employer is included in is dependant on the employer’s total average monthly withholding amount in preceding calendar years. Two such categories are employers who, two calendar years ago, had a total average monthly withholding amount of:
- $15,000 but less than $50,000 and are then required to remit deductions up to twice per month, depending on their payroll frequency (“Category 1”); and
- $50,000 or greater and are then required to remit deductions up to four times per month, depending on their payroll frequency (“Category 2”).
The Budget proposes to reduce the frequency of remittances of source deductions for the above categories of employers. Specifically the Budget proposes to:
- increase the threshold amount for Category 1 employers from $15,000 to $25,000; and
- increase the threshold amount for Category 2 employers from $50,000 to $100,000.
These changes will apply in respect of amounts withheld after 2014.
Tax Incentives for Clean Energy Generation
The Tax Act permits taxpayers to deduct capital cost allowance (“CCA”) on depreciable assets. The rate of CCA is dependent on the class of assets on which CCA is being claimed. Class 43.2 assets (specified clean energy generation and energy conservation equipment) are subject to an accelerated CCA rate of 50% per year on a declining-balance basis. Class 43.2 assets are essentially assets that generate or conserve energy by:
- using a renewable energy source (e.g. wind, solar, small hydro);
- using fuel from waste (e.g. landfill gas, manure, wood waste); or
- making efficient use of fossil fuels (e.g. high efficiency cogeneration systems that simultaneously produce both electricity and useful heat).
Eligible equipment of this nature is listed under Class 43.1 of Schedule II of the Income Tax Regulations, which list is incorporated by reference in Class 43.2. The main difference between the two classes is that to benefit from the higher accelerated rate of depreciation under Class 43.2, cogeneration systems and waste-fuelled electricity generation systems must meet a higher efficiency standard.
The available rate of CCA is referred to as “accelerated” because it is an exception to the general rule whereby the rate of CCA is intended to be based on the useful life of the asset. The Budget proposes to expand the eligible equipment for Class 43.2 (as well as Class 43.1) to include water-current energy equipment and equipment used to gasify eligible waste fuel for use in a broader range of applications. The goal of the change is to encourage investment in technologies that are more environmentally friendly and that may contribute to the diversification of Canada’s energy supply.
Water-Current Energy Equipment
“Water-current” energy equipment converts the kinetic energy of flowing water into electricity without the use of a physical barrier such as a dam. Wave and tidal energy equipment are generally already eligible under Class 43.2. The Budget would expand Class 43.2 to apply to water-current energy equipment. Eligible property will include support structures, submerged cables, transmission equipment, and control, conditioning and battery storage equipment. However, it will not include buildings, distribution equipment or auxiliary electricity generating equipment.
The availability of accelerated CCA for water-current energy equipment, as well as wave and tidal energy equipment, will be dependant on the property, when it becomes first available for use, complying with all applicable Canadian environmental laws, by-laws and regulations.
These changes will apply to property acquired on or after Budget Day that has not been used or acquired for use before Budget Day.
“Gasification” is a term used to describe the process that converts organic or fossil-based materials into hydrogen, carbon monoxide and carbon dioxide, resulting in a product known as “producer gas” or “syngas”. Gasification equipment is currently eligible under Class 43.2 as “fuel upgrading equipment” when it is used in an eligible cogeneration facility or an eligible waste-fuelled thermal energy facility. The Budget would expand Class 43.2 to apply to property used to gasify eligible waste fuel for other applications (e.g. to sell the producer gas for domestic or commercial use). Eligible property will include piping, storage equipment, feeding equipment, ash-handling equipment and equipment to remove non-combustibles and contaminants from the producer gas. However, it will not include buildings, other structures, or heat rejection equipment.
The availability of accelerated CCA for eligible property will be dependant on the property, when it becomes first available for use, complying with all applicable Canadian environmental laws, by-laws and regulations.
These changes will apply to property acquired on or after Budget Day that has not been used or acquired for use before Budget Day.
Consultation on Eligible Capital Property
The Budget announces a consultation on proposed changes to the eligible capital property (“ECP”) regime under the Tax Act. Currently, the Tax Act has CCA provisions for capital expenditures for tangible property (e.g. equipment, furniture and buildings) and a separate regime for capital expenditures in respect of intangible property (e.g. goodwill and customer lists). These assets are referred to under the Tax Act as ECP.
Expenditures on account of ECP are deductible (slowly) in computing income from business. Under the ECP regime, only 75% of an eligible capital expenditure is added to the cumulative eligible capital (“CEC”) pool, from which a deduction of 7% may be taken on an annual declining-balance basis.
The ECP regime further provides that 75% of an eligible capital receipt, in contrast, is subtracted from the CEC pool or, if the CEC pool is depleted, results in recapture of previously-deducted CEC. Any excess eligible capital receipts are included in income from the business at a 50% inclusion rate.
The Budget acknowledges that the ECP regime has become increasingly complicated and notes that certain stakeholders have suggested a replacement regime based on a new class of depreciable property to which the CCA rules would apply. Detailed draft legislative proposals will be released for consultation shortly, and the timing for the implementation of the proposals will be determined following the consultation.
IN THIS SECTION:
Adoption Expense Tax Credit
The Adoption Expense Tax Credit (“AETC”) under section 118.01 of the Tax was first introduced in 2006, effective for the 2005 and later taxation years. The AETC provides a 15% non-refundable tax credit for certain eligible adoption expenses incurred by adoptive parents who adopt a child under the age of 18. The credit may be claimed in the taxation year in which the adoption is finalized. The maximum annual expense per child was $10,000 when the credit was first introduced, but has been indexed since 2005 such that it would have been $11,774 per child for 2014.
The Budget proposes to increase the maximum eligible expenses to $15,000 per child for 2014, which will continue to be indexed for inflation for taxation years after 2014. The expansion of the AETC’s scope is intended to recognize the unique costs of adopting a child including fees paid to provincially licensed adoption agencies and legal costs incurred in relation to the adoption.
Medical Expense Tax Credit
The Medical Expense Tax Credit (“METC”) recognizes the effect of significant medical and disability-related expenses on the taxpayer and provides a tax credit in respect of eligible expenses. The list of eligible expenses is continually reviewed and updated in light of disability or medically-related developments and new technologies.
The METC provides a 15% tax credit for eligible medical and disability-related expenses (e.g., nursing home care, ambulance fees, and certain medical devices) incurred by a taxpayer in excess of a threshold that is the lesser of:
- 3% of the taxpayer’s net income; and
- $2,171 (the indexed amount for 2014).
The METC currently provides relief for amounts paid for therapy for an individual with one or more severe and prolonged impairments in physical or mental functions who is eligible for the disability tax credit (“DTC”) under section 118.3 of the Tax Act. The therapy must be prescribed by and administered under the general supervision of a medical practitioner or occupational therapist or, in the case of a mental impairment, a medical doctor or psychologist. In some instances, effective therapy requires the development of a plan designed to meet the specific needs of the individual, such as applied behaviour analysis therapy for a child with autism. Such plans may need to be updated and adjusted from time to time.
The Budget proposes to add, as an expense eligible for the METC, amounts paid for the development of an individualized therapy program (“ITP”) if the cost of the therapy itself would be eligible for the METC and each of the following conditions are satisfied:
- an ITP is required to access public funding for the individualized therapy, or a medical doctor or an occupational therapist prescribes an ITP (or, in the case of mental impairment, a medical doctor or psychologist prescribes an ITP);
- the ITP is designed for an individual with a severe and prolonged impairment in physical or mental functions who is, because of the impairment, eligible for the DTC; and
- the expenses are paid to persons ordinarily engaged in a business that includes the design of ITPs for unrelated individuals.
In addition, the Budget proposes to expand the list of eligible medical expenses to include certain expenses incurred for service animals specifically trained to assist diabetic individuals, including the cost of the service animal, costs for its care and maintenance, and reasonable travel expenses to allow the individual to attend a facility that trains eligible individuals to handle such service animals. These changes would apply to expenses incurred in 2014.
Search and Rescue Volunteers Tax Credit
In 2011, the Federal Government introduced the Volunteer Firefighters Tax Credit (“VFTC”) in section 118.06 of the Tax Act. The VFTC generally allows volunteer firefighters who perform more than 200 hours of eligible services in a taxation year to claim a tax credit of 15% based on an amount of $3,000.
The Budget proposes to add a new Search and Rescue Volunteers Tax Credit (“SRVTC”) allowing eligible ground, air and marine search and rescue volunteers (e.g., members of the Search and Rescue Volunteer Association of Canada, the Civil Air Search and Rescue Association, and the Canadian Coast Guard Auxiliary) to claim a 15% non-refundable tax credit based on an amount of $3,000. To be eligible for the SRVTC, an individual must perform at least 200 hours of eligible search and rescue volunteer services consisting primarily of:
- responding to and being on call for search and rescue and related emergencies;
- attending meetings of the organization; and
- participating in required training relating to search and rescue services.
The 200 hours do not include services provided by an individual otherwise than as a volunteer, and any volunteer hours provided to a particular organization will be disqualified if the individual also provides non-volunteer search and rescue services to that organization.
Individuals who are eligible for both the VFTC and the SRVTC may claim one tax credit or the other, but not both. Individuals who claim either the VFTC or the SRVTC will not be eligible for an existing tax exemption under subsection 81(4) of the Tax Act for up to $1,000 for honoraria paid by a government, municipality or public authority to an emergency services volunteer. Individuals claiming the SRVTC may be required by the Minister to provide written certification from a team president (or similar individual) of an eligible organization confirming the number of eligible hours performed. The SRVTC will be available in the 2014 and subsequent taxation years.
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 generally 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. This is in contrast to the general prohibition on the ability of corporations to flow-through such expenses, and provides an additional incentive for investors to provide equity to exploration corporations.
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, 2015.
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 2015 to support eligible exploration until the end of 2016.
Farming and Fishing Businesses
The lifetime capital gains exemption under section 110.6 of the Tax Act (the “LCGE”) currently provides for a lifetime exemption of $800,000, indexed for inflation, for capital gains incurred by individuals on qualified small business corporation shares, qualified farm property and qualified fishing property. In addition, the Tax Act allows for a deferral of capital gains (plus any recaptured depreciation) on intergenerational transfers by an individual to his or her child of farming property and fishing property.
The Budget proposes to simply the tax rules relating to the LCGE and intergenerational rollovers in respect of taxpayers involved in a combination of farming and fishing by amending subsection 248(29) of the Tax Act .
Tax Deferral for Farmers
Farmers who dispose of breeding livestock as a result of drought, flood or excess moisture conditions in prescribed regions (as prescribed on an annual basis based on recommendations made by the Minister of Agriculture and Agri-Food) may defer up to 90% of the sale proceeds from such livestock until at least the taxation year following the year or sale, or a later year if the adverse conditions persist. Farmers can then use the full amount of the tax-deferred proceeds to acquire replacement livestock, resulting in an expense that may offset the deferred income from the earlier sale.
For example, the deferral is currently available for cattle, goats and sheep that are over 12 months of age and are kept for breeding, as well as horses that are over 12 months of age and are kept for breeding in the commercial production of pregnant mares’ urine. The Budget proposes to extend the tax deferral to bees as well as to all types of horses that are over 12 months of age and are kept for breeding by amendments to section 80.3 of the Tax Act. The change will apply to the 2014 and subsequent taxation years.
Amateur Athlete Trusts
Amateur athlete trusts (“AATs”) are trusts established for the benefit of amateur athletes who are members of a registered Canadian amateur athletic association and who are eligible to compete in international sporting events as a Canadian national team member. AATs are designed to hold endorsement income, prize money, and income from public appearances and speeches. Such amounts may be contributed to an AAT if they are received in connection with the athlete’s participation in international sporting events. The contributed amounts are excluded from the athlete’s income in the year in which the contribution is made, and no tax is payable by the AAT on such income (including investment income). The property in an AAT is included in the beneficiary’s income and subject to income tax on the earlier of:
- the distribution of the property to the athlete; and
- 8 years after the last year in which the athlete competed as a Canadian national team member (at which time, any property that has not yet been distributed is deemed to have been distributed to the athlete).
An individual’s annual contribution to an RRSP is limited to 18% of the previous year’s earned income up to a contribution limit ($24,270 in 2014), minus a pension adjustment for the previous year’s savings in a Registered Pension Plan (“RPP”), plus unused RRSP contribution room from prior years. Currently, income contributed to an AAT does not count towards determining an athlete’s RRSP contribution limit, which can result in a reduction of RRSP room that would otherwise have been available if the amount contributed to the AAT was considered earned income in the year received.
The Budget proposes to allow income contributed to an AAT to qualify as earned income of the athlete who is the beneficiary of the AAT for the purposes of determining the RRSP contribution limit of such beneficiary. The change will apply to contributions made to AATs after 2013, but an election will also be available for income contributed to an AAT in 2011, 2012 and 2013 to qualify as earned income in each of those taxation years. Additional RRSP contribution room arising out of such election will be added to the athlete’s contribution room for 2014. The election must be made in writing and submitted to the CRA on or before March 2, 2015.
Pension Transfer Limits
The Tax Act permits individuals who are leaving defined benefit RPPs to transfer a portion of a lump-sum commutation payment to an RRSP on a tax-free basis. Generally, if the commutation payment is reduced because the RPP is underfunded, the amount that can be transferred tax-free to an RRSP is based on the reduced amount. The portion of the commutation payment that exceeds the transferable amount must be included in the taxpayer’s income in the year in which it is received.
The Federal Government introduced a special rule in 2011 whereby an individual leaving an RPP can in certain circumstances disregard the reduction in a commutation payment due to underfunding in calculating the amount that can be transferred tax-free to an RRSP. The transferable amount would instead be calculated based on the commutation payment that would have been received if the RPP were fully funded. The special rule currently applies to RPPs that are sponsored by an insolvent employer, have broad membership and are being wound-up. In addition, the CRA must approve the application of the rule. The Budget proposes to expand the rule to situations where the commutation payment to a plan member who is leaving an RPP has been reduced due to plan underfunding and either:
- the plan is an RPP other than an individual pension plan, and the reduction of the estimated pension benefit resulting in the reduced commutation payment is approved under pension benefits standard legislation; or
- the plan is an individual pension plan, and the commutation payment is the last payment made out of the plan.
In both of these situations, the application of the rule must still be approved by the CRA. The expansion of the rule will be effective in respect of commutation payments made after 2012.
GST/HST Credit Administration
Currently, individuals apply for the GST/HST Credit (a non-taxable benefit paid to individuals based on their adjusted family net income) by checking a box on their personal income tax return. When this box is checked, the CRA is required to determine the applicant’s eligibility for the credit and send that individual a notice of determination. The Budget proposes to eliminate the application process and allow the CRA to automatically determine each individual’s eligibility to receive the GST/HST Credit.
A notice of determination will be issued only to those who are eligible to receive the credit. However, ineligible individuals may request a notice of determination, thus preserving their right to object. In the case of eligible couples, the GST/HST Credit will be paid to the spouse or common law partner whose return is assessed first. This measure will apply in respect of the 2014 and subsequent taxation years.
Tax on Split Income
The rules governing tax on split income, informally known as the “kiddie tax” rules, are designed to prevent higher-income individuals (whose income would be subject to a higher marginal tax rate) from reducing income tax by splitting taxable income with lower-income minors. The rules operate by causing “split income” to be subject to the highest marginal tax rate in the hands of the lower-income minor, thereby negating the tax benefit of transferring the income to the minor. “Split income” paid or payable to a minor is generally defined as:
- taxable dividends and shareholder benefits received directly, or through a partnership or trust, in respect of unlisted (i.e. private company) shares of Canadian and foreign corporations (other than shares of a mutual fund corporation);
- capital gains from dispositions of such shares to persons who do not deal at arm’s length with the minor; and
- income from a partnership or trust that is derived from providing property or services to, or in support of, a business carried on by a person related to the minor or in which the related person participates.
The kiddie tax rules do not currently apply if income is allocated to a minor from a partnership or trust that derived the income from business or rental activities conducted with third parties. This allows taxpayers engaging in those types of activities to split business and rental income with minors by, for example, providing services to clients through a partnership of which a minor child is a member.
The Budget proposes to expand the definition of split income to include income that is, directly or indirectly, paid or allocated to a minor from a trust or partnership if:
- the income is derived from a source that is a business or a rental property; and
- a person who is related to the minor, at any time in the taxation year:
- is actively engaged on a regular basis in the activity of the partnership or trust of earning income from a business or the rental of property; or
- in the case of a partnership, has an interest in the partnership directly or indirectly through another partnership.
This change will apply to the 2014 and subsequent taxation years.
Graduated Rate Taxation of Trusts and Estates Eliminated
Currently, testamentary trusts and “grandfathered” inter vivos trust (certain inter vivos trusts created prior to June 18, 1971) are subject to special treatment under the Tax Act whereby they are permitted to take advantage of the graduated tax rates applicable to individuals. This benefit is not available for other personal trusts, which are generally subject to Canadian income tax at the highest marginal personal tax rate on all income earned by the trust. In order to avoid the high rate of tax, trust income is generally allocated out to the beneficiaries and taxable to them.
In the 2013 Budget, the Federal Government announced that it was considering the elimination of graduated tax rates for testamentary trusts and grandfathered inter vivos trusts. The Federal Government released a consultation paper on June 3, 2013, which proposed, among other things, the application of the highest marginal tax rate to all income earned by estates for taxation years ending more than 36 months after the death of the relevant individual and to all grandfathered inter vivos trusts and trusts created by will. A number of organizations made submissions to the Minister of Finance during the consultation period that ended on December 2, 2013. (See, e.g., STEP Canada’s submission, the Wills, Estates and Trusts Section of the Canadian Bar Association and CALU’s submission.)
The Budget proposes to implement most of the proposals set out in the June 3, 2013 consultation paper beginning in 2016. As set out in the consultation paper, there will be an exception for estates in respect of taxation years ending within the first 36 months after the individual’s death. This exception is assumes that the period required for the administration of an estate is typically 36 months from the date of death. In any estate with litigious matters, the administration can last significantly longer. Hopefully the legislation will include an ability for executors to apply for an extension of the 36 months in certain situations.
An important exception to the new tax rules that will be included is for testamentary trusts for the benefit of disabled individuals. Concerns were raised during the consultation period that such testamentary trusts were important in allowing disabled individuals to access income-tested benefits such as provincial social assistance benefits. Under the exception, graduated rates will continue to be provided for testamentary trusts having as their beneficiaries individuals who are eligible for the Disability Tax Credit. The Federal Government plans to release further details concerning the scope of this exception within the coming months. Hopefully, this exception will be integrated with the provincial rules for disability benefits to ensure that individuals receiving such benefits are not disadvantaged, not all of whom are eligible for the Disability Tax Credit.
In addition, the Budget proposes to eliminate the following additional tax benefits for testamentary trusts (subject to the 36-month estate exception) and grandfathered inter vivos trusts:
- the exemption from the income tax installment rules;
- the exemption from the requirement that trusts have a calendar year taxation year and fiscal periods that end in the calendar year in which the period began;
- the basic exemption in computing alternative minimum tax;
- preferential treatment under Part XII.2 of the Tax Act;
- classification as a personal trust without regard to the circumstances in which beneficial interests in the trust have been acquired;
- the ability to make investment tax credits available to a trust’s beneficiaries; and
- a number of tax administration rules that otherwise apply only to ordinary individuals.
Existing testamentary trusts that do not currently have a calendar year taxation year will have a deemed year-end on December 31, 2015. For estates falling within the 36-month exception where the 36-month period ends after 2015, such estates will have a deemed year end on the day on which the 36-month period ends, and will thereafter have a year-end of December 31st of each year. The changes with respect to the deemed year ends generally come into force on December 31, 2015, with the remainder of the changes applying to the 2016 and subsequent taxation years.
Budget Introduces Significant Welcome Changes in Treatment of Estate Gifts
Budget introduces a significant change in the tax treatment of charitable gifts made under a Will or beneficiary designation.
Under the current rules, where an individual makes a donation by Will, the donation is treated as having been made by the individual immediately before the individual’s death. Thus, the tax credits arising from the gift are applied to the donor’s final tax return. Where the full credit cannot be used on the donor’s final return, the excess credit can be carried back and used against the previous year’s income. The tax credits that arise on gifts made by Will are available only against the individual’s last two years’ income – they cannot be used to reduce tax that arises in the estate following the donor’s death.
By contrast, where a gift is directed to be made by the donor’s estate, the gift is available only against the tax that would otherwise be payable by the estate. Such gifts cannot be used to reduce the donor’s income in the year of death or the prior year. Distinguishing between gifts by Will and gifts by an estate requires an analysis of the terms of the Will and the extent of discretion that is afforded to the executors. As we have discussed in past issues of this Newsletter [see, for example Miller Thomson's Charities and Not-for-Profit Newsletter on Gifts by Will-Section 118.1(5) ], determining whether a particular gift is a gift by Will or a gift by the estate is not always easy, and the tax implications can vary significantly depending on the answer.
The Tax Act also applies similar rules where an individual designates a qualified donee as the beneficiary of proceeds on death under an RRSP, RRIF, TFSA or life insurance policy. Under these circumstances, the tax credit is available only against the individual donor’s income tax otherwise payable in the year of death. Excess tax credits can be carried back and used in the individual’s previous year’s returns, but not against tax incurred by the estate.
The Budget proposes to provide flexibility with respect to the tax treatment of such charitable gifts, where they occur as the result of a death after 2015. Rather than deeming gifts by Will and gifts by direct designation to have been made immediately before the individual’s death, these gifts will be treated as having been made by the estate. The gift will be deemed to occur when the property is actually transferred to the charity. Executors will then have the discretion to allocate the available tax credits against any of the following:
- the taxation year of the estate in the year the gift was made;
- any earlier taxation year of the estate; or
- the last two taxation years of the individual prior to death.
The Budget confirms that the current requirements for determining whether a gift is a direct designation will continue to apply. Generally, this means that the transfer of property to the estate must occur as a consequence of the death of the donor, and must occur within 36 months of death.
This change is welcome in that it provides significant flexibility to executors and trustees when dealing with the taxes incurred by a deceased individual and the individual’s estate upon death. While the Budget does not include specific legislative language to implement this change, it appears that the executors and trustees will be able to allocate tax credits between the estate and the deceased individual.
The new rules also reduce the significance of the distinction between gifts by Will and estate gifts. To be sure, they do not eliminate this issue. It appears from the Budget document that the new flexibility to allocate tax credits to either or both of the estate and the individual is only available where the gift constitutes a gift by Will. Thus, where the ability to allocate is significant, it will be necessary to determine whether the gift constitutes a gift by Will. However, the increased flexibility will mean that the trustees can use either type of gift against the estate’s tax, thus avoiding the need to analyse the nature of the gift where it is sufficient that it can be used against the taxes arising in the estate.
This measure will apply to the 2016 and subsequent taxation years. It will be interesting to review the details of the legislation that is drafted to implement this proposal; this will allow us to determine the scope of the new flexibility more definitely. Although the proposal as announced is one that will be welcomed by the charitable sector and estate planners, it is not clear whether the Budget proposals will deal with issues that can arise with the availability of tax credits for donations made from a spousal testamentary trust on the death of the spouse beneficiary (See, for example Miller Thomson's Wealth Matters Spring 2012.) It is hoped that the legislation in its final form will also address this issue.
The rules under section 94 of the Tax Act (the “NRT Rules”) apply to deem certain non-resident trusts to be resident in Canada for Canadian income tax purposes. The current NRT Rules were enacted in June, 2013, after first being introduced in the 1999 Federal Budget and revised some ten times. (Though enacted in 2013, the NRT Rules are retroactive to January 1, 2007.) The NRT Rules are designed to preclude the use of non-resident trusts by taxpayers to avoid Canadian income tax. The NRT Rules may apply when a person resident in Canada contributes property to a non-resident trust. However, the NRT Rules presently provide an exception for non-resident trusts where the contributor to the trust is an individual who has not been resident in Canada for a period exceeding 60 months.
This exception allows for the creation of so-called “immigration trusts” by individuals immigrating to Canada. The exception permitted an individual immigrating to Canada to establish a non-resident trust (i.e. a trust with non-resident trustees, with the central place of management and control remaining outside of Canada) for his or her benefit, together with that of his or her family members, prior to or at the time of immigrating to Canada. The immigration trust’s foreign-source income was not subject to Canadian tax until the new immigrant or immigrants who made contributions to the trust were resident in Canada for a period of 60 months. (Often, the immigration trust would be established in a low-tax jurisdiction.) The immigration trust could be dissolved or transferred to Canada just prior to that time, with a step-up in the cost base of the assets held within the trust during the 60-month period.
Although the newly-implemented NRT Rules were designed specifically to provide a 60-month exception for immigration trusts, the Federal Government states in the Budget that the exception raises “tax fairness, tax integrity and tax neutrality concerns” by providing benefits to certain persons that are not available to Canadian-resident persons who earn similar income directly or through a Canadian trust. Accordingly, the Budget proposes to eliminate the 60-month exemption from the application of the NRT Rules and related rules applicable to non-resident trusts. The changes will apply in respect of trusts for taxation years ending after 2014 if:
- at any time after 2013 and before Budget Day, the 60-month exception applies in respect of the trust; and
- no contributions are made to the trust on or after Budget Day and before 2015.
In any other case, the changes apply in respect of trusts for taxation years ending on or after Budget Day.
Improving the Application of the GST/HST to the Health Care Sector
Acupuncturists’ and Naturopathic Doctors’ Services
As the professional services of acupuncturists and naturopathic doctors are now regulated as a health profession in at least five provinces, the Budget proposes that acupuncturists and naturopathic doctors be added to the list of health care practitioners whose services rendered to individuals are exempt from GST/HST.
It is proposed that this measure will apply to supplies made after Budget Day.
Designing Training for Individuals with Disorder or Disability
Training that is specially designed to assist individuals with a disorder or disability is currently exempt from GST/HST. The Budget proposes to expand the exemption to services of designing such training. Effective to supplies made after Budget Day, the service of designing such training will be exempt if:
- it is supplied by a government or the cost of the service is fully or partially subsidised by a government program; or
- a recognized health care professional whose services are exempt certifies in writing, in the course of a professional relationship with an individual with a disorder or disability, the design service as being for training that is an appropriate means to assist, alleviate or eliminate the effects of the disorder or disability.
Eyewear Designed to Enhance Vision by Electronic Means
Recently developed electronic eyewear is being used to treat certain vision impairment. However, such eyewear does not currently qualify to be GST/HST zero-rated similar to other corrective devices such as eyeglasses or contact lenses. Therefore, the Budget proposes that eyewear specially designed to treat or correct vision by electronic means, if supplied on written order of a physician or optometrist for use by a consumer named in the order, will be added to the list of GST/HST zero-rated medical and assistive devices. This measure will apply to supplies made after Budget Day.
GST/HST Election for Closely Related Persons
Under section 156 of the Excise Tax Act, an election is available to deem most supplies between Canadian-resident registrants who are members of a closely related group and engaged exclusively in commercial activities to be made for nil consideration, thus attracting no tax. A closely related group is generally a group of corporations or partnerships with at least 90% common ownership. Currently, a new corporation or partner cannot avail itself of the election at the time of initial acquisition of assets from another member of its closely related group if the new corporation or partner has no other property before making the election and has not made any taxable supplies. The Budget proposes to extend the availability of the election to new members of a closely related group that have not yet acquired any property, provided that such members continue as going concerns engaged exclusively in commercial activities.
Additionally, effective January 1, 2015, parties to a new section 156 election will be required to file the election in a prescribed manner with the CRA. Currently, there is no requirement for the election to be filed. Generally, the deadline for filing will be the first day on which any of the parties to the election is required to file a return for the period in which the election becomes effective. Parties to an existing election that is in effect on January 1, 2015 will also be required to comply with this filing requirement, but will have until January 1, 2016 to do so.
Finally, the Budget proposes that parties to a section 156 election (or persons who conduct themselves as if such an election is in force) be subject to a joint and several (or solidary) liability provision with respect to any GST/HST liability arising out of supplies made between them on or after January 1, 2015.
Participants in a joint venture are permitted to make a joint election designating one of the participants as the person responsible for accounting for GST/HST in respect of the joint venture’s activities. Currently, the joint venture election is available only if the activities of the joint venture are prescribed by regulation as eligible activities for the purposes of the election. Eligible activities are generally restricted to exploration or exploitation of mineral deposits, the construction of real property and activities relating to the sale of lease of real property. To permit more commercial joint ventures activities and participants access to the benefits of the joint venture election, the Budget proposes to broaden eligible activities to allow participants in any joint venture to make the election as long as the activities of the joint venture are exclusively commercial activities and the participants are engaged exclusively in commercial activities. Complementary anti-avoidance measures will also be introduced.
To ensure that those who will be affected by these proposed measures have an opportunity to provide input, draft legislation will be released later in the year and stakeholders will be invited to make submissions prior to the tabling of the enacting legislation.
Strengthening Compliance with GST/HST Registration
Under the current legislation, a business that does not register for GST/HST as required cannot be compelled to do so. The Budget proposes that the Minister of National Revenue be given the discretionary authority to register the business and assign it a GST/HST registration number where a person fails to comply with the requirement to register even after being notified by the CRA. If attempts to contact the non-compliant business by the CRA are unsuccessful, the CRA will issue a formal notification and the person will be registered for GST/HST effective 60 days from the date of the notice.
This measure is expected to improve the CRA’s effectiveness of GST/HST compliance efforts and level the playing field for businesses that are complying with their GST/HST obligations.
This measure will apply on Royal Assent to the enacting legislation.
Other Excise Tax Measures
The Budget proposes various changes to restore the effectiveness of the excise duty to tobacco products such as increasing the rate of duty on cigarettes from $0.425 to $0.52575 for each five cigarettes to account for inflation, indexing tobacco taxes to the consumer price index, and proposing changes to the inventory tax on cigarettes.
The Budget also proposes to add a new administrative monetary penalty and to amend the criminal offences for the making of false statements or omissions in an excise tax return (applicable to the non-GST/HST portion of the Excise Tax Act). These provisions will be consistent with the GST/HST portion of the Excise Tax Act.
Charities and Not-for-Profit Measures
The 2014 Budget introduced several changes and developments that are of particular relevance to registered charities, their donors and not-for-profit organizations (NPO); these include:
- Enhanced tax recognition for individuals who donate ‘ecologically sensitive’ land in the form of an increased tax credit carry-forward period.
- Introduction of electronic filing of applications for charitable registration and annual charity returns.
- Revocation of charitable status for the acceptance of donations from state supporters of terrorism.
- Removal of the exemption for donations of ‘cultural property’ from the tax shelter anti-avoidance rules.
- Announcement that in the wake of CRA’s NPO Risk Identification Project, the Federal Government is now reviewing the tax exemption provision for non-profit organizations with a view to determining whether NPOs are currently subject to sufficient transparency and accountability provisions.
For a more detailed report on the Budget’s provisions relating to registered charities, their donors and NPOs, click here.
Aboriginal Tax Policy
The Federal Government has entered into 35 sales tax arrangements under which Indian Act bands and self-governing Aboriginal groups levy a sales tax within their settlement or 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 confirmed its continued support for direct tax arrangements between Aboriginal governments and provinces and territories.
Customs Tariff Treatment of the Governor General
Currently, articles imported for use by the Governor General are exempt from customs duties. The Governor General is the only individual with this type of broad exemption. The Budget proposes to amend the Customs Tariff to make the Governor General subject to the same tariff rules as other Government office holders.
Support of Offshore Oil and Gas Development
The Mobile Offshore Drilling Units Remission Order that allows for the duty-free temporary importation of mobile offshore drilling units (MODUs) used in oil and gas exportation is set to expire in May 2014. To eliminate a disincentive to exploration and to equalize the playing field with other oil and gas countries competing for offshore petroleum industry investment, the Budget proposes to eliminate the 20% Most-Favoured-Nation tariff on imported MODUs.
This measure will be effective for MODUs imported into Canada on or after May 5, 2014.
Budget 2014 confirms the Government’s intention 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 automobile expense deduction limits and the prescribed rates for the automobile operating expense benefit for 2012 announced on December 29, 2011, and for 2013 announced on December 28, 2012;
- Legislative proposals released on November 27, 2012 relating to income tax rules applicable to Canadian banks with foreign affiliates;
- Legislative proposals released on July 12, 2013 relating to income tax and excise duties and sales tax technical amendments;
- Legislative proposals released on August 16, 2013 relating to the foreign affiliate dumping rules;
- Legislative proposals released on August 23, 2013 relating to changes to the life insurance policyholder exemption test;
- Modifications to the Customs Tariff to implement the Notice of Ways and Means Motion tabled by the Government in Parliament on November 22, 2013, which clarified the tariff classification of certain imported food products;
- Legislative proposals released on November 27, 2013 relating to the tax rules governing Labour-Sponsored Venture Capital Corporations;
- Legislative proposals released on January 9, 2014 to require that international electronic funds transfers of $10,000 or more be reported to the Canada Revenue Agency;
- Legislative proposals released on January 17, 2014 clarifying GST/HST rules to prevent input tax credit claims that exceed tax actually paid; and
- Legislative proposals released on January 24, 2014 relating to the provision of a GST/HST exemption for hospital parking for patients and visitors.
Budget 2014 also reaffirms the Government’s commitment to move forward as required with technical amendments to improve the certainty of the tax system.