As December 31, 2013 quickly approaches, taxpayers are turning their attention to looming deadlines and potential opportunities to minimize or eliminate Canadian taxes. The enactment of Bill C-48, Technical Tax Amendments Act, 2012 on June 26, 2013, created some unique planning opportunities that taxpayers would be prudent to consider as the year draws to a close. This article will focus on the specific tax planning opportunities that exist for the 2013 year as a result of the aforementioned legislative changes.
2013 Tax Planning Opportunities
1. Consider Accelerating the Payment of Non-Eligible Dividends to 2013
Effective January 1, 2014, the tax paid on non-eligible dividends will increase significantly as a result of recent changes adjusting the dividend tax credit and gross up factor applicable to non-eligible dividends. The gross up factor applicable to non-eligible dividends will decrease from 25% to 18% and the effective rate of the dividend tax credit, expressed as a percentage of the grossed up amount, will decrease from 13.3% to 11%. According to the Federal Government, these changes were necessary because the existing integration mechanism over-compensated individuals for income taxes presumed to have been paid at the corporate level on active business income, and the dividend tax credit on non-eligible dividends placed an individual who received this dividend income from a corporation in a better tax position than if the individual had earned the income directly.
Taxpayers should consider paying out non-eligible dividends to shareholders prior to January 1, 2014, in order to minimize tax incurred on the payment of such dividends. It should be noted that there are no currently proposed changes with respect to federal tax rates on eligible dividends.
In some provinces, an increase in the personal tax rates combined with the increase in non-eligible tax rates will result in a greater increase in the amount of tax paid on non-eligible dividends. For example, taxpayers residing in British Columbia should be aware that once the increase in personal tax is taken into account, the top combined federal and British Columbia marginal tax rate on eligible dividends is set to increase from 33.71% in 2013 to 37.98% in 2014. Taxpayers should also review their owner-manager remuneration strategies and ensure that they have taken into account the increases in non-eligible dividend tax rates in all provinces and territories after 2013.
 Table 1 is reproduced from PWC’s Year End Tax Planner dated October 29, 2013, Helping Individuals and Owner-Managed Businesses Save Tax
 For Ontario, the rates assume that the individual is taxed at Ontario's personal income tax rate on incomes over $509,000 in 2013 (indexed for 2014). If the individual's income is $509,000 or less, but over $135,054 in 2013 (indexed for 2014), the figures for 2013 and 2014 are as follows: Interest & ordinary income [46.41%]; Capital gains [23.20%]; Canadian dividends (eligible) [29.54%]; Canadian dividends (non-eligible) [32.57% in 2013; 34.92% in 2014].
2. If Nova Scotia tables a budget surplus in its 2014-2015 fiscal year, the top combined marginal income tax rates for 2014 will be 48.25% for interest and ordinary income, 24.13% for capital gains, 32.42% for eligible dividends, and 36.32% for non-eligible dividends.
3. For New Brunswick, the 2014 rate reflects a 5.3% provincial non-eligible dividend tax credit rate. According to a New Brunswick Finance official, the government has not yet made a decision to change the 5.3% rate after 2013. Amendments to the legislation will be required to ensure the calculation in the legislation yields the intended rate.
4. For the Yukon, the rate that applies depends on the level of the taxpayer's other income, with 19.29% applying if the taxpayer has no other income.
5. Non-resident rates for interest and dividends apply only in certain circumstances. Generally, interest (other than most interest paid to arm's length non-residents) and dividends paid to non-residents are subject to Part XIII withholding tax.
1. Consider a Disposition of Eligible Property in 2014 to Take Advantage of the Increased Lifetime Capital Gain Exemption
Many taxpayers are already aware that only 50% of capital gains realized are recognized in calculating taxable income and that a lifetime capital gains exemption is available for capital gains resulting from the disposition of eligible property (e.g. qualified small business corporation shares, qualified farm property, and qualified fishing property). Taxpayers should be mindful that effective January 1, 2014, the lifetime capital gains exemption in respect of capital gains realized on the disposition of eligible property will increase from $750,000.000 to $800,000.00. As such, taxpayers planning to utilize their lifetime capital gains exemption on or prior to December 31, 2013, should consider postponing the disposition of eligible property until after January 1, 2014, to take advantage of the $50,000.00 increase in the lifetime capital gains exemption. The new $800,000.00 lifetime capital gains exemption will apply to all taxpayers, including those who previously used their then available lifetime capital gains exemption.
Taxpayers planning to utilize their lifetime capital gains exemption may also wish to consider restructuring the business to ensure that substantially all of the assets are used in an active business. For example, it may be necessary to move excess funds possibly on a tax deferred basis out of the operating corporation, or alternatively, bonuses and dividend distributions might be paid to ensure that the taxpayer will have access to lifetime capital gains exemption. It is also an opportune time for taxpayers to consider crystallizing the capital gains exemption to preserve access for future use, should the rules change.
2. Consider Whether the Thin Capitalization Rules are Applicable to the Taxpayer’s Corporation, Trust or Partnership
Taxpayers should be cognizant of recent changes to the thin capitalization rules as 2013 draws to a close. The thin capitalization rules were designed to prevent foreign owned corporations resident in Canada from using an excessive amount of debt to finance their Canadian operations. The thin capitalization rules limit the amount of debt owing to a specified non-resident that a corporation resident in Canada (or a partnership of which it is a member) can deduct interest expense on for tax purposes. Under the current rules, the corporation resident in Canada cannot deduct interest on debt that exceeds 1.5 times its equity. Any interest expense on debt that exceeds this ratio will not be deductible for Canadian tax purposes and will be re-characterized as a dividend to which Canadian non-resident dividend withholding tax will apply at a 25% (subject to reduction under an applicable tax treaty), instead of as interest.
Effective as of January 1, 2014, the thin capitalization rules will be extended to apply to: (1) Canada resident trusts (and to partnerships in which a Canadian resident trust is a member); and (2) Non-resident corporations and trusts that operate in Canada or elect to be taxed as a Canadian resident under section 216 of the Act (and to partnerships of which such a non-resident corporation or trust is a member). The new rules will apply with respect to existing, as well as new borrowing. The same 1.5 to 1 debt-to-equity limit will apply to Canadian resident trusts. A trust could designate the non-deductible interest as a payment of income of the trust to the non-resident recipient of the interest. The trust would then be able to deduct the payment in computing its income; however, the payment would be subject to Canadian non-resident withholding tax at a 25 percent rate (subject to reduction under an applicable tax treaty).
Similarly, the 1.5 to1 debt-to-equity limit will also apply to non-resident corporations and trusts that operate in Canada. However, since a Canadian branch is not a separate legal person from the non-resident entity and therefore does not have its own equity for purposes of the thin capitalization rules, a 3-5 debt to assets ratio is used to determine a notional amount of equity for the branch. For a non-resident corporation, the application of the thin capitalization rules could increase its liability for branch tax under Part XIV of the Income Tax Act (Canada) (the “Act”).
Taxpayers should be aware of these rules and review the capital structure of their business to ensure there will not be an excess interest deduction that will be disallowed. Entities impacted by these changes should consider, if necessary, reducing the amount of debt owing to foreign creditors or increasing the ‘equity amount’ for thin capitalization purposes in order to ensure compliance with the applicable debt to equity limitations taking effect on January 1, 2014.
3. Consider Accelerating the Purchase of Capital Assets Eligible for Scientific Research and Experimental Development (SR&ED) Treatment
Taxpayers should be aware of recent changes to the SR & ED tax incentive program and consider accelerating the timing of qualifying expenditures to 2013 to take advantage of higher ITC and maximize their tax benefit. An ITC can be claimed for qualifying SR&ED expenditures incurred in a tax year. Taxpayers should be aware that the general SR&ED ITC rate applicable to SR&ED qualifying expenditure pool balances at the end of a tax year will be reduced from 20 percent to 15 percent for tax years that end after 2013, except that for a tax year that includes January 1, 2014, the 5 percent reduction in the ITC rate will be pro-rated. It is also important to note that capital expenditures for property acquired after 2013 will no longer be eligible for SR&ED deductions nor ITCs.
4. Consider Accelerating the Purchase of Depreciable Capital Assets
Purchasing capital assets before the end of the year can provide your business with a deduction for capital cost allowance (CCA). The business can claim the CCA deduction in 2013 provided that the depreciable assets are purchased and available for use at year end. Taxpayers may wish to consider purchasing eligible M&P machinery and equipment. The CCA is enhanced from 30% declining balance to 50% straight line for property acquired prior to 2016.
5. Consider Reporting Tax Avoidance Transactions
The legislation implementing the mandatory tax avoidance transaction reporting regime in section 237.3 of the Act was enacted on June 26, 2013. The regime applies to certain tax avoidance transactions if the transaction was entered into after 2010; or was part of a series of transactions completed after 2010. For reportable transactions arising in 2013, the information return must be filed by June 30, 2014. Failure to file as and when required has numerous adverse consequences, including penalties, the denial of tax benefits, and the extension of the period during which the Canada Revenue Agency can reassess the taxpayer.
6. British Columbia Residents May Wish to Consider Accelerating Taxable Bonuses and Discretionary Dividends to 2013
Taxpayers residing in British Columbia should be aware that for 2014 and 2015, the personal tax rate on taxable incomes over $150,000.00 will increase from 14.7% to 16.8%. Taxpayers should review their remuneration strategy and those taxpayers expecting to receive annual income exceeding $150,000 in 2014 or 2015, may wish to consider accelerating taxable bonuses and discretionary dividends to 2013.
7. New Brunswick Residents May Wish to Consider Accelerating Taxable Bonuses and Discretionary Dividends to 2013
Taxpayers residing in New Brunswick should be aware that personal taxes are increasing at all income levels for 2014. Taxpayers should review their remuneration strategy and may wish to consider accelerating taxable bonuses and discretionary dividends to 2013.
8. Canadian-Controlled Private Corporations (CCPCs) in Nova Scotia
CCPCs in Nova Scotia should consider if deferring income to 2014 makes sense; Nova Scotia's small business rate will decrease to 3% (from 3.5%) on January 1, 2014, but the benefit of this rate decrease will be offset by a decrease in its small business threshold to $350,000 (from $400,000) in 2014.
9. Canadian-Controlled Private Corporations (CCPCs) in Prince Edward Island
CCPCs in Prince Edward Island should consider accelerating income to 2013 by minimizing discretionary deductions (e.g. CCA), but compare the actual tax saved and the time value of money; Prince Edward Island's small business rate increased to 4.5% (from 1%) on April 1, 2013.
The foregoing discussion addressed some of the available tax planning opportunities and challenges facing taxpayers as we approach the end of 2013. Taxpayers are encouraged to consider whether any of the topics discussed in this article are relevant in their circumstances and might present an opportunity to minimize tax as December 31, 2013 quickly approaches. This article is by no means a comprehensive description with respect to all matters taxpayers should consider as the year comes to an end; rather, it is intended to provide the taxpayer with insight into some planning opportunities that exist this year and upcoming tax changes in the next year.