Finance Minister Jim Flaherty today tabled his third Federal Budget of the minority Conservative Government. It evidences a more restrained approach for the Government than its previous two budgets. There are some welcome initiatives in the Budget and an absence of measures that leave one puzzled about the policy choices made by the Government in proposing the particular measures.
While there are a multitude of proposed adjustments relating to capital cost allowance rates, various tax credits, and other sundry measures, the most significant Budget developments are the enhancements relating to scientific research & experimental development undertaken by Canadian-controlled private corporations and the creation of a new tax-efficient savings vehicle, the tax-free savings account that will be available to every adult Canadian.
The Conservative Government also deserves credit for its pragmatic perspective in proposing revisions to the Section 116 withholding and clearance certificate obligations, which have become an unnecessary inconvenience and impediment to cross-border purchase and sale transactions.
International Tax Measures
The Budget contains two proposals applicable to non-residents investing in Canada, which may ease the compliance burden resulting from the disposition of certain investments and eliminate significant delays in receiving the full proceeds from such dispositions.
Section 116 Clearance Certificates
Generally, a non-resident of Canada (a Non-Resident) will be liable to pay Canadian tax on gains realized on the sale of taxable Canadian property (TCP) other than Treaty-Protected Property (defined in the Act to mean property, any gain from the disposition of which would be exempt from Canadian tax because of a tax treaty). TCP includes, among other things, real property situated in Canada, shares of Canadian private corporations and shares of a Canadian corporation that are listed where the holder (and persons not dealing at arm’s length with the holder) have owned more than 25% of any class or series of shares of the corporation during the 60 months preceding the disposition. In addition, shares of non-resident corporations and interests in partnerships are also TCP if they derive their value from certain types of TCP.
In certain cases, a tax treaty between Canada and the country of residence of the Non-Resident will exempt the disposition of TCP from Canadian taxes. As noted above, this property is referred to as Treaty-Protected Property.
Under Section 116, a Non-Resident must generally apply for a certificate confirming that the taxes on the disposition of TCP have been paid or provided for (a Certificate) and provide it to the purchaser at the time of payment of the purchase price.
With respect to property other than depreciable property, if no Certificate is provided, the purchaser generally becomes liable to pay to the Canada Revenue Agency (CRA) up to 25% of the purchase price of the TCP and is entitled to withhold this amount from the proceeds otherwise payable to the seller. This amount must be remitted to the CRA by the 30th day of the month following the month in which the purchaser acquires the property. In the case of depreciable property, the required withholding is greater.
In recent years, practical timing issues have developed in obtaining the Certificates. It has not been uncommon for a Non-Resident to have to wait three to four months to receive a certificate, whether or not tax is payable on the sale.
To address these delays, a practice has developed where the CRA issues a so-called comfort letter confirming that the purchaser can continue to hold funds withheld to comply with its obligations under the Act, that such funds need not be remitted to the CRA and that the purchaser will not incur any liability under the Act for not remitting such funds within the period provided for in the Act. The end result is that it can take a number of months for a Non-Resident seller to receive the amount withheld from the sale proceeds of TCP even though, under the relevant tax treaty, Canada cannot tax the gain arising from such sale.
In addition to having to comply with the Section 116 procedure described above, a Non-Resident who disposes of TCP is required to file a Canadian tax return to report the disposition.
The first budget proposal, which applies to dispositions after 2008, proposes to eliminate the liability of the purchaser of TCP to remit amounts to the CRA (and, as a corollary, the need to withhold from the purchase price) on an acquisition of TCP where three conditions are satisfied:
a. the purchaser concludes after reasonable inquiry that the Non-Resident is under a tax treaty that Canada has with a particular country, resident in the particular country;
b. the property would be Treaty-Protected Property of the Non-Resident if the Non-Resident were, under the tax treaty referred to in paragraph (a), resident in the particular country; and
c. the purchaser provides a notice to the CRA in respect of the acquisition within 30 days.
The effect of this proposal (combined with the second proposal discussed below) may be to ease the compliance burden of the Non-Resident seller and to allow the seller to receive the full sale price on closing. However, the effect is also to put the burden on the purchaser who will have to assess whether the conditions in (a) and (b) above are in fact satisfied. Given the dire consequences of being wrong, purchasers will likely want to err on the side of prudence and require a Certificate to be provided.
For example, the condition in paragraph (a) above requires the purchaser to make a "reasonable inquiry" to determine whether the Non-Resident is, under a tax treaty that Canada has with a particular country, a resident of the particular country. This issue is complicated since residence under a treaty is a mixed question of fact and law (determining whether such Non-Resident is liable to tax in the treaty country because of its place of management, place of residence etc.). Does a reasonable inquiry require a purchaser to obtain a certificate from the seller as to certain factual matters and possibly an opinion on the residence of the seller under the relevant treaty? It is noted that the requirement in paragraph (a) would be satisfied by making reasonable inquiries even if the purchaser’s conclusion were incorrect.
The second condition in paragraph (b) above involves the determination by the purchaser of whether the property being acquired is treaty-protected Property. Canada’s tax treaties generally exempt from Canadian tax gains realized by a Non-Resident on the disposition of shares of a Canadian company. However, Canada generally retains the right to tax gains arising from the disposition of shares in the capital of a company, the value of which is derived principally from real property situated in Canada (taking into account the expansive definition in the Income Tax Conventions Interpretations Act). Certain treaties (e.g., with the UK and with the Netherlands) exclude from the definition of "real property," property (other than rental property) in which the business of the company is carried on.
The second condition puts the onus on the purchaser to determine whether the property is Treaty-Protected Property. Based on the Budget proposals, reasonable inquiry is not sufficient. Again, in case of uncertainty, the purchaser will likely require a Certificate or withhold 25% of the purchase price.
The purchaser’s analysis will be further complicated in the case of multiple sellers or partnerships where these two conditions will need to be satisfied with respect to each seller or partner and possibly based on a number of different tax treaties.
The second proposal with respect to Section 116 will eliminate the need for a Non-Resident seller to obtain a Certificate when selling treaty-exempt property. This is achieved by adding treaty-exempt property to the definition of excluded property (which is property in respect of which a Non-Resident is not required to obtain a Certificate).
Treaty-exempt property is essentially Treaty-Protected Property. In addition, where the purchaser is related to the seller at the time the purchaser acquires the property, in order to qualify as treaty-exempt property, the purchaser must provide the CRA with the same information required from the purchaser in condition (c) above.
The same issues will arise on the characterization of property as treaty-exempt property as will arise on the characterization of property as Treaty-Protected Property and, presumably, in the case of non-related parties, as discussed above, the views of the purchaser will prevail. In the case of related parties, the notification process required of the purchaser for the property to qualify as treaty-exempt property and, therefore, as excluded property, should allow the CRA to monitor these transactions.
Elimination of Tax Return Requirement
The Budget also proposes to eliminate the requirement for Non-Residents to file a Canadian tax return where the realization of a taxable capital gain arises from an excluded disposition or is an excluded disposition of TCP (described below). In addition, non-resident corporations will not have to file a so-called treaty-based return where the exemption from tax arising from a treaty is as a result of the disposition of Treaty-Protected Property.
A disposition of property is an excluded disposition of a taxpayer where:
a. the taxpayer is a Non-Resident at that time;
b. no tax is payable under Part I of the Act by the taxpayer for the taxation year;
c. the taxpayer is, at that time, not liable to pay any amount under the Act in respect of any previous taxation year (other than an amount for which the Minister has accepted, and holds, adequate security under Section 116 or 220); and
d. each TCP disposed of by the taxpayer in the taxation year is:
i. excluded property within the meaning assigned by subsection 116(6); or
ii. a property in respect of the disposition of which the Minister has issued a Certificate to the taxpayer.
Business Tax Measures
Scientific Research and Experimental Development Program
As widely anticipated, the Budget proposed a number of amendments to the Act’s scientific research and experimental development (SR&ED) system. The Budget indicates that the proposed changes respond to feedback received by the Government during public consultations held last Fall. While this is true, the proposed amendments are minor relative to the issues that were brought to the Government’s attention during those consultations, as well as by the February 2008 pre-budget report of the House of Commons Standing Committee on Finance (the Commons Finance Committee).
Canada has consistently attempted to attract the increasingly mobile pool of international R&D work by holding itself out as a low-cost jurisdiction in which to perform R&D. The rising Canadian dollar, an SR&ED rate structure due for an overhaul, administrative problems, and changes made by many other jurisdictions to their R&D tax incentive systems have recently made this representation more difficult to justify. Against this backdrop, the Budget seems tepid at best, and failed to justify the changes it proposed (and did not propose) in this context.
The SR&ED program encourages taxpayers to undertake scientific and technology-related research and development activities that have the potential for significant economic impact. It does so by providing for (i) current deductibility for certain SR&ED related expenditures, many of which may not otherwise be deductible currently or at all, and (ii) investment tax credits (ITCs) calculated as a percentage of certain SR&ED expenditures. The general ITC rate is 20%, with an additional 15% provided for Canadian-controlled private corporations (CCPCs) in certain circumstances. The enhanced ITC rate for CCPCs applies to qualifying expenditures up to $2 million per year, but phases out as prior year taxable income climbs from $400,000 to $600,000 and prior year taxable capital climbs from $10 million to $15 million.
The SR&ED measures announced in the Budget propose four substantive changes to the ITC system, three of which will assist small to medium-sized CCPCs, and one that has general application.
The proposed ITC amendments that relate to CCPCs increase the expenditures on which the additional 15% ITC can be earned, and expand the taxable income and taxable capital phase-outs. The new rules compare to the old as follows:
The following table illustrates the effect of the proposed expenditure limit and phase-out rules on a CCPC’s refundable ITCs:
The proposed enhancement of the expenditure limit and the taxable income and capital phase-out rules will be applicable to taxation years that end on or after February 26, 2008, pro-rated based on the number of days in that taxation year that are after February 25, 2008.
While the proposed amendments move in the right direction, R&D performers in industries increasingly important to Canada’s economy, such as the pharmaceutical, energy and technology sectors, will argue that the Budget came up short. Many submissions to the Government last Fall recommended more generous income related phase-outs for the incremental 15% ITC available to CCPCs, as well as the elimination of the taxable capital phase-out. The Budget also failed to address a key recommendation of the Commons Finance Committee – that the enhanced ITC rate of 35% and partial ITC refundability be afforded to all taxpayers, instead of only CCPCs. Other countries, such as the UK, have gone this route. The international market for discretionary SR&ED work continues to become more competitive. Canada has lost some of its advantage in this regard as the Canadian dollar climbed last year. A strong argument can be made for more generous SR&ED tax incentives in the current economic climate.
SR&ED Performed Outside of Canada
The generally applicable amendment proposed to the ITC system addresses, in a minor way, one of the issues that was raised by many SR&ED performers during last Fall’s public consultation process. That is, expenditures in respect of SR&ED carried on outside of Canada do not currently qualify for ITC treatment. The Budget attends to this issue by proposing that wages in respect of Canadian-resident employees carrying on SR&ED activities outside of Canada qualify for ITC treatment, subject to certain conditions. For example, the activities must be directly undertaken by the taxpayer solely in support of SR&ED carried on by the taxpayer in Canada, and the wages can be no more than 10% of the total wages directly attributable to SR&ED carried on in Canada and may not include wages based on profits or subject to income tax imposed by another country.
Again, the Government is likely to be criticized for not going far enough in the right direction. During last Fall’s consultations, R&D performers provided many examples of cases in which SR&ED is conducted outside of Canada so as to provide economic benefits to Canada of the type the SR&ED system appears to be designed to encourage. The Budget did not address this broader issue.
Last Fall’s public consultation revealed many difficulties in the relationship between SR&ED claimants and the CRA. To address these, the Budget announced that the CRA will introduce a new SR&ED claim form, guide and eligibility self-assessment tool, and will review policies and procedures to ensure timeliness and consistency. The Budget announced an additional $10 million in annual funding to improve the CRA’s administration of the SR&ED program, and in particular to increase its access to the scientific and technical expertise required to assess SR&ED claims in a timely fashion.
Changes in the way the SR&ED system is administered can be as, or more, important than ITC limit increases of the type the Budget contains. In recent years, the CRA’s administration of the SR&ED system has been particularly uneven. Uncertainty related to whether a project may qualify for SR&ED due to the CRA’s unpredictability or a lack of clarity in the relevant provisions of the Act is enough to move some large projects out of Canada.
Other SR&ED Issues
The Fall consultations pointed to a variety of basic issues related to the SR&ED system that require the Government’s urgent attention. Many of these issues are of sufficient significance that it is not surprising the Government was not able to address them during the few weeks between the conclusion of the consultation process at the end of November, and today. These issues include the following:
- The definition of SR&ED and certain other key terms require clarification. As currently drafted, these encourage disputes between taxpayers and the CRA, and discourage taxpayers from engaging in many activities that are likely to cause the kind of economic growth the SR&ED system was designed to promote.
- The CRA needs to achieve greater consistency in its administration of the SR&ED system.
- A more efficient pre-approval process is required for SR&ED projects.
- The rules related to the use of partnerships in an SR&ED context are unduly restrictive, and cause unnecessary difficulties for taxpayers. This issue will become more important as joint ventures involving large amounts of capital devoted to SR&ED related to facing our environmental challenges come into being during the next several years.
- The treatment of SR&ED conducted outside of the Canada requires additional attention.
- Various important administrative rules relating to, among other things, contract payments and late-filed SR&ED claims, should also be re-worked.
Given the feedback already received by some SR&ED performers from the Government with respect to certain of these issues, it seems likely that further amendments to the SR&ED system will be proposed.
Temporary Incentive for M&P Machinery and Equipment
The 2007 Budget proposed a temporary increase in the capital cost allowance (CCA) rate for machinery and equipment used in manufacturing and processing and included in Class 43 of Schedule II of the Income Tax Regulations to a 50% straight line rate for eligible assets acquired on or after March 19, 2007 and before 2009.
The Budget proposes to extend the foregoing accelerated CCA treatment for three additional years. Machinery and equipment acquired in 2009 that would otherwise be included in Class 43 will be included in Class 29 and be subject to a 50% straight line rate. For assets acquired in the 2010 and 2011 calendar years, accelerated CCA will be provided on a declining basis. More specifically, eligible assets acquired in 2010 will generally be eligible for a 50% declining balance rate in the first taxation year ending after the assets are acquired, a 40% declining balance rate in the following taxation year and the regular 30% declining balance rate thereafter. Similarly, eligible assets acquired in 2011 will generally be eligible for a 40% declining balance rate in the first taxation year ending after the assets are acquired and the regular 30% declining balance rate thereafter. The half-year rule will apply to properties that are subject to this measure.
Accelerated CCA for Clean Energy Generation
Eligible energy generation equipment acquired after February 23, 2005 and before 2020, and meeting the requirements for inclusion in Class 43.2, qualifies for an accelerated CCA rate of 50% per year on a declining balance basis, subject to the half-year rule.
The Budget proposes to extend eligibility under this Class to the following types of assets used for generating clean energy and acquired on or after February 26, 2008 (i) certain ground source heat pump systems used in applications other than industrial processes or greenhouses (which are currently permitted), and (ii) equipment used to produce biogas through the use of animal matter and sludge from a licensed sewage treatment facility.
In certain cases, a taxpayer may sell the output produced by the property and include the property in Class 43.2 but in the case of certain thermal energy systems and equipment for the production of bio-oil or biogas, the output must be used by the taxpayer. The Budget proposes to remove restrictions relating to the use of the output, thereby increasing the viability of waste-to-energy systems. This measure applies to eligible assets acquired on or after February 26, 2008.
Aligning CCA Rates with Useful Life
The Budget proposes to adjust and set the rates of CCA in respect of certain types of depreciable capital property in order to align them with the useful life of the assets. The following types of property will have their CCA rates adjusted, generally applicable to assets acquired on or after February 26, 2008:
Specified Investment Flow-Through Trusts and Partnerships
Under the specified investment flow-through (SIFT) rules, certain publicly traded income trusts and partnerships are subject to a tax (SIFT Tax) on their "taxable distributions" in the case of a trust or their "taxable non-portfolio earnings" in the case of a partnership. Currently, the rate of SIFT Tax under the Act is made up of the federal general corporate tax rate and an additional tax of 13% which is in lieu of provincial tax. In order to ensure that the rate of SIFT Tax is the same as the federal-provincial tax rate for large public corporations with the same activities, the Budget proposes that the provincial component of the SIFT Tax for 2009 and subsequent taxation years be based on the general provincial corporate income tax rates in each province in which the SIFT has a permanent establishment.
To determine the average provincial income tax rate, a formula is proposed which takes into account wages and salaries of the SIFT in a province and gross revenues of the SIFT in a province.
Taxable distributions that are not allocated to any province will be subject to a 10% rate and the provincial tax rate applicable to amounts allocated to the Province of Québec will be deemed to be nil to reflect the provincial SIFT Tax imposed by Québec. It is not clear whether the proposed changes will have any effect on SIFT trusts since most SIFT trusts do not have permanent establishments; rather, the permanent establishment will be in a subsidiary corporation or partnership.
In addition to the foregoing amendments, the Budget also confirmed that the Government intends to proceed with the technical modifications to the SIFT rules announced on December 20, 2007, as modified to take into account consultations and deliberations since their release and to introduce measures to facilitate the conversion of SIFTs to corporations.
Employers are required to withhold and remit source deductions to the Receiver General of Canada and late remittances are subject to a penalty of 10% or 20%, depending on the circumstances. In addition, large remitters are required to remit payment directly to a financial institution.
The Budget proposes to replace the 10% fixed penalty applicable to payroll remittances with a graduated penalty regime ranging from 3% to 10%, which will vary depending on the lateness of the remittance, effective for remittances that are due on or after February 26, 2008. In addition, where a large remitter has remitted source deductions to the CRA at least one full day before the due date, under the Budget amendments, such remitter will be considered to be in compliance with the requirement that the payment be remitted to a financial institution.
Personal Income Tax Measures
The Budget contains a number of income tax measures aimed at providing tax relief to individuals in relation to investments, education and health. Selected personal income tax measures that may be of interest are summarized below.
1. Tax-Free Savings Account
Despite pre-Budget speculation that the Government would take some clear steps to follow through on its election promise of some form of capital gains exemption, no such proposal is forthcoming.
However, in a measure that will afford limited relief on the taxation of capital gains (and ordinary income), the Budget proposes that, beginning in 2009, individuals (other than trusts) that are resident in Canada and 18 years of age or older may establish a "Tax-Free Savings Account" (or TFSA).
In brief, an individual may contribute $5,000 annually to the account. Unlike an RRSP, contributions are not tax deductible. Income and gains of the TFSA are not subject to tax. Unlike an RRSP, amounts withdrawn from a TFSA are not subject to tax and, in addition, equivalent amounts may be recontributed in a subsequent year.
Financial institutions currently eligible to issue RRSPs including Canadian trust companies, life insurance companies, banks and credit unions will be able to offer TFSAs. Presumably life insurers will have to offer some form of variable annuity contract.
Beginning in 2009, an individual will acquire $5,000 of contribution room per year. Unused contribution room may be carried forward indefinitely. In addition, if the individual withdraws an amount from the account, that amount will be added to the contribution room at the beginning of the following year. Accordingly, withdrawals from the account do not result in a permanent loss of savings room. Excess contributions will be subject to a 1% monthly tax. In the same way that CRA advises tax-filers of their RRSP contribution room for a year, the Budget contemplates that CRA will determine the contribution room for individuals that file a tax return.
A TFSA will generally be allowed only to invest in investments that are "qualified investments" for an RRSP. This will preclude, among others, investments in many unlisted securities, commodities (other than certain gold or silver coins, bullion or certificates), real estate and futures or derivatives where the investor’s risk of loss exceeds its cost. An RRSP may invest in certain shares of small business corporations if the annuitant of the RRSP is not a "designated shareholder" or "connected shareholder" of the corporation. In very general terms, the annuitant would be a designated or connected shareholder if the annuitant and/or certain other non-arm’s- length persons owned 10% or more of the shares of any class or series of the corporation subject to a "safe-harbour" rule that applies if the total cost amount of such persons’ investments does not exceed $25,000. The Budget makes it clear that this safe harbour rule will not apply in determining whether a share is a qualified investment for a TFSA. The Budget does not describe the consequences of a TFSA acquiring or holding a non-qualified investment. In the case of an RRSP that acquires a non-qualified investment, the annuitant must include the value of the investment in income when acquired and the RRSP is taxable on any income and the full amount of any capital gain realized on the disposition of the investment.
Investment income and gains derived by a TFSA and amounts withdrawn from a TFSA will not be taxable. In addition, they will not be taken into account in determining income-tested benefits or credits delivered through the income tax system (such as the Age Credit) nor federal benefits based on the individual’s income level (such as OAS, GIS or EI benefits). This removes what would otherwise be a significant disincentive for low income individuals to use the TFSA.
Interest on funds borrowed to contribute to a TFSA will not be deductible. Unlike an RRSP, the assets in a TFSA may be used as collateral for a loan.
The income attribution rules will not apply to a TFSA. Consequently, an individual may lend or give funds to his or her spouse or common-law partner to enable that person to contribute to a TFSA.
On the individual’s death, the TFSA will become taxable on income and gains that accrue thereafter unless the individual’s spouse or common-law partner is designated as a successor accountholder. In that case, the account maintains its tax-free status. Alternatively, the assets can be transferred to the survivor’s own TFSA regardless of whether the survivor has available contribution room.
On breakdown of a marriage or common-law relationship, the assets of an individual’s TFSA may be transferred directly to the spouse. Such a transfer will not reinstate contribution room of the transferor or count against the contribution room of the transferee.
An individual must be a resident of Canada in order to establish a TFSA. If the individual becomes a non-resident, contributions will not be permitted while the individual is non-resident nor will additional contribution room accrue for any year throughout which the individual is non-resident. The individual will be able to maintain the TFSA while non-resident and the TFSA will not be subject to tax nor will the individual be required to pay tax on any withdrawals.
2. Dividend Tax Credit
The gross-up and dividend tax credit provisions in the Act applicable to dividends received by an individual from a taxable Canadian corporation are intended to relieve against double taxation. They presume that such dividends are paid out of the after-tax income of the corporation. Recent amendments to the Act increased the gross-up and dividend tax credit in respect of "eligible dividends."
The 2007 Economic Statement reduced the general federal corporate tax rate to 15% by 2012 and stated that changes to the dividend tax credit mechanism would be considered in order to reflect the appropriate tax treatment of dividend income.
The Budget proposes to reduce the eligible dividend gross-up from its current level of 45% to 44% effective January 1, 2010, 41% effective January 1, 2011, and 38% effective January 1, 2012. The enhanced dividend tax credit rate will also change on the same basis, moving from 11/18 of the gross-up amount to 10/17, 13/23 and 6/11. The Budget states that, expressed as a percentage of an eligible dividend amount received, the effective credit will "remain in line" with the general federal corporate income tax rate of 18 per cent in 2010, 16.5 per cent in 2011, and 15 per cent in 2012.
3. Mineral Exploration Credit
The flow-through share provisions of the Act allow a corporation that incurs certain expenses, including "Canadian exploration expense" (CEE), to renounce such expenses to an investor who can deduct such expenses in computing income.
In addition, certain CEE incurred in "grass roots" mineral exploration and renounced to an individual investor (other than a trust) will give rise to a 15% non-refundable tax credit. The amount of the credit must be deducted from the investor’s cumulative CEE account in the following year and, if the investor does not incur sufficient additional CEE in that year, the negative amount must be included in income.
Under the current provisions of the Act, only expenses incurred pursuant to flow-through share agreements made before April 1, 2008 may qualify. In addition, the expenses must be incurred, or deemed to be incurred under a "look-back" rule, by December 31, 2008.
The Budget extends again this oft-extended provision to flow-through share agreements entered into before April 2009 where the expenses are incurred, or deemed to be incurred under the look-back rule, by December 31, 2009. (The look- back rule will accommodate expenses incurred to the end of 2010.)
The Budget proposes to extend the number of years that contributions may be made to a Registered Education Savings Plan (RESP) from 21 years to 31 years and the deadline for the termination of an RESP to the end of the year in which includes the 35th anniversary of the Plan. In the case of a single-beneficiary RESP where the beneficiary is entitled to the Disability Tax Credit, the contribution years are to be extended to 35 and the termination deadline to the year that includes the 40th anniversary of the Plan. Under current rules, no contributions under a family RESP may be made in respect of a beneficiary who is 21 years of age or older. The Budget proposes to extend that age limit to 31 years.
Expenses eligible for the Medical Expense Tax Credit (METC) are to be expanded to include the cost and the care and maintenance of service animals specially trained to assist individuals who are severely affected by autism or epilepsy. In addition, prescribed devices or equipment are to be expanded to include certain devices for the treatment of a speech disorders, severe mobility disorders, severe mobility impairment and balance disorders.
The Budget also proposes to legislatively overrule cases, such as Breger v. R., a 2007 decision of the Tax Court of Canada, which held that medications could qualify for the METC if they were prescribed by a doctor and recorded by a pharmacist even though the medications could have been purchased "over the counter" without the intervention of a pharmacist. Under the Budget proposals, medications will only qualify if they "can lawfully be acquired for use by the patient only if prescribed by a medical practitioner or dentist."
The 2007 Budget proposed the addition to the Act of a new registered plan, the Registered Disability Savings Plan (RDSP), to help ensure the long-term financial security of a child with a severe disability. This measure is now law and is contained in Section 146.4 of the Act. The Budget proposes to modify Section 146.4 to prevent a beneficiary of an RDSP from collapsing a plan by revoking his or her Disability Tax Credit certification. Under the Budget proposals, an RDSP must terminate and the proceeds paid to a beneficiary at the end of the first calendar year throughout which the beneficiary has no severe and prolonged impairments that qualify the beneficiary for the Disability Tax Credit.
Charitable Tax Measures
The exemption provided in respect of capital gains realized on the donation of publicly-listed securities, shares of mutual fund corporations and units of mutual fund trusts to registered charities was extended by the 2007 Budget to capital gains realized on the donation of such securities to private foundations. The rule deems a taxpayer’s capital gain on the disposition to be zero.
As a corollary to the extension of the exemption to donations of eligible securities to private foundations, an "excessive business holding regime" was added to the Act in Section 149.2. It applies in respect of both publicly-listed and unlisted securities and is intended to address the concern that, by virtue of the combined shareholdings of a donor and the private foundation with which the donor has a relationship, the donor might retain influence over donated company shares. The regime requires a foundation to divest itself of shares if the combined holdings of the foundation and persons with whom the foundation does not deal at arm’s length exceed certain thresholds. The obligation to divest does not apply to "entrusted shares," being shares that were donated before March 19, 2007 and that are subject to a condition that they be retained by the foundation.
In recognition of the fact that unlisted shares may not be marketable, the Budget proposes to exclude from this divestment requirement shares held by the foundation on March 18, 2007 that are not listed on a designated stock exchange provided certain conditions are met, including that the foundation not indirectly own any listed shares of another corporation through the corporation in which it holds the unlisted shares.
The Budget proposes to deem shares acquired under certain corporate rollover rules in exchange for other shares to be the same shares as the exchanged shares for the purposes of the excess business holdings regime.
The Budget also proposes new attribution rules that will deem a foundation to own certain shares held by a trust on March 18, 2007 and to extend the anti-avoidance rules to certain trust arrangements that hold or acquire shares or other interests in corporations.
Donations of Medicine
The Act, as amended by the 2007 Budget, provides corporations donating medicine to a registered charity that has received a disbursement under a Canadian International Development Agency program with a deduction equal to the lesser of 50% of the amount, if any, by which the fair market value of the donated medicine exceeds its cost and the cost of the donated medicine.
The Budget proposes a number of refinements to the measure. First, to ensure that the charity has expertise in delivering medicine to the developing world, an eligible charity must be one that in the opinion of the Minister of International Cooperation meets certain prescribed conditions. Second, the expiry date of the donated medicine must be at least six months prior to the expiration date of the medicines.
These changes will apply to donations of medicine made on or after July 1, 2008.
Capital Gains and Donations—Exchangeable Securities
A taxpayer may donate certain publicly-traded securities to a registered charity or other qualified donee and claim a charitable donation tax credit or deduction for the full value thereof. In addition, the taxpayer’s capital gain on the disposition of the securities is deemed to be nil.
The Budget proposes to extend these provisions to certain exchangeable securities. For example, in a number of income trust structures, the operating business is carried on by a limited partnership. The vendor of the business may have retained a residual interest in the business by owning a partnership interest that is exchangeable for units of the income trust. The units of the income trust would be publicly traded securities for the purposes of the existing rule but the partnership interest would not be. If the owner of exchangeable limited partnership interest were to exercise the exchange right and immediately donate the trust units so acquired to a registered charity, a capital gain would be realized on the exchange. The owner would acquire the trust units at a cost equal to fair market value and would not realize a gain on gifting the units to the charity. However, the "net" result would be recognition of a capital gain and a charitable donation equal to the fair market value of the units.
The capital gains tax exemption for donations of publicly traded securities will be extended by the Budget to capital gains realized on the exchange of unlisted securities that are shares or partnership interests (other than prescribed interests in a partnership) for publicly traded securities, where
- the unlisted securities included, at the time they were issued, a condition allowing the holder to exchange them for the publicly traded securities;
- the publicly traded securities are the only consideration received on the exchange; and
- the publicly traded securities are donated to a registered charity or other qualified donee within 30 days of the exchange.
This proposal could also apply to the exchange of exchangeable shares and gifting of the publicly traded shares received on the exchange where the exchangeable shares are not themselves listed securities.
Special rules will apply where the exchangeable securities are partnership interests in order to ensure that the capital gains tax exemption only applies to the economic appreciation of the partnership interests. Partnership distributions are not included in income but reduce the adjusted cost base of the partnership interest. It is intended that gains arising because of reductions in the adjusted cost base of the partnership interest due to prior distributions not qualify for exemption. Accordingly, a taxable capital gain will be recognized on the exchange of a partnership interest equal to the lesser of the taxable capital gain otherwise determined and one-half of the amount, if any, by which the cost to the donor of the exchanged units exceeds the adjusted cost base to the donor of those interests (determined without reference to distributions of partnership capital).
The Budget proposal will apply to donations made on or after February 26, 2008. Accordingly, it will apply to certain exchanges that have already been made.
Sales and Excise Tax Measures
The 2008 Budget proposes several Goods and Services Tax/Harmonized Sales Tax (GST/HST) amendments. In summary, the proposals include:
- exempting from the GST/HST certain training which assists individuals in coping with disabilities or disorders (such as autism);
- expanding the list of GST/HST-free medical and assistive devices, the exemption from GST/HST in respect of medical services rendered to an individual, and the exemption in respect of the supply of prescription drugs;
- amendments related to the GST/HST treatment of long-term residential care facilities and related to the availability of the new residential rental property rebate; and
- extending GST/HST relief to land leased to situate wind-or-solar-power equipment for the production of electricity.
Medical Services and Devices
Under current rules, generally, basic health care services are exempt from the GST/HST and prescription drugs and certain medical devices are zero-rated. Suppliers of exempt health care services do not charge GST/HST to patients and cannot claim input tax credits to recover GST/HST paid on inputs. Suppliers of prescription drugs and certain medical devices do not charge purchasers GST on drugs and devices and are entitled to claim input tax credits. The Budget proposes to expand the latter GST/HST exemptions and relieving rules to a range of additional health care services, prescription drugs and medical devices applicable to supplies made after February 26, 2008. In summary, the proposals generally include:
- Training Services: Expanding the exemptions for basic health and education services to include training that is specially designed to assist individuals with a disorder or disability (such as autism) in coping with the effects of the disorder or disability or to alleviate or eliminate those effects if either 1) a person acting in the capacity of a practitioner, medical practitioner, social worker or registered nurse in the course of a professional-client relationship (or a health professional whose services are GST/HST exempt) has certified in writing that the training is an appropriate means to assist the particular individual in coping with the effects of the disorder, 2) the cost of training is fully or partially reimbursed under a government program, or 3) the training is supplied by a government. The training can be supplied to the person with the disability or to another individual who provides personal care or supervision to the particular individual otherwise than in a professional capacity. An exempt training service will not include training that is similar to the training ordinarily given to individuals who do not have a disorder or disability.
- Nursing Services: Expanding the existing exemption from GST/HST in respect of nursing services provided in institutional and residential settings to nursing services rendered to an individual by a registered nurse, a registered nursing assistant, a licensed or registered practical nurse or a registered psychiatric nurse if the service is provided within a nurse-patient relationship, regardless of where the service is performed. The proposals also include expanding the exemption for diagnostic services that are prescribed by regulation (such as blood tests and X-rays) to include those ordered by registered nurses.
- Medical and Assistive Devices: Expanding the list of zero-rated medical and assistive devices to include:
- devices specially designed for neuromuscular stimulation therapy or standing therapy if supplied on the written order of a medical practitioner for use by a consumer with paralysis or a severe mobility impairment (see also the preceding commentary regarding medical expense tax credit);
- chairs that are specially designed for use by an individual with a disability (when supplied on the written order of a medical practitioner);
- chest wall oscillation systems for use in airway clearance therapy; and
- service animals specially trained to assist an individual with a disability or impairment if they are supplied to or by an organization that is operated for the purpose of supplying such specially-trained animals (see also the preceding commentary regarding medical expense tax credit).
The Budget also proposes to clarify that only medical and assistive devices that are intended for human use may be zero-rated. Further, the Budget proposes to extend the GST/HST exemption in respect of professional services rendered by doctors and a number of other provincially-regulated health professionals to such services supplied indirectly through a corporation (i.e., rather than directly by the medical professional).
Currently, drugs are zero-rated when they are dispensed by a medical practitioner or by a pharmacist on the prescription of a medical practitioner. The Budget proposes to expand the latter exemption to all supplies of drugs to final consumers where the drugs are prescribed by health professionals (referred to as "authorized individuals") who are authorized to prescribe the drugs under provincial or territorial legislation.
The Budget also proposes certain clarifying amendments to some of the zero-rating provisions for prescription drugs. These amendments are generally intended to ensure that the drugs are zero-rated.
GST/HST Treatment of Long-Term Residential Care Facilities
Under current rules, long-term residential care facilities may not qualify for the GST New Residential Rental Property Rebate or for the GST/HST exemption that applies to residential leases and sales of used residential rental buildings (generally due to the fact that such facilities may be considered to be supplying a mix of health, personal care and accommodation services rather than supplying residential units). The Budget proposes amendments to clarify that GST/HST exempt treatment applies to long-term residential care facilities and to ensure that the GST New Residential Rental Property Rebate applies to such facilities (this proposal will apply to certain past transactions where the owner has paid tax on the facility).
GST New Residential Rental Property Rebate
The GST New Residential Rental Property Rebate generally provides an owner of a long-term residential rental facility with a 36 % rebate of the GST paid on the purchase price of newly-constructed or substantially renovated residential rental units (or on the units’ fair market value where the owner constructed or substantially renovated the facility and self-assessed tax). The Budget proposes certain amendments which are generally intended to clarify that for the rebate to be applicable it must meet the condition that the possession or use of the residential units in the facility be given to individuals for the purpose of their occupancy as a place of residence under a lease, licence or similar arrangement. The proposal will apply for past transactions where tax has been paid on the purchase of the facility or on self-assessment where the facility was constructed or substantially renovated by the owner. Also, it is proposed that an election be available where GST/HST has not been self-assessed on the facility on or before February 26, 2008 and the relevant legislative requirements for claiming the rebate (as amended) have been met.
The Budget also includes proposed amendments intended to clarify the GST/HST exemption rules related to head lease payments made by an operator to an owner of a long term residential care facility.
Property Leases for Wind and Solar Power Equipment
The Budget proposes to expand GST/HST relief currently available in respect of land leased to explore for or exploit mineral, peat, forestry, water or fishery resources to include land leased to situate wind or solar power equipment for the production of electricity. As a result, GST/HST will generally not apply to a supply of a right of entry or use to generate, or evaluate the feasibility of generating, electricity from the sun or wind (provided the supply is not made directly to a consumer or to a person who is not a GST/HST registrant and who acquires the right in the course of a business of making supplies to consumers).
Budget 2008 proposes a number of changes to tobacco taxation enforcement and compliance rules. Generally, the proposals will limit the possession and importation of tobacco manufacturing equipment to persons holding a licence and will make explicit the Minister’s authority to refuse to issue a licence where access to the premises of a licensee or registrant is impeded. The Budget also proposes various minor increases to tobacco excise duties.
Excise Duty on Imitation Spirits
The Budget proposes to treat imitation spirits (i.e., high-alcohol spirit-flavoured brewed products) like spirits rather than like beer for excise duty tax purposes effective February 27, 2008.