With the tabling of its federal Budget (“Budget 2019”), the Federal Government (the “Government”) has renewed its commitment to “investing” in the Canadian middle class (and in those aspiring to join the middle class). On the tax side, the Government has vowed to further its objective of bringing a greater measure of “fairness” to the Canadian tax system. However, with 2019 being an election year, it is no surprise that the tax changes announced today are modest in comparison to the substantial changes in prior Budgets, which mostly focused on the taxation of Canadian private corporations and their shareholders. Instead, Budget 2019 proposes amendments to certain Canadian tax rules, including to the provisions of the Income Tax Act (Canada) (“Tax Act”) and the Excise Tax Act (Canada) (“ETA”), which are largely technical in nature and, in some cases, designed to close perceived tax “loopholes”.
Budget 2019 proposes certain measures for which additional details and legislative amendments are to follow, as well as measures for which details and proposed legislative provisions have been provided. Budget 2019 also announces new spending and investments in the Canada Revenue Agency (the “CRA”).
This report summarizes the most significant tax-related contents of Budget 2019 that are of relevance to Canadian businesses, business owners and high net-worth individuals.
New Measures Proposed in Budget 2019
Part A – Personal Income Tax Measures
Expanding the Scope of Annuities Allowed under Registered Plans – Two new types of annuities will be permitted for certain registered plans. Advanced life deferred annuities (“ALDAs”) will be allowed for registered retirement savings plans, registered retirement income funds, deferred profit sharing plans, pooled registered pension plans (“PRPPs”) and registered pension plans (“RPPs”); and variable payment life annuities will be allowed under a PRPP and a defined contribution RPP. In addition, new rules are proposed to permit an ALDA to constitute a qualifying annuity purchase, or a qualified investment, for the purposes of certain registered plans. The commencement of an ALDA may be deferred until the end of the year in which the annuitant turns 85. The proposed new measures will take effect for the 2020 and subsequent taxation years.
Carrying on Business in a Tax-Free Savings Account (“TFSA”) – Budget 2019 proposes changes to expand the joint and several liability for tax payable by TFSAs that carry on a business or that hold non-qualified investments to the holders of those TFSAs. Presently, only the trustee of a TFSA is jointly and severally liable with the TFSA for tax payable by the TFSA. The tax liability of a TFSA trustee will be limited to the amount of property in the TFSA at a particular time, plus distributions of property from the TFSA on or after the date of issuance of a Notice of Assessment.
Mutual Fund Trust Allocations to Redeeming Unitholders – Budget 2019 proposes new rules to prevent or limit mutual fund trusts (“MFTs”) from claiming deductions in respect of allocated income or capital gains to redeeming unitholders, where the allocation inappropriately defers tax or converts returns on an investment of an MFT that would otherwise be ordinary income to capital gains for the redeeming unitholders. Under these new rules:
- An MFT generally will be precluded from claiming a deduction in respect of the portion of an allocation made to a redeeming unitholder that is greater than the capital gain that would otherwise have been realized by the unitholder on the redemption if the allocated amount is a capital gain and the unitholder’s redemption proceeds are reduced by the allocation; and
- An MFT generally will be denied a deduction in respect of an allocation to a redeeming unitholder if the allocated amount is ordinary income and the unithholder’s redemption proceeds are reduced by the allocation.
Part B – Business Income Tax Measures
Extended Access to the Small Business Deduction for Farming and Fishing Income – Budget 2019 proposes to amend the Tax Act’s exemption from the specified corporate income rules to sales of farming products and fishing catches to any of a farming or fishing corporation’s income from sales to any non-arm’s length purchaser corporation. The specified corporate income rules introduced in 2016 were intended to target inappropriate access by Canadian‑controlled private corporations (“CCPCs”) to the small business deduction. The new rules introduced significant uncertainty as to the amounts and types of income that would no longer qualify for the small business deduction. The new rules created concerns for farming and fishing corporations, especially those operating in close-knit rural communities with intertwined personal and business relationships. Of particular concern were in respect of sales to a co-operative corporation of which the CCPC was a member. Amendments were introduced to exempt sales to eligible farming and fishing co-operatives. Budget 2019 proposals will expand that exemption and provide additional relief for sales to any non-arm’s length purchaser corporation. In particular, the existing definition of “specified cooperative income” is to be repealed and replaced by a new definition for “specified farming and fishing income” all of which will be excluded from the definition of “specified corporate income”. These measures will apply to taxation years that begin after March 21, 2016.
Character Conversion Transactions – Budget 2019 proposes to amend provisions in the Tax Act regarding “derivative forward arrangement rules”. Generally speaking, those rules apply to catch “character conversion” transactions that seek to convert ordinary income into capital gains. The intended purpose of the amendment is to address certain transactions that exploit an exception relating to purchase agreements. Currently, this exception applies, in very general terms, when the difference between the fair market value of the property delivered on settlement of a purchase agreement and the amount paid for the property is attributable to an underlying interest other than certain excluded interests (e.g., revenue, income or cashflow in respect of the property over the term of the agreement or changes in the fair market value of the property over the term of the agreement). Budget 2019 proposes to amend this excluded interest exception to deny its availability where, very generally, it can reasonably be considered that one of the main purposes of the series of transactions is to convert into a capital gain an amount paid on the security, by the issuer of the security, during the period that the security is subject to the purchase agreement.
Scientific Research and Experimental Development (SR&ED) Program – Budget 2019 proposes to change the enhanced refundable SR&ED tax credit program for CCPCs to provide a more predictable phase-out of the enhanced SR&ED credit rate. Currently, CCPCs are eligible for enhanced SR&ED tax credits at a rate of 35% on qualifying SR&ED expenditures, up to $3,000,000 (the “Expenditure Limit”). The Expenditure Limit is reduced where taxable income from the previous taxation year is between $500,000 and $800,000 and is also reduced where taxable capital employed in Canada for the previous taxation year is between $10,000,000 and $50,000,000. Budget 2019 proposes to repeal the use of taxable income as a factor, and to only rely on the CCPC’s taxable capital employed in Canada, in determining a CCPC’s Expenditure Limit. CCPC’s with taxable capital up to $10,000,000 will benefit from the full $3,000,000 Expenditure Limit, regardless of taxable income. If a CCPC has taxable capital in excess of $10,000,000, its Expenditure Limit will be gradually reduced. This measure is proposed to be applied to taxation years that end on or after Budget Day. Budget 2019 does not propose changes to the SR&ED tax credit program for non-CCPCs.
Part C – International Tax Measures
Paramountcy of Transfer Pricing Rules – In circumstances where both the transfer pricing rules and another Tax Act provision apply to the same amount that is relevant in computing a taxpayer’s income, Budget 2019 proposes that the transfer pricing rules will apply in priority to the other provision. Although this paramountcy rule generally will apply to provisions relating to the computation of income under Part I of the Tax Act, it will not apply to situations in which a Canadian resident corporation has an amount owing from, or extends a guarantee to in respect of, an amount owing by a controlled foreign affiliate.
Extension of Foreign Affiliate Dumping Rules – Budget 2019 proposes amendments that will significantly extend the application of the Tax Act’s “foreign affiliate dumping” rules (the “FAD Rules”). Very generally, the FAD Rules currently apply where a corporation resident in Canada (a “CRIC”) is controlled by a non-resident corporation and the CRIC makes an “investment” (e.g., a contribution of capital, an acquisition of shares, etc.) in a foreign affiliate of the CRIC, or where a CRIC makes an investment in a foreign affiliate of a corporation that does not deal at arm’s length with the CRIC and the CRIC or the non-arm’s length corporation is controlled by a non-resident corporation. Budget 2019 proposes to extend the FAD Rules to CRICs that are controlled by a non-resident individual, a non-resident trust, or a group of persons that do not deal at arm’s length with each other comprising any combination of non-resident corporations, non-resident individuals and non-resident trusts. Where the FAD Rules apply, the CRIC is deemed to have a paid a dividend to the controlling non-resident and the “paid-up capital” of the shares of the CRIC that is otherwise created because of the investment is reduced.
Dividend Withholding Tax on Cross-Border Share Lending – In securities lending arrangements involving the lending of shares of Canadian resident corporations (“Canadian shares”) by a non-resident, the resident borrower of Canadian shares is generally required to make compensation payments to the non-resident for any dividends paid by the issuer of the lent shares (a “dividend compensation payment”). To address certain planning that avoids dividend withholding tax on such dividend compensation payments, Budget 2019 proposes amendments to ensure that such dividend compensation payments are always treated as a dividend and therefore, always subject to non-resident withholding tax. Further, to ensure that a dividend compensation payment arising under a securities lending arrangement that is made by a resident to a non-resident in respect of a share issued by a non-resident corporation is not inappropriately subject to dividend withholding tax, Budget 2019 proposes to broaden an existing dividend withholding exemption so that it includes a dividend compensation payment where the lent security is a foreign share and the arrangement is “fully collateralized”.
Part D – Excise Tax Matters
Budget 2019 proposes nominal changes to the GST/HST rules in the ETA. Of note for businesses is the ability to recover a larger portion of the GST/HST paid on zero-emissions passenger vehicles, whether acquired or imported into Canada or a participating province. GST/HST relief will also be provided to certain biologicals and health care services like human ova, in vitro embryos, and services provided by licensed podiatrists and chiropodists. Services rendered by a multi-disciplinary team of health practitioners will also be exempt from GST/HST if the individual services would otherwise be exempt.
Part E – Additional Proposed Measures to Watch for in 2019
Employee Stock Option Rules – In the Government’s view, the policy rationale behind the preferential tax treatment for employee stock options is to support start-up and growing Canadian businesses. To address a perceived inequity in the Tax Act’s current employee stock option rules that mainly favour high-income executives of “large, mature companies” rather than the employees of start-up or growing business operations, the Government will be proposing new measures for the taxation of employee stock option benefits that generally resemble the tax rules in effect in the United States. These new measures will impose an annual $200,000 cap on the value of securities acquired pursuant to an employee stock option grant that will be eligible for tax-preferred treatment under the current employee stock option rules, but will apply only to employees of “large, long-established and mature” businesses. The Government has vowed to keep access to the preferred taxation of stock option benefits uncapped for start-ups and growing Canadian businesses. Further details regarding the proposed new employee stock option rules will be released before the summer of 2019 and these new rules will apply on a go-forward basis only.
Intergenerational Business Transfers – The Government is committed to continuing its outreach to farmers, fishers and other business owners with respect to the transfer of businesses to future generations. In Budget 2019, the Government states that it will develop new proposals to facilitate intergenerational business transfers while otherwise “protecting the integrity and fairness of the tax system”. It is not clear from Budget 2019 when additional details and legislative proposals will be released, and if such details and proposals will be announced prior to the next federal election.
Beneficial Ownership Transparency – Following the announcement of more expansive tax reporting obligations for trusts in last year’s Budget (which new measures will be effective as of the 2021 taxation year), as well as the coming into effect of beneficial ownership record keeping requirements for federally incorporated corporations, the Government is proposing further amendments to the Canada Business Corporations Act (Canada) to make the beneficial ownership information that federally incorporated corporations are now required to keep more accessible to tax authorities and law enforcement agencies.
Base Erosion and Profit Shifting (“BEPS”) – In Budget 2019, the Government notes that it is taking the necessary steps to enact the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting into Canadian law. In addition, Canada is participating with the OECD on the standard of country-by-country reports that form part of the overall BEPS project and framework. This review is scheduled to be completed in 2020.
Part F – Other Matters
Increased Funding for the CRA –After completing a departmental review of the CRA’s service model, the Government announces in Budget 2019 that the CRA’s resources will be reallocated to improve service delivery. This will be done through improved digital services, a focus on the more timely resolution of objections and through the engagement of additional liaison officers. In addition, the Government is allocating $150.8 million over five years to the CRA to fund new initiatives and extend existing programs, including the hiring of additional auditors and increasing auditors’ technical expertise on non-compliance associated with cryptocurrency and the digital economy. A new data quality examination team will also be established to monitor the proper withholding, reporting and remittance of Canadian-source income earned by non-residents of Canada. Finally, the CRA will also extend its existing programs that deal with offshore non-compliance.
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