On February 11, 2014, Federal Minister of Finance, Jim Flaherty, introduced Economic Action Plan 2014. Entitled "The Road to Balance: Creating Jobs and Opportunities", this year's budget has been devised to confirm that Canada's finances are on track to return to a balanced budget in 2015. In addition, our government plans to keep taxes low and ensure that most programs and services that Canadians have come to expect are maintained. To start this journey, the government expects the deficit for 2014-15 to decline to $2.9 billion. Yesterday's announcement also contained two other important themes: supporting jobs and growth; and supporting families and communities.
While no new taxes are being introduced, this year's budget proposes a number of interesting tax changes which have been summarized below.
Corporate Tax Measures
Corporate Income Tax Rates
There were no proposed changes to existing corporate income tax rates in the budget. The general federal corporate income tax rates for 2014 remain unchanged from 2013 at 15% for the general rate and 11% for the small business rate.
Tax Incentives for Clean Energy Generation
Class 43.2 of Schedule II to the Income Tax Regulations provides an accelerated capital cost allowance ("CCA") rate (50% on a declining balance basis) for investments in specified clean energy generation and conservation equipment.
The budget proposes to expand Class 43.2 to include water-current energy equipment and equipment used to gasify eligible waste fuel for use in a broader range of applications. This proposal is applicable only to assets acquired on or after February 11, 2014, and that have not been used before that date.
Water current energy equipment will include equipment used primarily for the purpose of generating electricity using kinetic energy from flowing water. Eligible property will include support structures, submerged cables, transmission equipment, and control, conditioning and battery storage equipment, but will not include buildings, distribution equipment or auxiliary electricity generating equipment.
For gasification equipment used to gasify eligible waste fuel for other applications, eligible property will include equipment used primarily to create producer gas, including related piping, storage equipment, feeding equipment, ash-handling equipment and equipment to remove non-combustibles and contaminants from the producer gas, but will not include buildings or other structures, or heat rejection equipment.
Thin Capitalization Rules
For taxation years that begin after 2012, the thin capitalization rules limit interest deductibility on related third party debt to a debt to equity ratio of 1.5 to 1, pursuant to paragraph 18(4) of the Income Tax Act("ITA"). Part XIII of the ITA generally applies a 25% withholding tax, subject to reduction under a tax treaty, on 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.
The budget proposes to target back-to-back loan arrangements where an intermediary is interposed between two related parties (i.e., the Canadian debtor and certain non-resident persons) and extend the application of the thin capitalization and Part XIII rules.
A back-to-back loan arrangement will exist where, as a result of a transaction or series of transactions, the following conditions are met:
- a taxpayer has an outstanding interest-bearing obligation owing to a lender (the intermediary); and
- the intermediary or any person that does not deal at arm's length with the intermediary:
- has pledged a property of a non-resident person as security in respect of the obligation (a guarantee, in and of itself, will not be considered a pledge of property);
- is indebted to a non-resident person under a debt for which recourse is limited; or
- receives a loan from a non-resident person on condition that a loan be made to the taxpayer.
Where a back-to-back loan arrangement exists, the taxpayer will generally be deemed to owe an amount to the non-resident person (the deemed amount owing) equal to the lesser of:
- the outstanding amount of the obligation owing to the intermediary; and
- the fair market value of the pledged property or the outstanding amount of the debt for which recourse is limited or the loan made on condition, as the case may be.
Furthermore, the taxpayer will generally be deemed to have an amount of interest paid or payable to the non-resident person 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 obligation. The intention is for Part XIII withholding tax to apply to the extent that it would otherwise apply, but for the back-to-back loan arrangement.
These back-to-back loan arrangement rules will apply to taxation years commencing after 2014 with regards to thin capitalization. Regarding Part XIII tax, the new rules will apply to amounts paid or credited after 2014.
Eligible Capital Property
The budget proposes to introduce a new class of depreciable property for CCA purposes. The timing and implementation of this proposal is subject to further public consultation. Expenditures that are currently added to cumulative eligible capital ("CEC") at a 75% inclusion rate would be included in the new CCA class at a 100% inclusion rate. Due to the increased expenditure recognition, the new class would have a 5% annual depreciation rate (instead of 7% of 75% of eligible capital expenditures).
The new proposal would still be consistent with the acquisition, disposition and amortization of eligible capital property ("ECP"). The proposal would replace existing ECP rules by transferring a taxpayer's existing CEC pools to a new CCA class. All of the current rules applicable to depreciable property (e.g., the "half-year rule") would not change and will apply to this new CCA class. All future eligible capital expenditures and receipts would be accounted for through this new CCA class. As with the existing rules applicable to dispositions of depreciable property, future dispositions of ECP and other eligible capital receipts will result in the recapture of CCA and capital gains.
Under the budget proposal, CEC pool balances would be calculated and transferred to the new CCA class as of an implementation date. The opening balance of the new CCA class in respect of a business would be equal to the balance at that time of the existing CEC pool for that business. For the first ten years, the depreciation rate for the new CCA class would be 7% in respect of expenditures incurred before the implementation of the new rules.
Certain receipts received after the time at which the new rules are implemented could relate to property acquired, or expenditures otherwise made, before that time. In this respect, certain qualifying receipts would reduce the balance of the new CCA class at a 75% rate. Receipts that qualify for the reduced rate would generally be receipts from the disposition of property, the cost of which was included in the taxpayer's CEC, and receipts that do not represent the proceeds of disposition of property. The total amount of such qualifying receipts, for which only 75% of the receipt would reduce the new CCA class, would generally equal the amount that could have been received under the current ECP rules before triggering an ECP gain. This rule would ensure that receipts do not result in excess recapture when applied to reduce the balance of the new CCA class.
The budget proposes special rules that would apply in respect of goodwill and expenditures and receipts that do not relate to a specific property of the business, and that would be eligible capital expenditures or eligible capital receipts under the ECP rules. An expenditure that did not relate to property would increase the capital cost of the goodwill of the business and, consequently, the balance of the new CCA class.
The specific tax base erosion rule in paragraph 95(2)(a.2) of the ITA is intended to prevent Canadian taxpayers from shifting income from the insurance of Canadian risks to a foreign affiliate. Under these rules, such income earned by a controlled foreign affiliate of a taxpayer resident in Canada is considered foreign accrual property income ("FAPI"), and is taxable in the hands of the Canadian taxpayer on an accrual basis. This year's budget proposes to modify this rule to include insurance swaps commencing on or after February 11, 2014.
Insurance swaps generally involve transferring Canadian risks to a wholly-owned foreign affiliate of the taxpayer or to a non-arm's length person, which then exchanges those risks with a third party for foreign risks, while at the same time ensuring that the affiliate's overall risk and returns are essentially the same as they would have been had the affiliate not entered into the exchange.
The budget proposes to amend the existing anti-avoidance rule in the FAPI regime relating to the insurance of Canadian risks. In particular, it will be clarified that the rule applies where:
- after taking into consideration one or more agreements or arrangements entered into by the foreign affiliate, or by a person or partnership that does not deal at arm's length with the affiliate, the affiliate's risk of loss or opportunity for gain or profit in respect of one or more foreign risks can, or could if the affiliate had entered into the agreements or arrangements directly, reasonably be considered to be determined by reference to the returns from one or more other risks (i.e., the tracked risks) that are insured by other parties; and
- at least 10% of the tracked risks are Canadian risks.
Where the anti-avoidance rule applies, the affiliate's income from the insurance of the foreign risks and any income from a connected agreement or arrangement will be included in computing FAPI.
Consultation on Treaty Shopping
The government provided its concerns about the abuse of Canada's tax treaties through "treaty shopping" in last year's budget. "Treaty shopping" refers to arrangements whereby a person who is not entitled to benefits of a treaty with Canada uses an entity that is resident in a country with which Canada has a tax treaty to obtain Canadian tax benefits. The government released a consultation paper in 2013 whereby stakeholders had until December 13, 2013 to provide comments.
The concern with treaty shopping is shared by many of Canada's main economic partners. In July 2013, the Organization for Economic Co-operation and Development ("OECD") issued an "Action Plan" to address the issue of aggressive tax planning by multinational enterprises and referred to this issue as base erosion and profit shifting ("BEPS"). One of the main issues identified for action in the area of BEPS was the abuse of tax treaties.
As a result of the 2013 consultations, the budget is inviting comments from interested parties on a proposed rule to prevent treaty shopping. The rule would use a general approach focusing on avoidance transactions. It would also contain specific provisions on its application and safe harbor rules.
The objective of the government is to ensure that treaty benefits are provided to ordinary commercial transactions. Interested parties have the next 60 days (i.e., after yesterday's budget announcement) to provide comments.
The proposed rules are:
- 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 favorable 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 favorable 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.
The budget notes that, where a transaction results in a tax treaty benefit, it does not necessarily follow that one of the main purposes for doing the transaction was to obtain a benefit. The proposed rules would not apply to an ordinary commercial transaction solely because obtaining a tax treaty benefit was one of the considerations for making an investment. The budget documents provide some examples in relation to the intended application of the proposed rules for comment from interested parties.
Consultation on Tax Planning by Multinational Enterprises
As part of the government's ongoing efforts to protect the Canadian tax base and ensure fairness, it is inviting input from stakeholders on issues related to international tax planning that were identified in the BEPS Action Plan released in 2013 by the OECD. This consultation will help the government set priorities and facilitate its participation in discussions with the international community. The consultation period will end in 120 days (i.e., following the budget announcement).
In particular, the government is seeking input on how to ensure fairness among the various categories of taxpayers (e.g., multinational enterprises, small business, individuals, etc.) and how to better protect the Canadian tax base, while maintaining an internationally competitive tax system that is attractive to investors.
The government is seeking input on the following questions:
- What are the impacts of international tax planning by multinational enterprises 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 government?
- Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the government?
- What considerations should guide the government in determining the appropriate approach to take in responding to the issues identified - either in general or with respect to particular issues?
- Would concerns about maintaining Canada's competitive tax system be alleviated by a coordinated, multilateral implementation of base protection measures?
Enhanced Registration Compliance
The budget includes a proposal to grant the Minister of National Revenue discretionary authority to register and assign GST/HST registration numbers to persons who fail to register for the tax. A formal notification will be issued to non-compliant businesses indicating that registration will be effective 60 days from the date of the notice, but only after initial attempts by the Canada Revenue Agency to contact the non-compliant businesses and have them register have failed. This new compliance measure will apply once the enacting legislation receives Royal Assent.
Health Care Provisions
The federal government is proposing three changes in this budget to the GST/HST legislation to reflect the current nature of health care provided in Canada. All three of these measures will be effective for supplies made after February 11, 2014.
Expansion of Training Exemption for Individuals with a Disorder or Disability
Under the GST/HST, an exemption exists for training that is specifically designed to assist individuals with a disorder or disability in coping with the condition, or to ease or eliminate the effects of such a condition. However, this exemption does not currently cover the service of designing such training. The budget proposes to extend the exemption to include the services of designing training that is specially designed to assist individuals with a disorder or disability. The expanded exemption will apply to both the initial development and design of the plan, as well as any subsequent adjustments.
Note that the design service will only be exempt if at least one of the following two conditions is met:
- the design service is either supplied by a government or the cost of the service is fully or partially subsidized under a government program; or
- a recognized health care professional, who provides exempt services in the course of a professional-client relationship with an individual, provides written certification that the design service relates to training created to assist the individual in dealing with the effects of the disorder or disability.
Acupuncture and Naturopath Services
The GST/HST legislation exempts health care services covered under a provincial public health care plan, as well as services provided to individuals by specifically listed health care practitioners. The government is proposing to add acupuncturists and naturopathic doctors to the list of health care practitioners whose professional services are exempt from GST/HST when rendered to individuals.
Exemption for Specialized Electronic Enhancement Eyewear
Medical and assistive devices specifically designed for individuals with a disability, disease or illness are generally zero-rated for GST/HST purposes. Prescription eyeglasses and contact lenses qualify for zero-rating under these provisions. However, under the current legislation, new corrective eyewear designed to electronically improve the vision of visually impaired individuals does not qualify for zero-rating, as it is not considered to be eyeglasses or contact lenses.
The budget proposes to add eyewear specifically designed to treat or correct a defect of vision by electronic means to the list of zero-rated medical and assistive devices. To qualify for zero-rating, the eyewear must be supplied under a written order of a physician or optometrist for use by the individual named in that order.
Election for Nil Consideration
A provision in the GST/HST legislation allows members of a closely related group, who are registered residents of Canada and engaged exclusively in commercial activities, to elect to not account for tax on transactions between them. This is commonly referred to as the "nil consideration election", and it is available to corporations or partnerships within a closely related group where common ownership of at least 90% exists.
This relief is currently not available to new members of a closely related group at the time they first acquire assets from another member corporation. To address this potential concern, the government is proposing to extend the availability of the nil consideration election to new members that have not yet acquired any property, as long as the new members continue as going concerns engaged exclusively in commercial activities. This change will be effective January 1, 2015.
While the existing nil consideration election must be made in prescribed form, it does not have to be filed with the Canada Revenue Agency. The budget proposes that, effective January 1, 2015, parties to a new election will be required to file the election in a prescribed manner with the Canada Revenue Agency. The election will have to be filed by the first date on which any of the members of the closely related group is required to file a return for the period in which the election is effective. For closely related groups that have made a nil consideration election prior to January 1, 2015, the deadline for the new filing requirement will be extended to January 1, 2016.
The budget also proposes to make members electing for closely related group relief (or acting as though such an election is or was in place) joint and severally liable for any potential GST/HST liability created by supplies made between them on or after January 1, 2015.
Joint Venture Election
In order to simplify accounting for participants in certain specified joint ventures, a registered participant and another co-venturer may make an election to designate the registrant as the operator of a joint venture. Under this election, all properties and services supplied, acquired or imported for purposes of the venture are deemed to be supplied, acquired or imported by the operator and not the co-venturer.
Presently, this joint venture election is only available where the activities of the joint venture are prescribed in the Joint Venture (GST/HST) Regulations. Activities currently eligible for this election include the exploration or exploitation of mineral deposits, construction, and the sale or lease of real property or an interest in real property. The list of eligible activities is quite restrictive, meaning that certain commercial joint ventures cannot take advantage of the simplified compliance measures.
The government proposes to introduce new provisions to make the joint venture election available to participants in a joint venture, provided that both the joint venture and each of its participants are engaged exclusively in commercial activities. In addition, corresponding anti-avoidance measures will be introduced.
Later this year, the government plans to release draft legislation for this enhanced joint venture election and invite all interested parties to comment on the new rules before the final legislation is tabled.
The government is inviting input from stakeholders on the approach that should be taken to ensure that GST/HST is collected on e-commerce sales to Canadian residents. For example, should the government require foreign-based vendors to register for GST/HST if they make e-commerce sales to residents of Canada? This would be similar to the approach used in South Africa and the European Union. It should be interesting to see what approach Canada decides to take as a result of these consultations.
Previously Announced Measures
The federal government has also confirmed its intention to move forward with various previously announced tax measures, including:
- proposed changes to automobile expense deduction limits and prescribed rates for automobile operating expense benefits for 2012 and 2013 (see our Tax Development at 2014 Automobile Deduction Limits and Expense Benefit Rates for Business for information on the current limits and rates for 2014); and
- legislative proposals announced this past January to clarify the application of GST/HST in certain situations and prevent input tax credit claims from exceeding the actual amount of tax paid, as well as provide a new GST/HST exemption for hospital patient and visitor parking (see our Tax Development at The Department of Finance Canada Proposes Legislative Changes to the Excise Tax Act for further details on these proposed measures).
Tobacco Tax Measures
Excise Duty Rates
To adjust for inflation since 2002, the budget proposes to increase excise duty rates on tobacco products to the following:
- $0.52575 (from $0.425) for each five cigarettes or fraction thereof (or from $17.00 to $21.03 per 200 cigarettes);
- $0.10515 (from $0.085) per tobacco stick (or from $17.00 to $21.03 per 200 sticks);
- $6.57188 (from $5.3125) per 50 grams or fraction thereof of manufactured tobacco (or from $21.25 to $26.29 per 200 grams); and
- $22.88559 (from $18.50) per 1,000 cigars.
The additional duty paid on cigars will also increase from the greater of $0.067 per cigar and 67% of the sale price or duty-paid value to the greater of $0.08226 per cigar and 82% of the sale price or duty-paid value.
These changes are effective after February 11, 2014.
Treatment of "Duty-Free" Tobacco Products
To eliminate the current preferential treatment of tobacco products acquired in duty-free markets, effective after February 11, 2014, the "duty-free" rates for tobacco will be increased to generally match the new excise duty rates to be imposed on these products, as described above. Note that, for imported cigarettes, the excise duty rate for tobacco sticks will apply. Going forward, the duty-free rates will be linked to any changes in the excise duty rates.
Indexing Tobacco Taxes to the Consumer Price Index
The budget proposes that excise duty rates, including "duty-free" rates, will be indexed to the Consumer Price Index and adjusted, as necessary, every five years starting on December 1, 2019.
Inventory Tax on Cigarettes
To ensure that the above-noted excise duty rate changes apply to all cigarettes, a tax of 2.015 cents per cigarette will apply to inventories of cigarettes held by manufacturers, importers, wholesalers and retailers as at end of day on February 11, 2014. Taxpayers with 30,000 or fewer cigarettes on hand, as well as cigarettes held in vending machines, are excluded from this requirement.
Taxpayers must file returns and pay the inventory tax by April 30, 2014. Interest will apply to late or deficient payments.
An inventory tax on cigarettes will also apply each time an inflationary adjustment is made to the excise duty rate. As noted above, the first of these adjustments will begin on December 1, 2019.
Excise Tax Measures
Sanctions for False Statements
The government is proposing a new administrative monetary penalty for making false statements or omissions in an excise tax return and related offences under the non-GST/HST portion of the Excise Tax Act. The new monetary penalty will be the greater of $250 and 25% of the tax avoided.
In addition, the existing criminal offence will be revised to include a fine that will range from 50% to 200% of the tax evaded, along with a potential maximum five-year term of imprisonment, upon conviction on an indictment. If the amount of tax evaded is not ascertainable, the fine will range from $1,000 to $25,000 on summary conviction, and from $2,000 to $25,000 on conviction on an indictment.
These changes are intended to make the penalties for false statements and omissions consistent with those imposed under the GST/HST portion of the Excise Tax Act, and the new measures will apply to excise tax returns filed after the day of Royal Assent to the enacting legislation.
Customs Tariff Measures
Following last year's elimination of the special GST/HST exemption for the Governor General, the government has announced thatCustoms Tariff amendments will be introduced to eliminate a similar exemption from customs duties for articles imported for use by the Governor General.
In addition, the government has proposed the elimination of the 20% Most-Favoured-Nation duty rate on imported mobile offshore drilling units, in an effort to remove any potential disincentive to oil and gas exploration in Canada's Atlantic and Arctic offshore areas. Currently, this type of equipment can be temporarily imported into Canada on a duty-free basis under a Remission Order. With the Remission Order set to expire later this year, the government has decided to make the duty-free status permanent by amending the Customs Tariff, effective for goods imported into Canada on or after May 5, 2014.
Payroll Tax Measures
Employer Source Deduction Improvements
Employers are required to remit source deductions in respect of employees' income tax, Canada Pension Plan contributions and Employment Insurance premiums. The frequency of source deduction remittances will be reduced for some employers, in respect of amounts to be withheld after 2014.
Specifically, the government proposes to increase the threshold for average monthly withholding, at which employers are required to remit up to two times per month, from $15,000 to $25,000. In addition, the threshold for average monthly withholding, at which employers are required to remit up to four times per month, will increase from $50,000 to $100,000. The new thresholds will apply with respect to amounts to be withheld after 2014.
Aboriginal Tax Policy
Consistent with prior years, the federal government has confirmed its continued support for direct taxation arrangements under whichIndian Act bands and self-governing Aboriginal groups levy a sales tax within their jurisdictions.
The government notes that, to date, it has entered into 35 such sales tax arrangements of this nature. In addition, 14 agreements respecting personal income taxes are in effect with self-governing Aboriginal groups. Under these agreements, a personal income tax is imposed on all residents within an Aboriginal group's settlement lands. The government has also enacted legislation to facilitate similar direct taxation pacts between Aboriginal groups and provincial and territorial governments.
Further details on Economic Action Plan 2014 are available from the Department of Finance Canada web site at: