Minister of Finance Joe Oliver tabled his first federal budget on April 21, 2015. The first balanced budget in eight years, Economic Action Plan 2015 proposes what is described as “a low-tax plan for jobs, growth and security”. The budget includes new tax relief and increased benefits for Canadian families, improved tax credits and deductions for businesses, and new measures to strengthen tax compliance.
While no new taxes are being introduced, this year’s budget proposes several significant corporate income tax, international tax and commodity tax changes, which have been summarized below.
Corporate Income Tax Measures
Small Business Corporate Income Tax Rates
The budget proposes to reduce the small business tax rate from 11% to 9% by 2019. The reduction will be implemented as follows:
- effective January 1, 2016 – 10.5%;
- effective January 1, 2017 – 10%;
- effective January 1, 2018 – 9.5%; and
- effective January 1, 2019 – 9%.
The reduction in the small business rate will be pro-rated for taxation year-ends that do not coincide with the calendar year.
Small Business Deduction – Consultation on Active vs. Investment Business Income
The small business deduction is available on up to $500,000 of active business income of a Canadian-controlled private corporation. The deduction is intended to enhance the deferral of income tax on active business income retained in a private corporation, therefore encouraging the reinvestment of after-tax income for further growth.
The government has announced that it will undertake a review of the circumstances under which income from a business, the principal purpose of which is to earn income from property, should qualify as active business income. Interested parties have until August 31, 2015 to submit their comments.
Quarterly Remittance Category for New Employers
The budget proposes to permit new employers with source deductions less than $1,000 on a monthly basis to remit their source deductions on a quarterly basis, provided certain eligibility criteria are met. If the withholding amounts increase above the $1,000 threshold, then the frequency of remittance will be governed by the existing rules.
This measure will apply in respect of withholding obligations that arise after 2015.
Manufacturing and Processing Machinery and Equipment – Accelerated Capital Cost Allowance
Machinery and equipment acquired after March 18, 2007 and before 2016, used primarily in Canada for the manufacturing or processing of goods for sale or lease, is depreciated for tax purposes at an accelerated capital cost allowance (“CCA”) rate of 50% on a straight-line basis under CCA class 29.
This year’s budget proposes to replace CCA class 29 with a new CCA class 53, whereby qualifying assets used primarily in Canada for the manufacturing or processing of goods for sale or lease, which are acquired after 2015, but before 2026, will be depreciated for tax purposes on a 50% declining-balance basis. The half-year rule will continue to apply to the new proposed Class 53. Machinery and equipment acquired after 2025 will qualify for the 30% declining-balance rate and be placed in CCA class 43.
Consultation on Eligible Capital Property
The 2014 budget announced a public consultation on the proposal to repeal the eligible capital property regime and replace it with a new CCA class. The government has, and continues to receive, public consultation and representations regarding the new proposed CCA class, as well as the transitional rules.
Tax Avoidance on Corporate Capital Gains
Subsection 55(2) of the Income Tax Act (“ITA”) has an anti-avoidance rule that generally taxes as capital gains certain otherwise tax-deductible, inter-corporate dividends. This rule generally applies where a corporation that is about to dispose of shares of another corporation receives from that other corporation, tax-deductible dividends that, in substance, reflect the untaxed appreciation in the value of the other corporation. The tax-deductible dividends can decrease the fair market value of the shares to the point where the unrealized capital gain on the shares is reduced.
The anti-avoidance rule generally applies to a dividend where one of the purposes of the dividend was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition of any share at its fair market value. A notable exception to the application of the anti-avoidance rule is provided where the dividend can reasonably be attributed to after-tax earnings (called “safe income on hand”). This enables a corporation to distribute such earnings as a tax-deductible, inter-corporate dividend.
Where the anti-avoidance rule applies to the dividend received on a share, the dividend is treated as proceeds of disposition, if a corporation has disposed of the share or as a gain from a disposition of capital property, where a corporation has not disposed of the share.
While an anti-avoidance rule currently applies where a dividend significantly reduces the capital gain on any share, the same tax policy concern arises where dividends are paid on a share not to reduce a capital gain on that share, but instead, to cause the fair market value of the share to fall below its cost or to create a significant increase in the total cost of properties. In such cases, the shareholder could attempt to use the unrealized loss created by the payment of the dividend to shelter an accrued capital gain in respect of other property.
The following example was provided in the budget:
“Corporation A wholly owns Corporation B, which has one class of shares. These shares have a fair market value of $1 million and an adjusted cost base of $1 million.
Corporation A contributes $1 million of cash to Corporation B in return for additional shares of the same class, with the result that Corporation A’s shares of Corporation B have a fair market value of $2 million and an adjusted cost base of $2 million.
If Corporation B uses its $1 million of cash to pay Corporation A a tax-deductible dividend of $1 million, the fair market value of Corporation A’s shares of Corporation B is reduced to $1 million although their adjusted cost base remains at $2 million. At this point, Corporation A has an unrealized capital loss of $1 million on Corporation B’s shares.
If Corporation A transfers an asset having a fair market value and unrealized capital gain of $1 million to Corporation B on a tax-deferred basis, Corporation A could then sell its shares of Corporation B for $2 million and take the position that there is no gain because the adjusted cost base of those shares is also $2 million.”
The budget noted that:
“A recent decision of the Tax Court of Canada held that the current anti-avoidance rule did not apply in a case where the effect of a dividend in kind (consisting of shares of another corporation) was to create an unrealized capital loss on shares. The unrealized loss was then used to avoid capital gains tax otherwise payable on the sale of another property.”
“…to ensure that the anti-avoidance rule applies where one of the purposes of a dividend is to effect a significant reduction in the fair market value of any share or a significant increase in the total cost of properties of the recipient of the dividend. Related rules are also proposed to ensure that this amendment is not circumvented. For example, if a dividend is paid on a share of a corporation, and the value of the share is or becomes nominal, the dividend will be treated as having reduced the fair market value of the share.”
Synthetic Equity Arrangements and Consultation
- does not reasonably expect to eliminate all or substantially all of its risk of loss and opportunity for gain or profit in respect of the share; or·
- has transferred all or substantially all of its risk of loss and opportunity for gain or profit on the share to its own counterparty and has obtained the representations described above from that counterparty.
If the representations are subsequently determined to be inaccurate, the arrangement will be treated as a divident rental arrangement.
This measure will not apply to agreements traded on a recognized derivatives exchange, unless it can reasonably be considered that the taxpayer knows, or ought to know, the identity of the counterparty to the agreement.
The budget also proposes to implement an anti-avoidance rule that will deem certain agreements that do not meet the definition of a “synthetic equity arrangement” to be dividend rental arrangements. In particular, an agreement that has the effect of eliminating all or substantially all of a taxpayer’s risk of loss and opportunity for gain or profit in respect of a share will be deemed to be a dividend rental arrangement if one of the purposes of the series of transactions that includes such an agreement is to avoid this measure.
These measures will apply to dividends that are paid or become payable after October 2015.
Alternatively, from a tax policy perspective, it is arguable that a shareholder should always bear the risk of loss and enjoy the potential for gain on a Canadian share to be able to benefit from the inter-corporate dividend deduction on dividends received from that share. As such, the budget refers to an alternative proposal that would deny the inter-corporate dividend deduction on dividends received by a taxpayer on a Canadian share governed by a synthetic equity arrangement, regardless of the counterparty’s tax status. This proposal would have a much broader impact on taxpayers, but it would also eliminate some of the complexities of the proposed tax measures described above. Stakeholders have until August 31, 2015 to submit comments on whether the scope of the proposed tax measures should be broadened under this alternative.
International Tax Measures
Automatic Exchange of Information for Tax Purposes
The purpose of the exchange of tax information between countries is to promote compliance and to mitigate tax evasion. In November 2014, a new common reporting standard was endorsed by Canada and the other G-20 countries for automatic information exchange developed by the Organisation for Economic Co-operation and Development (“OECD”). The parties made a commitment to start exchanging information by 2017 or 2018.
Under the new standard, foreign tax authorities will provide information to the Canada Revenue Agency (“CRA”) on financial accounts held by Canadian residents in their jurisdictions. In return, the CRA will provide similar information to the foreign tax authorities on accounts in Canada held by residents of their jurisdictions. Financial institutions in Canada will be required to implement due diligence procedures to identify the accounts held by non-residents and report information on these accounts to the CRA.
Canada proposes to implement the common reporting standard starting July 1, 2017, allowing for a first exchange of information in 2018. Once the standard has been implemented, financial institutions will be required to have procedures in place to identify accounts held by non-residents of Canada in order to report the required information to the CRA. No reporting will be required on accounts held by Canadian residents with foreign citizenship.
Draft legislative proposals will be released for comment in the coming months.
Update on Tax Planning by Multinational Enterprises
The 2013 federal budget announced the government’s intention to consult on measures relating to legal tax planning arrangements undertaken by multinational enterprises that exploit the interaction between domestic and international tax rules in order to shift profits away from countries where income producing activities take place. In July 2013, the 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. This year’s budget provides no proposals on these measures, due to continuing discussions with the international community and a desire to obtain further input from stakeholders on the implementation of its recommendations.
Streamlining Reporting Requirements for Foreign Assets
A Canadian taxpayer that, at any time in a taxation year, owns specified foreign property with a total cost of more than $100,000 must file a Foreign Income Verification Statement (Form T1135). Revisions by the CRA to Form T1135 have placed a significant compliance burden on taxpayers whose foreign investment holdings are less than $250,000. To alleviate the compliance burden on these taxpayers, the budget proposes to simplify the reporting requirements for taxation years that begin after 2014, where the total cost of a taxpayer’s specified foreign property is less than $250,000 throughout the year. Where this applies, the taxpayer will be able to report these assets under a new simplified foreign asset reporting system, which will not be as onerous as the previous format. The current reporting requirements will continue to apply to taxpayers with specified foreign property having a total cost, at any time during the year, of $250,000 or more.
The Canadian tax system contains legislation that is intended to prevent Canadian taxpayers from shifting income from insurance of Canadian risks (i.e., risks of persons resident in Canada, property situated in Canada, or a business carried on in Canada) to a foreign affiliate resident in a lower-tax jurisdiction. Pursuant to these rules, such income earned by controlled foreign affiliate of a taxpayer resident in Canada is considered foreign accrual property income (“FAPI”) and is taxable to the Canadian taxpayer on an accrual basis.
Last year’s budget amended this rule to curtail sophisticated tax planning arrangements (sometimes referred to as “insurance swaps”) that attempted to circumvent these anti-avoidance rules. Since then, taxpayers have entered into alternative arrangements intended to achieve tax benefits similar to those that the 2014 amendment was intended to prevent.
As a result, this year’s budget proposes to amend the existing anti-avoidance rules in the FAPI regime relating to the insurance of Canadian risks to curtail these alternative arrangements where the affiliate receives consideration with an embedded profit component (based upon the expected return on the pool of Canadian risks) in exchange for ceding its Canadian risks.
In particular, effective for taxation years beginning on or after April 21, 2015, the rules will be amended as follows:
- a foreign affiliate’s income from the ceding of Canadian risks is included in computing the affiliate’s FAPI; and
- for these purposes, when a foreign affiliate cedes Canadian risks and receives as consideration a portfolio of insured foreign risks, the foreign affiliate is considered to have earned FAPI in respect of the ceding of the Canadian risks in an amount equal to the difference between the fair market value of the Canadian risks ceded and the foreign affiliate’s costs of having acquired those Canadian risks.
Interested stakeholders may provide comments on this proposed measure by June 30, 2015.
Withholding for Non-Resident Employers
Employment income earned by a non-resident in Canada is taxable unless the remuneration is exempt under a tax treaty with Canada. For example, a U.S. resident employee’s remuneration earned in Canada would be exempt from Canadian income tax if the remuneration does not exceed CAN$10,000. Despite exemptions from Canadian income tax under the tax treaty, a non-resident employer must withhold tax on remuneration earned in Canada, by its employees, unless the employee obtains a Regulation 102 waiver from the CRA exempting the employer from such withholding. This requirement results in a significant burden for non-residents, especially since, under the existing Regulation 102 waiver system, a waiver is granted only for a specific employee for a specific period of time.
In an effort to ease the administrative burden placed on non-resident employers who are engaged in cross-border trade with Canada, the budget proposes to provide an exception to the withholding tax requirements where the following conditions are met:
- the employee’s remuneration earned in Canada is exempt from Canadian income tax under the tax treaty with Canada;
- the employee is not in Canada for 90 days or more in any 12-month period that includes the time when the remuneration is paid;
- the employer (other than a partnership) is resident in a country with which Canada has a tax treaty (if the employer is a partnership, at least 90% of the partnership’s income for the fiscal period that includes the time when the remuneration is paid must be allocated to persons that are resident in a treaty country);
- the employer must not carry on business through a Canadian permanent establishment of the employer in its fiscal period that includes the time the remuneration is paid; and
- the employer must be certified by the Minister of National Revenue (the “Minister”) when the remuneration is paid.
Although a non-resident employer which meets the above requirements will not be required to withhold tax on the remuneration earned by its employees in Canada, it will continue to be subject to the reporting requirements under the ITA with respect to amounts paid to its employees. The new measure will apply to payments after 2015.
Previously Announced Measures
The budget confirmed that the government will proceed with the following previously announced tax and related measures, as modified to account for consultations and deliberations undertaken since their announcement or release:
- legislative proposals released on July 12, 2013, providing new rules to ensure an appropriate income inclusion for stub-year foreign accrual property income on dispositions of foreign affiliate shares;
- regulatory proposals released on February 19, 2015, establishing capital cost allowance rates of 30% for equipment used in natural gas liquefaction and 10% for buildings at a facility that liquefies natural gas; and
- measures announced on March 1, 2015 to support Canadian mining by extending the 15% Mineral Exploration Tax Credit for investors in flow-through shares for an additional year, until March 31, 2016, and ensuring that the costs associated with undertaking environmental studies and community consultations in order to obtain an exploration permit will be eligible for treatment as “Canadian Exploration Expenses”.
Commodity Tax Measures
Assessments and Alternative Arguments
In response to a recent court decision, and consistent with conventional practices in litigation, the budget proposes to amend the ITA, Excise Tax Act (“ETA”) and Excise Act, 2001 (“EA”) in order to clarify that the Canada Revenue Agency (“CRA”) or the courts are permitted to adjust or increase an amount included in an assessment that is under appeal or objection at any time, as long as the total value of the assessment is not increased. This change will preserve the Minister’s ability to offset a decrease in one component of an assessment with an increase in another component of the same assessment. As a result, when dealing with items included in an assessment under appeal or objection, the Minister will still have an opportunity to advance alternative arguments regarding the basis of the assessment, even if the normal statutory limitation period for the assessment has passed.
This change will apply to tax appeals initiated after the relevant legislative amendments have received Royal Assent.
Sharing Information in Collection Efforts
As it currently stands, the CRA is not allowed to use confidential information pertaining to taxpayers in order to collect debts related to non-tax programs, notwithstanding that some of these programs are administered by the CRA on behalf of federal and provincial governments and their agencies. This restriction has proven to be inefficient for the government and potentially frustrating for taxpayers. Accordingly, the budget proposes to amend the ITA, ETA and EA to allow taxpayer information to be shared internally within the CRA, where it is responsible for the collection of amounts related to non-tax programs, such as Employment Insurance and the Canada Pension Plan.
These measures will take effect once the enacting legislation has received Royal Assent.
Previously Announced Measures
The federal government has confirmed its intention to move forward with various previously announced tax measures, including: the measures announced in last year’s budget to make the joint venture election available to participants in a joint venture, where both the joint venture and each of its participants are engaged exclusively in commercial activities; and changes announced to the automobile expense deduction limits and prescribed rates for 2015. See our December 2014 Tax Development at: 2015 Automobile Deduction Limits and Expense Benefit Rates.
Aboriginal Tax Policy
As in prior years, the federal government continues to support direct taxation arrangements under which bands recognized under the Indian Act and self-governing Aboriginal groups levy a sales tax within their jurisdictions. To date, the government has entered into 35 such sales tax arrangements of this nature.
The government has also enacted legislation to facilitate similar direct taxation accords between Aboriginal groups and provincial and territorial governments.
Further details on Economic Action Plan 2015 are available from the Department of Finance Canada web site at: http://www.budget.gc.ca/2015/home-accueil-eng.html