Against the backdrop of a potential election and coming off the heels of unprecedented global fiscal and monetary stimulus, Finance Minister Jim Flaherty delivered the minority conservative government's sixth budget on March 22, 2011 (Budget 2011). Budget 2011 is intended to usher in phase two of Canada's Economic Action Plan designed to combat the effects of the global recession. Budget 2011 focuses on supporting job creation, supporting families and communities, investing in innovation, education and training, and preserving Canada's fiscal advantage.
Coined a "Low-Tax Plan for Jobs and Growth", Budget 2011, from a tax perspective, does not change corporate or personal tax rates but rather includes a variety of measures intended to advance the Government's agenda through a series of targeted credits and incentives and includes a number of measures intended to protect the integrity and fairness of the Canadian tax system by closing what the Government perceives to be "tax loopholes".
Highlights from Budget 2011 include the elimination of the tax deferral on income earned through a partnership by a corporation, an extension of the dividend stop-loss rules to restrict losses arising on the redemption or repurchase of stock held by certain corporations, and measures to eliminate the favourable treatment of costs related to oil sands projects. Budget 2011 also includes a variety of tax credits and allowances aimed at providing tax breaks for families, measures to eliminate income splitting arising from capital gains, and measures to expand certain anti-avoidance provisions in relation to the RRSP and RRIF regimes and the charitable sector.
BUSINESS TAX MEASURES
Use of Partnerships to Defer Corporate Tax Curtailed
Corporations that carry on business through a partnership have been able to defer the taxation of earnings of the partnership for up to 12 months in a single-tier partnership or for longer periods where multi-tiered partnerships were used.
The ability of a corporation to defer taxation of such income arises as:
a. Unlike an individual, a corporation or a trust, a partnership is not a taxpayer that pays tax on its income. Rather, the income (or loss) of a partnership is allocated to its partners who include their share of the income in calculating their own income for tax purposes.
b. The income earned by a corporation as a member of a partnership is included in the corporation's income for the corporation's taxation year in which the fiscal period of the partnership ends.
c. Therefore, if the partnership's fiscal period ends after the corporation's taxation year end, the inclusion by the corporation of income from the partnership is deferred. For example, a corporation with a December 31 st year end that was a member of a partnership with a fiscal period ending on January 31 st would not include its share of the partnership income for the fiscal period ending January 31 st until December 31 st of that year, thereby obtaining an 11 month deferral.
A similar deferral that was available to individuals that carried on business through a partnership or sole proprietorship was eliminated – subject to a 10-year transitional period – in 1995.
The Government is concerned that the use by corporations of partnerships to defer tax in this manner has become increasingly common and was unfairly permitting corporations to defer income to take advantage of declining corporate tax rates. As a consequence, Budget 2011 proposes a series of complex rules that will limit this deferral for corporations with a significant interest in partnerships.
In general terms, pursuant to Budget 2011:
a. The proposals will apply to a corporate partner (other than a professional corporation which since 1995 has been subject to other provisions limiting deferral) where:
- The corporate partner's taxation year differs from the fiscal period of the partnership; and
- The corporate partner has a significant interest in the partnership; more specifically, the corporate partner, together with affiliated and related parties, was entitled to more than 10% of the income of the partnership (or assets of the partnership on a wind-up) at the end of the last fiscal period of the partnership that ended in the corporation's taxation year.
b. Where these proposals are applicable, they will apply to taxation years of a corporation that end after March 22, 2011. The proposals will add to a corporation's income an amount in respect of the portion of the partnership's fiscal period (the Stub Period) that falls in the corporation's taxation year where the partnership's fiscal period ends after the end of the corporation's taxation year. This amount will be added to the corporation's income for the taxation year in issue. Such amount will be deducted from the corporation's income for its next taxation year and an amount will be included in the corporation's income in respect of the Stub Period of that next taxation year.
c. Transitional relief will generally be available such that no taxes will be payable in the first taxation year and, through a reserve mechanism, the additional income from the first taxation year will be brought into the corporation's income over the five taxation years that follow the first taxation year at an inclusion rate of 15%, 20%, 20%, 20% and 25%.
d. The addition to income (the Stub Period Accrual) is based upon a formula (the Formulaic Approach) which includes in the corporation's income an amount equal to the corporate partner's share of the partnership income from the fiscal period that ends in the taxation year of the corporation pro rated based upon the number of days in the Stub Period divided by the number of days in the partnership's fiscal period that includes the Stub Period. In respect of this inclusion:
- The inclusion for the Stub Period is based upon the corporation's share of the partnership income in the year that ended immediately prior to the start of the Stub Period.
- The Formulaic Approach may result in an over inclusion in income (i.e., where a corporation's share of income will decline in the next fiscal period of the partnership). Therefore, the proposals provide that the corporation can instead designate an amount for the Stub Period Accrual that is less than the amount determined under the Formulaic Approach. While any lower amount can be used under this designation approach (the Designation Approach), it can result in Under-Reported Stub Period Accrual (described below) which can, in some cases, be very onerous.
- Where the partnership incurs Canadian exploration expenses, Canadian development expenses, Canadian oil and gas property expenses or foreign resource expenses in the Stub Period, a corporate partner subject to these new provisions will be permitted to reduce its Stub Period Accrual by using its share of such expenses provided that the partnership has, prior to the corporation's return being filed, provided to the corporation information evidencing the nature and amount of each such expense and the corporate partner's share of that expense.
e. An Under-Reported Stub Period Accrual can arise where a
corporate partner uses the Designation Approach to designate a
smaller amount for inclusion under these provisions. If the
designated amount is less than the lesser of the actual pro-rated
income of the corporate partner from the partnership for the Stub
Period and the amount determined under the Formulaic Approach, the
corporate partner will be subject to an additional income inclusion
in the following year.
The additional income inclusion adjustment will be equal to the amount of the shortfall multiplied by the average prescribed interest rate applicable for underpayments of tax. However, if the shortfall exceeds 25% of the lesser of the pro-rated actual amount and the amount determined under the Formulaic Approach, there will be a further income inclusion equal to 50% of the additional income inclusion in respect of the shortfall in excess of the 25% threshold. No such inclusion will be required in the first taxation year of the corporate partner for which a Stub Period Accrual is calculated if that accrual is eligible for the five-year transitional relief referred to previously.
f. A one-time election will be available to partnerships with corporate partners that are subject to these new rules to adopt a new fiscal period that ends after March 22, 2011 but not later than the latest day (for all such corporate partners) that is the last day of the first taxation year that ends after March 22, 2011 of a corporate partner that was a member of the partnership on March 22, 2011.
g. As this one-time election could result in corporate partners having in their taxation year that includes the new year end of the partnership two fiscal year ends of the partnerships, the transitional rules also permit the corporation to include in the five-year reserves referred to previously the income from this second fiscal period (Alignment Income), such that, after the first taxation year, this Alignment Income can generally be included in the corporation's income at inclusion rates of 15%, 20%, 20%, 20% and 25% for the five taxation years following the initial taxation year.
h. The proposals include provisions dealing specifically with multi-tiered partnerships with differing fiscal periods. Such multi-tiered partnerships will be required to have the same fiscal period. This will be accomplished by permitting such partnerships, on a one-time basis, to choose a common fiscal period, failing which the common fiscal period of the partnerships will become December 31 st (beginning December 31, 2011). The proposals dealing with multi-tiered partnerships will include provisions, including transitional relief, generally similar to those dealing with single-tier partnerships.
Stop-Loss Rules on Share Redemptions
Budget 2011 proposes to extend the application of what are known as the "dividend stop-loss rules" to reduce or "stop" a loss of a corporation otherwise realized on the redemption or purchase for cancellation of a share of another corporation by the amount of any dividend deemed to be received by the corporate shareholder on the redemption or purchase to the extent that the dividend is deductible by the corporation in computing its taxable income.
Budget 2011 suggests that the new rules are being introduced to address "tax avoidance arrangements" that rely on the existing stop-loss rules "to, in effect, claim a double deduction on the redemption of shares". The double deduction that is being referred to is a deduction in computing taxable income for the amount of a deemed dividend arising on a redemption or purchase of a share and a deduction in computing income for a loss realized by the corporate shareholder on the share redemption or purchase. Budget 2011 characterizes this loss deduction as not being a "true economic loss".
Subject to certain exceptions, when a corporation redeems or acquires a share of its capital stock, the holder is deemed to receive a dividend in the amount by which the purchase price exceeds the paid-up capital (PUC) in respect of the share. The corporation receiving the deemed dividend may be entitled to a deduction (known as the "inter-corporate dividend deduction") for the amount of the deemed dividend in computing its taxable income, as it would with regular dividends. As Budget 2011 states, the inter-corporate dividend deduction is part of the regime generally intended to prevent dividends between Canadian corporations being subject to multiple levels of taxation.
At the same time, in computing its gain or loss on the disposition of the share, the corporation would reduce the amount of the proceeds of disposition by the amount of the deemed dividend. This may result in the proceeds of disposition of the share being less than the corporation's tax basis in the share, giving rise to a loss on the disposition of the share, which the corporation may be able to deduct in computing its income for the year.
Suppose that a share held by a corporation is worth $100, that the corporate holder's tax basis in the share is $50 and that the PUC in respect of the share is $30. On a redemption or purchase for cancellation of the share (for proceeds equal to the value of the share), the corporate holder would be deemed to have received a dividend of $70 (the amount by which the proceeds of $100 exceed the PUC of $30), which it may be able to deduct in computing its taxable income. For purposes of computing the corporate holder's loss on the disposition, the holder would reduce the proceeds of $100 by the deemed dividend of $70, resulting in net proceeds of $30. The corporate holder would then compute a loss in the amount of $20 (the amount by which the tax basis of $50 exceeds the adjusted proceeds of $30), which it may be able to deduct in computing its income.
Generally, the current dividend stop-loss rules apply to reduce the loss of a taxpayer from the disposition of a share by the amount of the deductible dividends received by the taxpayer on the share unless (i) the taxpayer, together with persons with whom the taxpayer does not deal at arm's length, does not hold more than 5% of the issued and outstanding shares of any class of the issuer, and (ii) the taxpayer has held the share throughout the 365-day period that ended immediately before the disposition.
The proposed rule provides that the amount of a deductible deemed dividend received by a corporation on redemption, acquisition or cancellation of a share of another corporation would be applied to restrict the loss of the corporation otherwise realized on the disposition of the share. The result of the rules in the above example would be to deny the loss of $20.
The proposed rule would apply whether the share was held directly or indirectly through a partnership or trust, but it would not apply if, at the time the dividend is deemed to be paid and received, (i) the shareholder is a private corporation (that is not a financial institution and does not hold the share through a partnership or trust that is a financial institution), and (ii) the payor is a private corporation.
The measure is proposed to apply to share redemptions that occur on or after March 22, 2011.
Oil Sands Properties — Intangible Costs and Expenses
Budget 2011 proposes to alter the deduction rates on costs and expenses incurred with respect to oil sands resource properties to align them with the rates applicable in the conventional oil and gas sector. These measures are two-fold: first, to no longer permit taxpayers to treat the cost of oil sands leases and other costs of oil sands properties as Canadian development expense (CDE) which are deductible at 30% on a declining balance basis, and second, to treat pre-production development expenses relating to a new oil sands mine as CDE and not Canadian exploration expense (CEE), which are deductible at 100%.
Cost of Oil Sands Properties
Effective for acquisitions made on or after March 22, 2011, costs of acquiring oil sands leases or other oil sand resource properties (including oil shale properties) will be treated as Canadian oil and gas exploration expense (COGPE), which are deductible at 10% on a declining balance basis. Taxpayers disposing of such properties will be required to reduce their cumulative COGPE or cumulative CDE pool, consistent with the manner in which the cost of such property was treated by the taxpayer.
Pre-Production Development Expense Incurred in Respect of Oil Sands Mines
Subject to the transitional rules described below, expenses incurred by a taxpayer for the purposes of bringing a new oil sands mine (including expenses in respect of oil shale mines) into production in reasonable commercial quantities, which previously were classified as CEE, will now be classified as CDE. The 2011 Budget includes transitional relief in recognition of the long time frames involved in developing oil sands mining projects.
The treatment of these expenses as CEE will be maintained for: (i) expenses incurred before March 22, 2011; and (ii) expenses incurred before 2015 in respect of new mines on which major construction began before March 22, 2011. The determination of when major construction will be considered to have begun will be based on the proposed rules in subsection 1104(2) of the Regulations to the Income Tax Act (Canada) (Tax Act) which applies to the phase out of the accelerated capital cost allowance for oil sands projects, presumably following the framework for delineating between "preliminary work activity" and "specified development phase" contained therein.
For all other expenses, the transition of the treatment of these expenses from CEE to CDE will be phased in over several years where the amount of such expenses will be required to be allocated between CEE and CDE on the following basis:
Qualifying Environmental Trusts
The Tax Act contains specific rules, referred to as the qualifying environmental trust (QET) rules, applicable to a taxpayer that operates a mine, quarry or waste disposal site and that may be required by contract or law to pre-fund, by way of a trust, the costs or reclaiming of restoring the site. Budget 2011 proposes changes to the QET rules in four areas: (i) the extension of the QET rules to trusts that are required to be established to deal with pipeline abandonment costs; (ii) the expansion of the QET rules to include trusts that are required to be maintained by an order of a tribunal; (iii) the expansion of the range of permitted investments by QETs; and (iv) the change in the rate of tax payable by QETs in Part XII.4. All of the proposed measures will apply to 2012 and subsequent taxation years.
In May 2009, the National Energy Board announced that companies operating pipelines under its jurisdiction will be required to set aside amounts to fund future reclamation costs associated with the abandonment of the pipeline. Budget 2011 proposes to expand the definition of QET to include trusts created after 2011 in connection with the reclamation of property primarily used for the operation of a pipeline.
Order of a Tribunal
Under existing rules, in order to qualify as a QET, the maintenance of the trust must be mandated under the terms of a contract entered into with the federal or a provincial government or under the laws of Canada or a province. Budget 2011 proposes to extend the QET rules to trusts created after 2011 where the maintenance of the trust is required under an order of a tribunal constituted under the laws of Canada or a province.
The existing QET rules impose a restriction on the types of permitted investment for QETs. Budget 2011 proposes to expand the types of eligible investments to include those investments described in paragraphs (c), (c.1) and (d) of the definition of "qualified investment" in section 204, other than certain prohibited investments. These provisions generally include securities listed on a designated stock exchange, investment grade debt obligations and debt obligations of entities listed on a designated stock exchange in Canada or of a corporation listed on a designated stock exchange outside of Canada. Generally speaking, prohibited investments include securities of which the issuer is or is related to a contributor or beneficiary under the QET or an issuer of which a contributor or beneficiary or a person related thereto has a "significant interest" in the issuer within the meaning of subsection 207.01(4).
Where a trust created prior to 2012 and the relevant regulatory authority makes a joint election, this proposed amendment can apply for 2012 and each subsequent taxation year.
Part XII.4 Tax
Generally, a QET (other than certain QETs) is required to pay tax under Part XII.4 on its income for the taxation year at a rate of 28%. Budget 2011 proposes to set the rate of tax payable by QETs under Part XII.4 to the general income tax rate applicable to corporations less the total of the general rate reduction percentage and the provincial abatement. For 2012, this rate is expected to be 25%.
Capital Cost Allowance
Manufacturing and Processing Sector
Budget 2011 proposes to extend the temporary incentive offered in respect of machinery and equipment acquired by a taxpayer, after March 18, 2007 and before 2012, primarily for use in Canada for the manufacturing or processing of goods for sale or lease. Under the incentive, such machinery and equipment is eligible for a temporary accelerated capital cost allowance (CCA) rate of 50% on a straight line basis (subject to the application of the "half-year rule") under Class 29 of the Regulations to the Tax Act (Regulations). It is now proposed that eligible machinery and equipment acquired before 2014 will be eligible for the CCA rate of 50%. Machinery and equipment acquired by a taxpayer, after 2013, primarily for use in Canada for the manufacturing or processing of goods for sale or lease will be required to be included in Class 43 of the Regulations, for which a 30 per-cent declining balance CCA rate applies.
Clean Energy Generation Equipment
Class 43.2 of the Regulations provides accelerated CCA (50% per year on a declining balance basis) for specified clean energy generation and conservation equipment. With a clear objective of encouraging a reduction of the use of fossil fuels such as coal or natural gas in favour of clean energy, Budget 2011 proposes to amend Class 43.2 to include equipment that is used by the taxpayer, or by a lessee of the taxpayer, to generate electrical energy in a process in which all or substantially all of the energy input is from waste heat. Eligible equipment will include electrical generating equipment, control, feedwater and condensate systems, and other ancillary equipment, but not buildings or other structures, heat rejection equipment (such as condensers and cooling water systems), transmission equipment or distribution equipment. Under the proposals, systems will not be eligible if they use chlorofluorocarbons (CFCs) or hydro chlorofluorocarbons (HCFCs), due to their negative environmental impacts. Budget 2011 mentions that this new measure could contribute to a reduction in greenhouse gas emissions, in support of Canada's target, set out in the Federal Sustainable Development Strategy, of reducing greenhouse gas emission levels by 17% by 2020 and could support the Strategy's target of reducing emissions of air pollutants.
This measure will apply to eligible assets acquired on or after March 22, 2011 that have not been used or acquired for use before that date.
PERSONAL TAX MEASURES
RRSPs — Anti-Avoidance Rules
Budget 2011 proposes to introduce anti-avoidance rules aimed at tax planning schemes using Registered Retirement Savings Plans (and Registered Retirement Income Funds, in both cases referred to here as RRSPs) that enable annuitants to access RRSP funds without triggering an income inclusion for tax purposes. The new rules will be based on three current anti-avoidance rules that apply to Tax-Free Savings Accounts (TFSAs): (i) the advantage rules, (ii) the prohibited investment rules, and (iii) the non-qualified investment rules.
Budget 2011 will introduce the "advantage" concept from the TFSA rules. The RRSP advantage concept will include:
- Benefits from transactions that would not have been undertaken between non-arm's length parties in an open market where it is reasonable to conclude that the transactions were undertaken to benefit from RRSP attributes;
- Payments (i) to an RRSP for services and (ii) of investment income where the income is tied to the existence of another investment;
- Benefits derived from asset transfer/swap transactions between RRSPs and other accounts of the annuitant (which are not treated as a contribution or withdrawal), which Budget 2011 suggests may be used to shift value to or from an RRSP without paying tax or using RRSP contribution room;
- Specified non-qualified investment income;
- Income derived from a "prohibited investment"; and
- Benefits from so-called "RRSP strip transactions".
Generally, the amount of tax payable in respect of any RRSP advantage will be the fair market value of the benefit or, in the case of the debt, the amount of the debt. The tax will be payable by the annuitant unless the advantage was extended by the issuer (or person not dealing at arm's length with the issuer) in which case the issuer will bear the tax.
Budget 2011 will extend to the RRSP regime the concept of "prohibited investments". Such investments include debt of the TFSA holder and investments in entities in which the TFSA holder (or non-arm's length persons) holds an interest of 10% or more or does not deal at arm's length. A special tax of 50% of the fair market value of the prohibited investment will apply to an annuitant upon its acquisition by the RRSP, refundable if the investment is disposed of by the end of the year following the year in which the tax applied, unless the annuitant knew, or ought to have known, that the investment was prohibited. Income (including capital gains) derived from such investments will be treated as an "advantage".
Budget 2011 proposes to replace current income inclusion and deduction rules for non-qualified investments with rules similar to those for non-qualified investments in TFSAs.
Examples of non-qualified investments include shares in private holding companies and foreign private companies. Under the new rules, a 50% tax will be payable by the RRSP annuitant based on the fair market value of the non-qualified investment at the time it is acquired, which will be refundable if the investment is disposed of by the end of the year following the year in which the tax applied, unless the annuitant knew, or ought to have known, that the investment was non-qualified. Investment income earned on non-qualified investments in an RRSP will remain taxable.
Investments that are both prohibited and non-qualifying will be deemed to be prohibited investments (and not non-qualifying).
Subject to two exceptions, the new provisions will apply to transactions occurring after March 22, 2011.
RESP — Asset Sharing among Siblings
Budget 2011 proposes to allow the transfer of assets between individual Registered Education Savings Plans (RESP) between siblings.
RESPs are tax-efficient vehicles to assist families in saving for a child's post-secondary education. The Government contributes to savings for RESPs such as through Canada Education Savings Grants (CESGs). There are two primary types of RESPs – an individual or family plan. Parents and grandparents (referred to as "subscribers") may set up family plans for related children. While the contribution limit for family RESPs is the same as the aggregate limit for individual RESPs, there is greater flexibility with respect to reallocating assets under family plans between beneficiaries (for example, to address the situation where one of the beneficiaries does not pursue post-secondary education). This is permitted where all the beneficiaries are connected to the original subscriber by blood or adoption and each beneficiary is added to the plan before the age of 21.
Currently, there is less flexibility to transfer assets between individual plans. In particular, tax penalties and repayment of Canada Education Savings Grants (CESGs) would apply to transfers of assets between individual RESPs unless the plans are for the same beneficiary or are plans where the beneficiaries are siblings, and the transfer occurs before the beneficiary under the receiving plan reaches 21 years of age.
The proposed measure would allow the transfer of assets between individual RESPs for siblings provided that the beneficiary of the plan receiving the assets was under 21 years of age when the plan was opened. The measure will apply to asset transfers that occur after 2010.
RDSPs — Shortened Life Expectancy
Budget 2011 proposes to enable certain beneficiaries of a Registered Disability Savings Plan (RDSP) more flexibility in accessing their savings without requiring repayment of Canada Disability Savings Grants and Bonds (CDSGs and CDSBs).
RDSPs are tax-efficient vehicles to assist parents to save for the long-term financial needs of a severely disabled child. The Government supports RDSPs through CDSGs and CDSBs, which, along with investment income earned in the RDSP that accumulates tax-free, is included in the beneficiary's income when paid out.
Currently, there is a "10-year repayment rule" which requires all CDSGs and CDSBs received by a RDSP in the preceding 10 years to be held by a financial institution as a holdback to ensure the support is used for long-term savings. In the event of withdrawal or termination of the plan within this period, the relevant amounts must be repaid to the Government. While the current rules accommodate the need for beneficiaries with shortened life expectancies to access their savings, the 10-year repayment rule still applies.
The new measure will allow RDSP beneficiaries who have a shortened life expectancy (a life expectancy of five years or less from the relevant time in the opinion of a medical doctor) to withdraw annually more of their RDSP savings without triggering the 10-year repayment rule, subject to specified limits and conditions. Qualifying beneficiaries that wish to take advantage of the rule must elect in prescribed form, otherwise the current RDSP rules, including the 10-year repayment rule, will continue to apply.
If an election is made, subsequent withdrawals will not trigger the repayment of CDSGs and CDSBs provided that the taxable portion of the withdrawals does not exceed $10,000 annually. Currently, each withdrawal is comprised of a taxable and non-taxable portion based on the relative proportions of taxable assets (such as CDSGs, CDSBs and investment income) and non-taxable assets (private contributions) in the plan.
Once an election is made, (i) subject to certain exceptions, no further contributions to the plan will be allowed, (ii) no new CDSGs and CDSBs will be paid into the plan (but the passing of the beneficiary may trigger the repayment rule), (iii) no entitlements to CDSG or CDSB will be carried forward, and (iv) minimum withdrawal requirements that would otherwise apply when the beneficiary reaches 60 years of age will take immediate effect. A plan holder will be entitled to reverse an election on a prospective basis at any time.
The proposed measure will apply after 2010 to withdrawals made after the implementing legislation receives Royal Assent. A transitional rule will generally allow beneficiaries making the election to use their 2011 withdrawal limit in 2012.
Individual Pension Plans (IPPs)
Budget 2011 proposes two new tax measures to apply to defined benefit registered pension plans (RPPs) with three or fewer members (if at least one member is related for tax purposes to an employer that participates under the plan) or RPPs that are a "designated plan" (at least 50% of total pension adjustments of members belong to individuals who are connected to the employer or who are highly compensated employees) where the rights of one or more members may reasonably be considered to exist primarily to avoid this new definition (in either case an IPP).
The first measure will introduce annual minimum withdrawals from IPPs once a plan member reaches 72 years of age, similar to current withdrawal requirements from Registered Retirement Income Funds. Generally, it is proposed that this measure apply to 2012 and subsequent taxation years.
The second measure proposes to restrict the ability to make contributions to an IPP in relation to past years of service. Budget 2011 proposes that the cost of past service under an IPP first be satisfied by transfers from RRSP assets or a reduction in the member's unused RRSP contribution room before new past service contributions are permitted. This measure will generally apply to IPP past service contributions made after March 22, 2011.
Employee Profit Sharing Plans
Budget 2011 identifies a concern that employee profit sharing plans (EPSPs) may be used to effectively direct profits to family members for purposes of tax deferral or reduction, or to avoid making Canada Pension Plan contributions and paying employment insurance premiums. The Government intends to engage in a consultative process with stakeholders to review the existing rules.
Tax on Split Income — Capital Gains
The Government notes that income-splitting techniques have arisen that use capital gains to avoid the tax on split income regime pursuant to which a higher income taxpayer is prevented in certain circumstances from splitting taxable income with lower-income individuals to benefit from the progressive marginal rate structure applicable to personal income (this regime is generally referred to as the "kiddie tax"). Accordingly, Budget 2011 proposes a new measure extending such tax to certain capital gains realized by, or included in the income of, a minor. Currently, the kiddie tax applies to "split income", which generally comprises taxable dividends (and shareholder benefits) received directly, or indirectly through a partnership or trust, in respect of unlisted shares of Canadian and foreign corporations (other than shares of a mutual fund corporation); and income from a partnership or trust if that income is derived from providing property or services to, or in support of, a business carried on by a person related to the child or in which the related person participates.
Under the proposed new measure any gain realized by a minor from a disposition of shares of a corporation to a person who does not deal at arm's length with the minor will be subject to the kiddie tax if taxable dividends on the shares would have been subject to the kiddie tax. Capital gains that are subject to this new measure will be treated as dividends and as such, will not benefit from capital gains inclusion rates nor qualify for the lifetime capital gains exemption. This measure will apply to capital gains realized on or after March 22, 2011, and the Government states that it will continue to monitor the effectiveness of the kiddie tax regime.
Mineral Exploration Tax Credit
Budget 2011 proposes to extend the flow-through mining expenditure credit for an additional year. Qualifying expenditures incurred by a corporation after March 2011 and before 2013 pursuant to flow-through share agreements entered into after March 2011 and before April 2012 may qualify for the flow-through mining expenditure credit.
Children's Arts Tax Credit
In a proposal largely based on the scheme of the Children's Fitness Tax Credit rules, Budget 2011 proposes a non-refundable tax credit equal to 15% of an amount up to $500 of registration or membership expenses paid for a child under 16 years of age to participate in a program involving participation in a supervised activity that has a significant artistic, cultural, environmental or academic focus or serves to develop certain prescribed skill sets. In order for a program to qualify, it must either last a minimum of five consecutive days or must constitute a weekly program lasting a minimum of eight consecutive weeks. If all other criteria are met, the full amount of the fees paid will be eligible for the credit. This proposal will be available in 2011 and subsequent taxation years and can be apportioned between more than one individual in respect of a qualifying child.
Volunteer Firefighters Tax Credit
The Volunteer Firefighters Tax Credit proposed in Budget 2011 will provide eligible volunteer firefighters meeting certain criteria with a non-refundable tax credit equal to 15% of $3,000 and will be available beginning in the 2011 taxation year. Where an individual claims this tax credit, the existing exemption for certain honoraria paid in respect of firefighting services will not be available.
Family Caregiver Tax Credit
The Family Caregiver Tax Credit proposed in Budget 2011 is intended to provide additional assistance to individuals who care for mentally and physically disabled dependants. The proposal provides these caregivers with the ability to claim a 15% non-refundable credit for each infirm dependant based on an amount of $2,000 (to be indexed for inflation beginning in 2013) in 2012 and subsequent taxation years.
Medical Expense Tax Credit for Other Dependants
The expenses that a taxpayer can claim under the Medical Expense Tax Credit in respect of his or her own eligible expenses or those of a spouse, common-law partner or minor child are generally unlimited. In contrast, a $10,000 limit is currently imposed on eligible expenses incurred by a taxpayer in respect of a dependent relative (other than a minor child). Budget 2011 proposes to remove this limit in respect of such dependants for the 2011 and subsequent taxation years.
Child Tax Credit Eligibility
Effective for the 2011 and subsequent taxation years, Budget 2011 proposes to repeal a restrictive rule in the Child Tax Credit (CTC) provisions that currently precludes more than one individual taxpayer in the same domestic establishment from claiming a CTC, even where each CTC is claimed in respect of a different person. The purpose of this proposal is to ensure that, where two or more families share one home, the CTC is available to each family.
Tuition Tax Credit — Examination Fees
Budget 2011 proposes to extend the Tuition Tax Credit to certain fees paid by a taxpayer to take an examination in 2011 or any subsequent taxation year in order to obtain a federally or provincially recognized professional designation or a licence or certification to practise a profession or trade in Canada, along with eligible ancillary fees.
Education Tax Measures — Study Abroad
Where an individual taxpayer is enrolled in a course as a full-time student at a university outside of Canada that leads to a degree, the student is currently barred from claiming Tuition, Education and Textbook Tax Credits if the course is less than 13 consecutive weeks in duration. Similarly, an individual taxpayer's entitlement to Educational Assistance Payments (EAPs) from a Registered Education Savings Plan is limited by a minimum duration requirement of 13 consecutive weeks. Budget 2011 proposes to reduce this minimum duration requirement to three consecutive weeks for purposes of qualifying for the Tuition, Education and Textbook Tax Credits. With respect to EAPs, the proposals will reduce the minimum duration requirement to three consecutive weeks where a beneficiary is enrolled on a full-time basis, but will maintain the 13 consecutive weeks requirement where the beneficiary is not enrolled on a full-time basis. These proposals will apply with respect to courses taken in 2011 and subsequent taxation years and to EAPs made after 2010.
Budget 2011 includes a number of proposals to strengthen the integrity of the charitable sector by enhancing transparency and strengthening the Canada Revenue Agency's (CRA) ability to impose certain sanctions.
A variety of rules currently applicable to registered charities will be extended to other entities that are also permitted to issue official donation receipts. Such "Qualified Donees" will include: registered Canadian amateur athletic associations (RCAAAs); Canadian municipalities; public bodies performing government functions in Canada; housing corporations constituted exclusively to provide low-cost housing for the aged; non-Canadian universities (which ordinarily have Canadian students); and certain other non-Canadian charitable organizations. Such extended rules contemplate:
- To be eligible to issue official donation receipts, Qualified Donees will generally be required to be listed on a publicly accessible list maintained by CRA. Similar lists are currently available but will now include all Qualified Donees.
- Qualified Donees must issue donation receipts only in accordance with the provisions of the Tax Act and the Regulations and maintain proper books and records in respect of donations and make same available to CRA upon request. CRA may suspend receipting privileges or revoke a Qualified Donee's status should it fail to comply with such requirements. In the case of an RCAAA issuing an improper donation receipt or failing to file an information return, monetary penalties may be imposed.
Such rules will be effective on or after the later of January 1, 2012 and Royal Assent of the enacting provisions.
The regime for RCAAAs will be tightened pursuant to Budget 2011. Current rules effectively require that an RCAAA's primary purpose and primary function be the promotion of amateur athletics in Canada. Budget 2011 proposes that such tests be narrowed to require such criteria to be the exclusive purpose and exclusive function of an RCAAA. However, like registered charities, an RCAAA will be permitted to carry on certain related activity. CRA will be permitted to publicly disclose certain information and documents in relation to an RCAAA. An RCAAA will also become subject to rules prohibiting it from providing an undue benefit to its staff, a fundraising company or other persons with whom it does business. Sanctions for failing to meet such criteria will include monetary penalties and the suspension or revocation of the RCAAA's registration. The Government is seeking feedback on the exclusivity requirements prior to June 30, 2011 and will consult with stakeholders in respect of the public disclosure requirement.
Budget 2011 proposes to enhance CRA's ability to consider certain misconduct in considering to refuse or to revoke the registration of a charity or an RCAAA. Under such proposals, CRA may consider circumstances where a director, a trustee, an officer or equivalent, or an individual who controls or manages such an organization:
- Has been convicted of a criminal or other offence relating to financial dishonesty or that is otherwise relevant to the operation of the organization;
- Has been involved with an organization whose registration has been revoked for serious non-compliance; or
- Was a promoter of a tax shelter (or gifting arrangement) in which a charity or RCAAA participated where the participant's charitable registration was revoked.
CRA will consult with stakeholders in developing guidance in this regard.
Budget 2011 will require amended receipts to be issued in respect of gifts that are returned by a Qualified Donee to a donor that has claimed a credit or deduction in respect of the original gift. CRA may reassess the donor to adjust the original credit or deduction.
Budget 2011 will alter the donation regime in respect of gifts of non-qualifying securities (NQS), certain options and publicly-listed flow-through shares (FTS):
- NQS generally include shares, debts or other securities issued by the donor or a person not dealing at arm's length with the donor. Budget 2011 proposes to defer the recognition of a donation of NQS until such time (within five years of the donation) as the Qualified Donee has disposed of the NQS for consideration that is not another NQS. Budget 2011 also proposes an anti-avoidance rule in respect of back-to-back type arrangements in respect of an NQS.
- Options granted to a Qualified Donee will effectively be ignored pursuant to proposals in Budget 2011. Instead, the donor will be entitled to a deduction or credit at the time the underlying property is acquired by the Qualified Donee pursuant to the option. The amount of the gift at such time will generally be the excess of the fair market value at that time of the underlying property over the amount paid by the donee to acquire the option and the underlying property. However, where the amount paid exceeds 80% of the fair market value of the property at the time it is acquired by the donee, the charitable credit or deduction will generally not be available.
- Despite the elimination of tax on capital gains in respect of gifts of publicly-listed securities introduced in prior federal budgets, Budget 2011 proposes to restrict that benefit in respect of publicly-listed FTS. Purchasers of FTS typically benefit from expenses flowed through the corporation and from certain flow-through tax credits. In the case where such FTS are donated to a Qualified Donee the donor would further benefit from a charitable tax credit and from relief from the capital gains tax in respect of any gain (ordinarily computed on the basis that the FTS has a cost of nil) arising from such a disposition of the FTS. Budget 2011 proposes to restrict the capital gains relief in such circumstances. Generally, the exemption from tax on capital gains for a donor gifting to a Qualified Donee publicly-traded FTS acquired by such donor pursuant to a flow-through share agreement entered into on or after March 22, 2011 will be available only to the extent that the capital gain of the donor arising from the disposition of the FTS exceeds an "exemption threshold". Generally speaking, the exemption threshold will be the excess of the donor's original cost of all FTS of the particular class over the amount of capital gains previously realized by the donor in respect of FTS of that class.
Budget 2011 proposes to extend the favourable tax-deferred treatment of investments made under the AgriInvest program to investments made under the new Agri-Québec program. These amendments will apply for the 2011 and subsequent taxation years.
Aboriginal Tax Policy
Budget 2011 states that the Government is willing to discuss and put into effect taxation arrangements with interested Aboriginal governments and that it supports taxation arrangements between interested provinces or territories and Aboriginal governments. The Government highlights existing sales tax arrangements under which Indian Act bands and self-governing Aboriginal groups levy a sales tax within their reserves or their settlement lands and existing arrangements respecting personal income taxes levied by self-governing Aboriginal groups.
Child Tax Benefit and GST Credit
To ensure consistency with existing notification requirements for the Goods and Services Tax/Harmonized Sales Tax (GST/HST) Credit purposes, Budget 2011 proposes to require an individual who receives the Canada Child Tax Benefit (CCTB) to notify the Minister of National Revenue of a marital status change. This measure will apply to marital status changes that occur after June 2011.
Pension Plan Wind-ups
In the context of previous accommodations made by the Government under the pension tax rules for members and retirees of underfunded pension plans that are being wound up due to an employer's insolvency, Budget 2011 states that CRA will clarify the application of the rules regarding the tax treatment of lump-sum amounts received by former employees or retirees in lieu of their right to health and dental coverage from employers who have become insolvent. Budget 2011 indicates that these amounts not be treated as income for tax purposes, in relation to insolvencies arising before 2012.
IMPORT AND TARIFF MEASURES
Following steps in recent federal budgets to reduce or eliminate import tariffs and the administrative burden on importers, Budget 2011 announced a process to simplify the Customs Tariff, promising to implement three kinds of changes through legislative or regulatory amendment:
- Reducing the customs processing burden — this includes reducing the number of tariff items in the Schedule to the Customs Tariff in order to facilitate the tariff classification of imported goods and reduce the number of "end-use provisions";
- Modifying the structure of the Customs Tariff to make it more "user-friendly"—- this includes amending the Schedule to make it easier to determine the tariff treatment of imports; and
- Revoking obsolete Customs Tariff provisions — this includes removing a number of the safeguard and emergency measures set out in the Customs Tariff that can no longer be used since they are inconsistent with Canada's obligations under free trade agreements.
The Government has promised that all such changes will be revenue neutral and stakeholder views will be sought where necessary. It remains to be seen whether this simplification process will be as wide-ranging as the tariff simplification initiative implemented by the government in 1998 and which resulted in significant changes to Canada's tariff structure.
The Government has also promised to introduce three new tariff items in Chapter 98 of the Schedule to the Customs Tariff which are intended to facilitate the importation of low-value non-commercial goods by post or courier. They will provide for Most-Favoured-Nation tariff rates of 0%, 8% or 20% depending on the goods being imported, similar to the treatment afforded to goods accompanying travellers under heading No. 98.26 of the Schedule.
Budget 2011 also reaffirms the Government's commitment to proceed with a series of previously announced measures, including:
- Legislation relating to measures announced in the 2010 federal budget;
- Legislative proposals released on July 16, 2010 and November 5, 2010 relating to income tax technical and bijuralism amendments;
- Legislative proposals released on December 16, 2010 relating to REITs;
- Proposed changes to certain GST/HST rules relating to financial institutions released on January 28, 2011;
- Outstanding draft legislative proposals relating to foreign affiliates; and
- Legislative proposals released on March 16, 2011 relating to the deductibility of contingent amounts, withholding tax on interest paid to certain non-residents, and the tax treatment of certain life insurance corporation reserves.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.