On March 29, 2012, the Minister of Finance introduced the federal government's 2012 budget (the Budget). As expected, no changes were made to overall corporate tax rates. However, significant changes were proposed to Canada's international tax rules, especially those applicable to U.S. and other foreign multinationals with Canadian operations. The government has proposed an ambitious set of anti-avoidance provisions aimed at curtailing the use of Canadian subsidiaries in multinational groups as holding companies for foreign affiliates and the push-down of financing expenses into Canada, as well as impeding common repatriation strategies. These proposals continue the targeting of repatriation strategies that was evident in the "upstream loan" rules described in Blakes Bulletin: Proposed Foreign Affiliate Amendments Require Review of Current and Past Transactions, released in August 2011. Existing cross-border structures and future investments or acquisitions involving Canadian members of a multinational group will now have to be re-evaluated with these changes in mind.
Changes to Thin Capitalization Rules
Existing law limits the ability of a corporation resident in Canada to incur deductible interest expense on cross-border debt owing to non-residents who are, or are related to, significant shareholders. A "bright-line" rule applies under which interest deductions are denied to the extent the debt/equity ratio exceeds 2:1.
The Budget proposes three significant changes to these rules, specifically:
- the 2:1 ratio will be changed to 1.5:1;
- disallowed interest will be re-characterized as a dividend, thus disqualifying, for example, any non-deductible interest paid to a U.S. resident from the related-party withholding-tax exemption in the Canada-U.S. tax treaty; and
- debt owing by partnerships -- formerly not addressed by the thin capitalization rules -- will now be imputed to any corporate partner for purposes of these rules.
Arrangements in place on Budget day (March 29, 2012) are not grandfathered. The 1.5:1 ratio will apply to tax years that begin January 1, 2013, or later. The treatment of disallowed interest as a dividend will apply to tax years that end on or after March 29, 2012 (with a proration rule reflecting the number of days before and after March 29, 2012), thus applying to interest expense that may have accrued before Budget day. The partnership rule will apply to tax years that begin on or after Budget day. All existing cross-border debt structures should be reviewed immediately and, in many cases, will need to be restructured before the end of 2012 to better align with the new rules.
Changes to Maximum Debt/Equity Ratio
The government notes that the Advisory Panel on Canada's System of International Taxation (Advisory Panel), which reported to the government in December 2008, observed that Canada's 2:1 ratio was higher than industry averages generally. It was also noted that the ratio appears high relative to world standards, since many other countries apply thin capitalization rules to a broader category of debt, such as debt guaranteed by a significant non-resident shareholder. The government previously introduced a proposal in 2000 (when the ratio was changed from 3:1 to 2:1) to subject such guaranteed debt to the thin capitalization rules but then withdrew the proposal amid widespread criticism. In the, apart from the partnership proposal discussed below, no attempt has been made to widen the rule; rather the ratio is simply being reduced to 1.5:1.
Treatment of Disallowed Interest as Dividend
Under current rules, any cross-border interest payments that exceed the thin capitalization limit are non-deductible but retain their character and are subject to withholding tax, as interest. Under the Canada-U.S. tax treaty, which contains a withholding-tax exemption for interest, this results in an anomalous situation in which cross-border payments of non-deductible interest -- which, in effect, are being treated as dividend-like distributions -- escape the withholding tax otherwise applicable to actual dividend distributions.
The proposed changes in the Budget will treat these non-deductible interest payments as dividends paid by the corporation for withholding tax purposes, resulting in the imposition of a 5%, 15% or 25% withholding tax, depending on the circumstances. The new rule will also apply dividend withholding tax to deemed income inclusions related to partnership debt attributed to a corporate partner under the new partnership rules discussed below.
Interestingly, in the context of non-deductible payments made to a resident of many treaty countries (such as Luxembourg or the Netherlands), the reclassification of non-deductible interest as a dividend may result in a withholding tax reduction -- since the dividend withholding rate for significant direct corporate shareholders in those treaties (5%) is less than the rate applicable to related-party interest payments (10%).
Since interest deductions are not required to be accompanied by any cash payment in the year, special rules are proposed under which the deemed dividend is deemed to be paid immediately before the end of the tax year in question.
Application of Thin Capitalization Rules to Partnership Debt
The government has acted on the Advisory Panel recommendation to extend the thin capitalization rules to partnership debt. Under the proposed rules, if a corporation resident in Canada is a member of a partnership that incurs debt, the corporation's pro-rata portion of that debt will be attributed to the corporation for purposes of applying the thin capitalization rules. The proration formula is based on the corporation's share of partnership income or loss for the year (and if the partnership has nil income or loss, the partnership is treated as if it had income of C$1-million). In order to avoid any effect on the income of other members of the partnership, the new rule does not deny a deduction to the partnership but instead treats the corporate member as having itself derived an amount of income corresponding to interest on the portion of the debt in excess of the new 1.5:1 limit. The Budget states that the source of this income will be determined with reference to the source against which the interest is deductible at the partnership level. It appears that there is no effect on the amount of partnership income or loss allocated to the corporate partner, or on its adjusted cost base or at-risk amount in respect of the partnership.
Relieving Rule for Loans to Foreign Affiliates
The Budget proposes a relieving rule designed to eliminate the double taxation that could otherwise arise where a corporation resident in Canada borrows money from a controlled foreign affiliate. In some cases, it is possible for the thin capitalization rules to deny a deduction while at the same time the interest income is taxed currently in the hands of the Canadian corporation as "foreign accrual property income" or "FAPI." For tax years ending after March 29, 2012, interest expense corresponding to such FAPI (net of any deduction relating to underlying foreign tax applicable to such FAPI) will be excluded from the thin capitalization rules.
Interestingly, there is no indication that the thin capitalization rules will be extended to debt owing by trusts or branches of foreign corporations. The extension of the rules to trusts and branches was first proposed in 2000, but this proposal was later withdrawn. The Advisory Panel recommended the extension of the rules to partnerships, trusts and branches. It seems that a fair inference may be drawn that the government has consciously decided to extend the rules to partnerships but not to trusts or branches.
The Budget states that withholding tax on interest that is deemed to be a dividend will be required to be paid at the time that such interest is paid or deemed paid. This will require careful monitoring of interest payments to ensure that withholdings are made on a timely basis, particularly when partnerships are involved.
Foreign Affiliate "Dumping"
Under existing law, multinational groups have a significant incentive to use their Canadian subsidiaries to acquire or hold investments in foreign operating subsidiaries. Many multinationals have organized or reorganized their corporate structures to take advantage of existing rules under which interest on debt associated with acquisitions of such subsidiaries is generally deductible and dividends out of foreign active business income in countries with treaties or tax information exchange agreements are generally excluded from taxable income. The net effect of this planning is to erode the Canadian tax base, frequently sheltering Canadian operating earnings from corporate income tax, and to utilize Canadian earnings outside Canada without payment of withholding tax. Under existing law, it is irrelevant whether or not (a) the acquired foreign subsidiary has any functional connection to the Canadian business, (b) management of the Canadian subsidiary was involved in the acquisition, or (c) there is any non-tax reason for having the Canadian subsidiary, rather than another group company, make or hold the investment.
The Budget proposes a sweeping and aggressive set of proposals to dramatically change the rules in this area. The new rules target not only internal reorganizations that shift ownership of foreign affiliates from a group company to the Canadian subsidiary (commonly referred to as "debt dumping") but also apply to bona fide arm's length acquisitions and to incremental investments in foreign subsidiaries already held in Canada. The rules introduce an unprecedented business purpose test under which adverse tax consequences are avoided only if it can be shown that the target has a closer connection to the Canadian subsidiary than it has to the parent. The rules are drafted in a sufficiently broad and one-sided way that there is a very real prospect of unintended effects.
The government estimates that it will collect an additional C$1.3-billion of taxes as a result of this measure, making it the largest revenue enhancing measure in the Budget.
Deemed Dividend Rule
The core of this new set of rules is a deemed dividend rule under which a corporation resident in Canada (a CRIC) is deemed to have paid a dividend to its foreign controlling corporation in the following circumstances:
- the CRIC makes an "investment" at any time in a non-resident corporation (the subject corporation);
- the subject corporation is (or becomes) a "foreign affiliate" of the CRIC (generally meaning that the CRIC has an interest in the subject corporation of 10% or more of any class of shares);
- the CRIC is controlled by a non-resident corporation (the parent); and
- the investment may not reasonably be considered to have been made by the CRIC, instead of being made or retained by the parent or another non-resident entity in the group, primarily for bona fide purposes other than to obtain a tax benefit.
An "investment" in a subject corporation means not only an acquisition of shares but also a capital contribution, a loan, an acquisition of a debt, option or other interest in the subject corporation or "any other transaction that is similar in effect." The latter phrase differs from traditional Canadian statutory drafting and introduces significant uncertainty into the rules. Perhaps an argument could be made that it could apply to the leasing of property to a foreign affiliate on the basis that a lease is "similar" to a secured debt.
Thus, the rule applies to existing structures where a foreign-controlled Canadian company simply funds its existing foreign subsidiary. Clearly, the objective of these rules is not only to prevent Canadian subsidiaries from incurring financing expenses but also to impede direct or indirect repatriation strategies that endeavour to make use of cash of a Canadian subsidiary to invest in foreign operations.
The amount of the dividend deemed to have been paid by the CRIC to its parent is essentially equal to the total non-share consideration paid or transferred by the CRIC in respect of the investment. In addition, the paid-up capital of any shares issued in connection with the investment is effectively deemed to be nil, thereby disentitling the CRIC to any enhanced thin capitalization "room" and preventing a distribution of a corresponding amount as a return of capital.
This draconian rule will require that a careful review of all the circumstances be undertaken before any Canadian subsidiary of a multinational makes an investment in any foreign corporation that is or would become a foreign affiliate, even in seemingly benign situations. While it is true that the new rule applies only where the investment cannot be shown to have been made primarily for non-tax reasons, specific interpretive provisions are proposed to be included in the legislation that list factors to be given "primary consideration" in determining whether the business purpose test is met. These rules set a very high threshold. These factors include:
- whether the business activities of the subject corporation are "more closely connected" to those of the CRIC than to any other group company;
- whether the investment is in non-participating shares (though the rules quickly add that no positive inference arises from the mere fact the shares are participating);
- whether the investment was made "at the direction or request" of the parent;
- whether negotiations with any third-party seller were "initiated by senior officers of the CRIC who were resident in, and worked principally in, Canada," or, where the seller initiated discussions, if the "principal point of contact was an officer of the CRIC";
- whether senior officers of the CRIC who were resident in, and worked principally in, Canada have "principal decision-making authority" in respect of the investment;
- whether the performance evaluation and compensation of senior officers of the CRIC who were resident in, and worked principally in, Canada is connected to the results of the subject corporation;
- whether senior officers of the subject corporation report to, and are functionally accountable to, senior officers of the CRIC who were resident in, and worked principally in, Canada to a greater extent than to senior officers of parent.
A specific anti-avoidance rule applies to investments in an intermediate foreign corporation that uses the proceeds to make an investment in a subject corporation.
This list of factors is so one-sided that it seems to virtually assure that the business purpose test will not be met in any multinational corporation with centralized management. In particular, treasury functions will invariably be centralized in head office. To expect that any group decision to make a material investment in a foreign company will not be made "at the direction or request" of the parent seems somewhat unrealistic. While it is clear that a business purpose test is intended by the legislation, such a test should not be made so difficult to meet that it will virtually never be usable. It seems as if the real objective of the rules is to effectively force Canadian subsidiaries of multinationals to either reinvest their free cash in Canada or dividend it to the parent company. However, it should be noted that the government has invited comments on the "business purpose" test before June 1, 2012.
Related rules are proposed to prevent the capitalization of contributed surplus associated with investments caught by the new rule and to deal with paid-up capital arising on corporate immigration and emigration. Notably, when a CRIC controlled by a non-resident corporation is a shareholder of a CRIC emigrating from Canada, the emigrating CRIC's departure tax will be computed as if its paid-up capital were nil. When a foreign-controlled corporation becomes resident in Canada, its paid-up capital will be reduced by the fair market value of shares of any non-resident corporation that becomes a foreign affiliate upon the immigration, and to the extent that the value of such shares exceeds the paid-up capital, a dividend will be deemed to be paid to the foreign parent.
The new rules generally apply to transactions or events that occur after March 29, 2012. Thus, while existing structures are generally not caught, any future funding by a foreign-controlled Canadian company of a foreign affiliate will be subject to these rules. All such structures should be carefully examined to determine exposure to the new rules.
The new rules would appear to curtail the type of arrangement that was successfully carried out in the Collins & Aikman case, at least in those cases where the business purpose test cannot be met.
Cost-Base Bump to Partnership Interests and New Rule for Calculating Gain from Sale of Partnership Interests
Under existing law, a step-up (or "bump") in the tax cost of non-depreciable capital property owned by a company being liquidated into its parent (or amalgamated with its parent) is available in some circumstances. These rules are often used in acquisitions of Canadian multinationals by foreign buyers to facilitate a post-closing reorganization to extract the foreign subsidiaries from Canada without Canadian tax. These same rules can be used to effectively expatriate intangible assets (or other assets ineligible for bump treatment such as depreciable or resource assets, inventory or goodwill) owned by a target company through a partnership at the time of acquisition. The assets, if held directly, would not have been eligible for the "bump," but partnership interests generally would be eligible. In some cases, the target will reorganize by contributing its intangibles or other assets to a partnership for the primary purpose of facilitating a bump. Once the basis in partnership interests has been bumped to fair market value, ownership of the partnership can then be transferred to other entities in the corporate group or sold to third parties, often non-residents of Canada.
The Budget proposes to shut down this planning by disallowing a bump of a partnership interest to the extent the accrued gain is attributable to partnership assets that would not have been eligible for a bump. The proposed amendments reduce the potential size of bump available for a partnership interest by an amount corresponding to the total accrued gain (ignoring liabilities) of the assets held directly by the partnership (or held indirectly through other partnerships) that are ineligible for bump treatment. This rule applies to windings-up that begin, and amalgamations that occur on or after March 29, 2012, subject to an exception, for transactions involving an acquisition of control (or legal obligation to acquire control) before that date, together with evidence in writing of an intention to wind up or amalgamate.
A second change proposes to double the tax rate payable on any gain (attributable to appreciation in value of property of the partnership other than non-depreciable capital property) realized on the sale of certain partnership interests if the buyer is a non-resident of Canada, effectively treating this portion of the capital gain as if it were ordinary income. This parallels an existing rule that imposes the same treatment on this portion of gains from sales of partnership interests to tax-exempt entities. The rule is also broadened by importing the "series of transactions" concept -- essentially, the punitive treatment will apply even to a sale of a partnership interest to a taxable resident of Canada if that sale is part of a "series of transactions" in which the partnership interest is acquired by a non-resident or a tax-exempt entity. An exception applies if, both immediately before and immediately after the disposition, the partnership uses all of its property in carrying on business through a permanent establishment in Canada. In any sale of a partnership interest to a taxable Canadian entity, it will be prudent to obtain representations that the buyer has no current intention to resell the interest to a tax-exempt or non-resident entity. This change applies to dispositions of partnership interests that occur on or after March 29, 2012 (with an exception for dispositions before 2013 pursuant to binding written agreements in place on March 29, 2012).
Transfer Pricing Secondary Adjustments
Canadian transfer pricing rules apply to transactions undertaken by Canadian residents with non-arm's length non-residents. Generally, Canadian rules are based on the "arm's length principle," as articulated in the Transfer Pricing Guidelines of the Organisation for Economic Co-operation and Development. The rules permit the Canada Revenue Agency (CRA) to adjust the prices agreed to in cross-border non-arm's length transactions, potentially increasing the taxable income of the Canadian taxpayer. Such an adjustment is generally referred to as a "primary" adjustment.
Many countries, including Canada, also assess "secondary" adjustments where, due to the use of non-arm's length prices, "excess" cash has accrued to a related non-resident. Where the related non-resident is a shareholder of the Canadian corporate taxpayer, the secondary adjustment is rationalized as a "shareholder benefit" that is deemed by the existing rules to be a dividend and thus subject to withholding tax. However, where the related non-resident is not a shareholder, the technical basis for assessing a secondary adjustment is sometimes less apparent.
The Budget proposes to codify the treatment of secondary adjustments by deeming an amount equal to the transfer pricing adjustment to be a dividend. This new rule could deem a dividend to be paid to any non-arm's length non-resident, including a sister company. An exception will be provided where the non-arm's length non-resident is a controlled foreign affiliate of the relevant Canadian corporation; in those cases, no secondary adjustment will apply. To the extent a deemed dividend arises under the new provisions, the existing shareholder benefit and other benefit provisions will not apply.
The Budget also proposes to codify the rules applicable to repatriations of amounts in the transfer pricing context. As an example, repatriation occurs when a non-resident agrees to repay amounts overcharged to a Canadian resident. Specifically, a statutory change is proposed under which the amount of a repatriation payment made by a non-arm's length non-resident to the Canadian resident will reduce the amount of the deemed dividend otherwise arising. However, it appears taxpayers will not have a right to repatriate—this will require the concurrence of the Minister of National Revenue. The deemed dividend will only be reduced to the amount, if any, that the Minister of National Revenue considers appropriate, having regard to all of the circumstances, including the amount of the deemed dividend and the amount of the repatriation payment. It is not clear to what extent these rules will change the existing practice of CRA. It should be noted that under existing practice, repatriation is dealt with by the competent authorities in the context of the overall competent authority agreement reached on the primary adjustment.
Eligible Dividend Designation
Dividends paid by a taxable Canadian corporation to a Canadian resident individual are subject to two levels of Canadian income tax: the first at the corporate level and the second at the level of the shareholder once a dividend has been received. The law generally alleviates double taxation in this regard by providing for a gross-up and credit mechanism that attempts to subject the corporation and its Canadian resident individual shareholder to approximately the same tax on income earned by the corporate as would have arisen had the shareholder earned the income directly.
Where a corporation pays Canadian income tax at the full rate, integration is achieved through an enhanced gross-up and credit mechanism applicable to a dividend paid to a Canadian resident individual that is designated, at the time such dividend is paid, by the corporation as an "eligible dividend." However, where a corporation designates a dividend as an "eligible dividend" in excess of a proxy for income on which it paid tax at the full rate (or in the case of a "Canadian-controlled private corporation" (CCPC), to the extent such corporation has not paid a dividend out of income for which tax was not paid at the full rate), the corporation may be subject to a special 20% tax on such "excessive eligible dividend designation." An "excessive eligible dividend designation" may only be avoided by filing an election whereby the corporation and each shareholder of the corporation agree that the excessive amount of the dividend be subject to the regular gross-up and credit mechanism. Further, a corporation that fails to designate a dividend as an "eligible dividend" at the time the dividend is paid is not allowed to so designate such dividend at a later date.
The Budget proposes two measures in this regard that are to be effective to taxable dividends paid on or after Budget day. First, it is proposed that a corporation be permitted to apportion a dividend as between an "eligible dividend" portion and the portion of the dividend that is subject to the regular gross-up and credit rules. This will eliminate the need to pay multiple dividends in the case where a corporation pays dividends that are partially eligible to be designated and partially not eligible to be designated. However, this proposal does not relieve a corporation of paying tax on any "excessive eligible dividend designations" to the extent the corporation incorrectly apportions a dividend as between the eligible and ineligible portions.
Second, the Budget proposes to give the Minister of National Revenue the authority to accept an "eligible dividend" designation that is filed within three years from the date when the designation was due, where the Minister of National Revenue is of the opinion that allowing such designation would be just and equitable in the circumstances, including to affected shareholders. This proposal provides welcome relief to Canadian resident shareholders of corporations that, for any reason, did not correctly designate a dividend as an "eligible dividend" at the time the dividend was paid, although it is unclear why the new rule applies only to dividends paid on or after Budget day. The stated purpose of this change is to improve tax fairness for corporations. If it is acknowledged that the current provisions are not fair to corporations, the Minister of National Revenue should be given the authority to accept late-filed designations of dividends paid before Budget day. It is also unfortunate that there is no absolute right to file a late designation, such as there is, for example, in the case of a capital dividend election.
Scientific Research and Experimental Development
The Canadian scientific research and experimental development (SRED) program provides for a deduction and credit mechanism for certain "qualified expenditures," which include both current and capital expenditures that meet the criteria to qualify. Generally, qualified expenditures may be deducted by the taxpayer and are added to a qualified expenditure pool, which, at the end of each taxation year, is generally eligible for an investment tax credit. The general rate for such credit is 35% for a corporation that is a CCPC and 20% for any other corporation. Further, for eligible CCPCs, such investment tax credits are generally refundable for qualified expenditures up to C$3-million.
As anticipated, the Budget proposes measures that narrow the benefits available to taxpayers in respect of the SRED program. First, the 20% rate of investment tax credit applicable to corporations that are not eligible CCPCs will be reduced to 15% for taxation years ending after 2013 (prorated for taxation years that straddle January 1, 2014). The 35% rate applicable to eligible CCPCs will not change.
Second, expenses that are capital in nature will no longer be eligible to be "qualified expenditures." Accordingly, capital expenditures that would previously have been "qualified expenditures" would now be subject to the usual treatment accorded to capital expenditures.
Third, where a taxpayer pays an amount to an arm's length party for an amount that is a qualified expenditure, only 80% of such amount will be included in the taxpayer's qualified expenditure pool and therefore will be eligible for the investment tax credit referred to above. Such percentage is an arbitrary proxy for the profit portion that the arm's length party charged the taxpayer to make the expenditure.
The Budget proposes to phase out the corporate tax credit available for "pre-production mining expenditures" gradually from its current 10% credit to zero with the tax credit for grassroots exploration expenditures being phased out more quickly, by 2014, than for new mine development expenditures, by 2016. Further, the Budget proposes to phase out the Atlantic investment tax credit for certain oil and gas and mining activities gradually by 2015, subject to extended transitional relief for certain oil and gas and mining projects where long timelines are involved. The availability of the Atlantic investment tax credit to activities other than the listed oil and gas and mining activities is not affected by this proposal.
Tax Shelter Arrangements
The Budget proposes to increase the penalty applicable to a promoter of a tax shelter when a person participates in an unregistered charitable donation tax shelter and to add an additional penalty on promoters of tax shelters who fail to meet reporting obligations with respect to annual information returns.
Further, the Budget proposes to limit the validity of tax shelter identification numbers to a period designated by the Minister of National Revenue, which, although unclear in the Budget, appears to generally be one calendar year. Apparently, this proposal will require tax shelters to reregister annually with the CRA. Tax shelter identification numbers obtained as a result of applications made prior to Budget day will be valid until the end of 2013.
CHANGES RELATED TO EMPLOYEE BENEFITS
The Budget includes proposed new rules with respect to retirement compensation arrangements (RCAs) and employees profit sharing plans (EPSPs). The changes are designed to foreclose the use of these arrangements to obtain unintended tax benefits. The Budget also includes proposed modifications to the taxation of employer-funded group sickness and accident insurance plans, and the Overseas Employment Tax Credit (OETC) is being phased out.
An RCA is generally a plan or arrangement (usually a trust) under which an employer or a former employer makes payments to a custodian to enable benefits to be paid to an employee or other beneficiary on, after or in contemplation of the employee's retirement. Contributions made by an employer to such an arrangement are generally deductible to the employer. However, a refundable tax is imposed on the employer at a rate of 50% on contributions to an RCA, as well as on income and gains earned or realized in the RCA. The beneficiary of an RCA is taxable only when amounts are received by him/her under the RCA.
The Budget proposes to address perceived abuses by applying a modified version of the "prohibited investment" and "advantage" rules that currently apply to other tax-sheltered plans such as tax-free savings accounts and registered retirement savings plans. The Budget proposes to impose a refundable tax on the custodian equal to 50% of the fair market value of any "prohibited investment" held by the RCA. The custodian will also be liable to pay a tax equal to the fair market value of any "advantage" in respect of an RCA. In certain cases, the beneficiary will be jointly and severally liable for the tax as well.
These proposals generally apply to "prohibited investments" acquired, and "advantages" extended received or receivable, by an RCA on or after March 29, 2012.
Under an EPSP, the employer makes tax-deductible contributions to a trust. These amounts must be allocated by the trustee to the beneficiaries each year. The trustee must also allocate earnings and realized gains and losses in the EPSP trust, as well as certain amounts in respect of forfeitures, on an annual basis. An EPSP beneficiary includes such allocations in employment income for the year in which the allocations are made. The employer may deduct EPSP contributions made in the first 120 days of a year in computing income for the preceding tax year. Neither employer contributions to an EPSP nor distributions to employees from an EPSP are subject to withholdings for federal tax or other federal statutory deductions, with the result that tax on amounts allocated to an EPSP beneficiary in a particular calendar year is not required to be paid until the individual files his/her tax return for that year in April of the next calendar year. There is, therefore, the possibility of tax deferral until the employee pays the tax on the amount included in income in connection with the allocation. An EPSP can effectively be used as a device to distribute its pre-tax profit to employees, reducing the overall tax on business profits as compared to the distribution of after-tax profits to shareholders by way of dividend.
In response to perceived abuses of the these rules to direct profits to family members of closely held companies, the Budget introduces a special tax payable by a "specified employee" (generally an employee who has a 10% or greater interest in the employer) on the portion of the employer's contributions to the EPSP that exceeds 20% of the specified employee's salary received from the employer. The special tax applies at the top marginal rate.
This proposal is generally applicable to contributions to an EPSP made by an employer on or after March 29, 2012.
Group Sickness or Accident Insurance Plans
There is currently no provision in the existing law that specifically imposes tax in respect of non-periodic payments under an employer-funded group sickness or accident insurance plan, either on the amount of the benefit or the amount of the employer contribution. However, periodic payments under such a plan are fully taxable where the employer contributes any part of the cost of providing the group sickness or accident insurance benefit.
The Budget proposes to include the amount of an employer's contribution under a group sickness or accident insurance plan in the income of an employee covered under the plan to the extent that such contribution is not in respect of benefits in the form of periodic payments.
This change will apply with respect to employer contributions made after March 28, 2012. However, where contributions are made in 2012, they will not be included in the affected employees' income until 2013.
While it is not clear that tax measures will be utilized to ensure compliance, the Budget also proposes that private-sector employers in federally regulated industries, which include telecommunications, banking, and air and rail transport, among others, will be required to obtain insurance to fund employee long-term disability benefits. Under this proposal, federally regulated employers would not be allowed to self-fund such benefits.
Overseas Employment Tax Credit
The Budget includes a proposal to phase out the OETC over four years. The OETC is a credit currently available to Canadian residents employed outside Canada by a Canadian resident or a foreign affiliate of a Canadian resident for more than six consecutive months. The employee must be engaged in providing services with respect to exploration or exploitation of certain natural resources, construction, engineering, agriculture or other similar activities. Where the OETC applies to an employee, he/she is eligible for a tax credit equal to the federal income tax on 80% of qualifying overseas income up to a maximum of C$100,000.
Under the Budget proposals, the OETC will be reduced by 20% per year beginning with 2013, and will be eliminated entirely in 2016.
The government confirmed its intent to proceed with several measures announced over the past several years, including the long-awaited technical amendments announced most recently in July 2010. All of the measures listed were announced (or re-announced) in one or more releases in or after 2010, giving rise to a reasonable inference that the government no longer intends to proceed with other measures announced at an earlier time, though this is not entirely clear. Specific mention was made of a new rule to be developed to alleviate the tax cost to Canadian banks of using excess liquidity of their foreign affiliates in their Canadian operations and of amendments to ensure that certain securities transactions undertaken in the course of a bank's business of facilitating trades for arm's length customers are not inappropriately caught by the FAPI base erosion rules. These latter rules were not proposed in definitive form but are to be developed in conjunction with industry representatives.
One welcome procedural change will facilitate partnership audits by enabling an authorized person to sign a waiver extending the reassessment period. Under current law, every partner is required to sign.
The government also proposes to expand the class of clean energy equipment eligible for accelerated capital cost allowance where waste-fuelled thermal energy equipment is involved. As well, the government extended the 15% credit available for flow-through mining expenditures renounced to individuals to flow-through share agreements entered into on or before March 31, 2013.
The government also reaffirmed its commitment to exploring new rules for the taxation of corporate groups, such as a loss transfer system or rules for consolidated group reporting. However, no definitive proposals have yet been released on this ongoing issue.
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