The following is a summary of certain fundamental tax measures contained in the Canadian federal government's budget ("Budget 2014") released on February 11, 2014.
MINING AND ENERGY SECTOR
Budget 2014 contains little in the way of incentives or other measures specifically targeted to the mining and energy sectors, although certain of the more general business and international tax measures discussed below may be relevant.
Flow-Through Shares: Extension of the Mineral Exploration Tax Credit ("METC")
Flow-through shares provide a major source of new capital to junior mining companies. These shares are attractive to investors for various reasons, including (i) the ability to deduct at the investor-level certain exploration expenses incurred and renounced by the issuing corporation; and (ii) the ability in certain circumstances to claim a special 15% METC in respect of the investment in the share. The existing METC is scheduled to expire at the end of March, 2014; however, consistent with the past several federal budgets, Budget 2014 proposes to extend the 15% METC for an additional year, until March 31, 2015. Otherwise, flow-through shares are unaffected by Budget 2014.
INTERNATIONAL TAX MEASURES
Budget 2014 contained only three specific legislative measures but announced two significant consultation initiatives with potentially far-reaching implications to multinational corporations.
Consultation Initiative on Treaty Shopping - New Domestic Rule on the Way?
Budget 2014 strongly signals an intention by the Department of Finance ("Finance") to release a domestic "treaty shopping" rule that will effectively override Canada's network of bilateral tax treaties. By doing so, Finance is clearly suggesting that (i) it is not satisfied with the current arsenal at its disposal in combating perceived treaty abuse; and (ii) it intends to stay ahead of many of its international counterparts in addressing this issue and adopting a domestic solution at the earliest possible moment.
Beginning with an announcement of a public consultation project in Budget 2013, Finance indicated a significant concern with an undue erosion of Canada's tax base through the inappropriate accessing of Canada's international tax treaty network by persons resident in third countries that are not otherwise entitled to claim the benefits of such tax treaties. A classic example is a resident of a non-treaty country structuring its Canadian investment through a holding company situated in a foreign country that has a beneficial tax treaty with Canada and thereby accessing reduced Canadian dividend and interest withholding tax rates or exemptions that would not otherwise be available. Such structures are colloquially referred to by Finance as "treaty shopping".
Budget 2014 refers to several international developments in this area since Budget 2013, including an update on the status of Finance's public consultation project on treaty shopping. Importantly, Finance notes the work currently being done by the Organization for Economic Cooperation and Development (the "OECD") to identify a consensus international approach to "treaty shopping" and that such work remains ongoing.
The general expectation in the Canadian tax community has been that Finance would likely pursue the enactment of a domestic anti-avoidance rule that would "override" Canada's tax treaties in an attempt to thwart treaty shopping; however, much debate has surrounded the appropriate form of such a rule and the manner and timing of its implementation (including any grandfathering for existing structures and the interaction with any suggestions by the OECD).
Budget 2014 announces the acceleration of Finance's efforts to address treaty shopping by outlining the "main elements" of a proposed domestic rule that would override Canada's tax treaties and by establishing a new public consultation process on these main elements. The main elements of the proposed rule are similar in many respects to the general anti-avoidance rule in section 245 of the Income Tax Act (Canada) (the "ITA"), but with various presumptions and safe harbours that must be navigated. Moreover, there is mention of a general exemption for "ordinary commercial transactions", the ambit of which is unclear.
Budget 2014 provides five examples of the potential application of the proposed rule and the possible parameters of the various presumptions and safe harbours. Subjective factors and analyses are seemingly pervasive throughout the proposed rule and examples, making it difficult to conclude with any certainty whether the proposed rule should or should not apply in cases that fall within a broad range of transactions that do not clearly fall at one end or another of the "treaty shopping" spectrum. However, the examples clearly address the three "treaty shopping" cases that the Canada Revenue Agency was unsuccessful in challenging (MIL (Investments) SA, 2006 TCC 460; aff'd. 2007 FCA 236; Prévost Car, Inc. 2008 TCC 231, aff'd 2009 FCA 57; Velcro Canada, 2012 TCC 57), reopening the door as to whether the type of structures that survived judicial scrutiny in those cases will continue to be viable from a treaty perspective.
There is a suggestion that the proposed rule would apply to all transactions as soon as such rule is enacted, although Finance is open to comments concerning appropriate transitioning (i.e., grandfathering for existing structures).
While still containing certain ambiguities, multinational enterprises now have some guidance as to the form that a proposed rule may take and can begin assessing the viability of their existing and proposed structures more thoroughly. This will undoubtedly be an issue worth watching closely over the next few months.
The consultation period on treaty shopping will be open for 60 days following Budget day, which period ends before the OECD is scheduled to release its study on treaty shopping in September 2014. This could be interpreted as a signal from Finance of its intention to be prepared to enact a domestic rule almost immediately after the release of the OECD's report.
Back-to-Back Loans: New "Look-Through" Rule
Budget 2014 proposes to introduce a new anti-avoidance rule addressing certain back-to-back cross-border loan arrangements structured through arm's length foreign intermediaries (i.e., foreign banks that facilitate borrowings by a Canadian subsidiary of a foreign parent). Finance considers that such structures may inappropriately avoid Canada's thin capitalization rules and interest withholding tax. The new measure may have broad implications to a number of financing arrangements and cash-pooling structures employed by multinational enterprises.
For example, a Canadian corporation that is controlled by a non-resident corporation is required to withhold and remit 25% of any interest paid to its non-resident parent (subject to a reduction under any applicable tax treaty) and is generally entitled to a deduction in computing its Canadian corporate tax liability in respect of such interest. However, Canada's thin capitalization rules in subsection 18(4) of the ITA generally limit the amount of such intercompany debt to a 1.5-to-1 debt-to-equity ratio, with any interest paid on excess debt being deemed to be a dividend for Canadian withholding tax purposes and the Canadian company being denied an income deduction in respect thereof. The general purpose of such a limitation on cross-border intercompany debt is to prevent the excessive erosion of the Canadian corporate tax base through deductible interest payments that are subject to treaty-reduced interest withholding tax rates.
A structure that has long been the subject of debate from a thin capitalization perspective is the use of an arm's length intermediary (e.g., a foreign bank) that will accept a deposit or some form of guarantee or loan from the foreign parent and will concurrently make a loan to the Canadian corporation. The underlying question is whether such a structure should be respected as a loan to the Canadian corporation by the arm's length party (and therefore not subject to the thin capitalization rules) or should instead be regarded as a loan by the foreign parent for this purpose. Illustrative of the general concern is the agreement that was apparently reached by Finance and the Canadian Bankers Association in the mid-1980's pursuant to which Canadian banks agreed they would not participate in similar cross-border back-to-back financing structures.
Finance notes in Budget 2014 that existing anti-avoidance measures (e.g., the general anti-avoidance rule in section 245 of the ITA) may be available to combat such structures; however, in keeping with recent trends in other areas of taxation, Finance has proposed new specific anti-avoidance provisions to address certain back-to-back loan structures involving intermediaries. Resolution 37 of Budget 2014 proposes to amend the thin capitalization rules and the interest withholding tax rules in sections 18 and 212 of the ITA, respectively, to add a "look-through" rule that will effectively disregard the intermediary where certain conditions are satisfied and will characterize the Canadian corporation as having received a loan directly from its foreign parent.
The potential application of this new rule is not limited to the baseline example provided above but may extend to relatively common "cash-pooling" transactions in which various entities within a multinational group all contribute excess cash into a notional cash-pool administered by a financial institution. Draws from the cash pool by a Canadian company could potentially invoke the application of this rule on the basis that the draw is effectively a loan from a related foreign entity. Cash pooling arrangements have a number of potential adverse Canadian income tax implications and this new measure now appears to be adding to the complexity of such transactions.
This measure will apply (i) in respect of the thin capitalization rules, to taxation years beginning after 2014, and (ii) in respect of Part XIII withholding tax, to amounts paid or credited after 2014.
Taxpayers that currently have a back-to-back loan in place or otherwise have received loans from entities that could be considered "intermediaries" that service other members of the multinational group should review the potential application of these measures to their particular circumstances and consider alternatives for reorganizing their debt and capital structures where necessary.
Consultation on Base-Erosion and Profit-Shifting ("BEPS") – Open Forum for Debate
Treaty shopping, discussed above, is part of the broader concept of "base erosion and profit-shifting", or "BEPS", which generally encapsulates any international tax issue relating to the reduction of a country's tax base through intercompany transactions. Finance has requested public feedback on various general questions relating to BEPS, signaling that Finance is considering further amendments to the rules relating to the taxation of international transactions. Very little can be discerned in the Budget materials concerning the direction that Finance may take or the specific issues that may be of concern to Finance; however, this dovetails with the ambitious BEPS project currently underway by the OECD and presumably sets the stage for Finance to, as with treaty shopping, be "ahead of the curve" in proposing future domestic tax measures.
The BEPS consultation period is twice as long as the treaty shopping consultation period (120 days following Budget day), clearly illustrating the ranking of Finance's priorities concerning international tax matters.
Captive Insurance – New Anti-Avoidance Rule
Certain anti-avoidance rules in the ITA are designed to prevent Canadian taxpayers from shifting income from the insurance of Canadian risks to an offshore, low rate or no tax jurisdiction in order to obtain a deferral of Canadian tax. The current rules treat such income earned by a controlled foreign affiliate ("CFA") of a Canadian resident taxpayer as foreign accrual property income ("FAPI"), which must be recognized by the Canadian resident taxpayer annually, regardless of whether such income is repatriated to Canada. Finance is concerned with "insurance swap" arrangements under which the CFA would "swap" the Canadian risks for foreign risks, while maintaining the CFA's risk profile and economic return. Budget 2014 proposes to amend the existing rules to clarify that the anti-avoidance rules will apply to such swap arrangements. This measure will apply to taxation years beginning after Budget day.
Offshore Regulated Banks – Higher Thresholds for FAPI Purposes
Budget 2014 proposes to implement a new rule that will make it more difficult for offshore investment income earned by a foreign regulated bank to qualify for an exemption from taxation in Canada pursuant to the FAPI rules, described above.
Where a Canadian taxpayer has established a foreign affiliate to earn certain types of investment income, such income is generally subject to taxation in Canada as FAPI; however, if the foreign affiliate qualifies as a particular type of foreign regulated financial institution and meets certain other conditions, the income may avoid FAPI treatment and "escape" Canadian taxation until the income is eventually distributed to the Canadian taxpayer.
Finance considers that the laws of certain foreign jurisdictions are overly-generous in their granting of foreign regulated financial institution status; accordingly, certain Canadian taxpayers may unreasonably benefit from the exemption described above. Budget 2014 proposes to introduce a new measure to raise the threshold that a foreign regulated financial institution must cross before the Canadian taxpayer can claim the exemption from FAPI treatment. This rule effectively uses the nature of the Canadian taxpayer's business as a proxy for determining whether the foreign entity should be respected as a regulated financial institution. This measure will most clearly affect foreign regulated financial institutions that are established by Canadians to carry out personal investment services for that Canadian (or the related corporate group) as opposed to investment services for third parties.
This measure will apply to taxation years that begin after 2014. Finance has invited public comments on this measure for 60 days following Budget day to ensure that the scope of the proposed rule has been properly crafted.
BUSINESS TAX MEASURES
Budget 2014 contains very few specific business tax measures, but those that were proposed are generally relieving in nature and should be well-received by a number of Canadian businesses.
Remittance of Source Deductions
Budget 2014 proposes to increase the thresholds at which an employer must make multiple monthly remittances in respect of employee source deductions. The threshold at which employers must remit twice per month is to be increased from withholdings of $15,000 to withholdings of $25,000, while the four times per month threshold is to be increased from $50,000 to $100,000.
These proposals would apply to amounts to be withheld after 2014.
Expansion of Accelerated Capital Cost Allowance ("CCA") for Clean Energy
Several proposals have been introduced by Finance over the past few years to provide a tax incentive for investment in clean energy generation equipment, including wind and solar equipment. These incentives are in the form of accelerated deductions for CCA in respect of the cost of the equipment (50% deduction on a declining-balance basis). Budget 2014 proposes to expand the existing category of eligible assets to include water-current energy equipment and equipment used to gasify eligible waste fuel.
These proposals would apply to property acquired on or after Budget day that has not been used or acquired for use before that date.
Consultation on Eligible Capital Property Regime
The eligible capital property regime in the ITA governs expenditures and receipts of a business that are treated differently from revenue or expenses on income account and which also are not governed by the rules relating to capital property. Common examples of eligible capital expenditures include the cost of goodwill when acquiring a business, and certain production quotas or franchise rights. Budget 2014 proposes to address the increasing complications with the regime by replacing it with a new class of depreciable property that would be subject to the CCA rules. A public consultation process is to be initiated and the timing of any change will be determined following the consultation.
CHARITIES AND NON-PROFIT ORGANIZATIONS
Continuing the trend of recent federal budgets, Budget 2014 contains various measures designed to either tighten or relax certain rules relating to charities and also raises potential concern to many non-profit organizations through the announcement of a formal "NPO" consultation process.
For registered charities, Budget 2014 proposed a number of rules, including:
- The risk of deregistration if a charity accepts a gift from a donor that is listed as a supporter of terrorism for purposes of the State Immunity Act;
- The extension to donors of the carryforward period for donations of ecologically-sensitive land;
- Increased flexibility for donations made as a result of death.
The announcement of public consultation initiatives was a common theme for Budget 2014. Apart from those discussed above, Budget 2014 announced the government's intention to review whether the income tax exemption for NPOs remains properly targeted, whether sufficient safeguards are in place, and announces the intention to release a consultation paper for stakeholder comment. This follows from the conclusion of the Canada Revenue Agency's three-year "Non-Profit Organization Risk-Identification Project" ("NPORIP") concerning tax compliance in the non-profit sector. It would seem that the NPORIP uncovered sufficient causes for concern to justify a formal public consultation process. Budget 2014 does not identify any specific concern or timetable for either the consultation or review processes.\
PERSONAL TAX MEASURES
The ITA contains rules that exempt a non-resident trust from Canadian income tax on foreign source income if all persons who contributed property to the trust have not resided in Canada for 60 months. Accordingly, when an individual immigrates to Canada these "immigration trusts" can provide for a tax holiday of up to 60 months. Budget 2014 proposes to eliminate the 60-month exemption from the rules that would otherwise deem such a trust to be a resident of Canada for purposes of the ITA.
This measure will apply for taxation years that end after 2014 for existing immigration trusts provided that no contribution is made to the trust for the balance of 2014. Otherwise, the measure will apply to taxation years ending after Budget day.
Graduated Rates for Trusts and Estates
Budget 2013 announced the government's intention to initiate consultations on the elimination of graduated tax rates for testamentary trusts and certain inter vivos trusts. The government was concerned with fairness in relation to the general treatment of inter vivos trusts, which pay tax at the highest marginal rate, as well as with an increased use of multiple testamentary trusts. A consultation process was undertaken in 2013.
Budget 2014 proposes to proceed with the measures set out by the government in the consultation process. The Budget proposes to apply a flat top-rate tax to grandfathered inter vivos trusts (i.e., those created before June 18, 1971) and trusts created by will and certain estates, with two principal exceptions:
- Graduated rates will apply for an estate for the first 36 months, in recognition of the time required to administer the estate of a deceased person; and
- Graduated rates will continue to apply to testamentary trusts having as beneficiaries persons who qualify for the disability tax credit.
In addition, the Budget proposes to eliminate certain preferential treatment afforded such trusts, including under rules relating to instalment payments, the requirement for a calendar year-end, alternative minimum tax and characterization as a personal trust.
These measures will apply to the 2016 and subsequent taxation years.
Broadening the Kiddie Tax
The ITA contains rules designed to prevent income splitting with minor children by subjecting certain income to tax at the highest marginal rate. Such income currently includes income from a partnership or trust that is derived from providing property or services to a business carried on by a person related to the minor or in which the related person participates. Budget 2014 proposes to broaden the scope of the "kiddie tax" to apply to income derived from business activities conducted with unrelated third parties.
This measure will apply to the 2014 and subsequent taxation years.
SALES TAX MEASURES
- Health Care: Most health care services are exempt from GST/HST. Budget 2014 proposes to extend this exemption to the design of a training plan for individuals with a disorder or disability, as well as to services of acupuncturists and naturopathic doctors.
- Closely Related Groups: The current election for nil consideration between members of a closely-related group is proposed to be extended to new members, and a filing requirement introduced.
- Joint Ventures: The government proposes to expand the joint venture election to joint ventures carrying on a broader range of activities.
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.