The Honourable James Flaherty, Minister of Finance, tabled the government's 2014 Federal Budget (Budget 2014) on February 11, 2014 (Budget Day). According to Budget 2014, the government is on track to return to balanced budgets in 2015. In keeping with commitments made at the beginning of the economic recovery, the government has focused on making the government more efficient by controlling direct program spending by federal departments, rather than raising taxes that are harmful to job creation and economic growth.
Budget 2014 proposes a number of business income tax, international tax, personal income tax, charity, non-profit organization and GST/HST measures which are discussed below. The government's intentions in introducing these measures are to improve the fairness and integrity of the tax system, to strengthen tax compliance and to reduce the tax compliance burden.
BUSINESS INCOME TAX MEASURES
Remittance Thresholds for Employer Source Deductions
Budget 2014 proposes to reduce the frequency of remittance of employee source deductions (for income tax, CPP contributions and EI premiums) for employers by increasing the threshold level of average monthly withholdings at which employers are required to remit up to two times per month (to $25,000 from $15,000), and increasing the threshold level of average monthly withholdings at which employers are required to remit up to four times per month (to $100,000 from $50,000). This measure will apply in respect of amounts to be withheld after 2014.
Tax Incentives for Clean Energy Generation
Budget 2014 proposes to expand Class 43.2 of Schedule II to the Income Tax Regulations – which provides an accelerated capital cost allowance (CCA) rate of 50% per year on a declining-balance basis for investment in specified clean energy generation and energy conservation equipment— to include eligible water-current energy equipment and eligible equipment used to gasify eligible waste fuel for use in a broader range of applications. These measures will apply to property acquired on or after Budget Day that has not been used or acquired for use before that date.
Water-current equipment converts the kinetic energy of flowing water into electricity without the use of physical barriers, such as a dam. Tidal energy equipment, which makes use of similar technology, is already included in Class 43.2. Gasification technology is a long established process that uses steam pressure to convert organic or fossil based materials into carbon monoxide, hydrogen and carbon dioxide. The resulting gas mixture is called "syngas" or "producer gas" and is itself a fuel, and can be burned directly or used as a starting point to manufacture fertilizers or other fuels. The principal advantage of gasification is that using syngas is potentially more efficient than a direct combustion of the original fuel.
Consultation on Eligible Capital Property (ECP)
Budget 2014 announces a public consultation on a proposal to repeal the existing ECP regime governing the tax treatment of certain expenditures of a capital nature (eligible capital expenditures) and receipts (eligible capital receipts), and replace it with a new CCA class available to businesses.
An eligible capital expenditure is generally a capital expenditure incurred to acquire rights or benefits of an intangible nature for the purpose of earning income from a business, other than an expenditure that is deductible as a current expense or that is incurred to acquire an intangible property that is depreciable under the CCA rules. Eligible capital expenditures include the cost of goodwill when a business is purchased. Under the ECP regime, 75% of an eligible capital expenditure is added to the cumulative eligible capital (CEC) pool in respect of the business and is deductible at a rate of 7% per year on a declining- balance basis.
An eligible capital receipt is generally a capital receipt for rights or benefits of an intangible nature that is received in respect of a business, other than a receipt that is included in income or in the proceeds of disposition of a capital property. The ECP regime provides that 75% of an eligible capital receipt is first applied to reduce the CEC pool and then results in the recapture of any CEC previously deducted. Once all of the previously deducted CEC has been recaptured, any excess receipt (an ECP gain) is included in income from the business at a 50% inclusion rate, which is also the inclusion rate that applies to capital gains.
Under the government's proposal, expenditures that are currently added to CEC (at a 75% inclusion rate) would be included in the new CCA class at a 100% inclus on rate. The new class would have a 5% annual depreciation rate (instead of 7% of 75% of eligible capital expenditures). The existing CCA rules would generally apply, including rules relating to recapture, capital gains and depreciation (e.g., the "half-year rule"). Special rules would apply in respect of goodwill and in respect of expenditures and receipts that do not relate to a specific property of the business and that would be eligible capital expenditures or eligible capital receipts under the ECP regime. Such expenditures and receipts would be accounted for by adjusting the capital cost of the goodwill of the business, which would be reflected in the new CCA class. Every business would be considered to have goodwill, even if there had been no expenditure to acquire goodwill.
CEC pool balances would be calculated and transferred to the new CCA class as of an implementation date. The opening balance of the new CCA class in respect of a business would be equal to the balance at that time of the existing CEC pool for that business. For the first 10 years, the depreciation rate for the new CCA class would be 7% in respect of expenditures incurred before the implementation of the new rules. Other transitional rules would apply in respect of receipts received after the time at which the new rules are implemented which relate to property acquired, or expenditures otherwise made, before that time. The government will also consider special rules to simplify the transition for small businesses as part of the consultation process.
The government intends to release detailed draft legislative proposals for comment at an early opportunity, with the timing of the proposal's implementation determined following the consultation.
INTERNATIONAL TAX MEASURES
Budget 2014 proposes to amend the existing anti- avoidance rule in the foreign accrual property income (FAPI) regime relating to the insurance of Canadian risks. The FAPI regime generally requires that income from property earned by, and income from certain businesses carried on by, a controlled foreign affiliate of a taxpayer resident in Canada be included in the taxpayer's income on an accrual basis.
Under current rules, a specific anti-avoidance rule in the FAPI regime provides that income from the insurance of Canadian risks is FAPI where 10% or more of the gross premium income (net of reinsurance ceded) of a foreign affiliate of the Canadian taxpayer in respect of all risks insured by the affiliate is premium income from Canadian risks. Some taxpayers, however, have entered into sophisticated tax-planning arrangements (sometimes known as "insurance swaps") designed to get around this rule. These arrangements generally involve transferring Canadian risks, originally insured in Canada, to a wholly owned foreign affiliate of the taxpayer. The Canadian risks are then exchanged with a third party for foreign risks that were originally insured outside of Canada, while at the same time ensuring that the affiliate's overall risk profile and economic returns are essentially the same as they would have been had the affiliate not entered into the exchange.
Budget 2014 will amend the existing anti- avoidance rule in the FAPI regime relating to the insurance of Canadian risks to clarify that the rule applies where:
- taking into consideration one or more agreements or arrangements entered into by the foreign affiliate, or by a person or partnership that does not deal at arm's length with the affiliate, the affiliate's risk of loss or opportunity for gain or profit in respect of one or more foreign risks can – or could if the affiliate had entered into the agreements or arrangements directly – reasonably be considered to be determined by reference to the returns from one or more other risks (the "tracked risks") that are insured by other parties; and
- at least 10% of the tracked risks are Canadian risks.
If the anti-avoidance rule applies, the foreign affiliate's income from the insurance of the foreign risks and any income from a connected agreement or arrangement will be included in computing its FAPI. This measure will apply to taxation years of taxpayers that begin on or after Budget Day.
Offshore Regulated Banks
Budget 2014 proposes to add new conditions to qualify for the regulated foreign financial institution exception from the definition of investment business under the FAPI rules. While income from an investment business carried on by a foreign affiliate of a taxpayer is included in the affiliate's FAPI, most financial services businesses are not considered investment businesses under certain legislative exceptions.
One such exception is the regulated foreign financial institution exception. The government is concerned that Canadian taxpayers that are not financial institutions may use this exception to carry on investment activities for their own account rather than for third party customers without paying Canadian tax on their investment profits. Such taxpayers often access the exception by establishing a foreign affiliate which is made subject to regulation under foreign banking and financial laws and carries on the investment activities.
The proposed new conditions will effectively restrict the availability of this exception to regulated Canadian financial institutions with significant capital deployed in Canada. Specifically, the new conditions will require the Canadian taxpayer:
- to be a regulated financial institution (i.e. a Canadian resident that is a Schedule I bank, trust company, credit union, insurance corporation or securities trader whose activities are regulated by OFSI or a similar provincial regulator), and
- to satisfy certain minimum capitalization requirements (at least 50% of the "total taxable employed in Canada" of the Canadian resident and related Canadian corporations must be attributable to taxable capital employed in Canada of regulated Canadian financial institutions, or, for banks, trust companies or insurance corporations, total equity of at least $2 billion).
In addition, the old requirements that the foreign affiliate must carry on a regulated foreign financial services business and the proprietary activities must comprise part of that business will continue to apply.
Budget 2014 notes that the government will continue to monitor developments in this area. The proposal will apply to taxation years of taxpayers that begin after 2014, with stakeholders being invited to submit comments concerning its scope within 60 days after Budget Day.
Budget 2014 proposes to add a specific anti- avoidance rule that would apply for both the thin capitalization provisions and the Part XIII withholding tax provisions imposed on interest paid to non-arm's length non-residents. This rule is intended to prevent a taxpayer from circumventing the provisions through the use of back-to-back loan arrangements. These arrangements generally involve interposing a third party (such as a foreign bank) between two related taxpayers (such as a foreign parent corporation and its Canadian subsidiary) in an attempt to avoid the rules that would apply if a loan were made directly between the two related taxpayers.
Specifically, Budget 2014 proposes that a back-to-back loan arrangement will exist where, as a result of a transaction or series of transactions, a taxpayer has an outstanding interest-bearing obligation owing to a lender (the intermediary), and the intermediary or any person that does not deal at arm's length with the intermediary (i) is pledged a property by a non-resident person as security in respect of the obligation (a guarantee, in and of itself, will not be considered a pledge of property), (ii) is indebted to a non-resident person under a debt for which recourse is limited, or (iii) receives a loan from a non-resident person on condition that a loan be made to that taxpayer.
If a back-to-back loan arrangement exists, the Canadian taxpayer will, in general terms, be deemed to owe an amount to the non-resident person. This taxpayer will also be deemed to have an amount of interest paid or payable to the non-resident person. The result is that the Canadian taxpayer could be denied an interest deduction under the thin capitalization provisions and would also be required to withhold Part XIII withholding tax on the deemed interest income. The non-resident person and the Canadian taxpayer will be jointly and severally (or solidarily) liable for the additional Part XIII withholding tax.
This measure will apply in respect of the thin capitalization provisions, to taxation years that begin after 2014, and in respect of Part XIII withholding tax, to amounts paid or credited after 2014.
Consultation on Treaty Shopping
In Budget 2013, the government announced a public consultation on "treaty shopping". Later in 2013, the government released a consultation paper, and received a number of submissions from stakeholders. In July 2013, the OECD issued an action plan to address the issue of aggressive tax planning by multinational enterprises, known as "base erosion and profit shifting" (BEPS Action Plan). The government has indicated that the OECD's recommendations in this regard will be relevant in developing a Canadian approach to address treaty shopping.
In Budget 2014, the government has proposed a rule to prevent treaty shopping. The rule is intended to address arrangements identified as an improper use of Canada's tax treaties in the consultation paper, and uses a general approach focused on avoidance transactions. The proposed rule would include provisions that relate to a main purpose test, a conduit presumption, a safe harbour presumption, and a relieving measure if it would be reasonable in the circumstances.
The government proposes to add the rule to the Income Tax Conventions Interpretation Act so that it would apply in respect of all of Canada's tax treaties, and the rule would apply to taxation years that commence after the enactment of the rule into Canadian law.
Interested parties are invited to provide comments within 60 days after Budget Day on the proposed rule (and any appropriate transitional relief) as well as on five examples provided setting out the intended application of the proposed rule to the following situations: assignment of income, payment of dividends, change of residence, bona fide investments, and safe harbour for an active business.
Consultation on Tax Planning by Multinational Enterprises (MNEs)
The government announced in Budget 2014 that it is seeking input from stakeholders on issues raised by the BEPS Action Plan, and is inviting comments from interested stakeholders "to help inform Canada's participation as a member of the OECD in considering options to increase the fairness and effectiveness of international tax rules...". The BEPS Action Plan made 15 specific recommendations or work streams with accompanying timelines. The action items were directed at hybrid entity and hybrid equity mismatches, ensuring transfer pricing outcomes are in line with value creation, improving information gathering methodology and requiring taxpayers to disclose aggressive tax planning arrangements, addressing the tax challenges of the digital economy, related party financing arrangements, and tax treaty actions. Budget 2014 invites stakeholders to comment on those action items, and in particular, how to ensure fairness among different categories of taxpayers (e.g., MNEs, small businesses and individuals), and how to better protect the Canadian tax base, while maintaining an internationally competitive tax system that is attractive for investment. The government has asked for input on five general questions, set out below:
- What are the impacts of international tax planning by MNEs on other participants in the Canadian economy?
- Which of the international corporate income tax and sales tax issues identified in the BEPS Action Plan should be considered the highest priorities for examination and potential action by the government?
- Are there other corporate income tax or sales tax issues related to improving international tax integrity that should be of concern to the government?
- What considerations should guide the government in determining the appropriate approach to take in responding to the issues identified – either in general or with respect to particular issues?
- Would concerns about maintaining Canada's competitive tax system be alleviated by coordinated multilateral implementation of base protection measures?
In addition, the government is inviting input from stakeholders on what actions it should take to ensure the effective collection of sales tax on e-commerce sales to residents of Canada by foreign-based vendors, including whether it should adopt the approach taken in some other countries and require foreign-based vendors to register with the Canada Revenue Agency and charge GST/HST if they make e-commerce sales to residents of Canada.
The government has invited interested parties to submit comments within 120 days after Budget Day.
PERSONAL INCOME TAX MEASURES
Pension Transfer Limits
In 2011, the government introduced a special rule that applies in certain circumstances to allow a member leaving a defined benefit registered pension plan whose estimated pension benefit has been reduced due to plan underfunding to disregard that benefit reduction in calculating his or her pension transfer limit. Budget 2014 proposes to allow this rule to apply in additional situations involving commutation payments made after 2012 which receive the approval of the Minister of National Revenue.
Loss of Graduated Tax Rates for Testamentary Trusts and Estates
Budget 2013 announced the government's intention to consult on possible measures to eliminate the special tax benefits that arise from taxing at graduated rates the taxable income of testamentary trusts and grandfathered inter vivos trusts. Budget 2014 proposes to generally proceed with measures described in the consultation paper released by the government on June 3, 2013. Specifically, Budget 2014 proposes to apply flat top-rate taxation to grandfathered inter vivos trusts, trusts created by will and certain estates (including a number of consequential changes). Two exceptions to this treatment are proposed:
- graduated rates will apply for the first 36 months of an estate that arises on and as a consequence of an individual's death and that is a testamentary trust; and
- graduated rates will continue to be provided in respect of testamentary trusts for the benefit of disabled individuals who are eligible for the Disability Tax Credit.
Also under this proposal, testamentary trusts, estates (after the first 36 month period) and grandfathered inter vivos trusts will not benefit from special treatment under a number of related tax rules, in particular:
- an exemption from the income tax instalment rules;
- an exemption from the requirement that trusts have a calendar year taxation year and fiscal periods that end in the calendar year in which the period began;
- the basic exemption in computing alternative minimum tax;
- preferential treatment in respect of tax imposed under Part XII.2 of the Income Tax Act;
- classification as a personal trust without regard to the circumstances in which beneficial interests in the trust have been acquired;
- the ability to make investment tax credits available to a trust's beneficiaries; and
- a number of tax administration rules that otherwise apply only to ordinary individuals.
Testamentary trusts that do not already have a calendar year taxation year will have a deemed taxation year-end on December 31, 2015 (or in the case of an estate for which that 36-month period ends after 2015, the day on which that period ends).
This measure will apply to the 2016 and subsequent taxation years.
Non-Resident Immigration Trusts
Budget 2014 proposes to eliminate the 60-month exemption from the rules deeming a non-resident trust to be resident in Canada for tax purposes. The exemption is currently available if contributors to a non-resident trust are individuals each of whom is resident in Canada for a total period of not more than 60 months (i.e. newly resident Canadians).
This measure will apply in respect of trusts for taxation years that end after 2014 if (i) at any time that is after 2013 and before Budget Day the 60-month exemption applies in respect of the trust, and (ii) no contributions are made to the trust on or after Budget Day and before 2015, or that end on or after Budget Day in any other case.
Other Personal Tax Measures
Budget 2014 also proposes to:
- Adoption Expense Tax Credit: increase the maximum amount of eligible expenses to $15,000.
- Medical Expense Tax Credit: expand eligible expenses to include the design of an individualized therapy plan and expenses for service animals assigned to individuals with severe diabetes.
- Search and Rescue Volunteers Tax Credit: introduce a non-refundable tax credit for eligible ground, air and marine search and rescue volunteers.
- Mineral Exploration Tax Credit: extend eligibility by one year to flow-through share agreements entered into on or before March 31, 2015 and in respect of eligible expenses which may be incurred until the end of 2016.
- Farming and Fishing Business: extend eligibility for the intergenerational transfers of farming property and fishing property and the $800,000 lifetime capital gains exemption to better accommodate taxpayers involved in a combination of farming and fishing.
- Amateur Athlete Trusts:allow income that is contributed to an amateur athlete trust to qualify as earned income for the purpose of determining the RRSP contribution limit of the trust's beneficiary.
- GST/HST Tax Credit: eliminate the need for an individual to apply for the GST/HST Credit and to allow the Canada Revenue Agency to automatically determine if an individual is eligible to receive the GST/HST Credit.
- Tax on Split Income(kiddie tax): extend the tax on split income to situations where a minor is allocated income from a partnership or trust that is derived from business or rental activities and the parent of the minor is actively engaged in the activities of the trust or partnership.
CHARITIES AND NON-PROFIT ORGANIZATIONS
Budget 2014 proposes to provide more flexibility in the tax treatment of charitable donations made in the context of a death that occurs after 2015. Qualifying donations made by will or designated under an RRSP, RRIF, TFSA or life insurance policy will no longer be deemed to be made by an individual immediately before the individual's death. Instead, these donations will be deemed to have been made by the estate, at the time at which the property that is the subject of the donation is transferred to a qualified donee. In addition, the trustee of the individual's estate will have the flexibility to allocate the available donation among any of: the taxation year of the estate in which the donation is made; an earlier taxation year of the estate; or the last two taxation years of the individual. To qualify for this proposed new treatment, the donation must be made within three years following the deceased individual's date of death to a qualified donee. This measure will apply to the 2016 and subsequent taxation years.
It is anticipated that this new measure will make it easier for individuals and their advisors to structure their post-mortem charitable giving in a way that best reflects the intentions of the donor while decreasing the complexity involved. It should also provide some welcome relief to estate executors who may otherwise struggle to administer an estate in the most tax-efficient manner while fulfilling the testator's charitable goals.
Donations of Certified Cultural Property
Budget 2014 proposes to remove, for certified cultural property acquired as part of a tax shelter gifting arrangement, the exemption from the rule that deems the value of a gift to be no greater than its cost to the donor. Other donations of certified cultural property will not be affected by this measure. This measure will apply to donations made on or after Budget Day.
State Supporters of Terrorism
Budget 2014 proposes that where a charity (or a Canadian amateur athletic association) accepts a donation from a foreign state listed as a supporter of terrorism for purposes of the State Immunity Act, or from an agency of such a state, the Minister of National Revenue may refuse to register the charity or may revoke its registration. This measure will apply to donations accepted on or after Budget Day.
Consultation on Non-Profit Organizations(NPOs)
Budget 2014 announces the government's intention to review whether the income tax exemption for NPOs is properly targeted and whether sufficient transparency and accountability provisions are in place. Concerns have been raised that some NPOs may be earning profits that are not incidental to carrying out the organization's non-profit purposes, making income available for the personal benefit of members or maintaining disproportionately large reserves. In addition, because reporting requirements for NPOs are limited, members of the public may not be adequately able to assess the activities of these organizations, and it may be challenging for the Canada Revenue Agency to evaluate the entitlement of an organization to the tax exemption.
This review will not extend to registered charities or registered Canadian amateur athletic associations. As part of the review, the government will release a consultation paper for comment and will further consult with stakeholders as appropriate.
It has been widely anticipated that Budget 2014 would touch on some of the uncertainty that has engulfed the not-for-profit sector over the past few years since the Canada Revenue Agency began taking a more restrictive position with respect to the ability of NPOs to generate income and its undertaking of the NPO Risk Identification Project, which was completed late last year. The Canada Revenue Agency's findings with respect to the project have yet to be released, though they are expected sometime this year. While this Budget 2014 announcement does not come as a surprise, what is perhaps currently the biggest question when it comes to NPOs and the Income Tax Act – whether a legislative amendment to paragraph 149(1)(l) will be made – remains to be answered.
Improving the Application of the GST/HST to the Health Care Sector
Certain health care services, such as those provided by physicians, are exempt from GST/ HST. Budget 2014 proposes to expand the list of GST/HST exempt health care services to include those provided by acupuncturists and naturopathic doctors. In addition, Budget 2014 also proposes to add prescribed eyewear designed to electronically enhance the vision of individuals with vision impairment to the list of medical and assistive devices eligible for zero-rating (which list presently includes eyeglasses and contact lenses).
GST/HST Election for Closely Related Persons
A group relief election is available allowing registrants that are resident in Canada, engaged exclusively in commercial activities and members of a closely related group to not account for tax on certain transactions between them. Currently, the election may not be available to a new member of a closely related group at the time of initial acquisition of assets from another member of that group if, for example, the new member does not have other property before making the election. Since it would be appropriate for the group relief election to apply under these circumstances, Budget 2014 proposes to extend, effective January 1, 2015, the availability of the group relief to new members that have not yet acquired any property, provided that the new members continue as going concerns engaged exclusively in commercial activities.
A filing requirement in relation to the group relief election will also be introduced. Prior to Budget 2014 such an election was required to be completed in prescribed form but not filed with the Canada Revenue Agency. Further, parties were permitted to specify an effective date on the election that was any time before the date of signing, provided that for all transactions after the effective date the parties had conducted themselves as though the election was in place, which generally means they had not charged the GST/HST on transactions between them.
Effective January 1, 2015, parties to a new election will be required to file that election with the Canada Revenue Agency. That election must be filed on or before the earliest due date of the GST/HST return of either party for the reporting period in which the election takes effect or on any day after the effective date that the Minister will allow. While, therefore, late filed elections may be permitted, the ability to retroactively make such an election may not be as widely available as is presently the case. Further, parties to existing elections must also comply with the new filing requirement on or before January 1, 2016.
In addition, parties to an existing or new group relief election (or persons that conduct themselves as if such election were in effect) will be subject to a joint and several (or solidary) liability provision with respect to the GST/HST liability that may arise in relation to supplies made between them on or after January 1, 2015.
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.