PLEASE NOTE: THIS INFORMATION WAS ORIGINALLY SUBMITTED BY COOPERS & LYBRAND, CANADA
Finance Minister Paul Martin's fifth Budget on 24 February set federal finances on a new course. With the deficit eliminated, the choice was whether to reduce the accumulated $583 billion national debt, reduce taxes, or undertake new spending initiatives. Debt reduction lost out, except for a $3 billion Contingency Reserve. Instead, program spending will increase, relatively minor tax relief will apply to lower and middle income Canadians, and general tax reductions have been postponed. The critical debt-to-GDP ratio will decline only slightly from 68% in 1997-1998 to 63% in 1999-2000 and even this decline is based on the Minister's gamble on continuing economic growth and low interest rates.
The Minister is staking his plan on investment in the Canadian Opportunities Strategy for education, including the previously-announced Millennium Scholarship Fund. But with no general personal or corporate tax reductions, Canada is left with significantly higher taxes than in the U.S. and other major competing countries. The students we finance today may be encouraged to turn South, exacerbating the existing "brain drain". The tax policies underlying measures to alleviate alternative minimum tax for RRSP contributions and broaden moving expense deductions make sense. But we question the extension yet again of the non-creditable surtax on the banks because capital taxes on all corporations are bad taxes and should be repealed.
BUSINESS TAX MEASURES
To promote new youth employment employers will receive a holiday from employment insurance premiums for new employees age 18-24 for 1999 and 2000.
Self-employed individuals will be allowed to deduct premiums for private health services plans where they are actively engaged in the business and the business is their primary source of income or their income from other sources does not exceed $10,000. The deduction only applies if coverage is provided to all permanent full-time arm's-length employees. The deductible amount is limited to amounts paid to third parties after the 1997 fiscal year of $1,500 for the owner and his/her spouse and $750 per child; no limit applies to amounts for arm's-length employees.
Costs of materials used in a scientific research and experimental development ("SR&ED") project will now be allowed in computing the related investment tax credit claim regardless of whether the materials are considered to have been consumed in the process or incorporated into a product or prototype. Corresponding recapture provisions will also apply if the product of the SR&ED project is sold or converted to commercial use after February 23, 1998. The rules that tax government and other forms of assistance will be expanded to ensure that forms of assistance received indirectly from these sources, such as through not-for-profit entities will also be taxable.
The rules that allow full deductibility of meals and entertainment expenses for events generally available to all employees (e.g. Christmas parties) will now be limited only to six "occasional events" per year. Full deductibility for meals and entertainment expenses at remote work sites will be expanded to sites that are at least 30 kilometres from the nearest urban centre of at least 40,000 people. Both these rules apply to expenses incurred after February 23, 1998.
The rules which impute interest benefits to employees will be clarified to ensure they apply to all cases where loans are received because of employment, even to assist in moves (existing exclusions for "home relocation loans" of up to $25,000 will still apply). Deductible moving expenses will now include mortgage interest and property taxes incurred after 1997 on a vacant former residence for up to three months, to a maximum of $5,000.
Employer-paid relocation expenses paid for loss on a former residence or for higher mortgage payments on a new residence will be taxable to the employee in the amount of 50% of the excess over $15,000. This applies to payments after February 23, 1998 where employment at the new work location begins after June 1998.
The reporting system for construction contract payments introduced in 1995 will be made mandatory for payments made after 1998 as a further measure to deal with the perceived underground economy in the construction industry. Further measures will be announced after more consultation with the industry.
The "temporary" 12% surcharge on the Part VI capital tax of banks, first proposed in 1995, will be extended again through to October 31, 1999. Companies prescribed to be "financial institutions" for purposes of the large corporations capital tax will be treated as financial institutions after 1998 for other purposes under the Act such as the "mark-to-market" rules for securities. Insurers will be allowed to deduct the "earthquake premium component" (but not the "earthquake reserve complement") of the reserve they are required to establish under OSFI guidelines.
Mutual funds trusts will be allowed to elect to fix their annual distributions of taxable income within one month after the year commencing for years ending after November 1998. If made, the election will also apply to the earlier year of unitholders for purposes of calculating their taxable income and adjusted cost bases. Employees of mutual fund trusts who are granted options after February 1998 will now be subject to the favourable rules that currently apply to public company stock options.
SALES TAXES AND DUTIES
Proposed minor amendments to the GST/HST include a broader scope and simpler filing for the visitor rebate program, to encourage the tourism and foreign convention sector; removal of certain anomalies for charities providing services to GST registrants, or operating bottle return depots; and streamlining the optimal GST rules for "direct sellers" to provide relief on bad debts and remove hidden tax. Countervailing and anti-dumping duties paid after February 23, 1998 will be deductible in the year paid and taxable in the year refunded.
INTERNATIONAL TAXATION MEASURES
Canada's Domestic and Treaty Tax Rules Harmonised
For 1998 and subsequent taxation years:
- Non-residents of Canada must exclude treaty-exempt income from their Canadian taxable income. Similarly, losses from treaty-protected businesses and property will not be deductible in computing a non-resident's Canadian taxable income after 1997.
- The foreign tax credit formula will be modified to ensure Canadian residents will be able to claim foreign tax credits in Canada only in respect of foreign tax paid on taxable foreign sourced income.
- From February 24, 1998, dual residents of Canada and a treaty country will be regarded as non-residents of Canada if they enjoy the benefits of a tax treaty which results in their exemption from or reduction of Canadian income tax.
- For taxation years that begin after 1998, non-resident corporations carrying on business in Canada will be required to file an information return disclosing if they are claiming a treaty-based exemption from Canadian tax. For example, this will identify those non-resident companies carrying on business in Canada without Canadian permanent establishments.
- Rules applying to the interpretation of treaties will be clarified to ensure pension payments are not regarded as annuities for treaty application and that the definition of "pension" will include amounts paid after 1996 under registered pension plans, registered retirement savings plans, registered retirement income funds and other retirement arrangements. Dispositions of "taxable Canadian property" after February 23, 1998 will be defined to be realised in Canada.
Anti-Avoidance Rules Expanded; Immigrating Corporations and Surplus Stripping
New rules will be introduced effective after February 23, 1998 to require a non-resident company to pay withholding tax if it owns shares of a Canadian-resident company when it immigrates to Canada. In such case, the Canadian-resident company will be deemed to have paid a dividend equal to the excess of the shares' fair market value over their paid-up capital. This deemed dividend is equivalent to the deemed dividend that would result from the sale of the shares of the Canadian-resident company to a second corporation resident in Canada for non-share consideration. Immigrating corporations with a Canadian branch will not be able to claim an investment allowance in the year before becoming resident in Canada and, as a result, will be required to pay branch tax arising in the year or deferred in respect of prior years.
Current anti-avoidance provisions are designed to prevent non-resident shareholders of Canadian corporations from stripping Canadian taxable surplus by selling shares of a Canadian subsidiary to another non arm's-length Canadian company. These rules are expanded after February 23, 1998 to apply to dispositions of shares of any corporation resident in Canada to any other corporation resident in Canada (it is assumed that the non-arm's-length test will still apply) and are expanded to also apply to the disposition of partnership interests of which the non-resident is a majority partner. These rules will not apply to the taxable Canadian property on which Canada's right to tax is not limited by tax treaty.
Share exchanges resulting from non-Canadian triangular mergers after February 24,1998 can now occur on a tax-deferred basis.
Foreign Tax Credit ("FTC") Limitation
New rules are proposed to restrict the availability of FTC relating to transactions involving property acquired after February 23, 1998. In general, these rules will restrict the amount of FTC for foreign withholding tax in respect of dividends and interest by reference to the gross profit realised from the security and further will deny FTC where the profit from the property, net of foreign tax, is not material relative to the foreign tax. These rules are focused on FTC arbitrage through transactions involving short-term holdings (less than one year) of shares or debt and interest rate swaps.
Loans To Non-Residents
Current rules deeming prescribed rates of interest to be earned by Canadian-resident corporations on below prescribed rate loans to non-residents outstanding for one year or longer will be expanded for taxation years and fiscal periods beginning after February 23, 1998 to include loans made by Canadian trusts with such corporate beneficiaries and partnerships with such corporate partners. The exemption currently provided for loans made to first-tier subsidiaries that use the borrowed funds for the purpose of gaining or producing income is modified so that the exemption will only apply if the amount owing arose in the course of carrying on an active business of the subsidiary.
PERSONAL TAX MEASURES
General Tax Relief
The Budget proposals include limited tax relief specifically targeted toward low and middle income taxpayers. The 3% surtax will be reduced by up to $250 but the reduction is reduced for taxpayers with income over $50,000 and is phased out completely if income exceeds $65,000. An additional supplement of $500 will be available in respect of each of the basic personal, spousal, and equivalent-to-spousal credits, but this will be reduced rapidly as incomes rise. For example, a single taxpayer earning in excess of roughly $19,500 will receive no benefit from the supplement.
Education and Student Loans
One of the centrepieces of the Budget is the Canadian Opportunities Strategy which includes the following measures:
- A non-refundable tax credit for interest payments after 1997 on federal or provincial student loans;
- Tax-free RRSP withdrawals after 1998 of up to $10,000 per year over a four-year period (subject to an overall limit of $20,000) to finance full-time education or training for the annuitant or his/her spouse. Amounts withdrawn will be required to be repaid without interest in equal instalments over a ten-year period, otherwise they will be included in income;
- Annual government matching grants of 20% of amounts contributed to a registered education savings plan after 1997 (maximum of $400 annually or $7,200 over the life of the plan); and
- Tuition credits and deductible child care expenses for part-time students starting in 1998.
Deductible contributions to registered retirement savings plans and registered pension plans (including those in respect of severance received) will no longer be considered preference items for alternative minimum tax ("AMT") purposes, retroactive to 1994.
Starting in 1998, the limit for deductible child care expenses will be increased from $5,000 to $7,000 for children under seven years of age and from $3,000 to $4,000 for other eligible children. Individuals who provide in-home care for relatives who are seniors or who are disabled will be entitled to claim a $400 credit against federal tax per dependent. The credit will be reduced to the extent that the dependent's income exceeds $11,500, and phased out completely where the dependent's income exceeds $13,853. In addition, expenses incurred by a supporting person for training courses related to the care of dependent relatives with mental or physical infirmities will now qualify for the medical expense credit.
STILL IN PROCESS
As one reviews this Budget's tax proposals and planned transactions, the 460-plus pages of income tax legislation currently before Parliament should not be ignored. Many of these changes will have retroactive effect - some as far back as 1994! A few items included in this "still in process" category are:
Charitable Donations - Introduce capital gains relief for gifts of certain listed securities, increase the general charitable donations income limit, deny charitable donation treatment for loan-back arrangements, and modify the rules for donations of private company shares to public charities. (In a separate announcement, the government also extended to January 31, 1998 the deadline for making most charitable donations that may be claimed for 1997 tax years.)
Transfer Pricing - As proposed in February 1997, a transfer pricing regime for transactions between non-arm's-length parties with new contemporaneous documentation requirements that imposes a significant penalty for those who do not determine and use arm's-length transfer prices.
Loss Trading - Restrictions on the utilization of losses by what are termed "affiliated" parties where property is transferred between them. These changes will generally apply to transfers of property that take place after April 26, 1995.
Matchable Expenditure Rules - Can affect the income tax treatment of post-November 18, 1996 transactions under which investors achieve tax shelter benefits by financing the business expenses of other taxpayers in exchange for a right to receive future income.
Tax Shelters - Measures to prevent perceived abuses through tax shelter promotions by affecting limited-recourse financing, extending the income base on which the alternative minimum tax is calculated and modifying the tax shelter identification rules. Many of these changes apply retroactively back to December 1, 1994!
Shares of Non-Resident Corporations - Changes treat certain shares of non-resident corporations, even when held by another non-resident corporation, as taxable Canadian property and thereby subject to tax in Canada on their disposition after April 26, 1995.
Adventures in the Nature of Trade - Measures requiring that inventory held as an adventure or concern in the nature of trade must be valued at its historical cost, rather than at the lower of cost or fair market value. Generally, this means that accrued losses on such property may be recognized only on post-December 20, 1995 arm's-length dispositions.
Foreign Property Limits for Deferred Income Plans - Changes seek to ensure that shares and indebtedness issued by Canadian companies and acquired after 1995 will not be "foreign property" only if the issuer has a substantial presence in Canada.
Unremitted Source Deductions - Amendments to the deemed trust provisions securing priority for the Crown in relation to certain statutory withholdings.
Impaired Loans - Harmonize the tax treatment of impaired loans (doubtful debts) with the new accounting standards established by the Canadian Institute of Chartered Accountants with respect to impaired loans.
There are other proposals, some announced as far back as 1996, that have not yet been tabled in legislative form, so taxpayers should proceed with caution where transactions of any significance are contemplated.
FOREIGN PROPERTY REPORTING DEADLINES
Due dates for new annual foreign property returns, first announced in February 1995, are fast approaching:
- April 30, 1998 - For transfers, loans, distributions from or indebtedness to a non-resident trust (Forms T1141 and T1142).
- June 30, 1998 - For investments in foreign affiliates (Forms T1134-A and T1134-B).
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or: David W. Steele, Coopers & Lybrand, 145 King Street West, Toronto, Ontario M5H 1V8, Canada on Fax: 1-416-941-8415 E-mail: Click Contact Link
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David W. Steele PricewaterhouseCoopers 145 King Street West Toronto, Ontario M5H 1V8 Canada Fax: 1-416-941-8415 E-mail: Click Contact Link
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