On March 22, 2016, Finance Minister Bill Morneau tabled the first federal budget ("Budget 2016") of the Justin Trudeau-led Liberals. As expected, Budget 2016 focuses on infrastructure spending, the elimination of certain tax measures and credits, and the tightening of tax legislation to eliminate structures that provided perceived benefits and abuse. It also introduces a new regime for the tax depreciation of eligible capital property and reduces the eligibility age for Old Age Security and Guaranteed Income Supplement from 69 to 65.
Canada's deficit for 2015-2016 is expected to be $5.4 billion, growing to $29.4 billion in 2016-2017, and gradually decreasing thereafter. There is no indication of when Canada will return to a balanced budget.
Details of the significant tax measures proposed in Budget 2016 are outlined below. Please contact us for additional information on any of these measures.
Business Tax Measures
Small Business Tax Rate
- Budget 2016 proposes to eliminate the previously legislated reductions to the federal small business tax rate applicable on the first $500,000 of business income earned by a Canadian-controlled private corporation ("CCPC").
- The small business tax rate will remain at 10.5 per cent after 2016.
Multiplication of the Small Business Deduction
- Budget 2016 proposes changes to address concerns about partnership and corporate structures that have been created to multiply access to the small business deduction.
- Partnerships have been used to multiply the number of small business deductions claimed by its partners in respect of the partnership's business. For example, these structures often would include an individual partner and a corporation owned by that partner. The partnership would pay the partner's corporation as an independent contractor for services it provides on behalf of the partner. The corporation would be entitled to a full small business deduction in respect of the service fee income earned from the partnership. Each partner of the partnership may have operated the same structure, thereby multiplying the number of small business deductions claimed in respect of the partnership's earnings for a year.
- Budget 2016 proposes to extend the specified partnership income rules to partnership structures in which a CCPC provides, directly or indirectly, services or property to a partnership where, at any time during the year, the CCPC or a shareholder of the CCPC is a member of the partnership or does not deal at arm's length with a member of the partnership.
- CCPCs have also been able to multiply access to the small business deduction from providing services or property to another private corporation when one of the shareholders of the CCPC (or a person that did not deal at arm's length with such a shareholder) had a direct or indirect interest in the private corporation.
- Budget 2016 proposes to amend the Income Tax Act where a CCPC's active business income from providing services or property to a private corporation will not be eligible for the small business deduction when the CCPC (or one of its shareholders, or a person who does not deal at arm's length with such a shareholder) has a direct or indirect interest in the private corporation.
- These measures will apply to taxation years that begin on or after March 22, 2016.
Avoidance of the Business Limit and the Taxable Capital Limit
- Certain corporate business structures allow more than one corporation in an associated group to claim a full small business deduction. These structures involve corporations earning investment income on property (such as interest on a loan) from an associated corporation (the "third corporation") that carries on an active business. In these situations, the investment income would be recharacterized as active income eligible for the small business deduction. Under current legislation, the third corporation could make an election to disassociate itself with the other corporations for purposes of claiming the small business deduction. The result is that more than one company receiving investment income from the third corporation can claim a full small business deduction on its investment income.
- Budget 2016 proposes to amend the Income Tax Act to ensure that investment income earned by a corporation from an associated corporation will not be eligible for the small business deduction and will be taxed at the general corporate income tax rate where an election to dissociate itself from the group has been made by a third corporation. In addition, where this election applies, the third corporation will now continue to be associated with each of the other corporations for the purpose of applying the $15 million taxable capital limit. The small business deduction available to an associated group of companies is fully eliminated when the group's taxable capital reaches $15 million.
Consultation on Active Versus Investment Business
- Budget 2015 announced a review of the circumstances in which income from a business (the principal purpose of which is to earn income from property) should qualify as active business income, and therefore, potentially be eligible for the small business deduction. The consultation period ended August 31, 2015.
- The Government is not proposing any modifications to these rules at this time.
Life Insurance Policies – Distributions Involving Life Insurance Proceeds
- When an individual dies, and a private corporation or a partnership owns a life insurance policy on that individual, the private corporation or partnership may add the portion of the death benefit in excess of the policyholder's adjusted cost base of the policy to the capital dividend account of a corporation or to the adjusted cost base of a partnership interest. Distributions from the capital dividend account of a corporation can be made on a tax-free basis. Similarly, tax-free distributions can be made by a partnership to the extent of a partner's adjusted cost base.
- Some taxpayers have structured their affairs such that the amount added to a corporation's capital dividend account or to the adjusted cost base of a partnership interest have been artificially increased.
- Budget 2016 proposes to amend the Income Tax Act to ensure that the capital dividend account rules for private corporations, and the adjusted cost base rules for partnership interests, apply as intended. The legislation will provide limits on these amounts.
- In addition, information-reporting requirements will be introduced and will apply where a corporation or partnership is not a policyholder but is entitled to receive a policy benefit.
Life Insurance Policies – Transfers of Life Insurance Policies
- Under existing rules, when a policyholder transfers an interest in a life insurance policy to a non-arm's length person, a special rule deems the policyholder's proceeds of disposition to be equal to the policy's cash surrender value.
- As a result, an individual policyholder of a life insurance policy was able to transfer the policy to a corporation, in exchange for a promissory note from the corporation equal to the policy's fair market value. Assuming a low or nominal cash surrender value, the transfer of the life insurance policy would not attract income tax, and the individual would receive a tax-free repayment of the promissory note from the corporation. Furthermore, when the life insurance policy benefit is received by the corporation, an amount could be paid tax-free to the corporation's shareholders through the capital dividend account.
- Budget 2016 proposes to amend the Income Tax Act to ensure that amounts are not received tax-free by a policyholder from the disposition of an interest in a life insurance policy. In applying the policy transfer rule, this measure will include the fair market value of any consideration received in exchange for an interest in a life insurance policy in the policyholder's proceeds of the disposition.
- This proposed measure will apply to dispositions of policies that occur on or after March 22, 2016.
Eligible Capital Property
- Budget 2014 announced a consultation on the conversion of eligible capital property ("ECP") into a new class of depreciable property.
- Budget 2016 proposes to repeal the current ECP regime and replace it with a new capital cost allowance ("CCA") class available to businesses and provide rules to transfer taxpayers' existing cumulative eligible capital ("CEC") pools to the new CCA class.
- Under the proposed rules, a new class of depreciable property for CCA purposes will be introduced. Expenditures that are currently added to the CEC pool (at a 75 per cent inclusion rate) will instead be included in the new CCA class at a 100 per cent inclusion rate. The new CCA class will have a five per cent annual depreciation rate. Other existing CCA rules will generally apply, including rules related to recapture, capital gains and depreciation (for example, the "half-year rule").
- Transitional rules are proposed so that CEC pool balances will be calculated and transferred to the new CCA class as of January 1, 2017. The opening balance of the new CCA class in respect of a business will be equal to the CEC pool balance that exists at that time. For the first ten years, the depreciation rate for the new CCA class will be seven per cent in respect of expenditures incurred before January 1, 2017.
- Budget 2016 proposes special rules to simplify the transition to the ECP regime for small businesses:
– Small initial balances relating to expenditures incurred before January 1, 2017 will be eliminated quickly by allowing the taxpayer to deduct, as CCA, the greater of $500 per year and the amount otherwise deductible for that year; and
– The first $3,000 of incorporation expenditures will be treated as a current expense rather than being added to the new CCA class.
Debt Parking to Avoid Foreign Exchange Gains
- To avoid realizing a foreign exchange gain on the repayment of a foreign currency denominated debt, some taxpayers enter into debt-parking transactions. In such transactions, instead of repaying a debt with an accrued foreign exchange gain, the debtor would arrange for a person with which it does not deal at arm's length to acquire the debt from the initial creditor for a purchase price equal to its principal amount, thereby "parking" the debt. The debt would remain outstanding to avoid the debtor from realizing a foreign exchange gain.
- Budget 2016 proposes to introduce rules such that any accrued foreign exchange gain on a foreign currency debt will be realized when the debt becomes a "parked" obligation.
Expanding Tax Support for Clean Energy
- Budget 2016 proposes to expand the accelerated rate CCA classes 43.1 (30%) and 43.2 (50%) to include certain eligible electric vehicle charging stations and electrical energy storage property.
- In addition, new legislation will be introduced to create tax rules in connection with emissions trading and emission allowances.
Valuation for Derivatives
- Budget 2016 proposes to exclude derivatives from the application of the inventory valuation rules. In addition, a new measure will be introduced to ensure taxpayers are not able to value derivatives using the lower of cost and market method under the general principles for the computation of profit for tax purposes.
- These proposed measures will apply to derivatives entered into on or after March 22, 2016.
Back-to-Back Shareholder Loan Rules
- Budget 2016 proposes to introduce a domestic back-to-back shareholder loan rule. Under the current rules, if a debt owing to a shareholder from a corporation is outstanding for more than a year, either the loan or a prescribed rate imputed interest benefit is included in the shareholder's income. In situations where the shareholder loan rules would otherwise apply but for the interposition of a third party between the corporation and the shareholder, legislation will be introduced to look through the third party and have the shareholder loan rules apply.
Personal Tax Measures
Canada Child Benefit
- Currently, there are two federal mechanisms for the provision of financial assistance to families with children under 18: the Canada Child Tax Benefit ("CCTB") and the Universal Child Care Benefit ("UCCB").
- Budget 2016 proposes to replace the CCTB and UCCB with a new Canada Child Benefit ("CCB") to better target families in need of the assistance.
- The CCB will provide a non-taxable maximum benefit of $6,400 per child under the age of six and $5,400 per child aged six through 17. The CCB maximum benefit is increased by an additional $2,730 for a child that is eligible for the disability tax credit. The CCB maximum benefit levels will be reduced based on family income and the number of children in the family.
- CCTB and UCCB payments will cease after June 2016 and CCB benefits will be paid monthly to eligible families, starting July 1, 2016.
Family Tax Cut
- Effective for 2016 and later taxation years, Budget 2016 proposes to eliminate the family tax cut that allowed a higher-income spouse, with at least one child under 18, to notionally transfer up to $50,000 of taxable income to their spouse or common-law partner, for the purpose of reducing the couple's total income tax liability by up to $2,000.
Education and Textbook Tax Credits
- Budget 2016 proposes to eliminate the education and textbook tax credits starting in 2017. Unused education and textbook tax credits carried forward from years before 2017 will remain available to be claimed in 2017 and subsequent years.
Children's Fitness and Arts Tax Credits
- Budget 2016 proposes to phase out the Children's Fitness Tax Credit by reducing the maximum eligible amount for 2016 from $1,000 to $500. The credit will remain refundable for 2016.
- Budget 2016 proposes to phase out the Children's Arts Tax Credit by reducing the maximum eligible amount for 2016 from $500 to $250. The credit will remain non-refundable for 2016.
- Both credits will be eliminated for the 2017 and subsequent taxation years.
Taxation of Switch Fund Shares
- Taxpayers who invest in mutual fund corporations (or investment corporations) are currently able to switch between different classes of funds within the same corporation, with the Income Tax Act deeming the exchanges not to be dispositions for income tax purposes.
- Budget 2016 proposes to amend the Income Tax Act such that an exchange between different classes of funds in mutual fund corporations will be deemed to be a disposition at fair market value.
- The proposed changes will not apply to exchanges where the shares received differ only in respect of management fees or expenses borne by the investor, and otherwise derive their value from the same fund or portfolio within the mutual fund corporation.
- The changes will apply to dispositions of shares that occur after September 2016.
Sales of Linked Notes
- A linked note is a debt obligation, where the return on investment is linked to the performance of one or more assets or indexes over the term of the debt obligation. Where a linked note is sold prior to maturity, a taxpayer is currently able to convert interest into a capital gain.
- Budget 2016 proposes to amend the Income Tax Act so that the return on a linked note retains the same character whether sold before, or held until, maturity. This will result in any gain on a linked note being treated as interest income and not as a capital gain.
- The changes will apply to dispositions of linked notes that occur after September 2016.
Labour-Sponsored Venture Capital Corporations Tax Credit
- For 2016 and subsequent taxation years, the labour-sponsored venture capital corporation ("LSVCC") tax credit will be restored to 15 per cent for share purchases of provincially registered LSVCCs prescribed under the Income Tax Act.
- The federal tax credit for federally registered LSVCCs will remain at five per cent for the 2016 taxation year and will be eliminated for the 2017 and subsequent tax years.
Teacher and Early Childhood Educator School Supply Tax Credit
- As of January 1, 2016, eligible teachers and early childhood educators will be able to claim a 15 per cent refundable tax credit on a maximum amount of $1,000 in eligible supplies for use in a school or a child care facility for the purpose of teaching or enhancing learning.
Ontario Electricity Support Program
- Effective January 1, 2016, the Ontario Electricity Support Program ("OESP") will provide assistance to low-income households in Ontario for the cost of electricity. The OESP will provide a monthly credit on a recipient's electricity bill. The amount of credit will be based on household income and the number of people living in the household.
- The amounts received under the OESP will not be taxable.
Mineral Exploration Tax Credit for Flow-Through Shares Investors
- The mineral exploration tax credit provides individuals who invest in mining flow-through shares with a credit equal to 15 per cent of specified mineral exploration expenses incurred in Canada.
- The eligibility for the mineral exploration tax credit will be extended for one year, to flow-through share agreements entered into, on or before March 31, 2017.
International Tax Measures
Base Erosion and Profit Shifting
- Budget 2016 confirms Canada's commitment to address Base Erosion and Profit Shifting ("BEPS"). The BEPS project, led by the G20 and the Organisation for Economic Co-operation and Development ("OECD"), aims to improve the integrity of international tax rules to ensure that businesses pay tax on profits in the jurisdictions where the underlying economic activity takes place.
- The Government proposes to act upon the OECD's BEPS project final reports by:
– Requiring multinational enterprises with annual consolidated group revenues in excess of €750 million where the ultimate parent of the group resides in Canada to file a country-by-country transfer pricing report, which Canada will in turn share with other jurisdictions. This reporting will be required for taxation years after 2015 and the first exchanges of country-by-country information are expected by June 2018;
– Amending its current and future tax treaties to introduce an anti-abuse rule or adopting and signing a multilateral instrument to prevent treaty shopping; and
– Exchanging certain tax rulings, starting in 2016, with other jurisdictions.
Cross Border Surplus Stripping
- Budget 2016 proposes to clarify the "anti-surplus-stripping" rule exception to situations where the non-resident does not own, directly or indirectly, shares of the Canadian purchaser corporation and does not deal at arm's length with the Canadian purchaser corporation.
Extension of the Back-to-Back Rules
- On rents and royalties paid to foreign payees, Canadian taxpayers may be able to take advantage of a lower Canadian withholding tax rate by interposing a second foreign payee resident in a jurisdiction, with which Canada has a tax treaty ("back-to-back" arrangement).
- Budget 2016 introduces measures, similar to those already in place for interest paid to non-Canadian residents, to prevent lower withholding taxes on rents and royalties paid in these situations after 2016.
- In addition, legislation will be added to capture economically-similar arrangements that have been structured to avoid these back-to-back rules and see-through provisions for back-to-back arrangements involving multiple intermediaries.
- Budget 2016 is proposing the following measures to apply to supplies made after March 22, 2016:
– Medical and assistance devices – To add insulin pens, insulin pen needles and intermittent urinary catheters to the list of zero-rated medical devices that can be purchased without having to pay GST/HST; and
– Purely cosmetic procedures – To clarify that the GST/HST applies to supplies of purely cosmetic procedures provided by all suppliers, including registered charities.
Closely Related Test
- For purposes of the elections under section 150 and section 156 of the Excise Tax Act (i.e. the election for exempt supplies and the election for nil consideration, respectively), a parent corporation and its subsidiary must be closely related. The parent corporation must own 90 per cent or more of the value and number of the voting shares of its subsidiary corporation.
- Budget 2016 proposes to require that, in addition to the current requirement discussed above, a parent corporation or partnership must also hold and control 90 per cent or more of the votes in respect of every corporate matter of the subsidiary corporation (with limited exceptions) in order to be considered closely related.
- This measure will generally apply as of March 23, 2017; however, this measure will apply as of March 23, 2016 where an election under section 150 or section 156 of the Excise Tax Act is filed after March 23, 2016.
Exported Call Centre Services
- Exported supplies of call centre services rendered to individuals by means of telecommunications (e.g., by telephone, email, or web chat) will be zero-rated if the service is supplied to a non-resident person that is not registered for GST/HST purposes, and it can reasonably be expected that the technical or customer support is to be rendered to individuals who are outside Canada.
Reporting of Grandparented Housing Sales
- Budget 2016 proposes to simplify the builder reporting requirements for GST/HST purposes for certain grandparented housing sales. A house sale is considered grandparented when an agreement of purchase and sale is entered into prior to a province joining the harmonized sales tax system, or when the province increases its HST rate.
GST/HST on Donations to Charities
- Budget 2016 proposes a relieving change to the GST/HST rules to deal with transactions where property or services are supplied in exchange for or in recognition of a donation to a charity. The new rules will ensure that only the portion of the donation equivalent to the value of the property or service supplied will be subject to GST/HST.
De Minimis Financial Institutions
- For taxation years beginning on March 22, 2016 or later, interest earned on demand deposits, as well as term deposits and guaranteed investment certificates with an original date to maturity not exceeding 364 days, will not be included in determining whether a person exceeds the $1 million annual threshold to be considered a de minimis financial institution.
Application of GST/HST to Cross-Border Reinsurance
- Legislation will be introduced to clarify the self-assessment rules for financial institutions in respect of imported reinsurance services and premiums. This measure will apply to any specified year of a financial institution that ends after November 16, 2005.
- Budget 2016 announces the Government's intention not to proceed with the measure announced in Budget 2015 that would provide an exemption from capital gains tax for certain dispositions of private corporation shares or real estate where the cash proceeds from the disposition are donated to a registered charity or other qualified donee within 30 days.
- Budget 2016 confirms the Government's intention to proceed with tax measures relating to the conversion of capital gains into tax-deductible inter-corporate dividends (section 55 of the Income Tax Act) as well as other measures which were announced in prior budgets but were not legislated before Parliament was dissolved in the fall of 2015.
- As a result of the introduction of the new top marginal personal income tax rate of 33%, there are a number of consequential amendments to be introduced to the Income Tax Act, including a federal tax rate increase from 28% to 33% on personal service business income earned by a corporation. This will result in a combined corporate income tax rate in Ontario of 44.57% on personal service business income.
Click here to download a copy of the tax letter (PDF), which includes Appendix A – Personal and Corporate Tax Rates.
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.