Enhancing Tax Integrity
Strengthening International Tax Integrity
- Canada commits to the multilateral efforts to address base
erosion and profit shifting ("BEPS")
- Strengthening transfer pricing rules
- Streamlining the implementation of treaty-related BEPS recommendations, including addressing treaty abuse
- Strengthening the cross-border anti-surplus stripping rule
- Extending the back-to-back loan rules
Strengthening Domestic Tax Integrity
- Changes to the taxation of small business corporations
- Use of life insurance policies to distribute amounts tax-free
- Preserving the integrity of foreign exchange computational rules in debt-parking transactions
- Preventing the asymmetrical recognition of gains and losses on derivatives for tax purposes
- Preventing deferral of capital gains tax in switch funds
- Changes to the taxation of linked notes
Other Tax Measures
- Simplification of the eligible capital property regime
- Donations of real estate and shares of private corporations
- Restoring the Labour-Sponsored Venture Capital Corporations Tax Credit
- Continuing the Mineral Exploration Tax Credit
The first Liberal budget in 10 years ("Budget 2016") is designed to "restore hope" and "reward hard work." Through measures designed at growing the middle class, Budget 2016 forecasts a deficit of $29.4 billion in 2016-2017, which will be reduced to $14.3 billion in 2020-2021. Budget 2016 is built on personal tax measures intended to help the middle class and business tax measures to strengthen international and domestic tax integrity. Notably, this budget may be as important for what is not included: an increase to the capital gains tax and changes to the taxation of stock options.
Strengthening International Tax Integrity
Base Erosion and Profit Shifting (BEPS)
On October 5, 2015, the Organisation for Economic Co-operation and Development ("OECD") released its final reports aimed at addressing base erosion and profit sharing ("BEPS"). In general terms, BEPS refers to tax planning arrangements pursuant to which profits are shifted away from one high tax jurisdiction to a low tax jurisdiction where very little economic activity may take place. In Budget 2016, the Government expresses its desire to move forward with a number of BEPS initiatives.
Transfer Pricing Documentation – Country-by-Country Reporting
Budget 2016 proposes to implement country-by-country reporting. As recommended by the OECD, country-by-country reporting is a form that a large multinational enterprise ("MNE") will be required to file with the tax administration of the country in which the MNE's ultimate parent resides. This report will include the global allocation by country of key variables for the MNE including: revenue, profit, tax paid, stated capital, accumulated earnings, number of employees, tangible assets, as well as the main activities of each of its subsidiaries. Where a jurisdiction receives a country-by-country report, that jurisdiction will automatically exchange such report with the other jurisdictions in which the MNE operates provided that certain prescribed conditions are satisfied. In certain circumstances, if the jurisdiction where the subsidiary resides is not able to obtain the country-by-country report from the parent jurisdiction, the tax administrator of the subsidiary may require the subsidiary to file such report.
Budget 2016 proposes to implement country-by country reporting for MNEs with total annual consolidated group revenue of EURO 750 million or more. Where the MNE has a Canadian parent it will be required to file the country-by-country report with the Canada Revenue Agency ("CRA") within one year of the end of the fiscal year to which the report relates. It is anticipated that the first exchanges between jurisdictions of country-by-country reports will occur by June 2018 provided that the CRA has formalized an exchange agreement with the other jurisdiction.
Country-by-country reporting will be required for taxation years that begin after 2015.
Revised Transfer Pricing Guidelines
Included in the BEPS initiative were certain revisions to the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations ("Transfer Pricing Guidelines") which were designed to improve the interpretation of the "arm's length" principle. These revisions are currently being reflected in CRA's audit and assessing practices. With respect to "low value added services" and "risk-free and risk adjusted returns" for minimally functional entities (i.e., cash boxes), the Government has stated that the CRA will not be adjusting its administrative practice at this time as it will await further work to be completed by the OECD in these areas.
Budget 2016 confirms the Government's commitment to addressing treaty abuse, in particular, treaty shopping. Rather than proceeding with a domestic treaty shopping rule (which was what was proposed initially by the Government in a previous budget), the Government has stated that the appropriate approach regarding treaty shopping will now depend upon the relevant circumstances and its particular treaty partner. In this respect, the Government notes that amendments to Canada's treaties can be achieved through bilateral negotiations between Canada and its treaty partners, a multilateral instrument that could be developed in 2016 or a combination of the two approaches. The multilateral instrument is a tax treaty that multiple countries could sign which would modify many of Canada's bilateral treaties.
Spontaneous Exchange of Tax Rulings
The BEPS initiative outlined a framework for the spontaneous exchange of certain tax rulings that could give rise to BEPS concerns (i.e., the lack of transparency amongst jurisdictions can give rise to mismatches in tax treatment and instances of double non-taxation). The framework covered six categories of rulings: (i)rulings related to preferential regimes; (ii) cross-border unilateral advance pricing arrangements;(iii)rulings providing for a downward adjustment to profits; (iv) permanent establishment rulings; (v)conduit rulings; and (vi) other types of rulings agreed to in the future.
Budget 2016 confirms the Government's intention to implement the BEPS framework for the spontaneous exchange of tax rulings. The CRA will commence exchanging tax rulings in 2016.
Cross-border surplus stripping
The Income Tax Act (the "Tax Act") contains an anti-surplus stripping rule, found in section 212.1, that is intended to prevent non-resident shareholders from artificially increasing the "paid-up capital" (PUC) of the shares of a Canadian corporation which it owns (PUC is generally a valuable tax attribute as it can be returned to non-Canadian shareholders without withholding tax). When this rule applies, the non-resident shareholder is either deemed to have received a dividend (which is subject to Canadian withholding tax) or the PUC of the shares that would otherwise have been increased as a result of the transaction is suppressed.
An exception to the above rule applies where the non-resident shareholder is effectively "sandwiched" between two Canadian corporations and the non-resident disposes of shares of the lower-tier corporation to the Canadian purchaser corporation in order to "unwind' the structure. The Government has stated that this exception is being misused by some taxpayers in order to artificially increase PUC. As a result, Budget 2016 proposes to amend the above exception to provide that it will not apply where a non-resident both (i) owns, directly or indirectly, shares of the Canadian purchaser corporation, and (ii) does not deal at arm's length with the Canadian purchaser. A specific rule is also proposed to address the situation where it may be uncertain whether consideration has been received by a non-resident from the Canadian purchaser corporation by deeming the non-resident to receive non-share consideration in such situations.
These measures will apply in respect of dispositions that occur on or after March 22, 2016 ("Budget Day").
Back-to-back loan rules
The current version of the "back-to-back" loan rules prevent taxpayers from interposing a third party between a Canadian borrower and a foreign lender in order to avoid the implications that would arise if a loan were made directly between the two taxpayers. Budget 2016 proposes to expand upon the current back-to-back loan rules in a numbers of ways.
Back-to-Back Rules for Rent, Royalties and Similar Payments
Similar to the mischief which the current version of the back-to-back loan rules is designed to prevent, there may be an incentive for taxpayers to interpose, between a Canadian resident payor of royalties and a non-resident payee, an intermediary located in a more favourable treaty country (to reduce the rate of Canadian withholding on such royalties). In order to address such situations, Budget 2016 proposes to address these back-to-back arrangements by extending the basic concepts of the current version of the back-to-back loan rules under Part XIII of the Tax Act to royalty payments. Where this back-to-back royalty rule applies, the Canadian resident payor will be deemed to have made the royalty payment directly to the ultimate non-resident recipient, and the withholding tax that otherwise would have been avoided under the arrangement will become payable.
This measure applies in respect of royalty payments made after 2016.
Character Substitution Rules
The current back-to-back loan rules contemplate a loan between a Canadian person and an intermediary in combination with a loan between the intermediary and another non-resident person. Similarly, the proposed back-to-back royalty rules referenced above contemplate two or more royalty arrangements. Budget 2016 proposes to extend the current version of the back-to-back loan rules (and the back-to-back royalty rules) to circumstances where such rules are avoided through the substitution of economically similar arrangements between the intermediary and another non-resident person. Specifically, these rules may exist in situations where:
- interest is paid by a Canadian resident person to an intermediary and there is an agreement thatprovides payments in respect of royalties between the intermediary and a non-resident person;
- royalties are paid by a Canadian resident person to an intermediary and there is a loan between theintermediary and a non-resident person; or
- interest or royalties are paid by a Canadian resident person to an intermediary and a non-residentpersons holds shares of the intermediary that include certain obligations to pay dividends or thatsatisfy certain other conditions.
Under these proposed character substitution rules, a back-to-back arrangement will exist where a sufficient connection is established between the arrangement under which an interest or royalty payment is made from Canada and the intermediary's obligations in each of the three situations described above. Where these rules apply an additional payment of the same character as that paid by the Canadian resident will be deemed to have been made directly by the Canadian resident payor to the other non-resident person.
Back-to-Back Shareholder Loan Rules
The shareholder loan rules under the Tax Act apply in respect of debts owing by a shareholder to a corporation. Where such rules apply either (i) the amount of the debt is included in the shareholder's income; or (ii) an amount determined by reference to a prescribed rate is included in the shareholder's income as a shareholder benefit. Where the shareholder is non-resident, these inclusions are deemed to be dividends subject to Canadian withholding tax.
Where the shareholder loan rules would otherwise apply, there may be incentives to use a back-to-back loan arrangement to avoid their application. Consequently, Budget 2016 proposes to amend the shareholder loan rules to include rules that are similar to the current back-to-back loan rules.
This measure will apply to back-to-back shareholder loan arrangement as of Budget Day.
Multiple Intermediary Structures
The current back-to-back loan rules apply in respect of structures that involve a single intermediary that borrows funds from a non-resident person and in turn makes a corresponding loan to a Canadian resident. Although such rules may apply in respect of structures which have two or more intermediaries, the manner in which such rules apply in such circumstances is not completely clear. As such, Budget 2016 proposes to clarify the application of such rules (and the back-to-back royalty and shareholder loan rules) in situations involving multiple intermediaries.
This measure will apply to payments of interest or royalties made after 2016 and to shareholder debts as of January 1, 2017.
Strengthening Domestic Tax Integrity
Changes to the taxation of small business corporations
Change to the Small Business Deduction Rate
Budget 2016 proposes to cancel the additional reductions in the small business tax rate planned for years after 2016. The small business deduction ("SBD") reduces the federal corporate income tax rate applying to the first $500,000 per year (the "Business Limit") of qualifying active business income earned by a Canadian controlled private corporation ("CCPC"). Announced last year by the Harper government, Budget 2015 proposed to increase the SBD in order to reduce the small business tax rate from 11% to 9%. This reduction was to be phased in over 4 years, with a 0.5% reduction applicable each year from 2016-2019. While the Liberal party election platform indicated that the full reduction would be maintained, Budget 2016 proposes to maintain only the first reduction applicable to 2016, but to cancel all future reductions, resulting in a small business tax rate of 10.5% in 2016 and following years. The full 2% reduction was expected to remove $1.2 billion annually from federal coffers. Budget 2016 also proposes to maintain the current gross-up factor and dividend tax credit rate applicable to non-eligible dividends received by an individual.
Multiplication of the Business Limit
Budget 2016 proposes a number of changes to the Tax Act to address concerns about partnership and corporate structures that multiply the $500,000 Business Limit to which the small business tax rate of 10.5% applies. Generally, CCPCs claiming the SBD are required to allocate a single Business Limit among associated corporations. The SBD is also phased out on a straight-line basis for a CCPC and associated corporations having between $10 Million and $15 million of taxable capital employed in Canada (the "Taxable Capital Limit").
Where a business is carried on through a partnership, the members of the partnership generally share one Business Limit in respect of the income from that business. Specifically, the specified partnership income rules (the "SPI Rules") in the Tax Act provide that the SBD that a CCPC that is a member of a partnership can claim in respect of its income from the partnership is limited to the lesser of (i) the active business income of the partnership that is attributed to it (its "Partnership ABI"), and (ii) its pro-rata share of a notional $500,000 Business Limit determined at the partnership level (its "SPI Limit").
Structures have been implemented to circumvent the application of the SPI Rules. In a typical structure, a shareholder of a CCPC is a member of a partnership that pays income to the CCPC for services rendered as an independent contractor. As a result, the CCPC may claim the SBD in respect of its active business income earned from providing such services to the partnership, up to the full amount of its Business Limit and without being subject to the SPI Limit.
To address this planning, Budget 2016 proposes to amend the Tax Act to extend the SPI Rules. For purposes of these rules, a CCPC will be deemed to be a member of a partnership under certain circumstances where it earns income from providing services or property to the partnership and a member of the partnership does not deal at arm's length with the CCPC or a shareholder of the CCPC. Active business income earned by a CCPC from providing property or services to a partnership will be deemed to be Partnership ABI of the CCPC if the CCPC is, or is deemed to be, a member of the partnership. Finally, the SPI Limit of a CCPC that is deemed to be a member of a partnership will be nil, unless an actual member of the partnership with which the CCPC does not deal at arm's length assigns all or a portion of its SPI Limit to the CCPC.
The new SPI Rules will apply to taxation years of a CCPC that begin on or after Budget Day.
Budget 2016 also proposes changes to the Tax Act to address concerns about corporate structures that multiply the Business Limit. Similar tax planning to that described above with respect to partnerships has been implemented to multiply the Business Limit in a corporate structure. Under such planning, a private corporation pays income to a CCPC for services rendered by the CCPC as an independent contractor, where the CCPC, 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.
Budget 2016 proposes to amend the Tax Act to address such corporate structures. A CCPC's active business income from providing services or property to a private corporation will be ineligible for the SBD where, at any time during the year, the CCPC, 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. This rule will not apply to a CCPC if all or substantially of its active business income is earned from providing services or property to arm's length persons other than the private corporation. A private corporation that is a CCPC will be entitled to assign all or a portion of its unused Business Limit to one or more CCPCs that earn active business income from providing services or property to the private corporation that is ineligible for the SBD under the proposed rules.
This measure will apply to taxation years that begin on or after Budget Day.
Avoidance of the Business Limit and the Taxable Capital Limit
The associated corporation rules in the Tax Act are relevant for applying both the $500,000 Business Limit and the $15 million Taxable Capital Limit for CCPCs wishing to claim the SBD. Under these rules, a CCPC is associated with another CCPC where the two are controlled by the same person and where the two are controlled by different related persons if one of the related persons owns at least 25% of the shares of the CCPC that is controlled by the other related person. However, a corporation that is wholly-owned by an individual is generally not associated with a corporation that is wholly-owned by another related individual.
In addition to the above association rules, subsection 256(2) of the Tax Act generally provides that two corporations that would not otherwise be associated are deemed to be associated if each of the corporations is associated with the same third corporation. If three corporations are all considered to be associated on this basis, for purposes of the SBD they are all required to share a single Business Limit and the taxable capital employed in Canada of each is counted in applying the Taxable Capital Limit. However, if the third corporation either (i) is not a CCPC, or (ii) elects under subsection 256(2), the other two corporations will be considered not to be associated with one another or with the third corporation for purposes of computing the applicable Business Limit and Taxable Capital Limit, and the third corporation cannot itself claim the SBD.
The exception to the deemed association rule in subsection 256(2) of the Tax Act does not affect the associated status of corporations for purposes of subsection 129(6) of the Tax Act, which is a rule that deems a CCPC's investment income (e.g., interest and rental income) that is derived from the active business of an associated corporation to be active business income.
Accordingly, where the exception applies under the above example to three corporation in an associated group, the other two corporations would generally not be associated for purposes of limiting the maximum SBD available and they would also retain the ability to treat investment income received from the third corporation as active business income against which the deduction may apply. Budget 2016 proposes to amend the Tax Act such that where the exception to subsection 256(2) applies in respect of a corporation, investment income derived by a CCPC from that corporation will be ineligible for the SBD. In addition, the corporation to which the exception applies will continue to be treated as associated with otherwise associated corporations for purposes of applying the Taxable Capital Limit.
This measure will apply to taxation years beginning on or after Budget Day.
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 SBD. The consultation period ended August 31, 2015. Budget 2016 announces that the government's analysis of the matter is complete and that no modifications are proposed to the rules at this time.
Use of life insurance policies to distribute amounts tax-free
Life insurance proceeds received as a result of the death of an individual insured under a life insurance policy (a "policy benefit") are generally not subject to tax. Private corporations may add the amount of a policy benefit it receives to its capital dividend account and pay such amount out to shareholders tax-free. Similar rules for partnerships account for a policy benefit being non-taxable. Budget 2016 notes that some taxpayers have structured their affairs so that there is an artificial increase in the corporation's capital dividend account or to the adjusted cost base of a partner's interest in a partnership. To curb this perceived abuse, Budget 2016 proposes to amend the Tax Act so that the capital dividend account rules and adjusted cost base rules apply as intended. The measures will also introduce information-reporting requirements that will apply where a corporation or partnership is not a policyholder but is entitled to receive a policy benefit.
Where a policyholder disposes of an interest in a life insurance policy to a non-arm's length person, a special rule (the "policy transfer rule") deems the policyholder's proceeds of disposition, and the acquiring person's cost, of the interest to be the amount that the policyholder would be entitled to receive if the policy were surrendered (the "interest's surrender value"). Where the policy transfer rule applies, the amount by which any consideration given for the interest exceeds the interest's surrender value is not taxed as income under the rules that apply to dispositions of interest in life insurance policies. Where the policy benefit is received by a private corporation, it can be paid tax-free to that corporation's shareholder. Where this is the case and consideration to acquire the interest was not recognized under the policy transfer rule, the amount of the excess is effectively extracted from the private corporation a second time as a tax-free, rather than a taxable, amount.
Budget 2016 proposes to amend the policy transfer rule such that the transferor's proceeds of disposition will include the amount by which the value of the consideration received by the transferor exceeds the interest's surrender value (the "excess"). The change is effective for transfers occurring on or after Budget Day. For transfers of policies to a private corporation that occurred prior to Budget Day, the addition to the corporation's capital dividend account in respect of the death benefit received under the policy will be reduced by the excess. This change will apply in respect of deaths occurring on or after Budget Day.
Finally, where a transfer was made prior to Budget Day, as a contribution for shares of a private corporation, the paid-up capital of the shares will be reduced by an amount equal to the excess. Similar rules will apply to the adjusted cost base of a partnership interest created on the transfer of an insurance policy to the partnership.
Debt-parking to avoid foreign exchange gains
The Tax Act contains rules for computing foreign exchange capital gains and losses on a debt that deem a gain made or loss sustained on a foreign currency debt that is on capital account to be a capital gain or loss from the disposition of the foreign currency. For this purpose, a gain or loss is only made or sustained when it is realized. To avoid realizing this gain, some taxpayers have entered into debt-parking transactions, whereby, instead of repaying a debt with an accrued foreign exchange gain, the debtor arranges for a non-arm's length person to acquire the debt from the initial creditor for a purchase price equal to the principal amount. From the initial creditor's perspective, the debt is repaid, and from the debtor's perspective, the debt would remain owning, thereby the foreign exchange gain is not triggered as the non-arm's length person would let the debt remain outstanding.
The debt-parking rules in the Tax Act were introduced to address this technique to avoid the application of the debt forgiveness rules. Similarly, Budget 2016 proposes to introduce rules that ensure any accrued foreign exchange gains on a foreign currency debt will be realized when the debt becomes a parked obligation. For this purpose, a foreign currency debt will become a parked obligation at a particular time where: (i) at that time, the current holder of the debt does not deal at arm's length with the debtor, or where the debtor is a corporation, has a significant interest in the corporation, and (ii) at any previous time, a person who held the debt dealt at arm's length with the debtor, and where the debtor is a corporation, did not have a significant interest in the corporation. Generally, a person will have a significant interest in a corporation if the person (and any non-arm's length persons) owns shares of the corporation to which 25% or more of the votes or value are attributable. Additional rules will be enacted where trusts and partnerships are involved. Exceptions will be provided so that a foreign currency debt will not become a parked obligation in the context of certain bona fide commercial transactions.
This measure will apply to a foreign currency debt that meets the conditions to become a parked obligation on or after Budget Day. There will be an exception where the meeting of these conditions occurs before 2017 and results from a written agreement entered into before Budget Day.
Valuation of Derivatives
In Kruger Inc. v. R., the Tax Court of Canada recently held that a derivative that provides rights to a taxpayer and is held on income account would be considered to be inventory. The implication is that a derivative that is held on income account, and that is not mark-to-market property nor part of an adventure or concern in the nature of trade, may be valued at the lower of its cost and its fair market value at the end of each year; this would allow losses on the derivatives to be recognized on an accrual basis while gains would only be recognized on disposition. Budget 2016 proposes to exclude derivatives from the inventory valuation rules while maintaining their status as inventory, and to introduce a related rule to prevent taxpayers from valuing derivatives at the lower of cost and market in the computation of profit for tax purposes.
This measure will apply to derivatives entered into on or after Budget Day.
Taxation of switch fund shares
Canadian mutual fund corporations are often organized as "switch funds", whereby each class of shares offered by the corporation offers exposure to a different portfolio of assets and investors may exchange their shares of one class for shares of another class to switch their economic exposure. Under the Tax Act, investors may currently execute such exchanges on a tax-deferred basis. Budget 2016 proposes to amend the Tax Act so that an exchange of mutual fund corporation (or investment corporation) shares that results in an investor obtaining exposure to a different portfolio will be considered to be a disposition at fair market value. This measure is proposed to apply to dispositions of shares that occur after September 2016. It will not apply to switches where the only difference between the share classes relates to management fees or expenses to be borne by investors.
Sale of linked notes
Budget 2016 proposes to amend the treatment of any gain realized on the sale of a linked note. A linked note is a debt obligation, usually issued by a financial institution, the return of which is linked in some manner to the performance of one or more reference assets or indexes – for example, a basket of stocks, a stock index, or a currency - over the term of the obligation. Currently, the Tax Act contains rules that deem interest to accrue on a prescribed debt obligation, which includes a typical linked note. In addition, a special rule provides that interest accrued to the date of the sale of a debt obligation is included in the income of the vendor for the year in which the sale occurs. Budget 2016 notes that some investors, who hold their linked notes as capital property, sell such notes prior to the date that the full amount of the return on the note would be included in their income, such that they convert the return on the notes from ordinary income to capital gains. These investors take the position that no amount in respect of the return on a linked note is accrued interest on the date of the sale of the note for purposes of the specific rule.
Budget 2016 will amend the Tax Act so that the return on a linked note retains the same character whether it is earned at maturity or reflected in a market sale. A deeming rule will be added to treat any gain realized on the sale of a linked note as interest that accrued on the debt obligation for a period starting before the time of sale and ending at that time.
This measure will apply to sales of linked notes that occur after September 2016.
Other Tax Measures
Simplification of the eligible capital property regime
In Budget 2014 the Government announced that it would begin a consultation process to discuss overhauling the current eligible capital property ("ECP") regime and incorporating it into the capital cost allowance ("CCA") regime. Despite opposition from various stakeholders due to the fact that such an overhaul would eliminate a significant tax deferral opportunity for corporate taxpayers arising from the treatment of ECP gains as active business income (as opposed to capital gains), Budget 2016 proposes to repeal the ECP regime and replace it with a new CCA class (Class 14.1of Schedule II to the Income Tax Regulations – a separate class and expenditure pool will exist for each business of a taxpayer), along the lines of what was announced in Budget 2014. In short, property that was ECP will become depreciable property and expenditures and receipts that were accounted for under the ECP regime will be accounted for under the rules for depreciable and capital property. Although both Budget 2014 and Budget 2016 refer to the motivation underlying the overhaul as being one of simplifying the tax compliance burden for taxpayers, Budget 2016 notes that the elimination of the deferral opportunity is indeed consistent with the Government's intent.
The ECP regime deals with the tax treatment of certain capital expenditures and receipts that are not otherwise accounted for as business revenues or expenses, or dealt with under the rules relating to capital property (including the CCA regime, which allows for the depreciation of certain capital assets). Under the ECP regime, businesses add expenses incurred to acquire certain "eligible capital property" (which generally includes intangible property such as goodwill) to a pool called the cumulative eligible capital ("CEC") pool at a rate of 75%. Amounts added to the CEC pool can be deducted on a declining-balance basis at a rate of 7% per year. Proceeds of disposition from the sale of "eligible capital property" reduce the CEC pool at a rate of 75%. Any reduction of the CEC pool past nil will result in recapture of any previously claimed CEC, and then any excess receipt (an ECP gain giving rise to the potential deferral opportunity referred to above) will be included in income from the business at a 50% inclusion rate.
Consistent with the Budget 2014 announcement, all expenditures (that would be eligible capital expenditures under the ECP regime) relating to the acquisition of a specific property of a taxpayer's business that are incurred as of January 1, 2017 will be included in the new CCA class at a rate of 100%, but would only be depreciable at a rate of 5% per year (instead of 7% of 75% under the ECP regime). Similarly, all receipts (that would be eligible capital receipts under the ECP regime) relating to the disposition of a specific property of a taxpayer's business that are realized as of January 1, 2017 will reduce the balance of the new CCA class at a rate of 100% (instead of 75% under the ECP regime). The existing CCA rules will generally apply, including those relating to recapture, capital gains and depreciation (e.g., the "half-year rule").
Special rules will apply in respect of goodwill and in respect of expenditures and receipts (that would be eligible capital expenditures and receipts under the ECP regime) that do not relate to specific property of the taxpayer's business (e.g., start-up costs). Such expenditures and receipts will be accounted for by adjusting the capital cost of the goodwill of the taxpayer's business (every business will be considered to have goodwill associated with it, even in the absence of an acquisition of goodwill) and, consequently, the balance of the new CCA class. Any such expenditure will increase the capital cost of the goodwill and the balance of the new CCA class. Any such receipt will reduce the capital cost of the goodwill and the balance of the new CCA class by the lesser of the capital cost of the goodwill (which may be nil) and the amount of the receipt. If the amount of the receipt exceeds the capital cost of the goodwill, the excess will be a capital gain. Previously deducted CCA in respect of the new CCA class will be recaptured to the extent that the amount of the receipt exceeds the balance of the new CCA class.
Budget 2016 proposes to have CEC pool balances calculated and transferred to the new CCA class as of January 1, 2017. For taxation years ending before 2027, the depreciation rate for the new CCA class will be 7% in respect of expenditures incurred before January 1, 2017.
Qualifying receipts received after January 1, 2017 that relate to property acquired, or expenditures made, before that date will reduce the balance of the new CCA class at a 75% rate. Receipts that qualify will generally be: (i) receipts from the disposition of property the cost of which was included in the taxpayer's CEC pool under the ECP regime, and (ii) receipts that do not represent the proceeds of disposition of property. The aggregate amount of such qualifying receipts, for which only 75% will reduce the balance of the new CCA class, will generally equal the amount that could have been received under the ECP regime before triggering an ECP gain. This rule is designed to ensure that receipts do not result in excess recapture when applied to reduce the balance of the new CCA class.
This measure, including the transitional rules, will apply as of January 1, 2017. In advance of that date, corporate taxpayers considering a disposition of their business assets in the short term may want to consider triggering accrued ECP gains prior to January 1, 2017 in order to crystallize the existing deferral opportunity in respect thereof under the ECP regime.
Donations of real estate and shares of private corporations
Budget 2016 reverses the proposal in the 2015 Federal Budget to exempt from capital gains tax certain dispositions occurring after 2016 of private company shares and other types of real estate where the cash proceeds are donated to a registered charity or other qualified donee within 30 days. Budget 2016 confirms that the Government does not intend to proceed with this measure.
Restoring the Labour-Sponsored Venture Capital Corporation ("LSVCC") Tax Credit
An LSVCC is a type of mutual fund corporation, sponsored by a labour union, which makes venture capital investments in small and medium sized businesses. Prior to 2015, investors in a LSVCC were entitled to a tax credit of 15% of the investment (to a maximum of $750). This credit began being phased out in 2015 and was to be completely eliminated in 2017. While some provinces continue to offer a provincial LSVCC tax credit to investors, in Ontario, the credit was eliminated in 2012.
In the Liberal Party's 2015 election platform, they stated their intention to reinstate the tax credit for contributions made to LSVCCs in full. Budget 2016 seems to scale back this proposal. Budget 2016 proposes to restore the federal LSVCC tax credit to 15% for shares of new and existing provincially registered LSVCCs for 2016 and subsequent taxation years. However, the federal tax credit for federally registered LSVCCs will remain at 5% for the 2016 taxation year and will be eliminated as previously planned for 2017 and subsequent taxation years.
Mineral Exploration Tax Credit for Flow-Through Share Investors
Budget 2016 proposes to extend the Mineral Exploration Tax Credit for an additional year, to flow-through share agreements entered into on or before March 31, 2017. The credit, which equals 15% of certain "grass-roots" mining expenditures incurred by a mining company and renounced to individual investors, is an additional incentive for individuals to invest in flow-through shares issued by such mining companies to fund mineral exploration. The credit was first introduced in the early 2000s and has traditionally been set expire after one year, but thus far has been renewed in each annual Federal Budget. The extension of this credit is consistent with the proposals in the Liberal Party's 2015 federal election platform.
Expanding tax support for clean energy
The CCA regime in the Tax Act provides for an accelerated CCA rate for investments in specified clean energy generation and conservation equipment to provide incentives for energy generation equipment that is environmentally friendly. Currently, the accelerated CCA rate applies to equipment that generates or conserves energy by using a renewable energy source, using a fuel from waste, and making efficient use of fossil fuels. Budget 2016 proposes expand the types of equipment eligible for the accelerated CCA rate to include certain electric vehicle charging stations and certain electrical energy storage properties. This measure will apply in respect of property acquired for use on or after Budget Day that has not been used or acquired for use before Budget Day.
It should be noted that while Budget 2016 reiterates the Liberal Party's commitment to eliminate fossil fuel subsidies, Budget 2016 does not contain proposals in respect of the Liberal election platform initiative to allow "Canadian exploration expense" deductions only in cases of unsuccessful exploration.
On December 7, 2015, the Government announced a reduction of the second personal income tax rate to 20.5% from 22% and the introduction of a 33% personal income tax rate on individual taxable income in excess of $200,000. Budget 2016 proposes further amendments to the Tax Act to reflect the new top marginal income tax rate for individuals that will: (i) provide a 33% charitable donation tax credit to trusts that are subject to the 33% rate on all of their taxable income, (ii) apply the 33% rate on excess employee profit sharing plan contributions, (iii) increase that tax rate on personal services business income earned by corporations to 33%, (iv) amend the definition of "relevant tax factor" in the foreign affiliate rules to reduce the relevant tax factor to 1.9, (v) amend the capital gains tax refund mechanism for mutual fund trusts to reflect the 33% top rate, (vi) increase the Part XII.2 tax rate on the distributed income of certain trusts, and (vi) amend the recovery tax rule for qualified disability trusts to refer to the new 33% rate.
These measures will apply to the 2016 and later taxation years.
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