On March 22, 2016, the Minister of Finance released the federal budget ("Budget 2016"). Below is a summary of the important tax changes contained in Budget 2016. For a more comprehensive discussion of Budget 2016, please click here.
Corporate Tax Measures
Extension to "Back-to-Back" Rules:
The back-to-back rules generally apply to transactions where an intermediary is interposed between a Canadian entity and a foreign entity for the purpose of benefiting from reduced rates of withholding tax on interest payments. Budget 2016 proposes to extend the back-to-back rules. There is no specific legislation regarding any of the proposals as of yet. However, commentary suggests the "back-to-back" rules will apply as follows:
- Back-to-back rent/royalty arrangements to be taxed, after 2016, where payment is made to an intermediary and the withholding rate applicable to that intermediary is lower than the rate that would have been payable to the ultimate recipient.
- Extended, after 2016, to cover situations where "character substitution" occurs, i.e. interest or a royalty is paid from Canada to the intermediary, and the intermediary makes a payment to the ultimate recipient that is different in nature, if sufficient connection is established between the arrangements.
- Shareholder loan provisions to be amended, effective after March 22, 2016, to trigger the existing back-to-back loan rules (domestic and cross-border) to the extent debts are owed to unconnected Canadian resident corporations acting as intermediaries so that income inclusion or withholding tax cannot be avoided by using the third party intermediary.
- Existing back-to-back rules, and the foregoing ones, will apply to arrangements with multiple intermediaries.
Eligible Capital Property ("ECP"):
- Concept of ECP is eliminated effective January 1, 2017.
- 100% of the cost of such property acquired after 2016 will be added to new CCA Class 14.1.
- Deductible on a 5% declining balance basis—7% for taxation years ending before 2027 in respect of property acquired before 2017.
- Existing cumulative eligible capital balances will be transferred to new Class 14.1 effective January 1, 2017.
- Normal CCA rules will apply to new Class 14.1 including the half-year rule, recapture and gains on disposition being treated as capital gains.
- There will be refundable tax payable by Canadian-controlled private corporations in connection with capital gains arising from the disposition of properties included in Class 14.1.
- There will be special transitional rules to help avoid excess recapture in respect of properties acquired before 2017.
Debt-parking/Foreign Exchange Gains:
- The debt-parking rules will be expanded to tax-accrued foreign currency gains on parked debt obligations.
- Applies to parked obligations after March 22, 2016.
- Gains realized on the disposition of a linked note will be taxed on income account to the extent the gain is not attributable to foreign currency fluctuations or, where a portion of the return on the linked note is based on a fixed rate of interest, market interest rate fluctuations.
- Applies to sales of linked notes that occur after September 2016.
Valuation for Derivatives:
- Derivatives are excluded from the application of the inventory accounting rules while maintaining the status of such property as inventory, preventing taxpayers from claiming losses on derivatives on an accrual basis.
- A related rule to be added which will specifically provide that, where a taxpayer values a derivative at the lower of cost or fair market value in computing profits, no deduction may be claimed in respect of the derivative unless the derivative is disposed of by the taxpayer in the year.
- Applies to derivatives entered into on or after March 22, 2016.
Transfers of Life Insurance Policies:
- Currently, where an interest in a life insurance policy is transferred to a non-arm's length person the proceeds are deemed to be equal to the cash surrender value even where the fair market value of the policy and the consideration received exceeds this amount.
- Budget 2016 proposes to amend the Tax Act to deny the tax benefits that can be obtained from transferring an interest in a life insurance policy to a non-arm's length corporation. Similar rules are proposed with respect to transfers of a life insurance policy to a partnership.
Small Business Taxation:
- Currently a Canadian-controlled private corporation ("CCPC") carrying on an active business in Canada benefits from a reduced federal rate of tax of 10.5% on the first $500,000 of active business income and single $500,000 business limit applies with respect to the business of a partnership. Where a CCPC is a member of a partnership and earns active business income by providing services or property to the partnership, the CCPC is entitled to its pro rata share of the $500,000 business limit.
- Changes are as follows:
- defer the reduction of the small business tax rate currently legislated for 2017, 2018 and 2019 and maintain the rate of 10.5%.
- limit access to the small business deduction ("SBD") with respect to partnership structures where a CCPC provides services or property to a partnership where at any time in the taxation 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. These measures are targeted at partnership structures established to circumvent the specified partnership income rule by ensuring that the CCPC is not a member of the partnership in question and thereby multiplying the small business limit amongst the partners. An exception is provided where all or substantially all of the income of the CCPC is earned from providing services to arm's length persons.
- where a CCPC earns active business income by providing services or property to another private corporation, and where in the taxation year, the CCPC, one of its shareholders, or a person who does not deal at arm's length with such shareholder has a direct or indirect interest in the private corporation acquiring the services or property, the CCPC providing such services or property will be ineligible for the SBD. An exception is provided where all or substantially all of the active business income for the taxation year is generally earned from providing such services or property to persons or partnerships with which the CCPC deals at arm's length.
- two corporations that are associated with each other because they are associated with the same third corporation will not be treated as associated if the third corporation is not a CCPC, or if it is a CCPC, it elects not to be associated with the other two corporations for the purposes of determining entitlement to the small business limit. As a result, the third corporation may not claim the SBD but the other two corporations may do so. The exception does not impact the associated corporation status for the purpose of treating a CCPC's investment income as active business income eligible for the SBD if that income is derived from the active business of an associated corporation. Budget 2016 propose to make amendments to ensure that the investment income derived under these circumstances will be ineligible for the SBD. Furthermore, the third corporation will continue to be associated with the other two corporations for the purpose of applying the $15 million taxable capital limit in relation to the SBD.
International Tax Measures
Cross-Border Surplus Stripping:
- Canadian corporations are generally entitled to return to their shareholders the paid-up capital ("PUC") of their shares free of tax. Where the shareholder is a non-resident, the PUC can be paid to the non-resident free of Canadian withholding tax.
- The Tax Act contains an anti-surplus stripping rule in section 212.1 which is intended to prevent a strip of retained earnings out of a Canadian corporation or an artificial increase in cross-border PUC. Subsection 212.1(4) of the Tax Act contains an exception that applies where a Canadian purchaser corporation acquires shares of a non-resident corporation which owns shares of another Canadian corporation (creating a "sandwich structure") and the non-resident corporation subsequently transfers the shares of the lower-tier Canadian corporation to the Canadian purchaser corporation.
- Budget 2016 introduces measures to "clarify" that, where a non-resident corporate group reorganizes a non-resident corporation with a Canadian subsidiary into a sandwich structure to increase cross-border PUC, the subsection 212.1(4) exception to the anti-surplus stripping rule in subsection 212.1 will not apply.
- More specifically, Budget 2016 proposes to "clarify" that the exception contained in subsection 212.1(4) of the Tax Act does not apply if, either at the time of the disposition or as part of a series that includes the disposition, a non-resident person both:
- owns, directly or indirectly, shares of the Canadian purchaser corporation, and
- does not deal at arm's length with the Canadian purchaser corporation.
- Budget 2016 also proposes to "clarify" for purposes of the application of section 212.1 of the Tax Act that, where no consideration would otherwise be received by a non-resident person from the Canadian purchaser corporation, the non-resident person is deemed to have received non-share consideration from the Canadian purchaser corporation the fair market value of which is equal to the amount, if any, by which the fair market value of the shares of the lower-tier Canadian subsidiary corporation exceeds the increase in the fair market value of the shares of the Canadian purchaser corporation.
- This measure will apply in respect of dispositions that occur on or after March 22, 2016.
Base Erosion and Profit Shifting ("BEPS"):
Budget 2016 will respond to the OECD release of final reports
for the Base Erosion and Profit Shifting ("BEPS")
initiative as follows:
- Country-by-country reporting: Will be required for multi-national enterprises ("MNEs") with total annual consolidated group revenue of EURO750 million or more—where the ultimate parent is a Canadian resident entity the county-by–country report must be filed with the CRA within one year of the end of the fiscal year to which it relates beginning with taxation years that end after 2015 although no draft legislative proposals were contained in Budget 2016 in this regard.
- Treaty Abuse and Treaty Shopping: Confirms Canada's commitment to consider the inclusion of either a general anti-abuse rule that uses the criterion of the principal purpose of an arrangement or transaction was to obtain treaty benefits in a way that is not in accordance with the object and purpose of the relevant treaty or the use of a more mechanical limitation on benefits rule in its tax treaties going forward.
- Multilateral Instrument: Canada is participating in international work to develop a multilateral instrument to streamline the implementation of treaty-based BEPS recommendations, including addressing treaty abuse.
- Transfer Pricing: The CRA will adopt and apply the revisions contained in the Transfer Pricing Guidelines emanating from the BEPS project in administering the arm's length principle mandated under Canada's transfer pricing rules at section 247 of the Tax Act.
- Exchange of Tax Rulings: CRA will undertake the spontaneous exchange of tax rulings with other tax administrations that could potentially give rise to BEPS concerns in the absence of such exchanges.
Personal Income Tax Measures
- Canada child benefit: Beginning in July 2016, the Canada child benefit program, will pay up to $6,400 per child under 6 and up to $5,400 per child for those aged 6 through 17. An additional amount of $2,730 per child eligible for the disability tax credit will continue to be provided. Families with less than $30,000 in net income are eligible to receive the maximum benefit and eliminated entirely for households earning more than $190,000. The program replaces the current Canada child tax benefit and universal child care benefit.
- Income Splitting Credit: Eliminates the income splitting tax credit, which allows couples with at least one child under the age of 18 to notionally transfer up to $50,000 of taxable income to their spouse for the purpose of reducing the couple's total income tax liability by up to $2,000.
- Labour-Sponsored Venture Capital Corporations Tax Credit: Restores the federal labour-sponsored venture capital corporation ("LSVCC") tax credit from 5% to 15% for share purchases of provincially registered LSVCCs prescribed under the Tax Act for the 2016 and subsequent taxation years. The federal LSVCC tax credit for federally registered LSVCCs will remain at 5% for the 2016 taxation year and be eliminated for the 2017 and subsequent taxation years.
- Teacher and Early Childhood Educator School Supply Tax Credit: Introduces a teacher and early childhood educator school supply tax credit, which allows an eligible educator to claim a 15% refundable tax credit based on an amount of up to $1,000 in expenditures made by the eligible educator in a taxation year for eligible supplies, as long as certain conditions are met.
- Children's Fitness and Arts Tax Credits: Phases out the children's fitness and arts tax credits by reducing the 2016 maximum eligible amounts to $500 from $1,000 for the children's fitness tax credit (which will remain refundable for 2016) and to $250 from $500 for the children's arts tax credit. Both credits will be eliminated in 2017 and subsequent years.
- Education and Textbook Tax Credits: Elimination of the education and textbook tax credit effective as of January 1, 2017. The ability to carry forward unused amounts in respect of the textbook and education tax credits will remain unaffected.
- Mineral Exploration Tax Credit for Flow-Through Share Investors: Extends the eligibility of the mineral exploration tax credit for one year to flow-through share agreements entered into on or before March 31, 2017. The mineral exploration tax credit is equal to 15% of specified mineral exploration expenses incurred in Canada and "flowed-through" to flow-through share investors.
- Top Marginal Income Tax Rate – Consequential Amendments: In order to reflect the new top personal tax rate of 33% on taxable income in excess of $200,000, a number of consequential amendments will apply to the 2016 and subsequent taxation years, including:
- A tax rate increase from 28% to 33% on personal service business income earned by corporations.
- A reduction in the "relevant tax factor" (which applies for purposes of the foreign affiliate rules) from 2.2 to 1.9.
- The application of the 33% rate to excess employee profit sharing plan contributions.
- The availability of a 33% charitable donation tax credit on donations over $200 made after the 2015 taxation year by trusts that are subject to the 33% rate on all of their taxable income.
- Switch Fund Shares: Measures will be introduced to prevent the deferral of capital gains tax on exchanges of shares by investors in mutual fund corporations structured as "switch funds." Applies to dispositions after September 2016.
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.