Canada: Tax Letters: 2016 Canadian Federal Budget Commentary

Last Updated: April 1 2016
Article by Garrett Louie

Finance Minister Bill Morneau delivered the 2016 Federal Budget on March 22, 2016. We are pleased to present the 2016 Federal Budget Commentary.

INTRODUCTION

PERSONAL TAX MEASURES

Tax Credits

Family Tax Cut
For 2016 and subsequent years, the Family Tax Cut, an income-splitting tax credit, is eliminated. This non-refundable tax credit allowed a higher-income taxpayer to notionally transfer up to $50,000 of taxable income to his/her lower income spouse or common-law partner for the purpose of reducing their total income tax liability by up to $2,000.

Children's Fitness and Arts Tax Credits
The Budget proposes to phase out the Children's Fitness Tax Credit and the Children's Arts Tax Credit by 2017. The maximum eligible amounts for the Children's Fitness Tax Credit and Children's Arts Tax Credit will be reduced to $500 and $250 respectively for 2016 and the credits will be eliminated for 2017 and subsequent years.

Education and Textbook Tax Credits
The Education and Textbook Tax Credits will be eliminated effective January 1, 2017. Unused credits carried-forward may still be claimed in 2017 and subsequent years. The Tuition Tax Credit will not be affected by these measures.

School Supply Tax Credit
The Budget proposes to introduce the Teacher and Early Childhood Educator School Supply Tax Credit, effective for the 2016 taxation year. The credit will apply on up to $1,000 of eligible supplies acquired on or after January 1, 2016 by an eligible teacher or early childhood educator.

Canada Child Benefit ("CCB")

Effective July 1, 2016, the CCB will replace the Universal Child Care Benefit and the non-taxable Canada Child Tax Benefit. The CCB will provide a maximum benefit of up to $6,400 per child under the age of 6 and $5,400 per child aged 6 through 17. The benefit will be phased out based on a family's adjusted family net income and the number of children in the family. For example, for a family with one child under 6, the benefit is fully phased out at an adjusted family net income of approximately $188,000. Monthly payments to eligible families will begin in July of 2016 and will be based on adjusted family net income for the 2015 taxation year. Amounts received under the CCB will not be taxable and will not reduce benefits paid under the GST credit. Furthermore, the CCB amounts will not be included in income for the purposes of federal income-tested programs delivered outside of the income tax system, such as the Guaranteed Income Supplement, the Canada education savings grant, the Canada learning bond, the Canada disability savings bond and the Canada disability savings grant.

Donation of Private Corporation Shares or Real Estate

Included in the 2015 Federal Budget were proposals for an exemption from capital gains tax for certain dispositions of private corporation shares or real estate where cash proceeds from the disposal are donated to a registered charity within 30 days. The 2016 Budget announced the Government's intention to not proceed with these measures.

Old Age Security and the Guaranteed Income Supplement ("GIS")

The Budget proposes to increase the GIS by up to $947 annually for low-income single seniors. The benefit is phased out at an income level of about $8,400. Benefits will be adjusted quarterly for cost of living. The Budget also proposes to lower the age of eligibility for Old Age Security and GIS benefits to 65 (from 67) and Allowance benefits to 60 (from 62) over the 2023 – 2029 period.

Northern Resident's Deduction

The Budget proposes to increase the maximum residency component of the Northern Resident's Deduction by 33%, to a maximum of $22 per day (prescribed zones) effective for the 2016 taxation year. Intermediate zones will be entitled to deduct half the increased amount.

BUSINESS INCOME TAX MEASURES

Small Business Tax Changes

The Budget proposes that the federal "small business tax rate" stay at 10.5%. This rate was previously scheduled to decrease to 9% by 2019.

The Budget also proposes changes to prevent the multiplication of access the small business deduction in certain situations.

In general, associated corporations are required to share a $500,000 small business deduction and similarly, corporate members of a partnership are required to share a $500,000 small business deduction on a pro-rata basis. In certain structures, a Canadian-Controlled Private Corporation ("ServiceCo") may be introduced to contract its services to non-arm's length partnerships and corporations. A separate small business deduction may then be claimed by ServiceCo in respect of these non-arm's length services, thereby allowing the small business deduction to be multiplied.

The Budget proposes to eliminate the multiplication of the small business deduction where ServiceCo provides services to a partnership, where ServiceCo or one of the shareholders of ServiceCo has a direct or indirect interest in the partnership or does not deal at arm's length with a member of the partnership. This prohibition does not apply where all or substantially all of the income is earned by providing services to arm's length persons other than the partnership.

Similarly the Budget proposes to eliminate the multiplication of the small business deduction where ServiceCo provides services to a private corporation, where ServiceCo, one of the shareholders of ServiceCo or a person not dealing at arm's length with a shareholder has a direct or indirect interest in the private corporation. The prohibition does not apply where all or substantially all of the income is earned by providing services to arm's length persons other than the corporation.

Eligible Capital Property ("ECP")

Current Regime
Eligible Capital Expenditures ("ECE") such as amounts incurred to acquire goodwill or customer lists are currently included in tax pools based on each business of a taxpayer at 75% of eligible costs and then allowed for at 7% declining balance. Subsequent dispositions may be taxed at the small business tax rate or the general tax rate, with 50% of amounts in excess of the original cost being taxable. The non-taxable portion is included in a corporation's capital dividend account.

New Regime
Such expenditures that are incurred on January 1, 2017 and onwards will be considered as being incurred to acquire depreciable property. Details include the following:

  1. A new capital cost allowance ("CCA") class 14.1 will be used and similar to the current ECP regime, will require a separate pool for each separate business of a taxpayer. The half-year rule will apply to acquisitions and the capital cost allowance rate will be 5% declining balance.
  2. 100% of the cost of the property will be included in the new Class 14.1 instead of 75% for ECEs.

Similar to dispositions of other depreciable assets, the sale of Class 14.1 assets occurring on January 1, 2017 and onwards will be subject to CCA recapture and capital gains treatment. This should result in a higher initial corporate tax rate than a sale of ECP under the current regime. Transitional rules will be in place for the transfer of existing cumulative eligible capital pools to the new regime.

Life Insurance

Distributions Involving Life Insurance Proceeds
The Department of Finance has noted that some taxpayers have been structuring their affairs such that the insurance benefit limit pertaining to life insurance proceeds received by a corporation or by a partnership is not operating as intended, thus eroding the tax base. The Budget proposes to amend the Income Tax Act to ensure that these rules apply as intended. These measures will apply to life insurance policy benefits received as a result of a death that occurs on or after March 22, 2016.

Furthermore, new information-reporting requirements may apply in certain corporate / partnership life insurance structures.

Transfers of Life Insurance Policies
Specific tax rules apply where a life insurance policy is transferred between non-arms length parties, potentially allowing for the extraction of funds from a corporation or a partnership tax-free. The Budget states that such results are unintended and erode the tax base, and proposes amendments to the Income Tax Act to address this issue for dispositions of life insurance policies that occur on or after March 22, 2016.

INTERNATIONAL

Treaty abuse

The Government of Canada confirmed its commitment to address tax treaty abuse as suggested by the Organization for Economic Co-operation and Development in its plans to address base erosion and profit shifting. Canada's tax treaties could be amended to include treaty anti-abuse rules.

Transfer Pricing Documentation

The Budget proposes to implement country-by-country reporting as part of Canada's initiatives towards addressing base erosion and profit shifting. Canadian multinational enterprises with total annual consolidated group revenue of €750M or more will be required to file a country-by-country report within one year of the end of the fiscal year to which the report relates. The reports will be automatically exchanged with other jurisdictions in which the multinational enterprise operates, provided that a legal framework exists to facilitate such an exchange. The first exchanges of reports are expected to occur by June 2018 and country-by-country reporting will be required for taxation years that begin after 2015.

SALES AND EXCISE TAX MEASURES

Medical and Assistive Devices

The Budget proposes to add Insulin pens, insulin pen needles and intermittent urinary catheters to the list of zero-rated medical devices for supplies made after March 22, 2016.

Closely Related Test

A "closely related" test allows for certain members of a group of corporations or partnerships to neither charge nor collect GST/HST on certain supplies made within the group. The Budget proposes an additional condition that must be met in order to meet the closely related test. Essentially, a corporation or partnership must 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 closely related.

For the full CPA 2016 Federal Budget Commentary click here.

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.

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