On March 22, 2017 ("Budget Day"), the Honourable William Francis Morneau, Canada's Minister of Finance, tabled Canada's annual federal budget ("Budget 2017"). Importantly, Budget 2017 does not increase the capital gains inclusion rate nor does it introduce any rules targeted at the use of private corporations to reduce or defer tax. Instead, Budget 2017 proposes to build on the current Government's previous actions, and to introduce targeted investments aimed at fostering economic growth and benefitting the middle class.
Specifically, Budget 2017 proposes to close tax loopholes and strengthen the integrity of the tax system by implementing the following initiatives:
- preventing the avoidance of deferral of income tax through the use of offsetting derivative positions in straddle transactions;
- extending anti-avoidance rules applicable to RRSPs and TFSAs to RESPs and RDSPs;
- clarifying the meaning of de facto or factual control for purposes of determining who has control of a corporation; and
- preventing the avoidance of tax on income from the insurance of Canadian risks by extending the foreign-affiliate base erosion rules to foreign branches of Canadian life insurers.
Budget 2017 also pledges to invest an additional $523.9 million over five years to prevent tax evasion and improve tax compliance.
Finally, Budget 2017 signals the Government's commitment to implementing strong standards for corporate and beneficial ownership transparency and improving the availability of beneficial ownership information for legal persons and legal arrangements, including trusts. However, Budget 2017 does not indicate what substantive changes will be implemented, only that the Government will work with Provinces and Territories to establish a national strategy.
STUDY ON THE USE OF PRIVATE CORPORATIONS IN TAX PLANNING
Budget 2017 indicates that there are tax planning strategies using private corporations, which can benefit high-income individuals, and refers to the following three strategies as examples:
- using private corporations to sprinkle income (via dividends and capital gains) among family members (who may be subject to tax at lower rates);
- holding a passive investment portfolio inside a private corporation so as to benefit from lower corporate income tax rates (although not stated, presumably in a manner so as to avoid the application of the additional refundable tax on aggregate investment income); and
- converting regular income into capital gains.
The use of these planning strategies is under review, as is whether there are features of the current system that have an adverse impact on genuine business transactions involving family members. Budget 2017 indicates that the federal government will release a paper in the coming months setting out the nature of these issues and its proposed policy responses. No further information is provided.
BUSINESS INCOME TAX MEASURES
Investment Fund Mergers
Conversion of Mutual Fund Switch Corporation into Multiple Mutual Fund Trusts
Budget 2017 proposes to extend the mutual fund merger rules (which currently permit two mutual fund trusts to be merged on a tax-deferred basis or a mutual fund corporation to be merged into a mutual fund trust) to facilitate the reorganization of a mutual fund corporation that is structured as a "switch" fund (typically such corporations have multiple classes of shares, each tracking a distinct investment fund) into multiple mutual fund trusts on a tax-deferred basis. Qualification for the deferral will require that all or substantially all of the assets allocable to a particular class of shares be transferred to a particular mutual fund trust and that the shareholders of the class become unitholders of that mutual fund trust.
This measure will apply to qualifying reorganizations that occur on or after Budget Day.
Segregated Fund Mergers
Budget 2017 proposes to allow insurers to effect tax-deferred mergers of segregated funds on a basis that is consistent with the mutual fund merger rules. In addition, it is proposed that segregated funds be able to carry over non-capital losses that arise in taxation years beginning after 2017 to other taxation years that begin after 2017, subject to the usual restrictions and limitations for carrying non-capital losses forward and back.
This measure will apply to mergers carried out after 2017 and to losses arising in taxation years that begin after 2017.
Timing of Gains and Losses on Derivative Transactions
Elective Use of the Mark-to-Market Method
Responding to the Federal Court of Appeal's ("FCA") decision in Kruger Inc. v. R., 2016 FCA 186 and the uncertainty surrounding the use of the mark-to-market rules by ordinary taxpayers in respect of certain property held on income account, Budget 2017 proposes to introduce an elective mark-to-market regime for taxpayers in respect of derivatives held on income account.
In Kruger, the FCA permitted a non-financial institution taxpayer to use mark-to-market accounting in computing its income from its dealings in foreign exchange options on the basis of the accurate picture of profit framework set out by the Supreme Court of Canada in Canderel Ltd. v. R., 98 D.T.C. 6100 (SCC).
Budget 2017 proposes to allow taxpayers to elect to mark-to-market all of their "eligible derivatives" by filing an election in prescribed form. Once the election is made, it will apply to all eligible derivatives of the taxpayer and will remain in effect for all subsequent years unless it is revoked with Ministerial consent. If the election is made and the taxpayer is a financial institution within the meaning of subsection 142.2(1) of the Income Tax Act (Canada) (the "Tax Act"), the mark-to-market rules in section 142.2 will apply to the taxpayer's eligible derivatives. If the taxpayer is not a financial institution, the taxpayer will be deemed to have disposed of its eligible derivatives for an amount equal to the fair market value thereof at the end of each taxation year and to have reacquired them at the same amount. Recognition of any accrued gain or loss on an eligible derivative as at the beginning of the first election year is deferred or suspended until the particular derivative is disposed.
An eligible derivative is generally defined to mean a swap agreement, forward purchase or sale agreement, forward rate agreement, futures agreement, option agreement or similar agreement if:
- it is not a capital property, a Canadian resource property, foreign resource property or an obligation on account of capital;
- either the taxpayer has produced audited financial statements in accordance with GAAP or the agreement has a readily ascertainable fair market value; and
- it is not a tracking property (other than certain excluded property) that is held by a financial institution as those terms are defined in subsection 142.2(1) of the Tax Act.
If the election is not made by a taxpayer (other than a financial institution), the measure clarifies that the taxpayer may not use a method similar to a mark-to-market method to compute its profits from, in general terms, an eligible derivative.
This election will be available for taxation years that begin on or after Budget Day.
Straddle Transactions
Budget 2017 proposes to introduce a specific anti-avoidance rule that targets straddle transactions. A new stop-loss rule will defer the realization of any loss on the disposition of a "position" to the extent of any unrealized gain on an "offsetting position."
A straddle transaction might be entered as follows: A taxpayer might enter into two or more positions in respect of an investment (often derivatives) that are expected to generate equal and offsetting gains and losses. The taxpayer would close out its position with the accrued loss shortly before the end of a taxation year and close out the position with the accrued gain shortly after the beginning of the next taxation year. The loss would be applied to any current year income while recognition of the gain would be deferred to the following year. Successive straddle transactions might then be entered into in order to defer recognition of the gain indefinitely.
A "position" is defined as one or more properties, obligations or liabilities that is a share, partnership interest, trust interest, commodity, foreign currency, derivative (swap, forward, future, option and similar), foreign denominated debt, most convertible debt, certain prescribed debt obligations, certain lending arrangements and interests in substantially all of the foregoing where it is reasonable to conclude that, if there is more than one property, each of them is held in connection with each other.
An "offsetting position" is generally defined to mean one or more positions held by the taxpayer, a non-arm's length or affiliated person or any combination thereof (a "connected person"), that would have the effect of eliminating all of the holder's risk of loss and opportunity for gain or profit in respect of the particular position and, where held by a connected person and not by the taxpayer, can reasonably be considered to have been held for such intended purpose.
The stop-loss rule will not apply to a position:
- held by a financial institution (as defined in the mark-to-market property rules), mutual fund trust or mutual fund corporation;
- that is a capital property of the taxpayer;
- that is part of certain types of hedging transactions entered into in the ordinary course of the taxpayer's business (including debt incurred in the course of an operating business or commodities that the holder of the position manufacturers, produces, draws, extracts or processes);
- that is part of a transaction or series of transactions, none of the main purposes of which is to defer or avoid tax; or
- where the offsetting position continues to be held throughout the 30-day period beginning on the date of disposition of the position and, at no time during that period, is the taxpayer's risk of loss or opportunity for gain or profit with respect to the position materially changed by another position that is entered into or disposed of, or would be if the other position were entered into or disposed of.
This measure would apply to any loss realized on a position on or after Budget Day.
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