Canada: Highlights Of Canada's 2017 Federal Budget

Last Updated: March 31 2017
Article by Torys Tax Practice

The federal budget (Budget 2017) tabled on March 22, 2017 (Budget Day) contains a number of proposed amendments to Canada's Income Tax Act (the Tax Act). This bulletin focuses on (i) business income tax measures, (ii) international tax measures, (iii) avoidance rules for registered plans, (iv) tax planning using private corporations and (v) the status of outstanding tax measures.

Business Income Tax Measures

Timing and Recognition of Gains and Losses on Derivatives

In computing profit from gains and losses on derivatives held on income account for purposes of the Tax Act, taxpayers (other than financial institutions subject to the mark-to-market rules) generally use general profit computation principals. One such method used by taxpayers is the realization method whereby gains and losses on derivatives held on income account are only included in the calculation of income for tax purposes upon realization of such gains or losses. Budget 2017 proposes two measures that specifically address the timing of the recognition of gains and losses on derivatives held on income account.

1. Elective use of mark-to-market method

Financial institutions are required to mark-to-market certain types of derivatives, thus having to recognize both unrealized gains and losses in computing their income. Currently, there is no such requirement for other taxpayers. However, the Federal Court of Appeal recently held that a non-financial institution taxpayer was allowed to use the mark-to-market method under general profit computation principals for purposes of calculating its income.

Budget 2017 proposes to allow taxpayers to elect to mark-to-market all derivatives it holds that are eligible derivatives. Once made, such election will remain effective going forward and revocation will be granted only upon consent of the Minister of National Revenue (the Minister). Upon making this election, the taxpayer will be required to include in computing income the increase or decrease in the value of the taxpayer's eligible derivatives on an annual basis.

This election will be available for taxation years that begin on or after Budget Day.

2. Straddle transactions

Canada's Department of Finance (Finance), has identified certain straddle transactions which allow taxpayers using the realization method to selectively realize gains and losses from derivatives (and other positions) held on income account. Finance describes the basic straddle transaction as one where a taxpayer enters into two or more derivative positions concurrently that are expected to generate equal and offsetting gains and losses. Prior to its taxation year end (Year 1), the taxpayer disposes of the positions that result in the realization of an accrued loss. The taxpayer then disposes of the offsetting position to realize an accrued gain early in the following taxation year (Year 2). The result is that the taxpayer can claim the loss in Year 1 while deferring the recognition of the offsetting gain to Year 2. Finance notes that this and other straddle transactions raise tax base and fairness concerns.

Budget 2017 proposes to implement a specific anti-avoidance rule to address the concerns raised by straddle transactions. This anti-avoidance measure will be in the form of a stop-loss rule which will defer the loss realization on a disposition to the extent that there is an unrealized gain on an offsetting position. Generally, such offsetting gain would not be realized until disposition provided it is not subject to mark-to-market income computation method.

This proposed stop-loss rule will apply in respect of a "position" which will generally be defined to include an interest in actively traded personal property (e.g., commodities), derivatives and certain debt obligations, and a related offsetting position will generally be one that "has the effect of eliminating all or substantially all of the taxpayer's risk of loss and opportunity for gain or profit in respect of the position". There will be exceptions to this stop-loss rule including that it will not apply: to a position held by a financial institution subject to the mark-to-market rules or by a mutual fund trust or mutual fund corporation; to a position that is part of certain ordinary course hedging transactions; if the offsetting gain position is held throughout a specified period starting on the date of the disposition of the related loss position; or to a position that is part of a series of transactions where none of the main purposes is the avoidance or deferral of tax.

This stop-loss measure will apply to any loss realized on a position entered into on or after Budget Day.

Clean Energy Generation Equipment: Geothermal Energy

Under the current capital cost allowance (CCA) rules, specified clean energy generation and conservation equipment is eligible for accelerated CCA treatment by way of inclusion in Class 43.1 or Class 43.2. Under the current CCA rules, equipment that uses geothermal energy is currently eligible for inclusion in Class 43.2 (which provides for a CCA rate of 50%) only if it is primarily used for the purposes of generating electricity; however, equipment that is used primarily for heating purposes does not qualify and is generally included in Class 1 (which is eligible for a CCA rate of 4%). The current regime also allows for:

  • costs of drilling and completing exploratory wells to be fully deducted in the year incurred as Canadian renewable and conservation expenses when it is reasonable to expect at least 50% of the capital cost of the property will be used in an electricity generation project included in Class 43.1 or Class 43.2; and
  • costs of drilling and completing geothermal production well for an electricity generation project that qualifies for Class 43.2 to be included in that class. Where such costs are not related to electrical energy generation (and are, for example, related to supplying heat) they may be included in Class 1 (CCA rate of 4%), Class 14.1 (CCA rate of 5%), Class 17 (CCA rate of 8%) or treated as a current expense.

Under the current regime, certain equipment that is part of a district energy system is eligible for inclusion in Class 43.1 or Class 43.2. Geothermal energy is not currently eligible as a thermal energy source for use in a district energy system.

Budget 2017 proposes several changes to this regime. The first proposed change is that geothermal energy equipment eligible for inclusion in Class 43.1 and Class 43.2 will be expanded to include geothermal equipment that is used primarily for the purpose of generating heat or a combination of heat and electricity. Certain eligible costs will include the cost of completing a geothermal well and the cost of electricity transmission equipment related to systems that produce electricity. The second proposed change is that geothermal heating will be made an eligible thermal energy source for use in a district energy system. The final proposed change is that for both electricity and heating projects, expenses incurred for the purpose of determining the extent and quality of geothermal drilling will qualify as a Canadian renewable and conservation expense.

These proposed changes 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.

Tax Measures Impacting the Petroleum Sector

Budget 2017 contains two measures directed at the petroleum sector.  The first proposal recharacterizes the tax treatment of expenses relating to the preparation and drilling of discovery wells (being exploratory wells that identify a previously unknown petroleum reservoir). Currently such expenses are treated as Canadian exploration expense (CEE) which can generally be deducted up to 100% in the year incurred. The proposal would recharacterize these expenses as Canadian development expense (CDE) which can only be deducted on a 30% declining balance basis. The proposal is stated to come into force for expenses incurred in 2019 and thereafter, except for expenses incurs prior to 2021 that the taxpayer has committed in writing (prior to Budget Date) to expend.

The second proposal would eliminate an incentive within the flow-through share rules which allows small corporations to incur up to $1 million of certain types of CDE, and to renounce those expenditures to subscribers of the flow-through shares as CEE. This measure is stated to be applicable to expenses incurred after 2018, with the exception of any commitments under a flow-through share agreement entered into prior to Budget Date.

While the Budget espouses the commitment of the Canadian government to its Federal Sustainable Development Program and its ongoing environmental stewardship, the absence of any similar changes to the mining sector (which continues to enjoy preferential tax treatment to the petroleum sector) is likely to be perceived by those in the petroleum sector as a continued targeting of that sector by the current government. In particular, the Budget's pronouncement that these changes could influence investment decisions in a way that could reduce environment impacts (i.e., that the changes may result in fewer wells being drilled) may be the most blatant example to date of the current government's desire to discourage further petroleum exploration activities in Canada.

Mineral Exploration Tax Credit for Flow-Through Share Investors

Budget 2017 has offered what has become the traditional one-year extension to the investment tax credit regime for flow-through shares in the mining sector. Consequently, eligible expenses will continue to qualify for a 15% mineral exploration tax credit for flow-through share agreements entered into on or before March 31, 2018.

Meaning of Factual Control

Various rules in the Tax Act refer to control of a corporation. These rules recognize two forms of control: de jure control (or legal control) and de facto control (or factual control). Legal control generally means the right to elect the majority of the board of directors of the corporation. On the other hand, factual control is intended to be broader than legal control and may exist even without the ownership of shares. The concept of factual control is relevant in the determination of whether a corporation is a "Canadian-controlled private corporation" (CCPC) and whether corporations are considered to be associated for purposes of the Tax Act.  These rules are important for determining a corporation's eligibility for refundable investment tax credits as well as a corporation's small business deduction limit.

The existence of factual control is a question of fact that is dependent on the relevant facts and circumstances of each particular situation.  Recent case law held that for a factor to be a relevant consideration in the determination of factual control, it must include a "legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability." 

Budget 2017 proposes to amend the Tax Act to clarify that all factors that are relevant in the circumstances should be taken into consideration in the determination of factual control and that the determination should not be limited to the requirements set out above. This measure will apply in respect of tax years that begin on or after Budget Day.   

Investment Fund Mergers

There are rules in the Tax Act that allow for tax-deferred reorganizations of investment funds in certain limited circumstances. Budget 2017 proposes to extend this ability to reorganize investment funds on a tax-deferred basis to several additional situations.

1. Merger of switch corporations into mutual fund trusts

Mutual funds are structured as "mutual fund trusts" or "mutual fund corporations" under the Tax Act. A "mutual fund trust" can have only one investment mandate whereas each class of shares of a mutual fund corporation can have a separate investment mandate which tracks a separate pool of investments (commonly referred to as a "switch corporation").  Under the Tax Act, two mutual fund trusts can be merged on a tax-deferred basis. Similarly, a mutual fund corporation can be converted or merged into a mutual fund trust on a tax-deferred basis.

Budget 2017 proposes to extend these rules to allow a switch corporation to reorganize into multiple mutual fund trusts on a tax-deferred basis. For a switch corporation to qualify for this tax-deferred exchange, (i) all or substantially all (generally 90% or more) of the property of the switch corporation must be transferred to one or more mutual fund trusts, (ii) no shareholder of the switch corporation receives any consideration other than units of one or more mutual fund trusts, (iii) in respect of each class of shares of the switch corporation, all or substantially all of the assets allocable to that class must be transferred to a mutual fund trust and the shareholders of that class must become unitholders of that mutual fund trust, and (iv) the switch corporation and the mutual fund trust(s) must file a joint election in prescribed form.

This measure will apply to qualifying reorganizations that occur on or after Budget Day.

2. Segregated fund mergers

The Tax Act does not contain rules that allow for a tax-deferred merger of segregated funds. Budget 2017 recognizes that segregated funds share many of the same qualities of mutual fund trusts and should be provided with consistent treatment. Therefore, Budget 2017 proposes to allow segregated funds to merge on a tax-deferred basis in a manner that is intended to be parallel to rules available for mutual fund trusts. 

Furthermore, Budget 2017 proposes to allow segregated funds to carry over non-capital losses to be applied in computing taxable income for years that begin after 2017. The losses eligible for carryover must arise in taxation years beginning after 2017, will be subject to the ordinary limitations set out in the Tax Act for carryback and carryforward of non-capital losses and the use of such losses will be restricted following a merger of segregated funds. 

The life insurance industry is invited to comment on the proposals. The measures will apply to segregated fund mergers implemented after 2017 and to losses arising in tax years beginning after 2017. 

International Tax Measures: Foreign Branches of Life Insurers

Ordinarily, a Canadian-resident person is subject to tax in Canada on its worldwide income from all sources. There is an exception provided in the Tax Act for corporations resident in Canada that carry on a life insurance business both in Canada and outside Canada (through a foreign branch). This exception provides that the life insurer is subject to tax in Canada in respect of its income from its insurance business carried on in Canada but not outside Canada. This rule is parallel to the treatment afforded to foreign affiliates of Canadian resident corporations since the foreign business income of such affiliates is generally not subject to tax in Canada (and usually exempt from tax when repatriated to Canada).

The Tax Act, however, contains rules within the foreign affiliate regime that deem the foreign affiliate's income from the insurance or reinsurance of a risk in respect of a person resident in Canada, a property situated in Canada or a business carried on in Canada (Canadian risks) to be included in the affiliate's foreign accrual property income (FAPI) which, in the case where the foreign affiliate is a controlled foreign affiliate, is taxed in Canada on an accrual basis in the hands of the Canadian corporation.  Budget 2017 proposes an analogous rule for Canadian-resident insurers with foreign branches to ensure that such insurers are subject to tax in Canada on their income from the insurance of Canadian risks. The intention is to prevent such corporations from shifting income from the insurance of Canadian risks to low or no tax jurisdictions.  The rule generally provides that, where more than 10% of the gross premium income of the foreign branch income from the insurance of risks (net of reinsurance) is in respect of Canadian risks, the insurance of Canadian risks by the foreign branch is considered to be included in the Canadian corporation's life insurance business carried on in Canada and the related policies are considered life insurance policies in Canada.

Furthermore, Budget 2017 proposed to extend certain anti-avoidance rules that were previously introduced into the FAPI regime to foreign branches of life insurers. The previously announced measures were intended to address so-called "insurance swaps" and ceding of Canadian risks.

Finally, a further anti-avoidance measure is proposed to apply to both foreign branches of and foreign affiliates of Canadian life insurance corporations. In particular, if a Canadian resident life insurer has, through its foreign branch, insured foreign risks and it can be reasonably concluded that the foreign risks were insured as part of a transaction or series of transactions one of the purposes of which was to avoid the application of any of the proposed rules set out above, the Canadian insurer will be treated as if such risks were Canadian risks. A parallel rule is proposed for foreign affiliates of Canadian resident corporations. 

This proposed measure will apply to taxation years that begin on or after Budget Day.

Anti-Avoidance Rules for Registered Plans

The Tax Act provides for certain beneficial tax treatment in relation to various registered plans: Registered Education Savings Plans (RESPs), Registered Disability Savings Plans (RDSPs), Tax-Free Savings Accounts (TFSAs), Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs). For TFSAs, RRSPs and RRIFs, there are a number of anti-avoidance rules including:

  1. the advantage rules;
  2. the prohibited investment rules; and
  3. the non-qualified investment rules.

Budget 2017 proposes to extend these anti-avoidance measures to apply to RESPs and RDSPs. These measures will generally apply to investments acquired after Budget Day and to transactions occurring after Budget Day (such transactions will include investment income generated after Budget Day where the investment was acquired prior to the implementation of the proposed changes).

Tax Planning Using Private Corporations

Budget 2017 noted a number of issues regarding tax planning strategies using private corporations, which can result in high-income individuals gaining unfair tax advantages. These strategies include:

  • Sprinkling income using private corporations, which can shift income from an individual facing a high personal income tax rate to family members who are subject to lower personal tax rates (or who may not be taxable at all).
  • Holding a passive investment portfolio inside a private corporation, which may be financially advantageous for owners of private corporations compared to otherwise similar investors.
  • Converting a private corporation's regular income into capital gains, which can reduce income taxes by taking advantage of the lower tax rates on capital gains.

Budget 2017 confirmed that the government is planning to review the use of these tax planning strategies involving private corporations by high-income earners and will release a paper on the matter in the coming months that will include proposed responses to these issues.

Status of Outstanding Tax Measures

Budget 2017 confirms the government's intention to proceed with certain tax and related measures (as modified to take into account consultations and deliberations since their announcement or release):

  • measures announced to improve fairness in relation to the capital gains exemption on the sale of a principal residence (announced October 3, 2016);
  • the measures announced in Budget 2016 on information-reporting requirements for certain dispositions of an interest in a life insurance policy;
  • proposals relating to income tax technical amendments (released on September 16, 2016);
  • proposals relating to the Goods and Services Tax/Harmonized Sales Tax (released on July 22, 2016); and
  • measures confirmed in Budget 2016 relating to the Goods and Services Tax/Harmonized Sales Tax joint venture election.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.