The lead-up to the March 22, 2017 Federal Budget ("Budget") was filled with fear and trepidation that the Trudeau Liberal Government ("Government") would use the Budget to grab more taxes from Canadians to pay for their platform promises. In particular, in advance of the Budget, there was concern that capital gains inclusion rates were likely to increase significantly, from the 50% inclusion rate to 75% or possibly even more.
The good news for taxpayers — at least for now — is that the Budget did not make any particularly significant tax rate changes at all.2 Unfortunately, that is not to say that the Budget was a tax non-event.
Shots Across the Bow
Tax professionals are always worried about something. It seems to be an occupational hazard, or perhaps a deeply-ingrained socialized character flaw. Perhaps it is that we've adopted Bruce Cockburn's song "The Trouble with Normal (is it always gets worse)" as our theme song — or maybe that's just me. In any case, it appears this Budget has left us with reason to be worried.
Contained deep in the Budget papers,3 under the heading "A Tax System That's Fair for Middle Class Canadians", is a discussion about "Tax Planning Using Private Corporations", setting out the theme that high-income individuals are using corporations to avoid paying their fair share of taxes. Some of the variety of strategies that the government notes it is concerned about include using private corporations to:
- allow high-income individuals to shift income to lower-income family members or other non-arm's length persons that can reduce (or even eliminate) overall taxes in a non-arm's length group;
- cause passive income to be taxed at much lower tax rates than if the income had been earned personally; and
- convert regular income into capital gains, which because of the high tax rates on dividend income can significantly reduce the integrated tax rate in connection with earning income through a corporation as opposed to if such income had been earned personally.
Some of the direct hits fired in the Budget, while disappointing, were at least foreseeable.
A number of strategies used by taxpayers to manage their tax situations and/or to benefit from certain fact patterns took direct hits in the Budget. For example, the use of straddle transactions (or "straddles", colloquially)4 to manage a taxpayer's taxable income appear to have been effectively eliminated in respect of straddles entered into on or after the date of the Budget. Also, the "de facto control" test, a test that is critical to causing a number of provisions in the Income Tax Act (Canada) ("Act") to become applicable, including the association rules,5 is proposed to be broadened significantly. The change to this test is intended to legislatively override recent case law that the Government obviously did not agree with.6
On the other hand, I don't know any advisors who foresaw the elimination of the so-called "billed-basis accounting" exclusion available to professionals who elect to defer the value of their work-in-process ("WIP"). Assuming that this proposal is enacted, professionals will be required to determine the lesser of the cost and fair market value of their WIP each year ("WIP Amount") and, beginning in the taxation year ending after the particular professional's current taxation year, the professional will be required to take 50% of the WIP Amount at year-end into income for that taxation year (for professionals with calendar year-ends, the relevant period for this first inclusion will be the taxation year ended December 31, 2018). Thereafter, the professional will be required to include the full year-end WIP Amount in income, subject to claiming deductions for the WIP Amount included in the preceding year.7
The government has touted this change as being capable of raising nearly half a billion dollars of tax revenues over the next three years.8 Sadly, I can't imagine that in the current political/class warfare environment the general public will have much sympathy for the professionals being forced to pay these additional taxes.
While the elimination of billed-basis accounting is likely to impact all professionals to a certain degree, it would appear to especially hurt lawyers and accountants, who often carry large WIP balances at year-ends. This is particularly the case for any professionals who work on a contingency basis.
Assuming the billed-basis accounting proposals are enacted, the future battleground for professionals seeking to defer taxation of their WIP will shift to the valuation of WIP, since it is the lesser of the cost and fair market value of the WIP that will be taxable. However, that is an article that can be written9 on another day.
CURRENT ITEMS OF INTEREST
Notice of Ways and Means Motion for 2017 Federal Budget
On April 7, 2017, the Department of Finance released a Notice of Ways and Means Motion and related explanatory notes to implement certain, but not all, provisions of the Federal Budget tabled in Parliament on March 22, 2017.
2017 Newfoundland and Labrador Budget
On April 6, 2017, the government of Newfoundland and Labrador introduced its 2017 Budget. The Budget contained no new taxes or tax increases except for gasoline tax changes.
2017 Prince Edward Island Budget
On April 7, 2017, the government of Prince Edward Island introduced its 2017 Budget. The Budget contained no new taxes or tax increases, but it did contain the following two changes:
- A 2% increase of the basic personal amount, spouse or common-law partner amount, and eligible dependant amount to claim a non-refundable tax credit.
- A change to protect the provincial education tax credit which would otherwise have been eliminated following the recent elimination of the federal education tax credit.
Appeal from Rule 58 determination of Tax Court judge allowed
The appellant had obtained court orders from two foreign jurisdictions which provided a rectification remedy
re-characterizing dividend payments made as loans, but the Minister of National Revenue refused to accept such re-characterization for Canadian tax purposes. The taxpayer appealed to the Tax Court of Canada which held, on a
Rule 58 application, that the foreign orders did not bind the minister. That decision was based on a finding that, under the Civil Code, homologation was required to render the foreign judgment enforceable in the province of Quebec and to bind the minister. The taxpayer appealed further to the Federal Court of Appeal.
The appeal was allowed. The appellate Court held, in agreement with the appellant, that foreign judgments must be taken as fact, even in the absence of homologation. The Civil Code provides that "an act purporting to be issued by a competent foreign public officer makes proof of its content against all persons. . ." The Court concluded that, as such, factual findings contained within those judgments were facts that could not be disregarded by a Court and that the foreign judgments in question were proof that the corporate resolutions had been rectified to authorize the dividend payments and to transform them into indebtedness. The Court held as well that as the minister was not a party to the foreign proceedings, there was nothing to enforce against the Minister and homologation was therefore a non-issue. On the question of the effect of the foreign orders with respect to the minister, the Court held that the resolution of that question would necessarily depend on the evidence adduced by the parties and the weight ascribed to the foreign orders as facts, pursuant to the provisions of the Civil Code. In the Court's view, such determination was to be made not on a Rule 58 application, but by the Tax Court judge on the basis of the full evidentiary record at his or her disposal. The appellate Court concluded, therefore, that it would allow the appeal, set aside the judgment of the Tax Court and decline to answer the question under Rule 58, and that it would also dismiss the Rule 58 motion before the Tax Court.
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