1999 Federal Budget: Balancing Canada's Fiscal and Physical Health - PricewaterhouseCoopers LLP
Speculation in the financial community and recent statements by the Canadian Finance Minister, the Honourable Paul Martin, and his officials, provided a clear preview of the February 16 budget. In fact, by the time Mr. Martin began his sixth budget address, there were few surprises. Substantial support to health care was a foregone conclusion, and Mr. Martin indeed did commit $11.5 billion to health care spending over the next five years.
Many will be disappointed with the rather limited personal tax relief offered, although there were fairly clear indications over the last several days that more significant relief would not be forthcoming. The tax reductions offered are obviously better than nothing, but Canada's individual tax structure remains onerous and a deterrent to productivity, savings and investment.
The Finance Minister presented "a balanced budget" for the second consecutive year and has committed to balanced budgets for the next two fiscal years. While there is an expressed intention to pursue limited reduction of the approximate $580 billion debt - debt currently generating well over $40 billion in annual interest charges - the magnitude of the debt remains a cloud, particularly if one ponders the effect of possible increases in interest rates.
Mr. Martin continues to emphasize a "knowledge and innovation" theme substantially unveiled in last year's budget and then confirmed through specific tax incentives and credits. The initiative continues in this budget, with a $2 billion financial commitment to specific knowledge and innovative investment programs and support strategies.
- Personal Tax Measures
- Broad-based tax relief measures
- Elimination of the 3% surtax
The 1999 budget completely eliminates the 3% general surtax for all taxpayers for the 2000 and subsequent taxation years. For the 1999 taxation year, the general surtax otherwise payable by an individual has been reduced by 50%. These two measures build on the 1998 budget proposal to eliminate or reduce the 3% general surtax for individuals with incomes below approximately $65,000. The surtax reductions can reduce marginal tax rates by as much as 0.435% for 1999 and 0.87% for 2000.
The 5% surtax on higher income earners, introduced years ago as a "temporary" deficit reduction measure, remains.
Increase in personal amounts
In a token response to growing criticism about "tax bracket creep," the amounts on which the basic personal credit and the spousal and equivalent-to-spouse ("spousal") credits or amounts are calculated will increase, along with the threshold at which the spousal credit begins to be reduced by a dependant's income.
RRSPs and RRIFs
On death, the value of an individual's registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) may be transferred tax-free to an RRSP or RRIF for a surviving spouse or, if there is no surviving spouse, to other qualifying dependants. Effective for deaths after 1998, this relief for the deceased's estate for distributions to other qualifying dependants will now be available even if there is a surviving spouse. On election, the measure will be retroactive for deaths that occurred after 1995. Other special transitional measures will apply to defined situations involving pre-1999 distributions.
Retroactive lump-sum payments
A retroactive lump-sum payment, such as an arbitration award, is currently taxable to the recipient in the year the payment is received. In some cases, this can result in more income tax than would have been payable had the payment been taxed in the year it was earned. Under the budget proposals, individuals receiving qualifying lump-sum payments of $3,000 or more after 1994 will be allowed to use a special mechanism to compute the income tax as if the payment had been received in the year to which it relates. Interest to reflect the delay in payment will be factored into the tax relief.
Child tax benefit
Enhancements to the Canada Child Tax Benefit (CCTB) and the National Child Benefit supplement were announced in the 1997 and 1998 federal budgets. The budget proposes further enrichments for 1999 and 2000.
Medical and disability
The list of expenses eligible for the medical expense tax credit for persons with disabilities is extended.
Income Splitting with Minor Children
New measures will apply to prevent individuals from splitting income with minor children commencing in the year 2000. Certain types of income will be carved out of a child's taxable income and taxed separately at top marginal rates. In calculating the tax payable on the targeted income, no deductions or personal credits may be claimed other than the dividend tax credit and the foreign tax credit. As a result, any income splitting advantages will be eliminated.
The changes are aimed at two types of income:
- taxable dividends earned by a minor child, whether directly or through a trust for the child's benefit. This change will apply, for example, to dividends paid on shares in a family-owned business that are owned by a minor child or a trust for the child's benefit;
- income earned by a minor child through a partnership or trust and derived from the provision of goods or services to a business carried on by:
- a person related to the child;
- a professional corporation of which the related person is a shareholder; or
- any other corporation of which the related person is a specified shareholder.
This change will apply, for example, to corporations or partnerships that provide management and administrative services to a professional's practice or other business if the income from providing those services accrues to a related minor child.
Corporate Tax Measures
The 12% surcharge imposed on the capital tax payable under Part VI by large financial institutions (excluding life insurers) has been extended to October 31, 2000. This is the fourth one-year extension of what was intended to be a "temporary tax."
Electricity generating sector
The 7% manufacturing and processing tax credit has been extended to corporations that produce electrical energy or steam for sale. Access to the credit will be phased in over four years, beginning in 1999.
Capital cost allowance (CCA)
Electrical generating equipment using solution gas otherwise flared during the production of crude oil will be eligible for CCA Class 43.1 (30% CCA rate). This change applies to property acquired after February 16, 1999.
Interest offset on tax overpayments and underpayments
After 1999, corporations will be permitted to offset refund interest on income tax overpayments and interest owing on unpaid income tax. This long-overdue measure is intended to eliminate the inequity that may arise because refund interest is taxable yet arrears interest is non-deductible.
Excise tax on tobacco industry
The annual exemption threshold from the excise tax on exports of Canadian tobacco products will be reduced from 3% to 2.5% of a manufacturer's production in the preceding year, effective for exports made after March 31, 1999.
Labour-sponsored venture capital corporations (LSVCCs)
Investment in small businesses
Several measures deal with a LSVCC's investments in small businesses: 150% of the investment in an Ontario Community Small Business Investment Fund (CSBIF) and 200% of the investment in an eligible business with assets of $2.5 million or less will count towards an LSVCC's federal business investment requirement;
- a federal tax will be imposed on federally registered LSVCCs to match the Ontario tax payable by investors in a CSBIF that fails to meet its investment requirement; and
- the period during which an LSVCC is exempt from the federal business investment requirement will be reduced from five years to two years, and will be further reduced, if the LSVCC so elects.
Consequential on Québec's proposal to allow funds invested in LSVCCs to be used under the Home Buyers' Plan and the Lifelong Learning Plan, the budget provides that the Québec rules applicable to the purchase of replacement shares in LSVCCs will also apply for federal purposes.
The budget proposes additional measures that give rise to tax consequences when there is a change of attributes of LSVCC shares, an amalgamation or merger involving a federally-regulated LSVCC or the voluntary deregistration of an LSVCC.
Non-Resident Trusts and Foreign Investment Funds
New rules deal with the taxation of non-resident trusts and offshore investment funds. In certain cases, Canadian residents are able to avoid Canadian tax by transferring or loaning property to offshore trusts that have no Canadian resident beneficiaries. To address this concern, all such trusts will be treated as residents of Canada and will be subject to Canadian tax on their accumulating income. This rule will apply whether or not the non-resident trust has beneficiaries who are resident in Canada. The Canadian resident transferor will be jointly liable (with the trust) for the trust's Canadian tax liability. Rules similar to existing foreign accrual property income (FAPI) rules for investments in controlled foreign affiliates will be applied to "foreign investment funds." Anti-avoidance rules that historically applied to offshore funds are now viewed as largely ineffective. A "foreign investment fund" will include a non-resident corporation, trust or other entity if more than 50% of the cost of its ssets are investment properties. Taxpayers will be subject to tax on either their pro rata share of the fund's undistributed income or on a "mark-to-market" basis, with increases or decreases in the market value of their investment being added to or deducted from income.
The rules for both non-resident trusts and foreign investment funds will be subject to exceptions for temporary residents, new immigrants, and bona fide vehicles not intended to avoid or defer Canadian tax (e.g., trusts and funds situated in the United States).
Non-Resident Funds with Canadian Advisors
New rules clarify that foreign investment funds will not be considered to be carrying on business in Canada merely by engaging Canadian advisors to provide investment management, advisory or administrative (so-called "back office") functions. For the rules to apply, the foreign fund must not sell units to Canadian resident investors. In addition, the foreign fund must establish that it deals at arm's-length with the Canadian advisors, or, failing the arm's-length test, that the fund's investment activities are passive in nature (based on an investment turnover test). These rules are intended to put Canadian service providers on an equal footing with service providers in the United States and United Kingdom. Rules in both of those jurisdictions specify circumstances in which foreign funds will not be subject to domestic taxation.
Civil Penalties for Misrepresentations by Third Parties
New civil penalties apply to third parties who make false statements or omissions. The new penalties will apply to a person who:
- plans, promotes or sells an arrangement that contains a false statement that may be used for tax purposes, (the penalty being the greater of $1,000 and 100% of the promoter's gross revenue in respect of the arrangement); or
- makes or participates in the making of a false statement or omission, by or on behalf of another person, that may be used for tax purposes, (the penalty being the greater of $1,000 and 50% of the amount of tax sought to be avoided or refunded).
What Mr. Martin Did Not Do
Mr. Martin's budget did not:
- provide substantial reductions in public debt;
- provide a substantive response to the mounting criticism (both inside Canada and beyond) of our individual tax system, particularly the high marginal rates and absence of full indexing of tax brackets and credits;
- remove the 5% surtax on Canadians earning taxable income of about $65,000 or more;
- respond in any way to the substantive corporate recommendations presented in the April 1998 report of the Technical Committee on Business Taxation; in fact, that report continues to be largely ignored by the government;
- accelerate promised increases in RRSP and pension plan contribution limits, currently scheduled for nominal increases only beginning in 2003 and 2004 respectively;
- ease the existing 20% foreign investment restriction on pensions and RRSPs.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a PricewaterhouseCoopers LLP professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your PricewaterhouseCoopers LLP advisor, or:
David W. Steele PricewaterhouseCoopers LLP Royal Trust Tower, P.O. Box 82 Toronto, Ontario M5K 1G8 Canada Fax: 1-416-365-2725 E-mail: email@example.com
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