Copyright 2009, Blake, Cassels & Graydon LLP
Originally published in Blakes Bulletin on Tax, January 2009
With numerous spending initiatives released in the days leading up to the January 27, 2009 federal budget (the Budget), many wondered whether the tabling of the Budget itself would be anti-climactic. The dollar amount of such measures and the impact of this cost on the government's finances will undoubtedly attract the lion's share of attention in coming days. However, the Budget did contain a few significant and positive tax proposals.
a) Repeal of Section 18.2
Perhaps the most significant corporate tax proposal contained in the Budget was the repeal of the so-called "Anti-Tax Haven Initiative" in section 18.2 of the Income Tax Act (Canada) (the Tax Act) before it becomes effective in 2012.
Originally intended to have much broader application, this controversial provision attracted much criticism even after enactment in a much more limited form. As enacted, section 18.2 was applicable to certain types of "double-dip" structures used by Canadian companies to finance their foreign subsidiaries. The provision challenged a longstanding principle that permits the deduction of interest on funds borrowed to invest in shares of a foreign company. The Advisory Panel on Canada's System of International Taxation (the Advisory Panel), in its Report released in December 2008, joined many organizations in urging the repeal of this provision. This recommendation was made, in part, because it was felt that section 18.2 would put Canadian companies at a competitive disadvantage to their foreign competitors.
There is no indication in the Budget documents as to whether the Department of Finance will introduce any proposals in the future aimed at dealing with double-dip financings.
b) Foreign Investment Entity (FIE) and Non-Resident Trust (NRT) Proposals
First introduced a decade ago, the FIE and NRT proposals have had almost as tortured and a much longer history than section 18.2. The ultimate fate of these proposals, however, remains an open question as the Budget documents indicate that they will be reviewed in light of the many submissions received concerning their complexity, uncertainty and breadth. The Advisory Panel, in recommending that the FIE and NRT proposals be reconsidered, noted the issues surrounding the integration of these proposals with the foreign affiliate rules.
c) Outstanding Foreign Affiliate Proposals
The Advisory Panel's recommendations included some far-reaching suggestions relating to the treatment of income from foreign affiliates, as well as capital gains on the disposition of shares of foreign affiliates. The Budget documents announced that the government will consider the Advisory Panel's recommendations before proceeding with the existing backlog of foreign affiliate amendments, originally proposed in 2004 but not yet enacted. While this is a welcome development, it means additional uncertainty in this area.
Without a doubt, the people in the Department of Finance dealing with these proposals, and the NRT and FIE proposals, have a busy year ahead.
d) Other Recommendations of the Advisory Panel
The Budget states that other recommendations of the Advisory Panel are being studied. These recommendations were described in our December 2008 Blakes Bulletin on Tax: Changing the Borders – Report of Canadian Advisory Panel on International Taxation and included recommendations to amend the thin-capitalization rules that limit deduction by corporations of interest on debt owing to significant shareholders and modifying withholding tax procedures on certain payments made to non-residents in respect of services rendered in Canada on sales of property. Recommendations to amend the thin-capitalization rules would have such rules apply to Canadian branches of foreign corporations and would reduce the debt-to-equity ratio used in the determination of thin-capitalization from 2.0:1 to 1.5:1.
a) Acquisition of Control – 'La Survivance' Legislatively Overturned
The Budget proposes an amendment to subsection 256(9) of the Tax Act, which generally deems an acquisition of control of a corporation to occur at the commencement of the day on which such control is actually acquired. It is proposed that this deeming provision not apply for purposes of determining if a corporation is, at any time, a "small business corporation" or a "Canadian-controlled private corporation" (a CCPC).
The purpose of this amendment is to address unintended effects that can result from the strict interpretation of the rule in subsection 256(9) endorsed by the Federal Court of Appeal in La Survivance v. R. The interpretation accepted in that decision meant that where control of a corporation that would otherwise be a small business corporation and a CCPC is deemed to have been acquired by a non-resident at the commencement of the day, but the actual sale giving rise to the acquisition of control does not occur until later in the day, the corporation would not be a small business corporation or a CCPC at the time of the sale. This would affect the vendor's eligibility for the lifetime capital gains exemption under section 110.6 of the Tax Act in respect of the sale or the classification of a capital loss realized on the sale as an allowable business investment loss.
The proposed amendment to subsection 256(9) is intended to prevent this result by ensuring that the deeming rule therein does not affect the status of a corporation as a CCPC or a small business corporation at the time of sale.
The proposed amendment will apply retroactively in respect of acquisitions of control that occur after 2005, except for acquisitions that occur before January 28, 2009 in respect of which the taxpayer elects, or is deemed to have elected, on or before the taxpayer's filing due date for the 2009 taxation year that this new measure will not apply. A taxpayer who has relied upon the interpretation endorsed in La Survivance in filing a tax return, a notice of objection or an appeal will be deemed to have made this election.
b) Capital Cost Allowance Measures
The Budget proposes a temporary 100% capital cost allowance (CCA) rate applicable to new computer hardware and systems software generally described in Class 50 and acquired after January 27, 2009 and before February 1, 2011. The "half-year rule" which generally limits the amount of CCA that may be claimed in the year of acquisition will not be applicable to such purchases. Certain conditions relating to the use of such property in Canada must be met, and the Budget documents indicate that the computer tax shelter rules will be applicable to computer equipment eligible for this 100% CCA rate.
The acquisition of qualifying equipment used primarily in manufacturing and processing in Canada is currently eligible for a 50% CCA rate on a straight-line basis. This temporary measure, originally proposed in the 2007 Budget and extended in 2008, was set to expire at the end of 2009 and be replaced by a 50% rate applicable on a declining balance basis for 2010 and 2011. (Proposed regulatory amendments to implement the original 2007 proposal were introduced in February 2008, but have not yet been enacted.) The Budget proposes extending the 50% CCA rate on a straight line basis for 2010 and 2011. However, the half-year rule will be applicable on such measure.
Finally, the Department of Finance will be consulting with stakeholders with a view to providing accelerated CCA treatment to qualifying property used in carbon capture and storage. The Budget documents do not set out when such an initiative may be expected to be put in place.
c) Small Business Deduction
The Budget increases the base amount of active business income of a CCPC eligible for the small business deduction under subsection 125(1) of the Tax Act (the small business limit) from C$400,000 to C$500,000 as of January 1, 2009. The increase to the small business limit will be pro-rated for corporations with taxation years that do not coincide with the calendar year.
A CCPC's eligibility for the small business deduction will continue to be reduced on a straight-line basis for corporations with taxable capital employed in Canada between C$10-million and C$15-million.
Hopefully the provinces will follow suit and increase provincial small business limits.
d) Mandatory Electronic Filing
Corporate Income Tax Returns
The Budget also includes procedural amendments to the Tax Act which will require corporations that meet certain prescribed conditions to file their tax returns electronically. The proposed amendments in the Budget do not include a detailed description of the conditions that will apply, but indicate that the electronic filing requirements will apply to corporations with annual gross revenues in excess of C$1-million for a taxation year. Exceptions may be made available by the Canada Revenue Agency for certain qualifying corporations such as non-resident corporations, insurance corporations and corporations filing in a functional currency.
The new electronic filing requirements for corporate tax returns will apply for taxation years ending after 2009. The Budget also introduces a penalty, applicable for taxation years ending after 2010, for taxpayers who fail to comply with the new requirement. The amount of the penalty is C$250 for taxation years ending in 2011, C$500 for taxation years ending in 2012, and C$1,000 for taxation years ending after 2012.
In keeping with the objective of improving efficiency through increased electronic filing, the threshold number of information returns required for mandatory electronic filing will be reduced from 500 to 50.
A new graduated penalty structure for failure to file information returns on time or in the correct form is also proposed. The maximum penalties under the proposed structure will be determined using fixed brackets based on the number of returns required to be filed. This would be a welcome change from the current regime, which imposes penalties on a per-failure basis and can therefore result in excessive penalties where a large number of information returns is involved.
These measures will apply to information returns required to be filed after 2009.
Personal Tax Measures
a) Tax Brackets and Personal Amounts
The Budget proposes increasing the two lowest personal tax brackets and the basic personal amount by 7.5% from their 2008 levels. The ceiling for the first personal income tax bracket (taxed at a 15% federal rate) will be raised from the 2008 level of C$37,885 to C$40,726 for 2009. The ceiling for the second bracket, in which income is taxable at a 22% federal rate, will be raised from its 2008 level of C$75,769 to C$81,452 for 2009.
The basic personal amount, the spousal and common-law partner amount and the eligible dependant amount will all be increased from their 2008 levels of C$9,600 to C$10,320 in 2009.
These increased thresholds and amounts will be indexed for inflation for 2010 and subsequent years.
b) Mineral Exploration Tax Credit
The mineral exploration tax credit, which is currently scheduled to expire at the end of March 2009, allows individuals who have invested in qualifying flow-through shares to obtain a tax credit equal to 15% of specified mineral exploration expenses incurred in Canada by the issuer of the shares and renounced to such investors. The Budget proposes extending its eligibility by one year, to flow-through share agreements entered on or before March 31, 2010.
c) Housing Related Measures
Home Renovation Tax Credit
The Budget introduces a new limited duration 15% non-refundable tax credit (the HRTC), which will be available in respect of "eligible expenditures" made in respect of an "eligible dwelling" (generally, a dwelling that is eligible to be an individual's principal residence). The HRTC will apply to expenditures in excess of C$1,000, but not more than C$10,000, resulting in a maximum credit of C$1,350 (C$9,000 x 15%). This limit will apply to the pooled expenditures of each family unit, generally consisting of an individual, the individual's spouse or common-law partner, and their children who were, throughout 2009, under 18 years of age.
Eligible expenditures for purposes of the HRTC are generally defined as expenditures incurred in relation to a renovation or alteration of an eligible dwelling that are of an enduring nature and are integral to the eligible dwelling. Routine repair costs and similar expenditures will be excluded.
The HRTC will apply only to the 2009 taxation year and only in respect of eligible expenditures for work performed or goods acquired after January 27, 2009 and before February 1, 2010. The credit will not be available in respect of expenditures made pursuant to an agreement entered into before January 28, 2009. The Budget estimates that the HRTC will cost C$500-million in 2008-2009 and C$2.5-billion in 2009-2010.
Home Buyers' Plan
The Budget proposes to increase the amount that first-time home buyers may withdraw from an RRSP to purchase or build a home without paying tax on the withdrawal from C$20,000 to C$25,000. This increase will apply to 2009 and subsequent years in respect of withdrawals made after January 27, 2009.
First-Time Home Buyers' Tax Credit
In addition to the enhancement to the Home Buyers' Plan described above, the Budget also introduces a new non-refundable tax credit equal to 15% of qualifying costs associated with purchasing a "qualifying home", such as legal fees, disbursements and land transfer taxes (up to a maximum credit of C$750 or C$5,000 of qualifying costs) where the closing of the purchase occurs after January 27, 2009.
A qualifying home is one that is eligible for the Home Buyers' Plan that the individual or the individual's spouse or common-law partner intends to occupy as their principal place of residence not later than one year after its acquisition.
RRSP/RRIF Withdrawals After Death
The Tax Act generally requires the fair market value of the investments in a taxpayer's RRSP and RRIF at the time of his or her death to be included in the taxpayer's income for the year of death. Any reduction in value of the RRSP or RRIF investments on the disposition or distribution of such investments by the estate of the deceased taxpayer cannot currently be carried back and applied to the income of the deceased taxpayer in the year ending with his or her death. The Budget proposes allowing such post-death decreases to be carried back against the deceased taxpayer's year-of-death RRSP/RRIF income inclusion. This measure will apply in respect of deceased annuitants where the final distribution from the RRSP/RRIF occurs after 2008.
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.