Canada: Federal Budget Commentary 2019 – Business Income Tax Measures

Scientific Research & Experimental Development (SR&ED)

Canadian-controlled private corporations (CCPCs) or associated groups of such corporations, are entitled to an enhanced (35 per cent vs 15 per cent) federal tax credit based on up to $3,000,000 of current SR&ED expenditures incurred in a taxation year (the "expenditure limit"), based on the following criteria:

  • A full enhanced credit is available if the taxable income in the previous taxation year of the particular corporation or the associated group is $500,000 or less.
  • $10 of the expenditure limit is lost (thereby eroding the enhanced credit) for every dollar of taxable income in the previous taxation year in excess of $500,000. The expenditure limit is reduced to zero if that taxable income exceeds $800,000.

The enhanced credit is also eroded if the corporation's (or the group's) "taxable capital employed in Canada" (essentially the aggregate of equity and debt) exceeds $10,000,000 and is eliminated if that taxable capital exceeds $50,000,000.

The Budget proposes to remove the erosion that is based on taxable income.

This proposal would apply to taxation years that end on or after March 19, 2019.

Support for Canadian Journalism

The Budget proposes to introduce the following measures to support organizations that are "Qualified Canadian Journalism Organizations" (QCJOs).
Effective January 1, 2020, QCJOs will be allowed to register for tax-exempt status as "qualified donees" that can issue charitable receipts. A QCJO must be a corporation or trust whose activities relate exclusively to journalism, is controlled by arm's-length persons and satisfies other conditions.

Retroactive to January 1, 2019, certain QCJOs will be eligible for a 25 per cent refundable tax credit on remuneration paid to eligible newsroom employees. The remuneration eligible for the credit will be capped at $55,000 per year per employee. The QCJO must be a corporation, partnership, or trust primarily engaged in the production of original written news content. Corporations must meet additional criteria.

Canadian Film or Video Production Tax Credit

This 25 per cent refundable tax credit is generally available, within limits, to qualified corporations that incur qualified labour expenditures in connection with an eligible Canadian film or video production.
Retroactive to March 12, 2018, joint Canada/Belgium productions will qualify for the credit.

Small Business Deduction — Farming and Fishing

A CCPC is generally entitled to pay federal tax at the small business rate, which is currently 9 per cent, on its first $500,000 of income from an active business carried on in Canada, provided that the $500,000 threshold is not reduced, nor the income in question restricted, under various rules of the Income Tax Act. Where income is not eligible for the small business deduction, a federal corporate tax rate of 15 per cent would apply instead.
Enacted in 2016, one such restriction prohibits specified corporate income (SCI) of a CCPC from being taxed at the small business rate. SCI generally encompasses income that the CCPC derives from the provision of services or property to private corporations in which the CCPC or other certain persons hold a direct or indirect interest. However, since the inception of the SCI rules, certain income that a CCPC derives from sales to a farming or fishing cooperative corporation is excluded from the definition of SCI.

Budget 2019 proposes to broaden the above-mentioned exclusion from the SCI rules. In particular, the sale of the farming products or fishing catches would no longer need to be made to a farming or fishing cooperative corporation, but merely to an arm's-length corporation.

This measure will apply to taxation years beginning after March 21, 2016.

Zero-Emission Vehicles

The Budget proposes to introduce a temporary enhanced first-year CCA rate of 100 per cent in respect of eligible zero-emission vehicles. These vehicles will be classified under one of two new CCA classes.

Class 54 will include zero-emission vehicles that would otherwise be included in Class 10 or 10.1. The amount on which CCA can be claimed is limited to a maximum of $55,000 plus sales taxes, per vehicle.

Class 55 will include zero-emission vehicles that would otherwise be included in Class 16.

This measure will apply to eligible zero-emission vehicles acquired on or after March 19, 2019, and that become available for use before 2028, subject to a phase-out for vehicles that become available for use after 2023. The taxpayer must claim the enhanced CCA for the taxation year in which the vehicle first becomes available for use.
The Budget proposes to amend the GST/HST rules to ensure consistency with these measures.

Character Conversion Transactions — Converting Income to Capital Gains

Capital gains are taxed at half the rate of regular income and typically at a substantially lower rate than dividend income. Consequently, where a choice is available without a change in risk, investors have a bias to earn capital gains.

In addition, an election is available to most Canadian investors to treat all Canadian securities as capital property. If one elects, all gains on dispositions of Canadian securities are treated as capital gains or losses from the year of election onwards.

To earn capital gains instead of income, taxpayers wishing to earn a return from a reference portfolio of investments (which could include both Canadian and foreign investments) that produce fully taxable income could, instead of holding the reference portfolio, enter into a derivative agreement (a forward purchase contract) to acquire Canadian securities at a future date at a specified price. The value of the Canadian securities to be acquired under the derivative agreement could be determined based on the returns that would have been realized on the reference portfolio. The investor would acquire the Canadian securities at the agreed price, then immediately sell the Canadian securities at their fair market value, realizing a capital gain or loss.

Before 2013, the mutual fund industry offered investment platforms that allowed investors to realize capital gains instead of income from underlying investments. This was accomplished using derivatives.

In 2013, legislation was enacted to treat gains from "derivative forward agreements" as income rather than capital gains. These are agreements for terms that exceeded 180 days and where the difference in the fair market value of the securities delivered on closing and the predetermined amount paid for those securities was derivative in nature — that is derived from some other reference portfolio or investment.

A "commercial transaction" exception to the derivative forward agreement rules was in place where the economic return was based on the performance of the actual property being purchased or sold in the future. This exception is needed so that normal commercial transactions such as business acquisitions were not caught.

The mutual fund industry has since developed structures that allowed the investor to acquire and sell the reference portfolio on closing. Since the return from the transaction was based on the reference portfolio, and it was the reference portfolio being sold, the gain was not "derived" from another portfolio — the commercial transaction exception applied. The disposition was still treated as a capital gain or loss.

The Budget proposes to deny the commercial transaction exception where it is reasonable to conclude that one of the main purposes of the series of transactions is to convert into a capital gain any income that would have been earned on the security during the period that the security is subject to the forward agreement.

The new rule applies to transactions/agreements entered into on or after March 19, 2019. Starting in 2020, it will also apply to agreements entered into prior to March 19, 2019.

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.

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