Originally published March 2010
On March 4, 2010, the federal government tabled its Budget. This bulletin summarizes the principal income tax measures affecting businesses contained in the Budget.
A. TAX RATES
Budget 2010 contains no changes to corporate and personal tax rates.
B. DOMESTIC CORPORATE TAXATION
SIFT Conversion and Loss Trading
Where control of a corporation is acquired, tax losses realized by the corporation arising in a pre-acquisition of control period may generally not be used to reduce tax payable in respect of a post-acquisition of control period. A special rule in the Income Tax Act (the "Act") generally deems an acquisition of control of a corporation (and its subsidiaries) to occur where the corporation issues shares in consideration for the shares of a target corporation in a "reverse takeover", e.g. where the shareholders of the target collectively receive shares of the acquirer representing, in the aggregate, control of the acquirer. Budget 2010 proposes to enact a similar rule to deem an acquisition of control of a corporation that issues shares in consideration for interests in a SIFT trust, a SIFT partnership or a real estate investment trust. This rule will effectively preclude transactions whereby an income trust converts to a corporation using a "lossco", in order to shelter further income with such losses.
Budget 2010 also proposes to ensure that the losses of a corporation whose shares are distributed on the winding-up of a SIFT trust whose sole beneficiary is a corporation will not be restricted under the "acquisition of control rules".
These rules apply to transactions undertaken after 4 p.m. Eastern Standard Time on March 4, 2010, other than transactions that the parties are obligated to complete pursuant to the terms of an arrangement in writing entered into before that time. By election, these provisions may also apply to transactions completed or agreed to in writing before that time.
Taxation of Corporate Groups
The federal government stated that it will consider introducing measures to make the taxation of corporate groups more efficient. Budget 2010 cited as examples of possible measures the introduction of a formal system of loss transfers and consolidated reporting. Consultation with stakeholders is expected prior to any changes.
Mineral Exploration Tax Credit
The 15% investment tax credit for flow-through mining expenses has been an important incentive for new investment in junior mineral exploration companies in Canada. First introduced in 2000, the measure has been extended by each budget every year since 2004. Budget 2010 extends it for another year. The tax credit will be available to flow-through share agreements entered into on or before March 31, 2011. Under the "look-back rule", funds raised with the benefit of the credit before April 2011 can be spent on mineral exploration up to the end of 2012.
Tax Incentives Relating to Clean Energy Generation
Specified clean energy generation and conservation equipment is generally eligible for a 50% declining-balance CCA rate. Budget 2010 proposes to expand the class of assets that qualify for this rate by broadening the range of qualifying heat recovery equipment and including specified distribution equipment that is part of a district energy system relying primarily on ground source heat pumps, active solar systems or heat recovery equipment. This measure will apply to eligible assets acquired on or after March 4, 2010 that have not been used or acquired for use before that date.
Budget 2010 also proposes to expand the list of corporations that are permitted to renounce certain start-up costs (Canadian Renewable and Conservation Expenses) to investors using flow-through shares to include corporations whose principal business is producing fuel and/or generating or distributing energy using specified clean energy generation equipment. This measure will apply in respect of taxation years ending after 2004.
Specified Leasing Property
To combat what is viewed as an improper use of some of the "specified leasing property rules" in order to claim capital cost allowance in respect of certain property leased to a lessee that is not subject to income tax in Canada, Budget 2010 proposes to extend the application of the "specified leasing property rules" to otherwise exempt property that is leased to a tax-exempt entity or to a non-resident pursuant to a lease entered into after 4:00 p.m. Eastern Standard Time on March 4, 2010.
Interest on Overpaid Taxes
Interest paid by the federal government on an overpayment of taxes is currently equal to the average yield of three-month Government of Canada Treasury Bills sold in the first month of the preceding quarter plus 2 percentage points. Following concerns expressed by the Auditor General, Budget 2010, effective July 1, 2010, proposes to remove the additional 2 percentage points from interest paid by the government to corporations on most taxes and levies, including income taxes, goods and services tax, harmonized sales tax and employment insurance premiums.
Television Set-top Boxes – Capital Cost Allowance
Satellite and cable set-top boxes that are acquired after March 4, 2010 and that have neither been used nor acquired for use before March 5, 2010 will be eligible for a declining-balance capital cost allowance rate of 40%.
C. EMPLOYEE STOCK OPTIONS
Budget 2010 contains important measures relating to the tax treatment of stock options.
Stock Option Cash-outs
An employee who has acquired securities of his employer under a stock option agreement is generally deemed to receive a taxable employment benefit equal to the difference between the fair market value of the security at the time of exercise and the amount paid by the employee to acquire the security. The employee may be permitted to claim a deduction (the "stock option deduction") equal to one-half of the benefit provided that certain conditions are met. The same rules may apply where an employee "cashes out" his option rights, i.e., disposes of the option for cash instead of exercising the option to acquire securities.
An employer is prevented from claiming a deduction where it sells or issues shares pursuant to an employee stock option. However, it is possible to structure employee stock option agreements so that, if employees elect to cash out their stock option rights for a cash payment from the employer, the benefit is eligible for the stock option deduction by the employee, while the cash payment is fully deductible by the employer. Accordingly, both an employer and an employee are entitled to a deduction in respect of a payment made to cash out the employee's option. Budget 2010 proposes to prevent this result by denying the stock option deduction to an employee who cashes out his option rights unless the employer makes an election to forego the deduction in respect of the cash-out payment.
These measures will apply to dispositions of employee stock options that occur after 4:00 p.m. Eastern Standard Time on March 4, 2010.
Other Proposals Affecting Employee Stock Options
Budget 2010 also proposes the following measures relating to the taxation of employee stock options:
Budget 2010 repeals the rules that permit an employee of a non-Canadian controlled private corporation to defer tax that would otherwise arise when the option is exercised on certain stock option benefits (up to an annual limit of $100,000) until such time as the acquired securities are sold. The repeal of the tax deferral election applies to employee stock options exercised after 4:00 p.m. Eastern Standard Time on March 4, 2010.
Budget 2010 proposes to provide relief to taxpayers who, under the current rules described above, elected to defer tax on stock option benefits and, due to falling share prices, realize insufficient proceeds of disposition on the optioned securities to pay the deferred tax liability. Under the proposal such taxpayers may generally elect to instead pay a special tax equal to the amount of the proceeds of disposition of the optioned securities (2/3 of the amount of the proceeds for residents of Quebec). In addition, electing taxpayers will be deemed to realize a capital gain designed to offset the benefit of any capital loss actually realized on the disposition of the optioned securities. Individuals who disposed of their optioned securities before 2010 will have to make an election for this special treatment on or before their filing due date for the 2010 taxation year (generally April 30, 2011) and individuals who have not disposed of their optioned securities before 2010 must do so before 2015. They will then have until their filing due date for the taxation year of disposition to make an election for this special treatment. It is worth noting that in the context of stock option benefits for employees of Canadian-controlled private corporations where the deferral of the benefits is automatic rather than elective, similar hardship may potentially result and Budget 2010 does not propose to provide relief in these circumstances.
Budget 2010 proposes to clarify that an employer is generally required to withhold and remit tax in respect of stock option benefits paid to an employee for the period that includes the issuance date of the security. If the stock option deduction applies in respect of the benefit, the amount required to be withheld is reduced by one-half. No source deduction is required at the time of exercise if the rule permitting tax deferral on options granted by a Canadian-controlled private corporation applies. The clarifications to remittance requirements will apply to benefits arising on the issuance of securities after 2010. The proposed tax remittance measure will not apply in respect of options granted before 2011 pursuant to an agreement in writing entered into before 4:00 p.m. Eastern Standard Time on March 4, 2010 where the agreement included, at that time, restrictions on the disposition of the optioned securities.
D. INTERNATIONAL TAXATION
Section 116 and Taxable Canadian Property
Non-residents are subject to tax in Canada on income and gains from the disposition of "taxable Canadian property" unless relief is available under an applicable tax treaty. Budget 2010 proposes to amend, effective after March 4, 2010, the definition of "taxable Canadian property" to generally exclude shares of any corporation, whether or not listed, unless more than 50% of the value of the shares is derived from one or any combination of real property situated in Canada, Canadian resource properties, timber resource properties or options or interests in any of the foregoing. In the case of corporations whose shares are listed on a designated stock exchange, Budget 2010 retains as an additional requirement that the holder, alone or together with non-arm's length persons, must have held 25% or more of any class of shares of the corporation at any time in the 60-month period before the disposition.
As a result of this proposal, non-residents will no longer be subject to tax in Canada on capital gains realized on the disposition of shares that would have been taxable Canadian property and would not otherwise have been exempt from tax in Canada by reason of the application of a tax treaty.
In addition, there will be no withholding and remittance requirements under section 116 of the Act for dispositions of shares that are now excluded from the definition of taxable Canadian property.
Foreign Tax Credit Generators
Budget 2010 closes the door on what are perceived to be schemes that artificially generate foreign tax credits or foreign tax deductions used to shelter income of a Canadian corporation on loans made, indirectly, to foreign corporations. To this end, measures will be adopted to deny claims for foreign tax credits, foreign accrual tax deductions and underlying foreign tax deductions in certain circumstances.
E. FOREIGN INVESTMENT ENTITIES AND NON-RESIDENT TRUSTS
The federal government announced in Budget 2009 that it would review the outstanding proposals relating to non-resident trusts ("NRT") and foreign investment entities ("FIE"). Budget 2010 announces revised proposals that replace the existing proposals and that will be the basis of legislative amendments to be released for comment.
Budget 2010 announces that the federal government will not continue with the outstanding proposals on FIEs. The current rules, referred to as the "offshore investment fund property rules" (which were supposed to be replaced by the FIE rules), will continue to apply with the following proposed modifications:
- the prescribed rate of interest applicable to the cost of an offshore investment fund property of a taxpayer will be increased and will now be equal to the three-month-average Treasury Bill rate plus two percentage points;
- the reassessment period in respect of offshore investment fund property and interest in NRTs will be extended by three years and the reporting obligations will be expanded.
The proposed modifications will apply for taxation years ending after March 4, 2010. A taxpayer who voluntarily complied with the outstanding FIE proposals in previous years may have those years reassessed or, at his option, claim a deduction in the current year for any excess income that he may have reported under the proposals.
The federal government announced its intention of enacting the outstanding proposed NRT rules, subject to substantial modifications announced in Budget 2010, including measures to:
- ensure that tax-exempt entities under the Act are not subject to the NRT rules unless they are used as a conduit to permit a Canadian resident to indirectly contribute to a NRT;
- allow what are viewed as bona fide commercial trusts to be exempt under the NRT rules;
- permit loans from Canadian financial institutions in the ordinary course of business to non-resident trusts without causing the trust to become resident in Canada under the NRT rules;
- exclude from the income of the trust, for Canadian tax purposes, income derived from property that was not contributed by a Canadian resident or certain former residents or property substituted therefor;
- attribute to a Canadian resident contributor its proportionate share of the trust's income for Canadian tax purposes, based on the fair market value of its contribution to the trust, and tax such resident contributor on such income instead of the trust. The NRT's liability for Canadian income taxes under the new rules would therefore be limited to income taxes on income derived from contributions by former Canadian residents and taxes that are otherwise levied on Canadian-sourced income of non-residents.
The proposed modifications will apply for the 2007 and subsequent taxation years. However, the attribution of the NRT's income to Canadian resident contributors will apply only to taxation years ending after March 4, 2010.
F. CHARITIES – MAJOR REFORM OF THE DISBURSEMENT QUOTA
Budget 2010 proposes major changes to a charity's disbursement quota. A charity must currently expend in any taxation year, on charitable activities, amounts at least equal to its disbursement quota. Generally speaking, the disbursement quota of a charity for a taxation year represents (i) 80% of the amount of gifts received by the charity in the previous year for which a tax receipt was issued by the charity or received from another charity (other than a specified gift or a gift of an enduring property, for example, a gift received by way of bequest or inheritance or a gift made subject to a direction that it be held by the charity for a period of at least 10 years) and (ii) 3.5% of the assets of the charity over $25,000 which are not used in charitable programs or administration.
In order to simplify the administration of charities and in light of the fact that the CRA has already issued guidelines regarding appropriate fundraising activities for a charity, Budget 2010 proposes to eliminate from the disbursement quota the 80% of gifts component, leaving only the 3.5% of assets component. Gifts of enduring property are therefore no longer relevant for charities.
For taxation years ending on March 4, 2010 or later, charities will therefore only be required to expend 3.5% of all assets over $25,000 not currently used in charitable programs or administration. Budget 2010 proposes to increase the $25,000 exemption to $100,000 for charitable organizations only. However, private and public foundations would still be subject to the $25,000 exemption.
Given these proposed modifications, Budget 2010 also proposes to strengthen the existing anti-avoidance rules dealing with the transfer of property between non-arm's length charities seeking to satisfy their disbursement quota. Budget 2010 also announces that the effectiveness of the CRA's guidance on acceptable fundraising activities will be monitored to ensure that its stated objectives are achieved.
G. OTHER MEASURES OR ANNOUNCEMENTS OF INTEREST
" Budget 2010 announced a public consultation regarding proposed rules to combat aggressive tax planning by requiring the reporting of certain transactions. In general terms, the rules would require taxpayers to report to the CRA an "avoidance transaction" (as defined in the Act) that bears at least two of the three following "hallmarks":
- the amount of fees payable to a promoter relate to the amount of the tax benefit obtained from the transaction;
- a promoter requires "confidential protection" about the transaction; and
- the taxpayer or a person who enters into the transaction on the taxpayer's behalf obtains "contractual protection" in respect of the transaction. Failure to report a reportable transaction could result in denial of the associated tax benefit unless the taxpayer pays a penalty and provides the required information.
- Budget 2010 confirms the government's intention to implement the proposed simplified GST/HST accounting method for the direct selling industry which was announced in Budget 2009, with certain enhancements.
- Budget 2010 proposes to eliminate the remaining customs tariffs on manufacturing inputs and machinery and equipment.
H. PREVIOUSLY ANNOUNCED INCOME TAX MEASURES
Budget 2010 confirms the government's intention to proceed with the following previously announced tax measures, as modified to take into account consultations and deliberations since their release:
- modifications to the Tax-Free Savings Account rules announced on October 16, 2009;
- increased flexibility for employer funding of registered pension plans by increasing the pension surplus threshold;
- measures released in draft form on December 18, 2009 relating to the income taxation of shareholders of foreign affiliates, as well as the remaining measures released in a previous draft relating to foreign affiliates;
- the income tax technical and bijuralism amendments that were previously released but not yet implemented.
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