An extensive package of draft legislative proposals was released for public comment by the Department of Finance on February 4, 2022 (the "Proposals") along with explanatory notes (the "Notes"). The Proposals include some, but not all, of the measures announced or carried over in the 2021 federal budget and prior budgets.
This update provides an overview of a selection of the Proposal's measures to amend the Income Tax Act (Canada) (the "Tax Act") and the Excise Tax Act (Canada) (the "ETA") that may be of interest to our clients, but is not exhaustive. The Proposals outlined in this update include those in respect of:
- Limitations on the Deduction of Excessive Interest and Financing Expenses
- Mandatory Disclosure Rules for Reportable Transactions, Notifiable Transactions and Uncertain Tax Positions
- Avoidance of Tax Debts
- GST/HST and Mining Cryptocurrency
Notwithstanding the size of the Proposals package, there are a number of previously announced tax measures that were not included in the Proposals. Notably outstanding are measures relating to the hybrid mismatch rules, transfer pricing rules, a tax on luxury goods, investment tax credits for carbon capture, utilization and storage, revisions to the general anti-avoidance rule, and the excise duty on vaping products. Also not included herein is a discussion of the draft Underused Housing Tax Act, which was released in January 2022 and discussed in this article: The Underused Housing Tax Act: A primer
Excessive interest and financing expense limitation proposals
The Proposals include measures to restrict certain taxpayers from deducting for income tax purposes net interest and financing expenses that are considered to be excessive when measured against a fixed ratio of the taxpayer's tax-adjusted earnings before interest, taxes, depreciation and amortization ("EBITDA") (the "EIFEL Proposals").
Generally, a taxpayer's deduction for "interest and financing expenses" (net of "interest and financing revenues") will be limited under the EIFEL Proposals to 30% (or 40% in the first transitional year) of the taxpayer's "adjusted taxable income", as specifically defined for these purposes. The deductibility limitations under the EIFEL Proposals are intended to apply on top of the various interest deductibility limits currently found in the Tax Act (e.g., paragraph 20(1)(c) and the thin capitalization rules).
The term "interest and financing expenses" under the EIFEL Proposals is broadly defined to include interest, as well as interest and various other financing expenses that have been capitalized (and deducted as capital cost allowance) or otherwise included in resource expenditure pools, amounts treated as imputed interest in respect of certain financing leases, and amounts that can reasonably be regarded as funding costs under certain agreements or arrangements.
The term "adjusted taxable income" is essentially a tax-adjusted EBITDA measure and, in very basic terms, is equal to a taxpayer's taxable income (or taxable income earned in Canada of a non-resident taxpayer) adjusted to reverse deductions for items such as net capital and non-capital losses, interest and financing expenses, capital cost allowance, and adjusted to reverse additions for items such as interest and financing revenues and untaxed income. Since the starting point in determining adjusted taxable income is taxable income, it effectively excludes inter-corporate dividends that are deductible.
Subject to certain exceptions, the EIFEL Proposals are intended to apply to: (i) Canadian resident corporations and trusts, (ii) non-resident corporations and trusts that have taxable income earned in Canada, and (iii) corporations and trusts described in (i) or (ii) in respect of their share of the net interest and financing expenses of any partnerships of which they are members. The following entities are intended to be exempt from the EIFEL Proposals:
- a Canadian-controlled private corporation that has, together with any associated corporations, taxable capital employed in Canada of less than $15 million;
- a corporation or trust resident in Canada that has a net interest expense of $250,000 or less, or if such corporation or trust is part of a group of entities, the aggregate net interest expense among Canadian members is $250,000 or less; and
- a corporation or trust resident in Canada if it is a standalone
entity, or if it is a member of a group of entities that consists
of Canadian residents, where the standalone entity and any other
group members carry on all or substantially all of their business
in Canada provided that:
- the standalone entity does not have and none of the other group
- a foreign affiliate, or
- a specified non-resident shareholder or beneficiary (very broadly, a specified interest includes an interest by votes or value of at least 25%, either alone or with non-arm's length persons); and
- all or substantially all of the interest and financing expenses of the standalone entity and each other group members is paid or payable to persons or partnerships that are not a "tax indifferent investor" (which broadly includes tax exempt entities, non-residents and discretionary trusts resident in Canada).
- the standalone entity does not have and none of the other group members have:
The EIFEL Proposals also include a set of "group ratio" rules that may be used as an alternative basis to compute the deduction limits for Canadian members of a "consolidated group". Under these rules, the maximum amount of interest and financing expenses that consolidated group members are, in the aggregate, permitted to deduct is generally determined as the total of each Canadian group member's "adjusted taxable income" multiplied by the "group ratio". The group may allocate this maximum deductible amount among its Canadian group members to maximize the use of deduction capacity where it is most needed.
The EIFEL Proposals provide for a 20-year carry-forward period for a deduction from taxable income of denied interest and financing expenses, subject to certain limitations. The EIFEL Proposals also provide for a three-year carry-forward of unused capacity to deduct interest and financing expenses and permit Canadian members of a group to transfer unused capacity to other Canadian members in certain cases.
The EIFEL Proposals are generally expected to apply in respect of taxation years beginning on or after January 1, 2023. Since the Department of Finance has invited submissions to be made on the EIFEL Proposals until May 5, 2022, further amendments may be forthcoming.
Taxpayers falling within the scope of the EIFEL Proposals, as currently drafted, should consult their tax advisors to better understand them and the impact that the EIFEL Proposals may have on them.
Mandatory disclosure rules
The Proposals expand the obligations of taxpayers, advisors and promoters to make information returns in respect of various transactions. The Proposals propose to broaden the application of the existing "reportable transaction" rules as well as introduce new reporting rules for a "notifiable transaction" and "reportable uncertain tax treatments".
Collectively, the objective of these measures is to ensure that taxpayers, their advisors and/or promoters are compelled to make information returns to provide the Canada Revenue Agency ("CRA") with needed information to ensure that the CRA is able to respond to tax risks and reassessments in a timely matter. The Minister of Finance is accepting submissions with respect to the mandatory disclosure rules in the Proposals until April 5, 2022.
The Proposals include changes to the reportable transaction regime contained in section 237.3 of the Tax Act. The changes relate to the scope of a reportable transaction, the compliance requirements and the penalties for non-compliance.
Scope of application
One of the most significant Proposals relating to the reportable transaction regime is the amendment to the definition of a "reportable transaction". The current definition defines a "reportable transaction" as an "avoidance transaction" (as defined for the purpose of the Tax Act's general anti-avoidance rule (the "GAAR")) that has at least two of the following three hallmarks: (1) the existence of an advisor or promoter whose fees are derived from the tax benefit obtained by the avoidance transaction or the number of taxpayers who participate; (2) an advisor or promoter in respect of the avoidance transaction has obtained "confidential protection" (generally defined as anything that prevents disclosure of details of a transaction) in respect of the transaction; or (3) the existence of "contractual protection" (which generally includes insurance, indemnity, compensation, or guarantee that protects a person in the event that the transaction or series does not produce the intended results; or a form of an undertaking of a promoter to defend the transaction if challenged) for the taxpayer or certain other persons. The Proposals eliminate the need to meet at least two of these hallmarks and now requires that only one of the three be present for a transaction to constitute a "reportable transaction."
The Proposals also expand the definition of "avoidance transaction" so it is no longer defined in the same manner as it is currently under the GAAR, which requires establishing that the transaction was primarily undertaken to achieve a non-tax benefit. As amended, it means a "transaction if it may reasonably be considered that one of the main purposes of the transaction, or of a series of transactions of which the transaction is a part, is to obtain a tax benefit." As a result of this change, it would be necessary to establish that none of the main purposes for carrying out the transaction was to obtain the tax benefit in order to not be considered a reportable transaction. Furthermore, a transaction may be reportable transaction without being an avoidance transaction for the purposes of the GAAR.
The Proposals accelerate the time for complying with the reporting requirements in respect of a reportable transaction to: within 45 days of the earlier of the day on which (a) the person enters into the reportable transaction; or (b) becomes contractually obligated to enter into the reportable transaction. Under the current rules, an information return for a reportable transaction is due by June 30th of the calendar year following the year in which the transaction became a reportable transaction.
Although the current reportable transaction rules include a relieving provision which provides that the filing of an information return by one person in respect of a reportable transaction satisfies the requirement for any other person who may otherwise be required to file an information return in respect of the same transaction, the Proposals propose to eliminate that relief. As such, multiple parties may be required to file an information return in respect of the same reportable transaction.
In addition to accelerating the time period for reporting, the Proposals propose to amend the penalties for failing to report a reportable transaction.
Under the Proposals, taxpayers failing to file a required information return may be assessed a maximum penalty of the greater of (a) $25,000 ($100,000 in the case of corporate taxpayers having an asset value of greater than $50 million), and (b) 25% of the tax benefit in respect of the transaction. Additionally, advisors, such as accountants or lawyers who provide any assistance or advice with respect to creating, developing, planning, organizing or implementing a reportable transaction may be assessed a penalty equal to the total of: (a) the fee charged in respect of the transaction; (b) $10,000; and (c) $1,000 per day, to a maximum of $100,000. In addition to the penalties, the CRA may deny any tax benefit that could result from the transaction.
If enacted as proposed, the proposed changes to the reportable transaction regime will have effect as of January 1, 2022, however, the penalty provisions will not apply until the legislation receives royal assent.
The Proposals introduce new provisions to the Tax Act that will require reporting of a "notifiable transaction." A "notifiable transaction" is a transaction or series of transactions designated by the Minister of National Revenue with the concurrence of the Minister of Finance. A notifiable transaction also includes a transaction that is "substantially similar," in terms of facts, tax consequences or tax strategy, to a designated transaction or series.
The Proposals will require taxpayers, advisors, and promotors to file an information return with respect to the notifiable transaction, generally within 45 days of the earlier of the day (a) on which the person enters into the notifiable transaction; or (b) becomes contractually obligated to enter into the notifiable transaction.
A backgrounder document released with the Proposals includes samples of transactions that are intended to be designated as notifiable transactions for the purposes of these rules. Broadly, such transactions include those that seek to:
- manipulate Canadian-controlled private corporation status to avoid anti-deferral rules applicable to investment income;
- use financial instruments or derivatives to generate artificial losses;
- avoid or defer various deemed disposition rules applicable to trusts;
- manipulate bankrupt status to reduce a forgiven amount in respect of a commercial obligation;
- rely on purpose tests in section 256.1 of the Tax Act to avoid a deemed acquisition of control; and
- use back-to-back arrangements to circumvent the thin capitalization rules and Part XIII of the Tax Act.
The proposed penalty provisions for failing to file a required information return in respect of a notifiable transaction mirror the Proposal's penalties described above in respect of failing to file a required information return in respect of a reportable transaction.
The notifiable transaction Proposals provide for a fairly narrow reporting exception for advice to which solicitor-client privilege applies, as well as a due diligence defence. It is noteworthy that, unless and until an information return in respect of a notifiable transaction is filed as and when required, the normal reassessment period for the taxation year is extended.
The Proposals in respect of a notifiable transaction, if passed, will generally apply to transactions that are entered into after 2021, except for the penalty provisions which will apply when the legislation receives royal assent.
Reportable uncertain tax treatments
The Proposals introduce new rules in the Tax Act that would require a "reporting corporation" to identify and report uncertain tax treatments which are reflected in the financial statements of the corporation for the year.
The Proposals define a "reporting corporation" as a corporation that:
- has "relevant financial statements" for the year (which, for these purposes, generally means audited financial statements of the corporation, or a consolidated group of which the corporation is a member, prepared in accordance with International Financial Reporting Standards ("IFRS") or other country-specific generally accepted accounting principles);
- has assets with a total carrying value of $50 million or more at the end of the taxation year; and
- is required to file a Canadian income tax return for the taxation year under the Tax Act (either as a result of being a corporation resident in Canada or a non-resident corporation with taxable income earned in Canada).
According to the Proposals, a reporting corporation would be required to file an information return with respect to a "reportable uncertain tax treatment," which is defined to mean a tax treatment of a transaction, or a series of transactions, in respect of which there is uncertainty reflected in the relevant financial statements of the corporation. The Notes specify that uncertainty is considered to be reflected financial statements when the tax attributes used in the financial statements (e.g., taxable profit, tax loss, tax bases, unused tax losses, unused tax credits, tax rates) are not consistent with the "tax treatment," which is largely modeled upon the definitions of "tax treatment" and "uncertain tax treatment" for IFRS purposes (e.g., consistent with IFRIC Interpretation 23).
Under the Proposals, an information return with respect to a reportable uncertain tax treatment is to be filed at the same time as the reporting corporation's income tax return is due. For each failure to report a reportable uncertain tax treatment, there is a non-compliance penalty of $2,000 for each week the failure continues, up to a maximum of $100,000, and generally will result in an extension of the normal reassessment period.
The reportable uncertain tax treatments Proposals are expected to apply for taxation years that begin after 2021, except for the penalty provisions which will apply when the legislation receives royal assent.
Avoidance of tax debts
Taxpayers that have income tax liabilities cannot avoid payment by transferring property to non-arm's-length parties. In such a case, the CRA may assess both the taxpayer and the transferee pursuant to subsection 160(1) of the Tax Act so that they are jointly and severally, or solidarily, liable for the tax. Such an assessment can be up to the amount by which the fair market value of the property at the time of transfer exceeds the fair market value at that time of the consideration given for the property.
In response to tax planning strategies that have circumvented the scope of section 160, the Proposals include new anti-avoidance provisions which deem a transferor and transferee of property to not be dealing at arm's length at all times in a transaction or series of transactions involving the transfer if:
- at any time during the period beginning immediately prior to the transaction or series of transactions and ending immediately after the transaction or series of transactions, the transferor and transferee do not deal at arm's length; and
- it is reasonable to conclude that one of the purposes of undertaking or arranging the transaction or series of transactions is to avoid joint and several, or solidary liability of the transferee and transferor for an amount payable under the Tax Act.
The Proposals also amend section 160 of the Tax Act to target:
- plans that attempt to circumvent the application of section 160 by avoiding the requirement that the transferor have an existing tax debt owing in or in respect of the taxation year in which the property is transferred, or any preceding taxation year;
- transactions or series of transactions that attempt to avoid section 160 by reducing the fair market value of consideration given for the property transferred in order to render all or a portion of a tax debt of the transferor uncollectible; and
- tax advisors that engage in planning to assist taxpayers with circumventing the application of section 160 by subjecting them to penalties equal to the lesser of (i) 50% of the tax that is attempted to be avoided through the planning, and (ii) $100,000 plus the advisor's planning fees.
If enacted, these Proposals will be retroactively effective to April 19, 2021.
GST/HST and mining cryptocurrency
The Proposals include the addition of new section 188.2 to the ETA which addresses the GST/HST treatment of "mining activities" with respect to "cryptoassets" and to remuneration received for performing mining activities. Currently, the ETA only addresses the supply of a virtual payment instrument, such as Bitcoin, which is treated as the supply of a financial instrument and not subject to GST/HST.
Proposed section 188.2 of the ETA adds three new definitions: (a) "cryptoasset," which is broadly defined and includes, but is not limited to, a virtual payment instrument; (b) "mining activities," which describes three categories of activities; and (c) "mining group operator." Generally, these new provisions deem "mining activities" to not be a supply for GST/HST purposes. This means that businesses engaged in these activities will not be required to charge GST/HST. However, they are also limited in their ability to claim input tax credits in respect of property or services used, consumed or supplied in the course of these activities. Further, these new provisions address the GST/HST treatment of remuneration paid for mining activities that is paid by way of property or service (and not, for example, fiat currency).
If passed, new section 188.2 of the ETA is deemed to come into force on February 5, 2022, with limited grandfathering. The Minister of Finance will accept submissions with respect to these draft provisions until April 5, 2022.
The Proposals also include a number of proposed amendments which are not discussed in detail in this article. Such Proposals are in respect of the following:
Reporting requirements for trusts
- Budget 2018 announced new and enhanced reporting requirements which were initially expected to apply to certain trusts for their taxation years ending after December 30, 2021. Since, however, the legislation in respect of these new reporting requirements is still pending, the CRA recently announced that it would continue to administer the existing rules for trusts, and would not administer the rules proposed in the 2018 Budget. The Proposals include revised "Reporting Requirements for Trusts", which, if passed, will apply to trusts for taxation years ending after December 30, 2022. Please refer to this article to learn more of about these Proposals: CRA significantly expands proposed trust reporting requirements to include bare trust arrangements
Mutual fund trusts – Allocations to redeemers by exchange traded funds
- Amendments to previously enacted measures which generally deny a mutual fund trust a deduction in respect of the portion of a capital gain allocated to a unitholder on a redemption of a unit of the mutual fund trust by unitholder where the capital gain allocated exceeds the capital gain that would otherwise have been realized by the unitholder on the redemption. Due to certain limitations which made it difficult for ETFs to comply with the previously enacted rules, new rules have been introduced which limit an ETF's deduction in respect of the net taxable capital gains allocated to redeeming unitholders.
Taxes applicable to registered investments
- Amendments to provide a more equitable method of applying the Part X.2 penalty tax to trusts or corporations that are a "registered investment" for a registered plan, by prorating the tax payable by the registered investment based on the extent to which securities of the registered investment are held by investors that are registered plans or certain other registered investments.
Registration and revocation rules applicable to charities
- Amendments (effective June 29, 2021) to the rules relating to the computation of tax payable upon revocation of a charity's registration when it becomes a listed terrorist entity.
Fixing contribution errors in defined contribution pension plans
- Amendments to permit plan administrators to correct certain contribution errors, made in 2021 and later years.
Capital cost allowance for clean energy equipment
- Amendments to expand capital cost allowance ("CCA") classes 43.1 and 43.2, which provide accelerated CCA rates of 30% and 50% respectively, and to provide for the qualification of certain associated intangible start-up expenses as deductible "Canadian renewable and conservation expenses."
Rate reduction for zero-emission technology manufacturers
- Amendments to reduce the general corporate income tax rate (from 15% to 7.5%) and the small-business corporation income tax rate (from 9% to 4.5%) in respect of eligible zero-emission technology manufacturing and processing income.
Film or video production tax credits
- Temporarily extending various film or video production tax credits.
Electronic filing and certification of tax and information returns
- Reducing the thresholds for mandatory electronic filing for tax and information returns for corporations and tax preparers.
- Requiring electronic payments for tax remittances in excess of $10,000.
- Reducing the thresholds (from $50,000 to $10,000) for mandatory remittances at a financial institution in respect of amounts payable under the ETA, Air Travellers Security Charge Act, and Part 1 of the Greenhouse Gas Pollution Pricing Act.
- Amendments to facilitate the use of electronic signatures in the filing of various returns under the Tax Act.
- Amendments to ensure that the CRA has the authority to compel persons to answer all proper questions (orally or in writing) and provide all reasonable assistance to CRA officials for any purpose related to the administration or enforcement of the Tax Act.
Disability tax credit
- Amendments to improve access to the disability tax credit.
Postdoctoral fellowship income
- Amendments to the definition "earned income" for registered retirement savings plan purposes to include postdoctoral income.
April 2020 one-time additional GST/HST credit payment
- Retroactive (from March 25, 2020) amendment to correct the formula relating to the one-time COVID-19 relief provided under the GST/HST credit rules.
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.