Canada’s Province Of Ontario Continues Tax Cuts

For the first time in more than half a century – since 1942/43 and 1943/44 – the Ontario government is projecting two consecutive balanced budgets. The government continues to focus its expenditures on priority sectors such as health care and education.

In a move that has been much talked about by various provinces in recent years, Ontario Finance Minister Ernie Eves (the Minister) tabled proposals with his May 2, 2000 budget to implement a "Made-for-Ontario" tax-on-income system, meaning individual Ontarians will no longer be tied to the personal federal income tax calculation.

The Minister also offered a challenge to the federal government to quickly increase the Registered Retirement Savings Plan (RRSP) maximum contribution limits. He announced that the government’s goal is to more than double its debt-reduction pledge from $2 billion to at least $5 billion during its mandate.

In a significant but not unexpected move, the Ontario government has initiated a tax-on-income system. Ontario tax will be calculated on taxable income and not on basic federal tax. The surprise seems to be that this overhaul is proposed for the 2000 taxation year, with withholding adjustments slated for July 1, 2000.

With the proposed new system, Ontario will decide how much tax is to be applied at a given level of income. The federal brackets will no longer be relevant to the calculation of Ontario personal tax.

For the 2000 taxation year, Ontario will set values for the basic personal credit, the age and disability credits, spousal credit and so on.

For at least the 2000 taxation year, Ontario tax brackets and amounts on which non-refundable credits are based will be the same as those for federal income tax purposes.

Ontario’s tax system will be specifically protected against future rate increases by the Taxpayer Protection Act. This Act ensures that present and future governments will not be permitted to increase tax levels without first asking permission from voters in a referendum. Voter approval will be required prior to introducing a bill that imposes any new tax or that increases the rate of existing taxes, unless other revenues are being reduced by at least as much.

The new tax system will be fully indexed to inflation, starting in the 2001 taxation year, thereby eliminating "bracket creep." Full indexation will apply to all Ontario tax brackets, non-refundable credits and surtax values.

With the exception of the charitable donations tax credit, Ontario non-refundable tax credits will be calculated by applying the lowest Ontario income tax rate (6.37% for the 2000 taxation year and 6.20% in 2001) to the amounts used to determine the federal non-refundable tax credits. In 2001, the amounts on which the tax credits are based will be indexed to inflation.

For charitable donations, Ontario’s lowest rate (6.37% in 2000 and 6.20% in 2001) will be applied to the first $200 of donations and the highest rate (11.16%) will be applied to allowable donations exceeding $200.

Ontario has a two-tiered surtax system that is calculated as a percentage of Ontario tax in excess of specified amounts. To parallel the reduction in the first and middle personal income tax rates, the tax thresholds above which the surtax rates apply will be lowered.

For the 2000 taxation year, the surtax will be 20% of Ontario income tax exceeding $3,561, plus 36% of Ontario income tax exceeding $4,468.

Similar adjustments are also proposed to the Ontario Tax Reduction, which reduces or eliminates Ontario personal income tax payable by low and moderate income taxpayers.

The combined federal and Ontario top marginal tax rate will decline as follows:

1. Rates for 2000 and 2001 reflect federal rate reductions.

2. The top bracket is the ordinary income level at which the top marginal tax rate applies, assuming only the basic personal tax credit is available.

The combined federal and Ontario effect, assuming only the basic personal tax credit is available, varies by income level as summarized in the following tables:

1. Assumed to be ordinary income, i.e. earned income plus interest and taxable capital gains (but excluding dividends).

1. The two tiers of the surtax apply to Ontario income tax in excess of the given thresholds. For example, for 2000, the surtax for a person who pays $10,000 of basic Ontario income tax will be 20% of $6,439 (the excess of $10,000 over the $3,561 threshold) plus 36% of $5,532 (the excess of $10,000 over the $4,468 2nd-tier threshold).

2. Rank is in comparison with the other provinces, with 1 being the highest rate. (Manitoba’s 2000 budget is due on May 10; for this ranking, its rates are assumed to stay constant.)

3. Rates for 2000 reflect announced federal rate reductions.

4. Rank will change if Manitoba’s rate decreases from 48.08% to below the Ontario rate.

The move from a tax system that paralleled the federal one, and that was determined on basic federal tax, to a new tax-on-income system will result in some anomalies. Accordingly, a number of aspects of Ontario’s personal income tax system for the 2000 and 2001 taxation years require special treatment. These include:

• the Ontario dividend tax credit;
• Ontario alternative minimum tax (AMT) calculation;
• Ontario overseas employment tax credit;
• certain lump-sum pension payments and DPSP payments received from pre-1972 plans;
• medical expenses paid for a dependant other than a spouse;
• the election by recipients of CPP/QPP disability benefits to have lump-sum benefits taxed in the year(s) to which they relate;
• treatment of inter-vivos trusts;
• income splitting with minor children;
• allocation of business income among provinces; and
• ordering of non-refundable tax credits.

Readers should consult their PricewaterhouseCoopers advisors for more details on the proposed adjustments.

The budget proposes to phase-in a reduction in the capital gains inclusion rate from 75% to 50% over the next five years. (The new federal inclusion rate is 66-2/3%). The changes are shown in the following table:

Related adjustments will also be made to:

• allowable business investment losses;
• net capital losses of other years; and
• the $500,000 lifetime capital gains exemption for qualified small business corporation shares and qualified farm property.

Based on 1999 tax assessments, eligible taxpayers will receive refunds of a portion of their 1999 Ontario personal income tax, including any surtax, and after deducting the Ontario Tax Reduction and any foreign tax credits, to a maximum of $200. As well as Ontario residents, taxpayers who were resident in other provinces or territories and who paid Ontario tax in 1999 on business income allocated to Ontario will be eligible for the rebate. Taxpayers who have not filed their 1999 personal income tax returns by December 31, 2000 will not be entitled to receive a rebate.

As with any personal income tax refunds, rebates will be set off against any federal, provincial or family support debts, prior to being paid out to eligible taxpayers.

To "level the playing field" with other self-employed individuals, Ontario has proposed that the right to incorporate be extended to all regulated professionals. Professionals will therefore be able to enjoy many of the same tax and non-tax advantages of incorporation. Some caveats: professional liability will not be limited in any way by practising within a professional corporation, nor will non-members of professional corporations be permitted to own shares.

Consultations are planned. The proposed changes will take effect upon Royal Assent.

Other personal tax measures include:

• Ontario Guaranteed Annual Income System (GAINS): Effective July 1, 2000, all seniors who have qualified for federal seniors’ benefits and have lived in Ontario for 10 years will be eligible for GAINS based on their income.
• Boathouse rental fees: Effective May 3, 2000, the Ministry of National Resources will (for now) suspend the practice of charging a nominal rental fee for landowners who have boathouses.
• Ontario Child Care Supplement for Working Families: A new single parent’s benefit will be introduced.

The budget includes two measures to help Ontario high technology corporations attract and retain employees. Both measures increase the attractiveness of employee stock options granted by such corporations.

The 1999 Ontario Budget provided a framework for new tax measures relating to stock option benefits. Consultations on the design of this program have resulted in the introduction of the Ontario Research Employee Stock Option Deduction.

The Ontario Research Employee Stock Option Deduction will substantially reduce or eliminate the Ontario personal income tax arising from the exercise and/or disposition of eligible stock options granted by eligible corporations to eligible employees. Specifically, the deduction permits employees of eligible corporations to deduct up to $100,000 annually in respect of the aggregate of:

• the taxable portion of eligible stock option benefits; and
• taxable capital gains arising from the sale of shares acquired by exercising eligible stock options.

The deduction may be claimed for stock options granted after the enabling legislation receives Royal Assent.

To qualify as an eligible corporation, a corporation must:

• carry on business through a permanent establishment in Ontario;
• directly undertake scientific research and experimental development (SR&ED) in Ontario; and
• incur, in the year preceding the year in which the stock option is granted, eligible research and development expenditures that are at least:
• $25 million; or
• 10% of the corporation’s total revenue.

To qualify as an eligible employee, a person must, among other things:

• spend at least 30% of his or her time undertaking SR&ED during the corporation’s taxation year in which the stock option is granted; and
• be a resident of Ontario on December 31 of both the year the option is granted and:
• in respect of a deduction for stock option benefits, the year the employee claims a deduction under the Income Tax Act (Canada) with respect to the stock option benefit; and
• in respect of a deduction for capital gains, the year in which the underlying shares are sold.

Not qualifying for the credit are individuals owning directly or indirectly, 10% or more of any class of shares of the eligible corporation.

To qualify as an eligible stock option, the stock option must qualify for a deduction under the Income Tax Act (Canada). Stock options that replace options granted before the enabling legislation receives Royal Assent will not qualify.

Employee stock option benefits arising from the exercise or disposition of stock options granted by eligible corporations will no longer be subject to Employer Health Tax. This proposal applies to options exercised after May 2, 2000.

An eligible corporation is a corporation that:

• qualifies as such for purposes of the Ontario Research Employee Stock Option Deduction (see above); and
• conducts significant SR&ED in Ontario.

The general corporate income tax rate, unchanged since 1985, is being reduced to 14.5% (from 15.5%) effective May 2, 2000. On January 1, 2001, the rate will be further reduced to 14%. Further cuts will be phased in. When fully implemented in 2005, the general corporate rate will decline to 8%.

Effective May 2, 2000, the tax rate on income from M&P, mining, logging, farming and fishing will be reduced to 12.5% from 13.5%. On January 1, 2001, the rate will be further reduced to 12%. Further cuts will be phased in. When fully implemented in 2005, the M&P rate will also decline to 8%.

1. Based on 2000 federal budget proposals.

Currently, the small business tax rate is 8%. This budget cuts the rate to 7%, effective May 2, 2000. Further rate reductions are planned until January 1, 2005, when the small business tax rate will be 4%.

The table above summarizes more good news for owner-managers. The small business deduction is currently available to Canadian-controlled private corporations (CCPCs) with taxable income up to $200,000. The $200,000 threshold will be increased to $400,000, over a 5-year period (to correspond with the scheduled rate reductions).

The small business deduction phase-out, which applies when taxable income is between $200,000 and $500,000, will also be changed over a 5-year period. Once fully implemented, the phase-out range will be from $400,000 to $1,000,000.

Rate reductions that parallel the scheduled reductions in the inclusion rate for individuals (discussed earlier) have been proposed. For corporations, the reduction in the inclusion rate will also apply to allowable business investment losses, net capital losses of other years, capital gains reserves and donations of listed securities and ecologically sensitive lands.

An incentive will be available to incorporated and unincorporated businesses that assist Ontario’s community colleges and universities to acquire new teaching equipment and learning technologies through donations or price discounts. Effective after May 2, 2000, the incentive will provide corporations with an additional 15% deduction and unincorporated businesses with a refundable tax credit of 5% on the price discount or donation value, provided certain eligibility conditions are met.

To encourage Ontario’s involvement in the media and entertainment industry, the following refundable tax credits will be enhanced:

• Ontario Film and Television Tax Credit;
• Ontario Production Services Tax Credit;
• Ontario Sound Recording Tax Credit; and
• Ontario Interactive Digital Media Tax Credit.

The Ontario Book Publishing Tax Credit will be enhanced to further support the publishing and development of first-time Canadian authors.

For taxation years ending after 2000, more Ontario small businesses will be eligible to use the relatively new Short-Form Corporations Tax Return. To achieve this, Ontario will increase the gross revenue and total asset thresholds to $1.5 million from $1 million.

Several changes will harmonize Ontario tax legislation with recent federal corporate tax measures. These tax measures will:

• parallel the capital cost allowance (CCA) changes that allow separate M&P property classes, and increase the CCA rates for rail assets, electrical generating equipment, and production and distribution equipment of a distributor of water or heat; and
• extend the M&P tax credit to corporations that produce and sell steam for uses other than the generation of electricity. For Ontario tax purposes, the credit will be phased in:
• commencing with an initial 1% retroactive to January 1, 2000,
• increasing to 1.5% on January 1, 2001; and
• reaching the full tax credit on January 1, 2002.

Ontario will, however, not harmonize with the 2000 federal budget proposal to treat provincial deductions for SR&ED in excess of actual expenses as government assistance.

In recognition of the "significant contributions to the Ontario economy" made by Ontario mineral producers, the following tax changes are proposed:

• The mining tax rate will be reduced to 10% (from 20%) over 5 years. Effective May 2, 2000, the rate will drop to 18%, with further 2% reductions planned each January 1, until January 1, 2004, when the fully phased-in rate of 10% will apply.
• The existing 3-year mining tax holiday will be extended to 10 years for new mines opened in remote Ontario locations after January 1, 2001. Further, after the proposed holiday, the profits from the operation of a remote mine will be taxed at 5%.

A new flow-through share incentive will offer individual shareholders a bonus deduction of 30% of "Ontario eligible expenses" relating to corporate exploration, in addition to the existing 100% deduction. The bonus deduction, which will be available following Royal Assent of the enabling legislation, will be limited to eligible exploration expenses incurred at the "grass-roots-level." Consultations with interested parties will be held this summer, to determine program definitions such as "grass-roots-level surface mining," as well as others.

To qualify as "Ontario eligible expenses," the company’s exploration expense must be incurred in Ontario, and to be eligible for renunciation, must qualify as a Canadian Exploration Expense (CEE), as defined in the federal Income Tax Act. For Ontario’s purpose, the definition of CEE will be modified where appropriate.

RST on motor vehicle insurance premiums will be eliminated over the next 5 years. The rate is reduced as shown in the following table:

1. Rate is determined by period of coverage.

The RST on repairs and replacements made under warranty will be eliminated over the next 5 years, as shown in the table above.

• Educational institutions: Commencing May 3, 2000, the following will no longer be subject to RST:

• donations made to Ontario educational institutions; and
• educational CD-ROMs purchased by schools, school boards, community colleges, universities and public libraries.

• Deposit insurance premiums: Deposit insurance premiums paid by Ontario credit unions and caisses populaires after May 2, 2000 will be exempt from RST.
• Building materials for farmers: The rebate for RST paid on building materials purchased by farmers will be replaced with a point-of-sale RST exemption.
• Seedlings used in reforestation of Crown lands: The government is proposing a new exemption in support of the reforestation of Crown lands in Ontario. Commencing May 3, 2000, forest resource license holders may purchase seedlings used in the reforestation of Crown lands exempt of RST.
• Admissions tax for charitable events: Admissions to events held under the auspices or sponsorship of certain organizations are exempt from the 10% RST on admissions. New rules will clarify how the tax applies to events sponsored by these organizations. To quality for the exemption, at least 90% of the net proceeds of seasonal games of professional sports teams must go to one or more of the sponsoring organizations listed in the legislation.

The government will introduce legislation to make the Land Transfer Tax refund program, related to the purchase of a new home by first-time home buyers, permanent effective April 1, 2000. It is also proposed that refunds not claimed at the time of registration must be claimed within 18 months after the home purchase is registered.

The fees that are charged by the OSC will be reduced by 10% on June 26, 2000. This is in addition to the 10% reduction in fees announced in the 1999 budget. The OSC is reviewing its fee structure and it is expected that a new fee schedule will be in place by July 2001.

Effective January 1, 2000, the tax rate on gross receipts arising from telephone and other equipment, including long distance calls, levied on telephone and telegraph companies under the Municipal Act and Provincial Land Tax Act will be reduced to 3% from 4%. The tax will continue to be reduced by one percentage point on January 1 of each subsequent year until the tax is eliminated in 2003.

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:

PricewaterhouseCoopers refers to the Canadian firm of PricewaterhouseCoopers LLP and other members of the worldwide PricewaterhouseCoopers organization.