In the midst of what Finance Minister Jim Flaherty described as an extraordinary time in our history — a global financial crisis and a global recession — the fourth Federal Budget of the Conservative Government was tabled today in the House of Commons. The Budget is replete with spending initiatives, but is somewhat light in new tax measures for businesses. The focus is principally on the individual taxpayer, which is perhaps not surprising given the election risk facing the Government.
Arguably, the Budget is somewhat timid in its tax measures in these unusual times. Additional measures could have been incorporated in the Budget to deal with the liquidity problems confronting many Canadian businesses. These could have included accelerating the planned reductions of corporate income tax rates to 2009, extending the loss carryback period from three to five years (matching President Obama's proposed business tax reforms), allowing losses to be sold by a taxpayer provided the proceeds were invested either directly or indirectly in an active Canadian business, and extending the flow-through share rules to permit all taxable Canadian corporations to renounce capital cost allowance and scientific research and experimental development tax attributes, provided that the share proceeds were expended on a new project or a major expansion of an existing project.
On the other hand, the Budget announces several positive tax changes that may fairly be described as unexpected, given previous statements from Minister Flaherty and Department of Finance officials. These welcome measures include the announcement that the Government will repeal Section 18.2 of the Income Tax Act (Act), which limits in certain circumstances the ability of a Canadian corporation to deduct interest on money borrowed to finance a foreign affiliate, and that it will give further consideration to proposed amendments concerned with the taxation of non-resident trusts (NRTs) and foreign investment entities (FIEs).
Business Tax Measures
The Budget reaffirms the commitment of the Government to reduce the general corporate income tax rate to 15% by 2012. The Budget states that as a result of the previously announced rate reductions, by 2010 Canada will have the lowest overall tax rate on new business investment of any of the G-7.
Increase to the Small Business Limit
Generally, the small business deduction reduces the federal corporate income tax rate applicable to $400,000 of qualifying business income of a Canadian-controlled private corporation (CCPC) to 11%. The Budget proposes to increase the amount of qualifying active business income of a CCPC eligible for the small business deduction (small business limit) to $500,000. The increase is effective on January 1, 2009. A CCPC that does not have a calendar taxation year will be required to pro-rate the increase. Associated corporations will continue to be required to allocate the small business limit. The rules that phase out the benefit of the small business deduction for corporations having taxable capital employed in Canada between $10 million and $15 million remain unchanged.
The Budget proposes a number of additional changes related to the proposed increase in the small business limit, as follows:
- Generally, CCPCs benefit from investment tax credits at an enhanced rate of 35% on up to $3 million of scientific research and experimental development expenditures annually. These credits, earned at the 35% rate, are either fully or partially refundable depending on the nature of the expenses to which they relate (current or capital). The $3-million expenditure limit is reduced if a CCPC's taxable income for the previous year was between $400,000 and $700,000. The Budget proposes that the $3-million expenditure limit begin to be reduced at the increased small business limit of $500,000 and be fully eliminated if the CCPC had taxable income of $800,000 or more in its prior taxation year. These changes apply where the prior taxation year ends after 2008.
- A CCPC with taxable income of less than $500,000 for its previous taxation year may pay the balance of its corporate tax owing at the end of the third month after the end of its taxation year – one month later than other corporations.
- A CCPC with taxable income of $500,000 for its 2009 and subsequent taxation years may make quarterly instead of monthly instalments of taxes.
Accelerated Capital Cost Allowance
Manufacturing and Processing Equipment
The Budget proposes that machinery and equipment acquired in 2010 and 2011, and used primarily for manufacturing and processing goods for sale or lease, benefit from a 50% straight line accelerated capital cost allowance (CCA) treatment.
In addition, the so-called half-year rule, which limits the claim for CCA to one-half the amount otherwise available in the year the property is available for use, will apply to property that is subject to this accelerated CCA treatment.
Generally, prior to the 2007 Budget, eligible manufacturing and processing equipment was eligible for a 30% declining balance CCA rate under Class 43. The 2007 Budget proposed that such equipment, if acquired before 2009, be included in Class 29 and be eligible for a 50% straight line CCA rate. The 2008 Budget extended this inclusion in Class 29 to eligible manufacturing and processing equipment acquired before 2010. The 2008 Budget also proposed accelerated CCA but at declining rates and on a declining balance basis for eligible manufacturing and processing equipment acquired in 2010 and 2011. Instead, the Budget now extends the inclusion in Class 29 to eligible manufacturing and processing equipment acquired in 2010 and 2011.
Computer Equipment and Systems Software
The Budget proposes to increase to 100% the CCA rate applicable to computer hardware and systems software acquired after January 27, 2009 and before February 1, 2011. Further, the half- year rule will not apply to property that is subject to this accelerated CCA treatment.
Computer equipment otherwise included in Class 50 will be eligible for this accelerated CCA regime. Such equipment is general-purpose electronic data processing equipment and systems software for that equipment. In addition, to be eligible for the accelerated CCA, the computer equipment and systems software must:
- be situated in Canada;
- be acquired for use in a business carried on in Canada or to earn income from property situated in Canada or for lease to a lessee who so uses the equipment or software; and
- not have been used, or acquired for use, for any purpose before it is acquired by the taxpayer.
Generally computer equipment and systems software, unless it qualifies as manufacturing and processing equipment and is therefore included in Class 29, is included in Class 50 and is subject to a 55% CCA rate on a declining balance basis. Computer equipment and systems software that would otherwise be included in Class 29 as manufacturing and processing equipment will also benefit from the 100% CCA rate.
It should be noted that computer software, other than systems software, is already subject to a 100% CCA rate under Class 12.
Certain rules that limit the availability to certain investors of CCA on computer equipment and software to reduce their income from other sources will continue to apply.
Mineral Exploration Credit
The flow-through share provisions of the Act allow a corporation that incurs certain expenses, including "Canadian exploration expense" (CEE), to renounce such expenses to an investor who can deduct such expenses in computing income.
In addition, certain CEE incurred in "grass roots" mineral exploration and renounced to an individual investor (other than a trust) will give rise to a 15% non-refundable tax credit to the investor. The amount of the credit must be deducted from the individual's cumulative CEE account in the following year and, if the investor's cumulative CEE account is negative at the end of that year because the investor did not incur sufficient CEE in that year, the negative amount must be included in income.
Under the current provisions of the Act (as a result of amendments made pursuant to the 2008 Budget), only expenses incurred pursuant to flow-through share agreements made before April 1, 2009 may qualify. In addition, the expenses must be incurred by the corporation, or be deemed under a "look-back" rule to be incurred, by December 31, 2010.
The Budget extends the provision by one year so that it will apply to flow-through share agreements made after March 2009 and before April 1, 2010 where the expenses are incurred by the corporation, or deemed under the look-back rule to be incurred, by December 31, 2010. The look-back rule will therefore accommodate expenses incurred to the end of 2011.
While there was pre-Budget speculation that there could be enhanced deductions made available to investors who purchase flow-through shares (including to finance oil and gas exploration) and that the flow-through share rules could be extended to issuers engaged in activities other than in the resource sector or certain renewable energy projects, only the mineral exploration credit was extended.
Acquisition of Control
The acquisition of control of a corporation is an event that triggers a number of tax consequences. Subsection 249(4) sets out rules that are deemed to apply to determine the year-end of the corporation at the time of acquisition, which rules are relevant for computing losses and other tax accounts of the corporation. Subsection 256(9) further provides that where control of a corporation is acquired at a particular time of a day, it is deemed to have been acquired at the commencement of the day for the purposes of the Act unless the corporation elects otherwise. This rule was generally interpreted to determine only when control of a corporation was acquired and not when it ceased to be held by the person who controlled the corporation until that time. However, in the 2006 Federal Court of Appeal case of La Survivance, the Court held that the rule applied equally to the person relinquishing control such that control was deemed to cease at the commencement of the day of transfer. While it could also have negative results, this interpretation had beneficial results in the case in that it permitted a capital loss realized on the sale of shares of a subsidiary sold by a public corporation to a CCPC to be available as a business investment loss. The basis for this was that since control of the subsidiary was acquired by the CCPC at the commencement of the day, the subsidiary's status changed to a CCPC at that time. Thus, it was a CCPC at the time the shares were actually transferred by the public corporation later in the day. The Court stated that Parliament should expressly override this rule of general application, which applied for the purposes of the Act, if it did not like the result.
The Budget responds to the Court's invitation and introduces a new rule to override this case, applicable to acquisitions of control that occur after 2005, to the effect that the application of the deeming rule regarding the timing of an acquisition of control will not affect the status of a corporation as a CCPC or small business corporation. Special transitional rules apply to an acquisition of control before January 28, 2009.
Currently, taxpayers are permitted to file their income tax information and returns electronically if they meet certain criteria. Starting for taxation years that end after 2009, corporations having revenue in excess of $1 million will generally be required to file their returns electronically. Exceptions will be available for certain corporations, such as non-resident corporations and those filing in a functional currency. In addition, the electronic filing of certain information returns will be required at lower levels starting after 2009. For example, T4 information forms will be required to be filed electronically if there are 50 or more employees (the current level is 500).
New penalties will also be imposed for filing a corporate income tax return in the incorrect format beginning in 2011, starting at $250 in 2011, $500 in 2012 and $1,000 for years after 2012. On the other hand, existing penalties for filing certain information returns late or incorrectly will be reduced and effectively capped at between $1,000 and $7,500, depending upon the number of information returns.
International Tax Measures
The Budget announces several international tax changes that are founded on the Final Report: Enhancing Canada's International Tax Advantage released December 10, 2008 (Final Report) of the Advisory Panel on Canada's System of International Taxation (Panel).
The Final Report
The Panel was formed by the Minister of Finance as part of the International Tax Fairness Initiative set out in the 2007 Budget. The Panel was formed for the purpose of: (1) improving the fairness, economic efficiency and competitiveness of Canada's system of international taxation; (2) minimizing compliance costs for business and facilitating administration and enforcement by the Canada Revenue Agency (CRA); and (3) developing practical and readily applicable changes, taking into account existing rules and tax treaties as well as fiscal implications.
In reviewing Canada's international tax system, the Panel focused on four main areas: (1) the taxation of outbound direct investment; (2) the taxation of inbound direct investment; (3) non-resident withholding taxes on interest, dividends, royalties and rents; and (4) administration, compliance and legislative process. Overall, the Panel was of the view that Canada's international tax system was a "good one," and rather than seeking to reform it, the Panel made seventeen recommendations to the Minister of Finance to improve it.
Historically, interest incurred by a Canadian taxpayer on borrowed money used to invest in or acquire shares of a foreign affiliate has been deductible, even though dividends on such shares may not effectively be subject to Canadian tax under the foreign affiliate rules. This allowed the interest deduction to shield other income from Canadian tax. In the 2007 Budget, the Government proposed to eliminate the deductibility of interest on debt incurred by corporations to finance foreign affiliates by means of adapting the existing tracing rule. More specifically, the proposal in the 2007 Budget would have required a taxpayer to pool all interest on borrowed money used to fund a foreign affiliate and defer the deduction for such interest until the taxpayer earned "non-exempt income" in respect of its investment in the foreign affiliate.
In response to serious concerns raised by the business and tax communities, Section 18.2 was enacted instead of the original proposal with the stated purpose of limiting or denying the deduction of interest and other amounts paid by a Canadian taxpayer incurred in respect of certain "double-dip" financing structures. Section 18.2 was scheduled to apply to interest and other amounts paid or payable in respect of a period or periods that begin after 2011.
The Panel considered the treatment of expenses incurred to earn foreign-source income as part of its review of Canada's outbound taxation system. The Panel noted that many other countries do not limit the deduction of interest on borrowed money used to invest in foreign corporations, even though dividends are exempt or mostly tax-free when repatriated. In order to ensure that Canada's tax system does not create disadvantages for Canadian businesses when they compete abroad, particularly in light of the current global financing environment, the Panel recommended that Section 18.2 be repealed and that no additional rules be adopted to restrict the deductibility of interest expense of Canadian corporations where the borrowed funds are used to invest in foreign affiliates.
The Budget adopts the recommendation of the Panel and proposes that Section 18.2 be repealed in respect of interest and other borrowing costs paid or payable in respect of periods that begin after 2011. Several other sections are proposed to be amended or repealed consequential upon the repeal of Section 18.2.
Foreign Affiliates, Non-Resident Trusts and Foreign Investment Entities
Measures to amend the taxation of Canadians in respect of non-resident trusts and interests in other non-resident entities were first proposed in the 1999 Budget. Despite the passage of nearly 10 years, the NRT and FIE rules to implement the 1999 Budget proposals have still not been enacted. The NRT and FIE rules have been the subject of much criticism over the years as being practically unworkable from the perspective of most taxpayers due to their complexity, overreach and overlap. The Government has issued many revised amendments to the proposals in the 10-year interval.
In addition, a number of the proposals contained in the draft legislation released in February 2004 relating to the foreign affiliate rules have not yet been enacted.
One of the Panel's recommendations is that the foreign affiliate property income, FIE and NRT regimes be reviewed and coordinated. In particular, the Panel believed that the proposed FIE and NRT rules should be reconsidered to ensure that their need and scope are consistent with the Panel's recommendations regarding the international taxation of outbound investments by Canadian businesses.
The Budget states that the Government will review the existing FIE and NRT proposals in light of the Panel's recommendations and other submissions before proceeding with measures in this area. It further provides that the Government will consider the Panel's recommendations relating to foreign affiliates before proceeding with the remaining February 2004 proposals.
The Government must provide clarity with respect to the Budget statement that the review will take place "before proceeding with measures in this area." It is currently proposed that the NRT and FIE rules generally apply retroactively to the 2007 taxation year. Taxpayers considering transactions need guidance as to whether they should be taking into account the current versions of the proposals as supplemented by Department of Finance comfort letters or whether any changes will be prospective only. Similar clarity is required in relation to the proposed changes to the foreign affiliate rules.
Personal Tax Relief
Increases in Basic Personal Amount and Income Tax Brackets
The basic personal amount will be increased to $10,320 in 2009 from $9,600 in 2008.
The top of the first personal income tax bracket (15%) will be increased from $37,885 in 2008 to $40,726 in 2009. The top of the second personal income tax bracket (22%) will be increased from $75,769 in 2008 to $81,452 in 2009. No changes are proposed to the top level of the third (26%) bracket ($126,264) or to the top (29%) bracket.
Normal indexation will apply to the new personal amount and bracket thresholds for future years.
Increase in Age Credit
The age credit is available to individuals 65 years of age and older. It is calculated by multiplying the lowest federal personal income tax rate of 15%, by an amount that is indexed to compensate for inflation. The Budget proposes that the amount on which the age credit is based be increased by $1,000 to $6,408 for 2009, and be indexed thereafter.
The age credit is subject to an income test and begins to be phased out to the extent that the individual's net income exceeds a threshold amount, being $32,312 in 2009. No change is proposed to the threshold or to the phase-out rate.
As a result of the proposed changes, the income level at which the age credit is fully phased out will increase to $75,032 from $68,365.
Enhancing the Working Income Tax Benefit
The working income tax benefit (WITB) is a refundable credit available to low-income individuals who have earnings from employment or a business (working income). The credit is 20% of working income in excess of $3,000 up to a maximum, and is clawed back at a 15% rate in respect of net income over a threshold. The purpose of the WITB is to supplement the incomes of low-income working individuals to ensure they are better off being employed.
The Budget proposes to enhance the tax relief provided by the WITB by $580 million for the 2009 and subsequent taxation years, which is expected to double the total tax relief provided by the WITB. No specific proposal is made in the Notice of Ways and Means Motion accompanying the Budget regarding the nature of the enhancements. In the Budget Papers, the Government states that it will consult with the provinces and territories before implementing the design of the enhanced WITB for the 2009 taxation year. As an example, the Government proposes for discussion a credit at a 25% rate (rather than 20%) reaching a maximum benefit at $6,700 of earned income (presumably working income) in excess of $3,000. The credit would be phased out at a rate of 15% of net income in excess of $10,500, with full phase out at net income of $16,667.
Changes to National Child Benefit Supplement and Canada Child Tax Benefit
The Budget proposes to apply the new upper limit of the 15% tax rate bracket ($40,726) rather than the current limit ($37,885) for the purpose of determining the amount of income that can be earned before the national child benefit supplement is fully phased out and the Canada child tax benefit begins to be phased out.
Housing Sector Initiatives
As part of its support for the housing sector, the Government has proposed new tax credits and increased tax-free access to RRSP funds. In this regard, to stimulate short-term spending, the Government will establish a home renovation tax credit (HRTC) that will provide Canadian families with tax credits of up to $1,350 each, for 2009 only. Further, the Government will increase the amount from $20,000 to $25,000 that first-time home buyers can withdraw on a tax-free basis from their RRSPs to purchase or build a home, and will establish a first-time homebuyers' tax credit of up to $750. Each of these measures is summarized below:
RRSP and RRIF – Loss Carryback on Death
In contrast to the ability under the Act to use capital losses incurred in the first taxation year ending after death against capital gains recognized in a deceased's terminal return, the Act currently provides no relief in respect of decreases in value in an RRSP or RRIF after the death of the annuitant and prior to the distribution of the fund's assets to the beneficiaries. Perhaps prompted by the sharp downturn in the markets during 2008, the Government has proposed such relief.
Under the Act, the fair market value of investments held in an RRSP at the time of an RRSP annuitant's death is generally included in the income of the deceased in the year of death. Subsequent increases in the value of the RRSP investments are generally included in the income of the beneficiaries of the RRSP upon distribution. Similar rules apply in respect of RRIFs.
The Budget proposes to allow, upon the final distribution of property from a deceased's RRSP or RRIF, the amount of post-death decreases in value of the RRSP or RRIF to be carried back and deducted against the year-of-death income inclusion. The amount that may be carried back will generally be calculated as the difference between the amount in respect of the RRSP or RRIF included in the income of the annuitant as a result of the death of the annuitant and the total of all amounts paid out of the RRSP or RRIF after the death of the annuitant.
This measure is to apply to permit a carryback to the deceased's terminal return where the final distribution from the RRSP or RRIF occurs after 2008. The deduction will not be available, except to the extent permitted by the Minister, where after the death of the annuitant the plan held a non-qualified investment or where the last payment out of the plan or fund was made after the year following the year in which the annuitant died.
As a consequence of this measure and the recent downturn in the market, there will be an increased incentive for the timely distribution of assets out of RRSPs and RRIFs following the death of an annuitant where there has been a decrease in the value of the plan assets subsequent to the death of the plan's annuitant.
The Budget proposes to allow certain network sellers who are not already entitled to use a simplified GST/HST accounting method to elect jointly with their sales representatives to use such a method. The proposal will apply to fiscal years of a network seller beginning after 2009.
Tariff Reductions on Machinery and Equipment
The Budget proposes to permanently eliminate tariffs on a range of machinery and equipment; currently, tariffs on such goods range from 2.5 % to 11 %. The elimination is proposed to apply to 214 tariff items that are currently listed in the schedule to the Customs Tariff. In certain instances, the proposed reductions will lead to consequential reductions to the rates of duty under other tariff treatments, including the General Preferential Tariff, the Australia Tariff and the New Zealand Tariff.
As a simplification measure, the Budget also proposes to revoke a number of specific tariff items and to replace them with more general tariff items, and proposes that additional tariff items be added.
The Budget also proposes to amend the Customs Tariff rules respecting the treatment of temporarily imported cargo containers. Generally, the Government intends to liberalize the use of these containers in Canada.
Previously Announced Measures
The Budget confirms the Government's commitment to certain previously announced tax measures, in particular the measures in the November 28, 2008 Notice of Ways and Means Motion. This Motion included a number of tax measures from the 2008 Budget, rules relating to the conversion of SIFTs to corporations, the clarification of the existing SIFT taxation rules and new measures for seniors such as the one-time reduction for 2008 in the minimum withdrawal amounts for RRIFs. Other measures that the Government stated would proceed are the amendments to the functional currency tax reporting rules (released on November 10, 2008), the extension of the deadline for the 2008 contributions to registered disability savings plans (announced December 23, 2008), amendments to the amateur athletic trusts rules (announced December 29, 2008), changes to the application of the GST/HST to the financial services sector (announced January 26, 2007) and modifications to the Customs Tariff for milk protein concentrates (announced June 12, 2008).
Possible Future Provincial Tax Measures
The Budget recognizes that Canada's ability to provide a competitive tax regime for businesses is significantly affected by the tax regimes of the provinces and territories.
British Columbia, Saskatchewan, Manitoba, Ontario and Prince Edward Island still impose a retail sales tax (RST). The Government notes that if those provinces were to adopt a value-added sales tax that provides businesses with an input tax credit for the taxes they pay on the acquisition of goods and services and this were to be harmonized with the GST, the marginal effective tax rate on new business investment would be reduced by more than 7%. The Budget suggests that in its efforts to achieve this result, the Government will show some flexibility in its negotiations with the provinces that still impose an RST. It should be noted, however, that harmonization may increase the tax burden of certain businesses not entitled to full input tax credits.
The Budget also requests the remaining provinces and territories to join Alberta and British Columbia in reducing their corporate income tax rates to 10% by 2012.
The Budget contains many proposals regarding the Employment Insurance (EI) program. In particular, the Budget proposes to freeze EI premium rates at $1.73 per $100 for both 2009 and 2010. For 2011 and beyond, the Budget states that the Canada Employment Insurance Financing Board (announced in the 2008 Budget) will begin setting EI premium rates on a break-even basis.
Some specific Budget proposals include:
- providing $500 million over two years to extend EI income benefits for individuals that participate in longer-term training (this measure is intended to benefit up to 10,000 workers);
- extending the Wage Earner Protection Program to cover severance and termination pay that is owed to eligible workers by employers that declare bankruptcy; and
- setting up an expert panel to determine how EI maternity and parental benefits should be made accessible to self-employed individuals.
Federally Regulated Pension Plans
The Budget refers to the "funding relief" proposals from the November 2008 Economic and Fiscal Statement for federally regulated defined benefit pension plans and proposes a further initiative, the details of which will be issued by OSFI at a later time. The 2008 initiatives related to solvency deficiencies arising in plan year-ends falling between November 1, 2008 and October 31, 2009. These initiatives (based on 2006 initiatives) will allow extension of the normal five-year amortization period for such a deficiency to 10 years if one of two pre-conditions are satisfied. The pre-conditions are: (1) obtaining plan member and retiree consent, or (2) securing the difference between the five- and 10-year funding by means of a letter of credit under prescribed conditions.
The Budget proposes for some relaxation to a rule that allows smoothing or averaging of the assets of the plan over a period of up to five years. This technique allows losses on pension fund investments to be recognized incrementally and would avoid immediate recognition of the losses in the pension fund following the sharp market declines in 2008. The current practice at OSFI is to prohibit recognition of smoothed asset values that are greater than 110% of the actual market value of the pension fund. The Budget proposes that OSFI relax this rule and increase the 110% limit (but the new maximum, if any, is not stated). However, there is a counterbalance to this proposal to maintain protection of plan member benefit security. Accordingly, where the 110% limit is exceeded, a form of deemed trust will apply in respect of the value of the deferred funding. No timing is specified for these proposals.
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