Budget 2025: Accelerated Depreciation (The So-called "Productivity Super-Deduction") & Combatting Tax Deferral Through Tiered Corporations

Budget 2025 announces various measures relating to the accelerated expensing of tax depreciation on certain capital properties (as well as reiterating the Government's intention to proceed with certain previously announced accelerated tax depreciation measures), collectively referred to in Budget 2025 as the "Productivity Super-Deduction". Budget 2025 also introduces proposed legislation to curb certain deferral strategies that some taxpayers were allegedly employing to defer tax through tiered corporations.

Accelerated Capital Cost Allowance

Existing CCA Regime

Depreciation for Canadian income tax purposes, referred to as ("capital cost allowance") or ("CCA"), generally permits an entity carrying on business in Canada to claim depreciation deductions in respect of certain capital property at specified rates. Depreciable capital property is generally divided into different classes, with each class generally eligible for a different tax depreciation (CCA) rate.

Although longer lasting capital assets are typically assigned a lower depreciation rate, reflecting the longer life of the asset, and shorter lived capital assets are typically eligible for a higher depreciation rate, there is a long Canadian tradition of using accelerated depreciation (i.e., higher depreciation rates or waiving the "half-year rule", as described below) to incentivize certain activities in a manner consistent with government policy of the time. Such accelerated CCA rates allow a taxpayer to claim an income tax deduction in respect of a capital expenditure sooner than would otherwise be possible if the depreciation rates were set solely with the view of matching the useful life of a capital asset.

In addition, under the ordinary CCA regime, most assets are subject to the so-called "half-year rule" that generally reduces the eligible CCA claim in the year a capital property is first available for use to one-half of the rate that would otherwise apply.

Currently, qualifying buildings used to manufacture or process goods for sale or lease (manufacturing or processing buildings) have a prescribed CCA rate of 10% (with other buildings typically only being eligible for a 4% CCA rate). To be eligible for the additional 6% CCA claim under existing rules, at least 90% of a building's floor space must be used to manufacture or process goods for sale or lease.

Proposed Acceleration of CCA for Manufacturing and Processing Buildings

Budget 2025 proposes to make temporary changes to the CCA regime entitling a taxpayer to immediate expensing for the cost of eligible manufacturing or processing buildings, including the cost of eligible additions or alterations made to such buildings. To be eligible for such immediate expensing, 90% of the building's floor space must be used to manufacture or process goods for sale or lease (analogous to the threshold for the additional 6% CCA available for manufacturing or processing buildings under current rules, as described above). Buildings eligible for the immediate expensing regime would not be subject to the above-described half-year rule, such that the full 100% of the eligible costs of the building may be expensed in the first year the building is used for manufacturing or processing.

Property that has previously been used, or acquired for use, for any purpose before it is acquired by a taxpayer seeking to make an accelerated CCA claim will only be eligible for such accelerated CCA regime if both of the following conditions are satisfied:

1. neither the taxpayer or any person not dealing at "arm's length" with the taxpayer previously owned the property; and
2. the property has not been transferred to the taxpayer on a tax-deferred "rollover" basis (e.g., pursuant to section 85 of the Income Tax Act (Canada) (the "Tax Act").

Budget 2025 notes that a taxpayer may be subject to recapture (i.e., may be liable to having all or a portion of the accelerated CCA claims reversed) if the taxpayer makes an accelerated CCA claim and then changes the use of the building.

The new measures apply for eligible property that is acquired on or after Budget Day and that is first used for manufacturing or processing before 2030. For property that is first used for manufacturing or processing in 2030 or 2031, an accelerated first year CCA rate of 75% would apply. Property first used for manufacturing or processing in 2032 or 2033 would be eligible for a first year CCA rate of 55%. The enhanced rate would not be available for property that is first used for manufacturing or processing after 2033 (at which point, the above-described 10% annual CCA rate would presumably apply).

Proposed Acceleration for Low-Carbon Liquefied Natural Gas Facilities

Budget 2025 also proposes to adopt an accelerated CCA regime for certain low-carbon liquefied natural gas ("LNG") facilities and equipment to replace a previous accelerated CCA regime that expired in 2024.

Previously, a temporary CCA measure that expired at the end of 2024 increased the applicable CCA rate on certain LNG equipment from 8% to 30% and on certain LNG buildings from 6% to 10%.

Budget 2025 proposes to replace the expiring LNG provisions with a narrower accelerated CCA regime for low-carbon LNG facilities. To be eligible for accelerated CCA under the new regime, a facility would need to meet certain elevated standards of emissions performance. Two potential levels of support could be applicable:

1. facilities that are in the top 25% in terms of emissions performance would be eligible for accelerated CCA with the same rates as the previous measures (30% for eligible LNG equipment and 10% for eligible LNG facilities); and
2. facilities that are in the top 10% in terms of emissions performance would be eligible for accelerated CCA rates of 50%, in the case of eligible LNG equipment, and 10%, in the case of eligible LNG buildings.

Such elevated rates would apply to property acquired after Budget Day and before 2035.

Previously Announced Accelerated CCA Proposals

In addition to the newly announced accelerated capital cost allowance measures in respect of manufacturing and processing buildings and certain LNG facilities, Budget 2025 reiterates the Government's intention to extend previously announced proposals for accelerated CCA in respect of "Productivity-Enhancing Assets" and "Purpose-Built Rental Housing". See our bulletin on these original announcements here.

Implications

Budget 2025 repeatedly notes that the various accelerated CCA incentives proposed under Budget 2025 and previously announced or implemented (the so-called Productivity Super-Deduction) will reduce Canada's marginal effective tax rate ("METR") (i.e., the tax rate on the next dollar of new investment) to 13.2%, which is stated to be the lowest amongst G7 peer countries (including the 17.6% METR purportedly applicable in the United States). Such a step was widely viewed as necessary to maintain competitiveness with tax reforms in the United States under the One Big Beautiful Bill Act that generally permitted immediate expensing of capital assets on a permanent basis (notably in contrast to the temporary accelerated depreciation measures in Budget 2025). The Government's expressed hope in Budget 2025 is that this tax advantage spurs investment and productivity in Canada.

While no doubt helpful to affected businesses, the nation-wide averages mask broad variability in the applicable rate, depending on the nature of capital assets used in a business. Budget 2025 notes the wide average METRs applicable to different industries/sectors, with some having a materially lower METR and others having a higher METR.

In addition, because Canada does not generally permit consolidated tax filings amongst members of an affiliated group, large accelerated depreciation deductions may be of only limited utility if a significant portion of an enterprise's revenue is earned by a different legal entity than the owner of the capital assets eligible for accelerated depreciation. Certain enterprises may benefit from targeted reorganization transactions to better match income tax deductions with revenues.

Finally, we note that accelerated CCA programs further shift the preference in certain M&A transactions for certain buyers to acquire a business by way of asset sale (such that the purchaser can claim accelerated CCA on the "stepped-up" capital assets acquired under the deal), as compared with a share acquisition where a buyer is generally required to depreciate capital assets based on the historical tax basis of the depreciable assets. Conversely, an accelerated depreciation regime increases the likelihood of vendors in an M&A transaction having significant recapture on an asset sale (potentially increasing the tax cost of an asset sale to a vendor relative to a share sale).

Tax Deferral Through Tiered Corporations

Budget 2025 also introduces an anti-avoidance measure to prevent certain strategies that were purportedly used to defer (potentially indefinitely) the taxation of certain investment income earned by Canadian-controlled private corporations ("CCPCs").

The alleged planning relates to certain elevated rates of taxation that apply to certain investment income (including dividends received from certain unconnected corporations) earned by CCPCs and certain private corporations (and subject corporations), a portion of which is generally refundable on the payment of certain dividends pursuant to the statutory regime governing "eligible refundable dividend tax on hand" (ERDTOH) and "non-eligible refundable dividend tax on hand" (NERDTOH, and together with ERDTOH, "RDTOH") balances.

Generally, a private corporation or subject corporation receiving a dividend from a "connected corporation"¹ with an RDTOH balance could be liable for tax under Part IV of the Tax Act, in an amount generally equal to the lesser of (i) 38.33% of the dividend received, and (ii) the dividend payor's RDTOH balance. In such circumstances, the dividend payor may be entitled to a refund of tax from the Canada Revenue Agency up to the greater of approximately (i) 38.33% of the amount of the taxable dividend paid, and (ii) an amount equal to the RDTOH balance at such time.²

Part IV tax is generally payable by the recipient corporation on the balance-due day³ for its taxation year in which the dividend is received (which can be after the balance-due day for the payer corporation's taxation year in which the dividend was paid). Budget 2025 makes reference to certain tax planning techniques allegedly employed by certain taxpayers to take advantage of this timing difference to defer (potentially indefinitely) the tax liability on investment income by interposing corporations with staggered year ends in a corporate chain. Budget 2025 cites the simple example of a corporation paying a taxable dividend at a time that is in the payor corporation's 2025 taxation year, and in the recipient corporation's 2026 taxation year.

Budget 2025 proposes to limit such planning opportunities by suspending the dividend refund that could be claimed by a payer corporation on the payment of a taxable dividend to an affiliated recipient corporation if the recipient corporation's balance-due day for the taxation year in which the dividend was received ends after the payer corporation's balance-due day for the taxation year in which the dividend was paid. Such suspended refunds would not apply if each corporate dividend recipient in the chain of affiliated corporations pays a subsequent dividend on or before the payor's balance-due day, such that no deferral is achieved by the affiliated corporate group. The corporation would generally be entitled to claim the suspended dividend refund in a subsequent taxation year when the recipient corporation pays a taxable dividend to a non-affiliated corporation or an individual shareholder.

Budget 2025 acknowledges that certain bona fide non-ordinary course dividends may arise in the context of an acquisition of control and consequently does not propose to apply the refund suspension rule in connection with a dividend paid within 30 days before an acquisition of control.

The proposed anti-deferral measure would apply to taxation years that begin on or after Budget Day.

Footnotes

1 Generally, a corporation that owns 10% or more of the votes and value of the payor.

2 Generally, only "eligible dividends" can trigger an ERDTOH refund, whereas only "non-eligible dividends" can trigger an NERDTOH refund.

3 Subject to certain exceptions, the "balance-due day" is two months after a corporation's year-end.

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2025