Selected Tax Measures In The 2025 Federal Budget - Canada

The Minister of Finance (Canada), the Honourable François-Philippe Champagne, presented the Government of Canada's (the "Federal Government") 2025 Federal Budget ("Budget 2025") on November 4, 2025 ("Budget Day"). Budget 2025 contains significant proposals to amend the Income Tax Act (Canada) (the "ITA") and the Excise Tax Act (the "ETA") while also providing updates on previously announced tax measures and policies.

Significant Budget 2025 proposals and updates include:

• introduction of a "Productivity Super-Deduction", a collection of measures including some previously announced, to allow for accelerated deduction of capital investments;
• broadening of the current anti-avoidance rule in respect of the 21-year deemed disposition for trusts;
• proposals to limit the deferral of refundable tax on investment income through tiered corporate structures with staggered year ends;
• changes in how multinational enterprises must analyze cross-border transactions between non-arm's length persons for purposes of the transfer pricing rules;
• proposals to clarify that income derived from assets held by a foreign affiliate of a Canadian insurance company that support Canadian insurance risks is taxable in Canada;
• elimination of the Underused Housing Tax; and
• a new reverse charge mechanism to combat "carousel fraud" under the Goods and Services Tax/Harmonized Sales Tax ("GST/HST"), starting with the telecommunications sector.

Selected proposals and tax measures are detailed below:

• Productivity Super-Deduction
• Personal Income Tax Measures
• Business Income Tax Measures
• International Tax Measures
• Sales and Excise Tax Measures
• Reductions in the Canada Revenue Agency
• Certain Previously Announced Tax Measures

Productivity Super-Deduction

Budget 2025 announces a "Productivity Super-Deduction" which includes a set of tax incentives that allow businesses to accelerate the deduction of new capital investments (the "Super-Deduction").

The Super-Deduction includes the following previously-announced measures:

• the Accelerated Investment Incentive, which provides an enhanced first-year write-off for most capital assets;
• immediate expensing of manufacturing or processing machinery and equipment;
• immediate expensing of clean energy generation and energy conservation equipment, and zero-emission vehicles;
• immediate expensing of certain productivity-enhancing assets, including patents, data network infrastructure, and computers; and
• immediate expensing of capital expenditures for scientific research and experimental development.

As discussed below, Budget 2025 proposes to introduce immediate expensing for manufacturing or processing buildings acquired on or after Budget Day and used for manufacturing or processing before 2030.

As part of the Super-Deduction, Budget 2025 proposes reinstating accelerated capital cost allowance for low-carbon LNG (liquefied natural gas) facilities. To be eligible for an accelerated capital cost allowance, a facility would need to meet new high standards of emissions performance. The Federal Government will provide details regarding the new emissions performance requirements at a later date.

The Federal Government notes that the Productivity Super-Deduction will reduce Canada's marginal effective tax rate for business investments by more than two percentage points.

Personal Income Tax Measures

Qualified Investments for Registered Plans

Previously, Budget 2024 invited stakeholders to provide suggestions on improving the clarity and coherence of the qualified investments regime for seven types of registered plans: Registered Retirement Savings Plans ("RRSPs"), Registered Retirement Income Funds ("RRIFs"), Tax-Free Savings Accounts ("TFSAs"), Registered Education Savings Plans ("RESPs"), Registered Disability Savings Plans ("RDSPs"), First Home Savings Accounts ("FHSAs"), and Deferred Profit Sharing Plans ("DPSPs"). The qualified investments regime governs what these plans can invest in. A broad range of assets are qualified investments, including mutual funds, publicly-traded securities, government and corporate bonds, and guaranteed investment certificates.

Based on feedback received through the consultation process, Budget 2025 proposes the following amendments to simplify the qualified investment rules. Notably, Budget 2025 does not include a proposal to reduce the mandatory minimum RRIF withdrawal.

Small Business Investments

There are two sets of rules for registered plan investments in small businesses:

1. the first set of rules applies to RRSPs, RRIFs, TFSAs, RESPs, and FHSAs and provides for investments in what are known as specified small business corporations, venture capital corporations, and specified cooperative corporations; and
2. the second set of rules applies only to RRSPs, RRIFs, RESPs, and DPSPs and provides for investments in eligible corporations, small business investment limited partnerships, and small business investment trusts.

Neither set of rules applies to RDSPs.

There is duplication and complexity within these rules, which leads to uncertainty as to the specific rules that are intended to apply in a particular case and has resulted in some investment categories being underutilized.

Budget 2025 proposes to simplify the rules relating to registered plan investments in small businesses, while maintaining the ability of registered plans to make such investments. In particular, the more broadly applicable first set of rules would be maintained and extended to RDSPs, while the second set of rules would be repealed. Consequently:

• RDSPs would be permitted to acquire shares of specified small business corporations, venture capital corporations, and specified cooperative corporations; and
• shares of eligible corporations and interests in small business investment limited partnerships and small business investment trusts would no longer be qualified investments.

These amendments would apply as of January 1, 2027. Interests in small business investment limited partnerships and small business investment trusts that are acquired before 2027 under the current rules would continue to be qualified investments. It is intended that shares of eligible corporations would continue to be qualified investments under the rules relating to specified small business corporations that would be maintained.

Registered Investment Regime

Registered investments are qualified investments for all registered plans. For a corporation or a trust to be a registered investment, it must be registered with the CRA.

Units of a mutual fund trust are qualified investments, but the mutual fund trust can also be a registered investment. In order for a trust or corporation that is not sufficiently widely held to qualify as a registered investment (e.g., a trust that does not have the 150 unitholders required to qualify as a mutual fund trust), the trust or corporation must hold only investments that would be qualified investments for the types of registered plans for which it is registered. Otherwise, the trust or corporation would be liable to pay a monthly tax of up to 1% of the acquisition-date fair market value of the non-qualified investment. Stakeholders have suggested that the registration process does not add sufficient value to justify its associated compliance and administration burdens.

Budget 2025 proposes to replace the registered investment regime with two new categories of qualified investments, which do not involve registration:

1. units of a trust that is subject to the requirements of National Instrument 81–102 published by the Canadian Securities Administrators (which regulates certain mutual funds and non-redeemable investment funds); and
2. units of a trust that is an investment fund (as defined in existing tax rules) managed by a registered investment fund manager as described in National Instrument 31–103 published by the Canadian Securities Administrators.

It is generally expected that units or shares of funds that were registered investments would continue to qualify, either under existing rules or under one or both of the new categories of qualified investment trusts.

The registered investment regime would be repealed as of January 1, 2027. The new qualified investment trust rules will take effect as of Budget Day.

Other Changes

Budget 2025 also proposes several technical legislative amendments to simplify the qualified investment rules. Notably, the qualified investment rules for six types of registered plans (i.e., all plans except DPSPs) will be consolidated into one definition in the ITA. In addition, the list of qualified investments prescribed in the Income Tax Regulations will be updated and reorganized by asset class.

Information Sharing – Worker Misclassifications

Previously, Budget 2024 announced that Employment and Social Development Canada ("ESDC") and the CRA would enter into data-sharing agreements to facilitate inspections and enforcement to address worker misclassification (i.e., employee or independent contractor). ESDC recently began sharing information with the CRA, but information-sharing restrictions in the tax rules (see section 241 of the ITA and section 295 of the ETA) prevent the CRA from sharing taxpayer information with ESDC.

Budget 2025 proposes to amend the information-sharing provisions of the ITA and the ETA to allow the CRA to share taxpayer information (under the ITA) and confidential information (under the ETA) with ESDC for purposes of the administration and enforcement of the Canada Labour Code as it relates to the classification of workers.

This measure would come into force on royal assent of the enacting legislation.

Expanding the 21-Year Rule Anti-Avoidance Rule

Under subsections 104(4) and (5) of the ITA, certain trusts are deemed to have disposed of their capital property and certain other property for fair market value proceeds on the 21st anniversary of the trust's creation. The rules prevent personal trusts from being used to postpone tax on accrued gains indefinitely.

In advance of a trust's 21st anniversary, other rules in the ITA allow for the rollout of property at cost to a beneficiary in satisfaction of the beneficiary's capital interest in the trust (see subsection 107(2) of the ITA). Provided certain conditions are met, the beneficiary receives the property at the trust's cost amount. However, further rules limit the availability of the rollout to non-resident beneficiaries (see subsection 107(5) of the ITA) or through the use of trust-to-trust transfers that do not involve dispositions at fair market value (see subsection 104(5.8) of the ITA).

Additionally, the CRA has consistently stated that it will consider applying the GAAR where transactions result in the avoidance of the 21-year rule by trusts.

As of November 1, 2023, the avoidance of a deemed disposition of trust property is a notifiable transaction under section 237.4 of the ITA (see CRA Notice NT-2023-2 "Avoidance of Deemed Disposal of Trust Property"). Failure to provide notice as required under section 237.4 results in penalties to the taxpayer and any advisor or promoter in respect of the notifiable transaction.

Budget 2025 reaffirms the Federal Government's concern that certain tax avoidance planning techniques have been employed to indirectly transfer trust property to a new trust, thereby avoiding both the 21-year rule and the anti-avoidance rule (i.e., the transfer from the trust to a corporation owned by the recipient trust).

To address these concerns, Budget 2025 proposes to amend subsection 104(5.8) of the ITA to restrict further the rollout where the trust property is transferred to another trust "directly or indirectly in any manner whatsoever." This measure will apply to transfers of property that occur on or after Budget Day.

Business Income Tax Measures

Immediate Expensing for Manufacturing and Processing Buildings

The capital cost allowance (CCA) system allows businesses to deduct the cost of depreciable property over time, with rates intended to reflect the useful life of assets. Currently, manufacturing or processing buildings in Canada qualify for a combined CCA rate of 10%—4% under Class 1 plus an additional 6%—provided at least 90% of the building's floor space is used for manufacturing or processing goods.

Budget 2025 proposes a temporary measure that allows for the immediate expensing of eligible buildings and qualifying improvements, resulting in a full deduction in the first year, provided they meet the 90% usage requirement. To qualify, the property must not have been previously owned by the taxpayer or a non-arm's length person and cannot be acquired on a tax-deferred rollover basis. Recapture rules may apply if the building's use changes after the expense has been incurred.

The measure applies to property acquired on or after Budget Day and first used before 2030. For later years, the enhanced deduction phases out: 75% for 2030–2031, 55% for 2032–2033, and no enhanced rate after 2033.

Scientific Research and Experimental Development ("SR&ED") Tax Incentive Program

Under the ITA, a taxpayer may deduct qualifying SR&ED expenditures in the calculation of its taxable income and/or, in some cases, claim an investment tax credit in respect of certain qualifying SR&ED expenditures.

A Canadian-controlled private corporation ("CCPC") may claim, in respect of a taxation year, a refundable tax credit equal to 35% of qualified SR&ED expenditures incurred by the corporation in the year (up to a certain expenditure limit).

In general, the expenditure limit of a CCPC for a taxation year is $3,000,000. However, the expenditure limit of a CCPC is reduced to the extent that its taxable capital employed in Canada (plus the taxable capital employed in Canada of other corporations associated with the CCPC) in the previous taxation year was between $10,000,000 and $50,000,000. If such taxable capital employed in Canada exceeds $50,000,000, the expenditure limit is reduced to nil. The expenditure limit is shared among corporations in an associated group.

A corporation other than a CCPC (and certain other taxpayers) may claim, in respect of a taxation year, a non-refundable tax credit equal to 15% of the qualified SR&ED expenditures incurred by the corporation (or other taxpayer) in the year (a CCPC may also claim this credit in respect of expenditures exceeding its expenditure limit for a taxation year).

The 2024 Fall Economic Statement indicated that the Federal Government intended to (i) increase the expenditure limit from $3,000,000 to $4,500,000 (and increase the lower and upper limits of the taxable capital "phase-out," indicated above, to $15,000,000 and $75,000,000, respectively), (ii) extend the eligibility for the refundable (enhanced) tax credit to eligible Canadian public corporations, and (iii) make certain SR&ED capital expenditures eligible for the deduction above and investment tax credit. Budget 2025 confirms that the Federal Government still intends to introduce legislation implementing these changes.

In addition, Budget 2025 proposes a further increase in the expenditure limit (as initially proposed in the 2024 Fall Economic Statement) for which a refundable tax credit may be claimed from $4,500,000 to $6,000,000. This measure would apply to taxation years that begin on or after December 16, 2024.

Critical Mineral Exploration Tax Credit

Under the ITA, a corporation may renounce certain expenses to holders of flow-through shares in the corporation. These expenses include Canadian exploration expenses (including Canadian renewable and conservation expenses) and Canadian development expenses. The holder of the shares may deduct such expenses in the calculation of their taxable income (or, in some cases, claim an investment tax credit in respect of such expenses).

If an individual (other than a trust) purchases flow-through shares of a corporation, and the corporation renounces flow-through critical mineral mining expenditures to the individual, the individual may be able to claim the critical mineral exploration tax credit in respect of such expenditures. The amount of the credit equals 30% of such renounced expenditures.

Flow-through critical mineral mining expenditures include certain Canadian exploration expenses incurred by a corporation in conducting mining exploration activity from or above the surface of the earth, primarily targeting critical minerals. A "critical mineral" includes copper, nickel, lithium, and various other minerals. Budget 2025 proposes an expanded definition of "critical mineral" that will include bismuth, cesium, chromium, fluorspar, germanium, indium, manganese, molybdenum, niobium, tantalum, tin, and tungsten.

These measures will apply to expenditures renounced under flow-through share agreements entered into after Budget Day and on or before March 31, 2027.

Clean Technology Manufacturing Investment Tax Credit

The Clean Technology Manufacturing Investment Tax Credit provides a refundable tax credit equal to 30% of the capital cost of eligible investments in new machinery and equipment. These assets must be used for manufacturing or processing key clean technologies, or for activities related to the extraction, processing, or recycling of critical minerals that support clean technology supply chains, such as lithium, cobalt, nickel, graphite, copper, and rare earth elements.

Budget 2024 sought to clarify that this investment tax credit would be available in the context of certain polymetallic projects (i.e., projects engaged in the production of multiple metals).

Under Budget 2025, the scope of eligible critical minerals will be broadened to include antimony, indium, gallium, germanium, and scandium.

This measure applies to property acquired and available for use on or after Budget Day.

Investment Tax Credit for Carbon Capture, Utilization, and Storage ("CCUS")

The CCUS investment tax credit is a refundable tax credit intended to support qualifying expenditures related to carbon capture, utilization, and storage projects. The credit rate varies depending on the type of equipment and the timing of the investment. For expenditures incurred between 2022 and 2030, the applicable rates are 60% for capture equipment used in direct air capture projects, 50% for other capture equipment, and 37.5% for transportation, storage, and utilization equipment. For expenditures incurred from 2031 through to 2040, these rates decrease to 30%, 25%, and 18.75%, respectively.

Eligibility for this investment tax credit depends on the end use of the captured carbon dioxide. Approved uses include dedicated geological storage and incorporation into concrete; enhanced oil recovery does not qualify.

Budget 2025 proposes to extend the full credit rates by five years, making them available for eligible expenditures incurred up to the end of 2035. Reduced rates would then apply from 2036 to 2040. In addition, the Federal Government will postpone the scheduled review of CCUS credit rates by five years, with the review now expected before 2035 instead of 2030.

Clean Electricity Investment Tax Credit

The Clean Electricity Investment Tax Credit (the "Clean Electricity ITC") is designed as a refundable tax credit equal to 15% of the capital cost of eligible investments in equipment used for low-emission electricity generation, electricity storage, and interprovincial or territorial transmission. The credit is available to a wide range of entities, including taxable Canadian corporations, provincial and territorial Crown corporations, corporations owned by municipalities or Indigenous communities, pension investment corporations, and the Canada Infrastructure Bank. The capital cost of eligible property may be reduced by any government assistance received.

Budget 2024 provided further details on the Clean Electricity ITC, confirming that eligibility for the full 15% credit would be subject to specific labour requirements. These requirements are generally satisfied by paying "covered workers" in accordance with a collective agreement, or at rates comparable to those under such agreements, and by ensuring that at least 10% of labour performed by workers in Red Seal trades is carried out by registered apprentices. Taxpayers who do not elect to meet these labour requirements may claim the Clean Electricity ITC at a reduced rate of 5%.

Budget 2024 also clarified that eligible corporations, whether directly or through a partnership, may claim only one of the following credits for a given expenditure: the Clean Electricity ITC, the Clean Technology Investment Tax Credit, the Carbon Capture, Utilization, and Storage Investment Tax Credit, the Clean Hydrogen Investment Tax Credit, the Clean Technology Manufacturing Investment Tax Credit, or the Electric Vehicle Supply Chain Investment Tax Credit. However, multiple credits may apply to the same project where different expenditures qualify under separate programs.

For Crown corporations, Budget 2024 indicated that certain conditions may be imposed—such as a public commitment to achieving a net-zero grid by 2035 and a commitment to pass on the value of the credit to ratepayers—following consultations with provinces and territories.

Budget 2025 proposes to expand eligibility to include the Canada Growth Fund and introduces an exception ensuring that financing provided by the Canada Growth Fund will not reduce the cost of eligible property for the purpose of calculating the credit. These measures apply to property acquired and available for use on or after Budget Day.

Tax Deferral Through Tiered Corporate Structures

Current rules in the ITA aim to prevent CCPCs from being used to defer personal tax on investment income (i.e., passive income such as capital gains or dividends). When a CCPC earns investment income, it pays an additional refundable tax that raises its effective tax rate to match the highest personal tax rate. This extra tax is refunded when the corporation pays a taxable dividend to its shareholders, since those dividends are then taxed at the personal level.

Corporate shareholders, however, generally do not pay tax on dividends received from other corporations because they can often claim an inter-corporate dividend deduction. To address this, Part IV of the ITA imposes a special refundable tax on the recipient corporation when it receives a dividend from a "connected corporation" (typically one in which it owns more than 10% of the votes and value). This tax is meant to offset the payer corporation's dividend refund.

An issue arises because the timing of these taxes can be manipulated through tiered corporate structures and mismatched year ends. Part IV tax is due on the dividend recipient's balance-due day for the year the dividend is received, which can be later than the dividend payer's balance-due day for the year the dividend was paid. By using corporations with staggered year ends, corporate groups have been able to collectively defer payment of tax on investment income by timing dividends across different fiscal years within the corporate group.

The amendments in Budget 2025 will suspend the dividend refund that a payer corporation would normally claim when paying a taxable dividend to an affiliated recipient corporation if the recipient's balance-due day falls after the payer corporation's balance-due day for the relevant taxation year. This restriction will not apply if each affiliated recipient corporation in the dividend chain pays a subsequent dividend on or before the payer's balance-due day, thereby eliminating any deferral within the group. Additionally, to accommodate legitimate commercial transactions, the rule will not apply if the payer corporation undergoes an acquisition of control and pays the dividend within 30 days prior to that acquisition.

A suspended dividend refund may generally be claimed in a later taxation year when the recipient corporation distributes a taxable dividend to a non-affiliated corporation or an individual.

This measure would apply to taxation years beginning on or after Budget Day.

Eligible Activities Under the Canadian Exploration Expense

Under the ITA, a corporation may renounce certain Canadian exploration expenses, incurred for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada, to holders of flow-through shares in the corporation. A holder of such flow-through shares may claim (i) a deduction in respect of such renounced expenses (for purposes of calculating their taxable income) and/or, (ii) in the case of an individual (other than a trust), the mineral exploration tax credit or critical mineral exploration tax credit (depending on the type of expense).

The CRA interprets the term "quality" in the definition of "Canadian exploration expense" as relating to the underlying physical characteristics of a mineral resource and not the economic viability of a mining project in respect of such mineral resource. Accordingly, the CRA typically views expenses for technical studies, being studies generally undertaken to assess the engineering feasibility of a mineral resource and economic viability of a mining project (not the underlying physical characteristics of a mineral resource), as being excluded from the definition of "Canadian exploration expense" under the ITA.

However, in a recent decision, the Supreme Court of British Columbia determined that "quality" (in the definition, under BC law, that is equivalent to "Canadian exploration expense" under the ITA) could also refer to the economic viability of a mineral resource.

Budget 2025 proposes to amend the ITA to clarify that an expense, incurred for the purpose of determining the quality of a mineral resource in Canada, does not include an expense relating to a determination of the economic viability or engineering feasibility of a mineral resource. The amendment will be effective as of Budget Day.

International Tax Measures

Transfer Pricing

Budget 2025 introduces updates to modernize Canada's transfer pricing regime which purport to better align domestic rules with the OECD Transfer Pricing Guidelines and international consensus on the arm's length principle (the "Transfer Pricing Changes").

The Transfer Pricing Changes reflect the Federal Government's response to stakeholder feedback following the consultations announced in Budget 2021 and were discussed in a consultation paper released by the Department of Finance on June 6, 2023.

The Transfer Pricing Changes announced that a new transfer pricing adjustment application rule will apply where the following two conditions are met:

1. there is a transaction or series of transactions between a taxpayer and a non-resident person with whom the taxpayer does not deal at arm's length; and
2. the transaction or series (once it has been analyzed and determined) includes actual conditions different from arm's length conditions.

These conditions are determined not only by contractual terms but also by "economically relevant characteristics." Under the Transfer Pricing Changes, a new definition of "economically relevant characteristics" is proposed which includes five comparability factors: contractual terms, functional profile, characteristics of the property or service, economic and market context, and business strategies. The first two factors require an assessment of the "actual conduct" of the parties to ensure that the factual substance of the transaction is considered and not just its legal form. The Transfer Pricing Changes would require that any in-scope transaction or series is analyzed and determined with reference to the transaction or series' economically relevant characteristics.

The Transfer Pricing Changes also introduced a refined definition of "arm's length conditions" that focuses on what the actual participants would have done in comparable circumstances if they were dealing at arm's length. Under this refined definition, a transaction (or series of transactions) will be considered to include conditions that differ from arm's length conditions where (i) the transaction or series lacks a condition that would exist between arm's length parties in comparable circumstances, or (ii) arm's length parties would not have entered in to the same transaction or series (or would have done so differently) in comparable circumstances.

This approach purports to move away from theoretical third-party scenarios and focus on realistic options available to the parties at the time of the transaction. In exceptional circumstances, this new definition will also permit substituting the original transaction with an alternative arrangement, or disregarding it entirely, if that reflects what arm's length parties would have done, consistent with OECD Transfer Pricing Guidelines. This is intended to ensure that Canadian tax outcomes mirror the economic reality of the transaction. These changes regarding "actual conduct" and "economic realities" follow from the introduction of an economic substance test in the general anti-avoidance rule in section 245 of the ITA.

Administrative Changes

Certain administrative measures for transfer pricing are also updated to improve compliance and audit efficiency while reducing taxpayer burden. These include an increase in the threshold for which the transfer pricing penalty will apply from a $5 million adjustment to $10 million, clarification of transfer pricing documentation requirements and alignment of said requirements with the new rules, simplified documentation requirements (where prescribed conditions are met), and a reduction in the time to provide documentation upon request from three months to 30 days. The requirement for taxpayers and partnerships to prepare or obtain records and documentation by their documentation-due date remains unchanged.

The Transfer Pricing Changes would apply to taxation years beginning after Budget Day.

Investment Income Derived from Assets Supporting Canadian Insurance Risks

Income earned by a controlled foreign affiliate of a taxpayer resident in Canada may be treated as foreign accrual property income ("FAPI"), which is taxable in the hands of the Canadian taxpayer on an accrual basis. There is a specific rule in the FAPI regime that includes in computing the affiliate's FAPI income from a business involving the insurance of Canadian risks (i.e., risks in respect of persons resident in Canada, property situated in Canada, or businesses carried on in Canada).

Budget 2025 proposes to amend the ITA to clarify that income derived from assets held by a foreign affiliate of a Canadian insurance company that support Canadian insurance risks is taxable in Canada. The Federal Government's rationale for introducing this clarification is that some taxpayers have taken the position that the specific FAPI rule does not apply to such investment income arising on such assets and noted that invested assets indirectly held by a foreign affiliate that are held to back Canadian risks are generally regarded as backing Canadian risks for actuarial and regulatory reporting purposes.

Budget 2025 proposes to clarify that investment income derived from assets held by a foreign affiliate in connection with the insurance or reinsurance of Canadian risks is included in FAPI regardless of which entity holds those assets. This measure would apply to taxation years that begin after Budget Day.

Sales and Excise Tax Measures

Budget 2025 proposes to make a major change to the GST/HST regime in Canada (which will likely be replicated in Quebec) to follow the European Union and other countries that impose a Reverse Charge Mechanism to combat "carousel fraud" in their value-added tax regimes. Budget 2025 also proposes to eliminate the Underused Housing Tax Act (for 2025 and future years), to remove the Luxury Tax from aircraft and vessels, and to clarify the GST/HST status of osteopathic services.

Combating Carousel Fraud in the GST/HST System

What Is Carousel Fraud?

Carousel fraud is a sophisticated scheme that exploits the design of typical value-added tax systems, including Canada's GST/HST. The scheme involves a series of real or fictitious transactions where one party—often called the "missing trader"—collects GST/HST but fails to remit it to the CRA. These schemes undermine the integrity of the tax system, reduce the Crown coffers, and are constantly evolving.

Recent decisions of the Tax Court of Canada have held that honest taxpayers who pay tax to these "missing traders" are not to be held responsible for this type of fraud, and that their responsibilities are limited to confirming the GST/HST registration number of their suppliers prior to claiming their own input tax credits.

Budget 2025 Response: Reverse Charge Mechanism

To address this issue, Budget 2025 proposes amendments to Part IX of the ETA that will introduce a Reverse Charge Mechanism ("RCM"), starting with the telecommunications sector, with additional sectors to be added by regulation in the future.

Under the RCM, it is proposed that:

• suppliers of specified telecommunication services will no longer collect GST/HST from purchasers that are registered under the traditional GST/HST regime and that are acquiring such services for the purpose of re-supply;
• purchasers of these services will be responsible for self-assessing the tax on their GST/HST returns and making any necessary remittances along with any other net tax to be remitted;
• if eligible, purchasers may claim input tax credits in the same return to offset such GST/HST; and
• invoicing requirements for suppliers will be amended to ensure that services covered by the RCM will need to be indicated.

Budget 2025 indicates that the specified services that would be covered by the RCM are real-time speech communication services and related data transmission services (e.g., the supply of VoIP minutes).

Draft legislation has not yet been issued, and the Federal Government has requested feedback on this proposal prior to completing its draft legislation. Given the additional burdens that this will create for suppliers with respect to changes to invoicing requirements and potential due diligence of customers' GST/HST registration status and purpose of purchase, we expect that there will be significant feedback from the public.

Clarifying GST/HST Treatment of Manual Osteopathic Services

Under current GST/HST rules, health care services covered by provincial health plans or provided by regulated professionals (e.g., physicians, dentists) are generally tax-exempt.

However, the legislation includes an outdated reference to "osteopathic services" that, although originally intended for osteopathic physicians, has apparently led to tax-exempt treatment of services provided by manual osteopathic practitioners, who are not regulated as physicians.

Budget 2025 proposes to clarify that manual osteopathic services are taxable under GST/HST and to apply this change to supplies made after June 5, 2025, with transitional relief for certain supplies made before Budget Day where no tax was charged or remitted.

Elimination of the Underused Housing Tax

Since January 1, 2022, the Underused Housing Tax ("UHT") has applied to certain owners of vacant or underused residential properties in Canada, primarily targeting non-resident, non-Canadian individuals. The tax is levied annually at a rate of 1% of the property value.

Budget 2025 proposes to eliminate the UHT starting with the 2025 calendar year, such that no UHT will be payable and UHT returns will not be required for 2025 and subsequent years. All the present requirements will, however, remain in effect for the 2022 to 2024 calendar years. Penalties and interest for non-compliance, including failure to file returns or remit tax, will continue to apply for these years.

Repeal of Luxury Tax on Aircraft and Vessels

The federal luxury tax presently applies to subject vehicles and aircraft valued at over $100,000 and vessels valued at over $250,000. It applies to sales, importations, leases, and certain improvements, and is calculated to be the lesser of 10% of the total value or 20% of the value exceeding the threshold.

Budget 2025 proposes to amend the Select Luxury Items Tax Act ("SLITA") to eliminate the luxury tax on any transactions involving aircraft and vessels, effective as of Budget Day.

Registered vendors will need to file a final return covering the reporting period that includes Budget Day. Although registrations under SLITA for aircraft and vessels will remain active until February 2028 to allow eligible vendors to claim available rebates, no further returns will be required for periods starting after Budget Day.

Reductions in the Canada Revenue Agency

Budget 2025 proposes significant reductions across nearly every federal agency, with projected cost savings between $8 billion to $12 billion per year. This is welcome news in respect of the Federal Government workforce that had ballooned by 100,000 employees over ten years to more than 360,000 employees in 2024. The Canada Revenue Agency's employee headcount increased from approximately 40,000 in 2015 to nearly 60,000 in 2025.

The CRA had received steady increases in annual funding in the last ten years, based in part on the hypothetical premise that every $1 invested in CRA operations could return an additional $5 of tax revenue. This rosy prediction—advanced by some senior officials at the CRA over several years—turned out to be entirely wrong. The CRA's own data revealed that the anticipated audit dollars did not materialize or had been wrongly calculated in the CRA's own estimates (see the Auditor General's reports in 2016 and 2018 that criticized certain of the CRA's operations and estimates).

Additionally, predictions of tax windfalls from new boutique tax legislation in the form of luxury taxes ($654 million over five years), digital services taxes ($7 billion revenue over five years), and underused housing taxes ($875 million over five years) proved to be over-estimated and failed to take into account the difficulty and costs associated with administering these taxes (or, for the DST, the political costs of angering a significant national trading partner). One estimate from 2024 indicated that the new UHT had raised $49 million of tax revenue while costing $59 million to administer.

Budget 2025 recognizes this, and projects greater administrative efficiencies within the CRA, including headcount reductions and the wind down of business units "no longer connected to government priorities" (i.e., spending more on administration than the tax dollars raised). As detailed above, the luxury taxes on aircraft and boats, and the entire Underused Housing Tax Act, will be eliminated.

Commendably, Budget 2025 predicts CRA service improvements resulting from artificial intelligence and process automation. The CRA has included references to artificial intelligence in its annual reports since 2019, and continued investments in this area could keep the CRA up to date with other tax administrations around the world. A 2025 OECD report indicated that AI deployments in tax administrations included detection of fraud/evasion, decision-making, audit, recommendations, process improvement, information provision to taxpayers (i.e., chatbots), and virtual assistants. Budget 2025 anticipates savings of approximately $120 million to $235 million annually (ironically, these amounts, not adjusted for inflation, "undo" some of the additional revenues allocated annually to the CRA over the last ten years).

Budget 2025 also predicts the reinvestment of some of these anticipated savings, which may result in greater tax compliance and better results regarding outstanding debt collection. Budget 2025 predicts approximately $700 million to $1.2 billion of additional revenue from these redirected CRA resources.

Tax simplification and realistic revenue predictions are required to "right-size" the CRA. The agency should be very good at delivering high-quality results in a few key areas. For too long, the CRA was asked to do too much, and the result was confusion and misallocation of scarce resources. Overall, the planned resource reallocations are a welcome "back to reality" for CRA operations.

Certain Previously Announced Tax Measures

Budget 2025 confirms the Federal Government's intention to proceed with certain previously announced tax and related measures as modified in response to consultations and deliberations, including:

• Legislative and regulatory proposals released on August 15, 2025.
• Legislative proposals released on June 30, 2025 with respect to the Canada Carbon Rebates for Small Businesses.
• The extension of the Mineral Exploration Tax Credit announced on March 3, 2025.
• Legislative proposals released on January 23, 2025 to extend the 2024 charitable donations deadline.
• Legislative and regulatory proposals announced in the 2024 Fall Economic Statement.
• Legislative and regulatory proposals to remove the GST on the construction of new student residences released on November 19, 2024.
• Legislative and regulatory proposals released on August 12, 2024.
• The proposed increase in the Lifetime Capital Gains Exemption to apply to up to $1.25 million of eligible capital gains announced in Budget 2024.
• Tax measures to amend the Excise Tax Act, the Air Travellers Security Charge Act, the Excise Act, 2001 and the Select Luxury Items Tax Act to give effect to the proposals relating to non-compliance with information requests and to avoidance of tax debts announced in Budget 2024.
• Legislative and regulatory proposals released on August 9, 2022 and August 4, 2023.
• Legislative amendments to implement the Hybrid Mismatch Arrangements rules announced in Budget 2021.

Budget 2025 reaffirms the Federal Government's commitment to move forward as required with technical amendments to improve the certainty and integrity of the tax system.

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.