Canada: Canadian Mini-Budget Tax Relief: More And Faster Than Promised

The public debt remains a concern. Three consecutive years of surpluses, the first time in 50 years, have been dedicated to reduction of the national debt – accounting for a debt reduction of $18.7 billion. Going forward, Mr. Martin anticipates a $10 billion debt reduction for the 2000/2001 fiscal year, lowering the debt to a still overwhelming $555 billion.

Mr. Martin did:

• increase and accelerate personal tax reductions;
• accelerate corporate tax rate reductions;
• slash the capital gains income inclusion rate to 50%; and
• promise tax deferral opportunities on certain foreign corporate reorganizations and share exchanges.

Mr. Martin did not:

• accelerate planned increases in RRSP and pension plan contribution limits currently scheduled for nominal increases in 2003 and 2004; or
• modify the $500,000 capital gains exemption for dispositions of qualifying family farms and shares of private Canadian companies.

The economic statement accelerates and increases personal tax cuts announced in last February's budget. Effective January 1, 2001:

• the lowest and middle rates will drop from 17% and 25% to 16% and 22%, respectively, and the taxable income thresholds at which rates cut in will be increased; and
• the top rate of 29%, now applying to taxable incomes above $60,009, will:

• drop to 26% on taxable incomes between $61,509 and $100,000; but
• continue to apply to taxable incomes exceeding $100,000.

The changes will result in the tax rates shown in the following table.

Commensurate with the tax rate reduction, the rate applying to the calculation of non-refundable tax credits and the alternative minimum tax will also drop to 16% from 17%.

The economic statement eliminates the 5% surtax effective January 1, 2001, instead of within 5 years, as proposed in the 2000 budget.

* The top bracket is $100,000 everywhere, except in New Brunswick (where the provincial surtax creates a bracket at $101,359 or more.) Rates include all federal, provincial and territorial income taxes and surtaxes. The final details of the provincial component of the taxation of Canadian dividends are not yet available for some provinces, and the rates shown may change.

* Actual amounts will vary depending on available credits, etc.

The economic statement further enhances the Canada Child Tax Benefit (CCTB), including the National Child Benefit (NCB):

• the NCB will be increased by $300 per child;
• the family income threshold at which the NCB supplement is fully phased out, and the CCTB base benefits begin to be phased out, will be increased to $32,000 in 2001; and
• the reduction rate applicable to CCTB benefits will be reduced to 4% (2% for one-child families) from 5% (2.5% for one-child families).

Effective 2001, tax credits available to persons with severe and prolonged disabilities will increase to $960 from $730. Tax credits for caregivers and infirm dependents as well as the supplement to the disability tax credit will increase to $560 from $406.

The economic statement increases the education tax credit available to post-secondary students as follows:

Consistent with the reduction in the capital gains inclusion rate (highlights following), the deduction available for stock option benefits is increased to one-half for benefits includable in income after October 17, 2000. The net effect is that one-half of the stock option benefit is subject to tax.

Following last February's reduction in the capital gains inclusion rate from three-quarters to two-thirds for gains realized after February 27, 2000, the economic statement further reduces the inclusion rate to one-half for gains realized after October 17, 2000. These changes are summarized below:

Illustrative Computation

A taxpayer having capital gains and losses in 2000 is potentially subject to three different inclusion rates as the example following (extracted from the economic statement) illustrates. The determination of the net taxable capital gain or allowable capital loss for that year can become a complicated exercise to the extent the gains and losses fall in differing periods during the year.

Doug sells shares in ABC Corporation on February 1, 2000, for a gain of $600. He later sells shares in XYZ Inc. on May 15, 2000, for a loss of $500. Finally, he sells more shares of ABC Corporation on December 1, 2000, for a gain of $400.

Doug determines separately his net gains and losses for the periods January 1-February 27, February 28-October 17, and October 18-December 31. For the first period, he has a net gain of $600; for the second period, he has a net loss of $500; for the third period, he has a net gain of $400.

Doug calculates his interim net gain and interim inclusion rate for the period January 1-October 17. His interim net gain is $100 (the $600 gain less the $500 loss). Because the net gain from the first period is larger than the net loss from the second period, Doug's interim inclusion rate is three quarters.

Doug now uses the interim gain of $100 and the interim inclusion rate of 75% for the period January 1-October 17, along with the net gain of $400 for the period October 18 to December 31 to determine his inclusion rate for the year. Doug uses the following formula:

(C x D + 50% x E) / (D+E)

Where C = 75%, D = $100, E = $400

Inclusion Rate = (75% x $100 + 50% x $400) / ($100 + $400) = 55%

To determine his taxable capital gain for the year, Doug applies this inclusion rate to his net gain for the year of $500 (i.e., the $100 interim net gain plus the $400 net gain for the period October 18 to December 31).

Taxable Capital Gain = 55% x $500 = $275

Under existing legislation, the capital gains inclusion rate is reduced by one-half for capital gains arising from certain donations of appreciated publicly traded securities and ecologically sensitive property to a charity. For 2000, the inclusion rate for such capital gains will be based on one-half of the capital gains inclusion rate for the period in which the donation occurred. For 2001 (and future years, where applicable), the inclusion rate will be one-half of the capital gains inclusion rate for that year.

February's budget provided individuals (but not trusts) a rollover of capital gains on the disposition of eligible small business investments when the proceeds of dispositions are reinvested in other small businesses. Effective October 18, 2000, the following changes will broaden access to the rollover:

However, under additional restrictions imposed by the economic statement eligible businesses:

• must be primarily carried on in Canada for 24 months while the investor holds the shares; and
• cannot include specified financial institutions, professional corporations and corporations with significant real estate holdings.

Consistent with the reduction in the capital gains inclusion rate, a one-half inclusion rate will apply to gains on dispositions of eligible capital property for taxation years ending after October 17, 2000. It appears that three-quarters of the cost of such property will continue to be added to the eligible capital property pool, while three-quarters of the proceeds of disposition will be credited to the pool.

February's budget reduced the federal general corporate tax rate from 28% to 27% effective January 1, 2001 and promised to further reduce the rate to 21% within five years. The timetable is now accelerated as follows:

As cautioned in the budget, the reduced rate will apply to corporate income not already benefiting from preferential tax rates. Thus small businesses enjoying reduced corporate rates, manufacturing companies accessing the manufacturing and processing tax credit, investment companies benefiting from the refundable tax provisions and mutual fund and investment corporations will not be eligible for the reduced rates. Nevertheless, the services and knowledge-based sectors of the economy will benefit.

A new 15% non-refundable investment tax credit will be provided to individuals (but not trusts) that invest in flow-through shares. The credit may be claimed in respect of specified Canadian mineral exploration expenses renounced to the shareholder and incurred:

• pursuant to a flow-through share agreement made after October 17, 2000; and
• after October 17, 2000 and before 2004.

The credit will reduce the Canadian exploration expenses otherwise deductible.

The credit is available only for expenses for "grass roots" surface exploration excluding expenses for digging test pits and preliminary sampling. The federal government commented that it will continue to review the definition of eligible expenses and other technical issues related to flow-through shares.

In certain reorganizations, a foreign corporation may "spin-off" or distribute to its shareholders shares of another foreign corporation. Often, the reorganization is a tax-free transaction in the foreign jurisdiction. Nevertheless, Canadian shareholders of the distributing corporation are generally treated as having received a taxable dividend. For spin-offs occurring on a tax-free basis in the United States, and for yet-to-be prescribed spin-offs occurring in other countries with which Canada has a tax treaty, Canadian shareholders will now be able to elect to reduce the tax cost of their holdings in the distributing corporation by the fair market value of the shares received.

The calculated cost base reduction to the shares of the distributing corporation will become the tax cost of the shares received by the taxpayer. The election will be available only if certain conditions are met including the fact that the US corporation making the distribution is widely held, public and actively traded.

The election option will be extended to certain distributions received by taxpayers after 1997 and before October 18, 2000, provided the taxpayers notify the Minister of Revenue in writing before July 2001.

A share-for-share exchange rollover rule will be developed providing Canadian resident shareholders with a tax deferral where the only consideration received in exchange for their shares of a Canadian corporation are shares of a foreign company. Currently, the rules only allow tax deferral where the consideration consists of shares of a domestic corporation. The rule will apply only when draft legislation has been developed in consultation with the private sector. If implemented as intended, cumbersome "exchangeable share" transactions currently used to economically achieve the same result could be a thing of the past.

Rather than compute their taxable capital gains and losses using the specific identification method, mutual fund trusts, mutual fund corporations, and segregated funds trusts will be offered a concessionary option whereunder they may treat their capital gains and losses as though they were earned evenly throughout their 2000

taxation year.

It appears under this option that the number of days in each period for which a different inclusion rate applies when divided by the total number of days in the taxation year, determines the portion of the gains for the year allocable to each of the periods. These gain amounts for the periods would then be used to determine the fund's effective capital gains inclusion rate for the year.

The manner in which a fund calculates its capital gains refund and reports the gains distributed to its unitholders must be consistent with the method chosen by the fund to calculate its own gains.

Segregated funds will not be able to use this alternative method in respect of gains allocated to a redeeming unitholder.

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.