On March 22, 2016, the Honourable Bill Morneau, Minister of Finance, introduced the Liberal government's first budget. Reprising the refrain from its recent election campaign, the new federal government presented this year’s budget as a plan that will deliver “real change” for the middle class and “those working hard to join it”. The budget focuses primarily on bolstering the middle class, job creation and economic growth, with substantial investments targeted for infrastructure, education, innovation and climate change initiatives, while also providing assistance to seniors, Aboriginals and veterans.
Numerous tax changes and government funding initiatives were announced as part of this year’s budget, as summarized below.
Personal Income Tax Measures
Tax Rates and Benefit Reduction
The federal government had previously announced personal tax reductions, effective for 2016, in the second lowest tax rate from 22% to 20.5% on earnings between $43,953 and $87,907 (based on 2015 income brackets). However, such reductions were also partially offset with increases in personal taxation and/or reductions in tax benefits, effective for 2016, as follows:
- The tax rate on incomes over $200,000 increased from 29% to 33%; and
- The tax-free savings account contribution limit was rolled back from $10,000 to $5,500 and indexing was reinstated.
This year’s budget followed up these offset measures with additional reductions, as follows:
- Income-splitting – The benefit that allows some families with children under 18 to reduce their taxes by up to $2,000 will be cancelled;
- Education and textbook Tax Credits – Commencing in 2017, the education and textbook tax credits are eliminated; and
- Children’s Fitness and Arts Tax Credits – Effective for 2016, the maximum eligible amounts will be reduced to $500 for the children’s fitness tax credit and $250 for the children’s arts tax credit, with the elimination of both credits occurring in 2017.
The New Canada Child Benefit
The new Canada Child Benefit (CCB) replaces the old Canada Child Tax Benefit and the Universal Child Care Benefit. The CCB will provide a tax-free maximum benefit of $6,400 per child under the age of 6 and $5,400 per child aged 6 through 17. A phase-out percentage exists for the benefit for adjusted family income between $30,000 and $65,000, and further reduction where income exceeds $65,000. The phase-out percentages are based on the number of eligible children with maximum levels of 23% and 9.5%, respectively, for each phase-out bracket for families with more than 3 children.
Stock Option Benefits
Subsequent to election in 2015, the federal government announced intentions to limit benefits otherwise afforded to the taxation of executive stock option benefits. Such current benefits include a 50% reduction in the employment stock option benefit otherwise included in taxable income at the date of exercise where the options were granted out of the money pursuant to paragraph 110(1)(d) of the Income Tax Act (ITA).
The budget was silent on any measures to reduce current eligible stock option benefits and any potential changes to alter the personal taxation of stock option benefits are not known at this time.
The federal government also announced various other changes to personal tax deductions and credits, as follows:
- Beginning 2016, the maximum northern residency deduction has increased to up to $11 per day per household member and, where no other member claims the deduction, to $22 per day;
- The mining exploration tax credit for flow-through shares is extended by one year and will apply to flow-through share agreements entered into on or before March 31, 2017; and
- Reinstatement of the federal labour-sponsored venture capital corporations (LSVCC) tax credit of 15% for acquisitions of LSVCC shares that are provincially registered for 2016 and subsequent years, including an opportunity to qualify certain existing provincial LSVCC (the federal LSVCC tax credit remains at 5% for 2016, but will be eliminated thereafter).
The federal government also announced an increase to education grants to low income families by up to 50%, to a maximum of $3,000 per eligible student per year.
Measures were also proposed to eliminate tax deferral opportunities for investors holding switch funds and to further restrict capital gain treatment on the disposition of linked notes by deeming the accrued, but unrealized, increase in value on the instrument to be accrued interest.
The new Liberal federal government has focused on a partial redistribution of wealth by extending benefits to lower income families through a combination of tax rate relief and enhanced subsidies through the new Child Tax Benefit and increases to student education funding.
To offset the cost impact of such measures, the federal government has reduced or eliminated tax credits and deferral programs previously benefiting a broader and wealthier base of the Canadian population, in combination with a tax rate increase for income earners over $200,000.
The budget also targets certain investment strategies utilizing switch funds and linked notes. However, despite prior commentary regarding current tax benefits afforded to stock options, the Liberal government provided no change to the existing stock option regime in the budget.
It will be important to consider the tax impact, as a family unit, to maximize access to new benefits under the budget and to understand the impact on net cash flow through tax rate increases and tax credit reductions.
Corporate Income Tax Measures
Impact on Small Businesses
The budget included various measures impacting small businesses in Canada by cancelling previously announced tax rate reductions, eliminating planning techniques that otherwise multiplied access to the small business deduction, and limiting access to the tax free distribution of life insurance proceeds through a corporation.
The general measures proposed, effective as of the date of the budget, include:
- Reductions in the small business tax rate, ultimately, to 9% which is currently legislated for 2017 through 2019 will be deferred. Accordingly, the small business tax rate will remain at 10.5%. The existing gross-up factor and dividend tax credit rate applicable to non-eligible dividends will be maintained for integration purposes.
- Where a Canadian controlled private corporation (CCPC) provides services or property directly or indirectly to a partnership, the resulting income will not be eligible for the small business deduction (SBD). This measure will eliminate planning structures to access 100% of the SDB on charges to a partnership that otherwise may have been income to the partnership subject to pro-rata eligibility for the SBD.
- A CCPC’s investment income is currently treated as active business income eligible for the SBD where the income is derived from the active business of an associated corporation, pursuant to subsection 129(6) of the ITA. The SBD must be shared between associated corporations, and where two companies are associated by relationship to a third company under subsection 256(2), such association may be broken by an election resulting in only the third company becoming ineligible for the SBD. The budget proposes that, where such an election is made, the investment income derived from an otherwise associated corporation’s active business will be ineligible for the SBD, and will be taxed at the general corporate income tax rate.
- The budget also proposes measures to restrict taxpayers from accessing the difference between the fair market value of an insurance policy disposed of to a corporation or partnership and the cash surrender value as a tax-free benefit through the capital dividend account when the policy is transferred to a corporation or partnership.
Accelerated capital cost allowance (CCA) rates are available for Classes 43.1 and 43.2 (a declining balance basis of 30% and 50%, respectively) for investments in specified clean energy generation and conservation equipment. The budget expands these classes to include eligible electricity vehicle charging stations and eligible stand-alone electrical energy storage property. Qualification for electrical energy storage property will be expanded to a range of short-term and long-term storage equipment that is ancillary to eligible generation equipment.
The budget proposes to clarify the tax treatment of emissions allowances and to eliminate potential situations of double taxation. Such allowances will be treated as inventory, but the “lower of cost and market” method will not be permitted for valuation purposes.
New Class 14.1 – Eligible Capital Property
The existing eligible capital property amortization regulations for various intangible properties allow for 75% inclusion at a 7% declining balance rate. Effective January 1, 2017, the budget proposes that 100% of eligible expenditures will be included in the new class 14.1. The rate of depreciation will be 5% on a declining balance basis. The half-year rule, recapture and capital gains provisions will continue to apply to the new class. The depreciation rate for property carried over to the new pool from a prior cumulative eligible capital property (CEC) class existing before January 1, 2017, will be depreciated at 7% until the year 2027.
The budget proposes to deem swap agreements, forward purchase or sale agreements, forward rate agreements, and option or similar agreements not to be inventory of the taxpayer for purposes of inventory valuation rules
Regulation 102 Payroll Withholding – Foreign Employers
Based on initiatives announced in the 2015 budget, legislation was released by the Department of Finance on July 31, 2015 to stream-line reporting requirements for foreign employers with employees temporarily working in Canada and otherwise exempt from personal taxation under a treaty. With the election of a new majority government, the legislation was not enacted into law.
The present budget affirms the new federal government’s intention to move forward with the simplified procedures, with the potential for further enhancements.
The federal government continues to encourage foreign employers to register and access the benefits afforded through the program. Failure to comply with Canadian payroll requirements can result in substantial penalties and interest, along with other punitive results, such as limiting access to refunds on withholdings on personal income otherwise exempt under a treaty.
International Tax Measures
Canada prevents the tax-free receipt by a non-resident person of amounts representing retained earnings or surplus in excess of the paid-up capital of a Canadian corporation shares through proceeds of disposition. The ITA contains “anti-surplus-stripping” regulations under section 212.1 that can apply when shares of a Canadian corporation are disposed of by a non-resident person to another corporation resident in Canada with which the non-resident person does not deal at arm’s-length.
The budget proposes to amend exceptions under subsection 212.1(4) to ensure that it does not apply where a non-resident corporation: (i) owns, directly or indirectly, shares of the Canadian purchaser corporation; and (ii) does not deal at arm’s-length with the Canadian purchaser corporation.
Foreign Exchange – Debt Parking
The budget proposes that any accrued foreign exchange gains on a foreign currency debt will be realized when the debt becomes a parked obligation.
Extension of the “Back-to-Back” Regime
The budget proposes to extend back-to-back principles to royalty payments subject to Part XIII withholding under the ITA after 2016. The proposed rules would deem the Canadian-resident payor to have made a royalty payment directly to the ultimate non-resident recipient, and the withholding tax otherwise avoided as a result of the back-to-back arrangement would become payable.
The budget proposes to further extend back-to-back rules to prevent avoidance through the substitution of economically similar arrangements between the intermediary and another non-resident (e.g., structuring a payment stream to avoid withholding through advantageous use of debt, interest, and royalty payments, in combination, through intermediary companies and the use of international tax treaties).
These rules would now also extend to debts owing to Canadian-resident corporations, rather than debts owing by Canadian-resident taxpayers. A debt owing by a shareholder of a Canadian-resident corporation could result in the shareholder being deemed to be indebted directly to the corporation.
Base Erosion and Profit Shifting (BEPS)
The federal government has reaffirmed Canada’s support of BEPS initiatives. Pursuant to Action 13, the Organisation for Economic Co-operation and Development (OECD) proposed updated global transfer pricing documentation standards for multinational enterprises (MNEs) for a multi-layer approach, as follows:
- A master file, filed in the parent jurisdiction;
- A local file, filed by the foreign affiliate in its jurisdiction of operation; and
- A country-by-country analysis filed in the parent jurisdiction.
The budget proposes to require country-by-country reporting for taxation years that begin after 2015 for Canadian MNEs with total annual consolidated group revenue of at least 750 million Euros. This reporting would be due within one year of the end of the fiscal year to which the report relates, with anticipated exchanges between jurisdictions of country-by-country reports by June 2018.
The federal government confirmed ongoing discussions with Canada’s tax treaty partners to initiate a minimum standard of guidelines with respect to tax treaty abuse. The budget indicated that Canada’s tax treaties may be amended to include treaty anti-abuse rules, developed through a combination of bilateral negotiations and/or multilateral instruments. Such actions are in the spirit of BEPS, Action 6, charging each participating country to adopt minimum standards to address treaty abuse situations.
Although the budget closed certain loopholes related to SBD planning structures for CCPCs and implemented a freeze to the small business tax rate, opportunities still exist for small business owners to integrate personal and corporate tax planning to optimize access to government incentives.
Multinational corporations should review their existing and upcoming holding structures in light of the federal government’s commitment toward BEPS initiatives. Canada is moving forward with OECD pronouncements under BEPS Actions 6 and 13. The landscape for global disclosure of transfer pricing and limitations on tax treaty abuse continues to evolve. Such measures are congruent with the Liberal theme of “transparency”, which now appears to extend further into the areas of beneficial ownership and substance over form of transactions, given the extension of the “back-to-back” regime. The importance of appropriate international operational substance and documentation will now be heightened in order to mitigate tax risk and properly maintain an optimal tax structure.
Commodity Tax Measures
Closely Related Test
Once again, the federal government has tightened the conditions under which two corporations can be considered to be closely related to each other for the purposes of the election for nil consideration. The election for nil consideration permits closely related corporations to do business with each other without the requirement to charge GST/HST. The 2014 budget required that, effective January 1, 2015, this election be filed with the Canada Revenue Agency (CRA), despite the previously less onerous requirement of retaining the election on file.
This year’s budget proposes to add an additional test when determining whether two corporations are closely related for purposes of the election. The current test requires a parent corporation or partnership to own 90% or more of the value and number of shares of a subsidiary corporation. The budget proposal will require a corporation or partnership to also hold and control 90% or more of the votes in respect of every corporate matter of the subsidiary corporation (with certain exceptions), in addition to meeting the conditions of the current test.
The change generally becomes effective on March 22, 2017. However, the measure will come into effect on March 23, 2016 for elections that are filed and become effective after March 22, 2016.
Donations to Charities
Where a supply is provided in exchange for a donation, GST/HST would generally apply to the entire value of the donation, subject to certain exceptions. To make the GST/HST treatment more consistent with the treatment for income tax purposes, effective March 23, 2016, GST/HST will only apply to the value of the property or services supplied in exchange for the donation, provided that an income tax receipt may be issued for a part of the donation under the “split-receipting” rules for charities. Note that this change will apply to supplies that are not already exempt from tax.
Transitional relief will also be provided for charities where GST/HST was not collected on the entire value of donations for which inducements were supplied between December 21, 2002 and March 22, 2016, provided that the inducement value was under $500 or GST/HST was only collected on the value of the inducement. Under this relieving provision, no additional GST/HST is owed. Otherwise, GST/HST must only be remitted on the inducement value.
De Minimis Financial Institutions
Under the GST/HST, special rules apply to financial institutions, such as banks, insurance companies, investment dealers and investment plans. Other persons that provide a significant amount of financial services, and effectively compete with these financial institutions, are also considered to be financial institutions for GST/HST purposes. These persons are referred to as “de minimis” financial institutions. Generally, if a person’s income, throughout the preceding taxation year from interest, fees or other charges with respect to the making of an advance, the lending of money, the granting of credit, or credit card operations, exceeds $1 million, that person qualifies as a de minimis financial institution.
In order to allow persons to participate in basic deposit-making activities (which generally is not in direct competition with typical financial institutions) without being treated like a financial institution, the budget proposes to exclude interest earned in respect of demand deposits, term deposits and guaranteed investment certificates, with an original date to maturity of less than 365 days, from the calculation used to determine whether the $1 million threshold has been reached. This measure will apply to taxation years beginning on or after March 22, 2016 and to fiscal years beginning before and ending on or after that date for the purposes of determining eligibility for the GST/HST Annual Information Return filing requirement for financial institutions.
Cross-Border Reinsurance and the Imported Supply Rules
Organizations not engaged in full commercial activities are generally required to self-assess GST/HST on imported property and services, including intangible personal property. Under specialized rules, financial institutions with a presence outside Canada are required to self-assess GST/HST on expenses incurred outside Canada relating to their Canadian activities. These rules specifically affect insurance companies that have branches outside Canada.
The budget proposes to remove ceding commissions and the margin for risk transfer (two common components of reinsurance services) from the tax base subject to the self-assessment requirement under the GST/HST imported supply rules for financial institutions. In addition, specific conditions will be added to the legislation, under which the rules for financial institutions will not impose GST/HST on reinsurance premiums charged by a reinsurer to a primary insurer.
These measures will apply retroactively to November 16, 2005, when the special GST/HST imported supply rules for financial institutions were introduced. Interestingly, financial institutions will be able to request a reassessment by the Minister for prior amounts owing under these rules, including penalties or interest. The reassessment must be requested within one year after the day that the amendments receive Royal Assent.
Zero-rating for Exported Call Centre Services
Exported services are generally zero-rated supplies for GST/HST purposes. The budget proposes to extend these zero-rating provisions to include the service of providing technical or customer support to individuals by means of telecommunications (e.g., by telephone, email or Internet chat features), provided that the service is supplied to a non-resident who is not registered for GST/HST and, at the time the service is rendered, the individuals to whom the support is primarily provided are located outside of Canada (or it is reasonably expected to be the case). This measure applies to supplies made after March 22, 2016, but it will also apply to supplies made on or before that date where the supplier failed, on or before that day, to collect the tax on the supply.
Health Related Measures
Numerous medical and assistive devices which are specifically designed to assist individuals with a chronic disease, illness or physical disability are zero-rated for GST/HST purposes. This year’s budget proposes to add insulin pens, insulin pen needles and intermittent urinary catheters to the list of zero-rated medical devices. The latter item will only be zero-rated when supplied under the prescription or written order of a medical doctor, registered nurse, occupational therapist or physiotherapist. These changes will take effect for supplies made after March 22, 2016, but will also apply to supplies of the insulin-related items made on or before that date, where the supplier failed to collect GST/HST on the transaction.
Supplies of purely cosmetic procedures are intended to be fully taxable for GST/HST purposes, regardless of the status of the supplier. The budget proposes to clarify that this treatment extends to cosmetic procedures supplied by registered charities. Cosmetic procedures will continue to be exempt to the extent that they are required for medical or reconstructive purposes, or will be paid for by a provincial health insurance plan.
Grandparented Housing Sales
The budget proposes to simplify the reporting required by builders for sales of housing grandparented under HST transitional rules, where the purchaser was not entitled to a GST New Housing Rebate or a GST New Residential Rental Property Rebate. Builders will now only be required to report those grandparented sales equal to or in excess of $450,000.
In addition, builders will be able to correct past reporting mistakes and can elect to report all past grandparented housing sales, in the aforementioned amounts, thereby avoiding penalties.
These measures will apply for reporting periods ending after March 22, 2016. Generally, builders have between May 1 and December 31, 2016 to file the election.
Limitations on Excise Tax Relief for Aviation and Diesel Fuel
The budget proposes to limit the relief provisions for excise tax on aviation and diesel fuel. Under the current provisions, relief is available when diesel fuel is used to produce electricity or is used as heating oil. The proposed changes will ensure that relief no longer applies to diesel fuel used in vehicles (for any mode of transportation), including any attached conveyances, to produce electricity. In addition, heating oil will be defined for excise tax purposes as fuel oil restricted for use to heat a home or building, and will no longer include situations where fuel oil is used in an industrial process.
These changes apply to fuel delivered or imported after June 2016, as well as fuel delivered or imported prior to July 2016 which is consumed, or intended to be consumed, after June 2016.
Enhancement of Certain Security and Collection Provisions
There are a number of provisions within the Excise Act, 2001 to assist in the enforcement and compliance of excise duties on tobacco products, spirits and wine. These measures are being enhanced by changes to the security and collection provisions within the legislation.
In order to hold a valid tobacco licence, tobacco manufacturers and prescribed persons must currently provide and maintain a maximum amount of $2 million as security with the CRA. In order to better reflect current tobacco duty rates, the maximum security amount will be increased to $5 million. This change will be effective on the later of June 23, 2016 and the day after the enacting legislation receives Royal Assent.
Currently, when an amount under the Excise Act, 2001 is assessed, and that assessed amount is subject to an objection or an appeal by the taxpayer, the CRA is restricted from taking collection action for the amount owing. The budget proposes to give the Minister of National Revenue the authority to require the payment of security by the taxpayer, and to collect an amount equivalent to that security where it has not been provided, in respect of amounts assessed, including penalties, in excess of $10 million. This measure will apply to amounts assessed, and any applicable penalties, after the day the enacting legislation receives Royal Assent.
Previously Announced Measures
The federal government has confirmed its intention to move forward with various previously announced tax measures, including changes to the GST/HST joint venture election and GST/HST relief for feminine hygiene products.
Aboriginal Tax Policy
As in prior years, the federal government has reiterated its support for direct taxation arrangements with interested Aboriginal governments. To date, the government has entered into over 50 such arrangements related to sales tax and personal income tax. The federal government will also continue to facilitate similar direct taxation accords between Aboriginal and provincial or territorial governments.
Other Tax Related Measures
The federal government also announced several interesting initiatives that could result in significant changes to the structure and administration of Canada’s tax system, including:
- A review of the current tax system in order to assess its efficiency and fairness, and to identify poorly designed or inefficient tax measures for possible elimination;
- The elimination of import tariffs for Canadian manufacturers on approximately a dozen manufacturing inputs, with plans to similarly eliminate tariffs on certain food manufacturing ingredients; and
- Further investment to bolster the ability of the CRA to fight tax evasion and improve tax compliance through the hiring of more auditors and tax specialists, further outreach efforts to encourage voluntary compliance, increased verification and risk-assessment activities, improved investigative work, and the use of more advanced data intelligence tools.
Measures to improve the level of service provided by the CRA have also been announced, including:
- Programs to reach out to persons with low and modest incomes to help ensure that tax returns are completed and filed, and potential tax benefits are not missed;
- Enhanced telephone services, including the addition of a dedicated support line for tax service providers;
- Redesigning correspondence with a view to making it more straightforward and easier to read; and
- Proposed service enhancements to increase capacity and allow for a more timely resolution of objections.
Government Funding Initiatives
This year’s budget also provides for a potential $8 billion in various new grant and incentive programs. These funding initiatives will be delivered to specific key investment sectors, including:
(all figures approximated from government budget documents)
$1.3 Billion for Hiring, Training and Human Resources Development
- Youth Employment Strategy to assist young people to successfully transition into the labour market through skills development and meaningful work experience;
- Investment in the Canadian labour force to access the training and support needed to develop skills and pursue opportunities for a better future;
- Apprenticeship for direct training in certified skilled trades; and
- Improvement in the socio-economic conditions of Indigenous peoples and their communities to bring about transformational change and skills development.
$1.6 Billion for R&D and Innovation
- Reinvigorate Canada’s research and science base by investing in infrastructure at post-secondary institutions;
- Supporting Canada’s continued leadership in space;
- Linking technology companies to global markets and expertise; and
- Helping small and medium-sized companies to innovate and grow.
$125 Million for Health Care and Food Safety
- Support for research and innovation in the health care system;
- Enhancing food safety; and
- Strengthening and modernizing Canada’s food safety system.
$1.1 Billion for Clean Technologies
- Advancing the development and demonstration of new technologies that address climate change, air quality, clean water and clean soil;
- Supporting the research, development and demonstration of clean energy technologies;
- Investing in electric vehicle and alternative transportation fuels infrastructure;
- Developing cleaner oil and gas technologies that reduce greenhouse gas emissions from the oil and gas sector; and
- Support for the transition to a cleaner transportation sector.
$1 Billion for Municipalities
- Infrastructure support to be delivered in two phases – Phase I to support infrastructure upgrades and rehabilitation, and Phase II to support the transition to a low-carbon economy (with further details to be announced in a future budget);
- Building municipal capacity to address climate change and the integration of the impact into asset management plans;
- Improving physical accessibility and safety for people with disabilities in Canadian communities; and
- New programs to extend and enhance broadband service in rural and remote communities.
$550 Million for Arts, Culture, Heritage and Tourism
- Marketing Canada’s tourism sector to seize opportunities with partners by augmenting marketing initiatives in international markets;
- Supporting world-class Canadian content and providing improved access to programs and services in the digital era;
- Promoting Canadian artists and cultural industries abroad; and
- Supporting various activities and events in honour of Canada’s 150th anniversary of Confederation.
$2.5 Billion for Agriculture and Food Safety
- Enhancing agricultural and agri-food innovation, competitiveness, market development and genomics.
Further details on Federal Budget 2016, “Growing the Middle Class”, are available from the Government of Canada web site at: http://www.budget.gc.ca/2016/home-accueil-en.html