On March 22, 2017, the Honourable Bill Morneau, Minister of Finance, introduced the Liberal government's second budget since being elected with a majority government. Similar to last year’s theme, the budget focuses on building a strong middle class through innovation, equipping Canadians with the skills needed to get better jobs, investing in communities, maintaining a healthy economy, and providing a fair tax system for the middle class.
Several interesting tax changes and government funding initiatives were announced as part of this year’s budget, as summarized below.
Personal Income Tax Measures
Subsequent to election in 2015, the federal government announced intentions to limit benefits otherwise afforded to the taxation of executive stock option benefits. Current benefits include a 50% reduction in the employment stock option benefit otherwise included in taxable income at 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 prior 2016 and current 2017 budgets are silent on this matter.
It had also been rumored that the Liberal government was considering increasing the current 50% inclusion rate for capital gains into personal and/or corporate taxable income. This year’s budget was also silent on this matter.
However, the 2017 budget has indicated that the government is reviewing transactions in private corporations that result in income that would otherwise be taxed at a higher rate in the hands of an individual being shifted to related family subject to lower rates of tax and/or transactions converting the remuneration of an individual into a capital gain.
The government is also reviewing the taxation of portfolio investments in private corporations.
Deductions and Credits
The budget announced the elimination of the following deductions, credits and accounting options:
- The public transit credit, effective for costs incurred after June 2017;
- The home relocation loan deduction for low interest rate benefits (up to $25,000 of benefit) for tax years on or after 2018; and
- The ability for designated professionals to elect to use billed-basis accounting.
On the other hand, the budget has enhanced the following credits and benefits:
- The repeal of the national child benefit supplement is delayed until July 1, 2018;
- A new Canada caregiver credit will replace the existing caregiver, infirm dependant, and family caregiver tax credits commencing in 2017;
- The medical tax credit will be enhanced to provide eligibility for those seeking medical intervention for child conception to claim the same costs as those seeking assistance for infertility (taxpayers can elect to have these measures apply for any of the ten immediately preceding taxation years);
- Provincially regulated nurses will be able to provide certification for the disability tax credit;
- Tax credits for flow-through share investors are extend one more year for agreements entered into before July 1, 2018; and
- The tuition tax credit is extended to include fees for post-secondary school courses for occupational skills, where the individual has reached the age of 16 by the end of the calendar year.
Corporate Income Tax Measures
General Domestic Measures
This year’s budget introduced the following corporate tax incentives:
- Accelerated capital cost allowance (CCA) Class 43.1 (30%) and Class 43.2 (50%) are expanded to include geothermal energy equipment used primarily for the purpose of generating heat or a combination of heat and electricity, and certain equipment in district energy systems that use geothermal heating as a thermal energy source;
- Canadian renewable and conservation expenses will include expenses to assess the quality of a geothermal resource and the cost of all geothermal drilling for electricity and heating projects;
- Discovery well costs will generally be classified as a Canadian development expense (CDE), with a 30% declining-balance basis, rather than a Canadian exploration expense (CEE), with a 100% deduction; and
- Eligible small oil and gas corporations can no longer treat the first $1 million of CDE as CEE.
Other Business Measures
Payroll Reporting Simplification
In order to reduce compliance costs, the budget proposes to allow employers to distribute annual T4 information slips electronically to current active employees without having to obtain express consent from those employees in advance.
Definition of Control
The ITA recognizes two forms of control of a corporation: de jure (legal) control and de facto (factual) control. The factual control test is used for the purpose of determining whether two or more Canadian controlled private corporations are “associated corporations”, which can limit access to certain deductions and credits (e.g., the small business deduction and SR&ED tax credits). A person may have factual control of a corporation even though the person does not have legal control of the corporation.
A recent court decision held that, in order for a factor to be considered in determining whether factual control exists, it must include “a legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability.”
To ensure that taxpayers do not inappropriately access certain tax preferences, the budget proposes to amend the ITA to clarify that, in determining whether factual control of a corporation exists, factors may be considered which are not limited to the requirements established by the court case.
Gains and Losses on Derivative Instruments
Derivatives are financial instruments, the value of which is derived from an underlying interest in an investment. The budget proposes to allow for an elective mark-to-market mechanism for derivatives held on income account, whereby the election will allow taxpayers to mark to market all of their eligible derivatives. Once made, the election will remain effective for all subsequent years, unless revoked with the consent of the Minister of National Revenue.
In addition, the budget proposes to introduce a specific anti-avoidance rule to address straddle transactions. A stop-loss rule will effectively defer the realization of any loss on the disposition of a position to the extent of any unrealized gain on an offsetting position. In general, a straddle transaction involves a taxpayer concurrently entering into two or more positions (usually derivative instruments) that are expected to generate equal and offsetting gains and losses. Strategically, the taxpayer triggers a deduction in respect of the realized loss against other income prior to the taxation of the offsetting gain in a following taxation year, otherwise achieving a tax deferral.
Fund Mergers, Reorganizations and Registered Plans
The budget proposes to allow for tax deferred mergers of segregated funds and the reorganization of mutual fund corporations structured as switch corporations. To improve the consistency of the tax rules that apply to investments held by registered plans, the budget proposes to extend existing anti-avoidance rules to RESPs and RDSPs. These anti-avoidance rules generally prevent the holding of non-arm’s length investments and shifting returns from a taxable investment to a registered plan.
International Tax Measures
Canadian life insurers will be taxable in Canada regarding income from the insurance of Canadian risks that are shifted to a foreign branch of a Canadian life insurer. Where 10% or more of the gross premium income earned by a foreign branch of a Canadian life insurer is premium income in respect of Canadian risks, the budget proposes to deem the foreign branch’s insurance of Canadian risks to be part of a business carried on by the life insurer in Canada and the related insurance policies to be life insurance policies in Canada.
The 2017 budget generally addresses certain loopholes and matters of tax fairness, while extending benefits in areas that the government wishes to promote. Such objectives are standard expectations of a government budget. The budget does not change any existing tax rates.
We anticipate that any material changes to the ITA will be deferred to a platform to be established following expected tax reform in the United States.
Canada continues to affirm its commitment toward Base Erosion and Profit Shifting (BEPS) initiatives, and has already moved forward with Organisation for Economic Cooperation and Development (OECD) pronouncements under BEPS Action 13 on December 15, 2016, through Bill C-29 which enacted “country by county” reporting requirements with the introduction of section 233.8 of the ITA.
The landscape for global transparency in transfer pricing and limitation of tax treaty abuse and tax avoidance transactions continues to move forward. Corporations are encouraged to monitor the evolving global tax landscape, ensure related party transactions are legally documented, and consider the enhancement of substance to international tax structures.
Commodity Tax Measures
Zero-rating of Non-prescription Naloxone
Prescription drugs, including a specified list of non-prescription drugs, are zero-rated for GST/HST purposes. Naloxone is a drug which is used to treat opioid overdoses, and it was previously zero-rated on the basis that it required a prescription prior to March 22, 2016. Health Canada’s decision to remove the requirement for a prescription in critical situations helps to avoid possible delays in administering the drug, but it also made the drug subject to GST/HST when supplied in that manner. To ensure consistency in the tax treatment of this drug, the budget proposes to add naloxone, including its salts, to the list of non-prescription drugs which are zero-rated, effective March 22, 2016. Note that this change does not apply to the supply or importation of naloxone on or before March 22, 2017, where the GST/HST was charged, collected, remitted or paid.
Registration Requirements for Ride-sharing Services
Under the Excise Tax Act, small suppliers (generally, organizations with annual taxable supplies of less than $30,000) are not required to register for GST/HST. However, taxi operators are an exception to this rule, and all taxi operators must register for GST/HST and collect tax on their fares, regardless of the amount of their total sales. For these purposes, taxi businesses are defined to include businesses which transport passengers by taxi for fares and are regulated under the laws of Canada or a province (or a municipality under the delegated authority of a province).
In recent years, new ride-sharing services operating through electronic platforms (i.e., Uber) have emerged which do not meet the current definition of a taxi business, even though they provide a similar service. As a result, taxi operators are left at a competitive disadvantage, since ride-sharing services may not be required to register for and charge tax, resulting in lower fares for customers. In order to ensure that the GST/HST is applied consistently to these types of services when provided on a commercial basis, the budget proposes to amend the definition of a taxi business, effective July 1, 2017, to include persons engaged in the business of transporting passengers by motor vehicle within a municipality where the transportation is arranged for or coordinated through an electronic platform. This change will require providers of ride-sharing services to register for and collect GST/HST, putting them on equal footing with conventional taxi operators.
Non-Resident Rebate for Tour Package Accommodations
Under the Foreign Convention and Tour Incentive Program, a GST/HST rebate is currently available to:
- A non-resident tour operator that purchased and resold an eligible tour package or purchased short-term or camping accommodation in Canada and resold it in an eligible tour package; and
- A non-resident individual, organization or business (other than a tour operator) that purchased an eligible tour package, where short-term or camping accommodation in Canada is included in the package.
Tour operators and eligible purchasers must meet a number of conditions to qualify for this rebate. Where the conditions are met, a tour operator may claim a rebate equal to 50% of the GST/HST paid on eligible tour packages, and 100% of the GST/HST paid on accommodation that it resells as part of an eligible tour package. For individuals, organizations or businesses, meeting the conditions allows them to access a rebate equal to 50% of the GST/HST paid on eligible tour packages.
This year’s budget proposes to eliminate the GST/HST rebate available to non-residents in respect of the accommodation portion of an eligible tour package. This change is generally effective for supplies made after March 22, 2017. However, under a transitional measure, the rebate will continue to be available for eligible tour packages or accommodation supplied after March 22, 2017, but before January 1, 2018, provided that the consideration for the supply is fully paid prior to the latter date.
Previously Announced Measures
The federal government has confirmed its intention to move forward with the following previously announced GST/HST measures:
- Proposed amendments to the drop-shipment rules and pension plan rules announced on July 22, 2016; and
- Changes to the joint venture election announced in the 2016 budget.
Excise Duty on Tobacco
The budget proposes the elimination of the tobacco manufacturers’ surtax of 10.5% on profits arising from the manufacture of tobacco or tobacco products in Canada. A proration of the surtax on a corporation’s profits will be required, based on the number of days in its taxation year on or before March 22, 2017, where the corporation’s taxation year includes and ends after that date.
In order to sustain the intended tax burden on tobacco products after the elimination of the surtax, the budget has announced the following increased excise duty rates on tobacco products, effective March 23, 2017:
- $0.53900 (from $0.52575) for each five cigarettes or fraction thereof (or $21.56 from $21.03 per 200 cigarettes);
- $0.10780 (from $0.10515) per tobacco stick (or $21.56 from $21.03 per 200 sticks);
- $6.73750 (from $6.57188) per 50 grams or fraction thereof of manufactured tobacco (or $26.95 from $26.29 per 200 grams); and
- $23.46235 (from $22.88559) per 1,000 cigars.
The additional duty paid on cigars will also increase and become the greater of $0.08434 per cigar (from $0.08226) and 84% (from 82%) of the sale price or duty-paid value.
In addition, manufacturers, importers, wholesalers and retailers holding an inventory of cigarettes at the end of the day on March 22, 2017 will be subject to an inventory tax of $0.00265 per cigarette (subject to certain exceptions).
Excise Duty on Alcohol
The budget also announced a 2% increase to the excise duty rates on alcohol, effective March 23, 2017. There are no special adjustments required for alcohol held in inventory where duties had been paid. Starting in 2018, the excise duty rates on alcohol products will automatically be indexed annually on April 1.
Other Tax and Duty Related Measures
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.
Customs Tariff and Special Import Measures
This year’s budget also proposed several regulatory amendments designed to improve access to the Canadian market for certain least developed countries, strengthen Canada’s trade remedy system, including enhancement of the system’s transparency, accessibility and fairness, and ensure compliance with obligations under World Trade Organization requirements.
The budget includes a proposed investment of $523.9 million over the next five years to address and identify tax evasion and enhance tax compliance. The federal government is seeking to hire additional auditors, increase verification measures, target domestic and international tax avoidance planning, and focus greater efforts on the underground economy.
Scientific Research and Experimental Development
The government announced a comprehensive review of business innovation programs with the help of external experts. This includes a review of the Scientific Research and Experimental Development (SR&ED) tax credit program to “ensure its continued effectiveness and efficiency.”
The budget also proposes to set up, in time, a new platform – to be called “Innovation Canada” – to “serve as a one-stop-shop for Canada’s innovators”. The purpose of Innovation Canada appears to be to consolidate and simplify access to Canada’s innovation-related support programs. It is not clear at this time if the intention is to have the SR&ED program administered by Innovation Canada.
SR&ED is also mentioned under “Closing Tax Loopholes” in the context of the potential impact of clarifications to the meaning of “factual control”. Small Canadian-controlled private corporations can access an enhanced refundable 35% SR&ED investment tax credit. The size test is based on the prior year taxable income and taxable capital of the associated group of companies, so some claimants may be impacted by this measure (see “Definition of Control” above).
The last external review of the SR&ED program was announced in the 2010 budget, commenced in October 2010, and resulted in a 2011 report titled “Innovation Canada: A Call to Action” – a document colloquially referred to as the “Jenkins Report” after the panel Chair, Tom Jenkins. Following on the heels of this report, the government announced and enacted sweeping changes to the SR&ED program, including significant reductions to both eligible expenditures and investment tax credit rates, apparently in response to the panel’s recommendation to “redeploy funds from the tax credit to a more complete set of direct support initiatives…” The result was increased funding available for numerous government grant programs. Time will tell if another round of similar changes will be coming in the near future.
The SR&ED program is enacted through the ITA and, as such, is administered by the Canada Revenue Agency (CRA). The government may decide to have the SR&ED program administered by Innovation Canada. Administration of tax credit programs outside of CRA is not unknown – product eligibility for the Ontario Interactive Digital Media Tax Credits, for example, is currently administered by Ontario Media Development Corporation, with financial review and payment of the credit remaining under CRA. We suspect that such a hybrid system may be part of future plans for the SR&ED program.
Government Funding Initiatives
This year’s budget provides for a potential $5 billion in various new grant and incentive programs in fiscal 2017-18. These funding initiatives will be delivered to specific key investment sectors, including (all figures approximated from government budget documents):
$440 Million for Skills, Innovation and Job Creation
- Establish a new organization for skills development to support private sector, educational institutions and not-for-profit organizations
- Support for equipment and facilities for post-secondary institutions, research hospitals and other not-for-profit organizations
- Identify the skills sought and required by Canadian employers
- New Youth Employment Strategy
- Continue to build partnerships between industry and educational institutions
- Fund for women-led technology firms
- New global talent stream as part of the Global Skills Strategy
$2.7 Billion for Infrastructure Investment and Municipal Government
- Stronger more connected communities through better public transit
- Encourage transition to clean growth economy
- Support for rural and northern communities
- Deliver better transportation infrastructure to support trade
- New Smart City Challenge
- Support for infrastructure projects at universities and colleges
- Increased support for the Disaster Mitigation Fund
$1.5 Billion for Green Infrastructure
- Support for next generation smart grid, storage and clean electricity technology demonstration projects
- Support deployment of emerging renewable energy technologies nearing commercialization
- Infrastructure for electric vehicle charging and natural gas and hydrogen refueling stations
- Climate adaptation and resiliency
$98 Million for Clean Technologies
- Support the expansion and growth of clean technology firms
- Promoting demonstrations in clean technology
- Research and development for clean energy and transportation
- Encouraging clean technology in the natural resources sector
- Capitalizing on international business development for clean technology
$215 Million for Innovation and Research and Development
- Support for a small number of business-led “Super Clusters”
- Consolidate and simplify existing business innovation programming for the Strategic Aerospace and Defence Initiative , Automotive Innovation Fund, and Technology Demonstration
- Venture Capital Catalyst Initiative to increase late stage venture capital available to entrepreneurs
- Support for “Futurepreneurs”
- Continued support through the National Research Council’s business innovation initiatives
- Strengthening Canada’s food safety system
- Support agriculture discovery science and innovation focusing on climate change and soil and water conservation
- Health innovation
- Advancing agricultural science and innovation
Further details on the 2017 federal budget can be found on the Government of Canada website at: http://www.budget.gc.ca/2017/home-accueil-en.html.