On February 27, 2018, the Honourable Bill Morneau, Minister of Finance, introduced the Liberal government's third budget. Maintaining the theme of building a stronger middle class, this year’s budget contains approximately $21.5 billion in spending over 6 years, with major initiatives to improve gender equality, advance research, innovation and skills development, facilitate reconciliation with Indigenous peoples, promote environmental sustainability, and support the health and wellness of Canadians. The budget projects a deficit of $18.1 billion for 2018-19.
From a tax perspective, this year’s budget addresses a broad range of matters, while continuing to focus on tightening certain loopholes, improving tax fairness, and clarifying the application of tax in certain situations.
The budget is noticeably silent on the subject of recent U.S. tax reform, with any potential reactive measures apparently deferred to future announcements. However, the budget confirms that the Department of Finance is analyzing the impact of various U.S. tax initiatives on the Canadian economy.
The most significant tax measures and government funding initiatives included in this year’s budget are summarized below.
Corporate Income Tax Measures
The budget does not change any existing tax rates for public or private (non-CCPC small businesses) corporations and contains no major alteration to the basis of Canadian taxation pursuant to the Income Tax Act. However, a few significant changes were announced.
General Domestic Measures
Small Business Taxation
Since election, the current Liberal government has focused on tax fairness and perceived abuses in the taxation of small business. The 2018 budget has reaffirmed previous measures to lower the small business tax rate from 10.5 per cent to 10 per cent, commencing January 1, 2018, and 9 per cent from January 1, 2019 onwards.
The government further confirmed prior announcements to address fairness in the taxation of small business owners through limitations on income sprinkling.
The budget also announced the following new measures:
- A new limitation to the benefit of the $500,000 small business deduction in regards to passive income. The limit will be reduced $1 for every $5 of investment income within an associated group over $50,000, with full elimination at $150,000 of investment income. The limitation will apply for years after 2018 at the greater of the new reduction and current reductions already in place for taxable capital in excess of $10 million.
- A new category of eligible refundable dividend tax on hand (ERDTOH) will be created to track Part IV taxes on eligible portfolio dividends. The old category will be renamed as non-eligible refundable dividend tax on hand (NRDTOH) to track tax on investment income and Part IV taxes on non-eligible portfolio dividends. An ERDTOH refund may be obtained on the payment of any taxable dividends (eligible or non-eligible). However, an NRDTOH refund must first be obtained on the payment of any non-eligible dividend.
- Accelerated capital cost allowance classes regarding Class 43.2 (50 per cent) [(i) geothermal energy equipment used primarily for the purpose of generating heat or a combination of heat and electricity, and (ii) certain equipment in district energy systems that use geothermal heating as a thermal energy source] are extended five years for purchases acquired before 2025.
- The at-risk rules are extended to clarify application of upper-tier partners, such that losses allocated to such partners in a tiered structure will be denied where the losses exceed this at-risk amount and not be available for carry-forward to future taxation years. Such losses will also not reduce the ACB of the lower tier partnership.
International Tax Measures
Canada continues to affirm commitment toward base erosion and profit shifting (BEPS) initiatives with continued participation in efforts sponsored by the Organisation for Economic Co-operation and Development (OECD).
Transactions with Foreign Affiliates
In addition, the budget addressed the following matters with respect to transactions with and by foreign affiliates:
- For years after 2019, the foreign affiliate information returns (Forms T1134 and T1135) filing deadlines will be aligned with the compliance timeline of Form T2 as six months after the year-end.
- The reassessment period in respect of income connected to a foreign affiliate will be extended by three years.
- The reassessment period in respect of a loss carry-back impacted by a transaction with a non-resident person not dealing at arm’s length will also be extended by three years.
- Various matters involving tracking arrangements to shift benefits between foreign affiliates and related parties. Under the current system, taxpayers whose foreign investment activities require less than 5 full-time employees pool their assets with other taxpayers in a common foreign affiliate to meet the 5 full-time employee test, thereby avoiding the application of the foreign affiliate property income (FAPI) tax rules. Even though the assets are pooled into one common foreign affiliate, the income attributable to each taxpayer is determined separately with respect to their specific contributed assets. These arrangements are sometimes referred to as “tracking arrangements”. For investment businesses, the “more than 5 full-time employee” test to exclude such a business from the application of the FAPI regime is being extended to each taxpayer under these tracking arrangements. Consequently, each taxpayer’s activity in this common foreign affiliate will now be deemed to be a separate business of the affiliate and will have to satisfy each condition in the investment business definition, including the 6 employee test, for the affiliate’s income from that business to be excluded from FAPI. This will be effective for tax years of a taxpayer’s foreign affiliate that begin on or after February 27, 2018.
- A foreign affiliate will be deemed to be a controlled foreign affiliate, if activity of the foreign affiliate accrues to the taxpayer under a tracking arrangement.
Personal Income Tax Measures
In a continued effort to improve disclosure, the budget proposes new reporting requirements, effective in 2021, for trusts to report:
- Identity of all trustees;
- Settlors; and
- Persons who can exert control on the apportionment of income and capital.
Such disclosures will occur through a T3 “Trust Income Tax and Information Return” that will apply to certain trusts in Canada and non-resident trusts required to file a T3 return. Penalties are also being introduced in the budget for failure to comply with these new reporting requirements applicable to returns filed for the 2021 and future years.
Deductions and Credits
The budget announced the following changes to credits and benefits:
- Extension of eligibility for the mineral exploration tax credit for flow-through share investors for an additional year for flow-through share agreements entered before April 1, 2019.
- The working income tax refundable credit will be renamed as the Canada Workers Benefit as assessed to qualifying individuals regardless of whether or not it is claimed on Form T1.
- The medical expense tax credit will be enhanced after 2017 to include animal costs incurred to assist with impairment.
Scientific Research and Experimental Development Update
Last year’s federal budget announced a comprehensive review of business innovation programs with the help of external experts. This process purported to include a review of the Scientific Research and Experimental Development (SR&ED) tax credit program to “ensure its continued effectiveness and efficiency.”
This year’s budget discloses that the comprehensive review took place across 20 federal departments and agencies, and represents the first such review of the entire business innovation program suite. The budget provides that, while overall innovation funding will increase, the number of programs will be streamlined by approximately two-thirds, from 92 reviewed programs to approximately 35. Of note, the SR&ED tax credit is not included in the list of 92 innovation programs reviewed. At this time, no changes to the SR&ED program have been announced.
Commodity Tax Measures
Consultations on the Rules for Holding Corporations
Under the current rules for holding corporations, input tax credits may be claimed for GST/HST paid on expenses in relation to the shares or indebtedness of a subsidiary that is exclusively in commercial activities. For these rules to apply, the holding company (i.e., a parent corporation) must be resident in Canada and related to the corporation in commercial activities.
The government is proposing to hold consultations regarding certain elements of these rules, including their restriction to corporations, as well as the extent of the relationship required between a parent and a subsidiary. In addition, the government has indicated that it will clarify the types of expenses in relation to which input tax credits may be claimed under these rules. Further information and draft legislative proposals are expected to be released for public consultation at a later date.
Treatment of Investment Limited Partnerships
The budget confirms that the government will move forward with legislative changes proposed on September 8, 2017, regarding the application of GST/HST to investment limited partnerships, subject to a couple of modifications. The original proposals clarified that GST/HST applies to the fair market value of any management and administrative services provided to an investment limited partnership by a general partner. In addition, effective January 1, 2019, investment limited partnerships will be considered “investment plans” as defined by the Excise Tax Act (ETA) and subject to the special GST/HST rules for investment plans, including the Selected Listed Financial Institution (SLFI) Attribution Method Regulations. Furthermore, the proposals provide relief for investment limited partnerships where the percentage of non-resident investors is calculated at 95 per cent or more for a fiscal year by deeming such entities to be non-residents for GST/HST purposes. As a result, these investment limited partnerships could potentially benefit from the zero-rating provisions for exports under Part V of Schedule VI to the ETA.
Under the modifications introduced in the budget, GST/HST will only apply to management and administrative services provided to an investment limited partnership by its general partner on or after September 8, 2017. Services rendered before that date will not be taxable, unless the general partner collected GST/HST in respect of those services. Tax will generally be payable on the fair market value of the services in the period in which the services are performed.
The budget proposals also allow investment limited partnerships to make an election to have the special rules for investment plans apply retroactively to January 1, 2018. This would be desirable where the use of the special rules results in a calculated liability for the provincial component of the HST that is less than what was actually paid or payable.
Previously Announced Measures
The federal government has confirmed its intention to move forward with the following previously announced GST/HST measures:
- Changes to the joint venture election announced in the 2016 budget; and
- The remaining legislative and regulatory proposals relating to GST/HST released on September 8, 2017.
Excise Duty on Recreational Cannabis
Following up on a consultation document released late last year, the budget outlines a proposed excise duty framework for the sale of recreational cannabis products. Once legislated under the Excise Act, 2001, duty will be imposed on all cannabis products legally available for purchase, including fresh and dried cannabis, cannabis oils, and seeds and seedlings for home cultivation. Cannabis cultivators and manufacturers will be required to obtain a license from the Canada Revenue Agency, remit applicable excise duty, and follow specific excise stamping rules.
In December 2017, the federal government and most provincial and territorial governments negotiated an agreement for the first two years after legalization, under which 75 per cent of cannabis excise duty revenues will be shared with participating jurisdictions. The remaining federal portion (i.e., 25 per cent) of cannabis excise duty revenues will be capped at $100 million annually, with any excess being distributed to the participating provinces and territories. The combined federal and provincial or territorial excise duty rates for cannabis are expected to be:
- $1.00 per gram of cannabis plant flower;
- $0.30 per gram of cannabis plant trim (which is plant material, other than the flower, used in a cannabis product); and
- $1.00 per seed or seedling for home cultivation.
The excise duties to be paid by licensed producers, however, will be equal to the greater of: the flat duty rate applied to the quantity of cannabis included in a final product at the time of packaging for retail sale; and a 10 per cent ad valorem rate applied to the dutiable amount (i.e., the selling price, excluding the excise duty) at the time of delivery.
The proposed excise duty will generally apply to any cannabis product that contains Tetrahydrocannabinol (THC). However, a packaged product that contains a concentration of 0.3 per cent or less THC will not be subject to excise duty. Similarly, prescription drugs derived from cannabis will not be subject to duty.
This framework is expected to be in place by the time recreational cannabis is legally available for retail sale. Transitional rules will also be introduced to account for timing differences in the production and distribution of cannabis products.
The ETA will also be amended to ensure that cannabis products which might otherwise be zero-rated under the provisions for basic groceries or agricultural seeds and grains will remain subject to GST/HST.
Excise Duty on Tobacco
The budget proposes to change the automatic inflationary adjustments to excise duty rates on tobacco products from every five years on December 1 to every year on April 1, starting in 2019. In addition, the excise duty rates on tobacco products will be raised to account for inflation since the last adjustment in 2014 and to further increase the duty on tobacco products.
As a result, effective February 28, 2018, the following excise duty rates will apply to tobacco products:
- $0.59634 (from $0.53900) per five cigarettes or fraction thereof ($23.85 per 200 cigarettes);
- $0.11927 (from $0.10780) per tobacco stick ($23.85 per 200 sticks);
- $7.45425 (from $6.73750) per 50 grams or fraction thereof of manufactured tobacco ($29.82 per 200 grams); and
- $25.95832 (from $23.46235) per 1,000 cigars, plus the greater of $0.09331 (from $0.08434) per cigar and 88 per cent (from 84 per cent) of the sale price or duty-paid value.
Manufacturers, importers, wholesalers and retailers holding an inventory of cigarettes at the end of the day on February 27, 2018 will generally be subject to an inventory tax of $0.011468 per cigarette, and will have until April 30, 2018 to file returns and pay the appropriate tax.
Government Funding Initiatives
This year’s budget provides for a potential $4.6 billion in various new grant and incentive programs in fiscal 2018-19. These funding initiatives will be delivered to specific key investment sectors, including (all figures approximated from government budget documents):
$516 Million for Skills for Tomorrow’s Economy
- Youth job creation
- Pre-apprenticeship programs
- Women apprenticeship pilot program
$3 Billion Investment in Canadian Scientists and Researchers
- Research in the areas of health, science, social sciences and humanities
- Business research for new innovative product development
- Support for regional economic development agencies for local business and community development
- Support for large investment initiatives to bring innovative products and solutions to market
$172 Million for Canada’s Heritage and Cultural Diversity
- Canadian content in media
$1.1 Billion for to Support the Low Carbon Economy
- Clean growth and greenhouse gas reduction initiatives
Consolidation of Funding Programs
In an ongoing effort to reduce costs, increase efficiency, and improve access to funding for high-potential firms, the government has announced a dramatic program of consolidation across its funding agencies. As noted above, from approximately 92 separate research and innovation programs, there will soon be about 35 programs, including four “flagship platforms”.
Further details on the 2018 federal budget can be found on the Government of Canada website at: https://www.budget.gc.ca/2018/home-accueil-en.html.
If you have any questions about how any of these budget proposals might impact your organization, please do not hesitate to call the Ryan TaxDirectTM line at 1.800.667.1600.