Focus on Tax Relief

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Introduction
Minister of Finance James Flaherty presented the new minority government's first budget on May 2, 2006. In his speech he was clear that nowhere is the government more focused than in the area of tax relief. The budget contains numerous tax measures which provide more than $26 billion in tax reductions over two years, with over 90% going to individuals.

The principal tax measures affecting individuals include the reduction of the GST to 6%, an income tax rate reduction, increased basic personal tax credits, a new employment tax credit, an increase in the pension income credit, and numerous other smaller changes. The most significant corporate tax change is the elimination of the federal capital tax, retroactive to January 1, 2006 — two years earlier than was originally scheduled.

The budget projects surpluses of $3.6 billion and $4.4 billion over the next two years. From the surpluses, there are planned debt reductions of $3 billion each year, bringing the federal debt as a percentage of GDP down to 31.7% by 2007-08.

For more information, please contact your PricewaterhouseCoopers adviser or any of the tax contacts listed on our Web site at www.pwc.com/ca/taxcontacts.

Corporate Tax Measures

General, M&P and surtax rates
The budget restores corporate income tax rate reductions announced by the previous government by:

• eliminating the corporate surtax in 2008 for all corporations; and
• reducing the general (and M&P) corporate income tax rate to 19% by 2010, in stages, as shown in the table below.

As a result of these measures, the effective federal corporate income tax rates (including the corporate surtax) will decrease as follows:

Small business rates and thresholds
The budget enhances tax relief to certain Canadian-controlled private corporations (CCPCs) by:

• increasing the limit up to which the small business income tax rate applies to $400,000 on January 1, 2007; and
• reducing the small business income tax rate to 11% by 2009, in stages.

The changes are summarized in the following table.

As a result of these measures, the effective federal small business income tax rates (including the corporate surtax) will decrease as follows:

Federal balance-due deadline
CCPCs that claim the small business deduction may pay their balance of corporate income tax owing three months after the end of their taxation year — a month later than other corporations. As a result of the increase in the small business limit, after 2007 some CCPCs with taxable income exceeding $300,000, but less than $400,000, will have an additional month to pay any balance of tax owing.

Refundable investment tax credits for CCPCs
CCPCs earn refundable investment tax credits at an enhanced rate of 35% on up to $2 million of scientific research and experimental development expenditures annually. As a consequence of the increase in the small business limit, for taxation years ending after 2006, the $2 million expenditure limit will be reduced when taxable income in the previous year is between $400,000 and $600,000 (increased from $300,000 and $500,000).

Carry-forward period for losses and investment tax credits
The carry-forward period for the following losses and investment tax credits (ITCs), incurred or earned in taxation years ending after 2005, will be extended from ten to twenty years:

• non-capital losses (under Parts I and IV) (e.g., business losses);
• farm and restricted farm losses;
• a life insurer's taxable Canadian life investment losses (under Part XII.3);
• Scientific Research and Experimental Development ITCs;
• Atlantic investment ITCs; and
• Mineral exploration ITCs.

Large Corporations Tax
Keeping with the former government's announcement, the budget eliminates the federal Large Corporations Tax retroactive to January 1, 2006.

Financial Institutions Capital Tax
The budget proposes to reduce the minimum tax on financial institutions (i.e., Part VI Financial Institutions Capital Tax) on July 1, 2006, by:

• increasing the exemption from $200 million to $1 billion; and
• adopting a single 1.25% rate on taxable capital over $1 billion.

The following table illustrates the changes:

Penalty for failing to file a return
The budget proposes that all large corporations that fail to file a corporate tax return (i.e., income or capital tax) will be liable for a penalty equal to 0.0005% of the corporation's taxable capital employed in Canada for the taxation year per month (up to 40 months) the return is late.

For corporations subject to Part VI Financial Institutions Capital Tax, an additional penalty of 0.25% for each month that the return is late (up to 40 months) of the Part VI tax that would be payable, ignoring the deduction of the corporation's Part I tax liability or unused Part I tax credit and unused surtax credit carryforwards.

These penalties will apply for 2006 and subsequent taxation years.

CCA for tools, utensils and instruments
Currently, tools, certain kitchen utensils and medical and dental instruments that cost less than $200 are eligible for a 100% capital cost allowance (CCA) rate, while those costing $200 or more are generally eligible for a 20% CCA rate. The budget increases the cost limit for the 100% CCA rate from $200 to $500 for items acquired after May 1, 2006.

Accelerated CCA for forestry bioenergy
The budget confirms the government's intention to proceed with proposed measures that extend eligibility for accelerated CCA (under Class 43.1 and 43.2) to cogeneration systems that use a type of biomass, commonly referred to as "black liquor," used in the pulp and paper industry. This change will generally apply to eligible assets acquired after November 13, 2005.

Apprenticeship Job Creation Tax Credit
An Apprenticeship Job Creation Tax Credit provides businesses (eligible employers) a non-refundable tax credit equal to 10% of the salaries and wages paid to qualifying apprentices after May 1, 2006, to a maximum credit of $2,000 per year per apprentice. Unused credits can be carried back three years and forward 20 years to reduce federal income taxes otherwise payable in those years.

A qualifying apprentice must work in a qualifying trade in the first two years of his or her provincially registered apprenticeship contract with an eligible employer. The qualifying trades will be prescribed and will include the 45 trades currently included in the Red Seal trades. The rules will prevent a related group of employers from receiving more than the $2,000 per year maximum credit available for each apprentice.

Personal Tax Measures

Personal tax rates
The budget implements the government's previous announcement that reduces the lowest personal tax rate from 16% to 15%, retroactive to January 1, 2005. However, it increases this rate from 15% to 15.5%, on July 1, 2006.

The following table shows changes to federal income tax rates and thresholds.

Top personal tax rates
The budget does not change the top personal tax rates on ordinary income, interest and capital gains. Top combined 2006 personal tax rates are outlined in the following table.

The table below shows the federal tax payable at various income levels.

Dividend tax credit
Except for a minor modification to the proposed federal dividend tax credit rate (i.e., from 19% of the taxable dividend to approximately 18.966%), the budget implements the government's November 23, 2005 announcement that reduces personal taxes on:

• certain dividends (eligible dividends) paid by Canadian-controlled private corporations (CCPCs), and
• generally all dividends paid by other Canadian resident corporations after 2005.

The following table illustrates the effect of the proposed changes on $100 of actual dividends.

To date, British Columbia, Manitoba, Prince Edward Island and Quebec have indicated that they will harmonize with the federal changes, with the result that the personal tax rate on eligible dividends will be lower in 2006 than in 2005 in these provinces. Other provinces have commented that they will wait until the federal legislation is released before making any final decision.

Although draft legislation has yet to be released, the Notice of Ways and Means Motion issued with the budget appears to indicate that the treatment of distributions will be different for corporations that generally pay eligible dividends from those that do not. For corporations that generally pay eligible dividends (e.g., public corporations), any ineligible dividends received by such corporations will be required to be paid out first. For corporations that will generally not pay eligible dividends (e.g., CCPCs that earn only investment income or active business income taxed at the small business rate), but have received eligible dividends, these corporations will be permitted to pay such eligible dividends to their shareholders.

The budget does not address whether the Part IV tax rate applicable to eligible dividends will be reduced from its current rate of 33.33%. Further, the budget does not elaborate on the mechanism to calculate any refunds out of refundable dividend tax on hand on the payment of eligible dividends.

Donations to charities
To encourage charitable giving, effective May 2, 2006, the budget reduces:

• the capital gains inclusion rate from 25% to nil for donations of publicly listed securities to public charities and ecologically sensitive lands to conservation charities; and
• the inclusion rate for donations of publicly listed securities acquired through employee stock options from 25% to nil.

Although not specifically addressed, presumably for qualifying donations of publicly listed securities and ecologically sensitive land by a Canadian-controlled private corporation (CCPC), the untaxed portion of the capital gain will be added to the CCPC's capital dividend account.

The table below illustrates the result of this change, assuming a $1,000 donation to public charities.

Basic personal credit
The budget revises the basic personal amount and the spouse/equivalent to spouse (or wholly dependent relative) personal amount, as follows:

Pension income credit
Commencing in 2006, the amount of pension income that qualifies for the pension income credit will increase from $1,000 to $2,000.

Universal Child Care Benefit (UCCB)
Commencing July 1, 2006, the Universal Child Care Benefit (UCCB) will provide all families with $100 per month ($1,200 per year) for each child under the age of 6. Families not currently receiving the Canada Child Tax Benefit (CCTB) must file a CCTB application form to receive the UCCB.

The UCCB will be taxable to the lower-income spouse, or common-law partner, but will not affect:

• income-tested benefits delivered through the income tax system;
• Old Age Security benefits;
• Employment Insurance benefits; and
• the child care expense deduction.

As a result of the introduction of the UCCB, the enhanced CCTB available for children under the age of 7 will be eliminated:

• by July 1, 2007, for children who attain the age of 6 before July 1, 2007; and
• by July 1, 2006, for all other children.

Canada Employment Credit
Commencing July 1, 2006, a new non-refundable tax credit may be claimed equal to the lesser of:

• employment income; and
• $250 ($1,000 after 2006) multiplied by the lowest marginal tax rate.

Tax credit for public transit passes
The budget provides a non-refundable tax credit for the cost of public transit passes (i.e., on local bus, streetcar, subway, commuter train or bus, or local ferry) with a minimum duration of a month. The credit may be claimed by the individual or the individual's spouse or common-law partner in respect of transit after June 30, 2006 for the individual, individual's spouse or common-law partner and the individual's dependent children under 19 years of age. Claims must be supported by receipts or passes.

Textbook tax credit
Commencing 2006, post-secondary students will be able to claim a non-refundable textbook tax credit. The amount on which the credit is calculated will be:

• $65 for each month the student qualifies for the full-time education amount; and
• $20 for each month the student qualifies for the part-time education amount.

Unused textbook tax credits will be added to unused tuition and education tax credit amounts for purposes of the carryforward as well as the transfer of unused amounts.

Scholarship and bursary income
Commencing in 2006, the budget provides a tax exemption for the full amount of scholarship, fellowship and bursary income received by a post-secondary student in connection with a program that entitles the student to claim the education tax credit (i.e., generally post-secondary programs and certain skills-training programs certified by the Minister of Human Resources and Social Development). Under the current rules, the exemption is limited to $3,000 of such income annually.

Children's fitness tax credit
The budget gives parents a non-refundable tax credit of up to $500 of fees for the enrolment of each child under 16 years of age in an eligible program of physical activity. The credit can be claimed commencing in 2007 and will be available to either parent. The government will undertake consultations to determine the programs that will be eligible for the credit. Claims for the credit will need to be supported by tax receipts.

Child Disability Benefit
The budget makes two changes to the Child Disability Benefit (CDB) to enhance assistance to families with children eligible for the disability tax credit:

• the maximum annual CDB will increase from $2,044 to $2,300 starting July 2006 and will be indexed to inflation thereafter; and
• the CDB will be extended to more families caring for a child eligible for the disability tax credit by reducing the rates at which the CDB is reduced as family income rises.

Refundable medical expense supplement
The budget enhances the refundable medical expense supplement in two ways:

• the maximum amount of the supplement is increased from $767 to $1,000 for 2006 and will be indexed to inflation thereafter; and
• the income threshold at which the supplement starts to be reduced will be set at its 2005 level of $21,663 and indexed for inflation thereafter, with the result that it will be $22,140 for 2006.

Apprenticeship Grant
Effective January 1, 2007, a new Apprenticeship Incentive Grant program will provide a taxable cash grant of $1,000 per year to apprentices in the first two years of a qualifying apprenticeship program.

Tradesperson's tool expense
The budget proposes that the total cost of eligible new tools acquired after May 1, 2006 by an employed tradesperson, exceeding $1,000 annually (indexed after 2007), will be deductible. To qualify for the deduction, an employer must certify that the employee is required to acquire the tools as a condition of, and for use in, the employment. The deduction will be limited to $500 per year.

Mineral Exploration Tax Credit for Flow-Through Shares
The mineral exploration tax credit for flow-through shares ceased to be available for flow-through share agreements issued after 2005. The credit equals 15% of specified mineral exploration expenses incurred in Canada.

The budget reintroduces this credit for flow-through share agreements entered into after May 1, 2006 and before April 1, 2007, for expenditures that are incurred before 2008, or in 2008 pursuant to the "look-back" rules.

Capital gains of fishers
The budget introduces the following tax measures for dispositions of property used in a family fishing business:

• an intergenerational rollover for transfers of qualified fishing property to a child or grandchild will be allowed in certain circumstances;
• the $500,000 lifetime capital gains exemption will be available for capital gains arising on a disposition of qualified fishing property; and
• the period to claim a reasonable reserve in respect of proceeds that have not been received by the taxpayer on the disposition of qualified fishing property is extended from 5 to 10 years.

The rules will apply for dispositions of qualified fishing property after May 1, 2006.

Sales and Excise Tax Measures

GST
The budget reduces the GST rate by one percentage point, from 7% to 6%, effective July 1, 2006.

Detailed transitional rules are provided for determining the GST rate applicable to transactions that straddle the July 1, 2006 implementation date, including rules that will apply in respect of sales of real property, imported goods and services, and other specific circumstances. A number of routine consequential amendments are also proposed as a result of the GST rate reduction, including changes to the computation of the housing rebate, changes to the streamlined accounting methods, and changes to the Air Travellers Security Charge rates.

The budget maintains the GST credit at current levels for lower-income Canadians and retains the existing GST rebate rates for new housing and purchases made by public service bodies.

Tobacco excise levies
The budget increases tobacco excise duties to offset the effect of the GST rate reduction. Because excise duty is imposed only at the time tobacco products are packaged or imported, existing inventories of tobacco products are subject to the old lower rates of excise duty and to the new lower GST rate. Therefore, to ensure that the increased duties are applied to all tobacco products, inventories of tobacco products held on June 30, 2006 will be subject to a new inventory tax.

Alcohol excise levies
Similar to the changes for tobacco products, the budget increases alcohol excise duties to offset the effect of the GST rate reduction.

Excise tax on jewellery
The budget repeals the excise tax on jewellery, clocks and articles made of semi-precious stones, effective May 2, 2006.

Vintners and small brewers
The budget exempts from excise duty the first 500,000 litres of wine produced by a vintner from 100 percent Canadian-grown agricultural products, and reduces the duty for beer produced by small and mid-sized brewers. These measures apply to wine and beer packaged after July 1, 2006.

Other Tax Measures

Administrative provisions
The government has been working on an initiative referred to as "Standardized Accounting", which aims to simplify tax compliance for business by harmonizing various administrative provisions across federal statutes. The first measures were announced in 2003. The budget harmonizes other administrative, interest and penalty provisions, primarily as they relate to the Excise Tax Act (GST).

2005 budget measures
A limited number of previously announced tax measures were not legislated before Parliament prorogued as a result of the election call. The budget confirms that the government will proceed with these measures, including those dealing with the:

• tax deferral on dividends paid by agricultural cooperatives;
• tax credit for adoption expenses;
• tax measures for persons with disabilities;
• expanded list of medical expenses eligible for the tax credit;
• increase in expenses that can be claimed by a caregiver; and
• various changes to the capital cost allowance provisions related to electricity assets, pipelines, telecommunications cables, and energy generation equipment.

Functional currency tax reporting
The Department of Finance commented that it intends to release legislative proposals for comment that could allow corporations, required for financial reporting purposes to report in a functional currency other than the Canadian dollar, to determine their income for Canadian tax purposes in that functional currency.