On March 22, 2017, the Federal Minister of Finance, Bill Morneau, presented the Liberal government’s second budget. This Tax Insights discusses the tax initiatives proposed in the budget.
The budget does not increase personal or corporate income tax rates. Also, despite much speculation, it does not increase the capital gains inclusion rate.
In the 2016 budget, the government committed to undertake a wide-ranging review of the increasingly complex tax expenditures that now exist. The review’s objective was to eliminate poorly targeted and inefficient tax measures, and allow the government to identify opportunities to reduce tax benefits that, in the government’s view, unfairly help the wealthiest Canadians rather than the middle class. The budget takes steps to further enhance fairness in the tax system and to improve its efficiency and effectiveness, many of which result from this review.
Tax Planning Using Private Corporations
The budget indicates that the government’s review of federal tax expenditures highlighted certain issues regarding tax planning and tax reduction strategies that use private corporations to gain unfair tax advantages for high-income individuals and which are not available to other Canadians. The budget identifies in particular the following strategies involving private corporations:
a) sprinkling income – causing income that would otherwise be realized by an individual taxable at a high personal tax rate to instead be realized (for example, through dividends or capital gains) by family members subject to a lower or nil rate of tax
b) holding portfolio investments – because corporate tax rates are generally much lower than personal rates, private corporations can facilitate the accumulation of earnings that can be passively invested
c) converting regular income into capital gains – causing income that would normally be paid as a salary or dividend to a principal to instead be converted into corporate capital gains, allowing funds to be distributed at a much lower tax rate
The government is further reviewing this area, including whether there are features of the current system that have an inappropriate and adverse impact on genuine business transactions involving family members. The government intends to release a paper in the coming months setting out the nature of these issues in more detail as well as proposed policy responses.
Meaning of Factual Control
The Income Tax Act (ITA) recognizes two forms of control of a corporation: de jure (legal) control and de facto (factual) control. The concept of factual control is broader than legal control and is generally used to restrict access to certain corporate tax advantages (such as the small business deduction and the refundable 35% SR&ED tax credit).
Legal control of a corporation is determined generally based on the right to elect the majority of the board of directors. Factual control is defined to exist where a person has directly or indirectly, in any manner whatever, influence that, if exercised, would result in control in fact of the corporation. Many court cases have discussed which specific factors may be useful in determining whether factual control exists.
However, a recent court decision held that 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.”
For taxation years beginning after March 21, 2017, the budget proposes that the ITA be amended to clarify that a determination of factual control not be limited in the manner contemplated by the recent court decision.
Timing of Recognition of Gains and Losses on Derivatives
Derivatives are sophisticated financial instruments whose value is derived from the value of an underlying interest. The budget proposes two measures to clarify the timing of the recognition of gains and losses on derivatives held on income account.
Elective use of the mark-to-market method
In the past, there was uncertainty if taxpayers could mark to market their derivatives held on income account under the general principles of profit computation. A recent Federal Court of Appeal decision allowed a taxpayer that was not a financial institution to use the mark-to-market method on the basis that it provided an accurate picture of the taxpayer’s income. To provide a clear framework for exercising the choice of using the mark-to-market method, the budget introduces an elective mark-to-market regime.
For taxation years beginning after March 21, 2017, taxpayers can elect to mark to market all of their eligible derivatives held on income account. The election will remain effective until it is revoked with the consent of the Minister of National Revenue. Generally, an eligible derivative will be any derivative held on income account that meets certain conditions, including that the derivative is valued in accordance with accounting principles at its fair value in a taxpayer’s audited financial statements or otherwise has a readily ascertainable fair market value. For eligible derivatives that were previously subject to tax on a realization basis, the recognition of any accrued gain or loss at the beginning of the first election year will be deferred until the derivative is disposed of.
In its simplest form, a straddle is a transaction in which a taxpayer concurrently enters into two or more positions – often derivative positions – that are expected to generate equal and offsetting gains and losses on account of income. The taxpayer then may attempt to benefit from a deferral of recognition of income on the “gain leg” or through a shifting of that gain to a tax-indifferent investor. Although straddle transactions are being challenged using certain judicial principles and existing provisions of the ITA, including the general anti-avoidance rule, these challenges can be time-consuming and costly. Accordingly, the budget proposes to introduce a specific anti-avoidance rule that targets 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. A gain in respect of an offsetting position would generally be unrealized where the offsetting position has not been disposed of and is not subject to mark-to-market taxation. For the purposes of the stop-loss rule, a position will generally be defined as including any interest in actively traded personal properties (e.g. commodities), as well as derivatives and certain debt obligations. An offsetting position with respect to a position held by a taxpayer will generally be a position that has the effect of eliminating all or substantially all of the taxpayer’s risk of loss and opportunity for gain or profit in respect of the position.
The stop-loss rule will be subject to a number of exceptions and will apply to any loss realized on a position entered into after March 21, 2017.
Taxpayers in certain designated professions (accountants, dentists, lawyers, medical doctors, veterinarians and chiropractors) may elect to exclude the value of work in progress (WIP) in computing their income. This election effectively allows such taxpayers to defer tax by deducting costs associated with WIP in advance of the matching revenue inclusion.
For taxation years that begin after March 21, 2017, the budget proposes to restrict the ability to deduct the cost of WIP, subject to a transitional period. For the first taxation year that begins after March 21, 2017, in computing income, 50% of the lesser of the cost of the WIP and its fair market value will be allowed as a deduction. For subsequent taxation years, 100% of the lesser of the cost of WIP and its fair market value will be required to be included in income.
Investment Fund Mergers
Merger of switch corporations into mutual fund trusts
Canadian mutual funds can be in the legal form of a trust or a corporation. Switch corporations are mutual fund corporations with multiple classes of shares, where typically each class is a distinct investment fund.
For qualifying reorganizations occurring after March 21, 2017, the budget proposes to extend the current mutual fund merger rules to facilitate the reorganization of a switch corporation into multiple mutual fund trusts on a tax-deferred basis. The rules will apply to a class of shares if all or substantially all of the assets allocable to that class are transferred to a mutual fund trust and the shareholders of that class become unitholders of that mutual fund trust.
Segregated fund mergers
Segregated funds are life insurance policies that have many of the characteristics of mutual fund trusts. The budget proposes to allow insurers to effect tax-deferred mergers of segregated funds if carried out after 2017.
The budget also proposes that segregated funds be able to apply non-capital losses arising in taxation years beginning after 2017 to other taxation years beginning after 2017. The use of these losses will be subject to the normal limitations for the carrying forward and back of non-capital losses and will be restricted following a segregated fund merger.
Electronic Distribution of T4 Information Slips
Tax Incentives for Clean Energy Generation Equipment: Geothermal Energy
For property acquired generally for use after March 21, 2017, the budget expands:
Canadian Exploration Expense: Oil and Gas Discovery Wells
Expenditures related to drilling or completing a discovery well (or building a temporary access road to, or preparing a site of, any such well) will generally be classified as Canadian development expense (CDE) (30% deduction on a declining-balance basis) instead of Canadian exploration expense (CEE) (100% deduction in the year incurred).
This applies to expenses incurred after 2018 (including expenses incurred in 2019 that are deemed to have been incurred in 2018 because of the “look-back” rule); it will not apply to expenses incurred before 2021, if the taxpayer has, before March 22, 2017, entered into a written commitment to incur those expenses.
Reclassification of Expenses Renounced to Flow-Through Share Investors
Eligible small oil and gas corporations can no longer treat the first $1 million of CDE as CEE. This applies to expenses incurred after 2018 (including expenses incurred in 2019 that are deemed to be incurred in 2018 because of the “look-back” rule), except for expenses incurred after 2018 and before April 2019 that are renounced under a flow-through share agreement entered into after 2016 and before March 22, 2017.
Additional Deduction for Gifts of Medicine
Corporations that donate medicine from their inventory to an eligible charity can claim, in addition to the general charitable income tax deduction, an additional deduction equal to the lesser of the cost of the donated medicine and 50% of the amount by which the fair market value of the donated medicine exceeds its cost.
For gifts of medicine made after March 21, 2017, this additional deduction for gifts of medicine will be eliminated.
Investment Tax Credit for Child Care Spaces
The investment tax credit for child care spaces is eliminated for expenditures incurred after March 21, 2017. Transitional relief is available for eligible expenditures incurred before 2020 pursuant to a written agreement entered into before March 22, 2017.
Insurers of Farming and Fishing Property
For taxation years beginning after 2018, the budget eliminates the tax exemption for insurers of farming and fishing property that is based on the proportion of their (and their affiliated insurers’) gross premium income earned from insuring property used in farming or fishing (including residences of farmers or fishers).
Consultation on Cash Purchase Tickets
The budget launches a consultation on the income tax deferral available in respect of deferred cash purchase tickets for deliveries of listed grains by farmers. Interested parties are invited to submit comments to the government by May 24, 2017.
Extending Base Erosion Rules to Foreign Branches of Life Insurers
The budget proposes to ensure that Canadian life insurers are taxable in Canada with respect to income from the insurance of Canadian risks that are shifted to a foreign branch of a Canadian life insurer. The proposals will be modelled on the existing anti-avoidance rule used for computing foreign accrual property income (FAPI) for controlled foreign affiliates. It will apply when 10% or more of the gross premium income (net of reinsurance ceded) earned by a foreign branch of a Canadian life insurer is premium income in respect of Canadian risks. When the proposal applies, it will 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 complementary anti-avoidance rules that currently apply for FAPI purposes for so called “insurance swaps” or the ceding of Canadian risks will be extended to foreign branches of Canadian insurers. If an insurer has insured foreign risks through its foreign branch and it can reasonably be concluded that foreign risks were insured by the life insurer as part of a series of transactions one of the purposes of which was to avoid the proposed rule, the life insurer will be treated as if it has insured Canadian risks. An analogous anti-avoidance rule will be introduced to reinforce the existing anti-avoidance rules in the FAPI regime.
This measure will apply to taxation years of Canadian taxpayers that begin after March 21, 2017.
Public Transit Tax Credit
As of July 1, 2017, this credit is eliminated. The cost of public transit passes and electronic fare cards attributable to public transit use that occurs after June 2017 will no longer be eligible for the credit.
Anti-Avoidance Rules for Registered Plans
For transactions occurring after March 22, 2017, certain anti avoidance provisions (i.e. the advantage rules, the prohibited investment rules and the non-qualified investment rules) that exist for tax assisted registered plans (i.e. Tax-Free Savings Accounts, Registered Retirement Savings Plan and Registered Retirement Income Funds) will be extended to Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs). The exceptions to this date are as follows:
Home Relocation Loans Deduction
As of 2018, the home relocation loans deduction is eliminated.
Tuition Tax Credit
For courses taken after 2016, the tuition tax credit will be extended to include tuition fees paid for occupational skills courses offered by a university, college or other post-secondary institution and that are not at the post-secondary level. To qualify, the course must be taken for the purposes of providing the individual with skills in an occupation and the individual must have attained the age of 16 before the end of the year.
Beginning 2017, the definition of “qualifying student” will be extended to include individuals in the circumstances noted above for the purposes of the tax exemption for scholarships and bursaries.
Ecological Gifts Program
The budget proposes a number of measures to protect gifts of ecologically sensitive property (“ecogifts”) for transactions or events occurring after March 21, 2017 as follows:
Disability Tax Credit Certification (Nurse Practitioners)
As of March 22, 2017, nurse practitioners, whose profession is regulated by provincial and territorial nursing regulatory bodies throughout Canada, will be permitted to certify for disability tax credit eligibility for impairments that are within the scope of their practice.
Medical Tax Credit – Eligible Expenditures
Beginning 2017, the medical expense tax credit will be extended so that individuals requiring medical intervention in order to conceive a child are eligible to claim the same expenses that would be eligible for individuals on account of medical infertility. The taxpayer will be entitled to elect for this measure to apply for any of the immediately preceding ten taxation years in their return of income in respect of the year.
Consolidation of Caregiver Credits
A new Canada Caregiver Credit will replace the existing caregiver credit, infirm dependant credit and family caregiver tax credit beginning 2017. The amounts are consistent with the existing credits and will be reduced dollar-for-dollar by the dependant’s net income above $16,163 (in 2017). The dependant will not be required to live with the caregiver to claim the credit. The Canada Caregiver Credit will no longer apply in respect of non-infirm seniors who reside with their adult children.
Mineral Exploration Tax Credit for Flow-Through Share Investors
The budget proposes to extend the eligibility for this credit for an additional tax year to flow-through share agreements entered into before April 1, 2018.
National Child Benefit Supplement
The budget proposes to delay the repeal of the reference to the National Child Benefit supplement reference in the Canada Child Benefit rules in the ITA until July 1, 2018. This change will not impact the calculation of the Canada Child Benefit.
Allowance for Members of Legislative Assemblies and Certain Municipal Officers
As of 2019, non-accountable allowances paid to certain officials will be included in income. The reimbursement of employment expenses will remain a non-taxable benefit to the recipient.
Taxi and Ride-Sharing Services
To ensure that the GST/HST applies consistently to taxi services and ride-sharing services, effective July 1, 2017, the definition of a taxi business will be amended to require providers of ride-sharing services to register for the GST/HST and charge tax on their fares in the same manner as taxi operators. These changes will only apply to transportation that is supplied in the course of a commercial activity, but will not apply to a school transportation service for elementary or secondary students or a sightseeing service.
GST/HST Rebate to Non-Residents for Tour Package Accommodations
The GST/HST rebate available to non-residents for the GST/HST payable in respect of the accommodation portion of eligible tour packages will be repealed in respect of supplies of tour packages or accommodations made after March 22, 2017. However, as a transitional measure, the rebate will continue to be available in respect of a supply of a tour package or accommodations made after March 22, 2017, and before January 1, 2018, if all of the consideration for the supply is paid before January 1, 2018.
Opioid Overdose Treatment Drug – Naloxone
As of March 22, 2016, naloxone (and its salts) will be added to the list of GST/HST-free non-prescription drugs that are used to treat life-threatening conditions. However, this measure does not apply in respect of any supply, importation or bringing into a participating province of naloxone occurring before March 23, 2017, for which GST/HST was charged, collected, remitted or paid.
As of March 23, 2017, the 10.5% tobacco manufacturers’ surtax is eliminated and tobacco excise duty rates on cigarettes and other tobacco products will increase.
In addition, inventories of cigarettes held by manufacturers, importers, wholesalers and retailers at the end of March 22, 2017, will be subject to a tax of $0.00265 per cigarette (subject to certain exemptions). Taxpayers will have until May 31, 2017 to file returns and pay the inventory tax.
Excise duty rates on alcohol products will increase by 2% effective March 23, 2017, in respect of duty that becomes payable after that date. The rates will be automatically adjusted by the Consumer Price Index on April 1 of every year, starting in 2018.
The budget proposes several amendments to customs tariff and special import measures:
Cracking Down on Tax Evasion and Combatting Tax Avoidance
The budget invests an additional $523.9 million over five years to prevent tax evasion and improve tax compliance. The budget builds on previous investments to support the Canada Revenue Agency in its continued efforts to crack down on tax evasion and combat tax avoidance by:
Global Skills Strategy
To help support talent-strapped companies doing business in Canada, a Global Skills Strategy will be launched to encourage faster access to global workers. The strategy will set a two-week standard for processing visas and work permits for global talent. As part of this strategy, the government will implement a new Global Talent Stream under the Temporary Foreign Worker Program (starting 2017-18), and introduce a new short-duration work permit exemption for work terms of fewer than 30 days in a year, or for brief academic stays, and will be used for short-term, inter-company work exchanges, study exchanges or the entrance of temporary expertise.
Aboriginal Tax Policy
The budget confirms the government’s willingness to discuss and put into effect direct taxation arrangements with interested Aboriginal governments, as well as its support of direct taxation arrangements between interested provinces or territories and Aboriginal governments.
The budget confirms that the government will proceed with the following previously announced measures, as modified to take into account consultations and deliberations since their announcement or release:
The budget also reaffirms the government’s commitment to move forward as required with technical amendments to improve the certainty of the tax system.