Highlights of Canada's 2015 Federal Budget
The federal budget tabled on April 21, 2015 (Budget 2015) contains a number of proposed amendments to Canada’s Income Tax Act (the Tax Act). This bulletin focuses on (i) business income tax measures, (ii) international tax measures and (iii) other proposed tax measures.
Business Income Tax Measures
Reduction of the Small Business Tax Rate
A corporation that is a Canadian-controlled private corporation throughout the taxation year is entitled to a small business deduction that effectively results in its first $500,000 of active business income being subject to federal tax at 11%. Budget 2015 proposes to further reduce the federal tax rate on the first $500,000 of active business income to:
- 10.5% effective Jan 1, 2016;
- 10% effective Jan 1, 2017;
- 9.5% effective Jan 1, 2018; and
- 9% effective Jan 1, 2019 and for future years.
These rates will be pro-rated where a Canadian-controlled private corporation does not have a calendar year taxation year.
Consequential to the reduction in the small business tax rate, Budget 2015 also proposes to amend the dividend gross-up and tax credit provisions for an individual (other than a trust that is a registered charity) receiving non-eligible dividends. The effective federal tax rate on non-eligible dividends received by individuals in the highest federal tax rate bracket (currently 21.2%) will increase between 2016 and 2019 (first increasing to 21.6% and then gradually increasing to 23%).
Consultation on Active Versus Investment Business
Under the Tax Act, active business income does not include income from a "specified investment business," which is a business the principal purpose of which is to derive income from property. Income from a "specified investment business" is not eligible for the small business deduction, unless the business has more than five full-time employees. According to Budget 2015, stakeholders have expressed concern as to the application of these rules in cases such as self-storage facilities and campgrounds.
Budget 2015 announces a review of the circumstances in which income from a business, the principal purpose of which is to earn income from property, should qualify as active business income. Stakeholders are invited to submit comments by August 31, 2015 regarding such a review. At this time, it does not appear that the consultation will focus on the corresponding characterization issues with respect to the foreign affiliate regime under the Tax Act.
Tax Support for Manufacturing Investments
Class 29 of Schedule II to the Income Tax Regulations (Regulations) provides a temporary accelerated capital cost allowance (CCA) rate of 50% on a straight-line basis for machinery and equipment acquired after March 18, 2007 and before 2016 used in Canada primarily in the manufacturing or processing of goods for sale or lease. Without Class 29, such eligible assets would fall under Class 43, which provides for a CCA rate of 30% on a declining-balance basis.
To support continued investment in machinery and equipment and help bolster productivity, Budget 2015 proposes to extend the accelerated 50% CCA rate for eligible assets for another 10 years by replacing Class 29 with a new Class 53. Class 53 will provide an accelerated CCA rate of 50% on a declining-balance basis for machinery and equipment acquired after 2015 and before 2026 used in Canada primarily in the manufacturing or processing of goods for sale or lease. Any eligible assets acquired after 2025 will generally fall under Class 43 (CCA rate of 30% on a declining-balance basis).
The half-year rule will apply to any Class 53 asset allowing only half of the CCA deduction otherwise available in the year in which the asset first become available for use. Eligible assets will be considered "qualified property" for the purposes of the Atlantic Investment Tax Credit.
Tax Avoidance of Corporate Capital Gains (Section 55)
Subsection 55(2) of the Tax Act is an anti-avoidance rule that generally taxes a dividend as a capital gain in circumstances where a corporation receives a tax-deductible dividend on shares of another corporation that has the purpose or effect of reducing the capital gain that would otherwise be realized on a disposition of the shares for their fair market value.
Generally, subsection 55(2) applies where, among other things, a corporate shareholder receives a tax deductible dividend and one of the purposes (or, in the case of a deemed dividend under subsection 84(3) of the Tax Act, one of the results) of the dividend was to effect a significant reduction in the capital gain that, but for the dividend, would have been realized on a disposition of any share at fair market value. Where subsection 55(2) applies, the dividend is treated as either proceeds of disposition (if the corporate shareholder has disposed of the shares) or as a gain from a disposition of capital property (if the corporate shareholder has not disposed of the shares).
Recent case law has held that subsection 55(2) does not apply where the effect of a dividend-in-kind was to create an unrealized capital loss on shares which, when realized, was used to shelter capital gains on the disposition of other capital property.
Budget 2015 proposes to amend subsection 55(2) to ensure that it applies where one of the purposes of a dividend is to effect a significant reduction in the fair market value of any share or a significant increase in the total cost of properties of the dividend recipient. Related rules are proposed to deal with stock dividends and dividends on shares having nominal value. A further amendment to subsection 55(2) is proposed so that any dividend to which it applies is treated as a gain from the disposition of capital property (whether or not the underlying shares are disposed of).
Currently, the Tax Act provides that subsection 55(2) does not apply to certain (actual or deemed) dividends if paragraph 55(3)(a) of the Tax Act applies. Budget 2015 proposes to amend paragraph 55(3)(a) so that only deemed dividends arising under subsection 84(3) qualify for the exception under paragraph 55(3)(a).
These measures will apply to dividends received by a corporation on or after April 21, 2015 (Budget Day).
Synthetic Equity Arrangement
Under the Tax Act, a corporation is generally permitted to deduct, in computing taxable income, dividends received from a taxable Canadian corporation. However, the Tax Act contains certain exceptions to the availability of this inter-corporate deduction for dividends. One such exception pertains to dividends received as part of a "dividend rental arrangement" of the dividend receiving corporation.
A "dividend rental arrangement" of a person is defined in the Tax Act to generally mean any arrangement entered into by the person where it may reasonably be considered that the main reason for entering into the arrangement was to enable the person to receive a dividend on a share and, under the arrangement, someone else bears the risk of loss or enjoys the opportunity for gain or profit with respect to the share in any material respect.
According to the Department of Finance (Canada) (Finance), certain taxpayers, including financial institutions, enter into financial arrangements where they retain the legal ownership of an underlying Canadian share, but the economic exposure has been transferred to a counterparty by way of an equity derivative. Finance states that some taxpayers take the position that the existing dividend rental arrangement rules do not apply to these arrangements with the result that the taxpayers not only benefit from the inter-corporate deduction for dividends, but also deduct the dividend-equivalent-payments to the counterparty. The focus is on transactions where the counterparty is a tax-exempt or a non-resident person not subject to tax under the Tax Act (a "tax-indifferent investor").
Budget 2015 proposes to broaden the definition of "dividend rental arrangement" to generally include a "synthetic equity arrangement". In general terms, a "synthetic equity arrangement" in respect of a share owned by a person is defined as one or more agreements or other arrangements that are entered into by the person with a counterparty that have the effect of providing all or substantially all of the risk of loss and opportunity for gain or profit in respect of the share to the counterparty. For these purposes, opportunity for gain or profit includes rights to, benefits from and distributions on a share.
The new rules do not apply if:
- the taxpayer can establish that no "tax-indifferent investor" has all or substantially all of the risk of loss and opportunity for gain or profit in respect of the share because of the synthetic equity arrangement or what is defined as a specified synthetic equity arrangement; or
- the relevant agreement is traded on a recognized derivatives exchange, unless it can reasonably be considered that the taxpayer knows or ought to know the identity of the counterparty.
The proposed rules apply to dividends that are paid or become payable after October 2015.
Finance also identified, as an alternative to the rules discussed above, a proposal that would deny the inter-corporate deduction for dividends in respect of a "synthetic equity arrangement" irrespective of the tax status of the counterparty. Finance states that such an alternative would eliminate some of the complexities of the rules discussed above, but would have a broader application. Stakeholders are invited to submit comments by August 31, 2015 concerning whether the scope of the measure should be broadened in such manner.
Consultation on Eligible Capital Property
In an effort to reduce the compliance burden, the federal budget tabled on February 11, 2014 (Budget 2014) announced a public consultation on the proposal to repeal the eligible capital property (ECP) regime and replace it with a new class of property to which the CCA rules would apply. The new CCA class would be available to businesses, and taxpayers would transfer their existing cumulative eligible capital (CEC) pools to this new CCA class. Expenditures currently being added to the CEC pool at a 75% inclusion rate would instead be included in the new CCA class at 100%. To compensate for this increased expenditure recognition, the new CCA class would have a 5% annual depreciation rate. In addition, special rules were proposed to address goodwill and eligible capital expenditures and receipts that do not relate to a specific property of the business, as well as certain transitional rules.
Budget 2015 provides an update on the consultation noting that the Government has heard from a number of stakeholders and continues to receive submissions on the proposal. The specific timing and detail of the proposal are not outlined in Budget 2015, but Finance says it intends to release detailed draft legislative proposals for comment before their inclusion in a bill.
International Tax Measures
Captive Insurance
The Tax Act contains rules within the foreign affiliate regime that deem certain types of Canadian-source income earned by a foreign affiliate of a corporation resident in Canada to be included in the affiliate’s foreign accrual property income (FAPI) which in the case where the foreign affiliate is a controlled foreign affiliate, is taxed in Canada on an accrual basis in the hands of the Canadian corporation.
One such rule applies to include in the FAPI of a foreign affiliate the affiliate’s income from the insurance or reinsurance of a risk in respect of a person resident in Canada, a property situated in Canada or a business carried on in Canada (Canadian risks). An anti-avoidance rule was introduced in Budget 2014 that applied to so-called "insurance swaps" under which a foreign affiliate insures foreign risks but retains economic exposure to Canadian risks. Where it applies, the anti-avoidance rule generally deems the foreign risks to be risks in respect of a person resident in Canada.
Budget 2015 states that the Government has become aware of alternative arrangements that Finance states are intended to achieve tax benefits similar to those that the 2014 amendment was intended to prevent. More specifically, the type of arrangement targeted by Budget 2015 is one in which the foreign affiliate receives consideration with an embedded profit component in exchange for ceding its Canadian risks, and the profit component is based on the expected return on the pool of Canadian risks. The Government states that the 2014 amendment may not apply to these alternative arrangements if the affiliate does not enter into an insurance swap that provides it with economic exposure to Canadian risks.
To ensure that profits from the insurance of Canadian risks remain taxable in Canada, Budget 2015 proposes to include in the FAPI of a foreign affiliate the affiliate’s income from ceding Canadian risks. For these purposes, where an affiliate cedes Canadian risks in consideration for a portfolio of foreign risks, the affiliate’s FAPI from ceding Canadian risks is an amount equal to the difference between the fair market value of the Canadian risks ceded and the affiliate’s costs in respect of having acquired those risks.
This proposed measure will apply to taxation years that begin on or after Budget Day. The Government has invited interested parties to submit comments on the proposal by June 30, 2015.
Non-Resident Employers and Withholding Taxes
Under the Tax Act, Canadian-source remuneration paid to a non-resident employee who provides services in Canada is generally subject to the same withholding, remitting and reporting requirements that otherwise apply to Canadian-resident employees, regardless of the amount of time that they spend in Canada. While a non-resident employee or an employer may apply for a Regulation 102 waiver from such obligations, this waiver procedure is not seen as a practical solution to the administrative burden imposed on non-resident employers to withhold, remit and report for what may be small amounts.
Budget 2015 proposes to allow an exemption for "qualifying non-resident employers" from these withholding, remittance and reporting obligations with respect to amounts paid to "qualifying non-resident employees." For these purposes, a "qualifying non-resident employee" at any time is generally defined to mean an employee who is resident in a country with which Canada has a tax treaty, is exempt from Canadian income tax on such amounts because of that tax treaty, and is not present in Canada for 90 days or more in any 12-month period that includes that time. A "qualifying non-resident employer" is generally defined to mean an employer that is resident in a country with which Canada has a tax treaty, does not carry on business through a permanent establishment in Canada, and that is at the time of the payment certified by the Minister of National Revenue (Minister). In particular, the Minister may certify an employer for a specified period of time if the employer has applied in prescribed form and containing prescribed information and the Minister is satisfied that the employer meets the conditions to be a "qualifying non-resident employer" and other conditions to be established by the Minister.
This proposed measure will apply in respect of payments made after 2015.
Update on Tax Planning by Multinational Enterprises
Canada and other members of the G-20 have been working with the OECD on the Action Plan on Base Erosion and Profit Shifting (BEPS). Finance states that input received from stakeholders on various issues related to international tax planning has helped shape Canada’s participation in the BEPS project. Budget 2015 confirms Canada’s commitment to what Finance described as a process to improve the tax system in a manner that balances tax integrity and fairness with global competitiveness. Recognizing that taxes are a key consideration driving investment decisions, Finance states that its approach is intended to create an environment in which businesses can thrive in a global economy and maintain Canada’s attractiveness as a destination for business investment.
Update on the Automatic Exchange of Information for Tax Purposes
In 2013, the G-20 countries committed to the automatic exchange of tax information in respect of financial accounts as a tool to promote tax compliance and fight tax evasion. In November 2014, Canada and the other G-20 countries endorsed a new common reporting standard that was developed by the OECD for this purpose. In February 2015, the G-20 Finance Ministers agreed to develop required legislative procedures in order to proceed with a first exchange of information by 2017 or 2018. The new reporting standard requires foreign tax authorities to provide the CRA with information relating to financial accounts held by Canadian residents in their respective jurisdictions and requires Canada to provide reciprocal information to foreign tax authorities in respect of holders of accounts in Canada that are resident in their particular countries. The reporting standard includes measures to protect taxpayer confidentiality and ensures information is used only by tax authorities for tax purposes.
Budget 2015 announces that Canada proposes to implement the new common reporting standard on July 1, 2017, allowing a first exchange of information in 2018. Canadian financial institutions will be required to have due diligence procedures in place to identify non-resident accountholders and obtain specified information relating to the accounts to be reported to the CRA to enable Canada to comply with the information exchange requirements. The CRA will formalize exchange agreements with other jurisdictions, upon which information will be exchanged on a reciprocal, bilateral basis. Draft legislative proposals will be released for comments in the coming months.
Other Proposed Tax Measures
Increase in Tax-Free Savings Account Contribution Limit
The Tax-Free Savings Account (TFSA) program was introduced in 2009. The TFSA is a registered savings vehicle that allows qualifying individuals to set money aside tax-free throughout their lifetime. Contributions to a TFSA are not tax-deductible. In 2009, the annual contribution limit for a TFSA was set at $5,000 per individual. By 2013, the annual limit had increased to $5,500.
Budget 2015 proposes to increase the annual contribution limit to $10,000 effective as of January 1, 2015. This limit will no longer be indexed to inflation.
Investments in Limited Partnerships by Registered Charities
Under the Tax Act, a registered charity generally means a charitable organization, private foundation or public foundation resident and created in Canada. Charitable organizations and public foundations can only carry on a business that qualifies as a "related business" under the Tax Act, and a private foundation is not permitted to carry on any business. Budget 2015 proposes amendments to ensure that a registered charity is not considered to carry on a business solely by reason of the acquisition or holding of an interest in a limited partnership. For this relieving provision to apply, the liability of the charity as a member of the partnership must be limited by operation of the law governing the partnership and the charity must (i) deal at arm’s length with each general partner of the partnership, and (ii) restrict its investment in the partnership (together with the investment(s) of all non-arm’s length entities) to 20% or less of the interests in the partnership on a fair market value basis.
The proposed measure will apply in respect of investments in limited partnerships that are made or acquired on or after Budget Day.