Business income tax measures
General anti-avoidance rule
Budget 2023 introduced significant legislative proposals to amend the GAAR. The GAAR is designed to negate the tax benefits arising from abusive tax avoidance transactions that may satisfy the technical requirements of the Tax Act but are found to misuse or abuse the underlying policy.
Although the GAAR was introduced 35 years ago, the government announced a comprehensive review of the GAAR in the 2020 Fall Economic Statement. The 2022 federal budget (Budget 2022) proposed to continue that review and on August 9, 2022, a consultation paper titled Modernizing and Strengthening the General Anti-avoidance Rule (Consultation Paper) was released. Following this release, there was a consultation period from August 9 to September 30, 2022, where interested parties had the opportunity to make submissions on the approaches outlined for modernizing the GAAR. Budget 2023 proposes legislation intended to address several of the concerns and suggested approaches outlined in the Consultation Paper.
For the GAAR to apply under the current Tax Act rules, the following three elements must be present: (i) there must be a tax benefit; (ii) an avoidance transaction; and (iii) the avoidance transaction or a series of transactions that includes the avoidance transaction leads to a misuse or abuse of particular provisions of the Tax Act.
The legislative proposals in Budget 2023 amend the GAAR to introduce: a preamble to address interpretative issues, a modified standard for identifying an avoidance transaction, a new economic substance test as part of the misuse and abuse analysis, a 25% penalty levied on the amount of a tax benefit resulting from transactions subject to the GAAR and an extension of the normal reassessment period in certain cases.
The government is currently holding a consultation period allowing interested parties to make submissions on these proposals until May 31, 2023. When the consultation period ends, the government intends to publish revised legislative proposals and announce the effective date for these amendments.
The GAAR has received significant judicial interpretation since its enactment 35 years ago. These legislative proposals introduce considerable uncertainty as to the validity of current GAAR jurisprudence, and if enacted could lead to new tax disputes to clarify the meaning and impact of the amendments.
The proposed legislation adds a preamble to the GAAR provisions, the purpose of which is to help address interpretive issues and ensure that the GAAR applies in the intended manner. The preamble outlines that: (i) the GAAR applies to deny the tax benefit from avoidance transactions that misuse provisions of the Tax Act while still allowing taxpayers to obtain benefits contemplated by particular provisions; (ii) the GAAR aims to strike a balance between a taxpayer’s need for certainty in planning their affairs and the government’s responsibility to protect the tax base and the overall fairness of the tax system; and (iii) the GAAR can apply regardless of whether a tax strategy is foreseen.
Currently, the GAAR stipulates that a transaction is an avoidance transaction where it results directly or indirectly in a tax benefit, unless it is carried out primarily for bona fide purposes other than to obtain the tax benefit. The proposed amendments lower this threshold and require that, in order to constitute an avoidance transaction, only one of the main purposes of the transaction is to obtain a tax benefit.
This amendment was discussed in the Consultation Paper, as the government stated that the current avoidance transaction standard was too stringent and, in its view, led courts to an inappropriate finding that GAAR did not apply in several instances. This lower threshold is consistent with other anti-avoidance rules in the Tax Act and the principal purpose test in the OECD’s Multilateral Instrument.
Budget 2023 states that the standard is intended to strike a reasonable balance as it would apply to transactions with a significant tax avoidance purpose but would not apply when tax is simply a consideration.
The proposed GAAR amendments include the addition of an economic substance test. According to Budget 2023, this expansion of the GAAR is in response to Supreme Court of Canada jurisprudence that has established a more limited role for economic substance.
The economic substance test will be considered at the misuse and abuse stage of the GAAR analysis. If there is a lack of economic substance it will be seen as an indication that the transaction is abusive tax avoidance. However, a lack of economic substance on its own does not end the analysis as it is still necessary to determine whether there is a misuse or abuse considering the object, spirit and purpose of the relevant provision. If a transaction lacks economic substance but the tax results are consistent with the purpose of the applicable Tax Act provisions, then the transaction would not be considered abusive tax avoidance.
The proposed amendments provide the following non-exhaustive list of factors that should be considered when determining if a transaction has economic substance: (i) whether there is no change in the opportunity for gain or profit and risk of loss; (ii) whether the expected value of the tax benefit exceeds the expected value of the non-tax economic return (which excludes foreign tax benefits); and (iii) whether the transaction is almost entirely tax motivated. The existence of one or more of these factors supports a finding that there is a lack of economic substance.
Budget 2023 notes that these proposed amendments do not supplant the general approach under Canadian income tax law which focuses more on the legal form rather than the substance of an arrangement. Further, Budget 2023 states that this amendment does not require determining the economic substance of a transaction but rather requires consideration of whether there is a lack of economic substance.
The proposed GAAR amendments introduce a significant new penalty for transactions subject to the GAAR, equal to 25% of the amount of the tax benefit resulting from such transactions, unless the transaction was disclosed to the Canada Revenue Agency (CRA) voluntarily or under the proposed mandatory disclosure rules. If the tax benefit relates to a tax attribute that has not yet been used, then the amount of the tax benefit is deemed to be nil for purposes of the penalty. The government intends to amend the proposed reportable transaction rules to permit voluntary reporting for these purposes.
Extended reassessment period
The proposed amendments include a three-year extension to the normal reassessment period for GAAR assessments. However, if the transaction has been disclosed to the CRA under the proposed mandatory disclosure rules or under the newly proposed GAAR voluntary reporting rule, then there is no extension to the normal reassessment period.
Tax on repurchases of equity
Further to the announcement in the 2022 Fall Economic Statement, Budget 2023 includes proposed legislation to implement a 2% tax on the net value of share repurchases by the following entities if any of their equity is listed on a designated stock exchange:
- Canadian-resident corporations (other than mutual fund corporations);
- real estate investment trusts;
- specified investment flow-through (SIFT) trusts;
- SIFT partnerships; and
- entities that would be SIFT trusts or SIFT partnerships if their assets were located in Canada.
As stated in the 2022 Fall Economic Statement, this tax is similar to the share buyback tax that was recently enacted in the United States under the Inflation Reduction Act of 2022.
The tax is calculated as 2% of the difference between the total fair market value of equity that is redeemed, acquired or cancelled in the taxation year and the total fair market value of equity that is issued in the taxation year. Certain transactions are not included in the tax calculation, including the issuance and cancellation of debt-like preferred shares and units that have a fixed dividend and redemption entitlement, and the issuance and cancellation of shares or units in certain corporate reorganizations and acquisitions, including certain amalgamations, liquidations, and share-for-share exchanges. For greater certainty, Budget 2023 specifies that normal course issuer bids and substantial issuer bids will be covered by the new tax.
The proposed legislation includes a de minimis threshold of $1 million, such that the tax will not apply if the total fair market value of equity that is redeemed, acquired or cancelled is less than $1 million in a taxation year (the amount is prorated for short taxation years). The de minimis threshold only considers equity repurchases and does not take into account equity issued in the year.
Under the proposed legislation, equity acquisitions by certain affiliates are deemed to be acquisitions by the entity itself, with exceptions for acquisitions that are intended to facilitate certain equity-based compensation arrangements and acquisitions made by registered securities dealers in the ordinary course of business. In addition, if a person or partnership undertakes a transaction or series of transactions to acquire equity of an entity to which these rules apply, and it is reasonable to consider one of the main purposes of the equity acquisition to be the avoidance of the 2% tax, the person or partnership will be considered an affiliate under these rules and the deeming provision described above will apply.
The tax applies to equity repurchases and issuances that occur on or after January 1, 2024, and relevant taxpayers that redeem, acquire or cancel equity will be required to file a return in prescribed form.
The government expects to recover $2.5 billion in revenue over the next five years from this tax.
Dividend received deduction by financial institutions
The proposed dividend denial refers to the inter-corporate dividend deduction and the mark-to-market rules under the Tax Act. As background to the proposal, we provide a brief background to these two regimes.
Generally, the inter-corporate dividend deduction permits a taxable Canadian corporation to deduct, in computing its taxable income, taxable dividends received on shares of other taxable Canadian corporations. This inter-corporate dividend deduction recognizes and is part of achieving a fundamental principle of Canadian taxation referred to as corporate integration. The inter-corporate dividend deduction is intended to recognize that the dividend was paid out of after-tax earnings and to prevent earnings being taxed more than once at multiple corporate levels.
The mark-to-market rules apply in respect of certain properties held by financial institutions. In very general terms, these rules require financial institutions to mark to market their holdings of certain securities and other instruments held as mark-to-market property. The mark-to-market rules also generally require that gains and losses on such securities and instruments be recognized by the financial institution on income account and not as capital gains and losses. For purposes of these rules, a financial institution includes a Schedule I or II bank under the Bank Act (Canada) and an insurance corporation. A mark-to-market property is defined to mean, among other types of property, a share of a corporation representing less than 10% of all the shares of the corporation by votes or value.
Budget 2023 proposes to deny any inter-corporate dividend deduction otherwise available to a financial institution in respect of taxable dividends received by the financial institution on shares held by the financial institution as mark-to-market property. The government explains the change by asserting that, “The policy behind the dividend received deduction conflicts with the policy behind the mark-to-market rules”. And further that, “The tax treatment of dividends received by financial institutions on portfolio shares held in the ordinary course of their business is inconsistent with the tax treatment of gains on those shares under the mark-to-market rules”.
It is submitted that, in fact, there is no conflict between the inter-corporate dividend deduction on a share that is held as mark-to-market property and the mark-to-market rules. The market-to-market rules have been part of the Tax Act for nearly three decades and the inter-corporate dividend deduction and the mark-to-market regime have lived harmoniously with one another since that time. There are in fact specific rules that ensure this result, such as a stop-loss rule that deals only with deductible dividends and losses realized by a financial institution on shares held as mark-to-market property. In fact, not only do the two regimes not conflict with one another, they could not conflict because they address two separate and distinct matters.
It is submitted that the Budget 2023 proposal to deny the inter-corporation dividend deduction for financial institutions on shares held by them as mark-to-market property represents a fundamental policy shift and an erosion of a core principle of the Tax Act, namely, corporate integration. There already exist in the Tax Act a myriad of rules that police the use of the inter-corporate dividend deduction in circumstances determined by the government to be abusive. These include the dividend rental arrangement rules in the Tax Act which in turn encompass rules dealing with synthetic equity arrangements. If the government perceives problems with those rules, it should be possible to address their deficiencies without a wholesale abandoning of a fundamental principle of Canadian taxation.
There is also concern that this legislative measure singles out Canadian financial institutions. While financial institutions are required to hold certain shares as mark-to-market property, mark-to-market treatment is not restricted to financial institutions. Other corporations whose ordinary business includes trading or dealing in securities are usually required to report gains and losses on their securities on income account and may report such gains and losses annually under a mark-to-market treatment. It is not clear why the inter-corporate dividend deduction and mark-to-market treatment is not problematic for the government for these corporations. The current proposal is a continuation of a pattern of singling out financial institutions, a pattern that includes the 15% Canada recovery dividend and the 1.5% additional annual tax on the income of financial institutions.
Clean technology and green energy measures
Consistent with the focus on the environment and what is described as the “clean economy”, Budget 2023 introduces (or in some cases expands on) a number of proposed measures in respect of clean technology and green energy initiatives, including:
- providing further details on the tax credit for clean hydrogen (CH Tax Credit);
- expanding the tax credit for clean technology investment to include equipment for geothermal energy projects (CTI Tax Credit);
- providing further details on the tax credit for carbon capture utilization, and storage (CCUS Tax Credit);
- introducing a refundable 15% tax credit for clean electricity (CE Tax Credit);
- introducing a refundable 30% tax credit for clean technology manufacturing and processing and critical mineral extraction and processing (CTM Tax Credit);
- expanding the eligible activities and extending the reduced tax rates in respect of zero-emission technology manufacturers; and
- expanding the flow-through share treatment (and expanding the critical mineral exploration tax credit) for producers of lithium from brines.
Of note is that businesses are only able to claim one of the CH Tax Credit, the CCUS Tax Credit, the CTI Tax Credit, the CE Tax Credit or the CTM Tax Credit in respect of a particular property even if such property is eligible for more than one of these tax credits. However, multiple tax credits could be available in respect of the same project, if such project includes different types of eligible property.
The introduction and expansion of the various refundable tax credits suggests that the government recognized that the use of refundable tax credits is often more valuable to businesses looking at investing in these growth areas as opposed to enhanced capital cost allowance (CCA) rates for manufacturing and processing and clean energy equipment. This is not surprising due to the fact that businesses in the “clean energy” industry are often in the development phase and less able to take advantage of the enhanced CCA rates.
Although Budget 2023 provides businesses with the opportunity to plan investments with the various tax credits in mind, many of the details regarding the application of the tax credits are yet to be released, including the interaction of the tax credits in the context of partnerships with taxable and tax-exempt members. Moreover, the refundable nature of these credits can assist with current financing, with the additional funding potentially tipping the scale towards making such projects financially viable.
Tax credit for clean hydrogen
The CH Tax Credit was first announced in the 2022 Fall Economic Statement. As expected, Budget 2023 sets out additional details regarding the CH Tax Credit, which is proposed to apply in respect of the cost of purchasing and installing eligible equipment for projects that produce hydrogen from: (i) electrolysis; or (ii) natural gas, provided emissions are abated using carbon capture utilization, and storage (CCUS). The rate of the CH Tax Credit varies between 5-40%, depending on carbon intensity of the hydrogen that is produced and whether certain labour conditions are met.
The CH Tax Credit will be available in respect of the cost of purchasing and installing eligible equipment, which will include:
- equipment required to produce hydrogen from electrolysis, if all or substantially all of the use of that equipment is to produce hydrogen through electrolysis of water, including electrolysers, rectifiers and other ancillary electrical equipment, water treatment and conditioning equipment, and equipment used for hydrogen compression and on-site storage; and
- equipment required to produce hydrogen from natural gas with emissions abated using CCUS, excluding equipment that is already described in Class 57 or Class 58 (which is eligible for the CCUS Tax Credit).
The CH Tax Credit is proposed to be available when eligible equipment becomes available for use in Canada after Budget Day. The CH Tax Credit is proposed to be phased-out beginning in 2034 such that the CH Tax Credit in respect of property that becomes available for use in 2034 will be subject to a 50% reduction and the CH Tax Credit will be completely phased out for any property that becomes available for use in subsequent years.
Tax credit for clean technology investment includes geothermal energy systems
Budget 2023 also announced new details regarding the CTI Tax Credit, which was proposed in the 2022 Fall Economic Statement. The CTI Tax Credit is a 30% refundable credit available to businesses investing in eligible property that is acquired and that becomes available for use on or after Budget Day, where it has not been used for any purpose before its acquisition.
Budget 2023 proposes to expand eligibility of the CTI Tax Credit to include geothermal energy systems that are eligible for Class 43.1. Eligible property includes equipment used primarily for the purpose of generating electrical energy or heat energy, or both electrical and heat energy, solely from geothermal energy, that is described in subparagraph (d)(vii) of Class 43.1 (which generally includes piping, pumps, heat exchangers, steam separators, and electrical generating equipment). Unfortunately, equipment used for geothermal energy projects that will co-produce oil, gas or other fossil fuels would not be eligible for the CTI Tax Credit.
The phase-out of the CTI Tax Credit announced in Budget 2023 differs from the previous phase-out in the 2022 Fall Economic Statement. Rather than starting the phase-out in 2032, as previously announced, the CTI Tax Credit rate would remain at 30% for eligible property that becomes available for use in 2032 and 2033 and would be reduced to 15% in 2034. The CTI Tax Credit would be unavailable after 2034.
Tax credit for carbon capture, utilization and storage
Budget 2023 proposed an expansion and additional design details of the CCUS Tax Credit that was originally proposed in Budget 2022 to be available to businesses that incur eligible expenses starting on January 1, 2022.
Budget 2023 proposes that dual use equipment that produces heat and/or power or uses water, that is used for carbon capture, utilization, and storage as well as another process (i.e., has a dual purpose), be eligible for the CCUS Tax Credit (as capture equipment), provided that such equipment satisfies all other conditions for the CCUS Tax Credit. The cost of such dual purpose equipment would be eligible for the CCUS Tax Credit on a pro-rated basis in proportion to the expected energy balance or material balance supporting the carbon capture, utilization, and storage process over the first 20 years of the project. Dual use power or heat production equipment would be eligible for the CCUS Tax Credit only if the energy balance is expected to be primarily used (i.e., more than 50%) to support the CCUS process or hydrogen production that is eligible for the proposed CH Tax Credit. Note that for equipment producing both heat and power, only one of the heat or power energy balance would need to meet this requirement. Carbon dioxide emissions from power and/or heat production equipment would need to be captured and stored or used for the equipment to be eligible.
Following the Minister of Environment and Climate Change Canada’s recommendation, Budget 2023 proposed that British Columbia be added to the list of eligible jurisdictions for dedicated geological storage, applicable to expenses incurred on or after January 1, 2022.
Budget 2023 also proposed certain requirements for storage in concrete to be considered an eligible use, including confirmation by way of a third-party validation statement before any CCUS Tax Credit relating to carbon dioxide storage in concrete could be claimed.
There were also details released in Budget 2023 regarding how CCUS Tax Credits related to eligible refurbishment costs incurred once the project is operating would be calculated and certain limits on such CCUS Tax Credits (e.g., CCUS Tax Credits would not be available in respect of costs incurred after the first 20 years of the project and would be limited to a maximum of 10% of the total pre-operational costs that were eligible for the CCUS Tax Credit).
The measures surrounding the CCUS Tax Credit would apply to eligible expenses incurred after 2021 and before 2041. Budget 2023 indicated that further details with respect to the CCUS Tax Credit will be included in legislative proposals to be released in the coming months.
Tax credit for clean electricity
Budget 2023 proposed a new CE Tax Credit, which would be a 15% refundable tax credit for eligible investments (which would include both new projects and the refurbishment of existing facilities) in:
- non-emitting electricity generation systems: wind, concentrated solar, solar photovoltaic, hydro (including large-scale), wave, tidal, nuclear (including large-scale and small modular reactors);
- abated natural gas-fired electricity generation (which would be subject to an emissions intensity threshold compatible with a net-zero grid by 2035);
- stationary electricity storage systems that do not use fossil fuels in operation, such as batteries, pumped hydroelectric storage, and compressed air storage; and
- equipment for the transmission of electricity between provinces and territories.
Importantly, the CE Tax Credit would be available for taxable and non-taxable entities such as Crown corporations and publicly owned utilities, corporations owned by Indigenous communities, and pension funds. Another key feature of the proposed CE Tax Credit is that, unlike the majority of the other proposed tax credits, the CE Tax Credit is proposed to be available in respect of the refurbishment of existing facilities.
The CE Tax Credit is proposed to be available as of the day of the 2024 federal budget for projects that did not begin construction before the day of Budget 2023 and is slated to be phased out by 2035.
Tax credit for clean technology manufacturing and critical mineral extraction and processing
Budget 2023 proposes the CTM Tax Credit, which is a refundable tax credit that applies in respect of clean technology manufacturing and processing, as well as critical mineral extraction and processing. The CTM Tax Credit rate is proposed to be equal to 30% of the capital cost of eligible property associated with eligible activities.
Eligible property will generally include machinery and equipment, including certain industrial vehicles, used in manufacturing, processing, or critical mineral extraction, as well as related control systems. Businesses that are interested in acquiring eligible property in order to receive the tax credit should note that there are proposed tax integrity rules dealing with situations where eligible property is subject to a change in use or sold within a certain period of time. These rules propose to recover a portion of the CTM Tax Credit in such cases.
Eligible activities for the purpose of the CTM Tax Credit would include:
- manufacturing of certain renewable energy equipment (e.g., solar, wind, water, or geothermal);
- manufacturing of nuclear energy equipment;
- processing or recycling of nuclear fuels and heavy water;
- manufacturing of nuclear fuel rods;
- manufacturing of electrical energy storage equipment used to provide grid-scale storage or other ancillary services;
- manufacturing of equipment for certain heat pump systems;
- manufacturing of zero-emission vehicles, including conversions of on-road vehicles;
- manufacturing of batteries, fuel cells, recharging systems, and hydrogen refueling stations for zero-emission vehicles;
- manufacturing of equipment used to produce hydrogen from electrolysis; and
- manufacturing or processing of upstream components, sub-assemblies, and materials provided that the output would be purpose-built or designed exclusively to be integral to other eligible clean technology manufacturing and processing activities, such as anode and cathode materials used for electric vehicle batteries.
In addition, eligible activities would also include the extraction and certain processing activities related to six critical minerals that are essential for clean technology supply chains: lithium, cobalt, nickel, graphite, copper, and rare earth elements. This would include activities both before and after the prime metal stage or its equivalent (generally, the point where the production processes have produced a marketable, saleable commodity which meets the specifications of its consumers).
Application and phase-out
Property acquired and available for use
January 1, 2024 until December 31, 2031
January 1, 2032 to December 31, 2032
January 1, 2033 to December 31, 2033
January 1, 2034 to December 31, 2034
The CTM Tax Credit would be phased-out after 2034. Notably, Budget 2023 did not outline whether or not the CTM Tax Credit would be refundable to entities that are tax-exempt.
Labour requirements related to certain investment tax credits
The 2022 Fall Economic Statement announced the intention to attach prevailing wage and apprenticeship requirements (Labour Requirements) to the CTI Tax Credit and the CH Tax Credit. Budget 2023 confirms that the Labour Requirements would also apply to the CE Tax Credit and the CCUS Tax Credit.
The prevailing wage requirement is designed to ensure that covered workers are compensated at a level that meets or exceeds the relevant wage, plus the substantially similar monetary value of benefits (i.e., health and welfare and vacation benefits) and pension contributions (converted into an hourly wage format), as specified in an “eligible collective agreement”. Generally, outside Québec an eligible collective agreement would be a comparable collective agreement for the relevant industry and type of work performed aligning with workers’ duties and location. In Québec, eligible collective agreements would be those negotiated in accordance with relevant provincial law.
To meet the apprenticeship requirement, a business would need to ensure that for a given taxation year, not less than 10% of the total labour hours performed by covered workers engaged in subsidized project elements be performed by registered apprentices. Covered workers are those whose duties correspond to those performed by a journeyperson in a Red Seal trade.
Reduced tax credits are proposed to be available if the Labour Requirements are not met:
Rate if Labour Requirements met
Rate if Labour Requirements not met
CTI Tax Credit
CH Tax Credit
15%/25%/40% (depending on carbon intensity)
5/15/30% (depending on carbon intensity)
CE Tax Credit
CCUS Tax Credit
Varying rates, depending on type of CCUS equipment
Reduction details to be announced at a later date
During the phase-out periods of the CTI Tax Credit and CH Tax Credits, the tax credit rate available would be reduced by 10% (to a minimum of zero), if the Labour Requirements are not met.
The Labour Requirements will apply to work performed on or after October 1, 2023 and will apply only with respect to workers whose duties are primarily of a physical or manual nature (e.g., labourers and tradespeople) and not to workers whose duties are primarily administrative, clerical, supervisory, or executive. Certain exemptions from the Labour Requirements apply in respect of the CTI Tax Credit. Businesses can choose to pay corrective remuneration to workers (including interest) and certain penalties in order to resolve non-compliance and be deemed to have satisfied the requirements.
Zero-emission technology manufacturers
Following up on the temporary measures introduced in the 2021 federal budget (Budget 2021), which reduced corporate income tax rates for qualifying zero-emission technology manufacturers by 50%, Budget 2023 proposes to apply reduced tax rates on eligible zero-emission technology manufacturing and processing income of 7.5% (where that income would otherwise be taxed at the 15% general corporate tax rate) and 4.5% (where that income would otherwise be taxed at the 9% small business tax rate). In addition, Budget 2023 proposes that income from certain nuclear manufacturing and processing activities would qualify for the reduced tax rates for zero-emission technology manufacturers for taxation years beginning after 2023.
The reduced tax rates applying to eligible zero-emission technology manufacturing and processing income have effectively been extended by two years and will begin to be phased out in 2032 with a full phase-out occurring in 2035.
Flow-through share treatment (and expansion of the critical mineral exploration tax credit) for lithium from brine
Budget 2023 proposes to include lithium from brines as a mineral resource for the purposes of the flow-through share rules in the Tax Act, which would allow:
- relevant principal-business corporations that undertake certain exploration and development activities to issue flow-through shares and renounce expenses to their investors; and
- individuals (other than trusts) who invest in flow-through shares to claim the Critical Mineral Exploration Tax Credit (a 30% non-refundable tax credit) in respect of specified critical mineral exploration expenses incurred by the corporation and transferred to the individual under a flow-through share agreement.
These measures should result in a meaningful premium in offering proceeds for those corporations that qualify and choose to raise equity through flow-through shares, providing support for the development of activities of this type.