Mar 22, 2011
"As promised in the Speech from the Throne last year, we will keep taxes low, while taking action to close unfair tax loopholes that allow a few businesses and individuals to take advantage of Canadians who pay their fair share."
The Honourable Jim Flaherty
The Honourable Jim Flaherty, Minister of Finance, tabled the sixth federal budget of the Conservative minority government today. In his Budget Speech, the Minister emphasized the need to protect the integrity and fairness of the Canadian tax system by closing "unfair tax loopholes." He also reaffirmed the government's plans to secure Canada's economic recovery from the global recession, create jobs, keep taxes low and preserve Canada's fiscal advantage. The projected deficit in 2010–11 is $40.5 billion, $29.6 billion in 2011–12 and is projected to continue declining to $0.3 billion in 2014–15. The government expects that there will be a surplus of $4.2 billion in 2015–16.
The 2011 Budget does not contain any new corporate income tax rate changes. Previously announced corporate income tax rate reductions are to continue as scheduled, which would result in the general federal income tax rate being 15% in 2012.
The 2011 Budget contains tax proposals to:
- eliminate the year-end deferral available to corporate partners;
- expand the stop-loss rules applicable to share redemptions;
- accelerate CCA for manufacturing and processing machinery and equipment;
- accelerate CCA for clean energy generation equipment; and
- limit the exemption from capital gains tax on donations of publicly listed flow-through shares.
In this Budget Briefing 2011, we summarize the 2011 Budget's tax proposals.
On March 16, 2011, the Department of Finance released income tax proposals concerning the withholding tax that applies to interest payments made to non-residents, the deductibility of contingent amounts, and the tax treatment of a life insurance corporation's reserves in respect of its segregated fund policies. These proposals are also summarized below.
BUSINESS INCOME TAX MEASURES
Elimination of corporate partnership deferral
Under the existing rules in the Income Tax Act (Canada) (ITA), a corporation that is a partner in a partnership must include in its income for its taxation year its share of the partnership's income for fiscal periods of the partnership that end in the corporation's taxation year. Where a fiscal period of the partnership does not end until after the taxation year-end of the corporation, the corporation can defer recognizing its share of partnership income for that partnership fiscal period, notwithstanding that a significant portion of the partnership income may have been earned or accrued as of the end of the corporation's taxation year. Where the corporation holds an interest in a tiered partnership structure, this deferral advantage can be multiplied.
The 2011 Budget proposes to eliminate this deferral advantage. The rules are generally similar to rules introduced in 1995 to eliminate the deferral advantage for individuals. The proposed rules are complex and are described herein only generally.
The rules would apply in a taxation year if a corporation is a member of a partnership at the end of the year and has a significant interest in the partnership, and the partnership has a fiscal period that differs from the corporate partner's taxation year. A corporation would be considered to have a significant interest in a partnership for a taxation year if the corporation, alone or together with affiliated and related persons, was entitled to more than 10% of the partnership's income (or assets in the case of a partnership wind-up) at the end of the last partnership fiscal period that ended in the taxation year.
In such case, the corporation would be required to include in its income, not only its share of partnership income for the partnership fiscal period that has ended in the corporation's taxation year, but also a portion of the partnership's income that can be considered to have accrued for the part of the current partnership fiscal period (the Stub Period) up to the corporation's taxation year end (the Stub Period Accrual), less an amount in respect of the Stub Period Accrual for the immediately preceding taxation year. Very generally, the Stub Period Accrual for a taxation year will be determined by a formula that takes into account the corporation's share of the actual partnership income for the partnership fiscal period or periods that have ended in the corporation's taxation year, and the number of days in the Stub Period relative to the number of days in the partnership's fiscal periods ending in the corporation's taxation year. Alternatively, the corporate partner may choose to designate a lesser amount as its Stub Period Accrual. If such designated amount is less than the lesser of the formula amount and the corporation's share of the actual partnership income for the Stub Period calculated on a pro-rated basis, the corporate partner will be required to include an additional amount in income in the immediately following taxation year (determined by reference to the prescribed interest rate for underpayments of tax for the relevant period), plus, where the shortfall exceeds a certain amount, a further penalty amount. Certain rules would allow a corporate partner, in computing the Stub Period Accrual, to deduct its share of a partnership's resource deductions for qualifying expenses incurred by the partnership in the Stub Period.
It is proposed that these new rules be effective for a corporation's taxation year that ends after March 22, 2011.
The 2011 Budget proposals also include measures to allow a one-time election by a single tier partnership to change its fiscal period to align with the taxation year of one or more corporate partners where certain conditions are met. In addition, special and more complex rules would be introduced to deal with tiered partnerships. Generally, it is proposed that all partnerships in such a tiered structure must adopt the same fiscal period. Partnerships that are not required under existing rules to have a December 31 fiscal period would be permitted a one-time election to choose a common fiscal period. The elected fiscal period must end before the first anniversary of March 22, 2011, and be not more than 12 months in duration. If no such election is filed, their common fiscal period would be deemed to end on December 31, 2011, and subsequent fiscal periods would end on December 31. The Stub Period Accrual described above would, with certain appropriate modifications, then apply to income earned by each corporate partner of a partnership that is in a tiered partnership structure if its taxation year does not align with the fiscal periods of the partnerships.
Finally, the rules propose certain transitional relief to mitigate the potential cash flow impact to a corporate partner of the termination of any deferral (including as a result of any one-time election). Specifically, in qualifying circumstances, a corporation will be able to recognize the incremental amount of income for the corporation's first taxation year that ends after March 22, 2011, gradually over the five taxation years that follow the first taxation year.
Expanded stop-loss rules for share redemptions
The ITA contains rules that apply in certain circumstances to reduce the amount of a loss that would otherwise be realized by a corporation on the disposition of a share by the amount of any tax-free dividends received or deemed to be received by the corporation on the share on or before the disposition. These "stop-loss" rules generally do not apply to a dividend received or deemed to be received on a share if the corporation held the share for at least 365 days immediately prior to disposing of it and when the dividend was received or deemed to be received, the corporation, together with non-arm's length persons, held no more than 5% of the issued shares of any class of the capital stock of the corporation from which the dividend was received or deemed to be received. The 2011 Budget would extend the stop-loss rules to apply to deemed dividends arising on the redemption of shares (whether the shares are held directly or indirectly through a partnership or trust), even where the corporate shareholder meets the 5% and 365-day tests. Deemed dividends received or deemed to be received on shares of a private corporation held by another private corporation whether directly or indirectly through a partnership or trust are excluded from the ambit of the proposals, provided that the corporation that receives the dividend or is deemed to receive the dividend is not a financial institution and does not hold the share through a partnership or trust that is a financial institution. This proposal would apply to redemptions that occur on or after March 22, 2011.
Accelerated CCA for manufacturing and processing
Machinery and equipment acquired by a taxpayer, after March 18, 2007 and before 2012, primarily for use in Canada for the manufacturing or processing of goods for sale or lease is eligible for a temporary accelerated capital cost allowance (CCA) rate of 50% on a straight line basis (subject to the application of the so-called "half‐year rule"). The 2011 Budget proposes to extend this temporary measure for a further two years to apply to eligible machinery and equipment acquired before 2014.
Accelerated CCA for clean energy generation equipment
Class 43.2 of Schedule II to the Income Tax Regulations currently provides for accelerated CCA (50% per year on a declining balance basis) for specified clean energy generation and conservation equipment. The 2011 Budget proposes to expand Class 43.2 to include certain equipment used by a taxpayer, or by a lessee of a taxpayer, to generate electricity in a process in which all or substantially all of the energy input is from waste heat, subject to several specific exceptions. Systems will not be eligible if they use chlorofluorocarbons (CFCs) or hydrochlorofluorocarbons (HCFCs). This new measure would apply to eligible equipment acquired on or after March 22, 2011 that has not been used or acquired for use before that date.
Qualifying environmental trusts
The 2011 Budget proposes several changes to the Qualifying Environmental Trust (QET) rules, including: extending the eligibility for QET treatment to trusts that are required to be established to fund reclamation costs associated with pipeline abandonment; expanding the range of eligible investments that QETs may hold; and setting the tax rate payable by a QET to the corporate tax rate. These changes would apply to 2012 and subsequent taxation years.
Intangible capital expenditures in oil sands properties
The 2011 Budget proposes two new measures intended to align the deduction rates for intangible costs in respect of oil sands properties with those of conventional oil and gas properties. First, the deduction rate for the cost of acquiring oil sands leases and other oil sands resource property would be reduced from 30% to 10% per year, in each case on a declining balance basis. This change would apply to acquisitions after March 21, 2011. Secondly, the deduction rate for pre-production development costs would be reduced from 100% to 30% per year, on a declining balance basis. This change would be effective as of 2015 for expenses incurred in respect of new mines on which major construction began before March 22, 2011. For other costs, the transition would be phased in on a gradual basis, becoming fully phased in by 2016.
PERSONAL INCOME TAX MEASURES
Tax on split income – capital gains
The 2011 Budget proposes to extend the current "tax on split income," also referred as the "kiddie tax," to capital gains. Very generally, the kiddie tax limits income-splitting techniques by imposing the highest marginal income tax rates on "split income," which may include taxable dividends received directly or indirectly on unlisted shares of Canadian or foreign corporations (other than mutual fund corporations) and income from certain partnerships and trusts.
The 2011 Budget proposes that the "tax on split income" would also be applicable to capital gains realized by, or included in the income of, minor children on the disposition of shares, directly or indirectly, to a non-arm's length person if the minor children would be subject to tax on split income in respect of any taxable dividends on those shares.
Capital gains that are subject to this proposal would be treated as taxable dividends (other than eligible dividends) and therefore would not benefit from the lifetime capital gains exemption, nor to the 50% capital gain inclusion rate. This proposal would be applicable to capital gains realized on or after March 22, 2011.
Employee profit sharing plans
Employee Profit Sharing Plans (EPSPs) enable business owners to align the interests of their employees with those of the business by sharing business profits with employees. According to the 2011 Budget, EPSPs have been used to direct profits to family members with a view to reducing and deferring income taxes, and avoiding contributions to Canada Pension Plan and the payment of Employment Insurance premiums.
The 2011 Budget announces that the government will review the existing rules for EPSPs to determine whether technical improvements are required in this area and will undertake consultations to seek the views of stakeholders before proceeding with any proposals in order to accommodate appropriate use of EPSPs.
IPPs – Minimum withdrawals and contributions for past service
The 2011 Budget proposes two new tax measures that would affect individual pension plans (IPPs). The first measure provides that annual minimum amounts would be required to be withdrawn, similar to current minimum withdrawal requirements from a RRIF, once a plan member reaches the age of 72. This requirement would apply to 2012 and subsequent taxation years.
The second measure provides that contributions made to an IPP that relate to past years of employment would be required to be funded first out of a plan member's existing RRSP assets or by reducing the individual's accumulated RRSP contribution room before new deductible contributions in relation to past service may be made. This measure would generally apply to IPP past service contributions made after March 22, 2011.
Mineral exploration tax credit
Individuals (other than trusts) who invest in flow-through shares may be entitled to additional tax benefits in addition to the renounced exploration expenses available on all flow-through shares. Where certain qualifying expenditures (essentially expenses incurred in mining exploration above or at ground level) are incurred and renounced to a holder of flow-through shares who is an individual (other than a trust), that holder is entitled to an investment tax credit equal to 15% of the renounced qualifying expenditures. This tax credit on "grass-roots" surface exploration expenditures is called the "mineral exploration tax credit."
The ITA currently requires that qualifying expenditures must be incurred by the corporation by the end of 2011 and renounced to the investor under an agreement made before April 2011. The 2011 Budget proposes to extend the 15% mineral exploration tax credit for another year, by extending; (1) the date for incurring qualifying expenditures to the end of 2012; and (2) the deadline for the corporation and the investor to enter into the flow-through share subscription agreement governing renunciation to March 31, 2012.
RESPs – Added flexibility to share assets among siblings
The 2011 Budget proposes to allow certain asset transfers between individual registered education savings plans (RESPs) for siblings after 2010 without triggering tax penalties or repayments of Canada Education Savings Grants. This proposal is designed to provide the same flexibility that is currently available for RESP family plans. This proposal would apply to asset transfers that occur after 2010.
RDSPs – Election for beneficiaries with shortened life expectancy
The 2011 Budget proposes to allow registered disability savings plan (RDSP) beneficiaries who have shortened life expectancies to withdraw more of their RDSP savings by permitting a certain amount of annual withdrawals without triggering disadvantages, such as the need to repay certain government grants and bonds (the 10-year repayment rule). To take advantage of this measure, the plan holder would be required to make an election and submit a medical certification. Subject to a transitional rule, this proposal would apply after 2010 to withdrawals made after Royal Assent to the enacting legislation.
RRSPs – Enhancement of anti-avoidance rules
In order to address concerns regarding the use of registered retirement savings plans (RRSPs) in tax planning schemes, the 2011 Budget proposes to enhance the existing RRSP anti-avoidance rules by introducing rules similar to the anti-avoidance rules that currently apply to tax-free savings accounts (TFSAs).
First, the 2011 Budget proposes to expand the existing RRSP "advantage" rules by adopting the "advantage" concept under the TFSA rules. Similarly to TFSA advantages, the amount of tax payable in respect of any RRSP advantage will generally be the fair market value of the advantage. Second, the 2011 Budget proposes to introduce a "prohibited investment" concept for RRSPs, based on the TFSA prohibited investment rules. As a result of this proposal, a special tax equal to 50% of the fair market value of the investment will apply to an RRSP annuitant on the acquisition of a prohibited investment by his or her RRSP, or at the time that an investment becomes prohibited, as the case may be. Finally, the 2011 Budget proposes to modify certain tax rules that apply when an RRSP acquires a "non‐qualified investment." Under this proposal, an RRSP annuitant would generally be subject to a special tax of 50% of the fair market value of a non-qualified investment acquired (or held) by his or her plan.
The proposed new rules are also intended to apply to registered retirement income funds (RRIFs). Generally, these new rules are proposed to apply to transactions occurring, and investments acquired, after March 22, 2011, subject to certain transitional rules.
Personal tax credits
The 2011 Budget proposes a series of measures introducing or enhancing personal tax credits. Except as noted, these measures apply for (or for eligible expenditures incurred as of) the 2011 and subsequent taxation years.
Children's arts tax credit
There is proposed a new 15% non-refundable tax credit in respect up to $500 of eligible expenses for enrolling a child under 16 in an eligible program of artistic, cultural, recreational or developmental activities. An additional credit is proposed for children under 18 who qualify for the existing disability tax credit. The proposed credit, which can be claimed by either parent or shared between them, would be similar in design to the existing children's fitness tax credit.
Volunteer firefighters tax credit
There is proposed a new 15% non-refundable tax credit on an amount of $3,000 to individuals who perform at least 200 hours of qualifying volunteer firefighting services to one or more fire departments in a taxation year. Volunteer service hours performed for a particular fire department would be ineligible in determining whether the 200 hours requirement has been met if the firefighter also provides non-volunteer firefighting services to that department. An individual who claims the credit would be ineligible for the existing tax exemption up to the $1,000 honoraria paid by certain public bodies in respect of firefighting duties.
Family caregiver tax credit
There is proposed a new 15% non-refundable tax credit on an amount of up to $2,000 for caregivers of dependants with a mental or physical infirmity, including spouses, common-law partners and minor children. It would apply beginning in 2012. The credit would be claimed as an enhanced amount for an infirm dependent under one of the existing dependency-related credits. The 2011 Budget also proposes to increase for 2012 the threshold at which the infirm dependant credit begins to be phased out, so that the enhanced amount is fully phased out at the same income level as the 2012 enhanced spousal or common-law partner credit. A dependant under 18 would be considered to be infirm for purposes of the enhanced credit only if he or she is likely to be, for a long and contiguous period of indefinite duration, dependent on others for his or her personal needs and care when compared generally to persons of the same age.
Medical and disability expense tax credit for other dependants
Under the existing provisions of the ITA, a taxpayer may claim a tax credit in respect of eligible medical and disability expenses incurred in respect of him or herself, his or her spouse or common-law partner, or his or her child under 18. In certain cases, a caregiver may also claim the medical expense tax credit in respect of eligible expenses of a dependent relative other than a spouse, common-law partner or child under 18, but in such cases the amount upon which the credit is based is limited to a maximum of $10,000 in eligible expenditures. The 2011 Budget proposes to remove this $10,000 limit.
Eligibility for child tax credit
The child tax credit is a non-refundable 15% credit based on an indexed amount that can be claimed by one parent for each child under 18. Under the existing provisions of the ITA, only one individual can claim the credit in respect of the same domestic establishment, such that when multiple families share a home, only one person in one family can claim the credit in respect of his or her own children. The 2011 Budget proposes to repeal the rule that limits the number of child tax credit claimants to one per domestic establishment.
Tuition tax credit – examination fees
The 2011 Budget proposes to extend the existing tuition tax credit to certain fees and charges paid in respect of an examination required to obtain a professional status recognized by federal or provincial statute, or to be licensed or certified to practise a profession or trade in Canada, provided such fees and charges exceed $100. The measure would not be applicable to any fee or charge that is not required to be paid by all individuals taking the occupational, trade or professional examination, to the extent that all such fees and charges for the individual for the year exceed $250. The credit would not apply to fees in respect of examinations taken in order to begin study in a profession or field.
Education tax measures – study abroad
Under the existing provisions of the ITA, tuition tax credits, education tax credits, textbook tax credits, and educational assistance payments from registered education savings plans are available to Canadian students in full-time attendance at universities outside of Canada in certain courses to the extent that the tuition fees are paid in respect of courses of at least 13 consecutive weeks. The 2011 Budget proposes to reduce the minimum course-duration requirement that a Canadian student enrolled in a foreign university must meet in order to be eligible for these tax measures, from 13 consecutive weeks to three consecutive weeks.
CHARITABLE SECTOR TAX MEASURES
Enhancement of the charitable donation regime
The 2011 Budget introduces a number of new measures to the ITA intended to protect the integrity of the charitable donation regime.
Expanded regulation of qualified donees
The 2011 Budget proposes to extend regulatory requirements that currently apply only to registered charities to certain other "qualified donees" that are eligible to issue an official donation receipt. Among other things, it is proposed that all qualified donees be required to be named in a publicly available list maintained by the CRA, and to maintain books and records in the same manner as a registered charity. In addition, all qualified donees would become subject to the requirements that apply to registered charities for the issue of official receipts for gifts. Failure to abide by these regulatory requirements can result in the suspension of receipting privileges or revocation of qualified donee status.
The 2011 Budget also proposes to provide the Minister of National Revenue with discretion to refuse or revoke the registration of a registered charity or Canadian athletic organization or to suspend its authority to issue donation receipts for certain criminal offences or previous misconduct of the charity or organization's directors, officers or certain controlling individuals. The 2011 Budget further proposes certain amendments to extend to registered Canadian Athletic Associations other key regulatory requirements that apply to registered charities.
These proposals would apply on or after the later of January 1, 2012 and Royal Assent to the enacting legislation.
Where an official donation receipt has been issued to a taxpayer in respect of donated property, and property has subsequently been returned to the taxpayer by the donee, the 2011 Budget proposes to generally require that a revised donation receipt be issued to the taxpayer by the donee and be sent to the CRA. The 2011 Budget also proposes to provide the Minister with the authority to reassess the taxpayer in any such circumstances to disallow the taxpayer's claim for a credit or deduction. This proposal would apply in respect of gifts or property returned to the donor on or after March 22, 2011.
Gifts of Non-Qualifying Securities
The ITA provides special rules in respect of the donation of non-qualified securities, which generally include shares, debt or other securities of the taxpayer or of a person not dealing at arm's length with the taxpayer. Among other things, these rules provide that a donor's tax recognition in respect of the donation of non-qualifying securities is deferred until such time within five years of the donation that the qualified donee has disposed of the non-qualifying security, and then generally only to the extent the donee then receives consideration other than a non-qualifying security of the donor. The 2011 Budget proposes to amend this rule to exclude any consideration that is a non-qualifying security of any person. This measure would apply in respect of securities disposed of by donees on or after March 22, 2011.
Granting of Options to Qualified Donees
The 2011 Budget proposes to clarify that the charitable donation tax credit or deduction is not available to a taxpayer in respect of granting an option to acquire property of the taxpayer to a qualified donee until the time that the donee acquires the property that is the subject of the option. The credit or deduction will only be available to the taxpayer at the time the donee acquires the property, and the amount of the credit or deduction will be based on the amount by which the fair market value of the property at the time of acquisition exceeds the total amounts, if any, paid by the donee for the option and the property. The donation tax credit or deduction would generally not be available to the taxpayer if the total amount paid for the property and the option exceeds 80% of the fair market value of the property at the time the property is acquired by the donee. This measure would apply in respect of options granted on or after March 22, 2011.
Charitable Donations of Flow-Through Shares
Flow-through shares are a financing tool available exclusively to corporations in the natural resources sector. Essentially, they allow corporations in this sector that incur qualifying exploration and development expenditures to issue shares (flow-through shares) to investors at a premium, such that a person subscribing for the flow-through shares is entitled to deduct for tax purposes certain expenditures made by the issuing corporation (in effect the corporation's qualifying expenditures "flow through" to the investors). Flow-through shares are described in greater detail here.
In simplified terms, where an investor pays $100 to purchase a flow-through share, that investor will be entitled to claim deductions from income of $100 (either immediately or over a period of years). The holder's cost of the flow-through share for tax purposes is deemed to be zero to reflect this tax benefit, meaning that the holder immediately has a built-in accrued capital gain of $100. As such, when the share is sold, the entire sale proceeds will be treated as a capital gain whether or not the share has experienced any appreciation in value.
In order to encourage donations, an investor may be exempted from tax on accrued capital gains on publicly-traded securities that are donated to a charity. This has led to some planning strategies in which flow-through shares have been issued to investors who thereafter donated them to charity in order to eliminate the built-in capital gain inherent in their shares ($100 in the example above) and receive the benefit of a charitable donation tax credit for the value of the donated shares. The interaction of the flow-through share deductions (including potentially the mineral exploration tax credit described above), the charitable donation tax credit and the elimination of the built-in capital gain on shares donated to charity could result in charitable donations of flow-through shares involving very little after-tax cost to the investor.
The 2011 Budget proposes to effectively restrict the charitable donation capital gains exemption for flow-through shares (or rights to such shares) donated to a charity to the amount of the gain in excess of the subscription price originally paid for the donated flow-through shares. Reverting back to the earlier example, there would be no exemption of the first $100 of capital gain: only to the extent that the value of the donated shares exceeded $100 (the price originally paid) would the capital gain be exempted. This proposal applies to flow-through shares acquired pursuant to a binding flow-through share subscription agreement made on or after March 22, 2011.
More particularly, when an investor acquires a particular class of flow-through shares pursuant to an agreement made on or after March 22, 2011, the subscription price paid for those shares would be added to the "exemption threshold" of that class of flow-through shares. When the taxpayer disposes of shares of that class in a charitable donation, the charitable donation capital gains exemption would effectively be available only to the extent that the capital gain exceeds the taxpayer's "exemption threshold" at that time. The "exemption threshold" in respect of that class would be the amount by which (1) the sum of the taxpayer's original cost of all flow-through shares of that class acquired pursuant to an agreement made on or after March 22, 2011 exceeds (2) capital gains (up to the exemption threshold at that time) on previous dispositions of shares of that particular class on or after March 22, 2011. These rules are supported by anti-avoidance rules applicable to donations of property acquired by the donor in a tax-deferred transaction.
SALES AND EXCISE TAX MEASURES
The 2011 Budget does not announce any new sales or excise tax measures. Among the previously announced sales tax measures that the government confirms it will proceed with are proposals announced on January 28, 2011 to refine a recently-implemented GST/HST regime for taxing investment plans (e.g., mutual funds, pooled funds, segregated funds of insurers and pension plans).
CUSTOM TARIFF MEASURES
In an effort to facilitate trade and reduce administrative burden for businesses, the 2011 Budget proposes the initiation of a process for the simplification of the Customs Tariff. The legislative and regulatory measures, once implemented, would result in the reduction of the number of tariff items, including the elimination of many end-use provisions; make more transparent the tariff treatments applicable to imports from various countries; and eliminate obsolete tariff provisions that can no longer be used under the terms of Canada's free trade agreements.
In addition, the 2011 Budget proposes that the importation process for non-commercial imports valued at less than $500 arriving by either post or courier would be simplified, by the levying of either 0%, 8% or 20% duty, depending on the description of the goods.
PREVIOUSLY ANNOUNCED MEASURES
The 2011 Budget confirms the government's intention to proceed with a number of previously announced tax measures, as modified to take into account consultations and deliberations since their release, including the following:
The government intends to proceed with "outstanding draft legislative proposals relating to foreign affiliates", as modified to take into account consultations and deliberations since their release. Unfortunately, this offers very little guidance regarding what changes may be made to these proposals – many of which have been outstanding for many years and will apply retroactively back to 2004 or earlier.
Sales tax measures
On January 28, 2011, the government proposed changes to certain GST/HST rules relating to investment plans (e.g., mutual funds, pooled funds, segregated funds of insurers and pension plans) and on October 28, 2010, the government proposed GST/HST relief for Royal Canadian Legion purchases of Remembrance Day poppies and wreaths. The 2011 Budget confirms the government's intention to proceed with both of these sales tax measures.
Implementing various 2010 Budget initiatives
The government intends to proceed with draft legislative proposals released on August 27, 2010 to implement a number of tax measures from the 2010 Budget and other previously announced tax initiatives.
Technical amendments previously proposed
Legislative proposals introduced (but not passed) in the 39th Parliament concerning restrictive covenants, Section 143.3 of the ITA, the general corporate income tax rate, investment income earned by cooperatives and credit unions and draft amendments to the Income Tax Regulations were re-announced by the government on July 16, 2010. The 2011 Budget confirms the government's intention to proceed with these proposals.
Other proposed technical amendments
On November 5, 2010, the government proposed additional technical amendments to the ITA dealing with partnerships, pensions, labour sponsored venture capital corporations and the lifetime capital gains exemption. The 2011 Budget confirms the government's intention to proceed with these proposals.
Real estate investment trusts
The 2011 Budget indicates that the government intends to proceed with changes proposed on December 16, 2010 concerning the rules for qualification as a REIT (and associated tax treatment).
MARCH 16, 2011 INCOME TAX PROPOSALS
On Wednesday, March 16, the Department of Finance (Canada) released draft legislation proposing specific amendments to the ITA in response to recent decisions of the Federal Court of Appeal. These proposals are summarized below. The Department of Finance has invited comments on these proposals by April 15, 2011.
Withholding tax on interest
Paragraph 212(1)(b) of the ITA imposes withholding tax on certain amounts of interest paid to a non-resident person by a person resident in Canada. Interest paid to a non-resident person dealing at arm's length with the Canadian resident payer is generally not subject to withholding tax. Paragraph 212(1)(b) of the ITA is proposed to be amended to impose withholding tax on interest paid to a non-resident (even if dealing at arm's length with the Canadian payer) where such interest is paid in respect of a debt or other obligation to pay an amount to a person with whom the payer is not dealing at arm's length. This amendment would impose withholding tax in the circumstances considered in Lehigh Cement Limited v. The Queen, 2010 FCA 124, where the entitlement to interest on debt owing by a Canadian to a related non-arm's length creditor was sold to an arm's length Belgian bank. (See Osler Update of May 19, 2010.) The Crown accepted that such interest qualified for exemption from withholding tax under the technical rule in former subparagraph 212(1)(b)(vii) of the ITA, but sought to impose withholding tax under the general anti-avoidance rule (GAAR). The Federal Court of Appeal found GAAR not to apply and the Supreme Court of Canada declined leave to appeal. The proposed amendment would apply to interest paid on or after March 16, 2011, other than interest in respect of a debt or obligation incurred before that date to a recipient of interest that acquired the entitlement to the interest as a consequence of an agreement or other arrangement entered into by the recipient and evidenced in writing before March 16, 2011.
Proposed Section 143.4 of the ITA would deny or defer recognition of an expenditure (whether an expense, expenditure or outlay made or incurred by the taxpayer, or a cost or capital cost of property acquired) to the extent that the taxpayer or a non-arm's length person has a right to reduce or eliminate an amount in respect of the expenditure (less any amount paid by the taxpayer to obtain such right), including a contingent right where it is reasonable to conclude that the right will become exercisable. Such contingent amounts would be recognized in subsequent periods if, when and to the extent paid. The proposal is to apply for taxation years ending on or after March 16, 2011. The proposed change is thus retroactive in effect, applying to expenditures incurred in the current taxation year, but prior to the announcement date, and does not grandfather existing arrangements.
This proposed amendment is a response to the decision in Collins v. The Queen, 2010 FCA 12, where the Federal Court of Appeal held, on rather unusual facts, that the deduction of interest expense payable, but not paid in the year, was not reduced by virtue of the right of the taxpayer to retire in the future its obligation to pay principal and accumulated unpaid interest by payment to the creditor of a much lesser sum. The Supreme Court of Canada denied leave to appeal.
While the proposed amendment responds to a specific (and unusual) fact situation, the scope of this proposal and range of circumstances in which a right to reduce an expenditure may be found to arise are not entirely clear based upon the wording of the proposal. Taxpayers should consider the potential application of this proposal having regard to their particular facts, in particular, any right the taxpayer may have to reduce any amount in respect of any expense, expenditure or outlay.
Segregated fund policy reserves
Life insurers are entitled to deduct policy reserves in respect of life insurance policies issued by them. Policy reserves are determined as prescribed by Part XIV of the Income Tax Regulations. In the case of a life insurance policy under which some or all of the benefits are based upon the value of a segregated fund maintained by the life insurer, the segregated fund is deemed to be a trust fund and any amounts allocated to, and benefits paid based upon the value of, the segregated fund are neither included in nor deducted from the life insurer's income for income tax purposes. Accordingly, paragraph 1406(b) of the Income Tax Regulations provides that a life insurer's deductible policy reserves in respect of such policies are to be determined without reference to any liability in respect of the segregated fund (other than a liability for guarantees given under the life insurance policy).
The effect of that regulation was considered by the Federal Court of Appeal in The Queen v. National Life Assurance Company of Canada, 2008 FCA 14. The Federal Court of Appeal decided that certain negative amounts (which amortize acquisition expenses through the policy reserves) were excluded by the regulation from the determination of the deductible policy reserves (thereby increasing the deductible amounts) because, in effect, those negative amounts were in respect of the life insurer's liability to pay benefits based upon the value of the segregated fund.
The proposed amendment to paragraph 1406(b) of the Income Tax Regulations responds to the decision in National Life. The amended regulation will be narrower and provide that only the liability to pay to the policyholder an amount out of a segregated fund is to be excluded from the determination of deductible policy reserves, thereby including any negative amounts in respect of that liability and any liability for guarantees in the determination of the life insurer's deductible policy reserves. The inclusion of the negative amounts in the determination of the deductible policy reserves will have the effect of reducing the deductible policy reserves.
The proposed amendment will apply to the 2012 and subsequent taxation years with the reduced deductions being recognized over a five year transition period.
To access the 2011 Budget and related documents
To access the March 16, 2011 Department of Finance draft income tax proposals
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