2018 Federal Budget
On February 27, 2018, Finance Minister Bill Morneau delivered the 2018 Federal Budget. In this Tax Update, we provide an analysis of the tax measures introduced.
Following the proposed measures for private corporations released on July 18, 2017, a series of modifying announcements during the week of October 16, 2017, and revised draft legislation released on December 13, 2017, this Budget was highly anticipated for its further impact on private corporations.
As promised by Finance on December 13, 2017, the 2018 Federal Budget introduces draft legislation addressing the Government’s concern that small business corporations earning passive investment income have a perceived tax advantage. Many had hoped that it would also provide much needed clarification on the revised tax on split income, but it did not. Fortunately, fears that new measures would be introduced affecting corporate distributions, in particular the capital dividend account, did not come to fruition.
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Business Income Tax Measures
Passive Investment Income Earned by Private Corporations
In its July 18, 2017 announcement, the Department of Finance gave notice of its intention to eliminate the perceived tax advantage of a corporation investing after-tax small business income. A discussion paper was released proposing potential methods. These methods were seen as cumbersome and resulting in highly punitive tax rates, and failed to recognize the many bona fide reasons for retaining and investing after-tax business income.
Following a consultation period, the Federal Government made announcements on October 18 and October 20, 2017, that confirmed its intention to move forward with passive investment income proposals. It also clarified that the proposals would apply on a go-forward basis, would apply only to annual investment income in excess of $50,000 and, finally, that they would ensure incentives are maintained for venture capital and angel investors. The announcements stated that draft legislation would be released as part of the 2018 Federal Budget.
In the end, the proposals released with the 2018 Federal Budget are less complex and more workable than the methods described in the initial discussion paper. The draft legislation addresses the perceived passive investment income tax advantage by introducing two measures that affect Canadian controlled private corporations: 1) a new limitation on access to the small business deduction, and 2) changes to the recovery of refundable dividend tax on hand.
Limitation of Small Business Deduction (SBD)
The first $500,000 of business income earned by an associated group of Canadian Controlled Private Corporations (CCPC) may be eligible for the SBD, which significantly reduces the corporate tax rate applicable to that income (currently 13.5% in Ontario).
Existing rules limit or “claw-back” the $500,000 small business limit for CCPCs whose associated group “taxable capital employed in Canada” exceeds $10,000,000, and eliminate the SBD if that amount exceeds $15,000,000.
The proposed provisions will reduce the associated group’s small business limit on a straight-line basis where the associated group earns “adjusted aggregate investment income” between $50,000 and $150,000. The reduction will be $5 for every $1 of investment income. Consequently, an associated group’s small business limit will be reduced to zero (5 × $100,000 = $500,000) in a particular year if its adjusted aggregate investment income is $150,000 or more.
The reduction of a corporation’s business limit for a particular year will be equal to the greater of the reduction under the existing taxable capital rule and the proposed rule.
Loosely, the “adjustments” in arriving at adjusted aggregate investment income include the addition of dividends from connected corporations, and the exclusion of taxable capital gains on the disposition of both business assets and shares of connected small business corporations.
This proposal will apply to taxation years that commence after 2018, with no grandfathering of passive income earned on existing investments. Anti-avoidance measures will discourage transactions designed to delay or avoid the new rules. Consequently, all future investment earnings will be included in this annual test, regardless of when the applicable investments were accumulated.
Changes to Refundable Dividend Tax on Hand (RDTOH)
Currently, a dividend refund is available to a private corporation at the rate of 38 1/3% of taxable dividends paid to the extent of available RDTOH. The taxable dividends paid can be either non-eligible dividends or eligible dividends; the latter is subject to a lower personal tax rate.
The Budget proposes to introduce measures that will generally allow a CCPC to recoup RDTOH only on the payment of non-eligible dividends. An exception will apply to RDTOH arising on the payment of (Part IV) tax on eligible portfolio dividends (generally, less than 10% ownership). This will be accomplished by creating an “eligible RDTOH” account and a “non-eligible RDTOH” account.
If a corporation pays a non-eligible dividend, it recoups non-eligible RDTOH before it recoups eligible RDTOH. If it pays an eligible dividend, it can recoup eligible RDTOH. Any taxable dividend paid, either eligible or non-eligible, will entitle the corporation to a refund of eligible RDTOH.
Transitional rules will determine allocation of existing RDTOH between the new non-eligible and eligible RDTOH accounts.
This measure will apply to taxation years that commence after 2018. An anti-avoidance measure will prevent the deferral of the new measures by creating a short taxation year.
Income Sprinkling Measures
The Budget confirmed that Finance will proceed with the implementation of the December 13, 2017, draft proposals that address income sprinkling involving private corporations. However, no additional draft legislation or clarifications were introduced.
Tax Support for Clean Energy
Capital cost allowance (CCA) Classes 43.1 and 43.2 provide accelerated CCA rates for investments in specified clean energy generation and conservation equipment. Class 43.2 was introduced in 2005 and is currently available in respect of property acquired before 2020. The Budget proposes to extend eligibility for Class 43.2 by five years to include property acquired before 2025.
Artificial Losses Using Equity-Based Financial Arrangements
For dividends paid, or dividend compensation payments on or after February 27, 2018, this Budget proposes an amendment which broadens the dividend rental arrangement rules and securities lending arrangement rules. Similar rules are proposed to clarify situations in which a dividend compensation payment can be deducted.
Stop-Loss Rule on Share Repurchase Transactions
The Budget proposes an amendment to the dividend stop-loss rule to decrease the tax loss on a repurchase, ocurring on or after February 27, 2018, of shares held by the taxpayer as mark-to-market property where it receives a tax deductible inter-corporate dividend on the repurchase. This amendment generally reduces the tax loss by the full amount of the deemed dividend.
At-Risk Rules for Tiered Partnerships
The Budget proposes to restrict the allocation of losses to members of a top-tier partnership in tiered partnership structures for taxation years that end on or after February 27, 2018, including losses incurred in tax years that ended prior to that date. The allocable losses of a second-tier partnership will be restricted by the at-risk amount of the top-tier partnership, and unused losses will not be eligible to be carried forward indefinitely. Such unused losses will be added to the adjusted cost base of the partnership interest of the second-tier partnership.
Health and Welfare Trusts (HWT)
The requirements and income tax consequences of HWTs are not set out in the Income Tax Act (ITA). Instead, the Canada Revenue Agency (CRA) published an administrative position. The Budget proposes to discontinue the application of CRA’s administration position after the end of 2020 in order to encourage conversion of such trusts to employee health and life trusts for which there are specific rules in the ITA. The Department of Finance has requested comments by June 29, 2018, on the transitional rules.
PERSONAL INCOME TAX MEASURES
Personal income tax rates will not increase under the Budget.
Canada Workers Benefit (CWB)
The Budget enhances the existing Working Income Tax Benefit and renames it as the Canada Workers Benefit, effective for 2019 and subsequent years. The Budget also proposes to allow the CRA to determine if a taxpayer is eligible for the CWB and assess, even if not claimed on their tax return. This measure applies to tax returns for 2019 and subsequent taxation years.
Medical Expense Tax Credit — Service Animals
The Budget proposes to include in the medical expense tax credit, expenses for animals specially trained to perform tasks for an individual with a severe mental impairment. Qualifying expenses include the cost of the animal, costs for care and maintenance such as food and veterinary care, and costs for training the individual in handling the animal. This measure will apply in respect of expenses incurred after 2017.
Registered Disability Savings Plans (RDSP)
Currently, if an individual whose capacity is in doubt does not have a legal representative in place, certain family members (parents, spouses and common-law partners) are allowed to be the RDSP plan holder. This provision was to expire at the end of 2018, however the Budget extends it to the end of 2023.
Foreign-born Status Indians who legally reside in Canada but are neither Canadian citizens nor permanent residents are eligible for the Canada Child Benefit (CCB), provided all other eligibility requirements are met. Effective July 1, 2018, the Budget proposes to make them retroactively eligible for the Canada Child Tax Benefit, the National Child Benefit supplement and the Universal Child Care Benefit, the predecessors to the current CCB.
Mineral Exploration Tax Credit for Flow-Through Share Investors
Eligibility of the Mineral Exploration Tax Credit is proposed to be extended for one year. The credit will apply to expenses renounced under flow-through share agreements entered into on or before March 31, 2019.
Employment Insurance Parental Sharing Benefit
The Budget proposes a new five-week Employment Insurance Parental Sharing Benefit, effective June 2019. This benefit will be available as a top-up in situations where both parents agree to share parental leave. It will be available to eligible two-parent families, including same sex-couples and adoptive parents. This new benefit is intended to provide greater flexibility, particularly for mothers, to return to work sooner.
Apprenticeship Incentive Grant for Women
Current legislation provides for the Apprenticeship Completion Grant, a one-time taxable cash grant of $2,000 to a registered apprentice who has completed their apprenticeship training and obtains their journeyperson certification. The Budget proposes a new Apprenticeship Incentive Grant for Women. Under this program, women in male-dominated Red Seal trades will be able to receive $3,000 per year for each of their first two years of training.
The Budget introduces an additional avoidance measure addressing transactions that otherwise circumvent the current rules preventing a non-resident from stripping surplus out of a Canadian resident corporation, a capital gain that is tax-free for Canadian purposes, rather than as a dividend subject to withholding tax.
Foreign Accrual Property Income (FAPI)
Foreign-source income that would otherwise be treated as passive, is considered active business income for the purposes of the FAPI rules where the foreign entity earning the income employs more than the equivalent of five full-time employees. The Budget introduces measures intended to prevent taxpayers from pooling their foreign investments and operations in tracked entities in order to meet the more than five employee threshold.
The Budget also proposes to introduce measures that are intended to prevent the avoidance of controlled foreign affiliate status by the use of tracked pooling arrangements similar to those described above.
The Budget proposes to extend the normal four-year reassessment period that is generally applicable to income arising from a taxpayer’s foreign affiliate by three years. The extended reassessment period will now coincide with that available to the CRA in connection with transactions between Canadian residents and non-arm’s-length non-residents. This measure will apply to taxation years that begin on or after February 27, 2018.
Where a taxpayer has transactions with a non-arm’s length non-resident, because the normal reassessment period available to the CRA is extended three years, there are circumstances that can prevent the CRA from reassessing a now statute-barred earlier year to which a taxpayer has carried back a loss. The Budget proposes to allow the CRA an additional three years to reduce a loss carried back to a prior taxation year to the extent that the reassessment involves the adjustment, in a later year, of the loss carry back. This measure will apply where the loss is carried back from a taxation year that ends on or after February 27, 2018.
The Budget proposes to shorten the filing deadline for the foreign affiliate information reporting (T1134) from the current 15 months after the Canadian company’s year-end, to six months after the year-end, to coincide with the filing deadline for the corporate tax return (T2). This proposal applies to taxation years that begin after 2019.
Sharing Information for Criminal Matters
The Budget proposes to significantly expand the legal means available to the CRA in order to facilitate the sharing of information related to tax offenses under Canada’s tax treaties, tax information exchange agreements and the Convention on Mutual Administration Assistance in Tax Matters.
The Budget proposes extensive new reporting requirements for most family trusts, effective 2021 and subsequent taxation years. These requirements could impose an obligation to file a return where none currently exists, such as where the trust earned no income in the year. The trust will be required to report the identity of all trustees, beneficiaries and settlors of the trust. In addition, the identity of each person who has the ability to exert control, through the trust terms or a related agreement, over trustee decisions in respect of the appointment of income or capital, must be disclosed.
The reporting requirements will apply to Canadian-resident express trusts and to non-resident trusts. This would include most personal “family” trusts used in tax planning. Among the trusts excluded from these new requirements are Graduated Rate Estates, Qualified Disability Trust and trusts meeting specific de minimus asset tests.
The Budget also introduces penalties for failure to file a trust return where the new reporting requirements apply.
Municipalities as Eligible Donees
Where a registered charity’s registration is voluntarily or involuntarily revoked, the Budget proposes to allow, subject to case-by-case approval, transfers of property to municipalities to be among the qualifying expenditures that can be made in order to reduce the otherwise applicable 100% revocation tax.
Universities Outside of Canada
Certain categories of “qualified donees,” including universities outside Canada, are required to register with the CRA and are listed on the CRA website. Under the Budget proposals, the duplicate exercise requiring foreign universities to also be prescribed in the Income Tax Regulations will be eliminated.
SALES TAX AND EXCISE TAX MEASURES
GST/HST and Investment Limited Partnerships
The Budget confirms the Federal Government’s intention to proceed with the legislative and regulatory proposals released on September 8, 2017, relating to the application of GST/HST to investment limited partnerships, with certain announced modifications.
Consultation on the GST/HST Holding Corporation Rules
The Government intends to consult on the application of the “holding corporation rule” that allows a parent corporation to claim input tax credits to recover GST/HST paid on expenses that can reasonably be regarded as relating to the ownership of shares or indebtedness of a related commercial operating corporation. The consultations will address the limitation of the rule to corporations and not other entities, and the degree of relationship between the parent corporation and the commercial operating corporation.
The Budget proposes to increase the excise duty on tobacco products on an annual basis rather than to automatically increase it every five years to account for inflation. In addition, the excise duty rate is proposed to be increased by the equivalent of $1 per carton of 200 cigarettes, including a tax on existing inventory.
The Budget proposes a new excise duty framework for cannabis products to be introduced as part of the Excise Act, 2001. The duty will generally apply to all products available for legal purchase including fresh and dried cannabis, cannabis oils and seeds and seedlings for home cultivation.
The new excise duty would not apply to packaged products that contain concentrations of no more than 0.3 per cent Tetrahydrocannabinol (THC) and pharmaceutical products that can only be acquired through a prescription.
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