Publication
On March 19, 2007, the Conservative Government tabled its second budget. The Budget contains measures designed to improve the efficiency of the tax system for Canadian business, as well as a host of targeted personal income tax measures.
BUSINESS INCOME TAX MEASURES
Status of Canada-U.S. Tax Treaty Negotiations / Withholding Tax Measures
The Budget announces that an agreement in principle has been reached by the two countries' representatives on the major elements of an updated Canada-U.S. tax treaty and that formal negotiations are expected to conclude in the very near future. The principal features include:
- elimination of withholding tax on arm's length cross-border interest payments, to be effective for the first calendar year following the entry into force of the treaty provisions;
- elimination of withholding tax on non-arm's length cross-border interest payments in three stages:
- reduction of withholding to 7% for interest paid in the first year following the entry into force of the revised treaty;
- reduction of withholding to 4% for interest paid in the second year following the entry into force of the revised treaty;
- reduction of withholding to 0% for interest paid in the third year following the entry into force of the revised treaty.
Other features of the treaty negotiations include:
- extension of treaty benefits to U.S. limited liability companies (LLCs);
- harmonization of pension contribution rules in Canada and the U.S.; and
- clarification of the treatment of cross-border stock options.
Elimination of Withholding Tax on Interest Paid to Other Arm's Length Non-Residents
Once both the arm's length and non-arm's length exemptions from withholding tax under the Canada-U.S. tax treaty are implemented, the Budget proposes to amend Canadian legislation to eliminate withholding tax on interest paid to all arm's length non-residents, regardless of their country of residence. This legislated exemption will apply to interest paid on or after the date on which the withholding tax exemptions in the Canada-U.S. tax treaty come into effect.
Foreign Affiliates
Interest Deductibility
Currently, dividend income paid by a foreign affiliate to its Canadian parent corporation out of its "exempt surplus" is not taxed in Canada. However, a Canadian corporation is entitled to deduct interest expense on debt incurred to finance the foreign affiliate. The Budget proposes to eliminate this interest deduction. The interest expense would be pooled for deduction if and as the shares of the foreign affiliate generate non-exempt income for the corporation. The proposal is to apply to interest payable after 2007 on new debt incurred on or after March 19, 2007. Existing non-arm's length debt will be subject to the new rule for interest payable after 2008 or after the expiry of its current term, whichever is sooner. Existing arm's length debt will be subject to the new rule for interest payable after 2009 or after the expiry of its current term, whichever is sooner.
Exempt Surplus
As a consequence of this new rule, it will no longer be necessary to link the earning of exempt surplus to the presence of a tax treaty. Rather, the exemption will be extended to active business income earned in tax treaty and non-treaty countries, provided the source jurisdiction has agreed to exchange information with Canada.
Taxpayer Information Exchange Agreements
The Budget proposes that all new tax treaties and revisions to existing treaties include new standards for the exchange of tax information. In addition, the Budget proposes to extend exempt surplus treatment for dividends received out of active business income of a foreign affiliate resident in a treaty country to dividends received out of the active business income earned by a foreign affiliate resident in a country that has agreed to a tax information exchange agreement (TIEA) with Canada. As an incentive for countries to enter into TIEAs with Canada, it is proposed that income earned by a foreign affiliate in a non-TIEA, non-treaty country would be taxed on an accrual basis. In the case of TIEA negotiations that begin after March 19, 2007, this accrual treatment would apply if negotiations of a TIEA are not completed within 5 years from the earlier of the commencement of the negotiations and the date on which Canada proposed the negotiations. In the case of a country presently negotiating a TIEA with Canada, this accrual treatment would apply if the negotiations are not successfully completed before 2014.
Active Business Income
The Budget proposes to tighten the rules under which certain passive income of a foreign affiliate can be treated as active business income. The proposal would require that a taxpayer have a qualifying interest of at least 10% in the entity paying amounts to the taxpayer's foreign affiliate.
Capital Cost Allowance Rates
General
A number of changes to capital cost allowance ("CCA") rates will be made to better reflect the useful life of assets. The Budget proposes to increase the following CCA rates:
- from 4% to 10% for buildings used for manufacturing or processing in Canada;
- from 4% to 6% for other non-residential buildings;
- from 45% to 55% for computer equipment;
- from 4% to 6% for natural gas distribution pipelines;
- from 4% to 8% for liquefied natural gas facilities;
These proposals apply to properties acquired on or after March 19, 2007.
The Budget also provides for a temporary increase from 30% to a 50% straight-line rate for manufacturing and processing machinery and equipment acquired after March 19, 2007 and before 2009.
Phase out of Accelerated CCA for Oil Sands
The Budget proposes to phase out the accelerated CCA for assets used in new mines or acquired for mine expansions.
- accelerated CCA will remain available for assets acquired before March 19, 2007 and assets acquired before 2012 that are part of a project phase on which construction commenced before March 19, 2007;
- for other assets, there will be a gradual phase out from 2011 to 2015.
Accelerated Capital Cost Allowance for Clean Energy Generation
In 2005, Class 43.2 of the Schedule II to the Income Tax Regulations was introduced to provide a 50% accelerated CCA for assets acquired on or after February 23, 2005 and before 2012. For assets acquired before February 23, 2005, accelerated CCA is provided under Class 43.1 at a 30% rate. The eligibility criteria for these classes are generally the same, except that cogeneration systems that use fossil fuels must meet a higher efficiency standard for Class 43.2. Systems that meet the lower efficiency standard continue to be eligible for Class 43.1. The Budget proposes to extend eligibility for Class 43.1 and Class 43.2 to wave and tidal energy and to add a broader range of applications involving active solar heating, photovoltaics, stationary fuel cells, production of biogas from organic waste, and pulp and paper waste fuels. In addition, the Budget proposes to extend eligibility for Class 43.2 to assets acquired before 2020.
Pharma Sector: Additional Deduction for Donation of Medicines
The Budget proposes to permit corporations to claim a special deduction in respect of donations of medicines from their inventory to eligible donees after March 19, 2007, in addition to any charitable donation deduction they may claim. The deduction would be equal to the lesser of (a) 50% of the amount by which the FMV of the donated medicine exceeds its cost and (b) the cost of the donated medicine.
Tax Credit for Creating Child Care Spaces
The Budget proposes to introduce a non-refundable investment tax credit available to businesses that create licensed child care spaces for children of their employees and potentially other children in the community. The credit would be equal to 25% of the eligible expenditures to a maximum of $10,000 per child care space.
Remittance and Filing Requirements, Instalment Thresholds
The Budget proposes to streamline and reduce the frequency of tax filings and remittances to ease the burden on small businesses. The Budget also proposes to increase the threshold at which businesses and individuals are required to pay income tax by instalment and employers are required to remit source deductions.
Incentive for the Elimination of Provincial Capital Taxes
In order to support and encourage the provinces to eliminate or accelerate the elimination of their capital taxes by 2011, the Budget proposes that a financial incentive will be provided by the federal government to provinces that enact legislation to eliminate their capital taxes on or after March 19, 2007, and before January 1, 2011. The amount of the federal incentive would equal the average expected increase in federal corporate income tax from the elimination of the deduction for provincial capital taxes paid. The incentive would also be available to provinces that restructure their capital tax on financial institutions into a minimum tax, similar to the federal minimum tax on financial institutions.
Fund Industry - T3 Information Returns
The Budget indicates that draft regulations will be introduced to balance the desire of taxpayers for sufficient time to prepare their tax returns, while providing commercial trusts the time required to compute income and prepare T3 information slips.
Prescribed Stock Exchanges
The concept of a "prescribed stock exchange" is relevant for a variety of reasons but the process of prescribing a stock exchange is stringent and time-consuming. In order to streamline and simplify compliance, the Budget proposes to create three categories of prescribed stock exchanges to better reflect the purposes of the tax provisions for which the exchanges are prescribed.
The first category ("designated stock exchanges") will consist of stock exchanges that have been designated by the Minister of Finance, and will include all existing stock exchanges that are currently prescribed in the Income Tax Regulations. The Minister's designation will be made by public notice. This category will apply for the purposes of all current references to "prescribed stock exchange" in the Income Tax Act, other than the section 116 withholding procedure and the securities lending rules.
The second category ("recognized stock exchanges") will consist of stock exchanges that are located in Canada or in another country that is a member of the Organization for Economic Co-operation and Development ("OECD") and that has a tax treaty with Canada. This category will also include all designated stock exchanges. There will be no formal identification of recognized stock exchanges. This category will apply for the purpose of the section 116 withholding procedure, meaning a purchaser of shares listed on one of these exchanges will not be required to withhold a portion of the purchase price from a non-resident vendor and the non-resident vendor will not be required to obtain a certificate of compliance. (However, whether or not the shares are taxable Canadian property will be unaffected.)
A third category ("stock exchanges") will include any stock exchange, wherever located, and will include all designated and recognized stock exchanges. As in the case of a recognized stock exchange, there will be no process by which an entity is formally identified as a "stock exchange". Instead, it is intended that the general legal and commercial meaning of the term will govern. This category will be used for the purposes of the securities lending rules.
These changes are proposed to be effective upon Royal Assent to the necessary amending legislation.
Mineral Exploration Tax Credit
The 15% investment tax credit for flow-through mining expenses has been an important incentive for new investment in junior mineral exploration in Canada. It was first introduced in Budget 2000, and has been extended by each Budget annually since 2004. Budget 2007 extends it another year. The tax credit will be available to flow-through share investors under issues agreed to on or before March 31, 2008. Under the "look-back rule", funds raised with the benefit of the credit before April 2008 can be spent on mineral exploration up to the end of 2009.
PERSONAL INCOME TAX MEASURES
Lifetime Capital Gains Exemption
The Budget proposes to increase the exemption from $500,000 to $750,000 for dispositions of qualified small business corporation shares and qualified farm and fishing property on or after March 19, 2007. Transitional rules will apply for capital gains realized in 2007.
Extension of RRSP, RPP and DPSP Maturity Date
Registered retirement savings plans, registered pension plans and deferred profit sharing plans must mature by the end of the year in which the annuitant attains 69 years of age. Commencing in 2007, the Budget proposes to extend the conversion date to the year in which the annuitant attains 71 years of age. The Budget proposes related changes to the rules requiring minimum payments from a registered retirement income fund.
Private Foundations
Elimination of Capital Gains
The Budget proposes to eliminate the tax on capital gains arising on the donation of publicly-traded securities to private foundations, effectively mirroring the treatment of donations to public charities in place since 2006. In addition, employees who acquire a publicly-traded security on the exercise of a stock option and who donate the security to a private foundation within 30 days may claim a special deduction, effectively eliminating all tax on the acquisition and donation of the security. These measures are intended to apply to gifts made on or after March 19, 2007.
Excess Business Holdings Regime
To address concerns regarding self-dealing opportunities within private foundations, the Budget proposes a new Excess Business Holdings Regime. The EBHR will place limits on a foundation's shareholdings in both publicly-listed and non-listed shares that take into account the holdings of persons not dealing at arm's length with the foundation.
- a foundation will be in a "safe harbour" if it holds 2% or less of any class of a corporation's shares;
- if a foundation's holdings exceed 2%, the foundation will be subject to reporting requirements in respect of its shareholdings and those of non-arm's length persons;
- a foundation will be required to divest itself of certain shareholdings where those holdings, together with those of non-arm's length persons, exceed 20% of the shares of any class of a corporation;
- related penalties and anti-avoidance measures are proposed;
- transitional rules are proposed to permit foundations to divest excess business holdings present on March 19, 2007 over a 5 to 20 year period.
Qualified Investments for Deferred Plans
Effective March 19, 2007, the range of qualified investments for RRSPs and other registered plans will be extended to include:
- any debt obligation that has an investment grade rating and that is part of an issuance of $25 million or more; and
- any security (other than a futures contract) that is listed on a designated stock exchange (which term will include the current list of prescribed stock exchanges).
Registered Disability Savings Plan
To assist taxpayers in saving for the long-term financial security of a child with a severe disability, the Budget proposes to introduce the Registered Disability Savings Plan (RDSP) modeled along the lines of the current Registered Education Savings Plan regime.
- contributions to the RDSP will not be deductible to the contributor;
- contributions limited to a lifetime maximum of $200,000 per beneficiary with no annual limit;
- government assistance in the form of Canada Disability Savings Grants (CDSG) to match contributions at rates of 100% to 300% depending on net family income and the amount contributed, to a maximum lifetime CDSG of $70,000 per beneficiary;
- additional government assistance in the form of a Canada Disability Savings Bond (CDSB) of up to $1,000 to be paid to the RDSP of low to modest income beneficiaries, to a lifetime maximum CDSB of $20,000;
- payments to a beneficiary must commence in the year the beneficiary attains 60 years of age;
- payments out of the plan that represent contributions will not be included in the beneficiary's income, although CDSGs, CDSBs and investment income will be so included;
- portions of the CDSGs and CDSBs may have to be repaid upon the beneficiary ceasing to be eligible for the disability tax credit or upon the death of the beneficiary;
- amounts paid out of an RDSP are not intended to be taken into account in determining eligibility for various benefits, including Old Age Security and Employment Insurance (with the intention of obtaining similar recognition under provincial and territorial income-support programs).
New Child Tax Credit
As of the 2007 taxation year, the Budget proposes to introduce a non-refundable tax credit based on an amount of $2,000 per child under 18 as at the end of a year, calculated at the rate of 15.5%.
Changes to Registered Education Savings Plan Regime
The Budget proposes the following enhancements to the RESP regime effective in 2007:
- eliminating the $4,000 annual contribution limit;
- increasing the lifetime contribution limit from $42,000 to $50,000;
- increasing the maximum annual Canada Education Savings Grant payment from $400 to $500; and
- extending RESP-eligible payments to more part-time studies.
Spousal and Other Amounts
As of the 2007 taxation year, the Budget proposes to increase the spousal/dependent person credit to $8,929 to match the basic personal amount. In addition, the threshold above which the dependent's income will reduce the available credit will be eliminated.
Phased Retirement
For years of service beginning in 2008, the Budget proposes to amend the rules regarding defined benefit pension plans (DBPP) to facilitate phased retirement. Workers would be entitled to receive benefits from a DBPP and simultaneously accrue further benefits under a DBPP of the same or a related employer. Eligible workers would be entitled to receive up to 60% of their accrued benefits provided they are at least 55 years of age and are eligible to receive a pension without the imposition of an early retirement reduction.
Public Transit Tax Credit
This measure was introduced in 2006. The Budget proposes to extend the credit to include the purchase of (a) electronic payment cards and (b) weekly passes where the taxpayer purchases 4 consecutive weekly passes and each such pass entitled the holder to unlimited transit use for a 5 to 7 day period. These measures are to apply after 2006.
Working Income Tax Benefit
To improve incentives for low-income Canadians to work and to remove the "welfare wall", the Budget proposes the Working Income Tax Benefit (WITB).
- the WITB is a refundable credit available to taxpayers 19 years of age or over and will be equal to 20% of each dollar earned in excess of $3,000 to a maximum credit of $500 ($1,000 for workers with families);
- the WITB will be reduced by 15% of net family income in excess of $9,500 ($14,500 for workers with families).
Working Income Tax Benefit Supplement for Persons with Disabilities
The Budget proposes to introduce a WITB Supplement for persons who qualify for the disability tax credit and who have at least $1,750 in earned income.
- each dollar of income in excess of $1,750 will be supplemented at a rate of 20% up to a maximum credit of $250;
- the Supplement will be reduced by 15% of net family income in excess of $12,833 ($21,167 for workers with families).
GST / COMMODITY TAXES
Exports of Intangible Personal Property
The Budget proposes to ease the GST rules regarding the export from Canada of intangible personal property. Under the proposals most such exports will now be exempt from GST.
Foreign Convention and Tour Incentive
The Budget proposes a new Foreign Convention and Tour Incentive Program that will replace the existing Visitor Rebate Program. The new program will provide GST relief for certain property and services used in the course of conventions held in Canada and the accommodation portion of tour packages for non-residents.
Green Levy on Fuel-Inefficient Vehicles
To promote the purchase of fuel-efficient vehicles in Canada, the Budget proposes a new tax called a "Green Levy" that will apply to new automobiles designed primarily to carry passengers, including station wagons, vans and sport utility vehicles, but not pick-up trucks, in accordance with the vehicle's fuel efficiency rating. The tax will be payable by the manufacturer or importer at the time a vehicle is delivered to a dealer, or is imported into Canada, after March 19, 2007. The tax will not apply to vehicles manufactured in Canada and exported for sale in other countries, or that are imported and subsequently exported.
Increased Annual Filing and Annual Remittance Thresholds
To reduce the paper burden of small and medium-sized businesses, the Budget proposes to increase the threshold at or below which registrants are permitted to file GST/HST returns annually and make one annual tax remittance.
Sales Tax Harmonization
The Budget indicates the federal government's willingness to work with provinces that impose a retail sales tax to move to a harmonized value-added tax regime, with the goal of reducing overall taxes on new business investment in Canada.
WHAT IS NOT IN THIS BUDGET
There has been public discussion about potential measures that the Government has not chosen to address in this Budget. The Budget is not proposing any general income splitting or joint tax return regime for spouses above and beyond the previously announced income splitting of pension income for seniors. The Government has not proposed any general changes to income tax brackets. The Government's relief for capital gains has been limited to increasing by half the exemption for gains from the sale of qualified small business corporation shares, as opposed to a broader relief for deferred capital gains as originally discussed during the election.
The purpose of this document is to provide information as to developments in the law. It does not contain a full analysis of the law nor does it constitute an opinion of Ogilvy Renault LLP or any member of the firm on the points of law discussed.
© Ogilvy Renault LLP 2007 - All Rights Reserved
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