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2016 Federal Budget Edition

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2016 FEDERAL BUDGET


As had been well-telegraphed in advance, the Federal Government has delivered a budget containing significant increases to government spending and deficit. The government is doing this in its stated belief that the best way to deliver more prosperity to more Canadians is by investing in the economy today. It is also targeting specific measures to the middle class.

The government previously announced in December the delivery of its promised tax rate reduction of 1.5% on income between $45,283 and $90,563 and tax rate increase of 4% on income over $200,000.

In this budget commentary, we provide an overview of the proposed tax changes and how they will impact Canadian businesses and individuals.


CORPORATE AND BUSINESS


Small Business Deduction Changes


The small business deduction rate will remain at 10.5% (The rate was to set to decrease to 9% by 2019). The gross-up rate on non-eligible dividends will be maintained at 17% and the dividend tax credit rate will be 21/29 of the gross-up amount.

There are a number of changes, effective for taxation years beginning on or after March 22, 2016, precluding the multiplication of the small business deduction to two or more Canadian Controlled Private Companies (“CCPCs”) in a number of situations so that these companies must instead share the $500,000 annual small business limit.

These changes will impact a number of the structures being used in particular by doctors, dentists, and other professionals. Situations include where a CCPC is incorporated to provide services or property under contract to a partnership or where a CCPC provides services or property to a private corporation where the CCPC, one of its shareholders, or a person who does not deal at arm’s length with such a shareholder, has a direct or indirect interest in the private corporation. In this situation the income earned by the CCPC will be ineligible for the small business deduction, and the CCPC may assign its share of its small business limit to the other companies. There are exceptions to this treatment, such as where all or substantially all the income earned by the CCPC is earned from providing services to other arm’s length persons.

The $500,000 deduction must be shared by associated corporations. Two otherwise unassociated corporations are associated with one another if they are each associated with the same third corporation. The third corporation may elect to not be associated with the other two companies (giving up its small business deduction), in order to not have this rule apply. Changes are made to prevent income derived by the other two companies from the third company from being eligible for the small business deduction.

The 2015 budget announced a review of income from certain business such as self storage rental, campgrounds, etc. and whether such income would be eligible for the small business deduction instead of income from property. The 2016 budget announced that no changes will be made.

Eligible Capital Property ("ECP")


The budget proposes to repeal the ECP regime and replace it with a new capital cost allowance (“CCA”) class. The new rules will apply as of January 1, 2017. ECP includes intangible property such as goodwill, customer list, licenses, franchise rights and quotas of indefinite duration.

Currently, the eligible capital expenditures (“ECE”) are added to cumulative eligible capital (“CEC”) at a 75% inclusion rate and the annual deprecation rate is 7% of 75% of ECE. The budget proposes to include the CEC in a new CCA Class 14.1 at a 100% inclusion rate and have a 5% annual depreciation rate. The existing CCA rules will generally apply, including rules relating to recapture, capital gains and depreciation, and the half-year rule.

As a result of these changes, the disposition of assets in Class 14.1 will give rise to recapture and capital gains. This change will result in a significant increase in income tax paid by many Canadian private companies. Currently, 50% of the gain on ECP is subject to income tax as active business income. By changing the income inclusion into a capital gain (i.e. investment income), the taxable capital gain is subject to refundable income tax, increasing the immediate federal income tax rate by approximately 12%.

CEC pool balances will be calculated and transferred to the new CCA class as of January 1, 2017. The opening balance of the new CCA class will be equal to the balance at that time of the existing CEC pool. For the first 10 years, the depreciation rate for the new CCA class will be 7% in respect of expenditures incurred before January 1, 2017.

The budget also proposes two special rules to simplify the transition of these new rules for small businesses. CCA in respect of expenditures incurred before 2017 will be equal to the greater of $500 per year and the amount otherwise deductible to allow small initial balances to be eliminated quickly. The first $3,000 of incorporation costs will be deductible as a current expense rather than added to the new Class 14.1.

Accelerated CCA for Clean Energy Equipment


The budget proposes to expand CCA Classes 43.1 and 43.2 for clean energy generation and conservation equipment for assets acquired on or after March 22, 2016 that have not been used or acquired for use before that time.

Certain electric vehicle charging stations and electrical energy storage equipment previously included in Class 8 (20% declining balance) will now be eligible for inclusion in Class 43.1 or 43.2 (30% and 50% declining balance, respectively).

CCA for Liquefied Natural Gas ("LNG")


The budget confirms to maintain the current accelerated CCA for certain LNG facilities and will allow it to expire as scheduled. That is, for assets acquired before 2025, an effective CCA rate of 30% is available for eligible liquefaction equipment and 10% is available for related buildings.


Emissions Trading Regimes


Regulated emitters are obligated to deliver emissions allowances to governments. The required allowances are determined by reference to the amount of emissions of a regulated substance, such as greenhouse gases, that are produced. These allowances may be purchased by emitters in the market, earned in relation to emissions reduction activities or provided by the government at a reduced price or cost.

The budget proposes to introduce specific rules to clarify the tax treatment of emissions allowances. These measures will apply to emissions allowances acquired in taxation years beginning after 2016 or on an elective basis for emissions allowances acquired in taxation years ending after 2012.

Under the new rules, emissions allowances will be treated as inventory for all taxpayers. There will be no income inclusions for the receipt of a free allowance. The deduction in respect of an accrued emissions obligation will be limited to the amount by which the obligation exceeds the cost of any emissions allowances acquired that can be used to settle the obligation. Each year a taxpayer claims a deduction in respect of an emissions obligation, and it will quantify its obligation based on the cost of emissions allowances acquired to settle its obligation and the fair market value of any emissions allowances it needs to obtain to fully satisfy its obligation. Deductions claimed in one year in respect of an emissions obligation to be satisfied in a future year will be brought back into income in the subsequent year and re-evaluated each year until the obligation is satisfied.

Proceeds received on the disposition of an emissions allowance, otherwise than in satisfaction of an obligation under the emissions allowance regime, and in excess of the taxpayer’s cost, will be included in computing income.

Valuation for Derivatives


The budget proposes to exclude derivatives from the application of the inventory valuation rules notwithstanding that such property could retain the status of being inventory property if it is held on income account. This proposal, effective March 22, 2016, would prevent derivatives that are not mark-to-market property from being written down to the lower of cost and market, thereby deferring the recognition of any loss until the property is disposed of.

Life insurance proceeds


Life insurance proceeds received as a result of the death are generally not subject to income tax. Changes are being made to ensure that the amount of benefit that can be removed from a corporation tax free as a capital dividend or from a partnership in the form of adjusted cost base ("ACB") apply as intended. In particular, the proposal will provide that the “insurance benefit limit” (i.e. the portion of the policy benefit received by the corporation or partnership that is in excess of the policyholder’s ACB of the policy) applies regardless of whether the corporation or partnership that receives the policy benefit is a policyholder of the policy. These changes will apply to policy benefits received as a result of a death that occurs on or after March 22, 2016.

Changes are also being made regarding the transfer of life insurance policies that will limit the consideration received to the amount of proceeds determined on the transfer for tax purposes. The proceeds of disposition for tax purposes is typically cash surrender value or “the amount that the policyholder would be entitled to receive if the policy were surrendered”. These changes will apply to dispositions that occur on or after March 22, 2016.

The budget also includes changes affecting some transfers that occurred prior to March 22, 2016, particularly where the transfer resulted in an increase in partnership ACB or share capital. These measures will apply to policies under which policy benefits are received as a result of deaths that occur on or after March 22, 2016.



PERSONAL


Canada Child Benefit


Currently there is a Canada Child Tax Benefit (“CCTB”) and Universal Child Care Benefit (“UCCB”). To simplify and consolidate these existing benefits, they will be replaced with a new Canada Child Benefit (“CCB”).

To be eligible for the CCB, an individual must be a resident of Canada for tax purposes and must reside with the qualified dependant and be the parent who primarily fulfils the responsibility for the care and upbringing of the qualified dependant, or be a shared custody parent.

The CCB provides a maximum benefit of $6,400 per child under the age of 6 and $5,400 per child aged 6 through 17. The benefit is not taxable and will not reduce benefits under the GST tax credit or federal income-tested programs delivered outside the tax system.

The CCB is phased out on the portion of family income exceeding $30,000 at the rates summarized below:

 

Phase-Out Rates (%)

Number of children

$30,000 to $65,000 

Over $65,000 

1

7.0

3.2

2

13.5

5.7

3

19.0

8.0

4+

23.0

9.5


An additional $2,730 Child Disability Benefit remains available for children qualifying for the disability tax credit. The phase-out of this additional amount will generally align with the CCB.

A taxpayer can request a retroactive payment of the CCB, CCTB or the UCCB for a month on or before the day that is 10 years after the beginning of that month, effective for requests made after June 2016.

The first benefit year will run July 2016 to June 2017 and will be based on adjusted family income for the 2015 taxation year.

Income Splitting Credit


The family tax cut is a non-refundable tax credit of up to $2,000 for eligible couples with minor children based on the net reduction of federal tax that would be realized if up to $50,000 of an individual's taxable income was transferred to the individual's eligible spouse or common-law partner. The credit is eliminated for 2016 and subsequent years.

Children’s Arts and Fitness Credits


The children’s arts and fitness credits are being phased out beginning in 2016. The maximum amount of eligible fitness expenditures is reduced from $1,000 to $500; however, the credit remains refundable. The maximum eligible fees for the arts credit is reduced from $500 to $250. Children eligible for the disability tax credit are entitled to an additional $500 of eligible expenditures. Both credits will be eliminated for 2017 and subsequent years.

Education and Textbook


The education and textbook credits are eliminated effective January 1, 2017. Unused credits prior to this date may continue to be carried forward to subsequent years. The federal tuition tax credit remains unchanged (Ontario recently eliminated its provincial tuition credit – see our Ontario budget commentary).

Other tax provisions that rely on the education and textbook credits to determine eligibility (e.g. scholarship exemptions) will be modified so that they are unchanged by the elimination of these credits.

Teacher and Early Educator School Supply Credit


A new 15% refundable credit is being introduced for eligible teachers on up to $1,000 of eligible supplies (e.g. paper, glue and paint for art projects, games, puzzles, supplementary books). To qualify, the eligible teacher must hold a valid teacher’s certificate in the province he or she is employed. The expenses must be incurred out of pocket and for the purpose of teaching or otherwise enhancing learning in a classroom or similar learning environment. Employer certification is required, and CRA may ask for receipts to substantiate any claims.

The credit applies to supplies acquired after December 31, 2015.


Northern Residents Deduction


Individuals who live in prescribed areas in northern Canada for at least six consecutive months are entitled to a residency deduction. The budget increases the residency deduction from $8.25 per day to $11 per day. Alternatively, where no other member of the household claims the deduction, the increase is from $16.50 per day to $22 per day. Individuals living in the Intermediate Zone will be entitled to one half of these amounts.


Labour-Sponsored Venture Capital Corporation (“LSVCC”) Tax Credit


The LSVCC tax credit is increased from 10% to 15% for share purchases of provincially registered LSVCCs prescribed under the Income Tax Act for 2016 and subsequent years. The budget also proposes to allow newly registered LSVCCs under existing provincial legislation to be eligible for prescription if the provincial legislation is currently prescribed for the purposes of the federal LSVCC credit. New provincial regimes will be eligible for prescription provided that the enabling provincial legislation is patterned on currently prescribed provincial legislation.


Ontario Electricity Support


Amounts received under the Ontario Electricity Support Program will be treated as tax exempt. This program, effective January 1, 2016, provides assistance to low-income households in Ontario for the cost of electricity.


Mineral Exploration Tax Credit


The 15% Mineral Exploration Tax credit is extended to flow-through share agreements entered into on or before March 31, 2007.


Donation of Private Company Shares


The 2015 budget proposes an exemption from capital gains tax for certain dispositions of private corporation shares or real estate. The 2016 budget has indicated that the government will not proceed with this plan.


Top Marginal Tax Rate Consequential Amendments


A new federal tax bracket was introduced back in December that imposes a 33% tax rate on income over $200,000. Several other income tax provisions that were based on the old top marginal rate of 29% have been amended (effective for 2016) to reflect the new top rate, including:

• Providing a 33% donation tax credit for donations over $200 to trusts that are subject to the top tax rate on all their taxable income (applies to donations made after 2015);

• Applying the 33% rate to excess employee profit sharing plan contributions;

• Increasing the tax rate on personal service business income earned by corporations to 33%;

• Adjusting the relevant tax factor in the foreign affiliate rules from 2.2 to 1.9;

• Amending the capital gains refund mechanism for mutual fund trusts to reflect the 33% top rate in the formulas that are used to compute refundable tax;

• Increasing Part XII.2 tax on certain income distributions from trusts to 40%;

• Adjusting the recovery tax rule applicable to qualified disability trusts; and

• Extending the 33% charitable donation credit to donations made by graduated rate estates during taxation years that straddle 2015 and 2016 (since the rate applies only to donations made after 2015).


Taxation of Switch Fund Shares


Switch funds can generally be described as mutual fund corporations that offer different types of asset exposure in different funds that are each structured into a separate class of shares within the mutual fund corporation. Currently investors can exchange shares of one class for another on a tax deferred basis, but effective September 2016, the exchange will be considered a disposition at fair market value for tax purposes. Some exceptions will apply, such as switches where the shares received differ only in respect of management fees or expenses borne by investors and otherwise derive their value from the same portfolio or fund as the original class of shares.


Sales of Linked Notes


A linked note is a debt obligation the return on which is linked in some manner to the performance of one or more reference assets or indexes over the term of the obligation. The reference asset or index – which can be a basket of stocks, a stock index, a commodity, a currency or units of an investment fund – is generally unrelated to the operations or securities of the issuer.

The budget proposes to treat the return on a linked note such that it retains the same character whether it is earned at maturity or a secondary market sale. A deeming rule will apply in certain cases to treat any gain realized on the sale of a linked note as interest (ignoring fluctuations in foreign currency for this calculation). An exception will apply to any portion of the gain that can reasonably be attributable to market rate interest fluctuations (provided that the return on the particular linked note is based on a fixed rate of interest).

Guaranteed Income Supplements


The budget proposes to increase the guaranteed income supplement top-up benefit up to $947 annually for the most vulnerable single seniors starting in July 2016.

The age of eligibility for Old Age Security and Guaranteed Income Supplement benefits is reduced to age 65 (from 67) and Allowance benefits to age 60 from 62 over the 2023 to 2029 period.

Couples who live apart for reasons beyond their control (e.g. living in long-term care facility) will receive higher benefits based on their individual incomes.


INTERNATIONAL


International Tax Changes


The budget included a number of changes in the area of international tax. These include:

• Eliminating an exception to the rules that require non-share consideration in excess of paid up capital to be a dividend where a non-resident person ("NR") disposes of shares of a Canadian corporation, the subject corporation) to another Canadian corporation, the purchaser corporation) that does not deal at arm’s length with NR;

• Extensions of back-to-back loan rules that apply for purposes of both the thin capitalization and withholding tax provisions to situations where an intermediary is put in place;

• Extension of back-to-back loan rules such that they will also apply to back-to-back arrangements involving royalty payments;

• Character substitution rules such that withholding tax provisions will also apply in cases where payments that are economically similar to interest and royalties are made as part of a back-to-back arrangement;

• Rules regarding debt parking (e.g. situations where non arm’s length parties acquire debt to avoid or delay recognizing a foreign exchange gain or a loss);

• Treaty abuse where going forward, Canada will consider either the principal purpose test or the limitation on benefits approach in its tax treaties;

• Canada Revenue Agency will commence exchanging tax rulings in 2016 with other jurisdictions that have committed to the minimum standard of exchanging rulings covering six categories of rulings: (i) rulings related to preferential regimes; (ii) cross-border unilateral advance pricing arrangements;(iii) rulings giving a downward adjustment to profits; (iv) permanent establishment rulings; (v) conduit rulings; and (vi) any other type of ruling agreed to in the future; and

• Automatic exchange of information between governments meaning that financial institutions must report information according to common reporting standards on accounts held by non-resident individuals and entities such as certain corporations, trusts and foundations. In Canada, the CRA signed the international Multilateral Competent Authority Agreement in June 2015 to activate the automatic exchange of financial information between tax jurisdictions beginning in 2018.

Transfer Pricing Documentation – Country-by-Country Reporting


The budget proposes to implement country-by-country reporting in Canada. The country-by-country report is a form that a large Multinational Enterprise (“MNE”) is required to file with the tax administration of the country in which the MNE’s ultimate parent entity resides. Information such as revenue, profit, tax paid, stated capital, accumulated earnings, number of employees and tangible assets, as well as the main activities of each of its subsidiaries is disclosed on the report.

The measure will apply to MNEs with total annual consolidated group revenue of €750M or more. Where such an MNE has an ultimate parent entity that is resident in Canada (or a Canadian resident subsidiary in certain circumstances), it will be required to file a country-by-country report with the CRA within one year of the end of the fiscal year.

Draft legislation will be released in the coming months.

Transfer Pricing Guidance


Recommendations from the OECD Action Plan on Base Erosion and Profit Shifting (“BEPS”) include revisions to Transfer Pricing Guidelines. These revisions provide for an improved interpretation of the arm’s length principal to ensure alignment of the profits of a MNE with the economic activities generating those profits. The budget states that the clarifications provided in the revisions generally support the CRA’s current interpretation and application of the arm’s length principle, as reflected in its audit and assessing practices. These revisions are thus being applied by the CRA as they are consistent with current practices.

However, in two areas where the revisions to the Transfer Pricing Guidelines are not yet complete, the budget says that CRA will not be adjusting its administrative practices at this time. The BEPS project participants are still engaged in follow-up work on the development of a threshold for the proposed simplified approach to low value-adding services. Work is also continuing to clarify the definition of risk-free and risk-adjusted returns for minimally functional entities (often referred to as “cash boxes”). Canada will decide on a course of action with regards to these measures after the outstanding work is complete.


GST/HST


Medical and Assistive Devices


Insulin pens, insulin pen needles, and intermittent urinary catheters will be added to the list of zero-rated medical devices. This means that supplier will not charge purchasers GST/HST on these supplies and will be entitled to claim input tax credits to recover GST/HST paid related to these supplies.


Purely Cosmetic Procedures


Cosmetic procedures are intended to be subject to GST/HST, regardless of the status of the supplier. The budget clarifies that GST/HST applies to procedures provided by all suppliers, including registered charities. These type of procedures include liposuction, hair replacement, hair removal, Botox injections and teeth whitening.

Cosmetic procedures required for medical or reconstructive purposes will continue to be exempt.


Call Centre Services


The budget proposes to modify the zero-rating rules for certain exported supplies of call centre services. Specifically, the supply of a service of rendering technical or customer support to individuals by means of telecommunications (e.g., by telephone, email or web chat) will generally be zero-rated for GST/HST purposes if:

• The service is supplied to a nonresident person that is not registered for GST/HST purposes; and

• It can reasonably be expected, at the time the supply is made, that the technical or customer support is to be rendered primarily to individuals who are outside Canada at the time the support is rendered to those individuals.

This measure will apply to supplies made after March 22, 2016 and to supplies made on or before March 22, 2016 in cases where the supplier did not, on or before that day, charge, collect or remit an amount as or on account of tax under Part IX of the Excise Tax Act in respect of the supply.


Reporting of Grandparented Housing Sales


The budget proposes to simplify special requirements for builders to report grandparented housing sales where the purchaser was not entitled to a GST New Housing Rebate or a GST New Residential Rental under transitional rules that applied when a province either started participating in HST or increased its HST rate.

The budget proposes to simplify builder reporting by:

• Limiting the reporting requirement to those grandparented housing sales for which the consideration is equal to or greater than $450,000; and

• Providing builders with an opportunity to correct past misreporting and avoid potential penalties by allowing them to elect to report all past grandparented housing sales for which the consideration was equal to or greater than $450,000.

This measure will apply for any reporting period of a person that ends after March 22, 2016. In addition, where builders make this election, the measure will also apply to any supply of grandparented housing for which the federal component of the HST became payable on or after July 1, 2010. Builders can generally make the election between May 1, 2016 and December 31, 2016.


Donations to Charities


The budget proposes a rule effective March 22, 2016 that provides that, when a charity supplies property or services in exchange for a donation, and when an income tax receipt may be issued for a portion of the donation, only the value of the property or services supplied will be subject to GST/HST. This will apply to supplies that are not already GST/HST exempt, and is intended to ensure that the portion of the donation that exceeds the value of the property or services supplies is not subject to GST/HST.

In addition, where a charity did not collect GST/HST on the full value of donations made in exchange for an inducement, for supplies made between December 21, 2002 (when the income tax split-receipting rules came into effect) and March 22, 2016, the budget provides that:

• If GST/HST was charged on only the value of the inducement, consistent with the income tax split-receipting rules, or if the value of the inducement was less than $500, the donors’ and charities’ GST/HST obligations will effectively be satisfied, resulting in no further GST/HST owing; and

• In other cases, the charity will be required to remit GST/HST on the value of the inducement only (i.e., the relieving split-receipting rules will apply).


De Minimis Financial Institutions


Persons who earn over $1 million in interest income in respect of bank deposits are considered financial institutions for GST/HST purposes in the following year.

Interest earned in respect of demand deposits, as well as terms deposits and GICs with an original due date to maturity not exceeding 364 days, will no longer be included in determining whether this $1 million threshold is reached.


Application of GST/HST to Cross- Border Reinsurance


The budget clarifies that two specific components of imported reinsurance services, ceding commissions and the margin for risk transfer, do not form part of the tax base that is subject to the self-assessment provisions contained in the GST/HST imported supply rules for financial institutions.

GST Closely Related Test


Closely related groups do not charge GST/HST on supplies made between each other. In addition to the existing criteria to be considered closely related, the budget proposes adding the requirement that the corporation or partnership must also control 90% or more of the votes in respect of every corporate matter of the subsidiary in order to be closely related (with limited exceptions).

Tariffs


Tariffs on about a dozen manufacturing inputs will be eliminated. Public consultations on tariffs on certain food manufacturing ingredients are expected to be launched.



OTHER CHANGES


Aboriginal Tax Policy


The budget states the government’s willingness to discuss and put into effect direct taxation arrangements with interested Aboriginal governments. The government will also continue to facilitate direct taxation arrangements between interested provinces or territories and Aboriginal governments.

Administrative Changes and Dispute Resolution


Additional funding will be provided to CRA to:

• Enhance CRA telephone services, including introducing a dedicated telephone support line for tax service providers;

• Make the CRA’s written correspondence more straightforward and easy to read;

• Clarify the rules governing the political activities of charities by having Finance and the CRA engage in discussion and consultations with charities and stakeholder groups;

• Increase CRA’s capacity to resolve taxpayer appeals and to provide more timely resolutions;

• Expand CRA’s local community organization volunteer program; and

• Improve the CRA’s ability to collect outstanding tax debts.



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Editor:

Brook Scarr, CPA, CA
Partner, Taxation

All rights reserved. Permission to reproduce or copy in any form or means is prohibited without the express written consent of SF Partnership, LLP. All information contained in this publication is general in nature, and should not be construed as professional advice. Readers are urged to consult their professional advisors before taking any action based on this publication. ©SF Partnership, LLP 2016