The Minister of Finance (Canada), the Honourable Bill Morneau, presented the Government of Canada's 2017 Federal Budget ("Budget 2017") on March 22, 2017 ("Budget Day"). Budget 2017 contains significant proposals to amend the Income Tax Act (Canada) (the "ITA") and the Excise Tax Act (the "ETA") while also providing updates on previously announced tax measures and policies.
Significant Budget 2017 proposals and updates include:
- Investing an additional $523.9 million over five years to prevent tax evasion and improve tax compliance.
- Extending the mutual fund merger rules to "switch" funds and segregated funds.
- Extending base erosion rules to Canadian life insurers with foreign branches.
- Two measures that clarify the timing of recognition of gains and losses on derivatives held on income account.
- Updates on Canada's participation in the Organisation for Economic Co-operation and Development ("OECD") project on Base Erosion and Profit Shifting ("BEPS").
Selected proposals and tax measures are detailed below:
Proposals to Reform the Tax System
A Fair and Efficient Tax System
In Budget 2017, the Canadian Government renewed its commitment to a fairer and more efficient tax system including by closing tax loopholes and eliminating ineffective and inefficient tax measures. Budget 2017 proposes an additional expenditure of $523.9 million over five years for the Canada Revenue Agency ("CRA") to fund new initiatives and extend existing programs to prevent tax evasion and improve tax compliance. The additional funding is to be used to hire more CRA auditors, develop systems to target high-risk international tax and abusive tax avoidance cases, and improve investigative work targeting criminal tax evaders.
Tax Planning Using Private Corporations
Budget 2017 raised the topic of tax planning using private corporations, although no specific measures were announced. The Canadian Government raised a concern that high-income individuals could gain unfair tax advantages by using tax reduction strategies, such as sprinkling income to family members using private corporations to achieve a lower overall tax rate, holding passive investments in a private corporation and converting private corporation ordinary income into capital gains, which benefit from a lower effective tax rate. The Canadian Government indicated that despite recent measures to limit certain planning arrangements, it is continuing its review of tax planning strategies involving private corporations. It also intends to review features of the income tax system that have a so-called "inappropriate, adverse impact of genuine business transactions involving family members". A paper should be released in the coming months setting out proposed policy responses to these issues.
International Tax Avoidance and Evasion - BEPS
Budget 2017 confirms Canada's commitment and continued participation in the OECD project on BEPS. The OECD BEPS project is intended to address concerns related to tax planning by multinationals ("MNEs") which rely on bilateral tax treaties and their interaction with domestic tax rules to minimize taxes for the overall enterprise.
Canada, along with other G20 members, endorsed the final package of reports and recommendations from the BEPS project which was released on October 5, 2015. Canada reiterated its commitment and participation in the BEPS project in Budget 2016.
Budget 2017 provides an update to the BEPS measures that have been or are in the process of being implemented, including:
- New legislation enacted in December 2016 introducing country-by-country reporting.
- Canada is pursuing signature of the multilateral instrument to streamline the implementation of treaty-related BEPS recommendations and is undertaking the necessary procedures to do so domestically.
- Canada is committed to improving the mutual agreement procedure in Canada's tax treaties.
- The CRA is engaging in spontaneous exchange of tax rulings with other tax administrations.
Practitioners and MNEs based in Canada, or with operations in Canada, continue to follow the Canadian Government's updates on the specific proposals that it intends to implement, as it was generally recognized that Canada already met the standards of some of the BEPS recommendations and other recommendations were not relevant to the Canadian context. To this end, Canada appears to be confirming that existing measures already address some of the BEPS recommendations. Budget 2017 notes that:
- Canada's "controlled foreign corporation" rules including the foreign accrual property income regime are robust.
- Canada has implemented requirements for certain taxpayers, advisors and promotors to disclose specified tax avoidance transactions to the CRA.
- The CRA is applying the revised interpretation of the arm's length principle in the Transfer Pricing Guidelines and will continue to do so.
Personal Income Tax Measures
Electronic Distribution of T4 Information Slips
Under the current rules, employers are required to send T4 slips to their employees' last known address or by delivering it to their employees. These slips may only be sent electronically with the express consent of the employee in advance. Budget 2017 proposes to allow employers to distribute T4 information slips electronically to current employees without having to obtain express consent from those employees in advance.
An employer will be required to have sufficient privacy safeguards in place which will be specified by the Minister. Paper T4s will be required where employees cannot access electronic T4s in a confidential manner such as employees on leave or former employees. An employee can also request paper T4s.
This measure will apply in respect of T4s issued for the 2017 and subsequent taxation years.
Extension of Mineral Exploration Tax Credit for Flow-through Share Investors
Budget 2017 proposes to extend eligibility for the 15% mineral exploration tax credit for one year to flow-through share agreements entered into on or before March 31, 2018.
Ecological Gifts Program
Budget 2017 proposes a number of measures to protect the integrity of gifts of ecologically sensitive property ("Ecogifts") for transactions or events occurring on or after Budget Day.
Transfer of Ecogifts: the 50% tax that applies when a charity, municipality in Canada, or municipal or public body performing a function of government in Canada, that is the recipient of the donated land changes the use of the property or disposes of it without the consent of Environment and Climate Change Canada ("ECCC") will be extended to the transferee in cases where Ecogifts are transferred between organizations for consideration and the transferee changes the use of the property or disposes of it without the consent of ECCC.
Program Administration: Budget 2017 clarifies that ECCC has the ability to determine whether the proposed changes to the use of lands would degrade conservation protections.
Approval of Recipients: the requirement for ECCC to approve recipients of Ecogifts will be extended, on a gift-by-gift basis, to municipalities and municipal and public bodies performing a function of government.
Private Foundations: private foundations will no longer be permitted to receive Ecogifts.
Personal Servitudes: in Québec, donations of personal servitudes will qualify as Ecogifts, provided they meet certain conditions, including a requirement that the personal servitude runs for at least 100 years.
Elimination of Home Relocation Loans Deduction
There is a deemed interest income inclusion when a person receives a loan because of their employment and the interest rate on the loan is below a prescribed rate. The amount of the benefit is determined by reference to the difference between these two rates. However, a deduction from taxable income is available in respect of a home relocation loan. Home relocation loans are generally loans used to acquire a new residence where the employee starts work at a new location. The amount deductible is generally limited to the annual benefit that would arise if the amount of the loan were $25,000. Budget 2017 proposes to eliminate the deduction in respect of home relocation loans noting that this deduction disproportionately benefits the wealthy and lacks a strong policy rationale.
This measure will apply to benefits arising in the 2018 and subsequent taxation years.
Anti-Avoidance Rules for Registered Plans
Budget 2017 proposes to extend the anti-avoidance rules that currently apply to Tax-Free Savings Accounts, Registered Retirement Savings Plans and Registered Retirement Income Funds to Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs).
These anti-avoidance rules include:
- The advantage rules, which help prevent the exploitation of tax attributes of a registered plan (e.g., by shifting returns from a taxable investment to a registered plan).
- The prohibited investment rules, which generally ensure that investments held by a registered plan are arm's length "portfolio" investments.
- The non-qualified investment rules, which restrict the classes of investments that may be held by a registered plan.
Subject to certain exceptions, this measure will apply to transactions occurring, and investments acquired after Budget Day. Investment income generated after Budget Day on previously acquired investments will be considered to be a "transaction occurring" after Budget Day.
Business Income Tax Measures
Investment Fund Mergers
Canadian mutual funds can be organized as trusts or corporations. Budget 2016 included a measure to prevent corporate rollover provisions in the ITA from being used by investors switching between a mutual fund corporation's "switch funds" on a tax-deferred basis. This opportunity had not been available to investors in mutual funds trusts.
Budget 2017 proposes amendments to facilitate the reorganization of a mutual fund corporation that is structured with switch funds into multiple mutual fund trusts on a tax-deferred basis. This proposal is to apply to qualifying reorganizations that occur on or after Budget Day.
Segregated funds are life insurance policies that have many similarities to mutual fund trusts. Budget 2017 proposes to allow insurers to merge segregated funds on a tax-deferred basis pursuant to provisions that are to be similar to the merger rules applicable to mutual fund trusts. This measure is to apply to mergers of segregated funds occurring after 2017.
Budget 2017 also proposes that segregated funds be permitted to carry over non-capital losses arising in taxation years that begin after 2017. The use of these losses is to be subject to normal limitations on the carrying forward and back of non-capital losses, including restrictions following a segregated fund merger.
Reclassification of Expenses Renounced to Flow-through Share Investors
Currently, an eligible small oil and gas corporation may treat up to $1 million of "cumulative development expenses" ("CDE") as "cumulative exploration expenses" ("CEE") when it is renounced to shareholders under a "flow-through share" agreement. In general, CEE may be deducted in its entirety from income of such investors in the year in which it is incurred, whereas only 30% of CDE is deductible each year on a declining balance basis. Consequently, CEE treatment is advantageous as it accelerates deductions available to investors. In addition, CDE incurred before March 31st by an eligible small oil and gas corporation, under a flow-through share agreement entered into before the end of the previous year, may be renounced to investors as CEE incurred in the previous year (the "Look-back rule").
Budget 2017 proposes to disallow eligible small oil and gas corporations from treating the first $1 million of CDE as CEE. Generally, this measure will apply in respect of expenses incurred after 2018 to which the Look-back rule does not apply to deem them as being incurred in 2018.
Treatment for Oil and Gas Discovery Wells
Budget 2017 proposes to treat certain exploration expenses incurred by oil and gas companies as CDE rather than as CEE. Currently, expenses incurred in drilling or completing an oil and gas "discovery well" (the first well drilled into a new reservoir) are treated as CEE, but are considered in Budget 2017 to be more appropriately classified as CDE because they typically relate to successful exploration activities already undertaken.
This measure will apply to expenses incurred after 2018, including those incurred in the first three months of 2019 which would otherwise have engaged the Look-back rule of the ITA and be deemed to have been incurred in 2018. However, these provisions will not apply in respect of expenses incurred before 2021 pursuant to a written commitment entered into before Budget Day to incur the expenses.
Meaning of Factual Control
Generally, the notion of "control" of a corporation under the ITA refers to de jure control, that is the right to elect the majority of the board of directors of the corporation. For certain limited purposes, such as the definition of "Canadian-controlled private corporation" and the associated corporations rules, the ITA also refers to de facto control which is more broadly defined. It exists where a person has any "direct or indirect influence that, if exercised, would result in control in fact of the corporation". In the assessment of the existence of de facto control, all the relevant factors generally need to be considered.
The recent decision of the Federal Court of Appeal in McGillivray (2016 FCA 99) has limited the scope of the de facto control test by restricting the influence to circumstances that include "a legally enforceable right and ability to effect a change to the board of directors or its powers, or to exercise influence over the shareholder or shareholders who have that right and ability" (the "Enforceable Right"). In the view of the Department of Finance, this restriction is not appropriate as it limits the scope of factors that may be taken into account in the analysis and from a policy perspective, the factual control test should not be dependent on the existence of such an Enforceable Right.
For taxation years that begin on or after Budget Day, the ITA will be amended and will specify that the determination of de facto control shall be done taking into account all factors relevant in the circumstances and shall not be limited to, and the relevant factors need not include, whether the taxpayer has an Enforceable Right.
Gains and Losses on Derivatives
Availability of Mark-to-Market in Profit Computation
Budget 2017 announces two new measures that clarify the scheme of the ITA in connection with the timing of the recognition of gains and losses on derivatives that are held on income accounts by taxpayers.
Elective Regime to use Mark-to-Market Method
Taxpayers computing gains and losses in connection with income from derivative financial instruments have been uncertain as to whether to follow the mark-to-market reporting rules. The proposals clarify that the mark-to-market method may be available in computing profit to taxpayers holding eligible derivative instruments on income account through a new election regime. An election is available for taxation years beginning after March 21, 2017, are effective for all subsequent years and may only be revoked with the consent of the Minister of National Revenue. To be eligible for such election, the derivative must be valued at fair value in a taxpayer's audited financial statements or have an otherwise readily ascertainable value.
Straddle Transactions - Anti-Avoidance
Budget 2017 recognizes that taxpayers holding derivatives may, in some circumstances, create a tax advantage by selectively timing dispositions through straddle transactions in which more than one derivative position in the market are held to generate offsetting gains and losses. Citing tax base erosion and fairness concerns, Budget 2017 proposes the introduction of anti-avoidance rules to prevent abuse through stop-loss rules which will defer the realization of any loss on the sale of a position to the extent of any unrealized gain on an offsetting position.
The new rule will not apply to positions: (i) held by financial institutions for the purposes of the mark-to-market rules or by mutual fund trusts or mutual fund corporations, (ii) which are part of the certain hedging transactions, (iii) that are offsetting and held for 30 days beginning on the date of disposition of the position; or (iv) that are part of a transaction or series of transactions none of the main proposes of which is to defer or avoid tax.
The stop-loss rules will generally apply to any loss realized on a position entered into after March 21, 2017.
Budget 2017 proposes to phase out the ability for certain professionals (i.e. accountants, dentists, lawyers, Quebec notaries, medical doctors, veterinarians and chiropractors) to exclude unbilled work in progress ("WIP") in calculating their income. Currently, these professionals can claim expenses on a current basis and only recognize income when services are actually billed.
For their first taxation year beginning on or after Budget Day, professionals will be required to recognize 50% of the lesser of the cost and the fair market value of WIP in computing income. For subsequent taxation years, 100% of the lesser of the cost and the fair market value of WIP will be so recognized.
International Tax Measures
Extending the Base Erosion Rules To Foreign Branches of Life Insurers
The tax treatment of Canadian-resident life insurance companies carrying on business abroad indirectly through a subsidiary or directly through a branch ("Foreign Branch") is different when it comes to income from the insurance of Canadian risks (e.g., risks in respect of persons resident in Canada). Generally, business income earned by a foreign affiliate or a Foreign Branch is not taxable at the Canadian taxpayer level. However, the foreign accrual property income ("FAPI") rules, which are aimed at taxing passive income of a foreign affiliate at the level of its Canadian parent when earned by the affiliate, contain an anti-avoidance rule whereby income of a controlled foreign affiliate from the insurance of Canadian risks is generally considered FAPI and is therefore taxable in the hands of the Canadian parent on an accrual basis. There is no analogous rule which prevents the shift of income from the insurance of Canadian risks by a Canadian life insurer to its Foreign Branch.
For taxation years that begin on or after Budget Day, the ITA will be amended to ensure that Canadian life insurers are taxable in Canada with respect to their income from the insurance of Canadian risks earned through a Foreign Branch unless less than 10 per cent of the gross premium income (net of reinsurance ceded) earned by the branch is premium income in respect of Canadian risks. In addition, anti-avoidance rules will be introduced to prevent the proposed rule being avoided through the use of "insurance swaps" or the ceding of Canadian risks. Finally, a life insurer will be treated as if it had insured Canadian risks if it can reasonably be concluded that the foreign risks he has insured through its Foreign Branch were insured as part of a transaction or series of transactions one of the purposes of which was to avoid the proposed rule.
Sales and Excise Tax Measures
Budget 2017 contains several proposed GST/HST changes, most of which are targeted at specific industries. Some of the more notable proposed changes are summarized below.
Prescription Drugs and Biologicals Amendments
Budget 2017 proposes to add naloxone (and its salts), a drug used for treating opioid overdose, to the list of zero-rated non-prescription drugs under paragraph 2(e) of Part I of Schedule VI of the ETA.
This proposed inclusion is expected to come into effect as of March 22, 2016, however it would not apply to any such drugs supplied, imported or brought into a HST-participating province on or before March 22, 2017, and for which GST/HST was charged, collected, remitted or paid.
Taxi Business Amendments
Budget 2017 proposes to broaden the definition of "taxi business" under the ETA to include commercial ride-sharing services that are similar to taxi services.
The proposed change would have the effect of requiring certain suppliers of commercial ride-sharing services to register for a GST/HST account and charge and collect GST/HST on their fares. Due to the operation of subsection 240(1.1), the registration and collection obligations would apply to such suppliers even if their total taxable sales remained below the $30,000 small supplier threshold.
The proposed change is expected to take effect as of July 1, 2017.
Previously Announced Tax Measures
Budget 2017 confirms the Canadian Government's intention to proceed with previously announced tax and related measures including:
- Measures announced on October 3, 2016 in relation to the capital gains exemption on the sale of a principal residence.
- The measure announced in Budget 2016 on information-reporting requirements for certain dispositions of an interest in a life insurance policy.
- Legislative proposals released on September 16, 2016 relating to income tax technical amendments.
- The legislative and regulatory GST/HST proposals released on July 22, 2016, including the changes to pension plan rules for master trusts and the revisions to the drop shipment rules.
- GST/HST measures relating to the joint venture election, as confirmed in Budget 2016.
Budget 2017 notes that such previously announced tax and related measures will be modified to take into account consultations and deliberations since their release and reaffirms the Canadian Government’s commitment to move forward as required with technical amendments to improve the certainty of the tax system.