Here’s what you need to know about the proposed Federal tax changes announced this week.
On Tuesday, February 27th, 2018 Finance Minister Bill Morneau tabled the 2018 Federal Budget, the third budget of Justin Trudeau’s liberal government. From a fiscal perspective, the 2018 Budget is more about what it doesn’t include – a path and timeline back to a balanced budget (Projected deficits of lesser than 12B each year until 2023…). From a tax perspective, the 2018 Budget did not contain a lot of changes but it does:
- Introduce draft legislation for a new tax system for holding passive investments inside a private corporation to phase out the small business deduction for corporations (and associated corporations) earning between $50,000 and $150,000 of passive investment income for taxation years that begin after 2018.
- Continue to close out perceived tax loopholes in the financial sector and certain tiered partnership structures.
- Impose international tax measures to limit the ability of non-resident shareholders to undertake transactions designed to extract Canadian corporate surplus in excess of a share’s paid-up capital.
- Enhance reporting requirements for certain Canadian resident trusts.
- Expand the ability for the Canada Revenue Agency to share information with other Canadian and international agencies.
The 2018 Budget is also notable for what it doesn’t include:
- Changes to the personal or corporate income tax rates.
- Clarification or modification to the income sprinkling rules released in December 2017.
- Changes to the inter-generational transfer of businesses.
- Any response to the US tax changes (other than it will do a review in the coming months to assess the impact).
- Changes to the capital gains inclusion rates or stock option deductions.
Business Tax Measures
Corporate income tax rates
The budget did not announce any changes to federal corporate income tax rates. As a result, corporate income tax rates for companies doing business in BC will remain as follows:
|Corporate Income Tax Rates - As of January 1 st , 2018|
|BC||Combined (Federal and BC)|
|Small business 1, 2||2%||12%|
1 For first $500,000 of taxable active business income
2 The budget confirms that measures to reduce the small business tax rate from 10% (from 10.5%), effective January 1, 2018, and to 9%, effective January 1, 2019, included in a Notice of Ways and Means Motions tabled on October 24, 2017 together with related amendments to the gross –up amount and dividend tax credit for taxable dividends will proceed as planned.
Corporate Tax Planning and Tax Reduction Strategies
As we discussed in 2018 BC Budget Tax Highlights, significant tax proposals were released (along with detailed draft legislation for the first two items) on July 18, 2017 that targeted the following three areas:
- Income sprinkling (including multiplication of the capital gains exemption)
- Converting income into capital gains
- Holding passive investments inside a private corporation
On December 13, 2017, updated draft legislation was released making substantial changes to the first items, abandoning the second item but no legislation for the third item. While some of the most problematic issues outlined in the July 18, 2017 legislation on income sprinkling were removed (including the restriction on multiplying the capital gains exemption), much uncertainty and complexity in applying the rules currently still remains. We believe much of this uncertainty (and certainly complexity) could be avoided by introducing a “bright-line” age test to be applied to adult family members over which income sprinkling would be allowed; however the government indicated its intention to move forward with the changes on income sprinkling as outlined in December (but provided no additional detail or clarification of what are considerable issues). We will continue to monitor this area.
Passive Investment Changes
Concerning the third item above, the 2018 Budget introduces draft legislation for holding passive investments inside a Canadian controlled private corporation that will apply for taxation years starting after 2018. These proposed rules are vastly different then what was outlined in the July 18, 2017 discussion paper. The good news is that the changes do not increase the tax rate on investment income earned inside Canadian controlled private corporation and do not increase the personal taxes on dividends received. Instead, the government has decided to target the small business deduction limit for corporate groups that are earning more than $50,000 of investment income. How this happens is outlined below.
There continues to be no changes in how foreign controlled corporations or public corporations are treated on investment income.
Business limit reduction
Canadian controlled private corporations (CCPC) (and their associated corporations) earning greater than $50,000 of Adjusted Aggregate Investment Income (see below) will have their $500,000 federal business limit reduced by $5 for every $1 of investment income earned above the $50,000 threshold amount. The result is that the $500,000 business limit will be eliminated when a CCPC earns $150,000 of investment income in a given taxation year. The 2018 Budget provides that the business limit reduction will be the greater of the amount under these new proposed rules and the rules currently in place to phase-out the business limit for an associated group of corporations with “taxable capital employed in Canada” between $10 million and $15 million.
Adjusted Aggregate Investment Income is a new concept which is meant to include investment income but adjusted for the following:
- Taxable capital gains (and losses) will be excluded to the extent they arise from the disposition of
- A property that is used principally in an active business carried on primarily in Canada by the CCPC or by a related CCPC; or
- A share of another CCPC that is connected with the CCPC, where, in general terms, all or substantially all of the fair market value of the assets of the other CCPC is attributable directly or indirectly to assets that are used principally in an active business carried on primarily in Canada, and certain other conditions are met;
- Net capital losses carried over from other taxation years will be excluded;
- Dividends from non-connected corporations will be added; and
- Income from savings in a life insurance policy that is not an exempt policy will be added, to the extent it is not otherwise included in aggregate investment income.
While these new rules will apply for taxation years that begin after 2018 and the 2018 Budget states that rules will apply to prevent transactions designed to avoid the measure, such as the creation of a short taxation year in order to defer its application and the transfer of assets by a corporation to a related corporation that is not associated with it.
Limiting access to refundable taxes
Currently when a CCPC earns investment income, a portion of the income taxes it pays on that income goes into a refundable dividend tax on hand (RDTOH) balance. This portion of the tax is refundable to the CCPC (a dividend refund) when it pays a taxable dividend to its shareholder.
When the CCPC also has earned active business income that was subject the high corporate tax rate, the CCPC has the ability to pay an eligible dividend. This eligible dividend is subject to tax in the hands of an individual at a much lower tax rate than a regular (or non-eligible) dividend.
Under the current tax rules, a CCPC is entitled to a dividend refund upon the payment of both an eligible and a non-eligible dividend. If the dividend refund arises when an eligible dividend is paid, there is a tax benefit obtained, which the 2018 Budget proposes to eliminate.
Effective for taxation years that begin after 2018, a CCPC will only be entitled to a dividend refund upon the payment of a non-eligible dividend (an exception is provided in respect of refundable taxes arising from eligible portfolio dividends received by a CCPC). In order to implement this change, the 2018 Budget proposes to introduce a new RDTOH account to operate in conjunction with the current RDTOH account. The new RDTOH account will be called “eligible RDTOH” and will separately track and pool only refundable taxes paid only under Part IV of the Income Tax Act. The RDTOH account under the current tax rules will be redefined as “non-eligible RDTOH” that will separately track and pool only refundable taxes paid resulting under Part I of the Act. The payment of a non-eligible dividend will result in a dividend refund only from non-eligible RDTOH account.
In addition, a CCPC paying a non-eligible dividend must claim a dividend refund from the non-eligible RDTOH account to the extent possible before obtaining a refund from its eligible RDTOH account.
In order to deal with any existing RDTOH balances, there are specific transitional measures:
- For CCPCs, the lesser of its existing RDTOH balance and 38 1/3% of the General Rate Income Pool (GRIP), if any, will be allocated to the eligible RDTOH account. Any remaining balance will be allocated to its non-eligible RDTOH account.
- For other private corporations, all of the existing RDTOH balance will be allocated to its eligible RDTOH account.
Other Business Tax Changes
At-risk rules for tiered partnerships
The Income Tax Act contains “at risk rules” to prevent investors in limited partnerships from claiming losses in excess of their at risk amount. The at risk amount generally represents the amount of invested capital that a limited partner has in the partnership (after taking into account income/losses allocated, withdrawals /contributions made plus the original investment). The Income Tax Act contains various anti-avoidance rules designed to prevent an artificial increase to the at risk amount. Following a recent court case, one area of perceived abuse by the government involves the use of tiered partnership structures. The 2018 Budget proposes new rules to ensure that the limited partnership losses of the lower-tier partnerships that can otherwise be allocated to its partners who are partnerships will be restricted to the upper-tier partnership’s at-risk amount in respect of the lower-tier partnership. In addition, limited partnership losses of a limited partner that is itself a limited partnership will no longer be eligible for indefinite carry-forward.
These budget proposals will be effective for taxation years ending on or after February 27, 2018, including in respect of losses incurred in taxation years that end prior to February 27, 2018. In particular, losses from a partnership incurred in a taxation year that ended prior to February 27, 2018 will not be available to be carried forward to a taxation year that ends on or after February 27, 2018 if the losses were allocated – for the year in which the losses were incurred – to a limited partner that is another partnership.
Clean Energy Generation Equipment
The eligibility for investment in specified clean energy generation and conservation equipment under class 43.2 of the capital cost allowance (CCA) tax regime is extended to property acquired before 2025 (from 2020). Class 43.2 generally allows for a 50% accelerated tax deduction rate on a declining balance for acquisitions of specified clean energy generation and conservation equipment.
Personal Tax Measures
Personal income tax rates
The budget did not announce any changes to federal corporate income tax rates. As a result, the top personal income tax rates for BC residents will remain as follows for the 2018 year:
|Personal Top Marginal Rates
(Income > $202,800)
|Interest and regular income||49.80%|
Note: The tables shown above represent the combined Federal/BC Provincial personal tax rates.
Personal Tax Changes
Reporting requirements for trusts
Starting January 1, 2021, most Canadian-resident family trusts and non-resident trusts that are currently required to file a T3 return will need to provide additional information contained in the trust deed (i.e. name of trustee, beneficiaries, settlor(s), protector/appointer) on an annual basis. Certain trusts will be excluded from the new reporting requirements. These trusts include those governed by registered plans (DPSP, RPP, RRSP, RRIF, TFSA, etc.), lawyer’s trust accounts, graduated rate estates and qualified disability trusts, trusts qualifying as non-profit organizations or registered charities, and trusts less than three months old or that generally hold less than $50,000 in assets throughout the year.
The Canada Revenue Agency will also be provided additional funding to help audit these returns and support the development of a platform to allow e-filing of the returns.
In addition to existing penalties that will continue to apply, new penalties for not filing a T3 return (including a beneficial ownership schedule where required) are being introduced equal to $25 per day, with a minimum penalty of $100, up to a maximum of $2,500. An additional 5% penalty (minimum $2,500) applied on the maximum value of property held during the year will apply where the failure to file was made knowingly or due to gross negligence.
Mineral exploration tax credit for flow-through shares
This personal tax credit is extended for an additional year and will apply to flow-through share agreements entered into on or before March 31, 2019.
Medical Expense Tax Credit
For 2018, this non-refundable tax credit is available for qualifying medical expenses in excess of the lesser of $2,302 and 3% of the individual’s net income. This credit is being expanded to include expenses incurred for service dogs, etc. to assist a patient suffering with a severe mental impairment.
Canada Workers Benefit
The Working Income Tax Benefit is renamed the Canada Workers Benefit and is intended to improve work incentives for low income Canadians. Effective for 2019 and subsequent taxation years, the maximum benefit under this program, and the disability supplement, will be increased and the phase-out threshold limit will also be increased.
International Tax Changes
Cross-border surplus stripping using partnerships or trusts
The current rules are intended to prevent a non-resident from obtaining a tax benefit through a transfer shares of a Canadian resident corporation to another Canadian resident corporation that it does not deal at arm’s length with. Effective February 27, 2018, the 2018 Budget proposes to introduce a comprehensive set of “look-through” rules to address tax planning undertaken to avoid these provisions through the use of a partnership (or trust) that owns shares of a Canadian corporation.
A number of changes have been proposed in this area, which include:
- The determination of an investment business for purposes of determining the foreign affiliate’s foreign accrual property income is modified to ensure that separate taxpayers are not combining their assets in a common affiliate and taking the position that the affiliate is carrying on a single business while their respective returns are determined separately by reference to their contributed assets.
- The determination of whether a foreign affiliate is a controlled foreign affiliate is modified to ensure taxpayers are not using tracking arrangements to avoid a controlled foreign affiliate status.
The above items are effective for taxation years that begin on or after February 27, 2018.
Previously, taxpayers had 15 months after their year-end for file the required information form relating to the foreign affiliate (Form T1134). Starting for taxation years that begin after 2019 the new deadline is 6 months after the taxpayer’s year-end.
Audits involving foreign affiliates – Extended reassessment period
Effective for taxation years beginning on or after February 27, 2018, the 2018 Budget extends a taxpayer’s reassessment period from (generally) four years to seven years after the initial assessment. The extension is only in respect of income arising in connection with a foreign affiliate of the taxpayer.
Administrative and Other Changes
Reassessment period for loss carrybacks – Non-resident non-arm’s length persons
Budget 2018 proposes to amend the Income Tax Act to provide the CRA with an additional three years to reassess a prior taxation year of a taxpayer, to the extent the reassessment relates to the adjustment of the loss carryback, where: a reassessment of a taxation year is made as a consequence of a transaction involving a taxpayer and a non-resident person with whom the taxpayer does not deal at arm’s length; the reassessment reduces the taxpayer’s loss for the taxation year that is available for carryback; and all or any portion of that loss had in fact been carried back to the prior taxation year.