From a tax perspective, the headline news is that Budget 2018 completes the Government of Canada’s general retreat from the astounding – and, to many in the tax community, largely incoherent – July Proposals to address passive investment income in private corporations.
The revised measures introduced on December 13, 2017, dealing with the expansion of the tax on split income rules, while clearer and more measured, were not without flaws. Some feared that Budget 2018 may reintroduce the rules addressing surplus stripping, which were taken off the table in mid-October. Those fears were unfounded.
Budget 2018 completes the retreat: the proposed rules governing passive investment income earned in private corporations do not bear any resemblance to the measures contained in the July Proposals. The Minister of Finance and his team should be commended for recognizing the serious problems with the July Proposals, and for addressing them effectively.
The remaining tax measures in Budget 2018 are, for the most part, either modest fixes of anti-avoidance rules in several areas, including international taxation, financial instruments and financial markets, and charities, or a reworking of social measures to make them more generous and accessible.
On the expenditure side, Budget 2018 presents a broad vision of gender equality, innovation and reconciliation, with a full panoply of programs and expenditures to address these themes.
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PASSIVE INVESTMENTS EARNED IN PRIVATE CORPORATIONS
Corporate income tax rates are significantly lower than the highest marginal income tax rate for individuals. This differential has been justified on the basis that the retained surplus is available to the corporation for reinvestment in the business or as safeguard against risks to the business. The differential further ensures Canada's corporate tax rate remains competitive with tax rates in other countries with which Canada competes for capital. The relatively low general corporate rate ("GCR") and the even lower small business rate ("SBR") have fostered Canada's reputation of welcoming productive business investment.
The July Proposals
The passive investment proposals in the July 18, 2017 Consultation Paper (the "July Proposals" and "July Consultation Paper") sought to address a perceived flaw in Canada's corporate tax rules by providing for a substantial reformulation of the rules governing passive investment income earned in a private corporation. From the perspective of the July Consultation Paper, the flaw - the "deferral advantage" - arises from the fact that an individual who incorporates a business will, after the payment of corporate level taxes at either the GCR or SBR, have more capital to invest pending the ultimate distribution of the corporate surplus by a dividend to the shareholder, as compared to an individual taxpayer who earned the same original amount and paid personal income tax in the year earned.
The July Consultation Paper suggested that the increase in the levels of income being earned in private corporations in recent years results from individual taxpayers incorporating their businesses so as to reduce current taxation on business income to the SBR or to the GCR. It was suggested that taxpayers were using their corporations to accumulate wealth or to "save". The July Proposals viewed the amount of the deferral advantage as equal to the passive income earned on this "incremental capital". Therefore, if all of that income from incremental capital were subject to a 100 per cent tax, half paid by the corporation in the year the passive income is earned and the other half paid on distribution, the deferral advantage would be eliminated.
A New Approach
Budget 2018 considerably scales back the policy objectives of the new rules governing passive investments earned in a private corporation. In fact, the new rules bear little resemblance to the July Proposals. Instead, two new passive investment rules relating to private corporations are proposed.
The first rule reduces eligibility for the small business deduction by a calculation based on corporation's investment income for a particular taxation year. The purpose of this rule is to reduce the funds in the corporation available for investment by subjecting the affected active business income to the GCR, rather than the SBR. The second rule seeks to deny the refund of Refundable Dividend Tax on Hand ("RDTOH") on the payment of eligible dividends that are paid from corporate income taxed at the GCR. Stated otherwise, for investment income to come out of a corporation in an integrated manner, the dividend must be a non-eligible dividend.
The first rule reduces the small business deduction by reducing the business limit for a corporation earning active business income pursuant to a formula which tracks the investment income of the corporation. For the purposes of this formula, investment income is defined as "aggregate investment income" with a number of adjustments. The intention is to eliminate the small business deduction in situations where the corporation is earning excess investment income, as determined by the formula. To the extent the corporation's income becomes subject to the GCR, a component of the deferral advantage is removed.
The reduction of the business limit is effected as follows. The corporation would calculate its adjusted aggregate investment income ("AAII") by adjusting its aggregate investment income as follows:
- Capital gains and capital losses realized on the disposition of "active assets" are not included in the calculation. For this purpose, "active assets" includes property that is:
- used principally in an active business carried on primarily in Canada by the corporation or by a corporation related to it; and
- shares of the capital stock of another corporation where the other corporation is connected to it and the shares would be qualified small business corporation shares were they owned by an individual;
- Net capital losses from previous years are not included;
- Dividends from a corporation that is not connected to the corporation are included in the calculation; and
- Income earned in the savings portion of a non-exempt life insurance policy is included.
The corporation would reduce its business limit by five times the amount that its AAII exceeds $50,000. Thus, if the AAII is $50,000, there is no reduction of the business limit. However, if the AAII is $100,000, the reduction to the business limit is $250,000. And if the AAII is $150,000, the reduction to the business limit is $500,000, and no small business deduction would remain available.
Under these rules, the total amount of investment income will adjust the SBR and there is no grandfathering of assets held by a corporation prior to Budget Day. Anti-avoidance rules will be put in place to deem corporations to be associated with each other for purposes of the ITA, if they enter into arrangements to avoid the application of these rules.
RDTOH Refund Only on Payment of Non-eligible Dividend
The second rule targets another component of the deferral advantage. Under the current rules, a corporation earning both active business income taxed at the GCR and investment income can pay an eligible (or a non-eligible) dividend using funds sourced from the investment income and be entitled to a refund of the associated RDTOH. The eligibility for the refund of the RDTOH is not tied to whether the dividend is an eligible or ineligible dividend. The proposed new rules would remedy this by denying the refund of the RDTOH, where the dividend is an eligible dividend.
This will be achieved as follows:
- There will be 2 RDTOH accounts:
- one account, the new account ("eligible RDTOH") will track Part IV tax paid on eligible dividends;
- The other, current RDTOH account ("non-eligible RDTOH") will track refundable taxes paid on non-eligible dividends and on investment income.
- Any dividend paid from the eligible RDTOH account, subject to an ordering rule, will entitle the corporation to a refund;
- The corporation will be entitled to a refund in the non-eligible RDTOH account on the payment of non-eligible dividends only;
- Dividends paid to a connected corporation that give rise to an RDTOH refund in the payor corporation will go into the correct RDTOH account of the payee, depending on the source of the dividend to the payor; and
- Where a corporation pays a non-eligible dividend, it will be required to take a refund from its non-eligible RDTOH account in priority to its eligible RDTOH account.
These rules apply for taxation years that begin after 2018. On a transitional basis, existing RDTOH accounts will be divided into eligible and non-eligible accounts. For a CCPC, the lesser of its existing RDTOH account and 38 1/3 per cent of its general rate income account will be allocated to its eligible RDTOH account. For other private corporations, all of its existing RDTOH will be allocated to its eligible RDTOH account.
Anti-avoidance rules will be put in place to restrict companies from deferring the application of these new rules through the creation of a shortened taxation year.
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REPORTING REQUIREMENTS FOR TRUSTS
The Government of Canada has proposed to amend the rules applicable to income tax reporting for certain trusts, with the stated purpose of reducing aggressive tax avoidance, tax evasion, money laundering and other criminal activities perpetrated through the misuses of certain vehicles.
Budget 2018 will require that certain trusts file a return of income (a T3 return), where such a requirement does not currently exist and to report new information. A trust that does not earn income or make distributions in a year is generally not required to file a T3 return. A trust is required to file a T3 return if the trust has tax payable or it distributes all or part of its income or capital to its beneficiaries. However, there is currently no requirement for the trust to report the identity of its beneficiaries.
The proposed new regime will apply to express trusts (being most trusts - whether testamentary or inter vivos - but excluding resulting or constructive trusts) and to non-resident trusts that are currently required to file a T3 return. The new regime will not apply to graduated rate estates, qualified disability trusts, mutual fund trusts, segregated funds, master trusts, trusts governed by registered plans, trusts that qualify as non-profit organizations or registered charities, trusts that have been in existence for less than three months or trusts that hold less than $50,000 in assets throughout the taxation year (provided such assets consist of deposits, government debt obligations and listed securities).
The new regime will require trusts to report the identity of all trustees, beneficiaries and settlors of the trust, as well as the identity of each person who has the ability to exert control over trustee decisions regarding the appointment of income or capital of the trust. Failure to comply with the new reporting requirements will give rise to penalties of $25 for each day of delinquency, with a minimum penalty of $100 and a maximum penalty of $2,500. An additional penalty will apply if the failure to file the T3 return was made knowingly or due to gross negligence, in an amount equal to five per cent of the fair market value of the property held by the trust during the relevant year, with a minimum penalty of $2,500. The new reporting requirements and penalty provisions will apply to returns required to be filed for a trust's 2021 and subsequent taxation years.
In conjunction with the foregoing, the Government of Canada has proposed to introduce legislative amendments to the Canada Business Corporations Act to strengthen the availability of beneficial ownership information and will be looking to collaborate with the provinces and territories to do the same with their provincial corporation statutes, so as to provide a more transparent overall system.
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AT-RISK RULES FOR TIERED PARTNERSHIPS
In response to the Federal Court of Appeal's decision in Canada v Green, 2017 FCA 107, Budget 2018 provides technical amendments addressing limited partnership losses in the context of tiered partnership structures, i.e. where one partnership (an "upper-tier partnership") is a partner in another partnership (a "lower-tier partnership").
Under the current rules, losses allocated by a limited partnership to a limited partner in excess of the limited partner's "at-risk amount" is the limited partner's "limited partnership loss" for the taxation year and not deductible in that year. A taxpayer can carry-forward "limited partnership losses" indefinitely, and deduct them in subsequent taxation years to the extent of the taxpayer's "at-risk amount" in subsequent years.
However, the longstanding position of the Canada Revenue Agency ("CRA") has been that an upper-tier partnership could not carry-forward a "limited partnership loss" from a particular year for deduction in subsequent taxation years, because it was not a "taxpayer" for purposes of the relevant Income Tax Act ("ITA") provision, nor could the upper-tier partnership allocate such losses to its own partners. This CRA position was successfully challenged by the taxpayer in Green.
Budget 2018 notes that the decision in Green could result in limited partnership losses becoming deductible in situations where, "under the long-standing understanding of the at-risk rules, they would have been restricted." To address this perceived concern, Budget 2018 will amend the ITA to specify that where the limited partner of the partnership is an upper-tier partnership, its loss in excess of its "at-risk amount" will not be deemed to be a limited partnership loss and not eligible for carry-forward. A further amendment to the ITA will reduce the reduction of the upper-tier partnership's adjusted cost base in the lower-tier partnership by such excess amount, thereby permitting the loss to be realized on a disposition of the lower-tier partnership.
In some instances, it would appear that these new rules will have the effect of converting what would otherwise be a non-capital loss to a capital loss. Careful consideration of these new rules will have to be undertaken in the context of any tiered partnership planning.
The rule will apply in respect of taxation years that end on or after Budget Day, including in respect of losses incurred by a lower-tier partnership in taxation years that ended prior to Budget Day.
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DIVIDEND STOP-LOSS RULES ON SHARE REPURCHASE TRANSACTIONS
Budget 2018 proposes to amend the "dividend stop-loss" rules in the ITA to decrease the amount of a tax loss that can be claimed by a taxpayer that holds shares as mark-to-market property where such shares are repurchased in circumstances where the taxpayer is deemed to receive a deductible intercorporate dividend on the repurchase.
Generally, where a corporate taxpayer disposes of shares on which it has received deductible intercorporate dividends, the "dividend stop-loss" rules of the ITA apply to limit the amount of the tax loss that would otherwise be realized by the taxpayer by the amount of such dividends. These rules apply equally to dividends deemed to be received by a taxpayer on a repurchase of its shares by the issuer.
With respect to shares held as mark-to-market property, where the dividend stop-loss rules apply, the current formula under which the allowable tax loss is computed only denies the portion of the loss that is equal to the excess of the original cost of the shares over their paid-up capital ("PUC"). Accordingly, under the current rules, it is possible for the denied tax loss to be less than the amount of the dividend deemed to be received by the taxpayer on the repurchase transaction. This allows the taxpayer to use losses that are not denied to offset other income (and may exceed any prior mark-to-market income inclusion of the taxpayer on the repurchased shares).
Budget 2018 proposes to amend the current rules so that the tax loss realized on the repurchase of a share that is mark-to-market property will generally be decreased by the full amount of any deemed dividend arising on such repurchase when that dividend is eligible for the intercorporate dividend deduction. Budget 2018 states that this rule is intended to target some Canadian financial institutions that seek to realize a tax loss on a share repurchase transaction in excess of the mark-to-market income previously realized by the institution on the shares. In the absence of such an amendment, Budget 2018 suggests, if the repurchased shares were fully hedged, the Canadian financial institution would realize an "artificial loss" on the shares.
The rule is proposed to apply to share repurchases that occur on or after Budget Day.
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ARTIFICIAL LOSSES USING EQUITY-BASED FINANCIAL ARRANGEMENTS
Budget 2018 proposes to amend certain rules first introduced by Budget 2015 to address arrangements that are perceived to use the intercorporate dividend deduction in an inappropriate manner.
Before 2015, certain types of equity derivatives could be used in transactions to which the "dividend rental arrangement" rules did not apply. The dividend rental arrangement rules deny the intercorporate dividend deduction to a taxpayer, where one of the main reasons for the arrangement is to allow one taxpayer to receive dividends on Canadian shares, while the risk of loss or opportunity for gain in respect of those shares accrues to another taxpayer. The Government of Canada was concerned that certain financial institutions entered into derivative arrangements, to which the dividend rental arrangement rules did not apply, pursuant to which the financial institution would retain ownership of the Canadian shares, receive dividends on those shares, and use the intercorporate dividend deduction, while making tax-deductible "dividend equivalent" payments to a counterparty that retained the economic attributes of the shares.
Budget 2015 introduced rules to deny the intercorporate dividend deduction for a dividend on a share in respect of which there was a "synthetic equity arrangement". A "synthetic equity arrangement" is an arrangement whereby a taxpayer surrenders the economic attributes of a share, but retains the right to receive dividends, while thereby remaining eligible for the dividend deduction. However, these rules do not apply if there is no "tax-indifferent investor" as a party to the arrangement.
The Government of Canada is concerned that certain taxpayers are still engaging in transactions that are not subject to the dividend rental arrangement or synthetic equity arrangement rules. Budget 2018 proposes further amendments to the ITA to address this in two ways.
Synthetic Equity Arrangements
A taxpayer that holds a Canadian share can satisfy the no tax-indifferent investor exception to the synthetic equity arrangement rules if the taxpayer can establish that no tax-indifferent investor has all or substantially all of the risk of loss and opportunity for gain in respect of the share by virtue of a synthetic equity arrangement or another equity derivative that is entered into in connection with a synthetic equity arrangement (a "specified synthetic equity arrangement"). Currently, a taxpayer can satisfy this exception by obtaining certain representations from its counterparty.
The Government of Canada has expressed concern that certain taxpayers take the position that the no tax-indifferent investor exception is available where there is no synthetic equity arrangement or specified synthetic equity arrangement, but a tax-indifferent investor still obtains all or substantially all of the risk of loss and opportunity for gain or profit.
Budget 2018 proposes to amend the no tax-indifferent investor exception to clarify that the exception cannot be met when a tax-indifferent investor obtains all or substantially all of the risk of loss and opportunity for gain or profit in respect of the Canadian share, even where there is no synthetic equity arrangement or specified synthetic equity arrangement.
The proposed change will apply to dividends paid on or after Budget Day.
Securities Lending Arrangements
Budget 2018 addresses planning that applies to complex securities lending and repurchase arrangements that the Government of Canada believes can artificially increase losses. In this planning, taxpayers enter into arrangements resembling securities lending arrangements, but which fail to meet the requirements of the current "securities lending arrangement" definition in the ITA. Under this type of planning, the taxpayer deducts both the dividend compensation payment and the intercorporate dividend, thereby generating an artificial loss.
Budget 2018 proposes to extend the securities lending arrangement rules to transactions that are substantially similar to such arrangements and thereby deny the intercorporate dividend deduction and limit the taxpayer's deduction to an amount equal to the dividend compensation payment.
Another minor amendment will also be made to the securities lending rules to clarify that the two-thirds dividend compensation payment deduction available to "registered securities dealers" does not apply where the intercorporate dividend deduction is denied, in which case the full amount of the dividend compensation payment will be deductible.
The new rules will apply to dividend compensation payments made on or after Budget Day unless the arrangement was put in place before Budget Day, in which case the new rules will apply after September 2018.
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INTERNATIONAL TAX MEASURES
Similar to Budget 2017, Budget 2018 does not contain significant new international tax measures, although Canada has been moving forward with implementing certain of the action items in the Base Erosion and Profit Shifting report of the Organisation for Economic Co-operation and Development. Since Budget 2017, Canada has already signed and, as of January 31, commenced domestic procedures to ratify, the Multilateral Convention to implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.
The proposals in Budget 2018 are primarily targeted at closing certain specific perceived international tax planning loopholes. Budget 2018 notes that any results contrary to the policy intent of the proposals that are not caught by the proposed rules should expect to be challenged under the general anti-avoidance rule.
Foreign Affiliate and FAPI Rules
Budget 2018 proposes certain changes to the foreign affiliate and foreign accrual property income ("FAPI") rules targeting a specific area of abuse. The trading or dealing in indebtedness rules are also to be amended so as to be more consistent with similar conditions currently in the "investment business" rules of the FAPI regime. The following proposed rules are effective for taxation years of a foreign affiliate that begin on or after Budget Day.
Under the current foreign affiliate rules, a foreign affiliate that employs more than five full-time employees (or the equivalent) in the active conduct of a business, the principal purpose of which is to derive income from property, could have that business excluded from the definition of "investment business" where certain other conditions are met. If the business of the foreign affiliate is excluded from the definition of "investment business," the affiliate's business is treated as an active business and income from that business is included in "exempt surplus" under Canada's foreign affiliate regime and excluded from immediate taxation under Canada's FAPI regime (where the foreign affiliate is a controlled foreign affiliate of its Canadian shareholder). The current "investment business" definition applies on a business-by-business basis.
The Government of Canada believes that certain taxpayers whose foreign investment activities would not otherwise have required more than five full-time employees have engaged in tax planning with other taxpayers to circumvent this rule. Such planning often involves taxpayers grouping financial assets together in a common foreign affiliate and carrying on investment activities outside Canada through that affiliate. The taxpayers then take the position that the foreign affiliate is carrying on a single business with more than five full-time employees. These arrangements generally require planning that ensures that each participating taxpayer retained control over its contributed assets and that any returns on such assets accrued to the relevant taxpayer ("tracking arrangements").
To prevent this type of planning in the future, Budget 2018 proposes that the activities carried on by a foreign affiliate using such tracking arrangements each be deemed to be separate businesses. Consequently, the proposed rule ensures that taxpayers involved in a tracking arrangement of this nature cannot unduly avoid the definition of "investment business."
Budget 2018 also proposes a rule to deem a foreign affiliate of a taxpayer to be a controlled foreign affiliate of the taxpayer, if FAPI attributable to activities of the foreign affiliate accrues to the benefit of the taxpayer under a tracking arrangement. This proposed rule is intended to ensure that each taxpayer involved in such a tracking arrangement, no matter how large the group, is subject to accrual taxation in respect of FAPI attributable to that taxpayer.
In addition to the five-employee requirement, another condition for the current exception to the definition of "investment business" requires a taxpayer to satisfy certain minimum capital requirements to qualify for the regulated foreign financial institutions exception of that definition. Budget 2018 proposes a similar minimum capital requirement within the trading or dealing in indebtedness rules. The trading or dealing in indebtedness rules are similar to the investment business rules, in that where the principal purpose of a business carried on by a foreign affiliate is to derive income from trading or dealing in indebtedness, the income of that business is generally treated as FAPI of the affiliate. This proposal ensures consistency between the two sets of rules.
Cross-Border Surplus Stripping Rules
Budget 2018 proposes to revise the cross-border surplus stripping rules. The proposed rules will apply to transactions that occur on or after Budget Day. In particular, the existing cross-border anti-surplus-stripping rules are intended to prevent a non-resident shareholder from extracting, tax-free, a Canadian corporation's surplus in excess of the PUC of its shares or to artificially increase the PUC of such shares. These rules can result in a deemed dividend to the non-resident or can suppress the PUC that would otherwise have been created. These cross-border surplus stripping rules prevent a non-resident shareholder from stripping a Canadian corporation's surplus tax-free through a transfer of the shares of one corporation resident in Canada to another such corporation with which the non-resident does not deal at arm's length, in exchange for shares of the later corporation or other forms of consideration. Since the rules do not expressly address situations where a non-resident person disposes of an interest in a partnership that owns shares of a Canadian resident corporation, Budget 2018 proposes to amend the rules to add look-through rules for partnerships and trusts. Under the amended rules, the assets, liabilities and transactions of a partnership or trust will be allocated to its members/partners or beneficiaries, as the case may be, based on the relative fair market value of their interests. As a result, the rules will apply to deem a dividend to the non-resident or supress the PUC of the underlying Canadian corporation, in the same manner as if the partnership/trust had not been interposed between the non-resident and the Canadian corporation.
Reporting Requirements - T1134
Taxpayers resident in Canada with a non-resident corporation or trust as a foreign affiliate or controlled foreign affiliate are required to file an annual Form T1134 information return relating to controlled and non-controlled foreign affiliates. Presently, Form T1134 is due 15 months after the end of the Canadian taxpayer's taxation year. Budget 2018 proposes to accelerate the deadline to file Form T1134 for taxation years beginning after 2019 to six months following the end of the taxpayer's taxation year (the same filing deadline for its income tax return). These forms are already an onerous burden for corporations with multiple foreign affiliates. These proposals could have significant administrative impact on certain Canadian companies.
Reassessments - Income Arising in Connection with a Foreign Affiliate
The CRA is generally barred from issuing a reassessment against a taxpayer once the normal reassessment period has expired. For most large corporate taxpayers, the period is four years following the date of the initial notice of assessment. The ITA currently provides for a three year extended reassessment period for assessments made as a consequence of a transaction involving a taxpayer and a non-arm's length non-resident (mostly commonly applicable to transfer pricing matters). Budget 2018 proposes to provide a similar three year extended reassessment period for reassessments in respect of income arising in connection with a foreign affiliate of the taxpayer. This proposed amendment would appear to permit the CRA to, among other things, issue a FAPI reassessment up to three years beyond the normal reassessment period. Previously, CRA could only raise such FAPI assessments if the FAPI could be said to have arisen as a consequence of a transaction involving a taxpayer and a non-arm's length non-resident. This measure applies to taxation years beginning on or after Budget Day.
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MINERAL EXPLORATION TAX CREDIT FOR FLOW-THROUGH SHARE INVESTORS
Once again, Budget 2018 proposes to extend the flow-through mining exploration tax credit. Annual extensions of this 15 per cent federal tax credit have been a feature of federal budgets since 2007.
The credit will be available to purchasers of flow-through shares under flow-through share agreements entered into on or before March 31, 2019. It will be available only in respect of a certain subset of Canadian exploration expenses relating to specified kinds of surface or "grassroots" exploration. Flow-through funds raised by mining exploration companies on or before March 31, 2019 may be expended on eligible expenditures before the end of 2020, and under the "look-back" rule, eligible expenditures may be renounced to purchasers for deduction and the 15 per cent credit in 2018.
The rule is intended as an additional stimulus to surface exploration in Canada. Similar provincial tax rules are in place in Ontario, British Columbia, Manitoba and Saskatchewan.
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TAX SUPPORT FOR CLEAN ENERGY
Class 43.1 and 43.2 provide accelerated capital cost allowance rates (of 30 per cent and 50 per cent, respectively) on a declining balance basis for certain clean energy generation and conservation equipment. Class 43.2 is currently limited to property acquired before 2020. In keeping with the Government of Canada's commitment to combat climate change, Budget 2018 proposes to extend eligibility for Class 43.2 by five years, making the accelerated capital cost allowance rate apply to qualifying property acquired before 2025.
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CHARITIES - MISCELLANEOUS TECHNICAL ISSUES
Revocation Tax -Reduction on Transfers of Property to Municipalities
The charitable registration of a charity may be revoked, either voluntarily or as a result of non-compliance with the provisions of the ITA. When a charity's status as a registered charity is revoked, the charity is subject to a revocation tax equal to 100 per cent of the total net value of its assets. A charity may reduce the amount of the revocation tax payable by gifting assets to one or more "eligible donees." An eligible donee, in respect of a revoked charity, is another registered charity, the majority of whose directors or trustees deal at arm's length with the directors or trustees of the charity with the revoked charitable registration.
Budget 2018 proposes to allow transfers of assets to municipalities for purposes of reducing the amount of revocation tax payable by a registered charity, subject to the approval of CRA on a case-by-case basis. It appears that approval will be granted in situations where a suitable eligible donee cannot be found and it would be in the interest of the community that the property be transferred to a municipality.
Universities Outside of Canada
Canadians may claim a charitable donation tax credit for donations made to universities outside Canada, provided such university is included in Schedule VIII of the Regulations. Since 2011, universities outside Canada have been required to register with CRA and to meet certain receipting and record-keeping obligations to qualify for inclusion in Schedule VIII. Once universities outside Canada are registered with CRA, notification is provided by listing them on the Government of Canada website, essentially requiring them to be listed on two separate, yet identical, lists. To streamline the registration process for universities outside Canada as qualified donees, Budget 2018 proposes to remove the requirement that universities outside Canada be prescribed in the Regulations, so as to expedite the process for foreign universities to qualify.
Other Related Measures
The Government of Canada will also evaluate whether Canadian newspapers may be permitted to seek and be granted charitable status for the not-for-profit provision of journalism, as this is seen to be in the public interest.
The Government of Canada previously struck an expert panel to study the issue of political activities undertaken by charities. Some recommendations were provided by this panel in 2017 and the Government of Canada expects to provide a response in the coming months.
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GST/HST AND EXCISE MEASURES
GST/HST and Investment Limited Partnerships
On September 8, 2017, the Government of Canada released draft GST/HST legislation and regulations to newly define an investment limited partnership ("ILP"). Despite some criticism for a lack of certainty in application, Budget 2018 maintains the previously announced definition of "investment limited partnership." The definition captures limited partnerships, the primary purpose of which is to invest funds primarily in financial instruments, i.e.,shares, debt, partnership interests, etc. where the limited partnership is, or is part of an arrangement or structure that is represented or promoted as, a hedge fund, mutual fund, private equity fund, venture capital fund or other "similar collective investment vehicle." By a second test, limited partnerships also will be ILPs if owned to 50 per cent or more by a "listed financial institution" ("LFI").
The first purpose was to subject an ILP to GST/HST calculated on the fair market value of management and administrative services provided by its general partner. (Absent the proposed amendment, a general partner would not be required to charge a partnership for services performed as partner of the partnership.) The rules will subject general partner distributions and remuneration to GST/HST on a broadly defined range of "management and administrative services" performed by a general partner.
A second purpose was to deem ILPs to be LFIs, resulting, inter alia, in the application of more rigorous allocations as between inputs into taxable and exempt activities by the ILP. In addition, where the ILP has investors resident in both a GST and an HST province (for example, in Alberta and Ontario), the ILP will be deemed to be a "selected listed financial institution" ("SLFI"), with a consequential requirement to comply with a detailed "special attribution method" calculation on an annual GST/HST return of the SLFI. For ILPs that are not SLFIs, but which have annual income over $1 million, there will be an equally onerous requirement to comply with an annual information return.
Budget 2018 confirms the intention to proceed with these proposals, subject to minor modifications. Budget 2018 introduces timing rules for the deemed payment of fair market value consideration to the general partner, as well as welcome transitional rules relative to the September 8, 2017 effective date. In addition, with respect to the second purpose of deeming the ILP to be an LFI, the application will be to a fiscal year of the partnership beginning after 2018, subject to a deeming rule imposing a calendar year fiscal year for GST/HST reporting from January 1, 2019. Budget 2018 provides for an election available to an ILP that is a SLFI to bring forward the application of the deeming rule to 2018, which would be of use where the special attribution method calculation would be expected to result in a lower overall GST/HST cost to the SLFI.
Finally, Budget 2018 includes a previously announced provision to deem an ILP to not be resident in Canada if the total value of all interests in the partnership held by non-resident members of the partnership is 95 per cent or more of the total.
However, Budget 2018 does not include two proposals identified by Finance in a 2016 consultation paper. The first proposal was to prescribe a non-resident limited partnership to be subject to self-assessment for GST/HST where investors resident in Canada hold a total value in the partnership of $10 million or more, and this represents at least 10 per cent of the value of the assets of the limited partnership. The second was to rebate GST/HST to certain "investment plans" (which would include ILPs) to the extent of its non-resident investors.
GST/HST Consultation on Holding Corporation Rules
A corporation that holds the shares of another corporation, but that does not itself carry on a commercial activity, is not entitled to claim an input tax credit in respect of GST/HST incurred on its acquisition of property and services under the ordinary rules in the Excise Tax Act ("ETA"). However, a special rule at section 186 of the ETA provides relief where a holding corporation owns shares of a related "operating" corporation, all or substantially all of the property of which was last acquired or imported for consumption, use or supply by the operating corporation exclusively in its commercial activities. Where that is the case, and the holding corporation incurs GST/HST on property or services that can reasonably be regarded as having been acquired or imported for consumption or use in relation to shares or indebtedness of the operating corporation, the holding corporation is deemed to have acquired or imported the property or service for use in its commercial activities.
Budget 2018 announced a consultation on certain aspects of section 186, particularly as it relates to the degree of relation required between the holding corporation and the operating corporation. Currently, section 186 only requires that the two corporations be related, which the ETA defines by reference to the ITA's concept of related persons and control. Thus, two corporations may be related by virtue of a 51 per cent control interest, a threshold far lower than, for example, the closely-related persons exemption at section 156 of the ETA. The Government of Canada may seek to narrow the relatively broad interpretation given by the courts to the phrase "in relation to" shares or debt of a related corporation.
Budget 2018 also announced an intention to clarify which expenses of the holding corporation will qualify for the GST/HST relief. This suggests that the Government of Canada may impose limits on certain kinds of expenses of the holding corporation.
However, Budget 2018 also indicates the consultation will address whether the rule is properly limited to corporations, opening the door to a long sought expansion of the rule to trusts and partnerships holding shares of qualifying corporations.
Consultation documents and draft legislative proposals are to be introduced in the near future.
Excise Taxes on Cannabis and Tobacco
On November 10, 2017, the Government of Canada released a proposed excise duty framework for cannabis products under the Excise Act, 2001. Budget 2018 confirmed the Government of Canada intends to proceed with amendments to the Act on that basis, subject to subsequent announcements.
Budget 2018 further announced that an existing inflationary adjustment for tobacco excise duty rates would be annualized, rather than occurring on the previous cycle of every five years. In addition, the Government of Canada announced an increase to the excise duty rates by an additional $1 per carton of 200 cigarettes, with corresponding increases for other tobacco products.
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Requirements for Information and Compliance Orders
The normal reassessment period under the ITA is generally three or four years after the date of an initial assessment, subject to extension or suspension in certain circumstances. Currently, the reassessment period tolls while the taxpayer contests a requirement for information ("RFI") seeking foreign-based information before the Federal Court. However, no tolling (or "stop the clock" rule) currently applies for other contested RFIs or while a compliance order (an order for a taxpayer to provide information and/or documents to the CRA) is challenged before the Federal Court.
Budget 2018 proposes to amend the ITA to create such a further tolling rule, effectively extending the reassessment period during contested RFIs and compliance orders. The tolling period generally would begin when an application before the Federal Court commences or when a taxpayer confirms opposition to a compliance order, and would run until the final disposition of the matter, including any appeals. The Government of Canada reasons that, without this amendment, delays while these matters are contested may hamper the CRA's ability to reassess with complete information on a timely basis.
Non-Resident Non-Arm's Length Persons
As noted above, the normal reassessment period may be extended in certain situations. For example, where a taxpayer carries back a loss to a prior year, the CRA has a further three years to reassess the prior year. The rule seeks to ensure that the loss carryback year remains open concurrently with the year in which the loss arose, allowing for adjustments to the original year affecting the amount of the loss to be applied back to the carryback year.
However, according to Budget 2018, the extended reassessment period for loss carryback years does not take into account the extended period for reassessments made as a consequence of a transaction with a non-arm's length non-resident (essentially, an extended period for transfer pricing adjustments). The Government of Canada perceived an inconsistency, as there may be circumstances in which the CRA makes a transfer pricing adjustment for a taxation year under the extended reassessment period, but is foreclosed from reopening an earlier year to which a taxpayer carried back a loss from that year.
Budget 2018 proposes to allow the CRA to adjust the amount of the loss carried back to a prior (potentially statute-barred) year, if required, where the original year is adjusted as a result of reassessment concerning a transaction with a non-arm's length non-resident. Budget 2018 includes an example to clarify: a loss from 2017 is carried back to 2014; six years later, in 2023, the CRA determines the 2017 loss was less than the amount carried back to 2014, on account of an adjustment involving a transaction with a non-arm's length non-resident; the 2014 year could be consequentially adjusted.
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CRA CRACKDOWN CONTINUES
As part of the Government of Canada's commitment to combat global tax evasion, Budget 2018 enhances information sharing with foreign tax administrations by allowing legal tools available under the Mutual Legal Assistance in Criminal Matters Act to be used for the sharing of criminal tax information. Since coming into force in 1990, the Act has facilitated the sharing of non-tax information for criminal law enforcement with the dozens of countries that have entered into mutual legal assistance agreements with Canada. Budget 2018 will permit the CRA to deploy these information gathering and sharing tools for tax information as well. In addition, the CRA will be empowered to obtain and share tax information internationally in respect of matters that, if within Canada, would constitute terrorism, organized crime, money laundering, criminal proceeds or designated substance offences.
These enhancements should have immediate impact. Budget 2018 specifically referenced a review of funds transfers between Canada and eight "countries of concern," amounting to 187,000 transactions worth over $177 billion that "merited closer scrutiny," along with Canada partnering with other jurisdictions and engaging in more than 1,000 "offshore audits" and more than 40 criminal investigations linked to offshore transactions.
Budget 2018 also addresses a perceived gap in the CRA's ability to disclose taxpayer information to domestic police for investigation or prosecution of serious offences. The Attorney General has authority to apply for a court order to obtain taxpayer information under the ITA. However, there is no similar provision under the Excise Tax Act or the Excise Act, 2001. Budget 2018 proposes to enable such information to be obtained under these statutes.
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FUNDING FOR TAX ENFORCEMENT AND THE TAX COURT
Budget 2018 echoed numerous CRA press releases in recent years proclaiming a "crackdown" on tax evasion and avoidance, once again regrettably convolving those distinct concepts.
The past two Federal Budgets have included substantial funding for the CRA's enforcement activities. Budget 2018 committed $90 million over the next five years, somewhat less than earlier years. $38.7 million will be allocated to the CRA to deal with information shared with Canada under the Common Reporting Standard, including expanded offshore compliance activities using improved risk assessment and business intelligence, and the hiring of more auditors. In addition, substantial funds are being allocated to the federal court system, including the Tax Court of Canada, to address a growing and increasingly complex caseload, with $42 million to be allocated to the Courts Administration Service and $9.3 million of funding on an ongoing basis.
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This analysis was prepared by the following members of the Gowling WLG Tax Group:
The Gowling WLG Tax Group delivers expert and innovative advice to our clients. Our team of tax professionals have leading practices in income tax, international tax planning, transfer pricing, Indigenous tax, executive compensation, indirect tax and customs, and tax dispute resolution.
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