The Minister of Finance presented the Government of Canada's 2020 Fall Economic Statement (FES) to Parliament on November 30, 2020. As anticipated, the FES highlighted the economic toll that the COVID-19 pandemic has taken on the Canadian economy, resulting in an anticipated deficit in excess of $380 billion. The FES included various legislative proposals, thereby resembling a form of mini-budget, understandably as the last Federal Budget was tabled in March 2019. This bulletin highlights the more significant income and sales tax proposals.
Employee Stock Option Deduction
Leading up to the 2015 federal election, the platform of the Liberal Party of Canada contained a pledge to cap or limit the availability of the employee stock option deduction provided for in the Income Tax Act (Canada) (ITA). Budget 2019 revisited the issue and announced the government's intention to impose an annual $200,000 limit on the stock option deduction for employees of large, long-established, mature companies, but few details were provided at that time. On June 17, 2019, the Minister of Finance tabled a Notice of Ways and Means Motion with proposed amendments to the ITA to implement the stock option proposals, including relief for the to-be-defined category of "start-ups, emerging or scale-up companies", but these proposals were deferred.
The FES resurrects the proposals, including draft legislation and some welcome clarity with respect to the category of companies previously referred to as start-ups, emerging or scale-up companies. The FES proposals are intended to apply to options granted after June 30, 2021.
The Current Rules
Under the current rules, a deduction may be available equal to 50 per cent of the benefit derived from exercising or disposing of an employee stock option. This 50 per cent inclusion rate results in taxation to the employee at capital gains-like rates. The current rules do not include limits based on the income level of the employee claiming the stock option deduction, the number or value of the options granted or on the size, maturity, sales level or profitability of the company granting the option. The current rules generally deny a deduction to the employer in respect of the grant or the exercise of the option.
The current rules differentiate between options granted by a Canadian-controlled private corporation (CCPC Options) and options granted by other corporations and mutual fund trusts (Non-CCPC Options).
For Non-CCPC Options, an employee is generally entitled to the 50 per cent deduction where:
- The exercise price of the option is no less than the fair market value (FMV) of the underlying security at the date the option is granted;
- The employee deals at arm's length with the grantor of the option immediately following the time of grant; and
- The share underlying the option satisfies the "prescribed share" tests set out in the regulations under the ITA, which seek to ensure that the underlying share is a "plain vanilla" common share.
For CCPC Options, an employee is generally entitled to the 50 per cent deduction where:
- The grantor is a CCPC at the time of the option grant;
- The employee deals at arm's length with the grantor of the option immediately following the time of grant; and
- The option is exercised and the shares acquired and held for two years prior to a disposition or exchange of the shares.
An employee holding CCPC options can also claim the deduction by meeting the more rigorous test for Non-CCPC Options.
The Legislative Proposals
The legislative proposals included in the FES do not alter the current rules for CCPC Options. Further, for the previously described category of "start-ups, emerging or scale-up companies", to which the legislative proposals will not apply, it is welcome that the government proposes a bright-line, revenue-based test. Companies that have revenues of $500 million or less (with rules for consolidated group revenues) in the year preceding the year of grant of an employee stock option (referred to herein, along with CCPs, as Non-Specified Persons) will not be subject to the new rules. Accordingly, options granted by Non-Specified Persons will continue to be governed by the rules set out above. For all other options, being those granted by "Specified Persons", the legislative proposals entail significant changes, for employees and employers.
The concept of a $200,000 annual vesting limit is retained from the 2019 proposals. An employee will only be entitled to the 50 per cent deduction in respect of $200,000 worth of options that vest in the same calendar year, with the $200,000 determined by reference to FMV of the shares underlying the options. Any options that exceed this cap will be treated as "non-qualified" options. If an individual is employed by more than one employer that deal with each other at arm's length, the employee will have a separate annual cap in respect of each employer.
For example, assume an employee who is employed by a Specified Person is granted options to acquire 10,000 shares that have a FMV at the date of grant of $80 per share, and all the options vest and are exercisable immediately. The $800,000 underlying-share value is four times the annual cap, with the result that ¾ of the options will be "non-qualified" options. Assume further that the employee exercises the options at a time when the share value has increased to $90 per share, such that a stock option benefit of $100,000 arises. The employee will be entitled to the 50 per cent deduction only in respect of one-fourth of the benefit, or $25,000, with the remaining $75,000 of benefit taxed at full rates. If, instead, the 10,000 options were to vest over a four-year period, each of those four years would have a separate $200,000 annual cap, with the result that none of the options would be "non-qualified".
The annual cap approach is an interesting policy choice. The government states that under the current rules the benefits accrue disproportionately to a small number of high-income individuals employed by large, established corporations. However, rather than impose an annual cap based on the income level of the employee, the legislative proposals impose the annual cap on all claimants who receive options from Specified Persons. This arguably risks penalizing employees who are not high-income earners year-over-year but for whom stock options and the 50 per cent deduction are an important part of their compensation package. That said, the $500 million revenue threshold for Specified Persons is arguably sufficiently high to ensure that all but the largest corporations can continue granting options under the current rules.
Determining the Vesting Year
If the option grant specifies the calendar year in which the right to exercise arises (otherwise than as a consequence of an event that is not reasonably foreseeable at the time of grant), then the year so specified will be the vesting year for purposes of applying the annual cap. In any other case, the vesting will be treated as occurring on a pro rata basis over the term of the option up to a maximum of 60 months from the date of the option grant.
Charitable Donations by Employees of Publicly-Listed Shares
Although not included in legislative proposals, the FES proposes to eliminate the ability of an employee to claim an additional 50% deduction in computing the stock option benefit where the share acquired under a non-qualified option (or cash derived from the sale of such shares) is donated to a qualified done (typically a registered charity). Instead, the employee would be limited to claiming a charitable donation tax credit.
Employer Deduction for Specified Persons
The Legislative Proposals provide a Specified Person with the ability to claim a corporate deduction in respect of non-qualified options, in an amount equal to the stock option benefit derived by an employee. The deduction is provided for in the computation of taxable income. The Specified Person must satisfy the notification requirements (discussed below) in order to claim the deduction. The deduction will only be available if the optionee is the employee of the Specified Person, although the deduction appears to be available in scenarios where the parent corporation of the Specified Person is the grantor of the option. Non-Specified persons such as CCPCs cannot "opt in" to the new regime in order to claim a deduction.
In addition, the option must otherwise have been eligible for the 50 per cent deduction but for having exceeded the annual cap. Accordingly, the option must have satisfied the tests set out above under "current rules" for Non-CCPC Options. Thus, no deduction will be available for, inter alia:
- options with a strike price that is less than the FMV of the underlying shares as at the date of grant;
- equity-based arrangements that rely on the "stock option" rules in the ITA but do not qualify for the 50 per cent deduction under the current rules (such as restricted share units); or
- options for which the underlying shares are not prescribed shares, presumably with the prescribed share test being applied at the time of exercise of the option.
With respect to the latter bullet, consider whether the legislative proposals can lead to a disqualification for preferential tax treatment for both the Specified Person and the optionee. For example, if the option has a FMV strike price but is a non-qualified option due to the annual cap being exceeded, the optionee would not be entitled to the 50 per cent deduction. However, if, prior to exercise, there is an event that causes the underlying shares to cease to be prescribed shares, the employer would be disqualified from claiming the corporate-level deduction. As a result, both parties could be denied the preferential treatment.
The legislative proposals also provide that the "limitation on expenditure" rules in section 143.3 of the ITA do not apply to prohibit the corporate deduction. Further, the legislative proposals expand the definition of "non-capital loss" in the ITA to treat a loss created by claiming a corporate deduction in respect of a non-qualified option as a non-capital loss.
Designation as Non-Qualified
The legislative proposals permit a Specified Person to designate one or more options as non-qualified options for purposes of the new rules, effectively denying the employee the 50 per cent deduction even though the options might otherwise meet the tests for the deduction and would not exceed the annual cap. This opens the door to the ability to claim a corporate-level deduction in respect of the option. Interestingly, the designation can only be made where the grantor of the option is the direct employer the employee. Accordingly, no designation can be claimed where a Canadian subsidiary corporation reimburses its foreign parent for the cost of granting options to employees of the Canadian subsidiary corporation.
The proposed amendments include a number of notification requirements. First, the employer of the optionee must notify the employee in writing where the option is a non-qualified option, either by virtue of exceeding the annual cap or because the employer has designated the option as "non-qualifying". This notification must be given within 30 days of the option being granted but no particular format appears to be required. Further, the employer of the optionee must also notify the Canada Revenue Agency (CRA) that the option is a non-qualified option, in a form to be prescribed for this purpose and filed on or before the tax return filing due date for the grantor's tax return for the year in which the option grant is made.
The FES includes several proposals to collect the federal Goods and Services Tax/Harmonized Sales Tax (GST/HST) on e-commerce transactions with Canadian consumers. Some of these measures are consistent with the international efforts to tax digital sales based on the location of the consumer, while others appear based on measures taken by the Provinces of Québec, Saskatchewan and British Columbia to extend the collection of their provincial value added and sales taxes to purchases from non-resident suppliers. However, one measure is novel, addressing the sale of goods shipped from locations inside of Canada.
The FES proposals include a simplified registration regime for non-resident vendors selling digital products and services, as well as for distribution platform operators selling such products and services, to Canadian consumers. The proposals also address the collection of GST/HST on goods warehoused or stored in Canada for shipment to a purchaser in Canada, including when sold by non-resident vendors and distribution platform operators. In addition, the proposals address the collection of GST/HST on supplies of short-term accommodation when facilitated by a digital platform.
While the proposals include detailed draft legislation, the government announced its willingness to "continue to work with the international community, provinces and stakeholders" in the more than six months before implementation slated for July 1, 2021. It would greatly simplify compliance if provinces that continue to charge their own value added or sales taxes would use this opportunity to integrate with the HST regime available under the Excise Tax Act (Canada) (ETA). It is unlikely any will want to engage in the politically risky venture of full integration, after British Columbia's failed attempt. However, it will be interesting to see if any of British Columbia, Manitoba, Saskatchewan partially conform their own tax collection regimes to what will become the nationally applicable standard on enactment of these proposals.
Cross-Border Sales to Consumers
In the past, non-residents that do not have a permanent establishment in Canada and are not carrying on business here have not been required to register to collect the GST/HST under the ETA. Instead, the ETA has required Canadian consumers to self-assess for the GST/HST. However, this requirement has been almost universally ignored by the Canadian consumer. In the result, the GST/HST has gone uncollected on online purchases from unregistered non-resident vendors. To address this, the government has made two proposals.
First, certain non-resident vendors selling digital products, digital services or traditional services, will be required to register for, collect and remit the GST/HST on their taxable sales to the Canadian consumer.
Second, certain distribution platform operators, operating a digital marketplace or platform, will be required to register for the GST/HST and to collect and remit the GST/HST on the sale of such digital products and services to the Canadian consumer by the unregistered non-resident vendors that it hosts. The distribution platform operator will be required to register, if the distribution platform facilitates either the making of supplies of certain intangible personal property or services by a non-resident that is not GST/HST registered, or the making of supplies of goods by a person that is not GST/HST registered. In general terms, an operator is a person that either controls or sets the essential elements of the transaction, or if this does not apply to any person, the person who directly or through arrangements with third parties, collects, receives or charges the consideration and transmit all or part of it to the supplier. Certain operators are excluded: (i) payment processors, (ii) listing, advertising or redirecting sites, and (iii) those that do not do set the conditions of the supply, authorize the charge and order or deliver the good or service. It is important to note that the definition of a distribution platform operator differs between the GST/HST, Saskatchewan and Québec regimes.
Such non-resident sellers and distribution platform operators would not be required to collect and remit the GST/HST on their sales and facilitated sales made to businesses. Any person that is registered for the GST/HST will be considered a business and any other person a consumer, such that the GST/HST registration number of a business will function as proof of its business status. If a GST/HST registered business is erroneously charged the GST/HST, it will have to request a refund from the non-resident vendor or distribution platform operator, as it will not be entitled to claim input tax credits or make a tax paid in error claim on such amounts.
The GST/HST will be collectible, and at a particular rate of GST/HST, based on the consumer's usual place of residence as established by specified indicators, such as the home address, billing address, Internet Protocol address of the device used, bank or payment information, and subscriber identification module (SIM) card that relate to the recipient. Generally, a consumer's usual place of residence will be considered to be in Canada, and in a particular province or territory of Canada, when two or more of these indicators identify the consumer's usual place of residence. However, the non-resident vendor or distribution platform operator will not be required to charge and collect the GST/HST to a consumer if the supply is linked or restricted to a specific location outside Canada: for example, for a service that relates to real property outside Canada, a service to be performed at a location outside Canada, or services rendered in connection with litigation outside Canada.
Similar to the successful regime recently imposed by the Government of Québec, the government will provide for simplified GST/HST registration and remittance. Non-resident vendors and distribution platform operators will be required to register under this regime once their total taxable supplies of digital products or services made to consumers in Canada (on their own behalf or facilitated for others) exceed, or are reasonably expected to exceed, $30,000 over a twelve-month period. Unlike the "normal" GST/HST registration, the non-resident vendor would not have to post security, but also would not be able to claim input tax credits to recover any GST/HST paid on their business inputs. Reporting and remittances in US dollars and Euros will be permitted.
These proposals are roughly consistent with the non-resident registration regimes imposed by the Provinces of both Québec and, to some extent, Saskatchewan in recent years.
These new rules will become effective July 1, 2021 and are anticipated to increase federal revenues by $1.2 billion over 5 years.
Goods Stored in Canada
In a further effort to impose GST/HST on cross-border sales to the Canadian consumer, the government has made three proposals relating to goods located in fulfillment warehouses in Canada or goods shipped from another place in Canada to a purchaser in Canada. GST/HST will continue to be levied on the import of goods.
First, distribution platform operators will be required to register under the 'normal' GST/HST registration regime and to collect and remit the GST/HST on sales of goods facilitated by the operator for all non-registered vendors, for goods that are located in fulfillment warehouses in Canada or shipped from another place in Canada to a purchaser in Canada. This will include sales made by both unregistered non-residents and residents. However, distribution platform operators will not be required to collect GST/HST on goods where the vendor is GST/HST registered. It also will include both sales made to consumers and GST/HST-registered businesses. However, distribution platform operators will not have to charge and collect GST/HST on their supplies of services to non-registered vendors.
GST/HST registered distribution platform operators will be eligible to claim input tax credits for GST/HST incurred by them in the ordinary course, as well as for GST paid by their non-registered vendors on the import of the goods, the latter being an important relieving measure for online sellers.
Distribution platform operators will be required to register once sales of goods facilitated through their platforms for non-registered vendors to consumers in Canada exceed or are reasonably expected to exceed $30,000 over a twelve-month period.
Second, non-resident vendors selling otherwise than on a distribution platform, will be required to register to collect GST/HST under the 'normal' GST/HST registration regime on such sales of goods located in fulfillment warehouses in Canada, or shipped from another place in Canada to a purchaser in Canada. Registered non-resident vendors will be eligible to claim input tax credits in respect of the GST/HST paid on inputs used in their commercial activities, including GST paid on their imports of goods.
Non-resident vendors will be required to register once their sales of goods, made without the use of a distribution platform to consumers in Canada, exceed or are reasonably expected to exceed $30,000 over a twelve-month period.
Third, fulfillment businesses in Canada will be required to notify the CRA and to maintain records of their non-resident clients and the goods they store on behalf of their non-resident clients. This will include persons who provide services of storing goods in Canada, other than services that are incidental to a freight transportation service, when offered for sale by non-resident persons.
It is notable that Québec’s current rules extend the Québec non-resident registration regime only to GST/HST-registered sellers of physical goods shipped from outside Québec to a consumer in Québec, but not to goods sold by a person not registered for the GST/HST, goods sold through digital platforms, or goods stored in warehouses in Québec. It is possible the Government of Quebec will introduce such provisions as a further measure for the collection of the Quebec sales tax.
These new rules will become effective July 1, 2021, and are anticipated to increase federal revenues by $1.6 billion over 5 years.
Short-term Accommodation through a Digital Platform
Short-term rentals of residential units for periods of less than a month where the price is more than $20 per day are subject to GST/HST. Individual owners often do not collect the applicable GST/HST. Where such rentals are facilitated through a digital accommodation platform provider, the current rules do not require the platform to account for the GST/HST on behalf of the owner.
To address this issue, the government proposes to apply the GST/HST to all short-term accommodation supplied in Canada through a digital accommodation platform. These rules are similar to rules introduced in British Columbia and Saskatchewan. Québec does not have a special regime for the collection of the Québec Sales Tax on short-term accommodations. Rather, such transactions are addressed by the simplified non-resident regime and there are special registration and collection rules in place for the collection of the tax on lodging by digital accommodation platforms.
Where the property owner or person responsible for providing the accommodation is GST/HST registered, the person will be required to collect and remit the GST/HST. However, where the property owner or person responsible for providing the accommodation is not registered, the accommodation platform operator will be deemed to be the supplier and be responsible for registering, collecting and remitting the GST/HST on the short-term accommodations as well as on any service fees charged to the guests.
In general terms, an "accommodation platform operator" is a person that either controls or sets the essential elements of the transaction, or if this does not apply to any person, the person who directly or through arrangements with third parties, collects, receives or charges the consideration and transmit all or part of it to the supplier.
An accommodation platform operator carrying on business in Canada and making more than $30,000 of taxable supplies will be required to register under the 'normal' GST/HST regime. A non-resident accommodation platform operator that is not carrying on business in Canada that is making more than $30,000 of taxable supplies of short-term accommodations in Canada will be required to register under the simplified regime described above with respect to the sale of digital goods and services. This will mean that the collection requirement for such non-resident short-term accommodation providers will only apply to supplies made to consumers (persons who are not GST/HST registered) and no input tax credits will be available.
In addition, accommodation platform providers will be required to keep records and report information to the CRA regarding the owners on behalf of which they have made the taxable supplies of short-term accommodation.
These new rules will become effective July 1, 2021 and are anticipated to increase federal revenues by $360 million over 5 years.
Digital Service Companies – Proposed Corporate Tax Measures
Consistent with the proposed GST/HST measures targeting non-resident sellers of goods and services, the government is also seeking to raise revenues by introducing a temporary corporate level tax on non-resident corporations providing digital services in Canada. No details were provided in the FES other than a proposed implementation date of January 1, 2022. An obvious impediment the government will have to address is how a new corporate tax will override Canada's bilateral tax treaties which generally would deny source state taxation (e.g., Canadian corporate taxation) when the non-resident digital service provider does not carry on business in Canada through a permanent establishment.
The reason this proposed corporate tax is of a temporary nature is because the government has been working with Organization for Economic Co-operation and Development (OECD) and other countries on a coordinated approach to global tax reform. For example, The Report on the Pillar One Blueprint regarding tax challenges arising from digitalization was approved by the member jurisdictions of the OECD/G20 Inclusive Framework on BEPS on 12 October 2020. However, no agreement has been reached by the members and significant work is still needed before consensus will be reached on many fundamental principles. One of the issues being considered in Pillar One pertains to the establishment of new taxing rights for countries where multinational corporations are providing digital services to consumers. Consequently, as the government remains committed to working with the OECD on a multilateral solution, this proposal is intended to be temporary until these other global measures are implemented in Canada.
The FES contained broad statements that oddly refer back to the era when the difficult concept of "artificiality" was wielded to seek to overturn tax planning that the CRA disliked. The FES refers to tax strategies that do not serve an economic purpose (other than mitigating tax), including by way of offshore structuring. Specific anti-avoidance rules will be reconsidered along with, in particular, the general anti-avoidance rule (GAAR).
The precise nature of the proposals was not set out in the FES. However, additional measures with respect to the foreign accrual property income rules and the transfer pricing rules may be contemplated depending on the outcomes in cases and leave applications pending before the Supreme Court of Canada. We may see amendments to the GAAR, including the codification of an economic substance test and/or measures to capture unrealized/potential tax benefits, as well as more restrictive purpose test(s) for deductibility generally.
Every year since 2016, the government has continued to strengthen tax compliance by deploying increasing resources to enhance the CRA's ability "to crack down on tax evasion and combat aggressive tax avoidance". The FES commits an additional $605 million over five years, starting in 2021-22, to invest in auditing, including hiring additional auditors focused on identified high risk activities, such as hiding income and assets offshore, the underground economy, money laundering and terrorist financing. The estimate is this will recover $1.4 billion in revenues. The CRA may be trying to make up for lost time, after months of severely restricted audit activities earlier this year, while the CRA was grappling with how to effectively function with the pandemic and resources were diverted to administering the Canada Emergency Response Benefit and the Canada Emergency Wage Subsidy, as well as other relief programs.