Pierre G. Alary
Partner
Transfer Pricing & National Tax Group
Article
Published08 April 2022
Federal budget 2022: Declining deficits and measured tax changes
56
minute read
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Federal Budget 2022 (Budget 2022) is a budget of optimism after two years of recession, pandemic, and now geopolitical instability. It speaks of the recovery of all jobs lost during the recession, the rebound of real GDP in Canada to a level higher than before the pandemic, and a booming economy.
In Budget 2022, the Minister of Finance hit all the hot topics on social media, from affordable housing to the environment and even the current conflict in Ukraine, weaving them into an unexpectedly prudent fiscal narrative.
By picking the pockets of Canada's banks and life insurers with additional taxes, Budget 2022 gives the government a massive source of new revenue which in turn helps the government to forecast substantially lower deficits over the next several years. Indeed, the government forecasts that Canada will have one of the lowest deficits as a percentage of GDP among the G7 countries through to 2023.
However, Budget 2022 isn't just about taxing Canada's largest financial institutions. There are a number of fiscal measures proposed in Budget 2022 which will impact businesses, large and small, as well as homeowners, charities, consumers, and working Canadians. Several of these measures create new tax incentives while others impose new taxes or shut down popular tax planning strategies such as flipping residential properties. One of the measures aimed at stopping the use of tax planning strategies by private corporations is estimated to raise more revenue than the special one time tax proposed in the budget on all the Canadian banks and insurance companies.
Budget 2022 addresses most of the items from the Liberal party's 2021 election platform, including incentives for clean technologies and home ownership, that the government hadn't previously implemented. However, there will be more to come. For example, the election platform included a new 15 per cent minimum tax on wealthy Canadians that was not proposed in Budget 2022. Instead, the government has promised to release details of that new tax in its fall economic and fiscal update. As well, it is conceivable that more changes will come as a result of the recent power-sharing deal with the New Democratic Party.
This is a budget with something for everyone. Our article contains a summary of the tax measures we thought would be of most interest.
Table of contents
- Investment tax credit for carbon capture, utilization and storage
- Clean technology tax incentives: Air-source heat pumps
- Critical mineral exploration tax credit
- Flow-through shares for oil, gas and coal activities
- Digital economy
- International tax reform
- Interest coupon stripping
- Application of the general anti-avoidance rule to tax attributes
- The substantive CCPC
- Taxable capital business limit for small businesses increases
- Department of Finance looking to close the door to surplus stripping (again)
- Minimum tax for high earners
- Personal income tax measures affecting home owners
- Financial institutions
- Relaxation of defined benefit pension plans borrowing restrictions
- Registered charities
- Excise duties
Learn more about Gowling WLG's Tax Group
1. Investment tax credit for carbon capture, utilization and storage
Budget 2022 proposes to introduce a new refundable investment tax credit (CCUS Tax Credit) for carbon capture, utilization, and storage (CCUS) technologies.
Eligible expenses, equipment, CCUS projects and CO₂ uses
Acquisition and installation costs incurred after 2021 and before 2041 for equipment that will be used in Canada solely for the capture, transport, storage or use of CO₂ in an eligible CCUS project would qualify for the CCUS Tax Credit. The CCUS Investment Credit may be claimed the year eligible expenses are incurred, regardless of when the equipment becomes available for use.
Eligible CCUS equipment would be included in two new capital cost allowance (CCA) classes of depreciable property: the first at a rate of 8 per cent on a declining-balance basis, and the second at a rate of 20 per cent on a declining-balance basis. The new classes will be eligible for enhanced first year depreciation.
Eligible CCUS projects are new projects that capture CO₂ that would otherwise be released into the atmosphere or capture CO₂ from the ambient air, prepare captured CO₂ for compression, compress and transport the captured CO₂, and store or use captured CO₂ for an eligible use.
Storage requirements
Eligible uses for CO₂ include dedicated geological storage and storage in concrete. Storage requirements must be approved by Environment and Climate Change Canada.
CCUS Tax Credit rate
The CCUS Tax Credit for eligible expenses incurred after 2021 through 2030 would be claimed based on the following rates:
- 60 per cent for eligible capture equipment used in a direct air capture project;
- 50 per cent for all other eligible capture equipment; and
- 37.5 per cent for eligible transportation, storage, and use equipment
The following lower rates would apply for eligible expenses incurred after 2030 through 2040:
- 30 per cent for eligible capture equipment used in a direct air capture project;
- 25 per cent for all other eligible capture equipment; and
- 18.75 per cent for eligible transportation, storage, and use equipment.
Recovery of CCUS Tax Credit
As projects become operational, taxpayers must track and account for the amount of CO₂ being captured and the portions being used for eligible and ineligible uses. Projects will be assessed every five years, to a maximum of 20 years. Where the portion of CO₂ going to ineligible uses exceeds 5 per cent of that described in the initial project plans, a recovery of CCUS Tax Credits will be calculated. Details of the recovery structure will be released at a later date.
Validation and verification
An initial project tax assessment to identify eligible expenses and applicable CCUS Tax Credit rate would be required for projects anticipated to have eligible expenses of $100 million or more over the life of the project. Natural Resources Canada must verify eligible expenses before a CCUS Tax Credit can be claimed. Verification would be processed at the end of a taxpayer's taxation year but before the taxpayer files its tax return the year so that the refund could be processed upon filing.
Financial disclosure report and knowledge sharing
Taxpayers would be required to prepare a climate-related financial disclosure report that highlights how their corporate-governance, strategies, policies and practices will contribute to the management of climate-related risks and opportunities and to the achievement of Canada's commitments under the Paris Agreement and net zero goal by 2050.
Public knowledge sharing in Canada would be required for CCUS projects expecting to have eligible expenses of $250 million or more over the life of the project.
Details on the financial disclosure report and knowledge sharing requirements will be provided at a later date.
2. Clean technology tax incentives: Air-source heat pumps
CCA for clean energy equipment
Depreciable property included in CCA Classes 43.1 and 43.2 benefit from accelerated depreciation rates of 30 per cent and 50 per cent, respectively. Moreover, where the majority of tangible property in a project is included in Classes 43.1 or 43.2, certain intangible start-up expenses are treated as Canadian Renewable and Conservation Expenses (CRCE), which are fully deductible in the year they are incurred and may be carried forward indefinitely. CRCE may also be renounced to subscribers of flow-through shares who may then deduct the full amount of the CRCE renounced in the year.
Budget 2022 proposes to include air-source heat pumps, primarily used for space or water heating, under Classes 43.1 and 43.2. Property that is acquired and becomes available for use on or after April 7, 2022 would generally be eligible for inclusion in Classes 43.1 and 43.2.
Rate reduction for zero-emission technology manufacturers
Reduced corporate tax rates (7.5 per cent for income otherwise subject to the general corporate tax rate and 4.5 per cent for income otherwise subject to the small business tax rate) were proposed in Budget 2021 for qualifying zero-emission technology manufacturers on eligible zero-emission technology manufacturing and processing income.
Budget 2022 proposes the inclusion of the manufacturing of air-source heat pumps used for space or water heating as an eligible zero-emission technology manufacturing or processing activity for purposes of the reduced corporate tax rate.
The reduced corporate tax rates would apply for taxation years that begin after 2021 and would be phased out starting in taxation years beginning in 2029 and fully phased out for taxation years beginning after 2031.
3. Critical mineral exploration tax credit
Mining corporations are able to renounce certain grassroots exploration expenses as Canadian exploration expenses (CEE) to subscribers of flow-through shares who may then deduct 100 per cent of such expenses for the taxation year in which such expenses are renounced. Subscribers who are individuals may also claim the mineral exploration tax credit (METC) equal to 15 per cent of such expenses incurred in Canada. The ability to renounce eligible expenditures to investors and the METC allows mining corporations to attract equity investors at a premium.
A new 30 per cent critical mineral exploration tax credit (CMETC) is proposed in Budget 2022 for specified minerals that are used in the production of batteries and permanent magnets, which are used in zero-emission vehicles, or are necessary in the production and processing of advanced materials, clean technology, or semi-conductors.
A qualified person (as defined under National Instrument 43-101 published by the Canadian Securities Administrators as of April 7, 2022) must certify that expenditures that will be renounced will be incurred as part of an exploration project targeting the specified minerals.
The CMETC would apply to expenditures renounced under eligible flow-through share agreements entered into after April 7, 2022 and on or before March 31, 2027.
4. Flow-through shares for oil, gas and coal activities
CEE and Canadian development expenses (CDE) incurred in the course of carrying out oil, gas and coal activities may also be renounced to subscribers of flow-through shares. Such subscribers may then deduct 100 per cent of such CEE and 30 per cent of such CDE, on a declining basis in calculating their taxable income
In order to support "Canada's international commitments to phase out or rationalize inefficient fossil fuel subsidies," Budget 2022 proposes to eliminate the flow-through share regime for oil, gas, and coal activities effective for flow-through share agreements entered into after March 31, 2023.
5. Digital economy
Budget 2022 proposes to require "reporting platform operators," that provide support to "reportable sellers" for relevant activities, to determine the jurisdiction of residence of their reportable sellers and to report certain information on them. The basis for the proposed rules is a need to track revenues earned by taxpayers through online platforms, to ensure that their income does not escape taxation.
Reporting platform operators are entities engaged in the following activities:
- contracting directly or indirectly with sellers to make the software that runs a platform available for the sellers to be connected to other users; or
- collecting compensation for the relevant activities facilitated through the platform.
The measures will generally apply to platform operators that are resident in Canada for tax purposes. However, they will also apply to platform operators that are not resident in Canada or a partner jurisdiction and that facilitate relevant activities by sellers resident in Canada or with respect to rental of immovable property located in Canada. A partner jurisdiction would be a jurisdiction that has implemented similar reporting requirements on platform operators and that has agreed to exchange information with the Canada Revenue Agency (CRA) on reportable platform sellers.
The measures will not apply to platform operators that demonstrate to the CRA that their business model does not allow sellers to profit from compensation received or that the platform does not have any reportable sellers nor to platform operators that facilitate the provision of relevant activities for which the total compensation over the previous year is less than €1 million, and that elect to be excluded from reporting.
Relevant activities of the reporting platform operators will include relevant services and sales of goods. Relevant services will include:
- personal services (i.e., services involving time- or task-based work performed by one or more individuals at the request of a user, unless such work is purely ancillary to an overall transaction or it is provided by a seller pursuant to an employment relationship with the platform operator or a related entity of the platform operator), for example, transportation and delivery services, manual labour, tutoring, data manipulation and clerical, legal or accounting tasks;
- rental of immovable property (residential or commercial property, as well as parking spaces); and
- rental of means of transportation.
A reportable seller will be an active user who is registered on a platform to provide relevant services or sell goods. However, sellers that represent a limited compliance risk will not be considered reportable sellers. These are:
- governmental entities;
- entities the stock of which is regularly traded on an established securities market;
- large providers of hotel accommodation that provide accommodation at a high frequency (i.e., more than 2,000 per year in respect of a property listing on an online platform); and
- with respect to the sales of goods, sellers who make less than 30 sales a year for a total of not more than €2,000.
Reporting platform operators will need to complete due diligence procedures to identify reportable sellers and their jurisdiction of residence. For platform operators that become reporting platform operators for the first time, the due diligence procedures will be required to be completed by December 31 of the second calendar year in which the platform operator is subject to the reporting rules.
These measures would apply to calendar years beginning after 2023, which would allow for the first declaration and information sharing for calendar year 2024 to occur in early 2025.
6. International tax reform
Budget 2022 reaffirmed the Government of Canada's intention to join the two-pillar plan for international tax reform agreed to on October 8, 2021 by the 137 members of the Organisation for Economic Co-operation and Development (OECD) and Group of 20 (G20) Inclusive Framework on Base Erosion and Profit Shifting (Inclusive Framework).
The overarching goal of Pillar One is to ensure that the largest and most profitable multinational enterprises (MNEs) pay a fair share of tax in the countries where their customers are located (market countries). Pillar Two introduces a minimum effective tax rate (ETR) of 15 per cent on the profits of large MNEs, regardless of where they are earned.
Pillar One
It is anticipated that MNEs with global revenues above €20 billion and a profit margin above 10 per cent will be subject to Pillar One. For such MNEs, 25 per cent of residual profits (i.e., profits in excess of 10 per cent of revenue) will be allocated to market countries using a revenue-based allocation key. As the reallocation of profits to market countries will result in cases of double taxation (referred to as Amount A), the Government of Canada is working with its international partners to establish a new multilateral tax framework where double taxation relief will be provided for Amount A by the countries where residual profit is taxed under traditional rules.
The draft legislative proposals released in December 2021 for a Digital Services Tax (DST) will serve as a back-up plan that could be imposed as of January 1, 2024, if the multilateral convention implementing the Amount A tax framework has not come into force.
Pillar Two
The ETR of 15 per cent introduced by Pillar Two will apply to MNEs with annual revenues of €750 million or more. The ETR will apply in every jurisdiction in which such MNEs operate. Pillar Two is intended to be implemented through changes to domestic laws. To ensure a coordinated implementation, the Inclusive Network approved model rules and commentary which countries are required to follow when implementing Pillar Two.
Under Pillar Two, if an MNE's ETR for a particular jurisdiction is below 15 per cent, a "top-up tax" will be charged to the MNE to ensure the profits in this jurisdiction are tax at the 15 per cent rate. There are two core charging rules for the top-up tax: the Income Inclusion Rule (IIR) and the Undertaxed Profits Rule (UTPR).
The primary rule is the IIR, which allows the country where the parent entity of an MNE is located to impose a top-up tax on the ultimate parent with respect to income from the MNE's operations in any jurisdictions where it is taxed at less than 15 per cent. If the ultimate parent's jurisdiction has not implemented the IIR, the secondary right to charge the top-up tax lies with the jurisdiction of the highest-tier intermediate parent entity within the MNE that has adopted the IIR.
Where neither the jurisdiction of the ultimate parent or any intermediate parent of an MNE has implemented the IIR, the UTPR will apply as a "backstop" rule. In such case, jurisdictions in which the MNE operates that have implemented the UTPR would impose the top-up tax on the group entities located in their jurisdiction.
Budget 2022 proposes to implement Pillar Two and a domestic minimum top-up tax. The Government of Canada anticipates the public release of draft implementing legislation for consultation along with the IIR and domestic minimum top-up tax in 2023. The UTPR would come into effect no earlier than 2024.
Budget 2022 also launched a public consultation to allow for the implementation of Pillar Two, where interested parties are invited to send written representations by July 7, 2022 to the Department of Finance's Tax Policy Branch.
Of the two measures, Pillar Two is expected to have a more important impact on MNEs, effectively taxing in Canada the income of foreign affiliates that was subject to a less than 15 per cent income tax in its home jurisdiction.
7. Interest coupon stripping
Interest paid or credited by a Canadian resident borrower (Canco Borrower) to a non-arm's length non-resident lender (NR Lender) is subject to a 25 per cent withholding tax pursuant to Part XIII of the Income Tax Act ( ITA), subject to a potential rate reduction by application of a tax treaty. Tax treaties will generally reduce the withholding rate to 10 or 15 per cent, while the Canada-U.S. tax treaty reduces it to nil. In an effort to avoid Part XIII withholding tax, certain taxpayers have entered into arrangements commonly referred to as interest coupon stripping arrangements. Generally, such arrangements involve an NR Lender selling its right to receive future interest payments (interest coupons) in respect of a loan made to a non-arm's length Canco Borrower to a party that is not subject to withholding tax.
An interest coupon arrangement generally exists if two conditions are met. First, the Canco Borrower pays or credits an amount to a person or partnership (interest coupon holder) as interest on a debt owed to the non-arm's length NR Lender. Second, the Part XIII tax payable with respect to the payment of this particular amount to the interest coupon holder is less than the Part XIII tax that would otherwise be payable on the payment of such particular amount to the NR Lender.
Budget 2022 seeks to address two variations of such arrangements. The first involves a NR Lender, not resident in the U.S., selling the interest coupons in respect of a loan made to a non-arm's length Canco Borrower to another person who is resident in the U.S. and eligible for benefits under the Canada-U.S. tax treaty. Such an arrangement would reduce the withholding tax from 25 per cent to nil. The second variation is similar to the first but the interest coupons are sold to a person resident in Canada.
Budget 2022 introduces an amendment to the interest withholding tax rules to ensure that the withholding tax paid under an interest coupon stripping arrangement is the same as if the arrangement was not entered into and the interest was paid to the NR Lender. In such case, the Canco Borrower will be deemed to pay an amount of interest to the NR Lender so that the Part XIII tax on the deemed interest equals the Part XIII tax otherwise avoided.
This new measure will apply to interest paid or payable that has accrued on or after April 7, 2022. However, where the debt is incurred and the arrangement is entered into before April 7, 2022, and the interest payments are made to an interest coupon holder that deals at arm's length with the NR Lender, the new measure will apply to interest accrued one year after April 7, 2022.
8. Application of the general anti-avoidance rule to tax attributes
The Department of Finance proposed a public consultation on the general anti-avoidance rule (GAAR) in November 2020, and again referenced it in Budget 2021. However, but for a Canadian Tax Foundation symposium in July 2021, there has been little public discussion about reforming the GAAR. That said, the most obvious area for reform was well-known, namely, that the definition of "tax benefit" does not apply to accrued but unrealized tax attributes. This gap was revealed by recent case law.
In 1245989 Alberta Ltd. v R, 2018 FCA 114 (Wild), the Federal Court of Appeal considered whether subsection 89(1) of the ITA had been misused to increase paid-up capital (PUC) in order to create a result that section 84.1 of the ITA was intended to prevent. Despite the PUC increase, there was no distribution of retained earnings – merely a potential for a future tax-free distribution rather than an actual distribution. The Court of Appeal stated that just as "pre-packaging of tax losses in [the prior case of] OSFC did not result in a tax benefit, the transactions that resulted in the increased PUC . . . did not result in a tax benefit." This conclusion was rooted in the text of the definition of "tax benefit" in subsection 245(1) of the ITA, which requires that there must have been a reduction, avoidance, or deferral of tax or other amount payable, or an increase in a refund of tax or other amount under the ITA. The latter part of the definition may be regarded as ambiguous: does it mean (1) an increase in a refund of tax or [an increase in] [an]other amount, or (2) an increase in a refund of tax or [a refund of] [an]other amount? While the Crown advocated for the former interpretation (which would arguably have captured an increased but unrealized tax attribute), the Court of Appeal concluded that the phrase meant "an increase in a refund of tax or a refund of another amount." Thus, an increased tax attribute that is not realized upon is not a tax benefit and, in the absence of a tax benefit, the GAAR is inapplicable.
The conclusion in Wild was affirmed by the Tax Court in Rogers Enterprises (2015) Inc. v R, 2020 TCC 92, a case that, among other things, concerned capital dividend account increases. The Tax Court again noted the ambiguity in the tax benefit definition and held that the words meant a refund of tax or a refund of another amount under the Act, confirming that the tax benefit definition as it read at the time did not apply to an increased but unrealized tax attribute.
Budget 2022 proposes to amend the GAAR to "apply to transactions that affect tax attributes that have not yet become relevant to the computation of tax." The amendments would apply to notices of determination issued on or after the date of the Budget. The amended tax benefit definition will segregate portions of the definition into paragraphs, and capture "a reduction, increase or preservation of an amount that could at a subsequent time (i) be relevant for the purpose of computing an amount referred to [elsewhere in the definition], and (ii) result in any of the effects described [elsewhere in the definition]." Consequential amendments will be made to the notification provision in subsection 152(1.11) of the ITA and the definition of "tax consequences" within the GAAR.
9. The substantive CCPC
Legislative response to avoidance of CCPC investment income tax rates
Budget 2022 introduces the concept of a "substantive CCPC," with the purpose of subjecting certain private corporations that are not otherwise Canadian-controlled private corporations (CCPCs) to the same taxation as CCPCs on their investment income. This is a legislative response to so-called "non-CCPC" planning that has been around for a number of years, but appears to have become more prevalent following the increase in personal and CCPC investment income tax rates announced on December 7, 2015, shortly after the 2015 Federal Election. The planning is common enough to have been the subject of an April 3, 2022 op-ed in the Globe and Mail.
More specifically, while most non-CCPCs pay a federal tax rate of 15 per cent (plus provincial rates of 8 per cent to 16 per cent, depending on the province), CCPCs benefit from a lower effective federal tax rate of 9 per cent on active business income to the extent they can claim the small business deduction, while paying approximately 38.7 per cent federal tax on investment income (i.e., passive income such as rents, interest, etc.). While most of the tax on CCPC investment income is refundable when taxable dividends are declared, the refundable tax mechanism is intended to eliminate a possible tax deferral on investment income earned through a corporation by Canadian resident individuals. In other words, the stated purpose of the increased but refundable tax imposed on CCPC investment income is based on the concept of corporate tax integration, with the intention of making individuals tax-indifferent between earning investment income personally or through a corporation.
While there are various forms, the common purpose of non-CCPC planning is to change the corporation's status from a CCPC to a corporation other than a CCPC, while retaining its Canadian residency, to obtain access to the lower rate of tax on investment income. For example, this might be achieved by forming or continuing the corporation under the laws of another country with which Canada does not have a tax treaty, usually "tax haven" type countries, while maintaining the corporation's Canadian residency status by keeping its mind and management in Canada. When used in connection with the sale of significant assets with substantial accrued gains, such planning can result in significant tax deferral if the proceeds are left in the corporation for reinvestment.
Our understanding is that the CRA had already begun to challenge non-CCPC planning using existing rules under an ongoing audit project, and the Department of Finance appears to be trying to mitigate the effect of the proposed legislative amendment on the existing CRA challenges, particularly under the GAAR, by noting that:
Although the manipulation of CCPC status can be challenged by the Government based on existing rules in the Income Tax Act, these challenges can be both time-consuming and costly. As a result, the Government is proposing a specific legislative measure.
While the Department of Finance states the new rules are intended to subject the substantive CCPCs to the same anti-deferral and integration mechanisms that CCPCs are subject to, the counter argument is that it just changes the line of where the increased investment tax rates apply. For instance, in many cases a Canadian resident individual could still co-invest up to 49.9 per cent through a private corporation with a non-resident or a public corporation and the corporation would be subject to the lower tax rate on investment income.
Under the new rules, a substantive CCPC will include: (i) a private corporation other than a CCPC that at any time in a taxation year is controlled, directly or indirectly in any manner whatever, by one or more Canadian resident individuals, and (ii) a private corporation other than a CCPC that at any time would, if each share of a corporation that is owned by a Canadian resident individual were owned by a particular individual, be controlled by that particular individual. In addition, a specific anti-avoidance rule is also proposed that would deem any private corporation (other than a CCPC) to be a substantive CCPC if it is reasonable to conclude that one of the purposes of any transaction (as defined for purposes of the GAAR in subsection 245(1) of the ITA), or series of transactions, was to cause the corporation not to qualify as a substantive CCPC. These m
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