The 2012 Federal Budget was delivered by the Finance Minister, Jim Flaherty, on March 29,2012. The following is a redacted summary of the changes as summarized by KPMG in their 2012 Federal Budgets Highlights newsletter.
A major thrust of the budget this year is innovation with more direct support provided for R&D in Canada and a scaling back of the benefits of the Scientific Research and Experimental Development (SR&ED) tax incentive program.
Also significant in this budget is the move by the government to close what it considers to be tax loopholes, including changes in the personal, corporate, charities and international tax areas.
SCIENTIFIC RESEARCH AND EXPERIMENTAL DEVELOPMENT INITIATIVES TAX MEASURES
- Reduction of general tax credit rate - The general SR&ED investment tax credit rate will be reduced to 15% (from 20%), effective January 1, 2014.
- Capital expenditures -Capital expenditures will be removed from the base of eligible expenditures for expenditures incurred in 2014 and subsequent years. All other expenditures such as salary and wages, materials, overhead expenses and contract payments remain eligible.
- Proxy overhead calculation -The prescribed proxy amount will be reduced to 55% (from 65%) of direct labour costs commencing January 1, 2014.
- Arm's-length contract payments - Only 80% of the contract payments will be used for purposes of
PERSONAL TAX CHANGES
Old Age Security and Guaranteed Income Supplement
The age of eligibility for Old Age Security (OAS) and Guaranteed Income Supplement (GIS) will be gradually increased from 65 to 67, starting April 2023, with full implementation by January 2029. This measure will not affect anyone who is 54 years of age or older as of March 31, 2012. In particular, individuals born on March 31, 1958 or earlier will not be affected. Individuals born on or after February 1, 1962 will have an age of eligibility of 67. Individuals born between April 1, 1958 and January 31, 1962 will have an age of eligibility between 65 and 67.
Option to defer OAS pension
Starting on July 1, 2013, individuals will be allowed to voluntarily defer their OAS pension, for up to five years. These individuals will then receive a higher actuarially adjusted annual pension.
Group sickness or accident insurance plans
The budget proposes to include the amount of an employer's contributions to a group sickness or accident insurance plan in an employee's income for the year in which the contributions are made to the extent that the contributions are not in respect of a wage-loss replacement benefit payable on a periodic basis. This measure will not affect the tax treatment of private health services plans or certain other plans.
This measure will apply in respect of employer contributions made on or after March 29, 2012 to the extent the contributions relate to coverage after 2012, except that such contributions made on or after March 29, 2012 and before 2013 will be included in the employee's income for 2013.
Retirement compensation arrangements
Proposed new prohibited investment and advantage rules to directly prevent RCAs from engaging in non-arm's length transactions. These rules will be based very closely on existing rules for Tax-Free Savings Accounts (TFSA) and Registered Retirement Savings Plans (RRSPs). As well, the budget proposes a new restriction on RCA tax refunds in circumstances where RCA property has lost value.
The prohibited investment rules will apply for investments acquired or investments that become prohibited investments on or after March 29, 2012. The advantage rules will apply to advantages extended, received or receivable on or after March 29, 2012, including RCA advantages that related to RCA property acquired, or transactions occurring, before March 29, 2012. Transitional rules will apply.
The budget proposes that, if RCA property has declined in value, the RCA tax will be refunded only in circumstances where the decline in value of the property is not reasonably attributable to prohibited investments or advantages, unless the CRA is satisfied that it is just and equitable to refund the tax. This measure will apply in respect of RCA tax on RCA contributions made on or after March 29, 2012.
Employees Profit Sharing Plans
The budget proposes a measure to limit certain employer contributions to Employees Profit Sharing Plans (EPSPs). The proposal introduces a special tax payable by a specified employee on an "excess EPSP amount".
A specified employee is one who has significant equity interest in the employer or who does not deal at arm's length with the employer. An "excess EPSP amount" will be the portion of an employer's EPSP contribution, allocated by the plan trustee to a specified employee, that exceeds 20% of the specified employee's salary received in the year from the employer.
The special tax will include two components: the first component will be equal to the top federal marginal tax rate of 29%. The second component will be equal to the top marginal rate of the province of the specified employee's residence (unless the specified employee resides in Quebec, in which case this component will be zero). A new deduction will be introduced to ensure that an excess EPSP amount is not also subject to regular income tax. A specified employee will not be able to claim any other deductions or credits in respect of an excess EPSP amount.
The CRA will have the discretion to waive or cancel the application of this measure if it considers it just and equitable to do so.
This measure will apply to EPSP contributions made by an employer on or after March 29, 2012, other than contributions made before 2013 under a legally binding obligation arising under a written agreement entered into before March 29, 2012.
Mineral Exploration Tax Credit
The Mineral Exploration Tax Credit is available to individuals who invest in flow-through shares. The credit is equal to 15% of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors. The budget proposes to extend eligibility for the tax credit for one year to flow-through share agreements entered into on or before March 31, 2013.
OTHER PERSONAL TAX MEASURES
Medical Expense Tax Credit
Expenses eligible for the Medical Expense Tax Credit will include blood coagulation monitors for use by individuals who require anti-coagulation therapy, including certain associated items, when they are prescribed by a medical practitioner. This measure will apply to expenses incurred after 2011.
Life insurance policy exemption test
The budget proposes to implement several changes regarding the life insurance policy exemption test which is the test that determines whether a life insurance policy is a tax-exempt policy.
The Investment Income Tax (IIT) on life insurance will be modified where appropriate to neutralize impacts of the proposed technical improvements to the IIT base. The government will consult with key stakeholders on these proposed improvements. Amendments to the tax provisions arising from these consultations will apply to life insurance policies issued after 2013.
Overseas Employment Tax Credit
Currently, employees who are residents of Canada and who qualify for the Overseas Employment Tax Credit (OETC) are entitled to a tax credit equal to the federal tax otherwise payable on 80% of their qualifying foreign employment income, up to a maximum foreign employment income of $100,000.
The budget proposes to phase out the OETC over four years, beginning with 2013. In particular, during the phase-out period, the 80% applied to an employee's qualifying foreign employment income will be reduced as follows:
- 60% for 2013
- 40% for 2014
- 20% for 2015.
The OETC will be eliminated for 2016 and subsequent years.
The phase-out rules will not apply to qualifying foreign employment income earned by an employee if the employer has committed in writing (e.g., the employer tendered an irrevocable bid in writing for a project) before March 29, 2012. In this case, the 80% will apply for 2013, 2014, and 2015. However, the OETC will be eliminated for 2016 and subsequent years.
Registered Disability Savings Plans
The budget proposes several measures related to registered disability savings plans (RDSPs), including:
Certain family members (spouse, common-law spouse, common-law partner, or parent of the disabled individual) may, on a temporary basis, become plan holders of a registered disability savings plans (RDSPs) for an adult individual who might not be able to enter into a contract. Currently, a plan holder must be either the beneficiary or their guardian or legal representative. This measure applies from the date of Royal Assent of the enacting legislation until the end of 2016.
Proportional repayment rule
Under current rules, Canada Disability Savings Grants (CDSGs) and Canada Disability Savings Bonds (CDSBs) paid into an RDSP in the preceding 10 years must be repaid to the government under certain conditions (the "10-year repayment rule"), including when an amount is withdrawn from an RDSP. The budget proposes to introduce a proportional repayment rule that will apply when a withdrawal is made from an RDSP. Generally, for each $1 withdrawn from an RDSP, $3 of any CDSGs or CDSBs paid into the plan in the 10 years preceding the withdrawal must be repaid.
Maximum and minimum withdrawals
The budget proposes changes to the maximum and minimum withdrawals from RDSPs. These changes will apply after 2013.
Rollover of RESP investment income
The budget proposes to allow investment income earned in a Registered Education Savings Plan (RESP) to be transferred on a tax-free (or "rollover") basis to an RDSP if the plans share a common beneficiary, if certain conditions are met. This measure will apply to rollovers of RESP investment income made after 2013.
Termination of RDSP following cessation of eligibility for the disability tax credit
The budget proposes to extend the period for which an RDSP may remain open when a beneficiary becomes disability tax credit-ineligible, i.e., the beneficiary's condition improves so that he or she becomes ineligible for the disability tax credit (DTC).
To have this measure apply, the plan holder is required to make an election in prescribed form on or before December 31st of the year following the first full calendar year for which the beneficiary is DTC-ineligible. The election will generally be valid until the end of the fourth calendar year following the first full calendar year for which a beneficiary is DTC-ineligible.
This measure will apply to elections made after 2013.
The budget replaces certain deadlines regarding the administration of an RDSP with a requirement that an RDSP issuer act "without delay" in notifying Human Resources and Skills Development Canada when an RDSP is established or transferred from one RDSP issuer to another.
BUSINESS TAX CHANGES
Eligible dividend designations
The budget proposes to allow a corporation to designate, at the time it pays a taxable dividend, any portion of the dividend to be an eligible dividend. The portion of the taxable dividend that is designated to be an eligible dividend will qualify for the enhanced dividend tax credit for eligible dividends and the remaining portion will qualify for the dividend tax credit for non-eligible dividends.
Under the budget proposal, the CRA will be allowed to accept a late designation of an eligible dividend if the corporation makes the late designation within the three-year period following the day on which the designation was first required to be made.
These measures will apply to taxable dividends paid on or after March 29, 2012.
Tax avoidance using partnerships
Elimitation of section 88 "bump" to partnership interests
The budget proposes changes to limit the application of the section 88 "bump" in the wind-up involving a partnership interest where all the fair market value of the partnership interest is derived from income assets.
Section 88 of the Income Tax Act (the Act) generally permits a taxable Canadian corporation that has acquired control of another taxable Canadian corporation to increase the cost base of certain capital assets acquired by the parent company on a wind-up or vertical amalgamation with the parent. The bump permits the parent to add the amount paid for the shares to the cost of certain assets acquired on the amalgamation or wind-up, within certain limits.
The bump applies to capital assets, such as land, shares of a corporation or interest in a partnership but does not apply to income producing assets such as eligible capital property, depreciable property, inventory and resource property.
The budget proposes to deny a bump in respect of a partnership interest to the extent that the accrued gain in respect of the partnership interest is reasonably attributable to the amount by which the fair market value of income assets exceed their cost amount.
These rules apply to income assets that are held directly by the partnership or indirectly through another partnership. However, assets directly owned by a taxable Canadian corporation, shares of which are owned by the partnership, will not be considered to be indirectly held by the partnership.
This measure will apply to amalgamations that occur, and wind-ups that begin, on or after March 29, 2012. However, the new measure will not apply where a taxable Canadian corporation amalgamates with its subsidiary before 2013, or begins to wind up its subsidiary before 2012, provided that before March 29, 2012 the corporation had acquired control or was obligated, as evidenced in writing, to acquire control of the subsidiary and the corporation had the intention, as evidenced in writing, to amalgamate with or wind up with the subsidiary.
Partnership disposition to a non-resident
Section 100 of the Act provides that income assets held by a partnership are fully taxable on the sale of the partnership to a tax-exempt person.
The budget proposes to apply section 100 to the sale of a partnership interest to a non-resident person or to an indirect transfer to a non-resident person or a tax-exempt entity. However, this proposal will not apply to the disposition of an interest to a non-resident person if the partnership, immediately before and immediately after the acquisition by the non-resident person, uses all of the property of the partnership in carrying on business through a permanent establishment in Canada.
This measure applies to dispositions of interests in partnerships that occur on or after March 29, 2012, except for arm's-length dispositions made before 2013 where the taxpayer is obligated pursuant to a written agreement entered into before March 29, 2012.
The CRA may not, for a fiscal period of a partnership, make a determination or redetermination of any income, loss, deduction or other amount in respect of the partnership if more than three years have elapsed since the latter of the filings deadline for filing the relevant information return and the day that it is actually filed. However, where a waiver is obtained by the CRA, the period of time for making the determination or redetermination is extended.
The budget proposes that a waiver may be made by one member of the partnership if the member is designated on behalf of all of the partners.
ACCELERATED CCA FOR CLEAN ENERGY GENERATION EQUIPMENT
Waste-fuelled thermal energy equipment
Class 43.2 provides accelerated CCA (50% per year on a declining balance basis) for investment in specified clean energy generation and conservation equipment. Currently, this class includes waste-fuelled thermal energy equipment, subject to the requirement that the heat energy generated from the equipment is used in an industrial process or a greenhouse. The budget proposes to expand Class 43.2 by removing this requirement. As a result, waste-fuelled thermal energy equipment will be able to be used in a wide range of applications, including space and water heating.
District energy system equipment
Certain equipment that is part of a district energy system is currently included in Class 43.1 or Class 43.2. The budget proposes to expand Class 43.2 by adding equipment that is part of a district energy system that distributes thermal energy primarily generated by waste-fuelled thermal energy equipment (that is itself eligible for inclusion in Class 43.2).
Energy generation from residue of plants
Currently, subject to certain requirements, equipment that uses plant residues to produce biogas or bio-oil is currently eligible for inclusion in Class 43.2. The budget proposes to add the residue of plants to the list of eligible waste fuels that can be used in waste-fuelled thermal energy equipment included in Class 43.2 or a cogeneration system included in Class 43.1 or Class 43.2.
The budget proposes that equipment using eligible waste fuels not be eligible under Class 43.1 or Class 43.2 if environmental laws and regulations are not complied with at the time the equipment first becomes available for use.
These measures apply to assets acquired on or after March 29, 2012 that have not been used or acquired for use before this date.
Corporate Mineral Exploration and Development Tax Credit
The budget proposes to phase out the corporate tax credit for pre-production mining expenditures. Currently, a tax credit of 10% is available. The credit will apply at a rate of 10% for exploration expenses incurred in 2012, and at a rate of 5% for expenses incurred in 2013. The credit will not be available for exploration expenses incurred after 2013.
The corporate tax credit will apply at a rate of 10% for pre-production development expenses incurred before 2014, at a rate of 7% for expenses incurred in 2014, and a rate of 4% for expenses incurred in 2015. The credit will not be available for pre-production development expenses incurred after 2015. However, transitional relief is provided in certain circumstances.
ATLANTIC INVESTMENT TAX CREDIT (AITC)
Oil and gas and mining activities
The budget proposes to phase out the 10% AITC for oil and gas and mining activities over a four-year period. The AITC will apply at a rate of 10% for assets acquired before 2014 for use in certain oil and gas and mining activities (a list of activities is provided in the budget document), at a rate of 5% for such assets acquired in 2014 and 2015. The AITC will not be available for such assets acquired after 2015. However, transitional relief is provided in certain circumstances.
Electricity generation equipment
Certain equipment is eligible for the AITC if the equipment is "qualified property". The budget proposes amendments so that qualified property will include certain electricity generation equipment and clean energy generation equipment used primarily in an eligible activity. In general, and subject to certain requirements, qualified property will include electricity generation equipment described in Class 17 or 48 and clean energy generation and conservation equipment described in Class 43.1 or 43.2.
This measure will apply to assets acquired on or after March 29, 2012 that have not been used or acquired for use before this date, except that the measure will not apply to acquisitions of assets that are used primarily in oil and gas or mining activities.
Hiring credit for small business
Last year's budget introduced a temporary Hiring Credit for Small Business of up to $1,000 per employer. The 2012 budget proposes to extend this temporary credit for one year. In particular, a credit of up to $1,000 against a small employer's increase in its 2012 Employment Insurance premiums over those paid in 2011 will be provided.
Taxation of corporate groups
In the 2010 federal budget, the government announced that it was going to explore whether new rules for the taxation of corporate groups, including tax loss consolidation or loss transfer rules, should be considered to improve the functioning of the corporate tax system. Public consultations were held between November 2010 and April 2011 and the government has indicated that discussions with applicable stakeholders, including the provinces and territories, are ongoing.
INTERNATIONAL TAX CHANGES
Thin capitalization rules
The budget proposes a series of measures that impact the thin capitalization rules.
Reduction of debt-to-equity ratio from 2:1 to 1.5:1
The thin capitalization rules limit the interest expense deduction of a Canadian resident corporation where the amount of debt owing to certain non-residents exceeds a 2:1 debt-to-equity ratio. These rules apply to debts owing to a specified shareholder that is not resident in Canada and any other non-resident who does not deal at arm's length with the non-resident. A specified shareholder is generally viewed as owning shares representing more than 25% of the votes or value of the corporation.
The budget proposes that the debt-to-equity ratio be reduced to 1.5:1 for all corporate taxation years that begin after 2012.
Inclusion of partnership debt in the debt-to-equity ratio
Currently, the thin capitalization rules only apply to Canadian resident corporations. The budget proposes to extend these rules to apply to debts owed by partnerships of which a Canadian resident corporation is a member.
In this situation, the debt of the partnership will be allocated to its Canadian resident corporation members based on their proportionate interest in the partnership. These debts will then be included in the corporation's debt-to-equity ratio under the thin capitalization rules.
Where this calculation results in an amount of non-deductible interest that is related to the debt allocated from the partnership, an amount equal to the interest on the portion of the allocated partnership debt that exceeds the permitted debt-to equity ratio will be required to be included in computing the income of the Canadian resident corporation that is a member of the partnership. The inclusion will be treated as either business or property income and the source of this inclusion will be determined by reference to the source against which the interest is deductible at the partnership level.
This measure is applicable in respect of debts of a partnership that are outstanding during corporate taxation years that begin on or after March 29, 2012.
Interest disallowed in the debt-to-equity ratio treated as dividends
The budget proposes to recharacterize the disallowed interest expense from the application of the thin capitalization rules as a dividend for non-resident withholding tax purposes. This recharacterization includes an amount that is required to be included in computing the income of a corporation in respect of a disallowed interest expense of a partnership.
The budget proposes that any disallowed interest expense of a corporation will be allocated to specified non-residents in proportion to the corporation's debt owing in the taxation year to all specified non-residents, including debts owing by the partnerships of which a corporation is a member. Withholding tax will then apply to the deemed dividend allocation. Withholding taxes on deemed dividends are due when applicable withholding taxes on interest payments are otherwise due. The corporation may allocate the disallowed interest expense to the latest interest payments made to any particular specified non-resident in the taxation year. Where the interest expense has not been paid by the end of the taxation year, the disallowed interest expense will be deemed to have been paid as a dividend to that specified non-resident at the end of the taxation year.
This measure applies to taxation years that end on or after March 29, 2012.
Foreign affiliate loans
The budget proposes that the thin capitalization rules will not include the interest expense of a Canadian-resident corporation that relates to interest that is taxable to the Canadian resident corporation as Foreign Accrual Property Income of a controlled foreign affiliate of the corporation.
This measure applies to taxation years of a Canadian resident corporation that end on or after March 29, 2012.
Foreign affiliate dumping
"Foreign affiliate dumping" is a term applied to certain transactions whereby a Canadian subsidiary uses borrowed funds to acquire shares of a foreign affiliate from its foreign parent, obtains an interest expense deduction in Canada on the borrowing and at the same time is eligible to receive exempt surplus dividends on the shares of the foreign affiliate that are exempt from taxation in Canada.
Certain transactions that could also be viewed as foreign affiliate dumping include:
- Acquisitions of shares of a foreign affiliate that are made with internal funds of a Canadian subsidiary, which are viewed as an extraction of funds from the Canadian subsidiary free of Canadian withholding tax
- Acquisitions of newly issued shares of a foreign affiliate where previously issues shares of the foreign affiliate are owned by the foreign parent or another non-resident member of the same corporate group
- Acquisitions of foreign affiliate shares from a foreign subsidiary of the foreign parent
- Acquisitions of foreign affiliate shares from an arm's-length party at the request of the foreign parent.
The budget proposes the following:
- Where certain conditions are met, a dividend will be deemed to be paid by a Canadian subsidiary to its foreign parent to the extent of the value of consideration given by the Canadian subsidiary for the acquisition of the shares of the foreign affiliate. Any deemed dividend will be subject to non-resident withholding tax.
- Furthermore, it is proposed that paid-up capital of any shares of the Canadian subsidiary that are given as consideration by the parent will be disregarded.
These rules will not apply to transactions that meet a "business purpose test". The factors to be considered in applying this test will be non-tax factors and are intended to assist in determining whether it is reasonable to conclude that the investment in, and ownership of, the foreign affiliate belongs in the Canadian subsidiary more than in any entity in the foreign parent's group. The government will receive submissions concerning the details of the proposed "business purpose test" before June 1, 2012.
This measure will apply to transactions that occur on or after March 29, 2012, other than transactions that occur before 2013 between parties that deal at arm's length and that are obligated to complete the transaction pursuant to a written agreement entered into before March 29, 2012.
Related paid-up capital suppression rules will apply in corporate immigrations and emigrations.
The budget indicates that the government intends to monitor further developments in this area.
Base erosion test-Canadian banks
The budget proposes that amendments will be developed on the so-called "Base Erosion Test" of the foreign accrual property income regime as it applies to Canadian banks. Specifically, amendments will be developed to alleviate the tax cost to Canadian banks of using excess liquidity of their foreign affiliates in their Canadian operations. Also, amendments will be developed to ensure that certain transactions that form part of a bank's business of facilitating trades for arm's-length customers are not caught by the base erosion test.
These amendments will be developed with industry representatives.
Transfer pricing adjustments
The transfer pricing rules that generally govern the transactions or series of transactions between parties who do not deal at arm's length are provided in section 247 of the Act.
Once an adjustment to the transfer price is made for income tax purposes by the CRA to reflect arm's-length terms and conditions (commonly referred to as a "primary adjustment"), a resulting adjustment is generally required to account for the part of the transaction which was not deemed to made at acceptable transfer pricing terms. This part of the transaction is generally referred to as the "secondary adjustment" and is viewed as a benefit conferred on the non-residents participating in the transaction.
It is proposed that section 247 of the Act be amended to confirm that the secondary adjustment be treated as a dividend for purposes of non-resident withholding tax Part XIII of the Act, with the result that related withholding tax will apply. Further, when such an adjustment is applicable, the Canadian corporation subject to the primary adjustment will be deemed to have paid a dividend to each non-arm's length non-resident that is part of the transactions in proportion to the amount of the primary adjustment that relates to that non-resident. This rule specifically applies regardless of whether the non-resident person is a shareholder of the Canadian corporation.
If a non-resident repatriates to the Canadian corporation an amount equal to its portion of the primary adjustment, and if the repatriation is made with the concurrence of the CRA, no deemed dividend will arise if the non-resident is a controlled foreign affiliate of the Canadian corporation.
These proposals will apply to transactions and series of transactions that occur on or after March 29, 2012.
Notice of Ways and Means Motion
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