Global economic growth slowed in 2015 to its weakest pace since the 2008-09 recession, led by slower growth in the emerging economies such as China and commodity-producing countries. The 2016 Budget projects a fiscal 2017 deficit of $29.4 billion, which is a result of the ongoing weakness in the global economy, increases in the Liberal Government’s spending commitments and lower than projected tax revenues. Nevertheless, the 2016 Budget emphasizes economic growth, job creation and the restoration of a vibrant middle class by introducing several grant and benefit initiatives, while prioritizing infrastructure, health care, education, innovation and clean energy spending.
The Government commits to invest more than $120 billion in infrastructure over 10 years, focusing on public needs such as transit, water systems and affordable housing over the next two years and a clean and low-carbon economy over the longer term. The 2016 Budget includes some specific tax measures for individuals, such as the introduction of the Canada Child Benefit and the elimination of the income splitting, fitness and arts tax credits. Corporate tax measures include revisions to the taxation of small business income, life insurance policies and eligible capital property. Despite the spending commitments and challenging economic landscape, the Government projects the maintenance of the federal debt-to-GDP ratio around 32% and the gradual reduction of the budgetary deficit through 2020-21 to $14.3 billion.
Small Business Tax Rate
The previously proposed gradual reduction of the small business tax rate has been repealed. Tax rates in Quebec and Ontario on a combined basis will be as follows for 2016:
Small Business Deduction
For taxation years that begin after March 21, 2016, structures designed to increase the small business deduction claim on active business income earned through a partnership will no longer be effective. In addition, the small business deduction will be limited where a corporation provides services or property in various non-arm’s length or internal circumstances. The taxable capital limit will now be shared among associated corporations notwithstanding any elections made to disassociate them for other purposes. Where corporations have elected to be disassociated with a common corporation, any investment income earned by these corporations from the common corporation will now be ineligible for the small business deduction.
Distributions Involving Life insurance Proceeds
Currently the portion of a life insurance policy benefit received by a corporation that exceeds the cost of the policy maybe added to the capital dividend account (CDA) of the corporation and withdrawn tax-free by the shareholders. New measures are proposed in order to prevent artificially increasing the amount added to the CDA. These rules will apply regardless of whether or not the corporation receiving the policy benefit is a policyholder. Similar rules will be adopted for policies held by partnerships and reporting requirements will also be introduced. The changes will apply to policy benefits received as result of a death occurring after March 22, 2016.
Transfers of Life Insurance Policies
The Budget proposes changes to deem the proceeds of disposition received by a taxpayer on the transfer of a life insurance to a private corporation to be equal to the fair market of the consideration received and not the cash surrender value of the policy as is currently the case. This rule will apply to transfers made on or after March 22, 2016.
Changes will also be made to reduce the capital dividend inclusion upon the ultimate death of the insured for private corporations where life insurance policies have been transferred for consideration in excess of their cash surrender value prior to March 22, 2016.
Foreign Exchange Gains on Debt Parking
New rules will be introduced under which a debtor will realize any accrued foreign exchange gains when a foreign currency debt becomes a parked obligation. Exceptions will be provided for foreign currency debt in the context of certain bona fide commercial transactions. These proposed rules will generally apply to foreign currency debt that becomes a parked obligation on or after Budget Day.
Valuation of Derivatives
Derivatives will be deemed not to be inventory for purposes of the inventory valuation rules. Therefore, no deduction will be available for unrealized losses. This proposed measure will apply to derivatives entered into on or after Budget Day.
Eligible Capital Property
The Budget proposes to repeal the eligible capital property regime and replace it with a new capital cost allowance (CCA) class effective January 1, 2017. The full cost of an eligible capital expenditure (rather than ¾ of the cost) will be added to the new class which will have an annual depreciation rate of 5%. For simplicity, the existing CCA rules, including rules relating to recapture, capital gains and depreciation will apply. Additions to the new CCA class will be subject to the half year rule.
Transition rules will apply to existing cumulative eligible capital pool balances beginning January 1, 2017. The existing pool balances will be transferred to the new CCA class and for the first ten years will be depreciated at an annual rate of 7%.
Back-to-Back Shareholder Loan Rules
The Budget proposes to introduce back-to-back rules in relation to Canadian resident borrowers. A back-to-back shareholder loan will exist where a shareholder of a Canadian resident corporation has a debt owing to an intermediary and in turn the intermediary owes an amount to the Canadian resident corporation or the Canadian resident corporation has provided security in respect of the debt. This measure will apply to back-to-back arrangements entered into as of March 22, 2016.
For back-to-back shareholder loans that were in place prior to March 22, 2016, the debt will be deemed to have become owing on March 22, 2016.
Top Marginal Income Tax Rate
Along with the announcement of a new top marginal personal income tax rate of 33% on individual taxable income in excess of $200,000 in December 2015, a number of consequential amendments to the Income Tax Act were introduced. The Budget proposes further amendments to other income tax rules that require adjustment. These measures will apply to the 2016 and subsequent taxation years.
Tax rates in Quebec and Ontario on a combined basis will be as follows for 2016:
Income Splitting Tax Credit
The income splitting tax credit of up to $2,000 for couples with at least one child under the age of 18 will be eliminated for the 2016 and subsequent taxation years.
Education and Textbook Tax Credits
The 15% non-refundable education and textbook tax credits will be eliminated effective January 1, 2017. Unused education and textbook credit amounts carried forward from years prior to 2017 will remain available to be claimed in 2017 and subsequent years. The tuition tax credit will remain unchanged.
Children’s Fitness and Arts Tax Credits
For 2016, the maximum eligible amounts for the children’s fitness tax credit and the children’s arts tax credit will be reduced to $500 and to $250 respectively. The supplemental amounts for children eligible for the disability tax credit will remain at $500 for 2016. Both credits will be eliminated for the 2017 and subsequent taxation years.
Labour-Sponsored Venture Capital Corporations Tax Credit (LSVCC)
The Budget restores the federal LSVCC tax credit of 15% for share purchases of provincially registered LSVCCs prescribed under the Income Tax Act for the 2016 and subsequent taxation years.
Canada Child Benefit
The Budget eliminates the Universal Child Care Benefit (UCCB) and the Canada Child Tax Benefit (CCTB) and replaces it with the new Canada Child Benefit (CCB). This new benefit will not be taxable and will be paid monthly starting in July 2016. To be eligible, an individual must be a resident of Canada, reside with the qualified dependent and be either the parent who provides for the primary care of the qualified dependent or a shared-custody parent.
The new maximum annual CCB will be $6,400 per child under the age of 6 and $5,400 per child between age 6 and 17. These benefits will be reduced based on family income.
Teacher and Early Childhood Educator School Supply Tax Credit
A new 15% refundable tax credit is introduced for eligible educators on eligible supplies up to $1,000 acquired on or after January 1, 2016.
Mineral Exploration Tax Credit for Flow-Through Shares
The 15% mineral exploration tax credit for flow-through shares is being renewed for an additional year for flow-through share agreements entered into on or before March 31, 2017.
Taxation of Switch Fund Shares
An exchange of shares of a mutual fund corporation (or investment corporation) that results in the investor switching between funds will now generally be considered for tax purposes to be a disposition at fair market value. This measure will apply to exchanges of shares that occur after September 2016.
International Tax Measures
Base Erosion and Profit Shifting
Canada has been actively engaged in the multilateral efforts of the G20 and the Organization for Economic Co-operation and Development (OECD) to address “base erosion and profit shifting” (BEPS). To improve the integrity of Canada’s international tax system, the Budget proposes to adopt recommendations addressing BEPS strategies used by multinational enterprises (MNEs). Details on these recommendations are set out below:
- Transfer Pricing Documentation – Country-by-Country Reporting
New legislation to strengthen transfer pricing documentation will introduce country-by-country reporting for MNEs with total annual consolidated group revenues of €750 million or more. Where such an MNE has an ultimate parent entity that is resident in Canada (or a Canadian resident subsidiary in certain circumstances), it will be required to file a country-by-country report with the Canada Revenue Agency within one year of the relevant fiscal year end. This new reporting will be required for taxation years that begin after 2015.
- Revised Transfer Pricing Guidance
The Budget does not include any proposed legislation relating to the revised OECD Transfer Pricing Guidelines for MNEs and Tax Administrations (the “Guidelines”) arising from the BEPS project. The Budget however confirms that revisions to the Guidelines generally support the CRA’s current interpretation and application of the arm’s length principle as reflected in its audit and assessing practices. The Budget also confirms that the CRA will not be adjusting its administrative practices in areas where the BEPS project is still on-going.
- Treaty Abuse
Canada will be amending its tax treaties in accordance with the BEPS minimum standard. Canada will either adopt a general anti-abuse rule based on the criterion of whether the principal purpose of an arrangement is to obtain treaty benefits (the principal purpose test) or a specific anti-abuse rule that will require satisfaction of a series of tests in order to qualify for treaty benefits (limitation on benefits rule). These changes will be implemented through bilateral negotiations or a multilateral instrument to be developed in 2016.
- Spontaneous Exchange of Tax Rulings
Canada will implement in 2016 the BEPS minimum standard for the spontaneous exchange of tax rulings with other committed jurisdictions.
Cross-Border Surplus Stripping
Amendments will be made to the anti-surplus stripping rule exception where a Canadian purchaser corporation acquires the shares of a non-resident corporation that itself owns shares of a Canadian corporation to ensure the exception applies as originally intended and not to allow for the artificial creation of paid-up capital in the shares of these subsidiaries. These measures will apply in respect of dispositions occurring on or after March 22, 2016.
Extension of the Back-to-Back Rules
There is an existing specific anti-avoidance rule for back-to-back loan arrangements that prevents taxpayers from interposing a third party between a Canadian borrower and a foreign lender in an attempt to avoid the application of withholding tax in respect of cross-border interest payments. The Budget proposes to extend the basic concepts of these rules to apply to back-to-back arrangements involving rent and royalties as well as payments that are economically similar to interest or royalty payments. The extension of the rules will apply to payments made after 2016.
The following GST/HST measures are applicable after Budget Day:
Insulin pens, insulin pen needles and intermittent urinary catheters are added to the list of zero-rated medical devices.
- Where property or services are provided in exchange for a donation, only the value of the property or services supplied will be subject to GST/HST.
- The Budget clarifies that GST/HST applies to supplies of purely cosmetic procedures provided by all suppliers, including registered charities.
Exported Call Center Services
Services of rendering technical or customer support to individuals by phone, email or web chat (i.e. call center services) will be zero-rated for GST/HST purposes if:
- the service is supplied to a non-resident person not registered for GST/HST purposes, and
- the technical or customer support is to be rendered primarily (more than 50%) to individuals who are outside Canada at the time the service is rendered.
De Minimis Financial Institutions Threshold
The determination of the threshold of de minimis financial institutions will exclude interest earned from conventional saving vehicles such as term deposits.
Closely Related Test
An additional condition will be introduced requiring that a corporation or a partnership must hold and control 90% or more of the votes in respect of every corporate matter of the subsidiary corporation.
Grandfathered House Sales
Builders will be able to correct past reportings and avoid penalties by making an election to report all past grandfathered sales for which the consideration is at least $450,000.
The Budget clarifies that the ceding commissions and the margin of risk transfer will not form part of the tax base that is subject to the self-assessment provisions. Specific conditions will be added to the legislation to ensure that GST/HST would not be imposed on reinsurance premiums charged by a reinsurer to a primary insurer. This measure will apply to any specified year of a financial institution that ends after November 16, 2005 and will allow a financial institution to request a reassessment solely for the purpose of taking into account the effect of this measure. The reassessment must be requested within one year after the date on which the proposals receive Royal Assent.
Diesel and Aviation Fuel
The relief for heating oil will apply only to heating in respect of buildings. The exemption for diesel fuel used to generate electricity in or by a vehicle will be removed. These excise tax measures are applicable after June 2016.
Aboriginal Tax Policy
The Government confirms its willingness to discuss and put into effect additional direct sales and personal taxation arrangements with interested Aboriginal governments.
Any individual who is an Indian under the Indian Act is eligible for the new Canada Child Benefit, assuming all other eligibility requirements are met.