On February 11, 2014, the Minister of Finance released the federal government’s 2014 Budget. The Budget continued last year’s theme of “closing tax loopholes” and “improving the fairness and integrity of the tax system,” and to that end proposed a number of specific amendments to the Income Tax Act (Canada) (the “Act”). The Budget also announced the federal government’s intention to consult on the possible introduction or elimination of certain significant income tax rules and regimes.
Below is a summary of the more significant income tax proposals outlined in the 2014 Budget.
- Kiddie Tax Extension – The so-called “kiddie tax” limits the ability to income-split with minors by applying the highest marginal tax rate to certain types of income earned by that minor, including: taxable dividends received from private corporations; capital gains realized on the disposition of private company shares to a non-arm’s length person; and income earned through a partnership or trust from the provision of property or services to a business carried on by a related person.
The 2014 Budget announced the extension of the kiddie tax to a new type of income: income earned through a partnership or trust from business or rental activities conducted with third parties, if a person related to the minor either, in the case of a partnership, has an interest in the partnership or is actively engaged on a regular basis in the activities of the partnership or trust. In essence, these amendments further restrain the ability to income-split with minor children through a partnership or trust. This measure will apply to 2014 and subsequent taxation years.
- Loss of Graduated Rates for Testamentary Trusts – Following the announcement made in the 2013 federal budget, the 2014 Budget proposes to apply flat top-rate taxation to all testamentary trusts (including estates), except to estates during their first 36-month “administration period.” In addition, testamentary trusts (except estates during their first 36 months) will lose their entitlement to certain tax-related benefits, including the ability to choose an off-calendar year-end, the basic exemption in computing alternative minimum tax (AMT), and the exemption from the income tax instalment rules. These measures will generally apply to 2016 and subsequent years.
- Loss of Immigrant Trusts – Under the Act, a non-resident trust is deemed to be a resident in Canada if, generally, a Canadian resident has contributed to the trust. A main, long-standing exception to this rule is with respect to a so-called “immigrant trust,” which is a trust the only contributors to which are persons who have been resident in Canada for fewer than 60 months.
The 2014 Budget proposes to eliminate the 60-month exemption on the basis that it raises “tax fairness, tax integrity and tax neutrality concerns.” As such, immigrant trusts have effectively become a thing of the past. The measure will apply to taxation years that end after 2014 for existing immigration trusts and that end on or after Budget Day in any other case.
- International Back-To-Back Loans – The thin capitalization rules generally limit the deductibility of interest expenses by a corporation or trust where the total of all debts owing to specified non-residents exceeds a 1.5-to-1 debt-to-equity ratio. In addition, Part XIII of the Act generally imposes a 25% withholding tax (subject to reduction under a tax treaty) on interest paid or credited to a non-arm’s length, non-resident person.
According to the 2014 Budget, some taxpayers have attempted to circumvent the application of those rules by establishing so-called “back-to-back” loan arrangements with an intermediary. That is, a third party (e.g., a foreign bank) is interposed between two related taxpayers in order to avoid the thin capitalization rules and withholding tax imposed by Part XIII. The 2014 Budget proposes to curtail the use of those arrangements by treating those arrangements as loans made directly by the relevant non-resident. These measures will generally apply after 2014.
- Offshore Regulated Banks – The foreign accrual property income (FAPI) regime requires that certain types of passive income, including income from an investment business, earned by a non-resident corporation that is controlled by a Canadian resident (a “controlled foreign affiliate”) be included in the Canadian taxpayer’s income on an accrual basis. One of the exceptions to this rule is for an investment business carried on by the non-resident as a foreign bank where the activities are regulated under the laws of the country in which the business is carried on.
Certain Canadian taxpayers that are not financial institutions have qualified for this exception by subjecting their controlled foreign affiliate to regulation under foreign banking laws. Budget 2014 indicates that the purpose of this rule was not to allow the affiliates to invest or trade securities on their own account and thus will add new conditions for the availability of this exemption, including that the Canadian resident be a regulated financial institution or that more than 50% of the taxable capital employed in Canada by the taxpayer is attributable to taxable capital employed in Canada by regulated financial institutions. This measure will apply to taxation years that begin after 2014.
- Consultation on Proposed Treaty Shopping Rules – The 2014 Budget reiterated the government’s opposition to “treaty shopping” and proposed to introduce a “main purpose” provision in the Act whereby a tax benefit provided under a treaty would not be available to a party involved in a transaction if the main purpose of that transaction was to obtain the benefit. In the absence of proof to the contrary, the requirement would be presumed satisfied if the relevant income is primarily used to make transfers to others who would not have been entitled to an equivalent treaty benefit.
Parties interested in providing comments on the proposed treaty shopping rules are requested to do so within 60 days after Budget Day.
- Consultation on the Possible Elimination of the Eligible Capital Property (ECP) Regime – The 2014 Budget announced the government’s intention to consult on the possible elimination of the ECP regime, which generally deals with property such as goodwill and other intangibles not included in a class of depreciable property. The rules relating to ECP have been in place for decades, and the government’s stated impetus for seeking their removal is because those rules have “become increasingly complicated” and certain stakeholders have apparently suggested simplifying the regime.
Generally, the 2014 Budget proposes to replace the ECP regime with a new class of depreciable property to which the capital cost allowance (CCA) rules would apply. Instead of 75% of an eligible expenditure being included in the taxpayer’s cumulative eligible capital pool, which may be deducted at the rate of 7% per year on a declining-balance basis, the proposals would see 100% of any eligible expenditure being included in a new CCA class of which 5% may be deducted per year on a declining-balance basis.
Specific legislation, including transitional rules, is expected to be released for public consumption in the near future, after which stakeholders will be invited to submit their comments to the Department of Finance.