A Critical Analysis of the Principal Income Tax Measures from Federal Budget 2022 (and Subsequent Legislative Proposals)

Published by Thorsteinssons LLP

Authors: Gloria Wang, Sarah Faber, and Alexander Demner

Budget 2022: A Plan to Grow Our Economy and Make Life More Affordable (“Budget 2022”) was tabled by the Federal Government on April 7, 2022 (“Budget Day”). The government professed a desire to return to fiscal responsibility after two years of COVID-19 support measures, and introduced a number of significant income tax proposals in furtherance thereof. Our recent post by Jennifer Flood and Greg DelBigio reviewed the proposals designed to increase the CRA’s enforcement powers and prosecute financial crime. In this post, we discuss certain key income tax proposals for individual and corporate taxpayers.

This post also considers proposed legislation released by the Department of Finance on April 26, 2022, which cover several of the proposed measures.

Housing

Budget 2022 contains a number of tax measures aimed at encouraging home ownership and discouraging those looking to profit off the hot housing market.

Under the first branch, the government introduced a new Tax-Free First Home Savings Account (“FHSA”). Individuals who do not own their home (and did not own it at any point in the last four years) may contribute up to $8,000 per year to a FHSA, to a total of $40,000. Contributions are deductible, and the money can subsequently be withdrawn tax-free if used for a “qualifying first home purchase” within 15 years of opening the FHSA. Unlike an RRSP or TFSA, contribution room does not carry forward from year to year, so any unused contribution room will be lost. The money withdrawn from the FHSA does not have to be paid back into the plan. Any money not used for a qualifying first home purchase can be transferred into an RRSP without reducing the taxpayer’s RRSP contribution room. Taxpayers will not be able to combine withdrawals from an FHSA with money “borrowed” from their RRSP under the existing home buyers’ plan in respect of the same qualifying home purchase. The home buyer’s tax credit will also increase from $750 to $1,500.

Under the second branch, the government has introduced two new measures that significantly increase taxes on so-called “house-flipping”. First, a proposed new deeming rule provides that, by default, any profits from the sale of residential property within 12 months of acquisition will be taxed as business income. Consequently, properties that have been owned for less than 12 months will no longer benefit from the 50% capital gains inclusion rate or the principal residence exemption. The new deeming rule would be subject to exceptions depending on the specific circumstances surrounding the sale (e.g., if sold due to death, divorce, or family enlargement). Second, under new section 192.1 of the Excise Tax Act, any assignment sale of a newly constructed or substantially renovated residential property made after May 6, 2022 will be subject to GST/HST on the total amount paid for the new home by its first occupant, less any amount attributable to the deposit. These two measures will increase the tax payable on many residential real estate transactions.

Charities

In a welcome move for the charitable sector, Budget 2022 proposed to relax certain rules around disbursement of funds by registered charities. Effectively, the proposals permit new arrangements – termed “charitable partnerships” in the budget plan – between registered charities and other organizations that are not themselves registered charities.

An amended definition of “charitable purposes” in subsection 149.1(1) of the federal Income Tax Act (the “ITA”) will allow registered charities to make “qualifying disbursements”. A “qualifying disbursement” could be either a disbursement to a qualified donee (as under the existing rules) or a disbursement to a “grantee organization” that is not a qualified donee as long as the following conditions are met:

  • the disbursement is in furtherance of one of the charity’s charitable purposes;
  • the charity ensures that the disbursement is exclusively applied to charitable activities in furtherance of a charitable purpose of the charity; and
  • the disbursement meets prescribed conditions.

This will be especially helpful for registered charities wishing to disburse funds to foreign organizations, which rarely qualify as qualified donees. Charities wishing to take advantage of these rules will be subject to enhanced record-keeping, accountability, and reporting requirements under new Regulation 3703, and must take care to ensure that proper oversight is in place for any partner organization that is not a qualified donee.

International Tax Reform

Canada has repeatedly professed its commitment to the “Two-Pillar Solution” agreed to by the 137 members of the OECD/G20 Inclusive Framework on October 8, 2021.

Pillar 1 is designed to reallocate taxing rights to subject large multinational enterprises to tax in countries where their customers (or users) are located. Since international consensus regarding the appropriate implementation of Pillar 1 may be some time away, Budget 2022 confirms that the government will continue to develop its proposed Digital Services Tax (DST) as a “back-up plan”. Draft legislation for the DST was released in December 2010, and for more on the DST see our summary here.

Pillar 2 is designed to establish a minimum tax rate of 15% for multinational enterprises that earn at least €750 million/year (subject to various exceptions and qualifications). In December 2021, the Inclusive Framework published model rules and model treaty provisions to be implemented by participant countries so that Pillar 2 will come fully into effect in 2024. The Canadian government expressed a commitment to that timeline and, in Budget 2022, announced a public consultation on the implementation of Pillar 2 in Canada and any adaptations that may be necessary to make the OECD’s model rules fit in the Canadian context. Submissions to the Department of Finance are sought by July 7, 2022.

Application of the General Anti-Avoidance Rule to Tax Attributes

Budget 2022 proposes to expand the general anti-avoidance rule (the “GAAR”) to apply to transactions that affect tax attributes (such as adjusted cost base and paid-up capital), even where such tax attributes have not yet factored into the computation of tax. The government’s measure is in response to cases such as 1245989 Alberta Ltd. v. Canada (Attorney General), 2018 FCA 114 (also referred to as Wild v. Canada), where the Federal Court of Appeal found there was no “tax benefit” within the meaning of the GAAR because the relevant tax attribute had not yet been utilized. The proposed expanded GAAR would apply to notices of determination issued on or after Budget Day.

Substantive Canadian-Controlled Private Corporations (“CCPCs”)

One of the most significant proposals in Budget 2022 is the proposed introduction of legislation targeted at “substantive CCPCs”, or private corporations that are not CCPCs but are controlled, directly or indirectly, by one or more Canadian residents. The genesis of the proposals is said to be a concern that certain taxpayers are “manipulating” their corporate status in order to defer tax on investment income. For context, corporations which are not CCPCs are not subject to the additional refundable tax on investment income that applies to CCPCs, and are thus subject to a lower upfront tax rate on such income; conversely, such corporations do not enjoy the benefits to which CCPCs are entitled (e.g., small business deduction, enhanced SR&ED claims, etc.).

Certain transactions involving non-CCPCs are currently being challenged under the GAAR. Budget 2022 describes, in general terms, legislative measures that would ostensibly obviate the need for such challenges being mounted in the future.

Budget 2022 contains few specifics regarding the proposed legislation. Based on the limited draft rules provided, a non-CCPC would be a “substantive CCPC” if it is controlled in law or in fact by Canadian-resident individuals (including pursuant to an aggregation rule). In addition, under a proposed anti-avoidance rule, a non-CPPC would be deemed to be a “substantive CCPC” where it is reasonable to consider that one of the purposes of a transaction, or series of transactions, was to cause the corporation not to be a “substantive CCPC”.

A “substantive CCPC” would, based on the narrative provided, be subject to an additional refundable tax of 382⁄3% on its aggregate investment income, of which 302⁄3% would be refunded on a payment of a dividend to an individual shareholder. Similarly, investment income earned by a “substantive CCPC” would be added to its low-rate income pool (“LRIP”) such that dividends paid would be non-eligible dividends that are not entitled to the enhanced dividend tax credit. Budget 2022 notes that the proposed “substantive CCPC” rules are not intended to affect “genuine non-CCPCs”, which are described as including private corporations that are ultimately controlled by non-residents and subsidiaries of public corporations.

Despite being subject to the same or similar tax consequences as a CCPC, it appears a “substantive CCPC” would not be entitled to the same benefits offered to CCPCs. In particular, there is no indication that a “substantive CCPC” would be entitled to claim the small business deduction, have a three (not four) year normal reassessment period, or be able to receive property on a tax-deferred basis under subsection 85(1) of the ITA. In fact, the proposed rules contemplate a one-year extension of the normal reassessment period for any consequential assessment of Part IV tax that arises from the corporation being assessed or reassessed a dividend refund.

The proposed “substantive CCPC” rules would prima facie apply to taxation years that end on or after Budget Day, meaning that the new legislation has some retroactive effect. A narrow exception for “genuine commercial transactions” is provided, pursuant to which the rules may apply only to taxation years that begin on or after Budget Day where certain arm’s length share sale transactions were agreed to before Budget Day and are completed before 2023.

Separately, Budget 2022 described certain contemplated statutory amendments targeted at CCPCs and individuals earning passive investment income through non-resident corporations. The budget plan described certain such structures as providing a tax-deferral advantage due to the lack of differentiation between types of passive income earned by foreign affiliates. The proposed rules, as described, would likely be highly technical and exceedingly complex. Specific draft legislation was not released alongside Budget 2022 and will need to be reviewed carefully once released.

The lack of concrete guidance in Budget 2022 regarding the above proposals leaves practitioners to speculate as to the exact statutory rules and scope of the substantive CCPC proposals. Common commercial arrangements involving the bona fide purchase and sale of businesses have already been negatively impacted, and there is a frustrating lack of guidance on certain fundamental compliance/reporting matters (e.g., effect on year-ends, LRIP computations, and reassessment periods).

Small Business Deduction (“SBD”)

Budget 2022 outlines an intent to encourage the growth of small to medium-sized businesses by extending the range of reduction for the small business limit. Previously, the small business limit was reduced on a straight-line basis when the combined taxable capital employed in Canada of a CCPC and its associated corporations was between $10 million and $15 million; the SBD was completely eliminated when the combined taxable capital reached $15 million. Under the proposed changes, the new range would be $10 million to $50 million, allowing more medium-sized CCPCs to benefit from the SBD. For example, a CCPC with $30 million taxable capital would now have up to $250,000 of the small business limit available, whereas its SBD would have been completely eliminated under the existing rules. The proposed measure would apply to taxation years beginning after Budget Day.

Genuine Intergenerational Share Transfers

In order to facilitate genuine intergenerational share transfers, private member Bill C-208 was passed last year. The measures enacted are intended to facilitate the sale of businesses by parents to their children (or grandchildren) by permitting the transferor to receive the same tax treatment as would apply on the sale of their business to an arm’s length third party. However, the government expressed concern that the measures would permit inappropriate “surplus stripping” transactions (i.e. the realization of share value by way of capital gains rather than dividends), without a genuine intergenerational business transfer taking place. Budget 2022 announces a consultation process for Canadians to share views on how the rules enacted by way of Bill C-208 should be modified (repeating previous statements that such modifications are forthcoming at some point). Submissions are required by June 17, 2022.

Canada Recovery Dividend and Additional Tax on Banks and Life Insurers

Budget 2022 proposes to introduce two different taxes on bank and life insurer groups, which would include a bank or life insurer and any other financial institution that is related to the bank or life insurer for the purposes of Part IV tax of the ITA. The proposed taxes are based on the taxable income of the bank or life insurer group.

    1. Canada Recovery Dividend (“CRD”) – a one-time 15% tax on taxable income for taxation years ending within 2021 (with a proration rule for shorter taxation years). Bank and life insurer groups would be permitted to allocate a $1 billion taxable income exemption by agreement amongst group members. The CRD would be imposed in the 2022 taxation year, but would be payable in equal amounts over five years.
    2. Additional tax of 1.5% for taxation years that end after Budget Day (prorated for the number of days in the taxation year after Budget Day). Bank and life insurer groups would be permitted to allocate a $100 million taxable income exemption by agreement amongst group members.

As of the date of this post, draft legislation has not been released. The proposed CRD and additional tax is expected to generate substantial revenue over the next five years.

Investment Tax Credit for Carbon Capture, Utilization, and Storage (“CCUS”)

Budget 2022 outlines a new investment tax credit for CCUS that was first announced in Budget 2021. The new CCUS tax credit would be available in relation to “eligible expenses”, which relate to the cost of purchasing and installing “eligible equipment” for an “eligible project” where the captured CO2 was used for an “eligible use”. The CCUS tax credit will be available in the taxation year that the “eligible expense” was incurred, regardless of when the “eligible equipment” becomes available for use.

Taxpayers who want to claim the CCUS tax credit will be required to produce a climate-related financial disclosure that highlights how their corporate governance practices help manage climate-related risks.

CCUS equipment and certain other costs related to CCUS projects would be included in two new capital cost allowance (“CCA”) classes and would be eligible for enhanced first year depreciation:

  • 8% CCA rate on a declining-balance basis for equipment that solely captures and transports CO2; and
  • 20% CCA rate on a declining-balance basis for equipment required for using CO2 in an eligible use.

Intangible exploration expenses and development expenses associated with storing CO2 will not be eligible for the CCUS tax credit, but they will be included in two additional new CCA classes.

The proposals include requirements for taxpayers to track and account for the amount and uses of CO2 being captured once a project is underway and “eligible expenses” would need to be verified by Natural Resources Canada before the CCUS tax credit can be claimed. Projects that expect to have “eligible expenses” of $100 million or more will be assessed in advance, although other projects will have the option to voluntarily opt into the assessment.