Budget 2023 – A Made-in-Canada Plan: Strong Middle Class, Affordable Economy, Healthy Future (“Budget 2023”) was tabled by the Department of Finance (“Finance”) on March 28, 2023 (“Budget Day”). The stated focus of Budget 2023 includes targeted inflation relief, stronger public health care and significant investments towards building Canada’s clean economy. Budget 2023 introduced numerous significant income tax proposals touching on personal, business and international income taxation matters.
This post is the second of a three-part series analyzing the principal tax measures in Budget 2023. The first post discussed proposals under the Income Tax Act (Canada) (the “Act”) which primarily affected individuals and private companies. In this post, we analyze select income tax proposals affecting public companies and financial institutions – namely, a proposed tax on equity repurchases, dividends received by financial institutions, and the tax treatment of credit unions.
Tax on equity repurchases
Budget 2023 proposes to implement a tax equal to 2% of the “net value” of most share repurchases by public entities. That tax was first announced in the 2022 Fall Economic Statement and comes after a similar tax in the United States equal to 1% of public share buybacks was enacted. The stated intent of the equity repurchase tax is to disincentive share repurchases, which, per the Budget, diverts corporate resources away from investments in workers and businesses in Canada.
The proposed tax – imposed under Part II.2 of the Act – applies broadly to the repurchase of “equity” by a “covered entity”, each as defined in the proposed subsection 183.3(1). “Equity” for this purposes includes shares of a corporation, income or capital interests in a trust, and interests as a member in a partnership. A “covered entity” includes the following entities, provided the equity of the entity is listed for trading on a designated stock exchange:
- a corporation resident in Canada (other than a mutual fund corporation);
- a mutual fund trust that is a “real estate investment trust” as defined in subsection 122.1(1) of the Act or a specified investments flow-through (“SIFT”) trust;
- SIFT partnerships; and
- entities that would be a SIFT trust or SIFT partnership if their assets were located in Canada.
The proposed 2% tax is levied on the difference, in the taxation year of the covered entity, between:
- the total fair market value (“FMV”) of the equity (other than “substantive debt”) of the covered entity that is redeemed, acquired or cancelled (other than by a “reorganization or acquisition transaction”) by the covered entity; and
- the total FMV of equity (other than substantive debt) of the covered entity that is issued in the taxation year (other than by a “reorganization or acquisition transaction”).
Non-voting, fixed value, and non-convertible preferred shares that have a fixed return are considered “substantive debt” and carved out of the definition of “equity”. Certain “reorganization or acquisition transactions” are also exempt from the proposed tax, including a redemption, acquisition or cancellation of equity in the course of a share exchange, wind-up, amalgamation or divisive “butterfly” reorganization; issuances of equity purely for cash or to an employee in the course of the employee’s employment also fall under that definition.
Transactions involving a “specified affiliate” of a covered entity that acquires equity of the covered entity may also be subject to the proposed tax. A specified affiliate of a covered entity means a corporation, trust or partnership that is controlled, directly or indirectly, by the covered entity or one in which the covered entity owns, directly or indirectly, more than 50% of the total FMV of the affiliate’s equity.
The proposed legislation also includes two anti-avoidance rules:
- First, subsection 183.3(3) provides that equity redeemed, acquired, cancelled or issued by a covered entity will be included in computing the equity repurchase tax if it is reasonable to consider that the primary purpose of the “transaction” or series of transactions is to cause a decrease in the total FMV of equity repurchased or increase in the total FMV of equity issued.
- Second, subsection 183.3(6) provides that if one of the main purposes of a transaction is to cause a person or partnership to acquire equity of a covered entity to avoid the tax otherwise payable, the person or partnership shall be deemed to be a “specified affiliate” for the duration of the transaction or series.
There is a de minimis exception from the new tax in proposed subsection 183.3(4). Specifically, no tax on repurchase of equity is payable where the FMV of equity that is redeemed, acquired or cancelled in the taxation year is less than $1 million (prorated for shorter taxation years).
The proposed equity repurchase tax will apply to repurchases and issuances of equity that occur on or after January 1, 2024. At 2% of the gross FMV of all equity repurchased (assuming no new equity issuances), this is a potentially severe tax which could materially impact planned corporate actions.
Dividend received deduction by financial institutions
Budget 2023 proposes to deny financial institutions from deducting dividends received on shares that are mark-to-market (“M2M”) property (or would be mark-to-market property if held by the corporation at any time in the year).
As background, M2M properties are subject to special rules in the ITA. Under such rules, realized gains on M2M properties are fully included in income and unrealized gains are included in computing the holder’s annual income. According to Budget 2023, shares held by a financial institution are generally M2M property when the institution holds less than 10% of the votes or value of the underlying company.
Separately, Canadian corporations – including financial institutions – are generally permitted to deduct dividends received from another Canadian corporation. According to Budget 2023, this deduction is inappropriate in circumstances where a financial institution receives the subject dividend on shares that are M2M property. The deduction allegedly conflicts with the M2M rules that require gains on such shares to be fully included in income.
Accordingly, Budget 2023 proposes to eliminate the ability for financial institutions to deduct dividends received on shares that are M2M property. If enacted, those measures would apply to dividends received after 2023.
Income tax and GST/HST treatment of credit unions
Credit unions are currently subject to specific income tax and GST/HST rules. A “credit union” is defined in subsection 137(6) of the Act, and that definition is also referenced in the Excise Tax Act for GST/HST purposes.
Under the current definition, a credit union must earn all or substantially all (generally understood as meaning 90% or more) of its revenue from specifically-enumerated sources. If that revenue requirement is not satisfied, the credit union will no longer benefit from preferential GST/HST treatment that would allow it to receive otherwise taxable supplies of goods and services from credit union centrals and other credit unions on an exempt basis.
Budget 2023 proposes to amend the Act by eliminating the revenue test from the definition of “credit union”. This change is based on the apparent fact that most credit unions are now full-service financial institutions that offer comprehensive services which generate revenue that falls outside the scope of the current definition.
The proposed amendments, for which draft legislation was not released, would apply for taxation years of a credit union ending after 2016.