{"id":2292,"date":"2021-04-23T15:47:37","date_gmt":"2021-04-23T15:47:37","guid":{"rendered":"https:\/\/www.thor.ca\/blog\/?p=2292"},"modified":"2021-04-23T16:02:59","modified_gmt":"2021-04-23T16:02:59","slug":"2021-federal-budget-a-critical-analysis-and-overview-of-the-principal-proposed-income-tax-measures","status":"publish","type":"post","link":"https:\/\/www.thor.ca\/blog\/2021\/04\/2021-federal-budget-a-critical-analysis-and-overview-of-the-principal-proposed-income-tax-measures\/","title":{"rendered":"2021 Federal Budget \u2013 A Critical Analysis and Overview of the Principal Proposed Income Tax Measures"},"content":{"rendered":"

Authors: Alexander Demner<\/a>, Tyler Berg<\/a>, and Gloria Wang<\/a><\/strong><\/p>\n

The federal government released<\/a> its 2021 budget on April 19, 2021. Coming in as the longest budget in Canadian history, Budget 2021 proposes a myriad of income tax measures. This blog provides an overview and critical analysis of the most significant income tax proposals which are of primary relevance to businesses, accountants, and other tax advisors.<\/p>\n

This article does not analyze the digital services tax announced in Budget 2021; see our earlier detailed blog on the digital services tax here<\/a>. For brevity, this article also does not substantively analyze many of the less significant tax measures announced in Budget 2021.<\/p>\n

International Tax Measures<\/u><\/strong><\/p>\n

Budget 2021 proposes to introduce two significant international income tax measures \u2013 rules limiting the deductibility of interest, and provisions addressing so-called \u201chybrid mismatch\u201d arrangements. Each follows separate Action Reports<\/a> released by the Organization for Economic Co-Operation and Development (\u201cOECD<\/strong>\u201d) examining base erosion and profit shifting (\u201cBEPS<\/strong>\u201d) concerns. No specific legislation for either measure was provided in Budget 2021.<\/p>\n

Interest Deductibility Limits<\/em><\/p>\n

Budget 2021 expresses concern regarding the deductibility of interest paid by Canadian businesses that \u201cerode the Canadian tax base\u201d \u2013 for example, through payments to related non-residents in low-tax jurisdictions or having Canadian businesses bear disproportionate amounts of a multinational group\u2019s third-party borrowings. Existing rules, such as the \u201cthin capitalization\u201d rules, restrict the ability to implement such profit-shifting techniques, but Budget 2021 nevertheless announces the federal government\u2019s intention to introduce an \u201cearnings-stripping\u201d rule (in line with the OECD\u2019s Action 4 Report<\/a>).<\/p>\n

As described, the new rules will essentially limit the net interest expense deductible by a business to 30% of its \u201ctax EBITDA\u201d (or 40% in the first year of the rules\u2019 application). Annex 6 in the budget outlines various special adjustments that would be made in computing tax EBITDA \u2013 e.g., deductible intercorporate dividends would be excluded, but payments \u201ceconomically equivalent to interest\u201d would be included. In our view, the specific formula(e) calculating tax EBITDA will be critical and may determine much of the scope and consequence to this rule.<\/p>\n

Proposed exemptions include: (i) Canadian-controlled private corporations<\/em> (\u201cCCPCs<\/strong>\u201d) that, together with associated companies, have less than $15 million of taxable capital employed in Canada; or (ii) corporate groups whose net Canadian interest expense is $250,000 or less. A \u201cgroup ratio\u201d rule will also be introduced that may permit otherwise-denied interest to be deducted if a corporate group\u2019s audited consolidated financial statements (subject to certain adjustments) imply that a higher deduction limit would be appropriate. Any denied interest would be subject to complex carryback and carryforward rules.<\/p>\n

Finance \u201cexpects\u201d that Canadian corporate groups without a non-resident member would not be subject to these rules. This seems justifiable given the lack of Canadian base erosion in such a structure. Notably, however, Budget 2021 does not expressly outline a safe harbour for purely Canadian corporate groups with no foreign affiliates<\/em> or other related non-resident entities.<\/p>\n

The proposed measures would apply to taxation years beginning on or after January 1, 2023. Draft legislative proposals are expected to be released for comment this summer. Since these measures are expected to generate over $5.3 billion by 2027 \u2013 nearly $2 billion more than the digital services tax \u2013the government will presumably be motivated to quickly move forward with these proposals.<\/p>\n

Hybrid Mismatch Arrangements<\/em><\/p>\n

A second anti-BEPS measure proposed in Budget 2021 relates to so-called \u201chybrid mismatch\u201d arrangements \u2013 described as cross-border tax avoidance structures that exploit the differing tax treatment of an entity or financial instrument under the laws of two or more countries. The budget extensively cites the OECD\u2019s Action 2 Report<\/a> in that regard.<\/p>\n

Two main rules are proposed under this heading:<\/p>\n