ABOUT THE AUTHORS: Ian Crosbie and Chris Anderson
are Partners at Davies Ward Phillips & Vineberg LLP
C anada’s Finance Minister delivered the 2010 Budget on 4 March
2010. Highlights of its income tax measures are reviewed below.
Foreign investment entities and non-resident
trusts
Complex proposals regarding foreign investment entities and
non-resident trusts were first introduced in the 1999 Budget and
have been re-introduced and revised several times over the last
decade. In response to concerns regarding the complexity of these
provisions and their numerous technical problems, the 2009 Budget
announced that the proposals would be reviewed before the
government proceeded with legislative amendments. The 2010 Budget
contains revised proposals, which will be subject to a consultation
process.
Foreign investment entities
The Budget abandons previously proposed changes in favour of
modest changes to the current foreign investment entity provisions.
These provisions require an income inclusion at a prescribed rate
with respect to shares, interests in, or debts of, a non-resident
entity. Such shares derive their value primarily from portfolio
investments, where it is reasonable to regard deferral or avoidance
of Canadian tax as one of the main reasons for acquiring the
interests. The Budget increases the rate used in computing this
income inclusion from the three month average Canadian Treasury
Bill rate to that rate plus two percentage points. It also extends
the existing rules to interests in certain trusts not subject to
the non-resident trust rules discussed below, and extends the
normal reassessment period by three years for these purposes.
Non-resident trusts
The Budget changes to the non-resident trusts proposals
generally are relieving in nature. The former proposals imposed
Canadian tax on the worldwide income of a non-resident trust where
there was a resident beneficiary or a resident contributor to the
trust, for which such beneficiaries and contributors could be
jointly and severally liable. The revised proposals contain a
carve-out for investments in non-resident trusts by tax-exempt
entities, expand the carve-outs from the application of the
proposed rules for commercial trusts, and provide that a Canadian
financial institution will not be considered a resident contributor
where it makes a loan to a non-resident trust in the ordinary
course of its business.
These proposals are subject to consultation, and it may
be some time before legislative amendments are seen
The revised non-resident trust proposals generally limit
taxation to income arising from property contributed to the trust
by residents of Canada and certain former residents (or property
substituted for such property), other than income otherwise subject
to Canadian tax. In addition, the trust’s income, subject to tax is
attributed to its resident contributors in proportion to their
relative contributions to the trust. The trust is entitled to a
deduction for the amount of its income payable to its beneficiaries
in the year and for amounts attributed to resident contributors.
These measures are generally proposed to apply in respect of the
2007 and subsequent taxation years, with the attribution of trust
income to resident contributors applicable in respect of taxation
years ending after 4 March 2010.
Countering arguments that Canada’s income tax treaties override
the non-resident trust rules, the Income Tax Conventions
Interpretation Act will be amended so that a trust that is
deemed to be resident in Canada under these rules will be
considered a resident of Canada for tax treaty purposes.
Because these proposals remain subject to a consultation
process, it may be some time before concrete proposed legislative
amendments are seen.
Charity reforms
The Budget proposes significant reforms to the disbursement
quota for Canadian charities. The disbursement quota rules
generally require charities to spend at least 80 per cent of their
previous year’s donation receipts (the ‘charitable expenditure
rule’), plus 3.5 per cent of all assets that are not used in
charitable programmes or administration (the ‘capital accumulation
rule’), where the value of these assets exceeds CAD25,000. The
disbursement quota was originally enacted to ensure that a
significant portion of a charity’s assets were used for charitable
purposes, but it has been criticised for disproportionately
affecting small charities.
The Budget proposes to raise the threshold for the capital
accumulations rule for charitable organisations (a category of
registered charities that generally carry on charitable activities
directly) to CAD100,000 for fiscal years ending after 4 March 2010
and to eliminate the charitable expenditures rule. The Budget also
proposes specific anti-avoidance rules to counter transactions
intended to delay or avoid the disbursement quota and to ensure
that amounts transferred between non-arm’s length charities will be
used to satisfy the disbursement quota of only one of the
charities.
Taxable Canadian property
Non-residents of Canada are taxed on gains from the disposition
of ‘taxable Canadian property’ (TCP), subject to relief under an
applicable tax treaty. Historically, TCP included all unlisted
shares of Canadian corporations.
The definition of TCP will be amended to exclude shares of
corporations and certain other interests that do not derive their
value principally from real property situated in Canada, Canadian
resource property, or timber resource property at any time during
the previous 60 months. While corresponding amendments are proposed
to continuity rules that deem property to be TCP in certain
circumstances, such as a share issued in exchange for a share that
was TCP on an amalgamation, reorganisation or tax deferred
transfer, where the continuity rules have applied to transactions
prior to the Budget date, shares may as a result continue to be
deemed to be TCP in circumstances where they would not otherwise be
TCP under the new rules.
These changes will greatly reduce the number of transactions to
which the pre-clearance and withholding requirements applicable to
a purchase of TCP from a non-resident will apply.
Registered disability savings plans
(RDSPs)
RDSPs were introduced as part of the 2007 Budget to provide
parents with a tax-efficient vehicle to save for a child with a
severe disability. A tax-free rollover of funds from a deceased
individual’s registered retirement savings plan to an RDSP will be
allowed for deaths occurring on or after 4 March 2010, subject to
the RDSP beneficiary’s contribution limit of CAD200,000. The Budget
also proposes a 10 year carryforward for unused entitlements to
federal government support for RDSP contributions, in the form of
Canada Disability Savings Grants and Canada Disability Savings
Bonds, starting in 2011.
Reporting of tax avoidance
transactions
The Budget announces public consultations on proposals to
require the reporting of certain tax avoidance transactions entered
into after 2010, or as part of a series of transactions completed
after 2010, which exhibit at least two of the following three
characteristics:
- A promoter or tax advisor is entitled to fees contingent upon
the obtaining of the tax benefit or its amount, or the number of
taxpayers involved.
- The promoter or tax advisor requires confidentiality regarding
the transaction.
- The taxpayer obtains contractual protection in respect of the
transaction.
If a reportable transaction is not reported on a timely basis,
the Canada Revenue Agency will be entitled to deny the tax benefit,
unless the taxpayer files the required information and pays a
penalty.
If a reportable transaction is not reported on a timely
basis, the Canada Revenue Agency will be entitled to deny the tax
benefit
Employee stock options
Several changes are proposed to the current rules regarding
employee stock options.
An employee who exercises or disposes of a stock option is
generally required to include the ‘in-the-money’ amount of the
stock option in employment income. Where certain conditions are
satisfied, the employee is entitled to a deduction equal to one
half of this employment benefit (the 50 per cent deduction).
Although an employer is not entitled to claim a deduction on the
exercise of stock options by its employees, it is generally
entitled to a deduction where it makes a cash out payment upon the
surrender to it of the option by the employee.
Employees will no longer be entitled to claim the 50 per cent
deduction where their stock options are cashed out, unless the
employer makes an election to not claim a deduction in respect of
the cash out payment.
A limited, but significant, ability to defer the taxation of the
employment benefit in respect of stock options for publicly listed
shares until the shares are sold, will be eliminated for stock
options issued after 4 pm (EST) on 4 March 2010 (and many existing
stock options) to avoid employees who made the deferral election
being unable to meet their tax obligations if there is a subsequent
decrease in the value of the shares.
Additionally, the Budget clarifies that payroll withholding and
remittance obligations apply to the employment benefit from the
exercise of stock options (other than certain stock options issued
by Canadian controlled private corporations).
Income trust conversions
Canadian income tax changes first announced in 2006 will subject
most income trusts (other than real estate investment trusts) to
entity-level taxation on 1 January 2011, eliminating the tax
benefits of the income trust structure. Consequently, many income
trusts have, or will convert into, corporations before the end of
2010. Some of these income trust conversions have been structured
to include a takeover of the income trust by an unrelated loss
company in an effort to allow the successor corporation to continue
to distribute cash flows without the incurrence of entity-level
taxation for a period of time.
The ability to use a corporation’s losses following an
acquisition of control is restricted, and control of a corporation
is deemed to have been acquired in certain circumstances, including
on a ‘reverse takeover’ of a public corporation by another
corporation. This rule will be extended to apply to most
conversions of income trusts into corporations occurring after 4 pm
EST on 4 March 2010, preventing this sort of tax advantaged
conversion transaction.
Foreign tax credits
The Budget proposes to eliminate the benefits from so-called
‘foreign tax credit generators’, which are transactions that allow
tax credits or other tax relief to both Canadian and foreign
participants for the same foreign tax.
Taxation of corporate groups
In 1985, the Canadian Department of Finance released a
discussion paper recommending the use of losses within a group,
which was never adopted. As a result, Canada has no comprehensive
loss consolidation regime and taxpayers often undertake complicated
transactions to synthesise such results. The Budget announces
public consultations on a formal system of loss transfers or
consolidated reporting for corporate groups.