BETWEEN THE NUMBERS
2017 Federal Budget Notes – What you Need to Know
FEDERAL BUDGET OVERVIEW
Numerous Canadians may have felt as if they were watching a Jaws movie as they awaited the release of Finance Minister Morneau’s 2nd Federal Budget. What tax policy sharks lay beneath? Increases in taxes on capital gains, Employee Stock Options, and/or dispositions of principal residences? Elimination of the lifetime capital gains exemption? How will President Trump’s planned tax reductions impact our tax policies? Preceding the 2017 Federal Budget, there was an unprecedented level of speculation and debate within the tax community on what legislative changes were forthcoming. In the end, the proposed changes were much less monumental than many predicted. However, a sequel to Federal Budget 2017 may soon be on the horizon, which may include additional tax measures prior to even the release of Federal Budget 2018.
Budget 2017 outlined only $200 million in net new spending, but also an increase to the deficit of more than $5 billion for 2017–18. Further, Budget 2017 projected deficits for 2017–18 of $28.5 billion, declining to $18.8 billion by 2021–22 (including an annual $3 billion contingency fund). To combat tax avoidance and evasion, the government plans to give the Canada Revenue Agency (CRA) an additional $523.9 million over the next five years to fund increased verification activities. Federal Budget 2016 already provided CRA with $800 million over five years for tax compliance initiatives. To the extent they have not already, taxpayers can reasonably expect substantially increased amounts of CRA verification and enforcement activity with increased levels of scrutiny. Taxpayers would be well advised to ensure their minute books, accounting records and other documents are in good order in addition to tax filing positions substantiated in anticipation of this brave new world.
The Budget 2017 does contain numerous additional tax and non-tax measures and announcements over and above what is reviewed in our 2017 Federal Budget Notes. We have focused on the most relevant tax aspects that may impact our clients.
BUSINESS TAX MEASURES
Small Business Tax Rate
Budget 2017 made no changes to the corporate tax rates and no changes to the previously deferred tax measures to reduce the Federal corporate income tax rate applicable to small business on its first $500,000 of corporate profits.
Tax Planning Using Private Corporations
Although no specific tax rule changes were announced concerning certain private corporation tax planning strategies, Budget 2017 outlined the review of the following strategies, which in their view may inappropriately reduce the taxable income of high-income taxpayers:
- Income sprinkling — causing income that would be taxable to an individual at a high rate to be realized by, and therefore taxed in the hands of, a family member subject to a lower marginal tax rate, commonly achieved through dividends or capital gains
- Holding of portfolio investments — corporate tax rates on ordinary business income are generally much lower than personal rates; retaining income in a private corporation can therefore facilitate accumulation of a larger pool of funds for investment
- Conversion of regular income into capital gains — causing income that would normally be paid to the shareholder as salary or dividend to be converted to capital gains, taxed at a significantly lower tax rate
A tax policy paper will be released in the ensuing months that will review these issues in detail and provide proposed policy responses.
Business owners should consider revisiting their tax planning (existing and contemplated) in light of the above.
Members of designated professions (accountants, dentists, lawyers, medical doctors, veterinarians, and chiropractors) may elect to exclude the value of their work in progress (WIP) in computing their taxable income. Thus, prior to Budget 2017, it was common for such professionals to recognize revenues at the time they would render their invoices to their clients.
Budget 2017 proposed to eliminate this WIP exclusion over a two-year period, effective for taxation years beginning after March 21, 2017. For the first affected taxation year, WIP will be valued at 50 per cent of the lesser of its cost and fair market value. This WIP then must be recognized for tax purposes and not excluded from income. For subsequent years, WIP, valued at the lesser of its cost and fair market value, must be recognized for tax purposes and cannot be excluded from income.
Professionals affected by these rules should review their existing accounting practices concerning WIP recognition and these may require modification. For instance, for many practices, the cost of WIP is not easily determinable or even tracked. The positive non-tax aspect of these rules could be that professionals may then be encouraged to improve their practice management and request retainers from clients and increase their billing frequency.
Meaning of Factual Control
There are two main definitions of control for tax purposes — de jure or de facto control. De jure control represents legal control of the corporation while de facto control represents factual control of the corporation. If two corporations are under common control (either de jure or de facto), they may have to share numerous corporate tax advantages, most notably the annual $500,000 small business deduction limit and the SR&ED refundable tax credit. What constitutes de facto control is broader than de jure control and can often be subjective. A recent tax court decision restricted de facto control to circumstances where the potential controller has an enforceable right to change the board of directors or its powers or can exercise influence over shareholders who have the right and ability to make such changes. The Budget proposes to effectively override the case law and taxpayers must now go back to making the determination of the association of multiple corporations based on all factors. Businesses should then consider reviewing what factors could factually associate two or more corporations. Then, the determination can be made whether it is feasible in changing their business methods to maintain these corporations from being associated.
Timing of Recognition of Gains and Losses on Derivatives
Prior to Budget 2017, some taxpayers would engage in a straddle transaction that would involve using sophisticated financial derivatives. The result would be to defer (possibly indefinitely) taxable income through a series of synthetically produced tax losses. The Budget proposed to introduce a specific anti-avoidance “stop-loss” rule, which will effectively defer the realization of any loss on the disposition of a position to the extent of any unrealized gain inherent in an offsetting position. This proposal will apply to any loss realized on a position entered into after March 21, 2017.
Child Care Space Investment Tax Credit
The Budget eliminates the investment tax credit for child care space expenditures incurred after March 21, 2017. Expenditures incurred before 2020 pursuant to written agreements entered into before March 22, 2017 will still be eligible for the investment tax credit.
Clean Energy Generation Equipment
Capital cost allowance (CCA) classes 43.1 and 43.2 provide for accelerated CCA on clean energy generation equipment. The Budget expands the assets qualifying for these classes to include geothermal energy equipment used primarily for the purpose of generating heat or a combination of heat and electricity and certain equipment in district energy systems that use geothermal heating as an energy source.
Canadian renewable and conservation expenses may be deducted in the year incurred, carried forward indefinitely for use in future years or transferred to investors through a flow-through share mechanism. The Budget proposes to include expenses incurred to determine the quality and extent of geothermal resources and the cost of geothermal drilling for electricity and heating projects in this category.
The measures are applicable for new property acquired for use and expenses incurred after March 21, 2017.
Distribution of T4 Information Slips
PERSONAL TAX MEASURES
Budget 2017 left personal tax rates unchanged from Budget 2016. Notwithstanding rampant prior speculation, there were no changes to the taxation of capital gains or employee stock options.
Tuition Tax Credit
Effective January 1, 2017, the Budget proposed to expand the types of courses that are eligible for the Tuition Tax Credit.
The Tuition Tax Credit can currently be claimed with respect to occupational skills courses taken at a non-post-secondary institution. In contrast, the credit cannot be claimed for similar non-post-secondary level courses taken at a college or university.
The Budget proposed to allow the Tuition Tax Credit to be claimed in the latter instance and, further, to allow the scholarship exemption for bursaries related to such courses, provided that all other conditions for the exemption are met.
Simplifying the Caregiver Credit System
The existing Caregiver Credit, Infirm Dependent Credit and Family Caregiver Tax Credit each have different eligibility rules. The Budget proposed to simplify these existing credits by replacing them with a single new, non-refundable credit, the Canada Caregiver Credit. This credit will provide tax relief of up to 15 per cent of $6,883 (in 2017) for expenses for care of dependent relatives with infirmities, and up to 15 per cent of $2,150 (in 2017) for expenses for care of a dependent spouse/common-law partner or minor child with an infirmity. There is no requirement for the dependent to live with the caregiver to claim the credit.
This new credit will start to be reduced when the dependent’s net income is above $16,163 (in 2017, indexed to inflation for taxation years after 2017).
Disability Tax Credit — Certification by Nurse Practitioners
The Budget proposed to allow nurse practitioners to certify impairments for purposes of the Disability Tax Credit. This measure will be effective for certifications made after March 21, 2017.
Medical Expense Tax Credit — Fertility-Related Expenses
For the 2017 taxation year and beyond, the Budget proposed to clarify the types of fertility-related expenses that are eligible for the Medical Expense Tax Credit. In particular, persons who require medical intervention to conceive, even if not infertile, will explicitly be allowed to claim the credit for expenses that would generally be eligible for someone who has an infertility condition.
Mineral Exploration Tax Credit for Flow-Through Share Investors
Eligibility for the Mineral Exploration Tax Credit is proposed to be extended for one year under the Budget. The credit will apply to flow-through share agreements entered into on or before March 31, 2018.
Public Transit Tax Credit
The Public Transit Credit is proposed to be eliminated under the Budget for transit use after June 30, 2017.
Home Relocation Loans Deduction
The Budget proposed to eliminate the home relocation loans deduction for benefits realized on January 1, 2018, and beyond. Accordingly, an individual who receives a loan from their employer that qualifies as an eligible home relocation loan will no longer be entitled to offset any imputed interest benefit in the 2018 taxation year and beyond.
Anti-avoidance Rules for Registered Plans
The anti-avoidance rules that currently exist for Registered Retirement Savings Plans and Tax-Free Savings Accounts are proposed to be extended to Registered Education Savings Plans (RESP) and Registered Disability Savings Plans (RDSP)under the Budget. These changes will apply to transactions occurring after March 22, 2017, with the following exceptions:
- The advantage rules will not apply to swap transactions occurring on or before June 30, 2017. Further, the proposed changes will not apply to swap transactions undertaken on or before December 31, 2021, where the purpose of the transaction is to ensure that the RESP or RDSP complies with the advantage or prohibited investment rules.
- In addition, an RESP or RDSP plan-holder may elect by April 1, 2018, not to pay advantage tax on the distribution of investment income from an investment that was held on March 22, 2017, but instead pay regular personal income tax.
First-Time Donor’s Super Credit
The Budget confirms the expiration of the First-Time Donor’s Super Credit, as planned, after 2017.
Allowances for Members of Legislative Assemblies and Certain Municipal Officers
The Budget proposes to include non-accountable allowances paid to certain officials in their income, beginning in the 2019 taxation year.