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TORONTO, March 4 /CNW/ - Finance Minister Jim Flaherty's federal budget tabled today forecasts a deficit of $53.8 billion for 2010, falling to $49.2 billion in 2011 and to $27.6 billion in 2012.
Among other tax changes, the budget tightens the rules for employee stock option benefits, curtails the use of losses on conversions of income trusts, and relaxes the disbursement quota rules for registered charities. The budget also presents a federal information reporting regime regarding "aggressive tax planning" for public consultation.
These and other tax highlights of the 2010 federal budget are discussed below.
Business Tax Changes
Income trust conversions and loss trading
In light of the tax on income trust distributions introduced in 2006, the tax rules allow income trusts, partnerships and other specified investment flow-throughs (SIFT) to convert to corporate form on a tax-free basis. The budget takes aim at what the government considers to be inappropriate use of the SIFT conversion rules to achieve inappropriate loss trading.
Current rules restrict the ability of a corporation to utilize tax losses where control of the corporation is acquired. These rules deem an acquisition of control to occur where shares of a public corporation are exchanged for another corporation. The budget proposes to extend these rules to situations where units of a SIFT trust or SIFT partnership are exchanged for shares of a corporation.
The acquisition of control rules are also amended to ensure they do not apply where the SIFT trust is wound up and distributes the shares of a corporation it holds. Under this change, where a SIFT trust, the sole beneficiary of which is a corporation, owns shares of another corporation, the wind-up of the trust does not trigger an acquisition of control of the other corporation and restrict the later use of that corporation's losses.
These rules apply to transactions undertaken on or after 4:00 pm (EST) on March 4, 2010 (except for transactions that parties are obligated to complete under a written agreement entered before that date).
Capital cost allowance changes
Accelerated CCA for heat recovery equipment
The budget proposes to expand the assets eligible for accelerated capital cost allowance (CCA) in Class 43.2 (50-percent on a declining balance basis). For assets acquired on or after March 4, 2010, Class 43.2 includes heat recovery equipment used in a broader range of applications. Such equipment recovers thermal waste for re-use in order to conserve energy or reduce energy requirements. Class 43.2 treatment is expanded by removing the restriction that required the recovered heat to be removed in a process of the same type that generated it.
Distribution equipment of district energy system
The budget also broadens Class 43.1 (30%) and Class 43.2 to include specified thermal energy distribution equipment that is part of a district energy system used by the taxpayer to provide district heating or cooling through the use specified renewable energy technologies. This measure applies to eligible assets acquired on or after March 4, 2010 that have not been previously used or acquired for use.
Canadian Renewable and Conservation Expenses
The tax rules allow certain "principal-business corporations", whose principal business is the generation of clean energy, to transfer their deductions for "Canadian Renewable and Conservation Expenses" to the corporation's flow-through share investors. The budget amends the definition of "principal-business corporation" to clarify that flow-through share eligibility extends to corporations in the principal business of producing fuel, generating energy, or distributing energy. These measures have effect for taxation years ending after 2004.
Television set-top boxes
Satellite set-top boxes for decoding digital television signals and cable set-top boxes acquired after March 4, 2010 are now eligible for a declining balance CCA rate of 40 percent.
Federal credit unions
The budget proposes to allow for the establishment of federal credit unions. As a result, the tax rules will be amended so that federal credit unions are subject to the same income tax rules as other credit unions.
Specified leasing property
The budget extends the leasing property rules to otherwise exempt property that is the subject of a lease to a government or other tax-exempt entity, or to a non-resident, unless the total value of the leased property is less than $1 million. An anti-avoidance rule prevents property from being dividing among separate leases in order to meet the $1 million exception. This measure applies to leases entered into after 4:00 p.m. (EST) on March 4, 2010.
Taxation of corporate groups
The budget announces that the government will explore new rules for the taxation of corporate groups, including a formal loss transfer system or consolidated reporting.
Personal Tax Changes
Employee stock options
Elimination of tax deferral election
Currently, employees of publicly-traded companies can elect to defer tax on up to $100,000 of employee stock option benefits vesting in a particular year. The budget repeals this tax deferral election for employee stock options exercised after 4:00 p.m. (EST) on March 4, 2010.
The budget also clarifies that employers are required to withhold and remit an amount in respect of the tax on the employment benefit associated with the issuance of a security. This measure does not apply to options granted before 2011 under a written agreement entered before 4:00 p.m. (EST) on March 4, 2010 where the agreement included restrictions on the optioned securities' disposition.
Relief for tax deferral election
The elimination of the deferral may cause difficulty for employees where the value of the optioned securities is less than the deferred tax liability on the underlying stock benefit. The budget proposes a special election to ensure that the tax liability on the deferred stock option benefit does not exceed the proceeds from the shares' disposition, taking into account tax relief from the use of capital losses on the shares against capital gains from other sources.
Stock option cash-outs
As of 4:00 p.m. (EST) on March 4, 2010, the employee stock option deduction of one-half of the employment benefit (available in certain conditions) can only be claimed where the employee exercises his or her options by acquiring securities from their employer. Previously, where employees disposed of their stock option rights for cash, the employment benefit could be eligible for the stock option deduction while the cash payment was fully deductible to the employer. Employers may continue to allow employees to cash out their stock option rights and claim the deduction, provided the employer makes an election to forgo the deduction for the cash payment.
The employee stock option rules are also changed to clarify that a disposition of rights under a stock option agreement to a non-arm's length person results in an employment benefit at the time of the disposition (including cash-out).
Mineral exploration credit
The budget extends the mineral exploration tax credit for flow-through share investors, which was set to expire at the end of March 2010. The credit will continue to be available for flow-through share agreements entered into on or before March 31, 2011.
Cosmetic procedures - Medical expense credit and GST/HST exemption
After March 4, 2010, expenses incurred for purely cosmetic medical procedures that are aimed solely at improving one's appearance, such as liposuction, hair replacement and teeth whitening, are no longer eligible for the medical expense credit. The budget also clarifies that GST/HST applies to supplies of such procedures and related goods made after March 4, 2010 and to earlier supplies where the supplier collected and remitted GST/HST in respect of the supply.
Tax-assisted disability and education savings plans
Tax-assisted Registered Disability Savings Plans (RDSP) are enhanced by the following measures:
- A deceased individual's RRSP funds can be transferred tax-free to the
RDSP of a financially infirm child or grandchild, effective for
deaths occurring on or after March 4, 2010, subject to the
beneficiary's lifetime contribution limit of $200,000.
- Starting in 2011, a 10-year carryforward is introduced for unused
entitlements to Canada Disability Savings Grants and Canada
Disability Savings Bonds.
Additionally, the budget clarifies that provincial payments into RDSPs and Registered Education Savings Plans made after 2006 will be treated the same way as federal grants and bonds so that the provincial payments will not affect federal payment amounts.
U.S. Social Security Benefits
The budget proposes to reinstate the 50-percent inclusion rate for U.S. Social Security benefits for Canadian residents who have been in receipt of such benefits since before 1996 and for their spouses and common-law partners who are entitled to receive pension benefits. This change addresses changes to the Canada-U.S. tax treaty that increased the inclusion rate to 85%, as of January 1, 2006 and applies to such benefits received in 2010 or later.
The budget includes several measures to clarify and tighten eligibility for the tax exemption for post-secondary scholarships, fellowships and bursaries.
International Tax Changes
Refunds under Regulation 105 and Section 116
Regulation 105 and section 116 impose withholding tax requirements on payors of funds to non-resident service providers and purchasers of taxable Canadian property, respectively, in certain circumstances. However, the ability to file income tax returns and claim refunds of overpayments under these provisions is subject to certain time limits while the CRA's ability to reassess for failure to withhold is not. Taxpayers may be unable to recoup overpayments of tax under these rules as a result.
The budget resolves this problem by permitting the CRA to issue refund of an overpayment of tax if the overpayment is related to an assessment of the payor or purchaser in respect of a required withholding under Regulation 105 or section 116 and the taxpayer files a return within two years of the assessment date.
Section 116 and taxable Canadian property
The budget amends the definition of "taxable Canadian property", for determinations after March 4, 2010, to exclude shares of corporations (and certain other interests) that do not derive their value principally from real or immovable property situated in Canada, Canadian resource property or time resource property (subject to the normal 60-month rule).
This change eliminates section 116 compliance obligations for purchasers and non-resident vendors of these types of properties and eliminates the need for tax reporting under section 116 for many investments.
Foreign tax credit generators
According to the budget, some Canadian companies have engaged in "foreign tax credit generator" schemes designed to avoid tax in respect of interest income on indirect loans to foreign corporations. To address such plans, the budget proposes to deny foreign tax credit claims, and deductions for foreign accrual tax and underlying foreign tax, where the tax law of the foreign jurisdiction considers the Canadian corporation to have a lesser direct or indirect interest in the foreign corporation or entity than the Canadian corporation is considered to have for Canadian tax purposes.
This measure has effect for foreign taxes incurred in respect of taxation years that end after March 4, 2010.
Foreign investment entities
The budget proposes limited enhancements to the foreign investment entity (FIE) rules, which now apply for taxation years that end after March 4, 2010. The FIE rules are amended to:
- Increase the prescribed interest rate for computing the income
inclusion for an interest in an offshore investment fund property to
the three-month average Treasury Bill rate plus two percentage points
- Broaden the rules requiring beneficiaries of certain non-resident
trusts to report income on a modified foreign accrual property income
basis so that these rules apply to any resident beneficiary who,
together with non-arm's-length persons, holds 10 percent or more of
the fair market value of any class of interests in a non-resident
- Extend the reassessment period by three years for interests in
offshore investment fund properties and interests in the non-resident
trusts described above and require more detailed reporting in respect
of "specified foreign property".
A taxpayer who voluntarily complied with the outstanding proposals in previous years can opt to have those years reassessed. If the taxpayer does not wish to be reassessed for those years, and had more income than would have been the case under the existing rules, the taxpayer will be entitled to a deduction in the current year for the excess income.
Under certain conditions, the tax rules treat a non-resident trust as being resident in which case the trust is required to pay tax on its income in the same manner as other residents of Canada. Proposed amendments have been outstanding for several years now which would have broadened the scope of non-resident trusts to which the deemed residence would apply and would have treated contributors and beneficiaries of the trust as being jointly liable, along with the trustee, for the Canadian tax of the trust.
The budget proposes to simplify the scope of the outstanding proposed amendments as follows:
- Entities exempt from tax under section 149 of the Income Tax Act (for
example, pension funds and registered charities) will be exempt from
the joint liability rule.
- The proposals will ensure that investments in bona fide commercial
trusts are not caught by the new rules by eliminating the deemed
Canadian residence rule by reason only of the trust acquiring or
holding restricted property.
- A commercial trust will not be caught by the deemed residence rules
if it satisfies certain criteria, including that the trust not be a
discretionary or personal trust and that each beneficiary be entitled
to both the income and capital of the trust. A commercial trust
cannot be varied in any way without losing its exempt trust status.
- The role of restricted property in the definition of "exempt trust"
is limited to shares or rights (or property deriving value from
these) acquired, held, loaned or transferred by a taxpayer as part of
a series of transaction or events in which "specified shares"
(generally, shares with fixed entitlement rights) of a closely-held
corporation were issued at a tax cost less than their fair market
- Loans by a Canadian financial institution to a non-resident trust
will not cause the financial institution to be a resident contributor
to the trust provided the loan is made in the ordinary course of the
financial institution's business.
The budget also proposes to modify the taxation of a trust that is deemed resident in Canada by dividing the trust's property into resident and non-resident portions. The resident portion will consist of property acquired by the trust through contributions from residents and certain former residents (and property substituted for such property). The non-resident portion will consist of all other property. Income from the non-resident portion will be excluded from Canadian taxation as long as it is not from sources in Canada on which non-residents would normally be required to pay tax.
Ordering rules will be introduced for distributions to trust beneficiaries. Distributions to Canadian resident beneficiaries will be deemed to be made first out of the resident portion of the trust's income. Distributions to non-resident beneficiaries will be deemed made first out of the non-resident portion of the trust. Withholding tax will apply to distributions to non-resident beneficiaries out of the non-resident portion.
For income retained in the trust, new rules are proposed to replace the joint and several liability of resident contributors for the tax payable by a deemed resident trust. Instead, resident contributors will be attributed and taxed on, their proportionate share of the trust's income for Canadian tax purposes.
Finally, the reassessment period for income in respect of trusts subject to these rules will be extended by three years and the Income Tax Conventions Interpretation Act will be amended to clarify that a trust that is deemed to be resident in Canada under these rules is a resident of Canada and subject to Canadian tax for treaty purposes.
The measures regarding non-resident trusts apply retroactively to the 2007 and later taxation years, except for the attribution of trust income to resident contributors, which applies only to taxation years ending after March 4, 2010. A new election allows a trust to be deemed resident for the 2001 and later taxation years.
The government invites comments on the FIE and NRT proposals by May 4, 2010. Finance will form a panel of tax practitioners to work with them and make recommendations on draft legislation to implement the revised proposals.
Interest on unpaid taxes
As of July 1, 2010, the interest rate payable by the CRA to corporations on overpayments will be set at the average yield of three-month Government of Canada Treasury Bills sold in the first month of the preceding quarter, rounded up to the nearest percentage point. The interest rate calculations for non-corporate taxpayers will not change.
Online Notices of Assessment
The budget proposes to amend the income tax, GST and other tax rules to allow for the electronic issuance of various notices of assessment. This measure will take effect on Royal Assent of the enacting legislation.
Indirect Tax Changes
GST/HST simplification for direct selling industry
The budget confirms the government's intention to implement the 2009 budget's proposals to simplify the GST/HST for the direct selling industry and proposes additional enhancements in this area.
Tariff reductions on manufacturing inputs and machinery and equipment
The budget proposes to eliminate the remaining tariffs on manufacturing inputs and machinery and equipment. The measure will assist Canadian businesses by lowering the costs of manufacturing inputs and machinery and equipment that are imported from outside North America. Tariffs on the affected goods vary from two percent to 15.5 percent and represent a non-recoverable tax on production inputs and on new investments that companies make in order to enhance their competitiveness and productivity.
The reductions apply to 1,541 tariff items as currently listed in the Schedule to the Customs Tariff. The tariff reductions will be given effect by amendments to the Customs Tariff and will have effect for goods imported into Canada on or after March 5, 2010.
Measures for Charities
Charities - Disbursement quota
Currently, registered charities are required to spend a certain amount of their accumulated capital ("disbursement quota") to ensure that a significant proportion of the charity's resources are devoted to charitable purposes. For fiscal years ending on or after March 4, 2010, the budget eases these requirements by:
- Eliminating the rule that requires charities to expend 80 percent of
their previous-year's receipted donations and certain other
- Increasing the disbursement quota exemption threshold for accumulated
capital to $100,000 (from $25,000) for charitable organizations (but
not for charitable foundations)
- Introducing anti-avoidance rules to situations where it can
reasonably be considered that a transaction's purpose was to delay or
unduly avoid the distribution quota and to ensure that amounts
transferred between non-arm's length charities are used to satisfy
the disbursement quota of only one charity.
Information Reporting Regime for Aggressive Tax Planning
The budget announces that the government will release proposals for consultation requiring taxpayers to report aggressive tax planning transactions. The federal regime will define a reportable transaction as a tax avoidance transaction that contains at least two of the following three hallmarks:
- The promoter or tax adviser in respect of the transaction is entitled
to contingent remuneration.
- The promoter or tax adviser requires "confidentiality protection" in
respect of the transaction.
- The taxpayer who entered the transaction obtains "contractual
protection" in respect of the transaction.
The new regime, as modified through consultations, would take effect after 2010.
SOURCE KPMG LLP
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