On February 27, 2018, the Minister of Finance introduced Canada’s 2018 Federal Budget (2018 Budget). The 2018 Budget includes measures affecting the taxation of passive income earned by private corporations, as was expected, although the changes are not as wide-spread as had been previously suggested. In addition, the 2018 Budget includes a mix of targeted anti-avoidance rules, legislative responses to recent jurisprudence and other narrow changes to address perceived problems in the existing provisions of the Income Tax Act (Act).
The 2018 Budget does not contain any proposals that are specific reactions to recent U.S. tax reforms, although the Department of Finance will be conducting a detailed analysis of the U.S. tax reforms to determine the potential impacts on Canada.
Many taxpayers will be relieved that the 2018 Budget also does not include an increase to the capital gains inclusion rate or any changes to the tax treatment of employee stock options.
International Tax Measures
Foreign Affiliate Changes
Cross-Border Surplus Stripping
Business Tax Measures
Passive Investment Income
At-risk Rules for Tiered Partnerships
Artificial Losses Using Equity-Based Financial Arrangements
Stop-loss Rule on Share Repurchase Transactions
Other Tax Changes
Tax Reporting for Trusts
Funding for Enforcement and Courts
Selected GST/HST Measures Relating to Investment Limited Partnerships
INTERNATIONAL TAX MEASURES
Foreign Affiliate Changes
The 2018 Budget includes a number of measures relating to Canada’s foreign affiliate (FA) regime, including reducing the time period to provide T1134 information returns and introducing rules designed to limit the benefits of so-called “tracking arrangements”.
The Notice of Ways and Means Motion (NWMM) that accompanied the 2018 Budget does not include draft legislation regarding any of the FA regime measures.
Generally, the FA regime applies to a Canadian taxpayer’s holdings in foreign corporations, called FAs. In particular, an FA is generally a foreign corporation in which the taxpayer holds at least 10 per cent of the shares of any class. The FA regime includes in the Canadian taxpayer’s income on a current basis any “foreign accrual property income” (FAPI), which is generally income from passive investments, of a controlled foreign affiliate (CFA) of the taxpayer. A CFA is generally an FA in which the taxpayer, either alone or together with a limited number of other persons, has a controlling interest. The FA regime also includes a full dividends-received deduction for dividends received by a Canadian taxpayer from an FA that are sourced from active business earnings of the FA in a country with which Canada has a tax treaty or a tax information exchange agreement.
Canadian taxpayers that hold FAs are required to provide detailed information on a T1134 Information Return. Currently, these information returns are required to be filed 15 months after the end of the taxpayer’s applicable taxation year. The 2018 Budget proposes to require these information returns to be filed within six months of the applicable taxation year, on the basis that this would align the deadline with a corporation’s deadline to file its Canadian federal income tax return.
Many taxpayers may find it challenging to obtain the information required within this shortened timeframe. In order to give taxpayers time to adjust to this significant change, the 2018 Budget proposes that the change will apply to taxation years that begin after 2019.
The 2018 Budget proposes two measures to deal with what the government perceives as inappropriate use of “tracking arrangements”. These are generally arrangements that involve pooling assets in an FA in a way that affords favourable treatment under the FA regime, but where the return from particular assets is streamed to particular investors such that they are not pooled economically.
As noted above, a Canadian taxpayer is required to include in its income on a current basis any FAPI earned by a CFA of the taxpayer. FAPI is defined to include income from an “investment business”, which is generally income from a business, the principal purpose of which is to earn income from property. An “investment business”, however, does not include a business that, among other requirements, employs more than five full-time employees (the six-employee test). This exception to the investment business definition (investment business exception) is applied on a business-by-business basis.
The 2018 Budget states that certain taxpayers have been using arrangements to pool the assets of a number of taxpayers in one FA with the intention that the six-employee test would be met by the FA where it could not be met if each individual taxpayer contributed its assets to a separate FA. In these arrangements, the government asserts that each taxpayer economically receives the return on its own assets contributed to the FA by share terms or contractual rights that stream income separately to each taxpayer.
The 2018 Budget proposes to introduce a rule whereby if income attributable to particular activities carried out by an FA accrues to the benefit of a particular taxpayer under a tracking arrangement, those particular activities will be deemed to be a separate business for purposes of the six-employee test. Each “deemed” separate business will then need to satisfy each condition in the investment business exception, including the six-employee test, in order for the FA’s income from that deemed business to be excluded from FAPI.
Similarly, the 2018 Budget asserts that taxpayers have been inappropriately avoiding current taxation of FAPI by pooling assets that would earn FAPI in an FA in which a large enough group of taxpayers have invested such that it is not a CFA of any particular taxpayer. However, instead of each taxpayer receiving the economic return of the whole FA’s portfolio, each taxpayer would receive the return on a specific investment portfolio by virtue of a tracking arrangement.
The 2018 Budget proposes to deem an FA of a taxpayer to be a CFA of the taxpayer if FAPI attributable to activities of the FA accrues to the benefit of the taxpayer under a tracking arrangement. It remains to be seen how broadly a tracking arrangement will be defined for purposes of these measures. Taxpayers who have investments in segregated or protected cell companies may be affected by this change.
When draft legislation is released, it should be reviewed carefully to ensure that bona fide commercial joint ventures are not inadvertently caught by the investment business rules and that foreign commercial investment funds that are structured as corporations are not inappropriately deemed to be CFAs of Canadian taxpayers.
Each of these measures that will apply to tracking arrangements will apply to taxation years of an FA that begin on, or after, February 27, 2018.
Trading or Dealing in Indebtedness
In 2014, the exception to the investment business definition applicable to regulated financial institution FAs was made more restrictive by requiring that the Canadian taxpayer meet certain criteria, including minimum capital requirements. Another rule that deems certain income of an FA from a business the principal purpose of which is to derive income from trading or dealing in securities to be FAPI also contains an exception that is dependent upon the Canadian taxpayer’s status. The 2018 Budget proposes to amend this latter exception to also require certain minimum capital requirements to be met, consistent with those required under the similar exception to the "investment business" definition.
This change will be effective for taxation years of an FA that begin on, or after, February 27, 2018.
Cross-Border Surplus Stripping
The Act currently contains a variety of rules aimed at preventing “surplus stripping”. These include specific provisions in section 212.1 of the Act to prevent the creation of additional cross-border paid-up capital (PUC) when a non-resident of Canada transfers shares of a Canadian corporation to another related Canadian corporation. These rules provide for a deemed dividend to the extent of any non-share consideration taken back in excess of the PUC of the shares of the transferred corporation. As currently drafted, section 212.1 does not expressly apply to the disposition of a partnership or trust that owns an interest in shares of a Canadian corporation.
The Department of Finance raised the concern that some taxpayers have been using partnerships or trusts as intermediaries to avoid the application of section 212.1 and inappropriately create cross-border PUC or strip surplus out of Canada without the imposition of dividend withholding tax. This could be done, for example, by transferring shares of a Canadian corporation to a partnership or trust, with the partnership or trust interests in turn being transferred to a non-arm’s-length Canadian corporation. The Department of Finance is also concerned with planning to avoid the application of similar rules in section 128.1 in the context of corporate immigration. The 2018 Budget proposes amendments to prevent such planning.
The 2018 Budget includes some, but not all, of the required amendments and describes the new anti-avoidance rule as a comprehensive look-through rule for partnerships and trusts. This rule would allocate or attribute the assets, liabilities and transactions of a partnership or trust to its members or beneficiaries, as the case may be, based on the relative fair market value of their interests.
Additionally, the 2018 Budget proposes to revise the definition of “equity amount” for purposes of the thin capitalization rules and the rules in subsection 84(1) to prevent taxpayers from benefiting from any contributed surplus generated in a transaction to which the anti-surplus stripping rule in section 212.1 applies.
These changes are proposed to apply to transactions that occur on, or after, February 27, 2018.
In recent budgets, the Department of Finance included what amount to self-serving statements about the applicability of the general anti-avoidance rule (GAAR) to transactions that will be covered by new rules, but that were undertaken prior to the budget. The 2018 Budget contains a similar self-serving statement in respect of these surplus stripping rules. This statement is even more detailed than previous versions, going so far as to assert that the use of discretionary interests for the purpose of obtaining “inappropriate results” under the proposed allocation rule, or “other planning that seeks to achieve indirectly what cannot be done directly” under these anti-surplus stripping rules (presumably sections 212.1 and 128.1), “would be inconsistent with the policy intent of these rules” and would be expected to be challenged under existing rules, including GAAR. This statement comes shortly after the court in Oxford Properties declined to put any weight on similar self-serving statements regarding the purpose of other statutory provisions. It remains to be seen to what extent courts will accept this statement of the policy of these rules in the context of a GAAR analysis.
The Act contains specific limitation periods after which the Canada Revenue Agency (CRA) generally is prohibited from reassessing taxpayers in respect of particular taxation years (the normal reassessment period). The normal reassessment period is generally three years from the date of mailing of the original notice of assessment for the particular taxation year for an individual or Canadian-controlled private corporation (CCPC), and four years for corporations that are not CCPCs. These periods are extended for a further three years in each case in a variety of circumstances, including in respect of transactions with related non-residents.
The 2018 Budget proposes three additional circumstances in which the limitation period applicable for reassessments can be extended.
- Foreign Affiliates
The normal reassessment is usually extended by three years in the case of reassessments relating to transactions involving the taxpayer and a related non-resident. The 2018 Budget states that assessments relating to a taxpayer’s FAs are generally time-consuming, as they often include information from foreign jurisdictions. While many assessments relating to FAs will already be subject to the extended reassessment period, the 2018 Budget proposes to extend the reassessment period by three years in respect of all income arising in connection with an FA.
This measure will apply to taxation years that begin on, or after, February 27, 2018.
- Loss Carrybacks
The Act already provides that if losses from a particular year (the loss year) are carried back and deducted in computing taxable income in a prior year (the carryback year), then the limitation period in respect of the carryback year is extended for three years. The purpose behind this rule is to ensure that the carryback year does not go statute-barred (so that the CRA does not become unable to reassess the use of the loss carried back) before the loss year. This rule does not, however, take into account the fact that the limitation period for the loss year may be extended by three years in certain circumstances.
The 2018 Budget proposes to extend the normal reassessment period for a carryback year by six years (an additional three years as compared to the current rule) to the extent the reassessment relates to the adjustment of a loss carryback where:
- A reassessment of a loss year is made as a consequence of a transaction involving a taxpayer and a non-arm’s-length non-resident
- The reassessment reduces the taxpayer’s loss available for carryback
- All or any portion of that loss had in fact been carried back to the carryback year.
This will extend the reassessment period to the date that is either nine or 10 years after the date of mailing of the original assessment for the carryback year. These are longer than any other fixed reassessment period currently in the Act.
This change will apply in respect of taxation years in which a carried back loss is claimed, where that loss is carried back from a taxation year that ends on, or after, February 27, 2018.
We understand that this rule is intended for ordinary course audit circumstances. That is, the reassessment period for the carryback year is proposed to be extended (by the additional three years) so as to align with the period in which one would expect that the CRA would issue any reassessments of the loss year. This rule is apparently not specifically aimed at allowing more time for consequential reassessments of a carryback year following protracted objections or appeals of a loss year, which could in theory extend beyond even the new reassessment period. The existing consequential reassessment rule in the Act, which allows the CRA one year after the expiry of the relevant objection or appeal rights, to make reassessments that are consequential on the change of a “balance” (including losses) applies only where the applicable balance is used in a subsequent year.
- Requirements for Information and Compliance Orders
The Act contains a variety of powerful audit tools to enable the CRA to gain access to documents and information that it believes may be relevant to the enforcement of the Act. These include requirements to produce documents or information (domestic requirements), requirements to produce documents or information that is available or located outside Canada (foreign requirements), and court orders requiring the production of documents or information sought under the general audit power or a domestic requirement (compliance orders).
Taxpayers have a statutory right under the Act to apply to the Federal Court for judicial review of a foreign requirement. As a result, the Act provides that the time between the date on which an application for judicial review is made to the Federal Court and the date on which such review is decided shall not count towards the normal reassessment period or any other limitation period in subsection 152(4) of the Act.
While taxpayers have a right to seek judicial review of domestic requirements and to contest applications for compliance orders, no similar timing rules suspend the running of the limitation period during these court challenges.
The 2018 Budget proposes to introduce a new “stop-the-clock” rule to provide for similar extensions of applicable reassessment periods where a domestic requirement or a compliance order is challenged in the courts by a taxpayer.
These changes apply in respect of challenges instituted after royal assent of the enacting legislation.
Canada signed the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (MLI) in the summer of 2017. Among other things, the MLI, once effective, will introduce a “principal purpose test” to most of Canada’s tax treaties (notably excluding the Canada–U.S. Tax Treaty, which already contains a detailed limitation on benefits rule) to combat so-called “treaty shopping”.
The 2018 Budget indicates that the MLI is a high priority for the government and that it intends to enact the MLI and ratify it to bring it into force.
BUSINESS TAX MEASURES
Passive Investment Income
The Department of Finance first announced detailed proposals to address the taxation of private corporations, including CCPCs, in July of 2017. The consultation period on these proposals generated extensive feedback from a wide variety of interested parties. Following the feedback, the Department of Finance announced that it was withdrawing proposals to limit access to the lifetime capital gains exemption and the “conversion” of dividends into capital gains, but would be proceeding with measures to address “income sprinkling” and limiting the deferral benefits otherwise available to private corporations earning in excess of C$50,000 of passive income per year. Revised income sprinkling proposals were released on December 13, 2017.
The 2018 Budget confirms the government’s intent to proceed with those income sprinkling proposals and contains the details of the much-anticipated measures relating to the earning of passive income in private corporations. The measures introduced to limit benefits to CCPCs earning in excess of C$50,000 of passive income per year represent a less extreme change to the system of taxation of private corporations generally than some of the ideas floated in the original July 2017 white paper. This is a welcome development and consistent with much of the feedback provided during the consultation period.
CCPC Business Limit
CCPCs enjoy the benefit of the “small business deduction”, allowing an effectively reduced rate of federal corporate income tax of 10.5 per cent on the first C$500,000 of qualifying active business income earned by the CCPC. The 2018 Budget confirms the government’s announced intent to reduce this rate to 10 per cent for 2018 and nine per cent for subsequent years.
The 2018 Budget proposes to reduce the maximum amount of active business income that can benefit from the small business deduction (the business limit) on a straight-line basis for CCPCs that have between C$50,000 and C$150,000 of passive income. CCPCs with more than C$150,000 of passive income in a particular taxation year would not be entitled to the small business deduction. This change will impact a CCPC only to the extent it has qualifying active business income in excess of its reduced business limit. For example, a CCPC earning C$100,000 of passive income will have a reduced business limit of C$250,000. Active business income above that reduced threshold will be subject to the general corporate tax rate.
The 2018 Budget explains the C$50,000 to C$150,000 range of passive income in respect of which the reduction applies, by reference to assumptions about rates of returns on passive assets. For example, assuming a five per cent return on investments, the C$50,000 lower limit of the rule becomes effective only for CCPCs with more than C$1-million of passive assets.
The proposed rules do not allow for any carry-forward of unused “capacity” to earn passive income to subsequent years, nor is there any indexing of the limit to reflect inflation or changes in the interest-rate environment. Accordingly, CCPCs earning less than C$50,000 of passive income in any particular year will face the same limits as any other CCPC in subsequent years. As noted below, CCPCs will also not be able to use net capital losses from prior or subsequent years to reduce their passive income for purposes of these rules.
No grandfathering is provided for accrued gains up to February 27, 2018.
Adjusted Aggregate Investment Income
For purposes of determining the reduced business limit of a CCPC, the 2018 Budget introduces a new definition of “adjusted aggregate investment income,” which will be based on the “aggregate investment income” of the CCPC used in computing refundable taxes applicable to CCPC investment income, with certain adjustments. These adjustments will include:
- Taxable capital gains and losses will be excluded to the extent they arise from the disposition of “active assets”, which include:
- Property used principally in an active business carried on primarily in Canada by the CCPC or a related CCPC;
- A share of another CCPC that is “connected” to the particular CCPC and that would, if the CCPC were an individual, be a “qualifying small business corporation share” for purposes of the lifetime capital gains exemption; and
- An interest in a partnership if the particular CCPC’s interest in the partnership is equal to or greater than 10 per cent of the total fair market value of all interests in the partnership, and the partnership satisfies asset tests similar to those necessary for a CCPC to qualify as a small business corporation.
- Net capital losses carried over from other taxation years will be excluded;
- Dividends from non-connected corporations will be added; and
- Income from savings in a life insurance policy that is not an exempt policy will be added, to the extent it is not otherwise included in aggregate investment income.
The most surprising of these adjustments is that capital losses carried forward or back from other years are disregarded. This exclusion can be punitive to CCPCs that undertake riskier investments, thus earning higher rates of return in some years and losses in others. It is unclear why the policy underlying the rules for carryforwards and carrybacks more generally would not apply to these new rules.
Consistent with existing rules, adjusted aggregate investment income will exclude income that is incidental to an active business.
The 2018 Budget also proposes related anti-avoidance rules to prevent various steps, including the creating of short taxation years and the transfer of assets to related but non-associated corporations, from effectively avoiding the impact of these changes.
These changes will be effective for taxation years beginning after 2018.
Refund of Taxes on Investment Income
The existing regime applicable to CCPCs includes the imposition of refundable taxes on investment income earned by private corporations. These taxes generally give rise to “refundable dividend tax on hand” (RDTOH), which can be refunded upon the payment of sufficient taxable dividends. Under the current system, all taxable dividends, whether or not they are designated as “eligible dividends”, can trigger a refund of RDTOH.
The 2018 Budget proposes significant changes to the RDTOH rules.
Investment income earned by a CCPC generally does not give rise to additions to the CCPC’s “general rate income pool”, and so does not increase the CCPC’s ability to pay eligible dividends. Eligible dividends paid to Canadian resident individuals are subject to an effective tax rate that is approximately five per cent to 11 per cent lower, depending on the province, than non-eligible dividends.
However, a corporation currently can obtain a refund of RDTOH upon the payment of any taxable dividends, whether designated as eligible (subject to a lower tax rate to individual recipients) or not. This presents a deferral opportunity, especially to large CCPCs that can pay out eligible dividends sourced from a large pool of active income in order to recover refundable tax on investment income that does not itself give the corporation the capacity to pay out eligible dividends without penalty. The 2018 Budget addresses the perceived deferral opportunity created by this dichotomy by introducing two new RDTOH accounts:
- Eligible RDTOH generally will track refundable taxes paid under Part IV of the Act on eligible “portfolio” dividends (i.e., eligible dividends paid by non-connected corporations); any dividend paid by a corporation, whether eligible or non-eligible, will entitle the corporation to a refund of its eligible RDTOH, subject to an ordering rule (described below)
- Non-eligible RDTOH will track refundable taxes paid under Part I of the Act on investment income and refundable Part IV tax paid on non-eligible “portfolio” dividends; refunds of non-eligible RDTOH will be available only as the result of paying non-eligible dividends.
The proposed ordering rule will require that, upon payment of a non-eligible dividend, a corporation will first obtain a refund of any non-eligible RDTOH.
Corporations that owe Part IV tax in respect of dividend refunds received by a connected corporation paying the dividend will be required to add the amount to the RDTOH account corresponding to the RDTOH account from which the connected payer corporation received a refund.
A corporation’s existing RDTOH account will be allocated among eligible RDTOH and non-eligible RDTOH as follows:
- For a CCPC, the lesser of its existing RDTOH balance and 38 1/3 per cent of its “general rate income pool” will be allocated to its eligible RDTOH account, with any remaining balance being allocated to non-eligible RDTOH
- For any other corporation, all of its existing RDTOH balance will be allocated to its eligible RDTOH account.
The changes to the RDTOH regime will apply for taxation years beginning after 2018, with anti-avoidance rules preventing the deferral of this application as the result of creating short taxation years.
At-risk Rules for Tiered Partnerships
As expected, the 2018 Budget announced measures to respond to the Federal Court of Appeal’s (FCA) decision in The Queen v. Green (Green) relating to the treatment of losses in tiered partnership structures. However, the proposals go further than expected and eliminate certain existing losses that resulted from such structures.
Generally, because a partnership is a flow-through entity for tax purposes, a taxpayer is able to deduct losses realized by a partnership of which the taxpayer is a member. Where the taxpayer is a limited partner, it is only able to deduct losses of the partnership to the extent of the taxpayer’s “at-risk amount”, which is generally the amount the taxpayer invested in the partnership. The excess amount is called a “limited partnership loss” and may be deducted by the taxpayer in a future year against income allocated by the partnership to the extent the taxpayer has an at-risk amount in respect of the partnership in that future year.
The CRA had a long-standing position that losses realized by a partnership (bottom partnership) could not be deducted by a member that is another partnership (top partnership) to the extent that the losses exceeded the at-risk amount of the top partnership in the bottom partnership. This position was seen as a trap for taxpayers looking to invest in tiered partnership structures.
The decision in Green held that the CRA’s long-standing position was incorrect, deciding that the at-risk limitation does not apply to a top partnership. Accordingly, losses realized by a bottom partnership could be deducted in computing the income of the top partnership without regard to the at-risk rules. Such losses could be allocated to the members of the top partnership, subject to the at-risk amounts of the members of the top partnership.
In Green, the Crown argued that the at-risk rules could be avoided altogether by using a general partnership as a top partnership (members of a general partnership are not subject to the at-risk rules). The FCA acknowledged that such a result was likely unintended and invited a legislative fix.
In response to Green, the 2018 Budget proposes that any excess of the losses of a bottom partnership allocated to a top partnership over the at-risk amount of the top partnership will not be deductible in computing the income of the top partnership (and therefore cannot be allocated to members of the top partnership). Such excess will not be a limited partnership loss and will therefore be completely lost, restoring the CRA’s long-standing position. To the extent that losses are made unavailable by this new rule, the reduction in the adjusted cost base of the bottom partnership interest held by the top partnership will be reversed.
While these measures apply to taxation years that end on, or after, February 27, 2018, the measures include rules that will eliminate any existing losses of a taxpayer that resulted from a loss allocated by a bottom partnership in excess of the at-risk amount of a top partnership (effectively converting the loss into adjusted cost base to the taxpayer of the taxpayer’s partnership interest). To the extent that a taxpayer deducted from its income losses from a tiered partnership structure in a year that ended before February 27, 2018, such deduction will not be affected by these measures.
Artificial Losses Using Equity-Based Financial Arrangements
The 2018 Budget continues the trend of introducing rules designed to limit perceived inappropriate tax benefits in connection with the use of equity derivative and structured transactions, which the government states have been entered into by financial institutions.
In particular, the 2018 Budget introduces amendments to the existing dividend rental arrangement (DRA) and securities lending arrangement (SLA) regimes to target certain specific transactions that the government contends are intended to inappropriately generate artificial tax losses.
Synthetic Equity Arrangements
The DRA regime generally denies an intercorporate dividends-received deduction where, among other requirements, a taxpayer receives a dividend on a share that is the subject of a DRA. The 2015 federal budget significantly broadened the DRA regime by expanding the definition of a DRA to include a “synthetic equity arrangement” (SEA). An SEA is, generally, an arrangement (typically one or more derivative instruments) under which a taxpayer transfers the risk of loss and opportunity for gain in respect of a share to a “tax-indifferent investor” (such as a tax-exempt or a non-resident). Under such an arrangement, the taxpayer receives a dividend on the share and makes a dividend equivalent payment to the tax-indifferent investor. But for the inclusion of an SEA in the definition of a DRA, the taxpayer could claim a dividends-received deduction in respect of the dividend and a deduction for the dividend equivalent payment made to the tax-indifferent investor — effectively a double dip.
In their current form, the SEA rules do not apply where the taxpayer can establish that no tax-indifferent investor has all, or substantially all, of the risk of loss and opportunity for gain or profit in respect of a share because of an SEA. The 2018 Budget asserts that certain taxpayers have been inappropriately relying on this exception by transferring all, or substantially all, of the risk of loss and opportunity for gain or profit in respect of a share to a tax-indifferent investor otherwise than through an SEA. The 2018 Budget proposes to amend the exception so that it will only apply where all, or substantially all, of the risk of loss and opportunity for gain or profit in respect of a share has not been transferred to a tax-indifferent investor or affiliated group of tax-indifferent investors, whether because of an SEA or otherwise.
This measure will apply to dividends that are paid on, or after, February 27, 2018.
Securities Lending Arrangements
The 2018 Budget also asserts that taxpayers are using securities loan and repurchase transactions that are deliberately structured not to meet all the SLA requirements for purposes of the Act, in order to create artificial losses in situations that are similar to, but arguably not caught by, the existing SEA rules. In such an arrangement, a corporate taxpayer borrows a Canadian share from a counterparty and is obligated to return an identical share to the counterparty in the future and, in the interim, to make dividend equivalent payments to the counterparty. The taxpayer would claim a dividends-received deduction in respect of dividends on the share. The taxpayer would also claim a deduction in respect of the dividend equivalent payment on the basis that the restrictions on the deductibility of dividend equivalent payments under the SLA rules do not apply because the transaction is not an SLA.
If such an arrangement were caught by the existing SLA rules, the DRA rules would apply to deny the dividends received deduction.
The 2018 Budget proposes to introduce the new concept of a specified SLA (SSLA). An SSLA is an arrangement (other than an SLA) under which:
(a) A person lends a share of a listed or public corporation to another person
(b) It may reasonably be expected that the other person will return an identical share to the person
(c) The person’s risk of loss and opportunity for gain is not changed in any material respect.
The SSLA definition is broader than the existing SLA definition, which also requires that a securities borrower make payments to the securities lender as compensation for dividends on the borrowed share. The associated definition of an SLA compensation payment will also be amended to include a dividend equivalent payment under an SSLA, such that certain rules applicable to the receipt and payment of SLA compensation payments will apply to dividend equivalent payments under an SSLA as well (including in particular the deemed treatment of dividend equivalent payments as dividends under the SLA rules such that the DRA rules will apply in respect of the arrangement).
As a result, if a taxpayer enters into an SSLA in respect of a share, the taxpayer will be unable to claim a dividends-received deduction for dividends received on the share where the DRA rules apply.
Separately, the 2018 Budget clarifies the application of the provision that governs the deductibility of dividend equivalent payments. The first provision generally provides for up to a two-thirds deduction for dividend equivalent payments on Canadian shares made by a registered securities dealer. The latter generally provides all taxpayers with a full deduction for such dividend equivalent payments made under an SLA that is also a DRA. The 2018 Budget clarifies that, where the latter provision applies, the former does not.
This measure will apply to dividend equivalent payments made on, or after, February 27, 2018, unless the applicable securities loan or repurchase transaction was in place before February 27, 2018, in which case the amendments will apply to dividend equivalent payments that are made after September 2018.
Stop-loss Rule on Share Repurchase Transactions
Financial institutions are generally subject to special rules relating to shares that are “mark-to-market property”. Generally, gains or losses on such shares are fully included or deducted from income and are required to be brought into, or deducted from, income on a mark-to-market basis annually. Dividends received or deemed to be received on a share of a Canadian corporation are generally eligible for a full deduction when received by another Canadian corporation. Dividend stop-loss rules restrict the ability to claim losses where dividends have been received on such shares. Special dividend stop-loss rules apply to shares that are mark-to-market property held by financial institutions.
Where shares of a Canadian corporation are redeemed by the issuer, the issuer is generally deemed to have paid a dividend equal to the difference between the redemption amount and the PUC of the shares redeemed. Such deemed dividend reduces the proceeds of disposition for purposes of determining the taxpayer’s gain or loss on the disposition of such shares. Any loss realized by the holder may be stopped under the dividend stop-loss rules.
Under the current dividend stop-loss rules applicable to shares that are mark-to-market property held by a financial institution, its loss that would otherwise result from a repurchase of shares of a Canadian corporation is stopped, but only to the extent that the original cost of the share exceeded its PUC. The loss would not be stopped to the extent of the financial institution’s net cumulative mark-to-market gain on the share. The Department of Finance was concerned that, to the extent that a financial institution had otherwise hedged that price risk when it acquired the share, the financial institution would have already obtained deductions that would fully offset such cumulative mark-to-market gain. Accordingly, the 2018 Budget proposes that the loss otherwise realized on a repurchase of shares of a Canadian corporation held as mark-to-market property by a financial institution will generally be decreased by the dividend deemed to have been received on the share repurchase.
This proposal is effective for share repurchases that take place on, or after, February 27, 2018.
OTHER TAX CHANGES
Tax Reporting for Trusts
The 2017 federal budget announced the government’s intention to examine ways to enhance the tax reporting requirements for trusts in order to improve the collection of beneficial ownership information. The 2018 Budget follows up on this announcement by proposing new reporting requirements for trusts.
The new requirements impose an obligation on certain trusts to file a tax return where no such obligation currently exists, and also impose additional information reporting requirements on an annual basis. These requirements will apply to express trusts (i.e., trusts created with the settlor’s express intent, usually made in writing) resident in Canada and to non-resident trusts that are currently required to file a return.
Where the new reporting requirements apply to a trust, the trust will be required to report the identity of all trustees, beneficiaries and settlors of the trust, as well as the identity of each person who has the ability (through trust terms or a related agreement) to exert control over trustee decisions regarding the appointment of income or capital of the trust (e.g., a protector). No specific proposals were included for this measure in the NWMM that accompanied the 2018 Budget. It will be interesting to see how the concept of a person who has the ability to exert control is defined for purposes of these rules.
Exceptions to the additional requirements are proposed for the following types of trusts:
- Mutual fund trusts, segregated funds and master trusts
- Trusts governed by registered plans
- Lawyers’ general trust accounts
- Graduated rate estates and qualified disability trusts
- Trusts that qualify as non-profit organizations or as registered charities
- Trusts that have been in existence for less than three months or that hold less than C$50,000 in assets throughout the taxation year (provided that such assets are restricted to deposits, government debt obligations and listed securities).
These new reporting requirements will apply to returns required to be filed for taxation years ending in, or after, the 2021 calendar year.
Funding for Enforcement and Courts
There have been efforts over recent years to increase the level and effectiveness of the CRA’s audit activities, in particular as they apply to tax avoidance. The 2018 Budget re-confirms CRA’s commitment to these efforts. It proposes an additional C$90.6-million of funding for CRA over the next five years to address additional cases that have been identified through enhanced risk assessment systems, both domestically and internationally. The 2018 Budget proposes a further additional C$38.7-million of funding over five years to the CRA to allow it to expand its offshore compliance activities.
The 2018 Budget also proposes an additional C$41.9-million of funding for the Courts Administration Service over the next five years, plus C$9.3-million per year on an ongoing basis. This funding is intended to support front-line registry and judicial staff at the federal courts, including the Tax Court of Canada, as the courts deal with a growing and increasingly complex caseload.
Selected GST/HST Measures Relating to Investment Limited Partnerships
As described in our September 2017 Blakes Bulletin: Finance Canada Seeks Comments on New Tax Proposals Regarding Investment Limited Partnership Rules, the Department of Finance proposed to impose Goods and Services Tax/Harmonized Sales Tax (GST/HST) on management and administrative services provided by the general partners of an investment limited partnership, even if the general partner is providing such services under obligations as a member of the partnership.
The 2018 Budget proposes to modify the Department of Finance’s original proposal so that the GST/HST applies to management and administrative services rendered by the general partner on, or after, September 8, 2017, and not to management and administrative services rendered by the general partner before September 8, 2017, unless the general partner charged GST/HST for such services before that date. The 2018 Budget also proposes that the GST/HST be generally payable on the fair market value of management and administrative services in the GST/HST reporting period (or if the service fees are invoiced, in the billing period) in which the services are rendered, at least in circumstances where the services are rendered pursuant to an agreement.
Notwithstanding these modifications, the proposed amendments remain similar to the original proposal and retain the problems that were identified when the rules were first published by the Department of Finance for comment. Namely, the new amendments, in conjunction with the existing rules, will likely lead to increased scrutiny of the activities of investment limited partnerships and may provide additional scope for disputes regarding the fair market value for services that are provided by general partners to investment limited partnerships.
For further information, please contact any member of our Tax group.