With the onset of this year’s unprecedented global pandemic, the federal government postponed the budget previously scheduled for March 2020. The government’s attention understandably shifted to the enactment of emergency relief measures designed to support Canadian businesses and individuals.
Facing continued public health measures and an unprecedented level of economic uncertainty, on November 30, 2020, the Deputy Prime Minister and Minister of Finance Chrystia Freeland (Minister) delivered a “mini-budget” referred to as the government’s Fall Economic Statement (FES) and titled Supporting Canadians and Fighting COVID-19. While the FES emphasizes continued emergency relief measures, it also includes several tax-related announcements of interest to domestic and foreign businesses.
Here is an overview of the key provisions in the FES, which are discussed in further detail below:
Overview of Proposed Tax Measures
Employee Stock Option Proposals
Emergency Pandemic Relief Proposals
Sales Tax Proposals
OVERVIEW OF PROPOSED TAX MEASURES
The government’s business tax announcements in the FES fall into two broad categories: measures to foster a “fairer tax system”, and extension of emergency pandemic relief measures. Further details on the extension of emergency pandemic relief measures appear below.
The “fairness” announcements may be summarized as follows:
- Definitive legislative proposals have been announced to implement the Budget 2019 proposal to limit the ability of employees to effectively be taxed at capital gains rates when they exercise an employee stock option (ESO). The proposed changes will apply to ESOs granted by certain large corporations on, or after, July 1, 2021. Where favourable ESO tax treatment is denied, the employer may claim a new corporate deduction in computing its taxable income. These proposals are discussed in greater detail below.
- Sales tax changes have been proposed to foster “a fair tax system for the digital economy”. Changes are proposed to the federal goods and services tax (GST) (and corresponding harmonized sales tax or HST in Ontario and the Atlantic provinces) payable by foreign digital suppliers. Following similar measures enacted in Quebec, the government proposes to impose GST/HST on cross-border supplies of digital products or services, short-term rental accommodation supplied through digital platforms and certain online supplies through domestic fulfilment warehouses. These changes apply from July 1, 2021 and are discussed in greater detail below.
- As foreshadowed in the September 2020 Throne Speech, and as announced by several other countries, the government said that it intends to enact a unilateral digital services tax (DST) so that foreign corporations providing digital services in Canada pay their “fair share”. Gross revenue-based DSTs enacted by other countries, notably France, have provoked punitive tariffs by the United States, which views DSTs as an inappropriate assault on U.S.-based digital businesses. Such measures may also violate tax treaties. The Minister, herself a veteran of contentious North American trade negotiations, emphasized Canada’s preference for a coordinated multilateral solution instead of this unilateral measure, which could provoke a similar U.S. response. Canada is an active participant in the ongoing work led by the Organisation for Economic Co-operation and Development to arrive at an internationally approved “unified approach” to address these issues by mid-2021. The DST will be deferred until 2022, and the tax will not apply once an acceptable multilateral approach takes effect. Further details are promised for Budget 2021. For more information about the Throne Speech, please see our September 2020 Blakes Bulletin: Canada’s New Employment Measures Look to Address COVID-19 Effects.
- Consistent with recent federal budgets and the government’s desire to be seen as “cracking down” on tax evasion and combatting “aggressive international tax avoidance”, the government announced a further increase in funding of the Canada Revenue Agency (CRA). On top of the C$350-million annual increases in CRA funds earmarked to attack perceived cross-border abuses, an additional C$606-million over five years is promised to “fund new initiatives and extend existing programs targeting international tax evasion and aggressive tax avoidance”. Any business engaged in cross-border transactions should expect even more aggressive audit scrutiny and potential challenges than in the past. The government expects CRA to raise an additional C$1.4-billion in government revenues.
- It is well known that foreign investors generally view Canada as a stable, safe jurisdiction in which to invest their savings. In recent years, this has put upward pressure on some urban residential real estate markets, as foreign high-net-worth individuals invest in these safe assets. In the FES, the government announced a new initiative to impose a “national, tax-based measure targeting the unproductive use of domestic housing that is owned by non-resident, non-Canadians”. The suggestion is that there may be a new foreign buyers’ tax that is designed to dampen this source of demand, reducing price pressures on residential real estate. Presumably, details will be released over the course of 2021.
- Finally, the Minister announced that a consultation will be launched in 2021 seeking stakeholder input on measures to modernize anti-avoidance rules in the Income Tax Act (Canada) (ITA), including the general anti-avoidance rule. The Minister referred to “increasingly complex structures” designed to “artificially lower” tax obligations. Of course, this refrain from the government is hardly novel, though one suspects that government-side losses in recent high-profile tax appeals may have played a role in this initiative. It is understood that details of the consultation, including timing, have not yet been finalized.
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EMPLOYEE STOCK OPTION PROPOSALS
The FES proposes to restrict access to preferential treatment of ESOs granted on, or after, July 1, 2021.
Under long-established rules in the ITA, an employee is not taxed at the time an ESO is granted. In general, tax is imposed on the option benefit – being the excess of the market value of the share over the strike price payable under the option – only at the time the option is exercised. Furthermore, preferential treatment – being taxation at the same rate as capital gains, which are taxed at one-half of the general tax rate – is available for qualifying ESOs.
In its 2015 election platform, the governing Liberals characterized this preferential treatment of ESOs as an inappropriate tax benefit that tends to favour higher income Canadians. Measures were proposed at that time to deny the preferential treatment to option gains above C$100,000. This proposal never proceeded, however, once the government became aware of the importance of ESOs as a key element of employee compensation for technology start-ups and other small or growing companies with limited cash resources that seek to align these employees’ incentives with those of the enterprise as a whole.
In the lead-up to the 2019 election, the Minister of Finance proposed revised restrictions in the 2019 federal budget on the preferential treatment of ESOs. Under this revised plan, favourable treatment would be preserved for employees of Canadian-controlled private corporations (CCPCs) and for an undefined category of “start-up, emerging and scale-up companies”. Stakeholder consultations were initiated to assist the government in defining this latter category of companies. Draft legislation was published in June 2019 ahead of the fall election and a revised version of those proposals was anticipated for the federal budget originally scheduled for March 2020.
It should come as no surprise that this unfinished business was included in the FES as part of a Notice of Ways and Means Motion (NWMM) to be approved by Parliament. The NWMM proposals, while still raising some anomalies, are a clear improvement from the June 2019 draft legislation. Many of the recommendations of stakeholders have been reflected. The NWMM also includes a precise description of excluded enterprises.
Application of the New Rules
In general, the new rules will apply to restrict the favourable treatment of ESOs granted by corporations and mutual fund trusts that:
- Are not CCPCs, and
- Have (or are part of a consolidated group whose “ultimate parent entity” has) annual gross revenues that exceed C$500-million. For this purpose, the “ultimate parent entity” is defined in the “country-by-country” reporting rules in the ITA.
The new regime does not apply to ESOs granted before July 1, 2021. Where the new restrictions might otherwise apply, consideration should be given to granting 2021 options during the first half of the year to escape these restrictions.
In contrast to the June 2019 legislative proposals, the NWMM provides that options that are exchanged under rules applicable to many merger and acquisition transactions will not be treated as newly issued options so that grandfathering will not be lost solely due to the issuance of an option after June 2021 under the usual rules for option exchanges. As well, if an issuer of a grandfathered option amalgamates after June 2021, a pre-July 1, 2021 option exchanged on the amalgamation will not be treated as newly issued.
As in the June 2019 legislative proposals, the new rules do not apply to options issued by corporations that are CCPCs at the time of grant. As noted above, they also do not apply where the issuer of the option is “small”. For this purpose, a corporation will be “small” unless it has gross revenue of over C$500-million or it is part of a group that files consolidated financial statements and that has gross revenue over C$500-million. Canada’s tax system, unlike that of most developed countries, does not generally provide for group consolidation.
The decision to use a gross revenue threshold, while having the advantage of clarity, raises several questions of consistency. If the intent was to exclude those growing corporations having difficulty accessing cash to compensate employees, raw gross revenue of the corporation or group seems like a highly imperfect proxy. As many businesses are currently experiencing, even a “large” company, when measured by gross revenue, may have difficulty accessing discretionary cash, and may rely heavily on stock-based compensation to align the incentives of key employees.
A specific potential anomaly in the approach taken to defining “small” corporations is that a start-up business that is funded by a “large” sponsor with a fixed interest, but whose ownership position is sufficient to give rise to the preparation of consolidated financial statements that include the “small” corporation will be caught by the new rules. This appears to disadvantage these sorts of start-ups as compared to other start-ups. It seems peculiar that the tax analysis will turn on the applicable accounting rules governing which entities need to be included in consolidated statements.
What the New Rules Mean for Employees
Generally, where the new rules apply, they will deny favourable employee treatment (taxation at one-half of the usual rate) for ESOs that vest in a particular calendar year to the extent the fair market value of the shares underlying those ESOs exceeds C$200,000 at the time of grant.
Unlike existing ESO rules, a key feature of the new rules is the new concept of the “vesting year”. For ESOs that vest over time – as is often the case for large, well-established companies – the vesting year is generally the year in which the ESO first becomes exercisable. In contrast, for growing companies, including those controlled by financial sponsors, vesting of ESOs is often based on performance metrics, or the occurrence of a liquidity event, rather than the mere passage of time. For this category of ESOs, the vesting year is determined by first determining the year in which the ESO becomes exercisable, and then treating all identical ESOs as having vested on a pro rata basis over the period beginning at the time of grant and ending at the earlier of the time they become exercisable, or the day that is 60 months after the time of grant if the options become exercisable after more than 60 months. This latter feature, while less than straightforward, is certainly an improvement over the June 2019 legislative proposals which would have treated the vesting year as the year in which all the options become exercisable, thereby more severely limiting access to the C$200,000 annual limit.
The employer is required to notify an affected employee in writing within 30 days of grant that the ESO is ineligible for favourable treatment by reason of these new rules. It is not immediately clear how this could be done where the options vest based on a performance metric or liquidity event. The employer must also notify CRA by the date that the employer’s tax return is due for the year of grant. One suspects that T4 reporting forms will have a new box in which the amount of an option benefit that is ineligible for favourable treatment will be indicated. Issuers of ESOs may also choose to treat all options as ineligible for favourable treatment. One reason an issuer might do this is to gain access to a greater employer deduction, as described in the next section.
Effect of the New Rules on Employers
Under existing law, issuers of ESOs are generally prohibited from claiming a deduction for a stock option benefit that is entitled to favourable tax treatment in the hands of an option holder. This prohibition may apply even where the ESO fails to qualify for favourable treatment, as would be the case where, for example, the option holder is “related” to the issuer or where the option was “in-the-money” when granted.
The proposed rules introduce a new, targeted employer deduction in computing taxable income. The amount that may be deducted is the amount of the ESO benefit that is taxed in the hands of the employee to the extent the employee is denied favourable ESO treatment solely as a result of the new rules, i.e., where the underlying shares for ESOs vesting in the year had an initial market value of over C$200,000.
Here again the NWMM wording is an improvement over that in the June 2019 proposals. The entity that may claim the deduction is the employer of the affected individual, even if the issuer of the option is another entity, as often occurs in corporate groups. In circumstances where the individual is employed by multiple entities in the group, the amount of any deduction may only be claimed by one of those entities. One potential trap is that the deduction is available only to an employer that is either a corporation or a mutual fund trust. If the employer is a trust that is not a mutual fund trust, it appears the deduction would not be available. Where a business is conducted through a partnership, advice should be sought to ensure the employment arrangements are structured in a way that ensures access to the appropriate deduction in circumstances where the new rules might apply.
Assuming the NWMM receives approval in Parliament, it is likely to be enacted into law in the near future. We invite businesses that use ESOs as part of their compensation packages to contact us for a more detailed briefing regarding their specific structures.
EMERGENCY PANDEMIC RELIEF PROPOSALS
Extension of the Canada Emergency Wage Subsidy
Originally introduced on April 11, 2020, and subsequently overhauled and extended, the Canada Emergency Wage Subsidy (CEWS) provides a subsidy (the maximum amount of which was initially 75 per cent, which was increased to 85 per cent for the July and August claim periods, and then reduced to the 65 per cent maximum currently in place), in respect of remuneration for eligible employees. The level of subsidy provided for a four-week claim period depends upon the extent of revenue reduction experienced by an eligible employer in the relevant month as compared to a “prior reference period” (either the same month in the prior year, or the average of January and February 2020, depending on the election made by the employer). For more information about the CEWS program, please see our July 2020 Blakes Bulletin: Government Proposes to Extend and Overhaul the Canada Emergency Wage Subsidy
The FES confirms the previously announced further extension of the CEWS and sets out parameters for the program between the end of the current claim period on December 19, 2020, and March 13, 2021. The FES states that details for any periods beyond March 13, 2021 will be proposed at a later date. The government had previously announced that it intended to extend the CEWS until June 2021.
For active employees, the maximum subsidy under the CEWS for each of the three four-week periods beginning December 20, 2020 will be increased once again to up to 75 per cent of eligible remuneration for the hardest-hit employers, being those experiencing a revenue decline of 70 per cent or more. This is comprised of a base subsidy and a top-up wage subsidy. For employers seeing revenue declines of 50 per cent or more, the base subsidy is 40 per cent, while employers experiencing a lesser revenue decline will have a base subsidy equal to their revenue reduction percentage multiplied by a factor of 0.8. The top-up wage subsidy is 35 per cent for employers seeing revenues reduced by 70 per cent or more, the product of 1.75 and the difference between the revenue reduction percentage and 50 per cent for employers seeing declines between 50 and 70 per cent, and zero per cent for employers experiencing a less than 50 per cent decline in revenues.
For furloughed employees, the wage subsidy will remain aligned with benefits available under Employment Insurance. In particular, the weekly wage subsidy for an employee on paid leave for the extension period will be the lesser of the amount of eligible remuneration actually paid to the employee in respect of the week, and the greater of C$500 and 55 per cent of the employee’s pre-crisis remuneration (up to a maximum weekly subsidy of C$595). Employers will continue to be entitled to a 100-per-cent subsidy for their portion of contributions in respect of the Canada Pension Plan, Employment Insurance, the Quebec Pension Plan and the Quebec Parental Insurance Plan for employees on paid leave.
Finally, the FES confirms that employers will continue to have a choice of using either the same month in the prior year (i.e., 2020) and the average of January and February 2020, as the “prior reference period” for purposes of determining their percentage revenue decline.
Extension of Canada Emergency Rent Subsidy
The Canada Emergency Rent Subsidy (CERS) was introduced on November 2, 2020, to replace the Canadian Emergency Commercial Rent Assistance program and provide rent support directly to tenants and property owners. Under the CERS, qualifying organizations are reimbursed for a percentage of eligible expenses (such as rent and property taxes) in respect of qualifying property, up to a maximum of C$75,000 in eligible expenses per location and an overall maximum of C$300,000 in expenses for the organization and its affiliates. The percentage reimbursement is determined on a sliding scale, up to a maximum of 65 per cent, based on the percentage revenue reduction suffered by the tenant or property owner. To be eligible for the 65 per cent rate, the entity must have suffered a revenue reduction of at least 70 per cent. Revenue reductions are determined for this purpose on the same basis as for the CEWS. An additional top-up (lockdown support) is available to organizations that were forced to shut down for at least one week due to an order or decision by a qualifying public health authority in response to the pandemic (i.e., a lockdown order). The amount of lockdown support varies, to a maximum of 25 per cent, based on the duration of the shut-down. For more information about the CERS program, please see our November 2020 Blakes Bulletin: Canada Emergency Rent Subsidy (CERS): New Direct Emergency Rent Subsidy for Businesses.
The FES extends the CERS to March 13, 2021, using the same rate structure that is currently in place, confirms that an entity must use the same method for computing its revenue decline under both the CEWS and the CERS, and confirms the government’s intention to proceed with a proposed change to the CERS rules, to permit amounts of eligible expense to be considered to have been paid when they become due under certain conditions. The FES states that details for any further extension of the CERS will be proposed at a later date.
Home Office Expenses
Recognizing that “millions of Canadians are unexpectedly working from home because of COVID-19,” the FES announces a simplified process for claiming tax deductions for home office expenses. Noting that further detail will be communicated by the CRA in coming weeks, the FES indicates that employees working from home will be permitted to claim up to C$400, based on the amount of time working from home, without the need to track detailed expenses or obtain signed forms from employers.
Temporary Support for Families with Young Children
The Canada Child Benefit (CCB) is a non-taxable monthly benefit for eligible families with children under the age of 18, the extent and availability of which is based on adjusted family net income. As an immediate support measure in recognition of the additional expenses borne during the pandemic by families with young children, the FES proposes four quarterly payments in 2021 to CCB-eligible families with children under the age of six, of either C$300 per child under six (in the case of families with family net income of no more than C$120,000) or C$150 per child under six (in the case of families with family net income over C$120,000). It is proposed that the rules that apply to the CCB would generally also apply to these quarterly payments.
SALES TAX PROPOSALS
Temporary GST/HST Relief on Face Masks and Face Shields
Supplies of face masks (medical and non-medical) and face shields that meet certain specifications made after December 6, 2020 will be zero-rated (i.e., taxed at zero per cent) for GST/HST purposes until their use is no longer broadly recommended by public health officials for the COVID-19 pandemic.
The FES also contains several significant proposed changes to the GST/HST system to address the growing digital economy in Canada, which we have summarized below.
New GST/HST Registration Requirement for Non-Resident Vendors of Digital Products and Services
Similar to the non-resident registration rules that were implemented by Quebec in 2019, the FES proposes a simplified, mandatory registration regime for non-resident vendors supplying digital products or services to consumers in Canada. Distribution platform operators who facilitate sales of digital products and services will also be required to register. The registration requirement is triggered when the total taxable supplies made directly by the vendor or facilitated by the distribution platform operator over a 12-month period exceed (or are expected to exceed) C$30,000. For more information about the non-resident registration rules implemented by Quebec in 2019, please see our April 2018 Blakes Bulletin: 2018 Quebec Budget: Non-Quebec Residents Required to Register under Provincial Sales Tax Regime.
The simplified GST/HST registration and remittance framework only requires registrants to collect GST/HST from Canadian consumers. Registrants under the simplified framework do not report “net tax” and will not be able to claim input tax credits to recover any GST/HST paid on their business inputs. Only business-to-consumer supplies are taxable under the simplified registration system. Canadian businesses should provide their GST/HST registration number to non-resident suppliers as evidence of an exemption from the simplified GST/HST (the business may be required to self-assess GST/HST on an “imported taxable supply” under the normal rules). A penalty will apply if a consumer provides a GST/HST registration number to a non-resident vendor to evade tax on the purchase of digital products or services acquired for personal consumption.
If a business is charged GST/HST in error by a non-resident registrant under the simplified framework, the business can claim a refund from the non-resident, but it is not eligible for an input tax credit or rebate for tax paid in error from the CRA. In other words, the CRA will not take any responsibility for the taxes that are collected by non-resident registrants under the simplified framework, presumably because it cannot be taken for granted that such amounts will be remitted to the CRA in the first place and the CRA’s enforcement options against non-residents under the simplified framework will necessarily be limited.
The simplified framework for GST/HST registration is proposed to come into force for supplies of cross-border digital products or services to the extent that the consideration for the supply becomes due (or is paid without having become due) on, or after, July 1, 2021.
GST/HST on Sales by Online Marketplaces
Digital platform operators that facilitate sales of third-party goods (i.e., online marketplaces or distribution platforms) are also subject to new GST/HST rules. The FES notes that the goods sold through such online marketplaces are increasingly being stored in fulfilment warehouses in Canada, and while applicable duties and taxes are charged at the border, the GST/HST is not consistently charged on the retail price because the vendors are non-registered non-residents. In particular, this creates a competitive advantage for a non-resident, non-registered vendor that is not carrying on business in Canada, and the distribution platform that facilitates the storage and shipping is not the supplier of the goods.
The FES proposes that distribution platform operators (whether resident or not) would be deemed to be suppliers in respect of sales they facilitate by non-registered vendors, of goods that are located in fulfilment warehouses in Canada or shipped from a place in Canada to a purchaser in Canada. Distribution platform operators would be required to collect and remit the GST/HST on the final sale price of the goods for which they were deemed to be the supplier. Registered distribution platform operators will be eligible for “flow through input tax credits” in respect of the tax paid at the border by non-registered third-party vendors that import their goods into Canada. Platform services supplied by the platform operator to non-registered vendors will be relieved from GST/HST. Critically, the proposed rules will be designed to ensure that they do not conflict with the existing drop shipment rules. For sales by non-resident vendors that are not made through a distribution platform (e.g., sales made by offering and selling the goods through the vendor’s own website directly to Canadians), a new rule requires such non-resident vendors to register and collect GST/HST with a full GST/HST registration (not a simplified registration). Such registration is only required where the non-resident vendors make “qualifying supplies” of tangible personal property to “specified recipients” (i.e., non-registered recipients, not including non-residents that are not consumers of the property) of over C$30,000 in a 12-month period. “Qualifying supplies” include taxable, non-zero-rated supplies of tangible personal property delivered in Canada, but exclude supplies of tangible personal property delivered from outside Canada that are sent by mail or courier.
Both the distribution platforms and Canadian fulfilment businesses will be required to report to the CRA and maintain certain records on their non-resident clients to assist the CRA in the administration of the GST/HST. The proposed new rules will generally apply to supplies made on, or after, July 1, 2021, and supplies made before July 1, 2021 if all the consideration is payable on, or after, July 1, 2021.
GST/HST on Platform-based Short-Term Accommodation
Short-term accommodation of a residential complex or a residential unit made to a person for a period of less than one month is subject to GST/HST.
The FES proposes a system with two options. Namely, if the property owner is registered, the property owner continues to be responsible for collecting the GST/HST if the property owner is a registrant. The accommodation platform operator will be deemed to be the supplier of short-term accommodation and be responsible for collecting the GST/HST if the property owner is not registered for GST/HST purposes.
Where the accommodation platform operator is carrying on business in Canada, the operator will be required to register under the normal GST/HST rules. A non-resident accommodation platform operator who is not carrying on business in Canada can register under the simplified registration/remittance system. Non-resident accommodation platform operators using the simplified registration system would be required to collect and remit the GST/HST on supplies of taxable short-term accommodation in Canada made to consumers only. At the same time, non-resident accommodation platform operators using the simplified registration system would not be able to claim input tax credits to recover any GST/HST paid on their business inputs. A GST/HST registered business will continue to be required to self-assess and remit the GST/HST on its purchases of short-term accommodation facilitated by a non-resident accommodation platform operator that is registered under the simplified GST/HST registration/remittance system, unless the purchase is for use exclusively in the business’s commercial activities.
GST/HST registered accommodation platform operators would be deemed to not have made a supply of services to the non-registered third-party property owner of short-term accommodation in Canada relating to facilitating the supply of the accommodation, which would help avoid the GST/HST (which would be unrecoverable to the unregistered vendor) being embedded in the final price of the short-term accommodation. However, a service fee charged by the accommodation platform operator to the guest for the services of facilitating the transaction between the guest and the property owner would be subject to GST/HST (charged at a rate based on the location of the property in Canada). Accommodation platform operators would be required to maintain records and report information to the CRA, including information on the underlying third-party property owners/suppliers using their platforms.
For further information, please contact any member of our Tax group.
Please visit our COVID-19 Resource Centre to learn more about how COVID-19 may impact your business.