Economic Action Plan 2012
March 29, 2012
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The Economic Action Plan 2012 (“Budget 2012”) released today by the Department of Finance reaffirms the Government’s commitment to continue exploring whether new rules for the taxation of corporate groups could improve how the corporate tax system functions.
A new system for the taxation of corporate groups means a fundamental change to the Canadian tax system. As a result, the Government will take into account the potential impact on taxpayers, the complexity of the tax system, any potential impact on revenue for federal, provincial and territorial governments, and the impact that a new system of group taxation could have on federal-provincial and federal-territorial tax arrangements.
• A reduction in the general SR&ED investment tax credit rate
• Extending the age of eligibility for OAS payments from 65 to 67 commencing in 2023
• Measures relating to oil and gas and mineral exploration, including phasing out the Atlantic Investment Tax Credit in oil & gas and mining
• Expanding support for clean energy generation
• Measures to improve tax fairness
• Changes to international tax policies
• Reducing the tax compliance burden for businesses
SCIENTIFIC RESEARCH & EXPERIMENTAL DEVELOPMENT (SR&ED)
Budget 2012 proposes a reduction in the general SR&ED investment tax credit rate. Effective January 1, 2014, the general SR&ED investment tax credit rate will be reduced from 20% to 15%. The enhanced 35% SR&ED investment tax credit rate applicable in respect of eligible Canadian-controlled private corporations will remain unchanged on up to $3,000,000 of qualified SR&ED expenditures annually.
Acting upon the recommendations of the Jenkins Panel, innovation in Canada will now be supported with more direct funding and less indirect funding through the SR&ED tax credit system. Budget 2012 announced $1.1 billion for direct research and development support as well as providing $500 million for venture capital initiatives.
Budget 2012 also proposes to narrow the base of eligible expenditures by removing capital expenditures. Other expenditure elements will remain eligible, including salary and wages, materials, overhead expenses and contract payments. This proposed change will affect capital expenditures incurred in 2014 and subsequent years.
In order to increase cost-effectiveness, Budget 2012 proposes two design improvements that will better align the tax credits received with actual business expenditures on SR&ED projects. The two design improvements will affect the calculation of overhead expenditures and of arm’s length contract payments:
• To limit instances where the rules result in tax credits being provided for overhead costs that exceed the actual costs incurred, Budget 2012 proposes to gradually reduce the “prescribed proxy amount” that is used to compute overhead expenditures under the so-called “proxy method,” from 65% to 55% of direct labour costs. The 55% rate will be fully phased in as of January 1, 2014.
• To remove the profit element from arm’s length contract payments, Budget 2012 proposes to allow only 80% of these contract payments to be used for the purposes of calculating the SR&ED tax credits. This change is consistent with the current tax treatment of non-arm’s length contracts, and will target the tax credits to SR&ED expenditures incurred, and not on profit margins. It will be effective as of January 1, 2013.
Budget 2012 announces actions by the Canada Revenue Agency to improve the predictability of the SR&ED tax incentive program. The Government will invest $4 million in 2012–13 and $2 million in 2013–14 to implement changes to the administration of the program. These actions will include:
• conducting a pilot project to determine the feasibility of a formal pre-approval process,
• enhancing the existing online self-assessment eligibility tool,
• working collaboratively with industry representatives to address emerging issues,
• making more frequent and effective use of “tax alerts”, and
• improving the Notice of Objection process to allow for a second review of scientific eligibility determinations.
OLD AGE SECURITY
Budget 2012 proposes to gradually increase the eligibility age to receive the old age security (“OAS”) payments from 65 to 67 beginning on April 1, 2023, with full implementation by January 2029. As of July 1, 2013 Canadians who prefer to keep working will be given the option to defer receipt of their OAS for up to five years, resulting in the eventual receipt of higher OAS benefits.
SUPPORTING JUNIOR MINERAL EXPLORATION
Budget 2012 proposes to extend the temporary 15% Mineral Exploration Tax Credit for flow-through share investors for an additional year. The temporary 15% Mineral Exploration Tax Credit for flow-through share investors helps junior exploration companies raise capital by providing an incentive to individuals who invest in flow-through shares issued to finance mineral exploration. This credit is in addition to the regular deduction provided for the exploration expenses “flowed through” from the issuing company.
The credit is scheduled to expire on March 31, 2012. However, Budget 2012 proposes to extend the credit for an additional year, until March 31, 2013.
PHASING OUT THE ATLANTIC INVESTMENT TAX CREDIT—OIL & GAS AND MINING
Budget 2012 proposes to phase out the Atlantic Investment Tax Credit for investments in the oil & gas and mining sectors. The tax credit will be 10% for assets acquired before 2014, 5% for acquisitions in 2014 and 2015, and it will no longer be available after 2015.
The Atlantic Investment Tax Credit is a 10% credit available for certain investments in new buildings, machinery and equipment used in the Atlantic region and the Gaspé Peninsula. Currently, the credit supports investments in farming, fishing, logging, manufacturing and processing, oil & gas, and mining.
PHASING OUT THE CORPORATE MINERAL EXPLORATION AND DEVELOPMENT TAX CREDIT
Budget 2012 proposes to phase out the 10% Corporate Mineral Exploration and Development Tax Credit over two years with it being 5% in 2013 and being fully phased out in 2014.
EXPANDING TAX SUPPORT FOR CLEAN ENERGY GENERATION
Budget 2012 proposes to expand the eligibility for the accelerated capital cost allowance for clean energy generation equipment to include a broader range of bioenergy equipment.
Budget 2012 proposes to expand the eligibility for accelerated CCA under Class 43.2 to include:
• Waste-fuelled thermal energy equipment used for space and water heating applications.
• Equipment that is part of a district energy system that distributes thermal energy primarily generated by waste-fuelled thermal energy equipment.
• Equipment that uses residue of plants (e.g. straw) to generate electricity and heat.
HIRING CREDIT FOR SMALL BUSINESS
The 2011 federal budget introduced a temporary hiring credit for small business of up to $1,000 per employer. Budget 2012 proposes to extend this credit for one additional year. A credit of up to $1,000 against a small employer’s increase in its 2012 employment insurance premiums over those paid in 2011 will be provided.
IMPROVING TAX FAIRNESS AND INTEGRITY
Budget 2012 proposes new measures to eliminate perceived abuses of the tax system to help keep overall tax rates low.
These initiatives include:
• Restricting the ability of foreign-based multinational corporations to transfer, or “dump”, foreign affiliates into their Canadian subsidiaries with a view to creating tax-deductible interest or distributing cash free of withholding tax, without providing any economic benefit to Canada.
• Improving the effectiveness of Canada’s thin capitalization rules, which seek to prevent Canadian corporate profits from being distributed to certain non-resident shareholders free of Canadian income tax by way of interest payments on excessive debt.
• Preventing the avoidance of corporate income tax through the use of partnerships to convert income gains into capital gains.
• Modifying the penalty for making unreported tax shelter sales to better match the penalty to the purported tax savings of the unreported tax shelter.
• Tightening the rules applicable to Retirement Compensation Arrangements.
• Tightening the rules applicable to Employees Profit Sharing Plans to discourage excessive contributions for employees with a close tie to their employer. Excessive ESP amounts will be the portion of an employer’s EPSP contribution that exceeds 20% of the specified employee’s salary received in the year by the specified employee from the employer. This measure includes a special tax payable to discourage excessive employer contributions.
PARTNERSHIPS AND SECTIONS 88 AND 100
Budget 2012 proposes two measures to ensure that partnerships cannot be used to circumvent the intended application of sections 88 and 100. The first measure will generally deny a section 88 increase to adjusted cost base in respect of a partnership interest to the extent that the accrued gain in respect of the partnership interest is reasonably attributable to the amount by which the fair market value of income assets exceed their cost amount. This measure will apply where the income assets are held directly by the partnership or indirectly through another partnership. For this purpose, assets directly owned by a taxable Canadian corporation, shares of which are held by the partnership, will not be considered to be indirectly held by the partnership.
Budget 2012 also proposes to extend the application of section 100 of the Income Tax Act to the sale of a partnership interest to a non-resident person, unless the partnership is carrying on business in Canada through a permanent establishment in which all of the assets of the partnership are used. In such cases, the income assets remain within the Canadian income tax base. This measure will also clarify that section 100 applies to dispositions made directly, or indirectly as part of a series of transactions, to a tax-exempt or non-resident person.
Transfer Pricing Secondary Adjustments
Budget 2012 proposes to amend section 247 of the Income Tax Act to confirm that secondary adjustments will be treated as dividends for withholding tax purposes. A Canadian corporation subject to a primary adjustment will also be deemed to have paid a dividend to each non-arm’s length non-resident participant in the transaction or series of transactions in proportion to the amount of the primary adjustment that relates to the non-resident, regardless of whether the non-resident is a shareholder of the Canadian corporation.
Budget 2012 also proposes, consistent with CRA administrative practice, to clarify that a non-resident is allowed to repatriate to a Canadian corporation that has been subject to a primary adjustment an amount equal to the portion of the primary adjustment that relates to the non-resident. If the repatriation is made by the non-resident with the concurrence of the Minister of National Revenue no deemed dividend will arise in respect of that non-resident. In addition, no deemed dividend will arise if the non-resident is a controlled foreign affiliate (as defined in subsection 17(15) of the Income Tax Act) of the Canadian corporation. In this instance, the benefit conferred on the non-resident is more akin to a capital contribution than a dividend.
Budget 2012 proposes to improve the integrity and fairness of the thin capitalization rules by:
• Reducing the debt-to-equity ratio from 2-to-1 to 1.5-to-1;
• Extending the scope of the thin capitalization rules to debts of partnerships of which a Canadian-resident corporation is a member;
• Treating disallowed interest expense under the thin capitalization rules as dividends for withholding tax purposes; and
• Excluding interest expense of a Canadian-resident corporation from the application of the thin capitalization rules to the extent that a portion of that interest is taxable in the hands of the corporation in respect of the FAPI of a controlled foreign affiliate of the corporation
Foreign Affiliate Dumping
Foreign affiliate dumping transactions often involve a Canadian subsidiary using borrowed funds to acquire shares of a foreign affiliate from its foreign parent corporation. These transactions are carried out in the expectation that interest paid by the Canadian subsidiary on such borrowed money is deductible in computing income for tax purposes while, at the same time, most dividends received by the Canadian subsidiary on the shares of the foreign affiliate are exempt from taxation, resulting in the erosion of the Canadian corporate tax base.
Budget 2012 proposes to implement a measure that will curtail foreign affiliate dumping while at the same time preserving the ability of Canadian subsidiaries of foreign parents to undertake legitimate expansions of their Canadian-based businesses. This measure proposes that, where certain conditions are met, a dividend will be deemed to be paid by a Canadian subsidiary to its foreign parent to the extent of any non-share consideration given by the Canadian subsidiary for the acquisition of the shares of a foreign affiliate. Any deemed dividend will be subject to non-resident withholding tax, as reduced by any applicable tax treaty. It further proposes to disregard the paid-up capital of any shares of the Canadian subsidiary that are given as consideration. This measure effectively extends an existing cross-border surplus stripping rule to cover transactions involving foreign affiliates.
Overseas Employment Tax Credit
Employees resident in Canada and who exercise their duties of employment primarily outside of Canada currently qualify for the Overseas Employment Tax Credit (the “OETC”). This tax credit equals to the federal tax otherwise payable on 80% of their qualifying foreign employment income, up to a maximum foreign employment income of $100,000.
Budget 2012 proposes to phase out the OETC over four years, beginning in 2013. During the phase-out period, the 80% tax credit rate applied to an employee’s qualifying foreign employment income will be reduced as follows:
• 60% for 2013;
• 40% for 2014; and
• 20% for 2015.
The OETC will be eliminated for 2016 and subsequent years.
The phase-out rules will not apply to qualifying foreign employment income earned by an employee if the employer committed in writing in relation to a project before March 29, 2012. In this case, the 80% will apply for 2013, 2014, and 2015. Nevertheless, the OETC will be eliminated for 2016 and subsequent years even for these projects.
Budget 2012 proposes a number of changes to the tax treatment of health-related goods and services in order to reflect the evolving nature of the health sector and the health care needs of Canadians, including:
• Exempting pharmacists’ professional services from the GST/HST, other than prescription drug dispensing services, which are already zero-rated under the GST/HST.
• Expanding the list of health care professionals who can order certain medical and assistive devices zero-rated under the GST/HST to reflect the increasing involvement of health care professionals, such as nurses, in giving orders for these devices.
• Expanding the list of GST/HST zero-rated medical and assistive devices and the list of expenses an individual may claim for income tax purposes under the Medical Expense Tax Credit (METC) to include blood coagulation monitors for use by individuals who require anti-coagulation therapy.
The changes to the GST/HST health-related measures will generally be effective March 30, 2012.
REDUCING THE TAX COMPLIANCE BURDEN FOR BUSINESSES
Improvements to the Rules for Paying Eligible Dividends
Under existing rules, if a corporation wishes to pay dividends, and only a portion of those dividends would be eligible for an enhanced dividend tax credit, that portion must be paid as a separate dividend in order for investors to be eligible to claim the enhanced dividend tax credit. Budget 2012 proposes amendments, for dividends paid on or after Budget Day, to allow a corporation to pay a single dividend and designate a portion of it as an eligible dividend.
A Doubling of the Goods and Services Tax/Harmonized Sales Tax (GST/HST) Streamlined Accounting Thresholds
Budget 2012 proposes to double the thresholds for eligibility to use these methods so that more small businesses and public service bodies have access to these simplified approaches. The GST/HST streamlined accounting methods simplify compliance for small businesses and public service bodies
Simplified Administration for Partnerships
In order to reduce the workload for partnerships that want to file waivers, Budget 2012 proposes to amend the Income Tax Act to provide the authority for a single designated partner to sign a waiver on behalf of all partners.
Graduated Penalties for Late Filing
CRA has instituted a new administrative policy to ensure that late-filed information returns penalties are charged in a manner that is both fair and reasonable. Where a business is unable to comply in a timely manner with a reporting obligation related to certain information returns, such as T4s, reduced penalties will be applied when the number of late-filed returns is small.
Improving the Employment Insurance Program
The Government is committed to making targeted, common-sense changes to make Employment Insurance (EI) a more efficient program that is focused on job creation and opportunities. Budget 2012 proposes:
• Limiting EI premium rate increases to 5 cents each year until the EI Operating Account is balanced;
• Providing $21 million over two years to enhance the content and timeliness of the job and labour market information that is provided to Canadians who are searching for employment;
• Investing $74 million over two years to ensure that EI claimants benefit from accepting work; and
• Investing $387 million over two years to align the calculation of EI benefit amounts with local labour market conditions.
As part of the Budget 2012 the Government proposes to eliminate the penny from Canada’s coinage system. The Canadian mint will no longer distribute the penny as of Fall 2012; however, consumers will still be permitted to use pennies indefinitely. Non-cash transactions will still be settled to the cent but any cash transactions should be rounded to the nearest five-cent increment.
The travellers’ exemption allows Canadians to bring back goods up to a specified dollar limit without having to pay duties or taxes, including customs duty, Goods and Services Tax/Harmonized Sales Tax, federal excise levies and provincial sales and product taxes.
The Government proposes to increase the value of goods that may be imported duty-free and tax-free by Canadian residents returning from abroad after a 24-hour absence from $50 to $200 and from $400 to $800 after a 48-hour absence, harmonizing them with U.S. levels. This change will be effective beginning on June 1, 2012.
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