Publication
Legal Alert: 2013 Economic Action Plan - Jobs, Growth, and Long-Term Prosperity
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March 21, 2013
By Raymond Adlington, at McInnes Cooper
The Economic Action Plan 2013, entitled Jobs, Growth and Long-Term Prosperity was released today by the Department of Finance. The projected federal deficit for 2012-2013 is $25.9B, with the government reaffirming its commitment to reducing this deficit in each of the next two fiscal years before returning to a balanced budget in 2015-2016 as previously announced.
The focus of the Economic Action Plan is supporting Jobs and Growth by:
- Connecting Canadians with Available Jobs
- Helping Manufacturers and Business Succeed in the Global Economy
- Creating the New Building Canada Plan
- Investing in World-Class Research and Innovation; and
- Supporting Families and Communities
As in past years, the government has announced a significant number of changes to the Canadian tax system with the announced objective by the Minister of Finance “to close tax loopholes, address aggressive tax planning, clarify tax rules, reduce international aggressive tax avoidance and tax evasion, and improve tax fairness.”
Highlights of the specific tax changes announced are:
- Increase in the lifetime capital gains exemption to $800,000, with future indexing.
- Changes to the ineligible dividend income inclusion amount and dividend tax credit.
- Accelerated capital cost allowance for manufacturing and processing machinery and equipment.
- Measures to curtail loss trading by corporations, partnerships and trusts.
- Extension of the thin capitalization regime to partnerships, trusts and branches of non-resident corporations.
- Elimination of specific tax planning using life insurance products, synthetic dispositions, and character conversions.
Also announced is an intention to consult on possible measures to eliminate the tax benefits that arise from taxing testamentary trusts at graduated rates.
Supporting Jobs & Growth
The Government’s announced focus in the Economic Action Plan is on supporting job creation and growth. The focal point of this strategy is the Canada Job Grant, scheduled to be implemented in March 2014 upon the expiry of the existing Labour Market Agreements in place between the Government of Canada and the provinces and territories. The Canada Job Grant will provide up to $15,000 per individual for short-duration, directed skill training programs at eligible institutions to meet the skills required by Canadian employers. The grant would be comprised of up to $5,000 provided by the federal government, with matching amounts provided by the province and employer. The Canada Job Grant is expected to provide 130,000 Canadians each year with access to the training they need to take gainful employment or improve their skills for in-demand jobs.
Recognizing the looming shortage of skilled tradespeople in Canada, the Government of Canada announced its intention to work with the provinces and territories to harmonize the requirements for apprentices in targeted skilled trades to allow for the completion of training and to encourage mobility. Federal procurement practices will also be changed to support the use of apprentices in federal construction and maintenance contracts.
Other targeted job opportunity initiatives are planned for persons with disabilities, youth, aboriginal peoples, and new immigrants.
Corporate Groups
In past budgets and economic action plans, the Department of Finance had announced that it was exploring whether new rules for the taxation of corporate groups – such as the introduction of a formal system of loss transfers or consolidated reporting – could improve the functioning of the corporate tax system in Canada. In the 2013 Economic Action Plan, the Department of Finance stated that it has concluded its study and that will not be proceeding to allow consolidated corporate tax filings. Going forward, the Government intends to work with provinces and territories regarding their concerns about the uncertainty of the cost associated with the current approach to loss utilization within related corporate groups.
Owner-Managed Businesses
In recognition of the importance of small business owners, farmers and fishermen, the Economic Action Plan proposes to increase the Lifetime Capital Gains Exemption (“LCGE”) to $800,000 from $750,000. This new limit will apply to dispositions beginning in 2014 of qualified small business corporation shares, and qualified farm and qualified fishing property. The new $800,000 limit will be indexed for inflation beginning in 2015. The LCGE was $500,000 from 1998 until 2007 when it was increased to $750,000. Details of how this change is to be implemented have yet to be announced, but individuals considering selling qualified small business corporation shares, and qualified farm and qualified fishing property for a purchase price in excess of $750,000 may consider deferring receipt of a portion of their sale proceeds until 2014 to take advantage of the increased limit.
Planning Point – Consider deferring portion of sale proceeds to 2014 to benefit from increased capital gains exemption limit.
Assuming there are no changes to the tax rates, the value of this increased capital gains exemption limit to an individual subject to the highest marginal tax rate is:
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Province
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New Brunswick
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Newfoundland and Labrador
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Nova Scotia
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Prince Edward Island
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Tax Savings on Increase Exemption
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$10,825
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$10,575
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$12,500
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$11,845
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The other significant change announced affecting business owners is a change to the income inclusion for ineligible dividends (typically dividends paid by corporations from profits subject to the low corporate tax rate) and the corresponding dividend tax credit. Currently, a recipient of an ineligible dividend is required to include 125% of the dividend in income and is able to claim a dividend tax credit (which reduces tax payable) of ⅔ of the 25% “gross-up” amount as well as a provincial dividend tax credit, the amount of which varies by province. The dividend tax credit system is designed to reduce the effective tax rate of dividends compared to other sources of income to reflect the fact that the corporation paying the dividend was subject to tax on the income earned to pay the dividend. Reductions in the corporate tax rate which have been implemented have affected this integration. As a result, the Economic Action Plan proposes to decrease the “gross-up” on dividend income from 25% to 18% and decrease the dividend tax credit from ⅔ of the current “gross-up” to 13/18 of the revised “gross-up.”
The net effect of this change is to increase the effective federal tax rate on ineligible dividends. The following chart illustrates the new effective federal tax rate on ineligible dividends for 2014 assuming no changes to federal tax rates for 2014:
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Federal Tax Bracket
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2013 Effective Rate – Ineligible Dividend
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2014 Effective Rate – Ineligible Dividend
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15% (To $42,707)
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2.1%
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4.7%
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22% (To $85,414)
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10.8%
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13.0%
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26% (To $132,406)
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15.8%
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17.7%
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29% (Over $132,406)
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19.6%
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21.2%
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This change will take effect for ineligible dividends paid after 2013. Therefore, consideration should be given to paying additional ineligible dividends during 2013 to avoid the higher rate which will be applicable beginning in 2014.
Planning Point – Consider paying additional ineligible dividends during 2013 to avoid increased tax rate beginning in 2014.
Other measures announced in the Economic Action Plan directly affecting owner managed businesses include:
- Continuing efforts to reduce red tape by instituting a pre-approval process for SR&ED claims by small businesses, increasing the use of the CRA Business Number for other governmental programs, and accelerating the approval process for the authorization of representatives of a small business to deal with the CRA.
- Extending for one year the temporary hiring credit for small business, which provides a $1,000 credit towards EI premiums paid where 2013 premiums exceed 2012 premiums. The CRA automatically applies this credit, so no specific claim or application is required.
Manufacturing & Processing
The manufacturing and processing sector is a key focus of the Economic Action Plan. The only specific tax incentive announced is an extension of the temporary accelerated capital cost allowance for new investment in machinery and equipment in the manufacturing and processing sector for an additional two years. Currently scheduled to expire at the end of 2013, the 50 per cent straight line depreciation rate will be extended for two years to include investment in eligible manufacturing or processing machinery and equipment in 2014 and 2015. By allowing a faster write-off of eligible investments, this measure provides concrete support to businesses in the manufacturing and processing sector to help them retool with new machinery and equipment to remain competitive in the current global environment.
For example, a manufacturer that purchases an eligible machine for $10,000 is able to deduct $2,500 in the first taxation year (because of the half-year rule, which requires that the asset be treated as if purchased in the middle of the taxation year), $5,000 in the second taxation year, and the remaining $2,500 in the third taxation year. In the absence of the temporary accelerated capital cost allowance, the machine would be depreciated at a 30-per-cent declining-balance rate, resulting in lower annual deductions from income over a much longer period of time (i.e., the depreciation period would be nine taxation years to deduct 95 per cent of the value of the machine).
Significant targeted investment was announced for manufacturers located in Southern Ontario. More broadly based, the Economic Action Plan announced that procurement procedures will be amended to ensure that equipment built for the Canadian Armed Forces will be built in Canada wherever possible.
Innovation
The Economic Action Plan contains no tax measures specifically targeted at innovation, other than $20M being invested over two years at the Canada Revenue Agency to improve the predictability and enhance enforcement of the Scientific Research and Experimental Development tax incentive program.
Instead, the Economic Action Plan contains several specific investments in innovation through investment in research partnerships with industry, genomics research through Genome Canada, and $225M to be used by the Canada Foundation for Innovation to support advanced research infrastructure priorities. The National Research Council is to receive additional funding to help the growth of innovative businesses in Canada, $20M is to be spent over three years to help small and medium-sized enterprises access research and business development services at universities, colleges and other non-profit research institutions of their choice.
The additional focus of the Economic Action Plan is to enhance Canada’s venture capital system. Specific initiatives announced are:
- $60M over five years to help outstanding and high-potential incubator and accelerator organizations expand their services to entrepreneurs.
- $100M through the Business Development Bank of Canada to invest in firms graduating from business accelerators.
- Promoting an entrepreneurial culture in Canada through new Entrepreneurship Awards.
- $18M over two years to the Canadian Youth Business Foundation to help young entrepreneurs grow their firms.
In a surprising move, the Economic Action Plan announced the phase out of labour-sponsored venture capital corporation tax credit by 2017 and further announced that no new registrations of labour-sponsored venture capital corporations would be permitted.
Overruling the Courts
The Economic Action Plan announced specific amendments to the Income Tax Act to overrule court decisions which the Department of Finance considers not to be in accordance with intended tax policy. Specifically:
- Where a beneficiary transfers property to a trust for fair market value consideration, attribution of income and capital gains arising from that property to the transferor will apply. This overrides the decision in The Queen v. Sommerer, 2012 FCA 207.
- The test for whether restricted farm losses may be claimed as a deduction against other sources of income will revert to the “chief source of income” test rather than a significant emphasis test. This overrides the decision in The Queen v. Craig, 2012 SCC 43, and restores the Moldowan test for the deduction of restricted farm losses.
Tax Integrity
The Economic Action Plan announced specific amendments to the Income Tax Act targeted at eliminating specific tax plans which the Department of Finance considers abusive. Included are:
- Synthetic Dispositions – If a taxpayer economically disposes of a property while continuing to own it for income tax purposes through loan arrangements, a forward sale, or put-call arrangements then under rules proposed by the Economic Action Plan, the taxpayer is deemed to have disposed of the property for proceeds equal to its fair market value. The taxpayer will also be deemed to have reacquired the property immediately after the deemed disposition at a cost equal to that fair market value. The deemed disposition and reacquisition will not have tax consequences for other parties involved in the synthetic disposition transaction.
- Character Conversion Transactions – If a taxpayer enters into an arrangement converting, through the use of derivative contracts, the returns on an investment that would have the character of ordinary income to capital gains then the return is considered as being distinct from the disposition of the derivative contract. This measure will apply to derivative forward agreements that have a duration of more than 180 days.
- Loss Trading (Part I) – The loss streaming rules currently applicable to corporation which eliminates the use of capital losses and limits the use of non-capital losses to the same or substantially similar business after an acquisition of control will be extended to trusts.
- Loss Trading (Part II) – Transactions involving the transfer of income producing property by an arm’s length person to a corporation which has accumulated losses in exchange for non-voting shares in an effort to avoid an acquisition of control and subsequently using the loss pools of the transferee corporation prior to actually acquiring control of the corporation. The Income Tax Act will be amended to deem there to have been an acquisition of control of a corporation that has loss pools when a person (or group of persons) acquires shares of the corporation that have more than 75% of the fair market value of all the shares of the corporation without otherwise acquiring control of the corporation.
- Thin Capitalization – An interest expense deduction is denied to a corporation to a related non-resident party if the debt to equity ratio exceeds 1.5:1. This measure is extended under the Economic Action Plan to trusts, partnerships and branches of a non-resident corporation.
- Scientific Research & Experimental Development – More detailed information will now be required to be provided on SR&ED program claim forms about SR&ED program tax preparers and billing arrangements. Failure to comply will result in a penalty of $1,000 being imposed on a joint and several basis.
- Leveraged Life Insurance Annuity Arrangements – A leveraged insured annuity involves the use of borrowed funds in connection with a lifetime annuity and a life insurance policy, both of which are issued on the life of an individual to reduce capital gains tax payable on death and to provide for tax-free growth within the insurance policy while obtaining a current interest deduction. Under the new rules announced in the Economic Action Plan, income accruing in such a life insurance policy will be subject to annual accrual-based taxation, no deduction will be allowed for any portion of a premium paid on the policy, and the capital dividend account of a private corporation will not be increased by the death benefit received in respect of the policy.
- 10/8 Arrangements – A 10/8 arrangement involves investing in a life insurance policy with a view to borrowing against that investment for the purpose of creating an annual interest-expense tax deduction for a long period of time. Under the new rules announced in the Economic Action Plan, if a life insurance policy, or an investment account under the policy, is assigned as security on a borrowing, and either the interest rate payable on an investment account under the policy is determined by reference to the interest rate payable on the borrowing or the maximum value of an investment account under the policy is determined by reference to the amount of the borrowing, then the deduction of interest and the life insurance premium will be denied and no addition to the capital dividend account will be permitted upon death.
In its ongoing battle against charitable donation tax shelters, the following changes were announced in the Economic Action Plan:
- Extension of the normal reassessment period in respect of a participant in a tax shelter or reportable transaction where an information return that is required for the tax shelter or reportable transaction is not filed on time. In particular, the normal reassessment period in respect of the tax shelter or reportable transaction will be extended to three years after the date that the relevant information return is filed.
- The Canada Revenue Agency is now permitted to collect 50% of the disputed tax, interest or penalties where an assessment or reassessment from the disallowance of a deduction or tax credit claimed in respect of a tax shelter while the issue is under dispute (either through an objection or further appeal).
Finally, the Economic Action Plan announced that the CRA will launch the Stop International Tax Evasion Program under which it will pay rewards to individuals with knowledge of major international tax non-compliance when they provide information to the CRA that leads to the collection of outstanding taxes due. The CRA will enter into a contract that will pay an individual only if the information results in total additional assessments or reassessments exceeding $100,000 in federal tax. The contract will provide for payment of up to 15 per cent of the federal tax collected (i.e., not including penalties, interest and provincial taxes). Payments will be made only after the taxes have been collected. Awards will be paid only where the non-compliant activity involves foreign property or property located or transferred outside Canada, or transactions conducted partially or entirely outside Canada.
Personal Tax Measures
The Economic Action Plan proposes some interesting changes in the area of personal taxation. Most significant is the statement that the Government is going to consult on possible measures to eliminate the tax benefits that arise from the graduated tax rates available to testamentary trusts and grandfathered (from pre-1971) inter vivos trusts. The ability to split income with a testamentary trust is a valuable planning tool to enhance the after-tax rate of return for the heirs of a deceased individual on the inheritance they receive. The use of testamentary trusts also provides valuable asset protection and can help minimize the claw-back of old-age security payments. The Government intends to release a consultation paper to provide stakeholders with an opportunity to comment on possible measures. This will certainly be something to watch for in the coming months.
As has become custom for the current government, also announced are several targeted enhancements to the personal tax credit regime. First-time charitable donors will have a temporary First-time Donor’s Super Credit (“FDSC”) available. The FDSC will provide qualifying donors an additional 25% tax credit for a first-time donor on up to $1,000 of donations. Only donations of money will qualify for the FDSC.
Planning Point – For first-time donors, consider carrying forward donations for multiple years to maximize use of the FDSC.
With respect to adoptions, the adoption period for the Adoption Expense Tax Credit is extended to begin prior to the matching of an adoptive parent to a child. It will instead commence at the time that an adoptive parent makes an application to register with a provincial ministry responsible for adoption or with an adoption agency licensed by a provincial government or, if an adoption-related application is made to a Canadian court at an earlier time, that earlier time.
Finally, the Economic Action Plan proposes to permanently eliminate all tariffs on baby clothes and sports and athletic equipment (excluding bicycles). The intention is that by lowering the cost of importing theses goods, this measure will support Canadian families and encourage physical activity and healthy living.
One negative change to the personal tax regime is the elimination of the safety-deposit box as a deductible expense.
The way individuals report foreign investments is changing. Starting for taxation year 2013, Form T1135 will be revised to require more detailed information including the name of the specific foreign institution or other entity holding funds outside of Canada, the specific country to which the property relates, and the foreign income generated from the property. The normal reassessment period for a taxation year of a taxpayer will be extended by three years if the taxpayer has failed to report income from a specified foreign property on their annual income tax return and Form T1135 was not filed on time by the taxpayer, or a specified foreign property was not identified, or was improperly identified on Form T1135.
Changes to the personal tax regime previously announced by the Government as forthcoming upon the balancing of the budget were not included this year. These are expected upon the balancing of the budget in 2015-2016. Specifically, the annual contribution limit of tax-free savings accounts has not changed in 2013 (aside from indexing), but the Government has previously indicated that the annual limit will be doubled upon the balancing of the budget. As well, it was proposed in the election platform of the Conservative Party for the 2011 federal election that income-splitting would be permitted for ordinary income (such as employment income) between spouses and common-law partners. This was not proposed this year but it is something we may see also in 2015 – 2016 once the budget is balanced.
GST Proposals
There are some modest changes to the GST/HST system included in the Economic Action Plan. In the health care arena, it has been proposed to expand the GST/HST exemption for homemaker services to exempt publicly subsidized or funded personal care services, such as bathing, feeding, and assistance with dressing and taking medication, rendered to an individual who, due to age, infirmity or disability, requires assistance in his or her home.
With respect to pensions, Budget 2013 proposes that an employer participating in a registered pension plan be permitted to jointly elect with a pension trust or corporation of that pension plan to treat an actual taxable supply by the employer to the pension trust or corporation as being for no consideration where the employer accounts for and remits tax on the deemed taxable supply. This measure will simplify compliance for employers as they would not have to account for tax on the actual taxable supply and would not have to make a subsequent tax adjustment to net tax. Employers participating in a registered pension plan will be permitted to be fully or partially relieved from accounting for tax on deemed taxable supplies where the employer’s pension plan-related activities fall below $5,000 and 10% of the total net GST (and the federal component of the HST) paid by all pension entities of the pension plan in that preceding fiscal year.
Please contact your McInnes Cooper lawyer or any lawyer in our McInnes Cooper Tax Team for discussion regarding this Tax Brief or any other tax matter.
McInnes Cooper has prepared this document for information only; it is not intended to be legal advice. You should consult McInnes Cooper about your unique circumstances before acting on this information. McInnes Cooper excludes all liability for anything contained in this document and any use you make of it.
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