Business Income Tax Small Business Tax Rate The small business deduction currently reduces to 11 per cent the federal corporate income tax rate applying to the first $500,000 per year of qualifying active business income of a Canadian-controlled private corporation (CCPC). There is a requirement to allocate the annual eligible income limit of $500,000 among associated corporations. Access to the small business deduction is phased out on a straight-line basis for CCPCs having between $10 million and $15 million of taxable capital employed in Canada. To compensate a taxable individual receiving dividends for corporate income taxes that are presumed to have been paid on the corporate income that funded those dividends, the tax rules provide a dividend tax credit (DTC). The DTC is generally meant to ensure that income earned by a corporation and paid out to an individual as a dividend will be subject to the same amount of tax as income earned directly by the individual. To further reduce taxes paid by small businesses, Budget 2015 proposes a twopercentage-point decrease in the 11-per-cent small business tax rate. The reduction will be implemented as follows: effective January 1, 2016, the rate will be reduced to 10.5 per cent; effective January 1, 2017, the rate will be reduced to 10 per cent; effective January 1, 2018, the rate will be reduced to 9.5 per cent; and effective January 1, 2019, the rate will be reduced to 9 per cent. The reduction in the small business rate will be pro-rated for corporations with taxation years that do not coincide with the calendar year. E C O N O M I C A C T I O N P L A N 2 0 1 5 457
Annex 5 In conjunction with the proposed reduction in the small business tax rate, Budget 2015 also proposes to adjust the gross-up factor and DTC rate applicable to noneligible dividends (generally dividends distributed from corporate income taxed at the small business tax rate). Specifically, Budget 2015 proposes to adjust the gross-up factor applicable to non-eligible dividends from 18 per cent to 17 per cent effective January 1, 2016, 16 per cent effective January 1, 2018 and 15 per cent effective January 1, 2019. The corresponding DTC rate will also be adjusted, moving from 13/18 to 21/29 of the gross-up amount effective January 1, 2016, 20/29 of the grossup amount effective January 1, 2017, and 9/13 of the gross-up amount effective January 1, 2019. Expressed as a percentage of the grossed-up amount of a non-eligible dividend, the effective rate of the DTC in respect of such a dividend will be 10.5 per cent in 2016, 10 per cent in 2017, 9.5 per cent in 2018 and 9 per cent after 2018, in line with the proposed reductions in the small business tax rate. Table A5.3 Small Business Tax Rate Reduction and DTC Adjustment for Non-Eligible Dividends 2015 2016 2017 2018 As of 2019 Small business tax rate (%) 11 10.5 10 9.5 9 Gross-up (%) 18 17 17 16 15 DTC (%) 11 10.5 10 9.5 9 Manufacturing and Processing Machinery and Equipment: Accelerated Capital Cost Allowance Machinery and equipment acquired by a taxpayer, after March 18, 2007 and before 2016 primarily for use in Canada for the manufacturing or processing of goods for sale or lease, qualifies for a temporary accelerated capital cost allowance (CCA) rate of 50 per cent calculated on a straight-line basis under Class 29 of Schedule II to the Income Tax Regulations. These assets would otherwise be included in Class 43 and qualify for a CCA rate of 30 per cent calculated on a declining-balance basis. Budget 2015 proposes to provide an accelerated CCA rate of 50 per cent on a declining-balance basis for machinery and equipment acquired by a taxpayer after 2015 and before 2026 primarily for use in Canada for the manufacturing and processing of goods for sale or lease. Eligible assets are those that would currently be included in Class 29. These assets will be included in new CCA Class 53. 458 E C O N O M I C A C T I O N P L A N 2 0 1 5
The half-year rule, which allows half the CCA deduction otherwise available in the taxation year in which an asset is first available for use by a taxpayer, will apply to machinery and equipment eligible for this measure. These assets will be considered qualified property for the purpose of the Atlantic Investment Tax Credit. Eligible assets acquired in 2026 and subsequent years will qualify for the 30-per-cent declining-balance rate under Class 43. Agricultural Cooperatives: Deferral of Tax on Patronage Dividends Paid in Shares Agricultural cooperative corporations play an important role in rural communities. To support the capitalization of these cooperatives, Budget 2005 introduced a temporary measure to provide a tax deferral that applies to patronage dividends paid to members by an eligible agricultural cooperative in the form of eligible shares. To be eligible for this tax deferral, a share must be issued after 2005 and before 2016. Absent the tax deferral, a patronage dividend paid in shares would be taxable to the member in the year received. The cooperative paying the dividend would also be required to withhold an amount from the dividend and remit it to the Canada Revenue Agency on account of the recipient s tax liability. Prior to the introduction of the deferral, a portion of the dividend was typically paid in cash in order to fund the member s tax liability. This cash portion could represent a significant outlay of capital for the agricultural cooperative. The tax deferral measure allows eligible members of eligible agricultural cooperatives to defer the inclusion in income of all or a portion of any patronage dividend received as an eligible share until the disposition (or deemed disposition) of the share. Further, when an eligible agricultural cooperative issues an eligible share as a patronage dividend, there is no withholding obligation in respect of the patronage dividend. Instead, there is a withholding obligation when the share is redeemed. An eligible share must not, except in the case of death, disability or ceasing to be a member, be redeemable or retractable within five years of its issue. Budget 2015 proposes to extend this measure to apply in respect of eligible shares issued before 2021. E C O N O M I C A C T I O N P L A N 2 0 1 5 459
Annex 5 Quarterly Remitter Category for New Employers Employers are required to remit source deductions to the Government in respect of employees income tax, as well as the employer and employee portions of Canada Pension Plan contributions and Employment Insurance premiums (collectively, withholdings ). These withholdings must be remitted on a weekly, twice-monthly, monthly or quarterly basis. An employer s remittance frequency is determined on the basis of its average monthly withholding amount in preceding calendar years. New employers must currently remit on a monthly basis for at least one year, after which time they may be eligible to apply for quarterly remitting if they have an average monthly withholding amount of less than $3,000 and have demonstrated a perfect compliance record over the preceding 12 months. To reduce the tax compliance burden, Budget 2015 proposes to decrease the required frequency of remittances for the smallest new employers by allowing eligible employers to immediately remit on a quarterly basis. Eligible employers will be new employers with withholdings of less than $1,000 in respect of each month. This amount corresponds to the withholdings related to one employee at a salary of up to $43,500, depending on the province of residence. Eligibility for quarterly remitting will depend on the employer maintaining a perfect compliance record in respect of its Canadian tax obligations. Employers will remain eligible for quarterly remitting, as provided under this measure, provided that their required monthly withholding amount remains under $1,000. If withholdings rise above that level, then the Canada Revenue Agency will classify an employer as a weekly, twice-monthly, monthly or quarterly remitter in accordance with the existing remittance rules. This measure will apply in respect of withholding obligations that arise after 2015. 460 E C O N O M I C A C T I O N P L A N 2 0 1 5
Synthetic Equity Arrangements The Income Tax Act permits a corporation to deduct, subject to certain exceptions, taxable dividends received in computing its taxable income. This inter-corporate dividend deduction is intended to limit the imposition of multiple levels of corporate taxation on earnings distributed from one corporation to another. The existing dividend rental arrangement rules are intended to deny the intercorporate dividend deduction to a shareholder where the main reason for an arrangement is to enable the shareholder to receive a dividend on a share and the economic exposure (expressed as a taxpayer s risk of loss or opportunity for gain or profit) to the share accrues to someone else. Certain taxpayers, typically financial institutions, enter into particular financial arrangements (synthetic equity arrangements) where the taxpayer retains the legal ownership of an underlying Canadian share, but all or substantially all of the risk of loss and opportunity for gain or profit in respect of the Canadian share is transferred to a counterparty using an equity derivative. Some taxpayers take the position that the existing dividend rental arrangement rules do not apply to these arrangements and claim an inter-corporate dividend deduction on the dividends received on the underlying Canadian share. A taxpayer that enters into a synthetic equity arrangement in respect of a share is generally required to transfer the economic benefit of any dividends received through dividend-equivalent payments to the counterparty. On the premise that the dividend rental arrangement rules do not apply, the taxpayer realizes a tax loss on the arrangement by taking advantage of the inter-corporate dividend deduction, resulting in tax-free dividend income, while also deducting the amount of the dividend-equivalent payments. Synthetic equity arrangements entered into with certain investors that do not pay any Canadian income tax on the dividend-equivalent payments received namely, tax-exempt Canadian entities and non-resident persons (collectively, tax-indifferent investors ) have the potential to significantly erode the Canadian tax base. Depending on the particular facts, synthetic equity arrangements can be challenged by the Government based on existing rules in the Income Tax Act. However, as any such challenge could be both time-consuming and costly, the Government is introducing specific legislative measures to ensure that the appropriate tax consequences apply to these arrangements. E C O N O M I C A C T I O N P L A N 2 0 1 5 461
Annex 5 To protect the Canadian tax base, Budget 2015 proposes to modify the dividend rental arrangement rules to deny the inter-corporate dividend deduction on dividends received by a taxpayer on a Canadian share in respect of which there is a synthetic equity arrangement. A synthetic equity arrangement, in respect of a share owned by a taxpayer, will be considered to exist where the taxpayer (or a person that does not deal at arm s length with the taxpayer) enters into one or more agreements that have the effect of providing to a counterparty all or substantially all of the risk of loss and opportunity for gain or profit in respect of the share. Where a person that does not deal at arm s length with the taxpayer enters into such an agreement, a synthetic equity arrangement will be considered to exist if it is reasonable to conclude that the non-arm s length person knew, or ought to have known, that the effect described above would result. In general terms, an exception to the proposed dividend rental arrangement rule will be provided where a 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 the share by virtue of a synthetic equity arrangement or another equity derivative that is entered into in connection with the synthetic equity arrangement. For this purpose, a taxpayer will be presumed to qualify for this exception if it obtains representations from its counterparty to the synthetic equity arrangement that the counterparty is not a tax-indifferent investor and either: does not reasonably expect to eliminate all or substantially all of its risk of loss and opportunity for gain or profit in respect of the share; or has transferred all or substantially all of its risk of loss and opportunity for gain or profit in respect of the share to its own counterparty and has obtained the representations described above from that counterparty. If the representations are later determined to be inaccurate, the arrangement will be treated as a dividend rental arrangement. This measure will not apply to agreements that are traded on a recognized derivatives exchange unless it can reasonably be considered that the taxpayer knows, or ought to know, the identity of the counterparty to the agreement. 462 E C O N O M I C A C T I O N P L A N 2 0 1 5
To support this measure, an anti-avoidance rule will deem certain agreements that do not meet the definition synthetic equity arrangement to be dividend rental arrangements. Specifically, agreements that have the effect of eliminating all or substantially all of the taxpayer s risk of loss and opportunity for gain or profit in respect of a share will be deemed to be a dividend rental arrangement if one of the purposes of the series of transactions that includes these agreements is to avoid the measure. This measure will apply to dividends that are paid or become payable after October 2015. Consultation From a tax policy perspective, a case can be made that a shareholder should always be required to bear the risk of loss and enjoy the opportunity for gain or profit on a Canadian share in order to take advantage of the inter-corporate dividend deduction on dividends received on that share. Accordingly, an alternative proposal could be supported that would deny the inter-corporate dividend deduction on dividends received by a taxpayer on a Canadian share in respect of which there is a synthetic equity arrangement, regardless of the tax status of the counterparty. Such a proposal would have a broader effect on the concerned taxpayers, but would eliminate some of the complexities of the measure described above. The Government invites stakeholders to submit comments by August 31, 2015 concerning whether the scope of the measure should be broadened as described above. Such a proposal, if adopted after the consultation, would not apply before the results of the consultation process are announced. Please send your comments to legislation-taxation@fin.gc.ca. Parties making a submission are asked to indicate whether they consent to have the submission posted on the Department of Finance website and, if so, the name of the individual or the organization which should be identified on the website as having made the submission. Submissions which are to be posted should preferably be provided electronically in PDF format or in plain text. The Department will not post submissions that do not clearly indicate consent to posting. E C O N O M I C A C T I O N P L A N 2 0 1 5 463
Annex 5 Tax Avoidance of Corporate Capital Gains (Section 55) The Income Tax Act contains an anti-avoidance rule that generally taxes as capital gains certain otherwise tax-deductible inter-corporate dividends. This rule typically applies where a corporation that is about to dispose of shares of another corporation receives from that other corporation tax-deductible dividends that in substance reflect the untaxed appreciation in the value of the other corporation. The taxdeductible dividends decrease the fair market value of the shares, or in some cases increase the cost of the shares, to the point where the unrealized capital gain on the shares is reduced. The anti-avoidance rule generally applies to a dividend where, among other things, one of the purposes of the dividend was to effect a significant reduction in the portion of the capital gain that, but for the dividend, would have been realized on a disposition of any share at its fair market value. Certain exceptions to the application of the anti-avoidance rule are provided. Notably, an exception is provided where the dividend can reasonably be attributed to after-tax earnings (called safe income on hand ), enabling a corporation to distribute such earnings as a tax-deductible inter-corporate dividend. Another exception allows for dividends received in certain related-party transactions. Where the anti-avoidance rule applies to the dividend received on a share, the dividend is treated as proceeds of disposition if a corporation has disposed of the share, or as a gain from a disposition of capital property where a corporation has not disposed of the share. As noted, the anti-avoidance rule currently applies where a dividend significantly reduces the capital gain on any share. However, the same tax policy concern arises where dividends are paid on a share not to reduce a capital gain on that share but instead to cause the fair market value of the share to fall below its cost or a significant increase in the total cost of properties. In that case, the shareholder could attempt to use the unrealized loss created by the payment of the dividend to shelter an accrued capital gain in respect of other property. 464 E C O N O M I C A C T I O N P L A N 2 0 1 5
Example Corporation A wholly owns Corporation B, which has one class of shares. These shares have a fair market value of $1 million and an adjusted cost base of $1 million. Corporation A contributes $1 million of cash to Corporation B in return for additional shares of the same class, with the result that Corporation A s shares of Corporation B have a fair market value of $2 million and an adjusted cost base of $2 million. If Corporation B uses its $1 million of cash to pay Corporation A a tax-deductible dividend of $1 million, the fair market value of Corporation A s shares of Corporation B is reduced to $1 million although their adjusted cost base remains at $2 million. At this point, Corporation A has an unrealized capital loss of $1 million on Corporation B s shares. If Corporation A transfers an asset having a fair market value and unrealized capital gain of $1 million to Corporation B on a tax-deferred basis, Corporation A could then sell its shares of Corporation B for $2 million and take the position that there is no gain because the adjusted cost base of those shares is also $2 million. A recent decision of the Tax Court of Canada held that the current anti-avoidance rule did not apply in a case where the effect of a dividend in kind (consisting of shares of another corporation) was to create an unrealized capital loss on shares. The unrealized loss was then used to avoid capital gains tax otherwise payable on the sale of another property. These transactions can have an effect identical to transactions that directly reduce a capital gain. Such transactions may be challenged by the Government under the existing general anti-avoidance rule. However, as any such challenge could be both time-consuming and costly, the Government is introducing specific legislative measures to ensure that the appropriate tax consequences apply. Budget 2015 proposes an amendment to ensure that the anti-avoidance rule applies where one of the purposes of a dividend is to effect a significant reduction in the fair market value of any share or a significant increase in the total cost of properties of the recipient of the dividend. Related rules are also proposed to ensure this amendment is not circumvented. For example, if a dividend is paid on a share of a corporation, and the value of the share is or becomes nominal, the dividend will be treated as having reduced the fair market value of the share. As well, changes will address the use of stock dividends (i.e., dividends that consist of additional shares of the same corporation) as a means of impairing the effectiveness of the anti-avoidance rule. E C O N O M I C A C T I O N P L A N 2 0 1 5 465
Annex 5 Budget 2015 proposes an amendment to ensure that any dividend to which the anti-avoidance rule applies is to be treated as a gain from the disposition of capital property. Budget 2015 also proposes that the exception for dividends received in certain related-party transactions be amended so that the exception will apply only to dividends that are received on shares of the capital stock of a corporation as a result of the corporation having redeemed, acquired or cancelled the shares. This measure will apply to dividends received by a corporation on or after Budget Day. Small Business Deduction: Consultation on Active versus Investment Business The small business deduction is available on up to $500,000 of active business income of a Canadian-controlled private corporation. The deduction is intended to enhance the deferral of income tax on active business income that is retained in a private corporation, therefore encouraging the reinvestment of after-tax income for further growth. Active business income does not include income from a specified investment business, which is generally a business the principal purpose of which is to derive income from property. A specified investment business does not include a business that has more than five full-time employees, with the result that income earned from such a business is eligible for the small business deduction even though its principal purpose is to derive income from property. Stakeholders have expressed concern as to the application of these rules in cases such as self-storage facilities and campgrounds. Budget 2015 announces a review of the circumstances in which income from a business, the principal purpose of which is to earn income from property, should qualify as active business income. The Government invites interested parties to submit comments by August 31, 2015. Please send your comments to business-entreprise@fin.gc.ca. 466 E C O N O M I C A C T I O N P L A N 2 0 1 5
Parties making a submission are asked to indicate whether they consent to have the submission posted on the Department of Finance website and, if so, the name of the individual or the organization which should be identified on the website as having made the submission. Submissions which are to be posted should preferably be provided electronically in PDF format or in plain text. The Department will not post submissions that do not clearly indicate consent to posting. Consultation on Eligible Capital Property To reduce the compliance burden for taxpayers, Budget 2014 announced a public consultation on the proposal to repeal the eligible capital property regime and replace it with a new capital cost allowance class. The Government has heard from a number of stakeholders and continues to receive submissions on the proposal. All representations will be considered in the development of the rules relating to the new capital cost allowance class as well as the transitional rules. It is the intention of the Government to release detailed draft legislative proposals for stakeholder comment before their inclusion in a bill.