THE MARCH 29, 2012 FEDERAL BUDGET This issue of the Legal Business Report provides current information to the clients of Alpert Law Firm on the March 29, 2012 Federal Budget. Although these proposals are likely to be implemented in their present form, these provisions are not yet law and the final legislation should be reviewed before initiating any transaction. It is important to note that this Legal Business Report only contains Budget highlights, and the 2012 Federal Budget should be consulted for the full list of tax implications arising from the Federal Budget. Alpert Law Firm is experienced in providing legal services to its clients in tax and estate planning matters, wealth preservation, tax dispute resolution, tax litigation, corporate-commercial transactions and estate administration. Howard Alpert has been certified by the Law Society as a Specialist in Estates and Trusts Law, and also as a Specialist in Corporate and Commercial Law. A. MEASURES AFFECTING INDIVIDUALS 1. Personal Income Tax Rates The 2012 Federal Budget proposes no changes to personal income tax rates. As a result, the top personal marginal tax rates (i.e., rates of tax which apply to taxable income above $132,406 but below $500,000) for an Ontario resident will remain unchanged. The top combined federal and provincial rates of tax are as follows: Personal Tax Rates 2012 Ordinary Income 46.41% Eligible Dividends 29.54% Non-eligible Dividends 32.57% Capital Gains 23.20% Due to an implementation of a surtax of 2% on individuals in Ontario with incomes over $500,000, a higher tax rate will take effect after July 1, 2012, and a further increase of the tax rate will apply after January 1, 2013. The top combined federal and provincial rates of tax for individuals in Ontario with incomes over $500,000 are as follows: LEGAL BUSINESS REPORT / JUNE 2012 1
Top Personal Tax Rates July 1, 2012 Jan 1, 2013 Ordinary Income 47.97% 49.53% Eligible Dividends 31.69% 33.85% Non-eligible Dividends 34.52% 36.47% Capital Gains 23.98% 24.76% 2. Retirement Compensation Arrangements A Retirement Compensation Agreement ( RCA ) can be utilized by an executive or senior employee to provide funding for their retirement in excess of the maximum pension benefit permitted under the Registered Pension Plan contribution limits. Employer contributions to the RCA for the benefit of an employee upon his retirement are fully deductible by the employer in the year they are made. However, under Part XI.3 of the Income Tax Act ( ITA ), a refundable tax at a rate of 50% is imposed on contributions made to the RCA, as well as on any income or gains realized by an RCA. The tax imposed on an RCA is generally refunded when distributions are made from an RCA to the employee who benefits from this arrangement. The Budget proposes new prohibited investment and advantage rules to prevent a RCA from engaging in nonarm s length transactions, as well as a new restriction on RCA tax refunds. (i) Prohibited Investments Where the beneficiary of an RCA is a specified beneficiary, defined as an employee who has a significant interest in his employer, the custodian of the RCA will be liable to pay a 50% tax on the fair market value of any prohibited investments acquired or held by the RCA. Prohibited investments include any debts of and investments in entities in which the RCA beneficiary has a 10% or greater interest. The Budget also proposes to hold the RCA beneficiary jointly and severally liable for the payment of the 50% tax imposed on the RCA custodian where such a transaction has taken place. This tax will be refundable if the RCA disposes of the prohibited investment by the end of the year following the year in which it was acquired (or such later time as the Minister of National Revenue considers reasonable) unless the persons liable for the tax knew or ought to have known that it was a prohibited investment. The Minister will also have the power to waive or cancel the tax where the Minister is satisfied that it is just and equitable to do so, having regard to all the circumstances. The new rules will apply to investments which are acquired, or become prohibited, after March 28, 2012. LEGAL BUSINESS REPORT / JUNE 2012 2
(ii) Advantages The Budget proposes to revise the definition of advantage in order to address specific forms of tax planning that individuals have engaged in with regards to RCAs. For instance, an RCA strip transaction, where an RCA buys high-value property and then intentionally erodes or transfers the value from the RCA without adequate consideration, will constitute an advantage and be subject to the existing advantage rules. An RCA advantage will be subject to a special tax equivalent to the fair market value of the advantage. The new rules will apply to advantages extended, received or receivable after March 28, 2012. (iii) Restriction on RCA Tax Refunds The Budget proposes that, if RCA property has declined in value, the RCA tax will only be refunded where the decline in value is not reasonably attributable to prohibited investments or advantages. This measure will apply to RCA contributions made after March 28, 2012. 3. Employees Profit Sharing Plans Employees Profit Sharing Plans ( EPSPs ) are trust arrangements that enable employers to share profits with employees. Generally, employer contributions to the plan are fully deductible. However, amounts received by the trust are taxable as though they were earned directly by the employees, regardless of whether or not they have been distributed to the employees. Although EPSPs do not allow employees to defer their income, it does permit employees to engage in income splitting strategies in order to reduce the payment of taxes. The Budget proposes to impose a special tax payable by a specified employee, who is defined as an individual with a significant equity interest in his employer, on an excess EPSP amount. Generally, an excess EPSP amount is the portion of an employer s EPSP contribution that exceeds 20% of the specified employee s salary from the employer. The special tax will be equal to the top federal marginal tax rate of 29% and the top marginal tax rate of the province of residence of the specified employee. This measure will apply to EPSP contributions made by the employer after March 28, 2012. LEGAL BUSINESS REPORT / JUNE 2012 3
4. Group Sickness or Accident Insurance Plans The Budget proposes to include the amount of an employer s contributions to a group sickness or accident insurance plan in an employee s income for the year in which the contributions are made to the extent that the contributions are not in respect of a wage-loss replacement benefit payable on a periodic basis. This measure will apply in respect of employer contributions made on or after Budget Day to the extent that the contributions relate to coverage after 2012, except that such contributions made on or after Budget Day and before 2013 will be included in the employee s income for 2013. 5. Eligible Dividends Split Dividend Designation and Late Designation In order to prevent dividends from being subject to taxation at the corporate level and then again at the personal shareholder level, the ITA credits individuals through the Dividend Tax Credit ( DTC ). Eligible dividends, where the dividends are paid out of retained earnings arising from income that was taxed at the general corporate income tax rate, entitle the shareholder to an enhanced DTC. The current rules stipulate that an enhanced DTC is available only if, at the time the dividend is paid, the corporation notifies each shareholder in writing that the dividend is designated as an eligible dividend. In order to simplify the process, the Budget proposes to allow a Canadian corporation to designate, at the time it pays a taxable dividend, any portion of the dividend to be an eligible dividend. The Budget also proposes to allow a late designation of a taxable dividend to be an eligible dividend if: (i) it is made within a 3 year period following the day on which the designation was first required to be made; and (ii) the Minister believes that accepting the late designation would be just and equitable in the circumstances. These measures will apply to taxable dividends paid on or after March 28, 2012. 6. Overseas Employment Tax Credit Currently, Canadian resident employees who qualify for the Overseas Employment Tax Credit ( OETC ) are entitled to a tax credit equal to the federal income tax otherwise payable on 80% of their qualifying foreign employment income, up to a maximum of $100,000. The Budget proposes to phase out the OETC over four years, whereby the factor applied to an employee s qualifying foreign employment income in determining the employee s OETC (currently 80%) will be reduced to 60% for 2013, 40% for 2014, 20% for 2015 and 0% for 2016 and subsequent taxation years. LEGAL BUSINESS REPORT / JUNE 2012 4
7. Old Age Security Eligibility Beginning April 2023, the age eligibility for Old Age Security and the Guaranteed Income Supplement will increase from 65 to 67. However, this change will not affect individuals who are 54 or older on March 31, 2012. 8. Registered Disability Savings Plans The Budget proposes several changes to the rules governing Registered Disability Savings Plans ( RDSP ). These include changes to: (i) who may become a plan holder; (ii) repayment rules for government repayments; (iii) maximum and minimum withdrawals; (iv) rules governing transfer of funds from Registered Education Savings Plans to RDSPs; (v) termination of RDSPs; and (vi) administrative rules. 9. Life Insurance Policy Exemption Test The Budget proposes to simplify the test that determines whether a life insurance policy is an exempt policy. The proposed technical improvements will apply to life insurance policies issued after 2013. B. MEASURES AFFECTING BUSINESSES 1. Corporate Income Tax Rates The 2012 Federal Budget proposes no changes to the federal corporate income tax rates. The following tax rates apply to December 31 year ends: General and M&P Income 2011 16.5% 2012 15% 2013 15% Canadian-Controlled Private Corporations Active Business Investment Income Income up to $500,000 11% 34.67% LEGAL BUSINESS REPORT / JUNE 2012 5
2. Scientific Research and Experimental Development Programs (SR&ED) In order to encourage the private sector to invest in research and development, allowable current and capital expenditures under the SR&ED program were fully deductible and generated an investment tax credit. The following are the new tax measures that are proposed in the 2012 Budget for SR&ED expenses. (i) SR&ED Investment Tax Credit Rate The Budget proposes to reduce the general 20% tax credit rate applicable to SR&ED qualified expenditure pool balances at the end of a taxation year to 15% for taxation years that end after 2013. For a taxation year that includes January 1, 2014, the 5% reduction in the investment tax credit will be pro-rated accordingly. The 35% rate for Canadian-controlled private corporations will remain unchanged for up to $3 million of qualified SR&ED expenditures annually. (ii) SR&ED Capital Expenditures The Budget proposes to render expenditures of a capital nature not eligible for SR&ED deductions and investment tax credits. This change would also apply to payments made to use property that would constitute capital property if it was purchased by the taxpayer. This measure applies to property acquired, as well as the right to use property, after 2013. (iii) SR&ED Overhead Expenditures SR&ED overhead expenditures may be claimed through the use of either the traditional method or the proxy method. The traditional method involves identifying and expensing each overhead cost directly related to SR&ED activities. Previously, the proxy method allowed taxpayers to include in their SR&ED qualified expenditure pool 65% of total salaries or wages of employees directly engaged in the SR&ED projects. The Budget proposes to reduce the rate at which the prescribed proxy amount is calculated to 60% for 2013, and to 55% after 2013. (iv) SR&ED Contract Payments Previously, a taxpayer who contracted out SR&ED work to an arm s length party was entitled to SR&ED investment tax credits in respect of the entire contract payment. The Budget proposes to only allow 80% of the cost of an arm s length contract to be eligible for SR&ED investment tax credits. LEGAL BUSINESS REPORT / JUNE 2012 6
Consistent with the above-mentioned proposed changes to the SR&ED capital expenditures, the amount of an arm s length contract payment eligible for SR&ED tax incentives will also exclude any amount paid in respect of capital expenditures incurred by the arm s length party in the fulfillment of the contract. Additionally, the amount that the arm s length party is required to net against its qualifying SR&ED expenditures because of the contract payment will be reduced by the amount received in respect of capital expenditures. This change will apply to expenditures incurred after December 31, 2012. 3. Tax Avoidance Through Use of Partnerships Pursuant to section 88 of the ITA, a taxable Canadian corporation ( Parent ) that has acquired another taxable Canadian corporation ( Subsidiary ) may increase the cost of certain capital assets acquired by the Parent on a vertical amalgamation with, or winding-up of, the Subsidiary ( Section 88 Bump ). The Section 88 Bump applies only to non-depreciable capital assets, such as land, shares of a corporation or an interest in a partnership. The Budget proposes to deny a Section 88 Bump 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 applies to amalgamations that occur and winding ups that begin after March 28, 2012. Section 100 of the ITA was enacted to ensure that income assets held by a partnership are fully taxable on the sale of the partnership by a taxpayer to a tax-exempt person. The Budget proposes to extend the application of section 100 of the ITA to the sale of a partnership made directly, or indirectly as a part of a series of transactions, to a tax-exempt or non-resident person. This measure will generally apply to dispositions of partnership interests occurring after March 28, 2012. 4. Partnership Waivers Pursuant to subsection 152(1.4) of the ITA, the Canada Revenue Agency may make a determination of any income, loss, deduction or other amount in respect of the partnership within three years from the later of (i) the deadline for filing the relevant partnership information and; (ii) the day it is actually filed. The Budget proposes that a single designated partner of a partnership may be empowered to waive, on behalf of all its partners, the three-year time limit for making a determination. This measure applies on Royal Assent to the enacting legislation. LEGAL BUSINESS REPORT / JUNE 2012 7
5. Thin Capitalization Rules Thin capitalization rules limit the deductibility of interest expense of a Canadianresident corporation where the amount of debt owing to non-residents exceeds a 2-to-1 debt-to-equity ratio. These rules apply to debts owing to (i) a non-resident specified shareholder who holds more than 25% of the votes or value of the corporation; or (ii) any other non-resident who does not deal at arm s length with a specified shareholder. The Budget proposes the following changes to the thin capitalization rules: (a) reduce the debt-to-equity ratio to 1.5-to-1 for corporate taxation years that begin after 2012; (b) extend the rules to debts owed by partnerships of which a Canadian-resident corporation is a member in respect of debts of a partnership that are outstanding during corporate taxation years that begin after March 28, 2012; (c) re-characterize disallowed interest expense as a dividend for non-resident withholding tax purposes under Part XIII of the ITA for taxation years that end after March 28, 2012; and (d) for taxation years that end after March 28, 2012, exclude the interest expense where a controlled foreign affiliate of a Canadian-resident corporation lends money to the corporation and the interest is also included in the foreign accrual property income of the affiliate. 6. Clean Energy Generation Equipment Under the capital cost allowance ( CCA ) system, Class 43.2 provides an accelerated CCA rate for investment in specified clean energy generation and conservation equipment. The Budget proposes to further expand Class 43.2 to include the following assets, provided that they are acquired after March 28, 2012: (a) waste-fuelled thermal energy equipment that may be used in a broad range of applications, including space and water heating; (b) district energy system equipment that distributes thermal energy primarily generated by waste-fuelled thermal energy equipment; and (c) equipment that generates heat and electricity from the residue of plants. LEGAL BUSINESS REPORT / JUNE 2012 8
7. Hiring Credit for Small Business The temporary hiring credit introduced in the 2011 Budget, which was available to employers whose total employment insurance ( EI ) premiums were $10,000 or less, will be extended for one year. Consequently, up to $1,000 may be claimed against the employer s increase in its 2012 EI premiums over those paid in 2011. C. GST/HST AND EXCISE TAX MEASURES 1. GST/HST Health Care Exemptions and Zero-Rating Expanded The Budget proposes the following improvements to the application of the GST/HST in the health care sector: (a) GST/HST exemption for the non-dispensing health care services that pharmacists are authorized to provide in the course of their professional practice; (b) zero-rate corrective eyeglasses or contact lenses if they are supplied under the authority of an assessment record produced by a person who is entitled by law to produce the record authorizing dispensing of corrective eyewear; (c) addition of blood coagulation monitoring devices and associated test strips to the zero-rated medical device list, as well as zero-rate medical and assistive devices when they are supplied based on a written order of a medical practitioner; and (d) addition of the drug Isosorbide-5-mononitrate, used to treat congestive heart failure, to the list of zero-rated non-prescription drugs. These measures will generally apply to supplies purchased after March 29, 2012. 2. GST/HST Streamlined Accounting Thresholds In order to further simplify GST/HST compliance for small businesses and public services bodies (PSBs), the existing streamlined accounting thresholds will be doubled. Thus, the annual taxable sales threshold at or below which eligible businesses can elect to use the Quick Method will increase to $400,000 of GST/HST-included taxable sales. Additionally, the annual taxable sales and purchases thresholds at or below which eligible businesses or PSBs can elect to use the Streamlined Input Tax Credit Method LEGAL BUSINESS REPORT / JUNE 2012 9
will increase to $1,000,000 of taxable sales. The PSB Rebate Calculation Method threshold will also increase from $2,000,000 to $4,000,000 of annual taxable purchases. This measure will be effective in respect of a GST/HST reporting period of a person beginning after 2012. D. CUSTOMS TARIFF MEASURES 1. Trade Measures to Support the Energy Industry The Budget proposes to eliminate the 5% Most-Favoured-Nation rate of duty on certain imported oils used as production inputs in gas and oil refining as well as electricity production. This measure will be effective in respect of goods imported after March 29, 2012. 2. Travellers Exemptions The Budget proposes to increase the travellers exemption for Canadian residents out of the country for 24 hours or more to $200 for goods other than alcohol or tobacco. Similarly, the new $800 exemption threshold will replace the current 48-hour exemption of $400 and the current 7-day exemption of $750. These new exemption levels will be effective in respect of travellers returning to Canada after May 31, 2012. E. OTHER TAX MEASURES 1. Gifts to Foreign Charitable Organizations The Budget proposes to modify the rules for the registration of certain foreign charitable organizations as qualified donees. The Minister of Revenue, after a consultation with the Minister of Finance, will have the discretionary power to grant qualified donee status to a foreign charitable organization if it pursues activities (i) related to disaster relief or urgent humanitarian aid; or (ii) in the national interest of Canada. This measure will apply to applications made by foreign charitable organizations on or after the later of (i) January 1, 2013; and (ii) Royal Assent to the enacting legislation. LEGAL BUSINESS REPORT / JUNE 2012 10
2. Registered Charities In an effort to enhance transparency and accountability by charities, the Budget proposes the following measures: (a) to grant the CRA the authority to suspend the tax-receipting privileges of a charity that (i) exceeds the limitations on political activities; or (ii) provides inaccurate or incomplete information in its annual information return; (b) to characterize a gift as an expenditure made by the charity on political activities where it can reasonably be considered that the purpose of the gift is to support the political activities of a qualified donee; and (c) to encourage tax shelter registration and reporting by: (i) increasing existing penalties applicable to promoters when a person participates in an unregistered charitable donation tax shelter; and (ii) introducing a new penalty for a promoter who fails to meet their reporting obligations. These measures will apply on Royal Assent to the enacting legislation. This issue of the Legal Business Report is designed to provide information of a general nature only and is not intended to provide professional legal advice. The information contained in this Legal Business Report should not be acted upon without further consultation with professional advisers. Please contact Howard Alpert directly at (416) 923-0809 if you require assistance with tax and estate planning matters, tax dispute resolution, tax litigation, corporate-commercial transactions or estate administration. No part of this publication may be reproduced by any means without the prior written permission of Alpert Law Firm. 2012 Alpert Law Firm. All rights reserved. LEGAL BUSINESS REPORT / JUNE 2012 11