CALU SPECIAL REPORT MARCH 2016
MARCH 2016 CALU Special Report Budget 2016: Growing the Middle Class Introduction On March 22 Finance Minister Morneau tabled his first budget, which is framed as Growing the Middle Class. A number of Liberal election promises targeted at this key electoral group are included in this budget. But there is much more in terms of changes to tax rules (including significant changes to the tax rules governing corporate owned life insurance) as well as future plans to review key elements of the tax and social support systems. This CALU Special Report will summarize the policy frameworks and tax proposals of greatest importance to CALU members and your clients. We d also like to thank PwC LLP for allowing CALU to reproduce its commentary relating to the proposals for eligible capital property. The Fiscal Position The Liberal party had announced as part of its 2015 election platform that it was prepared to take the federal government into a deficit position of approximately $10 million in 2016/17 and 2017/18 to fund new infrastructure investments, with a view to helping Canada get out of its economic funk. The Liberal party also indicated that it planned to return to balanced budgets by fiscal year 2019/20. However, in late February the Finance Minister announced a revised two-year economic and fiscal picture that was significantly more pessimistic. This reforecast is due primarily to lower expectations of GDP growth in Canada, which in turn relates primarily to lower oil prices. The deficit was now estimated to balloon to over $18 billion in 2016/17, and marginally fall to $15.5 billion in 2017/18, which included a $6 billion contingency reserve. More startling is that these higher deficit projections did not take into account any new infrastructure programs. Nor was there any mention of returning to balanced budgets in the foreseeable future. With this lead up to the federal budget, the other shoe has now dropped. The Government has announced plans to make additional expenditures and investments that will total in excess of $50 billion over the next six fiscal years. This will take the deficit to approximately $30 billion in each of the next two fiscal years, reducing to an annual deficit of approximately $14 billion by 2020/21. At the same time, the Government remains committed to returning to balance budgets, and will do so in a reasonable, realistic and transparent way. Despite these deficits, the Government stated its intentions to reduce the federal debt-to-gdp ratio to a lower level over a five-year period. It is projected that by the end of the 2020/21 fiscal period, this ratio will be comparable to the current ratio of approximately 30%. To facilitate this plan, the Government is proposing to repeal the Federal Balanced Budget Act that was - 1 - CALU Special Report March 2016
Special Report enacted in 2015 by the previous Conservative government. The Government has also stated that it will eliminate poorly targeted and inefficient programs, wasteful spending, and ineffective and obsolete government initiatives. As a first step towards meeting this commitment, Budget 2016 indicates there will be annual reductions of approximately $220 million in a variety of government spending programs. Going forward, the Government plans to identify other changes and better align government spending with priorities. In addition, in the coming year, the Government plans to undertake a review of the tax system to determine whether it works well for Canadians, with a view to eliminating poorly targeted and inefficient tax measures. Budget 2016 sets out government measures that focus on the following key areas: 1. Strengthening and growing the middle class. 2. Creating a better future for indigenous peoples. 3. Supporting a clean growth economy. 4. Focusing on the quality of life for Canadians. 5. Enhancing Canada s world position. 6. Creating an open and transparent government. 7. Improving tax fairness and strengthening the financial sector. With that background, the following focuses on the key budget proposals that will most impact CALU members and your clients. Conference for Advanced Life Underwriting www.calu.com President Kevin Wark, LL.B, CLU, TEP Administrative Assistant Kirisha Mahandran Administrator, Membership & Accounting Jenna Mantle Communications Consultant Caroline Spivak, ICD.D Administrative Consultant Val Osborne Life Insurance Tax Measures Two Measures of Importance a) Capital Dividend Account and Life Insurance Proceeds As members are well aware, life insurance proceeds received as a result of the death of the life insured under a life insurance policy are generally not subject to income tax. As well, where a private corporation is the beneficiary of a life insurance policy, it may add the amount of the death benefit, less the policy s adjusted cost basis (ACB) to that corporation immediately before death, to its capital dividend account (CDA). A private corporation can elect to pay a dividend as a capital dividend to the extent that the corporation s CDA has a positive balance, and such dividends are generally received tax-free by shareholders. Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 2 -
The income tax rules for partnerships also provide that a death benefit under a life insurance policy will effectively be received tax-free. The adjusted cost base of a partner s interest in a partnership is increased by an amount equal to the partner s share of the death benefit received by the partnership, less the ACB of the policy to the partnership immediately before death. A partner can generally withdraw funds from a partnership tax-free to the extent of the partner s adjusted cost base. In a corporate or partnership setting, there may be circumstances where it makes sense to split between separate entities the ownership and beneficiary designation of a particular life insurance policy. One common situation is where there is an insured buysell arrangement involving holding companies and an operating company, with the insurance being required in the operating company to fund a corporate share redemption or cross-purchase agreement. There may be a number of reasons to arrange for the insurance to be owned at the holding company level, with the operating company as the beneficiary. For example, this arrangement would protect the insurance policy from creditors of the operating company. As well, there may be a concern with holding the insurance at the operating company level in the event that this company is sold, and the holding companies want to retain the insurance on the lives of their controlling shareholders. This would require the transfer of the policy from the operating company to the holding companies, with potentially negative tax consequences. Arranging the insurance ownership and beneficiary designation in this manner can also result in a tax benefit. This is because the recipient corporation does not have an ACB in the policy for purposes of determining the credit to its CDA (or in the case of a partnership, an increase in the adjusted cost base of a partnership interest). Depending on the circumstances, this can result in a larger credit to the CDA (or an increase to the partners adjusted cost base) than would have been the case had the insurance proceeds been payable to the policyholder. The Canada Revenue Agency (CRA) has expressed concerns with these arrangements and indicated in technical interpretations that if the splitting of ownership and the beneficiary designation is undertaken primarily to increase the CDA addition arising on the receipt of the insurance proceeds, they may apply the General Anti-Avoidance Rule (GAAR) or other provisions of the Income Tax Act (the Act ) to either reduce the CDA addition or impute a taxable benefit to the arrangement. While CALU recognizes there are bona fide non-tax reasons to establish these arrangements, the tax benefits are not what were intended in the design of the rules. Therefore, as part of our discussions with the Department of Finance (Finance) relating to the exempt test rules, we recommended that the rules be amended to, in effect, track the ACB of the life insurance policy to the recipient corporation (or partnership). We also requested that the current rules continue to apply to amounts received in respect of insurance policies under which a corporation was a beneficiary prior to the effective date of these amendments. In Budget 2016, Finance indicates that the current rules provide unintended results and erode the tax base. Finance further states that while the CRA is challenging a number of these structures under the existing tax rules, the Act will be amended to ensure that the CDA rules for private corporations, and the adjusted cost base rules for partnership interests, will apply as intended. In effect, the proposed changes will ensure that the ACB is reduced regardless of whether the corporation or partnership that receives the death benefit is also the owner of the policy. The - 3 - CALU Special Report March 2016
Special Report new measure will also introduce information-reporting requirements that will apply where a corporation or partnership is not a policyholder but is entitled to receive a policy death benefit. The measure will apply to policy benefits received as a result of a death that occurs on or after March 22, 2016. Unfortunately, there is no grandfathering for current beneficiary arrangements as requested by CALU. We will be reviewing this issue in more detail and will provide a further update to members in the near future. b) Non-Arm s-length Transfers of Life Insurance Policies Where a policyholder disposes of an interest in a life insurance policy to an arm s-length person, the value of any consideration is included in computing the proceeds of the disposition. To the extent the proceeds of the disposition exceed the policy s ACB, there will be tax reporting for the policyholder. As well, the ACB of the policy to the person acquiring the policy will be equal to the value of the consideration that was provided to the policyholder. However, where a policyholder disposes of such an interest in a policy by way of a gift, by distribution from a corporation or in any other manner to a non-arm slength person, there are special rules that deem the policyholder s proceeds of the disposition, and the acquiring person s cost of the interest, to be the value of the policy at the time of the disposition (the nonarm s-length policy transfer rule ). The term value is defined to be the cash surrender value of the policy assuming the policy was surrendered at that time. As a result, where the non-arm s-length policy transfer rule applies, and the amount of consideration given for the interest in the policy exceeds the interest s cash surrender value (CSV), such excess amount is not taxed as income under the rules that apply to dispositions of interests in life insurance policies. As well, the ACB of the policy to the person acquiring that policy will not be increased for any consideration paid above the CSV of the policy. The application of the non-arm s-length policy transfer rule can create a significant tax benefit for shareholders of private corporations. For example, assume Ms. A is the sole shareholder of Holdco A. Ms. A acquired a $1 million T100 life insurance policy a number of years ago and recently had it appraised by an actuary for $400,000. Ms. A transfers the life insurance policy to Holdco A for $400,000 in cash and/ or debt. The non-arm s-length policy transfer rule will deem Ms. A to have disposed of the policy for its cash surrender value (which is nil), and no taxable gain would result from the transaction. As well, since the transaction took place at fair market value (FMV), no shareholder benefit should apply to the sale transaction. In effect, Ms. A has been able to extract $400,000 from Holdco A on a non-taxable basis. Holdco A will have an ACB in the policy equal to Ms. A s proceeds of disposition, or nil. Upon the death of Ms. A, the life insurance proceeds received by Holdco A will create a CDA addition equal to all, or substantially all, of the insurance proceeds. In turn, this will permit Holdco A to pay a tax-free capital dividend to the estate of Ms. A. Budget 2016 notes that these results are unintended and erode the tax base. There are similar concerns where insurance is transferred by a partner to a partnership, and where an interest in a policy is contributed to a corporation as capital. Budget 2016 is therefore proposing amendments to ensure that amounts are not inappropriately received tax-free by a policyholder as a result of a disposition of an interest in a life insurance policy. These proposals Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 4 -
will amend the non-arm s-length policy transfer rule to include the FMV of any consideration given for an interest in a life insurance policy in the policyholder s proceeds of the disposition, and the acquiring person s cost. In addition, where the disposition arises on a contribution of capital to a corporation or partnership, any resulting increase in the paid-up capital in respect of a class of shares of the corporation, and the adjusted cost base of the shares or of an interest in the partnership, will be limited to the amount of the proceeds of the disposition. These rules will be effective for transfers that take place on or after March 22, 2016. Considering the above example, these new rules would result in Ms. A having proceeds of disposition of $400,000 and a taxable inclusion equal to $400,000 less the ACB of the policy. Holdco in turn would have an ACB in the policy of $400,000, which will impact the amount that can be credited to the CDA upon Ms. A s death. Budget 2016 also proposes to amend the CDA rules for private corporations and the adjusted cost base rules for partnership interests to take into account policy transfers that took place prior to March 22, 2016. In effect, there will be a retroactive adjustment for certain non-arm s-length transfers that have already taken place, where the life insured dies on or after March 22, 2016. In particular, this amendment will apply where an interest in a life insurance policy was disposed of before March 22, 2016 for consideration in excess of the proceeds of the disposition determined under the non-arm s length policy transfer rule. In this case, the amount of the policy benefit otherwise permitted to be added to a corporation s CDA, or the adjusted cost base of an interest in a partnership, will be reduced by the amount of the excess. In addition, where an interest in a life insurance policy was disposed of before March 22, 2016 under the nonarm s length policy transfer rule to a corporation or partnership as a contribution of capital, any increase in the paid-up capital in respect of a class of shares, and the adjusted cost base of the shares or of an interest in the partnership, that may otherwise have been permitted will be limited to the amount of the proceeds of the disposition. This measure will apply in respect of policies under which policy benefits are received as a result of deaths that occur on or after March 22, 2016. CALU plans to review these proposed changes in more detail and will be soliciting member input before formulating its response to Finance. Charitable Gifting Measures A Reversal of Fortune In response to requests from registered charities, new rules were introduced in the 2008 federal budget that reduced the capital gain realized on the donation of certain securities (including shares in public corporations, units in a mutual fund trust and an interest in a segregated fund policy) to nil. This effectively increased the value of the charitable donation by eliminating the tax liability arising from the disposition of the security. Since the introduction of this measure the charitable sector has made ongoing representations to the government to expand the exemption from tax to the donation of private shares or real estate. However, Finance has resisted this change primarily due to valuation concerns how would the charity or the CRA verify the appropriate amount to receipt for a gift that may be illiquid and/or whose value cannot be easily ascertained? - 5 - CALU Special Report March 2016
Special Report Budget 2015 introduced a rather elegant solution to the valuation issue by exempting individual and corporate donors from tax on the sale of private shares or real estate to an arm s-length party, if the cash proceeds are donated within 30 days. If a portion of the cash proceeds is donated, the exemption from capital gains tax would apply to that portion. This measure was intended to apply to donations in respect of dispositions occurring after 2016. In July 2015 Finance released draft legislation to give effect to these proposals. CALU made an extensive submission supporting the overall tax policy goals of the legislation, while also outlining questions and concerns relating to its operation in certain situations. Since then CALU has followed up several times with Finance to determine their next steps in moving forward with this legislation. Budget 2016 has provided that answer. In a short sentence the Government announced that it no longer intends to proceed with this measure. This is an unfortunate development for the charitable community and hopefully this decision will be reconsidered in a future budget. Personal Tax Measures Focusing on the Middle Class 1. Canada Child Benefit Canada s existing child benefit system consists of a tax-free, income-tested Canada Child Tax Benefit with two components (the base benefit and the National Child Benefit supplement) and a taxable Universal Child Care Benefit received by all families, regardless of income. Budget 2016 proposes to replace the current child benefit system with the new Canada Child Benefit. The Canada Child Benefit has the following elements: It provides families with a single payment every month; Payments will be tax-free families will not have to pay back part of the amount received when they file their tax returns; It will be targeted to those who need it most lowand middle-income families will receive more benefits, and those with the highest incomes (generally over $150,000) will receive lower benefits than under the current system; and It will be more generous for qualifying families they will see an average increase in child benefits of almost $2,300 in the 2016/17 benefit year. The Canada Child Benefit will start in July 2016, and as noted, will replace the Canada Child Tax Benefit and the Universal Child Care Benefit. 2. Child Fitness Tax Credit and the Children s Arts Tax Benefit The Children s Fitness and Arts Tax Credits are currently worth up to $150 and $75 per child on up to $1,000 and $500 in eligible expenses, respectively. As part of the Government s efforts to simplify the Income Tax Act and better target support for families with children, Budget 2016 proposes to reduce the maximum eligible expenses for the Children s Fitness and Arts Tax Credits by half for 2016, and to eliminate both credits as of 2017. 3. Eliminating Income Splitting for Couples with Children As previously announced by the Government, Budget 2016 proposes to eliminate income splitting for couples with children under the age of 18 for the 2016 and subsequent taxation years. It was reconfirmed that pension income splitting will not be affected by this change. Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 6 -
4. Support for Post-Secondary Education Budget 2016 has proposed a number of reforms to the Canada Student Loans Program to assist with making post-secondary education more affordable. In support of the Government s commitment to improve the affordability of post-secondary education for low- and middle-income families, Budget 2016 also proposes to eliminate the Education and Textbook Tax Credits, effective Jan. 1, 2017. Savings realized from eliminating these credits will be used to enhance student financial assistance. Tax credit amounts carried forward from years prior to 2017 will still be claimable in 2017 and subsequent years. Measures proposed in Budget 2015 related to the Canada Student Loans Program and Canada Student Grants will not be pursued in order to better target support to students from low- and middle-income families. 5. Guaranteed Income Supplement Budget 2016 proposes to increase the Guaranteed Income Supplement (GIS) top-up benefit by up to $947 annually for lower income single seniors starting in July 2016, which will support those seniors who rely almost exclusively on Old Age Security (OAS)and GIS benefits and may therefore be at risk of experiencing financial difficulties. This enhancement more than doubles the current maximum GIS Income Supplement benefits available to the lowest-income single seniors. Budget 2016 indicates that this measure represents an investment of over $670 million per year and will improve the financial security of about 900,000 single seniors across Canada. Single seniors with annual income (other than OAS and GIS benefits) of about $4,600 or less will receive the full increase of $947. Above this income threshold, the amount of the increased benefit will be gradually reduced and will be completely phased out at an income level of about $8,400. Benefits will be adjusted quarterly with increases in the cost of living. 6. Enhancing the Canada Pension Plan In December 2015, the federal government began discussions on enhancing the Canada Pension Plan (CPP) with provinces and territories, with the goal of being able to make a collective decision before the end of 2016. Budget 2016 announces that the Government will launch consultations to give Canadians an opportunity to share their views on enhancing the CPP. 7. Old Age Security Program The OAS program provides a monthly payment to Canadians age 65 and older who apply and meet certain requirements. The main requirements are that the recipient must be 65 years of age or older, be a Canadian citizen or legal resident of Canada, and have lived in Canada for at least 10 years after turning age 18. The current benefit for an individual is approximately $570 per month, indexed quarterly to increases in the consumer price index. OAS benefits are funded out of general tax revenues rather than individual contributions. Recent demographic studies have indicated that retiring boomers will place a significant strain on the federal government s ability to fund OAS benefits in the future. As a result, the prior federal government implemented a gradual change in the age of eligibility from age 65 to 67, with full implementation by 2023. It comes as no surprise that Budget 2016 proposes to eliminate the provisions in the Old Age Security Act that increase the age of eligibility for OAS and GIS benefits from 65 to 67 and Allowance benefits from 60 to 62 over the 2023 to 2029 period. It is noted that restoring the eligibility age for OAS and GIS benefits to 65 will put thousands of dollars back - 7 - CALU Special Report March 2016
Special Report in the pockets of Canadians as they become seniors. These benefits are an important part of the retirement income of Canadians, particularly for lower-income seniors. Budget 2016 also proposes to introduce amendments to the Old Age Security Act that will ensure that couples who receive GIS and Allowance benefits and have to live apart for reasons beyond their control (such as a requirement for long term care) will receive higher benefits based on their individual incomes. Legislation is already in place to allow for senior couples who are both GIS recipients to receive benefits based on their individual incomes if the couple is living apart for reasons beyond their control. Investment Taxation Measures Eliminating Tax Advantages 1. Corporate Class Mutual Funds Canadian mutual funds can be in the legal form of a trust or a corporation. While most funds are structured as mutual fund trusts, some are structured as mutual fund corporations. Many of these mutual fund corporations offer different types of asset exposure in different funds, but each fund is structured as a separate class of shares within the mutual fund corporation. Investors are able to exchange shares of one class of the mutual fund corporation for shares of another class. By virtue of a general provision in the Act that applies to convertible corporate securities, this exchange is deemed not to be a disposition for income tax purposes. This deferral benefit that is available to taxable investors in these so-called switch funds is not available to taxpayers investing in mutual fund trusts or investing on their own account directly in securities. Budget 2016 proposes to amend the Act so that an exchange of shares of a mutual fund corporation (or investment corporation) that results in the investor switching between funds will be considered for tax purposes to be a disposition at FMV. The measure will not apply to switches where the shares received in exchange differ only in respect of management fees or expenses to be borne by investors and otherwise derive their value from the same portfolio or fund within the mutual fund corporation (e.g., the switch is between different series of shares within the same class). This measure will apply to dispositions of shares that occur after September 2016. 2. Indexed Linked Notes An indexed linked note (a linked note ) is a debt obligation, most often issued by a financial institution, the return on which is linked in some manner to the performance of one or more reference assets or indices over the term of the obligation. The referenced asset or index which can be a basket of stocks, a stock index, a commodity, a currency or units of an investment fund is generally unrelated to the operations or securities of the issuer. The Act contains rules that deem interest to accrue on a prescribed debt obligation, which includes a typical linked note. These rules require an investor in a linked note to accrue the maximum amount of interest that could be payable on the note in respect of a given taxation year. Investors generally take the position that there is no deemed accrual of interest on a linked note prior to the maximum amount of interest becoming determinable. Instead, the full amount of the return on the note is included in the investor s income in the taxation year when it becomes determinable, which is generally shortly before maturity. A specific rule provides that interest accrued to the date of sale of a debt obligation is included in the income of the vendor for the year in which the sale occurs. However, some investors, who hold their Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 8 -
linked notes as capital property, sell them prior to the determination date to, in effect, convert the return on the notes from ordinary income to capital gains, only 50% of which is included in their income. These investors take the position that no amount in respect of the gain on a linked note is accrued interest on the date of sale of the note for the purposes of this specific rule. On that basis, these investors include the full amount of the return on a linked note in the proceeds of disposition and claim the return on the note as a capital gain. To facilitate this planning, issuers of linked notes often establish a secondary market where investors can sell their linked notes prior to maturity to an affiliate of the issuer. Budget 2016 proposes to amend the Act so that the return on a linked note retains the same character whether it is earned at maturity or reflected in a secondary market sale. Specifically, a deeming rule will apply for the purposes of the rule relating to accrued interest on sales of debt obligations. This deeming rule will treat any gain realized on the sale of a linked note as interest that accrued on the debt obligation for a period commencing before the time of the sale and ending at that time. When a linked note is denominated in a foreign currency, foreign currency fluctuations will be ignored for the purposes of calculating this gain. An exception will also be provided where a portion of the return on a linked note is based on a fixed rate of interest. In that case, any portion of the gain that is reasonably attributable to market interest rate fluctuations will be excluded. This measure will apply to sales of linked notes that occur after September 2016. Corporate Tax Measures 1. Small Business Tax Rate and Dividend Tax Credit As first announced in Budget 2015, the small business deduction currently reduces to 10.5% 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). The rate is scheduled to be reduced over the next few years with a target of 9% in 2018. Access to the small business deduction is phased out on a straightline basis for CCPCs having between $10 million and $15 million of taxable capital employed in Canada, and there both the eligible income limit and taxable capital limit must be allocated among associated corporations. Budget 2016 proposes to eliminate the future small business rate reductions and hold the federal corporate income tax rate on qualifying active business income of a CCPC to 10.5%. In conjunction with the proposed freeze in the small business tax rate, Budget 2016 also proposes to maintain the current gross-up factor and dividend tax credit (DTC) rate applicable to non-eligible dividends (generally dividends distributed from corporate income taxed at the small business tax rate). Specifically, Budget 2016 proposes to maintain the current gross-up factor applicable to non-eligible dividends at 17% and the corresponding DTC rate at 21/29 of the gross-up amount of the dividend. 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 maintained at 10.5%. This measure is intended to preserve the integration of the personal and corporate income tax systems. - 9 - CALU Special Report March 2016
Special Report 2. Measures Affecting the Small Business Deduction The small business tax rate for CCPCs applies only to the first $500,000 per year of qualifying active business income (subject to a phase out where taxable capital employed in Canada is greater than $10 million). The eligible income limit and taxable capital limit are required to be shared among associated corporations so as to preclude the multiplication of access to the small business tax rate (by spreading active business income among multiple corporations) or the gaining of access to the small business tax rate (by separating the earning of active business income and the ownership of taxable capital employed in Canada). Certain structures have been used by owners of CCPCs in order to multiply or gain access to the small business tax rate. Budget 2016 proposes amendments to the Income Tax Act to address specific planning structures. Partnerships Multiplying Access to the Small Business Tax Rate The specified partnership income rules in the Act are intended to eliminate the multiplication of the small business tax rate among CCPC partners that are not associated with one another. The rules act so that there is a single income limit that applies in respect of the partnership s active business income and specifically provide that a CCPC partner s partnership income for which the small business tax rate can apply is the lesser of: (a) its share of the active business income of the partnership, and (b) its pro-rata share of a notional $500,000 eligible income limit based on its interest in the partnership (the specified partnership income limit ). This amount is added to any other active business income of the CCPC in calculating its income eligible for the small business tax rate. Absent these rules, each CCPC partner could claim a separate small business tax rate for its share (up to the eligible income limit) of the partnership s active business income. Some taxpayers were putting in place structures to circumvent these partnership rules. Budget 2016 notes that a typical structure has a shareholder of a CCPC become a member of a partnership and the CCPC contracting to provide services to the partnership. In this structure, the CCPC pays the small business tax rate on the full amount of its fees earned from the partnership and is not limited by the partnership notional $500,000 eligible income limit divided among its partners. The specified partnership income rules do not apply because the CCPC is not a member of the partnership. Budget 2016 proposes measures to address this tax planning by extending the specified partnership income rules to partnership structures in which a CCPC provides (directly or indirectly, in any manner whatever) services or property to a partnership where, any time in the CCPC s tax year, the CCPC or a shareholder of the CCPC is a member of the partnership or does not deal at arm s length with a member of the partnership. In effect, the active business income earned by the CCPC will be added to the partnership s active business income in determining the specified partnership income limit allocated to each partner and the CCPC can only get access to all or a portion of the specified partnership income limit to the extent it is assigned by an actual partner. These changes will apply to tax years that begin on or after March 22, 2016. However, an actual member of a partnership will be entitled to assign its specified partnership income limit in respect of its tax year that begins before and ends on or after March 22, 2016. Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 10 -
Corporations Multiplying Access to the Small Business Tax Rate Similar planning was also being implemented using corporations to multiply access to small business tax rate whereby a CCPC would earn active business income by providing services or property to a private corporation in which the CCPC or a non-arm s length person has a direct or indirect interest. Budget 2016 proposes measures that will render a CCPC s active business income from providing (directly or indirectly, in any manner whatever) services or property to a private corporation ineligible for the small business tax rate if, at any time in the CCPC s tax year, the CCPC, one of its shareholders or a person who does not deal at arm s length with a shareholder, has a direct or indirect interest in the private corporation. An exception will apply if all or substantially all of the CCPC s active business income is earned from providing services or property to arm s length persons other than the private corporation. In addition, rules will permit another CCPC to assign all or any portion of its unused eligible income limit to the CCPC so that all or a portion of the ineligible active business income can become eligible for the small business tax rate. These changes will apply to tax years that begin on or after March 22, 2016. However, a CCPC will be entitled to assign all or a portion of its unused eligible income limit in respect of its tax year that begins before and ends on or after March 22, 2016. Associated Corporations Multiplying and Gaining Access to the Small Business Tax Rate The associated corporation rules generally provide that associated corporations must share the eligible income limit (the $500,000 of active business income eligible for the small business tax rate) and the taxable capital limit (the $15 million limit on taxable capital employed in Canada after which the CCPC is no longer entitled to the small business tax rates on active business income). There are many rules for determining whether two corporations are associated for the purposes of these rules. One, subsection 256(2), provides a special rule under which two corporations will be deemed to be associated if each is associated with the same third corporation. In such a situation, if the total taxable capital employed in Canada of all three corporations exceeds $15 million, none of the corporations will be entitled to the small business tax rate on active business income. However, an exception can apply to this deeming rule if the third corporation either: (a) is not a CCPC, or (b) is a CCPC but elects not to be associated with the other two corporations for the purposes of the determining entitlement to the small business tax rate. In the latter situation, the third corporation will not be entitled to the small business tax rate on any of its active business income. The two other corporations, however, are then each entitled to the small business tax rate on its active business income, subject to its own eligible income limit and taxable capital limit. While the two other corporations are not treated as associated for the purposes of the taxable capital limit, they will continue to be associated for the purposes of subsection 126(6) which treats a CCPC s investment income as active business income eligible for the small business tax rate if the income is derived from the active business of an associated corporation (for example, interest and rental income). As a result, the two other corporations could benefit from the small business tax rate on investment income that traces to the active business of the third corporation, even though the third corporation would not have had access to the small business tax rate, either because it is not a CCPC or it filed the above-noted election. In addition, access to the small business tax rate by the - 11 - CALU Special Report March 2016
Special Report two other corporations is determined without regard to the taxable capital employed in Canada by the third corporation. CCPCs currently claiming access to the small business tax rate on investment income stemming from the above described scenario are being challenged by the Government under a specific anti-avoidance rule and GAAR. However, such challenges are time-consuming and costly. Budget 2016 proposes measures to amend the Act to ensure that investment income of a CCPC derived from an associated corporation s active business will be ineligible for the small business tax rate where the exception to the deemed association rule in subsection 256(2) applies. In addition, if the exception to subsection 256(2) applies, the third corporation will continue to be deemed associated with the two other corporations for the purposes of applying the $15 million taxable capital limit. These changes will apply to tax years that begin on or after March 22, 2016. 3. Consultation on Active Versus Investment Business Budget 2015 announced a review of the considerations for determining when a business, the principal purpose of which is to earn income from property, qualifies as an active business entitled to the small business tax rate. Under the current rules in the Act, such a business only qualifies as an active business when that business has more than five full-time employees. In addition, the determination of whether a business principal purpose is to earn income from property is a question of fact for which the CRA has published guidance and a significant body of case law has developed. The consultation period ended on Aug. 31, 2015 and the review of the rules is now complete. Budget 2016 announces that the Government is not proposing any modifications to these rules and specifically provides for the maintaining of the rule that allows such income from property to be active business income where the business has more than five full-time employees. 4. Eligible Capital Property (ECP) This section reproduced from source: PwC Canada, 2016 Federal budget Tax Insights, March 22, 2016. Used with permission. PricewaterhouseCoopers LLP The budget proposes to repeal the ECP regime and replace it with a new capital cost allowance (CCA) pool. The repeal of the ECP regime was referred to in the 2014 budget. These changes are intended to simplify the rules related to intangible properties. Under the current system, 75% of eligible capital expenditures (such as customer lists, licences, franchise rights, farm quotas and the acquisition of goodwill) are included in a cumulative eligible capital pool. A deduction can be claimed at the rate of 7% per year on a declining balance basis. Up to 75% of the proceeds received on the disposition of ECP reduce the CEC pool. If the receipts exceed the CEC pool, the excess first recaptures any previously claimed deductions. The remainder is included in business income at a 50% inclusion rate. Under the proposed rules a new CCA, Class 14.1, will be introduced. Starting January 1, 2017, 100% of expenditures that would previously have been included in the CEC pool will be included in this class. The rate of depreciation will be 5% (declining balance). The rules that currently apply to depreciable property, such as the half-year rule, recapture and capital gains, will apply to the properties included in this class. Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 12 -
Special rules will apply to expenditures that do not relate to a specific property of a business. Every business will be considered to have goodwill associated to it (even if no expenditures on goodwill have been made). Expenditures that do not relate to a particular property will increase the capital cost of the goodwill of the business and, consequently, the balance of the Class 14.1 pool. A receipt that does not relate to a specific property will reduce the capital cost of the goodwill of the business, and therefore the balance of the Class 14.1 pool, by the lessor of the cost of the goodwill (which may be nil) and the amount of the receipt. Any excess will be treated as a capital gain. Any previously deducted CCA will be recaptured to the extent that the receipt exceeds the balance of the Class 14.1 pool. CEC balances will be transferred to the new Class 14.1 pool as of January 1, 2017, including for taxpayers whose taxation year straddles January 1, 2017. The opening balance of the Class 14. 1 pool will be equal to the CEC balance as at December 31, 2016. The CCA depreciation rate for property included in the Class 14.1 pool related to expenditures incurred before January 1, 2017, will be 7% until 2027. For amounts received on the disposition of property after December 31, 2016, that relate to property acquired or expenditures made before January 1, 2017, will reduce the Class 14.1 pool at a 75% rate. Also included for the 75% rate, are receipts that do not represent the proceeds on the disposition of property. To simplify the transition, the budget proposes special rules for small businesses that allow a deduction: for expenditures incurred before 2017, equal to the greater of $500 and the amount otherwise deductible for the year, for years that end prior to 2027 and, in computing income, for the first $3,000 of incorporation expenses. Measures for Tax Integrity and Fairness Several actions intended to improve tax compliance, integrity and fairness are proposed. Tax Compliance Budget 2016 proposes to invest $444.4 million over five years for the CRA to combat tax evasion and avoidance by hiring additional auditors and specialists, developing a business intelligence infrastructure, increasing verification activities, and improving investigation quality that targets criminal tax evaders. It is expected that the revenue impact will be $2.6 billion over five years which does not include the expected revenue gain to be realized by provinces and territories. Budget 2016 also proposes to invest $351.5 million over five years for the CRA to improve its tax collection activities. It is anticipated that additional collections resulting from this measure will be $7.4 billion in tax debts over five years and is expected to complement efforts to encourage earlier payment and working with those who cannot pay amounts due. Domestic Tax Integrity Budget 2016 specifically highlights the concern of a high net worth individual s ability to use private corporations to inappropriately reduce or defer tax. A number of measures meant to address this concern are included in Budget 2016. Additional measures may be forthcoming as a result of the review of the tax system to be completed in the coming year. - 13 - CALU Special Report March 2016
Special Report International Tax Integrity Canada is engaged in the multi-jurisdictional efforts to address base erosion and profit shifting (BEPS) and increase the exchange of financial and tax information between taxing authorities. In addition to the various tax measures intended to protect the integrity of the Canadian tax base, the Government stated that it will undertake the spontaneous exchange of tax rulings that could give rise to BEPS concerns with other taxing administrations. Canada also intends to implement the automatic exchange of information on financial accounts held by non-residents within the OECD framework starting on July 1, 2017 with the first exchanges of information occurring in 2018. Legislative proposals for public comment will be issued in the near future. In Summary The Finance Minister appears to have delivered the goods on Liberal election promises geared to middleclass taxpayers. At the same time, a number of taxmotivated planning structures designed for high net worth and entrepreneurial Canadians have been shut down or heavily curtailed. The tax community, and by proxy their clients, have also been put on notice that this is not the end of the Government review of strategies or structures that inappropriately reduce or defer tax. CALU plans to be active in reviewing and discussing the specific proposals relating to life insurance with Finance. Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com March 2016 CALU Special Report - 14 -
Special Report About CALU The Conference for Advanced Life Underwriting (CALU) is a national professional membership association of established financial advisors (life insurance, wealth management and employee benefits), accounting, tax, legal and actuarial professionals. For 25 years CALU has engaged in political advocacy and government relations activities relating to advanced planning issues on behalf of its members and the members of its sister organization, Advocis, The Financial Advisors Association of Canada. Through these efforts, CALU represents the interests of some 11,000 insurance and financial advisors and in turn the interests of millions of Canadians For more information please visit www.calu.com. - 15 - CALU Special Report March 2016 Conference for Advanced Life Underwriting Suite 504-220 Duncan Mill Road North York, ON M3B 3J5 Tel: 647-799-1006 www.calu.com