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2016 Federal Budget Commentary

Introduction

The Honourable Bill Morneau, Minister of Finance, today tabled his first budget, “Growing the Middle Class,” which is expected to show a deficit of $29.4 billion in 2016-2017.   

Budget 2016 focused on five key areas:

  • Strengthening the Middle Class
  • An Innovative and Clean Economy
  • Canada’s Place in the World
  • An Inclusive and Fair Canada
  • Open and Transparent Government

The following is a brief overview of the key tax measures.

Personal Tax Measures

Canada Child Benefit

Budget 2016 proposes to replace the Canada Child Tax Benefit (CCTB) and Universal Child Care Benefit (UCCB) with a new Canada Child Benefit.

The Canada Child Benefit will provide a maximum benefit of $6,400 per child under the age of 6 and $5,400 per child aged 6 through 17. On the portion of adjusted family net income between $30,000 and $65,000, the benefit will be phased out at a rate of 7 per cent for a one-child family, 13.5 per cent for a two-child family, 19 per cent for a three-child family and 23 per cent for larger families. Where adjusted family net income exceeds $65,000, remaining benefits will be phased out at rates of 3.2 per cent for a one-child family, 5.7 per cent for a two-child family, 8 per cent for a three-child family and 9.5 per cent for larger families, on the portion of income above $65,000.

To recognize the additional costs of caring for a child with a severe disability, Budget 2016 proposes to continue to provide an additional amount of up to $2,730 per child eligible for the disability tax credit. The phase-out of this additional amount will be made to generally align with the Canada Child Benefit. Specifically, it will be phased out at a rate of 3.2 per cent for families with one eligible child and 5.7 per cent for families with more than one eligible child, on adjusted family net income in excess of $65,000, effective July 1, 2016. This additional amount will be included in the Canada Child Benefit payments made to eligible families.

Amounts received under the new Canada Child Benefit will not be taxable and will not reduce benefits paid under the goods and services tax (GST) credit.

Entitlement to the Canada Child Benefit for the July 2016 to June 2017 benefit year will be based on adjusted family net income for the 2015 taxation year.

Canada Child Benefit payments under this measure will start in July 2016. The CCTB and UCCB will be eliminated for months after June 2016.

Retroactive Payments

Currently, an individual can apply to receive retroactive payments of the CCTB and UCCB as far back as when the programs were introduced, provided they would have been eligible to receive the benefits at the time.

To be consistent with the time limit on retroactive claims of other tax amounts, Budget 2016 proposes to allow a taxpayer to request a retroactive payment of the Canada Child Benefit, CCTB or UCCB in respect of a month on or before the day that is 10 years after the beginning of that month, effective for requests made after June 2016.

Income Splitting Credit

A non-refundable income splitting tax credit is available for couples with at least one child under the age of 18. The credit allows a higher-income spouse or common-law partner to notionally transfer up to $50,000 of taxable income to their spouse or common-law partner for the purpose of reducing the couple’s total income tax liability by up to $2,000.

Budget 2016 proposes to eliminate the income splitting tax credit for the 2016 and subsequent taxation years.

Northern Residents Deductions

Individuals who live in prescribed areas in northern Canada for at least six consecutive months beginning or ending in a taxation year may claim the northern residents deductions in computing their taxable income for that year. These include both a residency deduction and a deduction for certain travel benefits.

The amounts that a taxpayer may deduct under the northern residents deductions depend on whether the taxpayer resides in the Northern Zone or the Intermediate Zone. Residents of the Northern Zone are eligible to deduct the full amounts, while residents of the Intermediate Zone may deduct half of the amounts.

Budget 2016 proposes to increase the maximum residency deduction that each member of a household may claim from $8.25 to $11 per day and, where no other member of the household claims the residency deduction, to increase the maximum residency deduction from $16.50 to $22 per day for the 2016 taxation year. Residents of the Intermediate Zone will be entitled to deduct half of these increased amounts.

Labour-Sponsored Venture Capital Corporations Tax Credit

A labour-sponsored venture capital corporation (LSVCC) is a form of mutual fund corporation, sponsored by an eligible labour body. LSVCCs are mandated, under their enabling legislation, to provide venture capital to small and medium-sized businesses.

Prior to 2015, individuals acquiring LSVCC shares qualified for a 15 per cent federal tax credit for investments of up to $5,000 each year. The federal LSVCC tax credit was reduced to 10 per cent for the 2015 taxation year and to 5 per cent for the 2016 taxation year. The credit is scheduled to be eliminated for the 2017 and subsequent taxation years.

To support provinces that use LSVCC programs to facilitate access to venture capital for small and medium-sized businesses, Budget 2016 proposes to restore the federal LSVCC tax credit to 15 per cent for share purchases of provincially registered LSVCCs prescribed under the Income Tax Act (ITA) for the 2016 and subsequent taxation years.

Budget 2016 also proposes that newly registered LSVCCs under existing provincial legislation be eligible for prescription if the provincial legislation is currently prescribed for purposes of the federal LSVCC tax credit.

The federal LSVCC tax credit for federally registered LSVCCs will remain at 5 per cent for the 2016 taxation year and be eliminated for the 2017 and subsequent taxation years.

Teacher and Early Childhood Educator School Supply Tax Credit

Budget 2016 proposes to introduce a teacher and early childhood educator school supply tax credit. This measure will allow an employee who is an eligible educator to claim a 15 per cent refundable tax credit based on an amount of up to $1,000 in expenditures made by the employee in a taxation year for eligible supplies.

Teachers will qualify as eligible educators if they hold a teacher’s certificate that is valid in the province or territory in which they are employed. Likewise, early childhood educators will qualify as eligible educators if they hold a certificate or diploma in early childhood education recognized by the province or territory in which they are employed.

For the cost of supplies to qualify for the credit, employers will be required to certify that the supplies were purchased for the purpose of teaching or otherwise enhancing learning in a classroom or learning environment. Individuals making claims will be required to retain their receipts for verification purposes.

This measure will apply to supplies acquired on or after January 1, 2016.

Ontario Electricity Support Program

The Ontario Electricity Support Program (OESP) is a program of the Government of Ontario that, effective January 1, 2016, provides assistance to low-income households in Ontario for the cost of electricity.

To ensure that income-tested benefits are not reduced as a result of OESP amounts, Budget 2016 proposes to exclude such amounts from the recipient’s income.

This measure will apply to the 2016 and subsequent taxation years.

Mineral Exploration Tax Credit for Flow-Through Share Investors

Flow-through shares allow resource companies to renounce or “flow through” tax expenses associated with their Canadian exploration activities to investors, who can deduct the expenses in calculating their own taxable income. The mineral exploration tax credit provides an additional income tax benefit for individuals who invest in mining flow-through shares, which augments the tax benefits associated with the deductions that are flowed through. This credit is equal to 15 per cent of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors.

Budget 2016 proposes to extend eligibility for the mineral exploration tax credit for one year, to flow-through share agreements entered into on or before March 31, 2017.

Education and Textbook Tax Credits

Budget 2016 proposes to eliminate the education and textbook tax credits. This measure does not eliminate the tuition tax credit. Changes will be made to ensure that other income tax provisions that currently rely on eligibility for the education tax credit or use terms defined for the purpose of the education tax credit will be unaffected by its elimination.

This measure will apply effective January 1, 2017. Unused education and textbook credit amounts carried forward from years prior to 2017 will remain available to be claimed in 2017 and subsequent years.

Children’s Fitness and Arts Tax Credits

Budget 2016 proposes to phase out the children’s fitness and arts tax credits by reducing the 2016 maximum eligible amounts to $500 from $1,000 for the children’s fitness tax credit (which will remain refundable for 2016) and to $250 from $500 for the children’s arts tax credit. The supplemental amounts for children eligible for the disability tax credit will remain at $500 for 2016.

Both credits will be eliminated for the 2017 and subsequent taxation years.

Top Marginal Income Tax Rate – Consequential Amendments

On December 7, 2015, the Government announced a reduction of the second personal income tax rate to 20.5 per cent from 22 per cent and the introduction of a 33 per cent personal income tax rate on individual taxable income in excess of $200,000, effective for the 2016 and subsequent taxation years. These proposals were included as part of Bill C-2, which was tabled on December 9, 2015.

The ITA contains a series of rules that either use the top personal income tax rate or use rates or formulas that reflect it.

Budget 2016 proposes further amendments to reflect the new top marginal income tax rate for individuals that will:

  • provide a 33 per cent charitable donation tax credit (on donations above $200) to trusts that are subject to the 33 per cent rate on all of their taxable income;
  • apply the new 33 per cent top rate on excess employee profit sharing plan contributions;
  • increase from 28 per cent to 33 per cent the tax rate on personal services business income earned by corporations;
  • amend the definition of “relevant tax factor” in the foreign affiliate rules to reduce the relevant tax factor from the current 2.2 to 1.9;
  • amend the capital gains refund mechanism for mutual fund trusts to reflect the new 33 per cent top rate in the formulas that are used in computing refundable tax;
  • increase the Part XII.2 tax rate on the distributed income of certain trusts from 36 per cent to 40 per cent; and
  • amend the recovery tax rule for qualified disability trusts to refer to the new 33 per cent top rate.

These measures will apply to the 2016 and later taxation years.

Taxation of Switch Fund Shares

Canadian mutual funds can be structured as mutual fund corporations. Many mutual fund corporations are organized as “switch funds”. These 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, in order to switch their economic exposure between the mutual fund corporation’s different funds. This exchange is deemed not to be a disposition for income tax purposes.

Budget 2016 proposes to amend the ITA 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 fair market value. 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.

Sale of Linked Notes

Budget 2016 proposes to amend the ITA 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.

Other Personal Measures

Employment Insurance

Budget 2016 proposes to make the following changes to Employment Insurance (EI):

  • Expanding access to EI for new entrants and re-entrants
  • Reducing the EI waiting period from two weeks to one
  • Extending the working while on claim pilot project
  • Simplifying job search responsibilities for EI claimants
  • Extending EI regular benefits in affected regions
  • Extending the maximum duration of work-sharing agreements

Canada Pension Plan

Budget 2016 indicates that the Liberal Government will launch consultations to give Canadians an opportunity to share their views on enhancing the Canada Pension Plan with the provinces and territories.

Old Age Security

Budget 2016 proposes to cancel the provisions of the Old Age Security Act that increase the age of eligibility for Old Age Security and Guaranteed Income Supplement benefits from 65 to 67 and Allowance benefits from 60 to 62 over the 2023 to 2029 period.

Business Income Tax Measures

Small Business Tax Rate

Budget 2016 proposes that the small business tax rate remain at 10.5 per cent after 2016.

Small Business Tax Rate

2016

2017

2018

2019

Existing Legislation

10.5

10.0

9.5

9.0

Proposed Legislation

10.5

10.5

10.5

10.5

Electric Vehicle Charging Stations

Budget 2016 proposes to expand Class 43.1 and 43.2 by making electric vehicle charging stations eligible for inclusion in Class 43.1 or 43.2, based upon whether they meet certain power thresholds. Electric vehicle charging stations set up to supply at least 90 kilowatts of continuous power will be eligible for inclusion in 43.2. Those charging stations set up to supply more than 10 kilowatts but less than 90 kilowatts of continuous power will be eligible for inclusion in Class 43.1

The measure will apply in respect of property acquired for use on or after Budget Day that has not been used or acquired for use before Budget Day.

Electrical Energy Storage

Budget 2016 proposes to clarify and expand the range of electrical energy storage property that is eligible for accelerated capital cost allowance (CCA) in Class 43.1 or 43.2 on the basis that it is ancillary to eligible generation equipment, to include a broad range of short- and long-term storage equipment.

Budget 2016 also proposes to allow stand-alone electrical energy storage property to be included in Class 43.1 provided that the round trip efficiency of the equipment is greater than 50 per cent.

The measure will apply in respect of property acquired for use on or after Budget Day that has not been used or acquired for use before Budget Day.

Emissions Allowances

Budget 2016 proposes to amend the ITA to introduce specific rules to clarify the tax treatment of emissions allowances and to eliminate the double taxation of certain free allowances. Specifically, these rules will provide that emissions allowances be treated as inventory for all taxpayers.

This measure will apply to emissions allowances acquired in taxation years beginning after 2016. It will also apply on an elective basis in respect of emissions allowances acquired in taxation years ending after 2012.

Multiplication of the Small Business Deduction

Budget 2016 proposes changes to address concerns about partnership and corporate structures that multiply access to the small business deduction.

Partnerships

Budget 2016 proposes to extend the specified partnership income rules to partnership structures in which a Canadian Controlled Private Corporation (CCPC) provides (directly or indirectly, in any matter whatever) services or property to a partnership during a taxation year of the CCPC where, at any time during the 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 general terms, for the purpose of the specified partnership rules:

  • a CCPC will be deemed to be a member of a partnership throughout a taxation year if;
    •  it is not otherwise a member of the partnership in the taxation year,
    •  it provides services or property to the partnership at any time in the taxation year,
    • a member of the partnership does not deal at arm’s length with the CCPC, or a shareholder of the CCPC, in the taxation year, and
    •  it is not the case that all or substantially all of the CCPC’s active business income (ABI) for the taxation year is from providing services or property to arm’s length persons other than the partnership;
  • a CCPC that is a member of a partnership (including a deemed member) will have its active business income from providing services or property to the partnership deemed to be partnership ABI; and
  • the specified partnership income limit (SPI limit) of a deemed member of a partnership will initially be nil (as it does not receive any allocations of income from the partnership). However, an actual member of the partnership who does not deal at arm’s length with a deemed member of the partnership will be entitled to notionally assign to the deemed member all of or a portion of the actual member’s SPI limit in respect of a fiscal period of the partnership that ends in the deemed member’s taxation year. (Where the actual partner is an individual, the assignable SPI limit of all members of the partnership will be determined as if they were corporations.)

This measure will apply to taxation years that begin on or after Budget Day. However, an actual member of a partnership will be entitled to notionally assign all or a portion of the member’s SPI limit in respect of their taxation year that begins before and ends on or after Budget Day.

Corporations

Budget 2016 proposes to amend the ITA such that a CCPC's active business income from providing services or property (directly or indirectly, in any manner whatever) in its taxation year to a private corporation will be ineligible for the small business deduction where, at any time during the year, the CCPC, one of its shareholders or a person who does not deal at arm’s length with such a shareholder has a direct or indirect interest in the private corporation. This ineligibility for the small business deduction will not apply to a CCPC if all or substantially all of its active business income for the taxation year is earned from providing services or property to arm’s length persons other than the private corporation.

A private corporation that is a CCPC will be entitled to assign all or a portion of its unused business limit to one or more CCPCs that are ineligible for the small business deduction under this proposal because they provided services or property to the private corporation.

This measure will apply to taxation years that begin on or after Budget Day. However, a private corporation will be entitled to assign all or a portion of its unused business limit in respect of its taxation year that begins before and ends on or after Budget Day.

Avoidance of the Business Limit and the Taxable Capital Limit

Budget 2016 proposes to amend the ITA to ensure that investment income derived from an associated corporation’s active business will be ineligible for the small business deduction and be taxed at the general corporate income tax rate where the exception to the deemed associated corporation rule applies (i.e. an election not to be associated is made or the third corporation is not a CCPC). In addition, where this exception applies (such that the two corporations are deemed not to be associated with each other), the third corporation will continue to be associated with each of the other corporations for the purpose of applying the $15 million taxable capital limit.

This measure will apply to taxation years that begin on or after Budget Day.

Distributions Involving Life Insurance Proceeds

Budget 2016 proposes to amend the ITA to ensure that the capital dividend account rules for private corporations, and the adjusted cost base rules for partnership interest, apply as intended. This measure will provide that the insurance benefit limit applies regardless of whether the corporation or partnership that receives the policy benefit is a policyholder of the policy. To that end, the 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 benefit.

This measure will apply to policy benefits received as a result of a death that occurs on or after Budget Day.

Transfers of Life Insurance Policies

Budget 2016 proposes amendments to the ITA 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. This measure will, in applying the policy transfer rule, include the fair market value 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 disposition.

The measure will apply to dispositions that occur on or after Budget Day.

Budget 2016 also proposes to amend the capital dividend account rules for private corporations and the adjusted cost base rules for partnership interests. This amendment will apply where an interest in a life insurance policy was disposed of before Budget Day for consideration in excess of the proceeds of the disposition determined under the policy transfer rule. In this case, the amount of the policy benefit otherwise permitted to be added to a corporation’s capital dividend account, 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 Budget Day under the 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 of the corporation, 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 Budget Day.

Debt Parking to Avoid Foreign Exchange Gains

Budget 2016 proposes to introduce rules so that any accrued foreign exchange gains on a foreign currency debt will be realized when the debt becomes a parked obligation.

This measure will apply to a foreign currency debt that meets the conditions to become a parked obligation on or after Budget Day. There will be an exception where the meeting of these conditions occurs before 2017 and results from a written agreement entered into before Budget Day.

Valuation of Derivatives

Budget 2016 proposes to exclude derivatives from the application of the inventory valuation rules while maintaining the status of such property as inventory. A related rule will also be introduced to ensure that taxpayers are not able to value derivatives using the lower of cost and market method under the general principles for the computation of profit for tax purposes.

The measure will apply to derivatives entered into on or after Budget Day.

Eligible Capital Property

Budget 2016 proposes to repeal the eligible capital property (ECP) regime, replace it with a new capital cost allowance (CCA) class available to businesses and provide rules to transfer taxpayers’ existing cumulative eligible capital (CEC) pools to the new CCA class.

Under this proposal, a new class of depreciable property for CCA purposes (Class 14.1) will be introduced. Expenditures that are currently added to CEC (at a 75 per cent inclusion rate) will be included in the new CCA class at a 100 per cent inclusion rate. As a result of this increased expenditure recognition, the new class will have a 5 per cent annual depreciation rate. To retain the simplification objective, the existing CCA rules will generally apply, including rules relating to recapture, capital gains and depreciation.

Special rules will apply in respect of goodwill and in respect of expenditures and receipts that do not relate to a specific property of the business and that would be eligible capital expenditures or eligible capital receipts under the ECP regime.

Under transitional rules, CEC pool balances will be calculated and transferred to the new CCA class as of January 1, 2017. The opening balance of the new CCA class in respect of a business will be equal to the balance at that time of the existing CEC pool for that business. For the first 10 years, the depreciation rate for the new CCA class will be 7 per cent in respect of expenditures incurred before January 1, 2017.

Budget 2016 also proposes the following special rules to simplify the transition for small businesses:

  • To allow small initial balances to be eliminated quickly, a taxpayer will be permitted to deduct as CCA, in respect of expenditures incurred before 2017, the greater of $500 per year and the amount otherwise deductible for that year. This additional allowance will be provided for taxation years that end prior to 2027.
  • In the past, many businesses have had relatively small CEC balances, which were solely due to their incorporation expenses. To reduce compliance burdens in respect of these expenses, a separate business deduction will be provided for these expenditures, such that the first $3,000 of these expenditures will be treated as a current expense rather than being added to the new CCA class. This will allow approximately 80 per cent of newly incorporated businesses to deduct the full amount of the incorporation expenses in their initial year.

This measure, including the transitional rules, will apply as of January 1, 2017

Mineral Exploration Tax Credit

The 15 per cent Mineral Exploration Tax Credit (METC) is scheduled to expire on March 31, 2016. Budget 2016 proposes to extend the credit for an additional year, until March 31, 2017.