2023 Federal budget commentary

Introduction

The Honourable Chrystia Freeland, Deputy Prime Minister and Minister of Finance, today tabled her third budget – “A Made in Canada Plan” – which plans to build a stronger, more sustainable, and a more secure Canadian economy – for everyone.

Budget 2023 focuses on:

• New targeted inflation relief for the Canadians who need it most;
• Stronger public health care, including dental care for millions of Canadians;
• Significant investments to build Canada’s clean economy, create good middle class careers, and help usher in a new era of economic prosperity for Canadians; and
• A responsible fiscal plan that will see Canada maintain the lowest deficit and the lowest net debt to GDP ratio in the G7.

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

Personal Income Tax Measures

Budget 2023 does not propose any changes to personal tax rates, and does not propose changes to the capital gains inclusion rate.

Employee Ownership Trusts

Budget 2023 proposes new rules to facilitate the use of Employee Ownership Trusts (EOTs) to acquire and hold shares of a business. The new rules would define qualifying conditions to be an EOT and propose changes to tax rules to facilitate the establishment of EOTs.

Qualifying Conditions

A trust would be considered an EOT if it is a Canadian resident trust (excluding deemed resident trusts) and has only two purposes. First, it would hold shares of qualifying businesses for the benefit of the employee beneficiaries of the trust. Second, it would make distributions to employee beneficiaries, where reasonable, under a distribution formula that could only consider an employee’s length of service, remuneration, and hours worked. Otherwise, all beneficiaries must generally be treated in a similar manner.

An EOT would be required to hold a controlling interest in the shares of one or more qualifying businesses. All or substantially all of an EOT’s assets must be shares of qualifying businesses. A qualifying business would need to meet certain conditions, including that all or substantially all of the fair market value of its assets are attributable to assets used in an active business carried on in Canada. An EOT would not be permitted to allocate shares of qualifying businesses to individual beneficiaries. A qualifying business must not carry on its business as a partner to a partnership.

Governance

When an existing business is sold to an EOT, individuals and their related persons who held a significant economic interest in the existing business prior to the sale would not be able to account for more than 40% of:

• the trustees of the EOT;
• directors of the board of a corporation serving as a trustee of the EOT; or
• directors of any qualifying business of the EOT.

Trust Beneficiaries

Beneficiaries of the trust must consist exclusively of qualifying employees. Qualifying employees include individuals employed by a qualifying business and any other business it controls, with the exclusion of employees who are significant economic interest holders, or have not completed a reasonable probationary period of up to 12 months.

Individuals and their related persons who hold, or held prior to the sale to an EOT, a significant economic interest in a qualifying business of the EOT would also be excluded from being qualifying employees.

Tax Treatment

The EOT would be a taxable trust and would therefore generally be subject to the same rules as other personal trusts. Undistributed trust income would be taxed in the EOT at the top personal marginal tax rate, whereas trust income distributed from an EOT to its beneficiaries would not be subject to tax at the trust level but at the beneficiary level.

Qualifying Business Transfer

A qualifying business transfer would occur when a taxpayer disposes of shares of a qualifying business for no more than fair market value. The shares must be disposed of to either a trust that qualifies as an EOT immediately after the sale or a corporation wholly‑owned by the EOT. The EOT must own a controlling interest in the qualifying business immediately after the qualifying business transfer.

Facilitating the Establishment of EOTs

In order to facilitate the establishment of EOTs, certain existing tax rules would be modified.

Ten‑Year Capital Gains Reserve

Budget 2023 proposes to extend the five‑year capital gains reserve to a ten‑year reserve for qualifying business transfers to an EOT. A minimum of 10% of the gain would be required to be brought into income each year, creating a maximum ten‑year deferral period. All individuals who disposed of shares in a qualifying business transfer would be eligible to claim the proposed expanded capital gains reserve.

Exception to Shareholder Loan Rules

Budget 2023 proposes to introduce a new exception to extend the repayment period from 1 to 15 years for amounts loaned to the EOT from a qualifying business to purchase shares in a qualifying business transfer.

Exception to 21‑Year Rule

Budget 2023 proposes to exempt EOTs from the 21‑year deemed disposition rule. If a trust no longer meets the conditions to be considered an EOT, the 21‑year rule would be reinstated until the trust next meets the EOT conditions.

The amendments listed above would apply as of January 1, 2024.

The Grocery Rebate

Budget 2023 proposes to introduce a one‑time increase to the maximum Goods and Services Tax Credit (GSTC) amount for January 2023 that would be known as the Grocery Rebate. Eligible individuals would receive an additional GSTC amount equivalent to twice the amount received for January. The Grocery Rebate would be paid as soon as possible following the passage of legislation, through the GSTC system. The maximum amount under the Grocery Rebate would be:

• $153 per adult;
• $81 per child; and
• $81 for the single supplement.

To legislate this change, the maximum GSTC amount for January 2023 would be replaced with an amount that is triple the maximum for that month under the current rules. For the January 2023 replacement payment only, the phase‑in and phase‑out rates would be tripled to 6% from 2% and to 15% from 5%, respectively. This ensures that the Grocery Rebate would be fully phased in and phased out at the same income levels as under the current GSTC rules for the 2022‑23 benefit year. There would be no change to the income thresholds at which the single supplement phases in and GSTC entitlement phases out.

Deduction for Tradespeople’s Tool Expenses

Budget 2023 proposes to double the maximum employment deduction for tradespeople’s tools from $500 to $1,000, effective for 2023 and subsequent taxation years.

Strengthening the Intergenerational Business Transfer Framework

Budget 2023 proposes to amend the rules introduced by Bill C‑208 to ensure that they apply only where a genuine intergenerational business transfer takes place.

A genuine intergenerational share transfer would be a transfer of shares of a corporation (the Transferred Corporation) by a natural person (the Transferor) to another corporation (the Purchaser Corporation) where a number of conditions are satisfied.

The following existing conditions would be maintained:

• each share of the Transferred Corporation must be a “qualified small business corporation share” or a “share of the capital stock of a family farm or fishing corporation” (both as defined in the Income Tax Act (ITA)), at the time of the transfer; and
• the Purchaser Corporation must be controlled by one or more persons each of whom is an adult child of the Transferor (the meaning of “child” for these purposes would include grandchildren, step-children, children‑in‑law, nieces and nephews, and grandnieces and grandnephews).

To ensure that only genuine intergenerational share transfers are excluded from the application of Section 84.1 of the ITA, additional conditions are proposed to be added. To provide flexibility, it is proposed that taxpayers who wish to undertake a genuine intergenerational share transfer may choose to rely on one of two transfer options:

• an immediate intergenerational business transfer (three‑year test) based on arm’s length sale terms; or
• a gradual intergenerational business transfer (five‑to‑ten‑year test) based on traditional estate freeze characteristics (an estate freeze typically involves a parent crystalizing the value of their economic interest in a corporation to allow future growth to accrue to their children while the parent’s fixed economic interest is then gradually diminished by the corporation repurchasing the parent’s interest).

The immediate transfer rule would provide finality earlier in the process, though with more stringent conditions. In recognition of the fact that not all business transfers are immediate, the gradual transfer rule would provide additional flexibility for those who choose that approach.

Both the immediate and gradual business transfer options would reflect the hallmarks of a genuine intergenerational business transfer.

The rules introduced by Bill C‑208 that apply to subsequent share transfers by the Purchaser Corporation and the lifetime capital gains exemption are proposed to be replaced by relieving rules that would apply upon a subsequent arm’s length share transfer or upon the death or disability of a child. There would be no limit on the value of shares transferred in reliance upon this rule.

The Transferor and child (or children) would be required to jointly elect for the transfer to qualify as either an immediate or gradual intergenerational share transfer. The child (or children) would be jointly and severally liable for any additional taxes payable by the Transferor, because of Section 84.1 of the ITA applying, in respect of a transfer that does not meet the above conditions. The joint election and joint and several liability recognize that the actions of the child could potentially cause the parent to fail the conditions and to be reassessed under Section 84.1.

In order to provide the Canada Revenue Agency (CRA) with the ability to monitor compliance with these conditions and to assess taxpayers that do not so comply, the limitation period for reassessing the Transferor’s liability for tax that may arise on the transfer is proposed to be extended by three years for an immediate business transfer and by ten years for a gradual business transfer.

Budget 2023 also proposes to provide a ten‑year capital gains reserve for genuine intergenerational share transfers that satisfy the above proposed conditions.

These measures would apply to transactions that occur on or after January 1, 2024.

Registered Education Savings Plans

Budget 2023 proposes to amend the ITA such that the terms of a Registered Education Savings Plan (RESP) may permit Educational Assistance Payment (EAP) withdrawals of up to $8,000 in respect of the first 13 consecutive weeks of enrollment for beneficiaries enrolled in full‑time programs, and up to $4,000 per 13‑week period for beneficiaries enrolled in part‑time programs.

Budget 2023 also proposes to enable divorced or separated parents to open joint RESPs for one or more of their children, or to move an existing joint RESP to another promoter.

These changes come into force on Budget Day.

Retirement Compensation Arrangements

Budget 2023 proposes to amend the ITA so that fees or premiums paid for the purposes of securing or renewing a letter of credit (or a surety bond) for a Retirement Compensation Agreement (RCA) that is supplemental to a registered pension plan will not be subject to the refundable tax.

This change would apply to fees or premiums paid on or after Budget Day.

Budget 2023 also proposes to allow employers to request a refund of previously remitted refundable taxes in respect of fees or premiums paid for letters of credit (or surety bonds) by RCA trusts, based on the retirement benefits that are paid out of the employer’s corporate revenues to employees that had RCA benefits secured by letters of credit (or surety bonds). Employers would be eligible for a refund of 50% of the retirement benefits paid, up to the amount of refundable tax previously paid.

This change would apply to retirement benefits paid after 2023.

Registered Disability Savings Plan

A temporary measure, which is legislated to expire on December 31, 2023, allows a qualifying family member, who is a parent, spouse or common‑law partner, to open a Registered Disability Savings Plan (RDSP) and be the plan holder for an adult whose capacity to enter into an RDSP contract is in doubt, and who does not have a legal representative.

Budget 2023 proposes to extend the qualifying family member measure by three years, to December 31, 2026. A qualifying family member who becomes a plan holder before the end of 2026 could remain the plan holder after 2026.

To increase access to RDSPs, Budget 2023 also proposes to broaden the definition of ‘qualifying family member’ to include a brother or sister of the beneficiary who is 18 years of age or older. This will enable a sibling to establish an RDSP for an adult with mental disabilities whose ability to enter into an RDSP contract is in doubt and who does not have a legal representative.

This proposed expansion of the existing qualifying family member definition would apply as of royal assent of the enabling legislation and be in effect until December 31, 2026. A sibling who becomes a qualifying family member and plan holder before the end of 2026 could remain the plan holder after 2026.

Alternative Minimum Tax for High‑Income Individuals

To better target the Alternative Minimum Tax (AMT) to high‑income individuals, Budget 2023 proposes several changes to its calculation.

Capital Gains and Stock Options

The government proposes to increase the AMT capital gains inclusion rate from 80% to 100%. Capital loss carry forwards and allowable business investment losses would apply at a 50% rate.

It is also proposed that 100% of the benefit associated with employee stock options would be included in the AMT base.

Donations of Publicly Listed Securities

The government proposes to include 30% of capital gains on donations of publicly listed securities in the AMT base, mirroring the AMT treatment of capital gains eligible for the lifetime capital gains exemption. The 30‑per‑cent inclusion would also apply to the full benefit associated with employee stock options to the extent that a deduction is available because the underlying securities are publicly listed securities that have been donated.

Deductions and Expenses

Under the new rules, the AMT base would be broadened by disallowing 50% of the following deductions:

• employment expenses, other than those to earn commission income;
• deductions for Canada Pension Plan, Quebec Pension Plan, and Provincial Parental Insurance Plan contributions;
• moving expenses;
• child care expenses;
• disability supports deduction;
• deduction for workers’ compensation payments;
• deduction for social assistance payments;
• deduction for Guaranteed Income Supplement and Allowance payments;
• Canadian armed forces personnel and police deduction;
• interest and carrying charges incurred to earn income from property;
• deduction for limited partnership losses of other years;
• non‑capital loss carryovers; and
• Northern residents deductions.

Expenses associated with film property, rental property, resource property, and tax shelters that are limited under the existing AMT rules would continue to be limited in the same manner.

Non‑Refundable Credits

Currently, most non‑refundable tax credits can be credited against the AMT. The government proposes that only 50% of non‑refundable tax credits would be allowed to reduce the AMT, subject to the following exceptions:

• the Special Foreign Tax Credit would continue to be allowed in full, and would be based on the new AMT tax rate; and
• the proposed AMT would continue to use the cash (i.e., not grossed‑up) value of dividends and fully disallow the Dividend Tax Credit.

Raising the AMT Exemption

The government proposes to increase the exemption from $40,000 to the start of the fourth federal tax bracket. Based on expected indexation for the 2024 taxation year, this would be approximately $173,000. The exemption amount would be indexed annually to inflation.

Increasing the AMT Rate

The government proposes to increase the AMT rate from 15% to 20.5%, corresponding to the rates applicable to the first and second federal income tax brackets, respectively.

The proposed changes would come into force for taxation years that begin after 2023.

Proceed to part 2