Part I – Canadian Entrepreneurs’ Incentive (and more)

Canadian Entrepreneurs’ Incentive

The draft legislation released on Aug. 12 provides our first opportunity to review the legislation to implement the Canadian Entrepreneurs’ Incentive. Detailed in the initial Budget 2024 release in April, this program was met with a lukewarm response and industry criticism due to perceived restrictions and limitations on qualification criteria. 

Several of the narrowest provisions were adjusted to allow greater potential access to the reduced inclusion rate on certain qualifying capital gains. Many provisions also draw from the existing legislation for the Lifetime Capital Gains Exemption (“LCGE”) rules. However, the definition of “excluded business” continues to be an incredibly narrow, complicated and subjective list, which will only create uncertainty for business owners. 

These adjustments include:

• Phasing in of the lifetime limit at a rate of $400,000 per year (rather than $200,000), reaching the $2,000,000 maximum by Jan. 1, 2029, rather than Jan. 1, 2034.
• Addition of qualified farming or fishing property, assuming it meets other criteria.
• The individual no longer needs to be a founding investor of the corporation and have held the shares for five years prior to disposition.
• The individual is only required to hold five per cent (down from 10 per cent) of issued and outstanding shares (having full voting rights) throughout the two-year period immediately before disposition.
• The property does not need to be shares, can be an interest in a partnership, or some forms of convertible debts.
• The individual must be actively involved in the business for three years prior (previously five years).

Employee Ownership Trust (“EOT”) Tax Exemption / Qualifying Cooperative Conversions

The draft legislation expands on the temporary $10 million capital gains exemptions and extended 10-year capital gains reserve for qualifying business transfer, clarifies ordering rules for use of EOT exemption and other exemptions on the same sale, related employees and their arm’s length relationship with EOTs. 

The most significant expansion relates to the ordering rules and ensuring the EOT exemption is claimed ahead of the LCGE exemption, the order in which multiple EOT exemptions are available in the same tax year, and limitation introduced if there are net investment losses in the year or allowable business losses. These order rules are very circumstantial and will need to be considered both at the time of sale and at yearend, as current year gains and losses, allowable business losses and capital loss carry forwards can affect the ability to fully utilize the exemption.

Also introduced are parallel rules where the purchaser is a “worker cooperative” in substitution for the EOT. 

Accelerated capital cost allowance (CCA)

The draft legislation proposes a temporary increase in CCA rates for the following properties:

Purpose-built rental housing – Increase in CCA rate from four per cent to 10 per cent on projects that began construction after April 15, 2024, and before 2031, and are available for use before 2036. Additionally, each asset would be prescribed to be a separate class of property. 

Productivity-enhancing assets (Class 44, 46 and 50) – Immediate expensing for eligible property in these classes where property is acquired after April 14, 2024, and becomes available for use before 2027.

Non-compliance with information requests

Several additional powers were granted to the Canada Revenue Agency (CRA) to extend its ability to gather information.

The draft legislation amends the existing subsection to extend the CRA’s audit power to include administrative enforcement of tax treaties or other listed international agreements; authorize requesting returns of income, supplementary return or any document; and introduce a new notice requiring taxpayers to provide answers, information or documentation under oath, affirmation or affidavit.

Also included is the introduction of a penalty ($50 per day, to a maximum of $25,000) where the CRA obtains a compliance order against a taxpayer from a court (where the tax liability in question is greater than $50,000), and extension of powers where the CRA may issue their own compliance notices. These measures were extended to the newly added powers for tax treaties and other listed international agreements. 

Charity-related

Under the proposed legislation, qualifying foreign charities registered after April 16, 2024, will be granted qualified done status for 36 months (previously 24 months). 

All foreign charities will be required to submit an annual information return to the CRA for taxation years beginning after April 16, 2024. Requirements regarding information that must be contained in official receipts have been amended to remove some required information to simplify and streamline the issuance process.

Additional amendments were also included to expand how the CRA can communicate with charities, mostly allowing delivery of notices and assessments electronically.

EIFEL – Interest deductibility limits

The proposed legislation expands the exemption from the Excessive Interest and Financing Expenses Limitations (“EIFEL”) rules for public-private partnerships meeting certain criteria on their interest and financing expenses incurred before 2036. Generally, this is for situations where arm’s length financing is used to build, convert or acquire a purpose-built residential rental property, but also includes certain regulated energy utility businesses carried on in Canada.

Withholding for non-resident service providers

The proposed amendments would allow the CRA to waive the 15 per cent withholding tax requirement otherwise required under Reg. 105 for payment to non-residents for services provided in Canada. This only applies where the non-resident would not otherwise be subject to Canadian income tax due to a tax treaty or is otherwise exempt.

Substantive CCPCs

New proposed legislation for Substantive CCPCs focuses on situations where such entities with Controlled Foreign Affiliates (“CFAs”) earning income from business which otherwise earn income that would be subject to the Canadian Foreign Accrual Property Income (“FAPI”) regime and is receiving dividend to repatriate the surplus of these CFAs. 

The most significant change to previous draft legislation was to create a carve-out for Foreign Accrual Business Income (“FABI”) of a foreign affiliate. This FABI carve-out relates only to provision of services recharacterized as FAPI, and real estate development and leasing, and requires an election. This legislation creates additional complexity in the foreign affiliate regime.

Mutual fund corporations

The draft legislation proposes to restrict a corporation from qualifying as a mutual fund corporation if specified persons have a substantial interest (greater than 10 per cent of the FMV) in the corporation, and the corporation is controlled by or for the benefit of one or more specified persons.

Tax debt avoidance 

The proposed amendments are designed to strengthen anti-avoidance provisions by introducing supplementary rules and expansion of the joint and several liability rules applicable to transactions or series of transactions on or after April 16, 2024. These rules should result in taxpayers who engaged in tax debt avoidance planning to be liable for the full amount of the tax. 

Bankruptcy status manipulation

The draft legislation repeals the existing exception to the debt forgiveness rules for bankrupt corporations, partnerships and trusts starting proceedings on or after April 16, 2024. This results in all bankrupt individuals and entities being subject to the general debt forgiveness rules for commercial debts.

Contact your Baker Tilly advisor to learn more about how we can help you navigate the complexities of the Canadian tax system.