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The Budget proposes to reduce taxes by a total of $58 billion over the next 5 years, more than was expected by most observers. Specific provisions include indexing to eliminate "bracket creep", a reduction in the income tax rate for middle-income earners and phasing out of the 5% deficit reduction surtax. It also proposes increases in both 2000 and 2001 in the foreign content limits of investments held in registered pension plans, RRSPs and RRIFs. The Budget also proposes a considerable enrichment - $2.4 billion per year - of the Canada Child Tax Benefit, along with a $2.5 billion increase in the health and social transfer payments to the provinces to help fund post-secondary education and health care. Budget provisions also include a number of enhancements to the tax treatment of capital gains. They include a reduction of the inclusion rate from 3/4 to 2/3 and a tax-free rollover of capital gains on qualified investments from one small business to another. The taxation of gains on qualifying stock options has been amended in response to concerns over the "brain drain" from Canada in high-tech industries. Certain public company stock option benefits will be taxed at the time the stock is disposed of as opposed to the current taxation regime of taxing the income when the stock is received. On the business side, the Budget proposes a progressive reduction in corporate tax rates to 21% from 28% for businesses. Small businesses will enjoy the full effect of this reduction effective on January 1, 2001 on certain income. A proposed series of spending initiatives will see $4.1 billion allocated between 1999-2000 and 2002-2003 to promote innovation and leading-edge research, develop environmental technologies and practices, and strengthen government infrastructures. In presenting the Budget, the Minister noted that Canada's real GDP growth in 1999 is expected to have averaged 3.5%, with further robust growth forecast for 2000 and 2001. Inflation exclusive of food and energy was held to 1.6%, and the unemployment rate of 6.8% at the end of 1999 was the lowest in nearly 24 years, the Minister said. He also forecast that the federal budget will be balanced or better for 1999-2000 and for the next 2 fiscal years, for a record of five consecutive balanced budgets. Program spending as a percentage of GDP is expected to fall to 11.6% in 2001-2002, while growth in program spending will be held to roughly the growth in population and inflation. TABLE OF CONTENTS PERSONAL TAX CHANGES back
The Budget restores full indexing to the personal income tax system for the 2000 and subsequent taxation years. Since 1986, amounts were indexed only for increases in the Consumer Price Index in excess of 3%. Low inflation rates have resulted in no changes for many years. The indexing factor for 2000 will be 1.4%. Amounts subject to indexing include the various personal credits, the tax brackets for individuals and the thresholds for repaying government allowances, such as the Old Age Security. Examples of the amounts that have been increased for the 2000 year as a result of indexing are:
The Budget promises to increase the basic personal credit to $8,000 within 5 years. Increases to the GST credit, as a result of indexing, will apply to amounts paid after June 2000.
Tax Rates The Budget also promises to increase the income levels at which the middle and top rates of income tax apply to $35,000 and $70,000, respectively, within 5 years. The current 5% surtax applies to federal income tax over $12,500 (an income level of approximately $65,000). The Budget increases the threshold, effective July 1, 2000, to $18,500 (an income level of approximately $85,000). On an annualized basis, the threshold will be $15,500 for the 2000 year. The Budget will reduce the surtax rate to 4% in 2001 and promises to eliminate the surtax within 5 years.
Canada Child Tax Benefit
Capital Gains Inclusion Rate Individuals will be required to report gains separately in their 2000 tax returns to distinguish dispositions before February 28 and after February 27, 2000. The inclusion rate will be determined on the following basis:
The carryover of net capital losses will depend on the effective inclusion rate for 2000. The special capital gain rules for donation of marketable securities for taxation years prior to 2002 are amended to take into account this reduction in the inclusion rate to provide for the "one-half taxable treatment". A 1/3 inclusion is provided for donations after February 27, 2000 while the 3/8 inclusion applies to donations prior to February 28, 2000. Capital gains reserves deducted in a year as a result of a portion of the proceeds of disposition being payable after the end of the year are taxed in subsequent years. For taxation years beginning after February 27, 2000, the taxable portion of a previous capital gains reserve will be subject to the 2/3 inclusion rate. Consequently, where possible, the inclusion in income of previous capital gains reserves should be delayed to the 2001 taxation year for individuals and taxation years beginning after February 27, 2000 for corporations. There are several situations where the Act provides a 1/4 deduction in respect of amounts fully included in income. The Budget proposes to increase these deductions from 1/4 to 1/3 to provide the same impact as for capital gains. These increased deductions apply to general stock options, stock options for employees of Canadian-controlled private corporations (CCPCs), prospectors' and grubstakers' shares, and employees' shares from a deferred profit-sharing plan. The $500,000 capital gains exemption for shares of a qualified small business corporation and qualified farm property will take into account this reduction in the capital gains inclusion rate. Consequently, the maximum deduction for this exemption will be reduced from $375,000 at the 3/4 rate to $333,333 at the 2/3 rate.
Capital Gains Rollover for Investment in Small Business The deferral will be available for capital gains realized after February 27, 2000 on the disposition of an eligible small business investment. There is no limit on the total amount of proceeds that can be reinvested but it cannot exceed the capital gain on an original investment of $500,000. In addition, the amount reinvested in shares of any particular corporation or related group cannot exceed $500,000. An eligible small business investment has the following characteristics:
A small business corporation is a CCPC where all or substantially all of the value of the assets are used in an active business carried on primarily in Canada, or are shares of other related small business corporations. An eligible active business corporation has a similar definition except that it does not have to be a CCPC throughout the time the investment is held. This means the investment could become a public corporation without disqualifying it. There will be look-through rules to account for assets held by the corporation through partnerships and trusts. The eligible small business investment must be held for more than 6 months to qualify. The replacement eligible small business investment must be purchased after the beginning of the year of the disposition and before the earlier of 120 days after the disposition and 60 days after the end of the year. The measure will also be available for capital gains on eligible investments held through a qualifying pooling arrangement. For the purpose of these rules, a special-purpose partnership will be treated as a joint venture allowing each investor to have their own share portfolio within the vehicle.
Employee Stock Option This deferral is not available for an employee who is a specified shareholder at the time the option was granted. A specified shareholder means a taxpayer, along with non-arm's length parties, who owns 10% or more of the shares of any class of the corporation. This restriction for a specified shareholder applies to shareholders of the employer, the corporation granting the option or the corporation whose shares could be acquired under the option. The deferral will not be available unless the exercise price under the option was the fair market value of the share when the option was granted. The security also must be listed on a prescribed stock exchange either in Canada or outside of Canada. The deferral is available to a maximum of $100,000 of security value vested per year. The security value is based on the value of the security at the time the options are granted. However, there are no restrictions on how many of the vested options can be exercised in any given year. In order for the employee to defer the stock option benefit, the employer will have to establish reporting arrangements to monitor compliance with the $100,000 limit and report the stock option benefit and related deduction when the shares are sold. Consultations will be held on the design of appropriate reporting arrangements. It is intended that employers will have reporting arrangements in place by the end of this year.
Donation of Stock Option Shares An individual will be allowed an additional deduction of 1/3 of the employment benefit realized on the exercise of the option, based on the lesser of the value of the shares at the time the option was exercised and the value of the shares at the time the shares are donated. The net result of this proposal, along with the proposal to increase the regular stock option deduction from 1/4 to 1/3, is that only 1/3 of the value is subject to tax. As this additional deduction is reduced for declines in value after exercise, the shares should be donated immediately upon exercise of the options. The shares must be donated within 30 days after their acquisition and in the year they are acquired. In order for the shares to qualify, the exercise price to acquire the shares must have been at least equal to the fair market value at the time the option was granted.
Foreign Property Content of Deferred Income Plans Under existing rules, every $1.00 invested by a deferred income plan in qualifying small business properties generates an additional $3.00 of foreign property investment limit, but total foreign content cannot exceed 40% of the cost of the plan's assets. The Budget does not change the 3 for 1 ratio. However, the foreign content maximum for deferred income plans holding qualifying small business investments will be raised to 45% for 2000 and 50% thereafter. The foreign property content rules will apply to segregated funds after 2001, rather than after 2000, as previously announced.
Disability Tax Credit A $2,941 supplement has been added, starting in 2000, to the disability credit base for disabled individuals under age 18. This amount is reduced by child and/or attendant care expenses claimed in excess of $2,000. The supplement and expense threshold will be indexed after 2000. Currently, unused disability credits may be transferred to a supporting spouse, parent, grandparent, child or grandchild. Effective for 2000 and subsequent years, unused credits may also be transferred to a supporting sibling, aunt, uncle, niece or nephew.
Child Care Expenses for Disabled Children
Medical Expenses
Attendant Care Expenses
Employment Insurance Parental Benefits
Personal Use Property
Charitable Donations For gifts of ecologically sensitive land to government or approved registered charities after February 27, 2000, the capital gains inclusion rate on any resulting gain will be cut in half, to 1/3 from 2/3.
Interest Offset
Scholarships, Bursaries and Fellowships
Non-Resident Individual Surtax
Same-Sex Couples
Presently, the general corporate tax rate for non-manufacturing active business income earned in Canada, is 28%. The Budget proposes to reduce this rate to 21% within 5 years. Effective January 1, 2001, the Budget allows a deduction which will reduce the corporate tax rate to 27%, prorated for taxation years that straddle that date. This beneficial tax deduction will not be available for investment corporations, mortgage investment corporations, mutual fund corporations, or non-resident owned investment corporations. A non-CCPC may claim the deduction from its federal tax otherwise payable, equal to 1% of the amount by which the corporation's taxable income for the year exceeds the total of:
a) its income for the year subject to the manufacturing and processing profits deduction;
A CCPC may also claim the deduction from its federal tax otherwise payable, as calculated above, but further reduced by its income for the year subject to the small business deduction, the corporation's aggregate investment income, and the amount of income subject to the accelerated tax reduction (as described below).
Accelerated Tax Reduction for Small Business A corporation that was throughout its taxation year a CCPC, may claim a deduction from its tax otherwise payable, equal to 7% of the amount by which the least of:
a) 150% of the corporation's small business deduction limit for the year;
exceeds the total of
d) its income for the year which is subject to the manufacturing and processed profits deduction;
There are special rules to allow this deduction to income earned through partnerships.
Summary of Federal Corporate Tax Rates
Thin Capitalization Rules The Budget proposes several changes to the thin capitalization rules for taxation years that begin after 2000:
1) The threshold debt to equity ratio will be lowered from 3:1 to 2:1.
Consultations will be held to determine if the thin capitalization rules should be expanded to entities other than corporations (i.e., partnerships that have non-resident members, trusts that have non-resident beneficiaries, and Canadian branches of non-resident companies carrying on business in Canada) and to debt substitutes, such as certain types of leases.
Capital Cost Allowance (CCA) System
1) A separate class election will be provided for class 43 M&P equipment costing more than $1,000, acquired after February 27, 2000. The UCC in each separate class, that is remaining after 5 years, must be transferred into the general class 43 UCC pool.
Scientific Research and Experimental Development ("SRED") If the expenditure limit for the corporation is nil, the government assistance will amount to the excess deduction multiplied by the maximum provincial tax rate applicable to active business income earned in the province by the corporation for the year. In any other case (typically, a CCPC whose taxable income in the preceding taxation year, coupled with the taxable incomes of its associated corporations, is less than $400,000), the government assistance will amount to the excess deduction multiplied by the provincial tax rate applicable to small business income earned in the province by the corporation for the year. There are currently numerous disputes between the government and taxpayers regarding SRED tax credits for internally developed software. The government feels that claims made by corporations whose core business is not software development are merely applications of available technology and are not activities the SRED program is intended to benefit. The government intends to hold consultations with industry to ensure current guidelines reflect government policy. If required, the government has committed to making amendments to the Income Tax Act.
Manufacturing and Processing (M&P) Tax Credit
Capital Tax Surcharge on Large Deposit-Taking Institutions
Non-resident Owned Investment Corporations ("NRO")
Weak Currency Borrowings Furthermore, any foreign exchange gain or loss realized on the repayment of such debt, and the gain or loss on any associated hedge, will be treated as business income. The above measures will apply as of July 1, 2000, in respect of indebtedness incurred after February 27, 2000. This measure will not apply to corporations whose principal business is the lending of money.
Foreign Tax Credit on Oil and Gas Production Sharing Agreements Many oil and gas producers operate in countries which impose levies under "production sharing agreements" involving the Canadian producer and the foreign government. These countries also generally impose an income tax. In such situations, confusion can arise as to whether or not the foreign government's share is in respect of production generated under the agreement or in satisfaction of the producer's income tax liability to that government. Canadian producers will receive a business foreign tax credit only to the extent an income or profits tax is paid to the foreign country. As a result, no credit will be available for payments made to the foreign government pursuant to a production sharing agreement. The Budget proposals will require that, for the payment to a foreign government to qualify for a business foreign tax credit, the amount must be computed with reference to net income, after recognition of relevant expenses. Further to this, the amount paid under the agreement must not be either a royalty or any other consideration paid for the exploitation of the resource. The Budget proposes that the amount eligible for a business foreign tax credit cannot exceed 40% of the Canadian producer's income from the business for the year. The Budget proposals will apply only where the foreign country itself levies what reasonably represents an income tax.
Foreign Exploration and Development Expenses ("FEDE") To respond to certain concerns raised with the existing FEDE provisions, the Budget proposes the following amendments:
1) To be deductible, the FEDE expenditures must be in respect of the acquisition of foreign resource property by the party incurring the expenditure.
GOODS AND SERVICES TAX (GST)/ HARMONIZED SALES TAX (HST) CHANGES back
The current GST/HST legislation imposes a cash flow burden on many export distribution centres. In order to eliminate this disincentive from carrying out such activities in Canada, qualifying export distribution centres will be able to use a certificate to purchase most inventory, parts and processing components on a GST/HST free basis. To qualify under the Export Distribution Centre Program export revenue must account for at least 90% of total Canadian revenue, and the amount of value added by the export distribution centre must stay within an as yet undetermined prescribed limit. The export-revenue and value-added tests will be applied at each year end to determine eligibility for continued use of the tax-free certificate. The Export Distribution Centre Program will come into force on January 1, 2001 so as to allow for industry consultation.
Export Trading House Program
Drop-Shipment Rules The Budget expands the list of tax-free qualifying services to include storage. Provided that the existing drop-shipment provisions are met, storage services may also be acquired on a GST/HST free basis for billings after February 28, 2000. Drop-shipment rules allowing for a GST/HST free purchase are also amended for railway rolling stock sold to unregistered non-residents. Effective for sales after February 28, 2000 railway rolling stock may be used in Canada by a non-resident for up to 60 days before export and retain its tax-free treatment. This rule accommodates current industry practice by not requiring railway rolling stock to be shipped empty to the foreign destination to qualify under the drop-shipment rule.
Exporters of Processing Services Program
GST/HST Collections
New Residential Rental Property Rebate Residential units will qualify if it can be reasonably expected that the first use of the unit will be renting it for periods of at least 12 months of continuous occupancy as a primary place of residence under one or more leases. Additionally the unit should be a self-contained residence having, at a minimum, a private kitchen, bath and living area. Typically for multiple-unit residential complexes the entire complex will be considered to meet the 12-month test if substantially all of the units meet the test. The full 2.5% rebate is available for rental units valued up to $350,000. The rebate will be phased out for values between $350,000 and $450,000 with no eligibility for rental units valued at $450,000 or more. Persons eligible for the rebate include both landlords who have paid tax on the purchase of new residential rental property or builder-landlords who have self-assessed the tax. For properties where a New Housing Rebate is also available there will be a corresponding reduction in the amount of the New Residential Rental Property Rebate. If a qualifying residential unit is first leased to an individual as a primary place of residence it will be eligible for the New Residential Rental Property Rebate. If the unit is sold within 1 year from the time it is first occupied to a purchaser who is not acquiring it for use as a primary place of residence, the amount of the rebate plus interest will be subject to recapture. Lessors of land for residential purposes are also eligible for the New Residential Rental Property Rebate in specified circumstances. The full rental rebate is available for land valued up to $87,500. The amount of the rebate will be phased out for values between $87,500 and $112,500 with no eligibility for values of $112,500 or more. Additionally, new residential trailer parks or additions leased after February 27, 2000 are eligible for the rebate. Rebate claimants will have 2 years from the end of the month in which the related tax becomes payable to claim the rebate.
Customs Duty Deferral Program Proposed changes include:
Canadian Countervailing Duty Laws
The Income Tax Act, Excise Tax Act and Customs Act will be amended to extend penalties to persons who hinder, molest or interfere with an official performing a collection function or any other duty to which that subsection currently applies.
Provision of Taxpayer Information to Police
Federal/Provincial Tax Information Sharing
Reduction in Tobacco Export Tax Exemption
Simplified Film Tax Incentives The objectives include:
The CICA wishes to gratefully acknowledge the contribution of those listed below in the preparation of this Federal Budget Commentary:
CICA has acted solely as publisher of this Federal Budget Commentary. Neither it, nor any Provincial Institute or Ordre of Chartered Accountants, nor any committee thereof, accepts any responsibility for its contents or for the use thereof. Furthermore, neither the CICA nor any person listed above involved in the preparation of this Federal Budget Commentary accept any contractual, tortuous or other form of liability for its contents or for any consequences arising from its use. |