Finance Minister Chrystia Freeland tabled the 2023 Federal budget on March 28th that projects the deficit to be $40.1 billion, representing an increase in the deficit by $10 billion, higher than originally forecasted last fall. The increased projected deficit is being attributed to declining economic growth and on new spending initiatives including the national dental program.
The budget is being promoted as a plan to reduce the impacts of inflation while focusing on new tax incentives to stimulate clean energy investments.
- A one-time “grocery rebate,” which will provide eligible families with up to $467, while single people with no kids could get up to $234.
- Changes to the rules involving “Employee Ownership Trusts”.
- Increase in the Tradespeople’s Tool Expense Deduction from $500 to $1,000.
- Registered Education Savings Plan (RESP) withdrawal limit increases.
- Broadening of the application of Alternative Minimum Tax (AMT).
- Updates to the rules introduced under Bill C-208 that were aimed to assist with intergenerational transfer of family farms and businesses.
- Expansion of the “General Anti-Avoidance Rule” (GAAR) to prevent perceived abusive tax avoidance.
- A $13-billion plan to expand dental care to families earning less than $90,000 a year.
Income Tax Measures
Intergenerational Business Transfers
The Canadian income tax system aims to achieve neutrality by ensuring that income earned directly by a Canadian-resident individual is taxed at roughly the same rate as income that is earned through a corporation. This objective is commonly referred to as integration.
Because capital gains are generally subject to a lower tax rate than dividends, individuals may seek to obtain significant tax benefits by entering into a series of transactions aimed at converting corporate distributions of after-tax business income from their corporations (ordinarily taxed as dividends) into lower-taxed capital gains. This practice undermines integration, resulting in individuals who earn the same amount of income having significantly different tax liabilities. Section 84.1 of the Income Tax Act is designed to address this type of tax planning by re-characterizing the capital gain as a dividend.
A private member’s bill from the 43rd Parliament (Bill C-208), introduced an exception to section 84.1, effective June 29, 2021, for certain share transfers from parents to corporations owned by their children or grandchildren.
Bill C-208 Follow-up
Although the stated purpose of Bill C-208 was to facilitate intergenerational business transfers in circumstances where section 84.1 inappropriately applied, the rules introduced by Bill C-208 contain insufficient safeguards and are available where no transfer of a business to the next generation has taken place.
More specifically, the amendments introduced by Bill C-208 do not require that:
- the parent cease to control the underlying business of the corporation whose shares are transferred,
- the child have any involvement in the business,
- the interest in the purchaser corporation held by the child continue to have value, or
- the child retain an interest in the business after the transfer.
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), 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, 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 following table outlines the proposed conditions to qualify as a genuine intergenerational business transfer under both options (transfers to grandchildren, nieces, and nephews would also qualify).
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 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 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.
Capital Gains Reserve
Budget 2023 also proposes to provide a ten-year capital gains reserve for genuine intergenerational share transfers that satisfy the above proposed conditions.
Coming into Force
These measures would apply to transactions that occur on or after January 1, 2024.
Alternative Minimum Tax for High-Income Individuals
The Alternative Minimum Tax (AMT) is a parallel tax calculation that allows fewer deductions, exemptions, and tax credits than under the ordinary income tax rules, and that currently applies a flat 15-per-cent tax rate with a standard $40,000 exemption amount instead of the usual progressive rate structure.
The taxpayer pays the AMT or regular tax, whichever is highest. Additional tax paid as a result of the AMT can generally be carried forward for seven years and can be credited against regular tax to the extent regular tax exceeds AMT in those years. The AMT does not apply in the year of death.
To better target the AMT to high-income individuals, Budget 2023 proposes several changes to its calculation. Key design features of the new AMT regime are described in detail below. Additional details will be released later this year.
Broadening the AMT Base
A number of changes are proposed to broaden the AMT base by further limiting tax preferences (i.e., exemptions, deductions, and credits).
Capital Gains and Stock Options
The government proposes to increase the AMT capital gains inclusion rate from 80 per cent to 100 per cent. Capital loss carry forwards and allowable business investment losses would apply at a 50-per-cent rate.
It is also proposed that 100 per cent of the benefit associated with employee stock options would be included in the AMT base.
Lifetime Capital Gains Exemption
Under current rules, 30 per cent of capital gains eligible for the lifetime capital gains exemption are included in the AMT base. The government proposes to maintain this treatment.
Donations of Publicly Listed Securities
The government proposes to include 30 per cent 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 per cent 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.
Currently, most non-refundable tax credits can be credited against the AMT. The government proposes that only 50 per cent 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.
The proposed AMT would continue to use the cash (i.e., not grossed-up) value of dividends and fully disallow the Dividend Tax Credit.
Some non-refundable credits that are currently disallowed would continue to be disallowed in full: the Political Contribution Tax Credit, the Labour Sponsored Venture Capital Corporations Credit, and the non-refundable portion of investment tax credits.
Raising the AMT Exemption
The exemption amount is a deduction available to all individuals (excluding trusts, other than graduated rate estates) that is intended to protect lower and middle-income individuals from the AMT.
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 per cent to 20.5 per cent, corresponding to the rates applicable to the first and second federal income tax brackets, respectively.
Carry Forward Period
The length of the carry forward would be maintained at seven years.
Treatment of Trusts
Trusts that are currently exempt from the AMT would continue to be exempt. The government will continue to examine whether additional types of trusts should be exempt from the AMT.
Coming into Force
The proposed changes would come into force for taxation years that begin after 2023.
Employee Ownership Trusts
An Employee Ownership Trust (EOT) is a form of employee ownership where a trust holds shares of a corporation for the benefit of the corporation’s employees. EOTs can be used to facilitate the purchase of a business by its employees, without requiring them to pay directly to acquire shares. For business owners, an EOT provides an additional option for succession planning.
Budget 2023 proposes new rules to facilitate the use of 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.
These changes would extend the capital gains reserve to ten years for qualifying sales to an EOT, create an exception to the current shareholder loan rule, and exempt EOTs from the 21-year deemed disposition rule that applies to certain trusts.
The following subsections describe the qualifying conditions and general rules that would apply to EOTs. Additional restrictions may be included, as necessary, to protect the integrity of the tax system.
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.
The trustees, including corporations that serve as trustees, would be required to be Canadian residents (excluding deemed residents). Trust beneficiaries (ages 18 and older) would elect the trustees at least once every five years. 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 per cent 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.
Beneficiaries of the trust must consist exclusively of qualifying employees. Qualifying employees would include all individuals employed by a qualifying business and any other qualifying businesses 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.
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. If the EOT distributes dividends received from qualifying businesses, those dividends would retain their character when received by employee beneficiaries and would therefore be eligible for the dividend tax credit.
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
To better accommodate the establishment and use of EOTs, certain existing tax rules would be modified.
Ten-Year Capital Gains Reserve
When taxpayers receive proceeds of a sale of capital property on a deferred basis, they are permitted to defer recognition of the capital gain until the year in which they receive proceeds. A minimum of 20 per cent of the gain must be brought into income each year, creating a maximum five-year deferral period. It is anticipated that sales to an EOT could have an extended period of deferred consideration.
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 ten per cent 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
Taxpayers who receive a shareholder loan are generally required to include the loaned amount in income in the year the loan is received, unless the loan is repaid within a year. If an EOT were to borrow from a qualifying business to finance the purchase of shares in a qualifying business transfer, the EOT would be required to repay borrowed amounts within one year of the qualifying business’ taxation year end to avoid paying taxes on the loaned amount.
Budget 2023 proposes to introduce a new exception to extend the repayment period from one 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
To prevent the indefinite deferral of tax on accrued capital gains, certain trusts are deemed to dispose of their capital property at 21-year intervals. An EOT is intended to allow for shares to be held indefinitely for the benefit of employees. Consequently, the 21-year rule could create a significant tax liability for the EOT.
Budget 2023 proposes to exempt EOTs from the 21-year 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.
Coming into Force
These amendments would apply as of January 1, 2024.
Deduction for Tradespeople’s Tool Expenses
Under the deduction for tradespeople’s tool expenses, a tradesperson can claim a deduction of up to $500 of the amount by which the total cost of eligible new tools acquired in a taxation year as a condition of employment exceeds the amount of the Canada Employment Credit ($1,368 in 2023). The total cost of eligible new tools cannot exceed the total of the employment income earned as a tradesperson and any apprenticeship grants received to acquire the tools, which are required to be included in income.
Budget 2023 proposes to double the maximum employment deduction for tradespeople’s tools from $500 to $1,000.
As a consequence of this change, extraordinary tool costs that are eligible to be deducted under the apprentice vehicle mechanics’ tools deduction would be those costs that exceed the combined amount of the increased deduction for tradespeople’s tool expenses ($1,000) and the Canada Employment Credit ($1,368 in 2023) or five per cent of the taxpayer’s income earned as an apprentice mechanic (including from apprenticeship grants), whichever is greater.
Coming into Force
These amendments would apply for 2023 and subsequent taxation years.
Registered Education Savings Plans
Registered Education Savings Plans (RESPs) are tax-assisted savings vehicles designed to help families accumulate savings for the post-secondary education of their children. Contributions to RESPs may be eligible for government matching grants, such as the Canada Education Savings Grant. Low- and middle-income families may also qualify for Additional Canada Education Savings Grants or the Canada Learning Bond.
Increasing Education Assistance Payment Withdrawal Limits
When an RESP beneficiary is enrolled in an eligible post-secondary program, government grants and investment income can be withdrawn from the plan as Educational Assistance Payments (EAPs) in order to assist with post-secondary education-related expenses. EAPs are taxable income for the RESP beneficiary.
The Income Tax Act requires that RESPs place limits on the amount of EAPs that can be withdrawn. For beneficiaries enrolled full-time (i.e., in a program of at least three consecutive weeks’ duration requiring at least 10 hours per week of courses or work in the program), the limit is $5,000 in respect of the first 13 consecutive weeks of enrollment in a 12-month period. For beneficiaries enrolled part-time (i.e., in a program of at least three consecutive weeks’ duration requiring at least 12 hours per month of courses in the program), the limit is $2,500 per 13-week period.
Budget 2023 proposes to amend the Income Tax Act such that the terms of an RESP may permit 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.
These changes would come into force on Budget Day. RESP promoters may need to amend the terms of existing plans in order to apply the new EAP withdrawal limits. Individuals who withdrew EAPs prior to Budget Day may be able to withdraw an additional EAP amount, subject to the new limits and the terms of the plan. The Income Tax Act allows for EAPs to be withdrawn up to six months after a beneficiary ceases to be enrolled in an eligible program.
Allowing Divorced or Separated Parents to Open Joint RESPs
At present, only spouses or common-law partners can jointly enter into an agreement with an RESP promoter to open an RESP. Parents who opened a joint RESP prior to their divorce or separation can maintain this plan afterwards, but are unable to open a new joint RESP with a different promoter.
Budget 2023 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.
Coming into Force
This change would come into force on Budget Day.
General Anti-Avoidance Rule
The general anti-avoidance rule (GAAR) in the Income Tax Act is intended to prevent abusive tax avoidance transactions while not interfering with legitimate commercial and family transactions. If abusive tax avoidance is established, the GAAR applies to deny the tax benefit created by the abusive transaction.
A consultation on various approaches to modernizing and strengthening the GAAR has recently been conducted. A consultation paper released last August identified a number of issues with the GAAR and set out potential ways to address them. As part of the consultation, the government received a number of submissions, representing a wide variety of viewpoints.
To respond to the issues raised in the paper taking into account stakeholder feedback, Budget 2023 proposes to amend the GAAR by: introducing a preamble; changing the avoidance transaction standard; introducing an economic substance rule; introducing a penalty; and extending the reassessment period in certain circumstances.
A preamble would be added to the GAAR, in order to help address interpretive issues and ensure that the GAAR applies as intended. It would address three areas where questions have arisen.
While the GAAR informs the interpretation of, and applies to, every other provision of the Income Tax Act, it fundamentally denies tax benefits sought to be obtained through abusive tax avoidance transactions. It in effect draws a line: while taxpayers are free to arrange their affairs so as to obtain tax benefits intended by Parliament, they cannot misuse or abuse the tax rules to obtain unintended benefits.
As noted in the original explanatory notes accompanying the GAAR, it is intended to strike a balance between taxpayers’ need for certainty in planning their affairs and the government’s responsibility to protect the tax base and the fairness of the tax system. “Fairness” in this sense is used broadly, reflecting the unfair distributional effects of tax avoidance as it shifts the tax burden from those willing and able to avoid taxes to those who are not.
Finally, the preamble would also clarify that the GAAR is intended to apply regardless of whether or not the tax planning strategy used to obtain the tax benefit was foreseen.
The threshold for the avoidance transaction test in the GAAR would be reduced from a “primary purpose” test to a “one of the main purposes” test. This is consistent with the standard used in many modern anti-avoidance rules and strikes a reasonable balance, as it would apply to transactions with a significant tax avoidance purpose but not to transactions where tax was simply a consideration.
The consultation paper raised a number of other issues with the avoidance transaction test, such as whether the avoidance of foreign tax should be considered a bona fide purpose. It is anticipated that this measure would produce appropriate results in circumstances where the issues arise and so, specific amendments to address these issues are not proposed.
A rule would be added to the GAAR so that it better meets its initial objective of requiring economic substance in addition to literal compliance with the words of the Income Tax Act. Currently, Supreme Court of Canada jurisprudence has established a more limited role for economic substance.
The proposed amendments would provide that economic substance is to be considered at the ‘misuse or abuse’ stage of the GAAR analysis and that a lack of economic substance tends to indicate abusive tax avoidance. A lack of economic substance will not always mean that a transaction is abusive. It would still be necessary to determine the object, spirit and purpose of the provisions or scheme relied upon, in line with existing GAAR jurisprudence. In cases where the tax results sought are consistent with the purpose of the provisions or scheme relied upon, abusive tax avoidance would not be found even in cases lacking economic substance. To the extent that a transaction lacks economic substance, the new rule would apply; otherwise, the existing misuse or abuse jurisprudence would continue to be relevant.
The amendments would provide indicators for determining whether a transaction or series of transactions is lacking in economic substance. These are not an exhaustive list of factors that might be relevant and different indicators might be relevant in different cases. However, in many cases, the existence of one or more of these indicators would strongly point to a transaction lacking economic substance. These indicators are: whether there is the potential for pre-tax profit; whether the transaction has resulted in a change of economic position; and whether the transaction is entirely (or almost entirely) tax motivated.
The transfer of funds by an individual from a taxable account to a tax-free savings account provides a simple example of how the analysis could apply. Such a transfer could be considered to be entirely tax motivated, with no change in economic position or potential for profit other than as a result of tax savings. Even if the transfer is considered to be lacking in economic substance, it is clearly not a misuse or abuse of the relevant provisions of the Income Tax Act. The individual is using their tax-free savings account in precisely the manner that Parliament intended. There are contribution rules that specifically contemplate such a transfer and, perhaps more fundamentally, the basic tax-free savings account rules would not work if such a transfer was considered abusive.
The proposal would not supplant the general approach under Canadian income tax law, which focuses on the legal form of an arrangement. In particular, it would not require an enquiry into what the economic substance of a transaction actually is (e.g., whether a particular financial instrument is, in substance, debt or equity). Rather, it requires consideration of a lack of economic substance in the determination of abusive tax avoidance.
A penalty would be introduced for transactions subject to the GAAR, equal to 25 per cent of the amount of the tax benefit. Where the tax benefit involves a tax attribute that has not yet been used to reduce tax, the amount of the tax benefit would be considered to be nil. The penalty could be avoided if the transaction is disclosed to the Canada Revenue Agency, either as part of the proposed mandatory disclosure rules or voluntarily. This would build upon the mandatory disclosure rules and ensure that the Canada Revenue Agency has early access to the information it needs to respond quickly to tax risks through informed risk assessments, audits and changes to legislation. As such, a consequential amendment would be made to the proposed reportable transaction rules to permit voluntary reporting.
A three-year extension to the normal reassessment period would be provided for GAAR assessments, unless the transaction had been disclosed to the Canada Revenue Agency. This extension reflects the complexity of many GAAR transactions, along with the difficulties in detecting them.
The government is interested in stakeholders’ views on these proposals and interested parties are invited to send written representations to the Department of Finance Canada, Tax Policy Branch at GAAR-RGAE@fin.gc.ca by May 31, 2023. Following this period of consultation, the government intends to publish revised legislative proposals and announce the application date of the amendments.
The Grocery Rebate
The Goods and Services Tax Credit (GSTC) helps to offset the impact of the GST on low- and modest-income individuals and families. The GSTC is non-taxable, income-tested, and indexed to inflation.
Budget 2023 proposes to introduce an increase to the maximum 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.
For the 2022-23 benefit year:
- GSTC entitlement is subject to a five-per-cent phase-out rate based on the portion of 2021 adjusted family net income above $39,826;
- for single adults without children, the additional single supplement is subject to a two-per-cent phase-in rate based on the portion of 2021 net income over $9,919; and
- single parents receive an additional maximum single supplement and the adult amount for their first child (the per-child amount is provided for each additional child).