Canada: 2022 Federal Budget Review

Introduction

The 2022 Federal Budget was tabled in the House of Commons on April 7, 2022 by the Honourable Chrystia Freeland, Canada's Deputy Prime Minister and Minister of Finance. With a Foreword that began with a thank you to Canadians for all that they have done to deal with the COVID-19 pandemic over the last 25 months; that highlighted the economic and other implications of the war in Ukraine; and that addressed challenges of affordability-particularly in the housing sector-faced by many Canadians today, the Deputy Prime Minister introduced a series of new legislative and tax measures.

Miller Thomson's Tax Group has reviewed the tax measures proposed in Budget 2022. In this review, we outline and discuss certain key measures of relevance to our practices and our client base across Canada. We will continue to track certain measures as they evolve and-as always-welcome your questions, comments and views.

Personal Income Tax Measures

Residential Property Flipping Rules

Budget 2022 proposes a new deeming rule to address the impact of property flipping on home prices. The proposed new rules are in response to concerns that individuals are "flipping" residential real estate properties within short periods of time and either accessing capital gains tax treatment on the sale of the properties, or claiming the principal residence deduction, when full income treatment should apply.

The proposed rules will deem profits from the sale of residential property (including rental property) as business income and thus, ineligible for capital gains treatment or the principal residence exemption. Exemptions will be available for life events like death, disability, separation, insolvency, household addition, personal safety, or involuntary dispositions.

New Annual Reporting Requirements for RRSPs and RRIFs

Payments out of, and contribution to, registered retirement savings plan (RRSP) and registered retirement income fund (RRIF) must be reported by financial institutions annually.

Budget 2022 proposes to increase the reporting requirement to include the total fair market value of property held in an RRSP or RRIF at the end of the calendar year. This reporting requirement parallels similar reporting requirements for financial institutions in respect of tax-free savings accounts.

Business Income Tax Measures

Canada Recovery Dividend and Additional Tax on Banks and Life Insurers

Budget 2022 introduces a temporary Canada Recovery Dividend (CRD) on bank and life insurer groups. These measures are intended to have large financial institutions help support Canada's recovery from the COVID-19 pandemic.

The CRD consists of a one-time 15% tax that would be imposed on taxable income for taxation years ending in 2021 (pro-rated for any short taxation years) and payable in equal annual instalments over five years beginning with the 2022 taxation year. Bank and life insurer groups (consisting of a bank or life insurer and any other related financial institutions) would be permitted to allocate a $1 billion taxable income exemption amongst group members.

Budget 2022 also introduces an additional 1.5% tax on the taxable income of banks and life insurer groups (consisting of a bank or life insurer and any other related financial institutions). This additional tax would apply to taxation years ending after the Budget Day (pro-rated for a taxation year that includes the Budget Day). Bank and life insurer groups would be permitted to allocate a $100 million taxable income exemption amongst group members.

Flow-Through Shares for Oil, Gas and Coal Activities

As part of the Federal Government's move away from fossil fuel subsidies, Budget 2022 proposes to eliminate the flow-through share regime for fossil fuel sector activities. Generally, flow-through shares allow issuers to transfer (or "renounce") certain exploration expenditures to investors (up to the amount invested).

For flow-through share agreements entered into after March 31, 2023, expenditures related to oil, gas, and coal exploration and development can no longer be renounced to flow-through share investors.

Small Business Deduction

Certain Canadian-controlled private corporations (CCPC) benefit from a reduced federal income tax rate applicable to qualifying active business income, being 9% as opposed to the generally applicable 15%. This small business rate applies to income of up to $500,000 per taxation year (the "small business limit"). The small business limit is reduced on a straight-line basis when: i) the applicable CCPC's taxable capital employed in Canada, together with that of associated corporations, is between $10 million and $15 million; or ii) the "adjusted aggregate investment income" of the CCPC, together with that of associated corporations, is between $50,000 and $150,000. The small business limit is the lesser of the two amounts determined by the reductions noted above.

Budget 2022 proposes to increase the upper limit of the range of the amount of taxable capital employed in Canada from $15 million to $50 million. Where the amount of taxable capital employed in Canada is the applicable test, the effect of this change will be a more gradual reduction in a CCPC's small business limit once the $10 million threshold is exceeded, fully reducing the small business limit at $50 million instead of the current $15 million. Given the numerous reductions of benefits associated with CCPCs, the increase in the upper limit of taxable capital employed should be a welcome change to the rules and in line with the shifting viewpoint on the scope and meaning of a small business.

Application of the General Anti-Avoidance Rule to Tax Attributes

Budget 2022 proposes to expand the application of the general anti-avoidance rule (GAAR) in section 245 of the Income Tax Act (Canada) (Tax Act) to include tax attributes as a tax benefit potentially subject to the application of the GAAR.

The proposed changes to the GAAR are in response to the 2018 Federal Court of Appeal decision in 1245989 Alberta Ltd. v Canada (Attorney General), 2018 FCA 114 (Wild). In Wild, the taxpayer had implemented a corporate reorganization that resulted in an increase to the paid up capital (PUC) of the shares held by the taxpayer in his holding company. Generally speaking, PUC may be returned to a taxpayer free of tax and is therefore a valuable tax attribute. The Minister reassessed the taxpayer under the GAAR to decrease the PUC of the shares. The taxpayer's appeal from the reassessment was dismissed by the Tax Court of Canada but allowed by the Federal Court of Appeal (FCA) through a reversal of the decision of the Tax Court. The FCA held that while the reorganization had changed the tax attributes of the shares, creating the potential for a tax-free distribution, that potential had not yet been realized and the Tax Act had not, to date, been misused or abused. Although the PUC of the shares had been increased, the increase in and of itself, without a tax-free distribution, did not constitute a tax benefit for purposes of the GAAR.

In response to the FCA decision in Wild, Budget 2022 proposes to amend the definition on "tax benefit" in section 245 of the Tax Act to include a reduction, increase or preservation of an amount that could be relevant for purposes of computing a tax benefit in the future or could result in a tax benefit in the future. The definition of "tax consequences" will also be amended to include any amount that is, or could at a subsequent time be, relevant for the purposes of computing income or tax under the Tax Act. Budget 2022 also proposes to expands the scope of the notice of determination provisions in subsection 152(1.11) of the Tax Act to permit the Minister to determine any amount that could, at a subsequent time, be relevant for purposes of computing income or tax payable.

The FCA noted in Wild that its judgment was without prejudice to the Minister's entitlement to reassess the taxpayers in future when the tax benefits had actually been realized. The Federal Government therefore presents the amendments not as changes to the rules, per se, but as measures that will increase certainty for taxpayers who will not be required to wait several additional years to confirm the tax consequences of a transaction. From the taxpayer's perspective, however, the changes can result in an unfavourable tax assessment in advance of any tax benefit having been realized and without the taxpayer having received a financial or economic benefit upon which additional taxes become payable. The impugned transactions need only "set the table" for a potential future tax benefit.

The proposed changes will apply to notices of determination issued on or after April 7, 2022.

Budget 2022 also notes that the Federal Government intends to release a consultation paper "in the near future" on modernizing the GAAR, with a consultation period running through summer 2022 and legislative proposals contemplated by the end of 2022.

Genuine Intergenerational Share Transfers

The battle over the practice of "surplus stripping"-where taxpayers convert taxable dividends into lower-taxed capital gains-continues. Last summer, Private Member's Bill C-208 received Royal Assent. This Bill introduced an exception to the historical surplus stripping rule to facilitate intergenerational business transfers. Since announced, the Department of Finance has expressed concern that the Bill may unintentionally allow surplus stripping without requiring that a genuine intergenerational business transfer take place.

The key to the Bill C-208 amendment was that it only apply in situations involving a "qualified small business corporation share" or a "share in the capital stock of a family farm or fishing corporation." The Bill addressed inequities in the Tax Act that apply to intergenerational transfers of small business corporations, family farm corporations, and family fishing corporations that favoured an unrelated purchaser over a familial purchaser.

Budget 2022 has announced a consultation process ending on June 17 for Canadians to share views on how the existing rules could be modified to protect the integrity of the tax system while continuing to facilitate genuine intergenerational business transfers. The Federal Government announced intentions to bring forward legislation if necessary, which could be included in a bill tabled this fall after the consultation process concludes.

Substantive CCPCs

Budget 2022 affirms the general objective of tax neutrality for individuals earning income directly versus indirectly through a corporation. Currently, passive investment income and capital gains earned in a private corporation are subject to certain refundable tax regimes under the Tax Act. These regimes are generally intended to subject a private corporation to the same level of taxation on such income prior to distribution to shareholders.

The Budget proposes amendments to target transactions whereby a private corporation would cease to be a CCPC (while still remaining resident in Canada) and consequently would not be subject to refundable tax on certain types of investment income and capital gains. In particular, the Budget introduces the new concept of a "substantive CCPC": generally, a private corporation that is resident in Canada and is not otherwise a CCPC but which is ultimately controlled in law or fact by one or more Canadian resident individuals. The new rules would include an extended concept of control, whereby a corporation would be considered to be controlled by Canadian resident individuals if such individuals own, directly or indirectly, sufficient shares in aggregate to control the corporation. A corporation that is a substantive CCPC would generally be subject to the same refundable taxes on all of its investment income and capital gains as if it were a CCPC, although the corporation would remain a non-CCPC for other purposes of the Tax Act. The substantive CCPC concept will be bolstered by a specific anti-avoidance rule aimed at efforts to avoid the new substantive CCPC regime, as well as measures to support the administration of the new rules.

The above changes related to substantive CCPCs generally apply to taxation years that end on or after Budget Day (with a limited exception for certain circumstances involving a transaction entered into before Budget Day).

Budget 2022 also proposes targeted amendments to the Tax Act in respect of passive investment income earned by CCPCs and their individual investors through non-resident corporations that are controlled foreign affiliates under the Tax Act. The amendments seek to eliminate a deferral advantage available to CCPCs and their individual shareholders who earn income in such a manner, and to achieve better overall integration. This would be achieved through a number of measures, including: applying the same relevant tax factor to individuals, CCPCs and substantive CCPCs in computing their available deductions from foreign accrual property income (FAPI); limiting certain amounts that can be added to a CCPC's general rate income pool balance; and by including certain amounts in the capital dividend accounts of CCPCs (and substantive CCPCs).

These measures related to investment income earned through controlled foreign affiliates would apply to taxation years that begin on or after Budget Day.

International Tax Measures

International Tax Reform

As part of the Organization for Economic Co-operation and Development (OECD)/G20 Inclusive Framework on Base Erosion and Profit Shifting, Canada and 136 other member countries agreed to a two-pillar plan for international tax reform in October 2021 (the "October Statement"). Budget 2022 summarizes the background of this plan and outlines Canada's next steps to facilitate implementation of Pillar One and Pillar Two.

Pillar One

Pillar One concerns the reallocation of taxing rights to ensure that profits of large multinational enterprises (MNEs) (having global annual revenues above ?20 billion) are subject to tax in the jurisdictions in which their users and customers are located. Under the current rules, a country is generally only entitled to tax profits of a foreign MNE that are associated with a subsidiary or "permanent establishment" in that country. The October Statement recognizes that the current rules are out of date and were not designed to address an increasingly digital economy.

With certain exceptions, Pillar One provides for an allocation framework that would apply to MNEs with global revenues above €20 billion and a profit margin above 10 per cent. Under the framework, 25 percent of the residual profit (i.e., profit in excess of 10 per cent of revenue) would be allocated to market countries using a revenue-based key.

The Federal Government is continuing to work with its international partners to develop the framework and the appropriate allocation formula, and intends to introduce implementing legislation after the terms are mutually agreed.

If a multilateral convention implementing Pillar One does not come into force by January 1, 2024, Canada intends on implementing its own Digital Services Tax (DST). Draft legislative proposals for the DST were released in December 2021 and the Federal Government is currently reviewing the feedback received from a public consultation.

Pillar Two

Pillar Two outlines a framework applicable to large MNEs (having annual revenues of at least €750 million) to ensure that their profits are subject to a minimum effective tax rate (ETR) of 15 per cent in every jurisdiction they operate. Generally, a large MNE is required to compute the ETR on its profits in each jurisdiction in which it operates and if the ETR for a particular jurisdiction is below 15 per cent, the MNE is subject to a "top-up tax" that brings the ETR on its profits from that jurisdiction to the 15 per cent minimum.

To facilitate coordinated implementation and ensure consistency, the Inclusive Framework approved detailed model rules (the "Model Rules"), published on December 20, 2021, as well as commentary providing guidance on their interpretation and operation, published on March 14, 2022.

Budget 2022 announces the commencement of a public consultation on the implementation in Canada of the Model Rules and a domestic minimum top-up tax.

Exchange of Tax Information on Digital Economy Platform Sellers

Digital platform operators have become the norm in our digital economy. The pandemic has led to an increased demand for online purchases of goods and services and an unprecedented growth for the digital economy. However, not all platform sellers are aware of the tax implications of the activities occurring on their platforms; such activities can also be largely invisible to revenue authorities such as the Canada Revenue Agency (CRA), making it difficult to locate instances of non-compliance with domestic tax laws.

The OECD has model rules for reporting by digital platform operators with respect to platform sellers. The framework calls for information sharing between tax administrations to facilitate tax compliance.

According to the OECD model rules, an online platform would report the information to one jurisdiction, and that jurisdiction would, in turn, share the information with the relevant tax authorities depending on the residence of each seller earning revenue through the platform and the location of real property being rented through the platform. The model rules can be accessed here: https://www.oecd.org/ctp/exchange-of-tax-information/model-rules-for-reporting-by-platform-operators-with-respect-to-sellers-in-the-sharing-and-gig-economy.htm.

Budget 2022 proposes implementing the model rules into Canadian law.

Canadian tax resident platform entities that are that are involved with the following activities would be subject to reporting requirements:

• contracting directly or indirectly with sellers to make the software that runs a platform available for the sellers to be connected to other users; or
• collecting compensation for the relevant activities facilitated through the platform.

The reporting measures also apply to platform operators that are not resident in Canada or a partner jurisdiction¹, but that facilitate activities (further described below), such as sales by sellers resident in Canada or rentals of real property located in Canada. For example, properties listed on Airbnb that are located in Prince Edward Country, but owned by a seller in China, would still be subject to reporting requirements.

Examples of relevant services are:

• personal services (i.e., services involving time or task-based work performed by one or more individuals at the request of a user, for example, transportation and delivery services, manual labour, etc.);
• rental of immovable property (residential or commercial property, as well as parking spaces); and
• rental of means of transportation.

A reportable seller is an active user who is registered on a platform to provide relevant services or to sell goods. Reporting platform operators must complete due diligence practices to identify reportable sellers and their jurisdiction of residence.

A reporting platform operator will be able to rely on the due diligence procedures from a previous year as long as it has verified the seller's address within the last 36 months and it does not have reason to question its past information. In accordance with the OECD Rules, the CRA would automatically exchange (send and receive) with partner jurisdictions the information received from Canadian platform operators on sellers resident in the partner jurisdiction and rental property located in the partner jurisdiction.

Exchanges of information will take place under the exchange of information provisions in tax treaties which provide important safeguards to protect taxpayer confidentiality and ensure that the exchanged information is not used inappropriately.

Reporting measures would apply to calendar years beginning after 2023. Exchange of information to take place in early 2025 with respect to the 2024 calendar year.

The CRA has already made public its project to pursue digital influencers earning income by providing promotions online for platforms such as YouTube and TikTok. It follows that the next steps of pursuing sellers such as Etsy (for goods) or Airbnb (for rentals) is both natural and expected. The digital economy is a global arena, such that exchanging information with partnering jurisdictions is a logical means of seeking to monitor and enforce compliance with Canada's domestic tax laws. But it remains to be seen how smoothly the data collection and exchange process will be and how it will evolve.

Interest Coupon Stripping

Budget 2022 proposes new rules targeted at interest coupon stripping arrangements that attempt to circumvent Canadian withholding tax on interest paid by a Canadian resident debtor to a non-resident under paragraph 212(1)(b) of the Tax Act.

An interest coupon stripping arrangement refers to an arrangement whereby a non-resident lender transfers its right to receive future interest payments (i.e., interest coupons) on a loan owing by a non-arm's length Canadian resident debtor to another party.

Budget 2022 proposes the addition of a specific anti-avoidance rule targeted at ensuring Canadian withholding tax is not reduced through the use of interest coupon stripping arrangements such as those described above.

In particular, proposed subsection 212(21) of the ITA defines the circumstances where the proposed anti-avoidance rule would apply. The proposed rule will apply where:

1. a Canadian resident debtor pays or credits interest to a person or partnership (the "interest coupon holder") on a debt (other than a "specified publicly offered debt obligation") owing to a non-arm's length non-resident or a partnership other than a Canadian partnership (the "non-arm's length lender"); and
2. the Canadian withholding tax that would have been payable on interest paid or credited to the non-arm's length lender is greater than the Canadian withholding tax payable on interest paid or credited to the interest coupon holder.

Where the conditions in proposed subsection 212(21) are met, proposed subsection 212(22) deems the Canadian resident debtor to have paid an amount of interest to the non-arm's length lender, such that the Canadian withholding tax payable equals the Canadian withholding tax that would have been payable if the interest coupon stripping arrangement had not been entered into. The proposed rules will not apply to certain publicly offered debt obligations.

The proposed rules will apply to interest paid or payable by a Canadian resident debtor to an interest coupon holder that accrued on or after April 7, 2022. However, a partial grandfathering rule applies in respect of interest that is:

1. on a debt incurred by the Canadian resident debtor before April 7, 2022; and
2. is paid or payable to an interest coupon holder that deals at arm's length with the non-resident lender and that acquired the interest coupon as a consequence of an agreement or other arrangement entered into and evidenced in writing before April 7, 2022.

In this case, the proposed rules will apply to interest paid or payable by the Canadian resident debtor that accrued on or after April 7, 2023.

Sales and Excise Tax Measures

Budget 2022 included two highly-targeted sales tax measures.

1. GST/HST on Assignment Sales by Individuals of Residential Housing - Budget 2022 proposes to deem all assignments of purchase and sale agreements in respect of newly constructed or substantially renovated single unit residential complexes taxable for GST/HST purposes. Any amount that was attributable to a deposit paid by the assignor to the builder would be excluded from the amount that is deemed to be taxable on the assignment sale. This measure provides clarity and consistency for these types of transactions and removes the fact-specific analysis that was previously required.
2. GST/HST Health Care Rebate - Generally, charities and certain non-profit organizations are eligible to claim a rebate to partially recover the GST/HST it paid in the course of making exempt supplies. Budget 2022 proposes to expand the GST/HST eligibility conditions for the hospital rebate to recognize the increasing role of nurse practitioners in delivering health care services, including in non-remote areas.

The Federal Government also confirmed its intention to proceed with the legislative proposals relating to the Select Luxury Items Tax Act and measures relating to crypto asset mining, which were both released earlier this year, and measures confirmed in Budget 2016 relating to the GST/HST joint venture election.

Further Funding Increase for the CRA

In addition to the foregoing measures, and in keeping with recent Federal Budgets, Budget 2022 includes increased funding for the CRA. According to the Federal Government, the CRA has invested thoroughly in resources to ensure tax compliance in Budget 2016. Budget 2022 continues in this vein in proposing to provide $1.2 billion over five years for the CRA to expand audits or larger entities and non-residents engaged in aggressive tax planning, as well as increase both the investigation and prosecution of those engage in criminal tax evasion.

Changes Applicable to Registered Charities

Budget 2022 proposed some significant changes that will impact registered charities. These include:

1. Changes to the Disbursement Quota ("DQ") rules for registered charities - While draft legislation has not yet been released, the proposed changes have been described as follows:
   • Increasing the DQ rate from 3.5% to 5% per cent for the portion of a registered charity's property not used in charitable activities or administration that exceeds $1 million;
   • Clarifying that expenditures for administration and management are not considered qualifying expenditures for the purpose of satisfying a charity's DQ;
   • Giving the CRA the discretion to reduce a charity's DQ obligation for any particular tax year, and allowing CRA to publicly disclose these decisions; and
   • Removing the accumulation of property rule, which exempts charities from including certain property in its calculation of its DQ.
2. Permitting Charities to work with Non-Qualified Donees - Budget 2022 includes new measures intended to facilitate disbursements by registered charities to organizations that are not qualified donees under the Tax Act. The new framework would allow registered charities to make "qualifying disbursements" to non-qualified donees (grantees) provided certain requirements are met. The disbursement must be in furtherance of the charity's charitable purposes and the charity must ensure that the funds are applied to charitable activities by the grantee. No legislation was introduced so the details are unknown but it appears that the proposal will involve a number of highly prescriptive accountability measures that must be met when a charity provides resources to organizations that are not registered charities.

Details of these and other proposals relevant to Charities can be found in the 2022 Federal Budget Edition of our Social Impact Newsletter.

Footnote

1. The Notice of Ways and Means defines "partner jurisdiction" as: A partner jurisdiction would be a jurisdiction that has implemented similar reporting requirements on platform operators and that has agreed to exchange information with the CRA on reportable platform sellers.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.