Highlights Of Canada's 2018 Federal Budget

The federal budget (Budget 2018) tabled on February 27 (Budget Day) contains a number of proposed amendments to Canada's Income Tax Act (Tax Act). This bulletin focuses on certain (i) business income tax measures; (ii) international tax measures, (iii) sales and excise tax measures and (iv) personal income tax measures, proposed therein.

Business Income Tax Measures

Passive Investment Income In July 2017, the Department of Finance (Finance) launched public consultations to address a perceived deferral advantage available to shareholders of private corporations. Finance was of the view that it was inappropriate for a private corporation to use its retained earnings derived from active business, which have been taxed at preferential corporate income tax rates, to finance passive investments held within the corporation. Considering the feedback received from stakeholders during the consultation period, Budget 2018 proposes two tax measures intended to limit such deferral advantage in respect of passive investment income earned by private corporations.

1. Business Limit The federal corporate income tax rate for Canadian-controlled private corporations (CCPCs) is currently 10.5% (small business rate) for qualifying active business income up to $500,000 (the business limit). A CCPC is required to share the business limit with associated corporations. Finance had previously proposed to reduce the small business rate to 10% for 2018 and to 9% effective 2019 to increase the availability of after-tax income for reinvestment in the active business.

   Budget 2018 proposes to reduce the business limit on a straight-line basis for CCPCs with passive investment income (earned by the CCPC and any associated corporations with which it shares the business limit) between $50,000 and $150,000. Business income earned by the CCPC above the reduced business limit will be taxed at the general corporate income tax rate rather than the small business rate. This measure is proposed to apply along with an existing rule that reduces the business limit where a CCPC (together with associated corporations) has taxable capital in excess of $10 million. The reduction in the CCPC's business limit will be the greater of the reduction under the proposed measure and the existing rule.

   For the purposes of this proposed measure, investment income will be calculated using the existing concept of aggregate investment income used in the Tax Act, with the following adjustments:

   Taxable capital gains (and allowable capital losses) arising from the following transactions will generally be excluded: disposition of property used principally in a Canadian active business by the CCPC or a related CCPC; disposition of shares of another connected CCPC where all or substantially all of the value of the other CCPC is attributable to assets used in a Canadian active business and certain other conditions are met; net capital losses carried over from other tax years will be excluded; dividends from non-connected corporations will be added; and to the extent not already included in aggregate investment income, income from savings in a life insurance policy (other than an exempt policy) will be added. Investment income that is incidental to an active business is generally considered to be active business income and, therefore, would not be included in such adjusted aggregate investment income.

2. Refundable Taxes on Investment Income Under the current tax system, passive investment income earned in a private corporation is generally subject to income tax at a rate that approximates the top personal income tax rate. A portion of this tax is generally added to the corporation's refundable dividend tax on hand (RDTOH) account and refunded to the corporation when paid out as taxable dividends to shareholders. A corporation can pay an eligible dividend (generally in respect of business income that was taxed at the general corporate rate) or a non-eligible dividend (generally in respect of most types of passive investment income and business income that was taxed at the lower small business rate). A corporation may receive a refund of taxes out of its RDTOH account, regardless of whether it pays eligible or non-eligible dividends. An individual receiving an eligible dividend is entitled to an enhanced dividend tax credit, whereas an individual receiving a non-eligible dividend is entitled to the ordinary dividend tax credit. Finance takes the view that this mechanism allows a private corporation to generate a refund of taxes paid on passive investment income by paying an eligible dividend sourced from general rate business income, thus creating a deferral advantage in respect of passive investment income.

   Budget 2018 proposes to limit the availability of a refund of a private corporation's RDTOH where it pays non-eligible dividends. There will be an exception for RDTOH that arises from eligible portfolio dividends, which will necessitate the creation of a new account (eligible RDTOH) that tracks refundable taxes paid under Part IV of the Tax Act on eligible portfolio dividends. The corporation's existing RDTOH account (non-eligible RDTOH) will track refundable taxes paid under Part I of the Tax Act on investment income and under Part IV of the Tax Act on non-eligible portfolio dividends. Refunds from eligible RDTOH will be obtained upon the payment of any taxable dividends, whereas refunds from non-eligible RDTOH will be obtained only upon the payment of non-eligible dividends. Even though a non-eligible dividend can give rise to refunds from both non-eligible RDTOH and eligible RDTOH, a corporation will first be required to obtain a refund from its non-eligible RDTOH before its eligible RDTOH.

   Where a corporation receives a dividend from a connected corporation and RDTOH is refunded to the payor corporation in respect of that dividend, the recipient corporation pays a refundable tax under Part IV of the Tax Act that is added to the recipient corporation's RDTOH account. Under the proposed measure, the amount added to the recipient corporation's RDTOH account will match the RDTOH account from which the refund was paid to the payor corporation.

   This proposed measure also includes a transitional rule setting out the manner in which to allocate a private corporation's existing RDTOH to its eligible RDTOH and non-eligible RDTOH. The allocation method differs for CCPCs and non-CCPCs.

   Anti-avoidance measures are also proposed to be put in place to prevent transactions designed to avoid the above measures, such as the creation of a short taxation year to defer application of the proposed rules.

   Each of the proposed measures described above will apply to taxation years that begin after 2018.

   Tax Support for Clean Energy Currently, certain specified clean energy generation and conservation equipment acquired before 2020 qualifies for accelerated capital cost allowance.

   Budget 2018 proposes to extend this treatment by five years to such equipment acquired before 2025.

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