Highlights Of Canada's 2022 Federal Budget

• Published date: 18 April 2022
• Subject Matter: Tax, Income Tax, Sales Taxes: VAT, GST, Withholding Tax
• Law Firm: Torys LLP
• Author: Torys LLP

On April 7, 2022 (Budget Day), Finance Minister Chrystia Freeland tabled her second budget in the House of Commons (Budget 2022).

What you need to know

• Canada recovery dividend (CRD) and additional tax on banks and life insurers. Budget 2022 proposes two additional taxes on bank and life insurer groups. The first is the CRD, which is a one-time 15% tax that will be imposed for the 2022 taxation year and payable in equal amounts over five years. The second is an additional 1.5% tax, that will generally apply to taxation years that end after Budget Day.
• Hedging and short selling by Canadian financial institutions. According to Budget 2022, Canadian banks engage in "aggressive tax planning arrangements" involving, on the one hand, a dividend received deduction claimed on a Canadian share owned by the bank, and on the other hand, the deduction of two-thirds of a dividend compensation payment by a related registered securities dealer on the short sale of an identical share. According to the government, this results in "an artificial tax deduction" that the government proposes to deny by way of specific legislation.
• Substantive Canadian-controlled private corporations (CCPCs). The refundable tax in Part I of the Income Tax Act (Tax Act) applicable to certain investment income earned by CCPCs (Part I refundable tax) will be extended to also apply to "substantive CCPCs" which are defined as Canadian-resident private corporations that (i) are controlled, directly or indirectly in any manner whatever by one or more Canadian-resident individuals; or (ii) would, if each share of a corporation that is owned by a Canadian-resident individual were owned by a particular individual, be controlled by the particular individual. This change will generally apply to taxation years ending on or after Budget Day, subject to a limited exception.
  
  Additional changes are also proposed to eliminate the tax-deferral advantage afforded a CCPC when it is a shareholder of a controlled non-resident corporation that earns certain passive income (referred to in the Tax Act as "foreign accrual property income" (FAPI)), effective for taxation years that end on or after Budget Day.
• Application of the general anti-avoidance rule (GAAR) to tax attributes. A 2018 Federal Court of Appeal decision held that the GAAR did not apply to a tax attribute that had not yet been used to reduce, avoid or defer tax. Budget 2022 proposes to override this decision so that the GAAR can apply to deny tax attributes that have not yet been used by taxpayers. This proposal will also impact obligations of taxpayers under the enhanced mandatory disclosure rules that the government published as draft legislation in February 2022. The new measure will apply to transactions that occur on or after Budget Day (subject to a limited exception).
• International tax reform: Pillar One and Pillar Two. Further to Canada's commitment to Pillar One (relating to the multilateral approach to reallocating taxing rights) and Pillar Two (relating to a global minimum tax) of the Inclusive Framework of the Organisation for Economic Co-Operation and Development (OECD) and the Group of 20 (G20) on base erosion and profit shifting (BEPS), in Budget 2022, the government indicated that
  • it intends for the domestic digital services tax (DST) proposals released in December 2021 to apply only if an international multilateral convention implementing Pillar One is not in force by January 1, 2024; and
  • draft legislation implementing Pillar Two, and an associated domestic minimum top-up tax, will be released for consultation and come into effect sometime in 2023, and in the meantime, it is seeking submissions on Canada's implementation of the detailed model rules for Pillar Two released by the OECD/G20 Inclusive Framework (Model Rules), with submissions due by July 7, 2022.
• Borrowing by defined benefit pension plans. Budget 2022 expands the ability of registered pension plans to borrow money and permits them to borrow for general purposes and not merely to acquire real estate or for a short term. This measure will apply to amounts borrowed by registered pension plans (other than individual pension plans) on or after Budget Day.

Click below or use the in-page navigation menu for analysis on key measures included in Budget 2022.

Business income tax measures

International tax measures

Personal income tax measures

Tax administration measures

Goods and services tax/harmonized sales tax (GST/HST) measures

Status of outstanding income tax measures

Business income tax measures

CRD and additional tax on banks and life insurers

Budget 2022 announced the introduction of the CRD, a one-time 15% tax applicable to bank and life insurer groups. A group for the purposes of the CRD will include a bank or life insurer and any other financial institution (for the purposes of Part VI of the Tax Act) that is related to the bank or life insurer.

The CRD will apply to a corporation's taxable income for taxation years ending in 2021 (a proration rule will apply for short taxation years). Bank and life insurer groups are permitted to allocate a $1 billion taxable income exemption from the CRD among group members. The tax liability for the CRD will be imposed in the 2022 taxation year and will be payable in equal amounts over five years.

Budget 2022 also proposes a new additional tax of 1.5% on the taxable income for members of bank and life insurer groups. The groups subject to this additional tax will be permitted to allocate a $100 million taxable income exemption among group members.

The new additional tax will apply to taxation years that end after Budget Day. For a taxation year that includes Budget Day, the new additional tax will be prorated based on the number of days in the taxation year after Budget Day.

No draft legislation has yet been released for the CRD or the new additional tax.

Hedging and short selling by Canadian financial institutions

Generally, the Tax Act allows Canadian corporations to deduct taxable dividends received on shares of other Canadian corporations. The Tax Act also allows registered securities dealers to deduct two-thirds of dividend compensation payments paid to lenders under securities lending arrangements (as an exception to the general rule whereby dividend compensation payments are not deductible).

According to the government, certain financial institutions are engaging in what the government refers to as "aggressive tax planning". Under such plans, a Canadian bank owns a Canadian share and claims a dividend received deduction. A related registered securities dealer borrows an identical share and sells it short, claiming a two-thirds deduction on dividend compensation payments made to the lender of the identical share. The government notes that such transactions could also be carried out by the registered securities dealer on its own. In such cases, the registered securities dealer owns the Canadian share and claims the dividend received deduction in addition to borrowing and selling short an identical share and deducting two-thirds of the dividend compensation payment.

According to the government, this results in an "artificial tax deduction" equal to two-thirds of the amount of the dividend compensation payment.

The government states that such arrangements could be challenged under existing rules of the Tax Act, but that such challenges could be time-consuming and costly. The government proposes to amend the Tax Act to deny a dividend received deduction where a taxpayer enters into a "specified hedging transaction", defined as:

• Where the taxpayer is not a registered securities dealer, a transaction entered into by a registered securities dealer that does not deal at arm's length with the taxpayer and that has the effect of eliminating all or substantially all of the taxpayer's risk of loss and opportunity for gain or profit in respect of certain shares owned by the taxpayer. In this case, the registered dealer must reasonably be considered to have entered into the transaction with the knowledge that, or ought to have known that, this result would occur.
• Where the taxpayer is a registered securities dealer, a transaction entered into by a registered securities dealer that has the effect of eliminating all or substantially all of the registered securities dealer's risk of loss and opportunity for gain or profit in respect of certain shares owned by the registered securities dealer.

The government also proposes to amend the Tax Act to allow a full (instead of two-thirds) deduction of the dividend compensation payment when a dividend received deduction is denied because the registered securities dealer entered into a specified hedging transaction.

The proposed legislation will apply to dividends and dividend compensation payments that are paid, or become payable, on or after Budget Day. However, if the relevant hedging transactions or securities lending arrangements were in place before Budget Day, the proposed legislation will apply to dividends and related dividend compensation payments that are paid after September 2022.

Substantive CCPCs

Budget 2022 introduces new rules to limit the ability of certain Canadian-resident private corporations to avoid CCPC status. Although CCPCs are entitled to a preferential tax rate on active business income, they are also subject to refundable taxes on certain types of investment income that other private "non-CCPCs" are not.

When combined with the non-refundable portion of the tax on investment income of a CCPC, this refundable tax is intended to approximate the top marginal personal income tax rate, minimizing any tax deferral opportunity for Canadian-resident individuals to earn investment income in a CCPC, as opposed to directly. This tax is refunded as the CCPC pays out certain taxable dividends. The changes to the Tax Act proposed in Budget 2022 will only impact Part I refundable tax, which is payable in respect of certain types of...