Highlights Of Canada's 2023 Federal Budget

• Jurisdiction: Canada
• Law Firm: Torys LLP
• Subject Matter: Tax, Income Tax, Capital Gains Tax, Sales Taxes: VAT, GST
• Author: Torys Tax Practice
• Published date: 20 April 2023

On March 28, 2023 (Budget Day), Finance Minister Chrystia Freeland tabled her third budget in the House of Commons (Budget 2023).

What you need to know

• General anti-avoidance rule (GAAR). Budget 2023 introduced significant changes to the GAAR in section 245 of the Income Tax Act (Canada) (Tax Act), including the introduction of a preamble meant to address interpretive issues, a reduced threshold for identifying an avoidance transaction, a new economic substance test, a 25% penalty levied on the amount of a tax benefit and an extension of the normal reassessment period in certain cases. Interested parties can provide written submissions on these proposals until May 31, 2023. Following this consultation period, the government intends to publish revised proposals and announce the effective date of these changes.
• Tax on repurchases of equity. Budget 2023 proposes legislation to implement a 2% tax on the net value of share repurchases by certain publicly traded entities, beginning on January 1, 2024, and subject to a de minimis threshold of $1 million.
• Dividend received deduction by Canadian financial institutions. Budget 2023 proposes to deny the inter-corporate dividend deduction in respect of dividends received by financial institutions on shares that are held as mark-to-market property.
• Clean technology and green energy measures. Budget 2023 introduces or expands on a number of proposed measures in respect of clean technology and green energy initiatives including tax credits for clean hydrogen, clean technology investment, carbon capture utilization and storage, clean electricity, clean technology manufacturing and processing and critical mineral extraction and processing. Budget 2023 also expands on certain tax advantages for zero-emission technology manufacturers and lithium producers.
• Intergenerational business transfers. In 2021 pursuant to a private member's bill in the 43^rd Parliament (Bill C-208), the anti-surplus stripping rule in section 84.1 of the Tax Act was amended to add a new exception to facilitate intergenerational business transfers between non-arm's length parties. According to Budget 2023, this exception contained insufficient safeguards to ensure that a "genuine" intergenerational business transfer had occurred, and accordingly, Budget 2023 proposes further amendments to section 84.1 (and consequential amendments to other provisions of the Tax Act) to address these perceived shortcomings.
• Employee Ownership Trusts (EOTs). Budget 2023 announces the introduction of an EOT, a form of employee ownership that can be used to facilitate the purchase of a Canadian-controlled-private corporation (CCPC) meeting certain additional conditions by its employees and as an additional option for succession planning to employees. In order to facilitate the establishment and use of EOTs to acquire and hold shares of a corporation, Budget 2023 proposes to create an exception to the current shareholder loan rule, to exempt EOTs from the 21-year deemed disposition rule applicable to certain trusts, and to extend the capital gains reserve to ten years for qualifying sales to an EOT. These rules will apply to transactions that occur on or after January 1, 2024.
• Alternative minimum tax (AMT). Budget 2023 proposes to expand the AMT, which is generally applicable to individuals (including certain trusts), to better target high-income individuals. The changes include raising the AMT flat rate from 15% to 20.5%, increasing the basic exemption amount under the rules and expanding the AMT base by further limiting the deductions, exemptions and tax credits currently available under the AMT regime. These changes will apply beginning in the 2024 taxation year.
• GST/HST treatment of payment card clearing services. Budget 2023 proposes to amend the GST/HST definition of "financial service" retroactively, to legislatively overrule the decision of the Federal Court of Appeal in Canadian Imperial Bank of Commerce v. Canada, 2021 FCA 10. This decision had held that payments made by CIBC to Visa in respect of CIBC-Visa credit cards were consideration for an exempt supply of a financial service, rather than consideration for a taxable supply of an administrative services. The proposed amendments apply unless the credit card company never charged collected or remitted GST/HST from credit card issuers.

Business income tax measures

General anti-avoidance rule

Budget 2023 introduced significant legislative proposals to amend the GAAR. The GAAR is designed to negate the tax benefits arising from abusive tax avoidance transactions that may satisfy the technical requirements of the Tax Act but are found to misuse or abuse the underlying policy.

Although the GAAR was introduced 35 years ago, the government announced a comprehensive review of the GAAR in the 2020 Fall Economic Statement. The 2022 federal budget (Budget 2022) proposed to continue that review and on August 9, 2022, a consultation paper titled Modernizing and Strengthening the General Anti-avoidance Rule (Consultation Paper) was released. Following this release, there was a consultation period from August 9 to September 30, 2022, where interested parties had the opportunity to make submissions on the approaches outlined for modernizing the GAAR. Budget 2023 proposes legislation intended to address several of the concerns and suggested approaches outlined in the Consultation Paper.

For the GAAR to apply under the current Tax Act rules, the following three elements must be present: (i) there must be a tax benefit; (ii) an avoidance transaction; and (iii) the avoidance transaction or a series of transactions that includes the avoidance transaction leads to a misuse or abuse of particular provisions of the Tax Act.

The legislative proposals in Budget 2023 amend the GAAR to introduce: a preamble to address interpretative issues, a modified standard for identifying an avoidance transaction, a new economic substance test as part of the misuse and abuse analysis, a 25% penalty levied on the amount of a tax benefit resulting from transactions subject to the GAAR and an extension of the normal reassessment period in certain cases.

The government is currently holding a consultation period allowing interested parties to make submissions on these proposals until May 31, 2023. When the consultation period ends, the government intends to publish revised legislative proposals and announce the effective date for these amendments.

The GAAR has received significant judicial interpretation since its enactment 35 years ago. These legislative proposals introduce considerable uncertainty as to the validity of current GAAR jurisprudence, and if enacted could lead to new tax disputes to clarify the meaning and impact of the amendments.

Preamble

The proposed legislation adds a preamble to the GAAR provisions, the purpose of which is to help address interpretive issues and ensure that the GAAR applies in the intended manner. The preamble outlines that: (i) the GAAR applies to deny the tax benefit from avoidance transactions that misuse provisions of the Tax Act while still allowing taxpayers to obtain benefits contemplated by particular provisions; (ii) the GAAR aims to strike a balance between a taxpayer's need for certainty in planning their affairs and the government's responsibility to protect the tax base and the overall fairness of the tax system; and (iii) the GAAR can apply regardless of whether a tax strategy is foreseen.

Avoidance transaction

Currently, the GAAR stipulates that a transaction is an avoidance transaction where it results directly or indirectly in a tax benefit, unless it is carried out primarily for bona fide purposes other than to obtain the tax benefit. The proposed amendments lower this threshold and require that, in order to constitute an avoidance transaction, only one of the main purposes of the transaction is to obtain a tax benefit.

This amendment was discussed in the Consultation Paper, as the government stated that the current avoidance transaction standard was too stringent and, in its view, led courts to an inappropriate finding that GAAR did not apply in several instances. This lower threshold is consistent with other anti-avoidance rules in the Tax Act and the principal purpose test in the OECD's Multilateral Instrument.

Budget 2023 states that the standard is intended to strike a reasonable balance as it would apply to transactions with a significant tax avoidance purpose but would not apply when tax is simply a consideration.

Economic substance

The proposed GAAR amendments include the addition of an economic substance test. According to Budget 2023, this expansion of the GAAR is in response to Supreme Court of Canada jurisprudence that has established a more limited role for economic substance.

The economic substance test will be considered at the misuse and abuse stage of the GAAR analysis. If there is a lack of economic substance it will be seen as an indication that the transaction is abusive tax avoidance. However, a lack of economic substance on its own does not end the analysis as it is still necessary to determine whether there is a misuse or abuse considering the object, spirit and purpose of the relevant provision. If a transaction lacks economic substance but the tax results are consistent with the purpose of the applicable Tax Act provisions, then the transaction would not be considered abusive tax avoidance.

The proposed amendments provide the following non-exhaustive list of factors that should be considered when determining if a transaction has economic substance: (i) whether there is no change in the opportunity for gain or profit and risk of loss; (ii) whether the expected value of the tax benefit exceeds the expected value of the non-tax economic return (which excludes foreign tax benefits); and (iii) whether the transaction is almost entirely tax motivated. The existence of one or more of these factors supports a finding that there is a...