Tax Perspectives: Review Of 2021 & 2022 Outlook

Published date14 January 2022
Subject MatterTax, Income Tax, Sales Taxes: VAT, GST, Tax Authorities
Law FirmMcCarthy Tétrault LLP
AuthorTax Perspectives, Stefanie Morand, Kabir Jamal, Erica M. Hennessey, Kalev Tamm, Dean Xiao, Julien Leblanc and Kassandra Grenier

2021 was a significant year from a Canadian tax perspective. This article provides an overview of important Canadian legislative and judicial tax developments of 2021, and looks ahead to potential significant Canadian tax changes in 2022.

Our commentary is divided into sections as follows:

  • Part 1 - Overview of Canadian Tax Developments in 2021
    • Income Tax - Legislation
    • Income Tax - Cases
    • Sales Tax
  • Part 2 - Outlook for 2022;

Part 1 - Overview of Canadian Tax Developments in 2021

INCOME TAX - LEGISLATION

On April 19, 2021, the Government of Canada (the "Government") released the 2021 federal budget (the "Budget 2021").[1]Budget 2021 was the Government's first federal budget in over two years and its first major announcement of measures intended to address the recovery of the Canadian economy from the fallout of the COVID-19 pandemic.Approximately eight months later on December 14, 2021 and following the summer 2021 federal election, the Government provided an economic and fiscal update (the "2021 Fiscal Update"). In the 2021 Fiscal Update, the Government reaffirmed its commitment to certain tax measures announced in Budget 2021 and announced certain new, targeted tax measures.

2021 also saw:

  • the enactment of certain tax measures that were previously announced by the Government in the 2019 federal budget ("Budget 2019"); and
  • a series of amendments to the Income Tax Act (Canada) (the "Tax Act") and the regulations thereunder relating to a myriad of federal relief measures (extended, modified and new) aimed at alleviating financial hardship due to the COVID-19 pandemic.

In the immediately following sections, we provide an overview of some of the more noteworthy 2021 measures.

Interest Deductibility Limits

Budget 2021 proposed a new earnings-stripping rule intended to address the potential erosion of the Canadian tax base through what the Government considers to be the inappropriate deduction of interest expense payable by a Canadian taxpayer, such as where (i) interest is paid to related parties resident in low-tax jurisdictions, (ii) the underlying debt is used to finance investments that earn non-taxable income, or (iii) the Canadian taxpayer bears a disproportionate burden of a multinational group's third-party borrowings.

The new rule will limit the amount of net interest expense that a corporation, trust, partnership or Canadian branch of a non-resident may deduct in computing its taxable income to no more than a fixed ratio of "tax EBITDA". For these purposes, "tax EBITDA" means taxable income before taking into account interest expense, interest income and income tax, and deductions for depreciation and amortization, as computed under Canadian tax rules.

Canadian group members will be entitled to transfer unused interest deductibility capacity to other Canadian members of the group whose net interest deductions would otherwise be limited by the rule. In addition, a Canadian member of a consolidated group may be entitled to a higher interest deduction limit where it is able to show that the ratio of net third party interest to book EBIDTA of its consolidated group indicates that the higher interest deduction limit would be appropriate.

Exemptions from the new rule are proposed to be available for Canadian-controlled private corporations ("CCPCs") if the taxable capital employed in Canada of the corporation and its associated corporations is less than $15 million, and for groups of corporations and trusts whose aggregate net interest expense among their Canadian members does not exceed $250,000. In addition, the new rule is not expected to apply to standalone Canadian corporations and Canadian corporations that are members of a group none of whose members is a non-resident.

Once enacted, the new rule is proposed to apply to taxation years that begin on or after January 1, 2023, will be phased in gradually with a fixed ratio of 40% for taxation years that begin in the 2023 calendar year and 30% for taxation years that begin on or after January 1, 2024, and will apply to both new and existing borrowings.

In Budget 2021, the Government stated that it expected to release draft legislative proposals for public comment in the summer of 2021; however, as at December 31, 2021, no such draft legislation has been released. We now expect the draft proposals to be released in 2022.

Hybrid Mismatch Arrangements

In alignment with the work of the Organisation for Economic Co-operation and Development ("OECD") in connection with the BEPS project, Budget 2021 proposed to introduce new rules to address "hybrid mismatch arrangements".

Hybrid mismatch arrangements involve arrangements that use differences in the income tax treatment of entities or instruments under the tax laws of Canada and one or more other countries to claim a deduction in one country in respect of a cross-border payment, the receipt of which is not included in the ordinary income of the recipient in the other country. They also include arrangements where a deduction is claimed in two or more countries in respect of a single economic expense.

Under the new rules, a payment made by a Canadian resident under a hybrid mismatch arrangement will not be deductible for Canadian income tax purposes to the extent that such payment is deductible in another country or is not included in the ordinary income of the recipient. Conversely, where a non-resident makes a payment under a hybrid mismatch arrangement that is deductible in another country, no deduction in respect of the payment will be permitted against the income of a Canadian resident; any amount of the payment received by a Canadian resident under a hybrid mismatch arrangement will also be included in income and, if the payment is a dividend from a foreign affiliate, will not be deductible in computing the taxable income of the Canadian resident.

Budget 2021 proposed to implement the new rules in two separate legislative packages. The first legislative package was to be limited to the deduction/non-inclusion mismatches in respect of hybrid instruments, and was expected to be released in 2021 for stakeholder comment and to be applicable as of July 1, 2022; however, as at December 31, 2021, no such draft legislation has been released. We now expect the draft legislation to be released in 2022. The second legislative package is to address other forms of hybrid mismatch arrangements, and is proposed to be released after 2021 and applicable no earlier than 2023.

Transfer Pricing

In Budget 2021, the Government announced its intention to begin a consultation process on Canada's transfer pricing rules with a view to protecting the integrity of the tax system while preserving Canada's attractiveness for foreign investment. This announcement was a response to the Supreme Court of Canada's decision on February 18, 2021 to dismiss the Government's application for leave to appeal the Federal Court of Appeal's decision in Canada v. Cameco Corporation (2020 FCA 112), which affirmed the Tax Court of Canada's decision not to apply Canada's domestic transfer pricing rules to certain long-term uranium purchase contracts between the corporate taxpayer and its Swiss subsidiary. The Government believes that the Cameco decision may encourage the inappropriate shifting of corporate profits outside of Canada (thereby reducing the Canadian tax base), and stated that the intention of the consultation process would be to allow stakeholders to comment on possible measures to improve Canada's domestic transfer pricing rules. Further commentary from our Firm on the Cameco decision can be found here.

As at December 31, 2021, the public consultation process on Canada's transfer pricing rules has not commenced.

Clean Energy Investment

Rate Reduction for Zero-Emission Technology Manufacturers

Budget 2021 proposed to reduce the federal corporate income tax rates on certain eligible zero-emission technology manufacturing and processing income to: (i) 7.5% (if that income would otherwise be taxed at the 15% general corporate rate); and (ii) 4.5% (if that income would otherwise be taxed at the 9% small business rate). To qualify for a rate reduction, at least 10% of a taxpayer's gross revenue from all active business carried on in Canada must be derived from eligible zero-emission technology manufacturing or processing activities. The reduced rates are proposed to apply to taxation years that begin after 2021 and to be gradually phased out beginning in 2029 and fully phased out for taxation years beginning in 2032.

CCA for Clean Energy Equipment

Budget 2021 proposed to amend the list of eligible clean energy equipment included in capital cost allowance ("CCA") classes 43.1 and 43.2 by expanding such CCA classes to include various clean energy equipment and to remove certain equipment that burns fossil fuels and/or waste fuels. The expansions of CCA classes 43.1 and 43.2 will apply in respect of eligible property that is acquired and becomes available for use on or after April 19, 2021. The removal of property from such classes will apply in respect of property that becomes available for use after 2024.

Tax Incentive for Carbon Capture, Utilization and Storage

Budget 2021 proposed to introduce an investment tax credit to promote the adoption of carbon capture, utilization and storage technologies. The Government proposed a 90-day consultation period with various stakeholders, following which legislation to implement the investment tax credit would be introduced at the "earliest opportunity."As at December 31, 2021, no such legislation has been released.

Digital Services Tax

Budget 2021 proposed to implement a digital services tax ("DST") as an interim measure until an acceptable multilateral approach comes into effect. The Government's aim is to ensure that the revenue earned by large businesses, whether foreign or domestic, from engagement with online users in Canada is subject to Canadian tax. Generally, the DST will apply at a rate of...

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