tax notes
TAX NOTES
February 27, 2018
BUDGET 2018 Passive Investment Income Earned by Private Corporations Budget 2018 proposes two specific initiatives designed to discourage private corporations from accumulating assets that generate passive investment income. The proposed rules will generally apply to taxation years commencing after 2018. 1.
Small Business Deduction Limitation
The small business deduction limit of a Canadian-controlled private corporation (“CCPC”) will be reduced under the amended subsection 125(5.1) if the “adjusted aggregate investment income” of the associated group of which the CCPC is a member exceeds $50,000. For every dollar of adjusted aggregate investment income in excess of $50,000, the small business deduction limit will be reduced by $5. Aggregate investment income will continue to be subject to refundable taxes at existing rates. To illustrate the application of this rule, assume that an associated group of CCPCs has more than $500,000 of active business income and $51,000 of adjusted aggregate investment income. The associated group’s small business deduction limit will be reduced by $5,000, which represents a tax cost of approximately $800.1 This initiative will apply to investment income generated by both future investments and existing investments. There is no grandfathering for future investment income generated by existing investment assets. To prevent the avoidance of subsection 125(5.1), subsection 125(5.2) will deem two or more corporations which are not otherwise associated to be associated for the purpose of subsection 125(5.1) if: 1. 2. 3.
The two corporations are related; One corporation lends or transfers property at any time, directly or indirectly in any manner whatever, to the other corporation; and One of the reasons the loan or transfer was made was to reduce the adjusted aggregate investment income of the associated group.
1
Based on the difference between the combined general corporate tax rate in Alberta (27%) and the combined small business tax rate in Alberta (11%) in 2019. 5000 SUNCOR ENERGY CENTRE 150 - 6th Avenue SW CALGARY, AB T2P 3Y7 Tel: (403) 260-3300 Fax: (403) 263-9649 Email: [email protected]
1980 MANULIFE PLACE 10180 - 101st Street EDMONTON, AB T5J 3S4 Tel: (780) 428-8310 Fax: (780) 421-8820 Email: [email protected]
100, 728 Spadina Crescent East SASKATOON, SK S7K 4H7 Tel: (306) 952-0894 Fax: (306) 952-2439 Email: [email protected]
2 Taxpayers will need to exercise caution in causing a CCPC to transfer or loan property to a related corporation, particularly if the motivation for the transfer is to permit the transferor CCPC to continue to be entitled to a full small business deduction. The proposed definition of adjusted aggregate investment income will be added to subsection 125(7). Adjusted aggregate investment income is a private corporation’s aggregate investment income, subject to certain adjustments. Most notably, taxable capital gains and losses from the disposition of “active assets” of the corporation are excluded from adjusted aggregate investment income, as are net capital losses carried forward or carried back from other taxation years. Additions to adjusted aggregate investment income include dividends from non-connected corporations and income from non-exempt life insurance policies. Subsection 125(7) will also be amended to include a definition of active assets. Active assets of a corporation include: 1. 2. 3.
2.
Property used principally in an active business carried on primarily in Canada by the particular corporation or a related CCPC; A share of a connected corporation that is a qualified small business corporation share; or An interest in a partnership if the fair market value of the interest is equal to or greater than 10% of the total fair market value of all interests of the partnership and: a. Throughout the preceding 24 month period, more than 50% of the fair market value of the partnership’s assets was attributable to active assets; and b. At the time of the disposition, all or substantially all of the fair market value of the partnership’s assets is attributable to active assets. Eligible RDTOH Account
The second initiative concerns the recovery of refundable dividend tax on hand (“RDTOH”) by a private corporation through the payment of eligible dividends. In taxation years commencing after 2018, the existing RDTOH pool will be replaced by two separate pools – eligible RDTOH and noneligible RDTOH. Proposed amendments to subsection 129(1) would only permit a refund of noneligible RDTOH when non-eligible dividends are paid. Eligible dividends will only result in a dividend refund to the extent of eligible RDTOH. Eligible RDTOH will consist of eligible dividends received from non-connected corporations (like public corporations), and eligible dividends received from a connected corporation that caused the payer corporation to receive a refund of eligible RDTOH. Refundable taxes paid on investment income and Part IV tax paid on non-eligible dividends are added to non-eligible RDTOH, as are eligible dividends received from a connected corporation that did not generate an eligible RDTOH refund for the payer corporation. Non-eligible dividends can generate refunds of eligible RDTOH, subject to an ordering rule. A noneligible dividend paid by a private corporation will first be applied to refund non-eligible RDTOH, then to refund eligible RDTOH if no non-eligible RDTOH remains.
3 Proposed subsection 129(5) contains a transitional RDTOH calculation for the first taxation year in which this measure is in effect. The eligible RDTOH opening balance will generally be the lesser of the corporation’s opening RDTOH balance and 38.33% of the corporation’s opening GRIP balance. A non-CCPC corporation will be deemed to be a CCPC for the purpose of calculating the corporation’s transitional eligible RDTOH balance. As mentioned, both the small business deduction limit measure and the RDTOH measure are applicable in taxation years beginning after 2018. However, the coming into force rules stipulate that, if a corporation accelerates a year-end and one of the reasons for doing so was to defer the application of these measures, these measures will apply to the corporation’s prior taxation year. Other Domestic Tax Measures Suspension of Normal Reassessment Period The normal reassessment period in subsection 152(3.1) will be subject to a “stop-the-clock” rule in instances where a requirement for information or compliance order has been issued and the taxpayer seeks to challenge the requirement or compliance order in the Federal Court. This measure will apply to challenges initiated after Royal Assent to the enacting legislation. Tiered Limited Partnership Losses In response to a recent Federal Court of Appeal decision that constrained the application of the atrisk rules in the context of tiered partnership structures, Budget 2018 proposes to clarify that the atrisk rules apply to a partnership that is itself a limited partner of another partnership. These legislative proposals will clarify that a partnership is a taxpayer for the purposes of section 96, and reduce the upper-tier partnership’s share of any loss from business or property (other than a farming business) that exceeds its at-risk amount. The amount of the denied loss will be allocated to the upper-tier partnership’s adjusted cost basis in the lower-tier partnership. This measure will apply in respect of taxation years that end on or after Budget Day. However, losses realized from a partnership prior to Budget Day cannot be carried forward to taxation years ending after Budget Day if the losses were allocated by a limited partnership to a limited partner that was a partnership. Trust Reporting Many types of inter vivos and testamentary trusts will be required to file T3 returns in circumstances where filing is not presently required, and will also be required to disclose additional information on an annual basis. This additional information will include the identity of all settlors, beneficiaries, trustees and protectors. New penalties will apply in the event of a failure to file a T3 return or the additional information return, with a maximum penalty equal to 5% of the highest fair market value of the property of the trust in the year in circumstances where the failure to file in respect of that year is deliberate or attributable to gross negligence. Draft legislation for this measure was not included in the Budget documents, but the Department of Finance has indicated that the proposed filing requirements will apply to a trust’s 2021 and
4 subsequent taxation years. It is not anticipated that filing requirements will be extended to graduated rate estates, registered plan trusts or charitable trusts. Prior Measures Budget 2018 confirmed that the Department of Finance intends to proceed with previously announced tax measures, as modified to take into account consultations since their release, including: 1.
2.
Reduction of small business tax rate announced in October 2017, along with the related adjustments to the gross-up amount and dividend tax credit for taxable dividends; and Tax on split income measures released in December 2017.
International Proposals Cross-Border Surplus Stripping Section 212.1 is intended to prevent a non-resident shareholder from extracting amounts in excess of paid-up capital from a Canadian corporation without receiving a dividend. In order to prevent the sale of partnerships and trust interests in order to achieve this outcome, Budget 2018 proposes to implement a series of “look-through” rules. For the purpose of section 212.1, the assets, liabilities and transactions of a partnership or trust – including shares of a Canadian corporation – will be allocated to its members or beneficiaries, as the case may be, based on the relative fair market value of their interests. This proposed measure is intended to apply to transactions that occur on or after Budget Day. Unfortunately, no draft legislation was released with the Budget documents. Foreign Affiliates The foreign accrual property income (“FAPI”) of a controlled foreign affiliate does not include income from an investment business if the controlled foreign affiliate employs more than five full-time employees in carrying on the investment business. In order to satisfy this test, some taxpayers combined their separate investment businesses into a single investment business carried on by a shared controlled foreign affiliate, with each taxpayer receiving a return based on the pool of assets they contributed and retaining a right to control the contributed assets. This single investment business would satisfy the employment threshold. Budget 2018 proposes a new rule that will deem investment businesses that are part of a tracking arrangement to be separate businesses to the extent of each taxpayer’s interest in the combined business. Each separate business of the controlled foreign affiliate will have to meet the employment threshold in order for the income from that business to be excluded from FAPI. Similar arrangements involve taxpayers combining their assets in a common foreign affiliate as part of a tracking arrangement, thereby preventing the foreign affiliate from becoming a controlled foreign affiliate of any taxpayer. Budget 2018 proposes that the non-controlled foreign affiliate will
5 be deemed to be a controlled foreign affiliate in these circumstances, such that each shareholder will be required to include FAPI to the extent of their tracked income. These measures will apply to taxation years of a taxpayer’s foreign affiliate that begin on or after Budget Day. Again, no draft legislation was released with the Budget documents. Normal Reassessment Period Extension The normal reassessment period in subsections 152(3.1) and (4) will be extended by three years where a taxpayer has income arising in connection with a foreign affiliate of a taxpayer. This measure is targeted at taxpayers who deal at arm’s length with one or more of their foreign affiliates, and therefore were not subject to the extension of the normal reassessment period for non-arm’s length transactions with non-residents. This measure will apply for taxation years that begin on or after Budget Day.
February 27, 2018
BUDGET 2018 Passive Investment Income Earned by Private Corporations Budget 2018 proposes two specific initiatives designed to discourage private corporations from accumulating assets that generate passive investment income. The proposed rules will generally apply to taxation years commencing after 2018. 1.
Small Business Deduction Limitation
The small business deduction limit of a Canadian-controlled private corporation (“CCPC”) will be reduced under the amended subsection 125(5.1) if the “adjusted aggregate investment income” of the associated group of which the CCPC is a member exceeds $50,000. For every dollar of adjusted aggregate investment income in excess of $50,000, the small business deduction limit will be reduced by $5. Aggregate investment income will continue to be subject to refundable taxes at existing rates. To illustrate the application of this rule, assume that an associated group of CCPCs has more than $500,000 of active business income and $51,000 of adjusted aggregate investment income. The associated group’s small business deduction limit will be reduced by $5,000, which represents a tax cost of approximately $800.1 This initiative will apply to investment income generated by both future investments and existing investments. There is no grandfathering for future investment income generated by existing investment assets. To prevent the avoidance of subsection 125(5.1), subsection 125(5.2) will deem two or more corporations which are not otherwise associated to be associated for the purpose of subsection 125(5.1) if: 1. 2. 3.
The two corporations are related; One corporation lends or transfers property at any time, directly or indirectly in any manner whatever, to the other corporation; and One of the reasons the loan or transfer was made was to reduce the adjusted aggregate investment income of the associated group.
1
Based on the difference between the combined general corporate tax rate in Alberta (27%) and the combined small business tax rate in Alberta (11%) in 2019. 5000 SUNCOR ENERGY CENTRE 150 - 6th Avenue SW CALGARY, AB T2P 3Y7 Tel: (403) 260-3300 Fax: (403) 263-9649 Email: [email protected]
1980 MANULIFE PLACE 10180 - 101st Street EDMONTON, AB T5J 3S4 Tel: (780) 428-8310 Fax: (780) 421-8820 Email: [email protected]
100, 728 Spadina Crescent East SASKATOON, SK S7K 4H7 Tel: (306) 952-0894 Fax: (306) 952-2439 Email: [email protected]
2 Taxpayers will need to exercise caution in causing a CCPC to transfer or loan property to a related corporation, particularly if the motivation for the transfer is to permit the transferor CCPC to continue to be entitled to a full small business deduction. The proposed definition of adjusted aggregate investment income will be added to subsection 125(7). Adjusted aggregate investment income is a private corporation’s aggregate investment income, subject to certain adjustments. Most notably, taxable capital gains and losses from the disposition of “active assets” of the corporation are excluded from adjusted aggregate investment income, as are net capital losses carried forward or carried back from other taxation years. Additions to adjusted aggregate investment income include dividends from non-connected corporations and income from non-exempt life insurance policies. Subsection 125(7) will also be amended to include a definition of active assets. Active assets of a corporation include: 1. 2. 3.
2.
Property used principally in an active business carried on primarily in Canada by the particular corporation or a related CCPC; A share of a connected corporation that is a qualified small business corporation share; or An interest in a partnership if the fair market value of the interest is equal to or greater than 10% of the total fair market value of all interests of the partnership and: a. Throughout the preceding 24 month period, more than 50% of the fair market value of the partnership’s assets was attributable to active assets; and b. At the time of the disposition, all or substantially all of the fair market value of the partnership’s assets is attributable to active assets. Eligible RDTOH Account
The second initiative concerns the recovery of refundable dividend tax on hand (“RDTOH”) by a private corporation through the payment of eligible dividends. In taxation years commencing after 2018, the existing RDTOH pool will be replaced by two separate pools – eligible RDTOH and noneligible RDTOH. Proposed amendments to subsection 129(1) would only permit a refund of noneligible RDTOH when non-eligible dividends are paid. Eligible dividends will only result in a dividend refund to the extent of eligible RDTOH. Eligible RDTOH will consist of eligible dividends received from non-connected corporations (like public corporations), and eligible dividends received from a connected corporation that caused the payer corporation to receive a refund of eligible RDTOH. Refundable taxes paid on investment income and Part IV tax paid on non-eligible dividends are added to non-eligible RDTOH, as are eligible dividends received from a connected corporation that did not generate an eligible RDTOH refund for the payer corporation. Non-eligible dividends can generate refunds of eligible RDTOH, subject to an ordering rule. A noneligible dividend paid by a private corporation will first be applied to refund non-eligible RDTOH, then to refund eligible RDTOH if no non-eligible RDTOH remains.
3 Proposed subsection 129(5) contains a transitional RDTOH calculation for the first taxation year in which this measure is in effect. The eligible RDTOH opening balance will generally be the lesser of the corporation’s opening RDTOH balance and 38.33% of the corporation’s opening GRIP balance. A non-CCPC corporation will be deemed to be a CCPC for the purpose of calculating the corporation’s transitional eligible RDTOH balance. As mentioned, both the small business deduction limit measure and the RDTOH measure are applicable in taxation years beginning after 2018. However, the coming into force rules stipulate that, if a corporation accelerates a year-end and one of the reasons for doing so was to defer the application of these measures, these measures will apply to the corporation’s prior taxation year. Other Domestic Tax Measures Suspension of Normal Reassessment Period The normal reassessment period in subsection 152(3.1) will be subject to a “stop-the-clock” rule in instances where a requirement for information or compliance order has been issued and the taxpayer seeks to challenge the requirement or compliance order in the Federal Court. This measure will apply to challenges initiated after Royal Assent to the enacting legislation. Tiered Limited Partnership Losses In response to a recent Federal Court of Appeal decision that constrained the application of the atrisk rules in the context of tiered partnership structures, Budget 2018 proposes to clarify that the atrisk rules apply to a partnership that is itself a limited partner of another partnership. These legislative proposals will clarify that a partnership is a taxpayer for the purposes of section 96, and reduce the upper-tier partnership’s share of any loss from business or property (other than a farming business) that exceeds its at-risk amount. The amount of the denied loss will be allocated to the upper-tier partnership’s adjusted cost basis in the lower-tier partnership. This measure will apply in respect of taxation years that end on or after Budget Day. However, losses realized from a partnership prior to Budget Day cannot be carried forward to taxation years ending after Budget Day if the losses were allocated by a limited partnership to a limited partner that was a partnership. Trust Reporting Many types of inter vivos and testamentary trusts will be required to file T3 returns in circumstances where filing is not presently required, and will also be required to disclose additional information on an annual basis. This additional information will include the identity of all settlors, beneficiaries, trustees and protectors. New penalties will apply in the event of a failure to file a T3 return or the additional information return, with a maximum penalty equal to 5% of the highest fair market value of the property of the trust in the year in circumstances where the failure to file in respect of that year is deliberate or attributable to gross negligence. Draft legislation for this measure was not included in the Budget documents, but the Department of Finance has indicated that the proposed filing requirements will apply to a trust’s 2021 and
4 subsequent taxation years. It is not anticipated that filing requirements will be extended to graduated rate estates, registered plan trusts or charitable trusts. Prior Measures Budget 2018 confirmed that the Department of Finance intends to proceed with previously announced tax measures, as modified to take into account consultations since their release, including: 1.
2.
Reduction of small business tax rate announced in October 2017, along with the related adjustments to the gross-up amount and dividend tax credit for taxable dividends; and Tax on split income measures released in December 2017.
International Proposals Cross-Border Surplus Stripping Section 212.1 is intended to prevent a non-resident shareholder from extracting amounts in excess of paid-up capital from a Canadian corporation without receiving a dividend. In order to prevent the sale of partnerships and trust interests in order to achieve this outcome, Budget 2018 proposes to implement a series of “look-through” rules. For the purpose of section 212.1, the assets, liabilities and transactions of a partnership or trust – including shares of a Canadian corporation – will be allocated to its members or beneficiaries, as the case may be, based on the relative fair market value of their interests. This proposed measure is intended to apply to transactions that occur on or after Budget Day. Unfortunately, no draft legislation was released with the Budget documents. Foreign Affiliates The foreign accrual property income (“FAPI”) of a controlled foreign affiliate does not include income from an investment business if the controlled foreign affiliate employs more than five full-time employees in carrying on the investment business. In order to satisfy this test, some taxpayers combined their separate investment businesses into a single investment business carried on by a shared controlled foreign affiliate, with each taxpayer receiving a return based on the pool of assets they contributed and retaining a right to control the contributed assets. This single investment business would satisfy the employment threshold. Budget 2018 proposes a new rule that will deem investment businesses that are part of a tracking arrangement to be separate businesses to the extent of each taxpayer’s interest in the combined business. Each separate business of the controlled foreign affiliate will have to meet the employment threshold in order for the income from that business to be excluded from FAPI. Similar arrangements involve taxpayers combining their assets in a common foreign affiliate as part of a tracking arrangement, thereby preventing the foreign affiliate from becoming a controlled foreign affiliate of any taxpayer. Budget 2018 proposes that the non-controlled foreign affiliate will
5 be deemed to be a controlled foreign affiliate in these circumstances, such that each shareholder will be required to include FAPI to the extent of their tracked income. These measures will apply to taxation years of a taxpayer’s foreign affiliate that begin on or after Budget Day. Again, no draft legislation was released with the Budget documents. Normal Reassessment Period Extension The normal reassessment period in subsections 152(3.1) and (4) will be extended by three years where a taxpayer has income arising in connection with a foreign affiliate of a taxpayer. This measure is targeted at taxpayers who deal at arm’s length with one or more of their foreign affiliates, and therefore were not subject to the extension of the normal reassessment period for non-arm’s length transactions with non-residents. This measure will apply for taxation years that begin on or after Budget Day.
