Budget 2023: Raising the Stakes for Aggressive Tax Planning
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The 2023 Canadian Federal Budget (“Budget 2023”) was released on March 28, 2023 (“Budget Day”), by the Department of Finance (“Finance”). As in prior years, Budget 2023 establishes some of Finance’s most significant tax measures and contains various proposals to amend the Income Tax Act (Canada) (“ITA”) and the Excise Tax Act (Canada) (“ETA”).
In contrast with what is now almost routine speculation, Budget 2023 does not contain any proposal to increase the capital gains inclusion rate. It does, however, contain significant proposed amendments in the business income tax context, including the following:
- significant changes to the general anti-avoidance rule (“GAAR”) to address some of Finance’s major concerns with the GAAR, including the introduction of a 25% penalty, which may have a chilling effect on tax planning;
- beginning in 2024, there will be a 2% tax levied on repurchases of equity by most publicly-listed Canadian corporations, trusts and partnerships;
- the elimination of the dividend received deduction for dividends received by financial institutions on shares that are mark-to-market properties; and
- a number of tax credits for green energy and manufacturing.
On the personal tax front, Finance proposes to increase the Alternative Minimum Tax (“AMT”) from 15% to 20.5% and to make various amendments that would broaden the tax base for the AMT. By exempting low-to-middle income earners, these measures are intended to target “high” income earners.
In order to address certain intergenerational transfers of businesses, Budget 2023 also contains proposed legislation to amend the rules introduced in Bill C-208 to ensure that they apply only to transactions involving genuine intergenerational business transfers.
Finance has not introduced any proposed amendments to the ITA in the international tax context in Budget 2023, but has provided an update on developments in international tax reforms and Canada’s status on implementing the objectives outlined in Pillar One and Pillar Two of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting.
Business Income Tax Measures
1. Modifications to the GAAR
In August 2022, Finance released a consultation paper discussing potential amendments to the GAAR to address perceived shortcomings in its scope. Budget 2023 proposes to:
- introduce a preamble that establishes a statutory interpretative guide for the GAAR;
- lower the threshold test in the definition of “avoidance transaction” from a “primary purpose” test to a “one of the main purposes” test;
- expressly introduce the concept of economic substance in the “misuse or abuse” analysis;
- impose a 25% penalty on the amount of any tax benefit assessed under the GAAR; and
- extend the period within which the Canada Revenue Agency (“CRA”) may assess or reassess under the GAAR by three years under certain circumstances.
Finance believes that adding a preamble to the GAAR in new subsection 245(0.1) of the ITA will help address interpretive issues and ensure that the GAAR applies as Finance intended. The proposed preamble provides that the GAAR:
a) applies to deny the tax benefit of avoidance transactions that result directly or indirectly either in a misuse or abuse of a provision of the ITA or any other listed enactments, while allowing taxpayers to obtain tax benefits contemplated by the relevant provisions;
b) strikes a balance between a taxpayer’s need for certainty in planning their affairs and the Government of Canada’s responsibility to protect the tax base and the “fairness” of the tax system; and
c) can apply regardless of whether a tax strategy is foreseen.
The GAAR applies only if there is an avoidance transaction, which is currently defined to refer to transactions that are primarily undertaken to obtain a tax benefit. Budget 2023 proposes to reduce this threshold test from a “primary purpose” test to a “one of the main purposes” test. Amending the GAAR in this manner could materially broaden its scope. However, Finance believes this proposed change strikes a reasonable balance, positing that the proposed test would apply to transactions with a significant tax avoidance purpose, but not to transactions where tax was simply a consideration.
Finance did not propose other amendments to the definition of “avoidance transaction” to address certain concerns, such as whether the avoidance of foreign tax should be considered a bona fide non-tax purpose. According to Finance, the expanded definition would produce “appropriate results” in circumstances where such issues arise – although it is unclear how this would be the case.
Finance also proposes to introduce an economic substance analysis in the misuse or abuse test. New subsection 245(4.1) provides that if an avoidance transaction is significantly lacking in economic substance, that tends to indicate that the transaction results in a misuse or an abuse. For these purposes, factors that tend to establish that a transaction or series of transactions is significantly lacking in economic substance include:
a) all or substantially all of the opportunity for gain or profit and risk of loss of the taxpayer – taken together with those of all non-arm’s-length taxpayers – remains unchanged, including because of a circular flow of funds, offsetting financial positions, or the timing between steps in the series of transactions;
b) it is reasonable to conclude that, at the time the transaction was entered into, the expected value of the tax benefit exceeded the expected non-tax economic return (which excludes both the tax benefit and any tax advantages connected to another jurisdiction); and
c) it is reasonable to conclude that the entire, or almost entire, purpose for undertaking or arranging the transaction or series was to obtain the tax benefit.
The introduction of a statutory economic substance concept in the GAAR may expand what constitutes a misuse or abuse and may encourage the CRA to reassess certain types of tax-motivated transactions that Finance finds abusive. Finance states, however, that a lack of economic substance will not always mean that a transaction is abusive and it would still be necessary to determine the object, spirit, and purpose of the provisions or scheme relied upon in line with existing GAAR jurisprudence.
Penalties and Extension of Reassessment Periods
Finance proposes to introduce a penalty for transactions subject to GAAR. The penalty would be 25% of the amount of the tax benefit. However, where the tax benefit involves a tax attribute that has not yet been used to reduce tax, the amount of the tax benefit would be considered to be nil for purposes of the penalty. The penalty, if otherwise applicable, could be avoided if the transaction is disclosed to the CRA, either as part of the proposed mandatory disclosure rules or voluntarily. Consequential amendments are proposed to the reportable transaction rules to permit voluntary reporting, which would effectively integrate GAAR with the mandatory disclosure rules.
Finally, a three-year extension to the normal reassessment period would be provided for GAAR assessments, unless the transaction had been disclosed to the CRA. This would effectively extend the limitation period to six, seven or 10 years, depending on the type of taxpayer and the transactions involved.
The proposed amendments, if enacted, may effectively compel taxpayers to self-report transactions that could be characterized as avoidance transactions in order to eliminate the risk of incurring the 25% penalty and the extended reassessment period.
Finance has invited public consultation on the proposed amendments to the GAAR until May 31, 2023, after which Finance will publish revised legislative proposals.
2. Tax on Repurchase of Equity
The 2022 Fall Economic Statement demonstrated Finance’s intention to introduce a tax on share buybacks by public corporations, and Budget 2023 delivers on this promise by introducing a 2% tax on the net value of a listed entity’s repurchase of equity. This tax applies to covered entities, which are generally Canadian-resident corporations (other than mutual fund corporations) whose shares are listed on a designated stock exchange, real estate investment trusts, specified investment flow-through (“SIFT”) trusts, and SIFT partnerships if they have units listed on a designated stock exchange. Equity for purposes of this rule means shares of the corporation or units of the trust or partnership.
The tax is computed as 2% of the net value of an entity’s repurchase of equity, defined as the fair market value of equity repurchased by the entity in a taxation year less the fair market value of equity issued from treasury in the taxation year. This so-called “netting rule” applies on an annual basis and corresponds to the entity’s taxation year for income tax purposes and generally takes into account all transactions undertaken by the entity that involve a repurchase of equity or the issuance of equity from treasury in the taxation year. There is an anti-avoidance rule that applies to increase equity for this purpose, if it is reasonable to conclude that the primary purpose of a transaction or series is to cause a decrease in the equity redeemed, acquired or cancelled, or to increase the equity issued by the covered entity in the taxation year. Normal course issuer bids and substantial issuer bids would constitute a repurchase of equity for purposes of this rule. However, both the issuance and cancellation of preferred shares or units with a fixed dividend and redemption entitlement, and the issuance and cancellation of shares or units in certain corporation reorganizations and acquisitions (e.g., certain amalgamations, liquidations, and share-for-share exchanges) would not be considered an issuance or repurchase of equity for purposes of this rule.
The proposed legislation introduces a (particularly low) de minimis threshold of $1 million — that is, the tax would not apply to a public entity if it repurchases less than $1 million of equity during the taxation year (prorated for short taxation years). The de minimis rule does not take into account equity issued in the year.
To support this measure, certain rules would deem an acquisition of equity by certain affiliates of a public entity to be a repurchase of equity by the entity itself. In addition, certain exceptions are proposed, including those intended to facilitate certain equity-based compensation arrangements, and acquisitions made by registered securities dealers in the ordinary course of business.
The tax on repurchases of equity would apply in respect of repurchases and issuances of equity that occur on or after January 1, 2024.
3. Dividend Received Deduction by Financial Institutions
The ITA generally permits a corporation to deduct the amount of dividends received from other taxable Canadian corporations or corporations resident in Canada in computing income for purposes of the ITA. This “dividend received deduction” (“DRD”) is intended to limit the application of tax at each level when dividends are paid through a corporate chain.
The mark-to-market rules in the ITA deem financial institutions to have disposed of their “mark-to-market properties” immediately before the end of each year for proceeds equal to their fair market value and to have reacquired those properties at a cost equal to those proceeds at the end of the year, forcing the recognition of accrued gains and losses on mark-to-market properties each year. Gains and losses realized from mark-to-market properties in a year, both those realized from actual dispositions in the year and those deemed to have been realized at the end of the year, are included in computing income for the year; they are not treated as capital gains or losses. Shares are generally mark-to-market properties of a financial institution when the financial institution holds less than 10% of the votes or value of the corporation that issued the shares (i.e., portfolio shares).
Finance believes that the treatment of dividends under the DRD conflicts with the policy underlying the mark-to-market rules. The mark-to-market rules essentially deem gains and losses on portfolio shares to be business income, but dividends received on those shares, which form part of the return earned by the financial institution from such shares, remain eligible for the DRD and are not included in computing the business income of the financial institution.
To align the treatment of dividends received by financial institutions on portfolio shares with the treatment of gains realized and deemed to have been realized by financial institutions on portfolio shares under the mark-to-market rules, Budget 2023 proposes to deny the DRD in respect of dividends received by financial institutions on shares that are mark-to-market properties. This measure would apply to dividends received after 2023.
4. Investment Tax Credit for Clean Hydrogen
Budget 2023 proposes to introduce the Clean Hydrogen Investment Tax Credit (the “CH Tax Credit”), which is a fully refundable tax credit on the purchase and installation cost of eligible equipment. Generally, the CH Tax Credit would be available only in respect of projects that produce all, or substantially all, hydrogen through their production process and only for projects that produce hydrogen from electrolysis or natural gas. In order to obtain the credit, there are many requirements with respect to the measurement of carbon intensity, what equipment is eligible, labour requirements and the approval of the front-end engineering design. Special rules also ensure that one project cannot utilize multiple different tax credits. The CH Tax Credit would be available for property that is acquired and that becomes available for use on or after Budget Day, but would be partially phased out starting in 2034 with property that becomes available for use in 2034 and fully phased out for property that becomes available for use after 2034.
5. Clean Technology Investment Tax Credit – Geothermal Energy
Budget 2023 proposes to expand the eligibility of the Clean Technology Investment Tax Credit (a 30% refundable credit) to include geothermal energy systems that are eligible for Class 43.1 of Schedule II of the Income Tax Regulations. The proposed changes would apply with respect to property that is acquired and becomes available for use on or after Budget Day, so long as it has not been used for any other purpose prior to its acquisition.
Budget 2023 also proposes to change the phase-out schedule of the Clean Technology Investment Tax Credit, such that the credit would be reduced to 15% in 2034 and unavailable after 2034.
6. Labour Requirements Related to Certain Investment Tax Credits
The intention to include wage and apprenticeship requirements for the Clean Technology and CH Tax Credit was announced in the 2022 Fall Economic Statement. Budget 2023 provided further commentary on the application, prevailing wage requirement, apprenticeship requirements and exemptions in relation to these measures. Budget 2023 further provides that the labour requirements would apply to work that is performed on or after October 1, 2023.
7. Investment Tax Credit for Clean Technology Manufacturing
The introduction of a refundable investment tax credit relating to clean technology manufacturing and processing and critical mineral extraction and processing is proposed by Budget 2023. The credit is equal to 30% of the capital cost of eligible property associated with eligible activities. Special rules also ensure that one project cannot utilize multiple different tax credits. This credit would be available for property that is acquired and becomes available for use on or after January 1, 2024. The credit percentage reduces in 2032 and is eliminated in 2035.
8. Zero-Emission Technology Manufacturers
Budget 2023 proposes to expand the eligible activities that qualify for the reduced tax rates for zero-emission technology manufacturers to include certain nuclear manufacturing and processing activities. This proposal would apply for taxation years beginning after 2023. Budget 2023 also proposes to begin the planned phase-out of the reduced tax rate for taxation years that begin in 2032, which is a three-year extension from the original phase-out timeline.
9. Investment Tax Credit for Carbon Capture, Utilization and Storage
A refundable investment tax credit for carbon capture, utilization and storage was proposed by Budget 2022 to be available for businesses incurring eligible expenses beginning on January 1, 2022. Budget 2023 provides additional design details in relation to the credit, including commentary on dual-use equipment, validating concrete storage requirements and refurbishment costs. Special rules also ensure that one project cannot utilize multiple different tax credits. The measures would apply to eligible expenses incurred after 2021 and before 2041.
10. Flow-Through Shares and Critical Mineral Exploration Tax Credit – Lithium from Brines
Budget 2023 proposes to amend the ITA to include lithium from brines as a mineral resource, such that eligible expenses made after Budget Day that relate to lithium from brines would qualify as Canadian exploration expenses and Canadian development expenses. Principal business corporations undertaking qualifying exploration and development activity could issue flow-through shares and renounce such expenses to their shareholders. Further, Budget 2023 proposes to make lithium from brines eligible for the Critical Mineral Exploration Tax Credit, a 30% non-refundable tax credit. This proposal would apply to flow-through share agreements entered into after Budget Day and before April 2027.
11. Income Tax And GST/HST Treatment of Credit Unions
Budget 2023 proposes to amend the definition of “credit union” in the ITA (which is used for both income tax and GST/HST purposes) to eliminate the existing revenue test and include a definition that more accurately captures the current operations of credit unions. This amendment would be applicable for taxation years of a credit union ending after 2016.
International Tax Measures
Canada is one of 138 countries that have committed to advance a two-pillar plan for international tax reform led by the OECD. Pillar One is intended to reallocate a portion of taxing rights over the profits of large multinational enterprises (“MNEs”) to jurisdictions where their users and customers are located. Pillar Two is intended to ensure that the profits of large MNEs are subject to an effective tax rate of at least 15%, regardless of where those profits are earned.
Budget 2023 provides an update on recent developments and upcoming implementation steps in relation to Pillar One and Pillar Two. Budget 2023 is otherwise silent with respect to the rules in the ITA in the international tax context.
1. Pillar One Update
Pillar One seeks to update the allocation of income of MNEs under international tax treaties. The existing framework in tax treaties, including Canada’s treaties, relies on principles of connection with a country based on a physical presence. These principles were designed for traditional brick-and-mortar businesses which might establish a physical presence in a foreign jurisdiction (i.e., a permanent establishment) for operating purposes and thereby cause the business to be taxable in that jurisdiction under current rules. However, the prevailing view is that these rules are dated and do not produce appropriate results in today’s digitalized economy where value is created in foreign jurisdictions without the requisite physical presence that would cause the business profits to be taxable in that jurisdiction. Pillar One, therefore, goes beyond the establishment of a physical presence in a foreign jurisdiction. Instead, it opts for a broader test in determining an economic nexus that a MNE has in a foreign jurisdiction, and a formulary allocation of residual profits to ensure that large MNEs “pay a fair share of tax” in the countries where their users and customers are located.
The federal government is working with international partners to develop the model rules and the multilateral convention needed to establish this new tax framework and bring it into effect. Budget 2023 reports that countries are working toward completing multilateral negotiations so that the convention to implement Pillar One can be signed by mid-2023 with a view to entering into force in 2024.
Finance released draft legislative proposals for a Digital Services Tax (“DST”) in December 2021. Budget 2023 states that Finance intends to release a revised draft of the DST before a bill is introduced in Parliament. The DST could be imposed as of January 1, 2024, but only if the multilateral convention implementing the Pillar One framework has not come into force. In that event, the DST would be payable as of 2024 in respect of revenues earned as of January 1, 2022.
2. Pillar Two Update
Pillar Two is a multilateral framework, which would impose a minimum effective tax rate of 15% on MNEs with annual revenues of €750 million or more. The minimum tax is designed to reduce profit shifting and, what Budget 2023 refers to as, the “race to the bottom” by ensuring that profits earned by MNEs will be subject to a minimum tax in each jurisdiction in which they operate.
There are two main components to Pillar Two: the Income Inclusion Rule (“IIR”) and the Undertaxed Profits Rule (“UTPR”). In general, if a jurisdiction has implemented IIR, it has a right to subject the ultimate parent entity of a MNE located in the jurisdiction to a top-up tax if that MNE operates in jurisdictions where it is subject to an effective tax rate of below 15%. The UTPR is a “backstop” rule and, if a jurisdiction has implemented UTPR, it may impose a top-up tax on a MNE operating within its jurisdiction if the jurisdiction where the ultimate parent entity of the MNE is located has not implemented IIR. Pillar Two provides that a jurisdiction may implement a domestic minimum top-up tax, which essentially mirrors and is credited against the tax liability that would otherwise arise under IIR or UTPR.
In Budget 2023, the federal government announced that it will introduce legislation to implement IIR and a domestic minimum top-up tax applicable to Canadian entities of MNEs with annual revenues of €750 million or more. The new rules will be in effect for fiscal years of MNEs that begin on or after December 31, 2023. The federal government also announced that it will introduce legislation to implement UTPR with effect for fiscal years of MNEs that begin on or after December 31, 2024. Budget 2023 noted that for the purposes of IIR, the domestic minimum top-up tax and UTPR, a MNE is considered to have the same fiscal year as its ultimate parent entity.
The federal government intends to release for public consultation draft legislative proposals for IIR and the domestic minimum top-up tax in the coming months. Draft legislative proposals for UTPR will be released at a later date.
Personal Tax Measures
1. Employee Ownership Trusts
Budget 2023 proposes to include the definition of an “employee ownership trust” (“EOT”) in the ITA, along with amendments that facilitate the acquisition and ownership by EOTs of shares of a corporation.
A trust would be an EOT under the ITA if it is a Canadian resident trust (but not a deemed resident trust) and satisfies a number of conditions, including:
(i) it holds shares of a “qualifying business” exclusively for the benefit of the employee beneficiaries of the trust;
(ii) the interest of each beneficiary of the trust is determined in the same manner, based on a reasonable application of any combination of certain specified criteria, including the employee’s length of service, remuneration and hours worked;
(iii) the trust must hold a controlling interest in the shares of one or more qualifying businesses;
(iv) all, or substantially all, of the trust’s assets must be shares of qualifying businesses;
(v) the trust must not distribute shares of a qualifying business to any individual beneficiaries; and
(vi) the trustees must meet certain specified conditions.
In addition, in order to be a “qualifying business,” a corporation must be a Canadian-controlled private corporation (“CCPC”) that meets certain conditions, including that all, or substantially all, of the fair market value of its assets are attributable to assets used in an active business carried on in Canada and that it does not carry on its business as a partner of a partnership.
Budget 2023 proposes that a “qualifying business transfer” would be a disposition by a taxpayer of shares of a corporation to a trust, or to a CCPC that is controlled and wholly owned by a trust, where the trust is an EOT that acquires control of the corporation at the time of the disposition and that meets certain other conditions.
Budget 2023 proposes to amend existing tax rules under the ITA in conjunction with the introduction of the EOT, including (i) the extension to a 10-year capital gains reserve for qualifying business transfers to an EOT; (ii) an exception to the shareholder loan rules, which extends the repayment period from one to 15 years for certain amounts loaned to the EOT from a qualifying business to purchase shares in a qualifying business transfer; and (iii) an exemption from the 21-year deemed disposition rule.
These amendments to the ITA would apply as of January 1, 2024.
2. Registered Education Savings Plan
Budget 2023 proposes to amend the ITA to allow Education Assistance Payment (“EAP”) withdrawals from a Registered Education Savings Plan (“RESP”) of up to $8,000 in respect of the first 13 consecutive weeks of full-time enrollment in an eligible post-secondary program and up to $4,000 per 13-week period for part-time enrollment in an eligible post-secondary program. Individuals who withdrew EAPs prior to Budget Day may be able to withdraw an additional EAP amount, subject to the new limits and the terms of the plan. The proposals also include the ability of parents who are divorced or separated to open a joint RESP for one or more of their children and to transfer an existing joint RESP to another promoter.
These proposals would come into force on Budget Day.
3. Retirement Compensation Arrangements
Budget 2023 proposes that fees or premiums paid to secure or renew a letter of credit or a surety bond for a retirement compensation arrangement (“RCA”) that is supplemental to a registered pension plan will not be subject to the 50% refundable tax on those fees and premiums. This proposal would apply to fees or premiums paid on or after Budget Day.
Budget 2023 further proposes to allow employers to request a refund of taxes that were previously remitted in relation to fees or premiums paid for letters of credit or surety bonds by an RCA trust based on retirement benefits that are paid by the corporation to employees who had RCA benefits secured by letters of credit (or surety bonds). Employers would be eligible for a refund of 50% of retirement benefits paid, up to the amount of the refundable tax previously paid. This proposal would apply to retirement benefits paid after 2023.
4. Registered Disability Savings Plans
Budget 2023 proposes to extend a temporary measure that was set to expire at the end of 2023 that allows a “qualifying family member,” which is currently defined as a parent, spouse or common-law partner, to open a Registered Disability Savings Plan (“RDSP”) and be the planholder for an adult whose capacity to enter into an RDSP contract is in doubt, and who does not have a legal representative. The temporary measure is proposed to be extended to December 31, 2026, and the definition of “qualifying family member” is proposed to be expanded to now include brothers or sisters who are 18 years or older. The proposed expansion of the qualifying family member definition will apply as of royal assent of the enabling legislation and be in effect until December 31, 2026. It is important to note that a sibling who becomes a qualifying family member and planholder before the end of 2026 could remain the planholder after 2026.
5. Alternative Minimum Tax for High-Income Individuals
Budget 2023 proposes a number of changes to the existing AMT regime to better target high-income individuals. These changes include: (i) broadening the base on which the AMT is levied; (ii) raising the AMT exemption amount; and (iii) increasing the AMT rate.
To broaden the AMT base, Budget 2023 proposes to:
- increase the AMT capital gains inclusion rate from 80% to 100%;
- include 100% of the benefit associated with employee stock options in the AMT base;
- include 30% of the capital gains on donations of publicly-listed securities in the AMT base; and
- disallow 50% of certain deductions, including the following: employment expenses (other than to earn commission income), deductions for CPP, QPP and PPIP contributions, moving expenses, childcare expenses, interest and carrying charges incurred to earn income from property, and non-capital loss carryovers.
The treatment relating to capital loss carryovers, allowable business investment losses, and capital gains eligible for the lifetime capital gains exemption would remain the same.
Budget 2023 proposes to allow only 50% of non-refundable tax credits to be credited against the AMT, subject to certain exceptions (i.e., the Special Foreign Tax Credit). The AMT exemption amount (which is a deduction available to all individuals) would increase from $40,000 to approximately $173,000. Further, Budget 2023 proposes to increase the AMT rate from 15% to 20.5%. There are no changes proposed to the carry forward period – additional tax paid because of the AMT can be carried forward for seven years and credited against regular tax to the extent it exceeds AMT in those years. Trusts that are currently exempt from AMT will continue to benefit from the exemption.
The proposed changes would come into force for taxation years that begin after 2023. Additional details relating to the new AMT regime will be released later this year.
6. Strengthening the Intergenerational Business Transfer Framework
Section 84.1 of the ITA acts as an anti-avoidance provision to tax certain amounts as dividends which would otherwise be taxed as capital gains. Effective June 29, 2021, an exception to section 84.1 was introduced by Bill C-208 for certain intergenerational transfers of shares by parents to corporations owned by their children or grandchildren to mirror the tax consequences of certain arm’s-length sales of shares. Budget 2023 recognizes that the exceptions provided in Bill C-208 did not contain adequate safeguards restricting these exceptions to bona fide intergenerational business transfers and had the potential of applying to situations where a true intergenerational transfer of a business had not occurred. In response, Budget 2023 proposes to include additional conditions to the rules introduced by Bill C-208, such that the exception would now only apply to genuine intergenerational business transfers.
Two transfer options are proposed for taxpayers who wish to fall under this exception: (i) an immediate intergenerational business transfer (i.e., three-year test) (the “Immediate Transfer”); or (ii) a gradual intergenerational business transfer (i.e., five-to-10-year test) (the “Gradual Transfer”). The Gradual Transfer would provide an added level of flexibility. A joint election is required by the transferor and the child for the transfer to qualify as either an Immediate Transfer or a Gradual Transfer, and the child would now be jointly and severally liable for any section 84.1 tax consequences resulting from the transfer.
Budget 2023 further proposes to extend the limitation period for assessing the transferor by three years for an Immediate Transfer and by 10 years for a Gradual Transfer. Budget 2023 has also expanded the meaning of adult child, which now includes grandchildren, step-children, children-in-law, nieces, nephews, grandnieces and grandnephews. It also proposes to provide a 10-year capital gains reserve for genuine intergenerational share transfers.
With respect to both transfer options, the following proposed conditions are required for genuine intergenerational business transfers:
1. Transfer of control of the business;
2. Transfer of economic interests in the business;
3. Transfer or management of the business;
4. Child retains control of the business; and
5. Child works in the business.
1. Transfer of Control of the Business
An Immediate Transfer requires that the parents immediately and permanently transfer both legal and factual control of the corporation to the child. This includes an immediate transfer of a majority of voting shares of the corporation, followed by a transfer of the balance of the voting shares within 36 months.
For a Gradual Transfer, the parents are required to immediately and permanently transfer only legal control by transferring a majority of the voting shares of the corporation, followed by the transfer of the remaining voting shares within 36 months. Transfer of factual control is not required.
2. Transfer of Economic Interests in the Business
For an Immediate Transfer, parents are required to immediately transfer a majority of the common growth shares of the corporation to the child, with the balance of common growth shares to be transferred within 36 months.
To meet the test for a Gradual Transfer, parents will need to immediately transfer a majority of the common growth shares, followed by the transfer of the remaining common growth shares within 36 months. Within 10 years of the initial sale, parents will need to reduce the fair market value of their debt and equity interests in the corporation to an amount not exceeding (i) 50% of the value of their direct or indirect interest in a farm or fishing corporation at the initial sale time, or (ii) 30% of the value of their direct or indirect interest in a small business corporation at the initial sale time.
3. Transfer of Management of the Business
For both the Immediate Transfer and the Gradual Transfer, parents will be required to transfer the management of the business to their child within a time frame that is reasonable in the circumstances. There is a 36-month safe harbour for this provision.
4. Child Retains Control of the Business
For an Immediate Transfer, the child will need to retain legal control of the corporation for 36 months following the share transfer. A Gradual Transfer requires the child to retain legal control of the corporation for a period that is the greater of 60 months or until the business transfer is completed. The child does not need to retain factual control for either transfer.
5. Child Works in the Business
The Immediate Transfer requires that at least one child remains actively involved in the business for 36 months following the transfer of shares. The Gradual Transfer requires that at least one child remains actively involved in the business for a period that is the greater of 60 months or until the transfer of the business is complete.
Budget 2023 also introduces relieving provisions for situations involving a subsequent arm’s-length transfer of shares and circumstances involving the disability or death of a child. It also eliminates previous limits on the value of the shares to be transferred,
These proposals would apply to transactions that occur on or after January 1, 2024.
Budget 2023 contains one significant sales tax measure aimed to nullify the decision of the Federal Court of Appeal in Canadian Imperial Bank of Commerce v. Canada, 2021 FCA 10, wherein the Court held that credit card and payment processing services supplied by Visa to the card issuing bank (and by extension to other participants in the Visa network) were tax-exempt financial services. This will be achieved by amending the definition of “financial service” in the ETA to expressly exclude a service by a payment card network operator of a service in respect of authorizing transactions, a clearing or settlement service, or a service provided in conjunction with the authorization service or clearing or settlement service. The amendment is aimed to ensure services by payment network operators to network participants are subject to GST/HST.
This measure will apply to a service rendered under an agreement for a supply if any consideration for the supply becomes due, or is paid without becoming due, after March 28, 2023. This measure would also apply to a service rendered under an agreement for a supply if all of the consideration for the supply became due, or was paid, on or before March 28, 2023, except where the following two conditions are both met:
(i) the supplier did not, on or before March 28, 2023, charge, collect or remit any amount as or on account of tax in respect of the supply; and
(ii) the supplier did not, on or before March 28, 2023, charge, collect or remit any amount as or on account of tax in respect of any other supply that is made under the agreement and that includes the provision of a payment card clearing service.
Previously Announced Measures
Budget 2023 confirms Finance’s intention to proceed with the following previously announced tax and related measures, as modified to take into account consultations and deliberations since their release:
- legislative proposals released on November 3, 2022, with respect to excessive interest and financing expense limitations, and reporting rules for digital platform operators;
- tax measures announced in the Fall Economic Statement on November 3, 2022, for which legislative proposals have not yet been released, including the extension of the residential property flipping rule to assignment sales;
- legislative proposals released on August 9, 2022, including with respect to the substantive Canadian-controlled private corporation rules, mandatory disclosure rules, hedging and short selling by financial institutions, reporting requirements for registered retirement savings plans/income funds, electronic filing and certification of tax and information returns, and borrowing by defined benefit pension plans;
- legislative proposals released on April 29, 2022, with respect to hybrid mismatch arrangements;
- legislative proposals released on February 4, 2022, with respect to GST/HST treatment of crypto asset mining;
- legislative proposals tabled in the Notice of Ways and Means Motion on December 14, 2021, to introduce the Digital Services Tax Act;
- the transfer pricing consultation announced in Budget 2021;
- measures outlined in Budget 2016 relating to the GST/HST joint venture election;
- the income tax measure announced on December 20, 2019, to extend the maturation period of amateur athletes trusts maturing in 2019 by one year, from eight years to nine years; and
- the federal government announced its intention to review the SR&ED program to ensure it is providing adequate support and improving the development, retention and commercialization of intellectual property, including the consideration of adopting a patent box regime. Finance will continue to engage with stakeholders on the next steps in the coming months.
If you have any questions about Budget 2023, please contact any member of our Tax Group.