Budget 2023 proposes to provide flexibility in the context of intergenerational transfers. Specifically, it proposes that taxpayers who wish to undertake a genuine intergenerational share transfer may choose to rely on one of two transfer options:
- An immediate intergenerational business transfer based on arm’s length sale terms, requiring that the parent immediately give up both de jure and de facto control, together with a majority of the common growth shares in the company, with the remainder transferred over not more than three years.
- A gradual intergenerational business transfer, with more relaxed rules but allowing for transition to occur over five to ten years.
The structures contemplate a traditional estate freeze, which generally involves the Transferor crystalizing the value of their economic interest in a corporation to allow future growth to accrue to their children, while the parent’s fixed economic interest is then gradually diminished by the corporation repurchasing the parent’s interest.
In both cases, the parents must transfer management of the business to the next generation within a reasonable time based on the particular circumstances (with a 36-month safe harbour). Parties would be required to file a joint election to identify the particular type of transfer, in addition to several ongoing requirements. Budget 2023 also proposes a ten-year capital gains reserve for transfers that satisfy these conditions.
Business income tax measures
General Anti-Avoidance Rule
Budget 2023 proposes to amend the general anti-avoidance rule (GAAR) in the Income Tax Act by:
- Introducing a preamble to create interpretative rules for applying GAAR.
- Lowering the requirements necessary for a transaction to be an “avoidance transaction” such that GAAR potentially applies.
- Introducing a rule making the absence of “economic substance” in a transaction potentially relevant to determining whether a “misuse or abuse” has occurred.
- Introducing a penalty where GAAR is applied.
- Extending the reassessment period to apply GAAR by three years.
The Government will establish a consultation period, allowing interested parties to submit their views on these proposals until May 31, 2023, after which the Government intends to publish revised legislative proposals and announce the application date of the amendments.
The preamble would be added in order to help address interpretive issues and ensure that the GAAR applies as intended. Specifically, it addresses three areas as follows, as set out in the text of the proposed draft amendment:
(0.1) This section of the Act contains the general anti-avoidance rule, which
(a) applies to deny the tax benefit of avoidance transactions that result directly or indirectly either in a misuse of provisions of the Act (or any of the enactments listed in subparagraphs (4)(a)(ii) to (v)) or an abuse having regard to those provisions read as a whole, while allowing taxpayers to obtain tax benefits contemplated by the relevant provisions;
(b) strikes a balance between
(i) taxpayers’ need for certainty in planning their affairs, and
(ii) 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.
Avoidance transaction standard
Currently, the threshold for a transaction to constitute an “avoidance transaction” to which GAAR may potentially apply is that obtaining a tax benefit be a “primary purpose” of the transaction (or the series of transactions of which the particular transaction is part). Budget 2023 proposes to reduce the avoidance transaction threshold such that a transaction will be an avoidance transaction if “one of the main purposes” of the transaction or series of transactions is to obtain a tax benefit. This is intended to broaden the applicability of the GAAR to transactions with a significant tax avoidance purpose, even if tax avoidance was not a “primary purpose” but (says the Government) would not apply to transactions where tax was simply a consideration.
Current jurisprudence has given only a limited role for economic substance when determining whether the GAAR applies. Budget 2023 proposes to add a new “economic substance” element to the “misuse or abuse” element of a GAAR analysis, ostensibly on the basis that GAAR’s “initial objective” required economic substance as well as literal compliance with the words of the Income Tax Act. This new rule would apply where a transaction lacks economic substance; otherwise, the existing misuse or abuse jurisprudence would continue to apply.
Under the proposed amendments, a lack of economic substance alone would not always mean that a transaction is abusive, but its absence will be considered a factor that is indicative of abusive tax avoidance. As is currently the case, the object, spirit and purpose of the provisions or scheme relied upon would still need to be determined. Where the tax results sought are consistent with the purposes of the provisions or scheme, there would be no finding of abusive tax avoidance even in cases lacking economic substance.
Additionally, the proposed amendments provide a non-exhaustive list of indicators for determining whether a transaction or series of transactions is lacking in economic substance. Where they apply, the existence of one or more of these indicators would strongly point to a transaction lacking economic substance. The indicators are:
- whether there is a potential for pre-tax profit
- whether the transaction has resulted in a change of economic position
- whether the transaction is entirely (or almost entirely) tax motivated
An example provided of a transaction that lacks economic substance but is not considered abusive is the transfer of funds from an individual’s taxable account to a tax-free savings account. While the transaction is entirely tax motivated, it does not result in a change of economic position and does not provide potential for pre-tax profit, it is clearly not a misuse or abuse of the relevant provisions of the Income Tax Act as those provisions are being used in the manner that Parliament intended.
Budget 2023 claims that the proposed amendment would not supplant the general approach under Canadian income tax law respecting the legal form of an arrangement, and would not require an enquiry into or determination of what the economic substance of a transaction actually is (e.g., whether a particular financial instrument is, in substance, debt or equity). Rather, the intended purpose of the amendment is to require the consideration of a lack of economic substance in determining whether a transaction is abusive tax avoidance.
Budget 2023 proposes to introduce a new penalty for transactions subject to the GAAR equal to 25 per cent of the amount of the tax benefit. This penalty does not apply to tax attributes that have not yet been used to reduce tax. This penalty will only apply to tax benefits received from transactions that were not disclosed to the Canada Revenue Agency (CRA) in a prescribed form. Where a transaction is disclosed to the CRA either specifically for this purpose or as part of the proposed mandatory disclosure rules, the penalty will not apply.
Extended reassessment period
Budget 2023 proposes the addition of a three-year extension to the normal reassessment period for GAAR assessments on undisclosed transactions. Where a transaction is disclosed to the CRA, the normal reassessment period would apply.
It is somewhat surprising that the Government chose Budget 2023 to advance the proposed amendment of GAAR in this manner to further tilt the playing field in GAAR cases in its favour. The August 2022 Discussion Paper released by the Government on this issue never explained exactly what its concerns were that required legislative amendment. Before proceeding with legislative proposals, answering questions about which cases the Government lost and should have won, and why, would have allowed a more informed and useful discussion of potential solutions. Instead, the Government has lurched forward into legislative amendments that constitute a major departure from existing tax policy.
For example, no explanation has been provided as to why penalties should apply whenever the Government successfully applies GAAR, separate and apart from the existing rules providing for penalties where gross negligence has been found (the CRA should expect to receive many, many notice filings of benign transactions as GAAR penalty insurance). The proposed new rule on economic substance is especially troubling in this regard. Notwithstanding the reference in Budget 2023 to requiring economic substance being part of GAAR’s “initial objective,” there is little or no evidence of that in the Explanatory Notes that accompanied GAAR’s enactment adding such a requirement now is a substantive moving of the goalposts. The term “economic substance” can mean may different things to different people, and the legislative inclusion of its absence as a potential marker of “bad” transactions is unwarranted and likely to embolden the CRA to apply GAAR beyond its intended scope. The Government has drawn the wrong conclusions from the GAAR cases in which it has been unsuccessful, and it should instead focus its attention on the proposals made in the Discussion Paper to better explain the legislative rationale of the Income Tax Act’s provisions. Further submissions on this development are likely in advance of the May 31 deadline.
Tax on repurchases of equity
As previously announced, Budget 2023 proposes a 2 per cent tax on the net value of share (and unit) repurchases by publicly traded Canadian corporations (excluding mutual fund trusts), REITS, SIFT trusts and partnerships (generally remnants from the Income Trust days) and certain other trusts and partnerships. The tax would apply in respect of repurchases of equity that occur on or after Jan. 1, 2024.
The tax is equal to 2 per cent of the net value of an entity’s repurchase of equity (i.e. shares or unit of the corporation, trust or partnership) which is defined as the fair market value of equity repurchased less the fair market value of equity issued from treasury. This “netting rule” would apply on an annual basis, corresponding to the entity’s taxation year. Both normal course issuer bids and substantial issuer bids would constitute the repurchase of equity for the purposes of the rule.
Certain exceptions to the netting rule are proposed. Specifically, the following transactions would not be considered an issuance or repurchase of equity:
- The issuance and cancellation of debt-like preferred shares and units, meaning shares and units with a fixed dividend and redemption entitlement.
- The issuance and cancellation of shares or units in certain corporate reorganizations and acquisitions, including certain amalgamations, liquidations, and share-for-share exchanges.
The tax would not apply to an entity in a taxation year if it repurchased less than $1 million of equity during that taxation year (prorated for short taxation years) as determined on a gross basis.
The acquisition of equity by certain affiliates of an entity would be deemed to be a repurchase of equity by the entity itself. Certain exceptions to this rule 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.
A similar tax in the U.S. is levied at the rate of 1 per cent. Under guidance issued by the Internal Revenue Service (Notice 2023-2, issued Dec. 27, 2022), the U.S. tax may also apply to a share buy-back by a non-U.S. (i.e., Canadian) public company if a U.S. affiliate “funds by any means (including through distributions, debt or capital contributions) the acquisition or repurchase” of the stock of the Canadian corporation. The proposed Canadian rules do not appear to levy the tax against a Canadian affiliate of a publicly-traded U.S. corporation where the Canadian affiliate funds the repurchase of share by the U.S. corporation.
Dividend received deduction by financial institutions
Budget 2023 has targeted the intercorporate dividend deduction taken by financial institutions (FIs) on shares that are subject to the mark-to-market rules, i.e., shares of corporations resident in Canada that an FI has less than 10 per cent of the votes or value of (portfolio shares). Budget 2023 also proposes that, for purposes of this new provision, a share (other than a share of an FI) that is a “tracking property” of a corporation at any time in a taxation year will be deemed to be “mark-to-market property” of the corporation for the year. This proposed amendment is meant to align the treatment of dividends and gains (treated on income account) on portfolio shares under the mark-to-market rules. This measure, which will apply to deny the deduction on dividends received by FIs on mark-to-market property after 2023, is projected to result in $3.15 billion in additional revenue over the next four years.
Budget 2023 proposes to introduce or expand a variety of measures to help with the Government’s energy transition strategies, including the following:
- Clean Electricity Investment Tax Credit: Budget 2023 proposes a 15 per cent refundable tax credit for eligible investments in: (a) Non-emitting electricity generation systems (wind & solar); (b) Abated natural gas-fired electricity generation; (c) Non fossil fuel stationary electricity storage systems; and (d) Equipment for the transmission of electricity between provinces and territories.
- Clean Technology Investment Tax Credit – Geothermal Energy (CTI Tax Credit): The 2022 Fall Economic Statement had proposed the CTI Tax Credit as a 30 per cent refundable credit available to businesses investing in eligible property that is acquired and that becomes available for use on or after Budget Day 2023. Budget 2023 proposes to expand the eligibility of the CTI Tax Credit to include equipment used primarily for the purpose of generating electrical energy and/or heat energy solely from geothermal energy systems that are eligible for Class 43.1 of Schedule II of the Income Tax Regulations.
Manufacturing and mining
- Investment Tax Credit for Clean Technology Manufacturing: Budget 2023 proposes to introduce a refundable investment tax credit for depreciable property that is used all or substantially all for certain clean technology manufacturing and processing, including: (a) manufacturing of certain renewable energy equipment for solar, wind, water or geothermal projects; (b) manufacturing of nuclear energy equipment; and (c) processing or recycling of nuclear fuels and heavy water; (d) manufacturing of nuclear fuel rods; (e) manufacturing of electrical energy storage equipment used to provide grid-scale storage or other ancillary services; (f) manufacturing of equipment for air- and ground-source heat pump systems; (g) manufacturing of zero-emission vehicles, including conversions of on-road vehicles; (h) manufacturing of batteries, fuel cells, recharging systems and hydrogen refueling stations for zero-emission vehicles; (i) manufacturing of equipment used to produce hydrogen from electrolysis; and (j) manufacturing or processing upstream components, sub-assemblies and materials provided that the output would be purpose-built or designed exclusively to be integral to other eligible clean energy technology manufacturing and processing activities, such as anode and cathode materials used for electric vehicle batteries.
In addition, the tax credit will apply to eligible equipment included in extraction and certain processing activities related to six critical minerals essential for clean technology supply chains: lithium, cobalt, nickel, graphite, copper, and rare earth elements.
- Flow-Through Shares and Critical Mineral Exploration Tax Credit (CMETC) – Lithium from Brines: Budget 2023 proposes to include lithium from brines as a mineral resource for the purposes of the Flow-Through Share Regime and CMETC.
Hydrogen production and carbon capture
- Clean Hydrogen Investment Tax Credit (CH Tax Credit): The CH Tax Credit will apply to the cost of purchasing and installing equipment for projects that produce (all or substantially all) hydrogen from: (a) electrolysis; or (b) natural gas, as long as emissions are abated using carbon capture and storage. The following credit rates would apply: (a) 40 per cent for a carbon intensity (CI) of less than 0.75kg; (b) 25 per cent for CI greater than or equal to 0.75kg, but less than 2kg; and (c) 15 per cent for a CI greater than or equal to 2kg, but less than 4kg. This will be determined without reference to any produced CO2 that is captured and stored or used, or excess electricity that may be sold to the electricity grid.
- Investment Tax Credit for Carbon Capture, Utilization, and Storage (CCUS Tax Credit): The CCUS Tax Credit was proposed in Budget 2022 as a refundable investment tax credit that would be available to businesses that incur eligible expenses starting on Jan. 1, 2022. Budget 2023 proposes that dual use equipment that produces heat and/or power or uses water, that is used for CCUS as well as another process would be eligible for the CCUS Tax Credit and would be treated as capture equipment.
In each case, the credits described above have a variety of other requirements and details, which should be reviewed together with the start and end dates applicable to each credit.
In addition, the 2022 Fall Economic Statement announced the Government’s intention to attach prevailing wage and apprenticeship requirements (together referred to as “labour requirements”) to the proposed CH Tax Credit and CTI Tax Credit. The Government also proposes to have these requirements apply to the proposed Clean Electricity Investment Tax Credit and the CCUS Tax Credit. The requirements would apply to work that is performed on or after Oct. 1, 2023. The Government announced that it is interested in feedback in the course of preparing draft legislative proposals. Budget 2023 sets out further details regarding these requirements:
- Prevailing wage – This proposed requirement would require that the total compensation of the relevant workers meet or exceed the relevant wage specified in an “eligible collective agreement”.
- Apprenticeship requirements – This proposed requirement would require that not less than 10 per cent of the total labour performed by Red Seal trades be performed by registered apprentices.
International tax measures
Budget 2023 contained no new international tax measures. In particular, while Budget 2023 reiterates the Government’s commitment to implementing the first package of cross-border hybrid mismatch arrangement proposals that were initially released in April 2022, it makes no reference to an anticipated second package of hybrid mismatch proposals addressing hybrid entities.
The Government also recommitted to implementing the two-pillar plan for international tax reform agreed to in 2021 by the members of the Organisation for Economic Co-operation and Development (OECD)/Group of 20 (G20). Pillar One deals with the digitization of the economy and Pillar Two proposes a global minimum tax regime. The Government intends to continue with its previously announced Digital Services Tax with effect retroactive to 2022, if the OECD Pillar One framework does not come into force by Jan. 1, 2024. In the coming months, the Government intends to release draft legislation related to portions of the Pillar Two global minimum tax regime, with the proposals taking effect in fiscal years beginning after Dec. 30, 2023.
Sales and excise tax measures
GST/HST treatment of payment card clearing services
Budget 2023 proposes to amend the GST/HST definition of “financial service” to exclude payment card clearing services rendered by a payment card network operator to ensure that such services are subject to GST/HST. The proposed GST/HST amendments respond to a recent court decision which found that GST/HST does not apply to the supply of payment card clearing services.
Payment card network operator is a defined term under the Payment Card Networks Act and includes all major credit cards networks that maintain clearing systems in respect of payment cards (credit, debit and charge cards) and render payment card clearing services (e.g., payment processing and messaging services) to system participants (e.g., a payment card issuer such as a bank). The proposed amendments will apply to the following services rendered by a payment card network operator under an agreement for:
- a service in respect of the authorization of a transaction in respect of money, an account, a credit card voucher, a charge card voucher or a financial instrument;
- a clearing or settlement service in respect of money, an account, a credit card voucher, a charge card voucher or a financial instrument; or
- a service provided in conjunction with a service referred to above.
The proposed amendments will generally apply to any consideration for the services which became due or was paid after Budget Day.
The Government has also proposed to allow the CRA to assess, reassess, or make an additional assessment of any amounts payable or remittable by a person under the proposed amendment to the definition of “financial service” at any time on or before the later of the day that is one year after the date on which the legislation receives Royal Assent and the “normal assessment period” date under the Excise Tax Act, which generally provides the CRA a four year period.
Alcohol excise duty
Budget 2023 proposes to temporarily cap the inflation adjustment for excise duties on beer, spirits and wine at 2 per cent, for one year only, as of April 1, 2023. The proposed measure would come into force on April 1, 2023.
Cannabis taxation – quarterly duty remittances
Budget 2023 proposes to allow all licensed cannabis producers to remit excise duties on a quarterly rather than monthly basis, starting from the quarter beginning on April 1, 2023.
Air Travellers Security Charge (ATSC)
Budget 2023 proposes to provide $1.8 billion over five years, starting in 2023-24, to maintain and increase the Canadian Air Transport Security Authority’s level of service, improve screening wait times, and strengthen security measures at airports.