Finance Minister, Bill Morneau, announced that the CRA would receive the cash injection to combat tax evasion and avoidance as part of his 2019 budget plan, released on March 19. This investment is in addition to the C$444.4 million and C$523.9 million provided to the CRA in the 2016 and 2017 federal budgets.
He expects these initiatives to raise $369 million in federal tax revenues over five years, although the actual figure could be significantly higher with the boost to regional treasuries. In addition, revenues could be enhanced yet further by Morneau’s announcement that the government will invest C$65.8 million over five years to improve the CRA’s information technology systems, including replacing legacy systems. He said that this will help the CRA stay ahead of non-compliance. Further, the government will amend the Canada Business Corporations Act to make the beneficial ownership information, maintained by federally incorporated corporations, more readily available to both tax authorities and law enforcement.
Morneau’s election-year budget was also filled with many more anti-avoidance measures to please voters ahead of the October election. “To ensure greater fairness in our tax system, we will take action to limit the benefit of the stock option deduction for executives of large, long-established corporations - while ensuring that everyday employees aren't affected, and that start-ups and emerging Canadian businesses can continue to grow, attract talent, and create more good jobs,” the finance minister declared in his address to Parliament.
Stock options
To limit the use of the employee stock option tax regime, and move toward aligning the tax treatment with the US for employees of large, long-established, mature firms, the government will cap the availability of the stock option deduction to an annual maximum of C$200,000.
However, several Canadian firms, including EY and Osler, have raised questions about how the rules will work in practice because legislative proposals have not been released and their definitions of “large, long-established, mature firms” and “start-ups or rapidly-growing Canadian business” remain unclear.
EY said in its post-budget tax alert: “Obvious questions concern the definition of ‘start-ups and rapidly growing Canadian businesses,’ which will not be subject to the limits.” It continued: “It is possible that these terms may refer to stock options granted by corporations that are Canadian-controlled private corporations (CCPCs), but there are many large CCPCs that could not be considered to be start-ups or rapidly growing Canadian business.”
“It is also unclear whether the limit would only apply to the 110(1)(d) deduction of the Income Tax Act, which provides a stock option deduction equal to 50% of the benefit realised, or whether it would also apply to the alternate deduction under 110(1)(d.1) for options granted or shares issued by a CCPC to arm’s-length employees,” EY concluded.
The firm suggested that corporations that do not qualify as start-ups or rapidly-growing Canadian businesses will need to track each stock option grant in order to determine the amount of the grant that will be eligible for the stock option deduction.
However, PwC and Deloitte pointed out that additional details on this measure will be released before the summer of 2019.
Closing loopholes
To further protect the tax base, the budget also proposes amending the transfer pricing rules to:
Introduce an ordering rule to ensure that the transfer pricing rules in the Income Tax Act (ITA) apply before other provisions of the Act;
Ensure that the term “transaction” has the same meaning in both the transfer pricing rules and the assessment rules in the Income Tax Act, allowing the government to rely on an extended three-year reassessment period in respect of a “transaction”, “arrangement”, or “event” involving a taxpayer and a non-arm’s length non-resident; and
Prevent non-resident taxpayers from avoiding Canadian dividend withholding tax on compensation payments made under cross-border share lending arrangements with respect to Canadian shares.
The ordering rule will prioritise a transfer pricing adjustment ahead of the application of other provisions of the ITA from taxation years beginning after March 2019, Osler explained in their tax alert.
However, KPMG noted that this ordering may have implications, for example, in the potential application of transfer pricing penalties.
Nevertheless, current exceptions to the transfer pricing rules that apply where a controlled foreign affiliate owes an amount to a Canadian resident corporation, or a guarantee is made in respect of an amount owing by such affiliate, would continue to apply, Osler said.
Separately, there are additional measures intended to prevent taxpayers from unfairly taking advantage of low tax rates:
Preventing mutual fund trusts from allocating capital gains or income to their redeeming unitholders where the use of that method inappropriately defers tax or converts fully taxable ordinary income into capital gains taxed at a lower rate;
Improving rules meant to prevent taxpayers from using derivative transactions to convert fully taxable ordinary income into capital gains taxed at a lower rate;
Extending the foreign affiliate dumping rules in the Income Tax Act to prevent a corporation resident in Canada that is controlled by a non-resident individual or trust from reducing its tax payable by investing in a foreign affiliate; and
Tackling tax abuse in the real estate sector and creating four dedicated residential and commercial real estate audit teams in high-risk regions.
Despite the announcements to tackle tax abuse across all sectors and internationally, Morneau’s budget was typical of a pre-election statement aimed at putting his party in a strong position. His ultimate objective was to please middle-income earners.
