On June 6, 2011, the Minister of Finance Jim Flaherty reintroduced the 2011 Federal Budget (the “Budget”) which was originally tabled on March 22, 2011 without any substantive changes to the tax measures.
Planning for tax avoidance is a legitimate approach to reducing income taxes. Tax avoidance is contrasted with tax evasion which is an improper and potentially illegal approach to tax reduction.
Although not newsworthy in a general public context, a theme that pervaded the Budget was a focus on addressing a number of tax reduction approaches that may have been used by taxpayers by proposing what can be termed as new anti-avoidance rules.
Our Miller Thomson LLP March 22, 2011, Federal Budget Review discusses a number of the anti-avoidance rules proposed in the Budget in a more detailed manner. This article intends to highlight a number of anti-avoidance rules contained in the Budget.
The Budget proposed substantial and complex changes to the taxation of corporate partners with significant interest in partnerships to limit what the Federal Government perceives as an inequitable tax deferral. The use of partnership structures to defer and potentially save corporate tax has become increasingly common in recent years. The Budget includes extensive proposals to eliminate the tax deferral strategy.
The Budget proposed to introduce a new “kiddie tax” for capital gains realized by, or included in the income of, a minor from a disposition of shares of a corporation to a person who does not deal at arm’s length with the minor, if taxable dividends on such shares would have been subject to the kiddie tax. Capital gains that are subject to this measure will be treated as non-eligible dividends.
The Budget proposed several changes to the Registered Retirement Savings Plan (“RRSP”) and Registered Retirement Income Fund (collectively referred to herein as “Deferred Plans”) rules to address concerns regarding the use of these tax Deferred Plans in certain tax planning strategies, including RRSP strips. The Budget proposals augment the existing anti-avoidance rules applicable to these Deferred Plans by introducing rules similar to some of the anti-avoidance rules that currently apply to tax-free savings accounts, namely: the “advantage” rules, the “prohibited investment” rules and the “non-qualified investment” rules. Subject to grandfathering, any income earned from a prohibited investment will be subject to a tax equal to the amount of the income and will be subject to a 50% tax on the fair market value of the investments unless disposed of before 2013.
With respect to individual pension plans (“IPP”), the Budget proposes new rules with respect to past service contributions. In effect, contributions made to an IPP that relate to prior years of employment will be required to be funded first out of a plan member’s existing RRSP assets or by reducing the individual’s accumulated RRSP contribution room, before new deductible contributions in relation to the past service may be made.
While no specific proposal was made in the Budget, the Federal Government noted that employee profit sharing plans (“EPSPs”) are increasingly being used by some business owners to direct profits to family members in order to reduce or defer taxes and to avoid paying Canada Pension Plan contributions and Employment Insurance premiums. The Federal Government says that it will review the existing tax rules for EPSPs to see if technical amendments are required and will undertake consultations to obtain the views of stakeholders before proceeding with any changes.
The application of certain stop-loss rules in the Income Tax Act (Canada) has been extended in the Budget to certain inter-corporate share dispositions. Specifically, any deemed dividend arising as a result of a redemption, acquisition or cancellation of a share held by a corporation (directly or indirectly through a trust) must now be included in computing the restriction on deduction of a loss realized in respect of the share. This extension of the stop-loss rule does not apply however, to deemed dividends arising upon the redemption, acquisition or cancellation of shares of a private corporation which are held, directly or indirectly by another private corporation.
While not specifically an anti-avoidance rule, the Budget proposed to limit the availability of the exemption from tax on capital gains where flow-through shares are donated to a qualified charity. Prior to this change, it was possible to combine the charitable donation tax credit or deduction with the flow-through share tax incentives to reduce the cost of charitable giving dramatically. The Budget proposed that the exemption from tax on the capital gain that arises from the donation of the shares will only apply to the extent that the cumulative capital gains in respect of the gift or disposition of the shares exceeds the original cost of the flow-through shares. This will have the effect in most provinces of causing a donation of flow-through shares to be treated in the same manner as a cash donation.