On August 9, 2022, legislative proposals relating to the Income Tax Act (the “Act”) and other tax legislation were released by the Department of Finance for public feedback (the “August Proposals”). The August Proposals seek to implement certain measures previously announced in the 2022 Federal Budget tabled in the House of Commons on April 7, 2022 (the “Budget”), as well as other previously announced technical amendments.
Miller Thomson’s Tax Group has reviewed the August Proposals. In this release, we outline and discuss certain key income tax and mandatory reporting measures of relevance to our practices and our client base across Canada. We will continue to track certain measures as they evolve and—as always—welcome your questions, comments and views.
Changes to the substantive CCPC rules
We previously reported on the substantive CCPC rules in our Budget Review, our article on share transactions involving a non-resident or public company and our article on post-Budget planning considerations. The August Proposals contain more comprehensive draft legislation to implement the substantive CCPC regime proposed by the Budget. If enacted as proposed, the rules would come into effect for tax years ending on or after April 7, 2022, with some exceptions. The key components of the draft legislation are the integration of substantive CCPCs into the Act and an anti-avoidance provision to address planning around substantive CCPC status. The August Proposals also include measures to address certain tax deferrals that were available to Canadian-controlled private corporations (“CCPCs”) with foreign subsidiaries. For further information and commentary, please refer to our update on changes to the substantive CCPC rules.
Changes to draft mandatory disclosure rules
The August Proposals include revisions to the draft legislation released in February 2022 (the “February Proposals”), which proposed amendments to the reportable transaction rules in section 237.3 of the Act and introduced notifiable transaction rules in new section 237.4 of the Act. Our previous report on the February Proposals contains a detailed summary of these amendments. This article only focuses on changes made by the August Proposals.
Importantly, the August Proposals generally delay the intended effective date of the new mandatory disclosure regime to 2023.
Reportable transaction rules
The most notable of the changes contained in the August Proposals are those made to the confidential protection and contractual protection hallmarks.
With respect to the confidential protection hallmark, the August Proposals narrow its scope by adding a requirement that the confidential protection provides confidentiality in respect of a tax treatment in relation to the avoidance transaction or series.
With respect to the contractual protection hallmark, as amended by the February Proposals, certain forms of insurance, protection, or undertaking that is offered to a broad class of persons and applies in a normal commercial or investment context was excluded from the definition. The August Proposals expand the exclusion by removing the requirement that it be offered to a broad class of persons, but also adds that the form of insurance, protection, or undertaking cannot extend contractual protection for a tax treatment in respect of the avoidance transaction.
In the February Proposals, where an information return in respect of a reportable transaction was not filed on time, the normal (re)assessment period was suspended until 3 years after the information return is filed. The August Proposals extend the suspension for mutual fund trusts and corporations that are not a CCPC to 4 years after the day on which the information return is filed.
Currently, an information return filed by one person in respect of a reportable transaction satisfies the requirement for any other person who may otherwise also be required to file. The February Proposals removed this relief, resulting in multiple parties being required to file for the same reportable transaction. The August Proposals provide a narrow exception to this requirement by clarifying that a person that only provided clerical or secretarial services with respect to the planning of the transaction is not required to file an information return.
Finally, the August Proposals repeal the definition of “solicitor-client privilege” in subsection 237.3(1) of the Act. Instead taxpayers and advisors will need to rely on the common law meaning of that term.
Similar to the August Proposals in respect of the reportable transaction rules, the normal (re)assessment period for mutual fund trusts and corporations that are not a CCPC will be suspended until 4 years (from 3 years as originally proposed) following the filing of the information return in respect of a notifiable transaction.
Similar to the August Proposals in respect of the reportable transaction rules, the August Proposals in respect of notifiable transactions clarify that a person that only provides clerical or secretarial services with respect to the planning will not be required to file an information return in respect of a particular notifiable transaction.
In addition, the August Proposals propose that the filing of an information return by an employer or partnership is deemed to have been made by each employee of the employer, or each partner of the partnership. Further, banks, insurance corporations and credit unions will generally not be required to report unless it has (or would reasonably be expected to have but for circumstances amount to gross negligence) knowledge that the particular transaction is a notifiable transaction.
Paragraph 212(13.1)(a) of the Act deems a partnership to be a person resident in Canada in respect of payments made by the partnership to non-residents where those payments are deductible in computing the partnership’s income from Canadian sources (subject to relevant exception or treaty). The purpose of this rule is to make withholding tax under Part XIII of the Act applicable to such payments. The August Proposals shift the focus of the test from the partnership to the partners of the partnership by amending paragraph 212(13.1)(a) of the Act to deem a partnership to be a resident of Canada in respect of the portion of payments made by the partnership to a non-resident that are deductible in computing a partner’s share of the partnership’s income (rather than the partnership’s income under the current rules) to the extent that the partner’s share is taxable under Part I of the Act. There is no set effective date for the application of these new rules but the August Proposals state that it will be no earlier than after the end of the consultation period, being September 30, 2022.
The August Proposals also amend 212(13.2), which will extend the potential application of withholding tax under Part XIII of the Act in two ways. First, it will also apply when a non-resident person pays or credits an amount to a partnership (other than a Canadian partnership). Second, it will now apply where a non-resident has filed an election under section 216 of the Act. Generally speaking, an election under section 216 of the Act permits taxation under Part I of the Act, as though a non-resident were resident of Canada, on a net rather than gross basis, and where a non-resident earns Canadian-source rent or timber royalty income. In general terms, current subsection 212(13.2) applies to payments made by a non-resident of Canada to another non-resident of Canada to the extent the payment is deductible in computing the payor’s taxable income earned in Canada. In such circumstances, the payor is deemed to be resident in Canada and the payment is thereby potentially subject to withholding tax under Part XIII of the Act. Where an election under 216 has been filed by a non-resident payor, the proposed amendments will extend the application of Part XIII withholding tax to payments made to non-residents by the payor where such payments are deductible in computing the payor’s income tax under the Act. These proposed amendments apply to amounts paid or credited after 2022.
Foreign affiliates changes
Finance’s proposed amendments to the Act and the Income Tax Regulations contain a number of changes to the foreign affiliate rules. Further information and commentary can be found in our update on proposed amendments to the foreign affiliate rules.
The extensive August Proposals also contain certain technical amendments, including one involving the wind-up of partnerships. In general, a partnership can be wound up on a tax-deferred basis pursuant to subsection 98(3) or 98(5) of the Act if certain conditions specified in those provisions are met. Subsection 98(3) allows a tax-deferred wind-up upon a proportionate distribution of the assets and liabilities to each partner of the partnership at the time of the dissolution of the partnership whereas subsection 98(5) allows a tax-deferred wind-up when a partnership business is carried on after the dissolution by a partner as a sole proprietor.
The tax-deferred wind-up of a partnership is bolstered by additional rules that determine certain tax consequences on the wind-up. Subsections 98(3)(b) and 98(5)(b) permit an increase in the cost base (i.e., bump) of non-depreciable capital property if the partner’s cost base in its partnership interest exceeds the total of the cash distributed to the partner on the wind-up and the cost amount of the partnership property distributed to the partner as a consequence of the wind-up. This bump is designed to facilitate an increase to the basis of the partnership property (non-depreciable capital property) distributed to the partner where the partner’s basis in its partnership interest is higher.
Paragraph 98(3)(c) contains certain restrictions on the bump allowed by paragraph 98(3)(b). Specifically, the bump amount cannot exceed the unrealized gain on the property at issue or the difference between the cost base of the partnership interest and the cost base of the proportion of the partnership property received by the partner plus any cash received on the wind-up. Similar rules are also provided in paragraph 98(5)(c) for purposes of the tax-deferred wind-up under subsection 98(5).
The August Proposals contain a new restriction applicable on the wind-up of a lower-tier partnership in a tiered partnership structure. The new rule applies to the bump to the unrealized gain available under paragraphs 98(3)(c)(i) or 98(5)(c)(i) (the property at issue in a tiered partnership being the partnership interest in the lower-tier partnership being dissolved). It restricts that bump by limiting the fair market value of the partnership interest in the lower-tier partnership by ignoring the increase in value of any property that would be ineligible for the bump if such property were to be distributed directly on a wind-up (i.e., if the tiered partnership structure did not exist).
The proposed change to the partnership wind-up rules align these rules with certain aspects of the bump rules available on a wind-up of a corporate subsidiary.
Generally, subsection 15(2) of the Act requires a person (other than a corporation resident in Canada) or a partnership, who is a shareholder of a corporation, and who has received a loan from the corporation (or from a related corporation or a partnership of which the corporation is a member) to include the amount of such loan in the shareholder’s income in the year the loan arose. The rule in subsection 15(2) is subject to certain exceptions as set out in the Act, including the current subsection 15(2.3) which provides that subsection (2) does not apply to a debt that arose in the ordinary course of the creditor’s business, or a loan made in the ordinary course of the lender’s ordinary business of lending money, provided that the parties made bona fide arrangements for repayment of the loan at the time the debt or loan arose.
New subsection 15(2.3) will exclude from this exception a money lending business where less than 90% of the aggregate outstanding amount of the loans of the business is owing by borrowers that deal at arm’s length with the lender.
For loans made after 2022, or for loans made before 2022 that remain outstanding on January 1, 2023, this means that the “ordinary business of lending money” exception will not apply if more than 10% of the loans made by the creditor are made to non-arm’s length parties. This will essentially exclude “captive” money lenders within a corporate group from relying on the exception in 15(2.3) of the Act.
The August Proposals also propose to add new subsection 15(2.31), which provides interpretive rules for determining the application of subsection 15(2.3) when one of the parties is a partnership. New paragraph 15(2.31)(a) is a look-through rule dealing with partnerships – a member of a partnership that is a member of another partnership will be deemed to be a member of the lower-tier partnership. New paragraph 15(2.31)(b) clarifies the circumstances in which a lender and a creditor will be considered to deal at arm’s length for purposes of subsection 15(2.3), and provides that where either the lender or the borrower is a partnership, each member of the partnership must deal at arm’s length with the other party, and where both parties are partnerships, each partner of the borrower partnership must deal at arm’s length with each member of the lender partnership.