Personal Income Tax Measures

22 mars 2013

( Disponible en anglais seulement )

IN THIS SECTION:

Synthetic Dispositions

The Budget introduces a measure to deal
with so-called “synthetic disposition arrangements.” These are described as
agreements or arrangements which eliminate all or substantially all of the risk
of loss and opportunity for gain or profit in respect of a property that a
person continues to own. Examples given in the Budget Papers of the kinds of
transactions which could be synthetic dispositions are:

  • a forward sale of property
    (whether or not combined with a secured loan);
  • a put-call collar;
  • exchangeable indebtedness;
  • a total return swap; and
  • a securities borrowing to
    facilitate a short sale of property that is identical or economically similar
    to a property already owned by the taxpayer (or a non-arm’s length person).

The Federal Government’s concern appears to
be that a taxpayer can monetize the value of an asset through hedging
transactions, derivatives and similar transactions without actually disposing
of the asset for tax purposes, with the result that the value of the asset is
realized but tax does not become payable until later – potentially much later.

The primary consequence of entering into a
synthetic disposition arrangement is a deemed disposition at fair market value
of the asset to which the synthetic disposition arrangement relates. The other consequences are discussed further
below.

Synthetic Disposition Arrangements –
What Are They?

A synthetic disposition arrangement in
respect of a particular asset owned by a taxpayer (the “Owner”) is one or more
agreements or arrangements entered into by the Owner or a person or partnership
that does not deal at arm’s length with the Owner (the “NAL Person”) that:

  • have the effect of eliminating
    all or substantially all of the risk of loss and opportunity for gain or profit
    in respect of the asset (or would have that effect if entered into by the Owner
    instead of the NAL Person);
  • where an agreement or
    arrangement has been entered into by an NAL Person, the agreement or
    arrangement can reasonably be considered to have been entered into, in whole or
    in part, for the purpose of eliminating all or substantially all of the risk of
    loss and opportunity for gain or profit in respect of the asset; and
  • do not result in a disposition
    of the asset within one year after the relevant agreements and arrangements are
    entered into.

Leases of tangible or corporeal property
are expressly excepted from being synthetic disposition arrangements. There is
no exception for leases of intangible property.

The Budget says that the synthetic
disposition arrangement measure is not intended to apply to ordinary hedging
transactions designed to manage risk of loss or to ordinary course securities
lending arrangements.

The one year period component of the
definition of synthetic disposition arrangement provides a
safe harbour rule from the deemed disposition under the new synthetic
disposition arrangement measure. If, for example, a taxpayer enters into a
forward sale of an asset combined with an immediate secured loan from the
forward sale purchaser of an amount equal to the forward sale purchase price
and the closing date is 364 days in the future, this will not be a synthetic
disposition arrangement.

However, the Budget Papers note that
transactions which eliminate risk of loss and chance of gain but do not
otherwise result in a current disposition for tax purposes can be challenged
based on the existing rules in the Tax Act. One would hope that CRA will
generally not pursue transactions that fall outside the new synthetic
disposition arrangement rule because there is a disposition within one year.
Presumably, this will depend on the circumstances of each particular
situation.

Where the relevant agreements or
arrangements are entered into by the Owner, there is no purpose test. Whether
the agreements or arrangements constitute a synthetic disposition arrangement
is determined by the effect or result of the agreements or arrangements. Where
the relevant agreements or arrangements are entered into by an NAL Person, they
will not constitute a synthetic disposition arrangement unless they were
entered into for the purpose of eliminating all or substantially all of the
risk of loss and opportunity for gain or profit in respect of the asset.

The definition of synthetic disposition
arrangement as proposed in the Budget is very broad. Taxpayers who regularly undertake hedging and
derivative transactions for financial, rather than tax, purposes may well find
it difficult to know with certainty when they are entering into a synthetic
disposition arrangement and when they aren’t.

Deemed Disposition

When a synthetic disposition arrangement
in respect of an asset is entered into (by the Owner or an NAL Person), the
Owner is deemed to have disposed of the asset for proceeds of disposition equal
to the fair market value of the asset at that time. If these proceeds exceed
the Owner’s tax cost for the asset, the Owner will have a gain taxable on
income or capital account depending on the usual factors. The synthetic disposition arrangement rule
does not address whether any resulting gain or loss is on income or capital
account.

The Owner is also deemed to have reacquired
the property immediately after the deemed disposition at a cost equal to fair
market value.

It appears that a deemed disposition as a
result of having a synthetic disposition arrangement will only accelerate the
taxpayer’s gain and will not accelerate losses. This is because the deemed
reacquisition of the subject asset would appear to engage the suspended or
superficial loss rules.

The deemed disposition and reacquisition of
the asset by the Owner as a result of having a synthetic disposition
arrangement will not have any tax consequences for other parties involved in
the relevant agreements or arrangements.

Other Consequences

The Budget provides for consequences of a
synthetic disposition arrangement in two areas where the length of ownership of
an asset is important – stop loss rules for shares and foreign tax credits.

The Budget will ensure that a synthetic
disposition cannot be used to continue legal ownership of an asset so as to
meet holding period tests in the stop loss and foreign tax credit provisions
while the taxpayer has eliminated all or substantially all of the risk of loss
and opportunity for gain or profit in respect of the particular asset.

In certain circumstances, dividends
received by a corporation on a share which are deductible by the recipient
under section 112 of the Tax Act will reduce a loss realized on a subsequent
disposition of the share. This stop loss rule will not apply in certain
circumstances if the share in question has been held for at least 365 days.

A taxpayer is deemed not to own a
particular share for the purpose of the stop loss rule described above if the
taxpayer has been deemed to have disposed of the share under the synthetic
disposition arrangement rule, or would be deemed to have disposed of the share
under the synthetic disposition arrangement rule if the one year safe harbour
were reduced to 30 days, and the taxpayer
did not own the share throughout the 365 days before the synthetic disposition
arrangement was entered into. This deemed “non-ownership” continues as long as
the agreements or arrangements, which result in there being a synthetic
disposition arrangement, remain in
effect.

In certain circumstances, the foreign tax
credit otherwise available to a Canadian taxpayer for foreign withholding taxes
paid on foreign source dividend or interest income can be reduced if the
taxpayer has disposed of the share or debt obligation on which the dividend or
interest was paid within one year after acquiring it.

If a taxpayer has been deemed to have
disposed of a share or debt obligation under the synthetic disposition
arrangement rule, or would be deemed to have disposed of a share or debt
obligation under the synthetic disposition arrangement rule if the one year
safe harbour were reduced to 30 days,
and the taxpayer did not own the asset throughout the 365 days before the
synthetic disposition arrangement was entered into, then, for the purpose of
the foreign tax credit limitation rule described above, the taxpayer is deemed
to have last acquired the relevant share or debt obligation on the earlier of
the time immediately before the share or debt obligation is disposed of and the
time that the agreements or arrangements that resulted in there being a
synthetic disposition arrangement are no longer in effect.

Application

The synthetic disposition arrangement measure
applies to agreements and arrangements entered into on or after Budget Day. It
will also apply to agreements and arrangements entered into before Budget Day
if their term is extended on or after Budget Day.

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Character Conversion Transactions

In an effort to close perceived tax
loopholes, the Budget is cracking down on financial arrangements commonly known
as character conversion transactions. Generally, character conversion
transactions are transactions that reduce tax by converting ordinary income
into capital gains by way of a derivative contract. Instead of challenging
these transactions under the current framework of the Tax Act, the Budget
proposes legislative amendments to curtail the perceived abuse.

Typically, a character conversion
transaction links a derivative investment with the purchase or sale of an
otherwise unrelated capital property to form a derivative forward agreement. The
pricing formula for the capital property is not based upon the performance of
the actual capital property. Instead, the pricing formula is based on the
performance of other portfolio investments that produce fully taxable income. If
these investments were not coupled together, income from the derivative
investment would be taxed as ordinary income and not as a capital gain.

To ensure the appropriate tax treatment of
the derivative-based return on a derivative forward agreement, the Budget
proposes to treat this return separately from the disposition of the capital
property that is purchased or sold under the forward agreement. This measure
will apply to derivative forward agreements that have a duration of more than
180 days.

The Budget proposes to amend various parts
of the Tax Act to curtail the perceived abuse. Generally, the proposed changes
will treat any return arising under a derivative forward agreement that is not
determined by reference to the performance of the capital property as being
purchased or sold on account of income.

The income (or loss) will be included (or
deducted) in the taxpayer’s income at the time of disposition if the capital
property is subject to a derivative forward sale agreement and included in the
taxpayer’s income at the time of acquisition if the capital property is subject
to a derivative forward purchase agreement.

In order to prevent double tax, the Budget
also proposes to have the adjusted cost base of the capital property
increased (or decreased) to the extent that any income (or loss) is recognized
as described above.

This measure will apply to derivative
forward agreements entered into on or after Budget Day. It will also apply to
derivative forward agreements entered into before Budget Day if the term of the
agreement is extended on or after Budget Day.

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Trust Loss Trading

The Tax Act restricts the use of pre- and
post-acquisition losses where a corporate taxpayer has undergone an acquisition
of control. Non-capital losses may be used to offset income earned in the same
business after the acquisition.

The Budget proposes to extend these
restrictions to trusts, with appropriate modifications. The proposed measure
will trigger the application of loss-streaming and related rules to a trust
when a person or partnership, together with affiliates, becomes a majority-interest
beneficiary of the trust, or when a group becomes a majority-interest group of
beneficiaries of the trust (each referred to as a “loss restriction
event”). Majority-interest is determined
with reference to the fair market value of income or capital interests in the
trust.

Existing rules deem certain transactions or
events to involve (or not involve) an acquisition of control of a corporation,
e.g. death of a shareholder and transactions within certain groups of
shareholders. These rules will be
extended to apply, with appropriate modifications, in determining whether a
trust is subject to a loss restriction event. As a result, it is expected that many
typical transactions or events involving changes in the beneficiaries of a
personal (family) trust will not be loss restriction events. Stakeholders are
invited to comment as to whether there are additional transactions or events
that should be treated similarly in determining whether a personal trust is
subject to a loss restriction event.

This measure, including any relieving
changes that may be made as a result of the public consultation, will apply to
transactions that occur on or after Budget Day, unless the transaction is completed
pursuant to the terms of a written agreement entered into before Budget Day,
pursuant to which the parties are not excused from completing the transaction
as a result of changes to the Tax Act.

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Non-Resident Trusts

The Tax Act contains an attribution rule
whereby the income or capital gains from property held by a trust, including a
non-resident trust, may be attributed to a Canadian resident taxpayer. Such
attribution may occur where a contributor to the trust retains “effective
ownership” over the property contributed to the trust in one of the following
manners:

  • the property may revert to the
    taxpayer;
  • the property may pass to
    persons to be determined by the taxpayer at a time subsequent to the creation
    of the trust; or
  • the property is held on
    condition that, during the existence of the taxpayer, the taxpayer retains
    control over the disposition of the property by the trust.

Historically, the Federal Government’s
position has been that a sale of property by a beneficiary to a trust would be
caught by the above rule, on the basis that the property sold to the trust may
revert to the beneficiary in the future. This was the Federal Government’s
position even where the sale occurred for fair market value consideration.

This position was held to be incorrect in
the recent case of Sommerer v. The Queen
(2011 TCC 212, upheld by the Federal Court of Appeal, 2012 FCA 207), where the Courts
held that the attribution rule did not apply on a sale of property to a trust
by a beneficiary for fair market value consideration. The trust in that case
happened to be a non-resident trust.

The Budget expresses the Federal
Government’s view that the result in Sommerer
was contrary to intended tax policy with respect to non-resident trusts.
Accordingly, the Budget proposes to amend the Tax Act such that when a Canadian
resident taxpayer transfers or loans property directly or indirectly to a non-resident
trust
and retains “effective ownership” over the property in the manner
described above, the transfer or loan will be treated as a transfer or loan of
“restricted property” by the taxpayer.
This will cause the deemed residence rules to apply to the trust.

It appears, however, that the reasoning in Sommerer will continue to apply to
Canadian resident trusts, such that sales of property by Canadian resident beneficiaries
to Canadian resident trusts for fair market value consideration should not
trigger the application of the attribution rule described above,
notwithstanding the CRA’s earlier administrative position.

These amendments will apply to taxation
years that end on or after Budget Day.

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Consultation on Graduated Rate Taxation of Trusts and Estates

Currently, income that arises in most inter vivos trusts is taxed at the
highest federal tax rate for individuals (i.e., 29%) when it is taxed in the
trust and not allocated out to a beneficiary. The income arising in an estate prior to
distribution of the estate, in testamentary trusts that are created by Will,
and in certain inter vivos trusts
(created before June 18, 1971) pay federal income tax at the graduated tax
rates applicable to individuals. Where a Will contains testamentary trusts for
several family members, the family can benefit from significant tax savings.
One result of this difference in applicable tax rates is that, for inter vivos trusts, annual income is
usually made payable to the beneficiaries, whereas with testamentary trusts,
the income can remain in the trust and added to capital in the subsequent year.

The Federal Government expressed concern in
the Budget that this difference in tax treatment for different types of trusts raises
questions of tax fairness and neutrality between the treatment of beneficiaries
of outright bequests and beneficiaries of inter
vivos
trusts. As well, concern about delays in administering and
distributing an estate in order to continue the availability of multiple
graduated rates was raised. In the Budget, the Federal Government expressed the
concern that tax planning strategies that incorporate multiple testamentary
trusts negatively impact the tax base.

The Federal Government announced in the Budget
that it will consult with stakeholders on possible measures to eliminate the
tax benefits that arise from taxing testamentary trusts, estates administered
over long periods, and pre-June 18, 1971 grandfathered inter vivos trusts at graduated rates. A consultation paper will be
released to the public to provide stakeholders with an opportunity to comment
on proposed measures.

While testamentary trusts are often used in
estate planning to hold bequests from the testator to his or her spouse,
children, or other family members, the achievement of tax savings from the
creation of these trusts is only one of a number of motivators. For example, many
trusts are established in Wills for minor beneficiaries or beneficiaries who
are not ready to manage the income the assets may generate. Testamentary trusts are also used for spouses
in second marriage situations, in order to preserve capital property for the
testator’s children. Testamentary trusts
are often used to protect spend-thrift family members from depleting their
assets imprudently, and for disabled beneficiaries in order to preserve their entitlement
to government benefits. It would be unfortunate if the Federal Government
instituted changes to the tax treatment of income in testamentary trusts that
would force trustees to pay out income to beneficiaries who are unable to
manage money or who would lose important government assistance as a result.

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Registered Pension Plans: Correcting Contribution Errors

The Budget proposes to enable
administrators of Registered Pension Plans (“RPPs”) to make refunds of
contributions in order to correct reasonable errors without first obtaining
approval from the Canada Revenue Agency (“CRA”) if the refund is made no later
than December 31 of the year following the year in which the inadvertent
contribution was made. If an RPP administrator seeks to correct a contribution
error after the deadline, the existing procedure, which requires an
administrator to seek authorization from the CRA, will continue to apply.
Refunds to an RPP member will generally be reported as income of the member in
the year received, and deductions claimed by the member in a prior year will
generally not be adjusted. For employers who generally use the accrual method
of calculating income, a refund of RPP contributions will normally reduce the
RPP contribution expense for the year to which it relates.

This measure will apply in respect of RPP
contributions made on or after the later of January 1, 2014 and the date of
Royal Assent to the enacting legislation.

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Labour-Sponsored Venture Capital Corporations Tax Credit

The Budget proposes to phase out the 15%
federal Labour-Sponsored Venture Capital Corporations (“LSVCC”) tax credit
provided to individuals for the acquisition of shares of LSVCCs on investments
of up to $5,000 each year (providing up to $750 in federal tax relief).

The federal LSVCC tax credit will remain at
15% when it is claimed for a taxation year that ends before 2015 and will be
reduced to 10% for the 2015 taxation year and 5% for the 2016 taxation year.
The federal LSVCC tax credit will be eliminated for the 2017 and subsequent
taxation years.

The Budget also proposes to end new federal
LSVCC registrations, as well as the prescription of new provincially registered
LSVCCs in the Tax Act. An LSVCC will not be federally registered if the
application for registration is received on or after Budget Day. A provincially
registered LSVCC will not be prescribed for purposes of the federal LSVCC tax
credit unless the application was submitted before Budget Day.

In order to assist with an orderly
phase-out of the federal LSVCC tax credit, the Federal Government is seeking
stakeholder input on potential changes to the tax rules governing LSVCCs,
including the rules related to investment requirements, wind-ups and
redemptions. The Federal Government will also work with provincial governments
with respect to the phase-out of the federal LSVCC tax credit. Stakeholders are
encouraged to submit comments with respect to potential changes by May 31,
2013.

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Lifetime Capital Gains Exemption

The Tax Act presently provides a lifetime
capital gains exemption (“LCGE”) of $750,000 in respect of the capital gains
realized on the disposition of qualified property (e.g., qualified small
business corporation shares and qualified farm property). Beginning in the 2014
taxation year, the Budget proposes to increase the LCGE by $50,000, to
$800,000. The new LCGE limit will apply to all individuals, even those who
have previously used their then available LCGE. The LCGE will also be indexed
to inflation for taxation years after 2014.

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Dividend Tax Credit

The “gross-up” factor and dividend tax credit
(“DTC”) applicable to non-eligible dividends was introduced to achieve tax “integration”
between income earned by an individual directly, and income earned by a
corporation and distributed to an individual as a dividend. Perfect tax integration would mean that the
total amount of tax paid in each situation would be the same. According to the Federal Government, the
current integration mechanism over-compensates individuals for income taxes presumed
to have been paid at the corporate level on active business income, and the DTC
on non-eligible dividends places an individual who receives this dividend
income from a corporation in a better tax position than if the individual had
earned the income directly.

The Budget proposes to adjust the current
DTC and gross-up factor applicable to non-eligible dividends in an effort to
achieve integration.

The Budget proposal to address this issue adjusts
the gross-up factor applicable to non-eligible dividends from 25% to 18% and
the corresponding DTC from 2/3 of the gross-up amount to 13/18. Expressed as a percentage of the grossed-up
amount of a non-eligible dividend, this adjusts the effective rate of the DTC
in respect of such a dividend from 13.3% to 11%. As a result, the effective federal tax rate
on non-eligible dividends will increase from 19.58% to 21.22%.

This measure will apply to non-eligible
dividends paid after 2013.

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Extension of the Mineral Exploration Tax Credit for Flow-Through Share Investors

Under flow-through share agreements,
corporations that incur certain expenses in connection with mineral exploration
work undertaken in Canada may renounce or “flow” such expenses through to their
shareholders. The shareholders may claim
a deduction from their income for the renounced expenses. A 15% federal tax credit is also available
for specified mineral exploration expenses once renounced.

The Budget proposes to extend the mineral
exploration tax credit for one additional year to flow-through share agreements
entered into on or before March 31, 2014.

The Tax Act contains a one-year look-back
rule, which enables funds raised in one calendar year that receive the benefit of
the mineral exploration tax credit to be spent on eligible exploration up to
the end of the following calendar year. The Budget proposals allow funds raised with
the credit during the first three months of 2014 to support eligible
exploration until the end of 2015.

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Adoption Expense Tax Credit

The Tax Act provides a non-refundable
adoption expense tax credit (the “AETC”) of 15% (up to a maximum of $11,669 in
2013) for expenses incurred by adoptive parents in relation to their adoption
of a child who is under the age of 18. Presently, the AETC covers adoption
expenses incurred from the time that a child is matched with his or her
adoptive parents to the time that he or she begins living with them. The AETC
is only available for the taxation year in which an adoption is finalized.

The Budget proposes to expand the scope of
the AETC by extending the adoption period to which the credit applies by
treating the time at which the adoption period begins as:

  • the time that an adoptive parent applies to a provincial government
    ministry or to a licensed adoption agency to register for adoption; or
  • if an application regarding the adoption of a child is made to a
    Canadian court, that earlier time.

The expansion of the AETC’s scope is
intended to better recognize that adoptive parents face adoption-related
expenses even before being matched with a child. The new measure will apply to
all adoptions that were finalized after the 2012 taxation year.

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Deduction for Safety Deposit Boxes

The cost of renting a safety deposit box
from a financial institution will no longer be tax-deductible. Historically, safety deposit box rental costs
were considered to fall within the category of expenses related to earning
income from business or investments. The
need to keep investment and business papers safe justified the
tax-deductibility of safety deposit box rental charges. However, in an increasingly electronic and
digital world, safety deposit boxes may no longer be used for business or
investment purposes, but rather, to hold valuables and other personal
property.

This measure will apply to all taxation
years that begin before or after Budget Day.

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