The Tax & Estate team summarizes the key measures focusing on business taxation within Canada’s Federal Budget 2022.
On April 7, 2022, Chrystia Freeland, Deputy Prime Minister and Minister of Finance, tabled Federal Budget 2022. Below is our summary of the key measures focusing on business taxation.
Read our summary about the personal tax measures contained in the budget.
Business income tax and internal tax measures
Small Business Deduction
The small business deduction (SBD) allows a Canadian-controlled private corporation (CCPC) to pay a reduced corporate tax rate of 9% relative to the higher general corporate tax rate of 15%. This deduction is applicable up to a CCPC’s first $500,000 per year of qualifying active business income (i.e., the “business limit”). There is a requirement to allocate the business limit among associated CCPCs.
In order to target this preferential tax rate to small businesses, the business limit is reduced on a straight-line basis when:
- the combined taxable capital employed in Canada of the CCPC and its associated corporations is between $10 million and $15 million; or
- the combined “adjusted aggregate investment income” of the CCPC and its associated corporations is between $50,000 and $150,000.
The business limit is the lesser of the two amounts determined by these business limit reductions.
With respect to the former reduction of a CCPCs ability to claim the SBD, Budget 2022 proposes to extend the range over which the business limit is reduced based on the combined taxable capital employed in Canada of the CCPC and its associated corporations. A corporation’s taxable capital employed in Canada is, in general, the total of its shareholder’s equity, surpluses and reserves, and loans and advances to the corporation, less certain types of investments in other corporations. The new range would be $10 million to $50 million. This change would allow more medium-sized CCPCs to benefit from the SBD. Furthermore, it would increase the amount of qualifying active business income that can be eligible for the SBD. For example, under the new rules:
- a CCPC with $30 million in taxable capital would have up to $250,000 of active business income eligible for the small business deduction, compared to $0 under current rules; and
- a CCPC with $12 million in taxable capital would have up to $475,000 of active business income eligible for the small business deduction, compared to up to $300,000 under current rules.
This measure would apply to taxation years that begin on or after Budget Day.
Below you will find a comparison of how the reduction of a CCPCs business limit is reduced by its taxable capital employed in Canada under both the prior rules and the new rules
|Taxable Capital||Business Limit Reduction||Business Limit|
|$10 Million||$ nil||$500,000|
|Taxable Capital||Business Limit Reduction||Business Limit|
|$10 Million||$ nil||$500,000|
Most Canadian small businesses operate as Canadian controlled private corporations (CCPCs) which are entitled to many tax advantages such as a lower tax rate for active business income up to $500,000 annually. However, there has been a recent trend for wealthy Canadians to convert existing CCPCs to non-CCPC status in order to save tax on the investment income. This is typically taken place through continuing the CCPC into an offshore jurisdiction, typically the British Virgin Islands.
However, the investment income earned by a CCPC is taxed at around 50% so there is no incentive for individuals in a higher tax bracket to earn investment income via a CCPC. This 50% includes an amount paid to a notional account called the Refundable Dividend Tax on Hand (RDTOH) which is designed to prevent corporate tax deferral. All or part of the RDTOH at the end of the tax year is refunded if a corporation pays taxable dividends to its shareholders during the tax year. On the other hand, the combined federal and provincial rate on investment income earned by a non-CCPC is subject to a general corporate tax rate of around 27% (26.5% in Ontario) which offers an opportunity to defer and save tax on investment income.
A fairly recent advanced tax planning strategy for small business owners is to first carry on a business as a CCPC for the tax benefits, and then convert the CCPC into a non-CCPC right before it realizes a capital gain or other investment income so that it will be taxed at lower rate.
There are two ways to create a private corporation that is a resident in Canada but not a CCPC:
- Give voting control to one or more non-residents, or
- Continue the corporation to a foreign jurisdiction while it is still controlled by Canadians.
Regarding the first method, the simplest way is to issue voting shares with no equity value to a non-resident. However, this may not always be available in any given situation.
The second method converts a CCPC into a non-CCPC by continuing into a foreign jurisdiction while the central mind and management of the corporation remains in Canada. Under subsection 250(5.1) of the Income Tax Act, a continued corporation is treated as having been incorporated in the jurisdiction into which it is continued.
Although the manipulation of CCPC status can be challenged by the Government based on existing rules in the Income Tax Act, these challenges can be both time-consuming and costly. As a result, the Government is proposing a specific legislative measure.
Budget 2022 proposes targeted amendments to the Income Tax Act to align the taxation of investment income earned and distributed by “substantive CCPCs” with the rules that currently apply to CCPCs. Substantive CCPCs, a new concept, would be private corporations resident in Canada (other than CCPCs) that are ultimately controlled (in law or in fact) by Canadian-resident individuals. Similar to the CCPC definition, the test would contain an extended definition of control that would aggregate the shares owned, directly or indirectly, by Canadian resident individuals, and would therefore deem a corporation to be controlled by a Canadian resident individual where Canadian individuals own, in aggregate, sufficient shares to control the corporation. This measure would address tax planning that manipulates CCPC status without affecting genuine non-CCPCs (e.g., private corporations that are ultimately controlled by non-resident persons and subsidiaries of public corporations).
Substantive CCPCs earning and distributing investment income would be subject to the same anti-deferral and integration mechanisms as CCPCs, with respect to such income. Specifically, investment income would be subject to a federal tax rate of 38 ⅔%, of which 30 ⅔% would be refundable upon distribution.
This measure would apply to taxation years that end on or after Budget Day. To provide certainty for genuine commercial transactions entered into before Budget Day, an exception would be provided where the taxation year of the corporation ends because of an acquisition of control caused by the sale of all or substantially all of the shares of a corporation to an arm’s length purchaser. The purchase and sale agreement pursuant to which the acquisition of control occurs must have been entered into before Budget Day and the share sale must occur before the end of 2022.
Hedging and Short Selling by Canadian Financial Institutions
The Income Tax Act generally permits a Canadian corporation, in computing its taxable income, to claim a deduction (the “dividend received deduction”) for the amount of a taxable dividend received on a share (a “Canadian share”) that it holds in another Canadian corporation. This dividend received deduction is intended to limit the imposition of multiple levels of corporate taxation on earnings distributed from one corporation to another. The Government is concerned that certain taxpayers in financial institution groups are engaging in aggressive tax planning arrangements whereby a dividend received deduction is claimed in circumstances giving rise to an unintended tax benefit. For example, where a Canadian bank owns Canadian shares, a registered securities dealer in the Canadian bank’s corporate group will borrow identical shares under a securities lending arrangement and sell the borrowed shares short. The corporate group thereby eliminates its economic exposure to the Canadian shares. The registered securities dealer will generally hold the short position during the entire period that the Canadian bank owns the Canadian shares.
Budget 2022 proposes to amend the Income Tax Act to deny the deduction for a dividend received where the taxpayer has entered into such transactions.
Application of the General Anti-Avoidance Rule to Tax Attributes
The General Anti-avoidance Rule (GAAR) is a concept which generally empowers the Canada Revenue Agency (CRA) to deny a tax benefit of transactions or arrangements which do not have any commercial substance and the only purpose of such a transaction is achieving the tax benefit. The need for a GAAR is usually justified by a concern that the integrity of the tax system needs to be strengthened. Where the GAAR applies to a transaction, the Income Tax Act contains a set of rules that are intended to allow the CRA to determine the amount of a tax attribute, such as the adjusted cost base of a property and the paid-up capital of a share, relevant for the purpose of computing tax. A 2018 Federal Court of Appeal decision held that the GAAR did not apply to a transaction that resulted in an increase in a tax attribute that had not yet been utilized to reduce taxes.
Budget 2022 proposes to amend the Income Tax Act to provide that the GAAR can apply to transactions that affect tax attributes that have not yet been used to reduce taxes.
The government intends to release in the near future a broader consultation paper on modernizing the GAAR, with a consultation period running through the summer of 2022, and with legislative proposals to be tabled by the end of 2022.
Genuine Intergenerational Share Transfers
Prior to June 29, 2021, when a small business owner sells the shares of their company to a corporation owned by their children or grandchildren, the small business owner would be taxed at the higher dividend rate. However, if that same transaction occurred with a corporation to which the small business owner was not related, the transaction would be taxed at the lower capital gains rates and may also allow the seller to access their lifetime capital gains exemption, resulting in no tax on the transaction. Bill C-208 evened the playing field by providing the same tax treatment for intergenerational transfers as is available when shares are sold to unrelated third parties.
Bill C-208 was a private member sponsored bill that allowed small business owners to claim capital gains treatment on the sale of the shares of their small business to family members and receive the same preferential tax treatment as selling to a third party. Prior to this bill, a business owner who sold the shares of their corporation to a related person would be penalized with proceeds being taxed as dividends rather than capital gains. The legislation was intended to facilitate intergenerational transfers. However, an exception to this rule may unintentionally permit surplus stripping without requiring that a genuine intergenerational business transfer takes place. Capital gains surplus stripping refers to tax strategies that permit a distribution of cash from a corporation as a capital gain instead of pulling the cash out as dividends, which are more highly taxed.
Budget 2022 announces a consultation process for Canadians to share views as to how the existing rules could be modified to protect the integrity of the tax system while continuing to facilitate genuine intergenerational business transfers. The Department of Finance is particularly interested in hearing from the agriculture industry. Comments should be received by June 17, 2022.
Interest Coupon Stripping
Per the Income Tax Act of Canada, a 25% non-resident withholding tax rate is applied on interest paid or credited by a Canadian resident to a non-resident. The withholding tax rate is generally reduced for interest paid to a resident in a country with which Canada has a tax treaty. These tax treaties reduce this withholding tax rate to either 10% or 15%. For interest paid to U.S. residents, the Canada-U.S. tax treaty generally reduces the withholding tax rate to nil. Amendments were introduced in 2011 to address interest coupon stripping arrangements though did not deal with two specific variations of the arrangement.
The first variation generally involves a non-resident lender, not resident in the U.S., selling the interest coupons in respect of a loan made to a non-arm’s length Canadian-resident borrower to another person who is resident in the U.S. The second variation involves a non-resident lender, not resident in the U.S., selling the interest coupons in respect of a loan made to a non-arm’s length Canadian-resident borrower to a person resident in Canada. These arrangements permit access to a nil treaty non-resident withholding tax rate or eliminates the application of any treaty withholding tax rate.
Budget 2022 proposes an amendment to the interest withholding tax rules to ensure that the total interest withholding tax paid under an interest coupon stripping arrangement is the same as if the arrangement had not been undertaken and instead the interest had been paid to the non-resident lender.
Canada Recovery Dividend and Additional Tax on Banks and Life Insurers
Budget 2022 proposes the following measures targeting banks and life insurer groups:
Canada Recovery Dividend (CRD) – Bank and life insurance groups are liable for a one-time 15% tax, payable in equal installment over 5 years, based on the corporation’s taxable income in taxation years ending in 2021 (proration available). Group members share a $1 billion taxable income exemption by agreement.
Additional 1.5% tax of taxable income – The same groups are subject to a 1.5% additional tax on their taxable income, with $100 million taxable income exemption shared amongst group members by agreement. This additional tax applies to taxation years ending after the Budget Day.
Investment Tax Credits for Carbon Capture, Utilization, and Storage
To incentivize a reduction of greenhouse gases emission, Budget 2022 proposes an investment tax credit available to businesses undertaking a suite of technologies referred to as carbon capture, utilization, and storage (CCUS). CCUS captures carbon dioxide (CO2) emissions and puts them into an eligible use. The available credit rates depend on the type and use of the equipment, as well as when the eligible expenses are incurred. Two new capital cost allowance (CCA) classes are introduced along with detailed rules on eligible equipment, eligible project, and eligible CO2 storage and uses. Businesses looking to claim the credits may be subject to initial project validation and expense verification, followed by regular assessments that may “claw back” previously claimed credits. Further report filing and knowledge sharing may also be mandatory. The proposed measures apply to eligible expenses incurred after 2021 and before 2041.
Clean Technology Tax Incentives – Air-Source Heat Pumps
Recognizing air-source heat pump as an electrical device that reduces greenhouse gases and air pollutants emissions, Budget 2022 proposes the following measures:
Capital cost allowance (CCA) eligibility – the measure expands eligibility under the existing CCA Class 43.1 and 43.2 to include air-source heat pumps used primarily for space or water heating, acquired and becomes available for use on or after Budget Day. Class 43.1 and 43.2 include energy generation/conservation equipment that qualifies for 30% and 50% CCA rates respectively (under certain conditions). Certain intangible start-up expenses also qualify for full deduction in the year incurred, indefinite carry-forward, or transfer to investors using flow-through shares.
Air-source heat pumps manufacturing qualify for reduced corporate tax rates introduced in 2021 – Budget 2021 introduced reduced corporate income tax rates (reduced to 7.5% for otherwise general corporate tax rate, 4.5% for otherwise small business tax rate) on eligible zero-emission technology manufacturing and processing income. Budget 2022 proposes to include the manufacture of air-source heat pumps used for space or water heating as an eligible zero-emission activity.
Flow-through Share Regimes
Critical Mineral Exploration Tax Credit
An investor holding flow-through shares can currently claim specified mineral exploration expenses incurred and renounced to them against their personal taxable income, as well as a tax credit called Mineral Explication Tax Credit (METC) equaling 15% of the flowed through expenses. Budget 2022 proposes a 30% Critical Mineral Exploration Tax Credit (CMETC) to support exploration of certain minerals used in producing batteries and permanent magnets, in turn the production of clean technology equipment (e.g., zero-emission vehicles). Investors cannot benefit from both METC and CMETC. Where eligible, CMETC can be claimed on expenses flowed through via agreements entered after Budget Day and by March 31, 2027.
Flow-Through Shares for Oil, Gas, and Coal Activities
Budget 2022 proposes to disallow expense renunciation to investors in flow-through share agreements for oil, gas, and coal activities, taking effect for agreements entered into after March 31, 2023. This measure aims to reduce environmental impacts of oil, gas and coal exploration and development.