2021 Canadian federal budget – Top 5 tax measures
Jeremy Ho and Kabir Jamal, partners in the Tax Group at McCarthy Tétrault, on five key tax proposals, from interest deductibility limits to a new digital services tax
On April 19, 2021, Deputy Prime Minister and Finance Minister Chrystia Freeland tabled the Liberal Government's 2021 budget ("Budget 2021"), the first federal budget in over two years. Budget 2021 includes a number of significant tax proposals. Five key tax proposals are briefly described below.
McCarthy Tétrault's detailed commentary on these and other tax proposals in Budget 2021 can be found here.
1. Interest Deductibility Limits
Budget 2021 proposes a new earnings-stripping rule intended to address the potential erosion of the Canadian tax base through what the Government considers to be the inappropriate deduction of interest expense payable by a Canadian taxpayer, such as where (i) interest is paid to related parties resident in low-tax jurisdictions, (ii) the underlying debt was used to finance investments that earn non-taxable income, or (iii) the Canadian taxpayer bears a disproportionate burden of a multinational group's third-party borrowings.
The new rule will limit the amount of net interest expense that a corporation, trust, partnership or Canadian branch of a non-resident may deduct in computing its taxable income to no more than a fixed ratio of "tax EBITDA". For these purposes, "tax EBITDA" means taxable income before taking into account interest expense, interest income and income tax, and deductions for depreciation and amortization, as computed under Canadian tax rules.
Canadian group members will be entitled to transfer unused interest deductibility capacity to other Canadian members of the group whose net interest deductions would otherwise be limited by the rule. In addition, a Canadian member of a consolidated group may be entitled to a higher interest deduction limit where it is able to show that the ratio of net third party interest to book EBIDTA of its consolidated group indicates that the higher interest deduction limit would be appropriate.
Exemptions from the new rule will be available for Canadian-controlled private corporations ("CCPCs") if the taxable capital employed in Canada of the corporation and its associated corporations is less than $15 million, and for groups of corporations and trusts whose aggregate net interest expense among their Canadian members does not exceed $250,000. Budget 2021 also states that "it is expected that standalone Canadian corporations and Canadian corporations that are members of a group none of whose members is a non-resident would, in most cases, not have their interest expense deductions limited under the proposed rule."
The proposed rule will be released for stakeholder comment this summer. Once enacted, the new rule will apply to taxation years that begin on or after January 1, 2023, will be phased in gradually with a fixed ratio of 40% for taxation years that begin in the 2023 calendar year and 30% for taxation years that begin on or after January 1, 2024, and will apply to both new and existing borrowings.
2. Hybrid Mismatch Arrangements
Budget 2021 proposes to introduce new rules to address "hybrid mismatch arrangements." Hybrid mismatch arrangements involve arrangements that use differences in the income tax treatment of entities or instruments under the tax laws of Canada and one or more other countries to claim a deduction in one country in respect of a cross-border payment, the receipt of which is not included in the ordinary income of the recipient in the other country. They also include arrangements where a deduction is claimed in two or more countries in respect of a single economic expense.
Under the new rules, a payment made by a Canadian resident under a hybrid mismatch arrangement will not be deductible for Canadian income tax purposes to the extent that such payment is deductible in another country or is not included in the ordinary income of the recipient. Conversely, where a non-resident makes a payment under a hybrid mismatch arrangement that is deductible in another country, no deduction in respect of the payment will be permitted against the income of a Canadian resident; any amount of the payment received by a Canadian resident under a hybrid mismatch arrangement will also be included in income and, if the payment is a dividend from a foreign affiliate, will not be deductible in computing the taxable income of the Canadian resident.
Budget 2021 proposes to implement the new rules in two separate legislative packages. The first legislative package, expected to be released in 2021 for stakeholder comment and to be applicable as of July 1, 2022, will be limited to the deduction/non-inclusion mismatches in respect of hybrid instruments. The second legislative package will address other forms of hybrid mismatch arrangements, and is expected to be released after 2021 and to be applicable no earlier than 2023.
3. COVID-19 Business Support Programs
Existing Business Support Programs
Budget 2021 proposes to extend the Canada Emergency Wage Subsidy ("CEWS"), Canada Emergency Rent Subsidy ("CERS") and the Lockdown Support programs until September 25, 2021, with the possibility of a further extension until November 20, 2021. For qualifying periods beginning June 6, 2021, the subsidy rates for both the CEWS for active employees and the CERS will be gradually reduced and both programs will require applicants to have a revenue decline of more than 10%. The CEWS for furloughed employees will remained aligned with the benefits available under Employment Insurance, but is proposed to end on August 28, 2021.
One new aspect of the CEWS program is that a publicly-listed corporation (and any employer controlled by a publicly-listed corporation) will be required to repay CEWS amounts received for qualifying periods beginning on or after June 6, 2021 in the event that the aggregate compensation for specified executives during the 2021 calendar year exceeds the aggregate compensation for specified executives during the 2019 calendar year.
Canada Recovery Hiring Program
Budget 2021 introduces the new Canada Recovery Hiring Program ("CRHP"), which is intended to facilitate hiring back laid-off employees and hiring new employees. The CRHP is an alternative subsidy to the CEWS, and will be available for qualifying periods from June 6 to November 20, 2021. Employers who are eligible for the CEWS will generally be eligible for the CRHP, except that, among other things, with respect to for-profit corporations, only CCPCs (including cooperative corporations that are eligible for the small business deduction) will be eligible. Such employers will be permitted claim the higher of the CRHP and the CEWS. The CRHP subsidy amount for the first three qualifying periods (from June 6 to July 3, 2021, July 4 to July 31, 2021, and August 1 to August 28, 2021) will be equal to 50% of the employer's incremental remuneration paid to eligible employees. The rate declines to 40% for the next period from August 29 to September 25, 2021; 30% for the subsequent period from September 26 to October 23, 2021; and 20% for the final period from October 24 to November 20, 2021. Incremental remuneration for a qualifying period is the difference between an employer's total eligible remuneration paid to eligible employees for the qualifying period and its total eligible remuneration paid to eligible employees for the baseline period, being March 14 to April 10, 2021. In both the qualifying period and the baseline period, eligible remuneration for each employee will be capped at $1,129 per week.
Immediate Expensing of Depreciable Property by CCPCs
Budget 2021 proposes to provide for temporary immediate expensing of certain eligible depreciable capital property acquired by CCPCs (up to $1.5 million per year). Eligible property will be capital property that is subject to the capital cost allowance ("CCA") rules, other than property included in CCA classes 1 to 6, 14.1, 17, 47, 49 and 51, which are generally long-lived assets. This measure will apply to eligible property acquired on or after April 19, 2021 and that becomes available for use before 2024.
4. Clean Energy Investment
Rate Reduction for Zero-Emission Technology Manufacturers
Budget 2021 proposes to reduce the federal corporate income tax rates on certain eligible zero-emission technology manufacturing and processing income to: (i) 7.5% (if that income would otherwise be taxed at the 15% general corporate rate); and (ii) 4.5% (if that income would otherwise be taxed at the 9% small business rate). To qualify for a rate reduction, at least 10% of a taxpayer's gross revenue from all active business carried on in Canada must be derived from eligible zero-emission technology manufacturing or processing activities. The reduced rates are proposed to apply to taxation years that begin after 2021 and to be gradually phased out beginning in 2029 and fully phased out for taxation years beginning in 2023.
CCA for Clean Energy Equipment
Budget 2021 proposes to amend the list of eligible clean energy equipment included in CCA class 43.1 and 43.2 by expanding such CCA classes to include various clean energy equipment and to remove certain equipment that burn fossil fuels and/or waste fuels. The expansions of CCA classes 43.1 and 43.2 will apply in respect of eligible property that is acquired and becomes available for use on or after April 19, 2021. The removal of property from such classes will apply in respect of property that becomes available for use after 2024.
Tax Incentive for Carbon Capture, Utilization and Storage
Budget 2021 proposes to introduce an investment tax credit to promote the adoption of carbon capture, utilization and storage technologies. The proposal is subject to a 90-day consultation period with various stakeholders in order to further design the investment tax credit.
5. Digital Services Tax
Budget 2021 proposes to implement a digital services tax ("DST") as of January 1, 2022 as an interim measure until an acceptable multilateral approach comes into effect. The Government's aim is to ensure that the revenue earned by large businesses, whether foreign or domestic, from engagement with online users in Canada (including through the collection, processing and monetizing of data and content contributions from those users) is subject to Canadian tax. Generally, the DST will apply at a rate of 3% of revenue (excluding VAT and sales taxes) earned from certain digital services that rely on engagement, data and content contributions of Canadian users. The DST will apply to an entity that has (or is part of a business group that has) global revenue from all sources of at least €750 million in the previous calendar year and in-scope revenue associated with Canadian users of more than $20 million in the particular calendar year. The DST proposal is subject to consultation with stakeholders, with draft legislation expected to be released in summer 2021.
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Jeremy Ho is a partner in the Tax Group of McCarthy Tétrault in Vancouver. Kabir Jamal is a partner in the Tax Group of McCarthy Tétrault in Toronto.