“On the international tax side, there were some fairly significant amendments,” says Michael Friedman, partner with McMillan LLP.
For instance, Friedman says the government has been focused for years on thin capitalization rules — the way in which non-residents capitalize their Canadian subsidiaries. Thin capitalization rules deny a deduction for interest if the debt-to-equity ratio exceeds a certain threshold.
“There is a general rule that said you have to respect a debt-to-equity ratio of 2:1 and it used to be 3:1. They’ve lowered it in the budget again to 1.5:1 and they’ve introduced other rules that will deem certain disallowed deductions to be dividends. That will be quite significant for non-residents who invest in Canada,” says Friedman, who says the government has spent considerable time studying what other countries do in this area.
The budget projected $300 million in additional tax revenue from that change alone. It also targeted certain planning taking place by multinational groups involving foreign affiliates and projected $1.3 billion in additional tax revenue from that.
“I’m not sure it would stop a company from coming to Canada but it’s very significant in terms of how multinationals finance their subsidiaries,” says Monica Biringer, a partner in the taxation group with Osler Hoskin & Harcourt LLP.
The budget also proposes to amend the Income Tax Act to restrict the ability of foreign-based multinational corporations to transfer, or “dump,” foreign affiliates into their Canadian subsidiaries with a view to creating tax-deductible interest or distributing cash free of withholding tax.
The budget also introduced two amendments to address tax avoidance through partnerships.
“The rule doesn’t currently take into account debt of partnerships, for example, so it’s expanded to include debt of partnerships. It’s a budget with a number of significant corporate tax measures,” said Biringer.
Friedman says the government has gone after some tax planning “loopholes” it is uncomfortable with in respect to retirement compensation arrangements.
A retirement compensation arrangement is a form of retirement savings arrangement generally funded by employer contributions. The 2012 budget proposes new prohibited investment and advantage rules to prevent RCAs from engaging in certain non-arm’s length transactions. The new rules will impose a special tax on RCAs, and will be closely based on existing rules for tax-free savings accounts and registered retirement savings plans. The budget also proposes new restrictions on the ability to obtain RCA tax refunds where the property of the RCA has decreased in value as a result of a prohibited investment or advantage.
“[Last week] they introduced some very detailed anti-avoidance rules dealing with that, and also further tightened the tax shelter rules in the Income Tax Act increasing the penalties on those that promote tax shelters and they’ve also tightened the reporting requirements for tax shelters. You’ve got the government having identified an area they’re concerned about and continuing the trend to try and deal with them,” says Friedman.
The changes result in making it somewhat more complicated to interpret while at the same time trying to address problems critics have raised over the years.
“From a government that has said they want to simplify the tax system and try and make it more efficient, these are very far-reaching and detailed tax proposals that make it more difficult to administer the act and comply. I have sympathy for the fact it’s a competing objective for them,” he says.
The government also extended the mineral exploration tax credit for flow-through shares and accelerated the capital cost allowance for clean energy equipment, which they have been doing for a number of years.
On the scientific research and experimental development side the government reduced the direct tax incentives provided through the tax system by hundreds of millions of dollars and will replace it with direct incentives.
“That’s a policy decision — they’re saying let’s promote scientific development directly rather than indirectly through the tax system,” says Friedman.
“The government has made these changes because they are trying to improve Canada’s position because Canada is perceived to be lagging behind other countries,” says Biringer. “They are following the script of a recent federal task force that said there should be more grants being given and fewer tax credits. I think it’s a bit of a gamble as to whether it will have the desired effect.”
On the pension front, Mark Newton, a partner with Heenan Blaikie LLP, says the government sent a mixed message when it comes to the restructuring of pensions and pushing eligibility for old age security from 65 to 67.
“My concern is it creates a sort of disjointed system. We’ve had a lot of equilibrium in our retirement income system and it’s still a very good system but things are starting to get a little dislocated. Everything has been based on age 65 and now we’re taking a major part of our entire system and moving it to age 67. What does that mean for the other pieces of the puzzle? I’m not sure the government has considered that in detail,” says Newton.
“We’re looking at the cost of [Old Age Security] rising from $30 billion to $100 billion which is no secret and throwing around those numbers puts fear into everyone, not realizing that still as a percentage of GDP the cost of OAS is not that great. By moving it to age 67 and with CPP still at 65 and the lucrative public pensions are still at age 65, the government is saying for most of our system age 65 is still the norm and yet the government will save money by shifting OAS to age 67. It doesn’t make sense. For many people there’s just not enough time to catch up.”