23
Mar

2016 Federal Budget Highlights – Corporate Income Tax

There has been many proposed changes that will affect corporate taxes; some of the things that may affect you are highlighted below.

Small Business Income Tax Rate
Budget 2016 proposes that the small business tax rate will remain at 10.5 per cent after 2016. In order to preserve the integration of the personal and corporate income tax systems, Budget 2016 also proposes to maintain the current gross-up factor and dividend tax credit (DTC) rate applicable to non-eligible dividends.

Under the current legislation, the small business rate was to be reduced by 0.5% annually, to 9% in 2019.

Multiplication of the Small Business Deduction
Budget 2016 proposes measures to prevent business owners from multiplying access to the $500,000 small business deduction limit using complex partnership and corporate structures.

Partnerships
The small business deduction that a CCPC which is a member of a partnership can claim in respect of its income from the partnership is limited to the lesser of the active business income that it receives as a member of the partnership (its “partnership ABI”) and its pro-rata share of a notional $500,000 business limit determined at the partnership level (its specified partnership income limit, or “SPI limit”). A CCPC’s SPI is added to its active business income from other sources, if any, and the CCPC can claim the small business deduction on the total (subject to its annual business limit).

Some taxpayers have implemented structures to circumvent the application of the SPI rules. In a common structure, a shareholder of a CCPC is a member of a partnership and the partnership pays the CCPC as an independent contractor under a contract for services. As a result, the CCPC claims a full small business deduction in respect of its active business income earned in respect of the partnership because, although the shareholder of the CCPC is a member of the partnership, the CCPC is not a member.

To address this, Budget 2016 proposes to extend the SPI rules. Basically, income paid by the partnership to a CCPC which is a member of the partnership, has a shareholder who is a partner in the partnership, or does not deal at arm’s length with a member of the partnership, will be restricted by the SPI provisions unless substantially all of the CCPC’s active business income is derived from provision of property or services to arm’s length persons other than the partnership.

As the CCPC is not a member of the partnership, its SPI limit will be nil. However, a partner who does not act at arm’s length to the CCPC will be permitted to allocate all, or a portion, of its own SPI limit to the CCPC.

This provision will apply to taxation years commencing on or after Budget Day.

Payments Between Private Corporations
Some tax planning to enhance small business deduction eligibility does not involve a partnership, and is also targeted in the 2016 Federal Budget. Such multiplication could occur in circumstances using multiple CCPCs.

Budget 2016 proposes to deny the small business deduction to a CCPC which earns active business income from providing services or property (directly or indirectly, in any manner whatever) to another private corporation (PCo) in which the CCPC, one of its shareholders or a person who does not deal at arm’s length with such a shareholder has a direct or indirect interest.

Budget 2016 proposes that a CCPC’s active business income from providing such services or property to PCo will be ineligible for the small business deduction unless all or substantially all of the CCPC’s active business income for the taxation year is earned from providing services or property to arm’s length persons other than PCo.

The Budget indicates that a payer, which is also a CCPC, will be permitted to assign a portion of its own unused small business deduction limit to the service provider CCPC (SCo). The assignment is limited to the least of SCo’s income from the services provided, PCo’s unused business limit not assigned to other corporations and, the amount determined by the Minister of National Revenue to be reasonable in the circumstances.

Avoidance of the Small Business Limit and the Taxable Capital Limit
Where two corporations are not otherwise associated, but are each associated with the same third corporation, they are also deemed associated with each other. Where that third corporation is not a CCPC, or files an election, then, for limited purposes (mainly access to the small business deduction), it is deemed not to be associated with the other two corporations. Therefore, the first two companies will not be associated with each other. The third corporation is not permitted to claim the small business deduction where it files such an election.

Property income, like rent and interest, paid to an associated corporation, will be active business income to the recipient if deductible against the payer’s active business earnings. This provision is not affected by the election described above.

Budget 2016 proposes to restrict the ability to claim the small business deduction in such cases. Income of this nature which is paid from the electing corporation to one of the other corporations will no longer be eligible for the small business deduction. It will remain active business income not eligible for the small business deduction.

Further, Budget 2016 indicates that the taxable capital of the electing corporation will be added to the taxable capital of each of the other corporations for the purpose of determining any reduction to their small business deduction limit. The small business deduction limit begins to be reduced where this taxable capital exceeds $10 million in the previous year.

These changes will apply to taxation years commencing on or after Budget Day.

Eligible Capital Property
Eligible capital property for income tax purposes includes intangible property such as goodwill and licences, franchises and quotas of unlimited duration, as well as certain other rights.

Budget 2016 proposes to replace the ECP regime with a new capital cost allowance (CCA) class (Class 14.1) available to businesses, and to provide rules to transfer taxpayers’ existing cumulative eligible capital (CEC) pools to the new CCA class. The proposal is not intended to affect the application of the Goods and Services Tax/Harmonized Sales Tax (GST/HST) in this area.

Expenditures that are currently added to CEC (at a 75 per cent inclusion rate) will be included in the new CCA class at a 100 per cent inclusion rate. Because of this increased expenditure recognition, the new class will have a 5 per cent annual depreciation rate (instead of 7 per cent of 75 per cent of eligible capital expenditures). To retain the simplification objective, the existing CCA rules will generally apply, including rules relating to recapture, capital gains and depreciation (e.g., the “half-year rule”).

As gains on property of this nature will now be capital gains, the tax deferral which was previously available on sales of ECP will be eliminated.

As part of this change, Budget 2016 also proposes some transitional rules, as follows:
• Under the proposal, CEC pool balances will be calculated and transferred to the new CCA class as of January 1, 2017. The opening balance of the new CCA class in respect of a business will be equal to the balance at that time of the existing CEC pool for that business.

  • For the first ten years, the depreciation rate for the new CCA class will be 7 per cent in respect of expenditures incurred before January 1, 2017.
  •  A taxpayer will be permitted to deduct as CCA, in respect of expenditures incurred before 2017, the greater of $500 per year and the amount otherwise deductible for that year. This additional allowance will be provided for taxation years that end prior to 2027.
  •  A separate business deduction will be provided for incorporation expenses, such that the first $3,000 of these expenditures will be treated as a current expense rather than being added to the new CCA class.

This measure, including the transitional rules, will apply as of January 1, 2017.

Active versus Investment Business
Budget 2015 announced a review of the circumstances in which income from a business, the principal purpose of which is to earn income from property, should qualify as active business income and therefore potentially be eligible for the small business deduction. The examination of the active versus investment business rules is now complete. No changes to these rules are proposed.

Life Insurance Policies
Budget 2016 proposes a number of complex changes to the rules surrounding taxation of life insurance policies, generally targeting strategies perceived as abusive. The discussion which follows is limited to a simplified outline of these changes.

Corporate and Partnership Life Insurance
Life insurance proceeds received due to the death of an insured individual are not taxable. A private corporation receiving such benefits adds them, to the extent they exceed the adjusted cost basis of the policy, to its capital dividend account (CDA), which can be paid out as a tax-free dividend to its shareholders.

Budget 2016 addresses structures perceived to allow excessive amounts to be received tax-free as a consequence of these provisions, generally involving a corporation being a beneficiary of a life insurance policy it does not also own. In very general terms, Budget 2016 proposes new measures to ensure that the adjusted cost basis of the policy reduces the amounts which a corporate recipient of insurance proceeds may add to its CDA.

Where a partnership receives life insurance proceeds, the adjusted cost base of the partners’ interest in the partnership is increased in the same manner a corporation’s CDA is increased. Budget 2016 proposes similar rules to restrict the increase in the adjusted cost bases of partnership interests.

Budget 2016 also introduces information reporting requirements for such situations. All of these provisions will be effective for policy benefits received in respect of deaths on or after Budget Day.

Transfer of Life Insurance Policy Interests
Prior to the Budget changes, a transfer of a life insurance policy between non-arm’s length parties was taxed on the basis that proceeds equaled the cash surrender value of the policy, if any. Budget 2016 proposes to tax the parties on the basis of proceeds equal to the full fair market value of the policy. As a result, such transfers will often attract significantly higher income tax costs. This change will apply to transfers on or after Budget Day.

For transfers which occurred prior to Budget Day for consideration in excess of the deemed proceeds (i.e. the cash surrender value), the increase to a corporate policyholder’s CDA, or the adjusted cost basis of the interests in a partnership to which a policy was transferred,

will be reduced by any proceeds paid for the policy in excess of the cash surrender value. This change will apply to policy benefits received as a result of deaths occurring on or after Budget Day, regardless of how long ago the policy was transferred to the corporation or partnership.

Valuation of Derivatives
Budget 2016 proposes to exclude derivatives from the application of the inventory valuation rules while maintaining the status of such property as inventory. A related rule will also be introduced to ensure that taxpayers are not able to value derivatives using the lower of cost and market method under the general principles for the computation of profit for tax purposes. Declines in value will not generate a deduction until and unless the position is closed at a loss. The measure will apply to derivatives entered into on or after Budget Day.

Expanding Tax Support for Clean Energy
Budget 2016 proposes to make electric vehicle charging stations eligible for inclusion in Class 43.1 or 43.2, based upon whether they meet certain power thresholds, and to make changes to Class 43.1 and 43.2 for electrical energy storage. These measures will apply in respect of property acquired for use on or after Budget Day that has not been used or acquired for use before Budget Day.

If you want to know how the changes may affect your corporation, please contact our office to speak with one of our professionals today.

The preceding information is for educational purposes only. As it is impossible to include all situations, circumstances and exceptions in a post such as this, a further review should be done by a qualified professional.

No individual or organization involved in either the preparation or distribution of this post accepts any contractual, tortious, or any other form of liability for its contents or for any consequences arising from its use.


Gregory & Associates