Canadian Tax and Estate Planning

On April 7, 2022, Finance Minister Chrystia Freeland delivered the 2022 federal budget.  There were several new initiatives announced including the introduction of the Tax-Free First Home Savings Account, the Multigenerational Home Renovation Tax Credit and the launching of the Canada Growth Fund, which is intended to attract private sector investments to help reduce emissions, grow low-carbon industries and new technologies, and support restructuring of critical supply chains.

The budget also included a few tax measures, some of which we will describe in more detail below.  These include:

• Allowing more medium-sized Canadian-Controlled Private Corporations to qualify for the small business deduction
• Eliminating the tax deferral on passive income by Canadian-owned private corporations
• Changes to the Foreign Accrual Property Income rules that provide tax deferral for controlled foreign affiliates owned by Canadian corporations
• Tax incentives for clean technology and carbon capture, utilization, and storage technologies
• Gains on residential real estate where the taxpayer owned the property for less than 12 months
• Changes to the GST such that assignments sales of new homes or condo units will be subject to GST/HST

For the last several years, there has been speculation before the budget announcement about a change to the capital gains inclusion rate. Again, this budget left the capital gains inclusion rate at 50 per cent.

Small business deduction

Under the existing rules, qualifying Canadian-Controlled Private Corporations (CCPC) receive a reduced federal corporate income tax rate on qualifying active business income up to $500,000 (small business limit). The reduction is known as the “small business deduction,” which reduces the federal general corporate income tax rate from 15 per cent to nine per cent.

Currently, access to the small business limit is restricted when the combined taxable capital employed in Canada of the CCPC and its associated corporations is between $10 million and $15 million; or, when the combined adjusted aggregate investment income (AAII) of the CCPC and its associated corporations is between $50,000 and $150,000. When taxable capital is equal to or greater than $15 million or, when AAII is equal to or greater than $150,000, access to the small business deduction is lost.

Budget 2022 proposes to provide greater access to the small business deduction by broadening the range in relation to the combined taxable capital employed in Canada of the CCPC and its associated corporations. The new range would be extended to $50 million (from $15 million currently).

Extending this range would allow more CCPCs to benefit from the small business deduction.

As an example, under the current rules, a CCPC with taxable capital of $20 million would not be able to access the small business deduction. However, under the new proposal, the same CCPC would now have up to $375,000 of qualifying active business income eligible for the small business deduction.  This would result in federal corporate income tax savings of up to $22,500.

Elimination of tax deferral on passive investment income using foreign corporations

The 2022 federal budget brought changes to eliminate tax deferral of passive investment income for Canadian resident taxpayers using foreign corporations.

The concept of substantive CCPC was introduced in the 2022 federal budget to target Canadian resident taxpayers who manipulate the status of a corporation that is essentially a CCPC in order not to be a CCPC.

A CCPC earning passive investment income and capital gain pays an additional refundable corporate income tax to bring the corporation tax rate in line with the highest marginal tax rate for an individual so that there is no tax deferral advantage using a corporation. This additional tax is refunded to the corporation when funds are distributed to the shareholder in order to achieve tax integration.

By causing the status to be a non-CCPC, passive income would avoid this additional refundable tax and tax-deferral is achieved. Common methods to manipulate the status include implementing a corporate continuance to a low-tax foreign jurisdiction or moving investment portfolios to an offshore corporation. This is ideal for a corporation earning certain types of passive income and not expected to make periodic dividend distributions to its Canadian shareholders. It is also used in divestitures so that the taxable capital gain would avoid this additional refundable tax.

A substantive CCPC would be a private corporation, other than a CCPC, that is a tax resident of Canada and is controlled legally or in fact by Canadian-resident taxpayers. Like the CCPC definition, the test would include 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.

Passive investment income earned and distributed by a non-CCPC that is deemed to be a substantive CCPC would be taxed in the same manner as a CCPC. Passive investment income would be subject to a federal tax rate of 38 ⅔ per cent, of which 30 ⅔ per cent would be refundable upon distribution. Furthermore, the investment income would be added to the corporation’s “low-rate income pool” such that distributions of such income would not entitle the shareholders to the enhanced dividend tax credit. However, a substantive CCPC would continue to be treated as non-CCPC for all other purposes of the Income Tax Act. These rules would apply for taxation years that end on or after April 7, 2022.

Foreign accrual property income

Another anti-deferral budget proposal involved a change to the formula on the foreign accrual property income (FAPI) calculation for a controlled foreign affiliate of a CCPC.

The purpose of the FAPI regime is to prevent Canadian taxpayers from gaining a tax deferral advantage by earning certain types of passive income, including investment income, offside active business income, etc., through a controlled foreign affiliate (i.e., a non-resident corporation in which the taxpayer has, or participates in, a controlling interest). The rules require the Canadian shareholder include in income their participating share of the controlled foreign affiliate’s FAPI.

The formula to determine FAPI includes a foreign accrual tax deduction that considers the foreign tax liability multiplied by a relevant tax factor (RTF). The RTF for a corporation is four and for an individual is 1.9, which reflects their respective Canadian tax rates. This results in a larger deduction for a corporation and a smaller deduction for an individual.

Consistent with the policy of having no tax deferral advantage in treating passive income earned by an individual and by a CCPC, the 2022 federal budget proposed to apply the RTF of 1.9 to the FAPI formula for a CCPC and a substantive CCPC in order to eliminate the tax deferral in the FAPI formula.

Clean technology tax incentives – Air-source heat pumps

Capital cost allowance

In determining their taxable income for a fiscal year, taxpayers are eligible to deduct a certain portion of eligible depreciable capital property they own. The amount of deduction, or capital cost allowance (CCA) is determined based on the class to which the asset belongs. Under existing regime, Class 43.1 and 43.2 includes specified clean energy generation and energy conservation equipment.

Budget 2022 proposes to include air-source heat pumps primarily used for space or water heating as part of Class 43.1 and 43.2.

Eligible property would include:

• Equipment that is part of an air-source heat pump system that transfers heat from the outside air, including:
  • refrigerant piping
  • energy conversion equipment
  • thermal energy storage equipment
  • control equipment
  • equipment designed to enable the system to interface with other heating and cooling equipment

Eligible property would not include:

• Building or parts of buildings
• Energy equipment that backs up an air-source heat pump system
• Equipment that distributes heated or cooled air or water within a building

Proposed expansion of Class 43.1 and 43.2 would apply to the eligible property that was acquired or became available to use on or after April 7, 2022.

Rate reduction for zero-emission technology manufacturers

Budget 2021 temporarily reduced, effective for taxation years that begin after 2021, corporate income tax rates for qualifying zero-emission technology manufacturers with respect to eligible zero-emission technology manufacturing and processing income. Corporate income tax rate was reduced to 7.5%, where eligible income would otherwise be taxed at 15% general corporate income tax rate, and 4.5%, where eligible income would otherwise be taxed at the 9% small business corporate income tax rate.

Budget 2022 proposes to expand definition of eligible zero-emission technology manufacturing or processing activities to include manufacturing of air-source heat pumps used for space or water heating Eligible activities would include the manufacturing of components or sub-assemblies only if such equipment is purpose-built or designed exclusively to form an integral part of an air-source heat pump.

Investment tax credit for carbon capture, utilization, and storage

Carbon capture, utilization, and storage (CCUS) technologies are aimed at capture of carbon dioxide (CO₂) emissions and their storage or utilization in various industrial processes. Budget 2022 proposes to introduce new refundable investment tax credit with respect to investments in CCUS technologies incurred after January 1, 2022.

CCUS investment tax credit will be determined based on the following rates that would apply to eligible expenses incurred after 2021 through 2030:

• 60 per cent for eligible capture equipment used in a direct air capture project
• 50 per cent for all other eligible capture equipment
• 5 per cent for eligible transportation, storage, and use equipment

Eligible expenses that are incurred after 2030 through 2040 would be subject to the following lower rates:

• 30 per cent for eligible capture equipment used in a direct air capture project
• 25 per cent for all other eligible capture equipment
• 75 per cent for eligible transportation, storage, and use equipment

Eligible expenses would consist of the cost of purchasing and installing eligible equipment that is used in an eligible project, which results in a portion of capture CO₂ being used for an eligible purpose. CCUS investment tax credit will be applicable to the eligible expenses independent of when eligible equipment becomes available for use. Where eligible equipment is being used in an eligible project that plans to store captured CO₂ through both eligible and ineligible uses, CCUS investment tax credit will be reduced by the proportion of the capture CO₂ that is expected to go to an ineligible use. When the project is operational, it will be assessed every five years to a maximum of 20 years to determine whether recovery of CCUS investment tax credit is required.

Eligible equipment

Equipment that will be used solely to capture, transport, store, or use CO₂ as part of an eligible CCUS project would be considered eligible equipment. Two new CCA (see section “Clean technology tax incentives – Air-source heat pumps” above for explanation) classes will be created to include eligible equipment for CCUS investment tax credit purposes:

• 8 per cent CCA rate on a declining-balance basis:
  • capture equipment: equipment that solely captures CO₂, including required processing and compression equipment (not including dual purpose equipment that supports CCUS and production)
  • transportation equipment: pipelines or dedicated vehicles for transporting CO₂
  • storage equipment: injection and storage equipment
• 20 per cent CCA rate on a declining-balance basis:
  • use equipment: equipment required for using CO₂ in an eligible use

In addition, the aforementioned classes would also include the cost of:

• converting existing equipment for use in a CCUS project or refurbishing eligible equipment
• equipment for monitoring and tracking CO₂
• buildings or other structures that solely support a CCUS project

Lastly, assets in these classes would be eligible for enhanced first year depreciation under the accelerated investment incentive.

Eligible project

For a project to be an “eligible project” within the context of CCUS investment tax credit, it must be a new project that captures CO₂ that would otherwise be released into the atmosphere, or captures CO₂ from the ambient air, prepares the captured CO₂ for compression, compresses and transports the captured CO₂, and stores or uses the captured CO₂. Direct air capture projects, which are eligible for a higher credit rate on capture equipment, must capture CO₂ directly from the ambient air. In addition, CO₂ must be captured in Canada but can be stored or used outside of Canada.

Eligible use of CO₂

Initially, eligible use would consist of dedicated geological storage and storage in concrete.

Changes to flow-through share regime

Flow-through shares are a type of common share issued by public corporations that allow an initial investor to claim tax deductions equal to the amount invested, and thus is generally issued by public corporations to investors at a premium relative to the price of the regular common shares. The ability of an investor to claim a deduction is achieved through a mechanism by which public corporations transfer or renounce Canadian exploration expenditures and Canadian development expenditures to investors. Investors can deduct Canadian exploration expenditures as a 100 per cent one-time deduction, while Canadian development expenditures are deducted over time using 30 per cent declining balance method. In addition, individual investors can benefit from the Mineral Exploration Tax Credit (METC), which is equal to 15 per cent of specified mineral exploration expenditures renounced to flow-through share investors.

Budget 2022 proposes two significant changes to the flow-through regime:

1. Effective April 1, 2023, eliminate the ability to renounce oil, gas and coal exploration or development expenditures to the investors.
2. Effective April 7, 2022, introduce enhanced critical mineral exploration tax credit (CMETC) for specified minerals. CMETC will equal to 30 per cent of specified mineral exploration expenditures renounced to flow-through share investors and will be applicable only to the expenditures incurred in exploration of certain specified minerals – copper, nickel, lithium, cobalt, graphite, rare earth elements, scandium, titanium, gallium, vanadium, tellurium, magnesium, zinc, platinum group metals and uranium. CMETC and METC will be mutually exclusive and cannot apply with respect to the same exploration expenditures. In order to qualify for CMETC, eligible expenditures would need to be renounced to investors under eligible flow-through share agreements entered on or before March 31, 2027.

Tax-Free First Home Savings Account

Budget 2022 proposes to create a new registered account called the Tax-Free First Home Savings Account (FHSA) to help individuals save for their first home, allowing for individuals to open an FHSA and begin contributing at some point in 2023.

Contributions to an FHSA would be tax-deductible and income earned in an FHSA would not be subject to tax. Qualifying withdrawals from an FHSA made to purchase a first home would be non-taxable.

An individual would not be permitted to make withdrawals under both the FHSA and home buyer’s plan for the same qualifying home purchase.

Eligibility

To open an FHSA, an individual must:

• Be a resident of Canada
• Be at least 18 years of age
• Not have lived in a home they owned at any time in the year or any of the preceding four calendar years

Contributions

Contributions to an FHSA would be subject to an annual contribution limit of $8,000, up to a lifetime contribution limit of $40,000. The annual contribution limit would not be non-cumulative, meaning any unused contribution limit from a prior year could not be added to the subsequent year’s $8,000 contribution limit. An individual would be able to contribute to more than one FHSA, but total contributions between all of their FHSAs could not exceed the annual and lifetime contribution limits.

Individuals would also be allowed to transfer funds from an RRSP to an FHSA on a tax-free basis, subject to the $40,000 lifetime and $8,000 annual contribution limits, but such transfers would not restore an individual’s RRSP contribution room.

Withdrawals

Only withdrawals to make a qualifying home purchase would not be subject to tax. Any amounts withdrawn for other purposes would be taxable. Individuals would be limited to making non-taxable withdrawals in respect of a single property in their lifetime.

Once the individual has made a non-taxable withdrawal to purchase a home, they would be required to close their FHSAs within a year from the first withdrawal and would not be eligible to open another FHSA. If an individual has not used the funds in their FHSAs for a qualifying first home purchase within 15 years of first opening an FHSA, their FHSA would have to be closed. Any unused savings could be transferred into an RRSP or RRIF or withdrawn on a taxable basis.

First-Time Home Buyers’ Tax Credit

Under current legislation, first-time home buyers who acquire a qualifying home can claim the First-Time Home Buyers’ Tax Credit (HBTC), a non-refundable tax credit of up to $750 calculated as 15 per cent of the $5,000 amount base.

A home is a qualifying home for the purposes of the HBTC if:

1. The home is acquired by the individual or the individual’s spouse or common-law partner
2. The individual or the individual’s spouse or common-law partner intends to occupy the home as their principal residence no later than one year after acquisition
3. The individual or the individual’s spouse or common-law partner did not own or occupy another home in the year or in any of the four preceding calendar years

Budget 2022 proposes to double the HBTC base amount to $10,000, which would provide a non-refundable tax credit of up to $1,500 for eligible home buyers, applicable to acquisitions of qualifying homes made on or after January 1, 2022.

Multigenerational Home Renovation Tax Credit

Budget 2022 proposes a new refundable credit, the Multigenerational Home Renovation Tax Credit, for a qualifying renovation that would create a second dwelling unit to permit an eligible person to live with a qualifying relation. The credit would be calculated as 15 per cent of the lesser  eligible expenses and $50,000, which would provide for a maximum refundable credit of $7,500.

An eligible person would be either:

• an individual that is 65 years of age or older
• an individual with disabilities that is 18 years of age or older, that is eligible for the Disability Tax Credit

A qualifying relation for the purposes of this credit is an individual who is 18 years of age or older that is related to the eligible individual.

The Multigenerational Home Renovation Tax Credit applies to an eligible dwelling, defined as a housing unit that is owned by either the eligible person or a qualifying relation, that is to be ordinarily resided in by both, following the renovations. The credit can either be claimed by the eligible person, the qualifying relation in respect of the eligible person, or shared between eligible claimants, on qualifying renovations as long as the total of amounts does not exceed $50,000 between claimants.

A qualifying renovation must enable an eligible person to reside in the dwelling by establishing a secondary unit within the dwelling for occupancy by the eligible individual or the qualifying relation. The secondary unit must be a self-contained unit with a private entrance, kitchen, bathroom facilities, and sleeping area.

This credit would apply for 2023 and subsequent taxation years for renovations on or after January 1, 2023.

Home Accessibility Tax Credit

Currently, the Home Accessibility Tax Credit allows a non-refundable tax credit at 15 per cent of eligible home renovation expenses up to $10,000, for a maximum credit of $1,500, for an eligible dwelling of an individual that is either eligible for the Disability Tax Credit or is 65 years of age or older.

Budget 2022 proposes to increase the annual expense limit of the credit to $20,000 to improve accessibility and support independent living for 2022 and subsequent taxation years.

Residential property flipping rule

Budget 2022 proposes to introduce a new deeming rule that would deem profits arising from dispositions of residential property that was owned for less than 12 months to be business income to target property flipping. By deeming the profits to be business income, the seller would not be eligible for the 50 per cent capital gains inclusion rate or the principal residence exemption. However, there are exceptions to the deeming rules for unanticipated life events causing the disposition, which would include events such as, but not limited to death, separation, or employment change.

This deeming rule would be applicable for properties sold on or after January 1, 2023.

GST/HST on assignment sales

Budget 2022 introduces a new rule which deems an assignment sale to be unconditionally subject to GST/HST.

 An assignment sale is where the original purchaser (assignor) of a pre-construction residential unit “sells” the unit before taking ownership of the unit to another person (the assignee).

Under current rules, an assignment sale may be either taxable or exempt for GST/HST depending upon the intent of the assignor. If the assignor had purchased the unit with the intention to occupy it as a place of residence, then the assignment sale would be exempt from tax. If there was no intent to occupy the unit as a place of residence, then the sale would be taxable. The new change would make all assignment sales taxable.

Typically, with assignment sales, the assignee pays the assignor an amount equal to deposits made to the builder, plus an assignment fee. For example, an assignee may pay the assignor $300,000 which represents a recovery of $75,000 paid to the builder as a deposit on the unit, and a $225,000 assignment fee. Since the builder will apply the deposit against the GST/HST included purchase price at closing, the new rule will obligate the assignor to collect GST/HST on the $225,000 assignment fee.  However, if the assignor is a non-resident of Canada, then the assignee will be required to self-assess the GST/HST and remit it directly to the Canada Revenue Agency.

Interestingly, the announced changes apply to assignment agreements entered into on or before May 7, 2022. This provides for new assignment sales to be entered into during the next month with the old rules applying.