Canadian Tax and Estate Planning

On March 28, 2023, Deputy Prime Minister and Minister of Finance Chrystia Freeland delivered the 2023 federal budget. The Minister boasted that Canada experienced the strongest economic growth in the G7 over the last year and that low-cost daycare has resulted in a record level of Canadian women participating in the workforce at 85.7 per cent.

After decades of low inflation and interest rates, coming out of the COVID-19 pandemic, the world has experienced high inflation rates and Canada was not spared. Over the last eight months, inflation has consistently fallen. While the Bank of Canada predicts that it will fall to approximately 2.6 per cent by the end of 2023, a survey of private sector economists predicts Canada’s economy to slow and that we will enter a shallow recession this year.

The government announced several investments that they say will grow our economy and create good middle-class jobs, strengthen the public health care system, and protect our environment. Initiatives include:

• A new one-time grocery rebate will be received in a lump-sum payment to qualifying taxpayers.
• Increasing RESP withdrawal limits for students for the first time in 25 years.
• Increasing health transfers to the provinces by $195.6 billion over the next 10 years.
• Implementation of the 988 Suicide Prevention Line that will be up and running by November 30, 2023.
• Expansion of the Canada Dental Care Plan to uninsured Canadians with an annual family income of less than $90,000.
• Investments in clean energy through tax credits on eligible investments and investments in infrastructure projects by the Canada Infrastructure Bank.
• Additional funding to support First Nations governments so they can deliver critical programs to their members.

There are a few income tax related announcements that impact an owner-managed business and its shareholders. The creation of Employee Ownership Trusts that are intended to support employee-ownership is a positive announcement. Changes to the intergenerational business transfer rules will come into force next year. And finally, the alternative minimum tax regime is being overhauled.

Overall, the budget is big on investments and small on substantive tax changes. Given the current economic uncertainty, it is what one would expect.

Clean Technology Investment Tax Credit

The 2022 Fall Economic Statement proposed the Clean Technology Investment Tax Credit, which has been reconfirmed in Budget 2023. It is a 30 per cent refundable credit that would be available to businesses investing in eligible capital property that is acquired and that becomes available for use on or after Budget day. The property must not have been used for any purpose prior to acquisition. The following types of equipment were eligible for the credit:

• Equipment to generate electricity from solar, wind, and water energy.
• Stationary electricity storage equipment that does not use any fossil fuels in operation, which includes, but is not limited to, batteries, flywheels, supercapacitors, magnetic energy storage, compressed air energy storage, pumped hydroelectric energy storage, gravity energy storage, and thermal energy storage.
• Active solar heating equipment, air-source heat pumps, and ground-source heat pumps Equipment to generate heat or electricity from concentrated solar energy;
• Equipment to generate heat or electricity from small modular nuclear reactors.
• Non-road zero-emission vehicles (e.g., hydrogen or electric heavy-duty equipment used in mining or construction) and charging or refuelling equipment that is used primarily for such vehicles Equipment used primarily for the purpose of generating electrical energy or heat energy, or both electrical and heat energy, solely from geothermal energy, including piping, pumps, heat exchangers, steam separators, and electrical generating equipment, but does not include equipment used for geothermal energy projects that will co-produce oil, gas or other fossil fuels

Budget 2023 proposes a phase out period beginning in 2034 when the credit will be reduced to 15 per cent, and it will no longer be available after 2034. Additionally, in order to qualify for a 30 per cent credit, businesses must meet certain labour conditions effective October 1, 2023, otherwise, they will only qualify for a 20 per cent credit. There are two labour requirements attached to this tax credit:

1. Prevailing wage requirement – all covered workers are compensated at a level that meets or exceeds the relevant wage, plus the substantially similar monetary value of benefits and pension contributions, as specified in an “eligible collective agreement”. Requirement can be met by either paying workers in accordance with an eligible collective agreement, or by paying workers at or above the equivalent prevailing wage, and through a combination of wages, pension contributions, and benefits. For this requirement, an eligible collective agreement for a particular worker is  one closely aligned with the worker’s tasks, location, experience level, and type of work.
2. Apprenticeship requirement – no less than 10 per cent of the total labour hours performed by covered workers engaged in subsidized project elements be performed by registered apprentices. Covered workers are those whose duties correspond to those performed by a journeyperson in a Red Seal trade. Additionally, the number of apprentices cannot exceed the number allowed by labour law or a collective agreement.

The labour requirements would apply in respect of workers engaged in the project, whether they are engaged directly by the business or indirectly by a contractor or subcontractor, as well as target workers with primarily manual or physical duties in nature.

Investment Tax Credit for Clean Technology Manufacturing

Budget 2023 proposes a new refundable investment tax credit for clean technology manufacturing and processing, and critical mineral extraction and processing. The proposed credit is equal to 30 per cent of the capital cost of eligible property associated with eligible activities, which are defined as follows:

• Eligible property – machinery and equipment, including certain industrial vehicles, used in manufacturing, processing, or critical mineral extraction, as well as related control systems. If the eligible property is subject to a change in use or sold within a certain period of time, a portion of the tax credit will be subject to a recovery mechanism.
• Eligible activities – activities related to clean technology manufacturing and processing, including:
  • Manufacturing of certain renewable energy equipment (solar, wind, water, or geothermal).
  • Manufacturing of nuclear energy equipment.
  • Processing or recycling of nuclear fuels and heavy water.
  • Manufacturing of nuclear fuel rods.
  • Manufacturing of electrical energy storage equipment used to provide grid-scale storage or other ancillary services.
  • Manufacturing of equipment for air- and ground-source heat pump systems.
  • Manufacturing of zero-emission vehicles, including conversions of on-road vehicles.
  • Manufacturing of batteries, fuel cells, recharging systems, and hydrogen refuelling stations for zero-emission vehicles.
  • Manufacturing of equipment used to produce hydrogen from electrolysis.
  • Manufacturing or processing of upstream components, sub-assemblies, and materials provided that the output would be purpose-built or designed exclusively to be integral to other eligible clean technology manufacturing and processing activities, such as anode and cathode materials used for electric vehicle batteries.
  • The extraction and certain processing activities related to six critical minerals essential for clean technology supply chains: lithium, cobalt, nickel, graphite, copper, and rare earth elements, including activities both before and after the prime metal stage or its equivalent.

The Investment Tax Credit for Clean Technology Manufacturing will apply to property that is acquired and becomes available for use on or after January 1, 2024. The credit is gradually phased out starting with property that becomes available for use in 2032, when the credit is reduced to 20 per cent, followed by a 2033 reduction to 10 per cent and a 2034 reduction to five per cent with a subsequent full phase-out after 2034.

Investment Tax Credit for Clean Electricity

Budget 2023 proposes a new 15 per cent refundable Investment Tax Credit for Clean Electricity. The tax credit is based on eligible investments which includes:

• Non-emitting electricity generation systems: wind, concentrated solar, solar photovoltaic, hydro (including large-scale), wave, tidal, nuclear (including largescale and small modular reactors).
• Abated natural gas-fired electricity generation (which would be subject to an emissions intensity threshold compatible with a net-zero grid by 2035).
• Stationary electricity storage systems that do not use fossil fuels in operation, such as batteries, pumped hydroelectric storage, and compressed air storage.
• Equipment for the transmission of electricity between provinces and territories.

In order to qualify for the credit, businesses must meet the aforementioned labour requirements to receive the full 15 per cent tax credit, other the tax credit is reduced to five per cent. This credit is available as of the day of the 2024 federal budget for projects that did not begin construction before March 28, 2023, and the credit will not be available after 2034.

It should be noted that where a particular property is eligible for more than one of the aforementioned tax credits, businesses can claim only one such tax credit for a given property.

The grocery rebate

Budget 2023 proposes to increase the maximum Goods and Services Tax Credit (GSTC) for January 2023. This increase, known as the grocery rebate, will allow eligible individuals to receive an additional GSTC amount up to the following maximum amounts, which are:

• $153 per adult;
• $81 per child; and
• $81 for the single supplement.

The grocery rebate would be paid through the GSTC system, once the legislation is passed, and is a one-time payment.

Intergenerational business transfers

Section 84.1 of the Act serves to prevent certain corporate distributions, resulting from transactions entered into by individuals, from being taxed as income from capital gains as opposed to being taxed as income from dividends. Certain intergenerational transfers of businesses could also be subject to this provision, resulting in these transfers being taxed at higher dividend tax rates.

Bill C-208, which was first introduced in June 2021, provided an exception to this recharacterization to allow for the intergenerational transfers of businesses that were inadvertently subject to section 84.1.

Budget 2023 proposes additional rules to ‘tighten’ the provision and to ensure that the exception only applies to genuine intergenerational business transfers.

The budget introduces two options for these transfers to occur:

• An immediate intergenerational business transfer (three-year test) based on arm’s length sales terms; or
• A gradual intergenerational business transfer (five-to-10-year test) based on traditional estate freeze characteristics.

The conditions for these two options are summarized as follows:

A joint election and joint liability would be required by the transferor and child for the transfer to qualify for the immediate or gradual intergenerational transfer. The child would be liable for any additional taxes payable by the transferor should the above conditions not be met.

The limitation period for reassessing the transferor’s tax liability would be extended to monitor compliance. The limitation period for reassessing the transferor’s liability for tax on the intergenerational transfer is extended by three years for an immediate business transfer and up to 10 years for a gradual business transfer.

Employee Ownership Trust

Budget 2023 introduces an additional option for succession planning known as the Employee Ownership Trust (EOT). The EOT structure allows business owners to sell the shares of their business to a trust to be held for the benefit of employees without the need for employees to pay directly to acquire these shares.

Qualifying conditions of an EOT

For a trust to qualify as an EOT, the trust must meet  several conditions, including:

• Be a Canadian resident trust.
• Hold shares of a qualifying business for the exclusive benefit of employee beneficiaries.
• Have all or substantially all of its assets be shares of qualifying businesses.
• Not carry on its business as a partner to a partnership.

Qualifying business transfer

To be a qualifying business transfer to an EOT, the business being transferred must have all or substantially all the fair market value of its assets used in an active business carried on in Canada. The shares of such a business would have to be disposed of to a trust that would qualify as an EOT or to a corporation wholly owned by an EOT, for no more than fair market value., The EOT must also own and hold a controlling interest of the business immediately after the transfer.

Restrictions on previous significant economic interest holders

Following the transfer of a business to an EOT, there would be restrictions imposed on the individuals and their related persons who had a significant economic interest prior to the sale, to limit their governance over the EOT and prevent them from being beneficiaries of the EOT.

Tax treatment

An EOT would be a taxable trust and generally follow the same tax rules as other personal trusts. Trust income retained in the trust would be subject to tax at the top personal marginal rates while income from the trust distributed to beneficiaries would retain its income character and would be taxable to the beneficiaries at their respective graduated tax rates.

Distributions for an EOT must generally be made to qualifying employees by similarly treating all beneficiaries, whether that be by having a distribution formula that could only consider an employee’s length of service, remuneration, and hours worked, or by having all beneficiaries receive equal amounts.

However, an EOT would not be permitted to allocate shares of qualifying businesses to its beneficiaries.

New tax rules to facilitate EOT structure

Capital gains reserve

On sales of capital property where a taxpayer receives proceeds on a deferred basis, the capital gain could typically be deferred over a period of up to five years, with a minimum of 20 per cent of the gain included in income each year, under current rules. To encourage qualifying business transfers to an EOT, Budget 2023 proposes to extend the current capital gains reserve deferral period of five years to be extended to a period of 10 years, with a minimum of 10 per cent of the gain recognized each year.

Shareholder loans

Under current rules, shareholders that borrow money from their corporation are generally subject to an income inclusion for the value of the amounts borrowed, unless the loan is repaid within a year. To facilitate financing for qualifying business transfers to an EOT, Budget 2023 proposes an exception to extend the repayment period to 15 years, for amounts borrowed by an EOT to finance the purchase of shares on a qualifying business transfer.

21-year rule

Certain trusts are subject to the 21-year deemed disposition rules, meaning a trust is deemed to dispose of its capital properties every 21 years at fair market value, to prevent indefinite deferrals of tax on accrued gains, under current tax rules. Budget 2023 proposes to exempt EOTs from the 21-year rule as long as the trust meets the qualifying conditions to be an EOT.

These amendments would apply as of January 1, 2024.

Alternative Minimum Tax (AMT)

Budget 2023 proposes several changes to the computation of the AMT.

The AMT tax is a parallel tax computation that allows for fewer deductions, exemptions, and tax credits compared to the ordinary income tax rules.

The budget includes several proposals that impact the computation of the AMT by broadening its base by further limiting tax preferences (i.e., exemptions, deductions, and credits), including the following:

• Increasing the capital gains inclusion rate from 80 per cent to 100 per cent.
• Capital loss carry forwards and allowable business investment losses are included at a 50 per cent rate.
• Stock option benefits included at a 100 per cent rate.
• Capital gains on donations of publicly listed securities are included at a 30 per cent rate.

Budget 2023 confirms however that the current 30 per cent inclusion rate for capital gains eligible for the lifetime capital gains exemption will be maintained.

Additionally, the AMT base is further broadened by limiting certain deductions and expenses to 50 per cent of the amounts incurred. Some of these deductions/expenses are as follows:

• Employment expenses (other than those to earn commission income).
• Deductions for CPP, QPP, and PPIP contributions.
• Moving expenses.
• Childcare expenses.
• Interest and carrying charges incurred to earn income from property.
• Deductions for limited partnership losses of other years.
• Non-capital loss carryovers.

Currently, where the rules allow for non-refundable tax credits to reduce the AMT, the budget proposes that only 50 per cent of most non-refundable tax credits will be used to reduce the AMT.

Other changes to the AMT include increasing the exemption amount and the exemption rate. The exemption amount is available to all individuals (excluding trusts, other than graduated rate estates) and is intended to shelter lower- and middle-income earners from the AMT. It is proposed that the exemption amount will increase from $40,000 to approximately $173,000, which will be indexed annually to inflation. The budget proposes an increase to the AMT rate from 15 per cent to 20.5 per cent.

The proposed changes will impact taxation years which begin after 2023.

For any questions regarding Budget 2023, please reach out to our Canadian Tax team.