The Liberal government released its first Federal budget on March 22, 2016. Although some of the measures were previously proposed, many were new and some came as a surprise. The significant income tax measures and related proposals include the following:
- Elimination of spousal income splitting: The former Conservative government enacted a rule that allowed spouses (or common-law partners) to notionally transfer up to $50,000 of taxable income from one spouse to the other, in order to save a maximum of $2,000 in federal tax. The Liberals campaigned on a promise to eliminate this measure, and they did so in this budget, effective for 2016 and subsequent years.
- Increased child tax benefit: The existing Canada Child Tax Benefit (CCTB) and the Universal Child Care Benefit (UCCB) will be replaced effective July 1, 2016 by a new Canada Child Benefit (CCB). The CCB will provide up to $6,400 per child under the age of 6 and $5,400 per child aged 6 through 17. The benefits will be reduced for adjusted family net income between $30,000 and $65,000 and reduced further for adjusted family net income over $65,000. The reduction rate also varies depending on the number of children in the family. The CCB will be paid monthly, it will not be taxable, and it will not be included in income for the purposes of certain federal income-tested programs, such as the Guaranteed Income Supplement, the Canada education savings grant, and the Canada disability savings grant. CCB benefits paid for the July 2016 to June 2017 benefit year will be based on adjusted family net income for the 2015 taxation year.
- Reinstatement of LSVCC: This was another expected measure, as it was proposed in the Liberals’ election platform. The former 15% credit on up to $5,000 of investments in labour-sponsored venture capital corporations (LSVCCs) is reinstated for 2016 and subsequent years. (The former government phased out the credit, and proposed to eliminate it entirely beginning in 2017.) However, the reinstatement applies only to provincially-registered LSVCCs and not federally registered LSVCCs.
- New school supplies credit: Again this was proposed in the Liberals’ election platform. Teachers and early child educators will be able to claim a 15% refundable credit on up to $1,000 of their expenditures on “eligible supplies”, which include construction paper, flashcards, items for science experiments, art supplies such as paper and paint, and stationery items. The credit is available for expenditures incurred in 2016 and later years.
- Extension of mineral exploration credit: This credit, which applies to certain mineral exploration expenses incurred by resource companies and renounced to investors in flow-through shares, has been extended annually in every Budget since 2003. This year is no exception, and the credit is extended by one year to flow-through share agreements entered into before April 2017.
- Education and textbook credits: These credits will be eliminated beginning in 2017. The tuition credit will remain in place. Unused education and textbook credits from 2016 and earlier can still be carried forward to 2017 and later years. In conjunction with the elimination of these credits, which are not income-tested, the government will increase the Canada Student Grant for low and middle-income families and part-time students, and increase the income limit at which former students must start repaying their Canada Student Loans. This proposal was also in the Liberals’ election platform.
- Children’s fitness and arts credits: These tax credits are reduced for 2016, and will be eliminated starting in 2017.
- Small business tax rate: In a surprise move that runs counter to what was in the Liberals’ election platform, the federal small business tax rate on the first $500,000 of active business income earned by a Canadian-controlled private corporation (CCPC) will remain at 10.5%. The budget cancelled further reductions to 9% over two years that had been enacted by the previous Conservative government and would have taken effect from 2017 to 2019. For individual recipients of dividends out of such income, the “gross-up” will remain at 17% of the dividend and the federal dividend tax credit will remain at 21/29 of the gross-up amount for 2016 and subsequent years. The proposed changes in the gross up and dividend tax credit for 2017 through 2019 (as outlined in our April Tax letter) were therefore cancelled.
- Partnerships and the small business deduction: As noted above, the income threshold for the small business tax rate for CCPCs is $500,000. If various CCPCs are a member of a partnership, they must share the $500,000 limit with respect to the business income earned from the partnership (the “specified partnership limit” for each member), and each CCPC’s share of the partnership income then forms part of that CCPC’s overall $500,000 limit. To get around this rule and to avoid sharing the $500,000 limit, individual partners formed CCPCs that were not partners of their partnership; the CCPCs then entered into contracts with the partnership to provide services to the partnership. Since the CCPCs were not partners, they were not subject to the specified partnership limit and therefore each CCPC could earn up to $500,000 of income from the partnership that could be subject to the small business tax rate. Similar structures had various CCPCs providing services to a corporation in order to get around the specified partnership limit rules. The budget effectively provides that these structures will be subject to the specified partnership limit rules. This measure applies to corporate taxation years that begin after March 21, 2016, with some transitional rules. The measure particularly affects large partnerships such law and accounting firms and medical practices, in which the professional partners often set up such structures.
- Taxing investors in “switch funds”: Mutual fund corporations can be structured such that investors in one class of shares in the corporation can “switch” them for another class without triggering a disposition for tax purposes. The switch essentially moves the investor to another fund within the corporation. Mutual fund trusts do not enjoy this advantage. To level the playing field, investors in mutual fund corporations who perform these switches after September 2016 will have a deemed disposition of the shares at fair market value.
- Eligible capital property rules eliminated: As proposed in the 2014 budget, the complicated rules for “eligible capital property” (ECP) will be eliminated. ECP is basically goodwill and certain other purchased intangibles. Under the new rules, such property will be depreciable property in a new class 14.1, depreciable at an annual rate of 5% on a declining balance basis, and subject to the regular capital cost allowance system. The new rules will apply beginning in 2017, with various transitional rules governing the move of existing ECP into Class 14.1.
- Donations involving real estate and private company shares: Last year’s Conservative budget proposed that capital gains on these properties would be exempt to the extent the proceeds were donated to charity. The rule was proposed to apply beginning in 2017. This budget cancelled this proposal.
What was not in the budget?
Interestingly, the Liberal government backed off from an election campaign promise to fully tax employee stock option benefits exceeding $100,000 per year.
Under current rules, most stock option benefits are taxed like capital gains, in that only half of the benefits is included in income. Despite the campaign promise, this year’s budget did not change the rules. Furthermore, the Minister of Finance indicated in a post-budget press conference that changes to the rules are not in the works. Various industries, and in particular the high tech industry which relies on employee stock options to attract talent, had lobbied the Minister to reverse the election campaign position and not change these rules. Evidently, that lobbying was effective.