2023 Federal Budget Highlights
On March 28, 2023, Finance Minister Chrystia Freeland tabled the Government’s 2023 Federal Budget. Read below for a summary of key tax changes:
- Personal Income Tax Measures
- Business Income Tax Measures
- Sales Tax and Excise Tax Measures
- International Tax Measures
- Other Measures
The Budget does not propose any changes to federal personal or corporate income tax rates, nor changes to the capital gains inclusion rate.
Personal Income Tax Measures
The Budget proposes to amend the rules introduced by Bill C-208 to ensure they apply only where a genuine intergenerational business transfer takes place. Bill C-208 was previously introduced as an exemption to Section 84.1 of the Income Tax Act, an anti-avoidance provision that seeks to recharacterize certain amounts that would otherwise be taxed at capital gains rates, as dividends that are subject to a higher tax rate. The budget proposes two options for the transfer of a business to the next generation:
- An immediate transfer, with arm’s length sales terms (three-year test); and
- A gradual transfer (five-to-ten-year test) based on traditional estate freeze characteristics.
Conditions for the Three-Year Test (Immediate Business Transfer)
- Parents must immediately transfer both legal and factual control, including an immediate transfer of a majority of voting shares, with the remaining voting shares to be transferred within 36 months;
- Parents must immediately transfer a majority of the common growth shares with the remaining growth shares to be transferred within 36 months;
- Management of the business must be transferred by the parent to the child within a reasonable time frame based on the particular circumstances (36-month safe harbour);
- The child(ren) retains legal control for a 36-month period following the share transfer; and
- At least one child must remain actively involved in the business for the 36-month period subsequent to the transfer.
Conditions for the Five-to-Ten-Year Test (Gradual Business Transfer)
- The parent must immediately transfer legal control, including an immediate transfer of a majority of voting shares, with the balance transferred within 36 months;
- The parent must immediately transfer a majority of the common growth shares and transfer the balance within 36 months. Additionally, within 10 years of the initial sale, the parents must reduce the economic value of their debt and equity interests in the business to either 50% of the value of their interest in a farm or fishing corporation at the initial sale time, or 30% of the value of their interest in a small business corporation at the initial sale time;
- Management of the business must be transferred by the parent to the child within a reasonable time frame based on the particular circumstances (36-month safe harbour);
- The child(ren) retains legal control of the business for the greater of 60 months or until the business transfer is completed; and
- At least one child must remain actively involved in the business for the greater of 60 months following the share transfer or until the business transfer is completed.
The proposed amendments expand the definition of “child” for these purposes to include children, grandchildren, stepchildren, children-in-law, nieces, nephews, grandnieces and grandnephews of the transferor.
The budget proposes to provide relieving rules for subsequent arm’s length share transfers or upon the death or disability of a child. There would be no limit on the value of shares transferred when relying on these relieving rules.
The transferor and the child(ren) would be required to jointly elect to have these provisions apply and would be jointly and severally liable for any additional taxes payable by the Transferor in respect of a transfer that does not meet the above conditions. The limitation period for reassessing the transferor’s tax liability in respect of these provisions is proposed to be extended by three years for an immediate business transfer and by ten years for a gradual business transfer.
The budget also proposes to provide a ten-year capital gains reserve (currently a five-year capital gains reserve applies) for intergenerational share transfers that meet the above conditions.
These measures are proposed to apply to transactions that occur on or after January 1, 2024.
Employee Ownership Trusts (EOT)
The Budget proposes new rules to facilitate the use of EOTs for employees to purchase and hold shares of a business. To qualify as an EOT, a trust must be a Canadian resident trust, and must meet the certain conditions, including:
- It must hold a controlling interest in the shares of one or more qualifying businesses for the exclusive benefit of certain qualifying employees;
- The beneficiaries of the trust must consist exclusively of employees, subject to certain exclusions;
- The interest of each beneficiary of the trust must be determined in the same manner, based on their length of service, remuneration and hours worked;
- All or substantially all of its assets must be a controlling interest in a Canadian-controlled private corporation, all or substantially all of the fair market value of the assets of which must be used in an active business carried on in Canada.
Conditions applicable to the trustees of an EOT include:
- Trustees must be Canadian residents and must be elected by the beneficiaries at least once every five years; and
- Individuals and their related persons who held 50 percent or more economic interest in a qualifying business prior to its sale to the EOT may not account for more than 40 percent of the trustees of the EOT, directors of the board of a corporation serving as a trustee, or directors of any qualifying business of the EOT.
For purposes of the EOT, a qualifying business transfer occurs when a taxpayer disposes of shares of a qualifying business to a trust that qualifies as an EOT immediately after the sale, or to a corporation wholly-owned by the EOT.
These rules extend the capital gains reserve to ten years (currently five years) for qualifying sales to an EOT, provide an exception to the current shareholder loan rules for loans to an EOT to acquire shares of a qualifying business, and provide an exemption to EOTs from the 21-year deemed disposition rule that applies to certain trusts.
These new EOT rules apply to transactions that occur on or after January 1, 2024.
Alternative Minimum Tax (AMT)
AMT applies a minimum amount of tax, regardless of a taxpayer’s deductions and exemptions, when the amount of taxes otherwise payable under the regular income tax system falls below a certain threshold.
The Budget proposes several changes to the calculation of AMT, including broadening the base on which AMT is calculated and increasing the applicable AMT rate to 20.5% (from 15%).
The AMT exemption amount is a deduction from AMT for individuals and graduated rate estates. The exemption will be increased from $40,000 to the start of the fourth federal tax bracket (approximately $173,000). The exemption amount would be indexed annually to inflation.
The proposed changes to the AMT rules would come into force for taxation years that begin after 2023.
A grocery rebate is proposed through an increase to the maximum Goods and Services Tax Credit (GSTC) for January 2023 that would provide eligible individuals with an additional amount of GSTC up to the following maximum amounts:
- $153 per adult;
- $81 per child; and
- $81 for the single supplement
The grocery rebate would be paid once the legislation is passed.
Retirement Compensation Arrangements (RCA)
The budget proposes amendments to the RCA rules such that fees or premiums paid for the purpose of securing or renewing a letter of credit (or a surety bond) for an RCA that is supplemental to a registered pension plan will not be subject to the 50% refundable tax. Further, employers will be able to request a refund of previously remitted refundable tax in respect of these fees or premiums based on the retirement benefits that are paid out of the employer’s corporate revenues to employees that had RCA benefits secured by letters of credits (or surety bonds). The amount eligible for a refund is 50 percent of the retirement benefits paid, up to the amount of refundable tax previously paid.
The proposed changes would apply to retirement benefits paid after 2023.
Other Personal Income Tax Measures
Other personal income tax measures proposed in the budget include:
- An extension to December 31, 2026, for the temporary measure to allow certain qualifying family members (parent, spouse, or common-law partner) to open a registered disability savings plan (RDSP) and be the plan holder for an adult who does not have a legal representative and whose legal capacity to enter into a RDSP is in doubt. The Budget also broadens the definition of a qualifying family member to include adult brothers and sisters of the beneficiary, to be effective upon the enabling legislation receiving royal assent.
- An increase to the maximum employment deduction for tradespeople’s tools from $500 to $1,000, effective for 2023 and subsequent tax years.
- Amendments to the Registered Education Savings Plan (RESP) legislation to permit Educational Assistance Payment withdrawals of up to $8,000 (currently $5,000) in respect of the first 13 consecutive weeks of enrollment for beneficiaries in full-time programs, and up to $4,000 (currently $2,500) per 13-week period for beneficiaries enrolled in part-time programs. The changes would come into force on Budget Day.
- The ability for divorced or separated parents to open joint RESPs for one or more of their children, or to move an existing joint RESP to another promoter. This change would come into effect on Budget Day.
- Allowing the CRA to share taxpayer information with an official of Employment and Social Development Canada or Health Canada for the purposes of administering or enforcing the Canadian Dental Care Plan.
Business Income Tax Measures
Amendments to the General Anti-Avoidance Rule (GAAR)
The GAAR is intended to prevent abusive tax avoidance transactions and seeks to deny tax benefits created by abusive transactions.
The budget proposes to amend the GAAR for the following:
- Introduction of a preamble to address interpretive issues, noting the GAAR applies to deny tax benefits sought to be obtained through abusive avoidance transactions and is intended to strike a balance between taxpayers’ need for certainty in planning their affairs and the government’s responsibility to protect the tax base and fairness of the tax system.
- Changing the avoidance transaction standard from a ‘primary purpose’ test to a ‘one of the main purposes’ test.
- Introduction of an economic substance rule, where the lack of economic substance may, in some cases but not always, indicate abusive tax avoidance.
- Introduction of a penalty equal to 25% of the tax benefit, which can be avoided if the transaction is disclosed to the CRA under the mandatory disclosure rules or voluntarily.
- A three-year extension to the normal reassessment period for GAAR assessments, unless the transaction has been disclosed to the CRA.
Green Government Incentives
The Budget includes the following Investment Tax Credit (ITC) changes related to green incentives:
- The introduction of a refundable Clean Hydrogen ITC, which provides a maximum credit of 40% for the cost of purchasing and installing eligible equipment for eligible projects. Eligible projects include those that produce hydrogen from electrolysis or natural gas. This measure would apply to property that is acquired and becomes available for use on or after Budget Day and would be phased out starting in 2034.
- The expansion of the eligibility for the Clean Technology ITC to include geothermal energy systems that are eligible for capital cost allowance pursuant to Class 43.1. The expansion would apply in respect of property that is acquired and becomes available for use on or after Budget Day, where it has not been used for any purpose before its acquisition, and would be phased out by 2034.
- The introduction of a new refundable 15% ITC for Clean Electricity for eligible investments, which includes non-emitting electricity generation systems, abated natural gas-fired electricity generation, stationary electricity storage systems, and equipment for the transmission of electricity between provinces and territories.
- The introduction of a refundable ITC for Clean Technology Manufacturing, equal to 30% of the capital cost of eligible property used in clean technology manufacturing and processing, and critical mineral extraction and processing. The tax credit would apply to property that is acquired and available for use on or after January 1, 2024 and would be gradually phased out by 2034.
- The expansion to the refundable ITC for Carbon Capture, Utilization and Storage (CCUS) to include dual-use equipment that produces heat and/or power or uses water, that is used for CCUS as well as another process. These measures apply to eligible expenses incurred after 2021 and before 2041.
Businesses would be able to claim only one of the above ITCs, if a particular property is eligible for more than one of these tax credits.
Further green initiatives proposed in the Budget includes:
- The expansion of eligible activities that qualify for the reduced general corporate tax rate for qualifying zero-emission technology manufacturers, to include manufacturing of nuclear energy equipment, processing or recycling of nuclear fuels and heavy water, and manufacturing of nuclear fuel rods. The expansion of eligible activities would apply for taxation years beginning after 2023. The budget further proposes to extend the availability of the reduced tax rates by three years such that the planned phase-out would start in tax years that begin in 2032.
- The expansion of the Critical Mineral Exploration Tax Credit (CMETC) to include lithium from brines as eligible expenses. Eligible expenses related to lithium from brines made after Budget Day will qualify as Canadian exploration expenses and Canadian development expenses. The expansion of the eligibility of the CMETC to lithium from brines would apply to flow-through share agreements entered into after Budget Day and before April 2027.
Other Business Income Tax Measures
Other Business income tax measures proposed in the Budget include:
- A proposed 2 percent tax on the net value of all types of share repurchases by public corporations in Canada, subject to certain exceptions. This tax would apply to Canadian-resident public corporations, real estate investment trusts, specified investment flow-through (SIFT) trusts, and SIFT partnerships with shares or units listed on a designated stock exchange, but not to mutual fund corporations. The tax would apply to repurchases and issuances of equity that occur on or after January 1, 2024.
- Proposal to deny the dividend received deduction for dividends received by financial institutions on shares that are mark-to-market property. This measure would apply to dividends received after 2023.
- Amendments to the Income Tax Act to eliminate the revenue test from the definition of a ‘credit union’ and amending the definition to account for how credit unions currently operate. The amendments would apply in respect of tax years of a credit union ending after 2016.
Sales Tax and Excise Tax Measures
GST/HST Treatment of Payment Card Clearing Services
The budget clarifies that payment card clearing services provided by payment card network operators will generally be subject to the GST/HST. The Budget has specifically excluded these services from the definition of “financial service” for GST/HST purposes.
This change will apply to services provided under an agreement for a supply if any consideration for the supply becomes due, or is made without becoming due, after March 28, 2023. It will also apply to services provided under an agreement for a supply if all payment for the supply became due or was made on or before March 28, 2023, except in situations where both the following conditions are met:
- The supplier did not charge, collect or remit any amount on account of tax in respect of the supply, on or before March 28, 2023; and
- The supplier did not charge, collect or remit any amount on account of tax, on or before March 28, 2023, in respect of any other supply made under the agreement and that includes the provision of a payment card clearing service.
Alcohol Excise Duty
The Budget proposes to temporarily cap the inflation adjustment for excise duties on beer, spirits and wine at 2 percent, for one year only, as of April 1, 2023.
The Budget proposes to allow all licensed cannabis producers to remit excise duties on a quarterly basis, rather than a monthly basis, starting from the quarter beginning on April 1, 2023.
International Tax Measures
The Budget confirms the government’s continued dedication to the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (BEPS), particularly regarding Pillars One and Two. It provides an update on recent developments and outlines Canada’s next steps in implementing the two Pillars.
The government is working with its international partners in an OECD-led initiative to develop model rules and a multilateral convention necessary to establish the Pillar One framework and bring it into effect. The intention is to sign the convention by mid-2023 and have it enter into force in 2024. The government plans to release revised draft legislative proposals for a Digital Services Tax (DST) for public review. The DST could be imposed from January 1, 2024, for revenues earned as of January 1, 2022, if the multilateral convention implementing the Pillar One framework has not yet come into force.
The budget reaffirms the government’s intention to introduce legislation to implement the Income Inclusion Rule (IIR) and a domestic minimum top-up tax for Canadian entities of multinational enterprises (MNEs) under Pillar Two. The government plans to release draft legislative proposals for the IIR and domestic minimum top-up tax for public consultation in the coming months, with draft proposals for the Undertaxed Profit Rule (UTPR) to follow.
The IIR and the domestic minimum top-up tax would be effective for fiscal years of begin on or after December 31, 2023. The UTPR would be effective for fiscal years that begin on or after December 31, 2024.
The Budget confirms the government’s intentions to proceed with the following previously announced tax and related measures including:
- Excessive Interest and Financing Expenses Limitations
- Reporting Rules for Digital Platform Operators
- Automatic Advance for the Canada Workers Benefit
- Investment Tax Credit for Clean Technologies
- Extension of the Residential Property Flipping Rule to Assignment Sales
- Borrowing by Defined Benefit Pension Plans
- Reporting Requirements for Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs)
- Fixing Contribution Errors in Defined Contribution Pension Plans
- The Investment Tax Credit for Carbon Capture, Utilization and Storage
- Hedging and Short Selling by Canadian Financial Institutions
- Substantive Canadian-Controlled Private Corporations
- Mandatory Disclosure Rules
- The Electronic Filing and Certification of Tax and Information Returns
- Canadian Forces Members and Veterans Amounts
- Hybrid Mismatch Arrangements
- GST/HST treatment of Cryptoasset Mining
- Legislative proposals tabled in a Notice of Ways and Means Motion on December 14, 2021 to introduce the Digital Services Tax Act
- The transfer pricing consultation announced in Budget 2021
- The income tax measure announced on December 20, 2019, to extend the maturation period of amateur athletes trusts maturing in 2019 by one year, from eight years to nine years
- Measures confirmed in Budget 2016 relating to the GST/HST joint venture election.
If you have any questions or would like further information relating to the 2023 Budget and its impact on you, please contact your Smythe advisor.