Tax Relief People Can See

Transcription

1 Canadian Federal Budget: May 2, 2006 Stikeman Elliott s Commentary Tax Relief People Can See The following commentary on the Canadian Government s Federal Budget, released May 2, 2006, was prepared by members of Stikeman Elliott s Tax Group. To no one s surprise, James Flaherty s first Budget speech began with the announcement of the much-heralded and controversial reduction in the rate of GST from 7 per cent to 6 per cent, effective July 1, What is more surprising is that no mention was made in this Budget of any further reduction in the GST. This seems a surprising omission in light of the Conservative Party s campaign promise to reduce the GST to 5 per cent over the next five years. Some may observe that the Harper government s commitment to that initiative has been shaken by the active debate amongst economists (including those in the Department of Finance) over whether the best way to stimulate the economy and to deliver relief to taxpayers is through cuts in commodity taxes or in income taxes. Time will tell (perhaps). The Budget materials indicate that a budgetary surplus of $8 billion is currently projected for , after giving effect to the personal tax rate reductions and personal exemption increases announced by the previous government last November and proposed to be honoured in today s Budget. The government s stated plan going forward is to reduce the accumulated debt by $3 billion a year. The estimated budgetary surplus of $3.6 billion for , after giving effect to the $9.9 billion of tax reductions and $4.4 billion of new spending initiatives proposed in the Budget, is intended to accomplish this objective. Is the tax relief afforded by this Budget more apparent than real? This is not an easy question to answer. Although Prime Minister Harper had suggested that his government s program would be different than that of its predecessor, a significant number of the 29 separate tax reductions referred to in the Budget speech are measures already announced by the former Liberal government, or variations on those. These include many of the big-ticket items in this Budget, such as reductions in personal and corporate tax rates, increases in the basic personal exemption, child care and elimination of the corporate surtax and federal capital tax. A notable additional inclusion is the enhancement of the dividend tax credit which had been announced by the former Minister of Finance on November 23, 2005 as the government s response to the concerns regarding income trusts. There is also the proposed extension of the non-capital loss carry-forward period of all taxpayers from 10 to 20 years, and the similar extension of the carry-forward period for investment tax credits to 20 years. There had been comment that this Budget would repeal the former Liberal government s announced but not enacted reduction in the lowest personal income tax rate from 16 per cent to 15 per cent, to fund the cost of the GST rate reduction. There was speculation that the Conservatives would replace that measure with a reduction of the two personal middle income tax rates, measures STIKEMAN ELLIOTT LLP MONTREAL TORONTO OTTAWA CALGARY VANCOUVER NEW YORK LONDON SYDNEY

2 that would have a considerably lower impact on the fisc. The approach actually taken in the Budget was to confirm the rate reduction for 2005 and the first half of 2006 (What else could they do?) and roll back the reduction to a 15.5 per cent rate effective July 1, 2006, resulting in an effective rate of per cent for 2006 and 15.5 per cent for 2007 and subsequent taxation years. The manner in which the Budget proposes to reduce tax by increasing the basic personal exemption is similarly complex. The Harper government made good on the Liberals commitment to increase the basic personal amount by $500 for 2005 and to bring it to $10,000 by 2009, but have altered the rate at which we get there. For 2006, the amount is increased by $200 for the first half of the year, in accordance with the timetable proposed by the Liberals (Again, what else could they do?) and then decreased by $400 for the second half of the year, with the effect that it is not increased at all for 2006 other than by way of indexation. The Budget does introduce a number of new measures, of varying significance. New business tax measures include proposed increases in the small business deduction and in the amount of income to which the small business rate applies, an increase (to $1 billion) in the threshold amount for the application of the financial institution capital tax, the proposed apprenticeship tax credit and enhanced capital cost allowance rates on certain tools. A point of interest to some is a reference in the Supplementary Information (Annex 3) to functional currency tax reporting. It is noted that certain Canadian resident corporations are required by Canadian and international accounting rules to determine income for financial reporting purposes in a currency other than the Canadian dollar if business activities are conducted primarily in that currency. It is proposed that consideration will be given to allowing corporations in these circumstances to determine income for Canadian tax purposes in that functional currency. A discussion draft of legislative proposals will be released for comment. On the personal tax side, there is a long list of new credits and other relief aimed at education, children s fitness, public transit use, pensions and disability. The most notable new measure or at least the most expensive is the proposed Canada Employment Credit, a non-refundable tax credit for individuals earning employment income equal to the lowest personal tax rate applied to employment income up to $250 for 2006 and $1000 for 2007 (indexed thereafter). It is estimated that in 2007 this measure will cost the government $1.815 billion. The Budget speech says that this credit is intended to recognize that it costs individuals something to work. Another measure of some interest is the proposal to reduce the capital gains inclusion rate to zero (currently 25 per cent) for charitable donations of listed publicly-traded securities. It is noted that consideration will be given to extending the exception for listed securities to donations to private foundations if appropriate self-dealing rules can be devised. In addition to the Budget s silence on further reductions in the GST rate, there are a number of tax measures notable by their absence. No mention was made of the capital gains tax deferral that was the subject of much discussion during the election campaign. Various measures that have been pending for a number of years interest and other expense deductibility, cross-border share-for-share exchanges, foreign investment entity rules, non-resident trust rules, and draft technical amendments were not mentioned in the Budget. Non-tax proposals in the Budget that are of general interest include proposed measures to provide temporary solvency funding relief to sponsors of federally-regulated defined benefit pension plans and proposed discussions with the provinces and territories regarding the allocation of unanticipated federal budget surpluses in excess of the $3 billion annual debt reduction to the CPP and QPP. The government also took the opportunity to announce as a priority its intention to engage the provinces and territories in discussions aimed at a establishing a common securities regulator for the country. BUSINESS INCOME TAX MEASURES RESOLUTION (20) Dividend Tax Credit In September of last year the then Minister of Finance created much angst in Canadian capital markets with the release of a consultation paper on tax and other issues related to publicly listed flow-through entities such FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 2

3 as income trusts and limited partnerships. While the consultation paper was in the most part a statement of the tax and other policy issues raised by the proliferation of income trusts in Canada, the Minister s subsequent announcement that the Canada Revenue Agency (CRA) would postpone providing advance tax rulings respecting flow-through entity structures lead many to believe that there was a black cloud on the horizon for the booming Canadian income trust industry. The public backlash to the announcement was quick and fierce and the then government appeared surprised that Canadians apparently loved their income trusts as much as Hockey Night in Canada. The markets were put at ease in November when the Minister announced that the solution to the income trust problem would be solved not by imposing any new taxes on income trusts but rather by reducing the income taxes on dividends paid by public corporations to lessen the tax inefficiencies of earning income through corporations, all with the objective of leveling the playing field between corporations and publicly listed flow-through entities such as income trusts. For the most part, the newly elected Conservative government had remained silent on this issue although it was widely speculated that it would adopt the dividend integration proposals introduced by the previous government. Ending the speculation, the Budget proposes changes to the taxation of dividends identical to those announced last November. In technical terms, the Budget proposes to increase the dividend gross-up and provide an enhanced dividend tax credit in respect of eligible dividends. Currently, dividends received by an individual from a taxable Canadian corporation are grossed-up by 25 per cent such that 125 per cent of the dividend is included in income. The individual also receives a dividend tax credit equal to 13 1/3 per cent of the grossed up dividend. These numbers would provide nearly perfect integration of the corporate and individual tax only at a combined federal/provincial corporate tax rate of 20 per cent. Since the current combined federal/provincial corporate tax rates applicable to public corporations significantly exceed 20 per cent, income earned by a corporation and paid to shareholders in the form of dividends is taxed at a higher rate than if the income was earned directly by the individual or by a flowthrough entity such as an income trust. To remove this inequality in tax treatment, the Budget introduces an enhanced dividend gross-up of 45 per cent, combined with a new 19 per cent dividend tax credit, that will make the total amount of tax on dividends received by individuals more comparable to the tax paid on income distributions received by individuals from income trusts. For purposes of the new rules, eligible dividends will be dividends paid after 2005 by public corporations resident in Canada and any other corporations resident in Canada (other than Canadian-controlled private corporations (CCPCs)) that are subject to the general corporate income tax rate. Eligible dividends will also include dividends paid after 2005 by CCPCs, to the extent that their income (other than investment income) is subject to tax at the general corporate tax rate (i.e. to the extent that their income exceeds their increased small business limit for the taxation year). The Budget indicates that special rules will be introduced to ensure that eligible dividends are measured correctly when a corporation becomes or ceases to be subject to the small business rate. Further, rules will also be introduced to ensure that dividends that flow through an intermediary corporation will have their character as either eligible or non-eligible dividends preserved. The table below compares the current top marginal tax rate for dividends earned by an individual resident in the province of Ontario to the top marginal rate for such dividends taking into account the changes proposed in the Budget, assuming that Ontario follows the federal lead and provides for an enhanced dividend tax credit. The table illustrates two important points. First, with a top marginal rate on dividends of per cent, the combined corporate and individual tax for 2006 on $100 of non-manufacturing income allocated to Ontario and paid as a dividend to an individual resident in Ontario and taxable at the top marginal rate will be $50.95, or $4.34 more than the tax that would be paid on the same $100 earned through an income trust by that same individual. Following full implementation of the corporate tax rate reductions announced in the Budget, the combined tax on that $100 of income will be $48.55 which is still $2.14 more than the tax that would be paid on $100 of income earned through an income trust by an individual resident in Ontario and taxable at the top marginal rate. The playing field is still not quite level. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 3

4 Second, the effective rate of per cent (which happens to be almost identical to the capital gains rate applicable to an individual resident in Ontario and taxable at the top marginal rate) shown in this table assumes that the individual s province of residence (in this case Ontario) also provides an enhanced dividend tax credit. Significantly, to date only Québec has announced a firm intention to provide an enhanced credit while certain other provinces have simply stated that they will either provide the enhanced credit or consider the issue once the actual proposal has been released. While the new rules for the taxation of dividends are a welcome change that remove a tax inefficiency that has persisted for far too long in the Canadian tax system, given that the changes fall short of completely leveling the playing field between corporations and flow-through entities and the remaining bias for taxexempts to invest in flow-through entities, it is unlikely that we will see an end to the income trust in Canada any time soon. EFFECTIVE DIVIDEND TAX RATES CURRENT Dividend Received Gross-Up Income Federal Tax DTC (13.34) Ontario Tax DTC Net Surtax Total Ontario Tax (5.14) Total Tax Effective Tax Rate % PROPOSED Dividend Received Gross-UP Income Federal Tax DTC Net Federal Tax (22.04) Ontario Tax DTC Surtax Total Ontario Tax (8.48) Total Federal and Ontario Tax Effective Tax Rate % 1 19% of grossed-up dividend % of grossed-up dividend. The Ontario Income Tax Act limits the gross-up to 11.16/29 multiplied by the federal DTC. RESOLUTIONS (21) & (22) General Corporate Income Tax Rate The general corporate income tax rate is currently 21 per cent (excluding the federal surtax). The Budget proposes to reduce the general corporate income tax rate to 20.5 per cent effective January 1, 2008, to 20 per cent effective January 1, 2009 and to 19 per cent effective January 1, These rate reductions were previously proposed by the Liberal government in the February 23, 2005 Federal Budget. While the Budget Speech and Supplementary Information both refer to the reduction of the general corporate income tax rate by 2 per cent effective January 1, 2010 to result in a rate of 19 per cent, the Notice of Ways and Means FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 4

5 Motion is inconsistent and refers to a 1.5 per cent reduction effective January 1, Presumably this will be revised to reflect a 2 per cent reduction. The tax rate will be prorated for taxation years that straddle the effective dates. As previously proposed, the reduction in the general corporate rate is applicable only to income that is taxed at the general corporate rate which does not include income subject to the small business deduction tax rate for CCPCs, investment income of CCPCs or income of credit unions eligible for the corporate tax rate reduction under section 137 of the Income Tax Act. In addition the rate reduction does not apply to mutual fund corporations, mortgage investment corporations or investment corporations (as defined in the Income Tax Act). The Budget also proposes to clarify that the general corporate income tax rate reduction applies only to taxable income that is subject to the rate of corporate income tax under section 123 of the Income Tax Act. This measure will be applicable for taxation years that begin on or after May 2, RESOLUTION (23) Corporate Surtax The Budget proposes to eliminate the corporate surtax for all corporations for taxation years that end after December 31, 2007, with proration for taxation years that straddle that date. This measure was previously proposed by the Liberal government in the February 23, 2005 Federal Budget, and the Income Tax Act has already been amended to eliminate the corporate surtax for small and medium-sized corporations effective January 1, The elimination of the corporate surtax is equivalent to a 1.12 per cent reduction in corporate income tax rates. RESOLUTIONS (24), (25), (26) & (27) Small Business Limit and Tax Rate The Budget proposes to enhance the amount of income on which the small business deduction may be claimed. The small business deduction operates to reduce the federal corporate income tax rate applicable to active business income earned by a CCPC. The small business limit represents the maximum annual amount of active business income of a CCPC which is eligible for this reduced rate of tax. In order to provide additional incentives to small businesses, the Budget proposes to increase the small business limit from $300,000 to $400,000, effective January 1, The small business limit increase will be pro-rated for taxation years that include days in both the 2006 and 2007 calendar years. Consistent with current law, the Budget confirms that the increased small business limited must be allocated amongst associated CCPCs. Access to the small business deduction will continue to be phased out on a linear basis for CCPCs that have between $10 million and $15 million of taxable capital employed in Canada. The proposed change to the small business limits arrives in the wake of similar tax measures in recent budgets that have been aimed at small businesses. Most notably, the 2003 Budget implemented a phased increase in the small business limit from $200,000 to $300,000, and the 2004 Budget accelerated the scheduled increase in the limit to $300,000 effective January 1, The Budget proposes consequential amendments to the specified partnership income rules, which essentially require a corporate partner of a partnership that is a CCPC to share the entitlement to the small business deduction based upon the proportionate interest of the corporate partner in the partnership. The formula for the sharing of the small business deduction in respect of specified partnership income will be amended to reflect the proposed $400,000 small business limitation. Corresponding changes will also be made to the investment tax credit rules applicable to CCPCs. Specifically, CCPCs are currently eligible to earn refundable investment tax credits at an enhanced rate of 35% on the first $2 million of qualifying scientific research and experimental development expenditures in each taxation year. Expenditures for scientific research and experimental development incurred in excess of the expenditure limit will generate nonrefundable credits at the general rate of 20%. Currently, the expenditure limit on which refundable investment tax credits may be claimed in a taxation year is reduced on a linear basis where either the taxable income of the CCPC increases from $300,000 to $500,000, or its taxable capital increases from $10 million to $15 million, in the preceding taxation year. Following from the proposed changes to the annual small business limit, the Budget proposes that the income range that will result in a reduction in the expenditure FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 5

6 limit on which refundable investment tax credits may be claimed will be adjusted upwards to between $400,000 and $600,000 of taxable income, applicable to taxation years that end in 2007 or subsequent years. The reduction in the expenditure limit based upon taxable capital will remain the same. In addition to raising the small business limit, the Budget also proposes to reduce the rate of taxation applicable to active business income of a CCPC that is eligible for the small business deduction. Currently, active business income of a CCPC that benefits from the small business deduction will be taxed at a federal corporate tax rate of 12%. The Budget proposes to reduce this rate of tax to 11.5% for 2008 and to 11% for These rate reductions will be pro-rated for taxation years that straddle the 2008 or 2009 taxation years. As discussed above, the Budget is also proposing to phase in a reduction in the general corporate tax rate applicable to active business income down to 19% from the current 21% by Once these rate changes have been fully implemented, the rate differential between active business income of a CCPC that is eligible for the small business deduction and active business income that is not eligible will be 8% in 2010 (19% versus 11%), one percent lower than the current rate differential of 9% (21% versus 12%). The Budget notes that the deadline imposed upon CCPCs that claim the small business deduction to pay any balance of tax owing at the end of a taxation year is one month later than the deadline applicable to other corporations, provided, in general, that the taxable income of the CCPC in the previous year is less than the small business limit for that year. The Budget notes that a consequence of increasing the small business limit will be that some CCPCs with taxable income above the current $300,000 limit, but below the proposed $400,000 limit, will now have an additional month to pay any balance of tax owing at the end of a taxation year. RESOLUTION (28) Carry Forward Periods for Business Losses and Investment Tax Credits Consistent with the previous government s announcement in the November 14, 2005 Economic and Fiscal Update, the Budget proposes to extend from 10 to 20 years the current carry-forward period applicable to non-capital losses incurred in taxation years that end after 2005 and investment tax credits (such as credits for scientific research and experimental development, Atlantic investment and mineral exploration) earned by taxpayers in taxation years that end after The 20-year period will also apply to farm losses, restricted farm losses, losses applied under Part IV of the Income Tax Act, and taxable Canadian life investment losses under Part XII.3 of the Income Tax Act incurred in taxation years that end after This measure further extends the carry-forward period that had already been extended from 7 years to 10 years pursuant to the 2004 Budget. RESOLUTIONS (29), (30) & (31) Federal Capital Tax Also consistent with the previous government s announcement in the November 14, 2005 Economic and Fiscal Update, the Budget proposes to accelerate the complete elimination of the federal capital tax on corporations (other than financial institutions) (LCT) effective as of January 1, 2006 (prorated for taxation years that do not coincide with the calendar year). In the 2003 Budget, the then Minister of Finance announced the gradual elimination of the much maligned LCT that is found in Part I.3 of the Income Tax Act over five years (beginning in 2004). The tax rate was legislated to be reduced from per cent to 0.2 per cent for calendar year 2004, to per cent for calendar year 2005, to per cent for calendar year 2006, and to per cent for calendar year 2007 (and completely eliminated by 2008). The capital deduction threshold was increased from $10 million to $50 million beginning for taxation years ending after The LCT was introduced in the 1989 Budget to help reduce the federal deficit by ensuring that all corporations pay federal taxes and thus contribute to deficit reduction and currently subjects most corporations (whether Canadian or foreign) to a per cent charge on their capital employed in Canada in excess of $50 million. Capital employed in Canada generally includes equity, debt, surpluses and reserves of a corporation, less certain types of investments in other corporations. The LCT is payable whether or not a corporation has taxable income in a year (subject to a deduction for any federal surtax that the corporation FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 6

7 may pay) and is essentially a form of minimum tax that may be payable even if a corporation is not profitable. In addition to the LCT, corporations are also subject to provincial capital taxes. Currently, only Manitoba, New Brunswick, Nova Scotia, Ontario, Québec and Saskatchewan impose similar capital taxes on corporations (other than financial institutions). However, most of these provinces have recently announced their own capital tax reform through either the elimination or reduction of these capital taxes (other than for financial institutions). Until provincial capital taxes on corporations are eliminated, corporations will continue to consider means of minimizing this cost of carrying on business in Canada. The elimination of the LCT is also reflected in proposed changes to other provisions of the Income Tax Act that are currently based on a corporation paying LCT (the carryforward for the deduction of federal surtax from LCT otherwise payable, the reduction of a CCPC s business limit for purposes of the small business deduction, the collection restrictions on the Minister of National Revenue when a taxpayer appeals a tax assessment, certain requirements for a corporation completing a notice of objection, and the penalty for certain corporations failing to file tax returns). RESOLUTION (32) Minimum Tax on Financial Institutions Although the Budget proposes the complete elimination of the LCT effective as of January 1, 2006, the Budget only proposes modest changes that effectively reduce the rate of the federal capital tax on financial institutions. Currently, Part VI of the Income Tax Act imposes a capital tax on financial institutions (banks, trust companies, mortgage loan companies and life insurance companies) equal to 1 per cent on taxable capital employed in Canada between $200 million and $300 million, and 1.25 per cent for taxable capital employed in Canada in excess of $300 million. This capital tax is payable whether or not a financial institution has taxable income in a year (subject to a deduction for federal income tax that the financial institution may pay) and is a form of minimum tax that may be payable even if a corporation is not profitable. Effective as of July 1, 2006, the Budget proposes an increase in the threshold of taxable capital employed in Canada to $1 billion, the excess of which will be subject to a single rate of tax of 1.25 per cent (pro-rated for taxation years that include July 1, 2006). However, these new proposals will not apply for the purpose of calculating a financial institution s unused Part I tax credit for carry-back to taxation years ending prior to July 1, Failing to eliminate the capital tax on financial institutions will ensure that Canada maintains its position as one of the few national taxing jurisdictions that taxes the capital, as well as the income, of certain corporations. Although the federal government continues to view financial institutions as a steady source of tax revenue, even in an economic downturn, perhaps this effective rate reduction proposed by the Budget is a precursor to the eventual elimination of this capital tax on financial institutions, consistent with the policy reasons for the elimination of the LCT. The provinces will hopefully follow the Minister of Finance s lead in reducing or eliminating all capital taxes, including the capital tax on financial institutions. RESOLUTION (33) Apprenticeship Job Creation Tax Credit The Apprenticeship Job Creation Tax Credit proposed in the Budget is intended to encourage employers to hire new apprentices in eligible trades. This proposal provides employers with a non-refundable tax credit equal to 10 per cent of the salaries and wages paid on or after May 2, 2006 to eligible apprentices (excluding profit sharing and bonuses) to a maximum credit of $2,000 per year per eligible apprentice. Special rules will apply to allocate the credit in cases where an apprentice works for two or more related employers. An eligible apprentice will be an apprentice who is working in a prescribed trade in the first 2 years of his or her provincially registered apprenticeship contract. The prescribed trades will initially include 45 listed trades, which may be expanded by regulation. Any unused credits may be carried back 3 years and forward 20 years by the employer to reduce federal income taxes otherwise payable. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 7

8 Capital Cost Allowance for Tools Tools that cost less than $200 are currently eligible for a 100 per cent capital cost allowance rate. Tools that cost $200 or more are eligible for a 20 per cent capital cost allowance rate. The Budget proposes to increase this cost limit to $500 for tools acquired on or after May 2, Electronic communication devices and electronic data processing equipment are to be excluded from this class of tools. The Budget also proposes to increase the cost limit from $200 to $500 for certain kitchen utensils and medical or dental instruments acquired on or after May 2, Accelerated Capital Cost Allowance for Forestry Bioenergy The Budget proceeds with the previous government s proposal to extend eligibility for accelerated capital cost allowance under Class 43.1 (30 per cent rate) and Class 43.2 (50 per cent rate) of Schedule II of the Income Tax Regulations to cogeneration systems that use a particular type of biomass (commonly referred to as black liquor ) used in the pulp and paper industry. This proposal would also allow certain expenses in respect of such cogeneration systems to qualify as Canadian renewable and conservation expenses, which can be renounced to flow-through shareholders and deducted by them. The proposed measure will apply to eligible assets acquired on or after November 14, 2005 that have not been used or acquired for use prior to that date. PERSONAL INCOME TAX MEASURES RESOLUTION (1) Personal Income Tax Rates The Budget follows through on the previous government s commitment to reduce the lowest personal tax rate from 16 per cent to 15 per cent for However, the Budget proposes to claw back half of the reduction by increasing the rate to per cent for 2006 and to 15.5 per cent for 2007 and subsequent taxation years. The effective rate of per cent for 2006 is the combined result of a rate of 15 per cent prior to July 1, 2006 and a rate of 15.5 per cent commencing on July 1, For the purposes of determining an individual s income tax liability, only the effective rate of per cent is relevant. However, the different rates applicable to the first and second halves of 2006 may affect the amount of source deductions that employers are required to withhold from salaries and wages. For 2006, the lowest personal tax rate applies to taxable incomes up to $36,378. This amount will be indexed for 2007 and subsequent taxation years. RESOLUTIONS (2), (3) & (4) Basic Personal Amounts The income tax system includes personal tax credits that allow every individual to receive a basic amount of income on a tax-free basis. The Budget affirms the previous government s commitment to raise this basic personal amount to $10,000 by For 2006, the basic personal amount will increase to $8,839 as a result of indexation for inflation, but will not otherwise be increased (for purposes of calculating employer withholdings the amount will be assumed to be $9,039 for the first half of 2006 and $8,639 for the second half of 2006). The basic personal rate will be further increased as follows: (i) for 2007, by indexation (from the amount of $8,639) plus an additional $100; (ii) for 2008, by indexation plus an additional $200; (iii) for 2009, by indexation plus the greater of $600 and the amount required to raise the basic personal amount to $10,000; and (iv) for 2010 and subsequent taxation years, by indexation. Personal amounts in respect of a spouse or common-law partner or wholly dependent relative will also be adjusted. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 8

9 RESOLUTION (5) Canada Employment Credit The Budget proposes to introduce a new non-refundable tax credit in recognition of work-related expenses incurred by employees. The new credit will take effect on July 1, 2006 and will grant employees a tax credit based on the lesser of $500 and their employment income for the year. Because the credit takes effect midway through 2006, the maximum amount on which the credit will be calculated for the 2006 taxation year is $250. The maximum amount on which the credit is calculated will be increased to $1,000 for 2007 and will be indexed for inflation thereafter. The amount of the credit will be calculated by multiplying the base amount by the lowest personal income tax rate for the taxation year. Accordingly, for 2007 the maximum amount of the credit will be $155 ($1,000 at 15.5 per cent). The estimated cost of the Canada Employment Credit is $890 million for 2006, and $1,815 billion for RESOLUTION (6) Universal Child Care Benefit The Budget proposes to introduce the Universal Child Care Benefit program pursuant to which parents of children under the age of 6 years will receive a payment of $100 per month ($1,200 per year) per child. Amounts received by parents in respect of the Universal Child Care Benefit will be taxable in the hands of the lower-income spouse or common-law partner, but will not be taken into account for purposes of calculating income-tested benefits delivered through the tax system, Old Age Security or Employment Insurance benefits, or the amount of expenses claimable under the child care expense deduction. Under the current Canada Child Tax Benefit program, parents are entitled to enhanced tax benefits in respect of children under the age of 7. These enhanced tax benefits will be eliminated (generally as of July 1, 2006 but subject to grandfathering in respect of children who attain the age of 6 years on or before June 30, 2007) as a consequence of introduction of the Universal Child Care Benefit. RESOLUTION (7) Capital Gains of Fishers The Budget proposes to allow individuals (and, in certain circumstances, personal trusts) to claim a lifetime $500,000 capital gains exemption in respect of capital gains arising on a disposition of certain property used in a family fishing business and also proposes to allow a tax deferral on certain inter-generational transfers of such property. The fishing property eligible for the special treatment will include real property, fishing vessels and eligible capital property used principally in a fishing business carried on in Canada in which the individual, or the individual s spouse or common-law partner, parent, child or grandchild was actively engaged on a regular and continuous basis. It will also include shares of family fishing corporations and partnership interests in family fishing partnerships. The rules will generally resemble the rules currently applicable to farmers disposing of qualified farm property, shares of family farm corporations and interests in family farm partnerships and will apply to dispositions of fishing property that take place on or after May 2, Generally, if property of an individual is transferred to the individual s child or grandchild (including by way of a transfer upon death), the transfer is treated as having taken place at fair market value and the individual may be taxable on any resulting capital gains. The Budget proposes a tax deferral, or intergenerational rollover in certain circumstances where an individual s qualified fishing property is transferred to the individual s child or grandchild. Pursuant to the intergenerational rollover, the child or grandchild s cost of the property for tax purposes would be equal to the transferring individual s cost amount of the property so that the child or grandchild assumes the tax position of the individual in respect of that property. In addition, the Budget proposes to extend the scope of the maximum reserve period of 10 years that is provided with respect to transfers by an individual of farm property to an individual s child or grandchild to include transfers of fishing property. This would allow individuals to claim a reasonable reserve in respect of amounts of proceeds that have not been received by a taxpayer from the disposition of eligible fishing property. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 9

10 RESOLUTION (8) Mineral Exploration Tax Credit The Budget proposes to re-instate the mineral exploration tax credit for flow-through shares issued under flow-through agreements entered into from May 2, 2006 to March 31, Using the look-back provisions in subsection 66(12.66) of the Income Tax Act, funds raised with the benefit of the credit can be spent on eligible exploration expenses prior to This investment tax credit is equal to 15 per cent of certain grass roots mining activities and was originally introduced in October, 2000 as a temporary tax incentive to be provided for certain flow-through share investments to stimulate flagging mining activity in Canada. Although initially proposed to apply only to expenses incurred up to December 31, 2003, the credit s annual extension became a fixture in federal budgets until the 2005 Budget when it was finally allowed to expire. RESOLUTIONS (9), (10) & (11) Tradespeople s Tool Expenses The Budget proposes that the total cost of eligible new tools acquired by an employed tradesperson in a taxation year, in excess of $1,000 (indexed after 2007), be deductible up to a maximum of $500 for that year from the income of the individual from employment as a tradesperson. An eligible tool is a tool that was not used for any purpose whatsoever before it was purchased by the individual. In general, electronic communication devices and electronic data processing equipment will not qualify as eligible tools. As well, the employer will have to certify that the employee is required to acquire the tools as a condition of, and for use in, his or her employment. The deduction will apply to new tools acquired on or after May 2, 2006 and will be in addition to the proposed new Canada Employment Credit described in Resolution (5) of the Budget. The deduction will also be in addition to the existing vehicle mechanics tools deduction, with some modifications made to the existing deduction to account for the introduction of the new tools tax deduction. The cost of the employee s tools for other income tax purposes (for example, upon the disposition of the tools) will be the acquisition cost less the deductible portion of that cost. Tools will be eligible for the existing rollovers that apply to transfers of property to a corporation or a partnership. For new tools purchased, the employee will be eligible for a rebate of the GST/HST paid on the portion of the purchase price that is deducted in computing employment income. RESOLUTION (12) Textbook Tax Credit The Budget proposes a non-refundable textbook tax credit that will be effective for the 2006 and subsequent taxation years. Individuals who are entitled to the education tax credit (generally, individuals enrolled in post-secondary education) will qualify to claim a textbook tax credit as well. The tax credit will be calculated by multiplying the lowest personal income tax rate for the taxation year (i.e per cent for 2006 and 15.5 per cent for the 2007 and subsequent taxation years) by the sum of (i) $65 for each month for which the student qualified for the full-time education tax credit, and (ii) $20 for each month the student qualified for the part-time education tax credit. Unused textbook tax credit amounts can be added to unused tuition and education tax credit amounts for the purposes of the carry forward to a future year, as well as the transfer of unused amounts to a spouse or common-law partner, parent, or grandparent according to the rules relating to unused education tax credits. RESOLUTION (13) Scholarship and Bursary Income To provide additional relief to students, the Budget proposes a full exemption from tax on scholarships, fellowships or bursaries received by an individual, effective for the 2006 and subsequent taxation years. Currently, only the first $3,000 of scholarship, fellowship or bursary income received by a student is not included in income. The full exemption will apply to amounts received by a student in connection with the student s enrolment at a designated educational institution in a program which entitles the student to claim the education tax credit, which generally would include programs at the post-secondary level and at institutions certified by the Minister of Human Resources and Social Development as providing skills in an occupation. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 10

11 RESOLUTION (14) Pension Income Credit The current pension income credit provides a non-refundable credit in respect of the first $1,000 of eligible pension income. That amount has not changed since the introduction of the credit effective in 1988, or since 1975 if one looks back to the prior pension income deduction introduced at the height of inflation in Eligible pension income includes, for individuals aged 65 and over, lifetime annuity payments under a registered pension plan, a registered retirement savings plan or a deferred profit sharing plan and payments out of or under a registered retirement income fund. For individuals under 65 years of age, eligible pension income includes lifetime annuity payments under a registered pension plan and certain other payments received as a result of the death of the individual s spouse or common-law partner. The Budget proposes to increase the amount of income eligible for the credit from $1,000 to $2,000 for the 2006 and subsequent taxation years. This will mean an annual tax savings of up to $155 per recipient. Translated into macro terms, it is estimated that this change will remove approximately 85,000 senior citizens from the tax rolls altogether and reduce federal tax revenues by $490 million in the current fiscal year and $405 million in the next fiscal year. RESOLUTION (15) Child Disability Benefit The Child Disability Benefit (CDB) forms one of the components of the Canada Child Tax Benefit. The CDB is payable in respect of children in low and modest income families who meet the eligibility criteria for the disability tax credit. The current rules provide that eligible families would be entitled to receive up to $2,044 per qualified child for the benefit year, however this entitlement begins to be phased out when family net income reaches a certain amount (the point in which the National Child Benefit (NCB) supplement is fully phased out, such amount being $36,378 in July 2006 for families with three or fewer children). Beyond that income level, the CDB is currently being reduced at a rate similar to the NCB. The Budget proposes to increase the maximum annual CDB from $2,044 to $2,300 and the benefit will continue to be indexed for inflation thereafter. The Budget also proposes to reduce the rates at which the CDB is reduced as family income rises, resulting in the CDB only being reduced to zero at significantly higher net family income levels. Both of these measures will be effective as of July, RESOLUTION (16) Refundable Medical Expense Supplement The refundable medical expense supplement (RMES) is currently 25 per cent of the total of the allowable portion of expenses that can be claimed under the medical expense tax credit and the expenses claimed under the disability supports deduction, with a maximum credit of $767 for The supplement is reduced by 5 per cent of net family income above a certain income threshold. In 2005, this income threshold was $21,663. The Budget proposes to increase the maximum credit amount from $767 to $1,000 effective for the 2006 taxation year and the maximum credit amount will continue to be indexed for inflation thereafter. The Budget also proposes to set the income threshold at which the RMES begins to be reduced at the current level for 2005 ($21,663) and such threshold will be indexed for inflation thereafter. For 2006, the income threshold will be $22,140. RESOLUTION (17) Tax Credit for Public Transit Passes The Budget proposes a non-refundable tax credit for the cost of public transit passes that are of a monthly duration or longer. Public transit will include transit by local bus, streetcar, subway, commuter train, commuter bus and local ferry. The tax credit will be calculated by reference to the lowest personal income tax rate for the taxation year (i.e per cent for 2006 and 15.5 per cent for the 2007 and subsequent taxation years) and can be claimed by the individual or the individual s spouse or common-law partner, in respect of eligible transit costs of the individual, the individual s spouse or common-law partner, and the individual s dependent children under 19 years of age. The credit will apply in respect of the portion of the cost of public transit passes that is in respect of transit on or after July 1, FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 11

12 RESOLUTION (18) Donation of Publicly-Listed Securities and Ecologically Sensitive Land The Budget proposes to eliminate capital gains tax in respect of gifts of listed publicly-traded securities to registered charities. Currently, one quarter of any such capital gain is taxable. The Budget also proposes to increase the deduction available on gifts of listed publicly-traded securities acquired on the exercise of employee stock options, effectively eliminating any taxable employment benefit in respect of the gain. Similar to capital gains, one quarter of the benefit realized on the donation of listed publicly-traded securities acquired on the exercise of employee stock options is currently taxable. These proposals will apply to donations made on or after May 2, The Ecological Gifts Program provides that individuals are eligible for the charitable donations tax credit and corporations are eligible for the charitable donations tax deduction when donations of ecologically-sensitive land and easements, covenants and servitudes on such land are made to approved conservation charities. Currently, one quarter of any such gain is taxable. The Budget proposes to eliminate capital gains tax in respect of donations of ecologically-sensitive land made to registered charities on or after May 2, RESOLUTION (19) Apprenticeship Grant The Budget proposes a new Apprenticeship Incentive Grant program that will be established, effective January 1, The program will provide a cash grant of $1,000 per year to apprentices in the first two years of an apprenticeship program in a qualifying trade. The qualifying trades will be prescribed and will include the 45 trades currently included in the Red Seal trades. The Red Seal allows a journeyperson to engage in their trade, without having to write further examinations, in any province or territory in Canada where the trade is recognized. The grant will be included in computing the income of the recipient for tax purposes in the year it was received. The Apprenticeship Incentive Grant program is in addition to current federal support provided to apprentices through the Employment Insurance program. ADMINISTRATIVE MEASURES RESOLUTION (34) Harmonization of Administrative Provisions (Standardized Accounting) In general, each federal tax statute imposes its own set of rules dealing with the payment of tax, interest and penalties. The government s efforts to harmonize these rules across the various statutes, referred to as the Standardized Accounting initiative, have been underway for many years. Specific amendments to the Income Tax Act and Excise Tax Act (non-gst provisions) were announced in the 2003 Budget. The 2006 Budget proposes a series of additional amendments to harmonize those statutes and others, including the Excise Tax Act (GST provisions), the Excise Act, 2001 and the Air Travellers Security Charge Act. The amendments are proposed to take effect on the later of April 1, 2007 and the date the enacting legislation receives Royal Assent. As a whole, the government expects these measures to be revenue-neutral. Many of the proposed measures are of little importance. The measures that simplify and harmonize the rules will be welcomed by taxpayers, especially businesses, which must now deal with the hodgepodge of rules found in these statutes, especially the rules dealing with the computation of interest and penalties. Other proposed measures will be much less welcome. They include (i) the introduction of late-filing penalties for those statutes that do not currently provide for them (i.e., the Excise Tax Act (GST and Non-GST), the Excise Act, 2001 and the Air Travellers Security Charge Act), and (ii) amendments that will make it more difficult for taxpayers to obtain refunds in a number of circumstances. Late-Filing Penalties The proposed penalty for late-filed returns under the Excise Tax Act (GST and Non-GST), the Excise Act, 2001 and the Air Travellers Security Charge Act is similar to the penalty now imposed under the Income Tax Act. The penalty will be imposed at a rate of 1 per cent of the outstanding balance on the return plus an additional.25 per cent for each complete month that the return remains outstanding, to a maximum of 12 FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 12

13 months. The 1 per cent penalty will also apply to the amounts owing in respect of returns that are outstanding as of the implementation date (the later of April 1, 2007 and the date the enacting legislation receives Royal Assent), although the.25 per cent portion of the penalty will begin to run only from that date. These new penalties should result in a rush of late filings in the days immediately prior to the implementation date. Refund Restrictions There are a number of proposed measures that will make it more difficult for taxpayers to obtain refunds. One of the proposed amendments to the Income Tax Act and Excise Tax Act (non-gst) will restrict the payment or offset of a credit, other than the Child Tax Benefit, to a taxpayer until the taxpayer has filed all of the returns required to be filed under any of the tax statutes. Another measure will permit the Minister to begin collection action against taxpayers by way of deduction or set-off against amounts owing to the taxpayer, under the Income Tax Act, the Excise Tax Act (non-gst) and the Excise Act, 2001, within 90 days from the date of a notice of assessment. The current rules in the Income Tax Act provide that the Minister is not permitted to collect amounts in dispute (or, in the case of large corporations, is permitted to collect only 50 per cent of the disputed amounts). The collection restrictions during the initial 90 day period the period during which an objection may be filed are an integral part of this restriction. Although this proposed amendment is buried in the 2006 Budget papers under provisions that purportedly deal only with Standardized Accounting, its practical effect may be to curtail significantly the ability of many taxpayers to avoid paying assessed amounts that are under objection or appeal. Reallocations of Tax On the plus side, one of the proposed measures would permit the Minister, at the request of a taxpayer, to reallocate amounts paid by the taxpayer under the Income Tax Act to amounts payable under one of the other tax statutes (under current rules, the Minister may only reallocate such amounts to other specified amounts under the Income Tax Act). With that change to the Income Tax Act, the Minister will be permitted to apply any amounts paid under any of the tax statutes against amounts payable under any of the other statutes. Any such reallocations will take effect from the date the amount was paid under the first statute BUDGET PROPOSALS RESOLUTIONS (35), (36), (37), (38), (40) & (41) Agricultural Cooperatives, Disability Tax Credit, Disability Supports Deduction, Medical Expense Tax Credit, Medical Expense Tax Credit Caregiver, Adoption Expense Tax Credit The Budget confirms the Minister of Finance s intention to proceed with the following proposals that were previously introduced in the 2005 Budget and tabled in the Notice of Ways and Means Motions on November 17, These proposals were not legislated before Parliament prorogued as a result of the recent election. These proposals include: (a) Agricultural Cooperatives Allowing eligible members of Canadian agricultural cooperatives to defer the inclusion in their income of patronage dividends received after 2005 in the form of eligible shares of the cooperative until such time as they dispose of the shares. (b) Disability Tax Credit A number of measures regarding eligibility for the disability tax credit effective for the 2005 and subsequent taxation years (including the clarity of legislation with respect to how impairments are conceptualized; aligning the legislative criteria for impairments in mental functions with wording used in the administration of these provisions; extending eligibility to those with multiple restrictions where the cumulative effect of FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 13

14 those restrictions is equivalent to a single marked restriction; to better define the activities that constitute lifesustaining therapy; and to add to the list of health practitioners who can certify eligibility for the disability tax credit). (c) Disability Supports Deduction Expanding the list of expenses for the disability supports deduction incurred for employment or education by adding expenses incurred for a number of services (including job coaching services, reading services, deafblind intervening services, bliss symbol boards, Braille note-takers, page-turners, specifically designed devices and software), effective for the 2005 and subsequent taxation years. (d) Medical Expense Tax Credit Expanding the list of eligible expenses by including a number of other medical expenses (including drugs purchased under Health Canada s Special Access Program, medical marijuana purchased in accordance with certain conditions and certain other expenses), and adding a two-criteria test for determining whether home renovation expenses qualify under the medical expense tax credit, effectively narrowing the scope of eligible expenses, both proposals to be effective for the 2005 and subsequent taxation years. (e) Medical Expense Tax Credit Caregiver: Increasing the eligible maximum amount claimed on behalf of a dependant relative from $5,000 to $10,000 for the 2005 and subsequent taxation years. (f) Adoption Expense Tax Credit Introducing a 16 per cent non-refundable tax credit for eligible adoption expenses, up to a maximum of $10,000 paid per completed adoption, effective for the 2005 and subsequent taxation years. Capital Cost Allowance The Budget also confirms the Minister of Finance s intention to enact regulations to implement changes to the capital cost allowance provisions for certain electricity assets, transmission pipelines, telecommunications cables and efficient and renewable energy generation equipment, as originally proposed in the 2005 Budget. GST AND EXCISE MEASURES Reducing the GST to 6 Per Cent The goods and services tax ( GST ) is a value-added tax that applies at the rate of 7 per cent to most supplies of goods and services in Canada. The Budget proposes to reduce the rate of GST from 7 to 6 per cent, effective July 1, The 1 per cent rate reduction will also apply to the harmonized sales tax ( HST ) in Newfoundland and Labrador, Nova Scotia and New Brunswick which, effective July 1, 2006, will generally apply at the rate of 14 per cent. Transitional Rules The Budget proposes a number of transitional rules in order to deal with the 1 per cent rate reduction in the GST. GST is generally payable on consideration for a supply on the earlier of the day payment is made by the recipient, the day the supplier issues an invoice, the date of the invoice, and the date of payment as set out in a written agreement. In the case of leases, GST is payable on the earlier of the day payment is made and the day it is required to be made under the lease agreement. If according to these rules GST becomes payable, or is paid, before July 1, 2006, generally the 7 per cent rate applies. If GST is not paid before July 1, 2006, and becomes payable on or after July 1, 2006, generally the 6 per cent rate applies. In addition to this general rule, the Budget creates a number of specific transitional rules for certain types of taxable supplies. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 14

15 (a) Sales of Real Property The Budget creates a number of specific transitional rules dealing with transfers of real property. If ownership or possession of real property is transferred to a purchaser under an agreement of purchase and sale before July 1, 2006, GST will apply to the supply at a rate of 7 per cent. If the agreement of purchase and sale is entered into after May 2, 2006, and ownership and possession of the property are transferred to the purchaser after July 1, 2006, GST will apply at the rate of 6 per cent. If, under an agreement, ownership and possession of real property is transferred to a purchaser on or after July 1, 2006 and the agreement of purchase and sale was entered into on or before May 2, 2006, then the applicable rate of GST will depend upon the nature of the property being transferred. If the property being transferred is not a residential complex (i.e. it is a commercial property), GST will apply at the rate of 6 per cent. Most purchasers of commercial properties will be registered for GST purposes, will generally be required to self-assess the GST (such that the vendor will not be required to collect GST) and will generally claim an input tax credit on the same GST return. Therefore, the rate of GST will not generally be material. If, in the above circumstances, the property is a residential complex (which includes houses, apartment buildings, etc.), the GST will apply at the rate of 7 per cent, but the purchaser will be entitled to apply to the CRA for a transitional rebate reflecting the rate reduction subject to any rebate adjustments (i.e. the new housing rebate). As most supplies of used residential complexes are exempt from GST, this provision will generally only apply to new houses, apartment buildings and other residential complexes. Where ownership and possession of a new residential complex is transferred to a purchaser after July 1, 2006, the net amount of GST paid by the purchaser will be the same regardless of whether the agreement to transfer the property was entered into before or after May 2, However, a purchaser who entered into the agreement before May 2, 2006 must apply to the CRA for the rebate, thereby allowing the CRA to review the transaction. (b) Deemed Supplies In certain circumstances, the Excise Tax Act deems tax to have been paid and collected on the fair market value of a taxable supply. For example, where the builder of a residential complex (e.g. a condominium unit) rents out a residential complex before it is sold, or occupies it personally, GST is deemed to have been paid and collected at that time. The transitional GST rules in the Budget propose that the 6 per cent GST rate will generally be used for GST that is deemed to have been paid or collected on or after July 1, 2006, and the 7 per cent rate will apply to GST that is deemed to have been paid or collected before July 1, (c) Imported Goods and Imported Taxable Services and Intangibles Imported Goods: GST applies at the rate of 6 per cent to goods that are either imported into Canada on or after July 1, 2006, or are released from Customs control on or after July 1, 2006 (for instance in the case of goods that were stored in a customs bonded warehouse). Imported Taxable Services and Intangibles: In certain circumstances (generally where the recipient of the supply is not engaged in commercial activities), a recipient of a supply of services or intangibles made, or deemed to be made, outside of Canada, must self-assess GST on the supply. The self-assessed GST is generally payable on the earlier of the day the consideration is paid for the supply and the day the consideration becomes due. If the GST becomes payable before July 1, 2006, the 7 per cent GST rate will apply. If the GST becomes payable on or after July 1, 2006, the 6 per cent GST rate will apply. Financial Institutions: On November 17, 2005, the government announced a proposal that would require financial institutions to self-assess GST on certain imported taxable supplies using a new set of rules. According to this proposal, GST on these transactions would be determined on an annual basis, and would generally become payable six months after the financial institution s taxation year end. The Budget proposes a transitional rule to deal with financial institutions whose taxation year straddles July 1, Under this transition rule, a financial institution must apportion the consideration it paid for the imported taxable supplies between the period before July 1, 2006 and the period beginning on July 1, The financial institution apportions the consideration between the two periods based on the number of days in each period over the total number of days in its taxation year. The financial institution is subject to GST at the rate of 6 FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 15

16 per cent on the amount allocated to the period beginning on July 1, 2006, and 7 per cent on the amount allocated to the period before July 1, (d) Taxable Benefits; Passenger Vehicles and Aircraft; and Employee/Partner Rebates In some circumstances, GST is calculated by reference to an amount determined under the Income Tax Act. In particular, some taxable benefits for employees and shareholders, certain input tax credits in respect of passenger vehicles and aircraft not used exclusively in commercial activities, and certain rebates of GST to employees or partners with respect to certain expenses are based on amounts determined for income tax purposes. Under the Excise Tax Act the amount of GST payable, creditable or subject to a rebate on these amounts is determined by multiplying the amount determined for income tax purposes by a percentage set out in the Excise Tax Act, or the regulations to the Excise Tax Act. The Budget proposes to amend the rates applicable in the above circumstances in order to take into account the reduction in the rate of GST. The GST on most taxable benefits for employees and shareholders is reduced from the current rate of 6 per cent to 5.5 per cent for the 2006 taxation year, and to 5 per cent for subsequent years. The prescribed rate for calculating the GST on the automobile operating expense benefit is proposed to be decreased from the current rate of 5 per cent to 4.5 per cent for the 2006 taxation year and to 4 per cent in subsequent years. (e) Anti-Avoidance Provision The fact that the rate reduction is not effective until July 1, 2006 could create opportunities for abusive transactions designed to access the 6 per cent rate on purchases or the 7 per cent rate on input tax credits. In order to minimize these opportunities, the Budget proposes an anti-avoidance rule which will apply to transactions between parties that are not dealing at arm s length. This anti-avoidance rule will not apply where the transaction was undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit arising from the rate reduction. Presumably, the Department is concerned that the type of sale repurchase transactions that were undertaken a the time of the implementation of the GST might be repeated (see for example, the case of Michelin Tires (Canada) Ltd. v. MNR, the first general anti-avoidance rule case decided in a Canadian court). It is not entirely clear, however, why the existing general anti-avoidance rule contained in the Excise Tax Act would not be sufficient to prevent such transactions. Other Measures The Budget proposes to make a number of amendments to the Excise Tax Act in order to make various provisions of the Act consistent with the 1 per cent decrease in the rate of GST. (a) Housing Rebate Purchasers of new homes are entitled to a rebate equal to the lesser of 3 per cent of the GST paid and $8,750. The rebate begins to be phased out when the price of the purchased home exceeds $350,000, and disappears entirely when the price exceeds $450,000. While the $350,000 and $450,000 thresholds remain the same, the total amount of the rebate will be reduced from $8,750 to $7,560 (36 per cent of the GST payable at a rate of 6 per cent on a $350,000 home). (b) Streamlined Accounting Methods Certain eligible public service bodies, and small businesses with worldwide annual taxable sales of $200,000 or less can use a Quick or Special Quick Method of accounting to simplify their GST calculations. Under the Quick Method, net tax is determined by multiplying eligible GST-included sales by a specified percentage which is less than 7 per cent (or less than 15 per cent for HST provinces). The specified percentage depends on the industry, on whether the supplies are made in a GST or an HST province, and on whether the business makes the supplies through a permanent establishment that is located in an HST participating or non-participating province. The type of business involved is also relevant. For example, a business that provides mostly services will generally be subject to a higher remittance rate than a business that is involved mostly in purchasing goods for resale. FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 16

17 The Budget proposes to reduce the specified percentages in order account for the 1 per cent reduction in the rate of GST. The new specified percentages will apply for reporting periods that begin on or after July 1, If a reporting period straddles July 1, 2006 (in the case of quarterly or yearly filers), the existing percentages will apply to consideration that becomes due, or is paid, before July 1, 2006, and the new percentages will apply to consideration that becomes due and is paid on or after July 1, The reductions in the specified percentages set out in the Budget result in taxpayers remitting roughly the same percentage of the GST they collected before and after the 1 per cent rate reduction in the GST. Public Service Bodies The Budget does not propose to change the rebate percentages used to calculate rebates payable to charities, qualifying non-profit organizations and selected pubic service bodies (such as universities, schools, and municipalities). Currently, many public service bodies elect under section 211 of the Excise Tax Act, so that the rental of a property by the public service body is a taxable supply. Accordingly, the election allows the public service body to claim input tax credits for costs and expenses incurred in respect of the property. If a public service body revokes this election, the public service body is deemed to have paid and collected tax equal to the basic tax content of the property (i.e. the unrecoverable GST that would have been paid on the acquisition of the property). Previously, public service bodies could claim a rebate for the GST deemed collected upon the revocation of the election. The Budget proposes that the rebate will no longer apply to the deemed GST when the public service body revokes the election. Provincial Impact While there will not be any impact to the rates of provincial sales taxes in most provinces, the rate of HST in the harmonized provinces, Nova Scotia, New Brunswick and Newfoundland and Labrador, will be reduced from 15 to 14 per cent. The provincial component will remain at 8 per cent. The provincial sales tax rates in Québec and Prince Edward Island will also be affected by the reduction in the rate of GST. Both Québec and Prince Edward Island charge their sales taxes on a GST-included price. Québec s sales tax applies to supplies of most goods and services at a rate of 7.5 per cent of the GST-included price. This previously resulted in an effective rate of per cent on most supplies (i.e. all supplies that were subject to GST at 7 per cent). Due to the 1 per cent reduction in the rate of GST, Québec s new effective rate of sales tax on GST taxable supplies will be 7.95 per cent. Prince Edward Island s revenue tax applies to sales of most goods (generally tangible personal property) at a rate of 10 per cent of the GST included price. Thus, the effective rate of Prince Edward Island s Sales tax will be reduced from 10.7 per cent to 10.6 per cent. GST Treatment of Debt Collection Services The Budget confirms that debt collection services that are generally provided by collection agents to financial institutions are taxable as they are not financial services for GST/HST purposes. Excise Tax on Jewellery Currently, the federal government imposes an excise tax on articles made of semi-precious stones, jewellery, precious and semi-precious stones and products of goldsmiths and silversmiths. After years of complaints from jewellery manufacturers and jewellers associations (who argued that the tax acted as an incentive to black market activities in jewellery, was overly complex, and involved significant administrative costs), the previous government proposed a reduction in the rate of this excise tax from 10 per cent to 8 per cent effective March 1, 2005, and a further reduction of 2 per cent each year (effective March 1 st ). The scheduled reductions of excise tax on these items would have completely eliminated the tax by March 1, The Budget proposes to accelerate the elimination of the excise tax on the above articles, and certain clocks by repealing the tax on these items effective May 2, FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 17

18 Tobacco Excise Levies The Budget proposes to increase the excise duties applicable to tobacco products to offset the impact of the GST rate reduction. The new rates are applicable to products that are packaged or imported on or after July 1, The new rates are also applicable to current inventories to ensure that increases in excise duties are applied in a consistent manner. This inventory tax will be applicable to taxpayers who hold more than 30,000 units (approximately 150 cartons of cigarettes) at the end of the day on June 30, Taxpayers who will be subject to this inventory tax will have until August 31, 2006 to remit and pay the tax. Alcohol Excise Levies Part III Alcohol Products The Budget proposes to increase alcohol excise duties to offset the impact of the GST rate reduction. Excise Duties for Vintners and Small Brewers Excise Duty on Wine Excise duty is imposed under the Excise Act, 2001 on wine produced in Canada. The Budget proposes to exempt from duty the first 500,000 litres of wine produced and packaged by a wine licensee in Canada per year which is made from agricultural products grown in Canada. The 500,000 litre threshold will be based on the quantity a licensee produces and packages during their particular fiscal year, for fiscal years that begin on or after July 1, The threshold includes all wine produced by a wine licensee and packaged on behalf of the licensee. Excise Duty on Beer Excise duty is imposed under the Excise Act on beer produced in Canada. Exports of beer are exempt from this excise duty. For imported beer, the duty is levied under the Customs Tariff on the beer at the time of importation. The Budget proposes excise duty relief for beer produced by small and mid-sized brewers. For 2006, the licensed Canadian brewers will be eligible for relief only in respect of beer they package on or after July 1, To qualify for the reduced rates in 2006, these producers must have produced and packaged no more than 300,000 hl in 2005 and must not exceed 300,000 hl in all of FEDERAL BUDGET COMMENTARY 2006 STIKEMAN ELLIOTT LLP 18

19 Stikeman Elliott s Tax Group Marie-Andrée Beaudry mabeaudry@stikeman.com Marc-André Bélanger mabelanger@stikeman.com Luc Bernier lbernier@stikeman.com Roanne C. Bratz rbratz@stikeman.com Glenn A. Cranker gcranker@stikeman.com Ronald K. Durand rdurand@stikeman.com David N. Finkelstein dfinkelstein@stikeman.com Franco Gadoury fgadoury@stikeman.com Charles C. Gagnon cgagnon@stikeman.com Khashayar Haghgouyan khaghgouyan@stikeman.com Frédéric Harvey fharvey@stikeman.com Richard J. Hay rhay@stikeman.com Leela Hemmings lhemmings@stikeman.com Robert Hogan rhogan@stikeman.com Kevin B. Kelly kkelly@stikeman.com Alan Kenigsberg akenigsberg@stikeman.com Dean A. Kraus dkraus@stikeman.com Michel Legendre mlegendre@stikeman.com Pierre-Louis Le Saunier pllsaunier@stikeman.com Rosemarie Lipman rlipman@stikeman.com John G. Lorito jlorito@stikeman.com Pierre Martel pmartel@stikeman.com Guy Masson gmasson@stikeman.com Frank Mathieu fmathieu@stikeman.com Trevor McGowan tmcgowan@stikeman.com Christian Meighen cmeighen@stikeman.com Lianne Miller lmiller@stikeman.com David Muha dmuha@stikeman.com Leigh Nicoll lnicoll@stikeman.com Richard W. Pound O.C., O.Q., Q.C., F.C.A. rpound@stikeman.com Cliff Rand crand@stikeman.com Maurice A. Régnier Q.C. mrégnier@stikeman.com Robert Reymond rreymond@stikeman.com Jean-Guillaume Shooner jgshooner@stikeman.com Antoine Stébenne astebenne@stikeman.com Susan Thomson sthomson@stikeman.com Tom Vowinckel tvowinckel@stikeman.com David Weekes dweekes@stikeman.com This publication provides general commentary only and is not intended as legal advice. A bound booklet of the Federal Budget commentary is available from Stikeman Elliott and is complimentary. To order a copy, please contact us at info@stikeman.com Stikeman Elliott LLP