On March 19, 2019, Minister of Finance, the Honourable William (Bill) Morneau tabled the government’s final Budget prior to the federal election, which will take place later this year. While Budget 2019 did little to introduce new tax measures or make significant changes to existing measures, there were a few noteworthy items that will affect the business and professional services industry. However, details for most measures, which are only in the proposal stages, were sparse with more information to be released later in the summer.
2019 Federal Budget Highlights
- Employee stock option deduction
- International tax planning and profit sharing
- Scientific Research and Experimental Development (SR&ED) tax credit updates
- CRA audit initiatives
- Foreign affiliate dumping
- Workforce training and tax credits
Watch our video summary and continue reading below:
Generally, when an individual exercises a stock option, a taxable stock option benefit is included in their income in the year of exercise. This stock option benefit is equal to the difference between the fair market value of the shares on the date the option is exercised and the option exercise price (plus the amount paid for the option, if any). If the stock options granted are for shares of a Canadian-controlled private corporation, the taxable benefit is included in the year the employee disposes of the shares (subject to certain other conditions). Under the current rules, generally the individual would be entitled to deduct one-half of the stock option benefit on their Canadian tax return under paragraph 110(1)(d) or paragraph 110(1)(d.1) of the Canadian Income Tax Act (ITA). In essence, the individual would be able to pay Canadian tax at capital gain rates on the stock option benefit.
Budget 2019 has introduced changes to the stock option regime in an effort to curtail the benefit for employees of “large, long-established, mature firms” all while continuing to support younger and growing Canadian businesses. These proposed changes are reflective of the U.S. tax treatment of stock options.
The new rules, as proposed in the Budget 2019, would include the following:
- No changes to the current rules for start-ups and rapidly growing Canadian businesses.
- An annual limit of $200,000 on employee stock option grants that may be eligible for the stock option deduction for employees of “large, long-established, mature firms”. This limit is based on the fair market value of the underlying shares at the time that the option is granted.
For example, an employee is granted an option to acquire 100,000 shares at a price of $10 per share, being the fair market value at the time the option is granted. The share price is $30 when the option is exercised. In this situation, 20,000 (20,000 x $10 = $200,000) options would qualify for the one-half stock option deduction under the existing legislation and the benefit on the remaining options would be fully taxed. As a result, upon the exercise of the shares, $1.6 million (($30-$10) x 80,000 shares) would be fully taxed while one-half of the remaining $40,000 stock option benefit ($20 x 20,000 shares) would be taxed. This would result in an overall income inclusion of $1.8 million, as compared to $1 million under existing legislation.
Budget 2019 proposals for stock options would only apply to stock options granted after the announcement of the legislative proposals on a go-forward basis. Further details will be released before the summer of 2019.
Budget 2019 affirmed the government’s ongoing commitment to the Base Erosion and Profit Shifting (BEPS) initiative and to increase the review of international tax plans and restructuring whereby profits are inappropriately shifted to other jurisdictions in order to achieve a more favourable tax rate.
One of the tools used to combat BEPS is Country-by-Country Reporting (CBCR). The CBCR is exchanged between many tax authorities, including the CRA. CBCR drew significant market attention as it required the disclosure of various financial and general business operations information to tax administrations. The first exchange of these reports occurred in 2018.
The government is currently participating in a review of the CBCR standards with other tax administrations. The stated goal is to ensure that CBCR actually provides tax administrations with better information to facilitate an assessment of taxpayers’ transfer pricing risks. This review is expected to be completed in 2020.
CBCR may become a significant tool used by local tax authorities to assess and select multinational entities for audits, including business and professional services firms. Entities filing CBCR need to clearly understand how tax administrations may view the disclosed information and be ready with documentation to defend their positions.
The Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (known as the Multilateral Instrument or MLI) is intended to allow participating jurisdictions to modify their existing tax treaties to address the concerns raised by the BEPS initiative, without having to individually renegotiate those treaties. Canada, along with 86 other jurisdictions to date, has signed the MLI. Canada has reiterated its commitment to take the necessary steps to enact the MLI into Canadian law and to ratify the MLI, as needed, to bring it into force.
TRANSFER PRICING MEASURES
Budget 2019 proposes two transfer pricing measures of note that will be applicable to the business and professional services industry. The proposals clarify technical questions raised by the tax community and are not expected to impact taxpayers’ day-to-day transfer pricing practices.
(a) “Order of Application” of transfer pricing rules
The first proposal clarifies that transfer pricing rules will apply in priority to other provisions of the Act. A previous provision of the Act provided similar guidance, however it was restricted to a narrower number of tax provisions. The Budget expands this understanding to all provisions of the Act.
The government confirmed that the proposed “Order of Application” rules will not impact the exceptions provided to Canadian resident corporations that have an amount owing from, or have extended a guarantee in respect of an amount owing by, a controlled foreign affiliate (CFA). This maintains the existing CFA safe harbour that reduces tax compliance burdens.
(b) Applicable reassessment period
The second proposal brings consistency to the Act. It proposes to apply the broader transfer pricing definition of a ‘transaction’ to the extended three-year reassessment period. The extended three-year reassessment period applies to CRA reassessments issued in relation to a transaction involving a taxpayer and a non-arm’s length non-resident.
The SR&ED tax credit encourages businesses to invest in the development of new technologies. In a global economy, providing such an incentive to businesses operating in Canada helps them grow and be more competitive. The program currently provides an enhanced Federal refundable credit of 35 per cent to CCPC’s and a non-refundable 15 per cent tax credit to all other companies performing SR&ED in Canada. The 35 per cent credit is dependent in part on a company’s prior year taxable income such that it begins to phase out at $500,000 with complete elimination at $800,000.
The government has now eliminated the taxable income threshold for accessing the higher credit of 35 per cent. This will help growing, Canadian-owned business and professional services firms, which conduct SR&ED, in commercializing their new technologies and growing their taxable income. The taxable capital threshold does however remain in place, such that companies with taxable capital of $10-$50 million will continue to be impacted by the grind down of the enhanced credit, and businesses with taxable capital of more than $50 million remain only eligible for the non-refundable 15 per cent credit.
The government hopes that this measure will help make Canada a leader in research, development, science and innovation, while creating new knowledge-based jobs helping to turn Canadian business and professional services firms into global leaders.
Budget 2019 proposes to invest an additional $150.8 million over the next five years to further combat tax evasion and aggressive tax avoidance. The CRA’s investment in its enforcement programs will fund new initiatives and extend existing programs, which include:
- hiring additional auditors to target additional areas of non-compliance and building technical expertise to target the growing number of cryptocurrency transactions and the digital economy, and potential for non-compliance;
- creating a new data quality examination team to ensure proper withholding, remitting and reporting of income earned by non-residents; and
- extending programs aimed at combatting offshore non-compliance.
The budget also proposes to invest $65.8 million over the next five years to improve the CRA’s information technology systems by replacing legacy systems in order to stay ahead of the use of new and advanced technologies. The CRA expects to account for $369 million of federal tax revenue over the next five years from these compliance initiatives and expects provincial and territorial tax revenues to increase as a result of the initiatives. Business and professional services firms can expect to see an increase in CRA’s limited scope reviews as well as complete audits in the near future.
The foreign affiliate dumping rules are intended to counter erosion of the Canadian tax base resulting from transactions in which a corporation resident in Canada (CRIC) that is controlled by a non-resident invests in a foreign affiliate using borrowed or surplus funds. In absence of these rules, the foreign parent is able to repatriate funds from the CRIC as a return of capital and free of dividend withholding tax.
Currently, the foreign affiliate dumping rules only apply where a CRIC is controlled by a non-resident corporation. The rules generally result in a suppression of paid-up capital created by the investment and/or a deemed dividend subject to non-resident withholding tax.
Budget 2019 proposes to extend these rules to CRICs that are controlled by a non-resident individual, a non-resident trust, or a group of persons that do not deal at arm’s length and are comprised of non-resident corporations, non-resident individuals, or non-resident trusts.
Budget 2019 also extends the meaning of ‘related’ with respect to these rules to certain non-resident trusts and their beneficiaries. This measure will apply to transactions and events that occur on or after March 19, 2019.
Business and professional services firms will gain greater access to highly skilled global talent due to the introduction of the Canada Training Credit and Employment Insurance Training Support benefit.
Canadians who are looking to upgrade their skills will be able to fund up to half of eligible tuition costs through the new Canada Training Credit, subject to certain conditions. Capped at a lifetime limit of $5,000, the credit allows eligible workers aged 25-64 to accumulate a credit balance of $250 per year and the credit balance would be included on CRA information sent to each individual every year.
The EI Training Support will provide up to four weeks of income support at 55 per cent of a person’s average weekly earnings to allow them to pursue a new skill, where prescribed conditions are satisfied. With this credit expected to launch in 2020, Budget 2019 also proposes to introduce an EI Small Business Premium Rebate to relieve pressures on the employer premium rates for small businesses as a result of this new credit.
RSM Canada will be closely following updates to the above proposals. For ongoing budget coverage and updates around these proposals, visit rsmcanada.com/budget.