2019 Post-election review of potential tax changes
TAX ALERT |
This year's Federal election was abuzz with promises to tackle climate change, to make life more affordable for average Canadians as well as to bolster the Canadian economy. The 2019 election resulted in the Liberals returning to power in Ottawa with a minority government. This Tax Alert briefly discusses certain proposed tax measures that were presented by the Liberal Party of Canada in their 2019 election platform or introduced as draft legislation during their previous term.
The 2019 Federal Budget proposed to limit the deductions that can be claimed by individuals exercising employee stock options (ESO). The draft legislation was tabled on June 17, 2019 and the proposed rules are expected to apply to stock options granted on or after Jan. 1, 2020. Currently, an employee may claim a deduction amounting to 50 per cent of the benefit realized from the exercise of an ESO if certain conditions are met. The proposed limit introduced a $200,000 annual cap on the deductibility of employee stock option grants for employees of ‘large, long-established, mature firms’. The $200,000 limit will apply on ESO grants that can continue to receive tax-preferred treatment and will be based on the fair market value of the underlying shares at the time the options are granted. Any ESO granted in excess of this annual grant will no longer be eligible for the 50 per cent deduction.
These new rules will not apply to ESOs issued by CCPCs or by non-CCPCs that are start-ups, emerging or scale-up companies. The draft legislation has not, however, provided a clear definition of what constitutes a ‘start-up, emerging and scale-up company’. The government is soliciting the advice of stakeholders to help define the characteristics of such companies.
The draft rules would apply to employers that are corporations or mutual-fund trusts. Employers will have to ensure that they notify employees and the Canada Revenue Agency (CRA) when options granted are subject to the new rules. If this preferential tax treatment is no longer available (or significantly circumscribed), attracting and retaining talent may become more of a challenge for middle market companies, other than non-CCPCs that are ‘start-ups, emerging or scale-up companies’ that meet the prescribed conditions.
Interest deductibility limitation
One major election promise put forward by the Liberals was to limit the deductibility of interest expense. The Parliamentary Budget Officer (PBO)’s Cost Estimate of Election Campaign Proposal targets corporations with net interest expenses of more than $250,000. Such corporations would only be allowed to deduct up to 30 percent of its earnings before interest, tax, depreciation, and amortization (EBIDTA) when computing its income. Interest would be deductible above the 30 per cent of EBITDA threshold if the corporation is part of a corporate group and the worldwide ratio of total net third party interest expense to EBIDTA of that group exceeds this level.
Due to the limited information made available in connection with this election promise, it is assumed that the interest expense cap would not apply to smaller CCPCs that are eligible for the small business deduction (i.e. CCPCs that earn less than $500,000 of active business income and taxable capital of less than $10 million) and those with less than $250,000 in net interest payments (interest payments minus interest revenues).
If this proposal is passed into law, Canadian businesses that debt finance may be impacted and limited in their ability to deduct interest expense. The long-established domestic rules that currently govern interest deductibility would accordingly need to be overhauled to implement this proposed change in policy.
To incentivize the use of renewable sources of energy, the Liberals have proposed to cut the federal corporate tax rate on ‘CleanTech’ businesses by half over three years. This will reduce the tax rates on small businesses from 9 to 4.5 per cent and on other corporations from 15 to 7.5 per cent. CleanTech businesses are generally referred to as businesses that develop technologies or manufacture products that have zero emissions.
Considering the importance each party placed on the need to tackle the climate crisis, these proposals have a high probability of being passed, in whole or in part, into law. Canadian companies involved in the design, development, and manufacturing of CleanTech may benefit from increased business opportunities with the reduced tax rates.
The Liberals during the election campaign continued to state that they do not intend to withdraw the federal carbon tax from Saskatchewan, Manitoba, Ontario and New Brunswick. While provinces and territories of Canada are allowed to implement their own carbon tax regimes based on the needs and requirements of their own jurisdictions, in the absence of a provincial system, the federal carbon tax rules may apply. The carbon tax is a levy applied on emissions from fossil fuel sources such as coal, natural gas, gasoline, etc. It is intended to discourage the use of carbon-heavy sources in order to help reduce Canada’s carbon emissions. Emitters would need to pay for each tonne of emissions they emit. The carbon price starts at $20 per tonne of carbon dioxide released, and will increase annually, reaching $50 per tonne in 2022.
In line with a commitment to uphold OECD's BEPS Action 1 and ensure that multinational corporations pay their fair share of tax on the revenue generated in Canada, the Liberals promised to impose a 3 per cent tax on the income of businesses in certain sectors of the digital economy. This tax would replicate the French digital tax (which was passed into law on July 11, 2019) and would act as a value-added tax that applies to companies that (i) provide advertising services and digital intermediation services, (ii) have worldwide revenue of at least $1 billion and (iii) have Canadian revenues of more than $40 million. Large tech companies such as Amazon, Apple, Facebook and Google would be sure to be impacted by such measures.
Family and affordability
In connection with homeownership, the Liberals have proposed measures to help reduce the number of vacant residential real estate properties owned by non-residents, which are believed to drive the increase in Canadian housing prices. The Liberals have proposed to impose an annual 1 per cent tax on the value of any residential real estate property owned by non-resident foreign entities (including individuals, corporations, partnerships and trusts) that is vacant for six months or more in a year. Exemptions are allowed for properties that are principal residences or that are occupied by a renter or by a non-arm’s length person for at least six months of the year.
With respect to assisting the cost of raising children, the Liberals campaigned to increase the amount of the Canada child benefits (a program introduced by the Liberals in 2016) by 15 per cent for children under the age of one as well as to create additional childcare spaces. The Child Disability Benefit (CDB) will be doubled for qualifying families from a maximum of $2,832 to $5,664 for each child who is eligible for such credit. It was also proposed to make employment insurance (EI) maternity leave and parental leave benefit exempt from income tax. This would provide much-needed relief to working parents as well as provide more employment opportunities to childcare specialists.
Other important announcements made by the Liberals were the changes made to the basic personal amount. The basic personal amount is a non-refundable tax credit that every Canadian resident is entitled to claim on his or her tax return in calculating tax payable for a tax year. Currently, this amount is $12,069, however, under the proposed legislation, the amount is set to increase to $15,000 over four years starting in 2020. This measure, although a costly one, is expected to help those in the lowest income bracket. On the other hand, the increase in the basic personal amount will phase out for individuals with income above $150,605 and will be completely eliminated for individuals with income above $214,557, both amounts to be indexed to inflation from 2020 and thereafter.
Takeaways for middle market businesses
As the mandate of governing Canada is returned to the Liberal Party of Canada, the new minority government will face numerous challenges. The Liberals will have to work together with other parties and may have to compromise on some of their priorities. As such, certain promises from their election campaign platform may not materialize.