Highlights of 2022 budget measures affecting businesses
Canada’s 2022 Federal Budget, tabled on 7 April 2022, includes a number of proposals that would affect domestic and multinational businesses, as well as measures to combat climate change (see our analysis of the full budget measures).
Small business deduction
The small business deduction (SBD) allows small businesses to benefit from a reduction in the federal corporate income tax rate from the general rate of 15% down to 9%. The SBD applies on the first CAD 500,000 of active business income earned by a Canadian controlled private corporation (CCPC), defined as the “business limit.” The business limit must be allocated amongst corporations that are associated in a tax year and is reduced by any portion the CCPC assigns to another corporation. The CCPC’s remaining business limit is then further reduced on a straight-line basis when:
- The combined taxable capital employed in Canada of the CCPC and any associated corporations is between CAD 10 million and CAD 15 million; or
- The combined adjusted aggregate investment income of the CCPC and its associated corporations is between CAD 50,000 and CAD 150,000.
The budget proposes to extend the range over which the business limit is reduced based on the combined taxable capital employed in Canada of a CCPC and its associated corporations. As from 7 April 2022, the maximum of the range for the taxable capital would be raised to CAD 50 million. This change would increase the amount of qualifying active business income that can be eligible for the SBD for companies with taxable capital up to CAD 50 million from the current CAD 15 million.
Canada Recovery Dividends and additional tax on banks and life insurers
The budget proposes to introduce Canada Recovery Dividends (CRD) as a one-time 15% tax on bank and life insurer groups on taxable income exceeding CAD 1 billion. A group would include a bank or life insurer and any other financial institution (as defined under Part VI of the Income Tax Act) that is related to the bank or life insurer.
The CRD will be determined based on the corporation’s taxable income for the taxation years ending in 2021, and the CAD 1 billion taxable income exemption will be allocated amongst bank and life insurer group members. The CRD liability will be imposed in the 2022 taxation year. Groups will be permitted to pay the CRD over five years in equal instalments.
The budget also proposes an additional tax on bank and life insurer groups of 1.5% on taxable income over CAD 100 million for taxation years that end after 7 April 2022. The CAD 100 million taxable income exemption will be required to be allocated by agreement amongst all group members. The additional tax will be prorated for the taxation year based on the number of days in the taxation year after 7 April 2022.
Substantive CCPCs: Deferral of tax using foreign entities
The budget proposes to prevent the deferral of tax on investment income by companies controlled by Canadian residents that are using foreign entities to avoid the tax imposed on CCPCs. The proposal would prevent such deferral by aligning the taxation of investment income of such corporations to CCPCs.
The budget introduces the term “Substantive Canadian Controlled Private Corporation” (SCCPC), which would expand the definition of control to deem the corporation to be controlled by Canadian individuals owning shares directly or indirectly. An SCCPC would pay tax on investment income at a federal rate of 38 2/3%, of which 30 2/3% would be refundable upon distribution to shareholders. The investment income earned would also be added to the “low rate income pool” of the SCCPC, which would prevent shareholders from receiving access to enhanced dividend tax credits, thereby making dividend income from a SCCPC less tax efficient than under the current rules. SCCPCs would continue to be treated as non-CCPCs for all other purposes of the ITA.
Further amendments to legislation are proposed to extend the normal reassessment period by one year for any consequential assessment of Part IV tax that arises from a corporation being assessed or reassessed a dividend refund.
These measures would apply to tax years that end on or after 7 April 2022 unless specific exceptions apply.
Application of the general anti-avoidance rule to tax attributes
Canada’s general anti-avoidance rule (GAAR) is intended to prevent abusive tax avoidance transactions. If abusive tax avoidance is established, the GAAR applies to deny the tax benefit created by the transaction. The Canada Revenue Agency (CRA) generally applies the GAAR once a transaction has caused an assessment of tax. Where the GAAR applies to a transaction, the CRA can utilise the rules to determine the amount of a tax attribute, such as the adjusted cost base of a property and the paid-up capital of a share, through a notice of determination.
The Federal Court of Appeal recently held that the GAAR did not apply to a transaction that resulted in an increase in a tax attribute that had not yet been utilised to reduce taxes. The budget proposes to allow the GAAR to also apply where transactions affecting tax attributes have not yet impacted the computation of tax. This measure would apply to notices of determination issued on or after 7 April 2022.
Deferring tax using foreign resident corporations: Foreign Affiliate Passive Investment Income
Budget 2022 proposes a significant change to the way foreign investment income from controlled foreign affiliates would be taxed when received by private corporations controlled by Canadians. The stated aim of the changes is to ensure the taxation of such investment income is consistent with the taxation of the income if received directly from the foreign affiliate by a Canadian resident individual instead of through a Canadian corporation. The immediate impact would be to reduce the deferral of tax on such income. These measures would apply to tax years beginning on or after 7 April 2022.
While Budget 2022 did not contain any significant new international tax measures, there are several measures that will impact organizations that operate internationally, summarized below:
- Pillar One and Pillar Two: As a participant in the OECD Base Erosion and Profit Shifting (BEPS) initiative, Canada has signed onto the two-pillar framework (known as Pillar One and Pillar Two), along with 137 other jurisdictions, to reform the international tax rules. Pillar One will ensure that large multinational corporations will be allocated their fair share of tax in the jurisdictions where their users and customers are located. The Canadian federal government is actively working with its international partners to develop the multilateral convention to bring the new rules into effect. In Budget 2022, the government confirmed it will continue to move forward with the previously proposed digital service tax if this multilateral convention does not come into force. Pillar Two will ensure that multinational enterprises are subject to a minimum effective tax rate of 15% on their profits globally. The Pillar Two framework is now largely finalised and countries are taking steps towards domestic implementation. Budget 2022 confirms that the government will be launching a public consultation on the implementation of Pillar Two rules (see our tax alert for more information about how these rules will impact your organization).
- Interest coupon stripping: Interest payments made by Canadian taxpayers to nonresidents are subject to a 25% withholding tax, which may be reduced under an applicable tax treaty. To avoid this withholding tax, taxpayers have entered into arrangements to sell the rights to a future interest to a party that is either not subject to a withholding tax or is taxed at a reduced rate. Budget 2022 proposes amendments such that the total withholding tax paid under an interest coupon stripping arrangement would be the same as if the arrangement had not been undertaken.
- Hybrid mismatches: Hybrid arrangements can be used to exploit tax differences between Canadian and foreign tax laws. The Department of Finance has released draft legislation on hybrid mismatch arrangements.
- Transfer pricing: In Budget 2021, the government announced its intention to consult on Canadian transfer pricing rules in light of recent Canadian court decisions, but the consultation paper has not been released. Budget 2022 confirmed the government’s intention to proceed with these measures.
- Interest deductibility: On 4 February 2022, the government released draft legislation relating to Excessive Interest and Financing Expenses Limitation (EIFEL), which will affect multinational corporations, cross-border investments, and other Canadian public and private enterprises. As currently proposed, the EIFEL rules would limit the deductibility of net interest expense to a fixed ratio, ultimately to be 30% of taxable income before interest, taxes, depreciation and amortization (referred to as tax EBITDA). The consultation period for these measures ended on 5 May 2022; the government is expected to proceed to finalize the legislation and introduce it as a bill. These rules are currently set to apply for taxation years beginning on or after 1 January 2023.
The budget also includes several proposals designed to encourage taxpayers to develop, adopt and invest in clean technologies:
- Investment Tax Credit for Carbon Capture, Utilization and Storage: The budget proposes a refundable investment tax credit for businesses that incur eligible carbon capture, utilization and storage (CCUS) expenses, starting on 2 January 2022. The CCUS tax credit would be available in respect of the cost of purchasing and installing eligible equipment used in an eligible CCUS, so long as the equipment was part of a project where the captured CO2 was used for an eligible use. Eligible equipment would include equipment that would be used solely to capture, transport, store or use CO2 as part of an eligible CCUS project. Investors in CCUS technologies would be able to claim the CCUS tax credit on eligible expenses in respect of the tax year in which the expenses were incurred, regardless of when the equipment becomes available for use. The CCUS tax credit would not be available for equipment in respect of which a previous owner has received the CCUS tax credit. The following rates would apply to eligible expenses incurred after 2021 through 2030:
- 60% for eligible capture equipment used in a direct air capture project;
- 50% for all other eligible capture equipment; and
- 37.5% for eligible transportation, storage and use equipment.
These rates would be reduced by 50% for the period from 2031 through 2040 to encourage the industry to move quickly to lower emissions.
Projects would be assessed at five-year intervals when they begin to capture CO2 to a maximum of 20 years to determine if a recovery of the CCUS tax credit is warranted. Assessments would be based on the total amount of CO2 going to an ineligible use over the five-year period being assessed. A recovery would be calculated if the portion of CO2 going to an ineligible use is more than five percentage points higher than set out in the initial project plans. Specific design features of the recovery will be released at a later date.
- Critical Mineral Exploration Tax Credit: Budget 2022 proposes to introduce a new 30% Critical Mineral Exploration Tax Credit (CMETC) for specified minerals consumed in the production of batteries and permanent magnets used in zero-emission vehicles, or in the production and processing of advanced materials, clean technology or semi-conductors. The specified minerals that would be eligible for the CMETC are copper, nickel, lithium, cobalt, graphite, rare earth elements, scandium, titanium, gallium, vanadium, tellurium, magnesium, zinc, platinum group metals and uranium. Eligible expenditures would not benefit from both the proposed CMETC and the existing Mineral Exploration Tax Credit (METC), which is equal to 15% of specified mineral exploration expenses incurred in Canada and renounced to flow-through share investors. The CMETC would apply to expenditures renounced under eligible flow-through share agreements entered into after 7 April 2022 and on or before 31 March 2027.
- Clean technology tax incentives: Air-source heat pumps: The budget proposes several incentives to encourage investment in air-source heat pumps, a specific type of clean energy generation equipment. An air-source heat pump is a device that uses electrical energy to provide interior space heating or cooling as an alternative to the use of fossil fuels. The budget recommends expanding eligibility under Classes 43.1 and 43.2 to include air-source heat pumps primarily used for space or water heating and including the manufacturing of air-source heat pumps used for space or water heating as an eligible zero-emission technology manufacturing or processing activity for purposes of the temporary corporate tax rate reduction for qualifying zero-emission technology manufacturers, previously announced as part of the 2021 budget.