Federal budget targets ‘tax abuses’

The federal budget will mean more red tape for corporations and the closing of certain tax “loopholes” as the Liberal government aims to clamp down on areas of perceived tax avoidance.

“It was targeted in terms of tax measures,” says Pamela Cross, a lawyer with Borden Ladner Gervais LLP’s tax group in Ottawa. “The budget had a series of measures aimed at specific perceived corporate tax abuses.”

Ash Gupta, a partner with Gowling WLG, says there weren’t fundamental changes to tax law but “a lot of tinkering around the edges and closing of perceived loopholes.”

“I think the big hit for business is going to be more red tape, more compliance, more reporting,” he says.

“For any Canadian business that has aspirations to grow nationally, that represents a further barrier to entry or more compliance with respect to growing a global business. It will mean more business for whoever does your transfer pricing compliance, for example. So more business for the big four accounting firms and perhaps shoring up in-house expertise.”

The budget contained a number of initiatives the government is going to pursue to ensure it aligns its policies more globally such as the Base Erosion and Profit Shifting initiatives of other jurisdictions.

There will be revised transfer pricing guidance to address some of the concerns raised at the Organization for Economic Cooperation and Development.

“The government made it clear it is moving forward with its OECD commitments and it will be introducing changes to its transfer-pricing regime on a case-by-case basis, re-negotiating the treaties so it can deal with perceived inequities of leakage of tax revenues to other jurisdictions. That’s one area where I think bigger business will be concerned,” says Cross.

There will also be an automatic exchange of tax rulings that are issued by governments. If Canada issues a ruling that blesses a transaction from a Canadian perspective, it will automatically send a copy to other jurisdictions so they can be addressed more proactively.

“In the near term, things may be more uncertain. In the long term, hopefully, the playing field will be clearer and everyone will understand the rules and the same set of rules will apply to everybody. I think that’s the objective of the OECD,” says Cross.

There is also a major change to the small business deduction that will affect many professional corporations including lawyers, doctors, engineers, and accountants.

Under existing legislation, the small business deduction is available to corporations that earn business income up to $500,000. The small business tax rate is 12 to 15 per cent and the deduction provides tax savings of up to $55,000.

Now those profits will be subjected to a 25- to 27-per-cent rate depending on which province you’re living in. The rate was intended to encourage people to preserve income in the professional corporation.

Professionals used PCs to claim the small business deduction by charging fees to a partnership of which the shareholder was a partner. This perceived loophole has now closed.

“With the new rules, it’s pretty much shut down,” says Kim Moody, of Moodys Gartner Tax Law LLP in Calgary. “We are going to struggle with that. Small business is used for anything not multinational or publicly traded. Our largest client is worth $5 billion — that’s not small.”

Essentially, professionals, such as lawyers, have been using professional corporations to claim the small business deduction by charging fees to a partnership of which the shareholder was a partner. The loophole has been slammed shut now as the fees are no longer eligible for a full small business deduction.

“It’s going to be bad. Any professional firm in Canada — pick all the Bay Street law firms — they are going to be affected because they have set up structures to essentially allow the multiplication of the small business deduction,” says Moody.

“There was so much rhetoric by the Liberals in their election campaign by the use of professional corporations as inappropriate tax avoidance vehicles,” he says.

The change for professional corporations is in effect for the 2016 tax year.

The good news from the budget is being seen in the commitment to spend $11.4 billion over four years in infrastructure, much of which will be implemented through public-private partnerships so the government can leverage private sector money.

“That’s a strong signal for our key domestic clients and international clients that Canada is going to be a good place to invest in particularly in the infrastructure and green energy space,” says Gupta.

Clean energy has been a buzzword in the last few budgets and there were references in this one as well.

What wasn’t named in the budget is also being celebrated, says Gupta. There had been speculation the budget would reduce or eliminate the favourable stock option treatment.

“They didn’t do that and it’s a strong message to Canadian companies that the government recognizes our stock option regime is key for growing business to attract and retain that top talent,” says Gupta.

There was also speculation capital gains rates might be moved from the 50 per cent it is currently back to two thirds or three quarters.

“I think the fact the government didn’t do anything there sends a strong message that long-term capital investment into business and companies is still being encouraged at the federal level,” he says.

The downside to business is that it reinforces a lack of certainty and predictability, says Gupta.

A couple of changes Gupta says had “the phones ringing off the hooks about” were around the switch-fund shares.

A long-standing tax position has been that when money is invested in a company and individuals take back shares, they can exchange that class of shares for a different class of shares without triggering a taxable event.

“The idea is once someone’s money is with a company they should only be taxed once the money leaves the company. The authorities didn’t like that so the rules have changed,” he says. “Where someone has switched from one class of shares to another in these switch funds, we will take it as if you have taken the money out of the company and put it into something else.

“On its face it seems like a small change, but it really does undermine that predictability and certainty our clients look for when trying to build an organizational architecture with long-term legs and sustainability,” says Gupta. “Changing rules midstream like this undermines that.”