To: All Investors Group Representatives From: Advanced Financial Planning Support and Corporate Taxation Date: February 16th, 1999 Re: 1999 Federal Budget
Federal Surtax
In the 1998 federal budget, the 3% federal surtax was eliminated for individuals earning approximately $50,000 or less, and was reduced for individuals with income between $50,000 and $65,000.
The 1999 budget proposes to reduce the surtax to 1½% for 1999 and eliminate it completely for 2000 and subsequent years. At the top marginal tax rate the tax savings per $1,000 of income will be $4.35 in 1999 and $8.70 in the year 2000.
The 5% surtax on high income earners remains in place.
Increased Personal Credits
The budget proposes to increase the basic personal credit and the credit for a dependent spouse (or equivalent to spouse credit) by $675 over the next 2 years. The $500 supplementary personal amount introduced for low income Canadians in the 1998 budget is being halved in 1999 and eliminated in the year 2000.
As a result of the above changes, the basic personal credit will be raised from $6,456 in 1998 to $6,794 in 1999 and $7,131 in the year 2000. The spousal and equivalent to spouse amounts will be increased from $5,380 to $5,718 in 1999 and $6,055 in the year 2000. (For low income Canadians the net effect will be an increase from $6,956 in 1998 to $7,044 for 1999 and $7,131 for 2000.)
In addition, the amount of income which a dependent spouse (or equivalent to spouse) can earn before the personal credit is reduced is being increased from $538 to $572 in 1999 and to $606 in the year 2000.
For an individual eligible for the basic personal exemption, the additional personal credit will result in a federal tax reduction of approximately $57 in 1999 and $115 in 2000 and subsequent years.
Changes to the Canada Child Tax Benefit
The benefit consists of a basic benefit for low and moderate income families and a supplement for low income families. Over the last 2 years, the federal government proposed a number of enhancements to the Child Tax Benefit. A number of these are still being phased in. The current budget proposes to increase the income threshold levels whereby benefits may be received. The basic benefit will start to be reduced when family income exceeds $29,590, up from $25,921. For a family of 2 children with family net income of $29,590, this results in an additional Child Tax Benefit of $184.
The Goods and Services Tax (GST) Credit
Currently, the GST credit provides a payment of up to $199 for each adult and $105 for each child in a family depending on income levels. There is also a supplement of up to $105 for single persons that is phased in at a rate of 2% of net income over $6,456. Effective July 1, 1999 a single taxpayer who has one or more qualified dependents will receive the full value of the supplement without the phase in, provided the taxpayer’s income does not exceed $25,921.
The budget also proposes to reduce the time it takes to include changes in family circumstances in the calculation and payment of the GST credit. The birth of a child may take up to 18 months before being reflected in the calculation. To allow for necessary system changes, this change is proposed to apply in 2001.
Medical Expense Tax Credit
The Medical Expense Tax Credit provides a non-refundable federal tax credit equal to 17% of qualifying unreimbursed medical expenses that exceed the lesser of 3% of net income, or $1,614.
The budget proposes to improve tax assistance for the care and education of persons with disabilities by extending the Medical Expense Tax Credit for the 1999 and subsequent taxation years to:
The Income Tax Regulations contain a list of medical devices and equipment eligible for the Medical Expense Tax Credit. The budget proposes that "talking textbooks", used in connection with enrollment at a Canadian educational institution by an individual with a perceptual disability, be added to the list.
Income Splitting Tax on Minors
The Income Tax Act contains numerous attribution rules aimed at discouraging income splitting between taxpayers and non-arms length minors (typically children and grandchildren). Despite these rules, opportunities for income splitting did and still exist.
This budget contains proposals designed to discourage a number of strategies that were, in most circumstances, available only to the owners of businesses earning active business income. For example, it was possible through proper planning to have dividends of a small business corporation taxed in the hands of a minor at the minor’s low marginal rates of tax. The combination of the minor’s personal tax credits and the dividend tax credit often permitted a substantial amount of dividend income to be paid to the minor with little or no incidence of personal tax. In most scenarios a trust would be employed to control the shares and afford control over expenditures made for the minor’s benefit. This budget contains proposals aimed at discouraging this and other income splitting techniques that are most often employed by business owners.
For the year 2000 and subsequent taxation years, individuals under 18 years of age at the end of a calendar year will be required to pay a special tax, computed at the top marginal rate, on the following types of income:
a) taxable dividends received directly or indirectly through a trust or partnership in respect of shares of a corporation (other than shares that are listed on a prescribed Canadian or foreign stock exchange);
b) benefits included in the minor’s income pursuant to section 15 of the Act, as a consequence of the ownership by any person of the shares described in paragraph a) (a common example of such a benefit would be a loan from a corporation to a minor); and
c) income from a partnership or trust where the income is derived by the partnership or trust from the business of providing goods or services to a business carried on by a relative of the child or in which the relative participates.
Income that is subject to this tax will not be eligible for any deductions or credits other than the dividend tax credit and foreign tax credit. An offsetting deduction in computing taxable income will be introduced to ensure that income that is subject to the new tax is not also subject to ordinary income tax.
A parent of a minor liable for this special tax will be jointly and severally liable for the tax if the parent was active in the business.
Income from property inherited from a parent will be exempt from this special tax, as will:
It is important to note that some income splitting opportunities remain. Income from employment or personal services of the minor will not be subject to this special tax, nor will these measures effect the taxation of income and capital gains from mutual funds gifted to a minor, either directly or by way of a trust.
Clients who have used the income splitting strategies targeted by these legislative proposals should consult with their accounting and legal advisors as to what, if any, action is required in reaction to these proposals. Retroactive Lump Sum Payments
Under existing tax law, a person receiving a lump sum payment made in respect of preceding years will be taxed on the payment in the year the payment is received. Due to progressive tax rates, the tax liability may be higher than if the payments had been taxed over time in the years that the income arose.
The budget has proposed that persons receiving "qualifying" retroactive payments may be taxed on such amounts as if these payments had been subject to tax in the year to which the payment relates.
A "qualifying" retroactive lump sum payment is the principal portion of a benefit (must be $3,000 or more) received in a year that relates to a preceding year throughout which the taxpayer was a Canadian resident. Eligible income sources are:
The interest portion of the lump sum payment will continue to be taxed in the year of receipt.
The federal tax relief is equal to:
a) The federal tax on the lump sum payment if taxed in year of receipt
MINUS
b) The federal tax liability plus interest on the qualifying lump sum payment if it had been taxed in the year to which it relates (interest is added to reflect the delay in payment of tax on the retroactive lump sum payment, using the prescribed rate for tax refunds).
These changes will apply to qualifying lump sum payments received after 1994. While the mechanism has not been announced, affected individuals should be able to request tax refunds.
With respect to pension amounts, it remains to be seen whether amounts in excess of the maximum transfer value or surplus amounts will be considered as qualifying retroactive lump sum payments.
Note that because provincial taxes are a percentage of federal tax in all provinces other than Quebec, tax relief under this change will result in a reduction of provincial tax owing. Quebec has a similar provision for income tax purposes.
The tax mechanism does not result in adjustments to income tax returns filed in prior years, so there are no adjustments to RRSP contributions and tax credits. As well, there will be no re-capture of income-tested benefits paid in prior years.
RRSP/RRIF Proceeds on Death
Currently, when an annuitant under a registered retirement savings plan (RRSP) or registered retirement income fund (RRIF) dies, the value of the RRSP or RRIF is generally included in computing the deceased’s income for the year of death.
If the deceased has a surviving spouse, this income inclusion may be transferred to a surviving spouse by distributing the RRSP or RRIF proceeds to the surviving spouse, or where there is no surviving spouse, the transfer is available for distributions made to the deceased’s financially dependent children or grandchildren.
Spouses and infirm children may defer the taxation on these distributions through transfers to annuities, RRSPs and RRIFs. Deferral of the taxation on the proceeds to minor children can be achieved through the acquisition of short-term annuities.
For deaths after 1998, the budget is now proposing relief for the deceased’s estate where there is a surviving spouse but the RRSPs or RRIFs are left to dependent children. In these cases, income inclusions may be borne by the dependent children rather than the estates of the deceased individuals. This provision will be useful in developing estate plans for separated persons or persons in a second marriage who would prefer to leave RRSP or RRIF proceeds to a dependent child.
The budget also proposes to allow the deceased’s estate and the recipient of an RRSP or RRIF distribution to elect to apply this measure for deaths that occurred after 1995. If the distribution was made before 1999 and the recipient would have been entitled to defer the taxation on the amount by making a transfer as described above, a transitional measure will allow the recipient a deduction in computing income for the year of the income inclusion if the transfer is made before March 2000.
The deadline for a transfer in respect of an RRSP or RRIF distribution made after 1998 will remain as the 60th day following the taxation year in which the distribution is made.
RRSP Withdrawal under the Home Buyers' Plan (HBP) and the Lifelong Learning Plan (LLP) from Quebec Labour-Sponsored Venture Capital Corporations (LSVCCs)
The HBP allows a qualifying individual to withdraw RRSP funds on a tax-free basis to purchase a home, while the proposed LLP allows a tax-free withdrawal to pay for education. HBP withdrawals are repayable over a 15 year period, while LLP withdrawals are repayable over a 10 year period. To the extent that a scheduled repayment for a year is not made, it is included in computing the participant's income for the year.
The Quebec government had proposed that an individual who makes a redemption of their LSVCC shares in order to participate in the HBP or LLP will have to acquire shares of an LSVCC, according to the repayment schedules stipulated above. For example, an individual who redeems his original shares in order to participate in the LLP will have to annually acquire replacement shares for an amount equal to at least 1/10 of the amount withdrawn from the LSVCC. Since there was no repayment of the Quebec LSVCC credit at the time of withdrawal, these replacement shares are not eligible for the credit. Where an individual fails to acquire LSVCC replacement shares, a special Quebec tax of 15% is imposed on the difference between the amount the individual is required to acquire annually in replacement shares and the amount they actually acquire. This allows the recovery of the LSVCC credit that Quebec provided on the purchase of the redeemed shares.
The federal budget proposes that purchases of replacement shares in Quebec LSVCCs also not be eligible for the federal LSVCC credit. In addition, where an individual fails to acquire a replacement share as per the repayment schedule, it is proposed to levy a federal penalty tax that matches the special 15% Quebec tax.
These proposals will apply from the date the corresponding Quebec proposals apply. Similar changes are not contemplated for federally-registered LSVCCs or LSVCCs registered in other provinces.
Interest on Corporate Taxes
Revenue Canada pays interest on overpaid taxes in some cases, but the rate of interest on refunds is 2% lower than the rate of interest that the taxpayer pays to the government on underpaid taxes. Furthermore, the interest on underpaid taxes is not deductible while the interest received on overpaid taxes is fully taxable.
This creates an inequitable situation for businesses with complex tax returns. To alleviate this inequity, it is proposed that for corporations only, interest on underpaid taxes may be offset by refund interest where both amounts apply to the same time period.
This provision will apply to periods after 1999.
Non-Resident Trusts and Foreign-based Investment Funds
The budget proposes tighter anti-avoidance rules on investments in foreign-based investment funds and transfers to non-resident trusts. The rules would subject a taxpayer’s pro-rata share of all undistributed income of a foreign-based investment fund or, if annual income could not be determined, the annual increase in the market value of the taxpayer’s interest in the fund to annual taxation.
Also, the budget proposes that where a Canadian resident transfers or loans property to a non-resident trust, the trust will be treated as a resident of Canada and taxed on all its undistributed income. This rule would apply whether or not the trust has a Canadian resident beneficiary.
Exceptions would apply to U.S. resident trusts, 5-year immigration trusts and non-resident trusts established for disabled individuals or children of divorced parents where the trust and beneficiary are resident within the same country.
These proposals would apply to taxation years starting after 1999 for investments in foreign-based funds, or transfers or loans of property to non-resident trusts, made on or after February 16th, 1999.
Foreign-based investment funds acquired before February 16th, 1999 and non-resident trusts to which a Canadian resident transferred or loaned property prior to February 16th, 1999 would become subject to the new rules for taxation years commencing after 2000.
Civil Penalties for Misrepresentation of Tax Matters by Third Parties
The budget proposes to introduce two new civil penalties on persons for misrepresentation of tax matters.
Advising or Participating in False Representation
This penalty will apply to any persons who participate in false statements or omissions with respect to tax matters of another person.
For example, the penalty could apply to an accountant or anyone else who knowingly includes a personal expense on a client’s business expense statement that is being used for tax purposes.
This penalty will be the greater of $1,000 and 50% of the amount of tax avoided.
Tax Shelter and Other Planning Arrangements
This penalty will apply to a person who plans, promotes or sells an arrangement that includes a false statement or omission that may be used for tax purposes.
The penalty will be the greater of $1,000 and 100% of the gross revenue derived by the person from the arrangement.
The purpose of this bulletin is to inform you of current developments, not to provide legal advice.
Investors representatives can direct their questions on the federal budget to the tax planning team in the Advanced Financial Planning Support department at 1-800-737-0447 (1-800-987-8677 for Quebec representatives only), menu selection 2-1-2.