There are six important tax changes coming into effect in Canada in 2023 that taxpayers and their advisors should be aware of to avoid unintended tax consequences and to ensure compliance with new reporting requirements. The changes include:
- New anti-flipping rules for residential real estate (commencing January 1, 2023).
- Proposed New Mandatory Disclosure Rules for certain tax transactions (which will come into effect on Royal Assent).
- New trust reporting requirements (for taxation years ending on or after December 31, 2023).
- Raising the amount of taxable capital at which the small business deduction is phased out from CA$15 million to CA$50 million (for taxation years that begin on or after April 7, 2022).
- Proposed amendments to the General Anti-Avoidance Rule (GAAR).
- New interest deductibility limitation rules.
1. New anti-flipping rules for residential real estate
Starting on January 1, 2023, new anti-flipping rules apply to dispositions of residential property that are held for less than a year. Under these rules, a taxpayer is deemed to carry on a business in respect of the sale of such a property and the sale is deemed to be on account of income and not capital. This means that taxpayers who sell residential property after owning the property for less than a year will not be eligible to claim the principal residence exemption on that sale, and they will have to report the sale of such properties as business income and not as disposition of capital property. Further, any loss in respect of a flipped property is deemed to be nil.
The new anti-flipping rules do not apply if the sale of the property occurred as a result of one or more of the following events:
- The death of the taxpayer or a person related to the taxpayer;
- One or more persons related to the taxpayer becoming a member of the taxpayer’s household or the taxpayer becoming a member of the household of a related person;
- The breakdown of the marriage or common-law partnership of the taxpayer if the taxpayer has been living separate and apart from their spouse or common-law partner for at least 90 days prior to the disposition;
- A threat to the personal safety of the taxpayer or a related person;
- The taxpayer or a related person suffering from a serious illness or disability;
- An eligible relocation of the taxpayer or the taxpayer’s spouse or common-law partner;
- An involuntary termination of the employment of the taxpayer or the taxpayer’s spouse or common-law partner;
- The insolvency of the taxpayer; or
- The destruction or expropriation of the property.
2. Proposed New Mandatory Disclosure Rules for certain tax transactions
The proposed New Mandatory Disclosure Rules for certain tax transactions will come into effect when the legislation implementing these rules receives Royal Assent.
The previous version of the Mandatory Disclosure Rules required taxpayers and advisors to report a transaction that is primarily undertaken in order to obtain a tax benefit where the transaction has two of the following three hallmarks present: contingency fees, confidential protection, and/or contractual protection. Under the New Mandatory Disclosure Rules, only one of three hallmarks will need to be met in order for the transaction to be a reportable transaction. Furthermore, the definition of “avoidance transaction” has been expanded to include a transaction where it may reasonably be considered that “one of the main purposes” of the transaction is to obtain a tax benefit. Previously, the transaction had to be undertaken “primarily” for the purpose of obtaining a tax benefit to be an “avoidance transaction”. This represents a lower threshold.
The Federal Government is also proposing to create reporting obligations for certain kinds of transactions, referred to as Notifiable Transactions, that the Canada Revenue Agency (CRA) has found to be abusive, and transactions identified by the CRA as transactions of interest.
Taxpayers, promoters and advisors involved in these Notifiable Transactions are required to report these transaction to the CRA. The Federal Government has proposed the following transactions to be Notifiable Transactions:
- Transactions that seek to avoid Canadian-controlled private corporation (CCPC) status in order to achieve a tax deferral advantage in respect of other investment income.
- Straddle loss creation transactions using a partnership: these transactions involve financial arrangements that seek to reduce tax by generating artificial losses with the use of complex financial instruments or derivatives.
- Avoidance of the deemed disposal of trust property through indirect transfers of trust property or transfers of trust value through dividends.
- Manipulation of bankrupt status to reduce a forgiven amount in respect of a commercial obligation.
- Reliance on purpose tests in section 256.1 to avoid a deemed acquisition of control.
- Back-to-back arrangements that avoid the application of thin capitalization rules or reduce or eliminate Part XIII tax.
Under the new rules, each person associated with a Reportable Transaction or a Notifiable Transaction must report separately. These transactions must be reported within 45 days of the date the person (or another person who entered into the transaction for their benefit) becomes contractually obligated to enter into, or actually enters into, the transaction (whichever is earlier).
Uncertain Tax Treatments
The Federal Government is proposing a requirement for specified corporate taxpayers to report particular uncertain tax treatments to the CRA where the following conditions are met:
- The corporation is required to file a Canadian return of income for the taxation year. That is, the corporation is a resident of Canada or is a non-resident corporation with a taxable presence in Canada.
- The corporation has at least CA$50 million in assets at the end of the financial year that coincides with the taxation year (or the last financial year that ends before the end of the taxation year). This threshold would apply to each individual corporation.
- The corporation, or a consolidated group of which the corporation is a member, has audited financial statements prepared in accordance with International Financial Reporting Standards (IFRS) or other country-specific GAAP relevant for domestic public companies (e.g., U.S. GAAP).
- Uncertainty in respect of the corporation’s Canadian income tax for the taxation year is reflected in those audited financial statements (e.g., the entity concluded it is not probable that the taxation authority will accept an uncertain tax treatment and thus, as described by the IFRS Interpretations Committee, it is probable that the entity will receive or pay amounts relating to the uncertain tax treatment).
Under these proposals, uncertain tax treatments would be required to be reported at the same time that the reporting corporation’s Canadian income tax return is due.
3. New trust reporting requirements
Under the current rules, a trust generally has an obligation to file a T3 Trust Income Tax and Information Return (T3 Return) for a tax year if the trust has taxes payable, the trust disposes of capital property or the trust distributes income or capital to its beneficiaries.
For applicable trusts with taxation years ending on or after December 31, 2023, new reporting rules will be in place for trusts, including the following:
- Most trusts will be required to file a T3 Return every year, even if there are no taxes payable, there was no disposition of capital property or there was no distribution of income or capital.
- A trust will be required to provide additional information in its T3 Return, including the name, address, date of birth, jurisdiction of residence and taxpayer identification number (or TIN, examples being a social insurance number or business number) for trustees, beneficiaries, settlors and anyone who has the ability to exert influence over a trustee decision regarding the appointment of income or capital (i.e. a protector).
- Bare trusts will also have to file a T3 Return each year.
- Failure to comply with the trust reporting obligations may result in gross negligence penalties up to 5% of the highest total fair market value of all the property held by the trust in the year.
Note that the definition of a “settlor” for purposes of these new trust reporting rules is found in subsection 17(15) of the Income Tax Act (Canada). Pursuant to this subsection, a settlor is deemed to mean any person or partnership that has made a loan or transfer of property, either directly or indirectly, in any manner whatever, to or for the benefit of the trust. A person or partnership that deals at arm’s length with the trust will not be considered a “settlor” if it:
- Makes a loan to the trust at a reasonable rate of interest; or
- Makes a transfer to the trust for fair market value consideration.
Certain trusts are exempt from filing T3s, including the following:
- Trusts that have been in existence for less than three months;
- Trusts that hold assets with a total fair market value that does not exceed CA$50,000 throughout the year, where certain kinds of assets are held, such as cash or shares listed on a designated stock exchange;
- Lawyer’s general trust account (but not specific client accounts);
- Trusts that qualify as non-profit organizations or registered charities;
- Mutual fund trusts, segregated funds and master trusts;
- A trust, all of the units of which are listed on a designated stock exchange;
- Graduated rate estates;
- Qualified disability trusts;
- Employee life and health trusts;
- Certain government funded trusts; and
- Trusts under, or governed by, a deferred profit sharing plan, pooled registered pension plan, registered disability savings plan, registered education savings plan, registered pension plan, registered retirement income fund, registered retirement savings plan, employee profit sharing plan, registered supplementary unemployment benefit plan or first home saving account.
This is a vast change in reporting obligations for most trusts, and casts a wide net by including bare trust arrangements. All taxpayers and their advisors need to review all trusts and bare trust arrangements as soon as possible to get ready for these new reporting obligations. Further, a review of all transactions, such as loans and transfers from non-arm’s length parties or from arm’s length parties that don’t fit within the exemption to the definition of “settlor” mentioned above, with each trust will be required.
4. Raising the amount of taxable capital at which the small business deduction is phased out from CA$15 million to CA$50 million
Previously, a Canadian Controlled Private Corporation’s (CCPC’s) small business deduction was reduced on a straight-line basis if the combined taxable capital employed in Canada of the CCPC and any associated corporations was between CA$10 million and CA$15 million. Thus, if the CCPC and any associated corporations have combined taxable capital employed in Canada of CA$15 million or more, the CCPC was not entitled to any small business deduction.
Bill C-32, which received Royal Assent on December 15, 2022, raised the upper limit of taxable capital employed in Canada at which the small business deduction is phased out from CA$15 million to CA$50 million for taxation years that begin on or after April 7, 2022. As a result, CCPCs and associated corporations with less than a combined CA$50 million in taxable capital employed in Canada will be entitled to receive the small business deduction.
5. Proposed amendments to the GAAR
In the 2020 Fall Economic Statement, the Federal Government committed to modernizing Canada’s anti-avoidance rules. Following this, the Government released a Consultation Paper with proposed amendments to the these rules, which was followed by a public consultation from August 9 to September 30, 2022. The Consultation Paper proposed the following changes:
- Amending the definition of “tax benefits” to include tax attributes.
- Providing an interpretive rule to specify what is not a “bona fide” purpose (a transaction or series of transactions that results in a tax benefit is not subject to the GAAR if it may reasonably be considered to have been undertaken or arranged primarily for bona fide purposes other than to obtain the tax benefit).
- Extending the definition of “transaction” to include a choice.
- Changing the definition of an “avoidance transaction” so that it applies where “one of the main purposes“ for undertaking the transaction (or series) is to obtain the tax benefit” rather than requiring that it be undertaken primarily to obtain the tax benefit.
- Modifying the “misuse and abuse analysis”, including shifting the judicially established onus to taxpayers, thereby requiring them to demonstrate that the tax benefit would be consistent with the object, spirit and purpose of the provisions relied upon by the taxpayer.
The Federal Government will likely table legislation with amendments to the GAAR in 2023.
6. New Excessive Interest and Financing Expenses Limitation rules
In February 2022 and November 2022, the Department of Finance Canada release proposed legislation regarding new Excessive Interest and Financing Expenses Limitation (EIFEL) rules. The objective of these rules is to address issues arising from taxpayers deducting excessive interest and other financing costs, principally in the context of multinational enterprises and cross-border investments.
The new rules apply to taxpayers that are corporations or trusts, and also applies in computing a non-resident taxpayer’s taxable income earned in Canada. The rules also apply indirectly in respect of partnerships, as interest and financing expenses and revenues of a partnership are attributed to members that are corporations or trusts, in proportion to their interests in the partnership.
The new rules do not apply to the following “excluded entities”:
- Canadian-controlled private corporations that, together with any associated corporations, have taxable capital employed in Canada of less than CA$50 million;
- Groups of corporations and trusts whose aggregate net interest expense among their Canadian members is CA$1 million or less; and
- Certain standalone Canadian-resident corporations and trusts, and groups consisting exclusively of Canadian-resident corporations and trusts, that carry on substantially all of their business in Canada. This exclusion applies only if, in general terms, no non-resident is a material foreign affiliate of, or holds a significant interest in, any group member, and no group member has any significant amount of interest and financing expenses payable to a non-arm’s length “tax-indifferent investor” (as defined in subsection 248(1)).
If the new EIFEL rules are enacted, then they will generally apply in respect of taxation years that begin on or after October 1, 2023. However, if a taxpayer undertakes a transaction or series of transactions to trigger an early taxation year-end for the purpose of deferring the application of the EIFEL rules, then an anti-avoidance rule applies to cause the EIFEL rules to apply earlier for the particular taxpayer. The rules apply with respect to existing as well as new borrowings.
Generally speaking, the EIFEL rules limit the amount of net interest and financing expenses that may be deducted in computing a taxpayer’s income to no more than a fixed ratio of earnings before interest, taxes, depreciation and amortization (EBITDA).
- Fixed ratio: the applicable fixed ratio of earnings is 30%. However, a fixed ratio of earnings of 40% will apply for a transition period for taxation years beginning on or after October 1, 2023 and before January 1, 2024 (subject to an anti-avoidance rule that denies a taxpayer the benefit of the 40% ratio, generally where the taxpayer undertakes a transaction to extend the period for which that ratio otherwise applies).
- Interest and financing expenses and revenues include, among other things:
- Interest and financing expenses that are “capitalized” and deducted as capital cost allowance or as amounts in respect of resource expenditure pools;
- An imputed amount of interest in respect of certain finance leases;
- Certain amounts that are economically equivalent to interest or that can reasonably be considered part of the cost of funding; and
- Various expenses incurred in obtaining financing.
- The new rules can limit the deductibility of interest expense incurred to invest in shares that produce inter-corporate dividends and dividends received from foreign affiliates.