Federal Budget 2023—no big changes but maximum minimums!

Finance Minister Chrystia Freeland tabled the 2023 Federal Budget on March 28, 2023. There were no tax rate increases and the capital gains inclusion rate hasn’t changed. However, a revamped alternative minimum tax and a global minimum tax for multinational enterprises are at the center of what will fund investments in clean technology, health care, and affordability items (like grocery rebates).

Also, of interest to insurance and investment advisors are measures concerning business succession, proposals for consultation on the general anti-avoidance rule, and some targeted items. Our summary of the items of most interest follows.

Alternative Minimum Tax for high-income individuals

The Alternative Minimum Tax (AMT) is a parallel tax calculation that allows fewer deductions, exemptions, and tax credits than under the ordinary income tax rules. AMT currently applies at a flat 15% tax rate, with a standard $40,000 exemption amount, and doesn’t use graduated rates.

An individual pays the AMT or regular tax, whichever is highest. Additional tax paid as a result of the AMT can generally be carried forward for seven years and can be credited against regular tax to the extent regular tax exceeds AMT in those years. The AMT doesn’t apply in the year of death. To narrow the scope of AMT to high-income individuals, there are several proposed changes to its calculation:

• capital gains and stock options – The capital gains inclusion rate will increase from 80% to 100%. Capital loss carry forwards and allowable business investment losses (ABIL) would apply at a 50% rate. One hundred per cent (100%) of the benefit associated with employee stock options would be included in the AMT base.

• lifetime capital gains exemption (LCGE) – Capital gains eligible for the LCGE would continue to be included at 30% for AMT.

• donations of publicly listed securities – Thirty per cent (30%) of the capital gain would be included in the AMT base.

• deductions and expenses – The AMT base would be broadened by disallowing 50% of certain deductions, including interest and carrying charges incurred to earn income from property, non-capital loss carryovers, and more.

• non-refundable credits – Currently, most non-refundable tax credits can be credited against the AMT. This is to be reduced to 50% of non-refundable tax credits that would be allowed to reduce the AMT, subject to the certain exceptions.

Raising the AMT exemption

The exemption amount is a deduction available to all individuals and graduated rate estates that’s intended to protect lower and middle-income individuals from application of the AMT.

This exemption would be increased from $40,000 to the start of the fourth federal tax bracket. Based on expected indexation for the 2024 taxation year, this would be approximately $173,000. The exemption amount would be indexed annually to inflation. Increasing this exemption amount greatly increases the level of income before AMT payments are necessary, reducing the impact on middle-income individuals.

Increasing the AMT rate

The AMT rate would increase from 15% to 20.5%, corresponding to the rates applicable to the first and second federal income tax brackets, respectively.

Carry-forward period

The length of the carry forward would be maintained at seven years.

The proposed changes to AMT listed above would come into force for taxation years that begin after 2023. Under these reforms, more than 99% of the AMT paid by individual Canadians would be paid by those who earn more than $300,000 per year, and about 80% of the AMT paid would be by those who earn more than $1 million per year.

General anti-avoidance rule

The general anti-avoidance rule (GAAR) is intended to prevent abusive tax avoidance transactions while not interfering with legitimate commercial and family transactions. If abusive tax avoidance is established, the GAAR applies to deny the tax benefit created by the abusive transaction.

The Budget proposes to amend the GAAR and begin a period of consultation, ending on May 31, 2023. The Department of Finance subsequently intends to publish revised legislative proposals and announce the application date of those amendments.

The following are the proposed changes to GAAR:

• add a preamble – This is meant to help address interpretive issues and make sure that the GAAR applies as intended.

• change the avoidance transaction standard – The threshold for the avoidance transaction test in the GAAR would be reduced from a “primary purpose” test to a “one of the main purposes” test.

• introduce an economic substance rule – This would be considered at the “misuse or abuse” stage of the GAAR analysis. Factors that’ll be considered when evaluating economic substance include the potential for pre-tax profit, a transaction that resulted in a change of economic position, and a transaction that’s entirely (or almost entirely) tax motivated. To the extent that a transaction lacks economic substance, the new rule may apply.

• introduce a penalty – A penalty would apply for transactions subject to the GAAR, equaling 25% of the amount of the tax benefit. Where the tax benefit involves a tax attribute that hasn’t yet been used to reduce tax, the amount of the tax benefit would be considered to be nil. The penalty could be avoided if the transaction is disclosed to the Canada Revenue Agency (CRA), either as part of the proposed mandatory disclosure rules or voluntarily.

• extend the normal reassessment period – A three-year extension to the normal reassessment period would be provided for GAAR assessments unless the transaction has been disclosed to the CRA.

Intergenerational business transfers

Bill C-208 was a private members' bill that previously introduced amendments to section 84.1 of the Income Tax Act (Canada), which prevented dividend recharacterization of capital gains for certain intergenerational transfers (see Bill C-208 – helping family business succession) Budget 2022 announced a consultation process to revisit these rules to consider more genuine intergenerational transfers.

Budget 2023 proposes to amend the rules introduced originally by Bill C-208. These rules continue to require the transferred shares be qualified small business corporation shares or qualified farm or fishing property shares at the time of transfer and that the purchaser corporation must be controlled by an adult child of the transferor.

The amendments provide for flexibility by allowing for two possible transfer options:

• an immediate transfer using a three-year test based on an arms-length sale

• a gradual intergenerational transfer based on a 5-to-10-year test using traditional estate freeze characteristics.

The budget proposes five hallmarks and related criteria that will determine the application of either transfer method. These include the following:

• transfer of control of the business
• transfer of economic interests in the business
• transfer of management of the business
• child retains control of the business
• child works in the business.

The criteria for each of these hallmarks will be different based on the transfer option.

The Budget also proposes that the transferor and the children are required to jointly elect for a transfer to qualify as either an immediate or gradual transfer. It’s also proposed that the capital gains reserve be extended to 10 years to satisfy the conditions. These measures would apply for transactions that occur on or after January 1, 2024. The Department of Finance has previously indicated transfers completed under an earlier iteration of the rules and completed prior to the introduction of new rules won’t be impacted.

Employee ownership trusts

The Budget proposes to introduce a new type of trust that holds shares of a corporation for the benefit of the corporation’s employees. These trusts are intended to facilitate the purchase of a business by employees and provide an additional succession-planning option for business owners.

For a trust to be considered an employee ownership trust (EOT), it must serve two purposes:

• It would hold shares for the benefit of the employee beneficiaries of the trust.
• It would make distributions to employee beneficiaries based on certain parameters, such as an employee’s length of service, remuneration, and hours worked.

An EOT would also be required to hold a controlling interest in the shares of a qualifying business. To be considered a qualifying business, all or substantially all of the fair market value of its assets are attributed to assets used in an active business carried on in Canada.

The EOT would be a taxable trust and be subject to the same rules as a personal trust. In other words, undistributed trust income would be taxed at the top marginal tax rate. Any income distributed from the trust to beneficiaries would be taxed in the beneficiary’s hands and not in the trust. Additionally, income distributed from the trust to the employee beneficiaries (i.e., dividends) would retain its character.

Beneficiaries of these trusts are restricted to qualifying employees and wouldn’t include individuals or related persons who owned the business prior to the sale. Qualifying transfers are restricted to dispositions at fair market value, where the EOT purchases shares of the corporation either directly or through a corporation owned by the EOT.

To facilitate the creation of EOTs, there are a series of modifications to existing tax rules, including:

• ten-year capital gains reserve – Currently, the Income Tax Act has a five-year deferral period for capital gains when sale proceeds are received over multiple years. The Budget proposes that taxpayers who sell their businesses to EOTs, and the proceeds are received on an instalment basis, could benefit from a 10-year deferral period where a minimum of 10% of the capital gains would be brought into income.

• exception to the shareholder loan rules – The Budget proposes to extend the repayment period for shareholder loans from 1 year to 15 years on qualifying business transfers.

• exception to the 21-year rule – An EOT would be exempt from the 21-year deemed disposition rule for trusts if it qualifies as an EOT.

An EOT won’t be able to transfer shares of the business to beneficiaries. The measures don’t contemplate what may occur on the death or disability of a beneficiary. These rules are proposed to be effective January 1, 2024.

Registered education savings plans

There are two changes provided to registered education savings plans (RESPs):

• increase of educational assistance payment cap – When an RESP beneficiary is enrolled in an eligible post-secondary program, government grants and investment income can be withdrawn from the plan as educational assistance payments (EAPs). EAPs are taxable income for the RESP beneficiary. Within the first 13 consecutive weeks of enrollment in a 12-month period, the current caps of $5,000 for full-time students and $2,500 for part-time students will increase to $8,000 and $4,000, respectively.

• allowing divorced or separated parents to open joint RESPs – Only spouses or common-law partners can jointly open an RESP. Parents who opened a joint RESP prior to their divorce or separation can maintain this plan afterwards but are unable to open a new joint RESP. The Budget proposes to enable divorced or separated parents to open joint RESPs for one or more of their children, or to move an existing joint RESP to another institution.

Both changes are effective on Budget Day (March 28, 2023). Individuals who withdrew EAPs prior to Budget Day may be able to withdraw an additional EAP amount, subject to the new limits and the terms of their plans. Also remember, EAPs can be withdrawn up to six months after a beneficiary ceases to be enrolled in an eligible program.

Quick hits

Registered disability savings plans

Currently a qualifying family member (parent, spouse, or common-law partner) can open a registered disability savings plan (RDSP) and be the planholder for an adult who doesn’t have the capacity to enter into an RDSP contract and who doesn’t have a legal representative. The 2023 Federal Budget proposes to add siblings (siblings of the beneficiary who are 18 years of age or older) as qualifying family members.

The qualifying family member measure will be extended to December 31, 2026. The proposed expansion of the existing qualifying family member definition would apply as of royal assent of the enabling legislation and be in effect until December 31, 2026. All qualifying family members, including siblings who become qualifying family members and planholders before the end of 2026, could remain the planholders after 2026.

Retirement compensation arrangements

The Budget proposes amendments so that fees or premiums paid for the purposes of securing or renewing a letter of credit (or surety bond) for a retirement compensation arrangement (RCA) that’s supplemental to a registered pension plan won’t be subject to refundable tax. Currently these fees are subject to refundable tax. It’s also proposed that employers can request a refund for previously paid refundable tax as it relates to letters of credit.

Automatic tax filing

Since 2018, the CRA has delivered a free and simple File My Return service, which allows eligible Canadians to auto-file their tax return over the phone. To make sure more low-income Canadians have the ability to quickly and easily auto-file their tax returns, the federal government will increase the number of eligible Canadians for File My Return to two million by 2025—almost triple the current number. Could this be the foundation for a broad-based automatic tax filing system, where Canadians can complete their returns in minutes? One can dream …

Making life more affordable for students

Federal Budget 2023 proposes to enhance student financial assistance for the school year, starting August 1, 2023. This includes:

• increasing Canada Student Grants by 40%—up to $4,200 for full-time students

• raising the interest-free Canada Student Loan limit from $210 to $300 per week of study

• waiving the requirement for mature students, aged 22 years or older, to undergo credit screening to qualify for federal student grants and loans for the first time.

These changes will allow post-secondary students to access up to $14,400 in enhanced Canada Student Financial Assistance for the upcoming school year. Students with disabilities and students with dependents will also receive an increase in Canada Student Grants.

Protecting Canadians from the risks of crypto assets

Budget 2023 announces that the Office of the Superintendent of Financial Institutions (OSFI) will consult federally regulated financial institutions on guidelines for publicly disclosing their exposure to crypto assets. In addition, the government will require federally regulated pension funds to disclose their crypto-asset exposures to OSFI. Simply put, regulation of crypto assets is expanding.

Tax on repurchases of equity

Also known as the “2% tax on share buybacks,” this tax will apply on the net value of share repurchases by public corporations in Canada. The net value of share repurchases is defined as the fair market value of equity repurchased minus the fair market value of treasury shares issued. Entities that repurchase less than $1 million of shares aren’t subject to the tax. For purposes of this tax, public corporations in Canada are to include specified investment flow-through (SIFT) trusts, SIFT partnerships, and real estate investment trusts (REITs). Does the inclusion of REITs lower their potential future returns and cash flow?

Deduction for tradespeople’s tool expenses

Under the deduction for tradespeople’s tool expenses, a tradesperson can claim a deduction of up to $500 of the amount by which the total cost of eligible new tools acquired in a taxation year, as a condition of employment, exceeds the amount of the Canada employment credit ($1,368 in 2023). This amount will double from $500 to $1,000, effective for 2023 and subsequent taxation years.

Extraordinary tool costs under the apprentice vehicle mechanics' tools deduction would be those costs that exceed the combined amount of the increased deduction for tradespeople’s tool expenses ($1,000) and the Canada employment credit ($1,368 in 2023) or 5% of the taxpayer’s income earned as an apprentice mechanic (including from apprenticeship grants), whichever is greater.

Our last thought on Federal Budget 2023

This 2023 Federal Budget maximizes the minimums. Based on the budget projections, minimum taxes may result in maximum revenues!