BUDGET HIGHLIGHTS

Finance Minister Paul Martin delivered his sixth budget on February 16, 1999. A balanced budget, or better, is expected for 1998–99, the second consecutive year in which the budget has been deficit-free. The government stated its commitment to balanced budgets or better in both 1999-2000 and 2000-01. "…Our country has finally left the era of deficit financing behind," the Minister said. The government plans to use last year’s surplus of about $3 billion to reduce the national debt to approximately $580 billion. The annual Contingency Reserve of $3 billion, if not needed, will be used to further pay down the accumulated debt.

On the spending front, the budget strengthens the federal government’s contribution to Canada’s health system by increasing the transfers, over the next 5 years, to the provinces and territories by $11.5 billion to be used specifically for health care. In addition, the federal government will invest nearly $1.4 billion over 4 years in health-care initiatives including health information systems and health-related research and innovation.

The budget brought very modest across-the-board tax cuts and delivered some targeted tax-relief measures to low and middle income families, such as improved Canada Child Tax Benefits. The budget attempts to improve fairness in the tax system by attacking income splitting through the use of family trusts. In addition, the government announced that it is considering the imposition of tax on Canadian taxpayers’ pro-rata share of all the undistributed income of foreign-based investment funds and non-resident trusts.

Personal Tax Measures

Basic Credits Increase

The 1999 budget proposes to increase the base for personal credits for 1999 to $7,044 for low-income persons and $6,794 for others. In 2000, the base will be $7,131 for all individuals. The base for the spousal and equivalent-to-spouse credits will rise to $5,718 in 1999 and $6,055 in 2000.

Surtax

The 1998 budget began the process of eliminating the 3% surtax for individuals with incomes less than $50,000, and reduced it for those with incomes in the $50,000 to $65,000 range. The 1999 budget completes this process by eliminating the surtax for all taxpayers, with one-half of the reduction occurring in 1999. There is no change to the 5% surtax that applies to high-income individuals.

Medical Expenses

The budget proposes to expand the list of expenses eligible for the medical expense tax credit for persons with disabilities.

Canada Child Tax Benefits

The budget proposes to increase the amount of the National Child Benefit (NCB) supplement by $180 per child in 1999 and by a further $170 per child in 2000. The income level at which the NCB supplement will be fully phased out is increased from $25,921 to $27,750 effective July 1999 and to $29,590 effective July 2000.

("Goods and Services Tax") GST Credit

The GST Credit provides for an additional credit of up to $105 for single individuals and single parents. The credit is phased in at the rate of 2% of income in excess of $6,456.

RRSP/RRIF Proceeds on Death

On the death of an individual, the fair value of his/her RRSPs or RRIFs is included in the deceased’s income or may be transferred tax free to an RRSP or RRIF of the surviving spouse or, if there is no surviving spouse, financially dependent children and grandchildren. For deaths after 1998, the budget proposes to extend this relief to allow the transfer to financially dependent children and grandchildren even if there is a surviving spouse. On election, this proposal will apply retroactively to deaths after 1995 and will also extend to March 2000 the deadline for transferring the proceeds of a deceased’s RRSP or RRIF to an RRSP or RRIF of a qualifying person.

Retroactive Lump-Sum Payments

Individuals may receive lump-sum payments, such as arbitration awards or spousal support, that include amounts that should have been included in income in an earlier year if the amounts had been received then. This often results in the income being subject to a higher rate of income tax in the year it is received, rather than the year or years to which it relates.

Under the budget proposals, individuals who receive qualifying amounts in excess of $3,000 after 1994 will be allowed to use a special method of computing the tax on these lump-sum payments if it is advantageous to them.

Income Splitting and Trusts

The budget proposes to severely restrict income splitting with individuals under 18 years of age. The new rules are to be effective in the year 2000 and subsequent taxation years. Existing structures are not grandfathered.

The budget proposes that individuals under 18 at the end of a calendar year will be subject to a special tax, computed at the highest marginal rate, on

• Taxable dividends received directly or through a trust or partnership
• Shareholder benefits and shareholder loans included in income
• Income from a partnership or trust, if the income is derived from the provision of goods or services to, in broad terms, businesses which are owned by a person or persons related to a partner or beneficiary.

The special tax can be reduced only by the dividend tax credit and the foreign tax credit. No other deductions or credits (including personal credits) are allowed. To avoid double taxation, the income subject to this special tax will not be subject to regular tax. The parent will be jointly liable for the special tax payable by the child if the parent is active in the business from which the income was derived.

A number of exceptions to these rules include:

• Taxable dividends on shares of listed public corporations
• Individuals whose parents are not residents in Canada at any time in the year
• Income from property inherited from a parent
• Income from other inherited property if, in the year of receipt of the income, the individual receiving the income is in full-time attendance at a post-secondary educational institution or is disabled.

Not all income splitting techniques have been eliminated. The new rules

• Have not addressed income splitting with a spouse or children 18 and over
• Have no impact on reasonable remuneration paid to minors
• Do not apply to capital gains realized for the benefit of a minor through a trust or partnership.

Civil Penalties for Misrepresentations by Third Parties

Canadian law does not currently impose civil penalties against third parties who knowingly, or in circumstances amounting to gross negligence, make false statements or omissions in respect of another person's tax matters. The budget proposes to apply two new penalties to third parties who make such false statements or omissions. These new penalties will apply after Royal Assent. Revenue Canada has the burden of proof of establishing the facts necessary to apply these penalties.

The first new penalty applies to tax shelter and other tax planning arrangements. Any person who knowingly plans, promotes or sells an arrangement that includes a false statement or omission, is subject to a penalty equal to the greater of $1,000 and 100% of the gross revenue derived, or to be derived, by the person, from the activity.

By way of example, the budget papers provide that this penalty would apply to a promoter of an art scheme whereby taxpayers acquire art at its fair market value and donate it to charity at an inflated appraised value.

The second new penalty applies to any person who makes a false statement or omission that may be used by a taxpayer. The penalty is equal to the greater of $1,000 and 50% of the amount of tax sought to be avoided by or refunded to the taxpayer.

The budget papers indicate that this penalty would apply, for example, where an accountant agrees to include the cost of a client’s family vacation as a business expense in the client’s tax return when the accountant knows the amount is a non-deductible personal expense.

A person who is subject to both of the new penalties pays only the greater of the two penalties.

Similar penalties will apply under the Excise Tax Act for GST/HST.

Non-resident Trusts and Offshore Investment Funds

The Income Tax Act contains rules which are intended to eliminate any tax deferral advantage that may be realized by a Canadian resident who invests funds in foreign-based investment funds. The Income Tax Act also contains anti-avoidance rules which attempt to tax the income earned by a non-resident trust with a Canadian-resident beneficiary.

The Department of Finance feels that the objectives of these rules are not being fully met and that high-income individuals are able, in some cases, to avoid Canadian tax by investing offshore. The Minister has put forth proposals which are not aimed at preventing Canadians from investing offshore, but rather ensuring that there is no tax advantage in so doing. Consultations will be initiated on the following proposed modifications:

1) Foreign-based investment funds

• A foreign-based investment fund ("Offshore Fund") is defined as any non-resident corporation, trust, fund or other entity where more than 50% of the cost of the entity's assets are investment properties, other than Offshore Funds situated in the U.S.
• Canadian taxpayers would be subject to tax on their pro-rata share of all of the undistributed income of the Offshore Fund, where they have access to sufficient information about the income of the fund. A foreign tax credit would be permitted for the taxpayer's share of the foreign taxes paid by the fund.
• Alternatively, Canadian taxpayers would be required to mark to market (that is, to add or to deduct from their income, as the case may be, the annual increase or decrease in the fair market value) their interest in the Offshore Fund.
• A five-year exception will apply for new immigrants and temporary residents.
• Additional exceptions may be added for Offshore Funds that are clearly not used to avoid or defer Canadian tax.
• The new rules would apply to any taxation year commencing after 1999 for Offshore Funds acquired by a Canadian taxpayer on or after February 16, 1999. For Offshore Funds acquired before February 16, 1999, the rules will apply to any taxation year commencing after 2000.

2. Non-resident trusts

• A non-resident trust will be treated as being resident in Canada and will be taxed on all of its undistributed income, where a Canadian resident transfers or loans property to the trust, whether or not the trust has a Canadian resident beneficiary. The Canadian resident transferor will be jointly liable with the trust for the payment of the tax.
• Distributions out of both current income and any previously untaxed accumulated income of the trust will be taxed in the hands of the beneficiaries.
• Exceptions are provided for certain trusts resident in the U.S., 5-year immigration trusts, and non-resident trusts set up for the benefit of individuals with disabilities or children of divorced parents (where the trust and beneficiaries are resident within the same country).
• Additional exceptions could be added for non-resident trusts that are clearly not used to avoid or defer Canadian tax, such as bona fide foreign charitable trusts.
• The proposed rules would apply to any taxation year commencing after 1999, with respect to non-resident trusts to which a Canadian resident transfers or loans property on or after February 16, 1999. Existing non-resident trusts would be subject to the proposed rules for taxation years commencing after 2000.

Labour-Sponsored Venture Capital Corporations (LSVCCs)

The federal government provides assistance for investments in LSVCCs by giving a tax credit equal to 15% of the cost of the investment up to a maximum credit of $750 per year. The budget proposes several measures to encourage LSVCCs to invest in the Ontario Community Small Business Investment Fund (CSBIF) and eligible small business. In addition, the budget proposes measures similar to Quebec’s proposal to allow funds invested in LSVCC shares to be used for purposes of the Home Buyers' Plan and the Lifelong Learning Plan.

Corporate Tax Measures

After 1999, corporations will be allowed to offset refund interest on income tax overpayments against interest owing on unpaid income tax, when the corporation requests it. Interest will only be payable or refundable on the net balance. This will help remove the inequity arising from the fact that refund interest is taxable, whereas arrears interest is non-deductible.

Miscellaneous Tax Measures

For each subcontractor, the following information would be reported by the contractor:

• The name or trade name under which the subcontractor carried on business.
• The business address of the subcontractor.
• The business number (BN) (or social insurance number for individuals without a BN).
• The total of amounts paid or credited to the subcontractor for the reporting period for construction services. These amounts must include provincial sales tax, GST and HST, where applicable. The amount paid to a subcontractor may not necessarily be readily available in the format required. Payors should consult with their computer advisors to ensure that the above-mentioned information can be collected and accessed as required.

Federal government departments and agencies began issuing information slips for contract payments made after 1997, and federal Crown corporations began reporting contract payments made after 1998.

Revenue Canada is continuing their consultation process with the construction industry regarding the specifics of the reporting requirements for contractors. The Contract Payment Reporting information return and slips should be available in 1999.

Goods and Service Tax ("GST") – Annual Reporting Election

Many clients ask us questions about the GST annual reporting election. Under the GST, a registrant can elect to report annually if his total GST taxable sales in the preceding year do not exceed $500,000. The GST return must be filed three months after the registrant’s fiscal year end. As well, the registrant is required to make quarterly installments if his net remittance for the year is over $1,500.

The election for annual reporting takes effect on the first day of the registrant’s next fiscal year or on the day on which the electing person becomes a registrant. Please contact your Goldfarb, Shulman, Patel & Co. LLP representative to obtain the necessary forms or if you have any further questions.

Employers usually remit payroll deductions on a monthly basis, or more frequently in the case of large employers. Revenue Canada has recently introduced a quarterly remittance system for smaller employers. It is not necessary to apply to become a quarterly remitter because Revenue Canada will notify those employers that qualify. A qualifying new company will become eligible to remit payroll deductions quarterly after 12 months of business. The quarterly remittances are due on the 15^th day of April, July, October and January in respect of each preceding quarter.

To qualify for quarterly remitting, an employer must:

• Have an average monthly withholding amount of less than $1,000 in either the first or the second preceding calendar year;
• Have a perfect compliance history in the previous 12 months for payroll deductions and GST; and
• Have no outstanding GST/HST returns or T4 information returns for the previous 12 months.

The Ontario budget of May 5, 1998 announced that the $400,000 exemption that was to take effect on January 1, 1999 was being accelerated to begin on July 1, 1998. Consequently, for 1998, the first $350,000 of payroll will be exempt from Employer Health Tax. In 1999 and later years, the first $400,000 of payroll will be exempt from Employer Health Tax.

Employer Health Tax Changes - Self-Employed Individuals